Kilroy Realty - Q3 2023

Transcript

Operator (participant)

Good afternoon. Thank you for attending the KRC 3Q 2023 Earnings Conference Call. My name is Victoria, and I'll be your moderator today. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. I would now like to pass the call over to your host, Bill Hutcheson, SVP, Investor Relations and Capital Markets with KRC. Thank you. You may proceed, Bill.

Bill Hutcheson (SVP of Investor Relations and Capital Markets)

Thank you, Victoria. Good morning, everyone. Thanks for joining us. On the call with me today are John Kilroy, Chairman and CEO; Justin Smart, our President; Rob Paratte, Chief Leasing Officer; and Eliott Trencher, our CIO and CFO. At the outset, I need to say that some of the information we will be discussing during this call is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information on this call and in the supplemental. Our call is being telecast live on our website and will be available for replay for the next eight days, both by phone and over the internet. Our earnings release and supplemental package have been filed on a Form 8-K with the SEC, and both are available on our website. John will start the call with our third quarter highlight.

Justin will review our in-process development pipeline, and Elliot will discuss our financial results and provide you with updated guidance. We'll be happy to take your questions. John?

John Kilroy (Chairman and CEO)

Thanks, Bill. Hello, everybody, and thank you for joining us today. Over the last several months, we have seen long-term outlook for office business improve. More companies are committing to and enforcing in-person work. As a result of higher physical occupancy levels, increased foot traffic, and commuter activity, cities are heading toward recovery. For example, New York City has been a leader in this regard, as large corporations insisted their employees return to the office. This has not only positively impacted physical occupancy levels, but has also restored a sense of urgency and vibrancy back to the city, and I should say, energy and vibrancy. The West Coast markets and the tech companies that dominate them have followed suit, and we anticipate the West Coast will follow a similar trend.

San Diego, which was the first mover amongst our markets, is a prime example of how high physical occupancy translates to leasing activity. Over the course of this year, physical occupancy in San Diego has gone up 20 percentage points and now sits above 80%. The region is 89% leased, with our primary cluster in Del Mar, 97% leased. Leasing activity in San Diego is amongst the best of any of our regions because higher physical occupancy is translating into tenant demand for space. It's important to note that the green shoots of increased demand are coming in the form of better tour velocity and leasing interest. In times like these, having the newest, most modern assets in the best locations is critical to attracting tenants at top of the market rents.

Additionally, in many of the cities in which we operate, things are beginning to change to the better from a policy perspective. Specifically, recent data points in San Francisco demonstrate there is self-awareness around the challenges the city is facing, and that policymakers and voters continue to take steps to correct the issues. A few notable examples: within the last 12 months, District Attorney Jenkins won re-election, which is an endorsement from voters of her law and order philosophy. The city is hiring more police officers and increasing their pay, and the Board of Supervisors approved delays to payroll tax increases and provided discounts for new businesses relocating to the city. We have much more work to do, but the train is finally moving in the right direction. Shifting to the economy, the labor market remains tight, and inflation, while lower, is not yet at target levels.

The market is suggesting that we are likely to be in a higher rate environment for longer. Any certainty on the trajectory of rates will take time, but ultimately will be good for the capital markets, even if things stabilize at current levels. However, from a commercial real estate perspective, the same concerns persist. Higher rates are putting near-term pressure on real estate valuations as loans originated in a low-rate environment come due and need to be refinanced. This dynamic, coupled with a pullback in bank lending following the regional banking crisis earlier this year, has created softer conditions in the transaction markets. We acknowledge there are going to be continued stress and refinancing risk in our sector. However, we believe we are well positioned against these headwinds.

As we talked about last quarter, in July, we closed on a $375 million, 11-year mortgage for a portion of our One Paseo Campus in San Diego. The loan has a fixed interest rate of 5.9%, and the additional liquidity enhances our financial strength and flexibility in this volatile market. The One Paseo Campus continues to perform incredibly well. Occupancy is approximately 95% across the entire project, and we have market-leading rents on the office, residential, and retail. Real estate always goes through cycles. I've been through six myself. We don't know when the headwinds will come or how long they will last, which is why we prioritize keeping Kilroy well-capitalized with robust platform liquidity and conservative leverage. As a result, we can stay patient and make prudent capital allocation decisions when we have conviction.

With this in mind, and given where financing markets are today, we are not anticipating any asset sales for the balance of the year. While markets and sentiment change based on where we are in cycle, the three pillars of our strategy have stayed constant: high-quality properties, strategic capital allocation, and a fortress balance sheet. This simple approach allows us to play offense in the good times and defense in the challenging times. We believe there will be opportunities in the future, and we are taking the steps to ensure that we are ready when the time comes. As of now, our goal remains the same: own and operate the highest quality portfolio of mixed-use office and life science properties, clustered in innovative and supply-constrained markets.

Turning to the third quarter highlights, and what has been a period of continued volatility, I'm happy to report that Kilroy continues to execute. We signed a total of 188,000 sq ft of leases during the quarter, as well as 117,000 sq ft of leases post-quarter end. We remain busy and are encouraged by the leasing momentum that we are building across our markets, and expect to secure more wins on the leasing front during the balance of this year. In many of our markets, we're seeing significant increase in demand. At the platform level, just as we have done in prior down cycles, we will continue to be opportunistic in sourcing efficient capital as needed, and we are laser-focused on making the right capital allocation decisions.

Lastly, on a personal note, this earnings call marks my 107th quarterly earnings as CEO. We actually have had 108, which is including today, as a public company, but I did miss one in 2007 due to the lack of wind competing in the Transpac Sailing Race from Los Angeles to Hawaii. Reflecting on my time spanning more than 50 years in the real estate industry and almost three decades at Kilroy as a public company, we have accomplished quite a bit, including a total transformation of our company coming out of the great financial crisis. As I look at the company today, I am proud of our tremendous team. We've never been better positioned from an asset quality, tenant base, and balance sheet perspective.

I want to thank every one of you for your support over the years, and I'm confident that Kilroy will continue to thrive, adeptly, handle whatever challenges come next, and outperform in the years to come. With respect to our search for the next CEO, we are entering the home stretch. We have been pleased, but not surprised, to see that the opportunity at Kilroy has attracted many qualified candidates, both internal and external, and we expect to have an announcement before the end of this year. That completes my remarks. Now, Justin will go through our development pipeline. Justin?

Justin Smart (President)

Thank you, John. At the end of the third quarter, our in-process development totaled approximately $1.7 billion, down slightly from last quarter due to the delivery of 9514 Town Center Drive in San Diego, which is 100% leased to an investment-grade credit tenant. There's roughly $490 million left to fund in the development pipeline, most of which is for the second phase of our Kilroy Oyster Point life science development in South San Francisco. As you may recall, KOP Phase 2 includes three buildings, and we anticipate they will stabilize in 2025. Indeed Tower, the only other project in our active pipeline, remains on track for stabilization in the fourth quarter of this year and is 74% leased. Regarding our future pipeline, we continue to advance entitlements and design on all projects.

As a reminder, the future pipeline consists of eight projects, diversified across five markets and has a mixture of life science, office, and residential. Similar to prior cycles, we will only start a new project when market conditions are favorable, and currently have no plans to break ground on anything in the near term. On a related note, new starts remain minimal, both nationally and in our markets. There are several drivers for this, including reduced pre-leasing demand and expensive financing. We anticipate the depressed supply will provide a tailwind for us, as a disproportionate amount of the demand continues to favor young, high-quality space. Our development pipeline, with significant entitlements in place, will provide a competitive advantage for Kilroy as the market improves. With that, I'll turn the call over to Elliot.

Eliott Trencher (CIO and CFO)

Thanks, Justin. FFO was $1.12 per share in the third quarter, a 7-cent decline from last quarter. The difference is predominantly due to lower NOI from the previously disclosed Pac-12 and Amazon move-outs, and higher G&A from executive retirement costs. On the same-store basis, third quarter cash NOI was roughly flat, as the burn-off of free rent was offset by a decline in occupancy. GAAP same-store NOI was down roughly 5%. At the end of the quarter, our stabilized portfolio was approximately 86% occupied and 88% leased. The decrease from the prior quarter was due to the previously discussed move-outs. Our net debt to third quarter annualized EBITDA multiples was in the low 6s.

Liquidity remains robust, with roughly $1.9 billion in total capacity, comprised of $1.1 billion from our line of credit and $790 million of cash and marketable securities. In total, our available cash is sufficient to cover the majority of our near-term development spend and address our next bond maturity in December 2024. During the quarter, we repurchased roughly $15 million of our December 2024 bonds at a discount, thereby reducing that maturity to roughly $410 million. One modeling note, we drew down the last $170 million from our term loan at the end of the quarter. So the third quarter interest expense needs to be adjusted if you are trying to use it as a starting point for the fourth quarter estimate. Now let's discuss our 2023 guidance.

As always, no acquisitions are forecasted, and as John mentioned, we do not anticipate any dispositions this year. Development spend for the fourth quarter is expected to be $100 million-$150 million. When factoring in the roughly $300 million of spend year to date, the full year estimate is now $400 million-$450 million, down $25 million from last quarter. With respect to G&A, we continue to track toward the midpoint of our range, inclusive of the previously discussed executive retirement costs. We are tightening the range for our full year average occupancy percentage to 87%-87.5%, with no change to the 87.25 midpoint. As a reminder, the fourth quarter occupancy will include Indeed Tower.

Cash same store NOI is now projected to be between 2.75% and 3.25%, a 100 basis point increase at the midpoint, due to better than anticipated parking income and some non-recurring revenue. In summary, our prior 2023 FFO guidance was $4.43-$4.53, with a midpoint of $4.48 per share. Based on our performance to date, we are adjusting and tightening the range to between $4.55 and $4.60. The new midpoint of approximately $4.58 represents a roughly 2% increase from the prior guidance. The biggest drivers behind the increase are better parking income, earlier revenue recognition on a few leases in the operating portfolio, higher interest income, and the adjustment to our disposition guidance.

To provide further clarity, our updated midpoint implies a fourth quarter FFO of roughly $1.05 per share, or $0.07 lower than the third quarter. To bridge the gap, we back out $0.03 due to lower occupancy, which factors in our move-outs and move-ins, and $0.04 for various other items, including higher interest expense. That completes my remarks. Now we will be happy to take your questions. Victoria?

Operator (participant)

Of course. We will now begin the question and answer session. In the interest of time, we ask, we ask that everyone limits themselves to one question and one follow-up question to ensure everybody has the opportunity to speak. If you'd like to ask a question, please press star, followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking a question. Our first question comes from the line of Nick Yulico with Scotiabank. Your line is now open.

Nick Yulico (Managing Director)

Thanks. I was hoping you could just start, you know, maybe, maybe Rob, with some commentary on, you know, where you're seeing, you know, more strength in terms of leasing in the portfolio, you know, types of tenants, size, size requirements, markets, versus, you know, where there's things that are a little bit more challenging, which I assume is more on the large tenant side.

Rob Paratte (Chief Leasing Officer)

Sure, Nick. Let me hit on a couple of just global comments about the leasing environment throughout our regions, and actually, I'd say throughout the nation. Tenants right now are seeking, have a preference for market-ready space. Shell condition space is less desirable and going to be harder to move. Tenants are also seeking flexibility, looking for one- to three-year terms in some cases, but in other cases, you're seeing lease terms as long as 10 years, but, you know, the average is falling somewhere around five years. We have a continued flight to quality, which our portfolio benefits from. What we're seeing in every market is that the best sublease space, every market has sublease space in it.

The best sublease space that's built out in a technology type build out or fit out is moving first, and we're starting to see some of that space get absorbed. The last thing I'd say, if you look at our Q3 leasing volume, Q3 is always the slowest time of year because you have summer and people are gone, it's just harder to get things done. So if you look at what we did in Q3, and then look at what we've done in a relatively short amount of time in Q4, I think it points to what John was saying in his comments about velocity and volume. Let me just... I'll touch on our markets. With San Francisco, probably the most notable market in our region, maybe in the country, there's been a demand surge.

We now have, starting in Q1 of 2023, we had about 2.5 million sq ft of demand. It's more than doubled now to about 5.5 million. That's largely being driven by artificial intelligence. Although the quarter, Q3, was a lower leasing volume than we expected, there's about 680,000 sq ft of very close to completion transactions with two large AI companies that we think will—we know will—close in Q4. If you take Q4 plus what's already been going on in the market, San Francisco could actually hit close to 1.2 million sq ft of leasing velocity for the Q4 quarter, which is on par with sort of the average before the pandemic. Venture capital funding has reached about $27 billion in the Bay Area.

The total for San Francisco in 2019 was $34 billion, and we feel like we're on track to meet that this year. Moving to Seattle, I think we have a—and I'm going to talk about Seattle and Bellevue. We have a tale of two cities. On the positive note, Seattle stands to benefit considerably from the AI move because it's got the second-largest concentration of AI talent behind the Bay Area in the country, so that's a very positive thing. Unfortunately, it hasn't resulted in an uptick in significant demand in Seattle. By contrast, Bellevue, big tech is back. We're seeing a lot of gaming companies with, you know, two large requirements, particularly. They're both over 400,000 sq ft.

So we think Bellevue is really improving, and a lot of that is not going to sublease space, it's going to new development. Los Angeles is such a fragmented market, I thought this might just give better color. Year to date, we've done 35 deals in Los Angeles, totaling 359,000 sq ft. Twenty-two of those were renewals, which equates to about 175,000 sq ft, and thirteen of those are about 120,000 sq ft. So it's quite a bit of leasing activity that I don't think really gets pointed out when you, when you look at the data.

Lastly, on a very positive note with San Diego, we signed yesterday a 15,000-square-foot lease at 2100 Kettner with the MLS San Diego soccer franchise, and we're very excited to have them come to the building, and we know that's gonna create more leasing momentum with the discussions we have going on, as well as with future prospects. Austin has. We have activity. I don't wanna get into the structure of it or how much of it, but we are continuing to work on transactions and exchanging paper with tenants. The last thing I'd say with life science in South San Francisco is that, you know, demand is not where we'd like it, but it is improving.

Several rounds of VC funding have been focused in the South San Francisco market, and we're starting to see some tenants that had requirements on hold come back to the market. Lastly, I'd say about South San Francisco, one large tenant in the market took sublease space off the market to the tune of about 100,000 sq ft. So we think that's a positive indicator of where things will go.

Nick Yulico (Managing Director)

Very helpful. Thanks, Rob. Just second question is on Riot Games. I wanted to see if you had any update on the, you know, the November expiration. And then it sounded like from how you talked about earlier this year, there was, you know, the tenant was sort of thinking also about, you know, the 2024 expiration, and I know they—I think they've taken some other space in that market already in West L.A. So, any update you can give there?

Rob Paratte (Chief Leasing Officer)

Sure. Riot will be downsizing in terms of their 2023 expiration. On the flip side, we're in discussions with them on a variety of scenarios for 2024, and I, I just can't go into more color on that, but we know they're looking at this as a downsize.

Nick Yulico (Managing Director)

Okay. Is it possible to get the downsized amount for this year?

Eliott Trencher (CIO and CFO)

So, in total, the expiration is about 160K. We expect that over 100K will be given back.

Nick Yulico (Managing Director)

Okay. Thanks, Elliot, Rob.

Operator (participant)

Thank you for your question. The next question comes from the line of Vikram Malhotra with Mizuho. Your line is now open.

Vikram Malhotra (Managing Director)

Thanks for taking the question. Just, wondering if you can dig into the life science comments a bit more, just, you know, give us a bit more color on prospects at, you know, KOP. You know, some of your peers in that region have said demand has doubled since April, and they're, you know, they're signing leases. So I'm just sort of wondering if you can give us more details on the types of activity or interest you're seeing, and just how should we think about timing and rents?

Rob Paratte (Chief Leasing Officer)

Okay, Vikram. Rents for new development have maintained at the rate they've been at, so there hasn't been an erosion. There is sublease space in the market, and like any office or life science, the sublease space that's high quality will move, and we've seen some of that happen. Other sublease space that's not high quality will remain on the market. As you may recall, we made a decision about a year ago to multi-tenant one of the three buildings at KOP, and we expect to have that complete by May of next year. In that multi-tenant scenario, by doing that, we actually increased the amount of activity that we've been seeing, because now we're able to talk to tenants about 40,000 sq ft, for example, which would be one of our floors.

And the key component of that multi-tenant scenario that I just described is that we're delivering it as lab specs, so it's basically ready to move in, and that's also a, you know, first to market kind of phenomenon that tenants really want. So that has helped our tour activity. There still are bigger requirements out there. They're just, as I said earlier, things are just taking longer to get done in this environment. And I'd say, generally, the geopolitical environment, you know, doesn't help. It seems to ebb and flow, but right now it's not great, so that does slow things down, but we haven't seen requirements taken off the market that have been in the market for the last six weeks or so.

Vikram Malhotra (Managing Director)

That, that's helpful. Just, I guess a bigger picture question: You know, you've referenced sort of the market turning, you know, policy-wise in San Fran things a little better or socioeconomic-wise, more tours, et cetera, but then at the same time, it feels like you're probably still waiting to deploy capital in opportunities. I'm just wondering if you can square the two. If you're seeing a turn, a sustainable turn from here, whether it's AI or other reasons-

you know, how when do you think sort of the time is to for you to use the balance sheet that you've sort of preserved for a while now?

John Kilroy (Chairman and CEO)

This is John, Vikram. How are you? We are-

Vikram Malhotra (Managing Director)

Thank you.

John Kilroy (Chairman and CEO)

We're looking at everything. We always do, we always have, even some things that we know are not particularly of interest, just to make sure that we are reading the market correctly, and that helps inform us for when it's time to make decisions. I don't believe right now is. We're seeing anything that we're seeing some things we like in all of our markets, in terms of quality and location. We're not seeing the pricing that we would like yet. Whether we will get there or not, don't know.

As loans get closer to becoming due, and refinancing becomes a reality that people must go through, if they have low interest rate debt that can't be replaced with regard to, you know, either the rate or with regard to the size of the loan, I think we'll see some opportunities loosen up. So we're going to remain very agile. There's no pressure on us with regard to having to do anything, and we are going to behave like we did back probably in 2010. It'll be, it'll be a little different, but when we, when we see things we like, we'll act with conviction, but it's not yet. It's not appropriate right now in our view, given so much volatility globally and in our industry. You're welcome.

Operator (participant)

Thank you for your question. The next question comes from the line of Blaine Heck with Wells Fargo. Your line is now open.

Blaine Heck (Executive Director of Senior Equity Research Analyst)

Great, thank you. John, just to follow up on that last question and answer, you mentioned how pricing hasn't gotten to the level that's kind of attractive, to, to you guys yet. Can you give us any sense of how far off that pricing is to where it might be interesting? Is it 10%, 25%? And then, you know, just generally, how, how have your targeted returns changed with the increase in rates?

John Kilroy (Chairman and CEO)

Well, there, there are buildings that are being sold at what appears to be good prices, when you look at the face number per square foot, but when you look at the repositioning cost and the re-tenant improvements cost and so forth, it gets up to a pretty high number. So, in terms of where things have to move, I'm not going to go there, Blaine, because it's asset dependent for sure. You know, all assets have benefits and flaws. Many of the things that are being traded are to have more flaws than benefits, in our opinion. And obviously, we've got to feel comfortable that we're buying into a market that we think is going to be improving, not going sideways. What was the second question? Forgive me.

Blaine Heck (Executive Director of Senior Equity Research Analyst)

Just how your returns targets have changed with the increase in rates and what you guys are looking for as far as IRRs?

John Kilroy (Chairman and CEO)

Yeah, I'm not really going to go down that route right now because we're not really looking at buying anything. And it's again, it's going to be obviously north of where it's been. If you look at sort of what we've developed over the last 10, 12 years, we've sort of averaged around 8% going in returns for brand-new product with built-in significant increases, and that's on an unleveraged basis. So, you know, that's sort of where we were, which was beating the market. And if we're going to buy something, we're going to want to feel very comfortable that we've got a best-in-class asset, or we can make it such, and then we're going to end up with a strong double-digit return. So, that's what our thinking is right now.

Blaine Heck (Executive Director of Senior Equity Research Analyst)

Great. Then just along those same lines, you know, can you talk about your thoughts on share repurchases, given where the stock is trading, and whether they might look as attractive or more attractive than, you know, acquisitions or development at this point?

John Kilroy (Chairman and CEO)

Yeah. Elliot, you want to handle that?

Eliott Trencher (CIO and CFO)

Yeah, Blaine, we obviously look at everything. Our priority right now is to, one, make sure the development is fully funded, and two, make sure the balance sheet is in tip-top shape. We do not have interest in repurchasing shares at the expense of leverage. I don't think that's a good trade-off. So we're going to continue to evaluate it, but that's sort of where we stand today.

Blaine Heck (Executive Director of Senior Equity Research Analyst)

Great. Thank you, guys.

Operator (participant)

Thank you for your question. The next question comes from the line of Caitlin Burrows with Goldman Sachs. Your line is now open.

Caitlin Burrows (VP)

Hi, good morning there. Maybe regarding the CEO transition, John, I know there's only so much you can say, but I guess at a high level, can you describe how much thought is being given to finding or interviewing qualified external candidates, and how the process is set up to reduce any potential, maybe bias of selecting an internal candidate over a qualified external candidate that maybe doesn't have the same tight current relationship with yourself or the board?

John Kilroy (Chairman and CEO)

Yeah, I can't, as you know, speak very much about that, but there is no bias whatsoever. We sought out, as we, I think, communicated pretty clearly, that we are opening up to the outside and inside, and there are strong candidates from both camps. With regard to the outside, there is no bias against. With regard to the process. You know, we're sort of entering the home stretch. Our hope is to be able to make an announcement by the year end. It's been a vigorous process. The whole board has been very engaged in it, and that's about what I can tell you.

Caitlin Burrows (VP)

Okay, got it. And maybe you guys had a large tenant move outs in the quarter at 360 Third Street, and now there's some vacancy in the San Francisco CBD, larger than it was. So could you talk maybe some more detail on what exactly you're seeing in San Francisco from a leasing activity perspective?

John Kilroy (Chairman and CEO)

Yeah, Rob, could you take-

Rob Paratte (Chief Leasing Officer)

Ah, sure, Caitlin. Yeah, sure. So as I said, you know, demand has more than doubled in San Francisco, and that's resulting in more tours throughout our portfolio as well. Three of our assets are undergoing what I would call refreshes, you know, upgrading lobbies and amenities and that sort of thing, because we wanna be ahead of the demand increase. Meaning, we want tenants to be able to walk in and see the improvements that have been done because it is a very competitive market. We're also in a really good position because of our balance sheet, where we can actually pick and choose who we're gonna do business with.

I think there's other competitors of ours that maybe desperate may be the wrong word to use, but very eager to do something that we may take a look at and say, "You know, we'll, we'll let that go to sublease space and wait for the right tenant to come along." So, we've seen it. The way I'd look at the San Francisco market is that there's about 800,000 sq ft of AI demand right now. What's interesting about that is, probably Q2 earnings call, I said the average tenant size was 5,000 sq ft for AI. It's now 15,000 sq ft, so it's tripled.

And what we're seeing in our portfolio is sort of a mix of AI interest, as well as there's a lot of law firm activity in San Francisco, and we're also seeing, you know, some professional services. So I wanna caution you, though, I mean, we still there's a, you know, long road here. We've got a lot of space on the market. Some of it's good, some of it's not. So, we think overall the trend is positive. It's just gonna take time to sort out.

Caitlin Burrows (VP)

Got it. Thank you.

Operator (participant)

Thank you for your question. The next question comes from the line of Michael Griffin with Citi. Your line is now open.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. Just wanted to touch on retention briefly. I know it increased quarter-over-quarter. I'm wondering if we should think about the current rate of retention as how it relates on a kind of a go-forward basis, this 40% or so level, kind of how we should think about it.

Eliott Trencher (CIO and CFO)

So Michael, this is Elliot. I mean, historically, we've sort of been in that 50-ish% range, ±. This year, we've been a little bit lower earlier in the year. As I said, it was a little bit better this quarter. It's going to be very choppy. In particular, in 2023, it was very choppy, given some of the larger move-outs that we've discussed. But we think over time, our long-term trend is sort of the right number, where we'll ultimately settle.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. And then maybe just a higher level question, just on those return-to-work mandates. John, I appreciate your commentary in the opening remarks, but how more forceful do you think these mandates need to be in order to see a turnaround in a lot of fundamentals in these markets? And then, if you could just remind us what the utilization rate kind of across your portfolio is, that'd be helpful.

John Kilroy (Chairman and CEO)

Yeah, I'm gonna... We're gonna double-team this, so I'm gonna ask Rob to jump in in a second on the second part of that question. Return to office has been fundamentally important. It's foundationally important to office, obviously. We've all had our, our concerns over the last couple of years, and rightfully so. Some companies are very, very vigorously enforcing. Others are, are increasing their enforcement. And there are some companies that are, as if we... You know, there very few that I know of, that are basically saying, "You, you can still work from home." There are very, very few in that category.

You know, there's been a little resistance, and as we've said over the course of this year, as the economy has deteriorated, it's likely that people are gonna get out of their homes and back into the office or find that they're permanently in their homes and no longer employed, and that's happened. So, more to come on that, but in terms of what we're seeing in our buildings and in our cities, is there's been significant increases in activity. We've talked about in previous calls how the public transportation systems have had significant increases in volume. Our parking garage is significant increase in volume. We're seeing the utilization rates in our buildings significantly increased. And Rob, I'm gonna pitch that to you to add a little bit more color on that aspect.

Rob Paratte (Chief Leasing Officer)

Sure. Michael, we're gonna triple team this because Elliot, Elliot will take part of this too. To add on to what John said, he's absolutely right. With the companies that we're talking to, most, if not all of them, have factored into their performance reviews physical presence in the office. That results in, you know, your pay being affected if you're not coming into the office, and that's sort of across the board with the tech companies that we deal with. That's the kind of meat they're putting into it.

And I think some of the others that, I won't name names, but some of the others have basically said, "If you're not in, you're not working here." So it's, it definitely is forceful, and it's definitely, if you use San Francisco again as a proxy, as John said, parking revenues up, the streets are busy now, literally Monday through Thursday. Friday's lighter, but it's busy... you know, most of the day, throughout the day in the Financial District, and then I'll let Elliot talk about-

Eliott Trencher (CIO and CFO)

In terms of our portfolio, we have a range across our markets. The Bay Area is sort of in the 40s, which is the lower end of our spectrum. As we talked about, San Diego is at the high end of our spectrum, over 80%.

Michael Griffin (Senior Equity Research Analyst)

All right. That's it for me. Thanks for the time.

Operator (participant)

Thank you for your question. The next question comes from the line of Camille Bonnell with Bank of America. Your line is now open.

Camille Bonnell (Equity Research Analyst)

Hi. Just following up on that last question, since there's still a lot of skepticism around the return to office mandates, and like you pointed out, there's evidence of this through your parking revenue. Can you elaborate on what assumptions are built into your Q4? Has guidance been updated to reflect the run rate of how parking has outperformed your budget, or is it still based on your initial projections set at the beginning of the year?

Eliott Trencher (CIO and CFO)

Yeah. So, Camille, this is Elliot. We're sort of somewhere in between. We obviously have three quarters of evidence, so we have a little bit more conviction on where things are going. But there's always some uncertainty and some seasonality to it all. So right now, we're kind of in between where we were in the beginning of the year and our third quarter run rate.

Camille Bonnell (Equity Research Analyst)

Okay. Separately, can you talk to the increase in marketable securities this quarter? Thank you.

Eliott Trencher (CIO and CFO)

Sure. So that's a function of the capital that we raised during the quarter, both the One Paseo secured loan and then the $170 million term loan. And some of that cash we have invested in short-term CDs. The way the accounting rules work, if there's anything over three months, it gets classified as a marketable security, and that's what is in that number.

Operator (participant)

Okay, thank you for your question. Our next question comes from the line of Jay Poskitt with Evercore. Your line is now open.

Jay Poskitt (Equity Research Associate)

Hi. I was wondering if you could provide a little bit of color just on any known move-outs in 2024. Appreciate the color on how retention will be choppy, but do you have any known move-outs in 2024 that you've highlighted?

Eliott Trencher (CIO and CFO)

So, Jay, this is Elliot. Rob and I will tag team this, but as we've talked about, only 2 expirations next year, over 100K, 1 in the Bay Area, 1 in Seattle. And so as far as the up, you know, added-

Rob Paratte (Chief Leasing Officer)

Yeah, just a little color. We're, I guess the term I'll use is we're chipping away at that. We have some transactions we're working on and more to come.

Jay Poskitt (Equity Research Associate)

Okay, thank you. And then just one other quick question. Indeed Tower is 74% leased, but the occupancy is lower at 60%. So with it being added to the operating portfolio in the fourth quarter, do you expect that gap to narrow in the fourth quarter, or would you expect that same occupancy to lease percentage gap to persist?

Eliott Trencher (CIO and CFO)

It's going to persist until the move-ins fully occur, which is going to take time. So, anticipate we'll be closer to the occupancy, and then the occupancy and the percentage lease will merge, but that will be more, mainly over 2024.

Jay Poskitt (Equity Research Associate)

Okay, thanks. That's all for me.

Operator (participant)

Thank you for your question. The next question comes from the line of Upal Rana with KeyBanc. Your line is now open.

Upal Rana (Director)

Great. Thanks. So you've highlighted a few of the moving pieces around, you know, Riot Games, Indeed Tower, and some of the known move-outs for 2024. Do you feel that 4Q will likely be sort of the floor on occupancy, and maybe you can start to begin to grow in 2024?

Eliott Trencher (CIO and CFO)

This is Elliot. We're certainly not going to give 2024 guidance at this point. What we can say is that as we look at the backdrop for 2024 as compared to 2023, you know, 2023, we had about 1.5 million sq ft expiring going into the year, five companies, 100K or larger, which actually comprised almost two-thirds of that, 1.5 million. Going into next year, we have about 1 million sq ft expiring, and as we said, two tenants over 100K. They're closer to about 30% of the total. So we anticipate it being much less binary in 2024 versus 2023. And then if we want to look at 2025, it's about 700K expiring with no tenants above 100K.

So, again, can't say how everything plays out, but it should be less binary.

Upal Rana (Director)

Okay, great. Thanks. And your decision to reduce the disposition guidance to zero, you know, is that timing related, or was that sort of related to some kind of, like, lack of interest? And if you could maybe give some color on some of the buyers and the buyer pool, that'd be helpful.

Eliott Trencher (CIO and CFO)

Yep. John, you want me to handle that?

John Kilroy (Chairman and CEO)

Yeah, Elliot, please.

Eliott Trencher (CIO and CFO)

Yeah. So it's a function of a few different things. One, as we came into the year, we gave a range that had zero at the low end, and in part, it was because we sort of knew that the market was a little tough to project, and we had no interest in playing into a weak market as a seller. Two, we did not project having raised $375 million via the One Paseo mortgage in the beginning of the year. So from a liquidity perspective, we had done much better than what we anticipated. And because of that, and because of the financing dynamics that John discussed-

... we didn't anticipate seeing much interest at pricing that we deemed acceptable. And that's why we decided not to pursue anything.

Upal Rana (Director)

Okay, great. And could you give us any color on the buyer pool? You know, what kind of buyers are sort of there, and any kind of financing that they're kind of looking at?

Rob Paratte (Chief Leasing Officer)

So

John Kilroy (Chairman and CEO)

Yeah, the-

Rob Paratte (Chief Leasing Officer)

Speaking generically... Go ahead, John.

John Kilroy (Chairman and CEO)

No, you go ahead. I'll follow up.

Rob Paratte (Chief Leasing Officer)

Generically speaking, the capital that seems to be out there in greatest force is the opportunistic capital. You can see that by some of the properties that have traded at pretty low per sq ft numbers. Now, as we evaluate that, we don't think the quality is commensurate with our portfolio, which is why we don't pursue it. That's where we've seen the deepest pool of capital. Those aren't the types of groups that we wanna be selling to, and it kind of plays into the decision we just talked about.

John Kilroy (Chairman and CEO)

Yeah, I have nothing to further to add. I think that's a good, good, summary.

Upal Rana (Director)

Great. Thanks.

Operator (participant)

Thank you for your question. The next question comes from the line of Dylan Burzinski with Green Street. Your line is now open.

Dylan Burzinski (Senior Associate)

Morning, and thanks for taking the question, guys. I guess just, just going back to your comment, and, and appreciate you're not gonna comment on how far pricing has to fall for you guys to get interested in deploying capital. But are there certain markets where you're sort of getting closer or more eager to deploying capital than others, given where pricing is?

John Kilroy (Chairman and CEO)

Well, it's... Yeah. We're not getting closer to deploying capital, but there are some signs of a few buildings that we like at pricing that would make sense and that qualitatively meet our desires. And I'm not gonna tell you which markets, because I just don't feel that we, from a competitive standpoint, wanna, you know, let other, as I say, competitors know what we're thinking.

You should-- I'm gonna, I'm gonna say what I said in Arizona NAREIT in 2009, and that was, "You'll see us in many different markets," and, and, and, and in this case, the markets that we're already in, "looking, and when we think the time is right, we will strike." We don't think the time is right yet, but there are some assets that are in need of being recapitalized, so we'll, we'll play the-- our cards very carefully, and we're in no hurry.

Dylan Burzinski (Senior Associate)

Appreciate that commentary. That's all I had. Thanks, guys.

Operator (participant)

Thank you for your question. The next question comes from the line of Peter Abramowitz with Jefferies. Your line is now open.

Peter Abramowitz (VP)

Yes. Thank you. Could you just talk a little bit about discussions for the rest of the space at Indeed Tower, and specifically new supply in Austin and how that's potentially impacting those discussions?

Rob Paratte (Chief Leasing Officer)

Sure. This is Rob.

John Kilroy (Chairman and CEO)

Go ahead, Rob.

Rob Paratte (Chief Leasing Officer)

Yeah. Just collecting my thoughts. So I guess with the new supply, there's new supply on the market in terms of sublease space, but one thing I would say is that we've seen a relatively large chunk of sublease space taken off the market by the tenant in the last quarter. So, you know, again, things are in flux right now in Austin. Another tech company actually took 100,000 sq ft fairly recently, because they undershot, you know, their headcount and how much space they need. So things are really dynamic right now. We do have activity. You know, we are the best building in the CBD, bar none, and we attract any tenant looking in the market is looking at us, and so it runs the gamut, as you've seen, financial services, law firms.

We've had tech interests, but I can't go into—I just—I'm not gonna get into, like, specific transaction and where we are, whether we're in LOI or in leases or what have you, but we have more news that will be forthcoming.

John Kilroy (Chairman and CEO)

This is John speaking. With regard to Austin, Indeed, and the marketplace in general, I was in Austin two weeks ago with our local sharpshooters and so forth, and going through kind of a segmentation evaluation of where Indeed sits amongst buildings that are either available today or that will be completed over the next couple of years. I'm very happy with where we're positioned with regard to quality and location and availability and so forth. There are some buildings that are being built in locations that befuddle us, that I don't think they'll do well at all. There are some buildings that have been up, that have tried to compete with us, but that we've never lost a deal to.

and we're not Pollyannish about any market or any, you know, there's no God-given right that Kilroy is gonna do better than everybody else. We work hard at it. But we, I think, are extremely well-positioned, and I like where we are with regard, you know, vis-a-vis product that's coming on stream and so forth. So we've not been, you know, we've achieved really good rental rates and good terms with very high-credit tenants. And we've got quite a few tenants that we're working with for the project, and I think we'll, well, I think we're gonna do very well this next year.

Peter Abramowitz (VP)

... Thanks, John. And one more. Could you—I appreciated the comments earlier about return to office. I think you said you're in the forties in the Bay Area. Wondering if you could dig in and just talk about how's return to office been in the South of Market submarket in San Francisco, kind of what you're seeing on the ground there, how successful companies are in getting people back to the office in that part of the city?

John Kilroy (Chairman and CEO)

Well, I'll start off with,

Rob Paratte (Chief Leasing Officer)

I can-

John Kilroy (Chairman and CEO)

Yeah, Rob, let me just start off on that. We, yeah, as you can tell, we're in different locations, so we have to play a little bit of delayed phone tag here. The office tenant, the big office tenant that's in phase one of KOP, which was the initial 700,000 sq ft that's fully leased, they have been... Their occupancy has been very high. They've been hosting in their atrium, that fits several hundred people, multiple times per week. It's my understanding, mostly AI people, and they're really active in that building, as are the folks in the life science portion of that phase. As far as the rest of the market goes, perhaps you could respond to that, Rob.

Rob Paratte (Chief Leasing Officer)

Sure. Yeah, I mean, I agree with John. The only thing I would add is that, in our South of Market portfolio, it somewhat depends on companies, but if you look at Adobe or Cruise, I mean, they're back to work, and so those are both South of Market. Our non-tech companies are more back, I guess, than our tech companies, but, you know, we're not monitoring company by company. But I would say that South of Market is visibly busier than it was, and it's equivalent to what I was saying about the Financial District as a whole. And when these two deals that I mentioned earlier happened in the fourth quarter, the 680,000 sq ft between two deals, both of those are locating South of Market. And they're office-

John Kilroy (Chairman and CEO)

This is John again. This is John again. I apologize there. I thought you had said South San Francisco. I happen to have a new speaker phone in the office here in San Diego, that this is our first time using it, and it's cutting in and out, so I apologize.

Peter Abramowitz (VP)

All good. Appreciate the color. Thank you.

Operator (participant)

Thank you for your question. Next question comes from the line of John Kim with BMO. John, your line is now open.

John Kim (Managing Director)

Thank you. On your cash and marketable securities, can I just ask what interest rate you're earning on that?

Rob Paratte (Chief Leasing Officer)

So it depends on the duration, but, right now, call it in the fives.

John Kim (Managing Director)

Is there anything in the marketable securities other than the CDs that you mentioned?

Rob Paratte (Chief Leasing Officer)

No.

John Kim (Managing Director)

Do you foresee... I know you talked about having a high balance for development spend and to retire debt in December of next year, but do you foresee maintaining a high cash balance in the short term, just to provide some liquidity for any opportunistic acquisitions?

Rob Paratte (Chief Leasing Officer)

Well, in the short term, you know, that cash is going to go to, effectively fund the development pipeline. So, it's reasonable to assume that it gets smaller over subsequent quarters because we're going to continue to fund it.

John Kim (Managing Director)

Okay. My last question is on the termination income that you had this quarter, which is pretty modest, but I was wondering if you could provide some color on that and what you're expecting for the remainder of the year.

Rob Paratte (Chief Leasing Officer)

So there's really just one small lease that paid a termination fee in San Francisco for retail space, is what really drove it. And we are not projecting any other termination income for the balance of the year.

John Kim (Managing Director)

Thank you.

Operator (participant)

Thank you for your question. There are no additional questions waiting at this time. I would now like to pass the conference over to the management team for further remarks.

John Kilroy (Chairman and CEO)

Thank you, Victoria, and thank you everyone for joining us today. We appreciate your continued interest in Kilroy. Have a good day.

Operator (participant)

That concludes today's call. Thank you for your participation, and enjoy the rest of your day.