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Edited Transcript of KRC earnings conference call or presentation 5-Feb-19 6:00pm GMT

Q4 2018 Kilroy Realty Corp Earnings Call

LOS ANGELES Feb 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Kilroy Realty Corp earnings conference call or presentation Tuesday, February 5, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* A. Robert Paratte

Kilroy Realty Corporation - EVP of Leasing and Business Development

* Jeffrey C. Hawken

Kilroy Realty Corporation - Executive VP & COO

* John B. Kilroy

Kilroy Realty Corporation - Chairman, President & CEO

* Stephen Rosetta

Kilroy Realty Corporation - CIO & Executive VP

* Tracy A. Murphy

Kilroy Realty Corporation - EVP of Life Science

* Tyler H. Rose

Kilroy Realty Corporation - Executive VP, CFO & Secretary

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Conference Call Participants

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* Craig Allen Mailman

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* Daniel Ismail

Green Street Advisors, LLC, Research Division - Analyst of Office

* Emmanuel Korchman

Citigroup Inc, Research Division - VP and Senior Analyst

* James Colin Feldman

BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst

* John P. Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* John William Guinee

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Nicholas Philip Yulico

Scotiabank Global Banking and Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Kilroy Realty Corporation Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Financial Officer. Please go ahead.

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [2]

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Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and Jeff Hawken as well as other senior members of our management team who are available for Q&A.

At the outset, I need to say that some of the information we will be discussing is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call and in the supplemental.

This call is being telecast live on our website and will be available for replay for the next 8 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 also available on our website.

John will start the call with a review of the fourth quarter and the year. Jeff will discuss conditions in our key markets, and I'll finish up with financial highlights and a review of our initial 2019 earnings guidance that was published yesterday in our earnings release, then we'll be happy to take your questions.

John?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [3]

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Thank you, Tyler. Hello, everybody, and thank you for joining us today. I'll begin this morning with a review of 2018 highlights and fourth quarter results and finish with the status of conditions in our markets that are driving our development activities and shaping our 2019 outlook and objectives.

First, last year's highlights. 2018 was an excellent year for us across the company. Our West Coast markets remain healthy and vibrant, and we turn -- and we, in turn, delivered a record-high leasing performance, signing 3.4 million square feet of leases in our stabilized portfolio and development program.

Cash and GAAP rents were up 15% and 36%, respectively, in the stabilized portfolio. We proactively addressed our 2018 and 2019 expirations. We signed a 12-year lease with Netflix for all of the 355,000 square feet of our office space at the mixed-use development project that is under construction in Hollywood. We also signed leases on 91% of the retail space and have commitments on roughly 2/3 of the office space at our One Paseo mixed-use project in Del Mar.

We commenced revenue recognition on all of the office space at 100 Hooper in San Francisco. We added a key life science development opportunity to our pipeline with the acquisition of Kilroy Oyster Point, a fully entitled approximately 40-acre waterfront site in South San Francisco.

We made 2 strategic property acquisitions totaling $257 million, one in South San Francisco and the other in San Francisco's technology quarter on Brannan Street. Both acquisitions are adjacent to existing KRC assets.

We generated $373 million on our capital recycling program through the disposition of 3 nonstrategic assets. We increased our dividend by 7.1% or 30% over the last 3 years. We strengthened our balance sheet, lowered our overall cost of capital and successfully managed earnings dilution with the issuance of over 1 -- of $1.1 billion in equity and debt. And we reinforced our commitment to building a sustainable enterprise with a pledge to achieve carbon-neutral operations by year-end 2020.

We also ranked #1 in sustainability across all publicly traded real estate companies in the world by GRESB and received numerous other awards for our leadership positions from the EPA and NAREIT.

Now let's get into the fourth quarter details. We had another outstanding quarter in leasing. In our stabilized portfolio, we signed new or renewing leases on 768,000 square feet of office space. Rents are up 25% on a cash basis and 51% on a GAAP basis.

Included in the fourth quarter was a 5-year renewal with Microsoft for 76,000 square feet in Silicon Valley that was to expire this year. The deal addressed the last of our five 2019 expirations exceeding 75,000 square feet.

We also signed a 10-year 71,000-square foot lease at our Orange County property that backfilled our 2019 expiration.

We were equally busy closing out our investment activities for the year. We completed a disposition of 3 nonstrategic assets for $373 million across 3 markets, Seattle, the San Francisco Bay Area and the 101 Corridor in Los Angeles. The average cap rate on the 3 transactions was in the low 5% range.

We also completed in December the $146 million acquisition of 345 Brannan Street in San Francisco. This building is connected to our 333 Brannan Street project that we developed and delivered in 2015, and both properties are currently occupied by Dropbox. Along with 301 Brannan, these buildings will serve as GM Cruise's new headquarters following Dropbox's move to The Exchange later this year.

Now I'll make a few comments about the market tone across the West Coast.

From San Diego to Seattle, every market we compete in is benefiting from broad-based economic growth fueled by the growing number of companies and industries competing for space and talent, not only in technology, media and life science but also a broad cross-section and sectors of the economy. This dynamic has resulted in one of the strongest market conditions we have seen with very limited supply and solid demand driving declining vacancy rates and higher rents.

Our other indicators we monitor also remain healthy. 2018 VC funding was at a record level in this cycle, and our West Coast markets accounted for 60% of the funding. Sublease activity in San Francisco remained disciplined with 1.7 million square feet or just about 2% of inventory.

Job growth in our markets also outperformed the rest of the nation, led by strong growth in San Diego and Seattle. And in terms of the investment market, high-quality, well-located assets in our markets continue to command strong valuations. And as we have seen, pricing in the $1,500 per square foot range in San Francisco, over $1,000 per square foot in Seattle and Los Angeles, and now $700 per square foot for older products in the San Diego submarket of Del Mar.

Now let's move to development. We have 2 projects that are nearing stabilization, 100 Hooper and The Exchange on 16th. Once stabilized in 2020, these 2 development properties will generate approximately $70 million of cash NOI. Based on current market cap rates, we believe the value creation on these 2 projects is approximately $850 million, doubling the value of our investment.

We have 3 projects currently in the construction process, 333 Dexter, a 650,000 square foot project in the South Lake Union submarket of Seattle; One Paseo, a 1.1 million square foot mixed-use office retail and residential project in coastal San Diego's Del Mar community; and our Hollywood development of 570,000 square foot mixed-use project.

In Seattle, we continue to make progress on lease negotiations with several tenants at 333 Dexter. The strength of the market in Seattle remains robust, and we expect to have a substantial leasing on this project by shell completion that is scheduled for later this year.

Also, I would like to bring you up to speed on the new tunnel that connects South Lake Union to the south end of the city. Just yesterday, SR 99 tunnel opened to traffic after 5.5 years of construction, improving traffic flow and transforming the pedestrian environment around our 333 Dexter project.

Travel time from south -- the south end of the city to the north end of the city is now estimated to be less than 3 minutes. That's a really big deal for our development and for South Lake Union.

At our One Paseo project, the retail space is essentially fully leased. Marketing is underway for the 608 residential units to be delivered over a time beginning mid-summer, and office pre-leasing activity is roughly 67%. The office component is commanding premium rents that are 25% to 30% higher than existing top-of-class product in the market.

With the Netflix lease now in place for all of the office space at our Hollywood development project, we commenced construction on the project's 193 residential units. We expect to deliver the office space to Netflix in mid-2020 and the residential tower later that year.

Taken together, these 3 projects represent a total estimated investment of over $1.5 billion with an average delivery time frame of early 2020.

Upon stabilization, projected cash NOI is close to $100 million with the product components to be 65% office and 35% residential and retail.

In terms of our development pipeline, we are making progress on both the Flower Mart and Kilroy Oyster Point. With regards to the Flower Mart, in early December, San Francisco's Board of Supervisors unanimously approved the Central SoMa Plan, which allows for Prop M allocations to be allocated this spring.

As anticipated, there have been a few lawsuits filed that oppose the Central SoMa Plan, and the timing on how those get sorted out is still unclear. We continue to see significant interest from a variety of large users in what is arguably one of the most sought-after commercial submarkets in the country.

At Kilroy Oyster Point, we are extremely well positioned with 2.5 million square feet of entitlements in a supply-constrained market that has a vacancy rate of about 2%. We are in numerous discussions with potential tenants in connection with Phase 1, which includes 3 buildings totaling 600,000 square feet.

Wrapping up, we will be focused on 3 key objectives in 2019. First, execution in our development pipeline. We continue to believe that development is the best way to create shareholder value at this point in the cycle, and our focus is to ensure that our current projects deliver on time and on budget, and that we make progress on securing entitlements to the Flower Mart.

Second, maximizing value on our stabilized portfolio. This includes leasing up our vacancies, driving rents where possible and proactively addressing expirations. And third, maintaining a strong and flexible balance sheet. This includes keeping our metrics conservative and having access to multiple forms of capital.

That completes my remarks. Now I'll turn the call over to Jeff for a closer look at our markets. Jeff?

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Jeffrey C. Hawken, Kilroy Realty Corporation - Executive VP & COO [4]

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Thanks, John. Hello, everyone. As John stated, conditions in our West Coast real estate markets remain healthy.

Let's begin in San Francisco, which remains among the strongest commercial real estate market in the country. 2018 was a spectacular year in leasing large blocks of space. There were 21 transactions greater than 100,000 square feet, outpacing 2017's record of 18. This drove rent increases across the market, and with no new product being delivered until 2023, we expect rents to continue to increase.

For the year, San Francisco delivered Class A rent growth of 12% year-over-year, more than twice the level the brokerage community had initially forecasted.

In San Francisco's SOMA, South Financial and Mission Bay districts, Class A direct vacancy rates were 1.8%, 4.6% and 6.6%, respectively. In South San Francisco, life science vacancy rate was 2%. And in Silicon Valley, Class A direct vacancy was 6.1%.

We are currently 98.5% leased in the Bay Area, and our in-place rents for the region are approximately 32% below market. In the Greater Seattle region, market conditions echo that of San Francisco. The region's record-setting growth has shown no indications of slowing down as the labor pool for the technology-focused workforce continues to migrate to Seattle. With limited supply, Class A rents hit a record high.

Class A direct vacancy in South Lake Union is 1.7%, and in Bellevue, it is 5.3%. Our Seattle portfolio is currently 97.7% leased. Our in-place rents are approximately 10% below market. In San Diego, market fundamentals in 2018 outperformed a strong 2017 in terms of vacancy, net absorption and rental rates. This was driven by expansion in the technology, life science and financial services sector. Most notably, Apple leased a 97,000 square foot project in University Town Center, deepening the technology concentration that already exists with major names like Amazon and Walmart Labs.

The vacancy for competitive product in Del Mar was approximately 9%. Our San Diego portfolio is currently 90.9% leased. We reported last quarter that our in-place rents were, for the first time in 40 quarters, at market. Rents have since continued to increase, and we are now approximately 4% below market in San Diego.

According to Crunchbase, Los Angeles is now ranked as the third largest tech ecosystem for start-ups in the nation. The region had a 6 consecutive year of positive net absorption, generating all-time high rents as major tech media companies, such as Netflix, HBO, Amazon, Facebook and Apple, continue to expand across the market. Class A direct vacancy in West L.A. was 6.5% and Hollywood was 7.9%.

Our Los Angeles portfolio is currently 96% point (sic) [96.9%] leased. In-place rents are approximately 13% below market. On a portfolio-wide basis, our estimated average in-place rents were approximately 20% below market. That is the greatest differential in company history. We are in excellent shape on our 2019 expirations. We have leased 929,000 square feet of the 1.4 million square feet set to expire in 2019, leaving only 4% remaining to be leased for this year. And we are focused on getting ahead of future expirations with only 2 expirations greater than 100,000 square feet in 2020.

In 2019, we will see the benefit of some of the big leases we executed last year, including Amazon in Seattle, and GM Cruise, DoorDash, Splunk and Nektar in San Francisco. We do expect, on average, about 3 to 4 months of downtime associated with each of these leases when the prior tenant moves out and we complete tenant improvements for the new tenant.

That's the snapshot of our markets. Now Tyler will cover our financial results in more detail. Tyler?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [5]

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Thanks, Jeff. FFO was $0.78 per share in the fourth quarter and includes 3 onetime items that, on a net basis, lowered FFO by $0.12 per share. On an adjusted basis, FFO would have been $0.90 per share for the quarter.

The first onetime item is a $0.12 per share charge related to the early redemption of our 2020 senior notes.

The second onetime item is a $0.12 per share noncash charge related to the potential accrued retirement benefits. And the third onetime item is a positive $0.11 per share gain on the sale of land in connection with the disposition of the Plaza Yarrow Bay asset. For the year, excluding these 3 onetime charges, FFO was $3.60 per share.

Same-store NOI continue to reflect strong growth in rental rates. GAAP NOI rose 3%. As anticipated, on a cash basis, NOI was down 0.9% due to free rent associated with new leases as well as the onetime benefit in the fourth quarter of last year.

For the year, cash and GAAP NOI both grew 3%. We ended the year with occupancy of 94.4%, in line with guidance. And we were 96.6% leased.

Moving to the balance sheet. We completed a number of transactions during the fourth quarter that have positioned us well for the new year. In October, we drew down the entire $200 million of 4.35% privately placed unsecured notes.

In November and December, we raised $400 million of 10-year unsecured senior notes at 4.75% and redeemed all $250 million of our 2020 bonds. Meanwhile, our overall financial position is sound with substantial additional funding capacity. We have total capacity under credit facility of just under $1.5 billion that includes approximately $735 million of availability under the revolver and $600 million under the accordion feature.

We have a large unencumbered portfolio with only 3 mortgages. We have very little floating rate debt and no significant maturities until 2022. Currently, our debt-to-market cap is in the mid-20s, and our debt to EBITDA is approximately 5.9x pro forma for the equity forward.

Now let's discuss our initial 2019 guidance provided in yesterday's earnings release. To begin, let me remind you that we approach our near-term performance forecasting with a high degree of caution, given all the uncertainties in today's economy. Our current guidance reflects information and market intelligence as we know it today. And any significant shifts in the economy, our markets, tenant demand, construction costs and new supply going forward, could have a meaningful impact on our results in ways not currently reflected in our analysis. Projected revenue recognition dates are subject to several factors that we can't control, including the timing of tenant occupancies.

With those caveats, our initial assumptions for 2019 are as follows. As always, we don't forecast acquisitions. We are targeting dispositions in 2019 of $150 million to $350 million. We anticipate 2019 development spending to be between $500 million to $600 million. We expect to commence revenue recognition on our Dropbox lease at The Exchange in 3 phases. The first phase in the third quarter, second phase at year-end and the third phase in 2020.

Our forecast for year-end office occupancy is between 94% and 95%. We project positive GAAP same-store NOI growth of 3% to 4%. We expect flat cash same-store NOI this year, given the downtime associated with TI build out on some of the large move-ins Jeff discussed. The downtime will impact our same-store numbers in the first half of the year, but should be positive in the second half of the year.

G&A is projected to be in the $81 million range. As we previously reported, we expect to draw down on the equity forward by May. From a 2019 FFO perspective, our 4Q normalized run rate was $0.90 or $3.60 on an annualized basis. We project the new lease accounting change will reduce FFO by approximately $0.09 per share, which will be partially reflected in G&A and partially in a new line item on our income statement. The dilution from our projected dispositions is estimated to be about $0.08 per share, subject to actual timing.

The impact from new development NOI, including The Exchange, One Paseo retail and residential is estimated to be about $0.18 per share positive. And finally, the impact of GAAP same-store, financing and other factors is estimated to be about $0.07 per share positive.

Taking all these assumptions into account, our initial earnings guidance for 2019 is $3.58 to $3.78 per share, with a midpoint of $3.68 per share. To put that into perspective, without the accounting change, our year-over-year FFO per share growth would be approximately 5%.

That's the latest news from KRC. Now we'll be happy to take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Craig Mailman with KeyBanc Capital Markets.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [2]

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On 333 Dexter, it sounds like you guys are in talks with potential tenants. I guess, I thought, maybe a deal could have come together a little sooner, given the quality of the product and the location. I mean, have people been waiting for the new connection to be completed? Or what do you think has kind of maybe delayed that a little bit relative to maybe Street expectations?

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A. Robert Paratte, Kilroy Realty Corporation - EVP of Leasing and Business Development [3]

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Hi, Craig. This is Rob Paratte, I'll handle that. And thanks for the compliment on the project. It's really looking great now. The I99 undergrounding project has been on people's minds and on the radar screen for several years. I think the great news is that with very little hiccups and delays, it's opened relatively on time, and that's a critical factor, and everyone's assessing that project and what it means for 333 Dexter.

And to your point, we're pleased with the activity we have. And I think, depending on the tenant, it's very company-specific and also dependent on size, just how long it takes from initial discussions to actually getting a lease executed.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [4]

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And do you think -- I mean, given kind of the tenants looking at it, how do you kind of envision that breaking out in terms of amount of tenants and kind of where are you guys maybe on demand versus availability?

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A. Robert Paratte, Kilroy Realty Corporation - EVP of Leasing and Business Development [5]

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Yes, I don't want to comment on the mix and that sort of thing at this point.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [6]

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Fair. And then, just on the Flower Mart, with the challenges from the community, kind of how has that changed maybe internally your view of commencement dates relative and maybe capital need tier. You guys have done a good job raising debt equity and doing dispositions. But I guess, as you guys are looking out at Oyster Point and Flower Mart into beyond 2019, it looks like maybe -- I would have thought maybe dispositions would have ramped a little bit as you guys were able to pull it back in '18. Is that kind of -- is there some fluidity there in terms of disposition volumes, just given some of the timing?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [7]

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Well, yes, we try to -- this is John. We try to kind of do just-in-time when we can. In terms of the Flower Mart, almost every project in -- of substance in California gets a sequel lawsuit. It's just the way the homeowners and the various property owners deal with projects. It costs you, I think, something like $30 to file a lawsuit in California. I have my own thoughts about how this is going to play out. I don't really want to air them publicly because it is fluid. We're working with the city, as are the order major developers that own properties in SOMA to try to get things resolved. And I think they'll clearly get resolved, it's just a question of how long.

In terms of the timing, even if we -- we expect to get our development agreement signed late in the -- sometime in the fourth quarter, that would permit us to start development. I don't think we'd want to start development with the lawsuits against Central SoMa. It's not against our project, it's against some other projects and -- some other issues related to other projects in the area. I don't think we'd want to start without those lawsuits being resolved, or at least sufficient clarity.

Having said that, we never anticipated starting construction until we move the Flower Mart. And the Flower Mart, we won't move until we get the development agreement signed. We'll continue with that. So will this delay our start from what we had projected, which was, I believe, end of '19, early or mid-'20? I don't know.

With regard to Oyster Point, that's all entitled and there's no issues there at all with regard to entitlements. And so we'll go through that phase by phase.

In terms of how that relates to dispositions and so forth, like I said, we'll look at dispositions or ventures with regard to our needs. And Tyler does a pretty good job figuring that out. So I think we're in really good shape across the board. Anybody else?

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [8]

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All right. That's helpful. Then I guess, just a tag onto that last one. You're kind of getting back the stock to where you guys did the forward deal. And just thoughts on cost of equity here relative to the yields versus dispos and the kind of the attractives of each of those capital sources?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [9]

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Tyler, do you want to take that one?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [10]

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Yes, I mean, right now, we don't have the need for capital, so we don't have to make that decision. But you're right, we have to balance the cost of equity versus the cost of debt versus the cost of joint ventures and the cap rates on dispositions, which still remains strong. So we don't need to make that decision today, but we'll be following that as we go forward.

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Operator [11]

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The next question comes from Manny Korchman with Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [12]

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Maybe for Jeff or Tyler. When you think about the remaining expirations in 2019, got about 500,000 left, how should we think about sort of retention on those? And I think, on the last call, you mentioned 175,000 square foot tenant as sort of the largest potential expiration, if that's one location and where does that sit?

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Jeffrey C. Hawken, Kilroy Realty Corporation - Executive VP & COO [13]

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Yes, so this is Jeff. On the 2019, so again, we've got about 460,000 square feet that remain in expirations, none of them are larger than 50,000 square feet. And so our negotiations with a lot of the remaining tenants, there's 2 or 3, about 25% of the remaining, we know they'll vacate, but again, they're all fairly small and spread across the portfolio.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [14]

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And Tyler, on the '19 disposition guidance, a few questions. One, how much of that is going to be JV versus outright sale? And then, just help us figure out sort of where timing yields will be on those planned dispositions?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [15]

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Yes, I mean, right now, we're not anticipating those will be ventures, so it will just be straight sales, but obviously, that could change. Timing would be sort of third quarter, midyear to third quarter. And cap rates, we always are fairly conservative on our cap rates, we're probably in the low-6s to pick a number.

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Operator [16]

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The next question comes from Jamie Feldman with Bank of America.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [17]

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I guess, just sticking with the guidance first. Tyler, can you give us some thoughts on what AFFO in your dividend coverage looks like based on your outlook?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [18]

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Yes, so our payout ratio based on our CapEx modeling at this point is sort of in the mid-80s.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [19]

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On AFFO?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [20]

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We think of it as FAD. But yes, AFFO, FAD.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [21]

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Okay. And then, can you help us think through just the -- or kind of quarterly, what same-store looks like and what earnings looks like? Just how do we -- whether on a GAAP and cash basis, just what the -- as we go throughout the year, what the changes will be?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [22]

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Yes, as I said earlier, the -- it will be negative in the first couple of quarters and positive in the second. I mean, on a cash basis, it's roughly in the negative 5% range for the first 2 quarters, and then positive 3% and 6% in the last 2 quarters. Those are the current estimates. But as you know, it's very hard to model same-store, so those numbers will move around.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [23]

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Okay. What about in terms of FFO?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [24]

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FFO quarterly guidance? We don't provide quarterly guidance.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [25]

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By quarters. Okay. And then, John, just thinking about the reserve for the retirement charge -- or the retirement reserve. 2 questions. One is can you just help us think through or give us your thoughts on that payment? And then, secondly, when you sit back and think about the next 10 years of this company, given you are thinking about retirement, how should we think about what Kilroy looks like over that period?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [26]

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Well, I'll let Tyler answer the first part, and I'll answer the second part. Tyler?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [27]

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Yes, so on the retirement accrual, based upon John's new employment contract, he would receive a cash payment if and when he retires. So it's a potential payment. It's a noncash charge at the moment. Under the accounting rules, potential payments upon retirement are counted for differently than normal severance payments. And so the bulk of the retirement payment is required to be expensed in the period the agreement is executed, so that's why it was expensed in the fourth quarter when the agreement was executed.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [28]

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In terms of the second part of your question, Jamie, we've been -- we've had a very robust succession planning going on for the last several years. We have a committee that's -- a board committee that's on top of that. And we deal with that at each board meeting that relates to emergency situations, whether it's me or anybody else as well as long term, we don't disclose who might be candidates for any particular position in regards to succession.

In regards to me, I just turned 70, I'm feeling pretty good, I think most people who know me know I'm -- I think I'm on top of my game. And yet, this is a 5-year extension. I had to make a decision on what I wanted to do. The company obviously wanted me to stay. We've got a lot of big projects and things going on. And my hope is that we will, over the next few years, be able to determine who the next CEO will be.

Will I move to Chairman and we have a new CEO in 5 years? I can't tell you specifically how it's going to go. But I think, to be very prudent for our shareholders and for all the stakeholders that we do business with and all the employees at Kilroy, it's important to have a plan.

So that's where we're at. And we have a lot of good candidates. I think the ideal person is probably a lot younger than me and a lot smarter than me, and we'll find out who that is.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [29]

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Okay. That's helpful. All right. And then, I guess, just final question, what are you assuming for leasing spreads in '19 in the guidance?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [30]

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Well, I think, Jeff went through the -- where we are by market. I mean, we're 24% under market for our 2019 expirations.

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Operator [31]

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The next question comes from Nick Yulico with Scotiabank.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [32]

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Just first, just a question on Oyster Point. John, trends in that market are very strong, as you talked about. It felt like this quarter, you'd announce a construction start there, yet you haven't. So I guess, I'm just wondering what's holding you back at this point from starting the first phase there?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [33]

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Well, nothing is holding us back. We've been under construction with the site work and all the roads and all the rest. Originally, when we structured the purchase and sale agreement, the previous owner was going to do that work. We took that work over for them, got an appropriate credit for the cost of that and for the timing and so forth. But we're well underway with all that, and we don't need to start yet. We have to make that decision fairly soon.

And our -- Tracy is here with me. The delivery day, assuming things just go seamlessly from the current site work and pre-development work to construction to completion, the completion date for shell is scheduled -- would be scheduled for when?

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Tracy A. Murphy, Kilroy Realty Corporation - EVP of Life Science [34]

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Roughly Quarter 2, 2021.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [35]

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Yes, so stay tuned.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [36]

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Okay. And in terms of -- I mean, do you feel like you need to get leasing done at Dexter before you start Oyster Point?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [37]

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No, I don't think the 2 are connected at all. Both are very strong markets, different kind of clientele. This -- we're right in the catbird seat with regard to South San Francisco life science. I think we've got the best material site down there. Of course, BioMed, Blackstone has been very successful. They started their building just next door to us and leased it, and they have another phase. So between them and we, we think we can [certainly] control that market.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [38]

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Okay. That's helpful. Just one other question, Tyler, on the same-store NOI guidance. Trying to square that up with the occupancy guidance. I mean, I get it that there is move-ins, move-outs that are affecting the year and the cadence of the year. But the occupancy guidance, looks like it's showing an increase in occupancy by the end of the year, and struggling to see how that happens with a flat cash same-store NOI growth guidance?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [39]

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Yes. Well, as I mentioned, the flat is being driven by the first half of the year, and it turns positive in the second half. So I think that the projections assume that the occupancy improves in the third and fourth quarter.

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Operator [40]

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The next question comes from John Guinee with Stifel.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [41]

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Hey, Tyler, about 8 months ago at the June NAREIT, you gave a pro forma FFO of $4.46. Assuming all the development hit, which is about $1.10 a quarter by year-end 2020, is that still attainable?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [42]

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Well, remember that, that was all things being equal. With the lease accounting change and other things, you have to adjust for that. But I think we still anticipate that same general growth of NOI on an annualized basis by the end of 2020, assuming that we've completed the development as we laid out, and if leased, Dexter's leased and so forth.

So -- and again, this came up on last call, but we have certain disposition and estimates in our numbers. And to the extent we decide to sell more than our current plan or sell less, that could either increase or decrease the number. And it's assuming leverage is consistent and so forth. So I think we still anticipate strong pickup in NOI by that point, but it does move around, and the lease accounting change will impact that.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [43]

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Okay. And then, John, I think you had mentioned that you think that you're going to get about $70 million of stabilized cash NOI for Dropbox plus Adobe at Hooper. Looks to us like that's about an 8-plus yield on cost on a cash basis. Is that an accurate way to look at it?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [44]

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Yes.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [45]

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Okay. And then, the last question is DIRECTV. How many years do you have left on that lease? And is that something that's pretty soon becomes -- decreases in value rapidly in the private market?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [46]

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No, I think the opposite. Tyler or Jeff, you can -- you remember better than I, how many years are left on that lease. What's the number?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [47]

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Yes, September of '27.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [48]

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Okay. So there is roughly 8 years left. Is that right? So 8, 8.5 years. In terms of the rent, it's way below market. And El Segundo has been a hotspot recently with the lack of available space on the west side. And with the traffic patterns continuing to deteriorate, the South Bay isn't the greatest market when you get down south of El Segundo to the Harbor Freeway. That area -- we've never liked it. But El Segundo has become very strong, both with regard to people trying to acquire product in the area as well as tenant demand, including a number of media tenants and so forth.

So I think our mark-to-market on that asset is, I'm looking at Steve across from me, I don't know if you know it, or Jeff, but it's -- the rent is really low there. The mark-to-market -- the rent is very low in our project in El Segundo.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [49]

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Okay. Can you repeat that El Segundo is a hotspot?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [50]

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Well, it's actually -- relatively speaking, okay, John. I mean, there's -- tall people in different cultures that aren't as tall as some of the people in other cultures. So it's all relative. But El Segundo has now become a much stronger market than we've seen over the last 10 or 15 years. So -- and I think that just -- I think -- so we're kind of debating. We've always -- we always took take a look at all of our assets annually, try to assess the markets where they're going. And I've been pretty pleased with the data on El Segundo in terms of where rents have gone and where demand has gone. Rob, I know the rents now in that market are getting to what in El Segundo? Or Jeff?

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Jeffrey C. Hawken, Kilroy Realty Corporation - Executive VP & COO [51]

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[350] full service growth per month, so they're definitely been increasing significantly.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [52]

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And that's about $0.70 or so, $0.60 more than what we've got with DIRECTV, I think.

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Operator [53]

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The next question comes from John Kim with BMO Capital Markets.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [54]

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I may be mistaken, but I think I'm pretty tall for my culture. You had a busy leasing quarter, and I realize that, but when the equity markets were in turmoil back in December, did you see any pullback in decision-making among any of your tech tenants that may have spilled over to this year?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [55]

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No, to the contrary. We do -- as I've mentioned many times before, and Rob and others have mentioned, we have NDAs with quite a few people. And when I say quite a few, I'm talking about dozens. And we share what we're doing, they share what they're doing and so forth. We've not seen any slowdown in people's rate of growth or their plans for growth. We've seen people have a shift deciding that they want to grow in a market versus another market because of labor, but we haven't really seen any decline.

And just from a trend standpoint, I think we're pretty well set up. If you look at the vacancy rates in most of our markets, they're really frictional. They're anywhere from 1% to 3% or 4%. The one difference is our Del Mar market in San Diego where the vacancy rate's higher. But if you break it down in the quality stuff, it's pretty low. And we're seeing good demand up and down. I keep waiting for it to slow down, and we just haven't seen it.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [56]

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Okay. And on 100 Hooper and The Exchange, on the $70 million of stabilized NOI that you expected that next year. Can you just update us on what you expect will be contributed this year, a quarter?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [57]

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Yes, we didn't provide details by quarter. But as we said, our new development for 2019 will be generating $0.18 of effective FFO to the bottom line. Or I'd say -- I should say NOI.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [58]

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For 2019?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [59]

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Yes.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [60]

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Okay. And then, Tyler, on the forward equity deal, is there any cost associated with waiting as far as when you execute the sale? In other words, are the proceeds dividend adjusted?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [61]

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Well, if we were to raise our dividend, it would impact it. But if we don't change our dividend, then no, it has no cost.

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John P. Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [62]

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So logically, when you just execute 12 months after the transaction?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [63]

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Yes. I mean, it depends on need for proceeds. If something came up earlier, we could draw down -- or we could draw down in pieces as well. So it's sort of like an ATM. But at the moment, we're planning to draw it entirely in May.

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Operator [64]

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The next question comes from Daniel Ismail with Green Street Advisors.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [65]

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Can you provide an update on yield expectations for the Academy resi and office component at One Paseo?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [66]

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Academy resi and which?

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [67]

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The office components in One Paseo.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [68]

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Yes, I don't want to get in really to office yields while we're leasing. It's not a very good thing from a competitive standpoint. So forgive me for not answering that one.

And on the resi, Tyler, where are we at? We're in the -- on Academy? We're sort of in the 6s range? Is that right?

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [69]

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Yes, 5% to 6% range.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [70]

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Okay. And maybe on Columbia Square resi, the drop in occupancy quarter-over-quarter, can you give us an update on your plans for that asset?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [71]

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Plans as in what?

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [72]

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Just on explaining why the drop in occupancy quarter-over-quarter.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [73]

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Sorry, I thought you...

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Stephen Rosetta, Kilroy Realty Corporation - CIO & Executive VP [74]

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Columbia Square.

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [75]

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Oh, Columbia Square. Steve -- I beg your pardon. I thought you were saying One Paseo, and I didn't get the connection.

But Steve, do you want to talk about One Paseo resi?

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Stephen Rosetta, Kilroy Realty Corporation - CIO & Executive VP [76]

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Sure. Hi, Daniel. So we went through a management change in the fourth quarter at that asset, and we've also been decreasing our short-term stays in that asset and going to a more of a traditional apartment rental market for longer-term occupancy. So we had a near-term dip, but we anticipate that by year-end or Q3 of this year, we'll be back around 95%.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Analyst of Office [77]

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Okay. That's helpful. And maybe just last one. We're only about a month into 2019, but any commentary from tenants on Proposition C in San Francisco?

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John B. Kilroy, Kilroy Realty Corporation - Chairman, President & CEO [78]

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What's funny is that some of our biggest tenants have really been big supporters of that, and I'm not hearing anything from anybody. And we talk to them all the time.

Rob, do you want to add to that?

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A. Robert Paratte, Kilroy Realty Corporation - EVP of Leasing and Business Development [79]

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Yes. I think the reality, Daniel, is that tenants that need to be in San Francisco, factor in the cost of occupancy in cities like San Francisco, New York, et cetera, are going to have those sorts of levies. So -- I mean, we monitor it, obviously, but we're not hearing any pushback or seeing any.

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Operator [80]

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This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Rose for any closing remarks.

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Tyler H. Rose, Kilroy Realty Corporation - Executive VP, CFO & Secretary [81]

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Thank you for joining us today. We appreciate your interest in KRC. So long.

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Operator [82]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.