Kilroy Realty Corporation

Good morning, everyone. Thank you for joining us.

On the call with me today are John Kilroy, our CEO; Jeff Hawken, our COO; Eli Khouri, our CIO; David Simon, our EVP of LA; Heidi Roth, our CAO; and Michelle Ngo, our Treasurer.

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 7 days both by phone and over the Internet. Our press 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 an overview of the quarter, Jeff will take you through a brief overview of our conditions in our key markets and I'll finish off with financial highlights and updated earnings guidance for 2012. Then we'll be happy to take your questions.

John?

Thanks, Tyler. Hello, everyone, and thank you for joining us today.

The second quarter continued to be a very active period for the company. KRC's larger operating platform and expanded management team continued to make meaningful impact on our ability to find and execute growth opportunities with substantial value.

While core asset pricing remains very aggressive, we continue to principally focus on a variety of value add acquisitions opportunities in the best west coast markets.

We are increasingly viewed as a leader in delivering the collaborative work spaces that growing tenants demand. And on a selective basis, we're increasingly comfortable moving forward with new development where market strength and visible demand clearly support the project.

Let's talk about what we've accomplished since our last call. We completed property acquisitions in the Greater Seattle markets of Lake Union and Bellevue, adding premier properties with strong rent growth potential to our Seattle portfolio, increasing it to now more than 1.7 million square feet.

Our newly acquired 3-building Lake Union waterfront office complex is 99% leased with in-place rents that are approximately 25% below market.

We purchased the campus at a significant discount to replacement cost with an estimated in-place cash return in the mid-5% range. We expect to capture significant value as the existing leases expire in a submarket that continues to lead the region in growth and tenant demand.

Our new Bellevue office building, Skyline Tower, is a 24-story LEED Silver Class A multi-tenant high-rise with spectacular views and a irreplaceable location amid Bellevue's most affluent residential and retail neighborhoods. It's adjacent to the Transit Center and appeals to both traditional officer users and tech and media tenants.

The office tower, currently 92% leased, is just 2 blocks from our existing Key Center office building, and was purchased well below replacement cost. Based on our original underwriting, the initial cash return is approximately 5%, and following the repositioning of the property through a comprehensive capital improvement and modernization program, we expect the stabilized return to be approximately 6%.

Moving to the Bay Area, we've completed the purchase of 2 development projects and we're actively pursuing additional opportunities in the region. With our development background and strong local management and presence, we believe that in select situations we can generate yields 150 to 300 basis points above what we would earn from a comparably fully-leased core acquisition property.

First, as we have previously discussed, in the City of Mountain View, we're developing a 341,000 square foot office campus for Synopsis under a 15-year lease. Already fully entitled, the project includes 2 5-story Class A buildings designed and preregistered to meet LEED gold certification requirements.

Project's initial cash return is approximately 6.5%. It is situated in the heart of Silicon Valley with convenient access to both light rail and Caltrain.

This is an excellent opportunity to increase our presence in an area that is growing rapidly and anchored by some of the world's largest technology companies, including Google, Facebook and Apple. We're projecting total development costs of approximately $200 million and expect to complete the project in 2015.

Second, we acquired a development site at 329 Brannan Street in San Francisco's SoMa district for approximately $18.5 million. This is literally at Main and Main.

Plans are still being finalized but with the site zone for 5 FAR coverage, we plan to build a 6-story office building designed to reflect the prevailing brick and timber character of the neighborhood, including our own properties at 301 and 250 Brannan Street. The building designed will incorporate large, open 4-plates and many other features popular with the creative tenants that dominate the area.

Brannan Street corridor is in high demand among the city's many technology and media companies with very limited available space. Our 2 existing properties there are both fully leased.

We expect to complete the entitlement process by year-end 2013 and deliver the building in 2015.

Our preliminary estimate of total cost for the project is approximately $85 million with an initial cash return of approximately 8%. Our fully developed basis for this best in class asset will compare very favorably with recent market transactions.

Third, through a combination of our longstanding development experience and local Bay Area relationships, we’ve been selected by the City Council of Redwood City to develop a 2-building office campus totaling approximately 260,000 square feet in an irreplaceable location. We are currently working with the city to finalize the development agreement and hope to acquire the land later this year.

Given early discussions, it may be possible to increase the overall project by almost 40% or over an additional 100,000 square feet

The site has tremendous visibility and is immediately adjacent to the Caltrain Station that’s part of the heavily used rail line connecting San Francisco and Silicon Valley. Access by an office tenant to Caltrain Station is highly desirable and there are very few sites remaining in the Valley that can offer this amenity.

We believe this is the best remaining site near a Caltrain station in the entirety of Silicon Valley.

The campus will be designed with all the features that knowledge-based tenants seek in today's modern work environment and will be ideal for tenants seeking a new headquarters location. We will develop and own the property with a local partner who will have a small minority interest.

We currently project a total investment based upon the 260,000 square foot scenario in the $140 million to $150 million range with a delivery date of 2015 and initial cash return in the 8% range.

Fourth, we have entered escrow to purchase another 100,000 square foot pre-leased development opportunity in one of the best markets in Silicon Valley. We’re under a confidential provision and detail due diligence to build a 90,000 square foot building for a tech tenant under a 10-year lease.

The total development cost is projected to be approximately $50 million for the initial return in the mid 7% range. We would complete construction in the fourth quarter of 2013.

In total, that is 4 development opportunities in the best San Francisco Bay Area markets. 2 100% pre-leased, totaling approximately 900,000 square feet, a projected investment of approximately $500 million and an average initial cash return in the mid 7% range.

Moving to Los Angeles, we are making significant progress here expanding our platform and capturing value-added opportunities. Earlier this week, we completed the purchase of Sunset Media Center, a 322,000 square foot 22-story Class A office building located on the corner of Sunset and Vine in the heart of Hollywood for approximately $79 million.

The purchase price, which was agreed to in early 2011, represents a 50% discount to replacement cost.

At $245 per foot, the acquisition price is also less than half of recent trades in the area. The property is currently 87% leased, with in-place rents approximately 30% below current market levels.

We have plans underway for an extensive renovation of the property that will reposition it into the premier Hollywood office and media center, attractive to a variety of entertainment and media tenants. As with most value add opportunities, occupancy and returns will fluctuate over the next year or so as we complete our renovation.

Based on our original projections, the stabilized cash return is expected to be approximately 7%.

While the Hollywood market per se is new for us, it embodies very similar characteristics and tenets as many of our other core markets. Our team, particularly, David Simon, our new EVP for Los Angeles, and Eli have substantial experienced in this area.

Hollywood has experienced a substantial revitalization from a residential and retail perspective. It remains a critical office location for much of the entertainment industry.

We expect to find other opportunities in this market over time.

We've also signed a purchase agreement for a stabilized West L.A. Building that will have excellent synergies with our existing West L.A.

Holdings and our new Hollywood Sunset Media Tower building. We're currently under a confidentiality agreement, but the purchase price is approximately $75 million with $40 million of assumed CMBS debt, is well leased and is expected to generate initial cash return of approximately 6.5%.

Closing is targeted for the end of the third quarter subject to the loan assumption.

From a leasing perspective, we made good progress during the quarter, signing new or renewing leases on approximately 850,000 square feet of space. Among the highlights, we signed a 10-year lease for a 123,000 square feet with Concur, a travel and expense management company, at Key Center in Bellevue, which is now 93% leased.

About 100,000 square feet of that space is currently occupied by tenants with upcoming expirations.

We made progress at our 373rd Street redevelopment project in San Francisco, where we are in lease negotiations with a ground floor tenant and in serious discussions with several other prospective tenants for a good portion of the remainder of the vacant space.

And in San Diego, we're making excellent progress backfilling the former HP space in Del Mar. We have 2 LOIs there with tenants that would take 4 of the 5 floors.

Overall, our pipeline of LOIs now totals approximately 400,000 square feet. GAAP rents are projected to be up about 17% on those transactions.

We continue to have 4 properties in our redevelopment portfolio. Cash rent will begin on the DirecTV space in December 1 of this year, although revenue recognition will depend on when the tenant completes its improvements.

TD Ameritrade is expected to take occupancy at the end of the third quarter, and Devry has now moved into its new space in Long Beach. And I mentioned we're making good progress at 373rd.

At stabilization, these buildings will generate approximately $22 million in cash NOI.

With regard to the sale of our industrial portfolio, the process is going very well. We've received a number of bids for the entirety of the portfolio and several for various portions of the portfolio.

We're in the midst of evaluating the best execution and expect to complete one or more transactions later this year. As we've previously discussed, we also maintain an active portfolio review process to identify potential future disposition candidates.

We anticipate additional property dispositions that could generate another $100 million to $200 million over the next 12 months.

As my comments today demonstrate, we're extremely active. Over the past 2 years, we've built organizational strength and capacity and are taking full advantage of our growing enterprise to capitalize on market opportunities and to continue to position the company for long-term growth.

While there remains considerable uncertainty in the macro environment, which can impact decision making, our core real estate markets are all showing improvement and all have had positive job growth over the last year.

In Bay Area and Seattle, we continue to see increasing demand for space, driven by a rapidly growing tech and media industries and all the support businesses they generate. In our Southern California markets, we're seeing steady improvement in real estate fundamentals.

As we have increased our visibility and regional capabilities, our expanded management team is finding more value-add in first looked opportunities. We are harvesting mature investments, recycling capital into higher financial assets and focusing our long-term value creation, and we have done it in a financially disciplined manner.

Well, in the past, I would review our individual submarkets. Going forward, Jeff is going to cover that for us.

Jeff?

Thanks, John. Hello everyone.

Our core real estate markets continue to show improvement from a year ago, although the rate of improvement varies from market to market.

Led by technology, entertainment, tourism and healthcare, California had 2% job growth over the past 12 months, significantly faster than that of the nation. As John mentioned, all of our core markets including Seattle, San Francisco, Los Angeles, Orange County, and San Diego have experienced positive job creation over the past 12 months.

Let me review each of our 5 regions, starting with San Diego. San Diego experienced positive absorption in the second quarter, marking nearly 3 years of improving fundamentals in the area.

We continue to see declines in the availability of large contiguous blocks of Class A space in select submarkets.

As John mentioned, we are making good progress in Del Mar with 2 LOIs in place to backfill 4 of the 5 HP floors. As we previously reported, we had 2 significant San Diego lease expirations in the quarter totaling approximately 235,000 square feet, which impacted our overall San Diego occupancy.

Our San Diego portfolio is currently 89% leased and 92% committed.

In Orange County, the industrial market continued to improve with vacancy now at 4.8% as a result of 4.4 million square feet of positive absorption since the second quarter of 2010. The Orange County office market saw significant positive absorption in the second quarter that totaled 950,000 square feet, driven by research-oriented businesses.

Orange County's unemployment rate continues to decline and is now 7.9%.

During the quarter, a 153,000 square foot industrial tenant defaulted and moved out of its space. This lowered our industrial occupancy to 93%.

Annual NOI impact of this lease was approximately $850,000. From a releasing perspective, current market rents are about 20% higher than the rate under the previous lease.

Overall, our Orange County office portfolio is 96% leased and our industrial portfolio is 93% leased.

Moving north, West Los Angeles remains the strongest submarket in the Greater L.A Metro Area, supported by an improving entertainment industry. We are 98% leased in West L.A.

Our South Bay markets, El Segundo and Long Beach, both had positive net absorption in the quarter and we are 96% leased on a combined basis in these markets.

On the 101 Corridor, we are 88% leased in our Calabasis properties, 91% leased in our Thousand Oaks property, 15% leased in our 265,000 square foot complex in Camarillo. Overall, our 101 Corridor properties totaling 651,000 square feet are 59% leased.

San Francisco remains our top performing market and arguably the strongest in the country with continued demand from the technology and media sectors. 2011, there were 9 leasing transactions over 100,000 square feet in San Francisco.

There have already been another 9 through the first half of 2012 and market demand remained strong at more than 2.5 million square feet. Vacancy rates continue to decline, and unlike other markets in the country, San Francisco has experienced tremendous rental growth with rates up more than 85% in Soma on a triple net basis since 2009.

The Silicon Valley, fundamentals are also very strong, although absorption was slightly negative in the second quarter. While the pace of activity slowed from record pace in prior quarters, brokers are reporting continued increases in asking rates, increased third quarter activity and limited available space in quality buildings.

Our San Francisco Bay Area portfolio now represents approximately 28% of our pro forma stabilized and annualized NOI. Overall, our stabilized Bay Area properties are 93% leased.

Seattle remains our second-best performing market with demand principally driven by technology, other knowledge industries in the FIRE category. The East Side and Lake Union markets remain the preferred choice for tenants.

The Bellevue market continues to tighten, as evidenced by the 123,000 square foot, 10-year headquarters leased with signed with Concur Technologies in the second quarter. There is now only one space in the market of over 50,000 square feet.

Our recent transaction with Concur was the largest lease in the market in over 3 years and demonstrates the desirability of Bellevue's housing, transportation and retail amenities.

In Greater Seattle, our overall portfolio is 95% leased, our East Side property is 92% leased and our Lake Union property is 99% leased. Including the completion of our recent acquisitions, Seattle generates 12% of our NOI on a pro forma basis.

That’s an update on our markets. Now I will pass the call to Tyler, who will cover our financial results in more detail.

Tyler?

Thanks, Jeff. FFO was $0.55 per share in the second quarter and $1.04 for the first 6 months of the year.

Those results included $0.03 of acquisition-related expenses, our public company and IT costs, the issuance of 576,000 shares under our ATM program and a delayed closing of our recent acquisitions. We ended the second quarter with stabilized occupancy at 90%.

That’s down from 91.6% at the end of the first quarter.

As Jeff mentioned, occupancy decreased in the quarter for 2 main reasons. The first was 2 lease expirations in San Diego, HP and Del Mar and Northrop and Rancho Bernardo.

Those reduced occupancy by roughly 150 basis points. We also had an industrial tenant default during the period.

This had no meaningful economic impact in the second quarter but reduced occupancy 100 basis points. This was partially offset by 60 basis points of occupancy gains in the operating portfolio.

As of today, our operating portfolio is 91% leased.

Same-store NOI for the second quarter was down 0.2% on a GAAP basis and 0.3% on a cash basis. Second quarter 2011 NOI included about a $0.01 a share from a one-time payment related to tenant default, and second quarter 2012 NOI included about a $0.01 a share of higher one-time expenses related to an electrical malfunction in one of our buildings for which we are pursuing an insurance claim.

Excluding those 2 items, our GAAP and cash same-store NOI would have been up approximately 2.5%.

For the first 6 months of the year, GAAP NOI was up 3.7% and cash NOI was up 4.2%. We project that third quarter same-store results will be relatively flat, given lower occupancy, but will increase again in the fourth quarter excluding any one-time items.

Second quarter operating expenses were higher than the first quarter by about $0.02, $0.01 related to the electrical issue I just mentioned and $0.01 related to higher utility cost, property management expenses and maintenance costs. Rents in our 850,000 square feet in the second quarter leasing were up 13% on a GAAP basis and 6% on a cash basis.

As John mentioned, rents on our LOIs are up 17%.

We estimate that rent levels in our overall portfolio are approximately 3% over market, reflecting a significant improvement from 10% a year ago.

As I mentioned during the second quarter, we also issued approximately $27 million of equity under our ACM program at a weighted average price of $46.05.

In June, we took advantage of lower long-term rates and closed a 15-year $97 million mortgage secured by office properties in Orange County and Los Angeles. The mortgage had an interest rate of 4.48%.

We used the loan proceeds to pay down a portion of the balance on our credit facility.

We also assumed 3 loans in connection with our acquisition totaling $172 million. As of today, taking into account all of our recent activity, we have approximately $240 million drawn on our bank lines.

With impending activity that John has outlined, we estimate that we would have about $375 million outstanding on our lines at the end of the year before proceeds on the sale of our industrial portfolio and assuming no additional funding.

Over the past several years we have significantly grown the company in terms of new assets and markets. With this have come added people and opportunities to further position the company for the future.

We're in the process of implementing a new information technology backbone to accommodate increased accounting, property management and construction activities. This will add about $0.01 to our 2012 G&A budget.

Now let's discuss updated guidance for 2012. To begin, let me remind you that we continue to approach our near-term performance forecasting with a high degree of caution given all the uncertainties in today’s economy.

Our internal forecasting guidance reflect information and market intelligence as we know it today. Any significant shifts in the economy or markets going forward could have a meaningful impact on our results in ways not currently reflected in our analysis.

With those caveats, our assumptions are as follows. Our guidance midpoint on last quarter’s call was $2.32 per share.

Based on our most recent acquisitions and the planned sale of the industrial portfolio, we are projecting an occupancy rate of year-end 2012 of 92%, subject to the impact of any additional acquisitions and dispositions.

There are a lot of other moving pieces that are impacting our numbers, including higher IT costs, slower than planned acquisition closings, delay in revenue recognition on 2 of our redevelopment projects, positive impact of new acquisitions and lower financing costs. Taken together, these move our midpoint to $2.30 per share.

Not included in that $2.30 for midpoint are $0.02 of dilution from the anticipated sale of our industrial portfolio in the fourth quarter and a projected $0.02 of additional acquisition-related expenses in the second half. So taking those 2 adjustments into consideration, our midpoint moves to $2.26 per share.

From there we're providing updated 2012 FFO guidance range of $2.21 to $2.31 per share.

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

Operator?

Just curious if you could give a little bit more color on the state of the industrial side. I know you said it's going well and kind of dismal [ph] portfolio and break up.

What do you guys think the updated timing to be for a portfolio sale versus sort of a break up? And in a break up sale, is there enough demand for all of the parts at this point or is there a lot of overlap in what people want to buy?

This is Eli, and I'll try to address that, then if John or Tyler has further comments we can. Look, the first thing I'd say is we're in the middle of a process, a very confidential process and a highly competitive process.

So we really need to limit our comments. I think as John already said, we have significant bids and a lot of interest in both the full portfolio purchase as well as subportfolios covering the entire portfolio when you add those subportfolios up.

We fully expect to execute a very strong transaction this year, as Tyler mentioned, the fourth quarter and I think that is entirely realistic. I don’t think we should comment much further given where we are in the process.

I would just say, I don’t the timing changes much between a full portfolio sale or something that is sold in tranches but I would've just -- conclude by saying I think we're very satisfied with the way things are going and where we are and we'll just keep you posted as the process unfolds.

Craig, this is John, just one added comment. Remember that a lot of these buildings we want to do a 1031 on because of the tax position.

So if there are delays, then, that would be probably triggered by Kilroy wanting to accommodate our tax position as opposed the interest of people to close this year. We're confident that we can close it all this year.

We just want to make sure that we're being tax efficient.

Yes.

I know you guys have said you were going to tranche it previously. Curious, though, did the industrial defaulter in the quarter cause any of the buyers take a step back and try to retrade or is that a non-issue?

No, that’s an opportunity because, as Tyler mentioned or Jeff mentioned, it's -- the current market is 20% over the lease that was vacated.

Okay. And then, just as I look at where you guys stand from potential line outstanding at year-end versus kind of the proceeds you can get from the industrial sale when it does close, just curious why you guys hit the ATM this quarter?

Well, as we said all along as we have been buying properties, we want to remain leverage neutral to the extent we can. Obviously, selling an industrial will help us do that but we acquired a fair amount properties and we wanted to take advantage of that.

I would add to that, Craig, this is John again, that what we are seeing are some pretty good opportunities in the market. We are seeing a number of non-marketed transactions right now that we think are pretty interesting.

We want to make sure we have plenty of powder to execute.

Okay. And then, I know you said you are looking at a couple more Bay Area redev and development opportunities.

How extents would you want to get with their development pipeline in San Francisco at this point in the cycle?

Well, it is obviously we want to spread it out. With regard to timing and with regard to markets, as we've mentioned, we have 4 developed opportunities up there are right now.

One is in the City Three and the best markets of the Silicon Valley. All share commonality that they're -- have strong transportation components, which is we are very focused on because of the modern work force needing that.

But if it is pre-leased and it is accredited tenants, then we feel pretty comfortable. We are not going to go hang out on a massive amount of speck billing.

We just -- we have never done that. We do not intend to do that.

I was hoping you could talk a little bit more about the sentiment among tech and media tenants. Understanding talking to brokers is that, there has been a little bit of air taken out of market since the Facebook IPO and then just some of the earnings releases we've seen this quarter from some of the tech companies.

What's kind of the latest sense of things out there?

Well, Jamie, I will start off ad then I am going to turn it over to Eli. But just the tech-related job growth has been very powerful.

It is more diverse and deeper than before. And it has really changed the complexion of the San Francisco economy.

And if you take a look at -- I am curious about your comments, some of the air has been taken out of it. I mean, Facebook, sure, that was a disappointment.

But right now, we are dealing with more people that have balance sheets in the SoMa and related markets -- I'll let Eli speak about the Valley -- than we have ever seen or the market's ever seen. There have been -- as Jeff made in his -- noted in his comments, there were 9 transactions of 100,000 square feet or more in 2011 in the city.

There have been 10 or -- 9 or 10 so far this year and there are quite a few more. And there are innumerable numbers that are in the 60,000 square foot range or 50,000 foot range.

Many of them have very strong balance sheets, so we are seeing increased demand. I am looking at a report that the CAC brokerage firm just put together, CAC Group.

And it deals with large tech companies or -- that are taking significant space or in the market to take significant space in San Francisco, as well as completed deals and so forth and what the pending transactions are in the market. And all of those things are up very significantly over last year and last year was the banner year.

So we are seeing a very strong demand and I am not going to say the trees grow to the sky, but we are pretty enthused about our position. Now with regard to the Valley.

I know there has been some comments that people have made with, is the Valley lost some steam or it hasn't --didn’t have the big absorption in the second quarter as it's had previously. Eli, maybe you could comment on that.

Yes. And the status -- I am sitting out there now.

First of all, I mean, we are very focused within the valley as we talked out several times. There are places you really want to be and there are places you don't want to be as much, and Kilroy personally is very focused on being the best -- with the best product, in the best locations, in the best markets.

And so, we feel like where we are positioned is very good. A lot of which you're seeing, I believe, with respect to this "stat", this second quarter is timing consideration.

There was a huge number of deals that came together in late 2011 and early 2012, and they kind of all consolidated at the same time and then there is some consolidation going around that. Now in the third quarter there are several deals that will be announced that are really already inked or about to be inked.

Significant deals, Dell and Amazon are taking significant number of spaces. There is another tenant that I will not mention taking another significant amount of space.

And there are several -- many other deals in the pipeline behind that. So it does not appear that there is going to be very positive momentum that is going to show up in the third quarter.

So and then you look at the level of activity that was in the end of '11 and early 2012 and that was a huge amount of activity. Even something that was less than that is still very, very healthy.

And the pipeline behind that continues to look -- where we sit, looking at the pipeline now, it does look healthy. So I think the second quarter so far looks to be much -- a tiny gap, so.

And then, in terms Seattle, especially, where you have been investing?

Well, Seattle received very strong demand. And it is the sort of the same suspects, have many of the same kind of companies.

Interestingly, a lot of the folks that are down in the valley and in the City of San Francisco are moving up and having expanded operations up in the northwest, particularly on the east side, and then of course over in the Lake Union area. And then what is also happening there is you end up with a lot of the companies that service and support these are expanding as well.

That’s one of the reasons we bought Skyline Tower. We see the opportunity to take a building that has good bones, has had a lot of money spent on its core and on its -- redoing the bathrooms and all the systems and all the rest, that we could go in and change the cosmetics of and really reposition so that it’s a crossover building, as we call it, which appeals to both the tech tenants as well -- media tenants as well as the historic kind of financial lawyers and that sort of thing.

In that market right now, there is about 1.8 million square feet of -- amongst the top tenants in the Greater Seattle and they range from healthcare and gaming and the Amazons of the world as well as some of the accountancy firms and eBays and so on, a broad cross-section of people. I can tell you that the building's that we bought about -- Eli, 400,000 feet, is that Fremont in the aggregate?

Roughly.

Yes, roughly.

Yes, where we are essentially leased, we have a group that’s going to get out, wants to get out early. We already have the space committed at very significantly higher rents.

And we're seeing great demand. We're enthused with our position up there.

And then just turning back to the guidance, for Tyler. I'm just trying to get a sense of kind of your internal growth outlook now versus the prior guidance.

Like do you have a kind of same-store NOI estimate? And how does that compare to your prior number?

Yes, I think the initial number at the beginning of the year was roughly 3% on a cash basis for the year. We had a big first quarter.

Some of that was due to some other income, and then we had down in the second quarter, which again was -- some of that was one-time negatives. And so, our goal -- our forecast for the end of year will probably come down a bit given the higher expenses, but it's in that 2% range, roughly.

So a 100 basis points lower?

Roughly. I mean, 2% to 3% from an overall annual perspective.

As I mentioned in my comments, the third quarter will be relatively flat and the fourth quarter should be up.

Okay. And then if you were to get some of that insurance money back for the electrical issue you had mentioned, is that in your numbers or would that be outside?

That would be outside.

And what do you think the magnitude could be?

Well, it was about $0.01 of loss and -- I don’t know, we are [indiscernible] at this point.

I'm here with Gabe Hilmoe. John, what would you say to some of your critics who would your acquisition redevelopment pace is a little rapid and maybe you should slow down and digest what you've got?

Do you think that there's any validity to that or do you feel comfortable that you've got more than enough capacity, though, from a management perspective as well as a systems and leasing perspective to take care of what you've already done?

I haven’t heard that criticism. And what I would say to anybody who's concerned about that is that most people who know me know that I'm kind of a control freak, or at least I like people who are control freaks.

I like to make sure that we're totally in control. I think we have, without question, the best management team up and down the west coast.

As you've seen, we've added top people throughout Seattle, San Francisco, Silicon Valley, now down in L.A. with David Simon, and I think we have the best value add guy on the planet.

We've always had terrific people throughout southern California. And of course, it's been reflected a little bit in our G&A and it's been reflected in what Tyler mentioned, that we're going to spend about $0.01 a share upgrading our IT systems and of course will parallel the existing systems while we get up and running on the new things.

We've invested very strongly in talent throughout the company and Jeff and his team have done a magnificent job integrating that in. I don’t see where we missed a beat.

That doesn’t mean that we can't miss it here or there, but I'm very pleased. And as somebody -- the old questions when you were out doing an IPO, what keeps you up at night?

Well, I always have a lot of things to keep me up, and I always say it starts with 6 kids. But moving from that it's are we doing the right things?

Are we making the right decisions? Are we managing our assets correctly?

And I think if we take a look at the -- there were some people who are a little bit skeptical when we first bought 303 Second Street in San Francisco and said, well, Kilroy, what are doing in San Francisco? You don’t know San Francisco, et cetera, et cetera.

We are now the largest owners of SoMa. We've done a terrific job there.

The team has done a great job. Similar kind of questions came up when we were in Seattle.

Is Seattle the place to be? Seattle seems like it's been a little bit behind.

You didn’t do that well when you had the one asset up by the airport in Seattle. And I think what we've demonstrated there is we bought the best assets, we've been very disciplined.

I'm very happy with our acquisition activity and we're matching it very nicely, I think, with our disposition activity, much more aggressive in evaluating which assets should be sold for one reason or another. So I think we have without question a team -- I've always been very proud of our team.

We have an amazing team now. And they're integrating very nicely.

We have a quarterly group of all our regional managers plus our operating heads that get together and talk about best practices, talk about what works, what they are seeing, developing new ideas and strategies and I think it is really paying off. So I am quite pleased with that.

Just thought I'd follow-up on that. On kind of uses of capital, you talked about redevelopment and development in the valley and the city.

It would seem to us that there is more on the market for sale from a stabilized asset perspective than there ever has been in a cycle in San Francisco. Would you contemplate taking on some stabilized assets or is pricing to the point where you do not think that is a good use of capital right now?

Well, let me give you an example. I mean, I'd love to buy more stabilized asset.

I'd love to buy more of the Fremonts of the world, where basically we do not have do anything, it has got great credit. It is fully leased, the rents are way below market and you just wait for a few years, the rents magically improve, at least that’s a [indiscernible].

The problem is, is that what we see now is the pricing in the city has gotten so aggressive for the kinds of assets we feel comfortable owning because we are so about location and physicality, and physicality is can the asset really stand the test of time and be attractive to the modern tenant that requires certain physical requirements. Some of the buildings do, some of them do not.

If they do not, we won't touch it. With regard to a case in point, the 329 Brannan building that we are going to be developing.

We are going to end -- be in there for around $500 a foot. We are going to have the best at the best location on Brannan Street, the best building on Brannan Street.

And there is a building that is being transacted right now. It is a good building, nowhere near as good as this, and that building is going for 6-what?

$615.

$615 a foot. So we are going to be over a $115 a foot less and take advantage of, I think, a lot more upside with the location and the product we have.

And obviously, end up -- that is why it is reflective of about an 8% going in yield as opposed to a yield on an acquisition that’s in the 5% range or less, maybe it is in the high 4% range. We looked at 555 Mission, love the building, fantastic.

I mean, Tishman started, did a great job, fantastic asset. But in the early 4 cap rates and -- we don't even think it gets to a 6 IRR, we are not going to buy that.

We do not see how -- that becomes an albatross around our neck. That's -- so when we take a look at development or redevelopment, it is because we feel comfortable that we have a -- not only the team to execute but a plan by which we can move that asset into much higher-yielding than we can in the current acquisitions.

Now at the same time, we announced on this call that we are acquiring asset in West L.A. and it's a going in yield of 6.5 and we have a plan that we think is going to substantially increase that over time.

But that was a very limited marketed deal and we had some particularly strong benefits, if you will, by us being the acquirer. So love to acquire more existing assets.

We are looking at a number of them, but on the trophy-type properties, I just don't see how it's going to make sense for us with the pricing that exists today.

And so you don't think kind of the supply of available -- or properties for sale was swamp demand and you might be able to kind of swoop in and get at a property at a fair price?

Well, if that happens, one of the things that we always pride ourselves on being is very agile and we are going to acquire when it makes sense, we are going to re-develop or develop when it makes sense and we are going to do none of the above when none of them makes sense. But to put in perspective, if we just look at top tier-1 competitive space in San Francisco.

As you know, in San Francisco right know Tishman Speyer has Foundry 3 under construction. That's roughly 250,000 feet.

It's going to be delivered sometime first quarter of 2014. I would imagine they'll probably get that pre-leased during construction.

It's a great location, which we were developing. There is 535 Mission which for sale, and that's a property right next to our 100 Mission building.

We took a look at it. It's not our cup of tea.

It's a building that has very small floors that we don't think are as attractive to the broad -- to the great majority of people that are looking for space in that market, it would -- 100,000 foot user would need like 12 floors. So that doesn’t really have the collaborative sort of space that most tenants are looking for today.

So I don't know when that one gets built, who knows, but I don't think it's going to really compete with the collaborative-type tech and media. There is another site that is -- and by the way, 535 Mission in round numbers is around 350,000 feet or so, Eli?

Yes.

And then there is 222 Second Street, which is also owned by Tishman Speyer. Our understanding is they're not going to pull any trigger on that until they've substantially leased Foundry 3, at least that's what the brokers tell us.

That's over 22 Second Street -- 222 Second Street, i.e., that’s a 27-story building. I think it's more of a financial type building than -- not because of its height but because of its floor place and so forth.

So I don't know when that gets built, and then there is the 350 Mission building which is in the market, which can be delivered in about 24 months, which, actually, I think that one is one that would make sense because it has big floor place, it is side loaded, it is -- it right enough. Terrific corner location and would be very much appealing to what I call a crossover crowd, which is -- whether it is lawyers or attorney -- or rather, accounts or the technology people.

So all in all, those 4 buildings can deliver about -- running the numbers, 1.2 million square feet of which 250,000 is under construction. And the others all want to start construction.

Somebody has got to finance them or have the money to pull the trigger. My bet is -- my guess would be you might see 2 of those buildings under construction at any given time, unless the one is under construction or fully leased, and then you would see more.

So I do not think you are going to see construction overwhelm the existing inventory. It is a very small part.

SoMa is about 30 million square feet, or South of Market is about 30 million square feet. And we are talking about roughly 3%, 3.5% potential supply over the next 2, couple of, 3 years.

From a capital perspective, how should we think about the next 12 to 18 months? Should we assume that the majority of the asset sale proceeds are used to 1031 into acquisitions and that the $500 million of development projects that you spoke about earlier in the call are funded mainly with new equity, given your desire to keep growth leverage neutral?

Well, yes, I think generally a combination of the dispositions and equity and debt to keep our leverage neutral, and it depends on which disposition opportunities we have and the timing of them and whether they are 1031s or not, so it is a complicated calculation. But -- and we will be providing more guidance on 2013 at the end of the year.

But in the meantime, I think the strategy is leverage neutral in general with dispositions and some equity when necessary.

Well, I guess, it seems like the majority of the asset sale proceeds have tax issues. So those would need to be reinvested through acquisitions, is that correct?

No, it depends. This is John, Josh.

It depends whether we sell some of the stuffs we bought in the last couple of years. We get all things remain.

From our standpoint, we review -- we're agnostic with regard to any particular building. We have no mother fixation with regard to any specific asset.

Can you talk about the size of the acquisition pipeline that you are looking at? It seems like you could have a lot of money coming in the door the next 12 months.

I think there are plenty of opportunities to take to accommodate the 1031 exchanges out of the level of asset sales we have been talking about.

And just to be clear on that. In terms of, if you are thinking of the industrial, we have things that we have already purchased which we can do reverse exchanges.

So we do not necessarily need to buy the full value of the industrial portfolio just to make the industrial portfolio tax situation work.

Okay. And secondly, if I could ask a question on rent spreads.

It looks like the rent spreads improved a lot and so did the mark-to-market. Can you just talk, qualitatively, how much of that do you think is improvement in the underlying fundamentals of your market?

How much of it is having a different product mix since you've added a lot to the portfolio? And how much is just the vintage of what is rolling?

Well, a couple things. One is that there obviously has been very strong demand in these Q markets that we have been in.

And with the expansion into San Francisco area and to Seattle, we have seen very strong upper pressure on demand, and obviously that translates into rates. The other thing, I think, that we have been -- I have been very happy with is that we are very focused.

We think we know -- I mean, after all we -- the company was started by my father years ago, we were dealing with aerospace companies and they were the technology companies of that era. And so, technology is something that we understand and -- through all our markets.

And I think we appeal very well to the technology crowd and to the modern collaborative workforce crowd because we buy or build buildings that respond to their needs and we manage them accordingly, so I think that's been very helpful. And then, I think, the other thing that we have been very strong on is in the transportation side of things.

The technology-type people have higher densities, sometimes as many as 12 per thousand in some of these big users as contrasted with the old lawyers and accountants at 3 or 4 per thousand. Well obviously, you've got to get people to and from work.

Transportation becomes key, 24x7 environment becomes key, housing optionality becomes key. And the combination of those things are something that we are very focused on when we acquire and/or develop, and I think that is paying dividends to us.

John, the construction and progress balance today is around 5% of enterprise [indiscernible]. If you add in the land balance, it's probably closer to 10% of your enterprise...

[Technical Difficulty]

I guess, the construction in progress balance is around 5% of your enterprise value, and if you add in the land bank it is probably close to 10%. Just trying to think about how you think through how much development risk you want to have as a percentage of balance sheet going-forward?

Well, we talked a little bit about this before in a previous call with regard to -- we have various covenants and so forth with regard to our lenders. We have various, I don’t know if they're called covenants, or at least essentially covenants or things you want to monitor with regard to our bond.

We don’t want to get anywhere near any of that. I look at this as -- yes, development is pre-leased.

That’s a whole different issue than a spec. I don’t see us going running around do spec buildings everywhere.

I think that’s not an appropriate strategy for this company and it's never been something that we have done en masse. I'm not afraid to start this building over on Grand Street, but before we pull the trigger on it, we're going to assess what the environment is at that particular time.

So we’re going to be disciplined, as we always have been, and we're going to keep an eye on being very conservative with regard to the balance sheet and with regard to any covenants we have, either with our bank line and/or essentially covenants or the equivalent with regard to our investment rate, credit rate.

And then you mentioned that aside from the -- or above the industrial sales, you thought you could pull maybe $100 million or $200 million of assets over the next 12 months. I guess, in the last call that number -- the total range was closer to $500 million to $700 million.

I guess, is the lower range just a function of timing? Is it a function of maybe on the acquisitions you want to do in the next 12 months, or how should we think about the kind of lower disposition rates going forward?

I'm not sure it's lower. I think we were probably looking at the combination of the industrial and of another couple hundred million to get to sort of a $500 million to $600 million range.

I don’t think it was -- I don’t think we -- if we, I think if we -- if I don’t think we misspoke, but it wasn’t...

The intent was not to reduce the projection of dispositions, I think where you might be being too precise in terms of the guidance there.

We haven’t pulled back on anything that we've been contemplating.

Just thinking about dispositions going forward. If you're exiting the Orange County industrial portfolio, as you look at your handful of office properties in Orange County, why continue to own office here in Orange County?

We may not.

Okay. So you said earlier everything is on the table and that may be something that you'd think about?

I don’t know how to say this any differently, that it's -- this is not like a home where you've got a wife and children and grandma's living in the guest cottage. This is a business and if we need -- if we think the best thing to do is to exit a market.

We exited that building in Seattle, which we wanted to get out of for a long time and now we're back in Seattle in the right areas and so forth. Orange County -- you've heard me say this a million times, Michael, as have others.

You got Don Bren. Don Bren is the king of Orange County.

And when you got somebody that's that dominant a player, you've got to be very selective. And I don’t see how you can do it in bulk unless you're just a market timer to go in and get out.

And that’s not really the business we're in. We've got some great -- we've got some little office buildings down there, which are kind of de minimis with regard to the enterprise.

We've got a really nice building at 2211 Michelson that we bought, we got at a really good price given what the quality of the building and so forth. And it could be that, that building, at some particular point, is better in somebody else's portfolio than ours.

Okay. And then I think I may have missed this in Jeff's comments, but can you just maybe quickly touch on the releasing prospect in San Diego?

And then also are there any other known move outs in the roll in the next year or 2 that might be worth talking about?

Yes. Well, Jeff, you want to handle the first part?

Yes. So Michael, in San Diego I think I mentioned we've got 2 LOIs that get us majority of the space of HP that vacated earlier this year.

Anticipating that will move in to fourth quarter of this year. And then on the 2 buildings from [indiscernible], we have activity on that space as well as other spaces available in the San Diego market.

So we're feeling pretty good about the level of activity and tours and so we're very comfortable that we're moving in the right direction there.

In terms of additional give backs, we've got about 350,000 square feet remaining this year. We've got 1 industrial property that we expect to have given back in the fourth quarter, and then if we kind of roll to 2013, we don’t have too many large spaces.

I think we've got 1 over 100,000 square feet of industrial site, 1 over 100,000 in office. And as we mentioned, in Seattle, [indiscernible] has already released about 100,000 square feet of space coming back next year.

So it's a little early now for 2013, but we've got a lot of activity and we feel like we're being very proactive.

Okay. And then last question for me would be, John, before you mentioned that maybe longer-term you might be more of a 50-50 in terms of geographic split north of L.A.

and south of L.A. and south.

You've obviously made a lot of progress on that, sooner than probably most people would have thought. Any additional thoughts on that or thoughts with respect to -- I know there's a bunch of Seattle properties that either recently were on the market or may still be on the market, that Beacon is selling?

And just any thoughts on whether you'll be looking at those to expand that to get closer to that 50% weighting?

Well, as I have said before, it's not a magic number. That sort of felt right.

We obviously were the shareholders. We also keep our eye on what -- the way things look from a bond capacity, because that effectively allows us to borrow, when we borrow at lower costs, which obviously helps the shareholders.

And I think that 50-50 sort of SoCal and north of SoCal feels about right. We are getting pretty close to that, particularly with the sale of the industrial and a few of the things we are talking about development-wise up north.

Those are not rigid. We obviously have more development that we will occur down in San Diego in due course.

And -- but there is nothing that is magic about this. I can tell you that we push back from most acquisition deals because we either don't like the physicality -- we make a quick decision.

We like the location or we don't like the physicality or we cannot get comfortable with regard to the numbers. We've looked at a number of things in Bellevue and elsewhere and had the opportunity, sort of the first choice, if you will.

But if pricing does not make sense, then we are just not going to pull the trigger. With regard to some of the -- the end of the company that you mentioned, I mean, they have lot of stuff downtown and some really nice buildings and some that are more challenged.

I am not personally a giant believer in the CBD of Seattle, not because there are not some really some good buildings where you can't make money over time. I think you can.

But it is not where the kind of the real growth is going in a big way. I'd love to own more in Lake Union.

I'd love to own more on the east side at the right location, not the suburbia locations. And we will see, and we will -- there will come points in the -- any different inflection points in the economy, where if we continue to have and maintain, as I want to make sure we do, our balance sheet, there will be times when other perhaps are a little bit nervous about buying and maybe we'll end up with another 303 Second Street, where we were able to see something a little bit earlier and really do a good job in acquiring.

So it is -- we are not trying to buying in bulk. We are trying to buy very selective and say very true to the tenets upon which we operate the company and which we, Eli, and David and everybody else has reinforced as they've join the team, very focused.

Tyler, there is obviously a lot of moving parts to the company right now. Do you guys have kind of a run rate for your debt to EBITDA and coverage if you kind of kind of put any future acquisitions other than what you've closed on hold, given where your balance sheet is right now?

Well, I think that moved up and down a little bit from the high 6s into the mid 7s. I think that -- if we projected that out to sort of the end of the year after we complete some dispositions that we are talking about, that number is back down into the 7% range, roughly.

We would like to keep it under 7%. It will be a little higher than that until we do the dispositions or other funding.

But we would like to keep it in that 7% range.

Okay. And you talked about, if you maybe [indiscernible] are, what, $370 million out on the revolver by end of the year?

How high do you feel comfortable running that balance before you term that out?

That is about where we'd want to be. And yes, so -- we want to have, as John mentioned earlier, capacity to do other things, so we are going to do that.

And once it gets in the $400 million range, we have the ability to grow that to $700 million. We have a term loan of $150 million that we can grow that to $250 million.

So we have plenty of capacity but we do not want that balance to get too high.

Yes, but remember, that's -- the pending activity takes us to $375 million at end of the year before proceeds from the sale of our industrial portfolio and -- or any other sale. So all these are -- there are a lot of component parts moving around for sure.

And all of us get together many times during the week, and how are we doing on this and how are we doing on that. But I think with the combination of some reverse exchanges and so forth, that $375 million should be quite a bit lower than that.

Tyler, just could we circle back to guidance. I guess it was $0.02 related to acquisition costs, $0.02 for the industrial sale and then what was the other $0.02, please?

Well, it related to all of the other things that we sort of talk about during the quarter. The higher IT costs, the delayed closings of some of our acquisitions that we originally forecasted to happen earlier, the list that I provided at that point.

All right. Okay.

The mix of all those things. And then, the -- you should year-end occupancy at 92%.

Where was that previously?

We had given 92% last quarter as well.

Okay. So it is unchanged.

And then, the industrial sale, you are expecting the entire bulk of it to sell in the fourth quarter?

Absolutely. In the numbers, yes.

As John said, there could be some timing issues there with the 1031s. But in our guidance, it's assumed all to happen in 2012.

My questions have been answered.

I am sorry, just a follow-up on the guidance. So you said the acquisition costs, the additional $0.02 of acquisition costs, that was not in prior guidance?

Right. Last quarter we gave $0.02 of acquisition-related expense guidance and that -- and we ended up having $0.03.

And now, we have a projection of an additional $0.02 of that which was not in our prior guidance.

Okay. So then, I guess, what's throwing me off is, my question before you said same-store was 3%, now you are at 2%.

But your occupancy is flat at 92%. You do have that -- it sounded like maybe $0.01 from operating expenses.

Why -- I do not understand the 100 basis point swing in the same store.

Well, we talked about why our expenses were higher, the IT costs are up. So the operating expenses -- and as I said in the third quarter, we have flat same-store due to lower occupancy.

So that is what -- I am not following.

Okay. Well, I guess, so the IT is not a G&A number, it is an NOI number?

It is a combination of it, if there is a lot in G&A. But there is some lap over in the property management G&A as well.

Thank you for your interest in KRC.