Kilroy Realty (KRC) is a real estate investment trust (REIT) that develops, owns and operates class A office space and industrial buildings. The firm makes money by developing properties, leasing them to tenants and selling stabilized properties at a profit. KRC leases office space to tenants in the healthcare, legal and financial services industries, and its top ten tenants represent only 37% of the company's total rental revenue.[1]

KRC operates 129 properties (86 office and 43 industrial buildings) all in Southern California, primarily in Los Angeles County, Orange County and San Diego County. These are high growth areas where high real estate costs form a barrier to entry for competitors. Demand for office buildings tends to follow the performance of the regional and U.S. economy. During boom times companies expand, hiring more workers and leasing a higher grade of office space. During economic downturns many companies try to save money by leasing less square footage. This is particularly troubling in the first quarter of 2008 when employment numbers are down and KRC has space up for re-lease.

Business Financials

As of December 31, 2007, KRC owned 86 office buildings and 43 industrial buildings totaling approximately twelve million square feet.[2] It earns revenue by leasing these properties to tenants for rents charged on a square foot basis. Properties are leased to industrial tenants on a triple net basis and leased to office tenants on a full service basis.[3] Full service means the landlord pays for tenants' share of real estate taxes, insurance, and operating expenses up to the amount inccurred in the first year of a tenants lease.[4] Any increase in expenses is paid by the tenant.

KRC grows its portfolio through development. The company owns 116.7 acres of land on which it has the ability to develop over two million square feet of office space.[5] In 2007 KRC had four properties in the process of development and another three that had completed the construction phase and were in the process of being leased.[6] All these properties were expected to reach stabilized occupancy by the end of 2009.[7] By using their development expertise to purchase prime land, keeping construction costs low and developing desirable buildings, KRC can earn higher returns through development than by purchasing stabilized properties, which have much more uniform capitalization rates. However, development also exposes the company to more risks than acquisition, including the risk that construction costs will be higher than anticipated, that the company will be unable to finance their short term, high rate construction loans, and that by the time the property is finished the market will have changed and there will be reduced demand.

In 2007 five of KRC's development properties, totaling 800,000 square feet, achieved stabilized occupancy.[8] In order to fund its development pipeline, the company also divested of five under-performing properties totaling 600,000 square feet.[9] The gain of square footage contributed to the company's revenue and net income increases.[10] Though in 2007 industrial properties accounted for 32% of KRC's total operating properties by square footage, industrial properties accounted for only 13% of total operating income, with office properties accounting for the other 87%.[11] The reason is the higher rental rates the company can achieve at its office buildings.

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In 2007 revenue and net income increased in the company's office portfolio due to increased square footage and more operating properties. This increase was partially offset by decreasing occupancy; in 2007 occupancy at KRC's office portfolio was 93.7% compared to 94.7% in 2006.[13] At the company's industrial properties net income declined from 2006 to 2007 due to a drop in occupancy from 97.6% in 2006 to 92.1% in 2007.[14] The decrease in occupancy was due to three properties in the company's Orange County portfolio that the company was having trouble re-leasing.[15] However, as of year end 2007 the company had leased approximately half the vacant space in those buildings, leading to a probable increase in revenues for 2007.[16]

In addition to adding space to its portfolio, revenue and net income increases at KRC are driven by increases in rental rates. In 2007 new leases yielded rents 15% higher than the leases which had expired.[17] Management at KRC believes that the company's portfolio is leased, on average, 15% below market rents leading to probable revenue increases when those properties renew leases.

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Trends and Forces

Demand for KRC's Office Properties Lag Behind Changes in the U.S. economy

The demand for office space is closely tied with the performance of the economy. During a boom economy employment rises and firms expand, leasing more square footage in higher quality buildings. Similarly, during economic contractions, employment falls, and companies no longer need as much office space and so cut back on the amount of space leased. The effect can take some time to have an effect on an office REIT's rents, however, as leases typically last for several years before they can be renegotiated. This poses a significant risk for KRC as the U.S. economy has been entering a recession in 2008.[19] In April the U.S. labor department released a report estimating that the U.S. had cut jobs by 232,000 in the first three months of 2008, the first time the economy had lost jobs three months in a row since 2003.[20] KRC is particularly exposed to this declining economy as leases on 31.5% of its total square footage are up for renewal in 2008 and 2009.[21] It is likely that when those leases expire, fewer companies will choose to re-lease, increasing vacancy, and those that do re-lease will do so at lower rates, decreasing revenues. If firms do lease for lower rates the effect will last over the entire life of the lease, lowering KRC's revenues for the next several years.

Increasing Imports Increases the Demand For KRC's Industrial Properties

According to the Census Bureau, U.S. imports increased 67% between 2002 and 2007.[22] Chinese imports have increased particularly quickly, rising 257% in the same period.[23] The demand for imports increases the demand for infrastructure surrounding the shipping industry, including receiving stations and distribution facilities.[24] The ports of Los Angeles and Long Beach, markets in which KRC operates, are receiving stations for many cargo ships arriving from China and are quickly reaching capacity as shipments have increased.[25] As ports reach capacity and require new infrastructure, property developers like KRC have a prime opportunity to benefit.

Changes in Interest Rates Affect KRC's Income and Stock Price

As a property developer KRC is exposed to interest rate risk. KRC, like many property developers, finances development using short term variable rate loans, and when a project reaches stabilization refinances to a low, fixed rate mortgage. Increasing interest rates lower KRC's income by increasing debt service payments on variable rate debt. They also increase the rate at which KRC must issue new debt, which in the case of fixed rate debt can cause large debt service payments over the life of the loan. During 2007 KRC reduced interest rate risk by refinancing and paying down a large portion of their variable rate debt - at the beginning of the year 39.0% of KRC's debt was variable rate debt, but by the end of 2007 only 13.2% of the company's 1.4B in debt outstanding was variable interest rate debt.[26] Interest rate fluctuations also affect KRC's stock price. Because of government regulation that requires REITs to pay out 90% of their taxable income as dividends, KRC has historically issued a stable dividend, 1.94 since 2004.[27] These consistent dividends mimic bond coupon payments. As interest rates rise, bonds provide a greater Return on investment (ROI) relative to KRC's stock. Since investors are able to earn a higher risk-adjusted return on fixed income instruments, they shift their investment out of KRC's stock and into bonds. When the number of people wishing to hold the stock decreases, the stock price falls.

Rising Construction Costs Are Lowering KRC's Return on investment (ROI)

Construction prices in the U.S. have grown dramatically in the past three and a half years, rising an average of 3-5% each year and far outstripping inflation.[28] A depressed dollar and the rising cost of fuel both contribute to increase the price of imported construction materials while a declining pool of specialized construction workers has led to a sharp 4.7% increase in wages from July 2006 to July 2007.[29] Rising construction costs decrease KRC's return on its development projects. They slow the company's growth and increase their expenses on existing projects. This decreases the company’s earnings, leading to a potential decrease in company stock price. However, there are some subtle benefits of rising construction costs. When construction costs rise developers cut back expansion as they are unable to earn a high return on their projects, helping KRC by keeping vacancy rates low and maintaining demand (and rental rates) for existing properties. Increasing construction costs can also increase the sale price of KRC's existing buildings as it becomes cheaper for property owners to acquire buildings rather than develop new ones.

KRC is Concentrated in Southern California, Increasing the Company's Geographic Risk

As of December 31st, 2007 all of KRC's properties, projects under construction, and undeveloped land was located in Southern California.[30] Because KRC is geographically concentrated, their ability to increase revenue and continue expansion depends upon the Southern California market. Because real estate is essentially a local business, by diversifying their geographic base a real estate operator can diversify its risks. For example, oversupply of properties in a market, reduction in market demand, changing market demographics and many government regulations, though sometimes influenced by national events, all occur primarily on the local level. Any adverse changes in any of these factors in Southern California affect KRC more than a company that is geographically diversified.


KRC competes with a wide range of office REITs to both lease space and acquire properties. KRC is differentiated from its competitors by its exclusive focus on Southern California; no other publicly listed office REIT operates exclusively in Southern California. The REITs KRC most closely competes with are described below. For a full list of office REITs, see REIT - Office.

  • Liberty Property Trust (LRY): LRY focuses on five varieties of properties, including big box warehouses, multi-tenant industrial facilities, flex/R&D buildings, and office space. As of 2006, the company owned over 65 million rentable square feet across 720 properties. Of these around 41% were offices, while 59% were industrial-use.[31] In total, LRY owns 649 properties, 353 industrial and 296 office properties.[32] It has properties throughout the country but in the past couple years has been pursuing a strategy of entering high growth markets like DC and Phoenix.
  • Brookfield Properties (BPO): BPO develops, owns and manages U.S. commercial office properties and develops residential land. The company's commercial property portfolio consists of interests in 109 properties totaling 73 million square feet, primarily located in New York, Boston, Washington D.C., Houston, L.A. and Toronto where its buildings can lease to a tenant base of government, energy and financial companies. As of May 21, 2008 BPO had a market cap of $8.25B.[33]
  • HRPT Properties Trust (HRP): HRPT acquires, owns and manages office buildings and industrial properties. HRPT operates both security and growth properties. Security properties are properties with stabilized occupancy leased to high credit quality tenants under long term leases. Growth properties are under-performing buildings with redevelopment potential. HRPT owns and operates over 500 properties with over 50% of the companies rents coming from their top five markets (Philadelphia, Washington DC, Oahu (Hawaii), Boston, and Southern California). As of May 21, 2008 HRP had a market cap of $1.74B.[34]

Market Share

Market share is listed by 2007 revenues.[35] In 2007, KRC held just 2% of total U.S. office REIT market share, by revenues. There are 14 U.S. exchange traded REITs focusing on office properties.[36] Of those, the top three Boston Properties (BXP), Brookfield Properties (BPO) and SL Green Realty (SLG) accounted for just over half of Market Share by 2007 revenues.

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  • Boston Properties (BXP): BXP owns 138 properties in just five areas of the United States: Midtown Manhattan, Boston, Washington D.C., San Francisco, and Princeton, N.J. The company operates high end class A buildings and its largest tenants are the legal and financial service Industry. BXP also owns two hotels, an industrial center, and a land bank in the Northeast with 10 million square feet of space for development.[38] As of May 21, 2008 BPO had a market cap of $11.85B.[39]
  • Brookfield Properties (BPO): BPO develops, owns and manages U.S. commercial office properties and develops residential land. The company's commercial property portfolio consists of interests in 109 properties totaling 73 million square feet, primarily located in New York, Boston, Washington D.C., Houston, L.A. and Toronto where its buildings can lease to a tenant base of government, energy and financial companies. As of May 21, 2008 BPO had a market cap of $8.25B.[40]
  • SL Green Realty (SLG) SLG owns and leases office space to corporations in Manhattan. The company owns more than 30 New York City office properties totaling over 22 million square feet.[41] In 2007, SL Green cemented its position as the Big Apple's largest landlord when it acquired Reckson Associates Realty Corp. The transaction added a total of 9 million square feet to its portfolio, including over 5 million square feet of suburban offices and 4 million additional square feet of prime Manhattan office space.[42] SLG faces a particular risk from the subprime crisis. By weakening the financial sector, the heart of the New York economy, it threatens to crimp demand for office space in the company's core market. As of May 21, 2008 SLG had a market cap of $5.71B.[43]


  1. KRC 2007 Form 10-K Page 18
  2. Reuters
  3. KRC 2007 Form 10-K Page 18
  4. KRC 2007 Form 10-K Page 18
  5. KRC 2007 Form 10-K Page 38
  6. KRC 2007 Form 10-K Page 39
  7. KRC 2007 Form 10-K Page 38
  8. KRC 2007 Form 10-K Page 3
  9. KRC 2007 Form 10-K Page F-21
  10. KRC 2007 Form 10-K Page 43
  11. KRC 2007 Form 10-K Page43
  12. KRC 2007 Financial Highlights
  13. KRC 2007 Form 10-K Page 43
  14. KRC 2007 Form 10-K Page 44
  15. KRC 2007 Form 10-K Page 44
  16. KRC 2007 Form 10-K Page 44
  17. KRC 2007 Form 10-K Page 51
  18. 2007 Form 10-K Page 39
  19. The New York Times.Com 3/07/08
  20. CNN.com "80,000 Jobs Lost, Employment Spikes" 4/04/2008
  21. KRC 2007 Form 10-K Page 51
  22. U.S. Census Bureau
  23. U.S. Census Bureau
  24. Commercial Property News, October 24, 2007
  25. Commercial Property News, October 24, 2007
  26. KRC 2007 Form 10-K Page 53
  27. Company Website, Dividend History
  28. National Real Estate Investor "Fed Rate Cut May Accelerate Rising Construction Costs" October 11th, 2007
  29. National Real Estate Investor "Fed Rate Cut May Accelerate Rising Construction Costs" October 11th, 2007
  30. KRC 2007 Form 10-K Page 51
  31. 2006 LRY 10-K, "Business," pg 4-5
  32. Reuters
  33. Google Finance
  34. Google Finance
  35. Google Finance
  36. InvestinREITs.com
  37. All Taken From Google Finance
  38. BXP's Investor Relations Website
  39. Google Finance
  40. Google Finance
  41. http://slgreen.com/about/ SL Green- About Us
  42. http://slgreen.com/about/company-history/ SL Green- Company History
  43. Google Finance
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