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| KRC > SEC Filings for KRC > Form 10-Q on 28-Oct-2009 | All Recent SEC Filings |
28-Oct-2009
Quarterly Report
The following discussion relates to our consolidated financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, property development timing, and investment amounts. Although the information is based on our current expectations, actual results could vary from expectations stated in this report. Numerous factors will affect our actual results, some of which are beyond our control. These include the breadth and duration of the current economic recession and its impact on our tenants, the strength of commercial and industrial real estate markets, market conditions affecting tenants, competitive market conditions, interest rate levels, volatility in our stock price, and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date this report was filed. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events, or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and related to investing in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information, see Item 1A: Risk Factors in our annual report on Form 10-K for the fiscal year ended December 31, 2008 and the discussion under the captions "-Factors That May Influence Future Results of Operations" and "-Liquidity and Capital Resources" below. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur.
Overview and Background
We own, operate, develop, and acquire office and industrial real estate located in Southern California. We qualify and operate as a self-administered REIT. We own our interests in all of our properties through the Operating Partnership and the Finance Partnership, and conduct substantially all of our operations through the Operating Partnership. We owned a 96.2%, 95.0%, and 94.9% general partnership interest in the Operating Partnership as of September 30, 2009, December 31, 2008, and September 30, 2008, respectively.
Factors That May Influence Future Results of Operations
Global Market and Economic Conditions. In the U.S., market and economic conditions continue to be challenging with tighter credit conditions and modest growth through the third quarter of 2009 as compared to the prior year. While recent economic data reflects a stabilization of the economy and credit markets, the cost and availability of credit may continue to be adversely affected. Concern about continued stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Volatility in the U.S. and international capital markets and continued recessionary conditions in global economies, and in the California economy in particular, may adversely affect our liquidity and financial condition and the liquidity and financial condition of our tenants. If these market conditions continue, they may limit our ability and the ability of our tenants to timely refinance maturing liabilities and access the capital markets to meet liquidity needs.
California Economic Conditions. The continuing economic crisis has particularly affected the economy of California. The State of California began its fiscal year on July 1, 2009 with a significant reported deficit. The California budget deficit could further impact and aggravate the current recessionary conditions within the state, which could adversely impact the financial conditions of our tenants. Given the budgetary situation in California, there is also the possibility that the California State Legislature could enact new tax legislation that could have an adverse impact on businesses operating in California, including us and our tenants, and, as a result, could have an adverse impact on our financial condition, results of operations, and cash flows.
Real Estate Asset Valuation. General economic conditions and the resulting impact on market conditions or a downturn in tenants' businesses may adversely affect the value of our assets. Periods of economic slowdown or recession in the U.S., declining demand for office or industrial properties, or decreases in market rental rates or market values of real estate assets could have a negative impact on the value of our assets, including the value of our properties and related tenant improvements. If we were required under GAAP to write down the carrying value of any of our properties to the lower of cost or market due to impairment, or, if as a result of an early lease termination we were required to remove and dispose of material amounts of tenant improvements that are not reusable to another tenant, our financial condition and results of operations would be negatively affected.
Leasing Activity and Rental Rates. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly developed or redeveloped properties, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Negative trends in one or more of these factors could adversely affect our rental income in future periods. The following tables set forth certain information regarding leases that commenced during the three and nine months ended September 30, 2009.
Leasing Commencement Information by Segment
For Leases That Commenced During the Three Months Ended September 30, 2009
Weighted
Number of Rentable Changes Average
Leases (1) Square Feet(1) Changes in in Cash Retention Lease Term
New Renewal New Renewal Rents(2) Rents (3) Rates (4) (in months)
Office Properties 12 14 53,416 230,936 14.7 % 5.2 % 47.2 % 66
Industrial Properties 1 1 4,000 98,200 43.2 % 7.6 % 96.1 % 117
Total portfolio 13 15 57,416 329,136 17.4 % 5.4 % 55.7 % 80
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Leasing Commencement Information by Segment
For Leases That Commenced During the Nine Months Ended September 30, 2009
Weighted
Number of Rentable Changes Average
Leases (1) Square Feet(1) Changes in in Cash Retention Lease Term
New Renewal New Renewal Rents(2) Rents (3) Rates (4) (in months)
Office Properties 25 34 155,356 473,316 11.8 % 6.1 % 53.9 % 58
Industrial Properties 3 5 109,000 436,735 17.4 % 1.1 % 55.1 % 79
Total portfolio 28 39 264,356 910,051 12.9 % 5.0 % 54.5 % 68
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(1) Represents leasing activity for leases that commenced during the period shown, including first and second generation space, net of month-to-month leases. Excludes leasing on new construction.
(2) Calculated as the change between GAAP rents for new/renewed leases and the expiring GAAP rents for the same space. Excludes leases for which the space was vacant longer than one year.
(3) Calculated as the change between stated rents for new/renewed leases and the expiring stated rents for the same space. Excludes leases for which the space was vacant longer than one year.
(4) Calculated as the percentage of space either renewed or expanded into by existing tenants or subtenants at lease expiration.
The increase in rental rates for industrial leases that commenced during the three months ended September 30, 2009 was largely due to one lease renewal for approximately 98,200 rentable square feet, and the increase in rental rates for industrial leases that commenced during the nine months ended September 30, 2009 was largely due to two lease renewals totaling approximately 298,800 rentable square feet.
While changes in rents were positive for leases that commenced during the three and nine month periods ended September 30, 2009, we cannot give any assurance that leases will be renewed or that available space will
be re-leased at rental rates equal to or above expiring stated rates for the same space. Leasing activity statistics for any given period are impacted by the number and mix of leases executed, the terms of the individual leases, and the submarkets in which leasing activity is located. Therefore, current period lease commencement activity may not be indicative of leasing trends in the future. An extended economic slowdown and continued tightening of the credit markets could have an adverse effect on our tenants and could impact our ability to maintain or increase rental rates in our submarkets.
In general, we have been experiencing decreases in rental rates in many of our submarkets due to current recessionary conditions and other related factors. During the third quarter of 2009, we executed 27 leases for an aggregate of 283,100 rentable square feet. The weighted average change in rents as compared to the expiring rents for the same space for these new leases was a 0.6% decrease in cash rents, and a 3.6% increase in GAAP rents. As of September 30, 2009, we believe that the weighted average cash rental rates for our overall portfolio are approximately 0% to 5% above the current average market rental rates, although individual properties within any particular submarket presently may be leased either above, below, or at the current market rates within that submarket, and the average rental rates for individual submarkets may be above, below, or at the average cash rental rate of our portfolio. As a result of the economic conditions, we are also experiencing decreased occupancy rates and protracted lease negotiations. As previously discussed, our rental rates and occupancy are impacted by general economic conditions, including the pace of regional economic growth and access to capital. Therefore, given the impact of the current economy on our submarkets, we cannot give any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current market rates. Additionally, decreased demand and other negative trends or unforeseeable events that impair our ability to timely renew or re-lease space could have further negative effects on our future financial condition, results of operations, and cash flows.
Scheduled Lease Expirations. The following table sets forth certain information regarding our lease expirations for the remainder of 2009 and the next five years, which is in addition to the 2.2 million rentable square feet, or 17.5%, of currently available space in our stabilized portfolio. Our ability to re-lease available space depends upon the market conditions in the specific regions in which our properties are located and general market conditions.
Lease Expirations by Segment Type(1)
Percentage of
Net Rentable Percentage of Annualized Average Annualized
Area Leased Annualized Base Base Rental Base Rental
Subject Square Feet Rental Revenue Revenue Revenue Per
Number of to Expiring Represented by Under Represented Square Foot Under
Expiring Leases Expiring Expiring Leases by Expiring Expiring Leases
Year of Lease Expiration Leases (Sq. Ft.) Leases (000's) (2) Leases (2) (000's)(2)
Office Properties:
Remainder of 2009 12 87,784 1.3 % $ 2,188 1.1 % $ 24.92
2010 80 1,225,330 17.6 30,457 15.2 24.86
2011 54 525,100 7.5 10,951 5.5 20.86
2012 53 674,187 9.7 17,928 8.9 26.59
2013 41 567,488 8.1 14,153 7.1 24.94
2014 36 944,449 13.5 23,835 11.9 25.24
Total Office 276 4,024,338 57.7 % $ 99,512 49.7 % $ 24.73
Industrial Properties:
Remainder of 2009 2 40,266 1.3 % $ 295 1.2 % $ 7.33
2010 13 367,112 11.9 3,003 11.7 8.18
2011 13 382,605 12.4 3,433 13.4 8.97
2012 10 451,672 14.6 3,057 11.9 6.77
2013 5 586,508 19.0 4,302 16.8 7.33
2014 9 466,578 15.1 3,743 14.6 8.02
Total Industrial 52 2,294,741 74.3 % $ 17,833 69.6 % $ 7.77
Total 328 6,319,079 62.8 % $ 117,345 52.0 % $ 18.57
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(1) The information presented reflects leasing activity through September 30, 2009. For leases that have been renewed early or space that has been re-leased to a new tenant, the expiration date and annualized base rent information presented takes into consideration the renewed or re-leased lease terms. Excludes space leased under month-to-month leases and vacant space as of September 30, 2009.
(2) Reflects annualized contractual base rental revenue calculated on a straight-line basis.
Leases representing approximately 1.3% and 15.8% of the occupied square footage of our stabilized portfolio are scheduled to expire during the remainder of 2009 and in 2010, respectively. The leases scheduled to expire during the remainder of 2009 and in 2010 represent approximately 1.3 million rentable square feet of office space, or 14.4% of our total annualized base rental revenue, and 0.4 million rentable square feet of industrial space, or 1.5% of our total annualized base rental revenue. As of September 30, 2009, we believe that the weighted average cash rental rates for leases scheduled to expire during the remainder of 2009 and in 2010 are approximately equal to the current average market rental rates, although individual properties within any particular submarket presently may be leased either above, below, or at the current market rates within that submarket, and the average rental rates for individual submarkets may be above, below, or at the average cash rental rate of our portfolio.
Sublease Activity. Of our leased space as of September 30, 2009, approximately 416,200 rentable square feet, or 3.4%, of the square footage in our stabilized portfolio was available for sublease compared to 485,600 rentable square feet, or 3.9%, as of December 31, 2008. Of the 3.4% of available sublease space in our stabilized portfolio as of September 30, 2009, approximately 2.8% was vacant space, and the remaining 0.6% was occupied. Approximately 51.8%, 31.5%, and 16.7% of the available sublease space as of September 30, 2009 is located in the Orange County, San Diego, and Los Angeles regions, respectively. Of the approximately 416,200 rentable square feet available for sublease as of September 30, 2009, there are no scheduled lease expirations in 2009 and four scheduled lease expirations in 2010 representing approximately 132,300 rentable square feet.
Development and Redevelopment Programs. Historically, a significant portion of our growth has come from our development and redevelopment efforts. We have a proactive planning process by which we continually evaluate the size, timing, costs, and scope of our development and redevelopment programs and, as necessary, scale activity to reflect the economic conditions and the real estate fundamentals that exist in our strategic submarkets.
We believe that a portion of our future potential growth will continue to come from our newly developed or redeveloped properties and our development pipeline. However, while we continue to evaluate development opportunities throughout Southern California and specifically in our core markets, we have currently delayed the timing and reduced the scope of our development program as a result of the economic conditions in our submarkets. As of September 30, 2009, we had no development projects under, or committed for, construction. As of September 30, 2009, we had one development property encompassing approximately 51,000 rentable square feet that was completed in the fourth quarter of 2008. This property is currently in the lease-up phase and has not yet been leased. As of September 30, 2009, we also had three development buildings, which we added to the stabilized portfolio in 2008, encompassing approximately 160,000 rentable square feet that have not yet reached stabilized occupancy of 95%. The average occupancy for these three buildings was approximately 13% as of September 30, 2009.
We believe that other possible sources of potential future growth are redevelopment opportunities within our existing portfolio and/or targeted acquisitions. Redevelopment efforts can achieve similar returns to new development with reduced entitlement risk and shorter construction periods. Depending on market conditions, we will continue to evaluate redevelopment opportunities within our portfolio when there is limited land for development in our strategic submarkets. We had no redevelopment properties in process as of September 30, 2009.
In light of current economic conditions, we may be unable to lease committed or completed development or redevelopment properties at expected rental rates or within projected timeframes, which could adversely affect our financial condition, results of operations, and cash flows.
Delays and scope reductions in our development program impact the average development and redevelopment asset balances qualifying for interest and other carry cost capitalization. As of September 30, 2009, our development pipeline included 116.7 gross acres of land with an aggregate cost basis of approximately $251 million. During the nine months ended September 30, 2009, we did not capitalize interest and carry costs on five of our seven development pipeline properties with an aggregate cost basis of approximately $82 million, as we determined these projects did not qualify for interest and other carry cost capitalization under GAAP. Additional delays and scope reductions could further impact the average development and redevelopment asset balances qualifying for interest and other carry cost capitalization and thus could further impact our results from operations.
City of San Diego. Given the geographic concentration of our future development
pipeline in San Diego County, our future operating results may be affected by
(i) the city of San Diego's current financial difficulties, (ii) the city of San
Diego's General Plan and Land Use update, (iii) the city of San Diego's zoning
ordinance updates, (iv) the city of San Diego's, the state's, and federal
agencies' future adoption of potential impact fees to address water supply
infrastructure, climate change legislation, including new regulations by the Air
Resource Board that may impact the operation and cost of construction and
industrial equipment, and mandatory energy and sustainable building code
requirements, (v) the potential new building permit moratorium due to state and
regional water agencies not issuing new water meters because of new water
rationing guidelines, and (vi) recent storm water runoff regulations and other
pending ordinances currently under consideration by the city, county, and state
water agencies and other agencies. Any of these factors may affect the city of
San Diego's ability to finance capital projects and may impact real estate
development, entitlements, costs of development, and market conditions in this
important region. As of the date this report was filed, we have not experienced
any material adverse effects arising from these factors.
Incentive Compensation. Our Executive Compensation Committee determines compensation, including equity and cash incentive programs, for our executive officers. The programs approved by the Executive Compensation Committee have historically provided for equity and cash compensation to be earned by our executive officers based on certain performance measures, including financial, operating, and development targets.
In the first quarter of 2009, our Executive Compensation Committee approved the 2009 Annual Bonus Program for executive management that will allow executive management to receive bonus compensation for achieving certain specified corporate performance measures for the year ending December 31, 2009. The provisions of the 2009 Annual Bonus Program were reported on Form 8-K filed with the SEC on January 29, 2009. As a result of the structure of this program and other performance-based programs that the Executive Compensation Committee may adopt in the future, accrued incentive compensation and compensation expense for such programs will be affected by our operating and development performance, financial results, the performance of the trading price of our common stock, and market conditions. Consequently, we cannot predict the amounts that will be recorded in future periods related to these compensation programs.
Share-Based Compensation. As of September 30, 2009, there was $11.1 million of total unrecognized compensation cost related to outstanding nonvested awards issued under share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.3 years. The $11.1 million of unrecognized compensation cost does not reflect the potential future compensation cost for the 2009 Annual Bonus Program or the development leasing component of the DPP since share-based awards have not been granted under these programs as of September 30, 2009. The compensation cost that will be recorded related to these programs will be based on the amounts ultimately earned and granted under these programs. See Note 5 to our consolidated financial statements included with this report for additional information regarding these programs.
Significant Tenants
The following table sets forth information about our fifteen largest tenants as
of the date of filing this quarterly report, based upon annualized rental
revenues as of September 30, 2009.
Percentage of
Total
Annualized Base Annualized Base
Property Rental Rental Initial Lease Lease Expiration
Tenant Name Segment Revenues (1) Revenues (1) Date(2) Date
(in thousands)
Intuit, Inc. Office $ 15,130 6.7 % November 1997 Various (3)
Bridgepoint Education, Inc.(4) Office 13,825 6.1 April 2007 Various (5)
Scripps Health Office 12,562 5.6 July 2004 Various (6)
CareFusion Corporation Office 10,087 4.5 July 2007 Various (7)
DIRECTV, Inc. Office 8,540 3.8 November 1996 July 2014
AMN Healthcare, Inc. Office 8,341 3.7 July 2003 July 2018
Fish & Richardson P.C. Office 6,071 2.7 October 2003 October 2018
The Boeing Company Office/Industrial 5,905 2.6 August 1984 Various (8)
Epson America, Inc. Office 5,538 2.5 October 1999 Various (9)
Verenium Corporation Office 5,158 2.3 November 2000 Various (10)
Hewlett-Packard Company Office 4,348 1.9 October 1999 April 2012
Fair, Isaac and Company, Incorporated Office 4,006 1.8 August 2003 July 2010
Avnet, Inc. Office 3,768 1.7 March 2003 February 2013
Scan Health Plan Office 3,637 1.6 February 1996 June 2015
Northrup Grumman Corporation Office 3,268 1.4 May 2001 Various (11)
Total $ 110,184 48.9 %
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(1) Based upon annualized contractual base rental revenue, which is calculated on a straight-line basis in accordance with GAAP, for leases for which rental revenue is being recognized by us as of September 30, 2009. . . .
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