For all the negative sentiment percolating across the national office market, there's one West Coast landlord that is becoming increasingly optimistic.
Los Angeles-based real estate investment trust Kilroy Realty is boosting its expectations for the remainder of the year as it begins to see signs of renewed leasing demand, an improving capital markets environment and the return of larger tech companies that have long bolstered its West Coast portfolio. The landlord signed upward of 400,000 square feet through the first quarter of the year, the highest first-quarter leasing volume reported since 2017 and a 40% increase compared to the same time last year.
"The quality of our portfolio and platform uniquely positions us to benefit from the recovery we're beginning to see take hold in our markets," Kilroy CEO Angela Aman, who took over the top leadership slot from John Kilroy Jr. in January, told analysts on the firm's earnings call Friday. "We're starting to see some signs of life in the transaction market, and as we navigate this environment, we'll be patient. We'll be both an opportunistic buyer and a strategic seller."
Kilroy, which posted a quarterly net income of nearly $50 million, is among a cohort of large office developers across the United States reporting a slow but evident pickup in tenants' interest in committing to physical spaces.
Along with competing firms such as Boston Properties, Hudson Pacific Properties, Highwoods Properties, Brandywine Realty Trust and Cousins Properties, Kilroy executives said they are watching some silver linings beginning to form as leasing activity gains momentum, tenants commit to longer terms and tour activity picks up alongside increased spatial requirements.
"We have seen a material uptick in tour activity over the last two quarters and certainly over the last six weeks," Aman said. "That doesn't mean you'll see executions, but you certainly can't sign leases without tour activity accelerating, so we're encouraged to see that."
The landlord is also becoming more flexible in terms of the types of deals it is willing to sign and the types of spaces it provides in order to cater to a broader spectrum of tenants and their shifting requirements. For example, Kilroy signed about 116,000 square feet of short-term leases last quarter, an option Aman said was a win-win situation for users not quite prepared to commit to long-term space and for the landlord in that the spaces required no upfront capital investments and provided a healthy revenue boost.
At some of its new developments, Kilroy is also investing in building out spec suites, or spaces in which a tenant can immediately move into without waiting or investing in extensive build-outs.
"We will see demand first with smaller-format users looking for move-in ready space," Aman said. "Where we have lost deals over the last few quarters is because we can't meet that immediate need, so we will be more competitive with those users looking for move-in-ready space. We want to capture all the demand that is in the market."
Patient, but Ready
For all of the renewed optimism of a widespread rebound, however, large office landlords still have a long way to go in regaining their pre-pandemic footing.
The national office vacancy rate, fueled by companies offloading record amounts of sublease space and responding to the effects of remote work, has climbed to nearly 14%, according to CoStar data. Tenants collectively handed back upward of 65 million square feet last year, boosting the total to more than 180 million square feet of move-outs since the start of 2020.
What's more, the leases that are being signed these days have shrunk considerably, averaging about 20% smaller than their pre-pandemic averages.
For Kilroy, the Southern California firm is focused on boosting occupancy across its portfolio, which is hovering just above 84%. While some areas in San Diego and Silicon Valley are nearly full, Aman said there are pockets in Los Angeles or San Francisco that, while improving, still require more attention.
"We had lots of activity in our L.A. portfolio and a range of different sizes and uses," she said. "So we are seeing some momentum there, but we have a fair amount of vacancy that needs to be addressed, and we need to see that momentum pick up."
The firm is willing to be patient, Aman said, and is strengthening its financial positioning so it's ready to capitalize on what it anticipates will be an imminent rebound.
While Kilroy remained mum on details about what it could sell or potentially acquire, the firm reported more than $2 billion of available liquidity, and executives said it would be willing to raise additional capital to take advantage of opportunities once they hit the market.
"There's a question of really making sure how much capital needs to be deployed into those transactions to reposition those assets and, as importantly, the expected timeline in order to stabilize, and those are big variables," Aman said. "We do think there is more market testing going on that will lead to more transaction activity. Our team is certainly ready and capable of underwriting a lot more transactions than we’ve seen over the last 12 months and trying to find interesting opportunities."
The company owns roughly 17 million square feet of office and life science space in California, Washington state and Austin, Texas. It also owns roughly 1,000 residential units across Southern California.