Even with the national office market's uneven recovery, Kilroy Realty is betting that demand among artifical intelligence startups will help the West Coast developer sail over any looming speed bumps as tech companies appear to be making a slow return back to taking on larger blocks of space.
The real estate investment trust based in Los Angeles reported a steady pickup in leasing activity across its extensive office portfolio, most notably among a spectrum of tech companies that are enforcing stricter in-person requirements and finding themselves in need of more space. The landlord signed roughly 235,000 square feet through the second quarter of the year, not including the nearly 185,000 square feet it leased last month alone.
CEO Angela Aman told analysts on the developer's earnings call Thursday that an emerging source of demand has come from tech companies that, up until recently, were aggressively working to shrink their real estate portfolios in a push to mitigate extraneous expenses.
"There's a recognition that they need to get more people back in the office, and it's encouraging to see that as a trend throughout the portfolio," she said. "That demand has been driven by the need for space and bringing people back from home to the office, and in general, leasing activity is accelerating. There's no question AI demand is really making an impact, especially in a market like San Francisco. It's primarily a dynamic we're seeing there, but it certainly isn't limited to San Francisco either."
More than 16 tenants are currently on the hunt for office space in the San Francisco Bay Area alone, the landlord reported, all of which have touted requirements of 100,000 square feet or more. Of those, about half represent demand from tech companies, in particular AI-focused startups or tech giants investing heavily in the space.
So while occupancy across Kilroy's portfolio has been on a steady decline over the past several years, executives say the bubbling demand is expected to translate into large deals not seen since before the COVID-19 pandemic.
"The numbers belie what's going on behind the scenes," Chief Leasing Officer Rob Paratte said on the call. "We're seeing pre-pandemic levels of demand and, in general, leasing activity is accelerating and it's looking good across our platform. Sure we have some markets that are a little slower, but generally, it's picking up."
'Major Benefit'
Kilroy, which posted a quarterly net income of more than $49.2 million during the second quarter, is among a cohort of large office developers across the United States reporting a pickup in tenants' interest in committing to physical spaces — especially as tenants that once eschewed in-office policies begin to ratchet up requirements of their own.
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 below 84%. While some areas in San Diego and Silicon Valley are nearly full, Aman said there are pockets in San Francisco and Los Angeles that, while improving, still require more attention. The landlord is also expecting three large move outs that total about 350,000 square feet before the end of the year. One is located in Seattle, and two will leave large vacancies in the greater Bay Area.
Even so, the renewed focus on in-office interactions and the improving economic outlook will only boost leasing momentum across Kilroy's footprint of high-quality offices, many of which have been bolstered by tenant's interest in the best and newest spaces.
"A major benefit to Kilroy during this recovery has been, and will continue to be, the indisputable flight to quality that we've seen play out in our sector and specifically in our markets," Aman said. "It's the driving factor behind virtually every conversation we're having with existing and prospective tenants, and these tenants are singularly focused on quality and amenitization of their space. That will only become more attenuated in an environment with virtually no new supply."
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.