KRC - NYSE

Hello, everyone, and welcome to the KRC Third Quarter '25 Earnings Conference Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions] I would now like to turn the call over to Doug Bettisworth, Vice President of Corporate Finance to begin. Please go ahead.

Good morning, everyone. Thank you for joining us. On the call with me today are Angela Aman, CEO; Jeffrey Kuehling, EVP, CFO and Treasurer; and Eliott Trencher, EVP, CIO. In addition, Justin Smart, President; and Rob Paratte, EVP, Chief Leasing Officer, will be available for Q&A. Please note that some of the information we will be discussing during this call is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information on this call and in the supplemental. This call is being webcast live on our website and will be available for replay for the next 8 days. Our earnings release and supplemental package have been filed on a Form 8-K with the SEC and both are also available on our website. Angela will start the call with a strategic overview and quarterly highlights. Eliott will provide an update on our recent transaction activity and Jeffrey will discuss our financial results and provide you with updated 2025 guidance. Then we'll be happy to take your questions. Angela?

Thanks, Doug, and thank you all for joining today's call. As we enter the final stretch of the year, Kilroy is capitalizing on accelerating momentum across our West Coast office and life science markets. Return to office continues to improve, supported by evolving workplace norms, shifting employer expectations and recognition of the office as a driver of culture, collaboration and innovation. These trends, in combination with improving quality of life dynamics are driving enhanced vibrancy, a resurgence in leasing activity and a meaningful increase in institutional investor interest in high-quality West Coast commercial assets. At the same time, rapid advancements in artificial intelligence are reshaping demand across both the office and life science sectors, accelerating innovation and reinforcing the strategic importance of well-located real estate in concentrated tech and biotech hubs. Nowhere is this more evident than in the Bay Area. In the city of San Francisco alone, office demand has reached a post-pandemic high of nearly 9 million square feet, up from approximately 7 million square feet last quarter, with much of this demand being driven by AI and other technology companies. Importantly, the growth in demand statistics has persisted even if the pace of lease executions has significantly increased with San Francisco leading all U.S. metros and office leasing growth over the last 12 months. Against this backdrop, I'm pleased to report another strong quarter of execution across our portfolio. During the quarter, we signed over 550,000 square feet of new and renewal leases, marking our highest third quarter of leasing activity and our strongest year-to-date performance in 6 years. Leasing momentum was robust in San Francisco with activity in the south of market or SOMA submarket, particularly notable. Our SOMA assets continue to outperform with over 95,000 square feet of new and renewal leases executed this quarter and a growing forward pipeline with tour activity in our SOMA assets up 170% year-over-year. At 201 Third Street, we signed a full floor lease with Tubi, a global streaming entertainment company for their new headquarters, marking the third consecutive quarter of major leasing at this property. Our continued success at 201 Third highlights the exceptional ability of our leasing, construction and asset and property management teams to understand and meet the evolving needs of today's tenants, many of whom are prioritizing landlords that can deliver speed from lease execution through tenant occupancy. Encouragingly, as the San Francisco recovery continues to accelerate. We're now seeing this momentum expand to nearby assets in our portfolio, which is 360 Third Street, where we recently signed our first lease since 2022. While the recovery in San Francisco certainly deserves a significant amount of focus and attention, it's important to note that we're seeing improving dynamics across nearly all of our markets with tenants demonstrating greater conviction and willingness to execute. During the third quarter, capitalizing on this improved sentiment, we made important progress in addressing some of our largest remaining 2026 lease expirations. In San Diego, we completed a long-term renewal with Scripps for their entire 119,000 square foot lease at Kilroy Center Delmar. And at Long Beach, we executed a short-term renewal with SCAN for 87,000 of their approximately 220,000 square feet at Aero. While we anticipate that SCAN will vacate at the end of their extended term and relocate into owner-occupied space, the phasing of this move out provides valuable near-term stability as we work to programmatically backfill. And subsequent to quarter end, we signed an additional 148,000 square feet of renewals related to 2026 lease expirations, as Jeffrey will detail in a moment. Taking into account the renewal signed subsequent to quarter end, 2026 lease expirations now total approximately 970,000 square feet, reflecting a retention ratio of over 40% on the pool reported at the beginning of this year. Our leasing team has worked diligently to renew tenants as early as possible, and I'm very pleased with the progress we've made to date. That said, the pool of remaining renewal opportunities in 2026 is now much more limited. The path forward will require a greater emphasis on new leasing activity. As a result, we're approaching the remainder of this year with a clear focus on capturing growing demand across our markets and ensuring that our assets are well positioned to outperform as momentum continues to accelerate. Turning to life science. We're encouraged by a variety of important signals that speak to the improving fundamentals we're seeing in our portfolio. The XBI is up more than 20% year-to-date with strong broad-based performance from both large and small cap biotech companies, fueled in part by greater clarity on the regulatory backdrop for the sector and a variety of positive company-specific clinical trial and drug approval announcement. In addition, biotech M&A volume has accelerated with large pharmaceutical companies actively pursue new pipelines to offset significant patent expirations over the coming years. Kilroy Oyster Point Phase 2, our premier development project in the heart of the South San Francisco life science ecosystem is benefiting from this material improvement in sentiment and activity. We're pleased to report that we've signed 84,000 square feet of leases to date with well-established biotech companies. In addition to the 24,000 square foot lease with Color that was announced in September, last night, we announced the execution of a 44,000 square foot lease with MBC BioLabs and a 16,000 square foot lease with Acadia Pharmaceuticals. MBC BioLabs is the Bay Area's leading life science incubator and has helped launch more than 500 companies collectively raising over $20 billion in capital. MBC's presence will help create a diversified tenant base of early-stage biotech companies at KOP, advancing our strategic goal of cultivating a dynamic innovation-driven life science ecosystem at Kilroy Oyster Point that will support the long-term growth and value creation of the project. MBC is expected to commence occupancy in the fourth quarter of 2026. Acadia Pharmaceuticals is a biopharmaceutical company committed to advancing therapies for underserved neurological disorders and rare diseases. And this recent execution marks Acadia's entry into the San Francisco Bay area. Already a valued Kilroy tenant in our San Diego portfolio, we're proud to expand our relationship as trusted partners. Acadia is expected to take occupancy in the second quarter of 2026. The future pipeline at KOP 2 is robust, and we're actively engaged with a variety of potential tenants, including several with larger format requirements. These discussions, though still early, reflect both an overall improvement in the life science market and a growing appreciation of Kilroy Oyster Point's purpose-built life science construction and market-leading amenitization. Based on the status of current conversations, we believe that KOP 2 is now well positioned to exceed our previously communicated goal of 100,000 square feet of lease executions by year-end, and we expect this project to be a meaningful contributor to the company's growth over the next several years. From a capital allocation perspective, we continue to be active and disciplined as we recycle capital with a focus on long-term cash flow growth and value creation. Our approach remains responsive to evolving dynamics in both the office and life science sectors as well as shifts in the relative attractiveness of the submarkets in which we operate, staying agile and prioritizing opportunities that align with our long-term strategic vision for the portfolio. During the quarter, we completed the previously announced sale of a 4-building campus in Silicon Valley for gross sales proceeds of $365 million, and the acquisition of Maple Plaza, a Class A office campus in the iconic Beverly Hills submarket of Los Angeles for $205 million. Maple Plaza marks Kilroy's first investment in Beverly Hills, a highly sought-after, well-amenitized and supply-constrained environment with one of the lowest vacancy rates in the Greater Los Angeles market, and the asset has quickly become the strongest driver of leasing activity in our Los Angeles portfolio. Looking forward, expect us to continue to thoughtfully and strategically rotate capital out of assets where we believe value has been maximized and as proceeds are realized, pursue a balanced mix of selective reinvestment opportunities and debt repayment, considering all redeployment alternatives with a focus on optimizing portfolio returns and maintaining a strong and flexible capital structure. With respect to future development pipeline, we continue to work through additional land parcel monetization and expect to have further announcements in the coming quarters. In addition, we've been hard at work on the Flower Mart project, which is our single largest investment in the future pipeline. As we pursue additional flexibility and optionality that will allow us to ultimately maximize value on the site while being responsive to the evolving needs of the San Francisco community. During September, as part of our redesign and reimagining and Flower Mart project, we submitted 4 development scenarios to the City's Planning Department, each illustrating a potential path forward for the site, including a range of commercial and residential uses. Our conversations with the city to date have been constructive and encouraging and while those discussions are still ongoing, we have now gained greater clarity on both the approval process and the time line required to secure the optionality we're targeting. As a result, based on the best information available today, we expect interest and other expense capitalization to Flower Mart to continue through June 2026. We'll keep you updated on this assumption as appropriate. In conclusion, I want to thank the entire Kilroy team for an extraordinary effort this quarter as the pace of leasing and transaction activity have accelerated. I couldn't be any more pleased with the energy, enthusiasm and execution that this team is delivering each and every day. Eliott?

Thanks, Angela. As Angela noted, fundamentals are accelerating across all of our markets, which is not only good for leasing, but also for transactions. Buyers are underwriting vacancy and rollover with more conviction, leading to deeper bidding pools, which in turn is giving sellers increased confidence they are transacting at market pricing. All of this is leading to more deals being marketed and closing. We have been fortunate to benefit from these trends as both a buyer and a seller. Starting with dispositions. We had a productive first 3 quarters of the year, closing on $405 million of previously disclosed sales. As we continue to evaluate dispositions, our strategy remains the same. Monetized properties in lower conviction locations at values that imply forward returns less than our cost of capital. We are fortunate to have the benefit of a strong balance sheet, meaning we are not going to sell at any price and instead, we'll only transact when a deal meets our rigorous thresholds. Turning to land sales. As previously discussed, we had $79 million under contract between 26th Street in Santa Monica and Santa Fe Summit in San Diego. Both buyers continue to advance their plans and the transactions will close upon receipt of entitlements, which we currently estimate to be mid-2026. We are making progress on additional land sales and remain on track to hit our goal of at least $150 million in gross proceeds. On the acquisition side, during the quarter, we bought Maple Plaza on Beverly Hill. Beverly Hills has many of the characteristics we look for in the submarket. It's centrally located within the west side of Los Angeles with proximity to decision-makers, amenities and a diverse mix of tenants across multiple industries. Because it is essentially located the barriers to entry are quite high with cumulative new supply of only 260,000 square feet over the last 10 years. Additionally, 3 of the neighboring properties totaling roughly 400,000 square feet have been acquired by users in recent quarters, which has further reduced competitive supply and enhanced vibrancy in the micro market. Maple Plaza was recently renovated and amenitized so there are no major capital projects required at this time. Our basis of roughly $670 per square foot is meaningfully below replacement costs, which we estimate to be roughly $1,200 per square foot. As we lease up vacancy, we anticipate a stabilized yield in the high single digits and an unlevered IRR in the low double digits. In the few weeks we have owned the building, leasing activity has been strong from a mix of new leasing from new and existing tenants, confirming our view on the market and our underwriting. We're very excited about this acquisition and believe the inflection of leasing fundamentals combined with below historical average interest in the office sector created a unique opportunity. We do not know how long a window like this will last or if other similar opportunities will present themselves since more capital is consistently coming into the office sector. However, we continue to evaluate the full spectrum of investment alternatives and will not be afraid to transact if we find something that meets our stringent criteria. With that, I will turn the call over to Jeffrey.

Thanks, Eliott. FFO for the quarter was $1.08 per diluted share, which includes approximately $0.03 per share of onetime items, including $0.02 per share related to real estate tax appeal wins, an additional $0.01 per share of noncash income related to a reversal of straight-line bad debt expense. Cash same-property NOI growth for the third quarter was 60 basis points with the previously mentioned real estate tax appeals contributing 150 basis points of growth. Occupancy statistics now reflect the recently stabilized redevelopment projects, 4400 Bahana Drive and 4690 Executive Drive, which represented a 50 basis point negative impact to occupancy during the third quarter. We expected that occupancy would dip on a sequential basis due to the redevelopment projects entering the stabilized pool and expected move-outs. However, occupancy improved modestly, ending at 81%, up from 80.8% at the end of the second quarter. The improvement relative to our prior expectations was a result of earlier than anticipated rent commitments totaling approximately 200,000 square feet, all of which were originally projected to take occupancy in the fourth quarter. At the end of the third quarter, the spread between leased and occupied space was 230 basis points, which represents meaningful embedded growth expected to materialize throughout the remainder of 2025 and into 2026. It's important to note that KOP 2 leasing activity is not included in this lease versus occupied spread and should be considered separately. We now anticipate that any improvement in occupancy in the fourth quarter will be modest due to the accelerated rent commencement activity that occurred in the third quarter. Additionally, our assumptions now reflect the bankruptcy-related October move-out of NeueHouse, a 95,000 square foot tenant at Columbia Square. While the departure is now reflected in our occupancy outlook, the space's high-quality build-out and historical significance are generating strong interest from prospective users and the team is working diligently to minimize downtime. Portfolio retention in the third quarter was approximately 60% and year-to-date retention, including subtenants, stands at 39%. Following quarter end, we executed a 79,000 square foot renewal with Ride Games at Westside Media Center and a 67,000 square foot lease with ByteDance, a current subtenant with a 2026 expiration at Key Center. While these recent transactions are not yet reflected in our operational metrics, we are very pleased with our leasing performance on 2026 expirations, which demonstrates strong momentum heading into next year. Turning to guidance. We raised our 2025 FFO outlook to a range of $4.18 to $4.24 per share, representing an $0.11 per share increase at the midpoint. This revision reflects several key updates to our expectations. We now anticipate approximately $0.05 of additional noncash income driven by tenants taking occupancy earlier than expected in the previously mentioned straight-line bad debt reversal that occurred in the third quarter. Our updated same-property NOI guidance contributes an incremental $0.03 per share, while interest capitalization adjustments account for $0.02 per share. As Angela mentioned, we have also updated our assumptions for the Flower Mart project, which is now expected to cease capitalization in June 2026. With the progress made to date and the recent submission of our development applications, we're in a stronger position to find the process time line and have updated our assumptions accordingly. As the reentitlement process advances, we anticipate reaching a point we are short of executing a demand-driven development, all feasible progress that the project will be complete, at which time, capitalization will need to be suspended indefinitely. We will continue to revisit our assumptions and provide updates as new information becomes available. As it relates to Kilroy Oyster Point, we are making excellent progress on the lease up of the project. Following the 84,000 square feet of lease executions to date in our healthy forward pipeline, it's appropriate to begin framing up the project's expected NOI and FFO impacts in 2026. Once the project transitions into the stabilized portfolio in January, capitalization will end and operating expenses, property taxes and interest expense will be recognized through the income statement. During the third quarter, operating expenses and property taxes and KOP 2 totaled approximately $5 million while capitalized interest totaled approximately $10 million, both of which are a reasonable quarterly run rates for next year. As tenants begin to take occupancy starting in the first half of 2026, the negative earnings impact from the projects will moderate before becoming a net contributor to growth in the coming years. With that, we're happy to answer your questions.

[Operator Instructions] Our first question today comes from the line of Nick Yulico with Scotiabank.

So first question is, I guess, just turning towards some of the expirations you talked about getting addressed for 2026. And I know you had a higher also retention ratio this quarter. So at a high level, I mean, are there any sort of thoughts you can give us on like next year, how to think about retention for expirations and then also getting some benefit, as you talked about from commencing occupancy on that gap right now between signed, but not occupied space?

Sure. Thanks, Nick. This is Angela. I'd start with sort of going back to where we started with the 2026 expiration pool at the beginning of 2025. We were showing about 1.9 million square feet, when you take into account all the leasing activity and renewal activity that's been completed through the third quarter and the almost 150,000 square feet of renewals that were signed subsequent to quarter end. We're down to a remaining expiration pool in 2026 of about 970,000 square feet. As I mentioned earlier, I think there's a limited opportunity for additional renewals out of that pool. So we do expect that you're going to see move-outs in 2026 for the majority of what's left in the 2026 expiration pool, and we'll need to offset that through new leasing, right, both through a combination of, as you point out, a pretty healthy spread between signed and commenced occupancy that's already been executed and then additional new leasing activity that can take effect during 2026. I think as we've talked about on prior calls, one thing I would note that's a little bit different in the current environment is across many of our markets, the interest that tenants have and getting into space as quickly as possible. We've seen that most notably in San Francisco, where there's a real demand, especially from some of the new business formation we're seeing in that market to really compress the time between lease execution and occupancy commencement, but we've also seen it in other markets as well, including the Pacific Northwest and even in San Diego and Austin. So our spec suites program can be really meaningful in addressing some of that remaining exploration activity in 2026 or offsetting it. So that's what we're focused on right now is really driving some additional renewals out of the '26 pool, but really focusing on new leasing and particularly the new leasing that can take occupancy during 2026.

Okay. And then just second question is on San Francisco. If you could talk a little bit more about how you're seeing your space be competitive in the market versus other options? And then also sort of an update on competitive sublease space that's in the market, and sort of just sort of depth of the tenant pool there overall?

Sure. Yes, I'll take the first part, and then going to turn it over to Rob to talk about some of the more specific dynamics in the market. But what we've continued to see in San Francisco is a real expansion of where tenants are looking for space in the market. And then again, a real priority on landlords who can move quickly and deliver certainty in terms of compressing that time period between lease execution and rent commencement. When we talk about sort of the -- where tenants are looking in the market, that's where we've seen a pretty remarkable sea change in activity from where we were 9 to 12 months ago, that's really captured our SOMA assets and in particular, 201 Third, where as I mentioned earlier, we've now completed 3 consecutive quarters of major leasing at that property. We're now seeing that activity expand further into SOMA and into assets like 360 Third Street. So we've seen really sort of a healthy dynamic is where tenants are willing to look at expanded. And then again, I think our vacancies are really well positioned given that we're very focused on delivering -- meeting those expectations and delivering space as quickly as possible.

Thanks, Angela. Nick, it's Rob Paratte. I guess I'd make a couple of points about the market. One is that larger tenants in San Francisco are starting to come back to the market and our touring. We're also seeing that in Seattle. And I think one change we're noticing in our portfolio is that there's, I'd say, less demand for bargain space and more demand for impactful space. And that impactful space ties directly to the return to office phenomenon that you're seeing where San Francisco particularly has dramatically improved in the past couple of quarters. AI demand continues to be a very strong driver in the market. There's about 1.5 million square feet of AI demand currently touring in San Francisco. And then relating to sublease space over 2 million square feet of sublease space has been basically taken off the market through either going direct, taken off the market by the sublessor or being leased. And that's a notable number. And when you look at the Kilroy portfolio, we've had 200,000 square feet taken off the market this quarter by tenants. So all of that points to, I think, a sustained recovery as the office fundamentals are improving and showing signs of sustained recovery, we're already at pre-pandemic levels, as Angela pointed out in some of the statistics. So I'm pretty convinced that not only the momentum we're seeing here in Q4 will continue into Q1 and '26.

Our next question comes from Jana Galan with Bank of America.

Congrats on a great quarter. I wanted to follow up on the increased leasing outlook near term at KOP 2 and just kind of the current demand in tours, whether that continues to be more traditional biotech or it's kind of across the board?

Sure. I'll -- let me kind of frame up where we are with life science in KOP in South San Francisco. So in Q3, there were slightly over 600,000 square feet of leases signed, which is on par again with pre-pandemic levels. Look, we're seeing -- I can only speak to our project. What we're seeing is that the best projects in the market are seeing the most demand. And our life science team -- dedicated life science team is nimble accretive and they're really quick to respond adding to this momentum, which gives me a lot of confidence that momentum will not only continue in Q4, the remainder of Q4 as Angela said, but well into Q1 and 2026. Life science demand rose over 20% from 1.8 million feet to 2 million feet in Q3, another very positive indicator. And I think the one thing that we've seen that's really changed, again, as I mentioned earlier, in San Francisco, there are large tenants that are coming back into the market. So combined with the life science demand, we're seeing -- we're also seeing other sectors that have improving demand, including semiconductors, AI and robotics. And that's not just South San Francisco specifically, it's a trend moving from South San Francisco down through the peninsula.

Yes. I think -- I mean, Rob's really hitting on the right point. We're thrilled to be at the point we are right now. It's 84,000 square feet of leases executed at KOP. As you've alluded to, we feel like we're very well positioned to exceed the goal we put out for ourselves last quarter of 100,000 square feet by year-end. I also think, as we indicated last quarter, we're very pleased that the first wave of deals we're signing at KOP 2 have all been biotech, biotech related. I think that's a really important point as we think about the future growth and evolution of this project in Phases 3, 4 and 5 down the road. We're being very intentional about creating the right sort of life science ecosystem at the project that can support that growth down the road as well. And then Rob made a really important point, which is we have lots of -- as we think about the pipeline going forward, there continues to be lots of demand from biotech and biotech related companies as we look out finishing this project, but we are seeing really important demand that's giving us a little bit more leverage in leasing for the remainder of KOP 2 from other uses outside of life science as well. So overall, I think a really healthy backdrop as we think about leasing up this project and ensuring that it's going to be a net contributor of growth over the next several years. We've got a lot of options and a lot of momentum. But again, really pleased that we're able, with these first leases that are being signed, take the first steps at creating that dynamic life science ecosystem on site.

And just given kind of the improvement and diversity in activity across the portfolio, should we think about that there'll be less reliance on kind of the shorter-term leasing going forward?

Yes. I mean this quarter, the shorter-term leasing, I think it was 129,000 square feet. Most of that was renewal activity. And I spoke to some of that in my prepared remarks. We're going to be flexible in this environment with tenants that need a little bit longer-term, even if they're vacating, just to give us additional opportunity and time to backfill some of that space. So there's probably some more of that short-term renewal activity over the coming quarters. I would say, as we think about the new leasing dynamic, we've signed very few actually new leases on a truly short-term basis. There continues in the city of San Francisco as we think about some of this new company formation and AI growth, specifically in the city of San Francisco, still a desire for leases that are shorter-term in nature than a traditional 10-year lease. So we are seeing that demand in sort of that 3- to 5-year window for many of these AI companies, but we do believe we're in a position to stretch those terms a little bit longer, where we can provide a reasonable path to growth and expansion for some of those tenants over the course of that term. They're prioritizing that flexibility as it relates to the shorter lease term because they do believe their businesses are going to grow and evolve and they want to make sure that they can have space over the next 5 to 10 years, that's going to meet their needs. So where we can provide that flexibility, we have a chance at getting those terms extended a little bit longer. But the truly short-term leases, again, have been almost all renewal activity. And that's, in many ways, just a normal recurring part of the business.

Our next question comes from Steve Sakwa with Evercore ISI.

Jeffrey, I don't know if you could provide a little bit more color on just the NeueHouse lease. I appreciate you for clarifying that, that really was, I guess, in the quarter end occupancy and comes out in the fourth quarter, but could you maybe just help size up for us kind of what the rent contribution was from NeueHouse in the third quarter so we could just kind of adjust the revenues appropriately for that?

Yes. We don't -- Steve, we don't typically talk about individual rent commencements on a tenant level basis. You've got the occupancy contribution about a 50 basis point -- 50 to 60 basis point impact on occupancy. I think the important point here is that we really held our average occupancy guidance flat despite taking that unexpected impact in the fourth quarter of this year. Rob and team, I'll let Rob comment on sort of the re-leasing backdrop for that space in a moment. But we're really focused on re-leasing that space as quickly as we can. It's got a very high-quality build-out, and we think there are opportunities that will really help us minimize downtime as we look to reposition that space, which will address some of the concern you're raising.

Steve, yes, we started fairly early on looking at opportunities for the former NeueHouse space in terms of what can be done with it. And I'm actually pretty pleased with the activity we've seen from a variety of sectors, including the hospitality and entertainment sectors. And as you know, the space is very highly designed, very well designed. We own all the FF&E. There's a lot of advantage to what's in the space, not only from a just architectural point of view, but the existing facilities, including multiple food and beverage opportunities. And I think most -- or not most importantly, but very important aspect is that the historic studio, the CBS former auditorium can house up to 400 people. And so that's a very limited commodity in Hollywood. And so that does seem to attract quite a bit of attention and can generate revenue. So again, we're seeing kind of a disparate group of interested parties right now that we're talking to.

And just any comment, Rob, just about kind of how the rent would maybe stack up to the prior rent? Would that be a roll up, roll down, flat?

Hard to say, Steve. It depends. I mean some of these uses may have more new for capital depending on if it moves toward hospitality. It's really going to be very deal specific, but it's quite unique space. And the thing I'd say is if you look in Hollywood to have historic space like this that ties back into the 30s and 40s and 50s at the prime of Hollywood that cache carries a lot of value for future users.

Our next question comes from Seth Bergey with Citigroup.

I guess the first one, just to go back to kind of the KOP leasing activity you've done. Can you provide a bit more color on kind of the lease economics you're achieving there? And maybe touch on kind of how those leases kind of compared to your initial underwriting?

I'll start with the beginning that the lease economics vary between whether it's a spec lab or whether it's going from shell construction. So there's variability there. But we're very attuned to what the market is and happy with where we're getting -- where we're achieving our rental rates. And TIs have no doubt gone up since we originally underwrote the project, but we're meeting the market in terms of where the demand is and providing that value that I mentioned earlier.

Yes, I think Rob categorized it exactly right, which is I do think rents have held in pretty well relative to our original underwriting, even on these first handful of deals we're executing, which you would expect to come in a little bit below. So rents are pretty much in line. Capital is higher and that's a comment we've made on prior calls as well. One thing I would note when you look at the -- our disclosure around the lease executions in the second -- or for first generation space in the supplemental, any deals that are signed for spec suites are burdened with 100% of the spec suite capital in those TI numbers, even though those tend to be almost by definition, some shorter-term deals and that capital is designed to be easily reusable for future tenants. So that's just one element I would note, as you think about some of the TI numbers you're seeing in the supplemental and we'll see on the spec suite deals going forward.

That's helpful. And then maybe for a second one. I believe in your prepared remarks, you mentioned 1.9 million square feet of kind of '26 expirations that kind of need to be backfilled primarily kind of by new leasing activity. Can you just kind of quantify kind of what the tour activity you're seeing on those spaces and maybe kind of how it compares to last quarter or some way to benchmark it just kind of as you guys are seeing this recovery in demand?

Yes. Let me make a point of clarification, and then I'll turn it over to Rob. But 1.9 million was the 2026 lease expiration tower we were facing at the beginning of 2025. Over the course of the last 3 quarters and with some renewal signed subsequent to quarter end, we're now down to 970,000 square feet of remaining 2026 lease expiration. So we've substantially addressed that original tower. That's translated into about a 40% retention on the original 1.9 million square feet with additional vacancy or potential move-outs being addressed through disposition. So we've actually been very successful at addressing the original 1.9 million. I'd just say tour activity across the board and the pipeline across the board looks really very strong right now. And we mentioned specifically in San Francisco, a 170% increase in tour activity in our SOMA properties, in particular, where we do have vacancy. We're seeing really great momentum. But I'll let Rob comment on the broader pipeline and tour activity.

Yes. Seth, the only thing I'd add to what Angela has said is that it goes beyond the market we're talking about. And it's just that demand is across the board increasing of the 900,000 feet remaining. There's always a chance someone -- a lot of times things pop up at the end, where somebody wants to hold over, it could end up in short-term or it could end up in a longer-term lease. But as Angela said, I think we've harvested most of what we can get. That said, we have marketing and business plans put together for all that vacancy for the 900,000 that remains. And we're really positioning it early on to start leasing it and are in conversations on some of it already.

Our next question comes from Anthony Paolone with JPMorgan.

I just want to go back to KOP and revisit the prior question a bit. Just a 2-parter there. One, at the rate -- at the rental rates you're achieving and what you're seeing out there? What would the yield be on your cost? And then the second part of that, the $1.25 billion. Remind me, is that fully loaded for tenant improvements, leasing commissions, prebuilts, all that?

Yes. I mean I'll make a couple of comments. We're 10% leased on this project right now, right? So we've got an 84,000 square foot lease on 875,000 square feet or thereabouts. So I think it's a little premature to talk to the total economics of the projects overall. I think as we continue to execute on this project and we demonstrate further progress on the leasing, it will be the right time to take a step back and talk about the overall economics of this project. But doing so on the first 3 leases that got executed is just a little bit premature. The numbers we have in the supplemental do reflect our original expectations as it related to capital. So at the right time, and again, as we get through additional leasing activity, we'll update as appropriate.

Okay. But -- so then, I mean, you mentioned the capital running a little bit ahead of plan rents kind of more or less in line. So does that mean it likely us to bump up a bit or still too early to tell?

It's still too early to tell. I think it's -- we'll continue to evaluate as we get additional leases signed and hope to have additional updates over the coming quarters.

Our next question comes from Brendan Lynch with Barclays.

You've mentioned some of the components that will feed into this, but guidance calls for a 1% contraction year-over-year, but same-property NOI was up 1.4% year-to-date. Maybe just walk us through some of the considerations that we should keep an eye on in the fourth quarter?

Yes. Thanks, Brendan. The big, I think, kind of bogey is just a difficult comp in the fourth quarter from last year. So we did recognize about $6.7 million of restoration fee income. So when you look at kind of the sequential decline, at least for the fourth quarter, you should see a pretty big run down or expect to see that.

Okay. That's helpful. And then maybe just -- you mentioned strength in all your markets. Maybe just hone in on Austin. It looked like you had a lot of leasing progress there at the Indeed Tower. Maybe any extra color that you can provide there and an update on the ground floor space that's available?

Sure, Brendan, and the ground floor space is exactly what I wanted to talk about, which is, I think, a really monumental accomplishment by our Austin team leasing what we call the post, which is a freestanding historic building on the project site. And we're not at liberty to disclose the tenant, but I'll say that they're a nationally recognized successful operator of food and beverage venues across the country and had many successful startups and built several chains through that entity. And this amenity, it's really an amenity, but it's not only an amenity for the building, it's suited for the tenants in the building, which we think is really going to improve the foot traffic and demand on the Sixth Street corridor, where we are, but it's also a really important amenity. It's big enough, meaningful enough that it's a big enough amenity for the overall Austin CBD. And all I can say is it's a complicated project. It took a long time. We have a multi-floor building that's historic that was in shell condition and will truly be special space. And I think all of us at Kilroy really look to our Austin team for having the perseverance and patience to go through that and execute it. And then what that leaves us with is our office space. And we continue -- again, I can't speak to the competition. I can only speak to what we see. And as Angela has said a couple of times, we're seeing a lot of activity on our spec suites oftentimes as they're under construction, they lease. So we're continuing on that program, and we don't have much contiguous space left for larger tenants, but we do have 2 floors that we're marketing. So we're really pleased with the activity we're seeing at Indeed Tower, and we think this post enhancement will also lead to increased activity. And I think long-term, just a great investment in that project.

Our next question comes from John Kim with BMO.

I had a couple of questions on your leasing pipeline at KOP 2. If you could maybe provide some more color on how large that pipeline is today versus last quarter or the last time you provided an update. And how many of these tenants are growing within the South San Francisco market versus just upgrading space within the market or musical chairs?

John, it's Rob. I'd say our demand -- I mean, we've said this for maybe 3 quarters now that our demand has continued to increase, at least we've seen an uptick and continuous uptick in tour activity. Suffice to say what I said earlier that we're confident in the pipeline we have in the remainder of Q4 and the executions that Angela talked about. And I think that our momentum is strong enough that Q1 and Q2 well into the rest of the year is going to be quite strong. The project, I've said this on a couple of calls is attracting interest from across the Bay Area. So we have a very concerted focused marketing effort. The project can accommodate tech as well as life science. The bulk of our activity is in the life science space because it's purpose-built life science, but other entities are also interested in it. So I'm very confident in the pipeline we got. And then I'm sorry, the second part of your question was are they seeking...

If they're seeking additional space within the market? Or is it just upgrading the space?

It's both. It's leases expiring, plus they're seeking upgraded space.

Okay. On the 970,000 square feet of potential move-outs next year, can you provide color on why these tenants are not renewing their space? And just your ability to backfill that space next year either through leasing or extending the current leasing?

Yes. I mean, I guess, I'd go back to the comments I made earlier. When you think about the 1.9 million we started the year with and look at just what's been re-leased on a long-term basis within that pool, we've achieved a 40% retention rate or a little bit over 40%, which is a material improvement since any year through the pandemic. So actually, on a total retention basis, those numbers are very strong. And I think what you're saying is normal course activity in the portfolio in any year, even close to pre-pandemic level of retention. So it's just a combination of tenants with shifting needs. We mentioned one example in my script that was a tenant moving to owner-occupied space. There's been some of that activity in the portfolio, but it really does just run the gamut. And again, at a 40% or better than 40% retention rate, we think we're back to pretty historical levels of activity from a move-out perspective.

Our next question comes from Upal Rana with KeyCorp.

I wanted to get your thoughts on your capital allocation strategy and priorities going forward, especially with the recent Maple Plaza acquisition and the expectation of getting the space back for next year?

Paul, it's Eliott. I mean, as we mentioned, we're looking at all different alternatives that are out there. So our general alternatives are anything from investing in an asset, be that an office asset or life sciences asset or buying back stock, and we just sort of evaluate the opportunities as they present themselves. Overall, we've been encouraged at the types of opportunities that are out there and we're fortunate enough to be successful in closing on Maple Plaza. But we'll see. We'll see what else comes out, but we're definitely spending time looking at all of the above.

Yes. And just to add to that, we're a net seller this year so far of about $200 million. We continue to evaluate what we think are a growing number of opportunities in the market. And then a point Eliott made earlier, which I just think is really important is that we do think we're in a really unique window of time here where fundamentals from a leasing perspective are getting better across all of our markets, and we're still early in institutional investor interest coming back to the market. We're seeing it happen across San Francisco, certainly, but really all of our West Coast markets. And that can change quickly and change the dynamic quickly in terms of what's actionable for us from an acquisition perspective, certainly helps us on the disposition side. So we'll continue to evaluate all opportunities and execute where we do feel like we're in a unique period of time where valuations are pretty compelling and compelling relative to other alternatives.

Okay. Great. That was helpful. And then as a follow-up, could you talk a little bit more about Flower Mart? And could you share any recent conversations you've had with the city on that project? You mentioned continuing GAAP interest there until June 2026, but any additional color there would be helpful.

Yes, sure. I'll take it, and we can certainly dig more into it, Justin's here as well to talk about it to the extent you have follow-up questions. But as I mentioned in my script, we submitted to the planning department recently, I believe, in early September, additional potential path forward for the Flower Mart that included a broader mix of commercial and residential uses. We're going through the exercise of the planning department to understand sort of what's achievable on the site and how that would lay out and what the ultimate path forward will look like from an execution perspective. So as I said earlier, we're pretty early days in those conversations, but everything to date has been constructive and encouraging. And I think we are aligned with the city in ensuring that whatever ultimately gets approved here meets the needs of the San Francisco community as it continues to evolve.

Our next question comes from Caitlin Burrows with Goldman Sachs.

I guess maybe just as a follow-up on the Flower Mart point. So it seems like over the, call it, year-to-date, the amount of activity that you've been able to continue doing has changed and your own expectations have changed. I guess, can you just go through like what those changes are and like the current expectation is for June 30? Like how much visibility do you have on that? Or is it kind of up to the city and that's causing the changes and kind of we'll see as it gets closer to June, if that changes again?

Thanks, Caitlin. As you might remember from prior calls, sort of the path we're taking here on the Flower Mart and what we're looking for in terms of additional flexibility and optionality that will help us maximize value on the site is unique relative to the way San Francisco has historically approved projects. So the time line and the path forward hasn't been completely clear, which is why we've tried to do the best job we can of being transparent with investors about what we know at different periods in time and then updating those expectations as appropriate. With us filing the additional proposals or additional potential paths for the Flower Mart with the planning department, in September, we have greater clarity on that process -- that step of the entitlement process and believe that will take us through the first half of 2026. As we continue to work through the process and get additional information, we'll update that assumption as appropriate.

Okay. And then just maybe a minor point on the Silicon Valley sale. Could you guys give us more detail just on when that closed in September if it was the beginning of the month or the end of the month?

It would be very end of the month.

Our next question comes from Michael Carroll with RBC.

I wanted to quickly circle up on the Flower Mart. Are you able to have discussions with potential partners as you kind of reentitle that site if you're going to build resi and/or sell off certain sites? Or is it just too early to tell? You can't have those discussions because you just don't know what the city is going to be willing to give you yet?

Yes. I think it's a little too early, right? I think if you take a look and it's been reported in the press at our application to the planning department, you see a wide range of uses for different potential paths that include commercial, a full commercial program like we're currently entitled for a fully residential program, a mix of different uses on site as well. So I just think what we're looking for right now is making sure that we have all the flexibility and optionality with our existing entitlements and with the development agreement to execute on whichever one of those paths is ultimately going to maximize value for the site, but we need to get a little bit further through that process to better understand it, to continue to evaluate economics in the market as those shift and change as well to be able to really determine the best path forward. So stay tuned. We're continuing to work through it. I'm really pleased with the progress we've made to date, but we have some significant work still to do.

Okay. That's helpful. And then just related to the other land sales that you kind of mentioned in your prepared remarks, are these really going to be focused on the parcels that have kind of been preannounced? Or are there other potential sales that could be announced that's new that we haven't heard about yet. I mean, I guess, are these like kind of the near-term type events? Or are these going to be a longer-term multiple year process to kind of wind down that land book?

Yes. I think to get to the $150 million, those are things that are actively being worked on right now. So I think that, that should be more near than long-term. And we've really focused our efforts on where we thought there were actionable items within the land bank. And so as markets continue to recover, I think that the opportunity set can really broaden, but we've tried to take it in phases and the $150 million is kind of that first phase, and then we'll reassess as to what the right next thing is to do with what remains.

Yes. But just to be clear, the $150 million includes both what has already been announced and some expectation of things that haven't been announced quite yet. I mentioned in my remarks, we hope to have additional announcements to get up to that $150 million number over the coming quarters. So as Eliott said, pretty near-term. Stay tuned.

Our next question comes from Omo Okusanya with Deutsche Bank.

Just a quick one around just some of the quarterly numbers. Eliott, could you again just walk us through the straight-line bad debt reversal exactly what that was? And also what drove the fairly large increase in tenant reimbursements quarter-over-quarter?

Tayo, it's Jeffrey. Straight-line bad debt, it's just a function related to a tenant moving from cash to accrual. So we had to unwind the previous adjustment we made in the prior period. From the reimbursement income from our perspective, we look at it from a net number. So we'll take into consideration operating expenses, real estate taxes. And when we look sequentially Q2 to Q3, it's about a $1.5 million change. So it's not a huge driver quarter-over-quarter.

Got you. Okay. That's helpful. And then on the whole slide in regards to just potential office demand from AI. And Angela, you kind of made a couple of comments earlier on. But I guess from our end, like how does one really kind of think through how large of an opportunity that is for KRC. I mean, could we kind of see some AI companies in some of the KOP Phase II cards? Like how do you kind of help us kind of think through that a little bit more about kind of new -- kind of new leasing that would come from that driver?

Yes. I mean I think if you look at -- and I mentioned the total requirements in market in the city of San Francisco right now being about 9 million square feet, which is a dramatic increase relative to even just last quarter, and we were totaling and had been covering around 7 million square feet for quite a while. A big driver of that is AI-related companies. I think it's probably over 30% of tenants in market at this point are AI or AI related. And we've definitely seen that be a driver of leasing activity across our portfolio. It wasn't interestingly a huge driver of leasing activity in our San Francisco portfolio in Q3, but we had just broad-based demand from a wide range of users. So that's definitely come back in the San Francisco market as well. But certainly, even in Q2, where we signed the 93,000 square foot lease with Harvey AI, it has been a driver of activity, particularly in our SOMA portfolio and we would expect that to continue. As I mentioned earlier, we've worked really hard to understand what those tenants need from landlords and how we can really hit that demand and that need and a lot of it has been from -- a lot of it has been from understanding their need for very near-term occupancy. And so getting tenants into space as quickly as possible, we're using existing improvements as we did in the case of Harvey AI building out spec suites trying to get in front of some of that demand, all those things are really impactful in our ability to capture an outsized share of AI demand going forward. As it relates to KOP and other projects in the portfolio, including other markets like Bellevue and South Lake Union, we're seeing demand from AI tenants across the board. We definitely executed some on the AI side in the Pacific Northwest. We've seen some of that demand at KOP, and we'll continue to work through and find ways that we can continue to capture that demand while also ensuring that our tenant profile overall remains broad-based and reflects a wide range of potential uses that will help us continue to maximize cash flow durability and growth over time.

Our next question comes from Dylan Burzinski with Green Street Advisors.

Eliott, just going back to your comments around sort of the capital markets and transaction environment improving in terms of owners bringing their -- being more comfortable bringing their properties to market. Are you seeing more of these types of assets that are being brought to market, more similar in risk profile to Maple Plaza or are you seeing more stabilized core deals coming to market. I guess just as you guys are evaluating these opportunities, given the existing level of vacancy in the market, are you guys more focused on maybe more stabilized type transactions? Or is it really a project level of risk-reward analysis that you guys are doing?

Yes. So we're really seeing all of the above, and we've seen core deals, core plus value-add and then heavy repositioning opportunities. And I think that speaks to just the overall trends. As far as where we try to spend our time, it's more bottoms up than top down. And we're looking at the dynamics of that particular asset in that particular submarket and then how it relates to other risks that are already existing in the portfolio. And so we want to make sure that we're smart and thoughtful about the kind of risk that we're taking and not necessarily doubling down on existing opportunities that already exist with vacancy that we had elsewhere in the portfolio. So in the instance of Maple, we were not in that submarket, but we spent a lot of time studying it and getting comfortable with the leasing trends, and we thought we could underwrite it in a way that give us enough runway to be able to execute on a lease-up plan. And so far, we feel encouraged by what we see.

Yes, I'd just add to that. I think our cost of capital has improved on both the debt and equity side over the last 3 to 6 months, which we're encouraged by. But we're still trading at a discounted cost of capital. And as a result, we're probably not the best buyer for truly core stabilized properties. We need to find opportunities where all of the core competencies on the Kilroy platform can be brought to bear to really drive value and create value through those acquisitions. I think we found that in the case of Maple Plaza, and that's how we're continuing to think through and look at opportunities across the board.

Our next question is a follow-up from Caitlin Burrows with Goldman Sachs.

I feel we've talked a lot about the leasing volume, but not as much on the pricing side. So it looks like the leasing spreads you guys report did get better in the third quarter. I guess as you guys look out to 2026, do you have an idea of, if you think like the year-to-date results or the 3Q results would be more telling of what could happen in the future? Any comments on what you expect on like the pricing side?

Yes. I think it's a really good question, Caitlin. I think it's a little bit difficult to answer when you think about how we report our spreads. There's no cutoff in terms of how long a space has been vacant. We're showing you basically a complete population. So it's really going to depend on where the new leasing activity happens across the portfolio in 2026. From a market-by-market perspective, we have markets where we believe we're below market and where leasing in those markets are going to result in pretty positive spread dynamics. And then markets, including the city of San Francisco, where we're probably still reporting a role -- a step down in rents as we re-lease space. I think the most important thing to consider about San Francisco and the overall dynamics in that market, is that obviously, as we all know, that's a market that really was challenging, very challenging. Even 12 months ago, still a lot of vacancy in the market that's starting to be addressed. We're getting more stability on the occupancy side. You're seeing it through new leasing activity. And as Rob mentioned earlier, sublease space coming off the market. So occupancy is starting to stabilize, starting to firm up a little and then starting to move in the right direction. As occupancy moves in the direction, there will be inherently more pricing power in the market. So I think we're at the -- I think all the pieces are in place, including that growing demand picture for things to continue to get better in San Francisco. The leases signed over the next year, probably on average in that market are going to be negative re-leasing spreads.