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Section 1: 10-Q (10-Q)

Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number: 1-12675 (Kilroy Realty Corporation)
Commission File Number: 000-54005 (Kilroy Realty, L.P.)
KILROY REALTY CORPORATION
KILROY REALTY, L.P.
(Exact name of registrant as specified in its charter)
 
 
 
Kilroy Realty Corporation
Maryland
95-4598246
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
Kilroy Realty, L.P.
Delaware
95-4612685
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
12200 W. Olympic Boulevard, Suite 200, Los Angeles, California 90064
(Address of principal executive offices) (Zip Code)
 
(310) 481-8400
(Registrant's telephone number, including area code)
 
 
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Registrant
Title of each class
Name of each exchange on which registered
Ticker Symbol
Kilroy Realty Corporation
Common Stock, $.01 par value
New York Stock Exchange
KRC
Securities registered pursuant to Section 12(g) of the Act:
Registrant
Title of each class
Kilroy Realty, L.P.
Common Units Representing Limited Partnership Interests
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Kilroy Realty Corporation    Yes  þ    No   o
Kilroy Realty, L.P.         Yes  þ    No   o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    
Kilroy Realty Corporation     Yes  þ    No   o
Kilroy Realty, L.P.         Yes  þ    No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Kilroy Realty Corporation
 
 
 
Large accelerated filer     þ
Accelerated filer     o 
Non-accelerated filer     o 
Smaller reporting company     o
Emerging growth company    o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
 
 
 
Kilroy Realty, L.P.
 
 
 
Large accelerated filer     o
Accelerated filer     o 
Non-accelerated filer     þ 
Smaller reporting company     o
Emerging growth company    o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    
Kilroy Realty Corporation Yes  o     No   þ
Kilroy Realty, L.P. Yes  o     No   þ
As of May 3, 2019, 100,973,534 shares of Kilroy Realty Corporation common stock, par value $.01 per share, were outstanding.
 



EXPLANATORY NOTE
This report combines the quarterly reports on Form 10-Q for the period ended March 31, 2019 of Kilroy Realty Corporation and Kilroy Realty, L.P. Unless stated otherwise or the context otherwise requires, references to “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” mean Kilroy Realty Corporation, a Maryland corporation, and its controlled and consolidated subsidiaries, and references to “Kilroy Realty, L.P.” or the “Operating Partnership” mean Kilroy Realty, L.P., a Delaware limited partnership and its controlled and consolidated subsidiaries.
The Company is a real estate investment trust, or REIT, and the general partner of the Operating Partnership. As of March 31, 2019, the Company owned an approximate 98.0% common general partnership interest in the Operating Partnership. The remaining approximate 2.0% common limited partnership interests are owned by non-affiliated investors and certain directors and officers of the Company. As the sole general partner of the Operating Partnership, the Company exercises exclusive and complete discretion over the Operating Partnership’s day-to-day management and control and can cause it to enter into certain major transactions, including acquisitions, dispositions, and refinancings and cause changes in its line of business, capital structure and distribution policies.
There are a few differences between the Company and the Operating Partnership that are reflected in the disclosures in this Form 10-Q. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the Company and the Operating Partnership operate as an interrelated, consolidated company. The Company is a REIT, the only material asset of which is the partnership interests it holds in the Operating Partnership. As a result, the Company generally does not conduct business itself, other than acting as the sole general partner of the Operating Partnership, issuing equity from time to time and guaranteeing certain debt of the Operating Partnership. The Company itself is not directly obligated under any indebtedness, but generally guarantees all of the debt of the Operating Partnership. The Operating Partnership owns substantially all of the assets of the Company either directly or through its subsidiaries, conducts the operations of the Company’s business and is structured as a limited partnership with no publicly traded equity. Except for net proceeds from equity issuances by the Company, which the Company generally contributes to the Operating Partnership in exchange for units of partnership interest, the Operating Partnership generates the capital required by the Company’s business through the Operating Partnership’s operations, by the Operating Partnership’s incurrence of indebtedness or through the issuance of units of partnership interest.
Noncontrolling interests, stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of the Company and those of the Operating Partnership. The common limited partnership interests in the Operating Partnership are accounted for as partners’ capital in the Operating Partnership’s financial statements and, to the extent not held by the Company, as noncontrolling interests in the Company’s financial statements. The Operating Partnership’s financial statements reflect the noncontrolling interest in Kilroy Realty Finance Partnership, L.P., a Delaware limited partnership (the “Finance Partnership”). This noncontrolling interest represents the Company’s 1% indirect general partnership interest in the Finance Partnership, which is directly held by Kilroy Realty Finance, Inc., a wholly owned subsidiary of the Company. The differences between stockholders’ equity, partners’ capital and noncontrolling interest result from the differences in the equity issued by the Company and the Operating Partnership, and in the Operating Partnership’s noncontrolling interest in the Finance Partnership.
We believe combining the quarterly reports on Form 10-Q of the Company and the Operating Partnership into this single report results in the following benefits:
Combined reports better reflect how management and the analyst community view the business as a single operating unit;
Combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
Combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
Combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.
To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
consolidated financial statements;
the following notes to the consolidated financial statements:
Note 4, Stockholders’ Equity of the Company;
Note 6, Partners’ Capital of the Operating Partnership;

i


Note 11, Net Income Available to Common Stockholders Per Share of the Company;
Note 12, Net Income Available to Common Unitholders Per Unit of the Operating Partnership;
Note 13, Supplemental Cash Flow Information of the Company; and
Note 14, Supplemental Cash Flow Information of the Operating Partnership;
“Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
—Liquidity and Capital Resources of the Company;” and
—Liquidity and Capital Resources of the Operating Partnership.”
This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for the Company and the Operating Partnership to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that the Company and Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.


ii


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
QUARTERLY REPORT FOR THE THREE MONTHS ENDED MARCH 31, 2019
TABLE OF CONTENTS
 
 
 
 
Page
 
 
PART I – FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
  
 
  
 
  
Item 1.
 
 
 
 
 
 
 
 
 
 
 
Item 2.
  
Item 3.
 
Item 4.
 
 
 
PART II – OTHER INFORMATION
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 




PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY CORPORATION

KILROY REALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except share data)
 
March 31, 2019
 
December 31, 2018
ASSETS
 
 
 
REAL ESTATE ASSETS:
 
 
 
Land and improvements
$
1,184,496

 
$
1,160,138

Buildings and improvements
5,300,313

 
5,207,984

Undeveloped land and construction in progress
2,131,358

 
2,058,510

Total real estate assets held for investment
8,616,167

 
8,426,632

Accumulated depreciation and amortization
(1,441,506
)
 
(1,391,368
)
Total real estate assets held for investment, net
7,174,661

 
7,035,264

CASH AND CASH EQUIVALENTS
49,693

 
51,604

RESTRICTED CASH
6,300

 
119,430

MARKETABLE SECURITIES (Note 10)
24,098

 
21,779

CURRENT RECEIVABLES, NET (Note 1)
28,016

 
20,176

DEFERRED RENT RECEIVABLES, NET (Note 1)
280,756

 
267,007

DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET (Note 1)
187,309

 
197,574

RIGHT OF USE GROUND LEASE ASSETS (Notes 1 and 9)
82,794

 

PREPAID EXPENSES AND OTHER ASSETS, NET (Note 2)
50,360

 
52,873

TOTAL ASSETS
$
7,883,987

 
$
7,765,707

LIABILITIES AND EQUITY
 
 
 
LIABILITIES:
 
 
 
Secured debt, net (Notes 3 and 10)
$
259,878

 
$
335,531

Unsecured debt, net (Notes 3 and 10)
2,552,883

 
2,552,070

Unsecured line of credit (Notes 3, 10 and 15)
185,000

 
45,000

Accounts payable, accrued expenses and other liabilities
373,691

 
374,415

Ground lease liabilities (Notes 1 and 9)
87,247

 

Accrued dividends and distributions (Note 15)
47,676

 
47,559

Deferred revenue and acquisition-related intangible liabilities, net
138,973

 
149,646

Rents received in advance and tenant security deposits
55,457

 
60,225

Total liabilities
3,700,805

 
3,564,446

COMMITMENTS AND CONTINGENCIES (Note 9)

 

EQUITY:
 
 
 
Stockholders’ Equity (Note 4):
 
 
 
Common stock, $.01 par value, 150,000,000 shares authorized, 100,967,024 and 100,746,988 shares issued and outstanding, respectively
1,010

 
1,007

Additional paid-in capital
3,976,204

 
3,976,953

Distributions in excess of earnings (Note 1)
(62,690
)
 
(48,053
)
Total stockholders’ equity
3,914,524

 
3,929,907

Noncontrolling Interests (Notes 1 and 5):
 
 
 
Common units of the Operating Partnership
78,413

 
78,991

Noncontrolling interests in consolidated property partnerships
190,245

 
192,363

Total noncontrolling interests
268,658

 
271,354

Total equity
4,183,182

 
4,201,261

TOTAL LIABILITIES AND EQUITY
$
7,883,987

 
$
7,765,707




See accompanying notes to consolidated financial statements.

1


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except share and per share data)
 
 
Three Months Ended March 31,
 
2019
 
2018
REVENUES (NOTE 1)
 
 
 
Rental income
$
199,382

 
$
162,871

Tenant reimbursements

 
19,150

Other property income
1,820

 
801

Total revenues
201,202

 
182,822

EXPENSES
 
 
 
Property expenses (Note 1)
38,149

 
31,671

Real estate taxes
18,639

 
17,146

Provision for bad debts (Note 1)

 
(265
)
Ground leases (Notes 1 and 9)
1,972

 
1,561

General and administrative expenses
23,341

 
15,559

Leasing costs (Note 1)
1,757

 

Depreciation and amortization
66,135

 
62,715

Total expenses
149,993

 
128,387

OTHER (EXPENSES) INCOME
 
 
 
Interest income and other net investment gain (Note 10)
1,828

 
34

Interest expense (Note 3)
(11,243
)
 
(13,498
)
      Total other (expenses) income
(9,415
)
 
(13,464
)
NET INCOME
41,794

 
40,971

Net income attributable to noncontrolling common units of the Operating Partnership
(700
)
 
(751
)
Net income attributable to noncontrolling interests in consolidated property partnerships
(4,191
)
 
(3,974
)
Total income attributable to noncontrolling interests
(4,891
)
 
(4,725
)
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
$
36,903

 
$
36,246

Net income available to common stockholders per share – basic (Note 11)
$
0.36

 
$
0.36

Net income available to common stockholders per share – diluted (Note 11)
$
0.36

 
$
0.36

Weighted average common shares outstanding – basic (Note 11)
100,901,390

 
98,744,220

Weighted average common shares outstanding – diluted (Note 11)
101,443,179

 
99,213,610
























See accompanying notes to consolidated financial statements.

2


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited; in thousands, except share and per share/unit data)
 
Common Stock
 
Total
Stock-
holders’
Equity
 
Noncontrolling Interests
 
Total
Equity
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-in
Capital
 
Distributions
in Excess of
Earnings
 
BALANCE AS OF DECEMBER 31, 2017
98,620,333

 
$
986

 
3,822,492

 
$
(122,685
)
 
$
3,700,793

 
$
259,523

 
$
3,960,316

Net income
 
 
 
 
 
 
36,246

 
36,246

 
4,725

 
40,971

Issuance of share-based compensation awards
 
 
 
 
1,864

 
 
 
1,864

 
 
 
1,864

Non-cash amortization of share-based compensation
 
 
 
 
5,094

 
 
 
5,094

 
 
 
5,094

Settlement of restricted stock units for shares of common stock
405,067

 
4

 
(4
)
 
 
 

 
 
 

Repurchase of common stock, stock options and restricted stock units
(192,195
)
 
(2
)
 
(13,640
)
 
 
 
(13,642
)
 
 
 
(13,642
)
Exchange of common units of the Operating Partnership
6,503

 

 
244

 
 
 
244

 
(244
)
 

Distributions to noncontrolling interests in consolidated property partnerships
 
 
 
 
 
 
 
 

 
(2,177
)
 
(2,177
)
Adjustment for noncontrolling interest
 
 
 
 
335

 
 
 
335

 
(335
)
 

Dividends declared per common share and common unit ($0.425 per share/unit)
 
 
 
 
 
 
(44,075
)
 
(44,075
)
 
(879
)
 
(44,954
)
BALANCE AS OF MARCH 31, 2018
98,839,708

 
$
988

 
$
3,816,385

 
$
(130,514
)
 
$
3,686,859

 
$
260,613

 
$
3,947,472

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Total
Stock-
holders’
Equity
 
Noncontrolling Interests
 
Total
Equity
 
Number of
Shares
 
Common
Stock
 
Additional
Paid-in
Capital
 
Distributions
in Excess of
Earnings
BALANCE AS OF DECEMBER 31, 2018
100,746,988

 
$
1,007

 
$
3,976,953

 
$
(48,053
)
 
$
3,929,907

 
$
271,354

 
$
4,201,261

Net income
 
 
 
 
 
 
36,903

 
36,903

 
4,891

 
41,794

Opening adjustment to Distributions in Excess of Earnings upon adoption of ASC 842 (Note 1)
 
 
 
 
 
 
(3,146
)
 
(3,146
)
 
 
 
(3,146
)
Issuance of share-based compensation awards

 
 
 
2,210

 
 
 
2,210

 
 
 
2,210

Non-cash amortization of share-based compensation (Note 7)
 
 
 
 
8,817

 
 
 
8,817

 
 
 
8,817

Settlement of restricted stock units for shares of common stock
393,240

 
4

 
(4
)
 
 
 

 
 
 

Repurchase of common stock, stock options and restricted stock units
(175,204
)
 
(1
)
 
(12,129
)
 
 
 
(12,130
)
 
 
 
(12,130
)
Exchange of common units of the Operating Partnership
2,000

 

 
78

 
 
 
78

 
(78
)
 

Distributions to noncontrolling interests in consolidated property partnerships
 
 
 
 
 
 
 
 

 
(6,309
)
 
(6,309
)
Adjustment for noncontrolling interest
 
 
 
 
279

 
 
 
279

 
(279
)
 

Dividends declared per common share and common unit ($0.455 per share/unit)
 
 
 
 
 
 
(48,394
)
 
(48,394
)
 
(921
)
 
(49,315
)
BALANCE AS OF MARCH 31, 2019
100,967,024

 
$
1,010

 
$
3,976,204

 
$
(62,690
)
 
$
3,914,524

 
$
268,658

 
$
4,183,182















See accompanying notes to consolidated financial statements.

3


KILROY REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
 
Three Months Ended March 31,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
41,794

 
$
40,971

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization of real estate assets and leasing costs
64,971

 
61,677

Depreciation of non-real estate furniture, fixtures and equipment
1,164

 
1,038

(Recoveries of) provision for bad debts and write-offs (Note 1)
(3,543
)
 
(265
)
Non-cash amortization of share-based compensation awards
7,211

 
3,598

Non-cash amortization of deferred financing costs and debt discounts and premiums
135

 
315

Non-cash amortization of net below market rents
(2,094
)
 
(2,543
)
Non-cash amortization of deferred revenue related to tenant-funded tenant improvements
(3,817
)
 
(4,281
)
Straight-line rents
(12,895
)
 
(5,359
)
Amortization of right of use ground lease assets
144

 

Net change in other operating assets
(8,382
)
 
(4,640
)
Net change in other operating liabilities
15,102

 
3,598

Net cash provided by operating activities
99,790

 
94,109

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Expenditures for development properties and undeveloped land
(181,695
)
 
(111,424
)
Expenditures for operating properties
(31,837
)
 
(35,302
)
Expenditures for acquisition of operating properties

 
(111,029
)
Net increase in acquisition-related deposits

 
(5,000
)
Proceeds received from repayment of note receivable

 
15,100

Net cash used in investing activities
(213,532
)
 
(247,655
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Borrowings on unsecured revolving credit facility (Note 3)
190,000

 
90,000

Repayments on unsecured revolving credit facility (Note 3)
(50,000
)
 
(10,000
)
Borrowings on unsecured debt

 
120,000

Principal payments and repayments of secured debt (Note 3)
(74,930
)
 
(878
)
Financing costs
(942
)
 
(460
)
Repurchase of common stock and restricted stock units
(12,130
)
 
(13,642
)
Distributions to noncontrolling interests in consolidated property partnerships
(6,301
)
 
(2,170
)
Dividends and distributions paid to common stockholders and common unitholders
(46,996
)
 
(43,033
)
Net cash (used in) provided by financing activities
(1,299
)
 
139,817

Net decrease in cash and cash equivalents and restricted cash
(115,041
)
 
(13,729
)
Cash and cash equivalents and restricted cash, beginning of period
171,034

 
66,798

Cash and cash equivalents and restricted cash, end of period
$
55,993

 
$
53,069

















See accompanying notes to consolidated financial statements.

4





ITEM 1: FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY, L.P.

KILROY REALTY, L.P.
CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except unit data)
 
 
March 31, 2019
 
December 31, 2018
ASSETS 
 
 
 
REAL ESTATE ASSETS:
 
 
 
Land and improvements
$
1,184,496

 
$
1,160,138

Buildings and improvements
5,300,313

 
5,207,984

Undeveloped land and construction in progress
2,131,358

 
2,058,510

Total real estate assets held for investment
8,616,167

 
8,426,632

Accumulated depreciation and amortization
(1,441,506
)
 
(1,391,368
)
Total real estate assets held for investment, net
7,174,661

 
7,035,264

CASH AND CASH EQUIVALENTS
49,693

 
51,604

RESTRICTED CASH
6,300

 
119,430

MARKETABLE SECURITIES (Note 10)
24,098

 
21,779

CURRENT RECEIVABLES, NET (Notes 1)
28,016

 
20,176

DEFERRED RENT RECEIVABLES, NET (Notes 1)
280,756

 
267,007

DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET (Note 1)
187,309

 
197,574

RIGHT OF USE GROUND LEASE ASSETS (Notes 1 and 9)
82,794

 

PREPAID EXPENSES AND OTHER ASSETS, NET (Note 2)
50,360

 
52,873

TOTAL ASSETS
$
7,883,987

 
$
7,765,707

LIABILITIES AND CAPITAL
 
 
 
LIABILITIES:
 
 
 
Secured debt, net (Notes 3 and 10)
$
259,878

 
$
335,531

Unsecured debt, net (Notes 3 and 10)
2,552,883

 
2,552,070

Unsecured line of credit (Notes 3, 10 and 15)
185,000

 
45,000

Accounts payable, accrued expenses and other liabilities
373,691

 
374,415

Ground lease liabilities (Notes 1 and 9)
87,247

 

Accrued distributions (Note 15)
47,676

 
47,559

Deferred revenue and acquisition-related intangible liabilities, net
138,973

 
149,646

Rents received in advance and tenant security deposits
55,457

 
60,225

Total liabilities
3,700,805

 
3,564,446

COMMITMENTS AND CONTINGENCIES (Note 9)

 

CAPITAL:
 
 
 
Common units, 100,967,024 and 100,746,988 held by the general partner and 2,023,287 and 2,025,287
held by common limited partners issued and outstanding, respectively (Note 6)
3,987,644


4,003,700

Noncontrolling interests in consolidated property partnerships and subsidiaries (Note 1)
195,538


197,561

Total capital
4,183,182


4,201,261

TOTAL LIABILITIES AND CAPITAL
$
7,883,987


$
7,765,707













See accompanying notes to consolidated financial statements.

5


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except unit and per unit data)

 
Three Months Ended March 31,
 
2019
 
2018
REVENUES (NOTE 1)
 
 
 
Rental income
$
199,382

 
$
162,871

Tenant reimbursements

 
19,150

Other property income
1,820

 
801

Total revenues
201,202

 
182,822

EXPENSES
 
 
 
Property expenses (Note 1)
38,149

 
31,671

Real estate taxes
18,639

 
17,146

Provision for bad debts (Note 1)

 
(265
)
Ground leases (Note 1 and 9)
1,972

 
1,561

General and administrative expenses
23,341

 
15,559

Leasing costs (Note 1)
1,757

 

Depreciation and amortization
66,135

 
62,715

Total expenses
149,993

 
128,387

OTHER (EXPENSES) INCOME
 
 
 
Interest income and other net investment gain (Note 10)
1,828

 
34

Interest expense (Note 3)
(11,243
)
 
(13,498
)
Total other (expenses) income
(9,415
)
 
(13,464
)
NET INCOME
41,794

 
40,971

Net income attributable to noncontrolling interests in consolidated property partnerships and subsidiaries
(4,286
)
 
(4,078
)
NET INCOME AVAILABLE TO COMMON UNITHOLDERS
$
37,508

 
$
36,893

Net income available to common unitholders per unit – basic (Note 12)
$
0.36

 
$
0.36

Net income available to common unitholders per unit – diluted (Note 12)
$
0.36

 
$
0.36

Weighted average common units outstanding – basic (Note 12)
102,925,166

 
100,815,477

Weighted average common units outstanding – diluted (Note 12)
103,466,955

 
101,284,867


























See accompanying notes to consolidated financial statements.

6


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CAPITAL
(Unaudited; in thousands, except unit and per unit data)
 
 
Partners’ Capital
 
Noncontrolling Interests in Consolidated Property Partnerships and Subsidiaries
 
 
 
Number of
Common
Units
 
Common
Units
 
 
Total
Capital
BALANCE AS OF DECEMBER 31, 2017
100,697,526

 
$
3,773,941

 
$
186,375

 
$
3,960,316

Net income
 
 
36,893

 
4,078

 
40,971

Issuance of share-based compensation awards
 
 
1,864

 
 
 
1,864

Non-cash amortization of share-based compensation
 
 
5,094

 
 
 
5,094

Settlement of restricted stock units
405,067

 

 
 
 

Repurchase of common units, stock options and restricted stock units
(192,195
)
 
(13,642
)
 
 
 
(13,642
)
Distributions to noncontrolling interests in consolidated property partnerships
 
 
 
 
(2,177
)
 
(2,177
)
Distributions declared per common unit ($0.425 per unit)
 
 
(44,954
)
 
 
 
(44,954
)
BALANCE AS OF MARCH 31, 2018
100,910,398

 
$
3,759,196

 
$
188,276

 
$
3,947,472

 
 
 
 
 
 
 
 


 
Partners’ Capital
 
Noncontrolling Interests in Consolidated Property Partnerships and Subsidiaries
 
 
 
Number of
Common
Units
 
Common
Units
 
Total
Capital
BALANCE AS OF DECEMBER 31, 2018
102,772,275

 
$
4,003,700

 
$
197,561

 
$
4,201,261

Net income
 
 
37,508

 
4,286

 
41,794

Opening adjustment to Partners’ Capital upon adoption of ASC 842 (Note 1)
 
 
(3,146
)
 
 
 
(3,146
)
Issuance of share-based compensation awards
 
 
2,210

 
 
 
2,210

Non-cash amortization of share-based compensation (Note 7)
 
 
8,817

 
 
 
8,817

Settlement of restricted stock units
393,240

 

 
 
 

Repurchase of common units, stock options and restricted stock units
(175,204
)
 
(12,130
)
 
 
 
(12,130
)
Distributions to noncontrolling interests in consolidated property partnerships
 
 
 
 
(6,309
)
 
(6,309
)
Distributions declared per common unit ($0.455 per unit)
 
 
(49,315
)
 
 
 
(49,315
)
BALANCE AS OF MARCH 31, 2019
102,990,311

 
$
3,987,644

 
$
195,538

 
$
4,183,182























See accompanying notes to consolidated financial statements.

7


KILROY REALTY, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)

 
Three Months Ended March 31,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
41,794

 
$
40,971

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization of real estate assets and leasing costs
64,971

 
61,677

Depreciation of non-real estate furniture, fixtures and equipment
1,164

 
1,038

(Recoveries of) provision for bad debts and write-offs (Note 1)
(3,543
)
 
(265
)
Non-cash amortization of share-based compensation awards
7,211

 
3,598

Non-cash amortization of deferred financing costs and debt discounts and premiums
135

 
315

Non-cash amortization of net below market rents
(2,094
)
 
(2,543
)
Non-cash amortization of deferred revenue related to tenant-funded tenant improvements
(3,817
)
 
(4,281
)
Straight-line rents
(12,895
)
 
(5,359
)
Amortization of right of use ground lease assets
144

 

Net change in other operating assets
(8,382
)
 
(4,640
)
Net change in other operating liabilities
15,102

 
3,598

Net cash provided by operating activities
99,790

 
94,109

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Expenditures for development properties and undeveloped land
(181,695
)
 
(111,424
)
Expenditures for operating properties
(31,837
)
 
(35,302
)
Expenditures for acquisition of operating properties

 
(111,029
)
Net increase in acquisition-related deposits

 
(5,000
)
Proceeds received from repayment of note receivable

 
15,100

Net cash used in investing activities
(213,532
)
 
(247,655
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Borrowings on unsecured revolving credit facility (Note 3)
190,000

 
90,000

Repayments on unsecured revolving credit facility (Note 3)
(50,000
)
 
(10,000
)
Borrowings on unsecured debt

 
120,000

Principal payments and repayments of secured debt (Note 3)
(74,930
)
 
(878
)
Financing costs
(942
)
 
(460
)
Repurchase of common units and restricted stock units
(12,130
)
 
(13,642
)
Distributions to noncontrolling interests in consolidated property partnerships
(6,301
)
 
(2,170
)
Distributions paid to common unitholders
(46,996
)
 
(43,033
)
Net cash (used in) provided by financing activities
(1,299
)
 
139,817

Net decrease in cash and cash equivalents and restricted cash
(115,041
)
 
(13,729
)
Cash and cash equivalents and restricted cash, beginning of period
171,034

 
66,798

Cash and cash equivalents and restricted cash, end of period
$
55,993

 
$
53,069

 















See accompanying notes to consolidated financial statements.

8


KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.    Organization, Ownership and Basis of Presentation

Organization and Ownership

Kilroy Realty Corporation (the “Company”) is a self-administered real estate investment trust (“REIT”) active in premier office and mixed-use submarkets along the West Coast. We own, develop, acquire and manage real estate assets, consisting primarily of Class A properties in the coastal regions of Greater Los Angeles, Orange County, San Diego County, the San Francisco Bay Area and Greater Seattle, which we believe have strategic advantages and strong barriers to entry. Class A real estate encompasses attractive and efficient buildings of high quality that are attractive to tenants, are well-designed and constructed with above-average material, workmanship and finishes and are well-maintained and managed. We qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). The Company’s common stock is publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “KRC”.

We own our interests in all of our real estate assets through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”). We generally conduct substantially all of our operations through the Operating Partnership. Unless stated otherwise or the context indicates otherwise, the terms “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” refer to Kilroy Realty Corporation and its consolidated subsidiaries and the term “Operating Partnership” refers to Kilroy Realty, L.P. and its consolidated subsidiaries. The descriptions of our business, employees and properties apply to both the Company and the Operating Partnership.

Our stabilized portfolio of operating properties was comprised of the following properties at March 31, 2019:

 
Number of
Buildings
 
Rentable
Square Feet
 
Number of
Tenants
 
Percentage 
Occupied
 
Percentage Leased
Stabilized Office Properties
94

 
13,236,373

 
473

 
92.5
%
 
96.2
%

 
Number of
Buildings
 
Number of
Units
 
2019 Average Occupancy
Stabilized Residential Property
1

 
200

 
72.8
%

Our stabilized portfolio includes all of our properties with the exception of development and redevelopment properties currently committed for construction, under construction, or in the tenant improvement phase, undeveloped land and real estate assets held for sale. We define redevelopment properties as those properties for which we expect to spend significant development and construction costs on the existing or acquired buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. We define properties in the tenant improvement phase as properties that we are developing or redeveloping where the project has reached cold shell condition and is ready for tenant improvements, which may require additional major base building construction before being placed in service. Projects in the tenant improvement phase are added to our stabilized portfolio once the project reaches the earlier of 95% occupancy or one year from the date of the cessation of major base building construction activities. Costs capitalized to construction in progress for development and redevelopment properties are transferred to land and improvements, buildings and improvements, and deferred leasing costs on our consolidated balance sheets at the historical cost of the property as the projects are placed in service.

As of March 31, 2019, the following properties were excluded from our stabilized portfolio. We did not have any redevelopment properties or properties held for sale at March 31, 2019.
 
Number of
Properties/Projects
 
Estimated Rentable
Square Feet (1)
In-process development projects - tenant improvement (2)
3
 
1,246,000

In-process development projects - under construction (3)
5
 
2,080,000

________________________
(1)
Estimated rentable square feet upon completion.
(2)
Includes 88,000 square feet of Production, Distribution, and Repair (“PDR”) space and 96,000 square feet of retail space.
(3)
In addition to the estimated office rentable square feet noted above, development projects under construction also include 801 residential units.

Our stabilized portfolio also excludes our future development pipeline, which as of March 31, 2019 was comprised of four potential development sites, representing approximately 59 gross acres of undeveloped land.

9

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





As of March 31, 2019, all of our properties and development projects were owned and all of our business was conducted in the state of California with the exception of eight office properties and one development project under construction located in the state of Washington. All of our properties and development projects are 100% owned, excluding four office properties owned by three consolidated property partnerships. Two of the three property partnerships, 100 First Street Member, LLC (“100 First LLC”) and 303 Second Street Member, LLC (“303 Second LLC”), each owned one office property in San Francisco, California through subsidiary REITs. As of March 31, 2019, the Company owned a 56% common equity interest in both 100 First LLC and 303 Second LLC. The third property partnership, Redwood City Partners, LLC (“Redwood LLC”) owned two office properties in Redwood City, California. As of March 31, 2019, the Company owned an approximate 93% common equity interest in Redwood LLC. The remaining interests in all three property partnerships were owned by unrelated third parties.

Ownership and Basis of Presentation

The consolidated financial statements of the Company include the consolidated financial position and results of operations of the Company, the Operating Partnership, the Finance Partnership, 303 Second LLC, 100 First LLC, Redwood LLC and all of our wholly-owned and controlled subsidiaries. The consolidated financial statements of the Operating Partnership include the consolidated financial position and results of operations of the Operating Partnership, the Finance Partnership, 303 Second LLC, 100 First LLC, Redwood LLC and all of our wholly-owned and controlled subsidiaries. All intercompany balances and transactions have been eliminated in the consolidated financial statements.

As of March 31, 2019, the Company owned an approximate 98.0% common general partnership interest in the Operating Partnership. The remaining approximate 2.0% common limited partnership interest in the Operating Partnership as of March 31, 2019 was owned by non-affiliated investors and certain of our executive officers and directors. Both the general and limited common partnership interests in the Operating Partnership are denominated in common units. Generally, the number of common units held by the Company is equivalent to the number of outstanding shares of the Company’s common stock, and the rights of all the common units to quarterly distributions and payments in liquidation mirror those of the Company’s common stockholders. The common limited partners have certain redemption rights as provided in the Operating Partnership’s Seventh Amended and Restated Agreement of Limited Partnership, as amended, the “Partnership Agreement”.

Kilroy Realty Finance, Inc., which is a wholly-owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1.0% common general partnership interest in the Finance Partnership. The Operating Partnership owns the remaining 99.0% common limited partnership interest. With the exception of the Operating Partnership and our consolidated property partnerships, all of our subsidiaries are wholly-owned.

The accompanying interim financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying interim financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. However, the results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. The interim financial statements for the Company and the Operating Partnership should be read in conjunction with the audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2018.

Variable Interest Entities
The Operating Partnership is a variable interest entity (“VIE”) that is consolidated by the Company as the primary beneficiary as the Operating Partnership is a limited partnership in which the common limited partners do not have substantive kick-out or participating rights. At March 31, 2019, the consolidated financial statements of the Company included two VIEs in addition to the Operating Partnership: 100 First LLC and 303 Second LLC. At March 31, 2019, the Operating Partnership was determined to be the primary beneficiary of these two VIEs since the Operating Partnership had the ability to control the activities that most significantly impact each of the VIE’s economic performance. As of March 31, 2019, the two VIEs’ total assets, liabilities and noncontrolling interests included on our consolidated balance sheet were approximately $452.4 million (of which $396.5 million related to real estate held for investment), approximately $32.1 million and approximately $184.3 million, respectively. Revenues, income and net assets generated by 100 First LLC and 303 Second LLC may only be used to settle their contractual obligations, which primarily consist of operating expenses, capital expenditures and required distributions.


10

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




At December 31, 2018, the consolidated financial statements of the Company and the Operating Partnership included three VIEs in which we were deemed to be the primary beneficiary: 100 First LLC, 303 Second LLC and an entity established during the fourth quarter of 2018 to facilitate a transaction intended to qualify as a like-kind exchange pursuant to Section 1031 of the Code (“Section 1031 Exchange”). In January 2019, the Section 1031 Exchange was successfully completed and the related VIE was terminated. At December 31, 2018, the impact of consolidating the VIEs increased the Company’s total assets, liabilities and noncontrolling interests on our consolidated balance sheet by approximately $615.4 million (of which $543.9 million related to real estate held for investment), approximately $45.1 million and approximately $186.4 million, respectively.
Accounting Pronouncements Adopted January 1, 2019

Effective January 1, 2019, we adopted Financial Accounting Standards Board (“FASB”) ASU No. 2016-02 “Leases (Topic 842)” (“Topic 842”) and the related FASB ASU Nos. 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01 which provide practical expedients, technical corrections and improvements for certain aspects of ASU 2016-02, on a modified retrospective basis. Topic 842 establishes a single comprehensive model for entities to use in accounting for leases and supersedes the existing leasing guidance. We evaluated each of the Company’s contracts to determine if the contract is or contains a lease and concluded that Topic 842 is applicable to the Company as a lessor in its tenant lease agreements and as a lessee in its ground leases.
Lessor Accounting
As a lessor, the Company’s leases with tenants for its real estate assets generally provide for the lease of space, as well as common area maintenance and parking. Under Topic 842, the lease of space is considered a lease component while the common area maintenance billings and tenant parking are considered nonlease components, which fall under revenue recognition guidance in Topic 606. However, upon adopting the guidance in Topic 842, the Company determined that its tenant leases met the criteria to apply the practical expedient provided by ASU 2018-11 to recognize the lease and non-lease components together as one single component. This conclusion was based on the consideration that 1) the timing and pattern of transfer of the nonlease components and associated lease component are the same, and 2) the lease component, if accounted for separately, would be classified as an operating lease. As the lease of space is the predominant component of the Company’s leasing arrangements, we accounted for all lease and non-lease components as one single component under Topic 842. As a result, the adoption of Topic 842 did not have any impact on the Company’s timing or pattern of recognition of rental revenues as compared to previous guidance. Transient daily parking revenue will be accounted for under the guidance in Topic 606 and included in other property income in our consolidated statements of operations.
To reflect their recognition as one lease component, rental revenues, tenant reimbursements and other lease related property income related to leases that also meet the requirements of the practical expedient provided by ASU 2018-11 have been combined in one line item subsequent to the adoption of Topic 842 for the three months ended March 31, 2019 in rental income on the Company’s consolidated statements of operations. In addition, under Topic 842, lessor costs for certain services directly reimbursed by tenants, which were previously presented on a net basis under previous guidance, are required to be presented on a gross basis in revenues and expenses. During the three months ended March 31, 2019, we incurred additional property expenses of $3.0 million, for which we were reimbursed, that were not required to be grossed up under the previous guidance. We presented this amount on a gross basis within rental income and property expenses in the Company’s consolidated statements of operations as a result of the adoption, which had no impact on net income.
Leasing Costs
Upon adoption of Topic 842, the Company elected to apply the package of practical expedients provided and did not reassess the following as of January 1, 2019: 1) whether any expired or existing contracts are or contain leases; 2) the lease classification for any expired or existing leases; and 3) initial direct costs for any existing leases. Under Topic 842, initial direct costs for both lessees and lessors would include only those costs that are incremental to the arrangement and would not have been incurred if the lease had not been obtained. As a result, beginning January 1, 2019, the Company will no longer capitalize internal leasing costs and third-party legal leasing costs and instead will expense these costs as incurred. These expenses are included in leasing costs and general and administrative expenses on our consolidated statements of operations in 2019. During the three months ended March 31, 2019, the Company expensed approximately $2.6 million of indirect leasing costs which would have been capitalized prior to the adoption of Topic 842.
The election of the package of practical expedients described above permits us to continue to account for our leases that commenced before January 1, 2019 under the previously existing lease accounting guidance for the remainder of their lease terms, and to apply the new lease accounting guidance to leases commencing or modified after January 1, 2019. On January 1, 2019, we recognized a $3.1 million cumulative-effect adjustment, primarily related to internal leasing costs and legal leasing costs for

11

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




tenant leases that had not commenced prior to that date, to increase distributions in excess of earnings for the Company and partners’ capital for the Operating Partnership in connection with our adoption of Topic 842.
Allowances for Tenant and Deferred Rent Receivables
Upon the adoption of Topic 842 on January 1, 2019, our determination of the adequacy of the Company’s allowances for tenant receivables includes a binary assessment of whether or not the amounts due under a tenant’s lease agreement are probable of collection. For such amounts that are deemed probable of collection, revenue continues to be recorded on a straight-line basis over the lease term. For such amounts that are deemed not probable of collection, revenue is recorded as the lesser of (i) the amount which would be recognized on a straight-line basis or (ii) cash that has been received from the tenant, with any tenant and deferred rent receivable balances charged as a direct write-off against rental income in the period of the change in the collectability determination. In addition, for tenant and deferred rent receivables deemed probable of collection we also may record an allowance under other authoritative GAAP depending upon our evaluation of the individual receivables, specific credit enhancements, current economic conditions, and other relevant factors. Such allowances are recorded as increases or decreases through rental income on our consolidated statements of operations.
Lessee Accounting
The Company’s ground leases are the primary contracts in which we are the lessee. Upon adoption of Topic 842 on January 1, 2019, the Company had four existing ground leases which were classified as operating leases. We elected to apply the practical expedient to use hindsight in determining the lease term of our existing ground leases. As discussed above, the Company also elected to apply the package of practical expedients provided by Topic 842 and therefore did not reassess the classification of these ground leases. Existing ground leases that commenced before the January 1, 2019 adoption date continued to be accounted for as operating leases, and the new guidance did not have a material impact on our recognition of ground lease expense or our results of operations. However, for periods beginning after January 1, 2019, we are now required to recognize a lease liability on our consolidated balance sheets equal to the present value of the minimum future lease payments required in accordance with each ground lease, as well as a right of use asset equal to the lease liability adjusted for above and below market intangibles and deferred leasing costs. The adoption of Topic 842 resulted in the recognition of right of use ground lease assets totaling $82.9 million and ground lease liabilities totaling $87.4 million on January 1, 2019. There was no material impact to our consolidated statements of operations or consolidated statements of cash flows as a result of adoption of this new guidance. For further information, refer to Note 9.

For leases with a term of 12 months or less where we are the lessee, we made an accounting policy election by class of underlying asset not to recognize right of use lease assets and lease liabilities. We recognize lease expense for such leases generally on a straight-line basis over the lease term.

The following are our updated significant accounting policies that have been affected by the adoption of Topic 842.

Significant Accounting Policies

Revenue Recognition and Allowances for Tenant and Deferred Rent Receivables

We recognize revenue from rent, tenant reimbursements, parking and other lease-related revenue once all of the following criteria are met: (i) the agreement has been fully executed and delivered, (ii) services have been rendered, (iii) the amount is fixed or determinable and (iv) payment has been received or the collectability of the amount due is probable. Lease termination fees are amortized over the remaining lease term, if applicable. If there is no remaining lease term, they are recognized when received and realized. Minimum annual rental revenues are recognized in rental revenues on a straight-line basis over the non-cancellable term of the related lease.

We carry our current and deferred rent receivables net of allowances for amounts that may not be collected. Prior to the adoption of Topic 842 on January 1, 2019, the allowances are increased or decreased through provision for bad debts on our consolidated statements of operations. Upon the adoption of Topic 842 on January 1, 2019, our determination of the adequacy of the Company's allowances for tenant receivables includes a binary assessment of whether or not the amounts due under a tenant’s lease agreement are probable of collection. For such amounts that are deemed probable of collection, revenue continues to be recorded on a straight-line basis over the lease term. For such amounts that are deemed not probable of collection, revenue is recorded as the lesser of (i) the amount which would be recognized on a straight-line basis or (ii) cash that has been received from the tenant, with any tenant and deferred rent receivable balances charged as a direct write-off against rental income in the period of the change in the collectability determination. In addition, for tenant and deferred rent receivables deemed probable of collection

12

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




we also may record an allowance under other authoritative GAAP depending upon our evaluation of the individual receivables, specific credit enhancements, current economic conditions, and other relevant factors. Such allowances are recorded as increases or decreases through rental income on our consolidated statements of operations. For the three months ended March 31, 2019 we recorded a reversal of an allowance for tenant and deferred rent receivables of $3.5 million resulting from the improved credit quality of a tenant that we previously recorded a provision against in Q2 2018. For the three months ended March 31, 2018 we recorded a reversal of an allowance for tenant and deferred rent receivables of $0.3 million related to three tenants.

Rental revenue recognition commences when the tenant takes possession or controls the physical use of the leased space. In order for the tenant to take possession, the leased space must be substantially complete and ready for its intended use. In order to determine whether the leased space is substantially complete and ready for its intended use, we begin by determining whether the Company or the tenant owns the tenant improvements. When we conclude that the Company is the owner of tenant improvements, rental revenue recognition begins when the tenant takes possession of the finished space, which is generally when Company-owned tenant improvements are substantially complete. In certain instances, when we conclude that the Company is not the owner (the tenant is the owner) of tenant improvements, rental revenue recognition begins when the tenant takes possession or controls the physical use of the leased space.

When we conclude that the Company is the owner of tenant improvements, we record the cost to construct the tenant improvements, including costs paid for or reimbursed by the tenants, as a capital asset. For these tenant improvements, we record the amount funded by or reimbursed by the tenants as deferred revenue, which is amortized on a straight-line basis as additional rental income over the term of the related lease.

When we conclude that the tenant is the owner of tenant improvements for accounting purposes, we record our contribution towards those improvements as a lease incentive, which is included in deferred leasing costs and acquisition-related intangible assets, net on our consolidated balance sheets and amortized as a reduction to rental income on a straight-line basis over the term of the related lease.

For residential properties, we commence revenue recognition upon lease commencement. Residential rental revenue is recognized on a straight-line basis over the term of the related lease, net of any concessions.

Tenant Reimbursements

Reimbursements from tenants, consisting of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, are recognized in rental income subsequent to the adoption of Topic 842 in the period the recoverable costs are incurred. Tenant reimbursements where we pay the associated costs directly to third-party vendors and are reimbursed by our tenants are recognized and recorded on a gross basis.

Other Property Income

Other property income primarily includes amounts recorded in connection with transient daily parking, tenant bankruptcy settlement payments, broken deal income and property damage settlement related payments. Other property income also includes miscellaneous income from tenants, restoration fees and fees for late rental payments. Amounts recorded within other property income fall within the scope of Topic 606 and are accounted for at the point in time when control of the goods or services transfers to the customer and our performance obligation is satisfied.

Accounting Pronouncements Effective in 2020 and Beyond

ASU No. 2016-13 “Financial Instruments - Credit Losses (Topic 326)”

On June 16, 2016, the FASB issued ASU No. 2016-13 (“ASU 2016-13”) to amend the accounting for credit losses for certain financial instruments. Under the new guidance, an entity recognizes its estimate of expected credit losses as an allowance, which the FASB believes will result in more timely recognition of such losses.  In November 2018, the FASB released ASU No. 2018-19 “Codification Improvements to Topic 326, Financial Instrument - Credit Losses.” This ASU clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20 “Financial Instruments – Credit Losses.” Instead, impairment of receivables arising from operating leases should be accounted for under Subtopic 842-30 “Leases – Lessor.” ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not anticipate that the guidance will have an impact on its consolidated financial statements or notes to its consolidated financial statements.

13

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




ASU No. 2018-13 “Fair Value Measurement (Topic 820)”
On August 28, 2018, the FASB issued ASU No. 2018-13 (“ASU 2018-13”) to amend the disclosure requirements for fair value measurements. The amendments in ASU 2018-13 include new, modified and eliminated disclosure requirements and are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting - Chapter 8: Notes to Financial Statements (the “Concepts Statement”), which the FASB finalized on August 28, 2018. The FASB used the guidance in the Concepts Statement to improve the effectiveness of Topic 820’s disclosure requirements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for any eliminated or modified disclosures. The Company currently anticipates that the guidance will not have a significant impact on the disclosures in the notes to its consolidated financial statements.
ASU No. 2018-15 “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40)”
On August 29, 2018, the FASB issued ASU No. 2018-15 (“ASU 2018-15”) to amend a customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. ASU 2018-15 can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact of ASU 2018-15 on its consolidated financial statements and notes to its consolidated financial statements.
2.    Prepaid Expenses and Other Assets, Net

Prepaid expenses and other assets, net consisted of the following at March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Furniture, fixtures and other long-lived assets, net
$
36,043

 
$
36,833

Notes receivable, net (1)
1,488

 
2,113

Prepaid expenses
12,829

 
13,927

Total prepaid expenses and other assets, net
$
50,360

 
$
52,873

________________________
(1)
Notes receivable are shown net of a valuation allowance of approximately $3.6 million and $2.9 million as of March 31, 2019 and December 31, 2018, respectively.

3.    Secured and Unsecured Debt of the Operating Partnership

Secured Debt

On February 11, 2019, the Company repaid at par a secured mortgage note payable for $74.3 million that was due in June 2019.

Unsecured Debt

The Company generally guarantees all of the Operating Partnership’s unsecured debt obligations including the unsecured revolving credit facility, the unsecured term loan facility and all of the unsecured senior notes.

Unsecured Revolving Credit Facility and Term Loan Facility

The following table summarizes the balance and terms of our unsecured revolving credit facility as of March 31, 2019 and December 31, 2018:


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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Outstanding borrowings
$
185,000

 
$
45,000

Remaining borrowing capacity
565,000

 
705,000

Total borrowing capacity (1)
$
750,000

 
$
750,000

Interest rate (2)
3.50
%
 
3.48
%
Facility fee-annual rate (3)
0.200%
Maturity date
July 2022
________________________
(1)
We may elect to borrow, subject to bank approval and obtaining commitments for any additional borrowing capacity, up to an additional $600.0 million under an accordion feature under the terms of the unsecured revolving credit facility and unsecured term loan facility.
(2)
Our unsecured revolving credit facility interest rate was calculated based on the contractual rate of LIBOR plus 1.000% as of March 31, 2019 and December 31, 2018.
(3)
Our facility fee is paid on a quarterly basis and is calculated based on the total borrowing capacity. In addition to the facility fee, we incurred debt origination and legal costs. As of March 31, 2019 and December 31, 2018, $4.4 million and $4.7 million of unamortized deferred financing costs, respectively, which are included in prepaid expenses and other assets, net on our consolidated balance sheets, remained to be amortized through the maturity date of our unsecured revolving credit facility.

The Company intends to borrow under the unsecured revolving credit facility from time to time for general corporate purposes, to finance development and redevelopment expenditures, to fund potential acquisitions and to potentially repay long-term debt.

The following table summarizes the balance and terms of our unsecured term loan facility as of March 31, 2019 and December 31, 2018:

 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Outstanding borrowings
$
150,000

 
$
150,000

Remaining borrowing capacity

 

Total borrowing capacity (1)
$
150,000

 
$
150,000

Interest rate (2)
3.60
%
 
3.49
%
Undrawn facility fee-annual rate (3)
0.200%
Maturity date
July 2022
________________________
(1)
As of March 31, 2019 and December 31, 2018, $0.8 million and $0.9 million of unamortized deferred financing costs, respectively, remained to be amortized through the maturity date of our unsecured term loan facility.
(2)
Our unsecured term loan facility interest rate was calculated based on the contractual rate of LIBOR plus 1.100% as of March 31, 2019 and December 31, 2018.
(3)
Prior to borrowing the full capacity of our unsecured term loan facility, the undrawn facility fee was calculated based on any unused borrowing capacity and was paid on a quarterly basis.

Debt Covenants and Restrictions

The unsecured revolving credit facility, the unsecured term loan facility, the unsecured senior notes, the Series A and B Notes due 2026 and Series A and B Notes due 2027 and 2029 and certain other secured debt arrangements contain covenants and restrictions requiring us to meet certain financial ratios and reporting requirements. Some of the more restrictive financial covenants include a maximum ratio of total debt to total asset value, a minimum fixed-charge coverage ratio, a minimum unsecured debt ratio and a minimum unencumbered asset pool debt service coverage ratio. Noncompliance with one or more of the covenants and restrictions could result in the full principal balance of the associated debt becoming immediately due and payable. We believe we were in compliance with all of our debt covenants as of March 31, 2019.

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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





Debt Maturities

The following table summarizes the stated debt maturities and scheduled amortization payments of our issued and outstanding debt as of March 31, 2019:

Year
(in thousands) 
Remaining 2019
$
1,380

2020
5,137

2021
5,342

2022
340,554

2023
305,775

Thereafter
2,362,694

Total aggregate principal value (1)
$
3,020,882

________________________ 
(1)
Includes gross principal balance of outstanding debt before the effect of the following at March 31, 2019: $16.7 million of unamortized deferred financing costs for the unsecured term loan facility, unsecured senior notes and secured debt and $6.4 million of unamortized discounts for the unsecured senior notes.

Capitalized Interest and Loan Fees

The following table sets forth gross interest expense, including debt discount/premium and deferred financing cost amortization, net of capitalized interest, for the three months ended March 31, 2019 and 2018. The interest expense capitalized was recorded as a cost of development and increased the carrying value of undeveloped land and construction in progress.

 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Gross interest expense
$
30,680

 
$
27,080

Capitalized interest and deferred financing costs
(19,437
)
 
(13,582
)
Interest expense
$
11,243

 
$
13,498


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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




4.    Stockholders’ Equity of the Company

At-The-Market Stock Offering Program

Under our at-the-market stock offering program, which commenced in June 2018, we may offer and sell shares of our common stock having an aggregate gross sales price up to $500.0 million from time to time in “at-the-market” offerings. In connection with the at-the-market program, the Company may enter into forward equity sale agreements with certain financial institutions acting as forward purchasers whereby, at our discretion, the forward purchasers may borrow and sell shares of our common stock under our at-the-market program. The use of a forward equity sale agreement allows the Company to lock in a share price on the sale of shares of our common stock at the time the agreement is executed but defer settling the forward equity sale agreements and receiving the proceeds from the sale of shares until a later date.

During the three months ended March 31, 2019, we executed 12-month forward equity sale agreements with financial institutions acting as forward purchasers under our at-the-market stock offering program to sell 875,494 shares of common stock at a weighted average sales price of $75.75 per share before underwriting discounts, commissions and offering expenses. The Company did not receive any proceeds from the sale of its common shares by the forward purchasers. The Company currently expects to fully physically settle the forward equity sale agreements and receive cash proceeds upon one or more settlement dates, at the Company’s discretion, prior to the final settlement dates under the forward equity sale agreements in March and April 2020, in which case we expect to receive aggregate net cash proceeds at settlement equal to the number of shares specified in such forward equity sale agreement multiplied by the relevant forward price per share. The weighted average forward sale price that we expect to receive upon physical settlement of the agreements will be subject to adjustment for (i) a floating interest rate factor equal to a specified daily rate less a spread, (ii) the forward purchasers’ stock borrowing costs and (iii) scheduled dividends during the term of the agreements. We have not settled any portion of these forward equity sale agreements as of the date of this filing. Upon physical settlement, the Company will contribute the net proceeds from the issuance of shares of our common stock to the Operating Partnership in exchange for an equal number of units in the Operating Partnership.

Since commencement of the program, we have completed sales of 447,466 shares of common stock through March 31, 2019 and 875,494 shares have been sold by forward purchasers under forward equity sale agreements, which have not been settled as of the date of this filing. We did not settle any forward sales of common stock under our at-the-market program during the three months ended March 31, 2019 and as of March 31, 2019, approximately $399.9 million remains available to be sold under this program. Actual future sales will depend upon a variety of factors, including but not limited to, market conditions, the trading price of the Company’s common stock and our capital needs. We have no obligation to sell the remaining shares available for sale under this program.

Forward Equity Sale Agreements

In August 2018, the Company entered into forward equity sale agreements with certain financial institutions acting as forward purchasers in connection with an offering of 5,000,000 shares of common stock at an initial gross offering price of $360.5 million, or $72.10 per share, before underwriting discounts, commissions and offering expenses. The forward purchasers borrowed and sold an aggregate of 5,000,000 shares of common stock in the offering. The Company did not receive any proceeds from the sale of its shares of common stock by the forward purchasers at the time of the offering. The Company currently expects to fully physically settle the forward sale agreements and receive cash proceeds upon one or more settlement dates, at the Company’s discretion, prior to the final settlement date under the forward sale agreements of August 1, 2019, in which case we expect to receive aggregate net cash proceeds at settlement equal to the number of shares specified in such forward equity sale agreement multiplied by the relevant forward price per share. The forward sale price that we expect to receive upon physical settlement of the agreements, which was initially $71.68 per share, will be subject to adjustment for (i) a floating interest rate factor equal to a specified daily rate less a spread, (ii) the forward purchasers’ stock borrowing costs and (iii) scheduled dividends during the term of the forward equity sale agreements. We have not settled any portion of these forward equity sale agreements as of the date of this filing. Upon physical settlement, the Company will contribute the net proceeds from the issuance of shares of our common stock to the Operating Partnership in exchange for an equal number of units in the Operating Partnership.


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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




5.    Noncontrolling Interests on the Company’s Consolidated Financial Statements

Common Units of the Operating Partnership

The Company owned an approximate 98.0%, 98.0%, and 97.9% common general partnership interest in the Operating Partnership as of March 31, 2019, December 31, 2018 and March 31, 2018, respectively. The remaining approximate 2.0%, 2.0%, and 2.1% common limited partnership interest as of March 31, 2019, December 31, 2018 and March 31, 2018, respectively, was owned by non-affiliated investors and certain of our executive officers and directors in the form of noncontrolling common units. There were 2,023,287, 2,025,287 and 2,070,690 common units outstanding held by these investors, executive officers and directors as of March 31, 2019, December 31, 2018 and March 31, 2018, respectively.

The noncontrolling common units may be redeemed by unitholders for cash. Except under certain circumstances, we, at our option, may satisfy the cash redemption obligation with shares of the Company’s common stock on a one-for-one basis. If satisfied in cash, the value for each noncontrolling common unit upon redemption is the amount equal to the average of the closing quoted price per share of the Company’s common stock, par value $.01 per share, as reported on the NYSE for the ten trading days immediately preceding the applicable redemption date. The aggregate value upon redemption of the then-outstanding noncontrolling common units was $153.3 million and $126.4 million as of March 31, 2019 and December 31, 2018, respectively. This redemption value does not necessarily represent the amount that would be distributed with respect to each noncontrolling common unit in the event of our termination or liquidation. In the event of our termination or liquidation, it is expected in most cases that each common unit would be entitled to a liquidating distribution equal to the liquidating distribution payable in respect of each share of the Company’s common stock.

6.    Partners’ Capital of the Operating Partnership

Common Units Outstanding

The following table sets forth the number of common units held by the Company and the number of common units held by non-affiliated investors and certain of our executive officers and directors in the form of noncontrolling common units as well as the ownership interest held on each respective date:

 
March 31, 2019
 
December 31, 2018
 
March 31, 2018
Company owned common units in the Operating Partnership
100,967,024

 
100,746,988

 
98,839,708

Company owned general partnership interest
98.0
%
 
98.0
%
 
97.9
%
Noncontrolling common units of the Operating Partnership
2,023,287

 
2,025,287

 
2,070,690

Ownership interest of noncontrolling interest
2.0
%
 
2.0
%
 
2.1
%

For further discussion of the noncontrolling common units as of March 31, 2019 and December 31, 2018, refer to Note 5.

7.    Share-Based Compensation

Stockholder Approved Equity Compensation Plans

As of March 31, 2019, we maintained one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan, as amended (the “2006 Plan”). The Company has a currently effective registration statement registering 9.2 million shares of our common stock for possible issuance under the 2006 Plan. As of March 31, 2019, approximately 0.3 million shares were available for grant under the 2006 Plan. The calculation of shares available for grant is presented after taking into account a reserve for a sufficient number of shares to cover the vesting and payment of 2006 Plan awards that were outstanding on that date, including performance-based vesting awards at (i) levels actually achieved for the performance conditions (as defined below) for which the performance period has been completed and (ii) at maximum levels for the performance and market conditions (as defined below) for awards still in a performance period.

2019 Share-Based Compensation Grants

In February 2019, the Executive Compensation Committee of the Company’s Board of Directors awarded 288,378 restricted stock units (“RSUs”) to certain officers of the Company under the 2006 Plan, which included 143,396 RSUs (at the target level

18

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




of performance) that are subject to market and/or performance-based vesting requirements (the “2019 Performance-Based RSUs”) and 144,982 RSUs that are subject to time-based vesting requirements (the “2019 Time-Based RSUs”).

2019 Performance-Based RSU Grant

The 2019 Performance-Based RSUs are scheduled to vest at the end of a three-year period (consisting of calendar years 2019-2021). A target number of 2019 Performance-Based RSUs were awarded, and the final number of 2019 Performance-Based RSUs that vest (which may be more or less than the target number) will be based upon (1) the achievement of pre-set FFO per share goals for the year ending December 31, 2019 that applies to 100% of the Performance-Based RSUs awarded (the “FFO performance condition”) and (2) a performance measure that applies to 50% of the award based upon a measure of the Company’s average debt to EBITDA ratio for the three-year performance period (the “debt to EBITDA ratio performance condition”) and a market measure that applies to the other 50% of the award based upon the relative ranking of the Company’s total stockholder return for the three-year performance period compared to the total stockholder returns of an established comparison group of companies over the same period (the “market condition”). The 2019 Performance-Based RSUs are also subject to a three-year service vesting provision (the “service vesting condition”) and are scheduled to cliff vest on the date the final vesting percentage is determined following the end of the three-year performance period under the awards. The number of 2019 Performance-Based RSUs ultimately earned could fluctuate from the target number of 2019 Performance-Based RSUs granted based upon the levels of achievement for the FFO performance condition, the debt to EBITDA ratio performance condition, the market condition, and the extent to which the service vesting condition is satisfied. The estimate of the number of 2019 Performance-Based RSUs earned is evaluated quarterly during the performance period based on our estimate for each of the performance conditions measured against the applicable goals. As of March 31, 2019, the number of 2019 Performance-Based RSUs estimated to be earned based on the Company’s estimate of the performance conditions measured against the applicable goals was 143,396, and the compensation cost recorded to date for this program was based on that estimate. Compensation expense for the 2019 Performance-Based RSU grant is recognized on a straight-line basis over the requisite service period for each participant, which is generally the three-year service period.

Each 2019 Performance-Based RSU represents the right, subject to the applicable vesting conditions, to receive one share of our common stock in the future. The determination of the grant date fair value of the portion of the 2019 Performance-Based RSU grants covered by the debt to EBITDA ratio performance condition was based on the $69.89 share price on the February 1, 2019 grant date. The determination of the grant date fair value of the portion of the 2019 Performance-Based RSU grants covered by the market condition was calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below, which resulted in a $72.57 grant date fair value per share.
 
Fair Value Assumptions
Valuation date
February 1, 2019
Expected share price volatility
19.0%
Risk-free interest rate
2.48%
Fair value per share on valuation date
72.57

The computation of expected volatility is based on a blend of the historical volatility of our shares of common stock over approximately 5.8 years, as that is expected to be most consistent with future volatility and equates to a time period twice as long as the approximate 2.9-year performance period of the RSUs, and implied volatility data based on the observed pricing of six month publicly-traded options on our shares of common stock. The risk-free interest rate is based on the yield curve on zero-coupon U.S. Treasury STRIP securities in effect at February 1, 2019.

The total grant date fair value of the 2019 Performance-Based RSU awards was $10.2 million on the February 1, 2019 grant date of the awards. For the three months ended March 31, 2019, we recorded compensation expense based upon the grant date fair value per share for each component multiplied by the estimated number of RSUs to be earned as discussed above.


19

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




2019 Time-Based RSU Grant

The 2019 Time-Based RSUs are scheduled to vest in three equal annual installments beginning on January 5, 2020 through January 5, 2022. Compensation expense for the 2019 Time-Based RSUs is recognized on a straight-line basis over the requisite service period for each participant, which is generally the three-year service vesting period. Each 2019 Time-Based RSU represents the right to receive one share of our common stock in the future. The total grant date fair value of the 2019 Time-Based RSU awards was $10.1 million, which was based on the $69.89 closing share price of the Company’s common stock on the NYSE on the February 1, 2019 grant date of the awards.

Share-Based Compensation Cost Recorded During the Period

The total compensation cost for all share-based compensation programs was $8.8 million and $5.1 million for the three months ended March 31, 2019 and 2018, respectively. Of the total share-based compensation costs, $1.6 million was capitalized as part of real estate assets for the three months ended March 31, 2019, and $1.5 million was capitalized as part of real estate assets and deferred leasing costs for the three months ended March 31, 2018. As of March 31, 2019, there was approximately $73.8 million of total unrecognized compensation cost related to nonvested incentive awards granted under share-based compensation arrangements that is expected to be recognized over a weighted-average period of 2.8 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to March 31, 2019.

8.    Future Minimum Rent
  
We have operating leases with tenants that expire at various dates through 2043 and are either subject to scheduled fixed increases or adjustments in rent based on the Consumer Price Index. Generally, the leases grant tenants renewal options. Leases also provide for additional rents based on certain operating expenses. Future contractual minimum rent under operating leases as of March 31, 2019 (under Topic 842) for future periods is summarized as follows:

Year Ending
(in thousands)
Remaining 2019
$
433,921

2020
645,256

2021
641,565

2022
643,068

2023
609,814

2024
561,301

Thereafter
2,782,219

Total (1)
$
6,317,144

______________
(1)
Excludes residential leases and leases with a term of one year or less.

Future contractual minimum rent under operating leases as of December 31, 2018 for future periods is summarized as follows:

Year Ending
(in thousands)
2019
$
566,783

2020
632,875

2021
631,835

2022
620,684

2023
586,371

Thereafter
3,240,143

Total (1)
$
6,278,691

______________
(1)
Excludes residential leases and leases with a term of one year or less.


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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




9.    Commitments and Contingencies

General

As of March 31, 2019, we had commitments of approximately $1.2 billion, excluding our ground lease commitments, for contracts and executed leases directly related to our operating properties and development projects.

Ground Leases

The following table summarizes our properties that are held subject to long-term noncancellable ground lease obligations and the respective contractual expiration dates:

Property
Contractual Expiration Date (1)
601 108th Ave NE, Bellevue, WA
November 2093
701, 801 and 837 N. 34th Street, Seattle, WA (2)
December 2041
1701 Page Mill Road and 3150 Porter Drive, Palo Alto, CA
December 2067
Kilroy Airport Center Phases I, II, and III, Long Beach, CA
July 2084
____________________
(1)
Reflects the contractual expiration date prior to the impact of any extension or purchase options held by the Company.
(2)
The Company has three 10-year and one 45-year extension options for this ground lease, which if exercised would extend the expiration date to December 2116. These extensions options are not assumed to be exercised in our calculation of the present value of the future minimum lease payments for this lease.

On January 1, 2019, we adopted Topic 842 and recognized ground lease liabilities on our consolidated balance sheets equal to the present value of the minimum lease payments required in accordance with each ground lease. We also recognized right of use ground lease assets equal to the ground lease liabilities adjusted for above and below market ground lease intangibles and deferred leasing costs. To determine the discount rates used to calculate the present value of the lease payments, we used a hypothetical curve derived from unsecured corporate borrowing rates over the lease terms. The weighted average discount rate for our ground leases was 5.15%. On January 1, 2019, we recognized right of use ground lease assets totaling $82.9 million and ground lease liabilities totaling $87.4 million. As of March 31, 2019, the weighted average remaining lease term of our ground leases is 52 years. For the three months ended March 31, 2019, variable lease costs totaling $0.7 million were recorded to ground leases expense on our consolidated statements of operations.

The minimum commitment under our ground leases as of March 31, 2019 (under Topic 842) for future periods is summarized as follows:

Year Ending
(in thousands) 
Remaining 2019
$
3,865

2020
5,154

2021
5,154

2022
5,154

2023
5,154

2024
5,154

Thereafter
228,465

Total undiscounted cash flows (1)(2)(3)(4)(5)
258,100

Present value discount
(170,853
)
Ground lease liabilities
$
87,247

________________________
(1)
Excludes contingent future rent payments based on gross income or adjusted gross income and reflects the minimum ground lease obligations before the impact of ground lease extension options.
(2)
One of our ground lease obligations is subject to a fair market value adjustment every five years; however, the lease includes ground rent subprotection and infrastructure rent credits which currently limit our annual rental obligations to $1.0 million. The contractual obligations for that ground lease included above assumes the lesser of $1.0 million or annual lease rental obligation in effect as of March 31, 2019.
(3)
One of our ground lease obligations includes a component which is based on the percentage of gross income that exceeds the minimum ground rent. The minimum rent is subject to increases every five years based on 50% of the average annual percentage rent for the previous five years. The contractual obligations for that lease included above assume the current annual ground lease obligation in effect at March 31, 2019 for the remainder of the lease term since we cannot predict future adjustments.
(4)
One of our ground lease obligations is subject to a fair market value adjustment every five years based on a combination of CPI adjustments and third-party appraisals limited to maximum increases annually. The contractual obligations for that lease included above assume the current annual ground lease obligation in effect at March 31, 2019 for the remainder of the lease term since we cannot predict future adjustments.
(5)
One of our ground lease obligations includes a component which is based on the percentage of adjusted gross income that exceeds the minimum ground rent. The minimum rent is subject to increases every ten years by an amount equal to 60% of the average annual percentage rent for the previous three years. The

21

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




contractual obligations for this lease included above assume the current annual ground lease obligation in effect at March 31, 2019 for the remainder of the lease term since we cannot predict future adjustments.

The minimum commitment under our ground leases as of December 31, 2018 for future periods is summarized as follows:

Year Ending
(in thousands) 
2019
$
5,154

2020
5,154

2021
5,154

2022
5,154

2023
5,154

Thereafter
233,619

Total (1)(2)(3)(4)(5)
$
259,389

________________________
(1)
Excludes contingent future rent payments based on gross income or adjusted gross income and reflects the minimum ground lease obligations before the impact of ground lease extension options.
(2)
One of our ground lease obligations is subject to a fair market value adjustment every five years; however, the lease includes ground rent subprotection and infrastructure rent credits which currently limit our annual rental obligations to $1.0 million. The contractual obligations for that ground lease included above assumes the lesser of $1.0 million or annual lease rental obligation in effect as of December 31, 2018.
(3)
One of our ground lease obligations includes a component which is based on the percentage of gross income that exceeds the minimum ground rent. The minimum rent is subject to increases every five years based on 50% of the average annual percentage rent for the previous five years. The contractual obligations for that lease included above assume the current annual ground lease obligation in effect at December 31, 2018 for the remainder of the lease term since we cannot predict future adjustments.
(4)
One of our ground lease obligations is subject to a fair market value adjustment every five years based on a combination of CPI adjustments and third-party appraisals limited to maximum increases annually. The contractual obligations for that lease included above assume the current annual ground lease obligation in effect at December 31, 2018 for the remainder of the lease term since we cannot predict future adjustments.
(5)
One of our ground lease obligations includes a component which is based on the percentage of adjusted gross income that exceeds the minimum ground rent. The minimum rent is subject to increases every ten years by an amount equal to 60% of the average annual percentage rent for the previous three years. The contractual obligations for this lease included above assume the current annual ground lease obligation in effect at December 31, 2018 for the remainder of the lease term since we cannot predict future adjustments.

Environmental Matters

We follow the policy of monitoring all of our properties, including acquisition, development and existing stabilized portfolio properties, for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to our stabilized portfolio properties that would have a material adverse effect on our financial condition, results of operations and cash flow, or that we believe would require additional disclosure or the recording of a loss contingency.

As of March 31, 2019, we had accrued environmental remediation liabilities of approximately $74.4 million recorded on our consolidated balance sheets in connection with certain of our in-process and future development projects. The accrued environmental remediation liabilities represent the remaining costs we estimate we will incur prior to and during the development process at various development acquisition sites. These estimates, which we developed with the assistance of third party experts, consist primarily of the removal of contaminated soil, performing environmental closure activities, constructing remedial systems and other related costs since we are required to dispose of any existing contaminated soil and sometimes perform other environmental closure or remedial activities when we develop new buildings at these sites.

We record estimated environmental remediation obligations for acquired properties at the acquisition date when we are aware of such costs and when such costs are probable of being incurred and can be reasonably estimated. Estimated costs related to development environmental remediation liabilities are recorded as an increase to the cost of the development project. Actual costs are recorded as a decrease to the liability when incurred. These accruals are adjusted as an increase or decrease to the development project costs and as an increase or decrease to the accrued environmental remediation liability if we obtain further information or circumstances change. The environmental remediation obligations recorded at March 31, 2019 were not discounted to their present values since the amount and timing of cash payments are not fixed. It is possible that we could incur additional environmental remediation costs in connection with these development projects.  However, potential additional environmental costs for these development projects cannot be reasonably estimated at this time and certain changes in estimates could occur as the site conditions, final project timing, design elements, actual soil conditions and other aspects of the projects, which may depend upon municipal and other approvals beyond the control of the Company, are determined.


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KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




Other than the accrued environmental liabilities discussed above, we are not aware of any unasserted claims and assessments with respect to an environmental liability that we believe would require additional disclosure or the recording of an additional loss contingency.

10.    Fair Value Measurements and Disclosures

Assets and Liabilities Reported at Fair Value

The only assets we record at fair value on our consolidated financial statements are the marketable securities related to our Deferred Compensation Plan. The following table sets forth the fair value of our marketable securities as of March 31, 2019 and December 31, 2018:

 
Fair Value (Level 1) (1)
 
March 31, 2019
 
December 31, 2018
Description
(in thousands)
Marketable securities (2)
$
24,098

 
$
21,779

________________________
(1)
Based on quoted prices in active markets for identical securities.
(2)
The marketable securities are held in a limited rabbi trust.

We report the change in the fair value of the marketable securities at the end of each accounting period in interest income and other net investment gain/loss in the consolidated statements of operations. We also adjust the related Deferred Compensation Plan liability to fair value at the end of each accounting period based on the performance of the benchmark funds selected by each participant, which results in a corresponding increase or decrease to compensation cost for the period.

The following table sets forth the net gain (loss) on marketable securities recorded during the three months ended March 31, 2019 and 2018:

 
Three Months Ended March 31,

2019
 
2018
Description
(in thousands)
Net gain (loss) on marketable securities
$
1,681

 
$
(404
)
    
Financial Instruments Disclosed at Fair Value

The following table sets forth the carrying value and the fair value of our other financial instruments as of March 31, 2019 and December 31, 2018:

 
March 31, 2019
 
December 31, 2018
 
Carrying
Value
 
Fair
Value
(1)
 
Carrying
Value
 
Fair
Value
 (1)
 
(in thousands)
Liabilities
 
 
 
 
 
 
 
Secured debt, net
$
259,878

 
$
264,029

 
$
335,531

 
$
335,885

Unsecured debt, net
2,552,883

 
2,622,474

 
2,552,070

 
2,546,386

Unsecured line of credit
185,000

 
185,158

 
45,000

 
45,058

________________________
(1)
Fair value calculated using Level II inputs, which are based on model-derived valuations in which significant inputs and significant value drivers are observable in active markets.
 

23

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




11.    Net Income Available to Common Stockholders Per Share of the Company

The following table reconciles the numerator and denominator in computing the Company’s basic and diluted per-share computations for net income available to common stockholders for the three months ended March 31, 2019 and 2018:

 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
Net income attributable to Kilroy Realty Corporation
$
36,903

 
$
36,246

Allocation to participating securities (1)
(509
)
 
(471
)
Numerator for basic and diluted net income available to common stockholders
$
36,394

 
$
35,775

Denominator:
 
 
 
Basic weighted average vested shares outstanding
100,901,390

 
98,744,220

Effect of dilutive securities
541,789

 
469,390

Diluted weighted average vested shares and common share equivalents outstanding
101,443,179

 
99,213,610

Basic earnings per share:
 
 
 
Net income available to common stockholders per share
$
0.36

 
$
0.36

Diluted earnings per share:
 
 
 
Net income available to common stockholders per share
$
0.36

 
$
0.36

________________________ 
(1)
Participating securities include nonvested shares, certain time-based RSUs and vested market measure-based RSUs.

Share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are considered participating securities. The impact of potentially dilutive common shares, including stock options, RSUs, shares issuable under forward equity sale agreements and other securities are considered in our diluted earnings per share calculation for the three months ended March 31, 2019 and 2018. Certain market measure-based RSUs are not included in dilutive securities for the three months ended March 31, 2019 and 2018, as not all performance metrics had been met by the end of the applicable reporting periods.

See Note 7 “Share-Based Compensation” for additional information regarding share-based compensation.


24

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




12.    Net Income Available to Common Unitholders Per Unit of the Operating Partnership

The following table reconciles the numerator and denominator in computing the Operating Partnership’s basic and diluted per-unit computations for net income available to common unitholders for the three months ended March 31, 2019 and 2018:

 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands, except unit and per unit amounts)
Numerator:
 
 
 
Net income attributable to Kilroy Realty, L.P.
$
37,508

 
$
36,893

Allocation to participating securities (1)
(509
)
 
(471
)
Numerator for basic and diluted net income available to common unitholders
$
36,999

 
$
36,422

Denominator:
 
 
 
Basic weighted average vested units outstanding
102,925,166

 
100,815,477

Effect of dilutive securities
541,789

 
469,390

Diluted weighted average vested units and common unit equivalents outstanding
103,466,955

 
101,284,867

Basic earnings per unit:
 
 
 
Net income available to common unitholders per unit
$
0.36

 
$
0.36

Diluted earnings per unit:
 
 
 
Net income available to common unitholders per unit
$
0.36

 
$
0.36

________________________ 
(1)
Participating securities include nonvested shares, certain time-based RSUs and vested market measure-based RSUs.

Share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are considered participating securities. The impact of potentially dilutive common units, including stock options, RSUs, shares issuable under forward equity sale agreements and other securities are considered in our diluted earnings per share calculation for the three months ended March 31, 2019 and 2018. Certain market measure-based RSUs are not included in dilutive securities for the three months ended March 31, 2019 and 2018, as not all performance metrics had been met by the end of the applicable reporting periods.

See Note 7 “Share-Based Compensation” for additional information regarding share-based compensation.


25

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




13.    Supplemental Cash Flow Information of the Company

Supplemental cash flow information is included as follows (in thousands):

 
Three Months Ended March 31,
 
2019
 
2018
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest of $18,901 and $13,051 as of March 31, 2019 and 2018, respectively
$
4,706

 
$
9,699

Cash paid for amounts included in the measurement of ground lease liabilities
$
1,220

 
$
1,239

NON-CASH INVESTING TRANSACTIONS:
 
 
 
Accrual for expenditures for operating properties and development properties
$
87,038

 
$
57,155

Tenant improvements funded directly by tenants
$
2,682

 
$
2,014

Initial measurement of operating right of use ground lease assets
$
82,938

 
$

Initial measurement of operating ground lease liabilities
$
87,409

 
$

NON-CASH FINANCING TRANSACTIONS:
 
 
 
Accrual of dividends and distributions payable to common stockholders and common unitholders
$
47,676

 
$
43,512

Exchange of common units of the Operating Partnership into shares of the Company’s common stock
$
78

 
$
244


The following is a reconciliation of our cash and cash equivalents and restricted cash at the beginning and end of the three months ended March 31, 2019 and 2018.

 
Three Months Ended March 31,
 
2019
 
2018
RECONCILIATION OF CASH AND CASH EQUIVALENTS AND RESTRICTED CASH:
 
 
 
Cash and cash equivalents at beginning of period
$
51,604

 
$
57,649

Restricted cash at beginning of period
119,430

 
9,149

Cash and cash equivalents and restricted cash at beginning of period
$
171,034

 
$
66,798

 
 
 
 
Cash and cash equivalents at end of period
$
49,693

 
$
53,069

Restricted cash at end of period
6,300

 

Cash and cash equivalents and restricted cash at end of period
$
55,993

 
$
53,069


14.    Supplemental Cash Flow Information of the Operating Partnership:

Supplemental cash flow information is included as follows (in thousands):

 
Three Months Ended March 31,
 
2019
 
2018
SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Cash paid for interest, net of capitalized interest of $18,901 and $13,051 as of March 31, 2019 and 2018, respectively
$
4,706

 
$
9,699

Cash paid for amounts included in the measurement of ground lease liabilities
$
1,220

 
$
1,239

NON-CASH INVESTING TRANSACTIONS:
 
 
 
Accrual for expenditures for operating properties and development properties
$
87,038

 
$
57,155

Tenant improvements funded directly by tenants
$
2,682

 
$
2,014

Initial measurement of operating right of use ground lease assets
$
82,938

 
$

Initial measurement of operating ground lease liabilities
$
87,409

 
$

NON-CASH FINANCING TRANSACTIONS:
 
 
 
Accrual of distributions payable to common unitholders
$
47,676

 
$
43,512


The following is a reconciliation of our cash and cash equivalents and restricted cash at the beginning and end of the three months ended March 31, 2019 and 2018.


26

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)




 
Three Months Ended March 31,
 
2019
 
2018
RECONCILIATION OF CASH AND CASH EQUIVALENTS AND RESTRICTED CASH:
 
 
 
Cash and cash equivalents at beginning of period
$
51,604

 
$
57,649

Restricted cash at beginning of period
119,430

 
9,149

Cash and cash equivalents and restricted cash at beginning of period
$
171,034

 
$
66,798

 
 
 
 
Cash and cash equivalents at end of period
$
49,693

 
$
53,069

Restricted cash at end of period
6,300

 

Cash and cash equivalents and restricted cash at end of period
$
55,993

 
$
53,069


15.    Subsequent Events

On April 17, 2019, aggregate dividends, distributions and dividend equivalents of $47.6 million were paid to common stockholders, common unitholders and RSU holders of record on March 29, 2019.

In April, financial institutions acting as forward purchasers under our at-the-market stock offering program sold an additional 325,710 shares of common stock at a weighted average sales price of $76.39 per share before underwriting discounts, commissions and offering expenses. The Company did not receive any proceeds from the sale of its common shares by the forward purchasers. As of the date of this report, approximately $375.0 million remains available to be sold under this program.

27


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

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. The results of operations discussion is combined for the Company and the Operating Partnership because there are no material differences in the results of operations between the two reporting entities.

Forward-Looking Statements

Statements contained in this “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Forward-looking statements include, among other things, statements or information concerning our plans, objectives, capital resources, portfolio performance, results of operations, projected future occupancy and rental rates, lease expirations, debt maturities, potential investments, strategies such as capital recycling, development and redevelopment activity, projected construction costs, projected construction commencement and completion dates, projected square footage of space that could be constructed on undeveloped land that we own, projected rentable square footage of or number of units in properties under construction or in the development pipeline, anticipated proceeds from capital recycling activity or other dispositions and anticipated dates of those activities or dispositions, projected increases in the value of properties, dispositions, future executive incentive compensation, pending, potential or proposed acquisitions, plans to grow our Net Operating Income and FFO, our ability to re-lease properties at or above current market rates, anticipated market conditions and demographics and other forward-looking financial data, as well as the discussion in “—Factors That May Influence Future Results of Operations,” “—Liquidity and Capital Resource of the Company,” and “—Liquidity and Capital Resources of the Operating Partnership.” Forward-looking statements can be identified by the use of words such as “believes,” “expects,” “projects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” and the negative of these words and phrases and similar expressions that do not relate to historical matters. Forward-looking statements are based on our current expectations, beliefs and assumptions, and are not guarantees of future performance. Forward-looking statements are inherently subject to uncertainties, risks, changes in circumstances, trends and factors that are difficult to predict, many of which are outside of our control. Accordingly, actual performance, results and events may vary materially from those indicated or implied in the forward-looking statements, and you should not rely on the forward-looking statements as predictions of future performance, results or events. Numerous factors could cause actual future performance, results and events to differ materially from those indicated in the forward-looking statements, including, among others: global market and general economic conditions and their effect on our liquidity and financial conditions and those of our tenants; adverse economic or real estate conditions generally, and specifically, in the States of California and Washington; risks associated with our investment in real estate assets, which are illiquid and with trends in the real estate industry; defaults on or non-renewal of leases by tenants; any significant downturn in tenants' businesses; our ability to re-lease property at or above current market rates; costs to comply with government regulations, including environmental remediation; the availability of cash for distribution and debt service and exposure to risk of default under debt obligations; increases in interest rates and our ability to manage interest rate exposure; the availability of financing on attractive terms or at all, which may adversely impact our future interest expense and our ability to pursue development, redevelopment and acquisition opportunities and refinance existing debt; a decline in real estate asset valuations, which may limit our ability to dispose of assets at attractive prices or obtain or maintain debt financing, and which may result in write offs or impairment charges; significant competition, which may decrease the occupancy and rental rates of properties; potential losses that may not be covered by insurance; the ability to successfully complete acquisitions and dispositions on announced terms; the ability to successfully operate acquired, developed and redeveloped properties; the ability to successfully complete development and redevelopment projects on schedule and within budgeted amounts; delays or refusals in obtaining all necessary zoning, land use and other required entitlements, governmental permits and authorizations for our development and redevelopment properties; increases in anticipated capital expenditures, tenant improvement and/or leasing costs; defaults on leases for land on which some of our properties are located; adverse changes to, or enactment or implementations of, tax laws or other applicable laws, regulations or legislation, as well as business and consumer reactions to such changes; risks associated with joint venture investments, including our lack of sole decision-making authority, our reliance on co-venturers’ financial condition and disputes between us and our co-venturers; environmental uncertainties and risks related to natural disasters; and our ability to maintain our status as a REIT. The factors included in this report are not exhaustive and additional factors could adversely affect our business and financial performance. For a discussion of additional factors that could materially adversely affect the Company’s and the Operating Partnership’s business and financial performance, see the discussion below as well as “Item 1A. Risk Factors,” and in our “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s and the Operating Partnership’s annual report on Form 10-K for the year ended December 31, 2018 and their respective other filings with the SEC. All forward-looking statements are based on information that was available and speak only as of the dates on which they were made. We assume no obligation to update any forward-looking statement that becomes untrue because of subsequent events, new information

28


or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws.

Overview and Background

We are a self-administered REIT active in premier office and mixed-use submarkets along the West Coast. We own, develop, acquire and manage real estate assets, consisting primarily of Class A properties in the coastal regions of Greater Los Angeles, Orange County, San Diego County, the San Francisco Bay Area and Greater Seattle, which we believe have strategic advantages and strong barriers to entry. We own our interests in all of our properties through the Operating Partnership and the Finance Partnership and generally conduct substantially all of our operations through the Operating Partnership. We owned an approximate 98.0%, 98.0%, and 97.9% general partnership interest in the Operating Partnership as of March 31, 2019, December 31, 2018 and March 31, 2018. All of our properties are held in fee except for the thirteen office buildings that are held subject to long-term ground leases for the land.

Critical Accounting Policies

Effective January 1, 2019, the Company adopted Financial Accounting Standards Board ASU No. 2016-02 “Leases (Topic 842) (“Topic 842”).” For discussion of the impact of this adoption on our significant accounting policies, see Note 1 “Organization and Basis of Presentation” to our consolidated financial statements included in this report.

Factors That May Influence Future Results of Operations

Development Program

We believe that a portion of our long-term future growth will continue to come from the completion of our in-process development projects and, subject to market conditions, executing on our future development pipeline, including expanding entitlements. Over the past several years, we increased our focus on development opportunities and expanded our future development pipeline through targeted acquisitions of development opportunities on the West Coast.

We have a proactive planning process by which we continually evaluate the size, timing, costs and scope of our development program and, as necessary, scale activity to reflect the economic conditions and the real estate fundamentals that exist in our submarkets. We expect to execute on our development program with prudence and will be pursuing opportunities with attractive economic returns in strategic locations with proximity to public transportation or transportation access and retail amenities and in markets with strong fundamentals and visible demand. We plan to develop in phases as appropriate and we generally favor starting projects with pre-leasing activity, as appropriate.

In-Process Development Projects - Tenant Improvement

During the three months ended March 31, 2019, the following development project progressed from the under construction phase to the tenant improvement phase:

One Paseo (Retail) - Del Mar, San Diego, California. We commenced construction on the retail component of this mixed-use project in December 2016, which is comprised of approximately 96,000 square feet of retail space with a total estimated investment of $95.0 million. As of the date of this report, the retail space of the project was 92% leased.

As of March 31, 2019, the following projects were also in the tenant improvement phase:

100 Hooper, SOMA, San Francisco, California, which we commenced construction on in November 2016. This project encompasses approximately 312,000 square feet of office and approximately 88,000 square feet of production, distribution and repair (“PDR”) space configured in two buildings with a total estimated investment of approximately $275.0 million. The office portion of the project is 100% leased to Adobe Systems Inc. and the PDR space is 52% leased as of the date of this report. We commenced revenue recognition on the lease with Adobe Systems Inc. on October 1, 2018. Cash rents on the lease commenced in March 2019 and will continue to commence in phases through the second quarter of 2020. The project is currently expected to be stabilized in the second quarter of 2019.

The Exchange on 16th, Mission Bay, San Francisco, California, which we commenced construction on in June 2015. This project will encompass approximately 750,000 gross rentable square feet consisting of 736,000 square feet of office space and 14,000 square feet of retail space at a total estimated investment of $585.0 million. The office space in the

29


project is 100% pre-leased to Dropbox, Inc. Cash rents will commence in the third quarter of 2019 through the first quarter of 2020. The estimated stabilization dates for Phase I, Phase II, and Phase III are the third quarter of 2019, the fourth quarter of 2019, and the third quarter of 2020, respectively.

In-Process Development Projects - Under Construction

As of March 31, 2019, we had the following five projects in our in-process development pipeline that were under construction:

Kilroy Oyster Point (Phase I), South San Francisco, California. In March 2019, we commenced construction on Phase I of this 39-acre life science campus situated on the waterfront in South San Francisco. This first phase encompasses approximately 630,000 square feet of office space at a total estimated investment of $600.0 million. We currently expect the cold shell to be ready and delivered for tenant improvements in the second half of 2021.

9455 Towne Centre Drive, University Towne Centre, San Diego, California. In March 2019, we commenced construction on this project which encompasses approximately 160,000 square feet of life science space at a total estimated investment of $125.0 million. We currently estimate the cold shell to be ready and delivered for tenant improvements mid-2020.

Netflix and Living // On Vine, Hollywood, California. We commenced construction on the office component of this mixed-use project in January 2018, which includes the project’s overall infrastructure and site work and approximately 355,000 square feet of office space for a total estimated investment of $300.0 million. The office space of this project is 100% pre-leased to Netflix, Inc. We commenced construction on the residential component of the project in December 2018, which encompasses 193 residential units at a total estimated investment of $195.0 million. The office component is currently expected to be delivered and ready for tenant improvements in the first quarter of 2020 and the residential component is currently expected to be completed in the fourth quarter of 2020.

333 Dexter, South Lake Union, Washington, which we commenced construction on in June 2017. This project encompasses approximately 650,000 square feet of office space at a total estimated investment of $380.0 million. Construction is currently in progress and the cold shell is currently estimated to be ready for tenant improvements in the second half of 2019.

One Paseo (Residential and Office) - Del Mar, San Diego, California. We commenced construction on the residential component of this mixed-use project in December 2016 which includes 608 residential units. The total estimated investment for the residential component of the project is approximately $375.0 million. The residential component of this project is expected to be completed and delivered in phases starting in the third quarter of 2019. We commenced construction on the office component of the project in December 2018, which encompasses 285,000 square feet of office space at a total estimated investment of $205.0 million. The office component of the project is currently expected to be delivered and ready for tenant improvements in the second quarter of 2020. As of the date of this report, the office component of the project is 60% pre-leased.

Future Development Pipeline

As of March 31, 2019, our future development pipeline included four future projects located in San Diego County and the San Francisco Bay Area with an aggregate cost basis of approximately $665.8 million at which we believe we could develop more than 4.0 million rentable square feet for a total estimated investment of approximately $3.5 billion to $5.0 billion, depending on successfully obtaining entitlements and market conditions.


30


The following table sets forth information about our future development pipeline.

Future Development Pipeline
 
Location
 
Approx. Developable Square Feet / Resi Units (1)
 
Total Costs
as of 3/31/2019
($ in millions)(2)
 
 
 
 
 
 
 
San Diego County
 
 
 
 
 
 
2100 Kettner
 
Little Italy
 
175,000 - 200,000
 
$
26.9

Santa Fe Summit – Phases II and III
 
56 Corridor
 
600,000 - 650,000
 
80.0

San Francisco Bay Area
 
 
 
 
 
 
Kilroy Oyster Point - Phase II - IV
 
South San Francisco
 
1,750,000 - 1,900,000
 
295.4

Flower Mart
 
SOMA