Growth at a Price

There's no use beating around the bush or trying to be clever; KilroyRealty (NYSE: KRC  ) is positive about the prospects for real estate in Southern California and the San Diego area in particular.

The company is focused almost exclusively on the southern Californian office and industrial property market and believes that the market shifted in 2005 from a renter's market to a landlord's market. There is evidence that other investors feel the same way, since General Electric (NYSE: GE  ) announced a deal in December to acquire another office REIT that's focused on the southern California market, Arden Realty (NYSE: ARI  ) .

Kilroy Realty, which has Boeing (NYSE: BA  ) as its largest tenant, reported earnings Monday night and turned in funds from operations (FFO) per share -- for the fourth quarter and fiscal 2005, respectively -- of $0.26 and $1.95. Both figures are down from last year's $0.59 and $2.70 because of increased expenses the company incurred funding its long-term compensation program.

According to the company's 10-Q, the compensation plan called for cash compensation to be earned at Dec. 31, 2005, provided that the company attained certain performance measures (measures based on annualized total stockholder returns on an absolute and relative basis). The footnote in the filing goes on to describe the various hurdles that the company's shares must clear in order for the absolute and relative portions of the plan to be paid out.

To simplify things quite a bit, the company's shares have performed very well over the last three years and executives will be amply rewarded. That's the entire reason behind the company's decline in FFO. The underlying business itself is actually quite healthy. And while the compensation plan is far from what I would consider shareholder-friendly, the company is working on a new plan, the details of which should be released in a subsequent filing with the SEC. Let's just hope the new plan rewards business performance instead of stock price performance.

In the meantime, on the Tuesday conference call, the company gave FFO guidance for 2006 of $3.11 to $3.27 per share, which is back in line with what would normally be expected from the company. At current prices, the midpoint of the forward FFO guidance gives a price-to-FFO multiple of 21.2 and a yield of 3%. That's a heady valuation for a REIT, but the company thinks it is set up very well for a period of strong long-term performance.

For more REIT Foolishness:

• Boston Properties: Structurally Sound
• A REIT Winner Among Us
• A REIT on Fire

Nathan Parmelee has no financial stake in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.