Image source: The Motley Fool.
Date
Tuesday, July 29, 2025 at 5:00 p.m. ET
Call participants
Chief Executive Officer — Angela Aman
Chief Investment Officer — Eliott Trencher
Head of Leasing — Rob Paratte
Chief Financial Officer — Jeffrey Kuehling
Need a quote from a Motley Fool analyst? Email [email protected]
Takeaways
Leasing volume: Over 400,000 square feet of new and renewal leases were signed in the quarter, reflecting improved tenant sentiment and increased demand.
San Francisco tenant demand: Active tenant demand in San Francisco nearly doubled to approximately 7 million square feet since 2023, with a 110% year-over-year increase in tour activity at South of Market assets.
AI tenant leasing: A 93,000 square foot lease was signed with an AI tenant at 201 3rd Street in SoMa, marking the second consecutive quarter of major leasing at this property.
San Diego lease rate record: Achieved the highest office lease rate ever recorded in San Diego County on a renewal and expansion at One Paseo in Delmark Heights.
Kilroy Oyster Point (KOP) leasing: Advanced to active lease negotiations on multiple transactions totaling approximately 100,000 square feet with life science and health care tenants, with execution anticipated in the second half of the year.
Property dispositions: Announced the sale of 501 Santa Monica for $40 million and executed a contract to sell a four-building Silicon Valley campus for $365 million, with closing expected at the end of the third quarter.
Gross disposition proceeds: Four transactions—two land sales and two operating properties—are expected to raise over $480 million in gross proceeds, including $41 million at 26th Street in Los Angeles and the previously announced Santa Fe Summit sale.
FFO including onetime items: Funds From Operations (non-GAAP) was $1.13 per diluted share, including approximately $0.11 per share in onetime items such as a $10.7 million lease termination fee and $6.9 million related to reversals and a net real estate tax refund.
Occupancy: Quarter-end occupancy was 80.8%, reflecting known tenant downsizing and asset sales impact.
Leased vs. occupied spread: The gap between leased and occupied space increased to 270 basis points, indicating built-in future growth.
Re-leasing spreads: GAAP re-leasing spreads were -11.2% and cash re-leasing spreads were -15.2%, both driven by a single large San Francisco lease; excluding that, cash re-leasing spreads would have been approximately +1%.
FFO guidance raised: 2025 FFO guidance increased to a range of $4.05-$4.15 per share, a $0.15 increase at the midpoint, reflecting improved expectations for Flower Mart capitalization and onetime items.
Same-property NOI guidance: Full-year same-property NOI growth is now forecast at -1% to -2%, a 75 basis point improvement at the midpoint from prior guidance.
Flower Mart capitalization update: Interest and other expense capitalization at Flower Mart is expected to cease at the end of 2025, with no capitalization assumed for 2026 under the current outlook.
Stock repurchase authorization:Kilroy Realty Corporation(KRC 2.71%) maintains nearly full availability under its $400 million share buyback program but has not used it to date.
Summary
Management emphasized a shift in portfolio strategy, focusing on selective reinvestment and asset sales to drive long-term cash flow growth and market concentration. Engagement with San Francisco city officials on the Flower Mart redevelopment provided greater clarity on timelines and increased the likelihood of achieving project flexibility. Executives communicated that net absorption is expected to improve in the fourth quarter, driven by scheduled lease commencements, while occupancy may decline further in the third quarter due to redevelopment assets entering stabilization. The company reported a growing presence of AI, health care, life science, and traditional office users in leasing pipelines and transaction activity across all major West Coast markets and select out-of-state submarkets such as Austin.
Kuehling stated, "The Q2 2025 occupancy statistics now exclude both the 89% leased four-building campus designated as held for sale and 501 Santa Monica, which was sold during Q2 2025."
Management highlighted active lease negotiations with multiple health care and life science tenants at KOP, with tour activity and speculative suite demand accelerating.
The disposition of Silicon Valley and Los Angeles assets is positioned to monetize lower-growth or higher CapEx buildings, adding liquidity and capital for prioritized reinvestment opportunities or debt reduction.
The expected cessation of capitalized interest at Flower Mart is conditioned upon the pace of entitlements and reimagining discussions with city officials, with additional updates to follow as these processes advance.
Aman confirmed the company is actively evaluating highest and best use for surplus land and reiterated that further land monetization may be pursued if not aligned with core competencies.
Paratte detailed that AI tenants, particularly in San Francisco, show preference for flexible, expandable floor plates with amenities and are less focused on power requirements than traditional R&D users.
Industry glossary
FFO (Funds From Operations): A key REIT performance metric that adjusts net income for real estate-specific items such as depreciation and gains or losses on asset sales.
NOI (Net Operating Income): Income from property operations after operating expenses, before debt service and capital items.
Re-leasing spreads: The percentage change in rental rates for leases that were recently renewed or re-leased compared to the previous in-place rent.
Capitalization of interest: Accounting practice allowing interest expense on development or significant redevelopment projects to be capitalized as a project cost while active construction is under way.
Spec suite: Move-in ready, prebuilt office or lab space designed for quick occupancy by small- to midsize tenants.
Full Conference Call Transcript
Angela Aman: Thanks, Doug, and thank you all for joining today's call. Before we begin, I want to take a moment to acknowledge the tragic events that played out last night in New York City. We're thinking about the victims, their families and everyone who is directly impacted by the traumatic events as they unfolded. Our hearts go out to everyone impacted. Turning to last night's release. I'm pleased to report on a strong quarter of execution across every discipline within our company, as West Coast office fundamentals continue to solidify.
During the quarter, we signed over 400,000 square feet of new and renewal leases, a material improvement both sequentially and year-over-year was a pickup in tenant sentiment and ongoing flight to quality dynamics in the office market uniquely position our premium portfolio to capture accelerating tenant demand. In parallel, we're seeing early indications of an improvement in the transaction environment [indiscernible] buyers and sellers appear more prepared to execute. An encouraging signal that market participants have greater conviction in the continued path of the West Coast office recovery. From a leasing perspective, we saw significant strength this quarter in both San Francisco and San Diego, with the recent inflection in activity in the city of San Francisco being particularly notable.
Active tenant demand in the city has nearly doubled since 2023, now totaling approximately 7 million square feet despite a significant increase in recent execution velocity. We appear to be at the tail end of major space givebacks by big tech companies and the market can now benefit from the substantial growth and expansion of companies in the AI space. In addition, positive trends in public safety and downtown revitalization efforts by the city's new administration have given tenants the confidence to expand their search parameters outside of the financial district and into the South of Market or [indiscernible] submarket, where our assets have seen a 110% year-over-year increase into our activity.
A clear example of these dynamics is a 93,000 square foot lease we signed in the second quarter with an AI tenant at our 201 3rd Street asset in SoMa. This large transaction marks the second consecutive quarter of major leasing at this property, and underscores the ability of our leasing team to understand the specific needs of rapidly scaling AI tenants, many of whom are actively prioritizing landlords who can accommodate their anticipated growth trajectories and provide flexibility that will allow them to grow incrementally over time. We're excited about the turnaround we're seeing play out in San Francisco and are well positioned to capitalize on the accelerating momentum.
In San Diego, which has been a consistently strong market for some time, we experienced broad-based activity in the second quarter across all submarkets. In Delmark Heights, we signed a renewal and expansion at One Paseo at the highest rate ever recorded for an office lease in San Diego County. In Little Italy, we signed a 24,000 square foot lease at our recently developed 2100 Kettner asset, continuing the accretive lease-up of some of the highest quality vacancy in our portfolio. And in UTC, we signed a 25,000 square foot lease at our [indiscernible] executive drive redevelopment projects with a leading research and health care Institute.
As it relates to development leasing at Kilroy Oyster Point, our premier development project in the heart of the South San Francisco life science ecosystem, we're pleased to report that we have advanced to active lease negotiations on multiple transactions, totaling approximately 100,000 square feet and we anticipate lease execution with these life science and health care tenants during the third and fourth quarters. As we progress deals that have been in the pipeline for some time, we've also continued to see meaningful engagement from new prospects as well.
Tour activity during the second quarter accelerated meaningfully and highlights the degree to which the quality and scale of Kilroy Oyster Point continues to resonate with high-caliber growth-oriented tenants taking purpose-built infrastructure in a primary innovation cluster even against the backdrop of a more challenging life science ecosystem. Turning to capital allocation. We'll remain active and disciplined as we recycle capital with a focus on long-term cash flow growth and value creation, being responsive to evolving dynamics in the office and life science sectors and changes in the relative attractiveness of the various submarkets in which we operate.
As we look forward, we believe that continued portfolio rotation executed thoughtfully and strategically will be key to unlocking value in today's environment. Our investments team has been very active over the last several quarters, on teeing up dispositions and underwriting acquisitions that fit with our long-term objectives. Accordingly, last night, we announced the disposition of an operating property in downtown Santa Monica and the execution of a contract to sell a 4-building campus in Silicon Valley, which is expected to close at the end of the third quarter. These dispositions at attractive valuation have allowed us to efficiently monetize several lower-growth assets that we believe would have required outsized reinvestment capital over the coming years.
As proceeds are realized, we'll pursue a balanced mix of selective reinvestment opportunities and debt repayment with a focus on optimizing portfolio returns and maintaining a strong and flexible capital structure. We're pleased to see the pipeline of actionable, value-accretive opportunities in some of the highest performing submarkets on the West Coast and in Austin continue to grow. And as always, we'll be evaluating such opportunities relative to all of our reinvestment options including leverage-neutral stock buybacks. As it relates to our future development pipeline, we've made further progress on monetizing land parcels that have the highest and best use outside of the company's core competencies.
As discussed last quarter, in April, we signed an agreement to sell a portion of our Santa Fe Summit site in San Diego. And last night, we announced an agreement to [indiscernible] at 26th Street in Los Angeles. These announced transactions, which aggregate total expected gross proceeds of $79 million represent over half of our stated goal of realizing $150 million from the monetization of the future pipeline, with proceeds to be realized over the next several years as reentitlement efforts are completed. The Flower Mart project, which consists of a 7-acre development site in the central SoMa submarket of San Francisco, remains our single largest investment in the future development pipeline.
As discussed on the last several conference calls, long-term value maximization at the Flower Mart will require the creation of significant additional flexibility and optionality as it relates to both the ultimate mix of uses on site and the phasing of development execution. Over the course of the last 6 months, our development team has worked diligently on a significant redesign and reimagining of the Flower Mart project that will allow us to be responsive to market conditions as they continue to evolve. As you may remember, we're currently entitled for a 2.3 million square foot primarily office project.
And while we remain very encouraged by the resurgence in office demand in San Francisco, we also remain convicted that maximizing value on the site will require a broader mix of uses than originally contemplated, which may allow for the development of certain components of the project earlier than otherwise anticipated. We have recently had constructive and encouraging conversations with the city regarding our proposed modifications to the program. While these discussions are still ongoing, we've gained greater clarity around both the approval process and the time line required to secure the flexibility we're working towards.
As a result, based on the best information we have available today, we expect interest and other expense capitalization at the Flower Mart to cease at the end of 2025. While we will update this assumption as appropriate, we're not currently assuming any capitalization of the project in 2026. I want to conclude by thanking the entire Kilroy team for another outstanding quarter of execution across all fronts. The pace of work has accelerated across the company as leasing and transaction activity has increased, and I'm grateful for the way the entire organization has responded.
At the same time, this team's willingness to innovate and embrace change is creating additional value for our stakeholders each and every day and positioning us for continued success in the quarters ahead. Eliott?
Eliott Trencher: Thanks, Angela. Before getting into the specifics on the transactions we announced last night, I want to expand on the long-term objectives of our capital allocation strategy that Angela referenced, highlighting 3 primary goals. First is something we have discussed on prior calls. Monetize nonincome-producing land that has a higher and better use beyond office or life science. Second, sell operating properties that are valued at favorable levels relative to our expectations for fundamentals. Third, concentrate investments in areas of conviction, specifically submarkets with diverse and robust demand drivers, high barriers to entry and a track record of significant and consistent rent growth. These goals have guided our actions to date.
And as we continue to execute, we are confident that we will further distinguish the Kilroy portfolio and better position the company for outsized cash flow growth. With that said, we're thrilled to have 2 land sites and 2 operating properties in various stages of completion. In total, these 4 transactions will raise over $480 million of gross proceeds. First, on the land sales. We're under contract to [indiscernible] at 26th Street in our Los Angeles region to a residential developer for $41 million or roughly $20 million per acre. Similar to our sale of a portion of Santa Fe Summit, 26th Street has a path to residential entitlements that does not require a full change of use.
We expect the transaction to close upon receipt of entitlements, which we estimate to be in 2026. Next, at the very end of the quarter, we completed the sale of 501 Santa Monica in Downtown Santa Monica to an institutional owner for $40 million or slightly over $500 per square foot. The building is one of our older properties and requires a substantial amount of capital due to both base building needs and leases rolling over in the coming years. In our view, the capital requirement was outsized compared to the growth prospects for the property, making this a logical disposition candidate.
Additionally, we are under contract to sell a 4-building campus in Silicon Valley for $365 million or $550 per square foot. This campus is 89% leased today going down to 65% leased in 2026, when 2 of the 4 buildings will be fully vacant. One of the vacant buildings is 25 years old and requires both base building capital and leasing capital. The other has been leased by a single tenant and requires leasing capital all of which adds up to a significant spend in a market that has seen pressure on rents in recent years. As we evaluated alternatives, we concluded that selling at this value generated the best risk-adjusted return for shareholders.
Finally, touching on acquisitions, we continue to diligently underwrite a variety of deals across all our existing markets. We do not have anything to announce at this time, but the opportunity set has improved in recent months in terms of both quantity and quality. We're optimistic that we will find investments that meet our criteria, generate little to no dilution in the short term and produce materially better cash flow growth in the medium and long term. With that, I will turn the call over to Jeffrey.
Jeffrey Kuehling: Thanks, Eliott. FFO for the quarter was $1.13 per diluted share, which includes approximately $0.11 per share of onetime items, including most notably, a $10.7 million lease termination fee which contributed $0.05 per share to FFO, net of noncontrolling interest. Additional onetime items include approximately $6.9 million or $0.06 per share, largely related to [indiscernible] reversals and net real estate tax refund benefit. . Cash same-property NOI growth in the second quarter was 450 basis points, with the previously mentioned onetime items on a cash basis, contributing 300 basis points. Turning to occupancy. We ended the second quarter at 80.8%, down from 81.4% at the end of the first quarter.
As previously communicated, this decline was expected and reflects the rightsizing and renewal by DermTech along with the early vacate related to the 23 [indiscernible] bankruptcy. It's worth noting that the second quarter occupancy statistics now exclude both the 89% leased 4-building campus designated as held for sale in 501 Santa Monica, which was sold during the second quarter. Accordingly, we made conforming updates to our lease expiration schedules to reflect the removal of [indiscernible] these assets. While their removal negatively impacted occupancy by 20 basis points, we were able to maintain the midpoint of our occupancy guidance range due to the team's continued success in accelerating lease commencement dates across the portfolio.
Looking ahead, we continue to expect a modest decline in occupancy in the third quarter, primarily due to the addition of 2 redevelopment projects entering the stabilized portfolio during the period. That said, we also remain optimistic, so we'll see positive net absorption in the fourth quarter, supported by significant lease commencements from previously executed leases. It's important to note that the spread between leased and occupied space increased to 270 basis points this quarter, a 100 basis point improvement year-over-year, representing significant built-in growth that will materialize in the portfolio throughout the second half of 2025 and into 2026.
The GAAP re-leasing spreads were negative 11.2% in the second quarter and cash releasing spreads were negative 15.2%, both of which were largely impacted by a single large lease in San Francisco. While this lease was completed at lower base rents, they require limited capital and produce strong net effective rent. Notably, the lease term, which is under 3 years will provide us with a valuable near-term occupancy while maintaining our ability to reprice the space as the market continues to improve. Excluding this one transaction, cash re-leasing spreads would have been approximately positive 1% [indiscernible] meaningful improvement relative to the prior quarter. Turning to guidance.
We raised our 2025 FFO outlook to a range of $4.05 to $4.15 per share, a $0.15 increase at the midpoint. This revised guidance reflects our updated expectations for capitalization of the Flower Mart accounting for $0.08 per share at the midpoint. The significant termination fee recognized in the second quarter, representing $0.05 per share and our updated same-property NOI guidance, representing $0.04 per share, all of which were partially offset by the anticipated net impact of announced capital recycling activities. Same-property NOI growth is now expected to range from negative 1% to negative 2%, a 75 basis point improvement at the midpoint.
Our updated guidance range implies a deceleration in same-property NOI growth throughout the second half of the year, largely due to the previously discussed impact of onetime items in the second quarter of this year. In addition, we recognized significant restoration in settlement fee income in the fourth quarter of 2024, which will create a difficult comparison for the fourth quarter of 2025. As Angela previously mentioned, we have updated our capitalization assumptions for the Flower Mart. When we initiated 2025 guidance in February, the range of possible outcomes reflected the uncertainty inherent in the process with the cessation of capitalization ranging from as early as June to the latest December.
Given the progress we have made today, we have updated our [indiscernible] for the cessation of interest and other expense capitalization to year-end. We will update this [indiscernible] as appropriate. But as previously mentioned, we are not currently assuming any capitalization of the product in 2026. Relative to sources and uses for the back half of this year, we expect to utilize the proceeds from the announced dispositions for a combination of reinvestment opportunities and debt repayment. As we approach our remaining 2025 bond maturity, we will evaluate the capital markets for an opportunistic execution window.
Our balance sheet is well positioned to support growth with a well-laddered maturity schedule and strong liquidity, which will provide valuable flexibility as opportunities present themselves. With that, we're happy to take your questions. Operator?
Operator: [Operator Instructions] Our first question today comes from the line of Jana Galan with Bank of America.
Jana Galan: Congrats on the leasing and transactions this quarter. Can you talk a little bit about the type of buyers out there, the breadth of the bidding pool and whether you're seeing some owner occupants. And then just discussions on valuation, whether it's more of a price per square foot discussion or cap rates and whether it's different in San Francisco versus L.A. ?
Eliott Trencher: Jana, it's Eliott. So every transaction is going to be different, and we touched on this a little bit last quarter with the different types of groups that we've seen out there. And there's everything from institutional buyers to high net worth to owner users and each group is going to think about it a little bit differently depending on the profile of the asset. So it's a little bit hard to kind of generalize, but what we've seen with the transactions that we completed were pretty good debt, frankly, across all these different types of opportunities. And each group is very different.
The 26th Street is an example, since that was going to a residential developer, had a very different set of folks that showed up relative to 501 Santa Monica. So we've been pretty methodical with how we've tried to approach the disposition market. And now that we're seeing some depth there, that kind of gave us confidence early in the year to start testing and we like what we saw, which is why we executed.
Angela Aman: Yes. I mean I'd just add to that. I agree with everything Eliott said. I do think you're seeing a widening out of the types of players that are evaluating, particularly office -- operating office assets in our core markets across the West Coast. As I mentioned in my prepared remarks, I think it really speaks to growing conviction and the continued path of the West Coast office recovery, which is a very encouraging sign. A lot more institutional buyers than what we would have seen 6 or 9 months ago.
Jana Galan: Great. And then on kind of the use of proceeds, you mentioned reinvestment and debt repayment, but also leverage neutral share buybacks. Can you remind us kind of what your authorized -- authorization is now in the buybacks?
Angela Aman: Yes. I think the total authorization size is about $400 million. So we've got capacity. We had re-upped that program, I think, around the time that I started. So we haven't use it. So we've got almost full authorization under that program.
Operator: Our next question comes from Steve Sakwa with Evercore ISI.
Steve Sakwa: Maybe Angela, could you just provide a little bit more detail on KOP 2, the activity? I think you said 100,000 feet -- is it life science? Is it traditional office? And can you maybe just broadly talk about the economics and how those deals may stack up to your original underwriting?
Angela Aman: Yes. Thanks, Steve. We're really very encouraged by the activity we've seen and continue to see at KOP. We've been talking about the kind of growing pipeline there for some time and the amount of tour activity that, that asset has seen. And we feel like the project that we delivered late last year is just really hitting the mark in terms of tenants that are looking for high-quality, purpose-built life science product, highly amenitized and in that core life science ecosystem. So the amount of activity we're seeing has been really, really encouraging. As I mentioned in my remarks, even despite sort of some headwinds from a life science broader ecosystem perspective.
What we did say on the call is we've moved to active lease negotiations with about 100,000 feet of primarily health care and life science tenants. So they're all more traditional life science health care uses. We do think that the project retains broad-based appeal to a wide range of potential tenants that are in the market, including more tech uses, people that would have demand for dry labs, more office-specific uses, but we do think this first 100,000 square feet will execute or more life science and health care oriented. So that's exciting for the project and bodes well for future growth and future phases as well. I think it's too early to talk more specifically about the economics.
I think rents have held up pretty well. They're certainly -- just given what's happened to the broader ecosystem overall, there is more capital going into certain [indiscernible]. But we think relative to the way this project was originally underwritten, we feel really good about the activity and how it's stacking up, but as we get leases signed, we can probably update more specifically.
Steve Sakwa: Okay. And then secondly, I know it's a bit early to really turn your eye to '26, but the lease expiration schedule does remain a bit elevated even though you were able to kind of remove I think, a large expiration with the pending sales in Silicon Valley. But just how are you thinking about I guess, retention for next year? And I guess do you have a thought on kind of when occupancy in the portfolio may bottom?
Angela Aman: Yes. I mean, let me take that in 2 pieces. One, just to talk about the occupancy trajectory for 2025, and then I'll sort of touch on your broader question for 2026. 2025, and this is consistent with what we've been saying for the last couple of quarters. The Q2 decline was fully expected. We had a downsize of a tenant that had gone bankrupt and was bought by another entity. We did a downsize in the second quarter. We also had a vacate related to the 23andMe bankruptcy. So those we saw coming and had communicated about them on the last call.
As we look out to the third quarter, I still think we're somewhat negative net absorption in Q3, but you are going to see a bigger occupancy impact due to the 2 redevelopment assets coming into the pool in Q3. So we should all be expecting that. The signed, but not commenced pool has now grown to 270 basis points, which represents a significant source of growth as we look into the second half of 2025 and into 2026. We've got 3 significant lease commencements coming out of that pool in the fourth quarter. So I fully expect that fourth quarter of this year were positive net absorption. As we look into 2026, a few things to note.
One, KOP comes into the pool in January of next year. And despite the fact that we're making really good progress, I think, on leasing activity at that property, nothing is going to be built occupancy at the time it comes into the pool. So that's going to set us back from a reported occupancy perspective, not necessarily a like-for-like occupancy perspective, but something we should all be prepared for. As we look at the expiration schedule for next year, obviously, we've been really diligently working on addressing those expirations. And the sale of the 4-building campus in Silicon Valley certainly addresses a significant portion of what we believe was going to be a vacate in 2026.
The lease expiration schedule is relatively first half weighted, especially in Q2. I think if you look at the lease expiration disclosure in the Q, the leasing team is working diligently across that entire pipeline to work with tenants to understand their needs for next year and address those as much as we can. But I do expect that we're going to see some larger vacates in the first half of the year. So we'll know more as we get into the next quarter or 2, but I do think retention that continues to be somewhat below our historical average is likely in 2026.
It's hard to talk more specifically about the timing of an occupancy trough next year as we feel this leasing momentum across the portfolio, both the operating portfolio and the development portfolio building. So I think we need another quarter or so to be able to give more specifics about the timing of occupancy or the trajectory of occupancy within 2026. But I think those are all important considerations as you think about next year.
Operator: Our next question comes from Nick Yulico with Scotiabank.
Nicholas Yulico: I guess first question is just following up on the activity you cited at KOP 2. Can you just talk about if that would be for some of the spec suites where commencement of NOI could be sooner, if it's related to that space?
Angela Aman: One of the transactions, we mentioned working on multiple transactions, one of the multiple transactions we're working on would be per spec suite user. We also think within the tour activity that's building at the project or is accelerated, there's additional spec suite users, but again, even if we sign the Q3 or Q4 of this year could potentially be first half next year occupancy.
Nicholas Yulico: Okay. Great. And then just second question is going back to the campus that in the works to sell? I mean, I know you gave some metrics on it. Is there any way to maybe talk a little bit more about how you're thinking about the pricing? And you said that you thought it was a good price relative to if you had to re-lease the asset. I know there was some leasing activity going on, but any more of just sort of like a cap rate type impact, stabilized yield on cost? How to sort of think about that transaction pricing?
Eliott Trencher: Nick, it's Eliott. So we're somewhat bound by an NDA, so we can't get into too many specifics on the transaction, but kind of talk about how we think about all of our dispositions is that we evaluate essentially what do we think the -- what are the proceeds that we're going to get and what is our forward-looking outlook for the cash flows at that particular project? And that's going to factor in whatever leasing needs to be done, whatever capital needs to be spent and what our view of what the rent outlook is.
And as we evaluate those, if we think that the forward-looking return is not all that great at a particular value, then that makes sense is something we should sell. And conversely, we've looked at some where we think the value is pretty attractive. And so that is something that we wind up holding. So we essentially do a wholesale analysis for any potential disposition.
Operator: Our next question comes from Blaine Heck with Wells Fargo.
Blaine Heck: One of the most common questions and concerns about the market that we hear is how to think about the net impact of AI with respect to office space requirements and leasing. Clearly, the AI companies are taking space, but we've seen some additional layoffs from big tech companies that seem to be related to AI displacement. So just wanted to see if you have any thoughts on that net impact of AI?
Angela Aman: Yes. Thanks, Blaine. I think this is an important topic to continue to watch and evaluate. I think -- as we look specifically at our markets, you've got a couple of different dynamics that I think are difficult to peel apart. I think it's easy to look at some of the job losses that have been created, particularly coming out of the traditional tech sector, and some of the language that's been used by some of the leaders of those companies to blame AI solely for those job losses. But I'd also remind everybody that we're coming off of a period where there was certainly some excess hiring that happened in the early days of the pandemic.
And so I think it's difficult to disaggregate those things. I think the more encouraging thing we're seeing is really company is not just in the tech space, but across broader corporate America, really beginning, and I think we're at the very early stages of this, to talk about AI, not just as an efficiency strategy, but as a growth strategy and an opportunity. And while it's easy potentially in some places and some parts of certain organizations to think about jobs that might be automated as a result of what's happening with AI.
It's much more difficult for any of us to really think about our [indiscernible] around all the jobs that are going to be created as a result of what's happening. I'm really pleased with our market positioning as we all sort of begin to watch some of these trends play out and think about how different markets are going to be impacted. It's clear that markets for us, like San Francisco, obviously, most significantly, but including Seattle and including San Diego and to some degree in L.A. are really beginning to benefit from the momentum we're seeing being created by new jobs, new industries, new growth avenues that are coming as a result of AI.
So it's certainly something to watch. It's something we need to be very mindful of as it relates to our longer-term capital allocation strategy, but it's also something that I think this portfolio will benefit from in the near to medium term.
Blaine Heck: Okay. Great. That's very helpful. And then just my second question, just touching back on dispositions. I guess, how would you characterize the size of the portfolio that you'd consider as noncore within the KRC portfolio? And are there any specific characteristics you're looking to get away from, whether that's by market or asset quality or otherwise?
Angela Aman: Yes, I'll start, and then I'll turn it over to Eliott to elaborate a little bit more. I think when we think about dispositions across the portfolio, I just start by reiterating, we like all of the markets we're operating in and see potential incremental growth in a number of our markets, including Pacific Northwest, Bellevue and Seattle, including San Diego and obviously, including [ Austin ] as well. So we see some real growth opportunities in those markets. We do -- within San Francisco and L.A., we're thinking about how to make sure that our portfolios in those markets are optimally positioned, right?
And so we alluded to some of that on the call in terms of making sure that we are exposed to the highest performing submarkets within those core markets, and that will be a major part of how we think about capital allocation going forward. At the end of the day, however, all of that market commentary aside, it still comes back to what Eliott mentioned earlier, which is an asset-by-asset underwriting and trying to make sure that every dollar of capital we have invested in the portfolio today is going to, from this point forward, earn a return in excess of our cost of capital.
And so there is a broader portfolio construction strategy thought process here and making sure we're allocated to submarkets and can deliver the kind of durability and growth we're looking for in the cash flow stream, but we also have to really think about individual asset pricing and where we can or should harvest capital to redeploy into other places.
Eliott Trencher: Yes, not much to add to that. But -- we touched on this a little bit last quarter. We're essentially looking at where our fundamental outlook overlays with where there is capital. And so if we see a good match between where our outlook is a little bit more pessimistic, but there is capital that is taking the other perspective that makes a good disposition candidate for us.
Operator: Our next question comes from Seth Bergey with Citi Group.
Seth Bergey: In the prepared remarks, you mentioned that you're kind of getting to the end of some of the larger space givebacks. Just kind of on the leasing pipeline, could you give more color on the types of tenants in the pipeline? Is it predominantly smaller to medium-sized tenants? Or are you starting to see a turn of larger tenants coming back into the market?
A. Paratte: It's Rob Paratte. I think it's sort of across the board. We have larger tenants that we're talking to in different submarkets, and we also have the typical deal size in a market like San Francisco, excluding the big deals, it's probably in the 25,000 to 30,000 foot range, and there's a lot of activity in that range. In San Diego, where we are in North County and [indiscernible], deals again tend to be on the 20,000, 30,000, 40,000 foot size range. But if you go to some of the really stellar markets like Bellevue, where we're operating deals are over 100,000 feet.
So as the recovery takes hold, you're seeing a pretty wide variety of transaction sizes and types of users. So using San Francisco, as an example, everyone is focused on AI, but law firms, crypto and banks have been quite active in that market. So you've got a blend of [ fire ] category mixed with technology.
Angela Aman: Yes. I mean I think just to add on to that, as Rob said, we're seeing broad-based demand, right, and all sort of size ranges. So one dynamic I'd sort of reemphasize, and we've talked about this on prior calls, is kind of what's happening with some of these tenants that might look like small deals in the San Francisco market, but are actually second, third, fourth expansions of AI tenants that are just growing really rapidly. And when those leases come up for lease renewal or -- they're looking at evaluating the market again in a few years, those are going to be a pretty substantial company.
There's a different question between what's the size of execution, what's the size of the company in the market today. Those are sort of disconnected in the market like San Francisco -- San Francisco because of this dynamic with AI companies taking the space they need today, but then growing incrementally over time pretty quickly. So it's an interesting dynamic to watch and to see play out.
Seth Bergey: Great. And then I know you don't have direct studio exposure, but just in terms of LA demand. Are you seeing any impact there from the tax incentives for that market?
Angela Aman: Not just yet. I mean I think we've seen some encouraging data on production that might be slated to come back to the market over the next couple of years. But it's been too early to see that impact, I think, near-term demand just AI.
Operator: Our next question comes from Caitlin Burrows with Goldman Sachs.
Caitlin Burrows: Maybe just back to Flower Mart. I was wondering if you could go through some of the types of conversations that you're having with the city. And I guess the thought is then what's the chance that they go beyond December 31. And to the extent you don't want to specifically comment on that, just kind of what's taken it from a potential of June 30 now December 31. In my kind of what's left in that potential timing that's left?
Angela Aman: Yes. I mean there's still a lot of variables at play here. And so what we're trying to do is provide as much transparency we can when we can provide it. And that's what we did when we initiated guidance this year. There were so many different paths this project could have taken, including, we could have had the city really shut down sort of our hopes that getting greater flexibility and optionality on the site.
So what we now know that we didn't know at the beginning of the year is that the city has been very receptive to working with us on a revised program that would allow us, hopefully, and what we're asking for is to maintain a lot of the entitlements we have in place, which is for a very high-density plan that has tremendous amounts of value in the right kind of market while also getting flexibility to change that plan or to modify that plan in a way that's responsive to what the community and the market needs in central [indiscernible] and hopefully can allow us to phase the development.
So you could see development in central SoMa market earlier than you might have otherwise. This city has been receptive. We've had conversations with them over the last a couple of quarters, but including some pretty recent conversations, we expect that there will be -- there are additional steps we're going to take here in the back half of the year, and we'll know more and be able to provide additional updates on next quarter's call. But for right now, our current assumption is that some of these efforts are completed by year-end, and we're not assuming any additional capitalization next year, but we will continue to update.
Caitlin Burrows: Got it. And then, Rob, I know you talked in 1 of -- either the last question or the one before that about the varying sizes of leases that you're seeing in like San Francisco versus San Diego. I guess, as you think about some of the differences of San Francisco versus San Diego, but probably L.A., even more important. I guess, how would you compare and contrast San Francisco versus those other markets? And like what's driving those differences today?
A. Paratte: Yes. Caitlin, I think the primary driver in San Francisco sort of starts with the VC funding that's been directed through the city of San Francisco, specifically for AI. And when you couple that with the talent base that's in San Francisco, it just makes a great combination that's creating that demand. We also think that, that demand is going to increase in Seattle. We've already seen NVIDIA and data bricks in our portfolio, and there's no reason that can't continue because that same talent pool is in Seattle/Bellevue. Los Angeles is really a bifurcated market again, and we'd like to see more activity on the left side and it to me personally, doesn't make sense why it's been slower.
But if you look at the winning submarkets in L.A. right now, there are Central City and Beverly Hills, both of which are doing quite well. Culver City is a third place, sort of active market. When you look at Apple is completing their 500,000-foot campus, that's going to mean continued content production, which I would attribute to sort of related to Hollywood, adjacent to Hollywood. So those are the drivers.
And I think it's -- again, San Francisco, Seattle or innovation on the technology side, in San Diego and again, sort of distinguishing our product from, I'll just say, typical downtown San Diego older high-rise product, we're dealing with companies that have thought leaders that are really developing new and better ways to think. And so you see private banking. You see Boston Consulting Group. You see JPMorgan, some of the big companies that have expanded in our portfolio are doing that because, again, of the talent base. And then I'd be remiss to not mention also there's a really robust life science market in San Diego, particularly in UTC and Torrey Pines and Del Mar.
So that innovation, although a little bit different than San Francisco because it's life science is something the San Diego benefits from. And I would suspect in the future, you'll see some defense benefits -- defense spending benefits that trickle into San Diego because it's always been a strong defense market.
Operator: Our next question comes from John Kim with BMO.
John Kim: On KOT 2, I was wondering if you could provide some color on whether or not these tenants are moving into South San Francisco or if they're just expanding or moving around within the submarket? And if you could provide any update on development yields, I think historically, we were looking at this at an 8% plus. I was wondering if that's still on the table. .
A. Paratte: John, I will answer the second one, and I'll address the first one. It's Rob. It's a variety. Again, some are in South San Francisco, some are new to market. And all I would say is the most active. If you look at the Bay Area as a whole in terms of life science, the most active submarket or sub portion of the market is South San Francisco and the Peninsula, which is directly adjacent. So again, we'll be able to give you a lot more color when we sign these, but it's a pretty broad spectrum.
Angela Aman: Yes. I'll just -- again, on the return point, I addressed this somewhat earlier. I think let us get some of these deals signed and we can give some better updates on how deals are coming together and how things are looking. I think I'd emphasize the project was underwritten pretty conservatively. I think rents look pretty good, but there's certainly more capital in some of these deals than originally contemplated, which reflects not really this project, but what's happened more broadly in life science. So let us continue to get some of this leasing done and we can provide more updates.
John Kim: Okay. Fair enough. On the Matilda campus sale, can you discuss the alternatives for the campus? I know, Eliott, you mentioned that the CapEx requirement most likely. But was there a direct lease with a subtenant with that's an option for you? And how you weigh that versus selling the assets. And also if you could confirm what the cap rate was at back of [indiscernible], we get to like a low 8% cap rate, but I was wondering what your perspective was?
Eliott Trencher: John, so as I mentioned earlier, we're on a pretty tight NDA, so we're somewhat restricted in what we could talk about here. But I think that you hit on an important point, which we sort of tried to touch on in the prepared remarks, which is the campus today is a little bit more occupied. And as we look forward, it's not going to have that same level of occupancy. So then the question becomes, what does that look like to try to lease it up. And we evaluated a few different scenarios on what that would potentially look like.
And in all of those different scenarios, we kind of concluded that to get the $365 million was more advantageous than trying to lease it up, spend the capital and get the kind of rents that we deem as market. So based on all of that, that's kind of how we came to the decision that this was a transaction worth pursuing.
Operator: Our next question comes from Brendan Lynch with Barclays.
Brendan Lynch: Angela, it sounds like there could be more demand at [indiscernible] coming behind the 100,000 square feet you referenced. Can you provide some color on the prospects that are in the earlier phases of -- turning on planning?
Angela Aman: Yes. I think it continues to run the gamut in terms of lots of life science and health care adjacent uses both sort of biomedical institutional uses, public biotech, private biotech really kind of across the spectrum. And as I mentioned earlier, we're seeing also good strong demand from more traditional tech uses, some AI uses that have needs of dry lab space. It's really -- it really kind of runs the gamut. So there was definitely a meaningful increase into our activity. And I think some of the deals that we're working now are building some real momentum in the campus.
So we're really encouraged by what's coming behind it, but also very focused on getting this first 100,000 square feet signed and executed.
Brendan Lynch: I think I've heard you guys in the past discussed kind of touring moving into kind of designing planning. Is there any other prospects that are in the design planning phase now?
Angela Aman: Yes, certainly. I think we're working with a number of different tenants on space planning behind the ones that are in active lease negotiation. Now we've got sort of prospects from initial tour stage all the way now through lease drafting and negotiations. So we're pleased by how the activity continues to shape up. We're excited to feel a degree of confidence in this project that we can communicate. We expect at least 100,000 square feet of lease executions in the second half of this year, and we'll continue to work at converting the pipeline that continues to grow at KOP into active leases as we move forward.
Operator: Our next question comes from Upal Rana with [ KeyCorp ].
Upal Rana: Angela, you mentioned the $150 million monetization goal, which you're about halfway there. Given the state of the transaction market, do you anticipate there could be some upside to monetizing more land?
Angela Aman: Yes. Look, I think everything -- and I've been pretty clear about this, I think, certainly, internally and externally since I started. We are really working hard at evaluating highest and best uses for every single parcel within the future land bank. We've got some parcels at KOP where we're again excited about what we're seeing and the potential for future growth there. It's clear to us as we talk to tenants, existing project today, and tenants that are looking at Phase II that the growth and scalability of the campus is a key consideration and a key benefit and competitive advantage that KOP has. We've talked about the Flower Mart at length.
That's the biggest component of the future land bank. And obviously, we believe the path to value maximizing -- value maximization there is continuing to do what we're doing in terms of expanding. We're providing more flexibility under the entitlements and creating a program that would allow us to phase execution in a responsible way. So we're working on that. So those are 2 pieces of the future land bank that I would say. I'd sort of put to the side and evaluate differently. Everything else, I think, we're actively looking, thinking about working on trying to make sure we understand highest and best use.
And where that highest and best use is not within our core competencies, we're certainly looking at monetizing those parcels. So there's certainly potential for more. Let us get through the [indiscernible] and we'll continue to update and keep you posted on that. But I think we've been really proactive as it relates to addressing that future land bank and acknowledging that in certain circumstances in submarkets the world has changed and where there's higher and best uses, we should respond accordingly.
Upal Rana: Okay. Great. That was helpful. And then on the increase in demand you're seeing in San Francisco, is there an impact of companies who had moved out of the area during the pandemic that are now coming back? Or would you say it's more homegrown demand?
Unknown Executive: It's a little bit less of the former in terms of companies that moved out that are coming back. I mean there have been some headlines about that. But a lot of -- a lot of the demand is new company formation or company expansion. When you look at -- this is a Q1 transaction. But if you look at JPMorgan renewing and expanding in south of market. That's a really important happening, I think, in terms of just confidence in the market and confidence in the business opportunities for a bank like that. So it's across the board. And I just think companies are going for the talent. They're also going for the quality space that's in the market.
And there's a real bifurcation in the vacancy rate that you see, where there's what I call leasable vacancy versus vacancy that's obsolete. And companies that are going to grow like the AI company that we did the deal with the 201 third are going to look for that ability to grow. They want a quality building, they want amenities. And that's going to be the attraction for companies coming to the city or those that are already in. And keep in mind, they're all bringing their employees back to work. So they need that type of space.
Operator: Our next question comes from Omotayo Okusanya with Deutsche Bank.
Omotayo Okusanya: I just wanted to go back to Caitlin's question around Flower Mart. And again, I guess I'm still struggling to understand the change in capitalization exactly what's really driving that? And then second of all, if you do end up with the local government kind of rethinking the project and you kind of get what you want, doesn't that kind of suggest you keep capitalizing in '26, because you're going to probably continue with development along those lines?
Angela Aman: Tayo, thanks for the question. I go back to sort of how we started communicating at this when we came out with original guidance. And if you remember what we talked about is knowing that we wanted to pursue more flexible entitlements and to allow the flexibility on site to be able to phase development differently. And at that time, it was not perfectly known whether or not that is something that would be palatable to the city or not. And as we've continue -- and so there was a path which we communicated, I think, pretty clearly when we came out with original guidance, where that wasn't palatable to all the different people involved and all the different constituencies.
And we probably were pencils down by June 30. And so that was what was embedded in the low end of guidance, right, that we didn't capitalize for the entire second half of the year. Where we stand today is that we do think the city has been -- we've had encouraging conversations with the city. Those conversations are continuing. We continue to work on an active redesign and reimagining of the Flower Mart project. There are some additional steps we need to take in the second half of the year, which we can be more clear about as we take them and those things become public.
But at this point, we believe that many of those activities will be done by year-end, and we'll need to stop capitalizing. To your point, there's a path under which we get flexibility and entitlements. And it doesn't -- it still doesn't make sense for us to commence a project at that point. And that's -- if we're not doing additional design work, where we're not doing any of the development work associated with continuing that project per accounting guidance, we'll have to stop capitalizing.
If those activities continue, we'll be able to continue capitalizing, but that is a pretty black and white decision, and that relates to the substance of the activities we're taking at the Flower Mart at that point in time at year-end. And we're sitting here today in July, it's still uncertain exactly where we'll be at year-end, and that's why we're committing to transparency here and continuing to communicate clearly about it on next quarter's call and as we move forward. That's kind of the best we can do today based on all the information we have available right now.
Operator: Our next question comes from Michael Carroll with RBC.
Michael Carroll: I have a quick follow-up on Flower Mart, and I know that was a very detailed explanation, so that was pretty helpful. But how soon do you think you could be willing to start a new development? Like you've got your new entitlement projects, would there be a scenario where you could start a new development, especially if it's a nonoffice build? Or is that something that Kilroy would be willing to do? Or would you want to bring a partner to kind of do that if it's like a different use like a resi use type thing?
Angela Aman: There are so many questions embedded in that 1 question. And I think it's a really insightful and good question. I don't -- we're going to have to evaluate it as we move forward. We're going to have to better understand how the site lays out in totality. How interconnected any residential piece might be with a future office development projects, whether or not we feel like it sort of stands alone and there are control issues across the balance of the site that's selling that parcel would impair the office development or whether or not we can just monetize it entirely.
Those are all questions that we'll have to sort through as we continue on the redesign and reimagining of the total plan. So it's just too early at this point. I think, to answer with any greater clarity, but I appreciate the question. And again, I'm committed to being as transparent as we can as we move forward.
Michael Carroll: Okay. That's great. That's helpful. And then just lastly, I know in the prepared remarks that you mentioned that there is selective reinvestment opportunities that the company is pursuing after you kind of get these asset sale proceeds. I mean, should we think about this as new real estate type of investments? I mean, if that's the case, is this kind of like an acquisition and development opportunities? Or what do those selective reinvestment opportunities look like?
Eliott Trencher: Michael, it's Eliott. So they're kind of all over the board, but not drastically different from the things that we've looked at historically. We're probably less inclined to do spec development. But I think outside of that, any kind of acquisition that has some sort of value-add component or maybe it's a little bit more of a core plus type opportunity, something where we think we can bring some sort of expertise, whether that's leasing expertise or whether that's capital expertise in a market that we think we know well or we think has pretty good growth prospects.
And as we sort of alluded to in our remarks, we're -- there are a bunch of those that we're evaluating over several different markets and submarkets and we'll kind of see how they play out.
Operator: Our next question comes from Dylan Burzinski with Green Street Advisors.
Dylan Burzinski: Appreciate all the comments that you guys have made related to sort of the demand pipeline, turning activity and whatnot. But I guess just one quick one as it relates to sort of new leasing. Obviously, a very strong quarter in 2Q. I mean, do you guys get the sense for that sort of being a good annualized run rate of, call it, new leasing of 1 million square foot on an annualized basis? Or was it maybe 1 or 2 large leases that sort of drove that higher this quarter. Can you guys just talk about sort of expectations on the new leasing front?
Angela Aman: Yes. Thanks, Dylan. I appreciate it. I do think -- we obviously talked about a growing pipeline and some excitement we have around the acceleration of development portfolio leasing. So we feel really good about that. As it relates to the balance of the operating portfolio, I think the team is doing an excellent job really across markets at driving new leasing and really focusing on expirations we have in the back half of '22 and into 2026. So I think there's lots of good activity building.
I'm hesitant to commit to any specific number, but I think I'm more encouraged than I've been at any point over the last 1.5 years in terms of how leasing is shaping up and the sustainability of the types of demand we're seeing across our core markets. So definitely encouraged and now we have to put our heads down and execute.
Operator: Next, we have a follow-up question from Nick Yulico with Scotiabank.
Nicholas Yulico: I just wanted to turn back to 2026 expirations. I think at one point, you talked about like a 200,000 square foot expiration and it was a large tenant that you thought would stay, but they could downsize. And I just want to see if you have any update on that or any of the other expirations next year?
Angela Aman: Yes. No update specifically on that at this point. What I did mention earlier is that we're very focused, especially in those expirations in the first half of 2026, where many of our 2026 expirations are pretty weighted, particularly in the second quarter. I do expect that we're going to have a few larger vacates or significant downsizes in that first half of the year time frame. We're actively working on discussions with many of those tenants now. It's just too early to say with finality.
Operator: Our final question today comes from Jamie Feldman with Wells Fargo.
James Feldman: So Rob, you may have answered this in a prior response to the question, but I guess on AI specifically, given that it sounds like it's a decent amount of the pipeline, can you talk more about the exact types of buildings, locations, urban versus suburban, floor sizes, power needs, amenities and build-outs we might see for those types of tenants. Is it any different from what you see from a typical tenant end market or in the market?
A. Paratte: Yes. Sure, Jamie. Again, there's sort of a spectrum the younger AI companies are going to look for prebuilt space that's ready to move into, and they're going to look for adjacency in that space, meaning space they can expand into because they're continuing to get funding, they're growing and all that. The power needs are generally along the lines of what office users use because we're not -- most of our tenants that are AI in the company aren't actually using the power per se on site. A lot of that's generated off-site or it's not R&D type space that we're leasing.
And I think the typical size, if you're looking in San Francisco, having a 30,000-foot floor plate, like we have a [indiscernible] is really important. I think, we're not at the point yet where tenants are wanting these 70,000 or 100,000 foot floor plates that they wanted in the last cycle. But 30,000 feet, that's a very clean floor. These companies are no nonsense. So they want -- they like a rectangle. They like a central core. They want to have a lot of open space. And the amenities that are important are the same as with any other tenant. It's outdoor space that's usable, it's restaurants, food, beverage, it's fitness either in the building or adjacent to.
Some of our -- whatever business centers and things like that are extremely popular and a big draw in fact, at [indiscernible], we have some of all of those pieces that become attractive to a tenant. And keep in mind, with the younger company having those amenities on site means that they don't have to build in foodservice, for example, or a conference center or what have you. So it's quite similar to other tech that we've leased to. They are -- they tend to be a little more dense in their use of space, which, as they grow, is going to be a good thing for us and other landlords.
Angela Aman: Yes. I mean the biggest dynamic and just everything Rob just said, that we continue to point out is that these tenants are really looking for flexibility. They're growing very quickly, and they're looking for landlords, but we'll work with them to accommodate that future growth where possible. And so that's been a key focus in terms of how Rob and the team have really gotten to understand exactly what they're looking for.
We're also working really hard, whether it's our spec suite program or in some recent examples, using existing build-outs in space that might have been vacated pretty recently because these tenants are really focused on taking many of them, very focused on taking occupancy as quickly as possible. Those are all really encouraging dynamics for us as a landlord in a market like San Francisco and at this stage of the recovery. So we've really been leaning in and figuring out how to meet those needs as well as we can.
Operator: Thank you. We have no further questions. And so this concludes our call. Thank you all for your participation, and you may now disconnect your lines.