We have seen several big tech companies decide to move or expand operations out of California's Silicon Valley and into cheaper locations, particularly Austin, Texas. Tesla, Apple, and Alphabet are just some of the big-name companies that have decided to plant a flag in the Lone Star State.
Office real estate investment trust (REIT) Kilroy Realty (KRC -0.27%) recently made a splashy purchase to enter the Austin market and take advantage of this partial exodus.
Austin, Texas. Image source: Getty Images.
Kilroy is heavily exposed to expensive West Coast markets
Kilroy is an office REIT that has historically targeted a few select West Coast markets, specifically San Diego, San Francisco, Los Angeles, and Seattle. The company develops Class A office properties, which are the most desirable in terms of age and amenities. It has heavy exposure to the tech industry, and its biggest tenants include Dropbox, General Motor's Cruise division, Microsoft, Adobe, and salesforce.com.
Recently Kilroy announced that it had bought Indeed Tower in Austin. CEO John Kilroy explained why in a press release: "I can't overstate how well Indeed Tower fits with our strategic and property objectives. It is arguably the best building in Austin, is in one of the best locations, provides us with scale that will support future growth, is anchored by an investment grade technology tenant and provides a value-add opportunity through lease-up in an office market that is strengthening."
Austin is becoming a destination for tech companies
Austin has the fourth-largest concentration of tech talent (behind San Francisco, Seattle, and New York), along with a relatively lower cost of living. That's why it's the top destination for tech migration. Over 80% of this REIT's top 15 tenants have a presence in the city. The rental fundamentals are strong as well, with lease rates growing around 50% over the past 10 years.
Kilroy picked up Indeed Tower at $800 per square foot, which compares favorably to its recent sale of its Dropbox headquarters in San Francisco (in The Exchange building) at $1,440 per square foot. This gives you an idea of the relative cost advantage of Austin and why many tech companies are choosing to put operations there.
The immediate impact is small, but it will make a more stable company
Will Kilroy's expansion into Texas have a material effect on earnings right off the bat? Probably not. It will have 730,000 square feet of space there, compared to 5.4 million in San Francisco. The REIT's exposure to Austin will amount to about 4% of its office portfolio. That said, this move will help diversify its risk, and its sale of The Exchange office building in San Francisco for $1.08 billion reduces its exposure to some possibly overheated markets.
Kilroy stock is trading at just under 19 times 2020 funds from operations per share. It declined to give guidance during its first-quarter earnings conference call due to COVID-19 uncertainties, but the multiple is certainly not excessive. Its quarterly dividend of $0.50 per share gives it a yield of 2.9%.
The company's tenants are some of the top tech names, and Kilroy collected 97.8% of contractual rent from its office clients last year. The office REIT is poised to follow its clients' exodus from the West Coast, which will help it recapture some of the business lost. This move won't immediately affect earnings, but it will help reduce its exposure to expensive office markets.
