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West Coast Office REITs Ended 2017 With High Occupancy, Strong Leasing Activity

Demand remains high for office space across California and the West Coast. Office dynamics were strong during the fourth quarter and throughout 2017 with public REITs reporting significant leasing activity, especially at new construction projects. High demand and low supply have been particularly helpful for new leases in the San Francisco Bay Area. Check out how some of the largest public REITs operating on the West Coast did last quarter and company expectations for 2018.

Kilroy Realty Corp.

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A rendering of Kilroy Realty's The Exchange, which Dropbox leased in historic fashion in 2017

During the fourth quarter, Kilroy Realty Corp. signed 1.4M SF of new leases and signed 678K SF of new or renewal leases within its stabilized portfolio, Kilroy Realty CEO John Kilroy said during a call with investors. Rents went up 15% across its portfolio.

The largest lease during Q4 within the stabilized portfolio was a 10-year, 207K SF lease with Okta for all of Delta Dental’s expiring 188K SF lease plus 19K SF at 100 First St. in San Francisco. Okta may also take an additional 48K SF when it becomes available in the building in 2020. Among the significant lease transactions last quarter was The Exchange in San Francisco. It is now fully leased with Dropbox signing a 15-year lease during the fourth quarter for the entire space.

At the end of 2017, Kilroy Realty’s stabilized portfolio in the Bay Area had an occupancy of 96.1%. Its Greater Seattle portfolio was 95.4% occupied. Its Los Angeles and Ventura counties portfolio was 93.3% occupied, while San Diego was 97.4% occupied. Across its entire portfolio, net operating income increased 9% in 2017 to $512M compared to about $470 in 2016.  

Kilroy Realty has five projects under development totaling 2.1M SF of office, 120K SF of retail and 237 residential units for an investment of about $1.7B. The company expects to generate $120M in net operating income from these projects, representing a 25% growth on NOI companywide from 2017. The developer is working through entitlements for its Flower Mart project in San Francisco and its recently acquired Little Italy project in San Diego.

The developer began construction on its Academy & Vine project in Hollywood in January. The first phase will build 306K SF of office, 24K SF of retail and parking. The expected completion is 2020 and the cost for the first phase is expected to be $190M. The second phase will create a 200-unit residential tower expected to cost $150M.

Its portfolio in Hollywood continues to benefit from strong demand and low supply, according to Kilroy. The market is being driven by demand from Apple, Netflix, Facebook and Amazon, as well as small and midsize companies in different industries.

Kilroy Realty acquired the Oyster Point Tech Center in South San Francisco earlier this year for $111M in an off-market transaction. The three-building campus has 146K SF and is 80% leased. Kilroy Realty was attracted to the acquisition because it has strong cash return on stabilization and is adjacent to a site where the developer has a recorded option within the Oyster Point submarket, Kilroy said. More information on the development option is expected to be available this year.

Year-end 2018 occupancy for its office portfolio is expected to be between 94% and 95%, Kilroy Realty Executive Vice President and Chief Financial Officer Tyler Rose said during a call with investors. Occupancy was 95% in 2017.

A slight decline in occupancy is expected due to a large lease expiration in San Diego and a lease expiration in Bellevue. Kilroy Realty plans to renovate the Bridgepoint space in San Diego upon lease expiration later this year, which will take the project out of service, Rose said.

Boston Properties

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Salesforce Tower in San Francisco

Boston Properties had leased 89.3% of its properties in San Francisco and Los Angeles by the end of 2017. Its West Coast portfolio consists of about 7.2M SF, a majority of which is within the San Francisco market. Its only Los Angeles asset is 50% ownership of the 1.1M SF Colorado Center in West Los Angeles. Boston Properties' San Francisco portfolio generated net operating income of $240M compared in 2017 compared to $218M in 2016.

As of the end of January, Salesforce Tower in San Francisco was 97% leased with 205K SF of new leases signed last quarter to add a law firm, a private equity firm, an investment manager and a co-working company to the tenant mix, Boston Properties President and Director Doug Linde said during a call with investors. First tenants have already begun moving in and the company expects the tower to generate a full contribution upon stabilization in Q3 2019.  

The company has increased its tenant improvements and concessions at Salesforce Tower during lease-up at the building, and Linde said the company can provide $100/SF for the remaining 30K SF for a 10- to 15-year lease. Rent has been going up as well and is now up 3%, which is paying for the concessions. When the company originally started leasing the building, it was getting rents in the low $60/SF range to $70/SF at the top of the building and rents are now in the high $80/SF range and above $90/SF, Linde said.

During 2018, Boston Properties will be looking to lease 80K SF at San Francisco's Embarcadero Center after a tenant moves from that center into Salesforce Tower. Boston Properties did lease 100K SF of office at Embarcadero Center during the quarter and already had offers pending for the 80K SF becoming available.

Columbia Property Trust

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650 California St. in San Francisco

Columbia Property Trust reported strong leasing activity during the year as well. 650 California in San Francisco is 96% leased, compared to 65% from six quarters ago, Columbia Property Trust Nelson Mills said during a call with investors.

At 221 Main, rents have been more than doubling and it has leased 68% of the building since its 2014 acquisition, according to Mills. The property is 92% leased. Columbia Property Trust also extended its 119K SF lease with DLA Piper at University Circle in Palo Alto, which also helped its leasing activity for the year.

The REIT reported net operating income for 2017 of $76M for San Francisco compared to $80.5M in 2016, and $4.5M for Los Angeles relatively unchanged from 2016. NOI decreased during the year for San Francisco due to Columbia Property Trust’s sale of a 22.5% interest in University Circle and 333 Market St. and is expected to decrease in the near term with the sale of an additional 22.5% in each of these properties.

Hudson Pacific Properties

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Rendering of ICON Tower in Los Angeles, the new Netflix headquarters

Hudson Pacific Properties increased its office portfolio revenue by nearly 11% to $171M during the last quarter compared to $154M in Q4 2016 largely due to additional revenue from rent, tenant recoveries and parking. The increase from rent came from the commencement of Netflix’s lease at ICON and rental revenue from its purchase of Hill7 and Page Mill Hill.

Net operating income increased 10.2% across the office properties from its existing portfolio during Q4. As of the end of 2017, the company’s stabilized and in-service office portfolio was 96.7% and 92.1% leased, respectively. The company completed 53 new and renewal leases for about 558K SF during the quarter.

Major leasing activity occurred across multiple Hudson Pacific sites within the last few months. NFL Enterprises extended its 168K SF lease at 10900 and 10950 Washington in Culver City through 2023, and Regus US signed a 46K SF lease to end in June 2030 at 95 Jackson and 450 Alaskan in Seattle. In Palo Alto, Baker McKenzie signed a 36K SF lease through March 2029 at Clocktower Square. Another law firm, Covington & Burling, signed a 27K SF lease through August 2028 at Palo Alto Square.  

In late February, Hudson Pacific Properties renewed a 103K SF lease at its 6922 Hollywood Blvd. asset with Trailer Park, which signed a 10-year lease. It also recently leased about 41K SF to Orbital Insight at Palo Alto Square through March 2025.

Hudson Pacific has been actively selling properties across its portfolio. In November, it sold its 65% joint venture interest in Pinnacle I and Pinnacle II in Burbank to Blackstone. Net proceeds were about $85M. In 2018, Hudson Pacific sold two properties in the Bay Area and Southern California, which closed in March, for $96M. In January, the company sold Embarcadero Place in Palo Alto for $136M and Peninsula Office Park in San Mateo for $22.5M.