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April 27, 2017

Massive Mission Bay office and lab project delayed by nine months, adds $75 million in costs

San Francisco Business Times

Roland Li

Kilroy Realty Corp. is delaying the opening of its Exchange project by about nine months and spending an additional $75 million to make it more attractive to life sciences tenants.

The Los Angeles-based developer (NYSE: KRC) said in an SEC filing that the Exchange will open in the second quarter of 2018 instead of the third quarter of this year. The four-building, 750,000-square-foot complex at 16th and Owens streets has been under construction since 2015.

Kilroy Realty Corp. also plans to invest an additional $75 million to make the project more attractive to lab space and life science users. Kilroy's total investment estimate is $560 million, up from $485 million in the previous quarter. Kilroy had spent $258.4 million on the project at the end of last month, according to SEC filings.

The property currently has no tenants. The developer is now pursuing a multi-tenant leasing strategy, rather than one giant deal with one user, executives said on Thursday during a quarterly earnings call.

"We have strong interest in the project from a variety of tech and life science tenants, and remain confident that the Exchange will be largely leased by warm-shell completion in the second quarter of next year," said John Kilroy, CEO of Kilroy Realty, on the call.

An analyst was critical that Kilroy still hasn't secured any tenants for the Exchange.

"While internal growth metrics remain strong, a seeming lack of letter of intent conversion at the Exchange on 16th (into a signed lease) raises concern," wrote BTIG, a financial research firm on Wednesday. BTIG rates Kilroy as a buy.

"Kilroy continues to benefit from robust tenant demand in its high-barrier West Coast markets," BTIG wrote earlier this month. "While leasing concerns at The Exchange persist, we ultimately expect a successful lease up and believe negative sentiment clouds the value embedded in Kilroy's development pipeline."

Kilroy executives remained upbeat about the Exchange and the Bay Area's office market.

"The demand remains healthy and consistently split between life sciences and tech" at the Exchange, Tracy Murphy, Kilroy's new vice president of Northern California and Life Sciences, said on the earnings call.

Murphy said the smallest potential tenant at the Exchange would likely occupy 75,000 square feet or more.

Murphy said the project's neighborhood had one of the most constrained office supplies in San Francisco, which helps Kilroy.

"Mission Bay is totally spoken for or committed for," said Murphy, who said the vacancy rate was under 3 percent. "There's nothing in Mission Bay. The next competitive option is whatever comes in South San Francisco. It's years away."

San Francisco's Prop. M, which restricts the amount of office space approved each year, could also severely curtail the amount of new office development if the law isn't changed.

The Exchange is one of the five large office projects under construction in San Francisco. The others are Salesforce Tower, which is nearly 70 percent leased; 350 Bush, which is about 50 percent leased; and the un-leased 181 Fremont and Park Tower.

At $746 per square foot in project costs, Kilroy is still spending less per square foot than some buyers of older downtown San Francisco office buildings. Recent deals have closed at $900 per square foot or more.

John Kilroy said on the call that he anticipates an 8 percent or better return on the project. Kilroy expects rents of $100 per square foot for life science space at the Exchange, higher than the $80 per square foot or more in new office projects. Kilroy's Bay Area portfolio is 97.4 percent leased.

CBRE and Kidder Mathews are the Exchange's leasing brokers. Hathaway Dinwiddie Construction is the general contractor. Rios Clementi Hale Studios and Flad Architects designed the project.

The Exchange also has about 700 parking spaces, which Kilroy said makes it more attractive than a project like Park Tower at 250 Howard St., which has almost no parking. Park Tower is two blocks from a BART station and next to the upcoming Transbay Transit Center, while the Exchange is in a neighborhood with less public transit.

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