Kilroy Realty Corp

NYSE:KRC

Earnings Call Transcript 2020-Q1

[Operator]

Hello, and welcome to the Kilroy Realty Corporation Q1 2020 Earnings Conference Call. [Operator Instructions] Please note, today's event is being recorded.

I now would like to turn the conference over to your host today, Tyler Rose. Mr. Rose, please go ahead.

[Tyler Rose, executive]

Good morning, everyone. Thank you for joining us. On the call with me today are John Kilroy and several other senior members of our management team who will be available for Q&A.

At the outset, I need to say that some of the information we will be discussing is forward-looking in nature. Please refer to our supplemental package for a statement regarding the forward-looking information in this call and in the supplemental. This call is being telecast live on our website and will be available for replay for the next 8 days, both by phone and over the Internet. Our earnings release and supplemental package have been filed on a Form 8-K with the SEC and both are also available on our website.

John will start the call with the actions we have taken to protect our employees, support our tenants and sustain our organization through this unprecedented health pandemic. He will then review the impact COVID-19 has had on our business, markets and development plans, and we'll wrap up with our priorities as we move through the remainder of the year.

I will provide brief first quarter financial highlights, give an update on rent collections and then review our current financial position. Then we'll be happy to take your questions. We're all calling in remotely, so bear with us if there are any delays in our responses. John?

[John Kilroy, executive]

Thanks, Tyler, and hello, everyone. Thank you for dialing in today. We appreciate that many of you are juggling a lot of personal and professional challenges right now. This is the first time I can honestly say that I've taken the load out of the washing machine 5 minutes before a conference call.

All of us at the company here hope that you and your loved ones are safe and healthy. And importantly, we want to acknowledge the men and women who are servicing the most critical elements of our society during this time. We're so grateful to everybody, medical professionals, researchers, grocers, truckers, all the rest. They're helping us stay well and shelter in place.

Here at KRC, we have been in daily communication with our employees, our tenants and our construction team since the West Coast began shutting down nonessential business activity roughly 6 weeks ago. Our corporate team, largely working from home, has adjusted its operating protocols to ensure that everyone, from our engineers to our Board of Directors, is getting the guidance and support they need to make good decisions.

All of our operating properties are open and staffed with on-site property managers and security, and all are following CDC recommendations for virus mitigation, including frequent, high-touch point cleaning and daily disinfecting.

To start, let me review where we stand financially and operationally. For those of you who follow our company closely, you know that we operate from a core set of business principles that emphasize financial strength, top-quality markets and assets, and strong credit tenants. We have basically built a moat around this company and came into this crisis in a strong position. We have significant liquidity, limited expirations, a young portfolio, access to multiple sources of capital, no near-term debt maturities, almost no secured debt and a well-capitalized tenant base.

Let me review this in more detail. Our balance sheet is solid. We have $1.4 billion of immediately liquid assets. This includes $1 billion of cash from the $725 million drawdown in mid-March of all our equity forward sales and $350 million from the recent issuance of private placement debt. We also have $370 million available in debt capacity under our credit facility.

Further adding to our balance sheet strength, we don't have any debt maturities until 2023, excluding our credit facility, which matures in the third quarter of 2022. Our stabilized portfolio was in excellent shape heading into this crisis and remained at 97% leased at the end of March. We have only 5% of our leases rolling annually over the next 3 years and our average lease term is approximately 7 years.

Having said that, we are seeing some stress in primarily nonoffice revenue streams, which I'll discuss in a moment. Our $2 billion of projects under construction, including the 3 projects now in the tenant improvement phase, have been effectively derisked and fully funded. The office and life science component of these projects is 90% leased to large technology, media and life science companies. The projects have a total remaining construction spend of approximately $725 million that is fully funded with the liquidity I discussed above. The properties are located in the submarkets in Seattle, South San Francisco, Los Angeles and San Diego and all remain under construction. Our relationship with large, stable, innovation-focused customers are proving to be an advantage. Our pro forma top 15 tenants account for approximately 50% of our annual revenues. They are, for the most part, publicly traded and investment-grade rated. These leases have an average term of longer than 10 years, with average annual rent escalators of 3%.

Some of our top tenants are even in the business of making stay-at-home life a little bit easier, including DoorDash, Apple, Amazon and Netflix. While we are in solid shape financially and operationally, the most immediate impact to our business is largely in the nonoffice components of our company, including retail, co-working, transient parking and residential. While none of them by themselves is that material, the impact from some may stay with us longer than others. Our exposure to retail is approximately 3% of our revenues and most of that is concentrated in a handful of properties, most notably One Paseo in San Diego.

As of now, we have established a program with approximately 90% of our retail tenants that provides them with 2 months of rent relief and gets added on to an extended term. Our co-working exposure is approximately 1.8% of our revenues, with most of it in one very high-quality property in Hollywood. Tyler will discuss this component further in his remarks.

We also have transient parking that makes up approximately 2% of our revenues. We estimate that this revenue stream, which includes daily, short-term and event parking, will be impacted while the stay-at-home orders are in place, but will ramp back up as people come back to work.

Lastly, leasing activity has quieted in our residential portfolio, which makes up approximately 2% of our revenues. Before the crisis hit, Columbia Square was 95% occupied. The first phase of One Paseo was already 70% leased and the second phase reached over 15% leased just a few weeks after opening. We have implemented a virtual tour and leasing program and we have made some success, but until the stay-at-home orders are lifted, we expect the pace of leasing and move-ins to be slow.

Notwithstanding the stress we're seeing in our nonoffice components, we're still making some leasing progress throughout the portfolio. Just in the last 2 weeks, we have signed 2 leases and are close on a third that total approximately 123,000 square feet that include a lease with a life science company in San Diego, a lease with a gaming company in Los Angeles and in Seattle, we are in advanced negotiations with a major technology company.

Given the unprecedented challenges we are working through, it is difficult to give a road map today for the next 6 to 12 months. And while we have always endeavored to provide clarity, this is not one of those times where we can. However, here are 4 key areas in which we will be laser-focused as we may move through this crisis.

First, we will continue with our conservative approach to balance sheet management. We are focused on maintaining a strong credit profile with low leverage and diversified access to capital. This includes continuing the effort to complete $150 million to $300 million of dispositions, which was the guidance range we had communicated on our last call. Before the crisis began, we were making good progress on 2 of dispositions. However, given the current environment, where lenders are unable to appraise and buyers unable to tour, we'll have to take a wait-and-see approach.

Second, we are highly focused on completing our $2 billion of under construction development. We are in the fortunate position of having largely secured construction materials and are now in the tenant improvement phase in several projects. We will continue to stay close to the construction ordinances across the various jurisdictions to ensure our projects are moving ahead safely and as close to on time as possible.

Third, our leasing teams are unwavering in their efforts to lease up vacant and expiring space. While new tenant tours are on hold, we continue to see progress with existing tenants for renewals and expansions. We have not seen a material re-trading of economic terms across the office and life science transactions and expect those sectors to see continued growth. And we have pre -- as we've previously reported, we only have 1 expiration over 100,000 square feet this year. That's the 130,000-some odd square foot lease at our Long Beach property, where we are in discussions to lease a significant portion of that space to a credit tenant.

Fourth, we are looking ahead. While, at this point, demand patterns for real estate sectors are unpredictable, in our discussions with our office and life science customers, it is clear there will be a flight to quality. They will focus on buildings that are sustainable, have modern systems and that can accommodate the changing protocols the companies are implementing. As you've seen over many years, we have been leaders in the functionality of space. We were one of the first to embrace sustainability, and most recently, we began focusing on Fitwel and WELL buildings. All of this, we think, differentiates us from many of our peers and we are now taking the lead and creating best practices for the future. We have already brought a hygienist onboard. We are rethinking how people enter a building and what they touch. We are evaluating how to manage elevator occupancy levels. We are studying ways to improve filtration systems, and we are working on new policies and procedures that emphasize personal space and adhere to social distancing guidelines. A lot more of this to come.

To wrap up, I want to make the point that our employees have done a phenomenal job in responding to rapidly changing circumstances. One of the few pleasures of this crisis for me has been to witness how effectively they have adapted on the fly, and the level of commitment and concern they have shown for our tenants, our business partners and one another. That's a picture of where we stand today at KRC. We believe that our organization and our people are well prepared to focus through this crisis and that our company is well positioned to move ahead.

That completes my remarks. Now I'll turn the call over to Tyler. Tyler?

[Tyler Rose, executive]

Thanks, John. We reported solid first quarter results that came in above our expectations. They do not, of course, reflect any meaningful impact from the current crisis. FFO was $1 per share in the first quarter, driven by early rent commencement at the Exchange, offset by a reduction in revenue of approximately $0.06 per share, primarily related to the cumulative impact of transitioning a co-working tenant and 2 retail tenants to a cash basis of reporting as a result of the pandemic.

Turning to same-store results. Cash NOI grew 14.9% and GAAP NOI was effectively flat in the first quarter. Cash NOI growth was largely driven by higher rental rates, cash commencement of several large leases as well as a cash lease termination payment that was accrued in 2019. Excluding the payment, cash same-store NOI was up 11.3%. GAAP NOI was impacted by the revenue reversals I just mentioned. Excluding the reversals, same-store GAAP NOI was up 4.2%.

At the end of the quarter, our stabilized portfolio was 93.5% occupied and 97.3% leased. In mid-March, as the severity and wide-ranging impact of the coronavirus became more apparent, we decided to physically settle all of our outstanding equity forwards, adding approximately $725 million of cash to our balance sheet.

Further, given the ongoing uncertainty in the capital markets and the potential delay in our dispositions, we accessed the private debt market and raised $350 million in 10-year debt at a rate of 4.27% to further add to our liquidity. We completed the transaction just 2 days ago. It was oversubscribed and upsized, and had a strong list of institutional investors.

With these 2 transactions and availability of $370 million under our revolver, our current liquidity totals $1.4 billion and our net debt to first quarter annualized EBITDA is 5.6x. This liquidity allows us to fund our remaining $725 million of development spending and further provides us with sufficient resources to be offensive should opportunities arise.

Additionally, we have plenty of room under our bank financial covenants, with more than a 45% cushion or approximately $250 million of NOI cushion.

As John mentioned, our top 15 tenants make up about 50% of our revenues. In addition, another 25% of our revenues come from publicly traded sponsored or investment-grade rated tenants.

Now let me give you some color on rent collections for the month of April. Across all property types, excluding the retail restructuring John mentioned, we have collected approximately 96% of our April contractual rent billings. Adjusted for the retail restructurings, we've collected 93% of our buildings, including 96% from office and 88% from residential. Generally, in terms of the pace of payments, there were a few delays, but by mid-month, we received a large majority of the expected buildings.

Lastly, we are withdrawing our earnings guidance for 2020 at this time given the uncertainties generated by the coronavirus and its impact on business activity. While we have identified the primary areas of potential impact on our portfolio from COVID-19 today, there are too many factors that could change our assumptions, including revenue recognition timing and other macro-related factors. Instead of formal guidance, we can offer the following assumptions based on what we know today, that may be of use in assessing our potential earnings results for the remainder of the year.

From a financing perspective, the early drawdown of equity and the debt offering will have a dilutive effect of approximately $0.17 per share on our earnings when compared to our original guidance. We have no plans to complete additional capital raises at this time. However, as our track record has shown, we take a conservative approach to managing our balance sheet, and we will be nimble to ensure adequate liquidity as needed. As John discussed, our disposition plan is likely delayed, with the timing unknown at this time. The retail rent relief program will have a minor earnings impact. From a cash perspective, 1 month of rent deferral for these tenants is approximately $1.5 million. Noncontractual parking income totals approximately $1.5 million of NOI per month. We expect the impact from this revenue stream to be closely tied to the shelter-in-place time frame.

Across the residential portfolio, we expect limited NOI of One Paseo and some occupancy declines at Columbia Square.

While it appears that we are on track as originally contemplated with revenue recognition on our development projects, shelter-in-place ordinances and availability of manpower may impact us. Our best estimate at this point is as follows: in Hollywood, Netflix // On Vine is on track to deliver in the fourth quarter and the On Vine residential tower is scheduled for the first quarter of 2021. In San Diego, the remaining 146 residential units at One Paseo are estimated to deliver late in the second quarter of this year and One Paseo office is scheduled to deliver in phases, starting late in the third quarter. And in Seattle, we expect the first phase of 333 Dexter, totaling about 330,000 square feet, to begin revenue recognition late in the third quarter of this year.

Finally, across our stabilized portfolio, we have several buildings that are undergoing tenant improvement work prior to the new tenants taking occupancy. For a time, about 30% of our TI projects were facing delayed completions. But those ordinances will be lifted as of May 4 and it appears this is now behind us.

That completes my remarks. Now we'll be happy to take your questions. Operator?

[Operator]

[Operator Instructions] And the first question today comes from Jason Green with Evercore.

[Jason Green, analyst]

Just a question on the private placement. Are you able to provide how much more expensive that would have been had you issued unsecured debt to the broader market? And also how deep the private placement market is today for the right companies?

[Tyler Rose, executive]

Yes. I mean one of the reasons we didn't do public bonds was the market is very volatile right now and the pricing recovery was unsure. So to be honest, it's hard to know exactly what the range would have been. But it's fairly close to the private placement. We did 4 1/4%, effectively, on our deal, and it may have been a little bit lower if we hit the right day on the public side, but it also could have been higher. So we don't have a lot of more visibility than that.

[Jason Green, analyst]

Got it. And then for the 3% of revenue from retail tenants, are you able to provide what collections were for those specific tenants?

[Tyler Rose, executive]

So for the -- obviously, we didn't bill for the tenants we gave rent relief for, so we didn't collect any of that. For the rents that we did bill for, we collected about 80%.

[Operator]

And the next question comes from Craig Mailman with KeyBanc Capital Markets.

[Craig Mailman, analyst]

Tyler, just on the kind of the cash accounting transition for those tenants, had they not paid in March either and that's why you guys recognize it in 1Q? Or they kind of -- you came to a recognition they wouldn't pay in April?

[Tyler Rose, executive]

Well, for the co-working tenant, they paid in March. But we don't want to get into the specific negotiations with all these tenants, but it was more of an April issue for the co-working tenant and our expectations for how that might play out. And with the retail tenants, we were having some issues with those tenants already.

[Craig Mailman, analyst]

That's helpful. Then, John, maybe just bigger picture. I know it's very early with everything going on, but kind of West Coast, Tennessee, early adopters of work-from-home relative to most East Coast tenants, but typically more dense. So just curious kind of where you think the rent or office demand could kind of shake out here as the pandemic eases?

[John Kilroy, executive]

Yes. Well, Rob Paratte, why don't you handle that? And maybe I'll follow up.

[A. Paratte, executive]

Sure. It's -- again, we're kind of right in the middle of this and focused on getting our tenants back to work with their employees safely. But when you really look at what's going to happen, I think, is that, if you take, for example, a company that's got 100 square feet per person right now, maybe they'll be looking at 150 square feet per person in the future. We don't know what offset will working from home have. Very hard to answer. But I can say with certainty that in the business sectors we focus on, whether it's life science, you can't create a virus or vaccine -- excuse me, a vaccine working from home. You can't create a Hollywood blockbuster film working from home and nor can you develop state-of-the-art software. So I think that working from home has probably been more legitimized than it ever has been. But I think it's not going to completely offset the increase in space I think the tenants are going to need in order to function going forward. So hard to say where we end up with this, but I'm confident that at least in the portfolio that Kilroy has, that John outlined in his remarks, these firms are going to need to and want to get back into the workplace.

[Craig Mailman, analyst]

That's helpful. And then just one last one. The development pipeline is well leased here, and you guys clearly have additional projects that could have started this cycle. Just thoughts on something like the Flower Mart here, if that gets delayed until next cycle. And then just also, as you guys think about the risk/reward of spec versus maybe being able to pick off some opportunities if there's distress here. Should we expect that maybe the balance of power kind of moves back to acquisitions versus development?

[John Kilroy, executive]

Well, I don't know about acquisitions right now because I haven't seen sufficient information with regard to opportunities of the kind of quality assets and locations that we like, where there's a price that we like. To the contrary, we've seen on the deals that have closed, they've continued to close at very low cap rates and not the kind of upside we want. So it's too early to tell on acquisitions. Obviously, we were, I think, the earliest and probably the most aggressive in 2010 when we could see that the -- that recession was going to see some daylight. And if those opportunities present themselves, we will.

On the question of development, as we commented on in our earlier remarks, we are 90% leased on office and life science. The 10% was just started this summer. That's the Kettner project down in Little Italy, submarket of San Diego, and I'm confident that's going to lease up while it's under construction.

In terms of spec development, you've seen us in the past be aggressive on spec development, but always balancing, not just building more and more spec, always making sure we were getting either things pre-leased substantially or the stuff we started was under construction before starting new spec. Clearly, the bias now versus 2 or 3 months ago is to be far more conservative on spec development. I see no potential for us starting any spec development for -- within the next 12 months. And I don't know that we'll start any development within the next 12 months, even if it's leased.

[Operator]

And the next question comes from Jamie Feldman with Bank of America.

[James Feldman, analyst]

Great. I guess, John, going back to some of your comments about some of the hygiene upgrades. I think you'd mentioned you hired a hygienist and you're focusing on upgrading assets. As you talk to tenants, I mean, what do you think the costs are to start getting buildings ready both for the near-term and then just kind of longer-term changes in design that we might start to see?

[John Kilroy, executive]

Yes. It's a really big question. We have a task force at Kilroy that consists of 12 people. It includes our Chief Engineer, who comes out of the life science biotech area and is one of the real leaders there. So this is really familiar ground for him. One of the things we've been doing, Rob and others and our asset management people have been meeting regularly or meeting virtually, regularly with our tenant base both from the tech, life science as well as the general other populations about what protocols their companies are developing. And as you know, in our portfolio, we have buildings that are leased exclusively to tenants and then we have some that are multi-tenant. And so they differ a little bit.

But I would get into a long list and a long litany, Jamie, of the things that we're doing. Some of them, I don't want to tell our competitors what we're doing because I intend to lead this. Just like we've been the leader in sustainability. We intend to lead the new wave, if you will, in this area. But we are doing the simple things, like we have robots that clean the filtration systems, the air conditioning conduit and so forth. We have -- we may end up with clean rooms in buildings where everything has got to go through it. We'll see about that. We have engaged a hygienist as I said. We're working on where all the logical places are to minimize touch and then to make sure that we are cleaning things appropriately and so forth. So these are all sort of the things that are happening right now. We're working with our tenant base as they repopulate these buildings. Most of the big tenants are not intending, from what we've been told, to go back and say, okay, all 100% of the population of this building is going to arrive on day 1. They're going to phase it with the most essential operations. And then on the spacing side of things, we're working with tenants, some of whom want to rearrange and have more square footage per person.

And then on the design side of it, you have sort of 3 things going on. One is the core portfolio, most of ours is very new, as you know, so it comports with many of the things that people want, which is more air conditioning capacity, greater width in stairwells, greater building -- floor-to-floor heights, more open spaces. You're going to see terraces and rooftop decks and controlled open spaces become far more valuable from everything we're hearing with our tenant base. So we think we're well positioned with many of our projects because they embrace all those things. But there will be some -- we already pressurize our lobbies in various ways. That may change. So we're really getting a tremendous amount of input, it's not always the same, from our various tech and life science companies, and we're putting together our own protocols. So this is going to be an ongoing process, but we intend, as I say, to be a leader in this response and effort.

[James Feldman, analyst]

All right. That's very helpful. Thinking about the different submarkets in the Bay Area, CBD San Francisco, Peninsula, Silicon Valley. Can you give us a sense of how those different submarkets are behaving differently and how the tenant base is dictating that? I mean we see headlines coming out of CBD San Francisco about higher space -- sublease space in the first quarter and layoff announcements seemed to be more concentrated there. But just from -- you guys are clearly on the ground. I'd love to get more of your thoughts on how those 3 areas are really differing right now.

[John Kilroy, executive]

Yes. Rob, do you want to take that one?

[A. Paratte, executive]

Sure. Jamie, I'll start with San Francisco. Unfortunately, the way the quarter fell between March and April, several transactions that were very close or on the cusp of being signed the last day of March, spilled over to April. So -- and a lot of that was in sublease space. But also there have been some significant renewals that were done to the tune of about 500,000 -- almost 600,000 square feet that fell right between the 30th and the 1st. So the data doesn't really show, I think, what the reality is in terms of just pure activity. There's no doubt that there's -- sublease space will come to market. But from what we're seeing in conversations we're having with a variety of folks, whether it be tenants that are subleasing or brokers or other owners, quality sublease space, as we've always said, is getting activity and is getting into significant documentation.

And those numbers I just went over in terms of sublease space, do not include the Macys.com space, which is terrific space. And I don't know Macy's strategy, but I assume they're probably trying to find a large single tenant because that building would be perfect for that.

On the -- in the Valley, where things are a little less dense in terms of just buildings, how buildings are laid out and that kind of thing. We have several companies that we've been talking to real time that are looking at a lot of the things John was talking about just in terms of getting people back to work. They're not talking about putting space on the market, but they're looking at pretty innovative ways to get their own employees into the work environment safely, so thermal imaging and that kind of thing. But in terms of the Valley itself, there have been -- on the capital side, there have been some deals that were put on hold in terms of just acquisition and that kind of thing. But from a leasing perspective, we are again right in the middle of this COVID thing. So it's much like San Francisco, just there is activity. It's just sporadic.

[James Feldman, analyst]

Okay. Do you think the shape of the downturn in this recession -- do you think it hits one of these -- the Silicon Valley any more or less than CBD San Francisco? Or do you think it would be pretty equal?

[A. Paratte, executive]

I think it's going to be interesting. I mean, I think I could -- like we've seen in Seattle and it's obviously in Silicon Valley and San Francisco, I think this radial approach to occupancy will become more popular. Meaning you may see less fully occupied dense campuses and more satellite type offices. But again, I would kind of go back to -- if you look at our premise about Silicon Valley, it's always been the haves and the have-nots. So those properties that are near transit lines and easily accessible and amenities and that kind of thing are still going to be the ones that I think lead any kind of recovery. Just the world isn't going to stop and people will want amenities, and they will be going out to dinner and that sort of thing in the future.

[John Kilroy, executive]

I think in the have and have-not, Jamie, where we would expect to see this, I use the term flight to quality in my prepared remarks. And you're going to -- I think based upon everything we're hearing from our big tenants, the focus is going to be on buildings they control; landlords that will work with them to introduce and enforce their protocols, particularly if they happen to be in a multi-tenant building; buildings that have the kinds of things you need to have in order to have greater separation, which again is higher ceiling, high -- greater ventilation systems, wider stairwells, added elevator capacity. I think there'll be a potential advantage for shorter buildings versus taller buildings, just because of travel times in elevators and whatnot, and people -- the whole social distancing thing, and the wellness and all the other things that are going to play into this. So in most cases, modern buildings are going to perform, I think, much better if they're in the right location compared to older buildings.

[Operator]

And the next question comes from Nick Yulico with Scotiabank.

[Nicholas Yulico, analyst]

I guess I just wanted to first go back to the co-working tenant that where you had to go to cash basis reporting. Can you just give us a feel for what drove that? And how we should think about the rest of the co-working tenancy, which I know you said, I think, is just under 2% of revenue. How confident you feel in terms of getting that rent right now?

[Tyler Rose, executive]

Well, I can cover the economics, and John can talk about co-working in general. But in terms of co-work, we don't have -- as you said, we don't have a lot. It's 1.8% of our revenues. It's really just 3 tenants throughout the portfolio: 1 in L.A., 1 in San Francisco and a little bit -- actually in San Diego and Seattle, I guess. But with that 1 tenant, as I mentioned earlier, they paid March, but they did not pay April. And we felt that it was the right thing to do to reverse all the straight-line rent and any accounts receivable that was outstanding at that point. So that's why we did what we did based on our view of how it may play out over time. And with the other tenants, 1 of them has paid rent and 1 of them we're negotiating with.

[John Kilroy, executive]

Just in terms of thoughts on co-working, I believe the 2 smaller coworkers we have are in buildings that we bought that had those tenants. The only 1 we did directly was the 1 in Hollywood, which is tremendous space and if we were to get that back, we'd do extremely well with it, take a little time to reposition. But I made no bones about it. I've never really come out and condemned co-working. I've regularly, either myself or Rob or Todd or whomever, have shared with you that we're just not believers in it. We'd never liked the idea that you didn't really have a credit entity. You have this rapid expansion going on, which -- with companies who weren't making any money. I'm old fashioned. I like companies that make money and can pay rent. I've been through a bunch of these recessions, and I can tell you that that's a much better situation than the alternative. I never liked the idea that we're putting up the capital for somebody else to create a positive arbitrage for themselves. I didn't like the fact that you had so many people coming in the building, you didn't know who they were. And so we're very fortunate that we don't have big exposure there. And in terms of where this goes, there are others that have a lot more exposure to it, and they probably have thought it through a bit more than I. I know that with our big tenants, some of whom have used the enterprise version of that, which works well for them. But their -- some of their concerns are, who else is in the building and how do we make sure that, that building, if it's multi-tenant, adopts and -- that everybody adopts the protocols that those bigger tenants have. And so this is going to play out over time, and we'll see how it works. I'm just glad we don't have a lot of the co-working space in our portfolio.

[Nicholas Yulico, analyst]

Okay. That's helpful. Just one other question is on -- as we think about your portfolio and -- maybe we could just get a little update on the exposure to bigger tenants versus smaller tenants? And as we're thinking about some of the smaller tenants in the portfolio, do you have any early indication you can give us in terms of potential credit issue, uncollectible rents and just kind of thinking about the piece of the portfolio that is smaller tenants that aren't as well capitalized?

[Tyler Rose, executive]

Yes. I can start there. So as we said, you can break it into pieces, right? The top 15 tenants make up about 50% of our revenues, and they're all strong companies. Another 25%, as I said in my remarks, of our revenues come from the other companies that are publicly traded, investment grade or sponsored. So it's really just the 5% at the bottom that are start-ups, VC-backed tenants that probably are a little bit more at risk. As I said in my comments, if you exclude co-working, we collected 97% of our office rent. So we haven't had a lot of issues to date. Obviously, it's going to play out over the next couple of months, and we'll see what happens. But we feel we're pretty well positioned on this, given the quality of the tenant base.

[Operator]

And the next question comes from John Kim with BMO Capital Markets.

[John Kim, analyst]

Tyler, looking at your 2020 assumptions, it appears that developments and the revenue recognition is really the main item of uncertainty. I just want to make sure that was the case. And then secondly, I wanted to know if you could provide any color on occupancy. You're at 97% leased today. You have 4% expiring this year. Is 93% truly the floor where occupancy can end up?

[Tyler Rose, executive]

Yes. On the latter one, I mean, we aren't giving guidance. So I'm not going to get into specifics, but no, I don't think it's the floor. I mean that's the issue. That's why we're not giving guidance, and which goes back to your first question. I mean, I think the other piece of where -- there is revenue recognition, there is developments coming online, but we just don't know how the office business is going to be impacted over the next several months and how fast it will come back. And if we will have other tenant issues. And so for those reasons, we can't really give guidance, and we don't know what our occupancy is going to be. I mean, I think it's in that range, but there's certainly the possibility that it could be lower than that. We don't think substantially, but -- and may not at all. I mean, we just -- we're hoping we come back to that number at the end of the year, but we'll just have to see.

[John Kilroy, executive]

Yes. The way I'd say it is that we don't have the expectation of being lower, but these are unprecedented times and bad stuff can happen. We're not seeing the bad stuff other than as we've expressed on this call with regard to various segments, particularly the nonoffice life science part of the business. But it's just uncertain.

[John Kim, analyst]

On Flower Mart, it looks like the Prop M guidelines made a requirement to begin construction within 18 months. Do you anticipate receiving extension on this? Or is this a pre-lease definition?

[John Kilroy, executive]

No, that's not the case.

[Operator]

And the next question comes from Blaine Heck with Wells Fargo.

[Blaine Heck, analyst]

John, do you have any concern about the level of supply that's going to be coming to the market in Seattle over the next few years, not just in Seattle proper, but also in Bellevue? I mean, it seemed as though the demand level was more than enough to support all of the oncoming supply pre-COVID. But I guess, has your view changed of the risk in that market at all?

[John Kilroy, executive]

Well, I think our view has changed in all markets to much more of a wait-and-see versus everything is rosy and proceed. You're quite right that the percentage of new development that is scheduled for, some of which is under construction in Bellevue, is unprecedented and is a significant amount as a percentage of the current supply. Rob, correct -- Rob, maybe you can handle this a little bit, but it's about 70% pre-lease of the stuff that's under construction, is that correct in Bellevue?

[A. Paratte, executive]

Yes. And there have been -- there are some transactions pending that are quite large, over 1 million feet with 1 company right now. I just can't name names, but the supply in Bellevue traditionally has been something we've watched very closely in terms of just having to compete against that. But if you look at our portfolio specifically, we're pretty locked up.

[John Kilroy, executive]

If you've noticed, we have not made any announcements about buying any development sites in Bellevue, while others have been buying some pre-leased, and that's great. But we have not. We have nothing from a development standpoint in Bellevue currently. And I don't anticipate us having anything unless there was some extraordinary opportunity.

With the 1 development site we have, other than a couple of little tiny ones next to 333 Dexter, which are 6,000 and 12,000 square foot lots, is the property that we bought called the, formerly known as the Vance. I guess it's still known as the Vance parcels. And that's going to take about 2 years for all the entitlement. We have a terrific land FAR basis there. And so if the market is still lousy in 2 years, we'll sit on the land. But in the meantime, we'll get it entitled appropriately and work all that stuff out and be ready to pull the trigger when and if it makes sense.

[Blaine Heck, analyst]

Got it. Very helpful. And then just out of curiosity, can you talk about what led to the earlier than expected revenue recognition at The Exchange? I think last quarter, the expectation was to have a Phase III recognition in the third quarter, but it seems as though they took the space here in the first quarter. I'm assuming they take -- took occupancy before the crisis, but any color or commentary on that would be helpful.

[Tyler Rose, executive]

Yes. No, the -- as you said, they just were able to get in more quickly. They wanted to get into the space, and they completed the work ahead of schedule. And so it came in ahead of our numbers. It's nothing more complicated than that.

[Blaine Heck, analyst]

All right. And then the last one. It looks like CapEx per square foot and concessions in general were a little lower this quarter. Can you just talk about whether that was a mix issue? And I guess maybe for Rob more generally, are you expecting to see a trend lower with respect to TIs and trade rent in your markets?

[A. Paratte, executive]

I'll handle the latter and Tyler, maybe, you can touch on the former. But as far as the latter goes in terms of more TI or less TI, it's hard to predict right now. I mean, I think that construction -- if things continue in the way they have, construction pricing may come down and tenant improvements, therefore, would as well. In terms of just anything that we see, I think it's really just maybe a longer construction period for certain projects. But already, we're seeing that cities are allowed to start construction again, particularly in San Francisco. So hard to predict.

[John Kilroy, executive]

Yes. In the area of construction right now, with the equivalent of social distancing or whatever they call for construction, there are new guidelines. And so that could very well slow things down a little bit because it could mean that instead of having perhaps 200 people on a job, you have 170 people. We just don't have any experience with it yet. It's too soon to tell. And all the cities are trying to figure this stuff out as well.

One thing that does trouble me, and I don't know, just intellectually, and I don't know if it will become a problem. I think what you'll see is a lot of less construction. And you're going to -- and I think you'll see potential slowdowns in planning departments and whatnot because these cities are all getting clobbered in the revenue side. And we don't know how that plays out. It doesn't impact us with regard to -- maybe modestly with regard to future tenant improvement work or something. But it doesn't impact us right now with regard to any development we have going on. Does it in the future? I don't know. The -- this is all going to play out over time, and I don't think anybody has a sufficiently clear -- there's no crystal ball here.

[Operator]

And the next question comes from Manny Korchman with Citi.

[Emmanuel Korchman, analyst]

Tyler, you talked about doing the entire slug of forward equity, but I don't think you necessarily mentioned why you guys chose to do that. Was it something in the contract that forced you to do it? Was it just you felt better having cash than a forward equity contract out there? Was there a deal that maybe you're targeting and want to have the capital ready to go? So why do it all now?

[Tyler Rose, executive]

Yes. No, it wasn't -- there was nothing in the contract that forced us to do it. Just out of an abundance of caution given the situation, we felt having the immediately available cash was the right thing to do. And by drawing down the equity, we didn't increase our leverage at the same time. I mean, we could have drawn the bank line, but that would have increased our leverage amount. And we felt it was more conservative to draw down the equity. So it was just an abundance of caution, being conservative and knowing that we would have the cash available to complete our development if things got crazy.

[Emmanuel Korchman, analyst]

And Rob, maybe going back to a point you made. I think you talked about tenants or maybe users being hesitant on a large massive assets or campuses, I think, is the term you used. And then you're building Flower Mart, which seems like a big campus for maybe 1, maybe 2 tenants. How do you balance those 2 thoughts as they -- do tenants want to have all their employees together? Or would they prefer to split them amongst assets or buildings?

[A. Paratte, executive]

Hard to predict. But I think the Flower Mart, the beauty of the Flower Mart is, it's -- you could do 1 large tenant, but you can do 5, 6 or 7 tenants. So -- and they are separate in distinct blocks of space. So for an urban setting, it's actually a much more spread out, if you will, format than a high rise. And when you -- back to one of John's earlier comments, if you look at something like the Flower Mart, we have so many fewer elevator travel times, meaning if people are going to restrict the number of people getting in cabs, that's going to have an impact on high rises. And Flower Mart with its layout is, I think, perfectly suited for accommodating whatever the new world brings in terms of just elevator density and capacity. So I see Flower Mart as something that's, in an urban setting like San Francisco or Manhattan or what have you, something that's actually more spread out than a typical office environment.

[John Kilroy, executive]

To put that in perspective, the Flower Mart, when it's fully built out, is the equivalent of almost 2 Salesforce Towers. But it's in 5 buildings, the tallest of which, I think, is 15 stories.

[Operator]

And the next question comes from John Guinee with Stifel.

[John Guinee, analyst]

Great. Big picture, John, state of California has been really aggressive on stay in place, very aggressive on residential tenant relief. Long-term impact on the political environment in California, do you think this turns California to the right or the left? Or no change?

[John Kilroy, executive]

Oh my God, John, I wish I knew the answer to that. I've been trying to figure that one out and influence it for most of my life. There's the little thing about, you stick your finger in Jello, you try to reshape, you pull it out, it looks exactly the same. I kind of wonder if that's a good analogy. I think the -- what I'm hopeful of here is that California has had its share of problems, some of them self-inflicted. I am seeing more dialogue between the political parties and between businesses and the unions. There's always going to be rancor. They're always going to stir it up for elections and whatnot. But I'm hopeful, and this may be just hope and not become reality, but I'm hopeful that people are going to see that we need to be able to work together and we need to have good protocols on this stuff. I do complement the state and the city of San Francisco and some of the other cities for taking aggressive action on this to begin with. You could criticize any particular aspect of it, just like you can criticize so many of the things the federal government has done and whatnot. But they're trying their best. There are some cities that I think in California have been jerks, and I won't mention who they are, but they're more south and north, and not too far south.

I just don't know how it will work on the politics side of things. That's a question. If I knew the answer to that, everybody would be asking me and probably paying me. The -- I do think that there is going to be a move towards, probably that will be legislatively become more prevalent, which for future buildings, the wellness aspect of it, the thoughtfulness with regard to how they perform and the kind of filtration systems and so forth they have to have. Where that goes, I'm not sure, but I think it's probably a logical fallout from this. I'm just so thankful we don't own a lot of older stock. The older stock that we do own was stuff that we could make into ultra modern buildings, maybe not on the facade, but on the inside. And I just think there's going to be a real have versus have-not in the flight to quality. And quality is not just fancier chandeliers, it's more in the systems and things I talked about before.

[John Guinee, analyst]

And then a little follow-up. Any thinking on split roll Prop 13, does it get tabled? Is it still on the ballot in November? How does that shake out?

[John Kilroy, executive]

Do you want to handle that, Tyler?

[Tyler Rose, executive]

Yes. Yes. No, it's still on the ballot. They went back and got more signatures on a slightly adjusted proposal. But the good news is what we're hearing anyway from our advisers is that it's polling worse than it did before. I think businesses and people are tired of the higher taxes. And so we'll see, but it's still on the ballot, but a long way to go before November, but the polling is getting worse for them.

[Operator]

And the next question comes from Tayo Okusanya with Mizuho.

[Omotayo Okusanya, analyst]

Yes. So I think a quick follow-up on the retail side. How are you guys kind of thinking about kind of bad debt expense related to retail given again, the number of retail tenants that have paid rents and some of them asking for rent relief or rent abatement?

[Tyler Rose, executive]

Yes. Under the new -- probably, under the new lease accounting, there really is no such thing anymore as bad debt expenses. So what you do is you reverse your revenue. It hits in revenues. And so that's what we did in the first quarter, we -- for those 2 tenants that we talked about. And we'll just have to see how it goes for the rest of the retail portfolio over time. But we have our eye on that. And as we said, we have a deferral or a rent relief program for 90% of those tenants, and we'll be monitoring that. But if they're not going to pay their rent over time, then we'll have to adjust in revenues.

[John Kilroy, executive]

Yes. This is John Kilroy. I was going to say with regard to retail, remember, there are -- we lump retail in to show, to reflect what percentage of revenue it is, but most of our retail are like an optical shop or a restaurant or something in an office building. The only concentration we really have of retailers at One Paseo, which is brand new, big open air area of single level, no escalators, no enclosure. It's the kind of retail that people want and it's the kind of physical plant where you can be more socially distanced or whatever the term is today. So it's going to take a while for retail to come back. I think restaurants, people are going to have a -- I'm not sure anybody wants to go eat in a crowded restaurant right now. So that's going to take a little while to come back. It's just too difficult to predict what the -- when we'll achieve rent collection. But as Tyler said, we're going to work with these folks.

[Omotayo Okusanya, analyst]

Understood. And then the 2 months of rent relief that's being given, is that -- are you just tacking on 2 months more onto the lease? Or are you -- is there possibility that it's going to get more term?

[John Kilroy, executive]

Well, there'll be -- in some cases, there'll be a negotiation. That's what we've offered just because we knew they weren't going to be able to withstand this. Our view is that most of our retailers are amenities to our office, life science or residents as the case may be. And we want to work with them. We're not going to let them pants us, but we do want to work with them. And in some cases, it will simply be -- in most cases, it's going to be we gave them 2 months of relief, they had 2 months of extension. Do we have to give them more relief depending upon the circumstances? If somebody didn't like the 2 months and the 2 months add-on, then we might customize and do something a little different. So it's going to -- that's all going to play out. It's not a lot of square footage. It's just not a lot of transactions, but we have a team working on it, and we should be able to address more, I would think, by the next call.

[Operator]

And the next question comes from Dan Ismail with Green Street Advisors.

[Daniel Ismail, analyst]

John, just wanted to follow up from a prior statement on state and local budgets, which are clearly under pressure in this environment and might be a driver of new permitting or rezoning of areas to shore up budgets. I know this is likely not a near-term issue, but are there any opportunities here for Kilroy? Thinking of the Blackwelder site in particular?

[John Kilroy, executive]

Yes. I don't want to go far down that road, Dan, let's just say that we have a team of people working on a variety of things that are kind of in the confines of your question. And who knows how this is going to play out. As you know, California is a very complicated place. It's very easy to file a lawsuit. One of the things that I hope will happen now is that -- and will it at the margin, or will it more seriously. Can we get rid of some of the NIMBYism that has made it so difficult to get things done, particularly when we know that we have to build more housing in the state. We have to build more apartments in the state. We have to be able to deal with the growth that we continue to have. And does that translate into more efficient planning policies? More to come. I'm hoping. But remember my Jello comment.

[Daniel Ismail, analyst]

Got it. And just on construction pricing, I understand that things are very difficult to predict in this environment, but they've been rising, call it, in low to mid-single digits the last few years and just what's happening with oil and other commodities, is it your expectation for that trend to reverse?

[John Kilroy, executive]

Yes, I think so. But again, there's no real data of substance or of enough things to confirm that. But what -- if you look at the architectural book or whatever they call it, or as we do, we also talk, but we do business with probably 20 major architectural firms that are either headquartered here or international. And most of them will tell you that their book of business has dried up. So that tells me that you're going to end up with a lot less construction. And the oil and other commodities you mentioned, it seems to me that that's likely to lower cost somewhat or at least lower the growth in costs. Labor is the other thing that's a big driver of this stuff, and I'm not sure labor costs are going to go down. And then don't know the implications that I mentioned earlier. I think at the margin, it's not going to be a big impact. But the fact that you may not be able to build certain things as quickly because of the new rules with regard to how close construction people can be and so forth. I mean there's always little things that just don't know how to answer.

[Operator]

And the next question comes from Dave Rodgers with Baird.

[Dave Rodgers, analyst]

First question, maybe for Tyler. Just a follow-up to something John has said earlier, about maybe being more conservative on development, no spec development and maybe no development. At what point in that process, maybe, do you have to think about the capitalization and of things like the Flower Mart land and improvement, KOP-based future phases in that process?

[Tyler Rose, executive]

Yes. So if we completely stop work and don't do any development work or entitlement work or permitting work, then we would have to evaluate whether we need to stop capitalizing interest. But clearly, we're not in that mode at all. As John said, we're going to get our projects ready to go. We just may not kick them off. And so if a year or 2 from now, we're all ready to go because it's going to take a while on all these projects and then the market is still not ready, then we'll have to address it at that point. But it's probably more of a medium than a longer-term issue.

[Dave Rodgers, analyst]

That's helpful. I appreciate that. And then, John, maybe one follow-up, and I did get kicked off the call for a bit, so if I missed this, I apologize. But San Diego is a much smaller portion of your portfolio today, and you've done a great job of kind of repositioning out. But just last cycle, that was particularly hard hit area for you with the number of vacant building. Can you kind of talk about how you feel about credit, San Diego, and just kind of the overall market down there today versus maybe what we saw in the last cycle?

[John Kilroy, executive]

Yes. Well, I mean, and you commented on, we got out of Sorrento Mesa. We got out of I-15 with the exception of Kilroy Sabre Springs, where it's mostly credit tenants. And we got out of Mission Valley and all the rest. So our concentration is there in Carmel Valley/Del Mar Heights. A little bit out on I-15 with Kilroy Sabre Springs. And then, of course, UTC area. And then we have the development site underway in Little Italy. And the credit quality of our tenants in San Diego is demonstrably higher, I'd say across the board, and Tyler jump in here. If you think about where Kilroy was in 2008 in San Diego, we had a lot of tenants that weren't that high credit. We had a lot of lease expirations coming up. And I think we went from like 99% leased to somewhere in the 70s in about 1.5 years period. We had so many terminations. Part of that was because of the fact that we acquired a lot of properties as well as done a lot of leasing. It just happen to be concurrent.

So we have much better lease expiration profile in San Diego and across the company. We have a much better credit profile in San Diego and across the country -- company. We have a much higher quality of building in San Diego, that flight to quality thing that I mentioned. And we're very well leased in San Diego, and so much of that has been done over the last couple of years. So I don't want to say -- I'm a karma guy. I want to be careful what I say because you might find that you turn the tide. But I think we feel pretty good about most of our tenants. And the quality of the enterprise and the quality of the people. That's the other thing. I think we have a far better team. So I'm pretty hopeful that San Diego is going to continue to be a winner. If you look at some of the deals we've done down there, it's been extremely high credit. We did One Paseo. It was all the JPMorgan, Bank of America, Deloitte Touche, that level of quality. And then the other stuff in Del Mar is very high quality as well. And of course, I can't tell you who the tenant is, everybody knows, but I'm not supposed to say who took the building -- I forget what we call it, the Town Center Drive building, which is 1 of the top 50 companies in the world. So we'll see.

[Operator]

And as that's all the time we have for questions right now, we would like to return the floor to Tyler Rose for any closing comments.

[Tyler Rose, executive]

Thank you for joining us today. We appreciate your continuing interest in KRC, and we wish you all remain healthy and safe. Thank you very much.

[Operator]

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.