Kilroy Realty Corp

NYSE:KRC

Earnings Call Transcript 2020-Q2

[Operator]

Good day and welcome to the Second Quarter 2020 Kilroy Realty Corporation Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Tyler Rose, Executive Vice President and Chief Executive Officer. 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 a look at our industry and markets and then highlight second quarter activities and our priorities as we move through the second half of the year. I will review second quarter financial results, give an update on rent collections and then review our current financial position. Then we'll be happy to take your questions.

We are once again calling in from different locations, so bear with us if there are any delays in our responses.

John?

[John Kilroy, executive]

Thank you, Tyler. Thanks, everyone, for joining us. We hope you are doing well in this extraordinary circumstances that we find ourselves today. It's always not easy to navigate. I've had my children please disappear, daddy has got a phone call right now. I'm sure many of you have to do the same.

Here at KRC, we remain vigilant in guiding our organization through the current crisis and positioning it to outperform in the future. We are working from a strong foundation. Financially, we have $1.3 billion of liquidity, no near-term debt maturities and a well-capitalized tenant base. Our development projects are 90% leased and fully funded.

Operationally, we have a well designed, highly sustainable and young portfolio, and we continue to make great progress on reducing our exposure to lease expirations. We've reduced our average annual expirations through 2022 to 4% or approximately 575,000 square feet, which compares to 6% at the beginning of the year and 5% as of last quarter.

We've received a lot of questions in recent months about how the pandemic could affect our industry, our markets and our company. So before I get into second quarter highlights, let me share some observations and thoughts.

We are in constant contact with our tenant base up and down the coast, and they are focused on reestablishing their work environment and getting back to the office, while at the same time, protecting the safety of their employees. The next 12 months is likely to be a transition period. There's likely to be trial and error, experimentation and stops and starts as the pandemic runs its course. As businesses gain experience with what works best for them, the results could have some implications for our industry.

For example, tenants will evaluate the quality of the physical workplace more than ever, with a particular focus on the ability to control their space, including lobbies, common areas and elevators to minimize physical interaction with outsiders and enhance security. Buildings with fewer stories to maximize elevator -- to minimize rather elevator usage, larger spaces with bigger floor plates, higher ceilings and larger commons areas to accommodate social distancing; more flexible spaces that allow for greater creativity and how interior office space is laid out and how traffic flow is directed; healthier spaces, including better HVAC systems, more natural light and fresh air, with increased access to roof decks and other outdoor spaces; and well-capitalized landlords, those willing to invest in people or infrastructure in their buildings in order to ensure a safe environment for all tenants.

While some of these considerations are driven by short-term needs, it is our view that they have become industry norms continuing a flight to new higher quality properties and accelerating the obsolescence of older buildings.

We believe these trends not only distinguish our portfolio from our peers but further validate our development strategy and our commitment to sustainability and wellness. Specifically, we have one of the youngest portfolios on the West Coast with an average age of 10 years. 43% of our portfolio is fit and well certified, the highest certification of any company in the world.

85% of our portfolio consists of low and mid-rise buildings. More than 90% of our buildings have large floor plates, allowing tenants greater flexibility for configuration. And approximately 90% of our portfolio offers rooftop decks and the outdoor common areas.

Another topic of discussion in this transition period is how prevalent work from home will become. It is still early, but our view is that workplace flexibility will become more common, and it will be in conjunction with the office, not replace the office. We're seeing tenant study decreased density levels in the workspaces and consider additional kitchens, dining and common areas that require more space.

From a broader perspective, the office, as we know, has been around as long as the modern corporation, and the role it plays in uniting a workforce around a common set of goals is as essential as ever. And while offices have evolved as organizational needs have changed, the successful corporate cultures that are in place today underscore the importance of communal space and physical proximity. All of the most essential attributes to today's highly successful companies, effective collaboration, continued innovation, higher productivity benefit greatly from personal human interaction.

A third question arising amid the crisis is how various real estate markets will perform. We believe that our West Coast markets are among the most attractive in the world. Amidst all the uncertainty over the last several months, one thing that has become clear is the strength and resiliency of the technology, media and life science companies that drive our markets.

These companies continue to grow their revenue, are well capitalized and are positioned for growth. The NASDAQ is near an all-time high. The IPO market is open. And the M&A has resumed with Amazon and Uber announcing high-profile deals in recent months. These key industries are concentrated in our markets are hard to duplicate in other areas of the country, and their success will help drive broader market recoveries.

A recent Bloomberg analyst -- analysis rather of the nation's 100 largest metro areas came to a similar conclusion. San Francisco, Silicon Valley and Seattle, all ranked among the top 5 regions best positioned for a relatively quick and strong recovery from the coronavirus recession.

This strength is visible in our current tenant roster. Three quarters of our annual rental revenue comes from technology, life sciences and media companies. Most of them are publicly traded and investment-grade rated, all of them ranked among the world's most innovative and successful businesses, and their collective presence is constantly attracting more innovation-driven firms, building a deep reservoir of ideas and talent that is very difficult to replicate.

Now moving to our second quarter highlights. Overall, rent collection remained strong across the quarter and into July. The average second quarter rent collection rate for all of our properties was 95% and a strong 98% for office and life science. And July's collection rate was also 95% across the portfolio and 97% for office and life science. Tyler will give a complete update in his remarks on these trends.

We executed 286,000 square feet of leases in our stabilized portfolio. Approximately 3/4 were renewals, and rental rates that were up 11% on a cash basis and 30% on a GAAP basis. This included 2 larger renewals, one in San Diego for 119,000 square feet and one in the Bay Area up 37,000 square feet. With the exception of an expiring Long Beach lease in the fourth quarter of this year, we have no exploration larger than 65,000 square feet until 2022. At the end of June, our stabilized portfolio was 96% leased.

We continue to execute on our $2 billion of construction projects. The total remaining construction spend across this pipeline is fully funded with existing liquidity. And the office and life science components of these projects are 90% leased. When stabilized over the next few years, the 6 projects will generate aggregate annualized cash net operating income of approximately $145 million.

I want to give a shout out to our development team at last -- as last month, the National Association for Industrial and Office Parks, NAIOP, selected KRC as its 2020 Developer of the Year. This is the association's highest honor and a significant acknowledgment of our company's ongoing efforts to lead through innovation.

On the disposition front, we selected a few smaller assets earlier in the year to dispose of. During the course of the year, we're unable to say exactly when these will take place because tours and lenders and things like that are unable to, in fact, come see the buildings given the restrictions.

To wrap up, let me reiterate a few points. Leasing activity has picked up a bit from March-April lows, and we have not seen a material impact, if any, on economics. The company has never been better positioned to be both defensive as well as offensive. Our stabilized portfolio is young, modern, sustainable and leads the world in wellness. Our explorations are limited. Our tenant base is largely healthy, well capitalized and poised for further growth. Our under-construction development projects are fully funded and 90% leased. Our future development pipeline is diversified across product types as well as markets and has an attractive basis. And our balance sheet is solid with significant liquidity, low leverage and no near-term debt maturities.

Lastly, I want to recognize the entire Kilroy team who continue to do a phenomenal job, whether it's working with our tenant partners, with the communities in which we operate or on internal corporate functions. Thank you all.

Now I'll turn the call back to Tyler. Tyler?

[Tyler Rose, executive]

Thanks, John. For the quarter, we reported FFO of $0.78 per share. This reflects $0.17 per share in total severance costs and $0.05 per share related to our assessment of tenant credit and collectibility of rent. Excluding the impact of these items, our underlying second quarter financial performance was solid with FFO at $1 per share.

Turning to same-store results. Cash NOI grew 10.9%, and GAAP NOI was down 1.3% in the second quarter. Cash NOI growth was largely driven by higher rental rates and cash commencement of several large leases. GAAP NOI was impacted by the revenue reversals I just mentioned. Excluding the revenue reversal, same-store GAAP NOI was up close to 2%. At the end of the second quarter, our stabilized portfolio was 92.3% occupied and 96% leased.

Moving to our balance sheet. In April, we completed a debt placement of $350 million, boosting our liquidity to $1.3 billion. That includes approximately $560 million in cash and $750 million available under our revolver.

Our net debt in second quarter annualized EBITDA is 5.7x, excluding the severance costs. This liquidity provides ample resources to fully fund our remaining $625 million of current development spending over the next 2 years. We also have plenty of room under our bank financial covenants with more than 60% cushion or approximately $250 million of NOI cushion.

Now let me give you some color on rent collection in the second quarter and July to date. Across all property types, we collected 95% of second quarter contractual billings. This reflects an average collection rate of 98% from office, 88% from residential and 32% from retail. And across July, our collection rate currently stands at 95%. This reflects a collection rate of 97% from office, 87% from residential and 46% from retail.

Lastly, given the uncertainties generated by the coronavirus, and it's the impact on the economy, we are not providing specific earnings guidance again this quarter. Instead, 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.

We project remaining 2020 development spending to be between $250 million to $300 million. Given the recent rollback on retail reopenings in our markets, we are currently in discussions with many of our retail tenants. As you may recall, last quarter, we established a 2-month retail rent relief program, which included approximately 90% of our retail tenants. This had a minor earnings impact. And from a cash perspective, 1 month of rent deferral for these tenants is approximately $1.5 million. We subsequently extended the rent relief program through July and expect to lengthen this program again.

Noncontractual parking income totals approximately $1.5 million of NOI per month. We expect to receive about 1/3 of this amount until the shelter-in-place rules are lifted.

At 333 Dexter in Seattle, we commenced revenue recognition on 312,000 square feet or 49% of the total project in June. The remaining phases are expected to come online next year.

In July, we commenced revenue recognition on another 36,000 square feet of space at One Paseo office in San Diego, bringing the total revenue commencement of this project to 20%. The project is leased to 8 tenants, so we expect revenue recognition in phases throughout the remainder of this year.

Also in July, we delivered 146 residential units at One Paseo. This was the third and final phase. As a reminder, we delivered the first phase of 237 units late last year and the second phase of 225 units earlier this year. In total, the 608 unit project is now 38% leased, and we've seen leasing momentum pick up over the last month.

We expect commencement of revenue recognition on the entirety of the Netflix // On Vine project or 355,000 square feet of space at the end of the year. And with respect to the residential portion, Living // On Vine, that's scheduled for delivery in the first quarter of 2021. From a financing perspective, we take a conservative approach to managing our balance sheet, and we will be nimble to ensure adequate liquidity or be opportunistic depending on market conditions.

With respect to cash same-store NOI growth, we've had a very strong first half of the year at 12.9%. We don't expect the second half to be as strong given some onetime items in last year's numbers and the impact of the credit issues we have discussed. While it's difficult to estimate at this point, we expect the full year to be in the mid-single-digit range. Lastly, we project G&A of approximately $18 million per quarter for the remainder of the year.

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

[Operator]

[Operator Instructions] The first question comes from Nick Yulico of Scotiabank.

[Nicholas Yulico, analyst]

I guess, first off, just, Tyler, I want to follow up on the same-store NOI number that you just -- I think you said about mid-single-digit range on same-store NOI for this year. I just wanted to be clear. Is that a cash number? And then does that exclude any impact from any of the tenant deferrals that you've given?

[Tyler Rose, executive]

It is a cash number. And no, it's not -- we're not excluding the deferral.

[Nicholas Yulico, analyst]

Okay. So that's actually -- the deferral is a negative impact to your reported same store?

[Tyler Rose, executive]

That's right. Yes.

[Nicholas Yulico, analyst]

Okay. That's helpful. And then I guess just going back to the leasing markets. Any more thoughts, John, on just how tech companies are sort of changing their views? I know particular Downtown San Francisco was a very hot market ahead of COVID. I heard rumblings of at least one larger tech company now not looking to do a lease in San Francisco this year now. Is behavior changing towards San Francisco or other of your markets? Sort of on a relative basis, how would you kind of rank the strength of your markets right now?

[John Kilroy, executive]

I'm going to have Rob deal with that, if I may. But before he starts in, I think it's safe to say that all companies are focused on what's COVID doing to their businesses. How is it impacting their real estate? How is it impacting their ability to get back to work? So anything and everything that can be put on pause generally is being put on pause, just as I'm sure it is in your family or your businesses, it's just human nature.

Rob, do you want to go through the markets here and start wherever you want at the last one?

[A. Paratte, executive]

Sure. Sure, John. This is Rob Paratte. Nick, I'd start by saying, if I want the Bay Area and Seattle together, publicly traded tech companies, as you know, have led the stock market since the pandemic started. And those publicly traded tech companies, many of which are our tenants, are pretty resilient. And they are the industries that are expected to come out faster. And various sectors of the tech market, like information services, software, publishing, scientific and R&D, all of those are going to be leaders when things normalize.

And I think kind of a broader answer to your question about what companies are talking about and putting stakes on hold goes directly to what John said. So the large company you mentioned in San Francisco that are on hold, literally did that. It's on hold until they can ascertain. I think a better forecast about when people do come back to work and how long that's going to take. And I think this all centers around when people can be vaccinated. It's one thing to get a vaccine. But people need to get vaccinated.

Specifically, up in Seattle, I'll just touch on this briefly. But notwithstanding what I said about the stock market, Bellevue is going through a major transformation, continues to during this pandemic, where space is being absorbed. Amazon just recently signed a 2 million square foot lease in Downtown Bellevue. They themselves are transforming that market by adding 15,000 employees to the Bellevue area. And they're not the only tech company there. We have Salesforce and Facebook, et cetera.

So I just think Seattle in itself will do well when things normalize, and I think a lot of what I've just said applies to the Bay Area as well. And when you layer into the Bay Area. The life science component, where now demand is up to 4 million feet, so it's almost 1 million feet more than what we were tracking last quarter. I think everything bodes well for a recovery when people can get back into work. And as you know, in California, we've had several, in fact, most cities have had to dial back their reopenings, which has impacted touring. Touring was up in May and June. And it's dialed back again, particularly in Los Angeles and San Francisco.

If you'd like, I'd just touch quickly on L.A. L.A. is doing well in certain submarkets like Hollywood and Culver City, where there's pretty strong demand, record demand actually from content producers. So we feel very good about those 2 submarkets.

[Nicholas Yulico, analyst]

And if I could just follow up, that's very helpful details, about San Francisco specifically, I mean, the BART system was already running at overcapacity before COVID. Now imagine it's just a lot more challenging to figure out how you get employees back to work in San Francisco using BART. Does that change the leasing dynamic? Does it push larger tech companies or -- to maybe increasingly look at Oyster Point instead of Flower Mart?

[A. Paratte, executive]

Do you want me to handle that, John?

[John Kilroy, executive]

Yes, go ahead.

[A. Paratte, executive]

Yes. I think companies will be looking at a variety of factors like that, Nick. I -- BART and Caltrain, which are major modes of mass transit in the Bay Area, have undertaken really strict protocols in terms of cleaning and everything just like the New York subways. And I think it's just too early to tell what modes of transportation people will use.

And keep in mind, a lot of the Bay Area, particularly San Francisco, employees are living in San Francisco. So it's not for most of the areas and neighborhoods that the tech workers are living in, it's not a far bike ride or walk to most office spaces.

[John Kilroy, executive]

I'd add to that. I do think that South San Francisco is very well positioned. We have a lot of life science that has demand, and there is increasing demand from tech. Part of that was simply because it's a -- this isn't even a pre-COVID thing, if you look at what's Stripe lease pre-COVID. It's very accessible from both the city and from further south in the Valley. In the Flower Mart, this is not even going to come on stream for a number of years. So I think it will do very well because of the fact that it is exactly the kind of product that companies are gravitating to, but more to come on that.

[Operator]

The next question comes from Emmanuel Korchman of Citi.

[Emmanuel Korchman, analyst]

Rob, maybe this is one for you. In Hollywood, it looked like you had a pretty sizable decline in occupancy. And I know on the last call, you talked about some co-working tenants that you're working through deals with. Is that vacancy related to that same coworking tenant? If not, can you give us some more color as to what drove that increased vacancy in Hollywood?

[John Kilroy, executive]

Tyler, if you want to...

[Tyler Rose, executive]

John, maybe I can -- yes, I'll jump in on that, Manny. Yes, it's not the co-working we discussed last quarter. There's still an occupancy. It's a marketing company in our Columbia Square project that had filed for bankruptcy. So there was about 50 basis points of impact to our occupancy.

[Emmanuel Korchman, analyst]

Great. And then, John, you talked about the resiliency of newer buildings or the demand that should be outside for newer buildings versus older ones. Can you possibly, in some way, address sort of the pricing gap between the 2? Are tenants just going to lease more actively in the newer buildings because it fits their needs better? Or is there going to be pricing that holds up in 1 class of buildings and less so on the other?

[John Kilroy, executive]

Yes. I think I've commented on this at least differentially in past calls, and I'm happy to elaborate. My sense is that we are entering a period where there will be a more extreme recognition at sort of the haves and have nots. You either have the kind of buildings that the big companies want and you will command a significant premium in rent. Or you don't have those kind of buildings, and I think that you're just been subject to high tides. Because most companies -- the big companies, if you're not the kind of product they want, they're not going to lease it at any rate.

[Operator]

The next question comes from Steve Sakwa of Evercore.

[Steve Sakwa, analyst]

I guess, one question, maybe a little difficult to answer today. But how do you guys sort of look at your mark-to-market on the overall portfolio? I realize market rents are a bit of an enigma, but where would you sort of put that figure today?

[Tyler Rose, executive]

Yes, this is Tyler. I'll start, and I can hand it over to Rob. Before this started, we were about -- across all of our markets, about 20% under market and good position. And that was like 30% in San Francisco and different amounts throughout the portfolio.

Rob, I'll let you sort of take a look or respond to where you think things have changed since then, if we have enough data point.

[A. Paratte, executive]

Steve, it's Rob. I don't know if we have enough data points, but you heard on our first quarter call, the leasing activity that kind of bridged the second and first quarter. In San Francisco, particularly rates of helped on direct space in Class A institutionally owned product. So a lot of the leasing that was done in that time period, Q1, Q2 was done at over $100 a foot fully serviced.

So those are -- pre-COVID rates are holding, I would say, in San Francisco and Seattle, although there just aren't that many data points. But if you look at some of the renewals we've done that John highlighted in his remarks, we've been able to increase our rental rates.

[Steve Sakwa, analyst]

Okay. And then maybe sort of a 2 parter. Just on sublease, in general, it's clear that San Francisco is seeing a pretty big uptick in the sublease space. And in particular, I know one of your large tenants Dropbox put close to 275,000 feet on the market, albeit for maybe a 5-year period. So can you maybe just speak to the sublease market in general? And what sort of pressures you might see as more of that comes to market in places like San Francisco?

[A. Paratte, executive]

Sure, Steve. Let me set the table with just some numbers. The sublease space in the market right now is about 5 million square feet, 2.3 million was added during COVID. And to put that in perspective, the direct vacancy rate in San Francisco right now is about 5.4%, and sublease is 2.5% of that. To compare that to the dot-com bust, direct vacancy was 6.8% -- excuse me, was 8.3% and sublease space was 6.8%. So very different dynamics dot com and today.

Of the sublease space that was added in April and June about the relative length of lease term is about 2.5 years. And according to JLL, what they refer to, 30% of that space is lift and shift space, which means basically tenant has -- it's a preplanned move where the tenant is moving into new facilities and subleasing the old. And I think that 2.5-year term corroborates that.

As I mentioned earlier, rents in Class A assets are maintaining their first year rental rates. And I think that would include in well-placed sublease space like the Macys.com space. I don't want to comment on any of our specific tenants and the subleasing that you mentioned with respect to Dropbox. I don't want to comment on their business.

But the last thing I'd say about sublease space in San Francisco is that 60% of what's on the market expires in the next 3 to 4 years. And that space will then, if it's not least, become direct space again. And I just believe with the institutional landlords, quality landlords with Class A product, there's not going to be the pressure because of the lack of direct inventory to drop rates.

The last piece of information which might be interesting for you is that in Q2, 850,000 feet of sublease space was either removed from the market, which means the sub-landlord decided not to sublease it or it was actually sublet. So there is activity. And I think a lot of tenants -- as John said earlier, a lot of tenants are trying to plan on uncertainty. So when there's 2- to 2.5-year or 3-year space, that provides the flexibility that I think can get tenants through this uncertain time.

[Steve Sakwa, analyst]

Okay. And just last question. I mean, John, you mentioned you've only got about 4% of your space rolling through 2022. So pretty minimal rollover exposure, including up in San Francisco. But are you doing things differently today to address that? Are you trying to pull forward more things or tenants coming to you more proactively? Sort of where is that discussion.

[John Kilroy, executive]

Yes, Steve, we've always tried to manage things pretty well. You can't always do what you like. But in this case, we've had the view that let's work with tenants that want to extend early. There's just not enough data points really, in some cases, on some of the recent renewals, these tenants, in one case, had an option and one case, I think, didn't have an option, both wanted to stay. One tenant, the larger one was very concerned about it going to arbitration because it could end up at being a rate that could have really gotten out of -- beyond their expectation.

And we just decided that we'd have a negotiated transaction where they could live with it and we could live with it. So that just happened to be -- it's very circumstantial. We're not actively going out endeavoring to sign up people that have 6 years left on a lease to a 10-year lease. We're having some requests to do that, and we'll evaluate each one of those independently.

[Operator]

The next question comes from John Kim of BMO Capital.

[John Kim, analyst]

I was wondering if you could share your views based on discussions you've had with tenants on the impact of this pandemic to the more secondary tech markets outside of the West Coast, whether or not you think tech tenants are going to expand further or conversely pulling back?

[John Kilroy, executive]

Rob, do you want to cover that one? I'm not sure we have enough data.

[A. Paratte, executive]

Sure. Yes. I don't -- it really hasn't come up in the conversations we've had, John. I mean, as I said earlier, every company, I think John said this, too, is focused on how to get people back to work and the facilities they have. And I think that you've seen tech expand dramatically in other markets like Austin and back East, et cetera. And that trend will likely not change because they just can draw on talent from a wider network.

[John Kim, analyst]

Based on the strong demand from life science tenants, can you discuss your willingness to start any spec development in life sciences? Or maybe even convert some office plan development to life sciences?

[John Kilroy, executive]

Yes. I don't know that we're looking at converting anything that's on the drawing boards. But as you know, many of our buildings that we have developed recently have been developed to be sort of a hybrid where you could do life science or office. Dropbox was one, Stripe was another. The building that we leased at 9455 Towne Center down San Diego, was -- became a major tech company, but it was designed for life science. So we're sort of doing more of that where we can go either way, where the market is robust for both kinds of users.

But John, with regard to development, there's nothing -- I've mentioned in this in prior calls. There's nothing that we can start, that we physically can start before -- I think it's the first quarter, maybe the end of the first quarter or next year, and that would be Phase 2 of Kilroy Oyster Point, which is life science. And so that's the next one up, again, subject to market conditions and all the other things that we always talk about, but we're seeing strong demand from life science there. We're seeing strong demand for tech there. That's likely to be the next start, again, subject to market conditions.

Phase 2 is 3 buildings. It's roughly 900,000 feet plus a parking structure. We have the entitlements in place. We're going through the building permit process now, and we should be in a position if we want the start in the first quarter of next year.

[John Kim, analyst]

Okay. And then finally, I realize it's a one-off event, but the termination payment for Jeff Hawken was surprisingly high this quarter. And I'm wondering if you could elaborate on how you and the Board concluded to this amount?

[John Kilroy, executive]

Yes. Well, it was pursuant to the agreement. His agreement was entered into in 1996. And so it was a legacy contract, and we paid what was pursuant to the contract. And we heard very clearly from the marketplace that they want us one way or another to solve, in essence, to get rid of the contract.

And Jeff, rightfully so, he was in a position where he didn't have to do anything. He had an evergreen contract with a stated amount in terms of what the payment was to get out of it. And so we went forward with him and concluded pursuant to the terms of the agreement. The Board didn't -- we didn't have any choices.

[John Kim, analyst]

Are there any remaining legacy contracts like that?

[John Kilroy, executive]

No, not in our company.

[Operator]

The next question comes from Blaine Heck of Wells Fargo.

[Blaine Heck, analyst]

Can you talk about any movement you're seeing in construction costs recently? And whether you think maybe the potential decreases in construction costs could keep pace with or even outpace any potential decreases in rents such that some of these future development projects can still pencil out to an acceptable yield or even maybe look better than what you might have had pro forma?

[John Kilroy, executive]

Yes, it's a good question. We monitor that monthly with all the pricing we do with major contractors. If you look at the -- the short accurate answer is I don't know. But we will -- obviously, time will tell. If you look at the construction starts around the country, they're down tremendously. If you look at the book of business that the major contractors have, they're down tremendously. If you look at the book of business that, I forget the name -- number of -- names of the publications that our team monitors. But if you look at the book of business that the architects have, it's challenged tremendously. So you're seeing a big contraction in construction starts and in projects that are being designed for the future, which -- all of which would suggest that commodity pricing as well as labor will end up being less expensive.

And if history serves correctly, that's what we're likely to see. Your supposition about rental going down and construction costs going down and yield perhaps remaining the same. And I'm kind of paraphrasing. I'm not sure the rent is going to go down for new construction.

People like us make the decision if we're going to start something, do we feel comfortable that the rents we need to have, we can get. And if we don't feel comfortable, we don't start. There's always the case where you start spec and you find that the market's changed and you don't get what you want, and that can happen.

I do think construction costs will go down. Labor never likes to talk about it going down because they're just -- that's something they don't like to acknowledge. It's just too early to tell, but a lot of things can throw these things off. If all of a sudden, there is a massive $1 trillion, $2 trillion infrastructure bill passed by the federal government, then commodity pricing is likely to not come down as much.

So too many variables to give you a specific answer, but I think it's a good question and one that we will continue to speak about on these calls.

[Blaine Heck, analyst]

Got it. That's helpful. And I think that makes sense. A quick one for my second. Last quarter, you guys mentioned being in discussions with a large credit tenant to backfill at least some of the 130,000 square foot move out in Long Beach. Just how have those discussions progressed? And as negotiation stand now, what are the prospects of getting that backfilled quickly?

[A. Paratte, executive]

Blaine, it's Rob. I don't want to get into too many specifics because a lot of people listen in on these calls. We have discussions going on right now with 3 different entities for space in that vacancy. And we feel good about the prospects for getting it leased up based on just the activity we see in the market. That's the best quality asset in the long beach market. And it's well recognized. And I just -- without predicting more, I just feel good about our prospects in terms of the activity we've got.

[Operator]

The next question comes from Jamie Feldman of Bank of America Merrill Lynch.

[James Feldman, analyst]

I'm wondering have you guys thought about redesigning any of your future developments based on new wellness standards or just what you think tenants might want post-pandemic.

[John Kilroy, executive]

Well, we're always thinking about it, Jamie, and we've been the leader -- as I mentioned in my comments, we are the world's leader in wellness, the world's leader. We're the world's leader in sustainability. I think we're probably the world's leader in rooftop decks.

We, as a company, have a culture and a mission to make sure that we are producing the very best of what people want and withstand -- have a long runway in front of it, contrast that with older stock that frequently can't physically change enough to be as modern as tenants want them to be. So we're doing that. We're already doing that.

We -- if -- I don't want to give any of our competitors any of our inside information of how we go about it. But we have a team of people both internally and that we work with externally that is really cutting edge. It's basically a war room kind of discussion of where are things going, how do we test it and it's proven to be a tremendous asset for Kilroy.

And it's one of the reasons we embraced sustainability and became the world's leader, and we embraced wellness and became the world's leader. And we're -- I think we're doing the same thing with regard to working with our tenants with regard to reintroduction to the workplace and the changes that may need to be made.

And of course, with regard to the buildings that we have underway, we have made some changes on some. With regard to the Flower Mart, we've broken that into smaller components so that we can -- it's sort of increments of anywhere 400,000 to 500,000 feet rather than starting one building. One of the buildings was about 1,400,000 feet. We've broken that into smaller components that can be joined. So things like that we're constantly working on how we create greater flexibility and optionality with regard to what we have to start, how we can break it up between tenants.

I mentioned in our last call that I think tenants are going to gravitate, the bigger tenants, more and more they already have but gravitate more and more to wanting to have absolute control of their premises and that is easier when it's a single building where they occupy all of it as opposed to being a portion of a much taller building. And I made in my comments earlier this morning or this afternoon specific about where you're located, that we're very geared towards low to mid-rise. We only have 2 buildings that are over 25 stories in the portfolio. So we're doing all the things you're asking about.

[James Feldman, analyst]

Okay. Do you think there's going to be a meaningful change to construction, like the costs in terms of the types of types of goods you'll put in the buildings?

[John Kilroy, executive]

That will cost more. Well, you've seen our construction costs. And if you were to go, and I don't look at other people's construction cost. But if you were to look at the supplementals to wherever you all look at to see what costs are for our buildings versus other buildings, I know we build to a higher level of quality than most of our competitors do. And I'm not speaking if it was just about reason to speaking about anybody who does the stuff we do with more flexibility and optionality. And yet, I think our cost structure has been pretty much in line with most others.

I remember my dad used to say to me there's engineering, which is how you engineer costs out of something and there's art, and that is how you end up building a better mousetrap but trying to keep it the same level of cost. And art is -- that is an artful thing, and we do a pretty good job at it. We, by no means, build the cheapest buildings. But we have -- as you've seen, almost always, we've been the market leader on rent. It's because we're delivering what people want.

[James Feldman, analyst]

That makes sense. And then at the beginning of the call, you talked about having lots of conversations with tenants and what different tenants are thinking about. Would you say there's a meaningful difference between sectors in terms of who's thinking about work from home and who is thinking about the hybrid model? And just curious if there's any kind of differentiation there.

[John Kilroy, executive]

Well, life science people are trying to do life science from home, right? So that kind of speaks to itself with regard to this to -- if you're a small tenant and you occupy 2,000 or 3,000 feet, and you've got to work from home right now by law, why would you renew your lease? You just wait for it -- there's always 2,000 feet available somewhere. I think the smaller tenants are likely to be less inclined to renew leases than big tenants.

But Rob, why don't you take that one because you spend so much time?

[A. Paratte, executive]

Yes. Jamie, and just -- I think John hit the nail on the head. It's just that the smaller tenants are probably more susceptible to what's going on today and that they can save money by not renewing lease, but we're not really seeing a sector-by-sector change. Everybody is talking about -- I think the fact is that work from home will be more acceptable and predominant than it had been in the past, but it's going to be a blend of work from home and office.

And I know again, I think I said this on our first quarter call, but just our own employee base, I know people are dying to get back to work. We're not really a tech company, even though we work closely with them. And I know that sentiment is echoed by a lot of companies. They're -- in fact, CEOs and executive teams are working hard to put programs together that make employees comfortable coming back to that workspace. So it's health screening, it's biometrics. It's all sorts of new technology that, frankly, a lot of our tenants are developing in order to make the work workspace safe so that employees feel comfortable coming back.

But I can't -- I think even fire category tenants, I think there's probably going to be some flexibility in work from home versus coming to work, but it's going to be balanced.

[James Feldman, analyst]

And are you seeing any pickup in demand for offices closer to where people live, like more of a distributed office footprint?

[A. Paratte, executive]

Yes, I think that's going to -- that was a trend in the past, and I think it's going to continue. I just think that no one -- other than being shut in their apartments, none of the young tech employees in San Francisco are talking about moving out. I mean, they want to get back out with their friends and they want to get back to work from what we're hearing.

And it's also why a lot of the facilities managers and corporate real estate executives that John and I talked to are reluctant to put space on the sublease market because they need the flexibility. And they're afraid that if they put something on the market and it gets sublet when things normalize. They're going to be short on space.

So there's just a lot of dynamics going on right now. And like John said in his remarks, there's going to be kind of some moves forward and maybe some of the backwards as we sort through this for the remainder of the year.

[John Kilroy, executive]

There's -- we're in discussions with a couple of tenants that are in the portfolio now that have needs for significant expansion. And some of that's driven by increase in workforce and some of it's being driven by reconfiguration of space.

I've had a lunch not too long ago with -- well pre-COVID. But with a -- I guess, we had a virtual lunch, that's right, where they have recently taken an entire building in one of the cities in which we operate, and it was several hundred thousand feet. And he said now with the elevator situation in that particular high rise, they need twice as much space because they can't operate in that building the way their protocols require them to operate, and they wish they had now. They hadn't taken that particular building. But they need to double up with his comment, double up in terms of the amount of space.

So we're going to see this kind of fits and starts. Some companies are going to put on hold that -- those decisions that they don't need to make. Some companies are going to have to reconfigure their space in a way that requires them to take more space. In some cases, we'll see companies that will reduce their footprint. And I think there's going to be a combination or a variety of all that stuff.

While we're all tired of COVID, I know with a bunch of kids at home and so forth, I think everybody would -- for all the reasons, we want to get through this thing. But the fact is, it hasn't been that long. It's been 3 or 4 months. And everybody is trying to figure out how to move forward in a constructive way. And we're going to see -- we're going to see that manifest itself in all the ways I just mentioned.

[Operator]

The next question comes from Dave Rodgers of Baird.

[Dave Rodgers, analyst]

Just a couple of cleanup questions for me. With regard to the severance, John or Tyler, were there more than just Jeff in that number? I mean, have you taken a little bit of a cut at just different parts of the organization, if so where, but just wanted to clarify on that versus just Jeff?

[John Kilroy, executive]

Well, yes, we have reduced our workforce some, and we're always going to be trying to rightsize. One of the things I always find it's tough, and I'm involved in some other entities beyond Kilroy and the big challenge that everybody has is nobody -- if you think of a game of football, there's 100 yards. You know where the goal line is. Or you know what the time line is. It's an hour game, it's 100 yards. The goal line is down there. And so there's some visual aids, if you will, on how you're doing and what decisions you should make depending upon the time you have left.

The thing about COVID is nobody knows how long it's going to last. Nobody knows where the goal lines are. Nobody knows how long the game is going to be. And I don't -- I shouldn't even put word game because it's a very serious issue.

And so how do you know what the right size of your organization is? My view is always to make sure that you have the talent you need to play offense and defense and adjust at the margin to make sure that you're -- not have excessive excess. And you saw us back in the, what was it, 2008, 2009, we made some pretty drastic headcount reductions. But there we could see that there were going to be a couple of years of significant downside.

And so that much of the development, if you go back to that chart that I frequently show about when we acquired, when we developed, when we dispose of assets, the thing I like about that chart is it shows that there are times when you're not doing any development, and therefore, you reduce the number of development people. There's times when you're not doing any acquisitions, and therefore, you reduce the number of acquisition people. And we're going to be mindful of that as we navigate the months and years ahead.

[Dave Rodgers, analyst]

So maybe for Rob, John. The utility or utilization of your office buildings today, maybe kind of probably was down in the low single digits at some point. Have you seen that recover at all or not? Where is that at today?

[A. Paratte, executive]

Dave, it has recovered. But keep in mind, for most of California, we had to, as governor knew some calls, adjust the dimmer switch downward again. So it's also changed again. But in May and June, there was definitely an uptick, I'd say, probably up to 25% to 35% occupancy just based on our parking garages and that sort of thing and part access information.

But again, once -- in California right now is spiking, as you know. It's kind of like New York was. So people are not in office as much as they were, but they're definitely wanting to get back. It's just a matter of, again, feeling safe and also government restrictions. Same thing for LA.

[Dave Rodgers, analyst]

Okay. And then I think Jamie asked a little bit about this. I don't want to be the dead horse. But on the new tenant activity, 5 deals, I think you signed in the quarter about 10,000 square feet each. It sounds like you guys were saying nothing much to conclude from that. It's obviously a small subset. But is there any directionality from that that would kind of give you better clarity on where we're headed in the third quarter or beyond?

[A. Paratte, executive]

I think if you're asking, I think that what we're going to see for the remainder of the year and probably Q1 is more emphasis on renewals than new space. But again, it's very market-oriented. For example, in San Diego -- in San Diego County, there were 40 deals over 20,000 feet completed. 80% of those were new deals, not renewals.

So there's net growth in San Diego in that example. And then other areas, you're just going to see, I think, renewals. So in San Francisco, it's about 55% right now, 50% to 55% renewal versus new for the activity. So again, very market-specific. Hollywood and entertainment, you'll see I think absorption.

[Dave Rodgers, analyst]

All right. And then maybe, Tyler, last question for you. On the tenant in Hollywood that you mentioned, the marketing firm that went bankrupt, that impact, was that covered in the prior reserves? Or did you take a special impact or were you able to go back and maybe get some kind of credit enhancement on that post their departure? Any thoughts around there would be helpful?

[Tyler Rose, executive]

It didn't have a financial impact in the second quarter. But obviously, going forward, assuming they don't recover, we'll have an impact in the second half of the year. But from earnings perspective, there was really no material impact in the second quarter.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Rose for any closing remarks.

[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]

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