Company Reports

The REIT sector in the US offers many companies that should see relatively stable cashflow growth over the next several years. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past three years with many reaching historical levels of net operating income growth, the REIT sector underperformed the broader equity markets in 2023 and into the first half of 2024. We believe that is due to the sector’s negative correlation with interest rates, as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, interest rates have fallen since the end of July, leading to a rally for the REIT sector. Still, we still view many of companies in the US REIT sector as being undervalued as the companies should continue to produce solid long-term growth.

Despite a rally over the past two months, we still view the US REIT sector as being undervalued. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors led combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past three years, with many reaching historical levels of net operating income growth, the REIT sector has underperformed the broader equity markets in 2023 and into the first half of 2024. We believe that the cause has been due to the sector's negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, interest rates have fallen since the end of July, leading to a rally for the REIT sector. We believe that US REITs will continue to see share price movements that are inverse of interest rate movements.

Kilroy is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use real estate properties in Los Angeles, San Diego, San Francisco Bay Area, Seattle, and Austin. It owns 121 properties consisting of approximately 17 million square feet. The company has positioned itself to benefit from the burgeoning life sciences sector with material exposure in its current portfolio and future development pipeline. We also welcome management’s focus on ESG as it aligns its office portfolio to meet the sustainability requirements of its clients.

No-moat-rated Kilroy Realty reported weak second-quarter numbers, with funds from operations of $1.10 per share about 7.5% lower on a year-over-year basis. The demand for office real estate in West Coast cities like Los Angeles and San Francisco continues to remain tepid as a result of city-specific factors and a slower recovery in physical office utilization rates for tech companies compared with other sectors. While Kilroy’s high-quality portfolio has held up significantly better than the overall market, the pressure on its portfolio remains intense.

The US REIT sector remains significantly undervalued, in our perspective. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past two years, with many REITs reaching historical levels of net operating income growth, the sector has underperformed the broader equity markets over the past two years. We believe that the cause has been the sector’s negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, we don’t believe that higher rates significantly change our fair value estimates for the sector. Additionally, interest rates are down from the October 2023 highs, and REIT share prices have generally inversely followed the movements of the US 10-year Treasury.

No-moat-rated Kilroy Realty’s first-quarter numbers were in line with our expectations as the firm reported funds from operations, or FFO, of $1.11 per share, which was around 9% lower on a year-over-year basis. The demand for office real estate in cities like Los Angeles and San Francisco remains tepid due to city-specific factors and a slower recovery in physical office utilization rates for tech companies compared with other sectors. The broader office REIT sector has rallied quite materially, but Kilroy’s shares have underperformed the sector because of concerns associated with San Francisco and the overall West Coast office recovery. The West Coast office market remains under tremendous pressure, but we continue to believe that Kilroy’s shares remain notably cheap from a long-term perspective. We are maintaining our $59 per share fair value estimate for Kilroy Realty as we incorporate first-quarter results.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

Kilroy is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use real estate properties in Los Angeles, San Diego, San Francisco Bay Area, Seattle, and Austin. It owns 121 properties consisting of approximately 17 million square feet. The company has positioned itself to benefit from the burgeoning life sciences sector with material exposure in its current portfolio and future development pipeline. We also welcome management’s focus on ESG as it aligns its office portfolio to meet the sustainability requirements of its clients.

No-moat-rated Kilroy Realty’s fourth-quarter numbers came in lower than our expectations. The firm reported funds from operations of $1.08 per share, around 7.7% lower than the $1.17 reported in the year-ago fourth quarter. The demand for West Coast office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The broader office REIT sector has rallied quite materially in the past few months in anticipation of interest-rate cuts. However, Kilroy’s shares have underperformed the sector over concerns associated with San Francisco and the overall West Coast office recovery. The West Coast concentration of the company was always a major risk to our thesis and has been a major overhang on the stock.

No-moat-rated Kilroy Realty's third-quarter results were largely in line with our expectations as the firm reported funds from operations, or FFO, of $1.12 per share in the third quarter, which was around 4.3% lower than the $1.17 per share FFO reported in the third quarter of the previous year. The demand for West Coast office real estate remains muted because of macroeconomic factors and a slower recovery in physical office utilization rates, but shares are compellingly cheap from a long-term perspective.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

No-moat-rated Kilroy Realty’s second-quarter results were largely in line with our expectations as the demand for west-coast office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The firm reported funds from operations of $1.19 per share in the second quarter, which was around 1.7% higher than the $1.17 per share FFO reported in the second quarter of the previous year. The short-term outlook for office real estate remains challenging, but shares are compellingly cheap from a long-term perspective.

Kilroy is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use real estate properties in Los Angeles, San Diego, San Francisco Bay Area, Seattle, and Austin. It owns 119 properties consisting of approximately 16 million square feet. The company has positioned itself to benefit from the burgeoning life sciences sector with material exposure in its current portfolio and future development pipeline. We also welcome management’s focus on ESG as it aligns its office portfolio to meet the sustainability requirements of its clients.

Kilroy Realty's shares have corrected by more than 60% since the onset of the pandemic even as the company's net operating income has increased by about 35% due to the completion of development properties and acquisitions. We recognize the uncertainty surrounding the future of office real estate. We also believe the environment will remain challenging for office owners in the near to medium term. That said, we think the selloff has been overdone and that the market is not recognizing the value of the company's nonoffice-related assets and its land bank.

No-moat-rated Kilroy Realty reported a decent set of numbers in the first quarter even as the demand for office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The firm reported funds from operations, or FFO, of $1.22 per share in the first quarter, which was around 5% higher than the $1.16 per share FFO reported in the first quarter of the previous year. The short-term outlook for office real estate remains challenging but shares are compellingly cheap from a long-term perspective. The gloomy West Coast office headlines do not accurately reflect the fundamentals of Kilroy's high-quality portfolio.

Kilroy Realty is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use real estate properties in Los Angeles, San Diego, San Francisco Bay Area, Seattle, and Austin. It owns 119 properties consisting of approximately 16 million square feet. The company has positioned itself to benefit from the burgeoning life sciences sector with material exposure in its current portfolio and future development pipeline. We also welcome management’s focus on ESG as it aligns its office portfolio to meet the sustainability requirements of its clients.

No-moat-rated Kilroy Realty reported a decent set of numbers in the fourth quarter amid a very challenging West Coast office market environment. The macroeconomic slowdown has severely affected the tech industry, with most firms focused on controlling their expenses. This has directly impacted the West Coast office market, which was already reeling with record-high vacancy rates. In our opinion, economic booms and recessions are part of every economic cycle and investors should value Kilroy’s premium real estate from a long-term perspective. The company owns tangible real estate at prime locations in highly supply-constrained markets that can be liquidated at a price that is substantially higher than the current stock price. The heart of our investment thesis for the company remains the same after analyzing the latest developments in the office market, but we think that the recovery may be longer. Kilroy’s superior-quality office portfolio should hold up considerably better than the overall West Coast office market in the upcoming quarters.

Kilroy Realty's west coast-focused office portfolio merits investor attention after the steep selloff of office REITs in the last few months. We recognize the uncertainty surrounding the future of office real estate and believe that the environment will remain challenging for office owners in the near to medium term. Having said this, we also believe the selloff has been overdone and that the current implied cap rate of 8.8% is completely divorced from the estimated private market valuation of Kilroy's office portfolio. Additionally, the market seems to be overlooking investments of over $2 billion that the no-moat-rated company has already made in its development pipeline. After adjusting the enterprise value for these investments, the stock's implied cap rate is 11.7% compared with our cap rate estimate of 5.3% for its office building portfolio as of the first half of 2022. This translates into a discount of around 63% to the estimated net asset value, or NAV, of the company’s portfolio.

No-moat-rated Kilroy Realty reported third-quarter results that were largely in line with our expectations as share prices of office REITs have declined significantly in the past few months. The firm reported funds from operations, or FFO, of $1.17 per share, 19.3% higher than the $0.98 in FFO during the third quarter of 2021. Meanwhile, same-store net operating income increased 2.2% compared with a year ago and same-store cash net operating income increased 6.4% on a year-over-year basis. The company reported stabilized occupancy rate of 90.8% in the third quarter, down 60 basis points on a sequential basis. Kilroy Realty remains our preferred pick for investors considering office REITs given its high-quality portfolio, low leverage, and appealing valuations. We are maintaining our $69 fair value estimate for Kilroy Realty after incorporating third-quarter results.

Kilroy Realty is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use real estate properties in Los Angeles, San Diego, San Francisco Bay Area, Seattle, and Austin. It owns over 115 properties consisting of approximately 15 million square feet. The company has positioned itself to benefit from the burgeoning life sciences sector with material exposure in its current portfolio and future development pipeline. We also welcome management’s focus on ESG as it aligns its office portfolio to meet the sustainability requirements of its clients.