As nervous investors keep dumping technology stocks, sectors that are viewed as safe harbors are enjoying an influx of cash. And chief among those perceived safe harbors are real estate investment trusts, including El Segundo-based Kilroy Realty Corp.
Kilroy has seen its share price go up steadily, closing Dec. 27 at $28.38, up 47.9 percent from its 52-week low of $19.19 back in January.
And since the tech sector is likely to be in a state of flux for the time being, analysts expect REIT shares to continue to outperform the market. Out of seven investment research firms tracking Kilroy shares, six recommend the company as a “buy” or “strong buy.”
Deutsche Banc Alex. Brown analyst Lou Taylor initiated coverage of Kilroy this month with a “strong buy” recommendation, citing the appeal of REITs as the “anti-tech” investment because of their visible earnings and predictable growth.
“Real estate companies enter each year knowing where approximately 85 percent of their revenues are coming from, thanks to contractually supported documents such as leases,” said Taylor in a release accompanying his recommendation. “This visibility provides terrific predictability.”
But aside from happening to be in a currently favored sector, Kilroy has solid fundamentals that underpin the stock’s performance, and the company’s focus on Southern California may protect it against a nationwide weakening of the real estate market.
For the third quarter ended Sept. 30, the company reported net earnings of $15.7 million (59 cents per share), compared to $10.9 million (39 cents per share) for the like quarter one year earlier. Revenues were $47.2 million for the quarter, up from $40.2 million.
However, earnings are not the best indicator of REIT performance, because they take into account the depreciation of the company’s assets, which in the case of a real estate-based company can be a very substantial cost.
As a result, REIT performance is generally measured by funds from operations, which do not take depreciation into account.
For the quarter ended Sept. 30, Kilroy reported funds from operations of $21.1 million (69 cents per share), compared to $20.7 million (64 cents per share) for the like quarter one year earlier. The company also declared a regular quarterly dividend of 45 cents per share last month.
Although there is growing concern about a nationwide economic slowdown, or even a recession, Kilroy is not likely to be impacted by softening demand. The company’s portfolio is weighted towards industrial and office properties in Southern California, submarkets that are showing little signs of weakening.
“Even if the economy slows, Kilroy is positioned in the market where people want to be,” said Craig Silver, an analyst with Sutro & Co. “They have many leases coming up for renewal in the next few years, and they will be able to get higher rates even if demand may not be what it was a year ago.”
Indeed, this year the company secured, on average, a 25-percent increase in rents on the leases that were renewed, according to Tyler Rose, senior vice president and treasurer with Kilroy. And it has 15 percent of its outstanding leases up for renewal in 2001. Rose expects average increases of between 15 and 20 percent on those renewals.
In addition, the company has top-of-the-line office buildings under development in Calabasas, El Segundo and West Los Angeles targeted at technology and entertainment tenants.
“All the new development we have is in Southern California, and we don’t see any signs of the market turning,” said Rose. “Most of our buildings are pre-leased, but we’re watchful of the economy and we’ll manage our development pipeline accordingly.”
One project that is suffering some of the fallout of the dot-com meltdown, though, is Kilroy’s Westside Media Center at Bundy Drive and Olympic Boulevard. In August, struggling online retailer eToys Inc. announced that it would not exercise its option to move into the planned third phase of this project. In fact, eToys has an 11-year lease for 150,000 square feet at the project’s second phase, but it looks ever more doubtful that the e-tailer is going to be around much longer.
Even so, the Westside office market is expected to withstand a drop-off in demand from dot-coms.
“There are some worries, but the market here is not going to be affected to the same extent as in Northern California,” said Silver. “They don’t have a very large amount of space here.”
Kilroy, meanwhile, hopes to benefit from high-tech companies looking for alternatives to the high rents in Northern California. The company has 862,000 square feet of new office space under construction in coastal San Diego County.
