Detailed Narrative
West Coast Market Recovery and Leasing Momentum
The company observed a continuation and broadening of the recovery across its patient-driven markets, fueled by strong new business formation, growth in AI, and shrinking shadow supply. This has led to diminishing inventory of high-quality available space and improving lease economics. Tenant urgency for early renewal discussions has increased, with Q2 leasing volume up 40% year-over-year. The forward leasing pipeline expanded significantly, with LOI and late-stage pipeline up 77%.
San Francisco Market Dynamics
San Francisco, the largest market, posted its fourth consecutive quarter of positive net absorption, driven by flight-to-quality dynamics. Average effective rents increased approximately 15% year-over-year. Active tenant demand surpassed 10 million square feet, a level not seen since 2019, with AI ecosystem representing approximately one-third of this demand. Tangible interest is migrating across multi-tenant assets in the South of Market submarket, which saw a 65% sequential increase in tour activity.
Life Sciences Sector Performance
Industry fundamentals in the life sciences sector continue to improve, with the XPI up more than 70% year-over-year. Biotech IPO and follow-on equity markets are open, and M&A/licensing activity is robust. At Kilroy Oyster Point Phase 2 (KOP 2), there has been a meaningful pickup in tour and proposal activity, with active interest in all unleased space and larger format users re-engaging the market. Robotics companies are also creating large requirements in the Peninsula, potentially reducing available R&D space for life sciences.
Capital Allocation and Balance Sheet Strength
Kilroy Realty is focused on simplifying the portfolio, improving cash flow durability, and maintaining financial strength. The company has sold $348 million year-to-date, including a $202 million LA residential sale. The capital markets for office and life science are strengthening, leading to improved pricing and certainty of execution for dispositions. The company also amended and extended its unsecured credit facilities, increasing available capacity and extending duration, resulting in approximately $1.6 billion of available liquidity.
Flower Mart Development Update
The company continues to work with the city of San Francisco on a revised plan for the Flower Mart site, expected to conclude in Q4 2026. The updated framework aims to provide greater flexibility around phasing📎 and a broader range of uses, including residential, to maximize optionality. Current rents do not yet support development economics for either office or residential, and expense capitalization is expected to stop at year-end 2026.
KOP 2 Leasing and Development Spend
At Kilroy Oyster Point Phase 2, a 38,000 square foot lease was executed with Edema Pharmaceuticals during the quarter. The primary component of the company's development spend, guided at plus or minus $150 million for the year, is allocated to KOP 2. Capital spend is expected to accelerate in the second half of the year as leasing activity and build-out for signed leases continue.
Acquisition Strategy
The improved transaction market presents acquisition opportunities, with the company actively evaluating several. The investment philosophy focuses on asset-by-asset evaluation, seeking mismatches between demand fundamentals and values. Kilroy typically targets core-plus or value-add opportunities where its expertise in leasing up vacancy, investing capital, or taking a position on future lease roll can create value, rather than purely core assets.