Accounting Kilroy Corp Assignment | Get Paper Help

USE THIS LINK FOR INFORMATION: https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0001025996&owner=exclude&count=40&hidefilings=0 -KILROY COMPETITION COMPETITION: Of the 19 other companies within the office REIT sector, Kilroy has three office REITs which directly compete with them. · Hudson Pacific Properties: Properties that directly compete with Kilroy are located in Los Angeles, San Francisco Bay Area, and Greater Seattle. They also have an emphasis on tech companies, and house Netflix, Google, salesforce, and Uber. · SL Green: Based out of New York, with 119.8 million square feet of office space. While not on the west coast, their property is on the equally attractive East Coast, with the potential to pull tech clients away from Kilroy. · Douglas Emmitt: They have approximately 10 million square feet of office space within 52 properties along with 2120 multifamily units within 8 properties located throughout Los Angeles’ Westside. Additionally, they have 6.8 million square feet of office space within 16 properties located in the Los Angeles Valley. QUESTION: [Need to talk about how Kilroy is better or worse than them] What about private competition? No need to go on getting all the names but is the competition intense? Not as intense? Should we care. Remember public REITs are much bigger than smaller real estate companies so- But then there are small real estate companies that can hold. Some research would be good.

Kilroy Realty Corp.

 

 

BUSINESS

Kilroy Realty Corporation has been in business since 1947. Specializing in class A properties totaling 14 million square feet and 112 buildings in four key markets along the West Coast: Great Los Angeles, San Diego, San Francisco Bay Area, and Greater Seattle. Kilroy’s primary goal is providing premium, adaptable work environments for a wide range of client industries, including technology, media, telecommunications, engineering, entertainment, healthcare, biotechnology, and professional services. With a keen focus on sustainability, many of their clients have been tenants for decades. [why do they focus on sustainability? Does it lower costs? Raise reputation? Do other office REITs not care about sustainability] How are Kilroy’s buildings different from other office REIT buildings?] Kilroy also has residential-

INDUSTRY

While there are several types of REITs ranging from self-storage to retail, Kilroy is in the Office REIT sector. Office REITs own and manage office real estate and rent out space within those properties to tenants. Property types can range from office parks to skyscrapers, depending on the market. Office REITs may focus on different types of markets or a specific class tenant ranging from biotech firms to government agencies. The focus of these REITs is acquisition, development, ownership, leasing and management of office locations. When Office REITs have anchor tenants they tend to benefit from longer leases as compared to tenants of industrial properties.

The Office REIT industry consists of 20 different REITs, 19 of which are public and 1 private. The office REIT sector has an average dividend yield of 3.45%, year over year rent growth of 2.90%, and an average occupancy rate of 90.20%. Total market capitalization of Office REITs $78.25 Billion.

Generally, REITs prosper when economic conditions are strong due to the fact that competition for office space drives up rents. REITs perform well when the economy is growing, and vacancy rates are low. According to REIT.com, the office REIT sector is the best real estate REIT. It provided a cumulative return of 179.24% from Sept 2002 to June 2017, or average annualized return of return of 7.21%. Compare this to to all REITs which has a 207.53% return over the same frame, or average annualized return of 7.91%. However, the economy has continued growing for over 10 years, the longest expansion on record. Although unemployment is the lowest in 50 years, there are some signs of inflation. There are no historical precedents to study for clues of what may come next. According to reit.com the outlook for REITs in 2020 remains favorable with modest economic growth expected and few signs of recession on the horizon. There have been low vacancy rates throughout the real estate markets coupled with growing demand and supply. Demand in 2019 has kept occupancy rates of all REIT owned properties near the record highs that were achieved in 2018. It is expected that these will carry over into 2020 and contribute to a higher FFO. Key items to watch out for are an increase in vacancies or slowing rent growth. In 2019 REITs posted their best performance since 2014. Additionally, we are seeing an unprecedented wave of volatility in the markets due to the Corona Virus outbreak. At this time there is no telling what lasting effect this will have on the office REITs industry as some tenants struggle to pay rent.

[Focus more on office REITs]

COMPETITION

Of the 19 other companies within the office REIT sector, Kilroy has three office REITs which directly compete with them.

• Hudson Pacific Properties: Properties that directly compete with Kilroy are located in Los Angeles, San Francisco Bay Area, and Greater Seattle. They also have an emphasis on tech companies, and house Netflix, Google, salesforce, and Uber.
• SL Green: Based out of New York, with 119.8 million square feet of office space. While not on the west coast, their property is on the equally attractive East Coast, with the potential to pull tech clients away from Kilroy.
• Douglas Emmitt: They have approximately 10 million square feet of office space within 52 properties along with 2120 multifamily units within 8 properties located throughout Los Angeles’ Westside. Additionally, they have 6.8 million square feet of office space within 16 properties located in the Los Angeles Valley.

[Need to talk about how Kilroy is better or worse than them] What about private competition? No need to go on getting all the names but is the competition intense? Not as intense? Should we care. Remember public REITs are much bigger than smaller real estate companies so- But then there are small real estate companies that can hold. Some research would be good.

 

 

 

 

3. Firm’s Strength/ Weakness: Overall analysis of firm’s moat and strategy

 

The SWOT analysis helps to understand a company’s strengths, weaknesses, opportunities and possible threats against it.

 

Strengths

Kilroy Realty Corporation is among the leading firms within the real estate industry. The company has over 65 years’ experience. Over the past five years they’ve shown strong performance across all areas of business. Specifically, in 2018 and 2019 they were able to achieve record high annual leasing for the company. The company has dealt with no litigation for the past 9 years. The company has elected to be treated as a REIT under the Internal Revenue Code of 1986. As a REIT, it would not be subject to federal income tax, provided it distributes at least 90% of its taxable income to its shareholders. Kilroy’s business strategy aims to only add properties to their portfolio that meet their standards for quality, location, amenities and long-term appreciation potential through acquisition of development. This has helped create a strong brand portfolio. Kilroy’s properties owned and managed real estate assets, consisting primarily of Class A properties that are located in vibrant business epicenters. Well known regions where their properties are located in the San Francisco Bay Area, Greater Los Angeles, Pacific Northwest and Greater San Diego. Kilroy’s 15 largest tenants include significant companies including some known companies such as Dropbox, Inc., GM Cruise, LLC, LinkedIn Corporation/Microsoft Corporation, DoorDash, Inc., and Amazon. [Need to talk about the properties themselves] look at their investor day presentation.

 

Weaknesses

The company depends on significant tenants therefore the loss of a significant

tenant could be a major risk factor. Throughout the MD&A for the past five years rental revenue has been their principal source of revenue. Another risk factor is that real assets are liquid. Expenses are nearly as twice as much in 2019 than they were in 2012. In 2019, expenses for Kilroy were $615,131 compared to $321,199 in 2012. The highest expense for both years has been depreciation and amortization followed by property expenses. [How likely are they likely to lose tenants or face lower rent due to COVID 19]

 

Opportunities

Kilroy holds attractive properties. However, their name is not as known as Century 21. The company has an opportunity to make their brand name known. Although Kilroy is a key player in the industry, their name is not as known as their competitors. Creating a better-known name is important for their future. The company should create a social media presence for future generations who can possibly become their future tenants. This allows the company to capture new customers and increase its market share. Kilroy aims to create all ground-up construction that will pursue LEED Gold certification or better. The LEED provides a framework for healthy, highly efficient, and cost-saving green buildings. LEED certification is a globally recognized symbol of sustainability achievement and leadership. During the past few years, Kilroy has significantly enhanced the sustainability profile of their portfolio, ending 2019 with 64% of our properties LEED certified. Real estate is a favored investment option, both for its long-term value and ability to generate greater returns for investors.  In the last few decades, commercial real estate has provided many opportunities for investment as with its greater capital availability and pricing. [No need to give recommendation to the firm, this is an investment thesis]

Aren’t other firms doing sustainability too?

Threats

Kilroy faces intense competition. The 5 largest players in the office REIT space, from largest to smallest, are Boston Properties, Inc.; Alexandria Real Estate Equities; Kilroy Realty Corporation; SL Green Realty Corp.; Highwood Properties.  Kilroy’s competitors are under REIT and they are all comparable to Kilroy based on their market cap, total revenue and total assets, all of them have a close range to one another. New technologies developed by competitors could be a serious threat to the industry. New technologies allow residential properties to sell things like parking spots that are not in use. These types of opportunities taken by the competition before Kilroy is a threat. The pandemic crisis of COVID-19 is a huge threat for the industry. Many employees are getting laid off who in turn need the money to pay rent to the company. Along with this issue is the effect of the stock market globally due to COVID-19 as of March 2020. [Good point but bigger threat is firms not leasing much office space after COVID 19]

 

4. Management Analysis: Due diligence on management

Overview

Kilroy Realty’s current executive team consists of five members.  John Kilroy has served as the company’s Executive Vice President and Chief Executive Officer (CEO) since the company incorporated in September 1996.  He has over 50 years of experience in real estate acquisitions, development, and management.

Serving as the firm’s Executive Vice President and Chief Operating Officer (COO) is Jeffrey Hawken, who has held the position of COO since the company went public in January 1997.  In addition to having over 30 years of experience working in property and asset management, Hawken also holds a California Real Estate Broker license and a Bachelor of Science degree in Business Administration from the University of Southern California.

With a Master of Business Administration degree from The University of Chicago and a Bachelor of Arts degree in Economics from the University of California-Berkeley, Tyler Rose has served as the Executive Vice President and Chief Financial Officer since December 2009.

The current Executive Vice President of Development and Construction Services is Justin Smart. He has held his current position at Kilroy since January 2013 and has over 25 years of experience in real estate development.

The most recent addition to the executive team is Heidi Roth, who acts as the Executive Vice President and Chief Administrative Officer. Roth has worked at Kilroy since 1997, where she has previously served as the Senior Controller and the Vice President of Internal Reporting and Strategic Planning.  Her qualifications include being a Certified Public Accountant and holding an Accounting degree from the University of Southern California.

Although he is no longer with the company, it is notable that Stephen Rosetta recently served as the Executive Vice President and Chief Investment Officer.  Rosetta holds a Master’s in Real Estate Development from the University of Southern California, and he was notably successful in growing Cushman & Wakefield’s San Diego office to generate $2 billion in revenue.  The company and Rosetta separated in August 2019, per the company’s 8-K that was filed on August 29, 2019.  As part of his separation agreement, Rosetta agreed to conditions of “non-solicitation, non-disparagement and confidentiality restrictions.”  Such conditions were not included in the company’s prior agreements with former executives. Following his departure, Rosetta joined a private real estate firm named IQHQ REIT.

The length of time the executives have remained at the company is a good indicator of the company’s performance.  Per Exhibit 3, the executive members with the longest tenure at Kilroy include John Kilroy (24 years), Jeffrey C. Hawken (23 years), and Tyler Rose (18 years).  The company believes it is in its best interest and in the interest of shareholders that John Kilroy continue to serve as the CEO and President. This is evident in their offer to Mr. Kilroy of 483,871 restricted stock units, which is documented in their 8-k report filed on December 31, 2018.  The fact that Mr. Kilroy is continuing to serve as the CEO and President is indicative of the company’s future success.

[not so relevant stuff should go to the Appendix]

Ownership

Per Exhibit 1, the ownership by directors and executive officers has been on a downward trend.  Of this group, John Kilroy Jr. has had the highest percentage of ownership. However, his stake has decreased by nearly 70% since 1997, with his ownership reducing from 4.8% to 1.6%.  The group as a whole has also seen decline by approximately 80%.  In the 1997, directors and executive officers owned 11% of the common shares; in 2019, this group only owned 2%.  The significant downward trend began in 2010. From 1997 to 2009, total ownership by directors and executives stayed within the range of 9% and 11%. In 2010, total ownership began to decline below 5%.

The top major stakeholders, or shareholders who own more than 5% of common shares, are the Vanguard group (14%), BlackRock (12%), and Cohen & Steers (11%). It is notable that only a small number of major stakeholders keep their shares long term.  Cohen & Steers and Vanguard have both maintained a long-term status as major stakeholders, holding onto their shares for 17 and 13 years, respectively.  In the past 23 years, 10 out of the 22 major stakeholders have maintained more than 5% ownership for only a year.

[Again, only relevant stuff- other stuff to the Appendix]

Strategy Execution

According to Kilroy’s 2020 proxy, the company was successful in reaching their goals related to capital recycling, development, net operating income, and leasing.  Kilroy implemented a capital recycling program that allowed them to provide additional capital to finance development and acquisitions. Kilroy issued 3.05% unsecured senior notes in the amount of $500.000, which allowed them to complete several investments, including adding $226,000 of value-add in California and acquiring a prime 1.37 acre of land in Seattle. In 2019, Kilroy completed the construction of 273 residential units.  Per Kilroy’s 2020 10-K, the company was successful in increasing their net operating income (NOI) by 11.4% compared to 2018. The company was also successful in ensuring that 100% of their Seattle portfolio was leased in 2019.

[Go back further, have they been good at execution]

Capital Allocation

From 2010 to 2019, Kilroy has acquired $3.2 billion in real estate properties.  Within this same cycle, the company also has $4.7 billion in development starts. [so did this projects work out?]

Compensation

There is a significant disparity between Kilroy’s CEO compensation and the compensation of its competitors.  Kilroy and its competitors have similar compensation policies that include a base salary, cash bonuses, and equity bonuses. Per exhibit 4, Kilroy experienced a 16% drop in stock price in 2018.  Competitors, such as Douglas Emmett (-10%), SL Green (-22%), and Hudson Pacific (-15%) also saw drops in their stock prices in 2018. Despite this drop, Kilroy increased the compensation of their CEO by 282%.  It is notable that, while Kilroy’s stock price dropped, their 2018 net income increased by 57%.  However, SL Green Realty’s net income increased by 144% in 2018, and their CEO’s compensation underwent a reduction by 23%.   This disparity is explained by the difference in what drives CEO compensation. Kilroy uses net income to drive compensation, while SL Green uses sales revenues.  We believe the significant increase in compensation for Mr. Kilroy is indicative of how crucial he is to the success of the company.

[Compare stock prices as well, again if it doesn’t matter then to the Appendix]

5. Major Investor Analysis: Due Diligence on major investors

 

The major investors in Kilroy group are The Vanguard Group, Inc. and affiliates owning 14.43 %, BlackRock Inc. who own 12.09 %, Cohen & Steers Inc. and affiliates owning 11.23 %, Norges Bank (The Central Bank of Norway) owning 5.94 % and PGGM Vermogensbeheer B.V. who own 5.29 percent of the total shares. Judging from the major investors in the company, they do provide assurance about the quality of the firm. Some reputable institutions such as Norway’s Central bank have invested in the company. This is good news for the shareholders since they are assured that the firm is well valued and it is of high quality.

Since 1997, the percentage of shares owned by directors has adopted a general negative trend, decreasing from 11 % down to 2.3 percent in 2019. The shares owned by more than 5 % of shareholders have increased from 6.9 percent in 1997 to 48.98 percent in 2019. The decrease in ownership by the directors is a sign that they have been selling their shares. This is a red flag as it implies that the shareholders will not be best served by the directors because the directors have a reduced vested interest in stock performance.

The business is not owned by one family, therefore, there is a low risk of misappropriation of funds. This offers extra credibility as the shareholders can be assured that their money will be directed towards the benefit of the business. The business has many passive investors. This is better than having large corporate investors who can exert their influence on the company to serve their interests. However, the business should have a fine mix of both passive and active investors so as to increase their ability to react to minor declines or distortions on fundamentals

 

 

 

6. Accounting Quality: Analysis of the firm’s financial reporting quality (e.g. internal control weakness, restatement, funny accounting).

 

The quality of financial reporting, in general, denotes the characteristics of the company’s financial statements and its degree of accuracy in presenting a faithful representation of the firm’s financial dealings over a given accounting period. This includes evaluating whether the financial statements and reporting system adhere to generally accepted accounting principles (GAAP) and as well as evaluating the disclosures of the company’s non-financial information such as business risks and the sustainability of the company profits, cash flows, and balance sheet items.

Overall, based on the due diligence analysis of the company’s financial reports and declarations, we can conclude that the Kilroy Corporation has a reliable financial reporting system and the quality of its published financial reports, in my opinion, can be said to be satisfactory. Kilroy files detailed annual and periodic declarations about its operations, and this implies that the management is transparent. There have also been relatively few audit issues in the last five years that would highlight any underlying unaddressed weaknesses in the company’s internal control systems. Additionally, the company has had few restatements of its financial statement accounts in the last five years further reinforcing my conclusion that Kilroy’s internal control systems are effective in identifying and preventing fraud.

However, a key weakness in the company’s internal controls system may be in interpreting applying Non-GAAP principles particularly in estimating the funds from operations (FFO) account, and this may affect the quality of their financial reporting. While other firms in the industry use a standard measure for estimating FFO for REITs, different REITs may calculate their FFO differently as some aspects of the FFO measure are subject to varying interpretations. This creates that Kilroy’s managers may exploit loopholes to pursue aggressive or conservative accounting policies to manipulate the company’s earnings. For example, in 2016, Kilroy began including “amortization of deferred revenue related to tenant-funded tenant improvements” on their property and excluding “the depreciation of the related tenant improvement assets” in calculating the company’s FFO for the period. Prior to the implementation, the company recorded amounts funded by tenants for tenant improvements as deferred revenue only when the company had determined that the company owns the improvements.

However, the company’s management could not provide a reconciliation of this accounting guidance and subsequently had to revise future filings to start their reconciliation with the GAAP to include the amount of amortization of deferred revenue for tenant funded tenant improvements in calculating the firm’s FFO.

A disclosure by the company also claims uncertainty and difficulty in forecasting adjusting items such as gains on sales of depreciable real estate and other items that have not occurred yet. And as a result, Kilroy’s FFO estimation does not include possible future gains or losses or the impact on operating results from other potential future property acquisitions or dispositions.

Kilroy has however resolved a majority of these issues as evidenced by declarations in the 8-k statements issued to declare resolutions of inconsistencies in implementing accounting policy. The company has addressed its key issues and has since adopted recommended policies.

The company’s management may adopt conservative accounting interpretations of the accounting principle during periods when corporate earnings are above target so as to decrease the corporation’s reported earnings and financial position for the current accounting period by understating revenues and overstating expenses. Managers may also employ aggressive policies to artificially smooth earnings during periods of sales downturns such ambiguity in interpreting GAAP principles raises minor concerns about the quality of the firm’s financial reporting. However, in overall, Kilroy’s financial reporting system is sound, and the quality of its financial reports can be said to be reliable.

In November 2005, Kilroy restated their income statement to show the impact of the change in their interest rate agreements.

Good job on the Non-GAAP but what about the competitors? Also, how much does this matter?

 

7. Financial Ratio Analysis: Engage in DuPont, ROIC, and other ratio analysis

 

 

Most investors are using its Price/Earnings ratio to analyze companies but since REIT is a different type of business compared to most, using Price to Funds From Operations (FFO) is one of the best ways to analyze REIT. Price/FFO ratio is a measure of whether REIT is expensive relative to its peers. We gathered 8 different competitors of Kilroy Realty Corp based on its market size and locations of their properties. We gathered data for the past 5 years and based on the graph above, Kilroy Realty Corp. has a pretty similar range in comparison to its competitors which indicates that Kilroy is not too expensive for investors to buy.

 

Make prettier graph- Calculate average-

Since most REIT companies are using debt to lever their companies, we want to make sure that Kilroy Realty Corp. is properly lever. Based on the leverage ratio (Debt/EBITDA) graph above, Kilroy is having a pretty stable trend going upwards. Most of its competitors have been having some fluctuations in their leverage ratio but Kilroy is showing a very stable progress in their leverage.

 

Bar graphs look better

 

8. Forecasting/ Valuation: Engage in forecasting and valuation

 

Based on Net Asset Value and its share price value on the graphs below, Kilroy Realty Corp. tends to lean towards overvalued throughout the years. It is overvalued by half in 2019. From Gurufocus.com, we also see the same pattern. Based on their DCF model, Kilroy Realty Corp.’s fair value is $19.80 where its share is currently trading on $64.40 (data from March 30, 2020). This indicates that Kilroy Realty Corp. is overvalued. Nonetheless, more than half of the competitors that we choose are having the same trend as Kilroy Realty Corp.

 

The gurufocus DCF inputs are wrong- if you don’t feel comfortable don’t put it in the report. You will be fine talking in terms of P/B, P/FFO, EBITDA growth, FFO growth etc- Also, REITs don’t use DCF much so-

 

 

9. Caveats: Extensive discussion on why your recommendation may not work

Caveats

While our recommendation is to buy, there are factors surrounding the current pandemic that, while not certain, may affect the viability of this recommendation. As such, these are discussed below.

According to Alan Kava, co-head of Merchant Banking Division Real Estate Group. Office leasing has declined in the 1^st quarter of 2020. This was due to downward pressure from tenants that simply may not survive this pandemic, causing additional vacancy.

There is added concern that working from home has proven to be fairly effective for service industries. Some have reported an increase in productivity and billable hours due to the forced work from home transition. There is concern that companies which are benefitting from added productivity of employees while working from home during shelter at home orders may realize they simply do not need so much square footage or may shift to high value locations in which rent is cheaper once the economy begins to re-open.

Additionally, there was already a trend toward densification. That is to say, the average space per employee has shrunk. Before the pandemic, offices had been converted toward less assigned seating to systems which employee’s check-in daily and choose their seating, all in the name of improving productivity, creativity, and interaction between different employees. These trends will have to be rethought in the wake of this pandemic, at least for a couple of years.

Ralph Rosenberg, former partner at Goldman Sachs and now Global Head of Real Estate at KKR points out a unique dilemma. Real estate value is created when there is compression between occupancy and supply, meaning high demand and low supply. Rosenberg believes a drop-in occupancy of 4-5% will greatly impact landlords’ ability to continue to increase rent. This would translate into muted value over a long period of time. Rosenberg also feels that, while there was already a trend for corporations to migrate to smaller growing cities, there could be a bigger shift in the market of more corporations falling in line with this trend which would, of course, further impact the value.

Roy March, CEO of Eastdil Secured believes the positive 1^st quarters figures many real estate REITs were reporting were simply a result of positive figures drifting from earlier activities, and were not really reflective of the market during this pandemic. Quarter 2 results should be more in line with the market conditions, and those numbers are expected to be down.

 

10. Conclusion: Brief conclusion about the report

 

Kilroy’s CEO has over 50 years of experience in the industry. The company increased their net operating income by 11.4% compared to 2018. Kilroy has a reliable financial reporting system and quality of financial reports. Kilroy shows a stable progress on their leverage ratio (Debt/EBITDA). Despite our times of hardship due to COVID-19 our recommendation is to buy at $70 or lower.