Kilroy Realty: Excessive Pessimism Presents an Enticing Opportunity for Patient Investors

Kilroy Realty’s KRC 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.

We estimate that the company will generate approximately $40 million NOI from its residential properties and $209 million NOI from its life sciences portfolio after the completion and stabilization of its in-process development projects. The estimated market value of the residential and life sciences portfolio of the company is $800 million and $3.8 billion respectively as per the current market cap rates. The market has mainly been concerned about the long-term demand impact of remote work dynamic on Kilroy’s property portfolio. However, the residential and life sciences properties are not as exposed to remote work risk as are offices. Further, the company has already incurred around $1.2 billion on a land bank that can be used for future developments. The conservative market value of Kilroy’s nonoffice-related assets and its land bank is around $5.8 billion (0.8+3.8+1.2). For context, this is approximately 1.45 times Kilroy’s market cap and 0.72 times Kilroy’s enterprise value.

We estimate that Kilroy’s office portfolio, which is projected to contribute 74% of stabilized NOI, should be worth at least $2.2 billion in an absolute worst-case scenario, where no new office leases are signed and offices cease to exist beyond a decade. The company is about fairly valued in the worst-case scenario for offices, thereby implying that the current valuation of the company is highly irrational.