Kilroy Realty: How Safe Is This 6.2% Dividend Yield From Class A Office?

Summary

• Kilroy Realty has maintained stable dividend distributions and currently offers a 6.2% yield despite the headwinds faced by office REITs.
• The REIT's portfolio consists of high-quality Class A properties in West Coast markets, with technology tenants making up 54% of annualized base rent.
• KRC's fourth-quarter revenue dipped due to higher office vacancy rates, but FFO coverage for the dividend remains strong.

Kilroy Realty (NYSE:KRC) last declared a quarterly cash dividend of $0.54 per share, kept unchanged sequentially and $2.16 per share annualized for a 6.2% dividend yield. KRC's dividends have formed a relative oasis of calm surrounded by a desert of chaos. Equity office REITs since the Fed embarked on its still ongoing fight with inflation have been characterized by wholesale dividend suspensions and cuts. The risks are compounded by office properties facing a new reality of work-from-home that has emptied some buildings and pushed up the national vacancy rate. This was 18% in January, up 130 basis points over its year-ago comp. KRC's stable dividend history is attractive and its 6.2% yield is at a high versus its pre-pandemic average.

What's in the portfolio? The internally managed REIT owned 121 office properties spread across 17,044,118 stabilized square feet as of the end of its fiscal 2023 fourth quarter. This had an 85% occupancy rate, dipping 100 basis points from 86% in the third quarter and with an 86.4% lease rate. The REIT also owned 1,001 residential units across 3 properties and with a 92.8% average occupancy through 2023.

KRC's office portfolio has been constructed from high-quality Class A properties mostly located in the West Coast markets of San Diego, Los Angeles, and the San Francisco Bay Area. Technology tenants form 54% of annualized base rent with life science and health care forming the second largest component of rent at 17%. KRC's buildings are well-designed and constructed to be sustainable and efficient buildings. However, while Class-A office buildings are facing less pressure, KRC is still seeing moveouts that are driving lower occupancy and dampening rental revenue and FFO.

Revenue, FFO, And Dividend Coverage

KRC's fourth-quarter revenue at $269.02 million, dipped by 5.4% over its year-ago comp due to higher office vacancy rate. It also missed consensus by $15.47 million. FFO for the fourth quarter was more positive at $129.3 million, around $1.08 per share, beating consensus by 3 cents. Critically, fourth-quarter FFO means 200% coverage over the quarterly dividend distribution. Further, the REIT is guiding for full-year 2024 FFO of $4.10 to $4.25 per share, 194% coverage over the dividend at the midpoint of the range. The dividend seems safe despite the cloudy outlook for growth. However, KRC's CFO Eliott Trencher poured some uncertainty on this during the fourth quarter earnings call with a statement that the board will need to make a judgment as to whether the current dividend level is appropriate and whether it needs to be adjusted up or down. This is also a boilerplate statement for dividends in earnings calls.

KRC's near-term dividend history of sustained dividend rises dispels the probability of a cut with the strong coverage and pending Fed rate cuts set to improve the outlook for FFO. KRC's leasing momentum has also been significant with 590,000 square feet of leases signed during the fourth quarter. This was the highest quarterly leasing volume since 2019 with GAAP and cash rents increasing respectively by 21.7% and 1.6% in the stabilized portfolio. The company leased 1.3 million square feet with an average lease term of approximately six years for the full year 2023.

Lease Expirations And Debt Maturities

KRC's lease expiration schedule is decent with 6.4% of total annual base rent expiring in 2024 and another 4.2% expiring in 2025. Current leasing momentum is positive and while KRC is likely set to see its vacancy rate get pulled lower, the current lease expiration schedule for the REIT should allow for continued leasing momentum to keep occupancy at a healthy level. KRC held total debt of $4.96 billion at the end of its fourth quarter with $403 million on unsecured notes coming due in 2024.

The REIT's $520 million unsecured term loan facility also matures this year but can be extended by up to two years. KRC held $2.2 billion of available liquidity at the end of the fourth quarter with half of this from cash and marketable securities and the other half from its existing line of credit. The REIT plans to spend $200 million to $300 million in 2024 on its developments.

KRC's substantial dividend coverage renders the REIT one of the most attractive office REITs. This comes with the Fed increasingly set to peel back the Fed funds rate with the CME FedWatch Tool placing the probability of no rate cuts by the end of 2024 at a low 1.24%. I'll likely pick up a position in KRC later this month with the REIT trading at a low 8.3x multiple versus the midpoint of its 2024 FFO range.