West Coast Office Markets Will Crumble Under Mounting Vacancy Pressures

Key Takeaways

• Declining office demand, tenant downsizing, and tech sector risks are pressuring occupancy, earnings stability, and leasing volumes in Kilroy's core urban markets.
  
• Rising capital needs for property upgrades and ESG compliance, along with asset value declines from market oversupply, are squeezing margins and long-term returns.
  
• Focused portfolio repositioning and demand in innovation hubs, paired with premium, sustainable assets, position Kilroy for enhanced growth, resilient revenues, and long-term value creation.

Catalysts

Kilroy is a leading U.S. landlord and developer, with operations in San Diego, Los Angeles, the San Francisco Bay Area, Seattle, and Austin.

• The persistent shift to remote and hybrid work continues to reduce overall office demand in Kilroy's core urban markets, contributing to elevated vacancies, declining lease rates, and sustained pressure on revenue growth for the foreseeable future.
  
• Technological advancements such as automation and artificial intelligence are enabling tenants to operate with fewer employees and smaller footprints, which will likely drive further reductions in tenant space requirements and significantly lower Kilroy's long-term leasing volumes and net operating income.
  
• Kilroy's strategic concentration in historically tech-centric West Coast markets like San Francisco and Seattle leaves the portfolio exposed to regional economic slowdowns, ongoing population outflows, and employment volatility in the technology sector, all of which threaten future occupancy rates and earnings stability.
  
• The company faces mounting capital expenditure pressures as aging properties require substantial recurring investment for upgrades and for meeting ever-tightening ESG and sustainability regulations, which will erode net margins and limit available funds for growth initiatives.
  
• The oversupply of premium office inventory in major coastal cities, coupled with investor and tenant preference shifts towards alternative asset classes such as industrial, data centers, and residential, will depress effective rents, increase landlord concessions, and result in lower asset values and weaker returns on invested capital over the long term.

Kilroy Realty Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Kilroy Realty compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Kilroy Realty's revenue will decrease by 0.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 19.2% today to 8.7% in 3 years time.
• The bearish analysts expect earnings to reach $98.2 million (and earnings per share of $0.4) by about August 2028, down from $218.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 52.2x on those 2028 earnings, up from 20.5x today. This future PE is greater than the current PE for the US Office REITs industry at 34.9x.
• Analysts expect the number of shares outstanding to grow by 0.77% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.36%, as per the Simply Wall St company report.

Kilroy Realty Future Earnings Per Share Growth

Risks

• Strong leasing momentum in key innovation markets such as San Francisco and San Diego, especially with the expansion of rapidly growing AI, life science, and healthcare tenants, indicates rising demand for modern, high-quality office space that could underpin revenue growth and occupancy stability.
  
• The company's strategic capital allocation-recycling lower-growth, higher-capex assets into stronger submarkets and development opportunities-positions the portfolio for improved returns and supports long-term net operating income and earnings expansion.
  
• Ongoing urban revitalization and public safety improvements in core markets like San Francisco are contributing to a rebound in tenant confidence and activity, which could sustain occupancy rates and support higher rent levels, positively impacting revenue.
  
• Elevated tenant demand for flexible, amenity-rich, and sustainable office and lab environments aligns with Kilroy's premium, LEED-certified portfolio, potentially allowing for premium rental rates and driving better net margins and tenant retention.
  
• Embedded development pipeline and monetizable land holdings offer future growth levers, enabling accretive redevelopment, phased project launches, and diversification across high-barrier, innovation-centric cities-providing avenues for long-term earnings and net asset value appreciation.

Valuation

• The assumed bearish price target for Kilroy Realty is $33.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Kilroy Realty's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $59.0, and the most bearish reporting a price target of just $33.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.1 billion, earnings will come to $98.2 million, and it would be trading on a PE ratio of 52.2x, assuming you use a discount rate of 8.4%.
  
• Given the current share price of $37.81, the bearish analyst price target of $33.0 is 14.6% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.