Share prices of Kilroy Realty (KRC -2.10%) plunged 40% over the past year, pushing the dividend yield up to levels not seen since the Great Recession. The interesting thing is that the real estate investment trust (REIT), which focuses on West Coast office space, actually had a fairly decent year in 2022. The problem is what could happen in 2023.
A solid year, for the most part
When office REIT Kilroy Realty announced fourth-quarter 2022 financial results, the biggest surprise was probably how strong the numbers were. Revenue rose to just shy of $1.1 billion from roughly $955 million in 2021. Funds from operations (FFO) in 2022 increased to $4.69 per share for the year, from $3.91. And occupancy only fell 30 basis points, declining to 91.6% from 91.9%.
image source: Getty Images.
That was against a backdrop in which a vast swath of the business world was still allowing employees to work from home and tech giants issued an increasing flow of announcements about layoffs. Technology companies are a key customer base for Kilroy and its portfolio, which is heavy on West Coast office properties. So despite a difficult environment, Kilroy appeared to turn in solid numbers.
That's the good news, driven partly by the company's focus on ensuring it owns relatively new buildings with desirable amenities. Kilroy believes its average portfolio age is lower than any of its closest peers. These factors help it attract and keep tenants, particularly those that have historically had to fight for talent. So why the dour mood on Wall Street?
Bracing investors for harder times
One of the big problems for Kilroy in 2023 is going to be occupancy. The full-year 2023 guidance on this vital metric is for occupancy to fall down to rates between 86.5% and 88%.
That's a manageable, but still material, year-over-year decline. Right now, the best outcome is for a 360-basis-point drop. Empty offices don't bring in rent, and finding new tenants takes time, so investors are clearly worried about what it will mean for the company.
The answer comes in the company's full-year FFO guidance, which is calling for an FFO range between $4.40 and $4.60 per share. That's down from $4.69 in 2022, meaning that FFO could decline as much as 6% or so.
In the grand scheme of things, that's really not so bad, with the company's below-market rents likely to help offset the occupancy hit as it signs new leases and re-signs existing tenants.
But investors are probably more worried about what 2023 means for 2024 and beyond. If there's a recession this year, as many on Wall Street fear, Kilroy's outlook will worsen. And that could mean even more pain in 2024 than Kilroy is expecting in 2023. Wall Street is clearly voting with its feet on this one, given the stock's steep decline over the past year.
KRC dividend yield data by YCharts.
The flip side is that Kilroy's 5.4% dividend yield is currently higher than it has been since the Great Recession. That suggests that the REIT is trading at historically cheap levels.
And while its focus on West Coast technology tenants is something of a worry today, it has for many years helped to fuel its growth. The technology industry is far more likely to keep growing over time than shrink.
And the company is also working to adjust its primary customer base, with investments in Texas, where many tech companies have started moving to. It seems more likely that the current headwinds will be temporary rather than permanent.
Hold your nose
It's understandable if Kilroy's heavy focus on the West Coast and technology tenants keeps you on the sidelines here. Diversification is important, and the REIT isn't nearly as diversified as some of the largest players in the office REIT niche.
However, if the focus here doesn't bother you, Kilroy looks historically cheap today. Those with strong stomachs might want to jump aboard and collect the generous 5.4% yield while awaiting a return to a more normal business environment, even if it takes a couple of years.
