10-K 1 krc10k12312012.htm FORM 10-K KRC 10K 12.31.2012


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
S
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to                     
Commission file number 1-12675 (Kilroy Realty Corporation)
Commission file number 000-54005 (Kilroy Realty, L.P.)
KILROY REALTY CORPORATION
KILROY REALTY, L.P.
(Exact name of registrant as specified in its charter)
 
 
 
 
Kilroy Realty Corporation
Maryland
95-4598246
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
Kilroy Realty, L.P.
Delaware
95-4612685
 
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
 
12200 W. Olympic Boulevard, Suite 200, Los Angeles, California 90064
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (310) 481-8400
Securities registered pursuant to Section 12(b) of the Act:
Registrant
Title of each class
Name of each exchange on which registered
Kilroy Realty Corporation
Common Stock, $.01 par value
New York Stock Exchange
Kilroy Realty Corporation
6.875% Series G Cumulative Redeemable
Preferred Stock, $.01 par value
New York Stock Exchange
Kilroy Realty Corporation
6.375% Series H Cumulative Redeemable
Preferred Stock, $.01 par value
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Registrant
Title of each class
Kilroy Realty, L.P.
Common Units Representing Limited Partnership Interests

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    
Kilroy Realty Corporation     Yes  x    No  £
Kilroy Realty, L. P. Yes x    No  £
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.   
Kilroy Realty Corporation Yes £     No  x
Kilroy Realty, L. P. Yes £     No  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
Kilroy Realty Corporation Yes  x    No  £
Kilroy Realty, L. P. Yes  x    No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Kilroy Realty Corporation Yes   x   No  £
Kilroy Realty, L. P. Yes   x   No  £
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Kilroy Realty Corporation
 
 
 
x Large accelerated filer
o Accelerated filer
o Non-accelerated filer
(Do not check if a smaller reporting company)
o Smaller reporting company
 
 
 
 
Kilroy Realty, L.P.
 
 
 
o Large accelerated filer
o Accelerated filer
x Non-accelerated filer
(Do not check if a smaller reporting company)
o Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    
Kilroy Realty Corporation Yes  £    No  x
Kilroy Realty, L. P. Yes  £    No  x
The aggregate market value of the voting and non-voting shares of common stock held by non-affiliates of Kilroy Realty Corporation was approximately $2,382,187,648 based on the quoted closing price on the New York Stock Exchange for such shares on June 30, 2012.
The aggregate market value of the voting and non-voting common units of limited partnership interest held by non-affiliates of Kilroy Realty, L.P. was approximately $12,415,519 based on the quoted closing price on the New York Stock Exchange for Kilroy Realty Corporation shares on June 30, 2012.
As of February 11, 2013, 74,895,990 shares of Kilroy Realty Corporation's common stock, par value $.01 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Kilroy Realty Corporation's Proxy Statement with respect to its 2013 Annual Meeting of Stockholders to be filed not later than 120 days after the end of the registrant’s fiscal year are incorporated by reference into Part III of this Form 10-K.




EXPLANATORY NOTE
     This report combines the annual reports on Form 10-K for the year ended December 31, 2012 of Kilroy Realty Corporation and Kilroy Realty, L.P. Unless stated otherwise or the context otherwise requires, references to “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” mean Kilroy Realty Corporation, a Maryland corporation, and its controlled and consolidated subsidiaries, and references to “Kilroy Realty, L.P.” or the “Operating Partnership” mean Kilroy Realty, L.P., a Delaware limited partnership, and its controlled and consolidated subsidiaries.
     The Company is a real estate investment trust, or REIT, and the general partner of the Operating Partnership. As of December 31, 2012, the Company owned an approximate 97.6% common general partnership interest in the Operating Partnership. The remaining approximate 2.4% common limited partnership interests are owned by non-affiliated investors and certain directors and officers of the Company. As the sole general partner of the Operating Partnership, the Company exercises exclusive and complete discretion over the Operating Partnership's day-to-day management and control and can cause it to enter into certain major transactions including acquisitions, dispositions, and refinancings and cause changes in its line of business, capital structure, and distribution policies.
      There are a few differences between the Company and the Operating Partnership that are reflected in the disclosures in this Form 10-K. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the Company and the Operating Partnership operate as an interrelated, consolidated company. The Company is a REIT, the only material asset of which is the partnership interests it holds in the Operating Partnership. As a result, the Company does not conduct business itself, other than acting as the sole general partner of the Operating Partnership, issuing equity from time to time and guaranteeing certain debt of the Operating Partnership. The Company itself is not directly obligated under any indebtedness, but guarantees some of the debt of the Operating Partnership. The Operating Partnership owns substantially all of the assets of the Company either directly or through its subsidiaries, conducts the operations of the Company's business and is structured as a limited partnership with no publicly-traded equity. Except for net proceeds from equity issuances by the Company, which the Company is required to contribute to the Operating Partnership in exchange for units of partnership interest, the Operating Partnership generates the capital required by the Company's business through the Operating Partnership's operations, by the Operating Partnership's incurrence of indebtedness or through the issuance of units of partnership interest.
     Noncontrolling interests and stockholders' equity and partners' capital are the main areas of difference between the consolidated financial statements of the Company and those of the Operating Partnership. The common limited partnership interests in the Operating Partnership are accounted for as partners' capital in the Operating Partnership's financial statements and, to the extent not held by the Company, as noncontrolling interests in the Company's financial statements. The Operating Partnership's financial statements reflect the noncontrolling interest in Kilroy Realty Finance Partnership, L.P. a Delaware limited partnership (the “Finance Partnership”). This noncontrolling interest represents the Company's 1% indirect general partnership interest in the Finance Partnership, which is directly held by Kilroy Realty Finance, Inc., a wholly-owned subsidiary of the Company. The differences between stockholders' equity, partners' capital and noncontrolling interests result from the differences in the equity issued by the Company and the Operating Partnership, and in the Company's noncontrolling interest in the Finance Partnership.
     We believe combining the annual reports on Form 10-K of the Company and the Operating Partnership into this single report results in the following benefits:
Combined reports better reflect how management and the analyst community view the business as a single operating unit;
Combined reports enhance investors' understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
Combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
Combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.
     To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
consolidated financial statements;
the following notes to the consolidated financial statements:
Note 6, Secured and Unsecured Debt of the Company;
Note 7, Secured and Unsecured Debt of the Operating Partnership;
Note 9, Noncontrolling Interests on the Company's Consolidated Financial Statements;

1



Note 10, Stockholders' Equity of the Company;
Note 11, Preferred and Common Units of the Operating Partnership;
Note 19, Net Income Available to Common Stockholders Per Share of the Company;
Note 20, Net Income Available to Common Unitholders Per Unit of the Operating Partnership;
Note 22, Quarterly Financial Information of the Company (Unaudited);
Note 23, Quarterly Financial Information of the Operating Partnership (Unaudited);
Note 25, Pro Forma Results of the Company (Unaudited); and
Note 26, Pro Forma Results of the Operating Partnership (Unaudited);

“Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of the Company”; and

“Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of the Operating Partnership”.

     This report also includes separate sections under Item 9A. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for each of the Company and the Operating Partnership to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that the Company and Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.


2



TABLE OF CONTENTS
 
 
  
PART I
 
 
 
 
Page
Item 1.
  
Item 1A.
  
Item 1B.
  
Item 2.
  
Item 3.
  
Item 4.
  
Mine Safety Disclosures
 
  
PART II
 
Item 5.
  
 
 
Item 6.
  
 
  
Item 7.
  
Item 7A.
  
Item 8.
  
Item 9.
  
Item 9A.
  
Item 9B.
  
 
  
PART III
 
Item 10.
  
Item 11.
  
Item 12.
  
Item 13.
  
Item 14.
  
 
  
PART IV
 
Item 15.
  
 
  
 




PART I

This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, including information concerning projected future occupancy and rental rates, lease expirations, debt maturity, potential investments, strategies such as capital recycling, development and redevelopment activity, projected construction costs, dispositions, future executive incentive compensation and other forward-looking financial data, as well as the discussion in “Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations-Factors That May Influence Future Results of Operations.” Forward-looking statements are based on our current expectations, beliefs and assumptions, and are not guarantees of future performance. Forward-looking statements are inherently subject to uncertainties, risks, changes in circumstances, trends and factors that are difficult to predict, many of which are outside of our control. Accordingly, actual performance, results and events may vary materially from those indicated in the forward-looking statements, and you should not rely on the forward-looking statements as predictions of future performance, results or outcomes. All forward-looking statements are based on currently available information and speak only as of the date on this report was filed with the Securities and Exchange Commission (the “SEC”).



4



ITEM 1.
BUSINESS
The Company

We are a self-administered REIT active in office submarkets along the West Coast. We own, develop, acquire and manage real estate assets, consisting primarily of Class A properties in the coastal regions of Los Angeles, Orange County, San Diego County, the San Francisco Bay Area and greater Seattle, which we believe have strategic advantages and strong barriers to entry. Class A properties encompass attractive and efficient buildings of high quality that are attractive to tenants, are well-designed and constructed with above-average material, workmanship and finishes and are well-maintained and managed. We qualify as a REIT under the Internal Revenue Code of 1986, as amended (the "Code").
Our portfolio of operating properties was comprised of the following office buildings at December 31, 2012.

 
Number of
Buildings
Rentable
Square Feet
Number of
Tenants
Percentage Occupied
Office Properties
114

 
13,249,780

 
530

 
92.8
%
 
During the fourth quarter of 2012 we disposed of our entire portfolio of 39 industrial properties and, as a result, no longer owned any industrial properties at December 31, 2012.
Our stabilized portfolio includes all of our properties with the exception of undeveloped land, development and redevelopment properties currently under construction or committed for construction, “lease-up” properties and properties held-for-sale. We define “lease-up” properties as properties we recently developed or redeveloped that have not yet reached 95% occupancy and are within one year following cessation of major construction activities. We define redevelopment properties as those projects for which we expect to spend significant development and construction costs on existing or acquired buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. Our stabilized portfolio also excludes our future development pipeline, which is comprised of nine potential development sites, including one office property moved from the stabilized portfolio to the development pipeline in the fourth quarter of 2012, representing 118.5 gross acres of undeveloped land.
As of December 31, 2012, the following properties were excluded from our stabilized portfolio:
 
Number of Properties
 
Estimated Rentable Square Feet (1)
Development properties under construction
4

 
1,416,000

Redevelopment properties under construction
1

 
410,000

Lease-up properties
1

 
98,000

________________________
(1) Estimated rentable square feet upon completion.
As of December 31, 2012, all of our properties and development and redevelopment projects are owned and all of our business is currently conducted in the state of California with the exception of ten office properties located in the state of Washington. We had no properties held-for-sale as of December 31, 2012.
We own our interests in all of our office properties through the Operating Partnership and the Finance Partnership. We conduct substantially all of our operations through the Operating Partnership of which we owned a 97.6% general partnership interest as of December 31, 2012. The remaining 2.4% common limited partnership interest was owned by certain of our directors and executive officers and non-affiliated investors. Kilroy Realty Finance, Inc., a wholly-owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1.0% general partnership interest. The Operating Partnership owns the remaining 99.0% limited partnership interest. We conduct substantially all of our development activities through Kilroy Services, LLC ("KSLLC"), which is a wholly-owned subsidiary of the Operating Partnership. With the exception of the Operating Partnership, all of the Company's subsidiaries are wholly-owned.


5



The following diagram illustrates our organizational structure as of December 31, 2012:



6



Available Information; Website Disclosure; Corporate Governance Documents
Kilroy Realty Corporation was incorporated in the state of Maryland on September 13, 1996 and Kilroy Realty, L.P. was organized in the state of Delaware on October 2, 1996. Our principal executive offices are located at 12200 W. Olympic Boulevard, Suite 200 Los Angeles, California 90064. Our telephone number at that location is (310) 481-8400. Our website is located at www.kilroyrealty.com. The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of, this annual report on Form 10-K or any other report or document we file with or furnish to the SEC. All reports we will file with the SEC will be available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials we file with the SEC at the SEC's public reference room located at 100 F Street, N.E., Washington, D.C. 20549. All reports that we will file with the SEC will also be available free of charge on our website at www.kilroyrealty.com as soon as reasonably practicable after we file those materials with, or furnish them to, the SEC.
The following documents relating to corporate governance are also available free of charge on our website under “Investor Relations—Corporate Governance” and available in print to any security holder upon request:
 
Corporate Governance Guidelines;
Code of Business Conduct and Ethics;
Audit Committee Charter;
Executive Compensation Committee Charter; and
Nominating / Corporate Governance Committee Charter.
You may request copies of any of these documents by writing to:
Attention: Investor Relations
Kilroy Realty Corporation
12200 West Olympic Boulevard, Suite 200
Los Angeles, California 90064

Business and Growth Strategies
Growth Strategies.    We believe that a number of factors and strategies will enable us to continue to achieve our objectives of long-term sustainable growth in Net Operating Income (defined below) and FFO (defined below) as well as maximization of long-term stockholder value. These factors and strategies include:
 
the quality and location of our properties;
our ability to efficiently manage our assets as a low cost provider of commercial real estate through our seasoned management team possessing core capabilities in all aspects of real estate ownership, including property management, leasing, marketing, financing, accounting, legal, construction and development management;
our ability to capitalize on inflection points in a real estate cycle to add quality assets to our portfolio at substantial discounts to long-term value, through either acquisition, development or redevelopment;
our strong financial position that has and will continue to allow us to pursue attractive acquisition and development and redevelopment opportunities;
our access to development, redevelopment, acquisition, and leasing opportunities as a result of our extensive experience and significant working relationships with major West Coast property owners, corporate tenants, municipalities, and landowners given our over 65-year presence in the West Coast markets;
our capital recycling program (see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity Sources” for additional information pertaining to the Company's capital recycling program and related 2012 property dispositions); and
our future development pipeline of undeveloped land sites.
“Net Operating Income” is defined as operating revenues (rental income, tenant reimbursements, and other property income) less property and related expenses (property expenses, real estate taxes, provision for bad debts, and ground leases) before depreciation. “FFO” is funds from operations as defined by the National Association of Real Estate Investment Trusts (“NAREIT”). See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations —Results of Operations” and “—Non-GAAP Supplemental Financial Measures: Funds From Operations” for a reconciliation of these measures to generally accepted accounting principles (“GAAP”) net income available to common stockholders.

7



Operating Strategies.    We focus on enhancing long-term growth in Net Operating Income and FFO from our properties by:
maximizing cash flow from our properties through active leasing, early renewals, and effective property management;
structuring leases to maximize returns and internal growth;
managing portfolio credit risk through effective underwriting, including the use of credit enhancements and interests in collateral to mitigate portfolio credit risk;
managing operating expenses through the efficient use of internal management, leasing, marketing, financing, accounting, legal, and construction management functions;
maintaining and developing long-term relationships with a diverse tenant base;
managing our properties to offer the maximum degree of utility and operational efficiency to tenants;
building substantially all of our recent development projects to Leadership in Energy and Environmental Design (LEED) specifications, achieving gold or silver certification levels for several of our buildings, including the first LEED Platinum ground-up commercial development in San Francisco at 350 Mission Street;
actively pursuing LEED certification for over 3.2 million square feet of office space within our existing portfolio;
aggressively pursuing high-performance environmental building initiatives that create economic value for our tenants, shareholders and employees;
continuing to effectively manage capital improvements to enhance our properties’ competitive advantages in their respective markets and improve the efficiency of building systems;
enhancing our management team with individuals who have extensive regional experience and are highly knowledgeable in their respective markets; and
attracting and retaining motivated employees by providing financial and other incentives to meet our operating and financial goals.
Acquisition Strategies.    We believe we are well positioned to acquire properties and development and redevelopment opportunities as the result of our extensive experience, strong financial position, and ability to access capital. We continue to actively monitor our target markets and focus on acquiring additional high quality office properties and development and redevelopment opportunities that:
provide attractive yields and significant potential for growth in cash flow from property operations;
present growth opportunities in our existing or other strategic markets; and
demonstrate the potential for improved performance through intensive management, repositioning and leasing that should result in increased occupancy and rental revenues.
Development and Redevelopment Strategies.    We and our predecessors have developed office and industrial properties primarily located in California since 1947. As of December 31, 2012, our future development pipeline was comprised of nine potential development sites, representing 118.5 gross acres of undeveloped land on which we believe we have the potential to develop over two million rentable square feet of office space, depending upon economic conditions. Our strategy with respect to development is to:
maintain a disciplined approach by emphasizing pre-leasing, commencing development in stages, or phasing, and cost control;
continue to execute our build-to-suit philosophy in which we develop properties to be leased by specific committed tenants providing for lower-risk development;
be the premier provider of modern and collaborative office buildings on the West Coast;
reinvest capital from dispositions of nonstrategic assets into new state-of-the-market development and acquisition assets with higher cash flow and rates of return;
evaluate redevelopment opportunities in supply-constrained markets because such efforts generally achieve similar returns to new development with reduced entitlement risk and shorter construction periods; and
execute on our development projects under construction and our future development pipeline.
Redevelopment opportunities are those projects in which we spend significant development and construction costs on existing buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. We may engage in

8



the additional development or redevelopment of office properties when market conditions support a favorable risk−adjusted return on such development or redevelopment. We expect that our significant working relationships with tenants, municipalities, and landowners on the West Coast will give us further access to development and redevelopment opportunities. We cannot assure you that we will be able to successfully develop or redevelop any of our properties or that we will have access to additional development or redevelopment opportunities.
Financing Strategies.    Our financing policies and objectives are determined by our board of directors. Our goal is to limit our dependence on leverage and maintain a conservative ratio of debt-to-total market capitalization. As of December 31, 2012, our total debt as a percentage of total market capitalization was 34.7%, and our total debt and liquidation value of our preferred equity as a percentage of total market capitalization was 38.1%, both of which were calculated based on the quoted closing price per share of the Company's common stock of $47.37 on December 31, 2012 (see "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of the Company - Capitalization" for additional information). Our financing strategies include:
maintaining financial flexibility, including a low secured to unsecured debt ratio, to maximize our ability to access a variety of both public and private capital sources;
maintaining a staggered debt maturity schedule in which the maturity dates of our debt are spread over several years to limit risk exposure at any particular point in the capital and credit market cycles;
completing financing in advance of the need for capital; and
managing interest rate exposure by generally maintaining a greater amount of fixed-rate debt as compared to variable-rate debt.
We utilize multiple sources of capital, including borrowings under our unsecured line of credit, proceeds from the issuance of public or private debt or equity securities and other bank and/or institutional borrowings, and dispositions of nonstrategic assets. There can be no assurance that we will be able to obtain capital as needed on terms favorable to us or at all. See the discussion under the caption “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations —Factors That May Influence Future Results of Operations” and “Item 1A: Risk Factors”.
Significant Tenants
As of December 31, 2012, our 15 largest tenants in terms of annualized base rental revenues represented approximately 34.1% of our total annualized base rental revenues, defined as annualized monthly contractual rents from existing tenants as of December 31, 2012. Annualized base rental revenue includes the impact of straight-lining rent escalations and the amortization of free rent periods and excludes the impact of the following: amortization of deferred revenue related tenant-funded tenant improvements, amortization of above/below market rents, amortization for lease incentives due under existing leases, and expense reimbursement revenue.
For further information on our 15 largest tenants and the composition of our tenant base, see “Item 2: Properties —Significant Tenants.”
Competition
We compete with several developers, owners, operators and acquirers of office and other commercial real estate, many of which own properties similar to ours in the same submarkets in which our properties are located. For further discussion of the potential impact of competitive conditions on our business, see “Item 1A: Risk Factors”.
Segment and Geographic Financial Information
For the year ended December 31, 2012, we only had one segment, our office properties segment. During the fourth quarter of 2012, we sold our entire portfolio of industrial properties and, as a result, no longer owned any industrial properties at December 31, 2012. For information about our office property revenues and long-lived assets and other financial information, see Note 18 to our consolidated financial statements included in this report and “Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations -Results of Operations.”
All of our properties are located and all of our business is currently conducted in the state of California with the exception of the ownership and operation of ten office properties located in the state of Washington.



9



Employees
As of December 31, 2012, we employed 201 people through the Operating Partnership, KSLLC, and Kilroy Realty TRS, Inc. We believe that relations with our employees are good.
Environmental Regulations and Potential Liabilities
Government Regulation Relating to the Environment. Many laws and governmental regulations relating to the environment are applicable to our properties, and changes in these laws and regulations, or their interpretation by agencies and the courts, occur frequently and may adversely affect us.
Existing conditions at some of our properties.    Independent environmental consultants have conducted Phase I or similar environmental site assessments on all of our properties. We generally obtain these assessments prior to the acquisition of a property and may later update them as required for subsequent financing of the property or as requested by a tenant. Site assessments are generally performed to American Society for Testing and Materials standards then-existing for Phase I site assessments and typically include a historical review, a public records review, a visual inspection of the surveyed site, and the issuance of a written report. These assessments do not generally include any soil samplings or subsurface investigations. Depending on the age of the property, the Phase I may have included an assessment of asbestos-containing materials. For properties where asbestos-containing materials were identified or suspected, an operations and maintenance plan was generally prepared and implemented.
Historical operations at or near some of our properties, including the presence of underground or above ground storage tanks, may have caused soil or groundwater contamination. In some instances, the prior owners of the affected properties conducted remediation of known contamination in the soils on our properties, and we do not believe that further clean-up of the soils is required. We are not aware of any such condition, liability, or concern by any other means that would give rise to material environmental liability. However, the assessments may have failed to reveal all environmental conditions, liabilities, or compliance concerns; there may be material environmental conditions, liabilities, or compliance concerns that arose at a property after the review was completed; future laws, ordinances, or regulations may impose material additional environmental liability; and environmental conditions at our properties may be affected in the future by tenants, third parties, or the condition of land or operations near our properties, such as the presence of underground storage tanks. We cannot be certain that costs of future environmental compliance will not have an adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to security holders.

Use of hazardous materials by some of our tenants.    Some of our tenants handle hazardous substances and wastes on our properties as part of their routine operations. Environmental laws and regulations may subject these tenants, and potentially us, to liability resulting from such activities. We generally require our tenants in their leases to comply with these environmental laws and regulations and to indemnify us for any related liabilities. As of December 31, 2012, other than routine cleaning materials, approximately 5% of our tenants handled hazardous substances and/or wastes on less than 4% of the aggregate square footage of our properties as part of their routine operations. These tenants are primarily involved in the life sciences business. The hazardous substances and wastes are primarily comprised of diesel fuel for emergency generators and small quantities of lab and light manufacturing chemicals including, but not limited to, alcohol, ammonia, carbon dioxide, cryogenic gases, dichlorophenol, methane, naturalyte acid, nitrogen, nitrous oxide, and oxygen which are routinely used by life science companies. We are not aware of any material noncompliance, liability, or claim relating to hazardous or toxic substances or petroleum products in connection with any of our properties, and management does not believe that on-going activities by our tenants will have a material adverse effect on our operations.
Costs related to government regulation and private litigation over environmental matters.    Under applicable environmental laws and regulations, we may be liable for the costs of removal, remediation, or disposal of certain hazardous or toxic substances present or released on our properties. These laws could impose liability without regard to whether we are responsible for, or even knew of, the presence or release of the hazardous materials. Government investigations and remediation actions may have substantial costs, and the presence or release of hazardous substances on a property could result in governmental clean-up actions, personal injury actions, or similar claims by private plaintiffs.
Potential environmental liabilities may exceed our environmental insurance coverage limits or transactional indemnities.    We carry what we believe to be commercially reasonable environmental insurance. Our environmental insurance policies are subject to various terms, conditions and exclusions. Similarly, in connection with some transactions we obtain environmental indemnities that may not be honored by the indemnitors or may fail to address resulting liabilities adequately. Therefore, we cannot provide any assurance that our insurance coverage or transactional indemnities will be sufficient or that our liability, if any, will not have a material adverse effect on our financial condition, results of operations, cash flows, quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to security holders.

10




ITEM 1A
RISK FACTORS
The following section sets forth material factors that may adversely affect our business and operations. The following factors, as well as the factors discussed in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations —Factors That May Influence Future Results of Operations” and other information contained in this report, should be considered in evaluating us and our business.
Risks Related to our Business and Operations
Global market and economic conditions may adversely affect our liquidity and financial condition and those of our tenants. In the United States, market and economic conditions continue to be challenging with stricter regulations and modest growth. While recent economic data reflects moderate economic growth in the United States, the cost and availability of credit may continue to be adversely affected by governmental budget and global economic factors. Concern about continued stability of the economy and credit markets generally, and the strength of counterparties specifically, has led many lenders and institutional investors to reduce and, in some cases, cease to provide funding to borrowers. Volatility in the U.S. and international capital markets and concern over a return to recessionary conditions in global economies, and in the California economy in particular, may adversely affect our liquidity and financial condition and the liquidity and financial condition of our tenants. If these market conditions continue, they may limit our ability and the ability of our tenants to timely refinance maturing liabilities and access the capital markets to meet liquidity needs.

All of our properties are located in California and Greater Seattle, Washington and we may therefore be susceptible to adverse economic conditions and regulations, as well as natural disasters, in those areas. Because all of our properties are concentrated in California and Seattle, Washington we may be exposed to greater economic risks than if we owned a more geographically dispersed portfolio. Further, within California, our properties are concentrated in Los Angeles, Orange County, San Diego County, and the San Francisco Bay Area, exposing us to risks associated with those specific areas. We are susceptible to adverse developments in the economic and regulatory environments of California and Greater Seattle, Washington (such as business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes, costs of complying with governmental regulations or increased regulation and other factors) as well as adverse weather conditions and natural disasters that occur in these areas (such as earthquakes, wind, landslides, fires and other events). In addition, California is also regarded as more litigious and more highly regulated and taxed than many other states, which may reduce demand for office space in California.

Any adverse developments in the economy or real estate market in California and the surrounding region, or in Seattle, Washington or any decrease in demand for office space resulting from the California or Seattle regulatory or business environment could impact our ability to generate revenues sufficient to meet our operating expenses or other obligations, which would adversely impact our financial condition, results of operations, cash flows, the quoted trading price of the Company's common stock and of the Operating Partnership's publicly-traded notes and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our performance and the market value of our securities are subject to risks associated with our investments in real estate assets and with trends in the real estate industry. Our economic performance and the value of our real estate assets and, consequently the market value of the Company's securities, are subject to the risk that our properties may not generate revenues sufficient to meet our operating expenses or other obligations. A deficiency of this nature would adversely impact our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Events and conditions applicable to owners and operators of real estate that are beyond our control and could impact our economic performance and the value of our real estate assets may include:
 
local oversupply or reduction in demand for office or other commercial space, which may result in decreasing rental rates and greater concessions to tenants;
inability to collect rent from tenants;
vacancies or inability to rent space on favorable terms or at all;
inability to finance property development and acquisitions on favorable terms or at all;
increased operating costs, including insurance premiums, utilities, and real estate taxes;
costs of complying with changes in governmental regulations;
the relative illiquidity of real estate investments;

11



changing submarket demographics;
the development of harmful mold or other airborne toxins or contaminants that could damage our properties or expose us to third-party liabilities; and
property damage resulting from seismic activity or other natural disasters.
        We depend upon significant tenants and the loss of a significant tenant could adversely affect our financial condition, revenues and results of operations. As of December 31, 2012, our 15 largest tenants represented approximately 34.1% of total annualized base rental revenues. See further discussion on the composition of our tenants by industry and our largest tenants under “Item 2: Properties -Significant Tenants.”
Our financial condition, results of operations, ability to borrow funds, and cash flows would be adversely affected if any of our significant tenants fails to renew its lease(s), renew its lease(s) on terms less favorable to us, or becomes bankrupt or insolvent or otherwise unable to satisfy its lease obligations.
Downturn in tenants' businesses may reduce our cash flows. For the year ended December 31, 2012, we derived approximately 99.2% of our revenues from continuing operations from rental income and tenant reimbursements. A tenant may experience a downturn in its business, which may weaken its financial condition and result in its failure to make timely rental payments or result in defaults under our leases. In the event of default by a tenant, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment.
 
The bankruptcy or insolvency of a major tenant also may adversely affect the income produced by our properties. If any tenant becomes a debtor in a case under federal bankruptcy law, we cannot evict the tenant solely because of the bankruptcy. In addition, the bankruptcy court might permit the tenant to reject and terminate its lease with us. Our claim against the tenant for unpaid and future rent could be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease. Therefore, our claim for unpaid rent would likely not be paid in full. Any losses resulting from the bankruptcy of any of our existing tenants could adversely impact our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.

A large percentage of our tenants' operate in a concentrated group of industries and downturns in these industries could adversely affect our financial condition, revenues and results of operations. As of December 31, 2012, as a percentage of our annualized base rental revenue, 36% of our tenants operated in the technology and media industry, 19% in the finance, insurance and real estate industry, 15% in the professional, business and other services industry, and 11% in the education and health services industry (of which approximately 5% are in the for profit education sector). As we expand our acquisition and development activities in markets populated by high growth tenants in the technology and media industry, our tenant mix may become more concentrated, further exposing us to risks associated with that industry. For a further discussion of the composition of our tenants by industry, see “Item 2: Properties—Significant Tenants.” An economic downturn in any of these industries, or in any industry in which a significant number of our tenants currently or may in the future operate, could negatively impact the financial condition of such tenants and cause them to fail to make timely rental payments or default on lease obligations, fail to renew their leases or renew their leases on terms less favorable to us, become bankrupt or insolvent, or otherwise become unable to satisfy their obligations to us. As a result, a downturn in an industry in which a significant number of our tenants operate could adversely affect our financial conditions and result of operations.
We may be unable to renew leases or re-lease available space. We had office space representing approximately 7.2%, of the total square footage of our properties that was not occupied as of December 31, 2012. In addition, leases representing approximately 7.1% and 10.4% of the leased rentable square footage of our properties are scheduled to expire in 2013 and 2014, respectively. Above market rental rates on some of our properties may force us to renew or re-lease expiring leases at rates below current lease rates. As of December 31, 2012, we believe that the weighted average cash rental rates for our overall portfolio, including recently acquired properties, are approximately at the current average quoted market rental rates, and weighted average cash rental rates for leases scheduled to expire during 2013 are approximately 5% below the current average quoted market rental rates, although individual properties within any particular submarket presently may be leased at, above, or below the current market rental rates within that submarket. We cannot provide any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current rental rates. If the average rental rates for our properties decrease or existing tenants do not renew their leases, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
We are subject to governmental regulations that may affect the development, redevelopment, and use of our properties. We are subject to governmental regulations that may have a material adverse effect on our financial condition, results of operations,

12



cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our properties are subject to regulation under federal laws, such as the Americans with Disabilities Act of 1990 (the “ADA”) pursuant to which all public accommodations must meet federal requirements related to access and use by disabled persons, and state and local laws addressing earthquake, fire, and life safety requirements. Although we believe that our properties substantially comply with requirements under applicable governmental regulations, none of our properties have been audited or investigated for compliance by any regulatory agency. If we were not in compliance with material provisions of the ADA or other regulations affecting our properties, we might be required to take remedial action, which could include making modifications or renovations to properties. Federal, state, or local governments may also enact future laws and regulations that could require us to make significant modifications or renovations to our properties. If we were to incur substantial costs to comply with the ADA or any other regulations, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
Our properties are subject to land use rules and regulations that govern our development, redevelopment, and use of our properties. Restrictions on our ability to develop, redevelop, or use our properties resulting from changes in the existing land use rules and regulations could have an adverse effect on our financial position, results of operations, cash flows, quoted trading price of our securities, our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.

Our debt level reduces cash available for distribution and may expose us to the risk of default under our debt obligations. Payments of principal and interest on borrowings may leave us with insufficient cash resources to operate our properties or to pay in cash the distributions necessary to maintain the Company's REIT qualification. Our level of debt and the limitations imposed by our debt agreements may have substantial consequences to us, including the following:
 
we may be unable to refinance our indebtedness at maturity, or the refinancing terms may be less favorable than the terms of our original indebtedness;

cash flows may be insufficient to meet required principal and interest payments;

we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;

we may default on our obligations, and the lenders or mortgagees may foreclose on our properties that secure the loans and receive an assignment of rents and leases; and

our default under one mortgage loan could result in a default on other indebtedness with cross default provisions.
If one or more of these events were to occur, our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected. In addition, foreclosures could create taxable income without accompanying cash proceeds,
which could require us to borrow or sell assets to raise the funds necessary to meet the REIT distribution requirements discussed below, even if such actions are not on favorable terms. As of December 31, 2012, we had approximately $2.0 billion aggregate principal amount of indebtedness, $90.9 million of which is contractually due prior to December 31, 2013. Our total debt and preferred equity at December 31, 2012 represented 38.1% of our total market capitalization (which we define as the aggregate of our long-term debt, liquidation value of our preferred equity, and the market value of the Company's common stock and the Operating Partnership's common units of limited partnership interest, or common units). In January 2013, we repaid $83.1 million of the total amount contractually due prior to December 31, 2013. In addition, on January 14, 2013, the Operating Partnership issued $300.0 million of 3.8% senior unsecured notes due 2023 and used the proceeds from the offering to repay the remaining outstanding balance on the Operating Partnership's $500 million unsecured revolving credit facility. For calculation of our market capitalization and additional information on debt maturities see “Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources of the Company—Capitalization and Liquidity Uses.”

The covenants in the Operating Partnership's revolving credit facility and term loan facility may limit our ability to make distributions to the holders of our common stock. The Operating Partnership's revolving credit facility and $150.0 million unsecured term loan facility contain financial covenants that could limit the amount of distributions payable by us on our common stock and preferred stock. We rely on cash distributions we receive from the Operating Partnership to pay distributions on our common stock and preferred stock and to satisfy our other cash needs, and the revolving credit facility and the term loan facility provide that the Operating Partnership may not, in any year, make partnership distributions to us or other holders of its partnership interests in an aggregate amount in excess of the greater of:
95% of the Operating Partnership's consolidated funds from operations (as similarly defined in each of the revolving credit facility and term loan facility agreements) for such year; and

13




an amount which results in distributions to us (excluding any preferred partnership distributions to the extent the same have been deducted from consolidated funds from operations for such year) in an amount sufficient to permit us to pay dividends to our stockholders that we reasonably believe are necessary to (a) maintain our qualification as a REIT for federal and state income tax purposes and (b) avoid the payment of federal or state income or excise tax.

In addition, the revolving credit facility and term loan facility provide that, if the Operating Partnership fails to pay any principal of or interest on any borrowings under the revolving credit facility or term loan facility, respectively, when due, then the Operating Partnership may make only those partnership distributions to us and other holders of its partnership interests necessary to enable us to make distributions to our stockholders that we reasonably believe are necessary to maintain our status as a REIT for federal and state income tax purposes. Any limitation on our ability to make distributions to our stockholders, whether as a result of these provisions in the revolving credit facility, the term loan facility or otherwise, could have a material adverse effect on the market value of our common stock and preferred stock.
A downgrade in our credit ratings could materially adversely affect our business and financial condition. The credit ratings assigned to the debt securities of the Operating Partnership and our preferred stock could change based upon, among other things, our results of operations and financial condition. These ratings are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any rating will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Moreover, these credit ratings do not apply to our common stock and are not recommendations to buy, sell or hold any other securities. If any of the credit rating agencies that have rated the debt securities of the Operating Partnership or our preferred stock downgrades or lowers its credit rating, or if any credit rating agency indicates that it has placed any such rating on a so-called “watch list” for a possible downgrading or lowering or otherwise indicates that its outlook for that rating is negative, it could have a material adverse effect on our costs and availability of capital, which could in turn have a material adverse effect on our financial condition, results of operations, cash flows and our ability to satisfy our debt service obligations and to make dividends and distributions on our common stock and preferred stock.
We face significant competition, which may decrease the occupancy and rental rates of our properties. We compete with several developers, owners, and operators of office and other commercial real estate, many of which own properties similar to ours in the same submarkets in which our properties are located but which have lower occupancy rates than our properties. Therefore, our competitors have an incentive to decrease rental rates until their available space is leased. As previously mentioned, as of December 31, 2012 we believe that the weighted average cash rental rates for our overall portfolio are approximately at the current average quoted market rental rates. If our competitors offer space at rental rates below the rates currently charged by us for comparable space, we may be pressured to reduce our rental rates below those currently charged in order to retain tenants when our tenant leases expire. As a result, our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders may be adversely affected.
In order to maintain the quality of our properties and successfully compete against other properties, we must periodically spend money to maintain, repair, and renovate our properties, which reduces our cash flows. If our properties are not as attractive to current and prospective tenants in terms of rent, services, condition, or location as properties owned by our competitors, we could lose tenants or suffer lower rental rates. As a result, we may from time to time be required to make significant capital expenditures to maintain the competitiveness of our properties. There can be no assurances that any such expenditure would result in higher occupancy or higher rental rates, or deter existing tenants from relocating to properties owned by our competitors.
Potential casualty losses, such as earthquake losses, may not be covered by insurance and payment of such losses may adversely affect our financial condition and results of operations. We carry comprehensive liability, fire, extended coverage, rental loss, and terrorism insurance covering all of our properties. Management believes the policy specifications and insured limits are appropriate given the relative risk of loss, the cost of the coverage, and industry practice. We do not carry insurance for generally uninsurable losses such as loss from riots or acts of God. In addition, all of our properties are located in earthquake-prone areas. We carry earthquake insurance on our properties in an amount and with deductibles that management believes are commercially reasonable. However, the amount of our earthquake insurance coverage may not be sufficient to cover losses from earthquakes. We may also discontinue earthquake insurance on some or all of our properties in the future if the cost of premiums for earthquake insurance exceeds the value of the coverage discounted for the risk of loss. If we experience a loss that is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. Further, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if the properties were irreparable.
We are subject to environmental and health and safety laws and regulations, and any costs to comply with, or liabilities arising under, such laws and regulations could be material. As an owner, operator, manager, acquirer and developer of real

14



properties, we are subject to environmental and health and safety laws and regulations. Certain of these laws and regulations impose joint and several liability, without regard to fault, for investigation and clean-up costs on current and former owners and operators of real property and persons who have disposed of or released hazardous substances into the environment. At some of the properties, there are asbestos-containing materials, or tenants routinely handle hazardous substances as part of their operations. In addition, historical operations, including the presence of underground storage tanks, have caused soil or groundwater contamination at or near some of the properties. Although we believe that the prior owners of the affected properties or other persons may have conducted remediation of known contamination at these properties, not all such contamination has been remediated. Unknown or unremediated contamination or the compliance with existing or new environmental or health and safety laws and regulations could require us to incur costs or liabilities that could be material. See "Item 1: Business — Environmental Regulations and Potential Liabilities."
 
We may be unable to complete acquisitions and successfully operate acquired properties. We continually evaluate the market of available properties and may continue to acquire office properties and undeveloped land when strategic opportunities exist. Our ability to acquire properties on favorable terms and successfully operate them is subject to the following risks:
 
we may potentially be unable to acquire a desired property because of competition from other real estate investors with significant capital, including both publicly traded REITs and institutional investment funds;

the possibility that, even if we enter into agreements for the acquisition of office properties, we may be unable to complete such acquisitions because they remain subject to customary conditions to closing including the completion of due diligence investigations to management's satisfaction;

we may be unable to finance acquisitions on favorable terms or at all;

we may spend more than budgeted amounts in operating costs or to make necessary improvements or renovations to acquired properties;

we may lease acquired properties at economic lease terms different than projected;

we may acquire properties that are subject to liabilities for which we may have limited or no recourse; and

we may be unable to complete an acquisition after making a nonrefundable deposit and incurring certain other acquisition related costs.
If we cannot finance property acquisitions on favorable terms or operate acquired properties to meet financial expectations, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders could be adversely affected.
We may be unable to successfully complete and operate acquired, developed, and redeveloped properties. There are significant risks associated with property acquisition, development, and redevelopment including the possibility that:
 
we may be unable to lease acquired, developed, or redeveloped properties at projected economic lease terms or within budgeted timeframes;

we may not complete development or redevelopment properties on schedule or within budgeted amounts;

we may expend funds on and devote management's time to acquisition, development, or redevelopment properties that we may not complete;

we may encounter delays or refusals in obtaining all necessary zoning, land use, and other required entitlements, and building, occupancy, and other required governmental permits and authorizations;

we may encounter delays, refusals, unforeseen cost increases, and other impairments resulting from third-party litigation; and

we may fail to obtain the financial results expected from properties we acquire, develop, or redevelop.
If one or more of these events were to occur in connection with our acquired properties, undeveloped land, or development or redevelopment properties under construction, we could be required to recognize an impairment loss. These events could also

15



have an adverse impact on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
 
While we historically have acquired, developed, and redeveloped office properties in California markets, over the past three years we have acquired ten properties in the state of Washington and may in the future acquire, develop, or redevelop properties for other uses and expand our business to other geographic regions where we expect the development or acquisition of property to result in favorable risk-adjusted returns on our investment. Presently, we do not possess the same level of familiarity with development of property types other than mixed-use, office, or with certain outside markets, which could adversely affect our ability to acquire, develop or redevelop properties or to achieve expected performance.
We could default on leases for land on which some of our properties are located. As of December 31, 2012, we owned eleven office buildings, located on various land parcels and regions, which we lease individually on a long-term basis. As of December 31, 2012, we had approximately 1.8 million aggregate rentable square feet, or 13.6% of our total stabilized portfolio, of rental space located on these leased parcels. In addition, we had ground lease obligations for the land at one redevelopment property encompassing approximately 98,000 rentable square feet. In 2012, we exercised our option to purchase this land for a purchase price of $27.5 million and we currently expect we will close the transaction in the second quarter of 2013. If we default under the terms of any particular lease, we may lose the ownership rights to the property subject to the lease. Upon expiration of a lease, we may not be able to renegotiate a new lease on favorable terms, if at all. The loss of the ownership rights to these properties or an increase of rental expense could have an adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Real estate assets are illiquid, and we may not be able to sell our properties when we desire. Our investments in our properties are relatively illiquid, limiting our ability to sell our properties quickly in response to changes in economic or other conditions. In addition, the Code generally imposes a 100% prohibited transaction tax on the Company on profits derived from sales of properties held primarily for sale to customers in the ordinary course of business, which effectively limits our ability to sell properties other than on a selected basis. These restrictions on our ability to sell our properties could have an adverse effect on our financial condition, results of operations, cash flow, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
We may invest in securities related to real estate, which could adversely affect our ability to pay dividends and distributions to our security holders. We may purchase securities issued by entities which own real estate and may, in the future, also invest in mortgages. In general, investments in mortgages are subject to several risks, including:
 
borrowers may fail to make debt service payments or pay the principal when due;

the value of the mortgaged property may be less than the principal amount of the mortgage note securing the property; and

interest rates payable on the mortgages may be lower than our cost for the funds used to acquire these mortgages.
Owning these securities may not entitle us to control the ownership, operation, and management of the underlying real estate. In addition, we may have no control over the distributions with respect to these securities, which could adversely affect our ability to pay dividends and distributions to our security holders.
Future terrorist activity or engagement in war by the United States may have an adverse effect on our financial condition and operating results. Terrorist attacks in the United States and other acts of terrorism or war, may result in declining economic activity, which could harm the demand for and the value of our properties. In addition, the public perception that certain locations are at greater risk for attack, such as major airports, ports, and rail facilities, may decrease the demand for and the value of our properties near these sites. A decrease in demand could make it difficult for us to renew or re-lease our properties at these sites at lease rates equal to or above historical rates. Terrorist activities also could directly impact the value of our properties through damage, destruction, or loss, and the availability of insurance for these acts may be less, and cost more, which could adversely affect our financial condition. To the extent that our tenants are impacted by future attacks, their businesses similarly could be adversely affected, including their ability to continue to honor their existing leases.
Terrorist acts and engagement in war by the United States also may adversely affect the markets in which our securities trade and may cause further erosion of business and consumer confidence and spending and may result in increased volatility in national and international financial markets and economies. Any one of these events may cause a decline in the demand for our office leased space, delay the time in which our new or renovated properties reach stabilized occupancy, increase our operating expenses, such as those attributable to increased physical security for our properties, and limit our access to capital or increase our cost of raising capital.

16



The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) will subject us to substantial additional federal regulation. There are significant corporate governance and executive compensation-related requirements that have been, and will in the future be, imposed on publicly-traded companies under the Dodd-Frank Act. Several of these provisions require the SEC to adopt additional rules and regulations in these areas. For example, the Dodd-Frank Act requires publicly-traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, heightens certain independence standards for compensation advisers and authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates for board seats using a registrant's proxy materials. Our efforts to comply with these requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management's time from other business activities. In addition, if stockholders do not vote to approve our executive compensation practices and/or our equity plan amendments, these actions may interfere with our ability to attract and retain key personnel who are essential to our future success. Given the uncertainty associated with both the results of the existing Dodd-Frank Act requirements and the manner in which additional provisions of the Dodd-Frank Act will be implemented by various regulatory agencies and through regulations, the full extent of the impact that such requirements will have on our operations is unclear. Accordingly, the changes resulting from the Dodd-Frank Act may impact the profitability of business activities, require changes to certain business practices, or otherwise adversely affect our financial condition, results of operations, cash flows, the quoted trading price of the Company's common stock and of the Operating Partnership's publicly-traded notes and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our property taxes could increase due to reassessment or property tax rate changes. We are required to pay some state and local taxes on our properties. In addition, the real property taxes on our properties may increase as our properties are reassessed by taxing authorities or as property tax rates change. For example, under a current California law commonly referred to as “Proposition 13,” property tax reassessment generally occurs as a result of a “change in ownership” of a property, as specially defined for purposes of those rules. Because the property taxing authorities may not determine whether there has been a “change in ownership” or the actual reassessed value of a property for a period of time after a transaction has occurred, we may not know the impact of a potential reassessment for a considerable amount of time following a particular transaction. Therefore, the amount of property taxes we are required to pay could increase substantially from the property taxes we currently pay or have paid in the past, including on a retroactive basis. In addition, from time to time voters and lawmakers have announced initiatives to repeal or amend Proposition 13 to eliminate its application to commercial and industrial property and/or introduce split tax roll legislation. Such initiatives, if successful, would increase the assessed value and/or tax rates applicable to commercial property in California, including our office properties. An increase in the assessed value of our properties or our property tax rates could adversely impact our financial condition, results of operations, cash flows, the quoted trading price of the Company's common stock and of the Operating Partnership's publicly-traded notes and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
Our business could be adversely impacted if there are deficiencies in our disclosure controls and procedures or internal control over financial reporting. The design and effectiveness of our disclosure controls and procedures and internal control over financial reporting may not prevent all errors, misstatements or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, there can be no guarantee that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Deficiencies, including any material weakness, in our internal control over financial reporting which may occur in the future could result in misstatements of our results of operations, restatements of our financial statements, or otherwise adversely impact our financial condition, results of operations, cash flows, the quoted trading price of the Company's common stock and of the Operating Partnership's publicly-traded notes and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
We face risks associated with security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems. We face risks associated with security breaches, whether through cyber attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations (including managing our building systems), and, in some cases, may be critical to the operations of certain of our tenants. There can be no assurance that our efforts to maintain the security and integrity of these types of IT networks and related systems will be effective or that attempted security breaches or disruptions would not be successful or damaging. A security breach or other significant disruption involving our IT networks and related systems could adversely impact our financial condition, results of operations, cash flows, the quoted trading price of the Company's common stock and of the Operating Partnership's publicly-traded notes and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
 

17



Risks Related to our Organizational Structure

Loss of our key personnel could harm our operations and adversely affect the quoted trading price of our securities The leadership and performance of our executive and senior officers, particularly John B. Kilroy, Jr., President and Chief Executive Officer, Jeffrey C. Hawken, Executive Vice President and Chief Operating Officer, Eli Khouri, Executive Vice President and Chief Investment Officer, Tyler H. Rose, Executive Vice President and Chief Financial Officer, and Justin W. Smart, Executive Vice President, Development and Construction Services, play a key role in the success of the Company. They are integral to the Company's success for many reasons, including that each has a strong national or regional reputation in our industry and investment community. In addition, they have significant relationships with investors, lenders, tenants and industry personnel, which benefit the Company. Our future performance will be substantially dependent on our ability to retain and motivate these individuals. The loss or limited availability of the services of our key personnel could materially and adversely affect our business, results of operations and financial condition and could be negatively perceived in the capital markets. 
Our growth depends on external sources of capital that are outside of our control and the inability to obtain capital on terms that are acceptable to us, or at all, could adversely affect our financial condition and results of operations. The Company is required under the Code to distribute at least 90% of its taxable income (subject to certain adjustments and excluding any net capital gain), and the Operating Partnership is required to make distributions to the Company to allow the Company to satisfy these REIT distribution requirements. Because of these distribution requirements, the Operating Partnership is required to make distributions to the Company, and we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, management relies on third-party sources of capital to fund our capital needs. We may not be able to obtain financing on favorable terms or at all. Any additional debt we incur will increase our leverage. Access to third-party sources of capital depends, in part, on general market conditions and the availability of credit, the market's perception of our growth potential, our current and expected future earnings, our cash flows and cash distributions, and the quoted trading price of our securities. If we cannot obtain capital from third-party sources, our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders may be adversely affected.
Our common limited partners have limited approval rights, which may prevent us from completing a change of control transaction that may be in the best interests of all our security holders. The Company may not withdraw as the Operating Partnership's general partner or transfer its general partnership interest in the Operating Partnership without the approval of the holders of at least 60% of the units representing common limited partnership interests, including the common units held by the Company in its capacity as the Operating Partnership's general partner. In addition, the Company may not engage in a merger, consolidation, or other combination or the sale of substantially all of its assets or such similar transaction, without the approval of the holders of 60% of the common units, including the common units held by the Company in its capacity as the Operating Partnership's general partner. The right of our common limited partners to vote on these transactions could limit our ability to complete a change of control transaction that might otherwise be in the best interest of all our security holders.
In certain circumstances, our limited partners must approve our dissolution and the disposition of properties contributed by the limited partners. For as long as limited partners own at least 5% of all of the Operating Partnership's partnership interests, we must obtain the approval of limited partners holding a majority of the units representing common limited partnership interests before we may dissolve. As of December 31, 2012, limited partners owned approximately 2.4% of the Operating Partnership's partnership interests, of which 1.7% was owned by John B. Kilroy, Sr. and John B. Kilroy, Jr. In addition, we agreed to use commercially reasonable efforts to minimize the tax consequences to common limited partners resulting from the repayment, refinancing, replacement, or restructuring of debt, or any sale, exchange, or other disposition of any of our other assets. The exercise of one or more of these approval rights by the limited partners could delay or prevent us from completing a transaction that may be in the best interest of all our security holders.
The Chairman of our board of directors and our President and Chief Executive Officer each have substantial influence over our affairs. John B. Kilroy, Sr. is the Chairman of our board of directors and the father of John B. Kilroy, Jr., our President and Chief Executive Officer. Each is a member of our board of directors, and together, as of December 31, 2012, they beneficially owned approximately 2.9% of the total outstanding shares of the Company's common stock. The percentage of outstanding shares of common stock beneficially owned includes 281,210 shares of common stock, 412,936 restricted stock units that were vested and held by John B. Kilroy, Jr. at December 31, 2012, and assumes the exchange into shares of the Company's common stock of the 1,335,135 common units of the Operating Partnership held by Messrs. Kilroy (which are redeemable in exchange for, at the option of the Company, an equal number of shares of the Company's common stock).
Pursuant to the Company's charter, no stockholder may own, actually or constructively, more than 7.0% (by value or by number of shares, whichever is more restrictive) of the outstanding Company common stock without obtaining a waiver from the board of directors. The board of directors has waived the ownership limits with respect to John B. Kilroy, Sr., John B. Kilroy, Jr., members of their families, and some of their affiliated entities. These named individuals and entities may own either actually or constructively, in the aggregate, up to 19.6% of the Company's outstanding common stock, excluding Operating Partnership units

18



that are exchangeable into shares of Company common stock. Consequently, Messrs. Kilroy have substantial influence on the Company, and because the Company is the manager of the Operating Partnership, on the Operating Partnership, and could exercise their influence in a manner that is not in the best interest of our stockholders, noteholders or unitholders. Also, they may, in the future, have a substantial influence on the outcome of any matters submitted to our stockholders or unitholders for approval.
 
There are restrictions on the ownership of the Company's capital stock that limit the opportunities for a change of control at a premium to existing security holders. Provisions of the Maryland General Corporation Law, the Company's charter and bylaws, and the Operating Partnership's partnership agreement may delay, deter, or prevent a change of control of the Company, or the removal of existing management. Any of these actions might prevent our security holders from receiving a premium for their common shares or common units over the then-prevailing market price of the shares of the Company's common stock.
In order for the Company to qualify as a REIT under the Code its stock must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been made) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares of the Company's stock may be owned, actually or constructively, by five or fewer individuals (as defined in the Code to include certain entities) during the last half of a taxable year (other than the first year for which an election to be a REIT has been made). The Company's charter contains restrictions on the ownership and transfer of its capital stock that are intended to assist the Company in complying with these requirements and continuing to qualify as a REIT. No single stockholder may own, either actually or constructively, absent a waiver from the board of directors, more than 7.0% (by value or by number of shares, whichever is more restrictive) of the Company's outstanding common stock. Similarly, absent a waiver from the board of directors, no single holder of the Company's 6.875% Series G Cumulative Redeemable Preferred stock (the “Series G Preferred Stock”) may actually or constructively own more than 9.8% (by value or by number of shares, whichever is more restrictive) of the Company's Series G Preferred Stock; and no single holder of the Company's 6.375% Series H Cumulative Redeemable Preferred stock (the “Series H Preferred Stock”) may actually or constructively own more than 9.8% (by value or by number of shares, whichever is more restrictive) of the Company's Series H Preferred Stock.
The constructive ownership rules under the Code are complex and may cause stock owned actually or constructively by a group of related individuals and/or entities to be owned constructively by one individual or entity. As a result, the acquisition of less than the applicable ownership limit of a particular class of the Company's capital stock could, nevertheless, cause that individual or entity, or another individual or entity, to constructively own stock in excess of, and thereby subject such stock to, the applicable ownership limit.
The board of directors may waive the ownership limits if it is satisfied that the excess ownership would not jeopardize the Company's REIT status and if it believes that the waiver would be in our best interest. The board of directors has waived the ownership limits with respect to John B. Kilroy, Sr., John B. Kilroy, Jr., members of their families, and some of their affiliated entities. These named individuals and entities may own either actually or constructively, in the aggregate, up to 19.6% of the Company's outstanding common stock, excluding common units that are exchangeable into shares of common stock. The board of directors has also waived the ownership limits with respect to the initial purchasers of the 4.25% Exchangeable Senior Notes due 2014 (the “4.25% Exchangeable Notes”) and certain of their affiliated entities to beneficially own up to 9.8%, in the aggregate, of the Company's common stock in connection with hedging the capped call transactions.
If anyone acquires shares in excess of any ownership limits, the transfer to the transferee will be void with respect to the excess shares, the excess shares will be automatically transferred to a trust for the benefit of a qualified charitable organization, and the purported transferee or owner will have no rights with respect to those excess shares.
The Company's charter contains provisions that may delay, deter, or prevent a change of control transaction. The following provisions of the Company's charter may delay or prevent a change of control over us, even if a change of control might be beneficial to our security holders, deter tender offers that may be beneficial to our security holders, or limit security holders' opportunity to receive a potential premium for their shares and/or units if an investor attempted to gain shares beyond the Company's ownership limits or otherwise to effect a change of control:
 
The Company's charter authorizes the board of directors to issue up to 30,000,000 shares of the Company's preferred stock, including convertible preferred stock, without stockholder approval. The board of directors may establish the preferences, rights, and other terms, including the right to vote and the right to convert into common stock any shares issued. The issuance of preferred stock could delay or prevent a tender offer or a change of control even if a tender offer or a change of control was in our security holder's interest. As of December 31, 2012, 8,000,000 shares of the Company's preferred stock were issued and outstanding, consisting of 4,000,000 shares of the Company's Series G Preferred Stock and 4,000,000 shares of the Company's Series H Preferred Stock; and


19



The Company's charter states that any director, or the entire board of directors, may be removed from office at any time, but only for cause and then only by the affirmative vote of the holders of at least two thirds of the votes of the Company's capital stock entitled to be cast in the election of directors.

The board of directors may change investment and financing policies without unitholder or stockholder approval, causing us to become more highly leveraged, which may increase our risk of default under our debt obligations.

We are not limited in our ability to incur debt. Our financing policies and objectives are determined by the board of directors. Our goal is to limit our dependence on leverage and maintain a conservative ratio of debt to total market capitalization. However, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. As of December 31, 2012, we had approximately $2.0 billion aggregate principal amount of indebtedness outstanding, which represented 34.7% of our total market capitalization. Our total debt and the liquidation value of our preferred equity as a percentage of total market capitalization was approximately 38.1% as of December 31, 2012. In addition, on January 14, 2013, the Operating Partnership issued $300.0 million of 3.8% senior unsecured notes due 2023. See “Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources of the Company— Capitalization” for a calculation of our market capitalization. These ratios may be increased or decreased without the consent of our unitholders or stockholders. Increases in the amount of debt outstanding would result in an increase in our debt service, which could adversely affect cash flow and our ability to pay dividends and distributions to our security holders. Higher leverage also increases the risk of default on our obligations and limits our ability to obtain additional financing in the future.
We may issue additional common units and shares of capital stock without unitholder or stockholder approval, as applicable, which may dilute unitholder or stockholder investment. The Company may issue shares of our common stock, preferred stock, or other equity or debt securities without stockholder approval, including the issuance of shares to satisfy REIT dividend distribution requirements. Similarly, the Operating Partnership may offer its common or preferred units for contributions of cash or property without approval by its unitholders. Further, under certain circumstances, the Company may issue shares of our common stock in exchange for the Operating Partnership's outstanding 4.25% Exchangeable Notes. Existing security holders have no preemptive rights to acquire any of these securities, and any issuance of equity securities under these circumstances may dilute a unitholder's or stockholder's investment.
Sales of a substantial number of shares of the Company's securities, or the perception that this could occur, could result in decreasing the quoted trading price per share of the Company's common stock and of the Operating Partnership's publicly-traded notes. Management cannot predict whether future issuances of shares of the Company's common stock or the availability of shares for resale in the open market will result in decreasing the market price per share of the Company's common stock. As of December 31, 2012, 74,926,981 shares of the Company's common stock and 8,000,000 shares of the Company's preferred stock, consisting of 4,000,000 shares of Series G Preferred Stock and 4,000,000 shares of Series H Preferred Stock, were issued and outstanding.
 
As of December 31, 2012, the Company had reserved for future issuance the following shares of common stock: 1,826,503 shares issuable upon the exchange, at the Company's option, of the Operating Partnership's common units; 639,487 shares remained available for grant under our 2006 Incentive Award Plan (see Note 12 to our consolidated financial statements); 1,048,863 shares issuable upon settlement of RSUs; and 1,540,000 shares issuable upon exercise of outstanding options, as well as 4,800,796 shares potentially issuable under certain circumstances, in exchange for the 4.25% Exchangeable Notes. The Company has a currently effective registration statement registering 1,708,131 shares of our common stock for possible issuance to the holders of the Operating Partnership's common units. That registration statement also registers 306,808 shares of common stock held by certain stockholders for possible resale. The Company also has a currently effective registration statement registering the 4,800,796 shares of our common stock that may potentially be issued in exchange for the Operating Partnership's presently outstanding 4.25% Exchangeable Notes. Consequently, if and when the shares are issued, they may be freely traded in the public markets.
Risks Related to Taxes and the Company's Status as a REIT
Loss of the Company's REIT status would have significant adverse consequences to us and the value of the Company's common stock. The Company currently operates in a manner that is intended to allow it to qualify as a REIT for federal income tax purposes under the Code. If the Company were to lose its REIT status, the Company would face adverse tax consequences that would substantially reduce the funds available for distribution to its stockholders for each of the years involved because:
 
the Company would not be allowed a deduction for dividends paid to its stockholders in computing the Company's taxable income and would be subject to federal income tax at regular corporate rates;

the Company could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and


20



unless entitled to relief under statutory provisions, the Company could not elect to be taxed as a REIT for four taxable years following the year during which the Company was disqualified.
In addition, if the Company failed to qualify as a REIT, it would not be required to make distributions to its stockholders. As a result of all these factors, the Company's failure to qualify as a REIT also could impair our ability to expand our business and raise capital and could adversely affect the value and quoted trading price of the Company's common stock.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code is greater in the case of a REIT that, like the Company, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within our control may affect the Company's ability to continue to qualify as a REIT. For example, to qualify as a REIT, at least 95% of the Company's gross income in any year must be derived from qualifying sources. Also, the Company must make distributions to its stockholders aggregating annually at least 90% of the Company's net taxable income (excluding any net capital gains). In addition, legislation, new regulations, administrative interpretations, or court decisions may adversely affect the Company's security holders or the Company's ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments. Although management believes that we are organized and operate in a manner to permit the Company to continue to qualify as a REIT, we cannot provide assurances that the Company has qualified or will continue to qualify as a REIT for tax purposes. We have not requested and do not plan to request a ruling from the IRS regarding the Company's qualification as a REIT.
 
To maintain the Company's REIT status, we may be forced to borrow funds during unfavorable market conditions. To qualify as a REIT, the Company generally must distribute to its stockholders at least 90% of the Company's net taxable income each year (excluding any net capital gains), and the Company will be subject to regular corporate income taxes to the extent that it distributes less than 100% of its net taxable income each year. In addition, the Company will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions it pays in any calendar year are less than the sum of 85% of its ordinary income, 95% of its net capital gains, and 100% of its undistributed income from prior years. To maintain the Company's REIT status and avoid the payment of federal income and excise taxes, the Operating Partnership may need to borrow funds and distribute or loan the proceeds to the Company so it can meet the REIT distribution requirements even if the then-prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from differences in timing between the actual receipt of income and inclusion of income for federal income tax purposes, or the effect of nondeductible capital expenditures, the creation of reserves, or required debt or amortization payments.

If a transaction intended to qualify as a Section 1031 Exchange is later determined to be taxable, we may face adverse consequences. From time to time we dispose of properties in transactions that are intended to qualify as Section 1031 Exchanges. If the qualification of a transaction as a Section 1031 Exchange is successfully challenged and determined to be currently taxable, we generally would be required to pay taxes on any gain recognized upon the disposition of the property, including any interest and penalties, for the particular year in question, to the extent such amounts were not otherwise distributed to our stockholders. In such case, we would have less cash available to distribute to our stockholders and may be required to borrow funds in unfavorable conditions in order to pay such amounts. In addition, we may be required to amend our tax returns for the applicable year in question, including any information reports we sent to our stockholders.

Dividends payable by REITs, including us, generally do not qualify for the reduced tax rates available for some dividends. “Qualified dividends” payable to U.S. stockholders that are individuals, trusts and estates generally are subject to tax at preferential rates. Subject to limited exceptions, dividends payable by REITs are not eligible for these reduced rates and are taxable at ordinary income tax rates. The more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including the shares of our capital stock.

The tax imposed on REITs engaging in “prohibited transactions” may limit our ability to engage in transactions which would be treated as sales for federal income tax purposes. A REIT's net income from prohibited transactions is subject to a 100% penalty tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. Although we do not intend to hold any properties that would be characterized as held for sale to customers in the ordinary course of our business, unless a sale or disposition qualifies under certain statutory safe harbors, such characterization is a factual determination and no guarantee can be given that the IRS would agree with our characterization of our properties or that we will always be able to make use of the available safe harbors.

21




Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments. To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our capital stock. If we fail to comply with one or more of the asset tests at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. In order to meet these tests, we may be required to forego investments we might otherwise make or to liquidate otherwise attractive investments. Thus, compliance with the REIT requirements may hinder our performance and reduce amounts available for distribution to our stockholders.

Legislative or regulatory action could adversely affect us. In recent years, numerous legislative, judicial and administrative changes have been made to the federal income tax laws applicable to investments in REITs and similar entities. Additional changes to tax laws are likely to continue to occur in the future, and any such changes may impact our ability to qualify as a REIT, our tax treatment as a REIT or the tax treatment of our stockholders.


ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
 

22



ITEM 2.
PROPERTIES
General
As of December 31, 2012, our stabilized portfolio of properties was comprised of the following office properties.
 
Number of
Buildings
Rentable
Square Feet
Number of
Tenants
Percentage Occupied at December 31, 2012
Office Properties
114

 
13,249,780

 
530

 
92.8
%
During the fourth quarter of 2012 we disposed of our entire portfolio of industrial properties and, as a result, no longer owned any industrial properties at December 31, 2012 (see Note 17 to our consolidated financial statements included in this report for additional information).
Our stabilized portfolio includes all of our properties with the exception of undeveloped land, development and redevelopment properties currently under construction or committed for construction, “lease-up” properties and properties held-for-sale. We define “lease-up” properties as properties we recently developed or redeveloped that have not yet reached 95% occupancy and are within one year following cessation of major construction activities. We define redevelopment properties as those projects for which we expect to spend significant development and construction costs on existing or acquired buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. Our stabilized portfolio also excludes our future development pipeline, which is comprised of nine potential development sites, including one office property moved from the stabilized portfolio to the development pipeline in the fourth quarter of 2012, representing 118.5 gross acres of undeveloped land.
As of December 31, 2012, the following properties were excluded from our stabilized portfolio:
 
Number of Properties
 
Estimated Rentable Square Feet (1)
Development properties under construction
4
 
1,416,000

Redevelopment properties under construction
1
 
410,000

Lease-up properties
1
 
98,000

________________________
(1) Estimated rentable square feet upon completion.
As of December 31, 2012, all of our properties and development and redevelopment projects are owned and all of our business is currently conducted in the state of California with the exception of ten office properties located in the state of Washington. We own all of our properties through the Operating Partnership and the Finance Partnership. All our properties are held in fee, except for the 11 office buildings that are held subject to long-term ground leases for the land (See Note 15 to our consolidated
financial statements included in this report for additional information regarding our ground lease obligations). We had no properties held-for-sale as of December 31, 2012.
In general, the office properties are leased to tenants on a full service gross, modified gross or triple net basis. Under a full service gross lease, we are obligated to pay the tenant’s proportionate share of real estate taxes, insurance, and operating expenses up to the amount incurred during the tenant’s first year of occupancy (“Base Year”) or a negotiated amount approximating the tenant’s pro- rata share of real estate taxes, insurance, and operating expenses (“Expense Stop”). The tenant pays its pro-rata share of increases in expenses above the Base Year or Expense Stop. A modified gross lease is similar to a full service gross lease, except tenants are obligated to pay their proportionate share of certain operating expenses, usually electricity, directly to the service provider. In addition, some office properties, primarily in the greater Seattle region, are leased to tenants on a triple net basis, pursuant to which the tenants pay their proportionate share of real estate taxes, operating costs, and utility costs.
We believe that all of our properties are well maintained and do not require significant capital improvements. As of December 31, 2012, we managed all of our properties through internal property managers.













23



Office Properties
The following table sets forth certain information relating to each of the stabilized office properties owned as of December 31, 2012.
Property Location
No. of
Buildings
 
Year Built/
Renovated
 
Rentable
Square Feet
 
Percentage
Occupied at
12/31/12(1)
 
Annualized
Base Rent($000’s)(2)
 
Annualized Rent Per Square Foot(2)
Los Angeles and Ventura Counties
 
 
 
 
 
 
 
 
 
 
 
23925 Park Sorrento,
Calabasas, California
1
 
2001
 
11,789

 
100.0
%
 
$
421

 
$
35.71

23975 Park Sorrento,
Calabasas, California
1
 
2002
 
100,592

 
93.1
%
 
3,162

 
34.74

24025 Park Sorrento,
Calabasas, California
1
 
2000
 
102,264

 
74.9
%
 
2,821

 
36.81

26541 Agoura Road
Calabasas, California
1
 
1988
 
90,156

 
100.0
%
 
1,628

 
18.06

2240 E. Imperial Highway,
El Segundo, California
1
 
1983/2008
 
122,870

 
100.0
%
 
4,458

 
36.28

2250 E. Imperial Highway,
El Segundo, California
1
 
1983
 
298,728

 
100.0
%
 
10,144

 
34.29

2260 E. Imperial Highway,
El Segundo, California
1
 
1983/2012
 
298,728

 
100.0
%
 
10,405

 
34.83

909 Sepulveda Blvd.,
El Segundo, California
1
 
1972/2005
 
241,607

 
89.8
%
 
5,609

 
26.27

999 Sepulveda Blvd.,
El Segundo, California
1
 
1962/2003
 
128,504

 
94.4
%
 
2,768

 
24.40

3750 Kilroy Airport Way,
Long Beach, California(4)
1
 
1989
 
10,457

 
86.1
%
 
99

 
18.17

3760 Kilroy Airport Way,
Long Beach, California
1
 
1989
 
165,278

 
92.7
%
 
4,379

 
28.85

3780 Kilroy Airport Way,
Long Beach, California
1
 
1989
 
219,745

 
92.2
%
 
5,589

 
28.15

3800 Kilroy Airport Way,
Long Beach, California
1
 
2000
 
192,476

 
100.0
%
 
5,538

 
28.77

3840 Kilroy Airport Way,
Long Beach, California
1
 
1999
 
136,026

 
100.0
%
 
4,915

 
36.13

3900 Kilroy Airport Way,
Long Beach, California
1
 
1987
 
126,840

 
90.9
%
 
2,588

 
23.62

12100 W. Olympic Blvd.,
Los Angeles, California
1
 
2003
 
150,167

 
92.3
%
 
5,392

 
38.90

12200 W. Olympic Blvd.,
Los Angeles, California
1
 
2000
 
150,302

 
99.7
%
 
4,504

 
39.39

12233 W. Olympic Blvd.,
Los Angeles, California(21)
1
 
1980/2011
 
151,029

 
96.8
%
 
2,580

 
48.18

12312 W. Olympic Blvd,
Los Angeles, California(3)
1
 
1950/1997
 
78,000

 
100.0
%
 
1,475

 
18.91

6255 W. Sunset Blvd,
Los Angeles, California
1
 
1971/1999
 
321,883

 
85.2
%
 
7,911

 
30.26

1633 26th Street,
Santa Monica, California
1
 
1972/1997
 
44,915

 
100.0
%
 
1,271

 
28.30

2100/2110 Colorado Avenue,
Santa Monica, California
3
 
1992/2009
 
102,864

 
100.0
%
 
3,846

 
37.39

3130 Wilshire Blvd.,
Santa Monica, California
1
 
1969/1998
 
88,339

 
76.5
%
 
2,329

 
34.48

501 Santa Monica Blvd.,
Santa Monica, California
1
 
1974
 
73,115

 
85.1
%
 
2,201

 
40.31

2829 Townsgate Road,
Thousand Oaks, California
1
 
1990
 
81,067

 
90.6
%
 
1,977

 
27.46

Subtotal/Weighted Average—
Los Angeles and Ventura Counties

27
 
 
 
3,487,741

 
94.0
%
 
98,010

 
31.66

San Diego County
 
 
 
 
 
 
 
 
 
 
 
12225 El Camino Real,
Del Mar, California(5)
1
 
1998
 
60,148

 
73.4
%
 
1,472

 
33.36


24



Property Location
No. of
Buildings
 
Year Built/
Renovated
 
Rentable
Square Feet
 
Percentage
Occupied at
12/31/12(1)
 
Annualized
Base Rent($000’s)(2)
 
Annualized Rent Per Square Foot(2)
12235 El Camino Real,
Del Mar, California(5)
1
 
1998
 
54,673

 
81.0
%
 
1,608

 
36.31

12340 El Camino Real,
Del Mar, California(5)
1
 
2002
 
87,405

 
86.9
%
 
3,276

 
43.14

12390 El Camino Real,
Del Mar, California(5)
1
 
2000
 
72,332

 
100.0
%
 
3,069

 
42.43

12348 High Bluff Drive,
Del Mar, California(5)
1
 
1999
 
38,710

 
82.0
%
 
1,123

 
35.38

12400 High Bluff Drive,
Del Mar, California(5)
1
 
2004
 
208,464

 
100.0
%
 
9,897

 
47.48

3579 Valley Centre Drive,
Del Mar, California(12)
1
 
1999
 
52,375

 
79.0
%
 
1,572

 
37.99

3611 Valley Centre Drive,
Del Mar, California(20)
1
 
2000
 
130,178

 
80.0
%
 
4,373

 
44.79

3661 Valley Centre Drive,
Del Mar, California(5)
1
 
2001
 
129,752

 
99.4
%
 
3,870

 
32.53

3721 Valley Centre Drive,
Del Mar, California(5)
1
 
2003
 
114,780

 
100.0
%
 
3,767

 
32.82

3811 Valley Centre Drive,
Del Mar, California(6)
1
 
2000
 
112,067

 
100.0
%
 
5,199

 
46.39

6200 Greenwich Drive,
Governor Park, California(6)
1
 
1999
 
71,000

 
100.0
%
 
1,704

 
24.00

6220 Greenwich Drive,
Governor Park , California(5)
1
 
1996
 
141,214

 
100.0
%
 
4,286

 
30.35

15051 Avenue of Science,
I-15 Corridor, California(6)
1
 
2002
 
70,617

 
%
 

 

15073 Avenue of Science,
I-15 Corridor, California(6)
1
 
2002
 
46,759

 
%
 

 

15231 Avenue of Science,
I-15 Corridor, California(13)
1
 
2005
 
65,638

 
100.0
%
 
1,331

 
20.28

15253 Avenue of Science,
I-15 Corridor, California(6)
1
 
2005
 
37,437

 
100.0
%
 
610

 
16.29

15333 Avenue of Science,
I-15 Corridor, California(25)
1
 
2006
 
78,880

 
46.4
%
 
765

 
20.89

15378 Avenue of Science,
I-15 Corridor, California(22)
1
 
1990
 
68,910

 
61.8
%
 
660

 
15.49

15435 Innovation Drive,
I-15 Corridor, California(5)
1
 
2000
 
49,863

 
100.0
%
 
1,243

 
24.93

15445 Innovation Drive,
I-15 Corridor, California(5)
1
 
2000
 
51,500

 
100.0
%
 
1,318

 
25.59

13280 Evening Creek Drive South,
I-15 Corridor, California(5)
1
 
2008
 
41,665

 
67.0
%
 
598

 
21.41

13290 Evening Creek Drive South,
I-15 Corridor, California
1
 
2008
 
61,176

 
%
 

 

13480 Evening Creek Drive North,
I-15 Corridor, California(5)
1
 
2008
 
149,817

 
100.0
%
 
7,779

 
51.92

13500 Evening Creek Drive North,
I-15 Corridor, California(5)
1
 
2004
 
147,533

 
100.0
%
 
6,280

 
42.57

13520 Evening Creek Drive North,
I-15 Corridor, California(5)
1
 
2004
 
141,129

 
92.4
%
 
4,648

 
36.48

7525 Torrey Santa Fe,
56 Corridor, California(6)
1
 
2007
 
103,979

 
100.0
%
 
3,012

 
28.97

7535 Torrey Santa Fe,
56 Corridor, California(6)
1
 
2007
 
130,243

 
100.0
%
 
3,693

 
28.35

7545 Torrey Santa Fe,
56 Corridor, California(6)
1
 
2007
 
130,354

 
100.0
%
 
3,609

 
27.69

7555 Torrey Santa Fe,
56 Corridor, California(6)
1
 
2007
 
101,236

 
100.0
%
 
3,175

 
31.36

2355 Northside Drive,
Mission Valley, California(5)
1
 
1990
 
53,610

 
84.5
%
 
1,235

 
27.25

2365 Northside Drive,
Mission Valley, California(5)
1
 
1990
 
91,260

 
86.8
%
 
2,281

 
28.81


25



Property Location
No. of
Buildings
 
Year Built/
Renovated
 
Rentable
Square Feet
 
Percentage
Occupied at
12/31/12(1)
 
Annualized
Base Rent($000’s)(2)
 
Annualized Rent Per Square Foot(2)
2375 Northside Drive,
Mission Valley, California(5)
1
 
1990
 
51,516

 
100.0
%
 
1,429

 
28.84

2385 Northside Drive,
Mission Valley, California(5)
1
 
2008
 
88,795

 
76.5
%
 
2,135

 
31.43

2305 Historic Decatur Road,
Point Loma, California(16)
1
 
2009
 
103,900

 
100.0
%
 
3,980

 
38.31

10020 Pacific Mesa Blvd,
Sorrento Mesa, California(3)
1
 
2007
 
318,000

 
100.0
%
 
7,683

 
24.16

4910 Directors Place,
Sorrento Mesa, California(6)
1
 
2009
 
50,925

 
49.9
%
 
963

 
37.90

4921 Directors Place,
Sorrento Mesa, California(5)
1
 
2008
 
56,136

 
100.0
%
 
1,347

 
24.00

4939 Directors Place,
Sorrento Mesa, California(6)
1
 
2002
 
60,662

 
100.0
%
 
2,276

 
37.52

4955 Directors Place,
Sorrento Mesa, California(6)
1
 
2008
 
76,246

 
100.0
%
 
2,881

 
37.79

5005 Wateridge Vista Drive,
Sorrento Mesa, California(26)
1
 
1999
 
61,460

 
%
 

 

5010 Wateridge Vista Drive,
Sorrento Mesa, California(6)
1
 
1999/2012
 
111,318

 
100.0
%
 
3,552

 
31.91

10770 Wateridge Circle,
Sorrento Mesa, California(18)
1
 
1989
 
174,310

 
97.5
%
 
3,073

 
18.08

6055 Lusk Avenue,
Sorrento Mesa, California(3)
1
 
1997
 
93,000

 
100.0
%
 
1,554

 
16.71

6260 Sequence Drive,
Sorrento Mesa, California(6)
1
 
1997
 
130,536

 
100.0
%
 
1,269

 
9.72

6290 Sequence Drive,
Sorrento Mesa, California(6)
1
 
1997
 
90,000

 
100.0
%
 
2,098

 
23.31

6310 Sequence Drive,
Sorrento Mesa, California(6)
1
 
2000
 
62,415

 
100.0
%
 
1,133

 
18.15

6340 Sequence Drive,
Sorrento Mesa, California(6)
1
 
1998
 
66,400

 
100.0
%
 
1,341

 
20.20

6350 Sequence Drive,
Sorrento Mesa, California
1
 
1998
 
132,600

 
100.0
%
 
2,507

 
18.91

10390 Pacific Center Court,
Sorrento Mesa, California(6)
1
 
2002
 
68,400

 
100.0
%
 
2,771

 
40.51

10394 Pacific Center Court,
Sorrento Mesa, California(6)
1
 
1995
 
59,630

 
100.0
%
 
1,077

 
18.06

10398 Pacific Center Court,
Sorrento Mesa, California(6)
1
 
1995
 
43,645

 
100.0
%
 
698

 
15.99

10421 Pacific Center Court,
Sorrento Mesa, California(17)
1
 
1995/2002
 
75,899

 
100.0
%
 
1,076

 
14.18

10445 Pacific Center Court,
Sorrento Mesa, California(6)
1
 
1995
 
48,709

 
100.0
%
 
1,029

 
21.13

10455 Pacific Center Court,
Sorrento Mesa, California
1
 
1995
 
90,000

 
100.0
%
 
1,112

 
12.36

5717 Pacific Center Blvd,
Sorrento Mesa, California(3)
1
 
2001/2005
 
67,995

 
100.0
%
 
1,503

 
22.10

4690 Executive Drive,
UTC, California(8)
1
 
1999
 
47,212

 
100.0
%
 
1,134

 
24.02

9785 Towne Center Drive,
UTC, California(3)
1
 
1999
 
75,534

 
100.0
%
 
1,374

 
18.19

9791 Towne Center Drive,
UTC, California(3)
1
 
1999
 
50,466

 
100.0
%
 
916

 
18.15

Subtotal/Weighted Average—
San Diego County
59
 
 
 
5,250,413

 
90.7
%
 
139,364

 
29.39

Orange County
 
 
 
 
 
 
 
 
 
 
 
8101 Kaiser Blvd.
Anaheim, California
1
 
1988
 
59,790

 
61.0
%
 
848

 
23.26

2211 Michelson,
Irvine, California(19)
1
 
2007
 
271,556

 
94.0
%
 
9,704

 
38.51


26



Property Location
No. of
Buildings
 
Year Built/
Renovated
 
Rentable
Square Feet
 
Percentage
Occupied at
12/31/12(1)
 
Annualized
Base Rent($000’s)(2)
 
Annualized Rent Per Square Foot(2)
111 Pacifica,
Irvine Spectrum, California
1
 
1991
 
67,496

 
100.0
%
 
1,377

 
21.77

999 Town & Country,
Orange, California
1
 
1977/2009
 
98,551

 
100.0
%
 
2,919

 
29.62

Subtotal/Weighted Average—
Orange County
4
 
 
 
497,393

 
92.0
%
 
14,848

 
32.98

San Francisco
 
 
 
 
 
 
 
 
 
 
 
4100 Bohannon Drive,
Menlo Park, California(6)
1
 
1985
 
46,614

 
100.0
%
 
1,719

 
36.88

4200 Bohannon Drive,
Menlo Park, California(6)
1
 
1987
 
46,255

 
100.0
%
 
1,573

 
39.78

4300 Bohannon Drive,
Menlo Park, California(6)
1
 
1988
 
62,920

 
41.7
%
 
876

 
33.42

4400 Bohannon Drive,
Menlo Park, California(6)
1
 
1988
 
46,255

 
84.2
%
 
1,159

 
32.62

4500 Bohannon Drive,
Menlo Park, California(6)
1
 
1990
 
62,920

 
100.0
%
 
2,041

 
32.44

4600 Bohannon Drive,
Menlo Park, California(6)
1
 
1990
 
46,255

 
71.2
%
 
1,297

 
39.39

4700 Bohannon Drive,
Menlo Park, California(6)
1
 
1989
 
62,920

 
100.0
%
 
2,275

 
36.16

303 Second Street,
San Francisco, California
1
 
1988
 
740,047

 
95.5
%
 
26,232

 
37.26

100 First Street,
San Francisco, California
1
 
1988
 
466,490

 
98.3
%
 
19,118

 
42.80

250 Brannan Street,
San Francisco, California(5)
1
 
1907/2001
 
92,948

 
100.0
%
 
3,983

 
42.85

201 Third Street,
San Francisco, California
1
 
1983
 
332,893

 
99.5
%
 
13,024

 
40.40

301 Brannan Street,
San Francisco, California(5)
1
 
1909/1989
 
74,430

 
100.0
%
 
3,024

 
40.63

4040 Civic Center,
San Rafael, California
1
 
1979/1994
 
130,237

 
98.1
%
 
2,528

 
20.30

599 Mathilda,
Sunnyvale, California
1
 
2000
 
75,810

 
100.0
%
 
2,201

 
29.03

Subtotal/Weighted Average—
San Francisco
14
 
 
 
2,286,994

 
95.5
%
 
81,050

 
37.74

Greater Seattle
 
 
 
 
 
 
 
 
 
 
 
601 108th Avenue NE,
Bellevue, Washington(23)
1
 
2000
 
488,470

 
90.4
%
 
11,851

 
27.24

10900 NE 4th Street,
Bellevue, Washington
1
 
1983
 
416,755

 
90.5
%
 
12,691

 
33.68

10220 NE Points Drive,
Kirkland, Washington(3)
1
 
1987
 
49,851

 
96.3
%
 
1,222

 
25.71

10230 NE Points Drive,
Kirkland, Washington(3)
1
 
1988
 
98,982

 
100.0
%
 
2,661

 
27.28

10210 NE Points Drive,
Kirkland, Washington(3)
1
 
1990
 
84,641

 
69.2
%
 
1,428

 
24.38

3933 Lake Washington Blvd NE,
Kirkland, Washington(3)
1
 
1993
 
46,450

 
100.0
%
 
1,209

 
26.03

15050 N.E. 36th Street,
Redmond, Washington(3)
1
 
1998
 
122,103

 
100.0
%
 
3,130

 
25.63

837 N. 34th Street,
Lake Union, Washington(3)
1
 
2008
 
111,580

 
100.0
%
 
2,694

 
24.14

701 N. 34th Street,
Lake Union, Washington(24)
1
 
1998
 
138,995

 
98.7
%
 
2,541

 
18.51

801 N. 34th Street,
Lake Union, Washington(3)
1
 
1998
 
169,412

 
100.0
%
 
4,423

 
26.11

Subtotal/Weighted Average—
Greater Seattle
10
 
 
 
1,727,239

 
93.3
%
 
43,850

 
27.37

TOTAL/WEIGHTED AVERAGE
114
 
 
 
13,249,780

 
92.8
%
 
$
377,122

 
$
31.33


27



_________________
(1)
Based on all leases at the respective properties in effect as of December 31, 2012. Includes month-to-month leases as of December 31, 2012.
(2)
Annualized base rental revenue includes the impact of straight-lining rent escalations and the amortization of free rent periods and excludes the impact of the following: amortization of deferred revenue related tenant-funded tenant improvements, amortization of above/below market rents, amortization for lease incentives due under existing leases, and expense reimbursement revenue. Excludes month-to-month leases and vacant space as of December 31, 2012.
(3)
For these properties, the leases are written on a triple net basis.
(4)
For this property, leases of approximately 5,000 rentable square feet are written on a modified gross basis, and a lease of approximately 2,000 rentable square feet is written on a full service gross basis.
(5)
For these properties, the leases are written on a modified gross basis.
(6)
For these properties, the leases are written on a modified net basis.
(7)
For this property, a lease of approximately 20,000 rentable square feet is written on a modified net basis, and leases of approximately 17,000 rentable square feet are written on a modified gross basis. The remaining 6,000 rentable square feet is currently being marketed for lease.
(8)
For this property, leases of approximately 19,000 rentable square feet are written on a modified net basis, and leases of approximately 28,000 rentable square feet are written on a modified gross basis.
(9)
For this property, leases of approximately 15,000 rentable square feet are written on a full service gross basis, leases of approximately 42,000 rentable square feet are written on a triple net basis, and leases of approximately 18,000 rentable square feet are written on a modified net basis.
(10)
For this property, a lease of approximately 15,000 rentable square feet is written on a modified gross basis, and a lease of approximately 56,000 rentable square feet is written on a triple net basis.
(11)
For these properties, leases of approximately 142,000 rentable square feet are written on a modified net basis, and a lease of approximately 37,000 rentable square feet is written on a modified gross basis.
(12)
For this property, a lease of approximately 41,000 rentable square feet is written on a modified gross basis. The remaining 11,000 rentable square feet is currently being marketed for lease.
(13)
For this property, a lease of approximately 47,000 rentable square feet is written on a modified net basis. A lease of approximately 18,000 rentable square feet is written on a modified gross basis.
(14)
For this property, leases of approximately 30,000 rentable square feet are written on a modified gross basis.
(15)
For this property, a lease of approximately 70,000 rentable square feet is written on a modified net basis, and a lease of approximately 15,000 rentable square feet is written on a triple net basis.
(16)
For this property, leases of approximately 82,000 rentable square feet are written on a modified gross basis, and a lease of approximately 22,000 rentable square feet is written on a gross basis.
(17)
For this property, leases of approximately 76,000 rentable square feet are written on a modified net basis.
(18)
For this property, leases of approximately 123,000 rentable square feet are written on a modified net basis, and leases of 47,000 rentable square feet are written on a modified gross basis.
(19)
For this property, leases of approximately 217,000 rentable square feet are written on a direct expense stop basis, and leases of 38,000 rentable square feet are written on a full service gross basis.
(20)
For this property, leases of approximately 104,000 rentable square feet are written on a modified gross basis. The remaining 26,000 rentable square feet is currently being marketed for lease.
(21)
For this property, leases of approximately 105,000 rentable square feet are written on a full service gross basis, and leases of 41,000 rentable square feet are written on a modified gross basis.
(22)
For this property, a lease of approximately 69,000 rentable square feet is written on a modified net basis, and a lease of approximately 43,000 rentable square feet is written on a modified gross basis.
(23)
For this property, a lease of approximately 360,000 rentable square feet are written on a triple net basis, and leases of approximately 73,000 rentable square feet are written on a full service gross basis.
(24)
For this property, a lease of approximately 118,000 rentable square feet are written on a triple net basis, and leases of approximately 20,000 rentable square feet are written on a modified net basis.
(25)
For this property, leases of approximately 37,000 rentable square feet are written on a modified gross basis. Leases of approximately 38,000 rentable square feet were executed with two tenants during the fourth quarter of 2012. The new leases are expected to commence in the first and third quarters of 2013.
(26)
For this property, a lease of approximately 61,000 rentable square feet was executed with one tenant during the fourth quarter of 2012. The new lease is expected to commence in the third quarter of 2013.



Completed and In-Process Redevelopment Projects

During the year ended December 31, 2012, we completed the following redevelopment projects, which were added to our stabilized portfolio of operating properties:
 
 
Construction Period
 
 
 
 
Completed Redevelopment Projects
 
Start Date
 
Completion Date
 
Rentable Square Feet
 
% Leased
2260 E. Imperial Highway
El Segundo, California
(1)
 
3Q 2010
 
4Q 2012
 
299,000

 
100
%
5010 Wateridge Vista Drive
Sorrento Mesa, California
 
3Q 2011
 
4Q 2012
 
111,000

 
100
%
 
 
 
 
 
 
410,000

 
100
%
_______________________
(1) Cash rent for this property commenced in December 2012. Completion of remaining tenant improvements and physical occupancy are expected to continue through April 2013.

28




As of December 31, 2012, we had the following redevelopment projects in lease up or under construction.
 
 
Estimated Construction Period
 
 
 
 
 
 
In-Process Redevelopment Projects
 
Start Date
 
Estimated Compl. Date
 
Estimated Stabilization Date (1)
 
Estimated Rentable Square Feet
 
% Leased
 
 
 
 
 
 
 
 
 
 
 
Projects In Lease-Up (2)
 
 
 
 
 
 
 
 
 
 
3880 Kilroy Airport Way
Long Beach, California (3)
 
3Q 2011
 
4Q 2012
 
4Q 2013
 
98,000

 
50
%
Under Construction
 
 
 
 
 
 
 
 
 
 
360 Third Street
San Francisco, California (4)(5)

 
4Q 2011
 
1Q 2013
 
1Q 2014
 
410,000

 
75
%
 
 
 
 
 
 
 
 
508,000

 
70
%
_______________________
(1) Based on management's estimation of the earlier of stabilized occupancy (95%) or one year from the date of substantial completion.
(2) Lease-up properties represent properties recently redeveloped that have not reached 95% occupancy and are within one year following cessation of major construction activities.
(3) This property was 50% leased prior to any redevelopment activity, which occurred in two phases. Redevelopment on the first half was completed during the second quarter of
2012, and the tenant has taken occupancy of this space. Redevelopment on the second half was completed in the fourth quarter of 2012.
(4) Approximately 91% of this project is being redeveloped because approximately 9% of the project was leased and occupied by an existing tenant upon acquisition in December
2011. In July 2012, approximately 17% of the building was completed and the tenant has taken occupancy of the space. The remaining 74% of the building remains under
redevelopment. Redevelopment costs are capitalized only on the portion of the building that is under redevelopment and not occupied by tenants.
(5) During the fourth quarter of 2012, the Company exercised its option to acquire the land underlying the current ground lease for $27.5 million. We currently expect that the
transaction will close in the second quarter of 2013.
In-Process and Future Development Pipeline and Other Land Holdings
The following table sets forth certain information relating to our in-process development pipeline as of December 31, 2012.
 
 
 
 
Estimated Construction Period
 
 
 
 
 
 
In-Process Development Pipeline
 
Location
 
Start Date
 
Estimated Compl. Date
 
Estimated Stabilization Date (1)
 
Estimated Rentable Square Feet
 
% Leased
 
 
 
 
 
 
 
 
 
 
 
 
 
San Francisco Bay Area
 
 
 
 
 
 
 
 
 
 
 
 
690 E. Middlefield Road
 
Mountain View
 
2Q 2012
 
1Q 2015
 
1Q 2015
 
341,000

 
100%
331 Fairchild Drive
 
Mountain View
 
4Q 2012
 
4Q 2013
 
4Q 2013
 
88,000

 
100%
350 Mission Street (2)
 
San Francisco
 
4Q 2012
 
1Q 2015
 
4Q 2015
 
400,000

 
100%
555 N. Mathilda Avenue
 
Sunnyvale
 
4Q 2012
 
3Q 2014
 
3Q 2014
 
587,000

 
100%
 
 
 
 
 
 
 
 
 
 
1,416,000

 
100%
_______________________________________
(1) Based on management's estimation of the earlier of stabilized occupancy (95%) or one year from the date of substantial completion.
(2) Estimated rentable square feet reflects existing entitlements for 27-story office tower. The Company is currently pursuing entitlements to increase this project to a 30-story office
tower, which would increase the estimated rentable square feet and total estimated investment.


29



The following table sets forth certain information relating to our future development pipeline as of December 31, 2012.

Project
 
Location
  
Estimated Rentable Square Feet
Future Development Pipeline
 
 
 
 
San Francisco Bay Area
 
 
 
 
333 Brannan Street
 
San Francisco
 
170,000

 
 
 
 
 
Los Angeles
 
 
 
 
Columbia Square (1)
 
Hollywood
 
600,000

 
 
 
 
 
San Diego
 
 
  
 
9455 Towne Centre Drive (2)
 
San Diego
 
150,000

Carlsbad Oaks—Lots 4, 5, 7 & 8
 
Carlsbad
  
288,000

Pacific Corporate Center—Lot 8
 
Sorrento Mesa
  
170,000

Rancho Bernardo Corporate Center
 
I-15 Corridor
  
320,000 - 1,000,000

One Paseo (3)
 
Del Mar
  
500,000

Santa Fe Summit—Phase II and III
 
56 Corridor
  
600,000

Sorrento Gateway—Lot 2
 
Sorrento Mesa
  
80,000

Subtotal
 
 
  
2,108,000 - 2,788,000

_______________________________________
(1)
The Company is planning to redevelop an existing building encompassing approximately 100,000 rentable square feet and develop a mixed-use plan encompassing approximately 500,000 rentable square feet, which will include office, multi-family and retail components.
(2)
The Company is planning to demolish the existing two-story 45,195 rentable square foot office building at this site and pursue entitlements to build a new 5-story 150,000 rentable square foot office building.
(3)
Estimated rentable square feet reflects existing office entitlements. The Company is currently pursuing mixed-use entitlements for this project which would increase the estimated rentable square feet.

The following table sets forth certain information about our other land holdings as of December 31, 2012.

Other Land Holdings
 
 
Project
 
Gross Site Acreage
17150 Von Karman
Irvine, California
 
8.5

During the fourth quarter of 2011, the Company completed demolition of the industrial building at 17150 Von Karman. Simultaneously, the Company successfully obtained entitlements to reposition this site for residential use in preparation of a possible land sale. The Company's ultimate decision to sell this site and the timing of any potential future sale is dependent upon market conditions and other factors.


30



Significant Tenants
The following table sets forth information about our 15 largest tenants based upon annualized base rental revenues, as defined below, as of December 31, 2012.
Tenant Name
Annualized Base Rental Revenue(1)
 
Percentage of Total Annualized Base Rental Revenue(1)
 
Lease Expiration Date
 
(in thousands)
 
 
 
 
DIRECTV, LLC
$
23,377

 
6.2%
 
September 2027
Intuit, Inc.
15,193

 
4.0
 
Various(2)
Bridgepoint Education, Inc
15,105

 
4.0
 
Various(3)
Delta Dental of California
10,275

 
2.7
 
May 2015
CareFusion Corporation (9)
9,256

 
2.5
 
August 2017
AMN Healthcare, Inc.
8,192

 
2.2
 
July 2018
Adobe Systems, Inc. (9)
6,557

 
1.7
 
Various(4)
Fish & Richardson P.C.
6,071

 
1.6
 
October 2018
Wells Fargo (9)
5,346

 
1.4
 
Various(5)
Scripps Health
5,199

 
1.4
 
June 2021
BP Biofuels
5,128

 
1.4
 
Various(6)
Lucile Salter Packard Children's Hospital at Stanford
5,109

 
1.4
 
Various(7)
Epson America, Inc.
4,915

 
1.3
 
October 2019
Scan Health Plan (9)
4,505

 
1.2
 
June 2015
Avnet, Inc.
4,163

 
1.1
 
Various(8)
Total
$
128,391

 
34.1%
 
 
_______________________________________
(1)
Represents annualized contractual base rent calculated on a straight-line basis in accordance with GAAP, excluding the above/below market rent amortization and expense reimbursement revenue, for leases from which rental revenue is being recognized by us as of December 31, 2012. 
(2)
The Intuit Inc. leases, which contribute $1.7 million and $13.5 million expire in December 2012 and August 2017, respectively.
(3)
The Bridgepoint Education Inc. leases, which contribute $1.0 million, $6.3 million and $7.8 million expire in February 2017, July 2018 and September 2018, respectively.
(4)
The Adobe Systems Inc. leases, which contribute $1.6 million and $5.0 million expire in May 2013 and July 2020, respectively.
(5)
The Wells Fargo leases, which contribute $0.05 million, $0.1 million, $1.0 million, $0.3 million, $0.4 million, $1.4 million, $2.0 million, $0.05 million and $0.1 million expire in March 2013, January 2014, November 2014, August 2015, July 2016, September 2016, September 2017, February 2018 and February 2019, respectively.
(6)
The BP Biofuel leases, which contribute $2.8 million and $2.3 million expire in November 2015 and March 2017, respectively.
(7)
The Lucile Salter Packard Children's Hospital at Stanford leases, which contribute $0.4 million and $4.7 million expire in November 2015 and September 2020, respectively.
(8)
The Avnet Inc. leases, which contribute $3.8 million and $0.4 million expire in February 2013 and January 2018, respectively.
(9)
The Company has entered into leases with various affiliates of the tenant name listed above.


31



 The following pie chart sets forth the composition of our tenant base by industry and as a percentage of our annualized base rental revenue based on the Standard Industrial Classifications as of December 31, 2012.


32




Lease Expirations
The following table sets forth a summary of our lease expirations for each of the next ten years beginning with 2013, assuming that none of the tenants exercise renewal options or termination rights. See further discussion of our lease expirations under “Item 1A: Risk Factors”.
Lease Expirations (1)
Year of Lease Expiration
# of Expiring Leases
 
Total Square Feet
 
% of Total Leased Square Feet
 
Annualized Base Rent (000’s)(1)
 
% of Total Annualized Base Rent(1)
 
 Annualized Rent per Square Foot(1)
2013
94

 
855,902

 
7.1
%
 
$
22,524

 
6.0
%
 
$
26.32

2014
121

 
1,250,019

 
10.4
%
 
36,098

 
9.6
%
 
28.88

2015
151

 
2,124,976

 
17.7
%
 
65,432

 
17.4
%
 
30.79

2016
74

 
808,217

 
6.7
%
 
21,119

 
5.6
%
 
26.13

2017
99

 
1,951,623

 
16.2
%
 
58,162

 
15.4
%
 
29.80

2018
52

 
1,281,765

 
10.6
%
 
49,569

 
13.1
%
 
38.67

2019
31

 
902,246

 
7.5
%
 
31,315

 
8.3
%
 
34.71

2020
30

 
1,200,994

 
10.0
%
 
36,562

 
9.7
%
 
30.44

2021
18

 
445,767

 
3.7
%
 
14,960

 
4.0
%
 
33.56

2022
8

 
128,076

 
1.1
%
 
5,153

 
1.4
%
 
40.23

2023 and beyond
16

 
1,088,198

 
9.0
%
 
36,228

 
9.5
%
 
33.29

Total(2)
694

 
12,037,783

 
100.0
%
 
$
377,122

 
100.0
%
 
$
31.33

_______________________

(1)
Annualized base rent includes the impact of straight-lining rent escalations and the amortization of free rent periods and excludes the impact of the following:  amortization of deferred revenue related tenant-funded tenant improvements, amortization of above/below market rents, amortization for lease incentives due under existing leases, and expense reimbursement revenue.  Additionally, the underlying leases contain various expense structures including full service gross, modified gross and triple net. Amounts represent percentage of total portfolio annualized contractual base rental revenue.
(2)
The information presented for all lease expiration activity reflects leasing activity through December 31, 2012 for our stabilized portfolio. For leases that have been renewed early or space that has been re-leased to a new tenant, the expiration date and annualized base rent information presented takes into consideration the renewed or re-leased lease terms. Excludes space leased under month-to-month leases, vacant space, and lease renewal options not executed as of December 31, 2012.


Secured Debt
As of December 31, 2012, the Operating Partnership had nine outstanding mortgage notes payable, which were secured by certain of our properties. Our secured debt represents an aggregate indebtedness of approximately $553.9 million. See additional information regarding our secured debt in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources—Liquidity Sources,” Notes 6 and 7 to our consolidated financial statements, and Schedule III—Real Estate and Accumulated Depreciation included with this report. Management believes that, as of December 31, 2012, the value of the properties securing the applicable secured obligations in each case exceeded the principal amount of the outstanding obligation.

ITEM 3.
LEGAL PROCEEDINGS
We and our properties are subject to routine litigation incidental to our business. As of December 31, 2012, we are not a defendant in, and our properties are not subject to, any legal proceedings that we believe, if determined adversely to us, would have a material adverse effect upon our financial condition, results of operations, or cash flows.

ITEM 4.
MINE SAFETY DISCLOSURES
None.

 

33



PART II

ITEM 5.
MARKET FOR KILROY REALTY CORPORATION'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “KRC.” As of the date this report was filed, there were approximately 65 registered holders of the Company's common stock. The following table illustrates the high, low, and closing prices by quarter, as well as dividends declared, during 2012 and 2011 as reported on the NYSE.
 
2012
High

 
Low

 
Close

 
Per Share Common
Stock Dividends
Declared

First quarter
$
46.61

 
$
37.92

 
$
46.61

 
$
0.3500

Second quarter
48.58

 
44.84

 
48.41

 
0.3500

Third quarter
49.88

 
44.78

 
44.78

 
0.3500

Fourth quarter
47.52

 
42.47

 
47.37

 
0.3500

2011
High

 
Low

 
Close

 
Per Share Common
Stock Dividends
Declared

First quarter
$
39.24

 
$
36.61

 
$
38.83

 
$
0.3500

Second quarter
41.94

 
38.04

 
39.49

 
0.3500

Third quarter
41.58

 
30.01

 
31.30

 
0.3500

Fourth quarter
38.57

 
29.25

 
38.07

 
0.3500

The Company pays distributions to common stockholders quarterly each January, April, July, and October at the discretion of the board of directors. Distribution amounts depend on our FFO, financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code, and such other factors as the board of directors deems relevant.

MARKET FOR KILROY REALTY, L.P.'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
There is no established public trading market for the Operating Partnership’s common units. As of the date this report was filed, there were 24 holders of record of common units (including through the Company’s general partnership interest).
The following table reports the distributions per common unit declared during the years ended December 31, 2012 and 2011.
2012
 
Per Unit Common
Unit Distribution
Declared

First quarter
 
$
0.3500

Second quarter
 
0.3500

Third quarter
 
0.3500

Fourth quarter
 
0.3500

2011
 
Per Unit Common
Unit Distribution
Declared

First quarter
 
$
0.3500

Second quarter
 
0.3500

Third quarter
 
0.3500

Fourth quarter
 
0.3500

During 2012 and 2011, the operating partnership redeemed 10,000 and 5,000 common units, respectively, for the same number of shares of the Company’s common stock.

34





PERFORMANCE GRAPH
The following line graph compares the change in cumulative stockholder return on shares of the Company's common stock to the cumulative total return of the NAREIT All Equity REIT Index, the Standard & Poor’s 500 Stock Index, and the SNL REIT Office Index for the five-year period ended December 31, 2012. We include an additional index, the SNL REIT Office Index, to the performance graph since management believes it provides additional information to investors about our performance relative to a more specific peer group. The SNL REIT Office Index is a published and widely recognized index that comprises 19 office equity REITs, including us. The graph assumes the investment of $100 in us and each of the indices on December 31, 2007 and, as required by the SEC, the reinvestment of all distributions. The return shown on the graph is not necessarily indicative of future performance.



35



ITEM 6.
SELECTED FINANCIAL DATA - KILROY REALTY CORPORATION     

The following tables set forth selected consolidated financial and operating data on an historical basis for the Company.  The following data should be read in conjunction with our financial statements and notes thereto and “Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations” included below in this report.

The consolidated balance sheet data as of December 31, 2012 and 2011 and the consolidated statement of operations data for the years ended December 31, 2012, 2011 and 2010 have been derived from the historical consolidated financial statements of Kilroy Realty Corporation audited by Deloitte & Touche LLP, an independent registered public accounting firm.  The consolidated balance sheet data as of December 31, 2010, 2009 and 2008 and the consolidated statement of operations data for the years ended December 31, 2009 and 2008 have been derived from the historical consolidated financial statements of Kilroy Realty Corporation and adjusted for the impact of subsequent accounting changes requiring retrospective application, if any.
Kilroy Realty Corporation Consolidated
(in thousands, except share, per share, square footage and occupancy data)