The fact that buying properties in Southern California is so difficult also has propelled Kilroy's stock. The company owns over 12 million square feet of office and industrial space in Southern California. Rather than try to buy in this low-yield environment, Kilroy is focusing on developing its huge land holdings in the region. Its development pipeline under construction now totals 644,000 square feet, and will cost $189 million. The company also plans an additional 1.1 million square feet of office development in San Diego, for a total investment of $409.1 million.
Kilroy will see cash yields of 9% to 9.5% on its current developments, substantially higher than the 5% to 6% acquisition cap rates in Southern California right now.
Kilroy is a "great story over the next three years because they don't have any pressure to buy (properties)," says AuBuchon, who rates the company buy. "They have this built-in internal growth pipeline." A.G. Edwards expects to receive or seek compensation from Kilroy within the next three months.
But it might be difficult to still take advantage of the upside on Kilroy. The company is trading at 18.6 times the consensus estimate for its 2006 funds from operations, a common metric for measuring REIT performance. Industrial REITs, on average, are trading at 14.5 times next year's FFO, and office REITs are at an average 14 times FFO, according to SNL Financial.
Kilroy's dividend yield is down to 3.3%. The average dividend yield for all REITs, except mortgage REITs, is currently 5.17%, according to SNL.
But with its strong development pipeline, analysts, on average, expect Kilroy to grow FFO 11% annually over the next five years. AuBuchon thinks 8% to 10% growth annually is more realistic. But even that growth rate is better than what can be expected for many REITs, which helps explain Kilroy's higher valuation.