Kilroy Realty, which lacks a moat, presents a compelling investment opportunity due to its high-quality office portfolio, especially following the recent selloff of office REITs. While we acknowledge the uncertainty surrounding the future of office spaces and anticipate a challenging environment for office owners in the near to medium term, we believe the recent selloff has been excessive. The current implied valuation of Kilroy’s shares appears disconnected from the private market valuations of its office portfolio. Long-term investors may find this stock attractive, as it is trading significantly below our fair value estimate of $59 per share.
Kilroy’s office portfolio is among the best in the publicly traded REIT sector, with an average age of just 11 years, compared to 30 years for its peers. Additionally, it performs well on various metrics, including rent spread and sustainability. The company is well-positioned to capitalize on the flight-to-quality trend, which is gaining momentum as employers seek to encourage employees to return to the office.
However, there are risks to consider. The recovery in physical office occupancy levels has been slow. According to Kastle Systems' weekly work barometer, average occupancy in office buildings is still around 50% of pre-pandemic levels. Another risk factor is Kilroy’s geographic concentration in California and its significant exposure to the technology and life sciences sectors.
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