Edgar Filing: KILROY REALTY CORP

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018



o	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)

(310) 481-8400
(Registrant's telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 þ No o

Kilroy Realty, L.P. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).

Kilroy Realty Corporation Yes þ No o

Kilroy Realty, L.P. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Kilroy Realty Corporation
Large accelerated filer þ		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
Emerging growth company o If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Kilroy Realty, L.P.
Large accelerated filer o		Accelerated filer o
Non-accelerated filer þ		Smaller reporting company o
Emerging growth company o If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Kilroy Realty Corporation Yes o No þ

Kilroy Realty, L.P. Yes o No þ

As of October 19, 2018, 100,746,988 shares of Kilroy Realty Corporation common stock, par value $.01 per share, were outstanding.

EXPLANATORY NOTE

This report combines the quarterly reports on Form 10-Q for the period ended September 30, 2018 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 September 30, 2018, the Company owned an approximate 98.0% common general partnership interest in the Operating Partnership. The remaining approximate 2.0% 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-Q. 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 generally 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 generally guarantees all 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 generally contributes 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, 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 interest result from the differences in the equity issued by the Company and the Operating Partnership, and in the Operating Partnership’s noncontrolling interest in the Finance Partnership.

We believe combining the quarterly reports on Form 10-Q 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, Stockholders’ Equity of the Company;


◦	Note 8, Partners’ Capital of the Operating Partnership;


◦	Note 13, Net Income Available to Common Stockholders Per Share of the Company;


◦	Note 14, Net Income Available to Common Unitholders Per Unit of the Operating Partnership;


◦	Note 15, Supplemental Cash Flow Information of the Company; and


◦	Note 16, Supplemental Cash Flow Information of the Operating Partnership;


•	“Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations


◦	—Liquidity and Capital Resources of the Company;” and


◦	—Liquidity and Capital Resources of the Operating Partnership.”

This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for 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.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

QUARTERLY REPORT FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018

TABLE OF CONTENTS



		Page
	PART I – FINANCIAL INFORMATION
Item 1.	FINANCIAL STATEMENTS OF KILROY REALTY CORPORATION	1
	Consolidated Balance Sheets as of September 30, 2018 (unaudited) and December 31, 2017	1
	Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2018 and 2017 (unaudited)	2
	Consolidated Statements of Equity for the Nine Months ended September 30, 2018 and 2017 (unaudited)	3
	Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2018 and 2017 (unaudited)	4
Item 1.	FINANCIAL STATEMENTS OF KILROY REALTY, L.P.	5
	Consolidated Balance Sheets as of September 30, 2018 (unaudited) and December 31, 2017	5
	Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2018 and 2017 (unaudited)	6
	Consolidated Statements of Capital for the Nine Months ended September 30, 2018 and 2017 (unaudited)	7
	Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2018 and 2017 (unaudited)	8
	Notes to Unaudited Consolidated Financial Statements	9
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	26
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	53
Item 4.	CONTROLS AND PROCEDURES (KILROY REALTY CORPORATION AND KILROY REALTY, L.P.)	54
	PART II – OTHER INFORMATION
Item 1.	LEGAL PROCEEDINGS	55
Item 1A.	RISK FACTORS	55
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	55
Item 3.	DEFAULTS UPON SENIOR SECURITIES	55
Item 4.	MINE SAFETY DISCLOSURES	55
Item 5.	OTHER INFORMATION	55
Item 6.	EXHIBITS	56
SIGNATURES		57

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY CORPORATION

KILROY REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



	September 30, 2018			December 31, 2017
ASSETS	(unaudited)
REAL ESTATE ASSETS (Note 2):
Land and improvements	$	1,127,100		$	1,076,172
Buildings and improvements	5,056,050			4,908,797
Undeveloped land and construction in progress	2,146,430			1,432,808
Total real estate assets held for investment	8,329,580			7,417,777
Accumulated depreciation and amortization	(1,411,529		)	(1,264,162		)
Total real estate assets held for investment, net	6,918,051			6,153,615
CASH AND CASH EQUIVALENTS	86,517			57,649
RESTRICTED CASH	—			9,149
MARKETABLE SECURITIES (Note 11)	23,353			20,674
CURRENT RECEIVABLES, NET (Note 3)	17,519			16,926
DEFERRED RENT RECEIVABLES, NET (Note 3)	261,003			246,391
DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET	183,118			183,728
PREPAID EXPENSES AND OTHER ASSETS, NET (Note 4)	72,675			114,706
TOTAL ASSETS	$	7,562,236		$	6,802,838
LIABILITIES AND EQUITY
LIABILITIES:
Secured debt, net (Notes 5 and 11)	$	336,866		$	340,800
Unsecured debt, net (Notes 5 and 11)	2,207,049			2,006,263
Unsecured line of credit (Notes 5, 11 and 17)	330,000			—
Accounts payable, accrued expenses and other liabilities	360,674			249,637
Accrued dividends and distributions (Note 17)	47,411			43,448
Deferred revenue and acquisition-related intangible liabilities, net	149,059			145,890
Rents received in advance and tenant security deposits	56,258			56,484
Total liabilities	3,487,317			2,842,522
COMMITMENTS AND CONTINGENCIES (Note 10)
EQUITY:
Stockholders’ Equity (Note 6):
Common stock, $.01 par value, 150,000,000 shares authorized, 100,746,988 and 98,620,333 shares issued and outstanding, respectively	1,007			986
Additional paid-in capital	3,965,405			3,822,492
Distributions in excess of earnings	(161,654		)	(122,685		)
Total stockholders’ equity	3,804,758			3,700,793
Noncontrolling Interests (Notes 1 and 7):
Common units of the Operating Partnership	76,486			77,948
Noncontrolling interests in consolidated property partnerships	193,675			181,575
Total noncontrolling interests	270,161			259,523
Total equity	4,074,919			3,960,316
TOTAL LIABILITIES AND EQUITY	$	7,562,236		$	6,802,838

See accompanying notes to consolidated financial statements.

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in thousands, except share and per share data)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
REVENUES
Rental income	$	162,288		$	159,954		$	489,674		$	475,527
Tenant reimbursements	21,754			19,665			60,471			58,228
Other property income	2,520			1,915			6,311			7,685
Total revenues	186,562			181,534			556,456			541,440
EXPENSES
Property expenses	35,163			33,070			99,401			97,615
Real estate taxes	17,462			16,371			52,421			50,878
Provision for bad debts (Note 12)	1,338			1,036			6,714			2,743
Ground leases	1,579			1,562			4,726			4,751
General and administrative expenses	19,277			14,514			56,599			43,750
Depreciation and amortization	62,700			62,567			189,421			185,737
Total expenses	137,519			129,120			409,282			385,474
OTHER (EXPENSES) INCOME
Interest income and other net investment gain/loss (Note 11)	342			1,526			1,147			3,629
Interest expense (Note 5)	(11,075		)	(16,151		)	(37,285		)	(51,476		)
Total other (expenses) income	(10,733		)	(14,625		)	(36,138		)	(47,847		)
INCOME FROM OPERATIONS BEFORE GAINS ON SALES OF REAL ESTATE	38,310			37,789			111,036			108,119
Net gain on sale of land	—			449			—			449
Gains on sales of depreciable operating properties	—			37,250			—			39,507
NET INCOME	38,310			75,488			111,036			148,075
Net income attributable to noncontrolling common units of the Operating Partnership	(691		)	(1,394		)	(2,008		)	(2,633		)
Net income attributable to noncontrolling interests in consolidated property partnerships	(3,219		)	(2,984		)	(10,833		)	(9,359		)
Total income attributable to noncontrolling interests	(3,910		)	(4,378		)	(12,841		)	(11,992		)
NET INCOME ATTRIBUTABLE TO KILROY REALTY CORPORATION	34,400			71,110			98,195			136,083
Preferred dividends	—			(808		)	—			(5,774		)
Original issuance costs of redeemed preferred stock and preferred units	—			(3,744		)	—			(7,589		)
Total preferred dividends	—			(4,552		)	—			(13,363		)
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS	$	34,400		$	66,558		$	98,195		$	122,720
Net income available to common stockholders per share – basic (Note 13)	$	0.34		$	0.67		$	0.97		$	1.24
Net income available to common stockholders per share – diluted (Note 13)	$	0.33		$	0.67		$	0.97		$	1.23
Weighted average common shares outstanding – basic (Note 13)	100,676,778			98,352,139			99,711,312			98,008,780
Weighted average common shares outstanding – diluted (Note 13)	101,228,334			98,911,612			100,208,645			98,591,048
Dividends declared per common share	$	0.455		$	0.425		$	1.335		$	1.225

See accompanying notes to consolidated financial statements.

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF EQUITY

(Unaudited; in thousands, except share and per share/unit data)



				Common Stock											Total Stock- holders’ Equity			Noncontrolling Interests			Total Equity
	Preferred Stock			Number of Shares		Common Stock			Additional Paid-in Capital			Retained Earnings / (Distributions in Excess of Earnings)
BALANCE AS OF DECEMBER 31, 2016	$	192,411		93,219,439		$	932		3,457,649			$	(107,997	)	$	3,542,995		$	216,322		$	3,759,317
Net income												136,083			136,083			11,992			148,075
Redemption of Series G and H Preferred stock	(192,411		)									(7,589		)	(200,000		)				(200,000		)
Issuance of common stock				4,427,500		44			308,768						308,812						308,812
Issuance of share-based compensation awards									5,291						5,291						5,291
Non-cash amortization of share-based compensation									19,013						19,013						19,013
Exercise of stock options				282,000		4			12,047						12,051						12,051
Settlement of restricted stock units for shares of common stock				317,848		3			(3		)				—						—
Repurchase of common stock, stock options and restricted stock units				(168,881	)	(2		)	(12,984		)				(12,986		)				(12,986		)
Exchange of common units of the Operating Partnership				304,350		3			10,936						10,939			(10,939		)	—
Contributions from noncontrolling interests in consolidated property partnerships															—			250			250
Distributions to noncontrolling interests in consolidated property partnerships															—			(12,234		)	(12,234		)
Adjustment for noncontrolling interest									(3,171		)				(3,171		)	3,171			—
Preferred dividends												(5,774		)	(5,774		)				(5,774		)
Dividends declared per common share and common unit ($1.225 per share/unit)												(123,390		)	(123,390		)	(2,545		)	(125,935		)
BALANCE AS OF SEPTEMBER 30, 2017	$	—		98,382,256		$	984		$	3,797,546		$	(108,667	)	$	3,689,863		$	206,017		$	3,895,880



	Common Stock											Total Stock- holders’ Equity			Noncontrolling Interests			Total Equity
	Number of Shares		Common Stock			Additional Paid-in Capital			Distributions in Excess of Earnings			Total Stock- holders’ Equity			Noncontrolling Interests			Total Equity
BALANCE AS OF DECEMBER 31, 2017	98,620,333		$	986		$	3,822,492		$	(122,685	)	$	3,700,793		$	259,523		$	3,960,316
Net income									98,195			98,195			12,841			111,036
Issuance of common stock (Note 6)	1,817,195		18			130,726						130,744						130,744
Issuance of share-based compensation awards						3,298						3,298						3,298
Non-cash amortization of share-based compensation						24,678						24,678						24,678
Exercise of stock options	1,000		—			41						41						41
Settlement of restricted stock units for shares of common stock	488,354		4			(4		)				—						—
Repurchase of common stock, stock options and restricted stock units	(231,800	)	(2		)	(16,551		)				(16,553		)				(16,553		)
Exchange of common units of the Operating Partnership	51,906		1			1,961						1,962			(1,962		)	—
Contributions from noncontrolling interests in consolidated property partnerships												—			8,273			8,273
Distributions to noncontrolling interests in consolidated property partnerships												—			(7,006		)	(7,006		)
Adjustment for noncontrolling interest						(1,236		)				(1,236		)	1,236			—
Dividends declared per common share and common unit ($1.335 per share/unit)									(137,164		)	(137,164		)	(2,744		)	(139,908		)
BALANCE AS OF SEPTEMBER 30, 2018	100,746,988		$	1,007		$	3,965,405		$	(161,654	)	$	3,804,758		$	270,161		$	4,074,919

See accompanying notes to consolidated financial statements.

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)



	Nine Months Ended September 30,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	111,036		$	148,075
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate assets and leasing costs	186,242			181,875
Depreciation of non-real estate furniture, fixtures and equipment	3,179			3,862
Increase in provision for bad debts (Note 12)	6,714			2,743
Non-cash amortization of share-based compensation awards	18,901			13,617
Non-cash amortization of deferred financing costs and debt discounts and premiums	816			2,398
Non-cash amortization of net below market rents	(7,647		)	(6,026		)
Gain on sale of depreciable operating properties	—			(39,507		)
Gain on sale of land	—			(449		)
Non-cash amortization of deferred revenue related to tenant-funded tenant improvements	(13,680		)	(12,394		)
Straight-line rents	(16,293		)	(25,537		)
Net change in other operating assets	(9,163		)	(16,970		)
Net change in other operating liabilities	37,110			24,855
Net cash provided by operating activities	317,215			276,542
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for acquisition of undeveloped land (Note 2)	(311,299		)	—
Expenditures for development properties and undeveloped land	(311,347		)	(270,839		)
Expenditures for acquisition of operating properties (Note 2)	(111,029		)	—
Expenditures for operating properties	(107,825		)	(61,875		)
Net proceeds received from dispositions	—			182,492
Net decrease (increase) in acquisition-related deposits	21,000			(30,490		)
Proceeds received from repayment of note receivable (Note 4)	15,100			—
Net cash used in investing activities	(805,400		)	(180,712		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on unsecured revolving credit facility (Note 5)	645,000			70,000
Repayments on unsecured revolving credit facility (Note 5)	(285,000		)	(10,000		)
Borrowings on unsecured debt (Note 5)	120,000			—
Principal payments on secured debt	(2,670		)	(5,740		)
Proceeds from the issuance of unsecured debt (Note 5)	50,000			250,000
Repayments of unsecured debt	—			(189,000		)
Financing costs	(2,278		)	(7,480		)
Net proceeds from issuance of common stock (Note 6)	130,744			308,812
Redemption of Series G and H Preferred stock	—			(200,000		)
Repurchase of common stock and restricted stock units	(16,553		)	(12,986		)
Proceeds from exercise of stock options	41			12,051
Distributions to noncontrolling interests in consolidated property partnerships	(7,014		)	(12,234		)
Contributions from noncontrolling interests in consolidated property partnerships	8,273			250
Dividends and distributions paid to common stockholders and common unitholders	(132,639		)	(297,993		)
Dividends and distributions paid to preferred stockholders and preferred unitholders	—			(7,409		)
Net cash provided by (used in) financing activities	507,904			(101,729		)
Net increase (decrease) in cash and cash equivalents and restricted cash	19,719			(5,899		)
Cash and cash equivalents and restricted cash, beginning of period	66,798			250,129
Cash and cash equivalents and restricted cash, end of period	$	86,517		$	244,230

See accompanying notes to consolidated financial statements.

ITEM 1: FINANCIAL STATEMENTS (UNAUDITED) OF KILROY REALTY, L.P.

KILROY REALTY, L.P.

CONSOLIDATED BALANCE SHEETS

(in thousands, except unit data)



	September 30, 2018			December 31, 2017
ASSETS	(unaudited)
REAL ESTATE ASSETS (Note 2):
Land and improvements	$	1,127,100		$	1,076,172
Buildings and improvements	5,056,050			4,908,797
Undeveloped land and construction in progress	2,146,430			1,432,808
Total real estate assets held for investment	8,329,580			7,417,777
Accumulated depreciation and amortization	(1,411,529		)	(1,264,162		)
Total real estate assets held for investment, net	6,918,051			6,153,615
CASH AND CASH EQUIVALENTS	86,517			57,649
RESTRICTED CASH	—			9,149
MARKETABLE SECURITIES (Note 11)	23,353			20,674
CURRENT RECEIVABLES, NET (Note 3)	17,519			16,926
DEFERRED RENT RECEIVABLES, NET (Note 3)	261,003			246,391
DEFERRED LEASING COSTS AND ACQUISITION-RELATED INTANGIBLE ASSETS, NET	183,118			183,728
PREPAID EXPENSES AND OTHER ASSETS, NET (Note 4)	72,675			114,706
TOTAL ASSETS	$	7,562,236		$	6,802,838
LIABILITIES AND CAPITAL
LIABILITIES:
Secured debt, net (Notes 5 and 11)	$	336,866		$	340,800
Unsecured debt, net (Notes 5 and 11)	2,207,049			2,006,263
Unsecured line of credit (Notes 5, 11 and 17)	330,000			—
Accounts payable, accrued expenses and other liabilities	360,674			249,637
Accrued distributions (Note 17)	47,411			43,448
Deferred revenue and acquisition-related intangible liabilities, net	149,059			145,890
Rents received in advance and tenant security deposits	56,258			56,484
Total liabilities	3,487,317			2,842,522
COMMITMENTS AND CONTINGENCIES (Note 10)
CAPITAL:
Common units, 100,746,988 and 98,620,333 held by the general partner and 2,025,287 and 2,077,193 held by common limited partners issued and outstanding, respectively (Note 8)	3,876,142			3,773,941
Noncontrolling interests in consolidated property partnerships and subsidiaries (Note 1)	198,777			186,375
Total capital	4,074,919			3,960,316
TOTAL LIABILITIES AND CAPITAL	$	7,562,236		$	6,802,838

See accompanying notes to consolidated financial statements.

KILROY REALTY, L.P.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in thousands, except unit and per unit data)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
REVENUES
Rental income	$	162,288		$	159,954		$	489,674		$	475,527
Tenant reimbursements	21,754			19,665			60,471			58,228
Other property income	2,520			1,915			6,311			7,685
Total revenues	186,562			181,534			556,456			541,440
EXPENSES
Property expenses	35,163			33,070			99,401			97,615
Real estate taxes	17,462			16,371			52,421			50,878
Provision for bad debts (Note 12)	1,338			1,036			6,714			2,743
Ground leases	1,579			1,562			4,726			4,751
General and administrative expenses	19,277			14,514			56,599			43,750
Depreciation and amortization	62,700			62,567			189,421			185,737
Total expenses	137,519			129,120			409,282			385,474
OTHER (EXPENSES) INCOME
Interest income and other net investment gain/loss (Note 11)	342			1,526			1,147			3,629
Interest expense (Note 5)	(11,075		)	(16,151		)	(37,285		)	(51,476		)
Total other (expenses) income	(10,733		)	(14,625		)	(36,138		)	(47,847		)
INCOME FROM OPERATIONS BEFORE GAINS ON SALES OF REAL ESTATE	38,310			37,789			111,036			108,119
Net gain on sale of land	—			449			—			449
Gains on sales of depreciable operating properties	—			37,250			—			39,507
NET INCOME	38,310			75,488			111,036			148,075
Net income attributable to noncontrolling interests in consolidated property partnerships and subsidiaries	(3,317		)	(3,086		)	(11,135		)	(9,648		)
NET INCOME ATTRIBUTABLE TO KILROY REALTY, L.P.	34,993			72,402			99,901			138,427
Preferred distributions	—			(808		)	—			(5,774		)
Original issuance costs of redeemed preferred units	—			(3,744		)	—			(7,589		)
Total preferred distributions	—			(4,552		)	—			(13,363		)
NET INCOME AVAILABLE TO COMMON UNITHOLDERS	$	34,993		$	67,850		$	99,901		$	125,064
Net income available to common unitholders per unit – basic (Note 14)	$	0.34		$	0.67		$	0.97		$	1.23
Net income available to common unitholders per unit – diluted (Note 14)	$	0.33		$	0.67		$	0.96		$	1.23
Weighted average common units outstanding – basic (Note 14)	102,721,806			100,429,332			101,773,540			100,160,595
Weighted average common units outstanding – diluted (Note 14)	103,273,362			100,988,805			102,270,873			100,742,863
Dividends declared per common unit	$	0.455		$	0.425		$	1.335		$	1.225

See accompanying notes to consolidated financial statements.

KILROY REALTY, L.P.

CONSOLIDATED STATEMENTS OF CAPITAL

(Unaudited; in thousands, except unit and per unit data)



	Partners’ Capital								Total Partners’ Capital			Noncontrolling Interests in Consolidated Property Partnerships and Subsidiaries
	Preferred Units			Number of Common Units		Common Units			Total Partners’ Capital						Total Capital
BALANCE AS OF DECEMBER 31, 2016	$	192,411		95,600,982		$	3,431,768		$	3,624,179		$	135,138		$	3,759,317
Net income						138,427			138,427			9,648			148,075
Redemption of Series G and H Preferred units	(192,411		)			(7,589		)	(200,000		)				(200,000		)
Issuance of common units				4,427,500		308,812			308,812						308,812
Issuance of share-based compensation awards						5,291			5,291						5,291
Non-cash amortization of share-based compensation						19,013			19,013						19,013
Exercise of stock options				282,000		12,051			12,051						12,051
Settlement of restricted stock units				317,848		—			—						—
Repurchase of common units, stock options and restricted stock units				(168,881	)	(12,986		)	(12,986		)				(12,986		)
Contributions from noncontrolling interests in consolidated property partnerships												250			250
Distributions to noncontrolling interests in consolidated property partnerships												(12,234		)	(12,234		)
Preferred distributions						(5,774		)	(5,774		)				(5,774		)
Distributions declared per common unit ($1.225 per unit)						(125,935		)	(125,935		)				(125,935		)
BALANCE AS OF SEPTEMBER 30, 2017	$	—		100,459,449		$	3,763,078		$	3,763,078		$	132,802		$	3,895,880



	Partners’ Capital					Noncontrolling Interests in Consolidated Property Partnerships and Subsidiaries
	Number of Common Units		Common Units						Total Capital
BALANCE AS OF DECEMBER 31, 2017	100,697,526		$	3,773,941		$	186,375		$	3,960,316
Net income			99,901			11,135			111,036
Issuance of common units (Note 8)	1,817,195		130,744						130,744
Issuance of share-based compensation awards			3,298						3,298
Non-cash amortization of share-based compensation			24,678						24,678
Exercise of stock options	1,000		41						41
Settlement of restricted stock units	488,354		—						—
Repurchase of common units, stock options and restricted stock units	(231,800	)	(16,553		)				(16,553		)
Contributions from noncontrolling interests in consolidated property partnerships			—			8,273			8,273
Distributions to noncontrolling interests in consolidated property partnerships						(7,006		)	(7,006		)
Distributions declared per common unit ($1.335 per unit)			(139,908		)				(139,908		)
BALANCE AS OF SEPTEMBER 30, 2018	102,772,275		$	3,876,142		$	198,777		$	4,074,919

See accompanying notes to consolidated financial statements.

KILROY REALTY, L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)



	Nine Months Ended September 30,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	111,036		$	148,075
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of real estate assets and leasing costs	186,242			181,875
Depreciation of non-real estate furniture, fixtures and equipment	3,179			3,862
Increase in provision for bad debts (Note 12)	6,714			2,743
Non-cash amortization of share-based compensation awards	18,901			13,617
Non-cash amortization of deferred financing costs and debt discounts and premiums	816			2,398
Non-cash amortization of net below market rents	(7,647		)	(6,026		)
Gain on sale of depreciable operating properties	—			(39,507		)
Gain on sale of land	—			(449		)
Non-cash amortization of deferred revenue related to tenant-funded tenant improvements	(13,680		)	(12,394		)
Straight-line rents	(16,293		)	(25,537		)
Net change in other operating assets	(9,163		)	(16,970		)
Net change in other operating liabilities	37,110			24,855
Net cash provided by operating activities	317,215			276,542
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for acquisition of undeveloped land (Note 2)	(311,299		)	—
Expenditures for development properties and undeveloped land	(311,347		)	(270,839		)
Expenditures for acquisition of operating properties (Note 2)	(111,029		)	—
Expenditures for operating properties	(107,825		)	(61,875		)
Net proceeds received from dispositions	—			182,492
Net decrease (increase) in acquisition-related deposits	21,000			(30,490		)
Proceeds received from repayment of note receivable (Note 4)	15,100			—
Net cash used in investing activities	(805,400		)	(180,712		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on unsecured revolving credit facility (Note 5)	645,000			70,000
Repayments on unsecured revolving credit facility (Note 5)	(285,000		)	(10,000		)
Borrowings on unsecured debt (Note 5)	120,000			—
Principal payments on secured debt	(2,670		)	(5,740		)
Proceeds from the issuance of unsecured debt (Note 5)	50,000			250,000
Repayments of unsecured debt	—			(189,000		)
Financing costs	(2,278		)	(7,480		)
Net proceeds from issuance of common units (Note 8)	130,744			308,812
Redemption of Series G and H Preferred units	—			(200,000		)
Repurchase of common units and restricted stock units	(16,553		)	(12,986		)
Proceeds from exercise of stock options	41			12,051
Distributions to noncontrolling interests in consolidated property partnerships	(7,014		)	(12,234		)
Contributions from noncontrolling interests in consolidated property partnerships	8,273			250
Distributions paid to common unitholders	(132,639		)	(297,993		)
Distributions paid to preferred unitholders	—			(7,409		)
Net cash provided by (used in) financing activities	507,904			(101,729		)
Net increase (decrease) in cash and cash equivalents and restricted cash	19,719			(5,899		)
Cash and cash equivalents and restricted cash, beginning of period	66,798			250,129
Cash and cash equivalents and restricted cash, end of period	$	86,517		$	244,230

See accompanying notes to consolidated financial statements.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization, Ownership and Basis of Presentation

Organization and Ownership

Kilroy Realty Corporation (the “Company”) is a self-administered real estate investment trust (“REIT”) active in premier office and mixed-use 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 Greater 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 real estate encompasses 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”). The Company’s common stock is publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “KRC.”

We own our interests in all of our real estate assets through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”). We generally conduct substantially all of our operations through the Operating Partnership. Unless stated otherwise or the context indicates otherwise, the terms “Kilroy Realty Corporation” or the “Company,” “we,” “our,” and “us” refer to Kilroy Realty Corporation and its consolidated subsidiaries and the term “Operating Partnership” refers to Kilroy Realty, L.P. and its consolidated subsidiaries. The descriptions of our business, employees and properties apply to both the Company and the Operating Partnership.

Our stabilized portfolio of operating properties was comprised of the following properties at September 30, 2018:



	Number of Buildings	Rentable Square Feet (unaudited)	Number of Tenants	Percentage Occupied (unaudited)		Percentage Leased (unaudited)
Stabilized Office Properties	104	13,891,493	524	93.5	%	96.6	%



	Number of Buildings	Number of Units	2018 Average Occupancy (unaudited)
Stabilized Residential Property	1	200	83.3	%

Our stabilized portfolio includes all of our properties with the exception of development and redevelopment properties currently committed for construction, under construction, or in the tenant improvement phase, undeveloped land and real estate assets held for sale. We define redevelopment properties as those properties for which we expect to spend significant development and construction costs on the existing or acquired buildings pursuant to a formal plan, the intended result of which is a higher economic return on the property. We define properties in the tenant improvement phase as properties that we are developing or redeveloping where the project has reached cold shell condition and is ready for tenant improvements, which may require additional major base building construction before being placed in service. Projects in the tenant improvement phase are added to our stabilized portfolio once the project reaches the earlier of 95% occupancy or one year from the date of the cessation of major base building construction activities. Costs capitalized to construction in progress for development and redevelopment properties are transferred to land and improvements, buildings and improvements, and deferred leasing costs on our consolidated balance sheets at the historical cost of the property as the projects are placed in service.

As of September 30, 2018, the following properties were excluded from our stabilized portfolio. We did not have any redevelopment properties or properties held for sale at September 30, 2018.



	Number of Properties/Projects	Estimated Rentable Square Feet ⁽¹⁾ (unaudited)
In-process development projects - tenant improvement⁽²⁾	2	1,150,000
In-process development projects - under construction ⁽³⁾	3	956,000

________________________


(1)	Estimated rentable square feet upon completion.


(2)	Includes 86,000 square feet of Production, Distribution, and Repair (“PDR”) space at 100 Hooper.


(3)	In addition to the estimated office and PDR rentable square feet noted above, development projects under construction also include 120,000 square feet of retail space and 608 residential units.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Our stabilized portfolio also excludes our future development pipeline, which as of September 30, 2018 was comprised of seven potential development sites, representing approximately 80 gross acres of undeveloped land.

As of September 30, 2018, all of our properties and development projects were owned and all of our business was conducted in the state of California with the exception of twelve office properties and one development project under construction located in the state of Washington. All of our properties and development projects are 100% owned, excluding four office properties owned by three consolidated property partnerships and a development site held by consolidated variable interest entities for future transactions intended to qualify as like-kind exchanges pursuant to Section 1031 of the Code (“Section 1031 Exchanges”).

Two of the three property partnerships, 100 First Street Member, LLC (“100 First LLC”) and 303 Second Street Member, LLC (“303 Second LLC”), each owned one office property in San Francisco, California through subsidiary REITs. As of September 30, 2018, the Company owned a 56% common equity interest in both 100 First LLC and 303 Second LLC. The third property partnership, Redwood City Partners, LLC (“Redwood LLC”) owned two office properties in Redwood City, California. As of September 30, 2018, the Company owned an approximate 93% common equity interest in Redwood LLC. The remaining interests in all three property partnerships were owned by unrelated third parties.

Ownership and Basis of Presentation

The consolidated financial statements of the Company include the consolidated financial position and results of operations of the Company, the Operating Partnership, the Finance Partnership, 303 Second LLC, 100 First LLC, Redwood LLC and all of our wholly-owned and controlled subsidiaries. The consolidated financial statements of the Operating Partnership include the consolidated financial position and results of operations of the Operating Partnership, the Finance Partnership, 303 Second LLC, 100 First LLC, Redwood LLC and all of our wholly-owned and controlled subsidiaries. All intercompany balances and transactions have been eliminated in the consolidated financial statements.

As of September 30, 2018, the Company owned an approximate 98.0% common general partnership interest in the Operating Partnership. The remaining approximate 2.0% common limited partnership interest in the Operating Partnership as of September 30, 2018 was owned by non-affiliated investors and certain of our executive officers and directors. Both the general and limited common partnership interests in the Operating Partnership are denominated in common units. Generally, the number of common units held by the Company is equivalent to the number of outstanding shares of the Company’s common stock, and the rights of all the common units to quarterly distributions and payments in liquidation mirror those of the Company’s common stockholders. The common limited partners have certain redemption rights as provided in the Operating Partnership’s Seventh Amended and Restated Agreement of Limited Partnership, as amended, the “Partnership Agreement.”

Kilroy Realty Finance, Inc., which is a wholly-owned subsidiary of the Company, is the sole general partner of the Finance Partnership and owns a 1.0% common general partnership interest in the Finance Partnership. The Operating Partnership owns the remaining 99.0% common limited partnership interest. With the exception of the Operating Partnership and our consolidated property partnerships, all of our subsidiaries are wholly-owned.

The accompanying interim financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying interim financial statements reflect all adjustments of a normal and recurring nature that are considered necessary for a fair presentation of the results for the interim periods presented. However, the results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The interim financial statements for the Company and the Operating Partnership should be read in conjunction with the audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2017.

Variable Interest Entities

The Operating Partnership is a variable interest entity (“VIE”) that is consolidated by the Company as the primary beneficiary as the Operating Partnership is a limited partnership in which the common limited partners do not have substantive kick-out or participating rights. At September 30, 2018, the consolidated financial statements of the Company included five VIEs in addition to the Operating Partnership: 100 First LLC, 303 Second LLC and three entities established during the second quarter of 2018 to facilitate potential future Section 1031 Exchanges. At September 30, 2018, the Operating Partnership was determined to be the

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

primary beneficiary of these five VIEs since the Operating Partnership had the ability to control the activities that most significantly impact each of the VIE’s economic performance. As of September 30, 2018, the five VIEs’ total assets, liabilities and noncontrolling interests included on our consolidated balance sheet were approximately $828.3 million (of which $753.8 million related to real estate held for investment), approximately $86.2 million and approximately $187.6 million, respectively. Revenues, income and net assets generated by 100 First LLC and 303 Second LLC may only be used to settle their contractual obligations, which primarily consist of operating expenses, capital expenditures and required distributions.

At December 31, 2017, the consolidated financial statements of the Company and the Operating Partnership included two VIEs in which we were deemed to be the primary beneficiary: 100 First LLC and 303 Second LLC. At December 31, 2017, the impact of consolidating the VIEs increased the Company’s total assets, liabilities and noncontrolling interests on our consolidated balance sheet by approximately $426.5 million (of which $382.1 million related to real estate held for investment), approximately $27.3 million and approximately $175.4 million, respectively.

Accounting Pronouncements Adopted January 1, 2018

Effective January 1, 2018, we adopted Financial Accounting Standards Board (“FASB”) ASU No. 2014-09 “Revenue From Contracts with Customers (Topic 606)” (“ASU 2014-09”) and the related FASB ASU Nos. 2016-12 and 2016-20, which provide practical expedients, technical corrections, and improvements for certain aspects of ASU 2014-09, on a modified retrospective basis. ASU 2014-09 establishes a single comprehensive model for entities to use in accounting for revenue from contracts with customers and supersedes most of the existing revenue recognition guidance.

We evaluated each of the Company’s revenue streams to determine the sources of revenue that are impacted by ASU 2014-09 and concluded that two revenue streams, sales of real estate and revenue from our multi-tenant parking arrangements, fall within the scope of Topic 606. We evaluated the impact of the adoption of the guidance on the timing of gain recognition for our historical dispositions and concluded there was no significant impact to our consolidated financial statements given the straight forward nature of our historical disposition transactions. We also evaluated the impact of the guidance on the timing and pattern of revenue recognition for our multi-tenant parking arrangements and determined there was no significant impact to our consolidated financial statements. We generally provide parking for our multi-tenant properties based on the prevailing market rate per parking space, which adjusts based on prevailing market rates during the tenant’s occupancy, and we recognize parking revenue as parking spaces are utilized by the tenant. Given the structure of these arrangements whereby the amount of parking revenue we recognize corresponds directly to the tenant’s use, we were able to apply the practical expedient provided in Accounting Standards Codification (“ASC”) 606-10-50-14(b) (the “right to invoice” practical expedient). As a result of applying this practical expedient, we are not required to disclose the transaction price allocated to future performance obligations for multi-tenant parking since we cannot predict or estimate the use of such parking spaces. During the three months ended September 30, 2018 and 2017, we recognized $6.7 million and $6.6 million, respectively, of parking revenue for arrangements that are within the scope of Topic 606, which is included in rental revenues on our consolidated statements of operations. During the nine months ended September 30, 2018 and 2017, we recognized $20.2 million and $20.3 million, respectively, of parking revenue for arrangements that are within the scope of Topic 606, which is included in rental revenues on our consolidated statements of operations. We concluded that the adoption of Topic 606 did not have a material impact on our consolidated financial statements or a material impact on the notes to our consolidated financial statements.

Effective January 1, 2018, we adopted FASB ASU No. 2017-09 “Compensation - Stock Compensation (Topic 718)” on a prospective basis. Under the guidance, an entity will not apply modification accounting to a share-based payment award if the award’s fair value, vesting conditions, and classification as an equity or liability instrument remain the same immediately before and after the change. The adoption of this guidance did not have an impact on our consolidated financial statements or notes to our consolidated financial statements.

Effective January 1, 2018, we adopted FASB ASU No. 2017-05 “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20)” (“ASU 2017-05”) on a retrospective basis. This standard clarifies the scope of the original guidance within Subtopic 610-20 “Gains and Losses from the Derecognition of Nonfinancial Assets” that was issued in connection with ASU 2014-09 which provided guidance for recognizing gains and losses from the transfer of nonfinancial assets in transactions with noncustomers. Additionally, ASU 2017-05 adds guidance pertaining to the partial sales of real estate and clarifies that nonfinancial assets within the scope of ASC 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty. For example, a parent may transfer control of nonfinancial assets by transferring ownership interests in a consolidated subsidiary. We evaluated the impact of the new amendments on our historical transactions and concluded that there was no impact. As such, the adoption of this guidance did not have an impact on our consolidated financial statements or notes to our consolidated financial statements.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Effective January 1, 2018, we adopted FASB ASU No. 2016-15 (“ASU 2016-15”) which provides guidance where there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows, on a retrospective basis. The adoption of this guidance did not have an impact on our consolidated financial statements or notes to our consolidated financial statements.

Effective January 1, 2018, we adopted FASB ASU No. 2016-01 (“ASU 2016-01”) which amends the accounting guidance on the classification and measurement of financial instruments and FASB ASU No. 2018-03 (“ASU 2018-03”) which provides technical corrections and improvements to ASU 2016-01, on a modified retrospective basis. The amendments require that all investments in equity securities, including other ownership interests, are reported at fair value with changes in fair value reported in net income. This requirement does not apply to investments that qualify for equity method accounting or to those that result in consolidation of the investee or for which the entity has elected the predictability exception to fair value measurement. Additionally, the amendments require that the portion of the total fair value change caused by a change in instrument-specific credit risk for financial liabilities for which the fair value option has been elected would be recognized in other comprehensive income. Any accumulated amount remaining in other comprehensive income is reclassified to earnings when the liability is extinguished. The adoption of this guidance did not have an impact on our consolidated financial statements or notes to our consolidated financial statements since our only financial instruments within the scope of ASU 2016-01 and 2018-03 are the marketable securities related to our deferred compensation plan which are classified as trading securities and marked to market at fair value through earnings each reporting period.

Accounting Pronouncements Effective January 1, 2019

ASU No. 2016-02 “Leases (Topic 842)”

On February 25, 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842)” (“ASU 2016-02”) to amend the accounting guidance for leases. The accounting applied by a lessor is largely unchanged under ASU 2016-02. However, the standard requires lessees to recognize lease assets and lease liabilities for leases classified as operating leases on the balance sheet. Lessees will recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it will recognize lease expense for such leases generally on a straight-line basis over the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted.

In July 2018, the FASB issued ASU No. 2018-11 which (1) simplifies transition requirements for both lessees and lessors by adding an option that permits an organization to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in its financial statements and (2) provides a practical expedient for lessors that permits lessors to make an accounting policy election to not separate nonlease components from the associated lease components, if the following two criteria are met: (1) the timing and pattern of transfer of the lease and nonlease components are the same and (2) the lease component would be classified as an operating lease if accounted for separately. For leases where we are the lessor, we plan to elect the optional transition relief and apply the practical expedients provided by ASU 2018-11. As a result, leases where we are the lessor will be accounted for in a similar method to existing standards with the underlying leased asset being reported and recognized as a real estate asset.

In August 2018, the FASB released an exposure draft to amend ASU 2016-02 that clarifies lessor treatment of sales taxes and other similar taxes collected from lessees, lessor costs paid directly by lessees and recognition of variable payments for contracts with lease and nonlease components. If the amendments are codified as currently drafted, we do not expect the amendments to have an impact on our consolidated financial statements.

ASU 2016-02 also specifies that upon adoption, lessors will no longer be able to capitalize and amortize certain leasing related costs and instead will only be permitted to capitalize and amortize incremental direct leasing costs. As a result, we have concluded that upon the adoption of the standard, we will be required to expense as incurred certain leasing costs we are currently able to capitalize and amortize as deferred leasing costs under existing guidance. We continue to evaluate the impact of this change in the guidance and we currently expect this change will have a material impact to the Company’s consolidated financial statements and results of operations upon adoption of the standard on January 1, 2019.

For leases where we are the lessee, specifically for our ground leases, the adoption of the standard will significantly change the accounting on our consolidated balance sheets since both existing ground leases and any future ground leases will be required to be recorded on the Company’s consolidated balance sheets as an obligation of the Company. Existing ground leases executed before the January 1, 2019 adoption date will continue to be accounted for as operating leases and the new guidance will not have a material impact on our recognition of ground lease expense or our results of operations. However, we will be required to recognize

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

a right of use asset and a lease liability on our consolidated balance sheets equal to the present value of the minimum lease payments required in accordance with each ground lease. As of September 30, 2018, our future undiscounted minimum rental payments under these leases totaled $248.6 million, with several of the leases containing provisions for rental payments to fluctuate based on fair market value and operating income measurements with expirations through 2093. In addition, we currently believe that for new ground leases entered into after the adoption date of the new standard, such leases could be required to be accounted for as financing type leases, resulting in ground lease expense recorded using the effective interest method instead of on a straight-line basis over the term of the lease. This could have a significant impact on our results of operations if we enter into material new ground leases after the date of adoption since ground lease expense calculated using the effective interest method results in an increased amount of ground lease expense in the earlier years of a ground lease as compared to the current straight-line method.

Accounting Pronouncements Effective in 2020 and Beyond

ASU No. 2016-13 “Financial Instruments - Credit Losses (Topic 326)”

On June 16, 2016, the FASB issued ASU No. 2016-13 (“ASU 2016-13”) to amend the accounting for credit losses for certain financial instruments. Under the new guidance, an entity recognizes its estimate of expected credit losses as an allowance, which the FASB believes will result in more timely recognition of such losses. In August 2018, the FASB released an exposure draft to amend ASU 2016-03. The proposed amendment would clarify that receivables arising from operating leases are not within the scope of Subtopic 326-20 “Financial Instruments – Credit Losses.” Instead, impairment of receivables arising from operating leases should be accounted for under Subtopic 842-30 “Leases – Lessor.” ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not currently anticipate that the guidance will have a material impact on the consolidated financial statements or notes to the consolidated financial statements.

ASU No. 2018-13 “Fair Value Measurement (Topic 820)”

On August 28, 2018, the FASB issued ASU No. 2018-13 (“ASU 2018-13”) to amend the disclosure requirements for fair value measurements. The amendments in ASU 2018-13 include new, modified and eliminated disclosure requirements and are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting - Chapter 8: Notes to Financial Statements, which the Board finalized on August 28, 2018. The Board used the guidance in the Concepts Statement to improve the effectiveness of ASC 820’s disclosure requirements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for any eliminated or modified disclosures. The Company currently anticipates that the guidance will not have a significant impact on the disclosures in the notes to the consolidated financial statements.

ASU No. 2018-15 “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40)”

On August 29, 2018, the FASB issued ASU No. 2018-15 (“ASU 2018-15”) to amend a customer’s accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. ASU 2018-15 can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently evaluating the impact of ASU 2018-15 on the consolidated financial statements and notes to the consolidated financial statements.

2. Acquisitions

Operating Property Acquisitions

During the nine months ended September 30, 2018, we acquired the three operating properties listed below from an unrelated third party. The acquisition was funded with proceeds from the Company’s unsecured revolving credit facility and unsecured term loan facility.



Property	Date of Acquisition	Number of Buildings	Rentable Square Feet (unaudited)	Purchase Price (in millions) ⁽¹⁾
345, 347 & 349 Oyster Point Boulevard, South San Francisco, CA	January 31, 2018	3	145,530	$	111.0

________________________


(1)	Excludes acquisition-related costs.

The related assets, liabilities and results of operations of the acquired properties are included in the consolidated financial statements as of the date of acquisition. The following table summarizes the assets acquired and liabilities assumed as of the date of acquisition, excluding acquisition-related costs:



	Total 2018 Operating Property Acquisitions

Assets
Land and improvements	$	50,928
Buildings and improvements ⁽¹⁾	59,123
Deferred leasing costs and acquisition-related intangible assets ⁽²⁾	4,470
Total assets acquired	$	114,521
Liabilities
Deferred revenue and acquisition-related intangible liabilities ⁽³⁾	$	3,521
Total liabilities assumed	3,521
Net assets and liabilities acquired	$	111,000

________________________


(1)	Represents buildings, building improvements and tenant improvements.


(2)	Represents in-place leases (approximately $3.8 million with a weighted average amortization period of 2.6 years) and leasing commissions (approximately $0.7 million with a weighted average amortization period of 3.5 years).


(3)	Represents below-market leases (approximately $3.5 million with a weighted average amortization period of 9.8 years).

Development Project Acquisitions

During the nine months ended September 30, 2018, we acquired the following development site, which is located adjacent to the three operating properties we acquired in January 2018, from an unrelated third party. The acquisition was funded with proceeds from the Company’s unsecured revolving credit facility and the Company’s at-the-market stock offering program.



Project	Date of Acquisition	City/Submarket	Type	Purchase Price (in millions) ⁽¹⁾
Kilroy Oyster Point	June 1, 2018	South San Francisco	Land	$	308.2

________________________

(1)

Excludes acquisition-related costs. In connection with this acquisition, we also recorded $40.6 million in accrued liabilities and environmental remediation liabilities at the date of acquisition, which are not included in the purchase price above. As of September 30, 2018, the purchase price and assumed liabilities are included in undeveloped land and construction in progress and the assumed liabilities are included in accounts payable, accrued expenses and other liabilities on the Company’s consolidated balance sheets.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

3. Receivables

Current Receivables, net

Current receivables, net consisted of the following as of September 30, 2018 and December 31, 2017:



	September 30, 2018			December 31, 2017
	(in thousands)
Current receivables	$	21,674		$	19,235
Allowance for uncollectible tenant receivables	(4,155		)	(2,309		)
Current receivables, net	$	17,519		$	16,926

Deferred Rent Receivables, net

Deferred rent receivables, net consisted of the following as of September 30, 2018 and December 31, 2017:



	September 30, 2018			December 31, 2017
	(in thousands)
Deferred rent receivables	$	265,858		$	249,629
Allowance for deferred rent receivables	(4,855		)	(3,238		)
Deferred rent receivables, net	$	261,003		$	246,391

4. Prepaid Expenses and Other Assets, Net

Prepaid expenses and other assets, net consisted of the following at September 30, 2018 and December 31, 2017:



	September 30, 2018		December 31, 2017
	(in thousands)
Furniture, fixtures and other long-lived assets, net	$	36,717	$	39,686
Notes receivable, net⁽¹⁾	2,046		19,912
Prepaid expenses & acquisition deposits	33,912		55,108
Total prepaid expenses and other assets, net	$	72,675	$	114,706

________________________


(1)	During the nine months ended September 30, 2018, a note receivable with a balance of $15.1 million was repaid to the Company. Notes receivable are shown net of a valuation allowance of approximately $2.9 million as of September 30, 2018.

5. Secured and Unsecured Debt of the Operating Partnership

The Company generally guarantees all of the Operating Partnership’s unsecured debt obligations including the unsecured revolving credit facility, the unsecured term loan facility and all of the unsecured senior notes.

Unsecured Senior Notes - Private Placement

On May 11, 2018, the Operating Partnership entered into a Note Purchase Agreement (the “Note Purchase Agreement”) in connection with the issuance and sale of $50.0 million principal amount of the Operating Partnership’s 4.30% Senior Notes, Series A, due July 18, 2026 (the “Series A Notes”), and $200.0 million principal amount of the Operating Partnership’s 4.35% Senior Notes, Series B, due October 18, 2026 (the “Series B Notes” and, together with the Series A Notes, the “Series A and B Notes”), pursuant to a private placement. The Company drew the full amount of the Series A Notes on July 18, 2018. As of September 30, 2018, there were no amounts issued or outstanding under the Series B Notes. On October 22, 2018, the Company drew the full amount of the Series B Notes, the proceeds of which were used to repay a portion of the outstanding balance on our unsecured revolving credit facility. The Series A and B Notes mature on their respective due dates, unless earlier redeemed or prepaid pursuant to the terms of the Note Purchase Agreement. Interest on the Series A and B Notes is payable semi-annually in arrears on April 18 and October 18 of each year beginning April 18, 2019.

The Operating Partnership may, at its option and upon notice to the purchasers of the Series A and B Notes, prepay at any time all, or from time to time any part of the Series A and B Notes then outstanding (in an amount not less than 5% of the aggregate

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

principal amount of the Series A and B Notes then outstanding in the case of a partial prepayment), at 100% of the principal amount so prepaid, plus the make-whole amount determined for the prepayment date with respect to such principal amount as set forth in the Note Purchase Agreement.

In connection with the issuance of the Series A and B Notes, the Company will enter into an agreement whereby it will guarantee the payment by the Operating Partnership of all amounts due with respect to the Series A and B Notes and the performance by the Operating Partnership of its obligations under the Note Purchase Agreement.

Unsecured Revolving Credit Facility and Term Loan Facility

The following table summarizes the balance and terms of our unsecured revolving credit facility as of September 30, 2018 and December 31, 2017:



	September 30, 2018			December 31, 2017
	(in thousands)
Outstanding borrowings	$	330,000		$	—
Remaining borrowing capacity	420,000			750,000
Total borrowing capacity ⁽¹⁾	$	750,000		$	750,000
Interest rate ⁽²⁾	3.23		%	2.56		%
Facility fee-annual rate ⁽³⁾	0.200%
Maturity date	July 2022

________________________


(1)	We may elect to borrow, subject to bank approval and obtaining commitments for any additional borrowing capacity, up to an additional $600.0 million under an accordion feature under the terms of the unsecured revolving credit facility and unsecured term loan facility.


(2)	Our unsecured revolving credit facility interest rate was calculated based on an annual rate of LIBOR plus 1.000% as of September 30, 2018 and December 31, 2017.

(3)

Our facility fee is paid on a quarterly basis and is calculated based on the total borrowing capacity. In addition to the facility fee, we incurred debt origination and legal costs. As of September 30, 2018 and December 31, 2017, $5.0 million and $6.0 million of unamortized deferred financing costs, respectively, which are included in prepaid expenses and other assets, net on our consolidated balance sheets, remained to be amortized through the maturity date of our unsecured revolving credit facility.

The Company intends to borrow under the unsecured revolving credit facility from time to time for general corporate purposes, to finance development and redevelopment expenditures, to fund potential acquisitions and to potentially repay long-term debt. Refer to Note 17 for repayments of outstanding borrowings under the unsecured revolving credit facility subsequent to September 30, 2018.

During the first quarter of 2018, we borrowed the full $150.0 million borrowing capacity of our unsecured term loan facility. In connection with the funding of the outstanding borrowings, we transferred $30.0 million of outstanding borrowings under the unsecured revolving credit facility to the balance of our unsecured term loan facility. As a result, only $120.0 million of cash proceeds were received from the funding of the unsecured term loan facility. The following table summarizes the balance and terms of our unsecured term loan facility as of September 30, 2018 and December 31, 2017:



	September 30, 2018			December 31, 2017
	(in thousands)
Outstanding borrowings	$	150,000		$	—
Remaining borrowing capacity	—			150,000
Total borrowing capacity ⁽¹⁾	$	150,000		$	150,000
Interest rate ⁽²⁾	3.23		%	2.66		%
Undrawn facility fee-annual rate ⁽³⁾	0.200%
Maturity date	July 2022

________________________


(1)	As of September 30, 2018 and December 31, 2017, $1.0 million and $1.2 million of unamortized deferred financing costs, respectively, remained to be amortized through the maturity date of our unsecured term loan facility.


(2)	Our unsecured term loan facility interest rate was calculated based on an annual rate of LIBOR plus 1.100% as of September 30, 2018 and December 31, 2017.


(3)	Prior to borrowing the full capacity of our unsecured term loan facility, the undrawn facility fee was calculated based on any unused borrowing capacity and was paid on a quarterly basis.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Debt Covenants and Restrictions

The unsecured revolving credit facility, unsecured term loan facility, unsecured senior notes, and certain other secured debt arrangements contain covenants and restrictions requiring us to meet certain financial ratios and reporting requirements. Some of the more restrictive financial covenants include a maximum ratio of total debt to total asset value, a minimum fixed-charge coverage ratio, a minimum unsecured debt ratio and a minimum unencumbered asset pool debt service coverage ratio. Noncompliance with one or more of the covenants and restrictions could result in the full principal balance of the associated debt becoming immediately due and payable. We believe we were in compliance with all of our debt covenants as of September 30, 2018.

Debt Maturities

The following table summarizes the stated debt maturities and scheduled amortization payments of our issued and outstanding debt, excluding unamortized debt discounts, premiums and deferred financing costs, as of September 30, 2018:



Year	(in thousands)
Remaining 2018	$	914
2019	76,309
2020	255,137
2021	5,342
2022	485,554
Thereafter	2,068,469
Total ⁽¹⁾	$	2,891,725

________________________


(1)	Includes gross principal balance of outstanding debt before the effect of the following at September 30, 2018: $13.3 million of unamortized deferred financing costs for the unsecured term loan facility, unsecured senior notes and secured debt, $5.7 million of unamortized discounts for the unsecured senior notes and $1.2 million of unamortized premiums for the secured debt.

Capitalized Interest and Loan Fees

The following table sets forth gross interest expense, including debt discount/premium and deferred financing cost amortization, net of capitalized interest, for the three and nine months ended September 30, 2018 and 2017. The interest expense capitalized was recorded as a cost of development and increased the carrying value of undeveloped land and construction in progress.



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(in thousands)
Gross interest expense	$	30,231		$	28,331		$	85,834		$	84,577
Capitalized interest and deferred financing costs	(19,156		)	(12,180		)	(48,549		)	(33,101		)
Interest expense	$	11,075		$	16,151		$	37,285		$	51,476

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

6. Stockholders’ Equity of the Company

Forward Equity Offering

On August 8, 2018, the Company entered into forward equity sale agreements with certain financial institutions acting as forward purchasers in connection with an offering of 5,000,000 common shares at an initial gross offering price of $360.5 million, or $72.10 per share, before underwriting discounts, commissions and offering expenses. The forward purchasers borrowed and sold an aggregate of 5,000,000 shares in the offering. The Company did not receive any proceeds from the sale of its common shares by the forward purchasers in the offering. The Company currently expects to fully physically settle the forward sale agreements and receive cash proceeds upon one or more settlement dates, at the Company’s discretion, prior to the final settlement date under the forward sale agreements of August 1, 2019. The forward sale price that we expect to receive upon physical settlement of the agreements will be subject to adjustment for (i) the forward purchasers’ stock borrowing costs and (ii) scheduled dividends during the term of the agreements. The full amount of this offering remains available for future settlement as of the date of this filing. Upon issuance of shares, the Company will contribute the net proceeds from these issuances to the Operating Partnership in exchange for an equal number of units in the Operating Partnership.

At-The-Market Stock Offering Program

In May 2018, the Company completed its then existing at-the-market stock offering program, under which we sold an aggregate of $300.0 million in gross sales of shares. In June 2018, the Company commenced a new at-the-market stock offering program (the “2018 At-The-Market Program”), under which we may currently offer and sell shares of our common stock with an aggregate gross sales price of up to $500.0 million. In connection with the 2018 At-The-Market-Program, the Company also entered into related forward purchase agreements whereby, at our discretion, we may sell shares of our common stock under the 2018 At-The-Market-Program under forward equity sale agreements. The use of a forward equity sale agreement would allow the Company to lock in a share price on the sale of shares of our common stock at the time the agreement is executed, but defer receiving the proceeds from the sale of shares until a later date. This also allows us to defer the potential dilutive impact of such offering of shares until such time as we settle the forward equity sale agreements.

Since commencement of our 2018 At-The-Market Program in June 2018, we have sold 447,466 shares of common stock through September 30, 2018, none of which were sold under forward equity sale agreements. Approximately $466.2 million remains available to be sold under this program.

The following table sets forth information regarding sales of common stock under our at-the-market offering programs for the nine months ended September 30, 2018:



	Nine Months Ended September 30, 2018
	(in millions, except share and per share data)
Shares of common stock sold during the period	1,817,195
Weighted average price per common share	$	73.64
Aggregate gross proceeds	$	133.8
Aggregate net proceeds after selling commissions	$	132.1

The proceeds from sales were used to fund acquisitions, development expenditures and general corporate purposes. Actual future sales will depend upon a variety of factors, including but not limited to, market conditions, the trading price of the Company’s common stock and our capital needs. We have no obligation to sell the remaining shares available for sale under this program.

7. Noncontrolling Interests on the Company’s Consolidated Financial Statements

Common Units of the Operating Partnership

The Company owned an approximate 98.0%, 97.9%, and 97.9% common general partnership interest in the Operating Partnership as of September 30, 2018, December 31, 2017 and September 30, 2017, respectively. The remaining approximate 2.0%, 2.1%, and 2.1% common limited partnership interest as of September 30, 2018, December 31, 2017 and September 30, 2017, respectively, was owned by non-affiliated investors and certain of our executive officers and directors in the form of noncontrolling common units. There were 2,025,287, 2,077,193 and 2,077,193 common units outstanding held by these investors, executive officers and directors as of September 30, 2018, December 31, 2017 and September 30, 2017, respectively.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The noncontrolling common units may be redeemed by unitholders for cash. Except under certain circumstances, we, at our option, may satisfy the cash redemption obligation with shares of the Company’s common stock on a one-for-one basis. If satisfied in cash, the value for each noncontrolling common unit upon redemption is the amount equal to the average of the closing quoted price per share of the Company’s common stock, par value $.01 per share, as reported on the NYSE for the ten trading days immediately preceding the applicable redemption date. The aggregate value upon redemption of the then-outstanding noncontrolling common units was $143.4 million and $154.5 million as of September 30, 2018 and December 31, 2017, respectively. This redemption value does not necessarily represent the amount that would be distributed with respect to each noncontrolling common unit in the event of our termination or liquidation. In the event of our termination or liquidation, it is expected in most cases that each common unit would be entitled to a liquidating distribution equal to the liquidating distribution payable in respect of each share of the Company’s common stock.

8. Partners’ Capital of the Operating Partnership

At-The-Market Stock Offering Program

During the nine months ended September 30, 2018, the Company utilized its at-the-market stock offering programs to issue shares of common stock (see Note 6 “Stockholders’ Equity of the Company” for additional information). The net offering proceeds were contributed by the Company to the Operating Partnership in exchange for common units for the nine months ended September 30, 2018 as follows:



	Nine Months Ended September 30, 2018
	(in millions, except share data)
Shares of common stock contributed by the Company	1,817,195
Common units exchanged for share of common stock by the Company	1,817,195
Aggregate gross proceeds	$	133.8
Aggregate net proceeds after selling commissions	$	132.1

Common Units Outstanding

The following table sets forth the number of common units held by the Company and the number of common units held by non-affiliated investors and certain of our executive officers and directors in the form of noncontrolling common units as well as the ownership interest held on each respective date:



	September 30, 2018		December 31, 2017		September 30, 2017
Company owned common units in the Operating Partnership	100,746,988		98,620,333		98,382,256
Company owned general partnership interest	98.0	%	97.9	%	97.9	%
Noncontrolling common units of the Operating Partnership	2,025,287		2,077,193		2,077,193
Ownership interest of noncontrolling interest	2.0	%	2.1	%	2.1	%

For further discussion of the noncontrolling common units as of September 30, 2018 and December 31, 2017, refer to Note 7.

9. Share-Based Compensation

Stockholder Approved Equity Compensation Plans

As of September 30, 2018, we maintained one share-based incentive compensation plan, the Kilroy Realty 2006 Incentive Award Plan, as amended (the “2006 Plan”). As of September 30, 2018, approximately 1.8 million shares were available for grant under the 2006 Plan. The calculation of shares available for grant is presented after taking into account a reserve for a sufficient number of shares to cover the vesting and payment of 2006 Plan awards that were outstanding on that date, including performance-based vesting awards at (i) levels actually achieved for the performance or market conditions (as defined below) for which the performance period has been completed and (ii) at target levels for the performance or market conditions (as defined below) for awards still in a performance period.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

2018 Share-Based Compensation Grants

In January and February 2018, the Executive Compensation Committee of the Company’s Board of Directors awarded 282,038 restricted stock units (“RSUs”) to certain officers of the Company under the 2006 Plan, which included 158,205 RSUs (at the target level of performance) that are subject to market and/or performance-based vesting requirements (the “2018 Performance-Based RSUs”) and 123,833 RSUs that are subject to time-based vesting requirements (the “2018 Time-Based RSUs”).

2018 Performance-Based RSU Grant

The 2018 Performance-Based RSUs are scheduled to vest at the end of a three-year period (consisting of calendar years 2018-2020). A target number of 2018 Performance-Based RSUs were awarded, and the final number of 2018 Performance-Based RSUs that vest (which may be more or less than the target number) will be based upon (1) the achievement of pre-set FFO per share goals for the year ending December 31, 2018 that applies to 100% of the Performance-Based RSUs awarded (the “FFO performance condition”) and (2) a performance measure that applies to 50% of the award based upon a measure of the Company’s average debt to EBITDA ratio for the three-year performance period (the “debt to EBITDA ratio performance condition”) and a market measure that applies to the other 50% of the award based upon the relative ranking of the Company’s total stockholder return for the three-year performance period compared to the total stockholder returns of an established comparison group of companies over the same period (the “market condition”). The 2018 Performance-Based RSUs are also subject to a three-year service vesting provision and are scheduled to cliff vest on the date the final vesting percentage is determined following the end of the three-year performance period under the awards. The number of 2018 Performance-Based RSUs ultimately earned could fluctuate from the target number of 2018 Performance-Based RSUs granted based upon the levels of achievement for the FFO performance condition, the debt to EBITDA ratio performance condition, the market condition, and the extent to which the service vesting condition is satisfied. The estimate of the number of 2018 Performance-Based RSUs earned is evaluated quarterly during the performance period based on our estimate for each of the performance conditions measured against the applicable goals. As of September 30, 2018, the number of 2018 Performance-Based RSUs estimated to be earned based on the Company’s estimate of the performance conditions measured against the applicable goals was 180,931, and the compensation cost recorded to date for this program was based on that estimate. Compensation expense for the 2018 Performance-Based RSU grant is recognized on a straight-line basis over the requisite service period for each participant, which is generally the three-year service period.

Each 2018 Performance-Based RSU represents the right, subject to the applicable vesting conditions, to receive one share of our common stock in the future. The determination of the grant date fair value of the portion of the 2018 Performance-Based RSU grants covered by the debt to EBITDA ratio performance condition was based on the $66.46 share price on the grant date. The determination of the grant date fair value of the portion of the 2018 Performance-Based RSU grants covered by the market condition was calculated using a Monte Carlo simulation pricing model based on the assumptions in the table below, which resulted in a $70.08 grant date fair value per share.



	Fair Value Assumptions
Expected share price volatility	20.00%
Risk-free interest rate	2.37%
Expected life	2.9 years

The computation of expected volatility is based on a blend of the historical volatility of our shares of common stock over approximately 5.8 years, as that is expected to be most consistent with future volatility and equates to a time period twice as long as the approximate 2.9-year performance period of the RSUs, and implied volatility data based on the observed pricing of six month publicly-traded options on our shares of common stock. The risk-free interest rate is based on the yield curve on zero-coupon U.S. Treasury STRIP securities in effect at February 14, 2018. The expected life of the 2018 Performance-Based RSUs is equal to the remaining 2.9-year vesting period as of February 14, 2018.

The total grant date fair value of the 2018 Performance-Based RSU awards was $10.8 million on the February 14, 2018 grant date of the awards. For the nine months ended September 30, 2018, we recorded compensation expense based upon the grant date fair value per share for each component multiplied by the estimated number of RSUs to be earned as discussed above.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

2018 Time-Based RSU Grant

The 2018 Time-Based RSUs are scheduled to vest in three equal annual installments beginning on January 5, 2019 through January 5, 2021. Compensation expense for the 2018 Time-Based RSUs is recognized on a straight-line basis over the requisite service period for each participant, which is generally the three-year service vesting period. Each 2018 Time-Based RSU represents the right to receive one share of our common stock in the future. The total grant date fair value of the 2018 Time-Based RSU awards was $8.4 million, which was based on the $70.37 and $66.46 closing share prices of the Company’s common stock on the NYSE on the January 29, 2018 and February 14, 2018, respectively, grant dates of the awards.

Share-Based Compensation Cost Recorded During the Period

The total compensation cost for all share-based compensation programs was $8.1 million and $6.4 million for the three months ended September 30, 2018 and 2017, respectively, and $24.7 million and $19.0 million for the nine months ended September 30, 2018 and 2017, respectively. Of the total share-based compensation costs, $1.5 million and $1.7 million was capitalized as part of real estate assets and deferred leasing costs for the three months ended September 30, 2018 and 2017, respectively, and $5.8 million and $5.4 million for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, there was approximately $24.3 million of total unrecognized compensation cost related to nonvested incentive awards granted under share-based compensation arrangements that is expected to be recognized over a weighted-average period of 1.8 years. The remaining compensation cost related to these nonvested incentive awards had been recognized in periods prior to September 30, 2018.

10. Commitments and Contingencies

General

As of September 30, 2018, we had commitments of approximately $776.5 million, excluding our ground lease commitments, for contracts and executed leases directly related to our operating properties and development projects.

Environmental Matters

We follow the policy of monitoring all of our properties, both acquisition and existing stabilized portfolio properties, for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to our stabilized portfolio properties that would have a material adverse effect on our financial condition, results of operations and cash flow, or that we believe would require additional disclosure or the recording of a loss contingency.

As of September 30, 2018, we had accrued environmental remediation liabilities of approximately $79.6 million recorded on our consolidated balance sheets in connection with certain of our in-process and future development projects. The accrued environmental remediation liabilities represent the remaining costs we estimate we will incur when we commence development at various development acquisition sites. These estimates, which we developed with the assistance of third party experts, consist primarily of the removal of contaminated soil and other related costs since we are required to dispose of any existing contaminated soil when we develop new properties at these sites.

We record estimated environmental remediation obligations for acquired properties at the acquisition date when we are aware of such costs and when such costs are probable of being incurred and can be reasonably estimated. Estimated costs related to development environmental remediation liabilities are recorded as an increase to the cost of the development project. Actual costs are recorded as a decrease to the liability when incurred. These accruals are adjusted as an increase or decrease to the development project costs and as an increase or decrease to the accrued environmental remediation liability if we obtain further information or circumstances change. The environmental remediation obligation recorded at September 30, 2018 was not discounted to its present value since we expect to complete the remediation activities in the next one to five years in connection with development activities at the various sites. It is possible that we could incur additional environmental remediation costs in connection with these future development projects. However, given we are in the pre-development phase on these future development projects, potential additional environmental costs cannot be reasonably estimated at this time and certain changes in estimates could occur as the site conditions, final project timing, design elements, actual soil conditions and other aspects of the projects, which may depend upon municipal and other approvals beyond the control of the Company, are determined.

KILROY REALTY CORPORATION AND KILROY REALTY, L.P.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Other than the accrued envir