KILROY REALTY CORP, 10-K/A, 1999-08-10

KILROY REALTY CORP
10-K/A, 1999-08-10
REAL ESTATE INVESTMENT TRUSTS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

AMENDMENT NO. 1 TO FORM 10-K

FORM 10-K/A

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998

[_] 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
(Exact name of registrant as specified in its charter)

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<S> <C>
Maryland 95-4598246
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)

2250 East Imperial Highway, Suite 1200 90245
El Segundo, California (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (310) 563-5500

Securities registered pursuant to Section 12(b) of the Act:

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Title of each class Name of each exchange on which registered
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<S> <C>
Common Stock, $.01 par value New York Stock Exchange
</TABLE>

Securities registered pursuant to Section 12(g) of the Act: None

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. Yes [X] No [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

The aggregate market value of the shares of common stock held by non-
affiliates of the registrant was approximately $564,582,505 based on the
closing price on the New York Stock Exchange for such shares on March 23,
1999.

As of March 23, 1999, 27,639,210 shares of common stock, par value $.01 per
share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement with respect to its 1999 Annual
Meeting of Stockholders to be filed not later than 120 days after the end of
the registrant's fiscal year are incorporated by reference into Part III
hereof.

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TABLE OF CONTENTS

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Page
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PART I

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Item 1. Business....................................................... 1
Item 2. Properties..................................................... 13
Item 3. Legal Proceedings.............................................. 23
Item 4. Submission of Matters to a Vote of Security Holders............ 23

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................ 24
Item 6. Selected Financial Data........................................ 26
Management's Discussion and Analysis of Financial Condition and
Item 7. Results of Operations.......................................... 28
Item 7A. Quantitative and Qualitative Disclosures About Market Risks.... 46
Item 8. Financial Statements and Supplementary Data.................... 48
Changes in and Disagreements with Accountants on Accounting and
Item 9. Financial Disclosure........................................... 48

PART III

Item 10. Directors and Executive Officers of the Registrant............. 49
Item 11. Executive Compensation......................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management. 49
Item 13. Certain Relationships and Related Transactions................. 49

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K............................................................ 50
</TABLE>

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PART I

ITEM 1. BUSINESS

General

Kilroy Realty Corporation (the "Company") was incorporated in September 1996
and commenced operations upon the completion of its initial public offering in
January 1997. The Company, which develops, owns, and operates office and
industrial properties, primarily in Southern California, operates qualifies,
and intends to continue to qualify as a self-administered and self-managed
real estate investment trust ("REIT") for federal and state income tax
purposes beginning with the year ended December 31, 1997. The Company is the
successor to the real estate business of Kilroy Industries, a California
corporation ("KI"), and certain of its affiliated corporations, partnerships
and trusts (collectively, the "Kilroy Group"). Since 1947, the Kilroy Group
has been engaged in the business of owning, acquiring, developing, managing
and leasing principally Class A suburban office and industrial buildings in
select locations in key suburban submarkets, primarily in Southern California.
As of December 31, 1998, the Company's portfolio of properties (including
properties owned by Kilroy Realty, L.P. (the "Operating Partnership") and
Kilroy Realty Finance Partnership, L.P., a Delaware limited partnership (the
"Finance Partnership")) included 80 office buildings encompassing
approximately 5.6 million rentable square feet (the "Office Properties") and
84 industrial buildings encompassing approximately 6.2 million rentable square
feet (the "Industrial Properties" and, together with the Office Properties,
the "Properties"). All but 15 of the Properties are located in Southern
California. As of December 31, 1998, the Office Properties were approximately
95.7% leased to 420 tenants and the Industrial Properties were approximately
96.0% leased to 253 tenants. In addition, as of December 31, 1998, the Company
had under development six office buildings and two industrial buildings which
when completed are expected to encompass approximately 544,000 and 390,000
rentable square feet, respectively.

The Company conducts substantially all of its activities through the
Operating Partnership in which, as of December 31, 1998, it owned an
approximate 86.8% general partnership interest. The remaining 13.2% limited
partnership interest in the Operating Partnership was owned by certain of the
Company's executive officers and directors, certain of their affiliates, and
other outside investors. As the sole general partner of the Operating
Partnership, the Company has control over the management of the Operating
Partnership, which owns 147 of the Company's 164 Properties. The remaining 17
properties are owned by the Finance Partnership in which the Company (through
a wholly-owned subsidiary) owns a 1.0% sole general partnership interest and
the Operating Partnership owns a 99.0% limited partnership interest.

The Company's strategy has been to own, develop, acquire, lease and manage
Class A suburban office and industrial properties in select locations in key
suburban submarkets, primarily in Southern California, which the Company
believes have strategic advantages compared to neighboring submarkets.

At December 31, 1998, the Company's ten largest office tenants represented
approximately 26.2% of total annual base rent rental revenue, defined as
annualized monthly contractual rents from existing tenants at December 31,
1998, determined in accordance with generally accepted accounting principles,
and its ten largest industrial tenants represented approximately 10.2% of
total annual base rental revenue. Of this amount, its largest tenant, Hughes
Electronics Corporation's Space & Communications Company ("Hughes Space &
Communications"), currently leases approximately 412,000 rentable square feet
of office space, representing approximately 7.4% of the Company's total annual
base rental revenues at December 31, 1998. The base periods of the Hughes
Space & Communications leases expire in January and July 2004.

The Company's five largest office tenants, based on annual rental revenues,
include: Hughes Space & Communications, a tenant since 1984, which is engaged
in high-technology commercial activities including satellite development and
related applications such as DirecTV; The Boeing Company; the State of
California (Caltrans); Sony Music Entertainment, Inc. and Unisys Corporation.
The Company's five largest industrial tenants, based on annualized rental
revenues, include: Mattel, Inc.; Celestica, Inc.; Kraft Foods, Inc.; Omni-Pack
and Mazda Motor of America, Inc. (See Item 2: Properties--Tenant Information
for further discussion on the Company's tenant base.)

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Business and Growth Strategies

Growth Strategies. The Company believes that a number of factors will enable
it to achieve its business objectives, including: (i) the opportunity to lease
available space at attractive rental rates because of high demand and
frictional vacancy levels in the Southern California submarkets in which most
of the Properties are located; (ii) the quality and location of the
Properties; (iii) the Company's ability to efficiently manage its assets as a
low cost provider of commercial real estate due to its core capabilities in
all aspects of real estate ownership including property management, leasing,
marketing, financing, accounting, legal, construction management and new
development; (iv) the Company's substantial development pipeline established
over the past several years; and (v) the Company's access to development and
leasing opportunities as a result of its significant relationship with large
Southern California corporate tenants, municipalities and landowners and the
Company's 50-year presence in the Southern California market. Management
believes that the Company is well positioned to capitalize on existing
opportunities because of its extensive experience in certain of its
submarkets, its seasoned management team and its proven ability to acquire,
develop, lease and efficiently manage office and industrial properties.

Operating Strategies. The Company focuses on enhancing growth in funds from
operations from its Properties by: (i) maximizing cash flow from the
Properties through active leasing and early renewals, increasing contractual
base rent to current market levels as leases expire and effective property
management; (ii) managing operating expenses through the use of internal
management, leasing, marketing, financing, accounting, legal administration
and construction management functions; (iii) maintaining and developing long-
term relationships with a diverse tenant group; (iv) attracting and retaining
motivated employees by providing financial and other incentives to meet the
Company's operating and financial goals; and (v) continuing to emphasize
capital improvements to enhance the Properties' competitive advantages in
their respective markets and improve the efficiency of building systems.

Development Strategies. The Company and its predecessors have developed
office and industrial properties, including high technology facilities,
primarily located in Southern California, for its own portfolio and for third
parties, since 1947. Over the past several years, the Company has established
a substantial development pipeline in its three target market regions, Los
Angeles, Orange and San Diego Counties. The Company's land inventory
(including land held through joint venture arrangements) can support future
development of over 3.0 million rentable square feet at a total budgeted cost
of over $500 million over the next four to five years. The Company's strategy
is to maintain a disciplined approach to development by focusing on pre-
leasing, phasing and cost control. The Company completed five office and
industrial projects during 1998 at an aggregate cost of $70.7 million. In
addition, as of December 31, 1998, the Company had approximately 934,000
rentable square feet under construction at a total budgeted cost of
approximately $118 million.

The Company may engage in the development of additional office and/or
industrial properties, primarily in Southern California, when market
conditions support a favorable risk-adjusted return on such development. The
Company's activities with third-party owners in Southern California are
expected to give the Company further access to development opportunities.
There can be no assurance, however, that the Company will be able to
successfully develop any of the properties.

Financing Policies. The Company's financing policies and objectives are
determined by the Company's Board of Directors. The Company presently intends
to maintain a conservative ratio of debt to total market capitalization (total
debt of the Company as a percentage of the market value of issued and
outstanding shares of common stock, including interests exchangeable therefor,
plus total debt). This ratio may be increased or decreased without the consent
of the Company's stockholders and the Company's organizational documents do
not limit the amount of indebtedness that the Company may incur. At December
31, 1998, total debt constituted approximately 32.5% of the total market
capitalization of the Company. The Company intends to utilize one or more
sources of capital for future growth, which may include undistributed cash
flow, borrowings under the Company's unsecured credit facility (the "Credit
Facility"), the issuance of debt or equity securities and other bank and/or
institutional borrowings. There can be no assurance, however, that the Company
will be able to obtain capital for any such developments or improvements on
terms favorable to the Company.

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Government Regulations

Many laws and governmental regulations are applicable to the Company's
Properties and changes in these laws and regulations, or their interpretation
by agencies and the courts, occur frequently.

Costs of Compliance with the Americans with Disabilities Act. Under the
Americans with Disabilities Act of 1990 (the "ADA"), all public accommodations
must meet federal requirements related to access and use by disabled persons.
Although the Company believes that its Properties substantially comply with
present requirements of the ADA, audits or investigations of all of its
Properties have not been conducted to determine compliance. The Company may
incur additional costs of complying with the act. Additional federal, state
and local laws also may require modifications to the Company's Properties, or
restrict its ability to renovate the Properties. The Company cannot predict
the ultimate amount of the cost of compliance with the act or other
legislation. Although management does not expect such costs to have a material
effect, such costs could be substantial.

Environmental Matters

Costs related to government regulation and private litigation. Environmental
laws and regulations hold the Company liable for the costs of removal or
remediation of certain hazardous or toxic substances released on its
Properties. These laws could impose liability without regard to whether the
Company is responsible for, or even knew of, the presence of the hazardous
materials. Government investigations and remediation actions may have
substantial costs and the presence of hazardous wastes on a property could
result in personal injury or similar claims by private plaintiffs. For
instance, third parties may seek recovery from for personal injuries
associated with asbestos-containing materials and other hazardous or toxic
substances if found on the Company's Properties. As of December 31, 1998, 26
of the Company's Properties contained asbestos-containing materials. Various
laws also impose liability on persons who arrange for the disposal or
treatment of hazardous or toxic substances for the cost of removal or
remediation of hazardous substances at the disposal or treatment facility.
These laws often impose liability whether or not the person arranging for the
disposal ever owned or operated the disposal facility. As the owner and
operator of its Properties, the Company may be considered to have arranged for
the disposal or treatment of hazardous or toxic substances.

Use of hazardous materials by some of our tenants. Some of the Company's
tenants routinely handle hazardous substances and wastes on its Properties as
part of their routine operations. Environmental laws and regulations subject
these tenants, and potentially the Company, to liability resulting from such
activities. The Company requires its tenants, in their leases, to comply with
these environmental laws and regulations and to indemnify the Company for any
related liabilities. As of December 31, 1998, less than 5% of the Company's
tenants routinely handled hazardous substances and/or wastes on the Company's
properties as part of their routine operations. These tenants were primarily
involved in the light industrial and warehouse business and more specifically
the light electronics assembly business. Management does not believe that
these activities by its tenants will have any material adverse effect on the
Company's operations. Furthermore, management is unaware of any material
noncompliance, liability or claim relating to hazardous or toxic substances or
petroleum products in connection with any of the Company's Properties.

Existing conditions at some of our properties. Independent environment
consultants conducted Phase I or similar environmental site assessments on all
of the Company's Properties. Site assessments generally include a historical
review, a public records review, an investigation of the surveyed site and
surrounding properties, and the issuance of a written report. These
assessments do not generally include soil samplings or subsurface
investigations. The Company's site assessments revealed that some of its
Properties contain asbestos-containing materials and that historical
operations at or near some of its Properties, including the operation of
underground storage tanks, may have caused soil or groundwater contamination.
Prior owners of the affected Properties conducted clean-up of contamination in
the soils on the properties and the Company does not believe that further
clean up of the soils is required. None of the Company's site assessments
revealed any other environmental liability that management believes would have
a material adverse effect on the Company's business, assets or

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results of operations. Management is not aware of any such condition,
liability, or concern by any other means that would give rise to material
environmental liability. However, the assessments may have failed to reveal
all environmental conditions, liabilities, or compliance concerns; there may
be material environmental conditions, liabilities, or compliance concerns that
arose at a property after the review was completed; future laws, ordinances or
regulations may impose material additional environmental liability; and
current environmental conditions at the Company's Properties may be affected
in the future by tenants, third parties, or the condition of land or
operations near its Properties (such as the presence of underground storage
tanks). If the costs of environmental compliance exceed the Company's budgeted
limits, it may be unable to make distributions to its stockholders.

Other federal, state and local regulations. The Company's Properties are
subject to various federal, state and local regulatory requirements, such as
state and local fire and life safety requirements. If the Company failed to
comply with these various requirements, it might incur governmental fines or
private damage awards. Management believes that the Company's Properties are
currently in material compliance with all of these regulatory requirements.
However, management does not know whether existing requirements will change or
whether future requirements will require the Company to make significant
unanticipated expenditures that will affect its ability to make distributions
to its stockholders. The City of Los Angeles adopted regulations relating to
the repair of welded steel movement frames located in certain areas damaged as
a result of the January 17, 1994 Northridge earthquake in Southern California.
Currently, these regulations apply to only one of the Company's Properties
representing approximately 78,000 square feet. Management believes that this
property complies with these regulations. Management does not know, however,
whether other regulatory agencies will adopt similar regulations or whether
the Company will acquire additional properties which may be subject to these
or similar regulations. Management believes, based in part on engineering
reports, that all of its Properties are in good condition. However, if
required to make significant expenditures under applicable regulations, the
Company's financial condition, results of operations, cash flow, quoted per
share trading price of its common stock and ability to pay distributions to
stockholders could be adversely affected.

Employees

As of March 10, 1999, the Company (primarily through the Operating
Partnership and Kilroy Services, Inc., an unconsolidated subsidiary of the
Company ("KSI")), employed 126 persons. The Company, the Operating Partnership
and KSI employ substantially all of the professional employees of the Kilroy
Group that are engaged in asset management and administration. As of March 10,
1999, the Operating Partnership employed 31 on-site building employees who
provided services for the Properties. The Company, the Operating Partnership
and KSI believe that relations with their employees are good.

Business Risks

This document contains certain forward-looking statements (as such term is
defined in Section 27A of the Securities Act of 1933, as amended (the "1933
Act"), and Section 21E of the Exchange Act of 1934, as amended (the "1934
Act")) pertaining to, among other things, the Company's future results of
operations, cash available for distribution, property acquisitions, lease
renewals, increases in base rent, fee development activities, sources of
growth, planned development and expansion of owned or leased property, capital
requirements, compliance with contractual obligations and general business,
industry and economic conditions applicable to the Company. These statements
are based largely on the Company's current expectations and are subject to a
number of risks and uncertainties. Actual results could differ materially from
these forward-looking statements. Factors that can cause actual results to
differ materially include, but are not limited to, those discussed below.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The following factors
should be considered in addition to the other information contained herein in
evaluating the Company and its business:

Most of the Company's Properties depend upon the Southern California
economy. As of December 31, 1998, 85.5% of the aggregate square footage of the
Company's stabilized portfolio and 88.4% of the Company's annualized base
rent, excluding expense reimbursements and rental abatements, came from
properties located in Southern California. The Company's ability to make
expected distributions to stockholders depends on its ability to generate
funds from operations in excess of scheduled principal payments on debt,
payments on the cumulative

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redeemable preferred units issued by the Operating Partnership, and capital
expenditure requirements. Events and conditions applicable to owners and
operators of real property that are beyond the Company's control may decrease
funds available for distribution and the value of the Company's Properties.
These events include: local oversupply or reduction in demand of office,
industrial or other commercial space; ability to collect rent from tenants;
vacancies or inability to rent available space on favorable terms; ability to
finance property development and acquisitions on favorable terms; increased
operating costs, including insurance premiums, utilities, and real estate
taxes; costs of complying with changes in governmental regulation; the
relative illiquidity of real estate investments; changing submarket
demographics and property damage resulting from seismic activity. The
geographical concentration of the Company's Properties may expose it to
greater economic risks than if it owned properties in several geographic
regions. Any adverse economic or real estate developments in the Southern
California region could adversely impact the Company's financial condition,
results from operations and cash flows.

The Company's significant debt level reduces cash available for distribution
and may expose the Company to the risk of default under its debt
obligations. Payments of principal and interest on borrowings may leave the
Company with insufficient cash resources to operate its Properties or to pay
distributions necessary to maintain its REIT qualification. The Company's
level of debt and the limitations imposed by existing debt agreements may have
important consequences on the Company, including the following: cash flow may
be insufficient to meet required principal and interest payments; the Company
may be unable to refinance its indebtedness at maturity or the refinancing
terms may be less favorable than the terms of its original indebtedness; the
Company may be forced to dispose of one or more of its Properties, possibly on
disadvantageous terms; the Company may default on its obligations and the
lenders or mortgagees may foreclose on the properties that secure the loans
and receive an assignment of rents and leases; and the Company's default under
one mortgage loan with cross default provisions could result in a default on
other indebtedness. If any one of these events were to occur, the Company's
financial position, results of operations and cash flows may be affected. In
addition, foreclosures could create taxable income without accompanying cash
proceeds, a circumstance which could hinder the Company's ability to meet the
strict REIT distribution requirements imposed by the Internal Revenue Code of
1986, as amended. As of December 31, 1998, the Company had $405 million
aggregate principal amount of indebtedness, $2.3 million of which is due prior
to December 31, 1999. The Company's debt to total market capitalization ratio
at December 31, 1998 was 32.5%.

The Company faces significant competition which may decrease the occupancy
and rental rates of its Properties. The Company competes with several
developers, owners and operators of office, industrial and other commercial
real estate, many of which have higher vacancy rates. For instance, occupancy
rates in the Company's El Segundo and Long Beach office property portfolios at
December 31, 1998 were 99.1% and 96.8%, respectively, in comparison to 94.8%
and 94.8%, respectively for the El Segundo and Long Beach office property
submarkets in total. In addition, the occupancy rate in the Company's Anaheim
industrial property portfolio at December 31, 1998 was 94.4% in comparison to
93.2% for the Anaheim industrial property submarket in total. The Company
believes that its lower vacancy rates means that, on average, its competitors
have more space currently available for lease than the Company. As a result,
the Company's competitors have an incentive to decrease rental rates until
their available space is leased. If the Company's competitors offer space at
rental rates below current market rates, the Company may be pressured to
reduce its rental rates below those currently charged in order to retain
tenants when its tenant leases expire. As a result, the Company's financial
condition, results of operations and cash flows may be adversely affected.

Potential losses may not be covered by insurance. The Company carries
comprehensive liability, fire, extended coverage and rental loss insurance
covering all of its Properties. Management believes the policy specifications
and insured limits are appropriate given the relative risk of loss, the cost
of the coverage and industry practice. The Company does not carry insurance
for generally uninsured losses such as loss from riots or acts of war. Some of
the Company's insurance policies, like those covering losses due to floods,
are insured subject to limitations involving large deductibles or co-payments
and policy limits. In addition, the Company carries earthquake insurance on
properties located in areas known to be subject to earthquakes in an amount
and with deductions which management believes are commercially reasonable. As
of December 31, 1998, 77 of the

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Office Properties aggregating 5.1 million square feet (representing 43.1% of
the Company's stabilized portfolio based on aggregate square footage and 66.3%
based on annualized base rent) were located in areas known to be subject to
earthquakes. As of December 31, 1998, 72 of the Company's Industrial
Properties aggregating 5.0 million square feet (representing 42.4% of the
Company's stabilized portfolio based on aggregate square footage and 24.5%
based on annualized base rent) were located in areas known to be subject to
earthquakes. While the Company presently carries earthquake insurance on these
properties, the amount of our earthquake insurance coverage may not be
sufficient to cover losses from earthquakes. In addition, the Company may
discontinue earthquake insurance on some or all of its Properties in the
future if the cost of premiums for earthquake insurance exceeds the value of
the coverage discounted for the risk of loss. If the Company experiences a
loss which is uninsured or which exceeds policy limits, it could lose the
capital invested in the damaged properties as the well as the anticipated
future revenue from those properties. In addition, if the damaged properties
are subject to recourse indebtedness, the Company would continue to be liable
for the indebtedness, even if the properties were unrepairable.

The Company may be unable to complete acquisitions and successfully operate
acquired properties. The Company intends to continue to acquire office and
industrial properties when strategic opportunities exist. The Company's
ability to acquire properties on favorable terms and successfully operate them
is subject to the following risks: the potential inability to acquire a
desired property because of competition from other real estate investors with
significant capital, including both publicly traded REITs and institutional
investment funds; even if the Company enters into agreements for the
acquisition of office and industrial properties, these agreements are subject
to customary conditions to closing, including completion of due diligence
investigations to management's satisfaction; the Company may be unable to
finance the acquisition on favorable terms; the Company may spend more than
budgeted amounts to make necessary improvements or renovations to acquired
properties; and the Company may lease the acquired properties at below
expected rates. If the Company cannot finance property acquisitions on
favorable terms, or operate acquired properties to meet financial
expectations, its financial position, results of operations, cash flow, quoted
per share trading price of its common stock and ability to pay distributions
to stockholders could be adversely affected.

The Company may be unable to successfully complete and operate developed
properties. Property development involves the following significant risks: the
Company may be unable to obtain construction financing on favorable terms; the
Company may be unable to obtain permanent financing at all or on advantageous
terms if development projects are financed through construction loans; the
Company may not complete development projects on schedule or within budgeted
amounts; the Company may encounter delays or refusals in obtaining all
necessary zoning, land use, building, occupancy, and other required
governmental permits and authorizations; the Company may expend funds on and
devote management's time to projects which the Company may not complete; and
the Company may lease the developed properties at below expected rental rates.
For example, one of our development projects was completed three months later
than initially projected, resulting in a corresponding delay in the
commencement of leasing activity at the particular property. The delay was
attributable to bad weather conditions which inhibited construction during the
"El Nino" climate condition which ran from 1997 through 1998. In addition,
during the fourth quarter of 1998, we withdrew our participation from a master
planned commercial development prior to the commencement of construction. If
any one of these events were to occur in connection with our projects
currently under development, the Company's financial position, results of
operations, cash flow, quoted per share trading price of its common stock and
ability to pay distributions to stockholders could be adversely affected.
While the Company primarily develops office and industrial properties in
Southern California markets, it may in the future develop properties for
retail or other use and expand its business to other geographic regions where
the development of property could result in more favorable risk-adjusted
returns. Presently, the Company does not possess the same level of familiarity
with development of other property types or outside markets which could
adversely affect its ability to develop properties or to achieve expected
performance.

The Company could default on leases for land on which some of its properties
are located. The Company owns ten office buildings located on land which the
Company leases on a long-term basis. If the Company defaults under the terms
of a lease, it may lose the property subject to the lease. The Company may not
be able

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to renegotiate a new lease, on favorable terms, if at all, upon expiration of
the lease and all its options. The leases for the land under the Kilroy
Airport Center, Long Beach expire in 2035. The leases for the land under the
SeaTac Office Center, including renewal options, expire in 2062. The lease for
the land under 12312 West Olympic Boulevard in Santa Monica expires in January
2065. The lease for the land under 9455 Towne Center in San Diego expires in
October 2043.

The Company depends on significant tenants. At December 31, 1998, the
Company's ten largest office tenants represented approximately 26.2% of total
annual base rental revenue and its ten largest industrial tenants represented
approximately 10.2% of total annual base rental revenue. Of this amount, its
largest tenant, Hughes Space & Communications currently leases approximately
412,000 rentable square feet of office space, representing approximately 7.4%
of the Company's total annual base rental revenues. The Company's revenue and
cash available for distribution to stockholders would be disproportionately
and materially adversely affected if any of its significant tenants were to
become bankrupt or insolvent, or suffer a downturn in their business, or fail
to renew their leases at all or on terms less favorable to the Company than
their current terms.

Downturns in tenants' businesses may reduce the Company's cash flow. As of
December 31, 1998, the Company derived 86.1% of its revenues from rents from
tenants. A tenant may experience a downturn in its business, which may weaken
its financial condition and result in its failure to make timely rental
payments. In the event of default by a tenant, the Company may experience
delays in enforcing its rights as landlord and may incur substantial costs in
protecting its investment. The bankruptcy or insolvency of a major tenant also
may adversely affect the income produced by the Company's Properties. If any
tenant becomes a debtor in a case under the Bankruptcy Code, the Company
cannot evict the tenant solely because of the bankruptcy. On the other hand,
the bankruptcy court might authorize the tenant to reject and terminate its
lease. The Company's claim against such a tenant for unpaid, future rent would
be subject to a statutory cap that might be substantially less than the
remaining rent actually owed under the lease. Even so, the Company's claim for
unpaid rent would likely not be paid in full. This shortfall could adversely
affect the Company's cash flow and its ability to make distributions to
stockholders. Although the Company has not experienced material losses from
tenant bankruptcies, its tenants could file for bankruptcy protection in the
future.

The Company may be unable to renew leases or re-let space as leases
expire. As of December 31, 1998, leases representing 13.2% and 11.3% of the
square footage of the Company's Properties will expire in 1999 and 2000. Above
market rental rates on some of the Company's Properties may force it to renew
or re-lease some expiring leases at lower rental rates. While the Company
believes that the average rental rates for most of its Properties are below
quoted market rates in each of its respective submarkets, the Company cannot
assure that leases will be renewed or that its Properties will be re-leased at
rental rates equal to or above the current rental rates. If the rental rates
for the Company's Properties decrease, existing tenants do not renew their
leases or the Company does not re-lease a significant portion of its available
space, its financial position, results of operations, cash flow, quoted per
share trading price of its common stock and ability to pay distributions to
its stockholders would be adversely affected.

Real estate assets are illiquid and the Company may not be able to sell its
Properties at the appropriate time. The Company's investments in its
Properties are relatively illiquid and therefore limits the Company's ability
to sell its Properties quickly in response to changes in economic or other
conditions. Limitations in the Internal Revenue Code and related Treasury
Regulations applicable to REITs may also limit the Company's ability to sell
its Properties.

KSI is subject to tax liabilities on net income which reduces the Company's
cash flow. KSI is subject to federal and state income tax on its taxable
income at regular corporate rates. Any federal, state or local income taxes
that KSI must pay will reduce the cash available for distribution to the
Operating Partnership and, ultimately, to the Company's stockholders.

The Company cannot depend upon distributions from KSI because its business
is not controlled by the Company. The Company has set up the following
structure to comply with the REIT asset tests that restrict its

7
<PAGE>

ability to own shares of other corporations: the Operating Partnership owns
100% of the non-voting preferred stock of KSI, representing approximately
95.0% of its economic value; and John B. Kilroy, Sr. and John B. Kilroy, Jr.,
the Company's Chairman of the Board of Directors and President and Chief
Executive Officer, respectively, own all of the outstanding voting common
stock of KSI, representing approximately 5.0% of its economic value. The
Company receives substantially all of the economic benefit derived from KSI's
business by virtue of the dividends that the Company receives from its
investment in the preferred stock. However, the Company cannot influence KSI's
operations, appoint its directors or officers, or require its Board of
Directors to declare and pay a cash dividend on the nonvoting preferred stock
owned the Operating Partnership. As a result, KSI may make decisions or pursue
business policies which could have an adverse effect on the Company's
financial position, results of operations, cash flow, quoted per share trading
price of its common stock and ability to pay distributions to stockholders.

KSI may be adversely affected by the Company's REIT status. Changes in the
requirements for REIT qualification may in the future limit the Company's
ability to receive increased distributions from the fee development operations
and related services offered by KSI.

Common limited partners of the Operating Partnership have limited approval
rights which may prevent the Company from completing a change of control
transaction which may be in the best interests of stockholders. The Company
may not withdraw from the Operating Partnership or transfer its general
partnership interest or admit another general partner without the approval of
a majority of the common limited partnership unitholders except in the case of
a "termination transaction" described under in the section entitled
"Description of Material Provisions of the Partnership Agreement of Kilroy
Realty, L.P.--Transferability of partnership interests" which requires the
approval of 60% of the common unitholders, including the Company because of
the common units it holds in its capacity as general partner. The right of
common limited partners to vote on these transactions could limit the
Company's ability to complete a change of control transaction that might
otherwise be in the best interest of its stockholders.

Limited partners of the Operating Partnership must approve the dissolution
of the Operating Partnership and the disposition of properties they
contributed. For as long as limited partners own at least 5% of all of the
common units of the Operating Partnership, the Company must obtain the
approval of limited partners holding a majority of the common units before it
may dissolve the partnership or sell the property located at
2260 East Imperial Highway at Kilroy Airport Center in El Segundo prior to
January 31, 2004. In addition, the Company may not sell 11 of its properties
prior to October 31, 2002 without the consent of the limited partners that
contributed the properties to the Operating Partnership, except in connection
with the sale or transfer of all or substantially all of its assets or those
of the Operating Partnership or in connection with a transaction which does
not cause the limited partners that contributed the property to recognize
taxable income. In addition, the Operating Partnership agreed to use
commercially reasonable efforts to minimize the tax consequences to common
limited partners resulting from the repayment, refinancing, replacement or
restructuring of debt, or any sale, exchange or other disposition of any of
its other assets. The exercise of one or more of these approval rights by the
limited partners could delay or prevent the Company from completing a
transaction which may be in the best interest of its stockholders.

The Company's Chairman of the Board of Directors and its President and Chief
Executive Officer each have potential conflicts of interest with the
Company.

The Company's Chairman of the Board of Directors and its President and Chief
Executive Officer each are engaged in competitive real estate activities. The
Company owns four office buildings and four industrial buildings in the El
Segundo submarket. John B. Kilroy, Sr. and John B. Kilroy, Jr., the Company's
Chairman of the Board of Directors and President and Chief Executive Officer,
respectively, own controlling interests in partnerships which own a complex of
three office buildings in the same submarket. The Operating partnership
manages the complex pursuant to a management agreement on market terms.
Policies adopted by the Company's Board of Directors to minimize this
conflict, including the requirement that John B. Kilroy, Sr. and John B.

8
<PAGE>

Kilroy, Jr. enter into non-competition agreements with the Company, may not
eliminate their influence over transactions involving these competing
properties.

The Company's Chairman of the Board of Directors and its President and Chief
Executive Officer each have substantial influence over the Company's
affairs. John B. Kilroy, Sr. and John B. Kilroy, Jr., the Company's Chairman
of the Board of Directors and President and Chief Executive Officer,
respectively, together hold two of the seven seats on the Company's Board of
Directors. They also beneficially own common limited partnership units
exchangeable for an aggregate of 2,598,639 shares of the Company's common
stock and currently vested options to purchase an aggregate of 176,666 shares
of common stock, representing a total of 10.0% of the total outstanding shares
of common stock as of December 31, 1998. Pursuant to the Company's charter no
other stockholder may own, actually or constructively, more than 7.0% of the
Company's common stock. Consequently, Messrs. Kilroy have substantial
influence on the Company and could exercise their influence in a manner that
is not in the best interest or the Company's stockholders. Also, they may, in
the future, have a substantial influence on the outcome of any matters
submitted to the Company's stockholders for approval.

There are limits on the ownership of the Company's capital stock which limit
the opportunities for a change of control at a premium to existing
stockholders. Provisions of the Maryland General Corporation Law, the
Company's charter, the Company's bylaws, and the Operating Partnership's
partnership agreement may delay, defer, or prevent a change in control over
the Company or the removal of existing management. Any of these actions might
prevent the stockholders from receiving a premium for their shares of stock
over the then prevailing market prices.

The Internal Revenue Code sets forth stringent ownership limits on the
Company as a result of its decision to be taxed as a REIT, including: no more
than 50% in value of the Company's capital stock may be owned, actually or
constructively, by five or fewer individuals, including some entities, during
the last half of a taxable year; subject to certain exceptions, the Company's
common stock shares must be held by a minimum of 100 persons for at least 335
days of a 12-month taxable year, or a proportionate part of a short taxable
year; and if the Company, or any entity which owns 10% or more of its capital
stock, actually or constructively owns 10% or more of one of the Company's
tenants, or a tenant of any partnership in which the Company is a partner,
then any rents that the Company receives from that tenant in question will not
be qualifying income for purposes of the Internal Revenue Code's REIT gross
income tests regardless of whether the Company receives the rents directly or
through a partnership.

The Company's charter establishes clear ownership limits to protect its REIT
status. No single stockholder may own, either actually or constructively, more
than 7.0% of the Company's common stock outstanding. Similarly, no single
holder of the Company's Series A Preferred Stock and Series C Preferred Stock
may actually or constructively own any class or series of its preferred stock,
so that their total capital stock ownership would exceed 7.0% by value of the
Company's total capital stock, and no single holder of Series B Preferred
Stock, if issued, may actually or constructively own more than 7.0% of the
Company's Series B Preferred Stock.

The Board of Directors may waive the ownership limits if it is satisfied
that the excess ownership would not jeopardize the Company's REIT status and
if it believes that the waiver would be in the Company's best interests. The
Board of Directors has already waived the ownership limits with respect to
John B. Kilroy, Sr., John B. Kilroy, Jr., members of their families and
certain affiliated entities. These named individuals and entities may own
either actually or constructively, in the aggregate, up to 19.6% of the
outstanding common stock.

If anyone acquires shares in excess of any ownership limits: the transfer to
the transferee will be void with respect to these excess shares; the excess
shares will be automatically transferred from the transferee or owner to a
trust for the benefit of a qualified charitable organization; the purported
transferee or owner will have no right to vote those excess shares; and the
purported transferee or owner will have no right to receive dividends or other
distributions from these excess shares.

9
<PAGE>

The Company's charter contains provisions that may delay, defer, or prevent
a change of control transaction.

The Company's Board of Directors is divided into classes that serve
staggered terms. The Company's Board of Directors is divided into three
classes with staggered terms. The staggered terms for directors may reduce the
possibility of a tender offer or an attempt to complete a change of control
transaction even if a tender offer or a change in control was in the Company's
stockholders' interest.

The Company could issue preferred stock without stockholder approval. The
Company's charter authorizes its Board of Directors to issue up to 30,000,000
shares of preferred stock, including convertible preferred stock, without
stockholder approval. The board of directors may establish the preferences,
rights and other terms including the right to vote and the right to convert
into common stock of any shares issued. The issuance of preferred stock could
delay or prevent a tender offer or a change of control even if a tender offer
or a change of control was in the Company's stockholders' interest. The
Operating Partnership has issued 1,500,000 Series A Cumulative Redeemable
Preferred Units which in the future may be exchanged one-for-one into shares
of Series A Cumulative Redeemable Preferred Stock, and 700,000 Series C
Cumulative Redeemable Preferred Units which in the future may be exchanged one
for one into shares of Series C Cumulative Redeemable Preferred Stock. In
addition, the Company has designated and authorized the issuance of up to
400,000 shares of Series B Junior Participating Preferred Stock. However, no
shares of preferred stock are currently issued or outstanding.

The Company has a stockholders' rights plan. On October 2, 1998, the
Company's Board of Directors adopted a stockholders' rights plan and declared
a distribution of one preferred share purchase right for each outstanding
share of common stock. The rights were issued on October 15, 1998, to each
common stockholder of record on that date. The rights have anti-takeover
effects. The rights would cause substantial dilution to a person or group that
attempts to acquire the Company on terms that the Company's Board of Directors
does not approve. The Company may redeem the shares for $.01 per right, prior
to the time that a person or group has acquired beneficial ownership of 15% or
more of its common stock. Therefore, the rights should not interfere with any
merger or business combination approved by the Company's Board of Directors.

The staggered terms for directors, the future issuance of additional common
or preferred stock and the Company's stockholders; rights plan may: delay or
prevent a change of control, even if a change of control might be beneficial
to the Company's stockholders; deter tender offers that may beneficial to the
Company's stockholders; or limit stockholders' opportunity to receive a
potential premium for their shares if an investor attempted to gain shares
beyond the Company's ownership limits or otherwise to effect a change of
control.

Loss of the Company's REIT status would have significant adverse
consequences to it and the value of the Company's stock. The Company currently
operates and has operated since 1997 in a manner that is intended to allow it
to qualify as a REIT for federal income tax purposes under the Internal
Revenue Code. If the Company was to lose its REIT status, it would face
serious tax consequences that would substantially reduce the funds available
for distribution to stockholders for each of the years involved because: the
Company would not be allowed a deduction for distributions to stockholders in
computing its taxable income and would be subject to federal income tax at
regular corporate rates; the Company could be subject to the federal
alternative minimum tax and possibly increased state and local taxes; unless
entitled to relief under statutory provisions, the Company could not elect to
be subject to tax as a REIT for four taxable years following the year during
which it was disqualified; and all distributions to stockholders will be
subject to tax as ordinary income to the extent of the Company's current and
accumulated earnings and profits. In addition, if the Company fails to qualify
as a REIT, it will not be required to make distributions to stockholders. As a
result of all these factors, the Company's failure to qualify as a REIT also
could impair its ability to expand its business and raise capital, and would
adversely affect the value of the Company's common stock.

Qualification as a REIT involves the application of highly technical and
complex Internal Revenue Code provisions for which there are only limited
judicial and administrative interpretations. The complexity of these
provisions and of the applicable treasury regulations that have been
promulgated under the Internal Revenue Code is greater in the case of a REIT
that holds its assets in partnership form. The determination of various

10
<PAGE>

factual matters and circumstances not entirely within the Company's control
may affect it's ability to qualify as a REIT. For example, in order to qualify
as a REIT, at least 95% of the Company's gross income in any year must be
derived from qualifying sources. Also, the Company must make distributions to
stockholders aggregating annually at least 95% of its net taxable income,
excluding capital gains. In addition, legislation, new regulations,
administrative interpretations or court decisions may adversely affect the
Company's investors or the Company's ability to qualify as a REIT for tax
purposes. Although management believes that the Company is organized and
operates in a manner so as to qualify as a REIT, no assurance can be given
that the Company will continue to be organized or be able to operate in a
manner so as to qualify or remain qualified as a REIT for tax purposes.

To maintain its REIT status, the Company may be forced to borrow funds on a
short-term basis during unfavorable market conditions. In order to maintain
its REIT status, the Company may need to borrow funds on a short-term basis to
meet the REIT distribution requirements even if the then prevailing market
conditions are not favorable for these borrowings. To qualify as a REIT, the
Company generally must distribute to its stockholders at least 95% of the
Company's net taxable income each year, excluding capital gains. In addition,
the Company will be subject to a 4% nondeductible excise tax on the amount, if
any, by which certain distributions paid in any calendar year are less than
the sum of 85% of it's ordinary income, 95% of it's capital gain net income
and 100% of it's undistributed income from prior years. These short-term
borrowing needs could result from differences in timing between the actual
receipt of income and inclusion of income for federal income tax purposes, or
the effect of non-deductible capital expenditures, the creation of reserves or
required debt or amortization payments.

The Company's growth depends on external sources of capital which are
outside of the Company's control. The Company is required under the Internal
Revenue Code to distribute at least 95% of its taxable income, determined
without regard to the dividends-paid deduction and excluding any net capital
gain. Because of this distribution requirement, it may not be able to fund
future capital needs, including acquisition financing, from operating cash
flow. Consequently, management relies on third-party sources of capital to
fund the Company's capital needs. Access to third-party sources of capital
depends, in part, on: general market conditions; the market's perception of
the Company's growth potential; the Company's current and expected future
earnings; the Company's cash distributions; and the market price per share of
the Company's common stock. If the Company cannot obtain capital from third-
party sources, it may not be able to acquire properties when strategic
opportunities exist or make the cash distributions to stockholders necessary
to maintain its qualification as a REIT.

The Company's Board of Directors may change investment and financing
policies without stockholder approval and become more highly leveraged
which may increase the Company's risk of default under its debt
obligations.

The Company is not limited in its ability to incur debt. The Company's Board
of Directors adopted a policy of limiting indebtedness to approximately 50% of
the Company's total market capitalization. Total market capitalization is the
market value of the Company's capital stock, including interests and units,
exchangeable for shares of capital stock, plus total debt. However, the
Company's organizational documents do not limit the amount or percentage of
indebtedness, funded or otherwise, that it may incur. The Company's Board of
Directors may alter or eliminate management's current policy on borrowing at
any time without stockholder approval. If this policy changed, the Company
could become more highly leveraged which would result in an increase in its
debt service and which could adversely affect cash flow and the ability to
make expected distributions to stockholders. Higher leverage also increases
the risk of default on the Company's obligations.

The Company may issue additional shares of capital stock without stockholder
approval that may dilute shareholder investment. The Company may issue shares
of its common stock, preferred stock or other equity or debt securities
without stockholder approval. Similarly, the Company may cause the Operating
Partnership to offer its common or preferred units for contributions of cash
or property without approval by the limited partners of the Operating
Partnership or the Company's stockholders. Existing stockholders have no
preemptive rights to

11
<PAGE>

acquire any of these securities, and any issuance of equity securities under
these circumstances may dilute a stockholder's investment.

The Company may invest in securities related to real estate. The Company may
purchase securities issued by entities which own real estate and may, in the
future, also invest in mortgages. In general, investments in mortgages include
several risks, including: borrowers may fail to make debt service payments or
pay the principal when due; the value of the mortgaged property may be less
than the principal amount of the mortgage note securing the property; and
interest rates payable on the mortgages may be lower than the Company's cost
for the funds used to acquire these mortgages. Owning these securities may not
entitle the Company to control the ownership, operation and management of the
underlying real estate. In addition, the Company may have no control over the
distributions with respect to such securities, which could adversely affect
its ability to make distributions to stockholders.

Sales of a substantial number of shares of common stock, or the perception
that this could occur, could result in decreasing the market price per share
for the Company's common stock. Management cannot predict whether future
issuances of shares of the Company's common stock or the availability of
shares for resale in the open market will result in decreasing the market
price per share of its common stock.

As of December 31, 1998, 27,639,210 shares of the Company's common stock
were issued and outstanding and the Company had reserved for future issuance
the following shares of common stock: 4,200,868 shares issuable upon the
exchange, at the Company's option, of common units issued in connection with
the formation of the Operating Partnership and in connection with property
acquisitions; 2,900,000 shares issuable under the Company's Stock Option and
Incentive Plan, and 1,000,000 shares issuable under the Company's Dividend
Reinvestment and Direct Stock Purchase Plan. Of the 27,639,210 shares of
common stock presently outstanding, all but 80,000 shares may be freely traded
in the public market by persons other than the Company's affiliates. In
addition, the Company has filed or has agreed to file registration statements
covering all of the shares of common stock reserved for future issuance.
Consequently, if and when the shares are issued, they may be freely traded in
the public markets.

The Company could be adversely affected if its year 2000 problems are
significant. The Year 2000 issue refers to a computer system's failure to
recognize dates on or beyond January 1, 2000. The failure of the Company's
systems or those of its vendors or tenants to correctly interpret dates beyond
the year 1999 could lead to disruptions in the Company's operations (see
Item 7: Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Company's expanded Year 2000 disclosure).

12
<PAGE>

ITEM 2. PROPERTIES

General

As of December 31, 1998, the Company owned (through the Operating and
Finance Partnerships) 80 Office Properties encompassing 5.6 million aggregate
rentable square feet and 84 Industrial Properties encompassing 6.2 million
aggregate rentable square feet. As of December 31, 1998, the Office Properties
were approximately 95.7% leased to 420 tenants and the Industrial Properties
were approximately 96.0% leased to 253 tenants. In addition, as of December
31, 1998, the Company had approximately 544,000 square feet of office space
and 390,000 square feet of industrial space under construction. All of the
Company's construction projects and all but 15 of the Company's Properties are
located in Southern California.

In general, the Office Properties are leased to tenants on a full service
gross basis and the Industrial Properties are leased to tenants on a triple
net basis. Under a full service lease, the landlord is obligated to pay the
tenant's proportionate share of taxes, insurance and operating expenses up to
the amount incurred during the tenant's first year of occupancy ("Base Year")
or a negotiated amount approximating the tenant's pro rata share of real
estate taxes, insurance and operating expenses ("Expense Stop"). The tenant
pays its pro-rata share of increases in expenses above the Base Year or
Expense Stop. Under a triple net lease, tenants pay their proportionate share
of real estate taxes, operating costs and utility costs.

The Company believes that all of its Properties are well maintained and,
based on recent engineering reports, do not require significant capital
improvements. As of December 31, 1998, the Company managed 75 of its 80 Office
Properties and 77 of its 84 Industrial Properties through internal property
managers.

13
<PAGE>

The Office and Industrial Properties

The following table sets forth certain information relating to each of the
Office and Industrial Properties owned as of December 31, 1998. The Company
(through the Operating Partnership and the Finance Partnership) owns a 100%
interest in all of the Office and Industrial Properties other than Walnut Park
Business Center, in which the Company owns an 87.7% interest as a tenant in
common, and the five office properties located at Kilroy Airport Center, Long
Beach, three office properties located at the SeaTac Office Center, one office
property located in Santa Monica, California and one office property located
in San Diego, California, each of which are held subject to leases for the
land on which the properties are located expiring in 2035, 2032, 2065 and 2043
(assuming the exercise of the Company's options to extend such leases),
respectively.

<TABLE>
<CAPTION>
Year Net Percentage Annual Average
No. of Built/ Rentable Leased at Base Rent Base Rent
Property Location Buildings Renovated Square Feet 12/31/98(1) ($000's)(2) Per Sq. Ft. ($)(3)
----------------- --------- --------- ----------- ----------- ----------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Office Properties:
Los Angeles County
26541 Agoura Road
Calabasas, California.. 1 1988 90,878 100.0% $1,593 $17.53
5151-5155 Camino Ruiz
Camarillo,
California(7)(4)...... 4 1982 276,216 100.0% 2,695 9.76
4880 Santa Rosa Road
Camarillo,
California(7)......... 1 1998 41,131 100.0% 725 17.63
Kilroy Airport Center,
El Segundo
2250 E. Imperial
Highway(5) 1 1983 291,187 97.6% 5,276 18.56
2260 E. Imperial
Highway(6) 1 1983 291,187 100.0% 7,677 26.36
2240 E. Imperial
Highway
El Segundo,
California(8)......... 1 1983 118,933 100.0% 1,584 13.32
185 S. Douglas Street
El Segundo,
California(7)......... 1 1978 60,000 100.0% 1,523 25.38
525 N. Brand Blvd.
Glendale, California... 1 1990 43,647 100.0% 1,254 28.73
Kilroy Airport Center,
Long Beach
3900 Kilroy Airport Way 1 1987 126,840 92.7% 2,488 21.16
3880 Kilroy Airport Way 1 1987 98,243 100.0% 1,392 14.17
3760 Kilroy Airport Way 1 1989 165,279 100.0% 3,443 20.83
3780 Kilroy Airport Way 1 1989 219,745 94.7% 4,712 22.64
3760 Kilroy Airport Way
Long Beach, California. 1 1989 10,592 100.0% 60 5.66
12312 W. Olympic Blvd.
Los Angeles,
California(7)......... 1 1950/1998 78,000 100.0% 1,602 20.54
12100-12166 West Olympic
Blvd.
Los Angeles,
California............ 1 1968 48,356 94.5% 684 14.97
2100 Colorado Avenue
Santa Monica,
California(7)......... 3 1992 94,844 100.0% 2,814 29.67
1633 26th Street
Santa Monica,
California(7)......... 1 1972/1997 43,800 100.0% 842 19.22
3130 Wilshire Blvd.
Santa Monica,
California(28)........ 1 1969/1998 88,338 69.1% 1,455 23.84
501 Santa Monica Blvd.
Santa Monica,
California............ 1 1974 70,000 85.5% 1,494 24.96
2829 Townsgate Road
Thousand Oaks,
California............ 1 1990 81,158 100.0% 2,299 28.33
23600-23610 Telo Avenue
Torrance,
California(9)......... 2 1984 79,967 51.9% 428 10.31
--- --------- ------
Subtotal/Weighted
Average--
Los Angeles County..... 27 2,418,339 95.6% 46,040 19.91
--- --------- ------
</TABLE>

14
<PAGE>

San Diego County
5770 Armada Drive
Carlsbad,
California(7)......... 1 1998 81,712 100.0% 1,071 13.11
2231 Rutherford
Carlsbad, California... 1 1998 39,000 100.0% 587 15.05
6220 Greenwich Drive
San Diego,
California(7)......... 1 1996 141,214 100.0% 2,076 14.70
6055 Lusk Avenue
San Diego,
California(7)......... 1 1997 93,000 100.0% 1,142 12.28
6260 Sequence Drive
San Diego,
California(7)......... 1 1997 130,000 100.0% 1,192 9.17
6290 Sequence Drive
San Diego,
California(7)......... 1 1997 90,000 100.0% 894 9.93
6340 & 6350 Sequence
Drive
San Diego,
California(7)......... 2 1998 200,000 100.0% 2,616 13.08
15378 Avenue of Science
San Diego,
California(7)......... 1 1984 68,910 100.0% 620 9.00
Pacific Corporate Center
San Diego,
California(14)........ 7 1995 411,402 100.0% 5,238 12.73
3990 Ruffin Road
San Diego, California.. 1 1998 45,634 100.0% 660 14.46
9455 Towne Center Drive
San Diego,
California(7)......... 1 1998 45,195 100.0% 569 12.59
12225-12235 El Camino
Real
San Diego,
California(15)........ 2 1998 115,513 100.0% 2,122 18.37
--- --------- -------
Subtotal/Weighted
Average--
San Diego County....... 20 1,461,580 100.0% 18,787 12.85
--- --------- -------
</TABLE>

15
<PAGE>

Orange County
3340 E. La Palma Avenue
Anaheim, California.... 1 1966 153,320 100.0% 1,084 7.07
1000 E. Ball Road
Anaheim, California.... 1 1956 100,000 100.0% 639 6.39
1230 S. Lewis Road
Anaheim, California.... 1 1982 57,730 100.0% 291 5.04
4155 E. La Palma Avenue
Anaheim,
California(18)........ 1 1985 74,618 87.8% 515 7.86
4125 E. La Palma Avenue
Anaheim,
California(18)........ 1 1985 69,472 100.0% 517 7.44
5325 East Hunter Avenue
Anaheim, California.... 1 1983 109,449 100.0% 604 5.52
3130-3150 Miraloma
Anaheim, California.... 1 1970 144,000 100.0% 677 4.70
3125 E. Coronado Street
Anaheim, California.... 1 1970 144,000 100.0% 841 5.84
5115 E. La Palma Avenue
Anaheim, California(7). 1 1967/1998 291,146 100.0% 1,442 4.95
1250 N. Tustin Avenue
Anaheim, California.... 1 1984 84,185 100.0% 746 8.86
</TABLE>

16
<PAGE>

<TABLE>
<CAPTION>
Year Net Percentage Annual Average
No. of Built/ Rentable Leased at Base Rent Base Rent
Property Location Buildings Renovated Square Feet 12/31/98(1) ($000's)(2) Per Sq. Ft. ($)(3)
----------------- --------- --------- ----------- ----------- ----------- ------------------
<S> <C> <C> <C> <C> <C> <C>
3250 East Carpenter
Anaheim, California.... 1 1998 41,225 100.0% $ 242 $ 5.87
Brea Industrial Complex
Brea, California(19)... 7 1981 276,278 100.0% 1,584 5.73
1675 MacArthur
Costa Mesa, California. 1 1986 50,842 100.0% 512 10.07
892/909 Towne Center
Drive
Foothill Ranch,
California............ 1 1998 303,327 100.0% 2,090 6.89
12681/12691 Pala Drive
Garden Grove,
California(20)........ 1 1970 84,700 44.9% 301 7.91
Garden Grove Industrial
Complex
Garden Grove,
California(21)........ 6 1971 275,971 100.0% 1,678 6.08
12752-12822 Monarch
Street
Garden Grove,
California(16)........ 1 1970 277,037 100.0% 1,005 3.63
7421 Orangewood Avenue
Garden Grove,
California............ 1 1981 82,602 100.0% 575 6.96
12400 Industry Street
Garden Grove,
California............ 1 1972 64,200 100.0% 328 5.11
Giltspur Building
Garden Grove,
California............ 1 1974 110,220 100.0% 777 7.05
Gothard Business Park
Huntington Beach,
California(22)........ 3 1977 56,638 89.8% 410 8.06
17150 Von Karman
Irvine, California..... 1 1977 157,458 100.0% 1,136 7.21
184-220 Technology Drive
Irvine, California..... 10 1990 158,070 84.0% 1,202 9.05
9401 Toledo Way
Irvine, California..... 1 1984 244,800 100.0% 1,363 5.57
2055 S.E. Main Street
Irvine, California(23). 1 1973 47,583 100.0% 305 6.41
13645-13885 Alton
Parkway
Anaheim,
California(24)........ 9 1989 143,117 87.4% 1,093 8.74
Dimension Business Park
Lake Forest,
California(25)........ 2 1990 45,257 100.0% 375 10.04
1951 E. Carnegie
Santa Ana, California.. 1 1981 100,000 100.0% 795 7.95
14831 Franklin Avenue
Tustin, California(23). 1 1978 36,256 100.0% 206 5.68
2911 Dow Avenue
Tustin, California..... 1 1998 54,720 100.0% 361 6.60
--- --------- -------
Subtotal/Weighted
Average--
Orange County.......... 59 3,838,221 95.4% 23,694 6.47
--- --------- -------
San Diego County
5759 Fleet Street
Carlsbad, California... 1 1998 82,100 100.0% 1,234 15.03
6828 Nancy Ridge Drive
San Diego, California.. 1 1982 39,669 100.0% 385 9.71
41093 County Center
Drive
Temecula, California... 1 1997 77,582 100.0% 542 6.99
--- --------- -------
Subtotal/Weighted
Average--
San Diego County....... 3 199,351 100.0% 2,161 10.84
--- --------- -------
</TABLE>

17
<PAGE>

(2) Base rent for the year ended December 31, 1998, determined in accordance
with generally accepted accounting principles ("GAAP") and annualized to
reflect a twelve-month period. Unless otherwise indicated, leases at the
Industrial Properties are written on a triple net basis and leases at the
Office Properties are written on a full service gross basis, with the
landlord obligated to pay the tenant's proportionate share of taxes,
insurance and operating expenses up to the amount incurred during the
tenant's first year of occupancy ("Base Year") or a negotiated amount
approximating the tenant's pro rata share of real estate taxes, insurance
and operating expenses ("Expense Stop"). Each tenant pays its pro rata
share of increases in expenses above the Base Year of Expense Stop.

(3) Annual Base Rent divided by net rentable square feet leased at December
31, 1998.

(4) The four properties at 5151-5155 Camino Ruiz were built between 1982 and
1985.

(5) For this property, a lease with Hughes Space & Communications for
approximately 96,000 rentable square feet, and with SDRC Software
Products Marketing Division, Inc. for approximately 6,800 rentable square
feet, are written on a full service gross basis except that there is no
Expense Stop.

(6) For this property, the lease with Hughes Space & Communications is
written on a modified full service gross basis under which Hughes Space &
Communications pays for all utilities and other internal maintenance
costs with respect to the leased space and, in addition, pays its pro
rata share of real estate taxes, insurance, and certain other expenses
including common area expenses.

(7) For this property, the lease is written on a triple net basis.

(8) For this property, leases with Hughes Space & Communications for
approximately 103,000 rentable square feet are written on a full service
gross basis except that there is no Expense Stop.

(9) For this property, the lease is written on a modified gross basis, with
the tenant paying its share of taxes and insurance above base year
amounts.
(footnotes continued on next page)

18
<PAGE>

(10) For this property, leases for approximately 65,000 rentable square feet
are written on a full service basis, with the tenants paying no expense
reimbursement, leases for approximately 38,000 rentable square feet are
written on a modified full service gross basis, and leases for
approximately 29,000 rentable square feet are written on a triple net
basis.

(11) For this property, leases for approximately 70,500 rentable square feet
are written on a full service basis, with the tenants paying no expense
reimbursement, leases for approximately 48,500 rentable square feet are
written on a modified full service gross basis, and leases for
approximately 21,000 rentable square feet are written on a triple net
basis.

(12) For this property, a lease for approximately 21,000 rentable square feet
is written on a modified full service grass basis, and leases for
approximately 11,000 rentable square feet are written on a triple net
basis.

(13) For this property, the lease is written on a full service basis, with the
tenant paying only its portion of real estate taxes above the base year
amount.

(14) The leases for this property are written on a modified net basis, with
the tenants responsible for their pro-rata share of common area expenses
and real estate taxes.

(15) For this property, a lease for 60,840 rentable square feet is written on
a triple net basis.

(16) For this property, a lease for 15,728 rentable square feet is written on
a triple net basis, and leases for 15,156 rentable square feet are
written on a modified full service gross basis.

(17) This property was 100% leased to one tenant in February 1999 with annual
base rent of $0.1 million.

(18) The leases for this industrial property are written on a modified triple
net basis, with the tenants responsible for estimated allocated common
area expenses.

(19) The seven properties at the Brea Industrial Complex were built between
1981 and 1988.

(20) For this property, a lease for 14,700 rentable square feet commenced in
February 1999 with annual base rent of $0.1 million resulting in total
occupancy as of March 10, 1999 of 62.0%.

(21) The six properties at the Garden Grove Industrial Complex were built
between 1971 and 1985.

(22) For this property, leases for approximately 38,000 rentable square feet
are written on a modified full service gross basis, and leases for
approximately 12,000 rentable square feet are written on a full service
basis, with the tenants paying no expense reimbursement.

(23) For this property, the lease is written on a full service gross basis.

(24) For this property, leases for approximately 53,000 rentable square feet
are written on a full service gross basis, with the tenants paying no
expense reimbursement, leases for approximately 53,000 rentable square
feet are written on a modified triple net basis with the tenants
responsible for estimated allocated common area expenses.

(25) For this property, leases for approximately 26,000 rentable square feet
are written on a full service basis, with the tenants paying no expense
reimbursement, and leases for approximately 19,000 rentable square feet
are written on a modified full service gross basis.

(26) This industrial property was originally designed for multi-tenant use and
currently is leased to a single tenant and utilized as an indoor multi-
vendor retail marketplace.

(27) For this property, leases for approximately 115,500 rentable square feet
are written on a triple net basis and, leases for approximately 46,500
rentable square feet are written on a full service basis, with the
tenants paying no expense reimbursement.

(28) This property was managed by third-party managers at December 31, 1998.

(29) This table does not include one industrial property with an aggregate
113,248 rentable square feet which was occupied at December 31, 1998.
This property is part of a three building complex that was constructed by
the Company. As substantial tenant improvements still needed to be
completed at December 31, 1998, the complex is included in construction
in progress at December 31, 1998.

19
<PAGE>

Development Projects

The following table sets forth certain information as of December 31, 1998,
relating to each of the Company's Development Projects which were either in
the lease-up phase (construction was complete except for tenant improvements),
under construction or scheduled to begin construction in the first quarter of
1999. The Company owns a 100% interest in all of the Development Projects
other than 5010 Wateridge Vista Drive and Carmel Center Building 1, in which
the Company will own a 50% interest.

<TABLE>
<CAPTION>
Projected Projected Projected Square Leasing Status at
Stabilization Total Feet upon December 31,
Project Location/Submarket Date(1) Investment(2) Completion 1998(3)
- -------------------------- ---------------- ------------- ---------------- -----------------
(dollars in
millions)
<S> <C> <C> <C> <C>
Development Projects in
Lease-up:
Industrial
1211-1231 North Miller
Street/
Orange County............ 3rd Quarter 1999 $ 20.8 379,300 82.0%
------ -------
Total Development
Projects in Lease-up... $ 20.8 379,300 82.0%
====== =======
Development Projects Under
Construction:
Office
6215 Greenwich Drive/San
Diego.................... 2nd Quarter 1999 $ 8.7 71,000 100.0%
12348 High Bluff Drive/San
Diego.................... 3rd Quarter 1999 6.1 39,300 80.9%
5010 Wateridge Vista
Drive/San Diego(4)....... 4th Quarter 1999 29.0 172,800 100.0%
Kilroy Airport Center,
Long Beach Phase III/
Los Angeles.............. 1st Quarter 2000 22.6 136,000 38.8%
Del Mar Build-to-Suit/San
Diego.................... 1st Quarter 2000 15.4 72,300 100.0%
Carmel Center Building
1/San Diego(4)........... 3rd Quarter 2000 10.2 52,900 0.0%
------ -------
Subtotal................ 92.0 544,300 73.6%
------ -------
Industrial
3355 E. La Palma
Avenue/Orange County..... 3rd Quarter 1999 14.9 211,400 100.0%
440, 925 and 1075 Lambert
Road/
Orange County............ 3rd Quarter 1999 10.9 178,500 29.0%
------ -------
Subtotal................ 25.8 389,900 67.5%
------ -------
Total Development
Projects Under
Construction........... $117.8 934,200 71.0%
====== =======
</TABLE>
- --------
(1) Based on management's estimation of the earlier of stabilized occupancy
(95.0%) or one year from the date of substantial completion.

(2) Represents total projected development costs.

(3) Represents executed leases and signed letters of intent to lease at
December 31, 1998.

(4) Represents projects being developed in conjunction with The Allen Group, a
group of affiliated real estate and development companies based in
Visalia, California. See separate discussion in Item 7: Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Capital Expenditures Section for further discussion.

20
<PAGE>

Tenant Information

The following table sets forth information as to the Company's ten largest
office and industrial tenants based upon annualized rental revenues for the
year ended December 31, 1998.

<TABLE>
<CAPTION>
Percentage of
Annual Total Base Lease
Base Rental Rental Initial Lease Expiration
Tenant Name Revenues(1) Revenues Date(2) Date
- ----------- ----------- ------------- -------------- --------------
(dollars in
thousands)
<S> <C> <C> <C> <C>
Office Properties:
Hughes Aircraft
Corporation's Space &
Communications
Company(3)............. $ 9,183 7.4% August 1984 Various
The Boeing Company(4)... 5,160 4.2 February 1992 Various
State of California(5).. 3,216 2.6 July 1997 Various
Sony Music
Entertainment, Inc. ... 2,814 2.3 June 1997 December 2008
Unisys Corporation...... 2,655 2.1 March 1997 April 2001
Northwest Airlines:
El Segundo............ 1,523 1.2 August 1978 February 2001
Seattle............... 718 0.6 May 1980 April 2005
Pacific Bell............ 1,994 1.6 December 1998 February 2009
Intuit, Inc. ........... 1,968 1.6 November 1997 June 2004
Raytheon Company(6)..... 1,651 1.3 April 1996 Various
National Digital
Television............. 1,602 1.3 July 1998 July 2008
------- ----
Total Office Properties. $32,484 26.2%
======= ====
Industrial Properties:
Mattel, Inc. ........... $ 2,138 1.7% May 1990 October 2000
Celestica, Inc. ........ 1,530 1.2 May 1998 May 2008
Kraft Foods, Inc. ...... 1,449 1.2 November 1997 February 2006
Omni-Pak................ 1,443 1.2 August 1998 July 2008
Mazda Motor of America,
Inc. .................. 1,365 1.1 July 1997 July 2000
Industrial Computer
Source................. 1,192 1.0 November 1997 July 2005
Packard Hughes
Interconnect and
General Motors
Corporation............ 1,062 0.9 May 1997 January 2001
Extron Electronic(7).... 930 0.8 February 1995 Various
Southern Plastic Mold,
Inc. .................. 774 0.6 September 1997 September 2003
Raab Karcher
Electronics............ 687 0.6 February 1998 January 2013
------- ----
Total Industrial
Properties............. $12,570 10.2%
======= ====
</TABLE>
- --------

(1) Determined in accordance with GAAP.

(2) Represents date of first relationship between tenant and the Company or
the Company's predecessor, the Kilroy Group.

(3) Hughes Space & Communications leases of 291,187 and 103,035 net rentable
square feet expire July 2004 and January 2004, respectively. Leases with
other Hughes-affiliated entities of 7,515, 5,559 and 5,158 net rentable
square feet expire November 2001, December 1999 and November 1999,
respectively.

(4) The Boeing Company lease at SeaTac Office Center expires January 2002. The
Boeing Company (formerly McDonnell Douglas Corporation) leases at Kilroy
Airport Center Long Beach of 64,530, 24,536 and 17,921 net rentable square
feet expire January 2002, December 2000 and December 1999, respectively.

(5) State of California leases of 124,921, 22,543, 21,781 and 11,425 net
rentable square feet expire April 1999, December 2002, May 2009 and August
2000, respectively.

(6) Raytheon Company (formerly Hughes Aircraft Company) leases of 96,133 and
11,556 net rentable square feet expire October 2000, and a lease of 9,387
net rentable square feet expires January 2002.

(7) Extron Electronics leases of 100,000 and 57,730 net rentable square feet
expire April 2005, and January 2005, respectively.

21
<PAGE>

At December 31, 1998, the Company's tenant base was comprised of the
following industries, broken down by percentage of total portfolio base rent:
manufacturing, 40.5%; services, 21.7%; transportation, communications and
public utilities, 14.1%; finance, insurance and real estate, 11.0%; retail
trade, 4.4%; government, 4.1%; wholesale trade, 3.0%; construction, 1.1%; and
agriculture, forestry and fishing, 0.1%. Following is a list comprised of a
representative sample of 25 of the Company's tenants whose annual base rental
revenues were less than 1.0% of the Company's total annual base revenue at
December 31, 1998:

<TABLE>
<S> <C> <C>
AMN Healthcare, Inc. Denso International America Pacific Engineering Services
Advanced Survey Concepts EVA Airways Corporation Salem Communications
AIG Claim Services, Inc. Family and Sport Chiropractic Sentinel Monitoring Corp
Arrowhead General Insurance Horizon's Technology, Inc. Southern Plastic Mold
Arinc, Inc. Liner Yankelevitz Sunshine Sox Hosiery
Best, Best & Krieger Lynden Air Freight, Inc. Staar Surgical AG, Inc.
Bits Technology Corporation Miller and Company Sverdrup Civil, Inc
Catalina Marketing Corp. Paper Solutions Ink The Polk Company
ThermoTrex Corporation
</TABLE>

Lease Expirations

The following table sets forth a summary of the Company's lease expirations
for the Office and Industrial Properties for each of the ten years beginning
with 1999, assuming that none of the tenants exercise renewal options or
termination rights.

<TABLE>
<CAPTION>
Average Annual
Percentage of Rent Per Net
Total Leased Rentable
Net Rentable Square Feet Square Foot
Number of Area Subject to Represented Annual Base Rent Represented by
Expiring Expiring by Expiring Under Expiring Expiring
Year of Lease Expiration Leases(1) Leases (Sq. Ft.) Leases(2) Leases (000's)(3) Leases
- ------------------------ --------- ---------------- ------------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
Office Properties:
1999.................... 125 925,552 16.5% $12,019 $12.99
2000.................... 77 361,580 6.4 6,137 16.97
2001.................... 77 1,022,774 18.2 11,631 11.37
2002.................... 40 510,389 9.1 6,485 12.71
2003.................... 35 218,541 3.9 3,161 14.46
2004.................... 23 675,469 12.0 14,567 21.57
2005.................... 19 668,935 11.9 9,322 13.94
2006.................... 8 299,502 5.3 4,879 16.29
2007.................... 8 298,989 5.3 4,828 16.15
2008 and beyond......... 14 641,497 11.4 14,230 22.18
--- --------- ----- -------
Total................... 426 5,623,228 100.0% $87,259 $15.52
=== ========= ===== =======
Industrial Properties:
1999.................... 84 613,841 10.1% $ 3,905 $ 6.36
2000.................... 66 933,399 15.3 4,482 4.80
2001.................... 42 1,033,741 16.9 5,020 4.86
2002.................... 6 176,860 2.9 1,575 8.91
2003.................... 23 724,853 11.9 4,349 6.00
2004.................... 7 426,318 7.0 2,747 6.44
2005.................... 6 327,757 5.4 2,394 7.30
2006.................... 6 534,900 8.8 3,518 6.58
2007.................... 2 135,885 2.2 1,081 7.96
2008 and beyond......... 13 1,197,250 19.6 8,718 7.28
--- --------- ----- -------
Total................. 255 6,104,804 100.0% $37,789 $ 6.19
=== ========= ===== =======
</TABLE>
(footnotes continued on next page)

22
<PAGE>

- --------
(1) Includes tenants only. Excludes leases for amenity, retail, parking and
month-to-month tenants. Some tenants have multiple leases.

(2) Based on total leased square footage for the respective portfolios as of
December 31, 1998 unless a lease for a replacement tenant had been
executed on or before January 1, 1999.

(3) Determined based upon aggregate base rent to be received over the term
divided by the term in months multiplied by 12, including all leases
executed on or before January 1, 1999.

Mortgage Debt

On December 31, 1998, the Operating Partnership had outstanding five
mortgage loans representing aggregate indebtedness of approximately $133
million which were secured by certain of the Office and Industrial Properties
(the "Secured Obligations"). See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources" and Note 6 to the Company's combined and consolidated financial
statements included herewith. Management believes that as of December 31,
1998, the value of the properties securing the respective Secured Obligations
in each case exceeded the principal amount of the outstanding obligation.

ITEM 3. LEGAL PROCEEDINGS

Neither the Company nor any of the Company's Properties are presently
subject to any material litigation nor, to the Company's knowledge, is any
material litigation threatened against any of them which if determined
unfavorably to the Company would have a material adverse effect on the
Company's cash flows, financial condition or results of operations. The
Company is party to litigation arising in the ordinary course of business,
none of which if determined unfavorably to the Company is expected to have a
material adverse effect on the Company's cash flows, financial condition or
results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of stockholders during the fourth
quarter of the year ended December 31, 1998.

23
<PAGE>

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's common stock began trading on the New York Stock Exchange
("NYSE") on January 28, 1997, under the symbol "KRC." Prior to January 28,
1997, there was no established public trading market for the Company's common
stock. The following table illustrates the high, low and closing prices by
quarter in 1998 and 1997, as reported on the NYSE. On March 10, 1999, there
were approximately 235 registered holders of the Company's common stock.

<TABLE>
<CAPTION>
Common
Stock
Dividends
1998 High Low Close Declared
---- ------ ------ ------ ---------
<S> <C> <C> <C> <C>
First quarter............................... $29.25 $26.31 $28.56 $0.4050
Second quarter.............................. 28.31 24.69 25.00 0.4050
Third quarter............................... 25.56 19.00 23.00 0.4050
Fourth quarter.............................. 23.38 19.50 23.00 0.4050
</TABLE>

<TABLE>
<CAPTION>
Common
Stock
Dividends
1997 High Low Close Declared
---- ------ ------ ------ ---------
<S> <C> <C> <C> <C>
January 28 to March 31...................... $28.13 $23.00 $26.63 $0.2583
Second quarter.............................. 26.63 23.13 25.25 0.3875
Third quarter............................... 27.00 24.00 27.00 0.3875
Fourth quarter.............................. 28.88 25.75 28.75 0.3875
</TABLE>

The Company pays distributions to common stockholders on or about the 10th
day of each January, April, July and October at the discretion of the Board of
Directors. Distribution amounts depend on the Company's funds from operations,
financial condition and capital requirements, the annual distribution
requirements under the REIT provisions of the Internal Revenue Code of 1986,
as amended (the "Code"), and such other factors as the Board of Directors
deems relevant.

During the first and fourth quarters of fiscal year 1998, the Operating
Partnership issued 703,869 common units of the Operating Partnership, valued
by the Company at approximately $18.1 million (based on the Company's closing
price per share of common stock on the NYSE), to entities controlled by
Richard S. Allen, a member of the Company's Board of Directors at December 31,
1998, in partial consideration for the contribution of certain properties to
the Operating Partnership. An Executive Vice President of the Company received
303,316 of the total 703,869 common units. The common units become convertible
into shares of the Company's common stock, on a one-for-one basis, one year
after issuance date. The common units were issued in reliance upon an
exemption from registration provided by Regulation D under the Securities Act
as a transaction by an issuer not involving a public offering.

During the second quarter of fiscal year 1998, the Operating Partnership
issued 90,787 common units of the Operating Partnership, valued by the Company
at approximately $2.5 million (based on the Company's closing price per share
of common stock on the NYSE), to a partnership controlled by John B. Kilroy,
Sr., the Company's Chairman of the Board of Directors, and John B. Kilroy,
Jr., the Company's President and Chief Executive Officer, in partial
consideration for the contribution of certain undeveloped land to the
Operating Partnership. The common units may be exchanged, at the Company's
option, into shares of the Company's common stock, on a one-for-one basis, one
year after issuance date. The common units were issued in reliance upon an
exemption from registration provided by Regulation D under the Securities Act
as a transaction by an issuer not involving a public offering.

24
<PAGE>

During the second and third quarters of 1998, the Company issued 1,200,000
and 300,000 8.075% Series A Cumulative Redeemable Preferred units,
respectively, representing limited partnership interests in the Operating
Partnership with a liquidation value of $50.00 per unit, in exchange for a
gross contribution to the Operating Partnership of $60.0 million. The Series A
Preferred units are exchangeable, at the option of the majority of the
holders, for shares of the Company's 8.075% Series A Cumulative Redeemable
Preferred stock, beginning 10 years from the date of issuance, or earlier
under certain circumstances. The Series A Cumulative Redeemable Preferred
units were issued in reliance upon an exemption from registration provided by
Regulation D under the Securities Act as a transaction by an issuer not
involving a public offering.

During the fourth quarter of 1998, the Company issued 700,000 9.375% Series
C Cumulative Redeemable Preferred units, representing limited partnership
interests in the Operating Partnership with a liquidation value of $50.00 per
unit, in exchange for a gross contribution to the Operating Partnership of
$35.0 million. The Series C Cumulative Redeemable Preferred units are
exchangeable at the option of the majority of the holders, for shares of the
Company's 9.375% Series C Cumulative Redeemable Preferred stock, beginning 10
years from the date of issuance, or earlier under certain circumstances. The
Series A Cumulative Redeemable Preferred units were issued in reliance upon an
exemption from registration provided by Regulation D under the Securities Act
as a transaction by an issuer not involving a public offering.

During the first quarter of 1999, the Operating Partnership issued 119,460
common units of the Operating Partnership, valued by the Company at
approximately $2.5 million (based on the Company's closing per share price of
common stock on the NYSE), to entities controlled by Richard S. Allen, a
member of the Company's Board of Directors at December 31, 1998, in partial
consideration for the contribution of certain undeveloped land to the
Operating Partnership. An Executive Vice President of the Company received
42,564 of the total 119,460 common units. The common units may be exchanged,
at the Company's option, into shares of the Company's common stock, on a one-
for-one basis, on or after October 31, 2000. The common units were issued in
reliance upon an exemption from registration provided by Regulation D under
the Securities Act as a transaction by an issuer not involving a public
offering.

25
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

Kilroy Realty Corporation and the Kilroy Group
(in thousands, except per share, square footage and occupancy data)

<TABLE>
<CAPTION>
Kilroy Realty Corporation
Consolidated Kilroy Group Combined
------------------------- -------------------------------------
February 1, January 1,
Year Ended 1997 to 1997 to Year Ended December 31,
December 31, December 31, January 31, -------------------------
1998 1997 1997 1996 1995 1994
------------ ------------ ----------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Statements of Operations
Data:
Rental income.......... $117,338 $56,069 $2,760 $35,022 $33,896 $32,577
Tenant reimbursements.. 14,152 6,751 306 3,752 3,002 1,643
Development services... 14 698 1,156 919
Sale of air rights..... 4,456
Interest income........ 1,698 3,571
Other income........... 3,096 889 4 76 398 1,084
-------- ------- ------ ------- ------- -------
Total revenues....... 136,284 67,280 3,084 39,548 42,908 36,223
-------- ------- ------ ------- ------- -------
Property expenses...... 19,281 8,770 579 6,788 6,834 6,000
Real estate taxes
(refunds)............. 9,579 4,199 137 1,673 1,416 (448)
General and
administrative
expenses.............. 7,739 4,949 78 2,383 2,152 2,467
Ground leases.......... 1,223 938 64 768 789 913
Development expenses... 46 650 737 468
Option buy-out cost.... 3,150
Provision for
potentially
unrecoverable
pre-development costs. 1,700
Interest expense....... 20,568 9,738 1,895 21,853 24,159 25,376
Depreciation and
amortization.......... 26,200 13,236 787 9,111 9,474 9,962
-------- ------- ------ ------- ------- -------
Total expenses....... 86,290 41,830 3,586 46,376 45,561 44,738
-------- ------- ------ ------- ------- -------
Income (loss) before
equity in income of
unconsolidated
subsidiary minority
interests and
extraordinary gains... 49,994 25,450 (502) (6,828) (2,653) (8,515)
Equity in income of
unconsolidated
subsidiary............ 5 23
-------- ------- ------ ------- ------- -------
Income (loss) before
minority interests and
extraordinary gains... 49,999 25,473 (502) (6,828) (2,653) (8,515)
Minority interests:
Distributions on
Cumulative Redeemable
Preferred units....... (5,556)
Minority interest in
earnings.............. (5,621) (3,413)
-------- ------- ------ ------- ------- -------
Income (loss) before
extraordinary gains... 38,822 22,060 (502) (6,828) (2,653) (8,515)
Extraordinary gains--
extinguishment of
debt.................. 3,204 20,095 15,267 1,847
-------- ------- ------ ------- ------- -------
Net income (loss).... $ 38,822 $22,060 $2,702 $13,267 $12,614 $(6,668)
======== ======= ====== ======= ======= =======
Share Data:
Weighted average shares
outstanding--basic.... 26,989 18,445
======== =======
Weighted average shares
outstanding--diluted.. 27,060 18,539
======== =======
Net income per common
share--basic.......... $ 1.44 $ 1.20
======== =======
Net income per common
share--diluted........ $ 1.43 $ 1.19
======== =======
Distributions per
common share.......... $ 1.62 $ 1.42
======== =======
</TABLE>

26
<PAGE>

<TABLE>
<CAPTION>
December 31,
------------------------------------------------------
Kilroy Realty
Corporation
Consolidated Kilroy Group Combined
--------------------- -------------------------------
1998 1997 1996 1995 1994
---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Investment in real
estate, before
accumulated
depreciation and
amortization.......... $1,194,284 $ 834,690 $ 227,337 $ 224,983 $ 223,821
Total assets........... 1,105,928 757,654 128,339 132,857 143,251
Mortgage debt and line
of credit............. 405,383 273,363 223,297 233,857 250,059
Total liabilities...... 449,529 305,319 242,116 254,683 273,585
Total minority
interests............. 180,500 55,185
Total stockholders'
equity/(accumulated
deficit).............. 475,899 397,150 (113,777) (121,826) (130,334)

Other Data:
Funds from
Operations(1),(2)...... $ 71,174 $ 39,142 $ 5,433 $ 2,365 $ 1,447
Cash flows from(3):
Operating activities... 73,429 28,928 5,520 10,071 6,607
Investing activities... (343,717) (551,956) (2,354) (1,162) (1,765)
Financing activities... 267,802 531,957 (3,166) (8,909) (4,842)
Office Properties:
Rentable square
footage............... 5,600,459 4,200,734 1,688,383 1,688,383 1,688,383
Occupancy.............. 95.7% 94.3% 76.0% 72.8% 73.3%
Industrial Properties:
Rentable square
footage............... 6,157,107 5,027,716 916,570 916,570 916,570
Occupancy.............. 96.0% 91.9% 97.6% 98.4% 79.7%
</TABLE>
- --------
(1) As defined by the National Association of Real Estate Investment Trusts
("NAREIT"), "Funds from Operations" represents net income (loss) before
minority interest of common unitholders (computed in accordance with
GAAP), excluding gains (or losses) from debt restructuring and sales of
property, plus real estate related depreciation and amortization
(excluding amortization of deferred financing costs and depreciation of
non-real estate assets) and after adjustments for unconsolidated
partnerships and joint ventures. Non-cash adjustments to arrive at Funds
from Operations were as follows: in all periods, depreciation and
amortization; in 1996, 1995 and 1994, gains on extinguishment of debt; and
in 1998 and 1997, non-cash compensation. Further, in 1996 and 1995, non-
recurring items (sale of air rights and option buy-out cost) were
excluded. Management considers Funds from Operations an appropriate
measure of performance of an equity REIT because it is predicated on cash
flow analyses. The Company computes Funds from Operations in accordance
with standards established by the Board of Governors of NAREIT in its
March 1995 White Paper, which may differ from the methodology for
calculating Funds from Operations utilized by other equity REITs and,
accordingly, may not be comparable to Funds from Operations reported by
such other REITs. Further, Funds from Operations does not represent
amounts available for management's discretionary use because of needed
capital reinvestment or expansion, debt service obligations, or other
commitments and uncertainties. See the notes to the financial statements
of the Company and the Kilroy Group. Funds from Operations should not be
considered as an alternative to net income (loss) (computed in accordance
with GAAP) as an indicator of the Properties' financial performance or to
cash flow from operating activities (computed in accordance with GAAP) as
a measure or indicator of the Properties' liquidity, nor is it indicative
of funds available to fund the Properties' cash needs, including the
Company's ability to pay dividends or make distributions.

(2) Funds from Operations for 1997 is derived from the results of operations
of Kilroy Realty Corporation for the period February 1, 1997 to December
31, 1997.

(3) Cash flow for 1997 represents the cash flow of the Kilroy Group for the
period January 1, 1997 to January 31, 1997 and Kilroy Realty Corporation
for the period February 1, 1997 to December 31, 1997.

27
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion relates to the consolidated financial statements of
the Company and the combined financial statements of the Company's
predecessor, the Kilroy Group, and should be read in conjunction with the
financial statements and related notes thereto. Statements contained in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" that are not historical facts may be forward-looking statements.
Such statements are subject to certain risks and uncertainties, which could
cause actual results to differ materially from those projected. You are
cautioned not to place undue reliance on these forward-looking statements.

Overview and Background

The Company, which owns, operates and develops office and industrial real
estate, primarily in Southern California, commenced operations in January 1997
and operates as a self-administered REIT. The Company succeeded to the real
estate business of the Kilroy Group, the Company's predecessor. The Kilroy
Group had been engaged in the acquisition, management, financing, construction
and leasing of office and industrial properties and providing development
services to third party owners for a fee. The combined financial statements of
the Kilroy Group comprise the operations, assets and liabilities of the
properties contributed to the Company in connection with its formation, the
formation of Operating Partnership and completion of the Company's initial
public offering ("IPO"), (collectively, the "Formation Transactions"), on
January 31, 1997. The Company owns its interests in all of its Properties
through the Operating Partnership and the Finance Partnership, and conducts
substantially all of its operations through the Operating Partnership. The
Company owned an 86.8% and 87.8% general partnership interest in the Operating
Partnership as of December 31, 1998 and 1997, respectively.

The Company's revenue is derived primarily from rental income, including
tenant reimbursements. While the Company's revenue growth in 1998 and 1997 was
due primarily to the completion of $254 million and $507 million of
acquisitions, respectively, the market for property acquisitions has become
more competitive. As a result, management believes that the most significant
part of the Company's revenue growth over the next two to three years will
come from its substantial development pipeline. Management also believes that
continued improvement of the real estate market in the Company's principal
markets and the continued economic expansion of Southern California, which
continues to lead the state in both job and economic growth, will result in
strong demand for office and industrial space. Consequently, management
currently expects that the Company's revenue in the next one to two years will
also grow as a result of re-leasing, at higher lease rates, approximately
1.3 million square feet of office space and 1.5 million square feet of
industrial space currently subject to leases expiring during the next two
years. In addition, the Company intends to continue its leadership as a low
cost operator through integrated operations and disciplined cost management.

Results of Operations

During the year ended December 31, 1998, the Company acquired 25 office and
16 industrial properties encompassing 1.4 million and 674,000 aggregate
rentable square feet, respectively, for an aggregate acquisition cost of $254
million. In addition, the Company completed $70.7 million in property
development consisting of the renovation of two buildings encompassing 369,000
rentable square feet, the construction of two buildings encompassing 345,000
rentable square feet and the construction of three buildings encompassing
379,000 rentable square feet which were completed except for tenant
improvements at December 31, 1998. The Company's policy is to include
properties in its stabilized portfolio upon the earlier of one year from the
date of substantial completion or the date the property reaches stabilized
occupancy of 95.0%. During 1997, the Company acquired 41 office and 55
industrial properties encompassing 2.2 million and 3.7 million aggregate
rentable square feet, respectively, for an aggregate acquisition cost of $507
million. Operating results for acquired properties and completed development
properties are included in the consolidated financial statements of the
Company subsequent to their respective acquisition or completion dates.

28
<PAGE>

As a result of the 41 properties acquired subsequent to December 31, 1997
and the development of the five new properties completed in 1998, rentable
square footage in the Company's portfolio of stabilized Properties increased
2.6 million rentable square feet, or 28.3%, to 11.8 million rentable square
feet at December 31, 1998 compared to 9.2 million rentable square feet at
December 31, 1997. As of December 31, 1998, the Company's portfolio of
stabilized Properties was comprised of 80 Office Properties encompassing 5.6
million rentable square feet and 84 Industrial Properties encompassing 6.2
million rentable square feet. The portfolio occupancy rate at December 31,
1998 was 95.9%, with the Office and Industrial Properties 95.7% and 96.0%
occupied, respectively, as of such date.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

The 1997 results include the Company's results for the period February 1,
1997 to December 31, 1997 and the Kilroy Group's results for the period
January 1, 1997 to January 31, 1997.

<TABLE>
<CAPTION>
Year ended
December 31,
---------------- Dollar Percentage
1998 1997 Change Change
-------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental income........................... $117,338 $58,829 $58,509 99.5%
Tenant reimbursements................... 14,152 7,057 7,095 100.5
Development services.................... 14 (14) (100.0)
Interest income......................... 1,698 3,571 (1,873) (52.5)
Other income............................ 3,096 893 2,203 246.7
-------- ------- -------
Total revenues........................ 136,284 70,364 65,920 93.7
-------- ------- -------
Expenses:
Property expenses....................... 19,281 9,349 9,932 106.2
Real estate taxes....................... 9,579 4,336 5,243 120.9
General and administrative.............. 7,739 5,027 2,712 53.9
Ground leases........................... 1,223 1,002 221 22.1
Development expense..................... 46 (46) (100.0)
Provision for potentially unrecoverable
pre-development costs.................. 1,700 1,700 100.0
Interest expense........................ 20,568 11,633 8,935 76.8
Depreciation and amortization........... 26,200 14,023 12,177 86.8
-------- ------- -------
Total expenses........................ 86,290 45,416 40,874 90.0
-------- ------- -------
Income before equity in income of
unconsolidated subsidiary, minority
interests and extraordinary gains........ $ 49,994 $24,948 $25,046 100.4%
======== ======= =======
</TABLE>

29
<PAGE>

Rental Operations

Management evaluates the operations of its portfolio based on operating
property type. The following tables compare the net operating income, defined
as operating revenues less property and related expenses (property expenses,
real estate taxes and ground leases) before depreciation, for the Office and
Industrial Properties for the years ended December 31, 1998 and 1997. The 1997
results include the Company's results for the period February 1, 1997 to
December 31, 1997 and the Kilroy Group's results for the period January 1,
1997 to January 31, 1997.

<TABLE>
<CAPTION>
Year ended
December 31,
--------------- Dollar Percentage
1998 1997 Change Change
------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Office Properties
Operating revenues:
Rental income.............................. $82,164 $43,756 $38,408 87.8%
Tenant reimbursements...................... 10,599 5,490 5,109 93.1
Other income............................... 2,899 488 2,411 494.1
------- ------- -------
Total.................................... 95,662 49,734 45,928 92.3
------- ------- -------
Property and related expenses:
Property expenses.......................... 16,373 8,516 7,857 92.3
Real estate taxes.......................... 6,209 2,710 3,499 129.1
Ground leases.............................. 1,223 1,002 221 22.1
------- ------- -------
Total.................................... 23,805 12,228 11,577 94.7
------- ------- -------
Net operating income, as defined............. $71,857 $37,506 $34,351 91.6%
======= ======= =======
</TABLE>

Total revenues from Office Properties increased $45.9 million, or 92.3% to
$95.6 million for the year ended December 31, 1998 compared to $49.7 million
for the year ended December 31, 1997. Rental income from office buildings
increased $38.4 million, or 87.8% to $82.2 million for the year ended December
31, 1998 compared to $43.8 million for the year ended December 31, 1997. Of
this increase, $13.3 million was generated by Office Properties acquired
during 1998 (the "1998 Office Acquisitions") and $0.1 million was generated by
the Office Properties developed in 1998 (the "1998 Office Development
Properties"). In addition, $21.5 million of the increase was attributable to a
full year of operating results for the Office Properties acquired during 1997,
subsequent to the IPO on January 31, 1997 (the "1997 Office Acquisitions").
The remaining $3.5 million of the increase was generated by the 13 office
properties owned at the IPO and still owned at December 31, 1998 (the
"Existing Office Properties"), and represented a 10.0% increase in rental
income for the Existing Office Properties. The increase generated by the
Existing Office Properties was primarily the result of leasing activity at the
SeaTac Office Center, including a lease for 211,000 rentable square feet with
The Boeing Company (the "Boeing Lease"), which was effective January 1, 1998.
Excluding lease-up at the SeaTac Office Center, occupancy remained consistent
and the Existing Office Properties experienced an approximate 2.8% increase in
rental income attributable to increases in rental rates.

Tenant reimbursements from Office Properties increased $5.1 million, or
93.1% to $10.6 million for the year ended December 31, 1998 compared to $5.5
million for year ended December 31, 1997. Of this increase, $1.2 million was
attributable to the 1998 Office Acquisitions and the 1998 Office Development
Properties, and $2.3 million was attributable to the 1997 Office Acquisitions.
The remaining $1.6 million of the increase was generated by the Existing
Office Properties, of which $1.2 million represented tenant reimbursements
under the Boeing Lease. Other income from office buildings increased $2.4
million, or 494.1% to $2.9 million for the year ended December 31, 1998
compared to $0.5 million for the same period in 1997. The $2.4 million
increase was primarily due to the recognition of a $1.9 million net lease
termination fee on an office property in San Diego, California. This property
was subsequently re-leased at higher rates for a longer term. In addition, in
1998 the Company earned a $0.5 million consulting fee for assisting an
existing tenant with potential expansion plans.

30
<PAGE>

Total expenses from Office Properties increased $11.6 million, or 94.7% to
$23.8 million for the year ended December 31, 1998 compared to $12.2 million
for the year ended December 31, 1997. Property expenses increased $7.9
million, or 92.3% to $16.4 million and real estate taxes increased $3.5
million, or 129.1% to $6.2 million for the year ended December 31, 1998
compared to $8.5 million and $2.7 million, respectively, for the year ended
December 31, 1997. Of the collective increase of $11.4 million in property
expenses and real estate taxes, $3.2 million was attributable to the 1998
Office Acquisitions and the 1998 Office Development Properties, and
$6.6 million was attributable to a full year of operating results from the
1997 Office Acquisitions. The remaining $1.6 million of the increase at the
Existing Office Properties was primarily due to the increase in variable costs
associated with the lease-up of space, and an increase in real estate taxes at
the SeaTac Office Center which resulted from the completion of substantial
renovations. Ground lease expense increased $0.2 million for the year ended
December 31, 1998 compared to the same period in 1997 primarily as a result of
a full year of ground lease expense on two of the 1997 Office Acquisitions.

Net operating income, as defined, from Office Properties increased $34.4
million, or 91.6% to $71.9 million for the year ended December 31, 1998
compared to $37.5 million for the year ended December 31, 1997. Of this
increase, $31.1 million was generated by the 1998 Office Acquisitions, the
1998 Office Development Properties and the 1997 Office Acquisitions. The
remaining increase of $3.3 million was generated by the Existing Office
Properties and represents an 11.2% increase in net operating income for the
Existing Office Properties, which was primarily attributable to lease-up at
the SeaTac Office Center.

<TABLE>
<CAPTION>
Year ended
December 31,
--------------- Dollar Percentage
1998 1997 Change Change
------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Industrial Properties
Operating revenues:
Rental income............................. $35,174 $15,073 $20,101 133.4 %
Tenant reimbursements..................... 3,553 1,567 1,986 126.7
Other income.............................. 197 405 (208) (51.4)
------- ------- -------
Total................................... 38,924 17,045 21,879 128.4
------- ------- -------
Property and related expenses:
Property expenses......................... 2,908 833 2,075 249.1
Real estate taxes......................... 3,370 1,626 1,744 107.3
Ground leases.............................
------- ------- -------
Total................................... 6,278 2,459 3,819 155.3
------- ------- -------
Net operating income, as defined............ $32,646 $14,586 $18,060 123.8 %
======= ======= =======
</TABLE>

Total revenues from Industrial Properties increased $21.9 million, or 128.4%
to $38.9 million for the year ended December 31, 1998 compared to $17.0
million for the year ended December 31, 1997. Rental income increased $20.1
million, or 133.4% to $35.2 million for the year ended December 31, 1998
compared to $15.1 million for the year ended December 31, 1997. Of this
increase, $3.4 million was generated by the Industrial Properties acquired
during 1998 (the "1998 Industrial Acquisitions") and $2.1 million was
generated by the Industrial Properties developed in 1998 (the "1998 Industrial
Development Properties"). In addition, $14.0 million was attributed to a full
year of operating results from the Industrial Properties acquired in 1997,
subsequent to the IPO on January 31, 1997 (the "1997 Industrial
Acquisitions"). The remaining $0.6 million of the increase was generated by
the 11 industrial buildings owned at the IPO and still owned at December 31,
1998 (the "Existing Industrial Properties") and represented a 7.4% increase in
rental income for the Existing Industrial Properties. The increase was
primarily the result of the lease-up of 46,000 rentable square feet at the La
Palma Business Center in the second quarter of 1998, which had been vacant
since the second quarter of 1997. Excluding the lease-up at La Palma Business
Center, occupancy and rental rates for the Existing Industrial Properties
remained consistent.

31
<PAGE>

Tenant reimbursements from Industrial Properties increased $2.0 million, or
126.7% to $3.5 million for the year ended December 31, 1998 compared to $1.5
million for year ended December 31, 1997. Of this increase, $0.4 million was
attributable to the 1998 Industrial Acquisitions and the 1998 Industrial
Development Properties, and $1.4 million was attributable to a full year of
operating results from the 1997 Industrial Acquisitions. The remaining $0.2
million was attributable to the Existing Industrial Properties, of which $0.1
million represented an increase in tenant reimbursements at the La Palma
Business Center due to lease-up of space, and $0.1 million correlated with the
increase in real estate taxes reimbursable by tenants. Other income decreased
$0.2 million, or 51.4% to $0.2 million for the year ended December 31, 1998
compared to $0.4 million for the same period in 1997. Other income for the
year ended December 31, 1997 included $0.2 million related to receivables
which were previously written off as uncollectible.

Total expenses from Industrial Properties increased $3.8 million, or 155.3%
to $6.3 million for the year ended December 31, 1998 compared to $2.5 million
for the year ended December 31, 1997. Property expenses increased $2.1
million, or 249.1% to $2.9 million and real estate taxes increased $1.7
million, or 107.3% to $3.3 million for the year ended December 31, 1998
compared to $0.8 million and $1.6 million, respectively, for the year ended
December 31, 1997. Of the collective $3.8 million increase in property
expenses and real estate taxes, $1.1 million was attributable to the 1998
Industrial Acquisitions and the 1998 Industrial Development Properties and
$2.6 million was attributable to the 1997 Industrial Acquisitions. The
remaining $0.1 million increase was attributable to the Existing Industrial
Properties and was due to an increase in real estate taxes attributable to the
reassessment of property values at the date of the IPO. Property expenses for
the Existing Industrial Properties remained consistent for the year ended
December 31, 1998 compared to the same period in 1997.

Net operating income, as defined, from Industrial Properties increased $18.0
million, or 123.8% to $32.6 million for the year ended December 31, 1998
compared to $14.6 million for the year ended December 31, 1997. Of this
increase, $17.7 million was generated from the 1998 Industrial Acquisitions,
the 1998 Industrial Development Properties and a full year of operating
results from the 1997 Industrial Acquisitions. The remaining increase of $0.3
million was generated by the Existing Industrial Properties and represented a
4.3% increase in net operating income for the Existing Industrial Properties,
which was primarily attributable to lease-up at the La Palma Business Center.

Non-Property Related Income and Expenses

Interest income decreased $1.9 million, or 52.5% to $1.7 million for the
year ended December 31, 1998 compared to $3.6 million for the year ended
December 31, 1997. The decrease was attributable to the interest earned in the
prior year on the $116 million of net proceeds received from the Company's IPO
on January 31, 1997 and the $146 million of net proceeds received from the
Company's follow-on offering in August 1997 (the "August Offering"), which
were invested in short-term investments and which the Company used for the
acquisition of properties and repayment of indebtedness prior to January 1,
1998.

General and administrative expenses increased $2.7 million, or 53.9% to $7.7
million for the year ended December 31, 1998 compared to $5.0 million for the
year ended December 31, 1997, due to increased management, administrative and
personnel costs associated with the Company's increased portfolio size.

Interest expense increased $9.0 million, or 76.8% to $20.6 million for the
year ended December 31, 1998 compared to $11.6 million for the same period in
1997, primarily due to a general increase in borrowings and higher monthly
average outstanding balances under the Company's Credit Facility during 1998
and $32.9 million of mortgage debt assumed in connection with fourth quarter
1997 acquisitions. The Company's weighted average interest rate decreased 0.5%
to 7.3% at December 31, 1998 compared to 7.8% at December 31, 1997.

Depreciation and amortization expense increased $12.2 million, or 86.8% to
$26.2 million for the year ended December 31, 1998 compared to $14.0 million
for the same period in 1997. The increase was due to partial year depreciation
on $254 million of 1998 Office and Industrial Acquisitions and a full year of
depreciation on the 1997 Office and Industrial Acquisitions.

32
<PAGE>

Net income for the year ended December 31, 1998 included a $1.7 million
provision for potentially unrecoverable pre-development costs. The provision
provides for costs incurred for development projects that the Company may at
some point in the development process decide not to pursue. The provision was
established by estimating probable exposures to these types of costs for each
of the projects in the Company's development pipeline and applying a series of
probability factors based on the Company's historical experience.

Net Income

Net income before equity in income of unconsolidated subsidiary, minority
interests and extraordinary gains increased $25.0 million, or 100.4% to $50.0
million for the year ended December 31, 1998 from $25.0 million for the year
ended December 31, 1997. The increase was primarily due to the increase in net
operating income from the Office and Industrial Properties of $34.4 million
and $18.0 million, respectively, which was primarily due to the acquisition of
1.4 million and 674,000 rentable square feet of office and industrial space,
respectively, during 1998, and operating the 2.2 million and 3.7 million
rentable square feet of office and industrial space acquired during 1997 for a
full year in 1998. The increase in net operating income was offset by an
increase in interest expense of $8.9 million and an increase in depreciation
and amortization of $12.2 million.

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

The 1997 results include the Company's results for the period February 1,
1997 to December 31, 1997 and the Kilroy Group's results for the period
January 1, 1997 to January 31, 1997.

<TABLE>
<CAPTION>
Year ended
December 31,
--------------- Dollar Percentage
1997 1996 Change Change
------- ------- -------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental income.......................... $58,829 $35,022 $ 23,807 68.0 %
Tenant reimbursements.................. 7,057 3,752 3,305 88.1
Development services................... 14 698 (684) (98.0)
Interest income........................ 3,571 3,571 100.0
Other income........................... 893 76 817 1075.0
------- ------- --------
Total revenues....................... 70,364 39,548 30,816 77.9
------- ------- --------
Expenses:
Property expenses...................... 9,349 6,788 2,561 37.7
Real estate taxes...................... 4,336 1,673 2,663 159.2
General and administrative............. 5,027 2,383 2,644 111.0
Ground leases.......................... 1,002 768 234 30.5
Development expense.................... 46 650 (604) (92.9)
Option buy-out cost.................... 3,150 (3,150) (100.0)
Interest expense....................... 11,633 21,853 (10,220) (46.8)
Depreciation and amortization.......... 14,023 9,111 4,912 53.9
------- ------- --------
Total expenses....................... 45,416 46,376 (960) (2.1)
------- ------- --------
Income (loss) before equity in income of
unconsolidated subsidiary, minority
interests and extraordinary gains....... $24,948 $(6,828) $ 31,776 465.4 %
======= ======= ========
</TABLE>

33
<PAGE>

Rental Operations

The following tables compare the net operating income, as defined, for the
Office and Industrial Properties for the years ended December 31, 1997 and
1996. The 1997 results include the Company's results for the period February
1, 1997 to December 31, 1997 and the Kilroy Group's results for the period
January 1, 1997 to January 31, 1997.

<TABLE>
<CAPTION>
Year ended
December 31,
--------------- Dollar Percentage
1997 1996 Change Change
------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Office Properties
Operating revenues:
Rental income.............................. $43,756 $29,545 $14,211 48.1%
Tenant reimbursements...................... 5,490 3,413 2,077 60.9
Other income............................... 488 76 412 542.1
------- ------- -------
Total.................................... 49,734 33,034 16,700 50.6
------- ------- -------
Property and related expenses:
Property expenses.......................... 8,516 6,495 2,021 31.1
Real estate taxes.......................... 2,710 1,334 1,376 103.1
Ground leases.............................. 1,002 768 234 30.5
------- ------- -------
Total.................................... 12,228 8,597 3,631 42.2
------- ------- -------
Net operating income, as defined............. $37,506 $24,437 $13,069 53.5%
======= ======= =======
</TABLE>

Total revenues from Office Properties increased $16.7 million, or 50.6% to
$49.7 million for the year ended December 31, 1997 compared to $33.0 million
for the year ended December 31, 1996. Rental income from office buildings
increased $14.2 million, or 48.1% to $43.8 million for the year ended December
31, 1997 from $29.6 million for the comparable period in 1996. This
improvement was due to an increase of 2.5 million square feet of office space
under lease, from 1.3 million square feet at December 31, 1996 to 3.8 million
square feet at December 31, 1997, excluding the lease with The Boeing Company
for 211,000 rentable square feet, which was effective January 1, 1998.
Approximately 335,000 rentable square feet of the increase reflected four
office buildings acquired in connection with the IPO on January 31, 1997 (the
"IPO Office Properties") and 2.1 million rentable square feet represented the
41 office buildings purchased during 1997, subsequent to the IPO. The
remaining increase in office space under lease was primarily the result of
leasing activity at Kilroy Airport Center, El Segundo and Kilroy Airport
Center, Long Beach. However, the increase in square footage under lease was
offset by a decrease in average rent per rentable square foot at Kilroy
Airport Center, El Segundo, from $21.34 per square foot for the year ended
December 31, 1996 to $19.92 for the same period in 1997, as a result of the
re-negotiation and extension of a lease with Hughes Space and Communications
in November 1996. Average rent per rentable square foot also decreased at
Kilroy Airport Center, Long Beach, from $25.05 per rentable square foot for
the year ended December 31, 1996 to $21.61 for the same period in 1997 due to
the re-leasing of 20,000 square feet and the lease-up of 24,000 square feet to
McDonnell Douglas Corporation at a rate substantially lower than under the
previous leases.

Tenant reimbursements from Office Properties increased $2.1 million, or
60.9% to $5.5 million for the year ended December 31, 1997 compared to $3.4
million for year ended December 31, 1996. The $2.1 million increase was
primarily due to tenant reimbursements from the IPO Office Properties and the
41 office buildings acquired during 1997, subsequent to the IPO. Other income
from the Office Properties for the year ended December 31, 1997 included $0.1
million in lease termination fees, a $0.1 million gain on the sale of
furniture and equipment, and $0.3 million in property management fees.

Total expenses for the Office Properties increased $3.6 million, or 42.2% to
$12.2 million for the year ended December 31, 1997 compared to $8.6 million
for the year ended December 31, 1996. Property expenses

34
<PAGE>

increased $2.0 million, or 31.1% to $8.5 million and real estate taxes
increased $1.4 million, or 103.1% to $2.7 million for the year ended December
31, 1997 compared to $6.5 million and $1.3 million, respectively, for the year
ended December 31, 1996, primarily due to the purchase of the IPO Office
Properties and the 41 office buildings, all of which were acquired during
1997. Ground lease expense increased $0.2 million during the year ended
December 31, 1997 compared to the same period in 1996 primarily as a result of
ground leases on two of the buildings acquired in January 1997.

Net operating income, as defined, from Office Properties increased $13.1
million, or 53.5% to $37.5 million for the year ended December 31, 1997
compared to $24.4 million for the year ended December 31, 1996. This increase
was primarily due to the purchase during 1997 of the IPO Office Properties and
the 41 office buildings acquired during 1997, subsequent to the IPO.

<TABLE>
<CAPTION>
Year ended
December 31,
-------------- Dollar Percentage
1997 1996 Change Change
------- ------ ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Industrial Properties
Operating revenues:
Rental income................................ $15,073 $5,477 $9,596 175.2%
Tenant reimbursements........................ 1,567 339 1,228 362.2
Other income................................. 405 405 100.0
------- ------ ------
Total...................................... 17,045 5,816 11,229 193.1
------- ------ ------
Property and related expenses:
Property expenses............................ 833 293 540 184.3
Real estate taxes............................ 1,626 339 1,287 379.6
Ground leases................................
------- ------ ------
Total...................................... 2,459 632 1,827 289.1
------- ------ ------
Net operating income, as defined............... $14,586 $5,184 $9,402 181.4%
======= ====== ======
</TABLE>

Total revenues from Industrial Properties increased $11.2 million, or 193.1%
to $17.0 million for the year ended December 31, 1997, compared to $5.8
million for the year ended December 31, 1996. Rental income from industrial
buildings increased $9.6 million or 175.2% to $15.1 million for the year ended
December 31, 1997 compared to $5.5 million for the same period in 1996. This
improvement was due to an increase in industrial space under lease from
894,000 square feet at December 31, 1996 to 4.6 million square feet at
December 31, 1997, an increase of 3.7 million square feet. The increase was
due to the purchase of three industrial buildings in connection with the IPO
on January 31, 1997 (the "IPO Industrial Properties") with approximately
380,000 square feet under lease at December 31, 1997, and the purchase of 55
industrial buildings subsequent to the IPO, with approximately 3.4 million
square feet under lease at December 31, 1997. The remaining increase was
primarily attributable to a full year of operating results from the lease-up
of 62,000 square feet of industrial space in the fourth quarter of 1996.

For the year ended December 31, 1997, tenant reimbursements from Industrial
Properties increased $1.2 million, or 362.2% to $1.5 million compared to $0.3
million for the year ended December 31, 1996. This increase was primarily due
to tenant reimbursements from the IPO Industrial Properties and the 55
industrial buildings, all of which were acquired during 1997. Other income
from the Industrial Properties for the year ended December 31, 1997 included
$0.2 million in lease termination fees and $0.2 million in receivables
previously written off as uncollectible.

Total expenses for the Industrial Properties increased $1.8 million, or
289.1% to $2.4 million for the year ended December 31, 1997 compared to $0.6
million for the year ended December 31, 1996. Property expenses increased $0.5
million, or 184.3% to $0.8 million and real estate taxes increased $1.3
million, or 379.6% to

35
<PAGE>

$1.6 million for the year ended December 31, 1997 compared to $0.3 million and
$0.3 million, respectively, for the year ended December 31, 1996, primarily
due to the purchase of the IPO Industrial Properties and the 55 industrial
buildings, all of which were acquired during 1997.

Net operating income, as defined, from Industrial Properties increased $9.4
million or 181.4% to $14.6 million for the year ended December 31, 1997
compared to $5.2 million for the year ended December 31, 1996. This increase
was primarily due to the purchase of the IPO Industrial Properties and the 55
industrial buildings, all of which were acquired during 1997.

Non-Property Related Income and Expenses

Interest income increased $3.6 million due to interest earned on the $116
million of net proceeds received from the Company's IPO and the $146 million
of net proceeds received from the August Offering, both of which were invested
in short-term investments and which the Company used for the acquisition of
Properties and repayment of indebtedness prior to January 1, 1998.

Development services revenue and expenses decreased $0.7 million and $0.6
million, respectively, to $14,000 and $46,000, respectively, for the year
ended December 31, 1997 compared to $0.7 million and $0.7 million,
respectively, for the year ended December 31, 1996. On February 1, 1997,
development services began to be performed by KSI.

General and administrative expenses increased $2.6 million, or 111.0% to
$5.0 million during the year ended December 31, 1997 over the same period in
1996 due to the incremental costs of operating a public company and the
additional management, administrative and personnel costs of operating a
larger portfolio of properties.

Interest expense decreased $10.2 million, or 46.8%, to $11.6 million for the
year ended December 31, 1997 from $21.8 million for the year ended December
31, 1996, primarily as a result of the repayment of $127 million in debt with
the net proceeds of the IPO in January 1997. In addition, the Company's
weighted average interest rate decreased 0.9% to 7.8% at December 31, 1997
compared to 8.7% at December 31, 1996.

Depreciation and amortization expense increased $4.9 million, or 53.9% to
$14.0 million for the year ended December 31, 1997 compared to $9.1 million
for the year ended December 31, 1996. The increase was due to partial year
depreciation on the $507 million of property acquisitions in 1997.

Net Income

Net income before equity in income of unconsolidated subsidiary, minority
interests and extraordinary gains was $25.0 million for the year ended
December 31, 1997 compared to a $6.8 million loss for the same period in 1996.
The net change in net income before extraordinary gains of $31.8 million was
due primarily to the line items discussed above, an increase in net operating
income from the Office and Industrial Properties of $13.1 million and $9.4
million, respectively, an increase in interest income of $3.6 million, a
decrease in interest expense of $10.2 million and an increase in depreciation
and amortization of $4.9 million. In addition, during the year ended December
31, 1996, there was a $3.2 million expense related to the accrued costs of an
option buy-out for the cancellation of an option to purchase a 50.0% interest
in Kilroy Airport Center, El Segundo.

Liquidity and Capital Resources

In February 1998, the Company increased its borrowing capacity and converted
its previously secured line of credit into a $350 million unsecured revolving
Credit Facility. The Credit Facility bears interest at a rate of either LIBOR
plus 1.00%, LIBOR plus 1.13% or LIBOR plus 1.25% (6.81% at December 31, 1998),
depending on the Company's leverage ratio at the time of borrowing, and
matures in February 2000, with an option to extend for one year. The new
Credit Facility replaced the Company's $250 million secured revolving credit

36
<PAGE>

facility (the "Secured Credit Facility"). In October 1998, the Credit Facility
agreement was amended to include construction in progress in the value of the
Company's unencumbered assets, to modify certain financial covenants and to
allow the Company to enter into separate construction financing arrangements.
The agreement was also amended, while preserving the interest rate options
discussed above, to provide that borrowings may bear interest at LIBOR plus
1.38%, depending upon the Company's leverage ratio at the time of borrowing.
Availability under the Credit Facility depends upon the value of the Company's
pool of unencumbered assets and was $77.0 million at December 31, 1998. At
December 31, 1998 there were outstanding borrowings of $272 million and one
letter of credit in the amount of $1.0 million drawn against available Credit
Facility borrowings. The $1.0 million letter of credit was issued in
connection with a signed commitment letter for a mortgage loan that the
Company expects to complete in the first quarter of 1999 (see discussion
below).

In July 1998, the Company entered into two interest rate cap agreements with
a total notional amount of $150 million to effectively limit interest expense
for borrowings under the Credit Facility during periods of increasing interest
rates. The agreements have LIBOR based cap rates of 6.50% and expire in July
2000. The Company's exposure is limited to the $0.2 million cost of the cap
agreements, which the Company is amortizing over the term of the Credit
Facility. The 1998 amortization was included as a component of interest
expense in the consolidated statement of operations.

The Company had mortgage debt outstanding at December 31, 1998 and 1997 of
$133 million and $131 million, respectively. At December 31, 1998, the
Company's mortgage debt was comprised of five mortgage loans in the amounts of
$82.0 million, $19.0 million, $13.4 million, $11.3 million, and $7.7 million.
At December 31, 1997, the Company's mortgage debt was comprised of the same
five mortgage loans in the amounts of $83.1 million, $14.0 million, $13.8
million, $11.7 million, and $7.9 million as well as a $0.9 million promissory
note. On January 31, 1998, the Company increased the amount of its $19.0
million mortgage loan from $14.0 million to $19.0 million and extended the
maturity date to January 31, 2000. In addition, the Company repaid the $0.9
million promissory note in January 1998. The $82.0 million mortgage loan
requires monthly principal and interest payments based on an interest rate of
8.35%, amortizes over 25 years, and matures in February 2022. In February
2005, the interest rate resets to the greater of 13.35% or the sum of the
interest rate for U.S. Treasury Securities maturing 15 years from the reset
date plus 2.00%. The $19.0 million mortgage loan requires monthly payments of
interest computed at a variable rate of LIBOR plus 1.50%. The $13.4 million
mortgage loan bears interest at 8.45% and matures in December 2005. The $11.3
million mortgage loan bears interest at 8.43% and matures in November 2014.
The $7.7 million mortgage loan bears interest at 8.21% and matures in October
2013. Principal and interest payments are payable monthly on the $13.4
million, 11.3 million, and $7.7 million mortgage loans. As of December 31,
1998 and 1997, the Company's mortgage loans had a weighted average interest
rate of 8.22%.

In December 1998, the Company entered into a commitment letter with a lender
for a mortgage loan collateralized by nine office and industrial properties.
The commitment expires on March 24, 1999 and provides, subject to the
completion of specified terms and conditions, for a mortgage loan with a
principal balance of $95.0 million, monthly principal and interest payments
based upon a fixed interest rate of 7.20% and a 25 year amortization schedule,
and a maturity date of March 2009. The Company intends to use the proceeds
from the $95.0 million mortgage loan to pay down outstanding borrowings on the
Credit Facility. On February 8, 1999, the Company entered into a commitment
letter with a lender for a mortgage loan collateralized by an office property
and the related ground leases. The commitment has a term of 60 days and
provides, subject to the completion of specified terms and conditions, for a
mortgage loan with a principal balance of $30.0 million, monthly principal and
interest payments based upon a fixed rate of 7.15% and an 18 year amortization
period, and a maturity date of March 2018. The Company intends to use the
proceeds from the $30.0 mortgage loan to repay the Company's existing $19.0
million mortgage loan. In connection with signing the commitment letter for
the $95.0 million mortgage loan, the Company issued one letter of credit for
$1.0 million in December 1998 and another letter of credit for $1.0 million in
January 1999 to cover the deposit and application costs required by the
mortgagor. Both letters of credit were issued against available Credit
Facility borrowings and will expire upon the closing of the mortgage loan.

37
<PAGE>

In January 1998, the Company filed a "shelf" registration statement on Form
S-3 with the SEC which registered $400 million of equity securities of the
Company. The registration statement was declared effective by the SEC on
February 11, 1998. Through December 31, 1998, the Company completed four
underwritten offerings aggregating 3,012,326 shares of common stock and two
direct placements aggregating 161,884 shares of common stock with aggregate
net proceeds of $81.8 million. As of March 10, 1999, an aggregate of
$313 million of equity securities were available for issuance under the
registration statement. The Company, as general partner of the Operating
Partnership and as required by the terms and conditions of the Operating
Partnership's partnership agreement, contributed the net proceeds of such
offerings to the Operating Partnership, which used the net proceeds to repay
borrowings under the Credit Facility.

In February 1998, the Company issued 1,200,000 8.075% Series A Cumulative
Redeemable Preferred units, representing limited partnership interests in the
Operating Partnership (the "Series A Preferred units"), with a liquidation
value of $50.00 per unit, in exchange for a gross contribution to the
Operating Partnership of $60.0 million. The Company used the contribution
proceeds, less applicable transaction costs and expenses of $1.7 million, for
the repayment of borrowings outstanding under the Credit Facility. In April
1998, the Company issued an additional 300,000 Series A Preferred units for a
gross contribution to the Operating Partnership of $15.0 million. The Company
used the contribution proceeds, less applicable transaction costs and expenses
of $0.4 million for the repayment of borrowings outstanding under the Credit
Facility. The Series A Preferred units, which may be called by the Operating
Partnership at par on or after February 6, 2003, have no stated maturity or
mandatory redemption and are not convertible into any other securities of the
Operating Partnership. The Series A Preferred units are exchangeable at the
option of the majority of the holders for shares of the Company's 8.075%
Series A Cumulative Redeemable Preferred stock beginning February 6, 2008, or
earlier under certain circumstances.

In November 1998, the Company issued 700,000 9.375% Series C Cumulative
Redeemable Preferred units, representing limited partnership interests in the
Operating Partnership (the "Series C Preferred units"), with a liquidation
value of $50.00 per unit, in exchange for a gross contribution to the
Operating Partnership of $35.0 million. The Company used the contribution
proceeds, less applicable transaction costs and expenses of $0.9 million, for
the repayment of borrowings outstanding under the Credit Facility. The Series
C Preferred units, which may be called by the Operating Partnership at par on
or after November 24, 2003, have no stated maturity or mandatory redemption
and are not convertible into any other securities of the Operating
Partnership. The Series C Preferred units are exchangeable at the option of
the majority of the holders for shares of the Company's 9.375% Series C
Cumulative Redeemable Preferred stock beginning November 24, 2008, or earlier
under certain circumstances.

On March 10, 1999, the Company filed a registration statement on Form S-3
with the SEC which, in connection with the adoption of the Company's Dividend
Reinvestment and Direct Purchase Plan (the "Plan"), registered 1,000,000
shares of the Company's common stock. The Plan, which is designed to provide
the Company's stockholders and other investors with a convenient and
economical method to purchase shares of the Company's common stock, consists
of three programs: the Dividend Reinvestment Program (the "DRIP"), the Cash
Option Purchase Plan (the "COPP") and the Waiver Discount Plan (the "WDP").
The DRIP provides existing common stockholders with the opportunity to
purchase additional shares of the Company's common stock by automatically
reinvesting all or a portion of their cash dividends. The COPP provides
existing common stockholders and other investors with the opportunity to
purchase additional shares of the Company's common stock by making optional
cash purchases, at no discount to market, between $100 to $5,000 and $750 to
$5,000, respectively, in any calendar month. The WDP provides existing common
stockholders and other investors with the opportunity to purchase additional
shares of the Company's common stock by making optional cash purchases, at a
discount to market of up to 2.00% of the average per share price reported on
the NYSE, of greater than $5,000 in any calendar month. The Plan will acquire
shares of the Company's common stock from either new issuances directly from
the Company, from the open market or from privately negotiated transactions,
except for transactions executed under the WDP which will be purchased only
from previously unissued shares of

38
<PAGE>

common stock. Participation in the Plan is entirely voluntary, and can be
terminated at any time. The Company intends to use the proceeds received from
the Plan, less transaction costs, for development and investment activities,
repayment of outstanding indebtedness and general corporate uses. This
registration statement has not yet been declared effective by the SEC.

Capital Expenditures

As of December 31, 1998, the Company had approximately 544,000 and 390,000
rentable square feet of office and industrial space, respectively, under
construction at a total budgeted cost of approximately $118 million. The
Company has spent an aggregate of $41.4 million on these projects as of
December 31, 1998. The Company intends to finance the remaining $76.4 million
of development costs with borrowings under the Credit Facility and working
capital. In addition, at December 31, 1998, the Company has also spent $60.5
million on land and pre-development costs for phased development projects
which are planned for the next five years.

At December 31, 1998, the Company had escrow deposits of $0.4 million for
the contemplated acquisition of one office building with 50,000 aggregate
rentable square feet. The aggregate acquisition cost of the land and building
is estimated to be approximately $9.0 million. The Company intends to finance
the acquisition with borrowings under the Credit Facility and working capital.

In connection with an agreement signed in October 1997 with The Allen Group,
a group of affiliated real estate development and investment companies based
in Visalia, California ("The Allen Group"), the Company is committed to
purchase two office properties totaling 254,000 rentable square feet for an
aggregate purchase price of $40.1 million. The Company intends to finance
these acquisitions with borrowings under the Credit Facility and the issuance
of approximately $11.0 million of common units of the Operating Partnership.
In addition, the original agreement contemplated the acquisition by the
Company of two industrial buildings in San Rafael, California and Las Vegas,
Nevada, respectively, and one office building in Redwood City, California for
an aggregate purchase price of $22.8 million. Based on the current amended
agreement, the Company is no longer obligated to purchase these three non-
strategic properties.

The transaction with The Allen Group provides for the development of two
office projects in San Diego, California with up to 1.0 million aggregate
rentable square feet for an estimated aggregate development cost of
approximately $150 million. The Company has agreed to purchase a 50% managing
interest in the two projects upon completion of all necessary entitlements and
infrastructure and is expected to manage the development of both projects. In
January 1999, the Company purchased a managing interest in phase 1 of the
first project for an aggregate purchase price of $2.1 million. The 2 acres of
undeveloped land were acquired from an entity controlled by Richard S. Allen,
a member of the Company's Board of Directors at December 31, 1998, with
borrowings under the Credit Facility and the issuance of 7,771 common units of
the Operating Partnership valued at $0.2 million based on the closing share
price of the Company's common stock as reported on the NYSE. An Executive Vice
President of the Company who was previously a member of The Allen Group
received 5,400 of the total 7,771 common units. The Company has the option to
purchase The Allen Group's remaining interest in both projects for a purchase
price to be determined upon completion of the projects. Construction of phase
1 of both office projects commenced in the fourth quarter of 1998 and the
total budgeted investment of phase 1 of both projects of $39.2 million is
included in the total budgeted cost of $118 million discussed above.

The Company believes that it will have sufficient capital resources to
satisfy its obligations and planned capital expenditures for the next twelve
months. The Company expects to meet its long-term liquidity requirements
including possible future development and property acquisitions, through
retained cash flow, long-term secured and unsecured borrowings, including the
Credit Facility, and the issuance of debt securities or the issuance of common
units of the Operating Partnership.

39
<PAGE>

Historical Recurring Capital Expenditures, Tenant Improvements and Leasing
Costs

The following tables set forth the non-incremental revenue generating
recurring capital expenditures, excluding expenditures that are recoverable
from tenants, tenant improvements and leasing commissions for renewed and re-
tenanted space incurred for the three years ended December 31, 1998, 1997, and
1996 on a per square foot basis.

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Office Properties:
CAPITAL EXPENDITURES:
Capital expenditures (in thousands).................. $ 975 $ 479
Per square foot...................................... $ 0.20 $ 0.16
TENANT IMPROVEMENT AND LEASING COSTS(1):
Replacement tenant square feet......................... 276,992 17,068 161,827
Tenant improvements (in thousands)................... $ 334 $ 112 $ 1,809
Per square foot leased............................... $ 1.21 $ 6.56 $ 11.18
Leasing commissions (in thousands)(2)................ $ 588 $ 28 $ 379
Per square foot leased............................... $ 2.12 $ 1.64 $ 2.34
Total per square foot................................ $ 3.33 $ 8.20 $ 13.52
Renewal tenant square feet............................. 265,154 278,658
Tenant improvements (in thousands)................... $ 266 $ 1,474
Per square foot leased............................... $ 1.00 $ 5.29
Leasing commissions (in thousands)(2)................ $ 235 $ 354
Per square foot leased............................... $ 0.89 $ 1.27
Total per square foot................................ $ 1.89 $ 6.56
Total per square foot per year......................... $ 0.84 $ 1.55 $ 3.86
Average lease term..................................... 6.2 5.3 5.2

Industrial Properties:
CAPITAL EXPENDITURES:
Capital expenditures (in thousands).................. $ 256 $ 336
Per square foot...................................... $ 0.05 $ 0.11
TENANT IMPROVEMENT AND LEASING COSTS(1):
Replacement tenant square feet......................... 420,194 145,581 107,318
Tenant improvements (in thousands)................... $ 258 $ 507
Per square foot leased............................... $ 0.61 $ 4.72
Leasing commissions (in thousands)(2)................ $ 185 $ 157 $ 134
Per square foot leased............................... $ 0.44 $ 1.08 $ 1.25
Total per square foot................................ $ 1.05 $ 1.08 $ 5.97
Renewal tenant square feet............................. 549,158 323,825
Tenant improvements (in thousands)................... $ 35 $ 8
Per square foot leased............................... $ 0.06 $ 0.02
Leasing commissions (in thousands)(2)................ $ 85 $ 73
Per square foot leased............................... $ 0.16 $ 0.23
Total per square foot................................ $ 0.22 $ 0.25
Total per square foot per year......................... $ 0.22 $ 0.31 $ 0.89
Average lease term..................................... 5.8 4.3 6.7
</TABLE>
- --------
(1) Includes only tenants with lease terms of 12 months or longer. Excludes
leases for amenity, parking, retail and month-to-month tenants.

(2) Equals the aggregate of leasing commissions payable to employees and third
parties based on standard commission rates.

40
<PAGE>

Capital expenditures may fluctuate in any given period subject to the
nature, extent, and timing of improvements required to be made to the
Properties. The Company believes that all of its Office and Industrial
Properties are well maintained and, based on recent engineering reports, do
not require significant capital improvements.

Tenant improvements and leasing costs may also fluctuate in any given year
depending upon factors such as the property, the term of the lease, the type
of lease, the involvement of external leasing agents and overall market
conditions.

Building and Lease Information

The following tables set forth certain information regarding the Company's
Office and Industrial Properties at December 31, 1998:
Occupancy by Segment Type

<TABLE>
<CAPTION>
Square Feet
Number of -------------------------------
Region Buildings Total Leased Available Occupancy
- ------ --------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Office Properties:
Los Angeles............... 27 2,418,339 2,311,809 106,530 95.6%
Orange County............. 27 1,010,926 939,593 71,333 92.9
San Diego................. 20 1,461,580 1,461,580 -- 100.0
Other..................... 6 709,614 646,788 62,826 91.1
--- ---------- ---------- -------
80 5,600,459 5,359,770 240,689 95.7%
--- ---------- ---------- -------

Industrial Properties:
Los Angeles............... 8 679,736 673,199 6,537 99.0%
Orange County............. 60 3,951,463 3,770,436 181,027 95.4
San Diego................. 3 199,351 199,351 -- 100.0
Other..................... 13 1,326,557 1,267,799 58,758 95.6
--- ---------- ---------- -------
84 6,157,107 5,910,785 246,322 96.0%
--- ---------- ---------- -------
Total....................... 164 11,757,566 11,270,555 487,011 95.9%
=== ========== ========== =======
</TABLE>

Lease Expirations by Segment Type
<TABLE>
<CAPTION>
Percentage of
Square Total Leased
Footage Square Feet Annual Base
Number of of Represented Rent Under
Expiring Expiring by Expiring Expiring Leases
Year of Lease Expiration Leases(1) Leases Leases(2) (in 000's)(3)
- ------------------------ --------- --------- ------------- ---------------
<S> <C> <C> <C> <C>
Office Properties:
1999......................... 125 925,552 16.5% $12,019
2000......................... 77 361,580 6.4 6,137
2001......................... 77 1,022,774 18.2 11,631
2002......................... 40 510,389 9.1 6,485
2003......................... 35 218,541 3.9 3,161
--- --------- ---- -------
354 3,038,836 54.1% $39,433
--- --------- -------
Industrial Properties:
1999......................... 84 613,841 10.1% $ 3,905
2000......................... 66 933,399 15.3 4,482
2001......................... 42 1,033,741 16.9 5,020
2002......................... 6 176,860 2.9 1,575
2003......................... 23 724,853 11.9 4,349
--- --------- ---- -------
221 3,482,694 57.1% $19,331
--- --------- -------
Total........................ 575 6,521,530 57.8% $58,764
=== ========= =======
</TABLE>
- --------
(1) Includes tenants only. Excludes leases for amenity, retail, parking and
month to month tenants. Some tenants have multiple leases.
(footnotes continued on next page)

41
<PAGE>

(2) Based on total leased square footage for the respective portfolios as of
December 31, 1998, unless a lease for a replacement tenant had been
executed on or before January 1, 1999.
(3) Determined based upon aggregate base rent to be received over the term,
divided by the term in months, multiplied by 12, including all leases
executed on or before January 1, 1999.

Leasing Activity by Segment Type
For the year ended December 31, 1998

<TABLE>
<CAPTION>
Number of
Leases Square Feet
------------ ---------------- Retention Weighted Average
New Renewal New(1) Renewal Rate Lease Term (in months.)
--- ------- ------- ------- --------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
Office Properties....... 57 77 276,992 265,154 61.1% 74
Industrial Properties... 73 59 420,194 549,158 62.7% 70
--- --- ------- -------
Total................... 130 136 697,186 814,312 62.2% 72
=== === ======= =======
</TABLE>
- --------
(1) The lease-up of 697,186 square feet to new tenants includes re-leasing of
273,580 square feet and first generation leasing of 423,606 square feet.

Year 2000

The Year 2000 issue ("Y2K") refers to the inability of certain computer
systems, as well as certain hardware and equipment containing date sensitive
data, to recognize accurate dates commencing on or after January 1, 2000. This
has the potential to affect those systems adversely. In 1997, the Company's
Information Technology Committee, which is comprised of representatives from
senior management and various departments including accounting, property
management and management information systems, identified three phases in the
Company's Y2K efforts: discovery and assessment, remediation and
implementation, and testing and verification. Although many of the phases are
being completed simultaneously, the following sections describe the activities
that the Company has or expects to perform to meet its Y2K objectives, as well
as management's assessment of the Company's risk of non-compliance.

The Company's State of Readiness

The initial phase of discovery and assessment consists of evaluating and
identifying all of the Company's information technology and non-information
technology systems that contain date sensitive data. The following summary
describes the classifications of systems that were identified and the
Company's current state of readiness for each classification.

Information Technology Systems

The Company's information technology systems fall into three general
categories: accounting and property management systems, network operating
systems, and desktop software. The Company replaced its accounting and
property management system, acquired all new network hardware and software,
and updated all of its desktop systems and software after its IPO in early
1997. The new accounting and property management system, which was tested upon
its implementation in 1997, and all the Company's network hardware and
software, desktop systems and software packages are Y2K compliant as asserted
by the software vendors. Management believes there is no material Y2K exposure
with respect to its information technology systems.

Building Management Systems

The Company has identified five categories of building management systems
that could have potential Y2K exposure: building automation (e.g., HVAC),
security card access, fire and life safety, elevator, and office equipment.
During 1998, property management executives and personnel began gathering data
to identify all of the Company's Y2K sensitive building management systems and
to assess whether such systems are currently

42
<PAGE>

Y2K compliant or will need to be modified or replaced. Management expects to
complete the discovery and assessment phase and be able to determine the
Company's state of readiness as to building management systems by May 1999. In
addition, management expects to complete the remediation and implementation
phase by September 1999 and the testing and verification by the end of fiscal
year 1999.

Costs to Address the Company's Y2K Efforts

Since the replacement of the accounting and property management system, the
acquisition of new network hardware and software, and the installation of
updated desktop systems and software was performed as a result of the Company
becoming a publicly traded REIT and not in response to Y2K compliance issues,
and further, since phase 1 of the building management systems efforts are
being performed by 13 salaried Company employees who are not paid for overtime
and who management expects will spend 10% of their annual working hours over a
two to three year period focusing on Y2K compliance issues, Y2K costs incurred
to date have been minimal and have not been material to the Company's
financial position or results of operations.

While expected future costs, which will include costs to complete phases 2
and 3 for the building management systems, are not readily quantifiable at
this time, it is management's belief that a significant portion of such costs
will be treated as operating expenses and will be reimbursable to the Company
under most tenant leases. Consequently, management does not believe that such
expenses will have a material effect on the Company's financial position and
results of operations.

Efforts to Identify the Y2K Issues of Significant Third Parties

Due to the Company's diverse tenant base, the success of the Company's
business is not closely tied to the success of any one particular tenant. In
addition, the success of the Company's business is also not closely tied to
the operations of any one vendor, supplier or manufacturer. However, the
Company is in the process of surveying significant tenants, vendors, suppliers
and other relevant third parties to determine that their systems will be Y2K
compliant and that the Company's normal operations will continue without
interruption. Management anticipates this project will be completed by
September 1999.

The Risks of Y2K Non-Compliance

Management does not believe that the impact of the Y2K issue will have a
material adverse effect on the Company's financial condition or results of
operations. This belief is based upon both the analysis of the Company's Y2K
issues and the Company's assessment of the Y2K exposure related to tenants,
vendors, and other significant third parties as discussed above. No assurance
can be given about facts and resultant effects of Y2K issues unknown to the
Company at this time.

The Company's worst case Y2K scenario would be that the Company's
information and building management systems fail. In the event that the
Company's information systems fail, the Company would be forced to manually
perform its accounting and property management record-keeping functions until
the information systems could be restored. In the event that the Company's
building management systems fail, the Company's tenants would not have access
to or be able to conduct their normal business activities at the Company's
Properties until the building management systems could be restored. These
events could have a material adverse effect on the Company's financial
position and results of operations.

Developing Contingency Plans

The Company does not currently have a contingency plan in place in the event
of a Y2K failure. Such a contingency plan is expected to be developed by the
end of the third quarter 1999.

43
<PAGE>

Distribution Policy

The Company makes quarterly distributions to common stockholders from cash
available for distribution and, if necessary to meet REIT distribution
requirements and maintain its REIT status, may use borrowings under the Credit
Facility. All such distributions are at the discretion of the Board of
Directors. Amounts accumulated for distribution are invested primarily in
interest-bearing accounts and short-term interest-bearing securities, which
are consistent with the Company's intention to maintain its qualification as a
REIT. Such investments may include, for example, obligations of the Government
National Mortgage Association, other governmental agency securities,
certificates of deposit and interest-bearing bank deposits.

Historical Cash Flows

The principal sources of funding for acquisitions, development and capital
expenditures are the Credit Facility, public equity financing, cash flow from
operating activities and secured debt financings. The Company's net cash
provided by operating activities increased $44.5 million, or 153.8% to $73.4
million for the year ended December 31, 1998 compared to $28.9 million for the
year ended December 31, 1997. The increase was primarily due to the increase
in net income resulting from the 1998 Office and Industrial Acquisitions, a
full year of operating results from the 1997 Office and Industrial
Acquisitions and increased net operating income, as defined, generated by the
Existing Office and Industrial Properties owned at the IPO and still owned at
December 31, 1998. The increase was partially offset by increased interest
expense and general and administrative expenses.

Cash used in investing activities decreased $208 million, or 37.7% to $344
million for the year ended December 31, 1998 compared to $552 million for the
year ended December 31, 1997. The decrease was due primarily to the purchase
of 25 Office and 16 Industrial Properties during 1998 for $236 million (net of
$18.1 million of contributed value in exchange for which the Company issued
common units of the Operating Partnership), the purchase of 56 acres of
undeveloped land for $25.4 million (net of $2.5 million of contributed value
in exchange for which the Company issued common units of the Operating
Partnership), expenditures for construction in progress of $65.5 million, and
$13.5 million in additional tenant improvements and capital expenditures for
the year ended December 31, 1998 versus the acquisition of four Properties in
connection with the IPO for an aggregate cost of $58.2 million, the
acquisition of 41 Office and 55 Industrial Properties during 1997, subsequent
to the IPO, for an aggregate cost of $488 million (net of $19.3 million of
contributed value in exchange for which the Company issued common units of the
Operating Partnership and $41.1 million of mortgage debt assumed in connection
with acquisitions), the purchase of 50 acres of undeveloped land for
$25.4 million, expenditures for construction in progress of $10.1 million, and
$6.1 million in additional tenant improvements and capital expenditures for
the year ended December 31, 1997.

Cash provided by financing activities decreased $264 million, or 49.7% to
$268 million for the year ended December 31, 1998 compared to $532 million for
the year ended December 31, 1997. Cash provided by financing activities for
the year ended December 31, 1998 consisted primarily of $81.8 million in net
proceeds from the issuance of 3,012,326 shares of common stock through four
underwritten offerings and the issuance of 161,884 shares of common stock
through two direct placements, the issuance of $75.0 million of 8.075%
Series A Preferred units and $35.0 million of 9.375% Series C Preferred units
(net of $3.0 million aggregate transaction costs), and net proceeds of $132
million from the issuance of mortgage debt and net borrowings on the Credit
Facility, partially offset by $48.8 million in distributions paid to common
stockholders and common unitholders. Cash provided by financing activities for
the year ended December 31, 1997 consisted of $544 million in net proceeds
from the Company's IPO in January 1997 and follow on offering in August 1997,
proceeds of $98.0 million from the issuance of mortgage debt (of which $96.0
million was issued in connection with the IPO), and net proceeds of $142
million from borrowings under the Credit Facility, partially offset by the
repayment of $227 million of indebtedness (of which $219 million was repaid in
connection with the IPO) and $21.7 million in distributions paid to common
stockholders and common unitholders. The increase in distributions of $27.1
million, or 125.0% to $48.8 million for the year ended December 31, 1998 from
$21.7 million for the year ended December 31, 1997 was due to a greater number
of common shares and common units outstanding for the four quarters ended
March 31, June 30, September 30 and December 31, 1998 versus

44
<PAGE>

the period from February 1 to March 31, 1997 and the three quarters ended June
30, September 30, and December 31, 1997, as well as an increase in the
distribution rate to $1.62 per share for the year ended December 31, 1998 from
$1.42 per share for the year ended December 31, 1997.

Funds from Operations

The Company considers Funds from Operations, as defined by NAREIT, an
alternative measure of performance for an equity REIT. Funds from Operations
is defined by NAREIT to mean net income (loss) before minority interest of
common unitholders (computed in accordance with GAAP), excluding gains (or
losses) from debt restructuring and sales of property, plus real estate-
related depreciation and amortization (excluding amortization of deferred
financing costs and depreciation of non-real estate assets), and after
adjustment, for unconsolidated partnerships and joint ventures. The Company
considers Funds from Operations an appropriate measure of performance of an
equity REIT because it is predicated on cash flow analyses. The Company
believes that in order to facilitate a clear understanding of the combined
historical operating results of the Company, Funds from Operations should be
examined in conjunction with net income (loss) as presented in the financial
statements included elsewhere in this report. The Company computes Funds from
Operations in accordance with standards established by the Board of Governors
of NAREIT in its March 1995 White Paper, which may differ from the
methodologies used by other equity REITs and, accordingly, may not be
comparable to Funds from Operations published by such other REITs. Funds from
Operations should not be considered as an alternative to net income (loss)
(computed in accordance with GAAP) as an indicator of the Properties'
financial performance or to cash flow from operating activities (computed in
accordance with GAAP) as an indicator of the Properties' liquidity, nor is it
indicative of funds available to fund the Properties' cash needs, including
the Company's ability to pay dividends or make distributions.

The following table presents the Company's Funds from Operations, by
quarter, for the year ended December 31, 1998 and the period from February 1,
1997 to December 31, 1997:

<TABLE>
<CAPTION>
1998 Quarter Ended
--------------------------------------------
June
December 31, September 30, 30, March 31,
------------ ------------- ------- ---------
(in thousands)

<S> <C> <C> <C> <C>
Net income.................. $10,173 $ 9,985 $ 9,785 $ 8,879
Add:
Minority interest in
earnings............... 1,528 1,451 1,432 1,210
Depreciation and
amortization........... 7,041 6,740 6,565 5,854
Other................... 126 175 112 118
------- ------- ------- -------
Funds from Operations....... $18,868 $18,351 $17,894 $16,061
======= ======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
1997 Quarter Ended February 1,
----------------------------------- to March 31,
December 31, September 30, June 30, 1997
------------ ------------- -------- ------------
(in thousands)

<S> <C> <C> <C> <C>
Net income.................... $ 8,820 $ 6,480 $4,108 $2,652
Add:
Minority interest in
earnings................. 1,182 977 768 486
Depreciation and
amortization............. 4,832 3,660 3,000 1,744
Other..................... 118 118 118 77
------- ------- ------ ------
Funds from Operations......... $14,952 $11,235 $7,996 $4,959
======= ======= ====== ======
</TABLE>

45
<PAGE>

Inflation

The majority of the Company's leases require tenants to pay most operating
expenses, including real estate taxes and insurance, and increases in common
area maintenance expenses. The effect of such provisions is to reduce the
Company's exposure to increases in costs and operating expenses resulting from
inflation.

New Accounting Pronouncement

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities," ("SFAS 133"). SFAS 133 is effective for fiscal years
beginning after June 15, 1999 and requires all derivatives to be recorded on
the balance sheet at fair value as either assets or liabilities depending on
the rights or obligations under the contract. SFAS 133 also establishes new
accounting methodologies for the following three classifications of hedges:
fair value, cash flow and net investment in foreign operations. Management
believes the adoption of SFAS 133 will not have a material impact on the
Company's financial position or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Since the Company's IPO in January 1997, management has executed a financial
strategy which has positioned the Company to be flexible and responsive to the
variations in the public and private financial markets. The principal
objectives of the Company's current debt and capital management strategies are
to maintain prudent amounts of leverage and to minimize capital costs and
interest expense while carefully and continuously evaluating available debt
and equity resources.

The primary market risk faced by the Company is the risk of interest rate
fluctuations. More specifically, the primary market risk faced by the Company
is market risk resulting from increasing LIBOR based interest rates since
interest expense on $291 million of the Company's total $405 million of debt,
including borrowings under the Credit Facility, are tied to a LIBOR based
interest rate. As a result, the Company pays lower rates of interest in
periods of decreasing interest rates and higher rates of interest in periods
of increasing interest rates. To mitigate the effect of changes in interest
rates on Credit Facility borrowings and in compliance with Credit Facility
debt covenants, in July 1998, the Company entered into two interest rate cap
agreements with a total notional amount of $150 million to effectively limit
interest expense for borrowings under the Credit Facility during periods of
increasing interest rates. The agreements have LIBOR based cap rates of 6.50%
and expire in July 2000. The Company's exposure is limited to the $0.2 million
cost of the cap agreements, which the Company is amortizing over the term of
the Credit Facility. The unamortized cost at December 31, 1998 was $0.1
million.

The Company is also subject to market risk resulting from fluctuations in
the general level of U.S. interest rates since $114 million of the Company's
total $405 million of debt arrangements are established at a fixed weighted
average interest rate of 8.39%, and since quarterly distributions of $1.5
million and $0.8 million paid to Series A Preferred unitholders and Series C
Preferred unitholders, respectively, are calculated based upon a fixed rate of
8.075% and 9.375%, respectively. As a result, the Company will pay
contractually agreed upon fixed rates of interest regardless of fluctuations
in the general interest rate environment.

The tabular presentation below provides information about the Company's
interest rate sensitive financial and derivative instruments. All of the
Company's interest rate sensitive financial and derivative instruments are
designated as held for purposes other than trading.

For notes receivable from related parties, the table depicts the repayment
of principal and accrued interest based upon the anticipated completion dates
of the related projects. The table also presents the related interest rate
indices for such notes receivable from 1999 through the repayment dates.

For the Credit Facility, the table presents the assumption that the
outstanding principal balance at December 31, 1998 will be paid upon the
Credit Facility's maturity in February 2000, and that the option to

46
<PAGE>

extend the term of the Credit Facility until February 2001 will not be
exercised. The table also presents the related maximum interest rate index for
outstanding Credit Facility borrowings in 1999 and 2000.

For variable rate mortgage debt, the table presents the assumption that the
outstanding principal balance at December 31, 1998 will be paid upon maturity
in January 2000. The table also presents the related interest rate index for
outstanding variable rate mortgage debt borrowings in 1999 and 2000.

For fixed rate mortgage debt, the table presents the assumption that the
outstanding principal balance at December 31, 1998 will be paid according to
scheduled principal payments and that the Company will not prepay any of the
outstanding principal balance. The table also presents the related weighted-
average interest rate for outstanding fixed rate mortgage debt borrowings from
1999 through 2003 and thereafter.

For the Series A and Series C Preferred units, the table presents the
assumption that the outstanding Preferred Units at December 31, 1998 will be
exchanged into shares of the Company's 8.075% Series A and 9.375% Series C
Cumulative Redeemable Preferred stock, respectively, in 2008 when the Preferred
units become exchangeable at the option of the majority of the holders. The
table also presents the related weighted-average interest rate for outstanding
Preferred units from 1999 through the exchange date, however the same interest
rates will apply when the Preferred units are exchanged into the Cumulative
Redeemable Preferred stock.

For interest rate caps, the table presents notional amounts, average cap
rates and the related interest rate index upon which cap rates are based, by
contractual maturity date. Notional amounts are used solely to calculate the
contractual cash flow to be received under the contract and do not reflect
outstanding principal balances at December 31, 1998.

Interest Rate Risk Analysis--Tabular Presentation
Financial Assets and Liabilities
Outstanding Principal by Expected Maturity Date
(dollars in thousands)

<TABLE>
<CAPTION>
Maturity Date Fair Value
--------------------------------------------- at
There- December 31,
1999 2000 2001 2002 2003 after Total 1998
------ ------ ----- ----- ----- ------ ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Notes receivable from
related parties:
LIBOR based........... $ 6.5 $ 6.5 $ 6.5
Average interest rate LIBOR
index................ +1.85%

Prime based........... $ 2.3 $ 2.3 $ 2.3
Average interest rate PRIME
index................ +1.00%

Liabilities:
Line of credit:
Variable rate......... $272.0 $272.0 $272.0
Average interest rate LIBOR LIBOR
index................ +1.38% +1.38%

Mortgage debt:
Variable rate......... $ 19.0 $ 19.0 $ 19.0
Average interest rate LIBOR LIBOR
index................ +1.50% +1.50%

Fixed rate............ $ 2.3 $ 2.5 $ 2.7 $ 2.9 $ 3.1 $100.9 $114.4 $121.2
Average interest rate. 8.39% 8.39% 8.39% 8.39% 8.39% 8.39%

Series A and C Preferred
units:
Fixed rate............ $107.0 $107.0 $ 99.2
Average interest rate. 8.49% 8.49% 8.49% 8.49% 8.49% 8.49%
</TABLE>

47
<PAGE>

Interest Rate Risk Analysis--Tabular Presentation
Financial Derivative Instruments
Notional Amounts by Contractual Maturity
(dollars in thousands)

<TABLE>
<CAPTION>
Maturity Date
----------------------------------------- Fair Value at
There- December 31,
1999 2000 2001 2002 2003 after Total 1998
----- ------ ---- ---- ---- ------ ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Rate
Derivatives Used to
Hedge the Line of
Credit:
Interest rate cap
agreements:
Notional amount....... $150.0 $150.0 $0.1
Cap rate.............. 6.50% 6.50%
Forward rate index.... LIBOR LIBOR
</TABLE>

Changes in Primary Risk Exposures

In December 1998 and February 1999, the Company signed commitment letters for
two fixed rate mortgage loans that the Company expects to complete during the
first and second quarters of 1999. The first mortgage loan is expected to have
a principal balance of $95.0 million, monthly principal and interest payments
based upon a fixed interest rate of 7.20% and a 25-year amortization schedule,
and a maturity date of March 2009. The Company intends to use the proceeds from
the new $95.0 million fixed rate mortgage loan to pay down outstanding
borrowings on its existing variable rate Credit Facility. The second mortgage
loan is expected to have principal balance of $30.0 million, monthly principal
and interest payments based upon a fixed rate of 7.15% and an 18-year
amortization schedule, and a maturity date of March 2018. The Company intends
to use the proceeds from the new $30.0 million fixed rate mortgage loan to pay
off its existing $19.0 million variable rate mortgage loan.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included at "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K."

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

48
<PAGE>

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting
presently scheduled to be held on May 17, 1999.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting
presently scheduled to be held on May 17, 1999.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Item 12 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting
presently scheduled to be held on May 17, 1999.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting
presently scheduled to be held on May 17, 1999.

49
<PAGE>

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) and (2) Financial Statements and Schedules

The following consolidated financial information is included as a separate
section of this annual report on Form 10-K:

<TABLE>
<S> <C>
Independent Auditors' Report........................................... F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997........... F-3
Consolidated Statements of Operations for the year ended December 31,
1998, and the period February 1, 1997 to December 31, 1997 and
Combined Statements of Operations for the period January 1, 1997 to
January 31, 1997 and for the year ended December 31, 1996............. F-4
Consolidated Statements of Stockholders' Equity for the year ended
December 31, 1998 and the period from February 1, 1997 to December 31,
1997.................................................................. F-5
Combined Statements of Accumulated Deficit for the period January 1,
1997 to January 31, 1997 and for the year ended December 31, 1996..... F-6
Consolidated Statements of Cash Flows for the years ended December 31,
1998 and 1997 and Combined Statement of Cash Flows for years ended
December 31, 1996..................................................... F-7
Notes to Consolidated and Combined Financial Statements................ F-8
Schedule of Valuation and Qualifying Accounts.......................... F-35
</TABLE>

All other schedules are omitted since the required information is not
present in amounts sufficient to require submission of the schedule or because
the information required is included in the financial statements and notes
thereto.

(3) Exhibits

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
3.1 Articles of Amendment and Restatement of the Registrant(1)
3.2 Amended and Restated Bylaws of the Registrant(1)
3.3 Form of Certificate for Common Stock of the Registrant(1)
3.4 Articles Supplementary of the Registrant designating 8.075% Series A
Cumulative Redeemable Preferred Stock(10)
3.5 Articles Supplementary of the Registrant, designating 8.075% Series A
Cumulative Redeemable Preferred Stock(13)
3.6 Articles Supplementary of the Registrant designating its Series B
Junior Participating Preferred Stock (to be filed by amendment)
3.7 Articles Supplementary of the Registrant designating its 9.375% Series
C Cumulative Redeemable Preferred Stock(15)
4.1 Registration Rights Agreement, dated January 31, 1997(1)
4.2 Registration Rights Agreement, dated February 6, 1998(10)
4.3 Registration Rights Agreement, dated April 20, 1998(13)
4.4 Registration Rights Agreement, dated November 24, 1998(15)
4.5 Registration Rights Agreement, dated as of October 31, 1997(7)
</TABLE>

50
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
4.6 Rights Agreement, dated as of October 2, 1998 between Kilroy Realty
Corporation and ChaseMellon Shareholder Services, L.L.C., as Rights
Agent, which includes the form of Articles Supplementary of the
Series B Junior Participating Preferred Stock of Kilroy Realty
Corporation as Exhibit A, the form of Right Certificate as Exhibit B
and the Summary of Rights to Purchase Preferred Shares as Exhibit
C(16)
10.1 Fourth Amended and Restated Agreement of Limited Partnership of Kilroy
Realty, L.P., dated November 24, 1998(15)
10.2 Omnibus Agreement, dated as of October 30, 1996, by and among Kilroy
Realty, L.P. and the parties named therein(1)
10.3 Supplemental Representations, Warranties and Indemnity Agreement by
and among Kilroy Realty, L.P. and the parties named therein(1)
10.4 Pledge Agreement by and among Kilroy Realty, L.P., John B. Kilroy,
Sr., John B. Kilroy, Jr. and Kilroy Industries(1)
10.5 1997 Stock Option and Incentive Plan of the Registrant and Kilroy
Realty, L.P(1)
10.6 Form of Indemnity Agreement of the Registrant and Kilroy Realty, L.P.
with certain officers and directors(1)
10.7 Lease Agreement, dated January 24, 1989, by and between Kilroy Long
Beach Associates and the City of Long Beach for Kilroy Long Beach
Phase I(1)
10.8 First Amendment to Lease Agreement, dated December 28, 1990, by and
between Kilroy Long Beach Associates and the City of Long Beach for
Kilroy Long Beach Phase I(1)
10.9 Lease Agreement, dated July 17, 1985, by and between Kilroy Long Beach
Associates and the City of Long Beach for Kilroy Long Beach Phase
III(1)
10.10 Lease Agreement, dated April 21, 1988, by and between Kilroy Long
Beach Associates and the Board of Water Commissioners of the City of
Long Beach, acting for and on behalf of the City of Long Beach, for
Long Beach Phase IV(1)
10.11 Lease Agreement, dated December 30, 1988, by and between Kilroy Long
Beach Associates and City of Long Beach for Kilroy Long Beach Phase
II(1)
10.12 First Amendment to Lease, dated January 24, 1989, by and between
Kilroy Long Beach Associates and the City of Long Beach for Kilroy
Long Beach Phase III(1)
10.13 Second Amendment to Lease Agreement, dated December 28, 1990, by and
between Kilroy Long Beach Associates and the City of Long Beach for
Kilroy Long Beach Phase III(1)
10.14 First Amendment to Lease Agreement, dated December 28, 1990, by and
between Kilroy Long Beach Associates and the City of Long Beach for
Kilroy Long Beach Phase II(1)
10.15 Third Amendment to Lease Agreement, dated October 10, 1994, by and
between Kilroy Long Beach Associates and the City of Long Beach for
Kilroy Long Beach Phase III(1)
10.16 Development Agreement by and between Kilroy Long Beach Associates and
the City of Long Beach(1)
10.17 Amendment No. 1 to Development Agreement by and between Kilroy Long
Beach Associates and the City of Long Beach(1)
10.18 Ground Lease by and between Frederick Boysen and Ted Boysen and Kilroy
Industries, dated May 15, 1969, for SeaTac Office Center(1)
10.19 Amendment No. 1 to Ground Lease and Grant of Easement, dated April 27,
1973, among Frederick Boysen and Dorothy Boysen, Ted Boysen and Rose
Boysen and Sea/Tac Properties(1)
</TABLE>

51
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.20 Amendment No. 2 to Ground Lease and Grant of Easement, dated May 17,
1977, among Frederick Boysen and Dorothy Boysen, Ted Boysen and Rose
Boysen and Sea/Tac Properties(1)
10.21 Airspace Lease, dated July 10, 1980, by and among the Washington State
Department of Transportation, as lessor, and Sea Tac Properties, Ltd.
and Kilroy Industries, as lessee(1)
10.22 Lease, dated April 1, 1980, by and among Bow Lake, Inc., as lessor,
and Kilroy Industries and SeaTac Properties, Ltd., as lessees for
Sea/Tac Office Center(1)
10.23 Amendment No. 1 to Ground Lease, dated September 17, 1990, between Bow
Lake, Inc., as lessor, and Kilroy Industries and Sea/Tac Properties,
Ltd., as lessee(1)
10.24 Amendment No. 2 to Ground Lease, dated March 21, 1991, between Bow
Lake, Inc., as lessor, and Kilroy Industries and Sea/Tac Properties,
Ltd., as lessee(1)
10.25 Property Management Agreement between Kilroy Realty Finance
Partnership, L.P. and Kilroy Realty, L.P.(1)
10.26 Environmental Indemnity Agreement(1)
10.27 Option Agreement by and between Kilroy Realty, L.P. and Kilroy Airport
Imperial Co.(1)
10.28 Option Agreement by and between Kilroy Realty, L.P. and Kilroy
Calabasas Associates(1)
10.29 Employment Agreement between the Registrant and John B. Kilroy, Jr.(1)
10.30 Employment Agreement between the Registrant and Richard E. Moran
Jr.(1)
10.31 Employment Agreement between the Registrant and Jeffrey C. Hawken(1)
10.32 Employment Agreement between the Registrant and C. Hugh Greenup(1)
10.33 Noncompetition Agreement by and between the Registrant and John B.
Kilroy, Sr.(1)
10.34 Noncompetition Agreement by and between the Registrant and John B.
Kilroy, Jr.(1)
10.35 License Agreement by and among the Registrant and the other persons
named therein(1)
10.36 Form of Indenture of Mortgage, Deed of Trust, Security Agreement,
Financing Statement, Fixture Filing and Assignment of Leases, Rents
and Security Deposits(1)
10.37 Mortgage Note(1)
10.38 Indemnity Agreement(1)
10.39 Assignment of Leases, Rents and Security Deposits(1)
10.40 Variable Interest Rate Indenture of Mortgage, Deed of Trust, Security
Agreement, Financing Statement, Fixture Filing and Assignment of
Leases and Rents(1)
10.41 Environmental Indemnity Agreement(1)
10.42 Assignment, Rents and Security Deposits(1)
10.43 Form of Mortgage, Deed of Trust, Security Agreement, Financing
Statement, Fixture Filing and Assignment of Leases and Rents(1)
10.44 Assignment of Leases, Rents and Security Deposits(1)
10.45 Purchase and Sale Agreement and Joint Escrow Instructions, dated April
30, 1997, by and between Mission Land Company, Mission-Vacaville,
L.P. and Kilroy Realty, L.P.(2)
10.46 Agreement of Purchase and Sale and Joint Escrow Instructions, dated
April 30, 1997, by and between Camarillo Partners and Kilroy Realty,
L.P.(2)
10.47 Purchase and Sale Agreement and Escrow Instructions, dated May 5,
1997, by and between Kilroy Realty, L.P. and Pullman Carnegie
Associates(4)
</TABLE>

52
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.48 Amendment to Purchase and Sale Agreement and Escrow Instructions,
dated June 27, 1997, by and between Pullman Carnegie Associates and
Kilroy Realty, L.P.(4)
10.49 Purchase and Sale Agreement, Contribution Agreement and Joint Escrow
Instructions, dated May 12, 1997, by and between Shidler West
Acquisition Company, LLC and Kilroy Realty, L.P.(3)
10.50 First Amendment to Purchase and Sale Agreement, Contribution Agreement
and Joint Escrow Instructions, dated June 6, 1997, between Kilroy
Realty, L.P. and Shidler West Acquisition Company, L.L.C. and Kilroy
Realty, L.P.(3)
10.51 Second Amendment to Purchase and Sale Agreement, Contribution
Agreement and Joint Escrow Instructions, dated June 12, 1997, by and
between Shidler West Acquisition Company, LLC and Kilroy Realty,
L.P.(3)
10.52 Agreement of Purchase and Sale and Joint Escrow Instructions, dated
June 12, 1997, by and between Mazda Motor of America, Inc. and Kilroy
Realty, L.P.(4)
10.53 Amendment to Agreement of Purchase and Sale and Joint Escrow
Instructions, dated June 30, 1997, by and between Mazda Motor of
America, Inc. and Kilroy Realty, L.P.(4)
10.54 Agreement for Purchase and Sale of 2100 Colorado Avenue, Santa Monica,
California, dated June 16, 1997, by and between Santa Monica Number
Seven Associates L.P. and Kilroy Realty L.P.(4)
10.55 Second Amendment to Credit Agreement and First Amendment to Variable
Interest Rate Indenture of Mortgage, Deed of Trust, Security
Agreement, Financing Statement, Fixture Filing and Assignment of
Leases and Rent dated August 13, 1997(5)
10.56 Purchase and Sale Agreement and Joint Escrow Instructions, dated July
10, 1997, by and between Kilroy Realty, L.P. and Mission Square
Partners(6)
10.57 First Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated August 22, 1997(6)
10.58 Second Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 5, 1997(6)
10.59 Third Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 19, 1997(6)
10.60 Fourth Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 22, 1997(6)
10.61 Fifth Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 23, 1997(6)
10.62 Sixth Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 25, 1997(6)
10.63 Seventh Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated September 29, 1997(6)
10.64 Eighth Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated October 2, 1997(6)
10.65 Ninth Amendment to the Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between Kilroy Realty, L.P.
and Mission Square Partners, dated October 24, 1997(6)
</TABLE>

53
<PAGE>

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
10.66 Contribution Agreement, dated October 21, 1997, by and between Kilroy
Realty, L.P. and Kilroy Realty Corporation and The Allen Group and
the Allens(8)
10.67 Purchase and Sale Agreement and Escrow Instructions, dated December
11, 1997, by and between Kilroy Realty, L.P. and Swede-Cal
Properties, Inc., Viking Investors of Southern California, L.P. and
Viking Investors of Southern California II, L.P.(9)
10.68 Amendment to the Contribution Agreement, dated October 14, 1998, by
and between Kilroy Realty, L.P. and Kilroy Realty Corporation and The
Allen Group and the Allens, dated October 21, 1997(15)
10.69 Amended and Restated Revolving Credit Agreement, dated as of October
8, 1998 among Kilroy Realty, L.P., Morgan Guaranty Trust Company of
New York, as Bank and as Lead Agent for the Banks, and the Banks
listed therein.(14)
10.70 Amended and Restated Guaranty of Payment, dated as of October 8, 1998,
between Kilroy Realty Corporation and Morgan Guaranty Trust Company
of New York.(14)
21.1 List of Subsidiaries of the Registrant(17)
*23.1 Consent of Deloitte & Touche LLP
*24.1 Power of Attorney (included in the signature page of this Form 10-K)
**27.1 Financial Data Schedule
</TABLE>
- --------
*Filed herewith

**Previously filed

(1) Previously filed as an exhibit to the Registration Statement on Form S-11
(No. 333-15553) as declared effective on January 28, 1997 and incorporated
herein by reference.

(2) Previously filed as exhibit 10.11 and 10.12, respectively, to the Current
Report on Form 8-K, dated May 22, 1997, and incorporated herein by
reference.

(3) Previously filed as exhibit 10.57, 10.58 and 10.59, respectively, to the
Current Report on Form 8-K, dated June 30, 1997, and incorporated herein
by reference.

(4) Previously filed as exhibit 10.54, 10.59, 10.60, 10.61 and 10.62,
respectively, to the Current Report on Form 8-K, dated June 30, 1997, and
incorporated herein by reference.

(5) Previously filed as an exhibit to the Registration Statement on Form S-11
(No. 333-32261), and incorporated herein by reference.

(6) Previously filed as an exhibit on Form 10-Q, for the quarterly period
ended September 30, 1997, and incorporated herein by reference.

(7) Previously filed as an exhibit to the Current Report on Form 8-K/A, dated
October 29, 1997, and incorporated herein by reference.

(8) Previously filed as exhibit 10.70 and 10.71, respectively, to the Current
Report on Form 8-K, dated November 7, 1997, and incorporated herein by
reference.

(9) Previously filed as exhibit 10.70 to the Current Report on Form 8-K, dated
December 17, 1997, and incorporated herein by reference.

(10) Previously filed as an exhibit to the Registrant's Current Report on Form
8-K dated February 6, 1998 and incorporated herein by reference.

(11) Previously filed as an exhibits to the Current Report on Form 8-K (No. 1-
12675) dated October 2, 1998 and incorporated herein by reference.

(12) Previously filed as an exhibit to the Current Report on Form 8-K (No. 1-
12675) dated October 29, 1997 and incorporated herein by reference.

(13) Previously filed as an exhibit to the Current Report on Form 8-K (No. 1-
12675) dated April 20, 1998 and incorporated herein by reference.

54
<PAGE>

(14) Previously filed as an exhibit on Form 10-Q (No. 1-12675) for the
quarterly period ended September 30, 1998 and incorporated herein by
reference.

(15) Previously filed as an exhibit to the Current Report on Form 8-K (No. 1-
12675) dated November 24, 1998 and incorporated herein by reference.

(16) Previously filed as an exhibit to the Current Report on Form 8-K (No. 1-
12675) dated October 2, 1998 and incorporated herein by reference.

(17) Previously filed as an exhibit to the Registration Statement on Form S-11
(No. 333-15553) and incorporated herein by reference.

(b) Reports on Form 8K

The Company filed the Current Report on Form 8-K (No. 1-12675), dated
November 24, 1998, in connection with the private placement of 700,000 9.375%
Series C Cumulative Redeemable Preferred Units of Kilroy Realty, L.P.

55
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on August 6, 1999.

Kilroy Realty Corporation

/s/ John B. Kilroy, Jr.
By: ___________________________________
John B. Kilroy, Jr.
President and Chief Executive
Officer

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and
directors of Kilroy Realty Corporation, hereby severally constitute John B.
Kilroy, Sr., John B. Kilroy, Jr., Jeffrey C. Hawken, Richard E. Moran Jr. and
Ann Marie Whitney, and each of them singly, our true and lawful attorneys with
full power to them, and each of them singly, to sign for us and in our names
in the capacities indicated below, the Form 10-K filed herewith and any and
all amendments to said Form 10-K, and generally to do all such things in our
names and in our capacities as officers and directors to enable Kilroy Realty
Corporation to comply with the provisions of the Securities Exchange Act of
1934, and all requirements of the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorneys, or any of them, to said Form 10-K and any and all amendments
thereto.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<C> <S> <C>
/s/ John B. Kilroy, Sr.
_________________________________ Chairman of the Board August 6, 1999
John B. Kilroy, Sr.

/s/ John B. Kilroy, Jr. President, Chief Executive
_________________________________ Officer and Director August 6, 1999
John B. Kilroy, Jr. (Principal Executive
Officer)

/s/ Richard E. Moran Jr. Executive Vice President
_________________________________ and Chief Financial August 6, 1999
Richard E. Moran Jr. Officer (Principal
Financial Officer)

/s/ Ann Marie Whitney Vice President and
_________________________________ Controller (Principal August 6, 1999
Ann Marie Whitney Accounting Officer)

_________________________________ Director
John R. D'Eathe

/s/ William P. Dickey
_________________________________ Director August 6, 1999
William P. Dickey

/s/ Matthew J. Hart
_________________________________ Director August 6, 1999
Matthew J. Hart

/s/ Dale F. Kinsella
_________________________________ Director August 6, 1999
Dale F. Kinsella
</TABLE>

<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED AND KILROY GROUP COMBINED

FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997
AND FOR THE THREE YEARS THEN ENDED

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report............................................. F-2

Consolidated Balance Sheets as of December 31, 1998 and 1997............. F-3

Statements of Operations for the year ended December 31, 1998 and the
period February 1, 1997 to December 31, 1997 and Combined Statements of
Operations for the period January 1, 1997 to January 31, 1997 and for
the year ended December 31, 1996........................................ F-4

Consolidated Statements of Stockholders' Equity for the year ended
December 31, 1998 and the period February 1, 1997 to December 31, 1997.. F-5

Combined Statements of Accumulated Deficit for the period January 1, 1997
to January 31, 1997 and for the year ended December 31, 1996............ F-6

Consolidated Statements of Cash Flows for the years ended December 31,
1998 and 1997 and Combined Statement of Cash Flows for the year ended
December 31, 1996....................................................... F-7

Notes to Consolidated and Combined Financial Statements.................. F-8
</TABLE>

F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of Kilroy Realty Corporation:

We have audited the accompanying consolidated balance sheets of Kilroy
Realty Corporation (the "Company") as of December 31, 1998 and 1997, the
related consolidated statements of operations and shareholders' equity for the
year ended December 31, 1998 and the period February 1, 1997 to December 31,
1997, and the combined statements of operations and accumulated deficit of the
Kilroy Group (described in Note 1) for the period January 1, 1997 to January
31, 1997 and the year ended December 31, 1996; and the consolidated statements
of cash flows for the years ended December 31, 1998 and 1997 and the combined
statements of cash flows for the year ended December 31, 1996. Our audits also
included the financial statement schedule listed in the index at Item 8. These
financial statements and the financial statement schedule are the
responsibility of the management of the Company. Our responsibility is to
express an opinion on these financial statements and the financial statement
schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1998 and
1997, and the results of operations and cash flows of the Company and the
Kilroy Group for the respective stated periods in conformity with generally
accepted accounting principles. Also in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated and combined
financial statements taken as a whole, presents fairly in all material
respects, the information set forth therein.

Deloitte & Touche LLP

Los Angeles, California
March 10, 1999

F-2
<PAGE>

KILROY REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

<TABLE>
<CAPTION>
December 31,
---------------------
1998 1997
---------- ---------
<S> <C> <C>
ASSETS
------

INVESTMENT IN REAL ESTATE (Notes 1, 2, 3, 13, 15, 19,
and 20):
Land and improvements................................. $ 253,500 $ 177,118
Buildings and improvements............................ 828,425 622,901
Undeveloped land and construction in progress, net.... 112,359 34,671
---------- ---------
Total investment in real estate...................... 1,194,284 834,690
Accumulated depreciation and amortization............. (145,437) (121,780)
---------- ---------
Investment in real estate, net....................... 1,048,847 712,910
CASH AND CASH EQUIVALENTS............................... 6,443 8,929
RESTRICTED CASH......................................... 6,896 5,680
TENANT RECEIVABLES, NET (Note 4)........................ 15,630 7,367
NOTES RECEIVABLE FROM RELATED PARTIES (Note 13)......... 8,798
ESCROW DEPOSITS (Note 12)............................... 350 5,114
DEFERRED FINANCING AND LEASING COSTS, NET (Note 5)...... 16,168 13,053
PREPAID EXPENSES AND OTHER ASSETS....................... 2,796 4,601
---------- ---------
TOTAL ASSETS......................................... $1,105,928 $ 757,654
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------

LIABILITIES:
Mortgage debt (Note 6)................................ $ 133,383 $ 131,363
Line of credit (Note 7)............................... 272,000 142,000
Accounts payable and accrued expenses................. 18,091 9,711
Accrued distributions (Note 9)........................ 12,895 10,804
Rents received in advance and tenant security
deposits............................................. 13,160 11,441
---------- ---------
Total liabilities.................................... 449,529 305,319
---------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 13)

MINORITY INTERESTS (Note 8):
8.075% Series A Cumulative Redeemable Preferred
unitholders.......................................... 73,718
9.375% Series C Cumulative Redeemable Preferred
unitholders.......................................... 34,410
Common unitholders.................................... 72,372 55,185
---------- ---------
Total minority interests............................. 180,500 55,185
---------- ---------
STOCKHOLDERS' EQUITY (Note 9):
Preferred stock, $.01 par value, 28,300,000 shares
authorized,
none issued and outstanding..........................
8.075% Series A Cumulative Redeemable Preferred stock,
$.01 par value,
1,700,000 shares authorized, none issued and
outstanding..........................................
Series B Junior Participating Preferred stock, $.01
par value,
400,000 shares authorized, none issued and
outstanding..........................................
9.375% Series C Cumulative Redeemable Preferred stock,
$.01 par value,
700,000 shares authorized, none issued and
outstanding..........................................
Common stock, $.01 par value, 150,000,000 shares
authorized,
27,639,210 and 24,475,000 shares issued and
outstanding, respectively............................ 276 245
Additional paid-in capital............................ 487,467 403,163
Distributions in excess of earnings................... (11,844) (6,258)
---------- ---------
Total stockholders' equity........................... 475,899 397,150
---------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $1,105,928 $ 757,654
========== =========
</TABLE>

See accompanying notes to consolidated and combined financial statements.

F-3
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED AND
KILROY GROUP COMBINED

STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

<TABLE>
<CAPTION>
Kilroy Realty Corporation Kilroy Group
------------------------- -------------------------
February 1, January 1,
Year Ended 1997 to 1997 to Year Ended
December 31, December 31, January 31, December 31,
1998 1997 1997 1996
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
REVENUES (Note 15):
Rental income............. $ 117,338 $ 56,069 $ 2,760 $ 35,022
Tenant reimbursements..... 14,152 6,751 306 3,752
Development services...... 14 698
Interest income........... 1,698 3,571
Other income (Note 2)..... 3,096 889 4 76
---------- ---------- ---------- ----------
Total revenues.......... 136,284 67,280 3,084 39,548
---------- ---------- ---------- ----------
EXPENSES:
Property expenses (Note
15)...................... 19,281 8,770 579 6,788
Real estate taxes (Note
15)...................... 9,579 4,199 137 1,673
General and
administrative........... 7,739 4,949 78 2,383
Ground leases (Note 15)... 1,223 938 64 768
Development expense....... 46 650
Option buy-out cost....... 3,150
Provision for potentially
unrecoverable
pre-development costs
(Note 2)................. 1,700
Interest expense.......... 20,568 9,738 1,895 21,853
Depreciation and
amortization............. 26,200 13,236 787 9,111
---------- ---------- ---------- ----------
Total expenses.......... 86,290 41,830 3,586 46,376
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE EQUITY
IN INCOME OF UNCONSOLIDATED
SUBSIDIARY, MINORITY
INTERESTS AND EXTRAORDINARY
GAINS...................... 49,994 25,450 (502) (6,828)
EQUITY IN INCOME OF
UNCONSOLIDATED SUBSIDIARY.. 5 23
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE
MINORITY INTERESTS AND
EXTRAORDINARY GAINS........ 49,999 25,473 (502) (6,828)
MINORITY INTERESTS:
Distributions on
Cumulative Redeemable
Preferred units.......... (5,556)
Minority interest in
earnings................. (5,621) (3,413)
---------- ----------
Total minority
interests.............. (11,177) (3,413)
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE
EXTRAORDINARY GAINS........ 38,822 22,060 (502) (6,828)
EXTRAORDINARY GAINS (Note
2)......................... 3,204 20,095
---------- ---------- ---------- ----------
NET INCOME.................. $ 38,822 $ 22,060 $ 2,702 $ 13,267
========== ========== ========== ==========
Net income per common
share--basic (Note 16)..... $ 1.44 $ 1.20
========== ==========
Net income per common
share--diluted (Note 16)... $ 1.43 $ 1.19
========== ==========
Weighted average shares
outstanding--basic (Note
16)........................ 26,989,422 18,445,149
========== ==========
Weighted average shares
outstanding--diluted
(Note 16).................. 27,059,988 18,539,299
========== ==========
</TABLE>

See accompanying notes to consolidated and combined financial statements.

F-4
<PAGE>

KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Year Ended December 31, 1998 and the
Period February 1, 1997 to December 31, 1997
(in thousands, except share and per share data)

<TABLE>
<CAPTION>
Additional Distributions
Number of Common Paid-in in Excess of
Shares Stock Capital Earnings Total
---------- ------ ---------- ------------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE AT FEBRUARY 1,
1997................... 50 $ 1 $(104,540) $(104,539)
Issuance of common
stock (Note 9)....... 24,375,000 $244 438,894 104,540 543,678
Issuance of restricted
stock (Note 11)...... 100,000 1 1
Restricted stock
compensation (Note
11).................. 422 422
Repurchase of common
stock................ (50) (1) (1)
Adjustment for
minority interest.... (36,153) (36,153)
Dividends declared
($1.42 per share).... (28,318) (28,318)
Net income............ 22,060 22,060
---------- ---- -------- --------- ---------
BALANCE AT DECEMBER 31,
1997................... 24,475,000 245 403,163 (6,258) 397,150
Issuance of common
stock (Note 9)....... 3,174,210 31 81,782 81,813
Restricted stock
compensation (Note
11).................. 531 531
Repurchase of common
stock................ (10,000) (285) (285)
Adjustment for
minority interest.... 2,276 2,276
Dividends declared
($1.62 per share).... (44,408) (44,408)
Net income............ 38,822 38,822
---------- ---- -------- --------- ---------
BALANCE AT DECEMBER 31,
1998................... 27,639,210 $276 $487,467 $ (11,844) $ 475,899
========== ==== ======== ========= =========
</TABLE>

See accompanying notes to consolidated and combined financial statements.

F-5
<PAGE>

KILROY GROUP

COMBINED STATEMENTS OF ACCUMULATED DEFICIT

January 1, 1997 to January 31, 1997 and the Year Ended December 31, 1996
(in thousands)

<TABLE>
<S> <C>
BALANCE AT JANUARY 1, 1996.......................................... $(121,826)
Deemed and actual distributions to partners, net of contributions. (5,218)
Net income........................................................ 13,267
---------
BALANCE AT DECEMBER 31, 1996........................................ (113,777)
Deemed and actual contributions from partners, net of
distributions.................................................... 6,535
Net income........................................................ 2,702
---------
BALANCE AT JANUARY 31, 1997......................................... $(104,540)
=========
</TABLE>

See accompanying notes to consolidated and combined financial statements.

F-6
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED AND KILROY GROUP COMBINED

STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended
December 31,
------------------------------
1998 1997 1996
--------- --------- --------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................... $ 38,822 $ 24,762 $ 13,267
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization.............. 26,200 14,023 9,111
Provision for uncollectible tenant
receivables and unbilled deferred rent.... 1,107 1,078 1,266
Provision for potentially unrecoverable
pre-development costs..................... 1,700
Restricted stock compensation.............. 531 422
Extraordinary gains........................ (3,204) (20,095)
Minority interest in earnings.............. 5,621 3,413
Accrued distributions on Cumulative
Redeemable Preferred units................ 1,094
Other...................................... (281) (23)
Changes in assets and liabilities:
Tenant receivables....................... (9,370) (5,403) (335)
Deferred leasing costs................... (2,652) (4,819) (1,349)
Prepaid expenses and other assets........ 1,483 (3,654)
Accounts payable and accrued expenses.... 7,455 2,097 1,162
Accrued cost of option buy-out and tenant
improvements............................ (1,390) 1,390
Rents received in advance and tenant
security deposits....................... 1,719 1,626 1,103
--------- --------- --------
Net cash provided by operating
activities............................ 73,429 28,928 5,520
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for rental properties........... (242,287) (512,071) (2,354)
Expenditures for undeveloped land and
construction in progress.................... (98,438) (34,671)
Notes receivable from related parties........ (8,798)
Decrease (increase) in escrow deposits....... 4,764 (5,114)
Net investment in and advances from (to)
unconsolidated subsidiary................... 1,042 (100)
--------- --------- --------
Net cash used in investing activities.. (343,717) (551,956) (2,354)
--------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock... 81,813 543,678
Net proceeds from issuance of Cumulative
Redeemable Preferred units.................. 107,034
Proceeds from issuance of mortgage debt...... 5,000 98,000 21,143
Net borrowings on line of credit............. 130,000 142,000
Principal payments on mortgage debt.......... (2,979) (226,549) (19,091)
Financing costs.............................. (3,007) (4,325)
Restricted cash.............................. (1,216) (5,680)
Distributions paid........................... (48,843) (21,702)
Deemed and actual contributions from
(distributions to) partners, net............ 6,535 (5,218)
--------- --------- --------
Net cash provided by (used in)
financing activities.................. 267,802 531,957 (3,166)
--------- --------- --------
Net (decrease) increase in cash and cash
equivalents................................... (2,486) 8,929
Cash and cash equivalents, beginning of
period........................................ 8,929
--------- --------- --------
Cash and cash equivalents, end of period....... $ 6,443 $ 8,929 $ 0
========= ========= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized
interest.................................... $ 18,442 $ 13,095 $ 25,175
========= ========= ========
Distributions paid to Cumulative Redeemable
Preferred unitholders....................... $ 4,462
=========
NON-CASH TRANSACTIONS:
Accrual of distributions payable (Note 9).... $ 12,895 $ 10,804
========= =========
Issuance of common units of the Operating
Partnership to acquire rental properties and
undeveloped land (Note 3)................... $ 20,569 $ 19,263
========= =========
Issuance of mortgage debt to acquire rental
properties (Note 3)......................... $ 41,102
=========
</TABLE>
See accompanying notes to consolidated and combined financial statements.

F-7
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

Three Years Ended December 31, 1998

1. Organization and Formation Transactions

Kilroy Realty Corporation (the "Company") was incorporated in Maryland in
September 1996 and commenced operations upon the completion of its initial
public offering in January 1997. The Company, which develops, owns and
operates office and industrial properties located in California, Washington,
Nevada and Arizona, qualifies and operates as a self-administered real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended.

The Company is the successor to the real estate business of the Kilroy
Group, which consisted of the combination of Kilroy Industries ("KI") and
various entities, the properties of which were under the common control of KI
and/or its stockholders, including the Company's Chairman of the Board of
Directors, John B. Kilroy, Sr., and the Company's President and Chief
Executive Officer, John B. Kilroy, Jr. KI had historically been engaged in the
acquisition, management, financing, construction and leasing of office and
industrial properties and providing development services to third party owners
for a fee. The accompanying combined financial statements of the Kilroy Group
have been presented on a combined basis because of common ownership and
management and because the entities were the subject of a business combination
with the Company in 1997.

The Company completed its initial public offering of 12,500,000 shares of
$.01 par value per share common stock ("common stock") on January 31, 1997.
The offering price of $23.00 per share resulted in gross proceeds of $288
million. On February 7, 1997, the underwriters exercised their over-allotment
option and, accordingly, the Company issued 1,875,000 additional shares of
common stock and received gross proceeds of $43.1 million. The aggregate
proceeds to the Company, net of underwriters discount and offering costs, were
approximately $303 million. The initial public offering, including the
exercise of the over-allotment option in connection therewith, is hereinafter
referred to as the "IPO".

The following transactions occurred simultaneously with the completion of
the IPO (collectively, the "Formation Transactions"):

. The Company consummated various purchase agreements to acquire four
properties for approximately $58.2 million in cash.

. The Company became the sole general partner of Kilroy Realty, L.P. (the
"Operating Partnership"). Upon completion of the IPO, the Company
contributed substantially all of the net proceeds of the offering in
exchange for an approximate 84.5% interest in the Operating Partnership.
The Company also contributed cash to purchase 100% of Kilroy Realty
Finance, Inc. ("Finance Inc."), which was formed to serve as the general
partner of Kilroy Realty Finance Partnership, L.P. (the "Finance
Partnership"). The Operating Partnership executed various option and
purchase agreements whereby it issued 2,652,374 common limited
partnership units in the Operating Partnership ("common units"),
representing an approximate 15.5% partnership interest, to the
continuing investors in exchange for interest in properties. The
continuing investors included John B. Kilroy, Sr. and John B. Kilroy,
Jr., certain Kilroy family members and certain entities owned by them.
The Operating Partnership contributed certain properties to the Finance
Partnership in exchange for a limited partnership interest therein. All
properties acquired by the Company are held by or through the Operating
Partnership or the Finance Partnership. Unless otherwise indicated, all
references to the Company include the Operating Partnership, the Finance
Partnership and Finance Inc.

. The Finance Partnership and the Operating Partnership borrowed $84.0
million and $12.0 million, respectively, under two mortgage loans.

F-8
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

. The Operating Partnership used a portion of the IPO proceeds and the
proceeds of the new mortgage borrowings of $96.0 million to repay
approximately $219 million of indebtedness.

. The Operating Partnership contributed certain assets valued at
approximately $0.1 million to Kilroy Services, Inc., an unconsolidated
subsidiary of the Company, ("KSI"), for 100% of its non-voting stock,
representing a 5% ownership interest and a 95% economic interest in KSI.
The voting common stock is owned entirely by John B. Kilroy, Sr. and
John B. Kilroy, Jr.

The transfer of the properties and operating interests of affiliates of the
Company to the Operating Partnership for cash or common units was accounted
for at the historical cost of those interests.

In September 1998, the Company formed two limited liability companies,
Kilroy Gateway Partners, L.L.C. and Kilroy Carmel Partners, L.L.C.
(collectively, the "LLCs") to develop two office projects in San Diego,
California in conjunction with The Allen Group, a group of affiliated real
estate development and investment companies based in Visalia, California (see
Note 12). At December 31, 1998, the Company owned a 100% interest in both of
the LLCs.

As of December 31, 1998, the Company's stabilized portfolio consisted of 80
office buildings (the "Office Properties") and 84 industrial buildings (the
"Industrial Properties," and together with the Office Properties, the
"Properties"), which encompassed approximately 5.6 million and 6.2 million
rentable square feet, respectively, and was 95.9% occupied. The Company owns
its interests in all of its Properties through the Operating Partnership and
the Finance Partnership, and conducts substantially all of its operations
through the Operating Partnership. The Company owned an 86.8% and 87.8%
general partnership interest in the Operating Partnership as of December 31,
1998 and 1997, respectively.

2. Basis of Presentation and Significant Accounting Policies

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 and Finance Inc. The
consolidated financial statements as of and for the year ended December 31,
1998 also include the consolidated financial position and results of
operations of the LLCs. The operating results of the development services
business conducted by KSI are accounted for under the equity method of
accounting. All significant intercompany balances and transactions have been
eliminated in the consolidated financial statements.

The combined financial statements of the Kilroy Group reflect a combination
of real estate properties which were under the common control of KI and/or its
stockholders, including John B. Kilroy, Sr. and John B. Kilroy, Jr., and which
were contributed to the Operating Partnership for 2,652,374 common units upon
consummation of the IPO. The Kilroy Group is considered the predecessor entity
to the Company due to common ownership and management; therefore, its combined
financial statements are presented for comparative purposes. All significant
intercompany balances and transactions have been eliminated in the combined
financial statements.

Significant Accounting Policies:

Rental properties--Rental properties are stated at the lower of historical
cost less accumulated depreciation or estimated fair value. The cost of rental
properties includes the purchase price or development costs of the properties.
Costs incurred for the acquisition, renovation and betterment of the rental
properties, excluding internal pre-acquisition costs related to the purchase
of rental properties, are capitalized to the Company's investment in that
property. Maintenance and repairs are charged to expense as incurred.

F-9
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

The Company evaluates fair value for financial reporting purposes on a
property by property basis using future undiscounted cash flows, excluding
interest charges. In the event that periodic assessments or other factors
revealed a potential impairment condition, the Company would recognize an
impairment loss to the extent the carrying amount exceeded the fair value of
the property. The Company had not recorded any such impairment losses at
December 31, 1998 and 1997.

Depreciation and amortization--The cost of buildings and improvements are
depreciated on the straight-line method over estimated useful lives of 25 to
40 years for buildings and the shorter of the lease term or useful life,
ranging from five to 20 years, for tenant improvements. Depreciation expense
for buildings and improvements for the year ended December 31, 1998, the
eleven months ended December 31, 1997, the one month ended January 31, 1997
and the year ended December 31, 1996 was $23.7 million, $11.5 million,
$0.7 million and $7.9 million, respectively.

Construction in progress--Project costs clearly associated with the
development and construction of a real estate project are capitalized as
construction in progress. In addition, interest, real estate taxes and other
costs are capitalized during the period in which activities necessary to get
the property ready for its intended use are in progress. Once the development
and construction of a real estate project are completed and the property is
ready for its intended use, the costs capitalized to construction in progress
are transferred to land and improvements and buildings and improvements as the
historical cost of the property.

At December 31, 1998, construction in progress was carried net of a $1.7
million allowance for potentially unrecoverable pre-development costs. The
allowance, which provides for costs incurred for development projects that the
Company may at some point in the development process decide not to pursue, was
established by estimating probable exposures to these types of costs for each
of the projects in the Company's development pipeline. Management's
determination of the allowance was calculated on a project by project basis
using a series of probability factors based on the Company's historical
experience. The allowance is increased by provisions charged against income.
The allowance for potentially unrecoverable pre-development costs at December
31, 1998 is maintained at a level believed to be adequate by management.

Cash and cash equivalents--The Company considers all money market funds with
an original maturity of three months or less at the date of purchase to be
cash equivalents.

Restricted cash--Restricted cash consists of cash held as collateral to
provide credit enhancement for the Company's mortgage debt and cash reserves
for capital expenditures and tenant improvements.

Tenant receivables and related revenue recognition--Leases with tenants are
accounted for as operating leases. Minimum annual rentals are recognized on a
straight-line basis over the term of the related lease. Unbilled deferred rent
receivables represent the amount that straight-line rental income exceeds
rents currently due under the lease agreement. Included in tenant receivables
are tenant reimbursements which are comprised of additional amounts receivable
from tenants based on common area maintenance expenses and certain other
expenses that are accrued in the period in which the related expenses are
incurred.

Tenant receivables and unbilled deferred rent receivables are carried net of
an allowance for uncollectible tenant receivables and unbilled deferred rent.
Management's determination of the adequacy of the allowance is based upon
evaluations of individual receivables, past loss experience, current economic
conditions, and other relevant factors. The allowance is increased by
provisions charged against income. The allowance for uncollectible tenant
receivables and unbilled deferred rent is maintained at a level believed
adequate by management to absorb potential losses from both current and
deferred tenant receivables at December 31, 1998 and 1997.

F-10
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Deferred financing and leasing costs--Costs incurred in connection with debt
financing and property leasing are capitalized as deferred financing and
leasing costs. Deferred financing costs include loan fees which are amortized
using the effective interest method over the terms of the respective loans.
Deferred leasing costs include leasing commissions which are amortized on the
straight-line method over the initial lives of the leases which range from
five to 10 years.

Development services--Development services revenues represent fees earned by
the Kilroy Group for supervision services provided for building development of
non-owned properties. Fees were typically a percentage of total development
costs plus reimbursement for certain expenses. Unreimbursed expenses were
recorded as development expenses and included items such as wages, equipment
rental and supplies. The Company's development services have been performed by
KSI since February 1, 1997.

Other income--Other income includes revenue earned from lease termination
fees, overhead charges for construction management, and management fees.
Included in other income for the year ended December 31, 1998 was a $1.9
million net lease termination fee on an office property in San Diego,
California.

Option buy-out costs--In September 1996, the Kilroy Group amended the terms
of certain of its lease agreements. Such amendments required the Kilroy Group
to pay $3.2 million in consideration for the cancellation of an option to
purchase a 50% equity interest in Kilroy Airport Center, El Segundo, which was
reflected in the combined statement of operations for the year ended December
31, 1996. In November 1996, $2.3 million of the total liability of $3.7
million was paid by KI and its stockholders. In January 1997, $0.1 million of
the amount was paid by the Kilroy Group and the remaining balance was paid by
the Company with the proceeds from the IPO.

Extraordinary gains--On January 31, 1997, pursuant to a forbearance
agreement with an insurance company, the Kilroy Group exercised the right to
purchase a mortgage note payable with a principal balance of $20.2 million and
$2.4 million of accrued interest for $16.1 million. The forgiveness resulted
in an extraordinary gain of $3.2 million including the write-off of $1.3
million of deferred financing fees. During June 1996, a bank note with an
aggregate principal balance of $16.5 million and $5.7 million of accrued
interest was settled for $2.1 million. The forgiveness of $20.1 million was
recorded as an extraordinary gain.

Property taxes--There were no delinquent property taxes at December 31, 1998
and 1997.

Income taxes--The Company believes it qualifies and intends to continue to
qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code
of 1986, as amended (the "Code"), beginning with the taxable year ended
December 31, 1997. As a REIT, the Company is generally not subject to
corporate Federal income taxes so long as it distributes at least 95% of its
taxable income to its stockholders and satisfies certain quarterly
requirements of the Code relating to the composition of its income and assets.
The Company had met all of its REIT distribution and technical requirements at
December 31, 1998 and 1997. State income tax requirements are essentially the
same as Federal tax requirements.

Fair value of financial instruments--The Company calculates the fair value
of financial instruments using available market information and appropriate
present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and in
many cases, could not be realized in immediate settlement of the instrument.
Fair values for certain financial instruments and all non-financial
instruments are not required to be disclosed. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company
at December 31, 1997 and 1998, respectively.

F-11
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Derivative financial instruments--The Company's derivative financial
instruments at December 31, 1998 consisted of two interest rate cap agreements
with an aggregate notional amount of $150 million. The Company purchased the
interest rate cap agreements to effectively limit interest expense exposure on
borrowings under the Company's unsecured credit facility (the "Credit
Facility") during periods of increasing interest rates. The Company did not
have any derivative financial instruments at December 31, 1997.

The Company's interest rate cap agreements consist of agreements with other
counterparties to receive, at specified intervals and over specified periods
of time, payments equal to the excess, if any, between the hypothetical
interest rate (cap rate) and the then current market rate of interest as
calculated by reference to a specified notional amount and a specified
interest rate index. The only amount the Company is obligated to pay is an
initial premium, which is included in other assets and amortized to interest
expense ratably over the remaining term of the Credit Facility. At the time
the agreements were entered into, the cap rates exceeded market. The interest
rate specified by the agreements have been and are expected to continue to be
highly correlated with the cap rate. Interest payments to be received as a
result of interest rate cap agreements are accrued in other assets and
recognized as a reduction of interest expense related to the designated debt
(the accrual accounting method). There were no payments from the interest rate
cap agreements accrued at December 31, 1998 and 1997.

Upon termination of an interest rate cap agreement, any resultant gain, to
the extent it represents the value attributable to the market rate of interest
exceeding the cap rate (the intrinsic value) and assuming that outstanding
borrowings under the Credit Facility continue to equal or exceed the notional
amounts of the terminated interest rate caps, would be deferred in other
liabilities and amortized over the remaining term of the cap agreement as a
reduction of interest expense. Additional gains or losses would be recognized
in earnings. Any notional amount of agreements in excess of outstanding
borrowings under the Credit Facility would be marked to market with changes in
market value recorded in other income or expenses.

Comprehensive income--The Company does not have any items which meet the
definition of other comprehensive income as defined in Statement of Financial
Accounting Standards No. 130 "Reporting Comprehensive Income." Consequently,
the Company's net income is equal to its comprehensive income.

Use of estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reported periods. Actual results could differ from those estimates.

Reclassifications--Certain prior year amounts have been reclassified to
conform to the current year's presentation.

Concentration of credit risk--149 of the Company's total 164 Properties are
located in Southern California. The ability of the tenants to honor the terms
of their respective leases is dependent upon the economic, regulatory and
social factors affecting the communities in which the tenants operate.

One office property tenant, Hughes Space & Communications, accounted for
approximately 7.4% and 14.7% of the Company's total base rental revenues for
the year ended December 31, 1998 and the eleven months ended December 31,
1997, respectively. At December 31, 1998 and 1997, the Company had no
outstanding tenant receivables from this tenant.

The Company has cash in financial institutions which is insured by the
Federal Deposit Insurance Corporation ("FDIC") up to $0.1 million per
institution. At December 31, 1998 and 1997, the Company had cash accounts in
excess of FDIC insured limits.

F-12
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Recent accounting pronouncements--In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
SFAS 133 is effective for fiscal years beginning after June 15, 1999 and
requires all derivatives to be recorded on the balance sheet at fair value as
either assets or liabilities depending on the rights or obligations under the
contract. SFAS 133 also establishes new accounting methodologies for the
following three classifications of hedges: fair value, cash flow and net
investment in foreign operations. Management believes the adoption of SFAS 133
will not have a material impact on the Company's financial position or results
of operations.

3. Property Acquisitions

During the year ended December 31, 1998, the Company consummated a series of
transactions to acquire 25 office and 16 industrial buildings (collectively,
the "1998 Acquisitions"), (see Notes 19 and 20) for an aggregate purchase
price of approximately $236 million in cash and 703,869 common units of the
Operating Partnership valued at approximately $18.1 million from entities
controlled by Richard S. Allen, a member of the Company's Board of Directors
at December 31, 1998 (see Note 13). The office and industrial buildings
contain approximately 1.4 million and 674,000 of aggregate rentable square
feet, respectively. The Company also consummated a series of transactions to
acquire approximately 56 acres of undeveloped land for an aggregate purchase
price of approximately $25.4 million in cash and 90,787 common units of the
Operating Partnership valued at approximately $2.5 million from a partnership
controlled by John B. Kilroy, Sr. and John B. Kilroy, Jr. (see Note 13). The
1998 Acquisitions were funded primarily with existing working capital and
borrowings on the Credit Facility.

During the period February 1, 1997 to December 31, 1997, the Company
consummated a series of transactions to acquire 41 office and 55 industrial
buildings (collectively, the "1997 Acquisitions") for an aggregate purchase
price of approximately $488 million in cash and 753,838 common units of the
Operating Partnership valued at approximately $19.3 million. Of the total
753,838 common units issued in connection with building acquisitions, 588,736
were issued to Richard S. Allen, a member of the Company's Board of Directors
at December 31, 1998, The Allen Group, a group of affiliated real estate
development and investment companies based in Visalia, California, (together
with Richard S. Allen, "The Allen Group"), and certain other executive
officers of The Allen Group (see Note 13). In connection with the 1997
Acquisitions, the Company also assumed four mortgage notes totaling $40.2
million and issued a promissory note in the amount of $0.9 million. The office
and industrial buildings contained approximately 2.2 million and 3.7 million
of aggregate rentable square feet, respectively. The Company also consummated
a series of transactions to acquire approximately 50 acres of undeveloped land
for an aggregate purchase price of approximately $25.4 million in cash. The
1997 Acquisitions were funded primarily with existing working capital and
borrowings on the Company's secured revolving credit facility.

4. Tenant Receivables

Tenant receivables consisted of the following at December 31:

<TABLE>
<CAPTION>
1998 1997
------- -------
(in thousands)
<S> <C> <C>
Tenant rent, reimbursements, and other receivables........ $ 8,837 $ 5,096
Unbilled deferred rent.................................... 8,249 3,407
Allowance for uncollectible tenant receivables and
unbilled deferred rent .................................. (1,456) (1,136)
------- -------
Tenant receivables, net............................... $15,630 $ 7,367
======= =======
</TABLE>

F-13
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

5. Deferred Financing and Leasing Costs

Deferred financing and leasing costs are summarized as follows at December
31:

<TABLE>
<CAPTION>
1998 1997
-------- -------
(in thousands)
<S> <C> <C>
Deferred financing costs.................................. $ 6,792 $ 4,326
Deferred leasing costs.................................... 20,506 16,299
-------- -------
Total deferred financing and leasing costs............ 27,298 20,625
Accumulated amortization.................................. (11,130) (7,572)
-------- -------
Deferred financing and leasing costs, net................. $ 16,168 $13,053
======== =======
</TABLE>

6. Mortgage Debt

Mortgage debt consisted of the following at December 31:

<TABLE>
<CAPTION>
1998 1997
-------- --------
(in thousands)
<S> <C> <C>
Mortgage note payable, due February 2022, fixed interest
at 8.35%, monthly principal and interest payments(a)..... $ 82,025 $ 83,139
Mortgage note payable, due January 2000, interest at LIBOR
+ 1.50% (7.05% at December 31, 1998), monthly interest
payments................................................. 19,000 14,000
Mortgage note payable, due December 2005, fixed interest
at 8.45%, monthly principal and interest payments........ 13,385 13,765
Mortgage note payable, due November 2014, fixed interest
at 8.43%, monthly principal and interest payments........ 11,323 11,651
Mortgage note payable, due October 2013, fixed interest at
8.21%, monthly principal and interest payments........... 7,650 7,908
Promissory note, repaid January 1998, fixed interest at
5.00%.................................................... 900
-------- --------
$133,383 $131,363
======== ========
</TABLE>
- --------
(a) The mortgage note is subject to increases in the effective interest rate
to the greater of 13.35% or the sum of the interest rate for U.S. Treasury
Securities maturing 15 years from the reset date plus 2.00%, beginning
February 2005.

The Company's mortgage debt was secured by 24 properties at December 31,
1998 with a combined net book value of $166 million and 23 properties at
December 31, 1997 with a combined net book value of $165 million. As of
December 31, 1998 and 1997, the Company's mortgage debt had a weighted average
interest rate of 8.22%.

Scheduled principal payments for the above mortgage loans at December 31,
1998 were as follows:

<TABLE>
<CAPTION>
Year Ending
----------- (in thousands)
<S> <C>
1999....................................................... $ 2,260
2000....................................................... 21,456
2001....................................................... 2,670
2002....................................................... 2,902
2003....................................................... 3,154
Thereafter................................................. 100,941
--------
Total.................................................... $133,383
========
</TABLE>

F-14
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Two of the mortgage loans contain covenants restricting the sale of certain
properties and requiring the Company to meet minimum debt service coverage
ratios. All of the mortgage loans have financial reporting requirements. The
mortgage notes payable are secured by deeds of trust on certain of the
Company's Properties and the assignment of certain rents and leases associated
with those Properties.

On February 8, 1999, the Company entered into a commitment letter with a
lender for a mortgage loan collateralized by an office property and the
related ground leases. The commitment has a term of 60 days and provides,
subject to the completion of specified terms and conditions, for a mortgage
loan with a principal balance of $30.0 million, monthly principal and interest
payments based upon a fixed rate of 7.15% and an 18 year amortization
schedule, and a maturity date of March 2018.

7. Line of Credit

In February, 1998, the Company increased its borrowing capacity and
converted its previously secured $250 million revolving credit facility into a
$350 million unsecured revolving Credit Facility with a bank group led by
Morgan Guaranty Trust Company of New York. The Credit Facility bears interest
at a rate of either LIBOR plus 1.00%, LIBOR plus 1.13% or LIBOR plus 1.25%
(6.81% at December 31, 1998), depending on the Company's leverage ratio at the
time of borrowing, and matures in February 2000, with the option to extend for
one year. In October 1998, the Credit Facility agreement was amended to
include construction in progress in the value of the Company's unencumbered
assets, to modify certain financial covenants and to allow the Company to
enter into separate construction financing arrangements. The agreement was
also amended, while preserving the interest rate options discussed above, to
provide that borrowings may bear interest at LIBOR plus 1.38%, depending upon
the Company's leverage ratio at the time of borrowing. The Credit Facility is
used to finance property acquisitions and development and for general
corporate uses. Availability under the Credit Facility depends upon the value
of the Company's pool of unencumbered assets and was $77.0 million at December
31, 1998. The fee for unused funds is 0.20% based on outstanding balances. At
December 31, 1998, there were borrowings of $272 million and one letter of
credit in the amount of $1.0 million outstanding under the Credit Facility.
The $1.0 million letter of credit was issued in connection with a signed
commitment letter for a mortgage loan that the Company expects to complete in
the first quarter of 1999 (see Note 6).

In July 1998, the Company entered into two interest rate cap agreements with
a total notional amount of $150 million to effectively limit interest expense
for borrowings under the Credit Facility during periods of increasing interest
rates. The agreements have LIBOR based cap rates of 6.50% and expire in July
2000. The Company's exposure is limited to the $0.2 million cost of the cap
agreements, which the Company is amortizing over the term of the Credit
Facility and which was included as a component of interest expense in the
consolidated statement of operations. The $0.1 million unamortized balance of
the cost of the cap agreements was included in other assets in the
consolidated balance sheet at December 31, 1998.

As of December 31, 1997, the Company maintained a $250 million secured
revolving credit facility (the "Secured Credit Facility") with a bank group
led by Morgan Guaranty Trust Company of New York. The

F-15
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Secured Credit Facility bore interest at rates that ranged from LIBOR plus
1.38% to LIBOR plus 1.50%, depending on the Company's leverage ratio at the
time of borrowing, and was scheduled to mature on May 30, 1999, with the
option to extend for one year. The Secured Credit Facility was used to finance
property acquisitions and development and for general corporate uses.
Availability under the Secured Credit Facility was dependent upon, amongst
other things, the value of the Company's underlying collateral securing it and
was $62.7 million at December 31, 1997. At December 31, 1997 the line of
credit was secured by 66 properties with a combined book value of $358
million. The fee for unused funds was 0.25% based on outstanding balances. At
December 31, 1997, there were borrowings of $142 million outstanding under the
Secured Credit Facility.

The Credit Facility contains covenants requiring the Company to meet certain
financial ratios and reporting requirements. Some of the more restrictive
covenants include a minimum debt service coverage ratio, a maximum total
liabilities to total assets ratio, a maximum total secured debt to total
assets ratio, a minimum cash flow to debt service and fixed charges ratio, a
minimum consolidated tangible net worth and a limit of development activities
as compared to total assets. The Company was in compliance with all of the
Credit Facility and Unsecured Credit Facility covenants at December 31, 1998
and 1997, respectively.

Interest capitalized for the year ended December 31, 1998 and the eleven
months ended December 31, 1997 was $8.2 million and $1.5 million,
respectively. There was no interest capitalized for the month of January 1997
and the year ended December 31, 1996.

8. Minority Interests

In November 1998, the Company issued 700,000 9.375% Series C Cumulative
Redeemable Preferred units, representing limited partnership interests in the
Operating Partnership (the "Series C Preferred units"), with a liquidation
value of $50.00 per unit, in exchange for a gross contribution to the
Operating Partnership of $35.0 million. The Company used the contribution
proceeds, less applicable transaction costs and expenses of $0.9 million, for
the repayment of borrowings outstanding under the Credit Facility. The Series
C Preferred units, which may be called by the Operating Partnership at par on
or after November 24, 2003, have no stated maturity or mandatory redemption
and are not convertible into any other securities of the Operating
Partnership. The Series C Preferred Units are exchangeable at the option of
the majority of the holders for shares of the Company's 9.375% Series C
Cumulative Redeemable Preferred stock beginning November 24, 2008, or earlier
under certain circumstances.

The Company makes quarterly distributions to the Series A and Series C
Preferred unitholders on the 15th day of each February, May, August and
November. Included in the Series A and Series C Preferred unit balances

F-16
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

on the balance sheet at December 31, 1998 were $0.8 million and $0.3 million
of accrued distributions payable to the Series A and Series C Preferred
unitholders, respectively.

During the year ended December 31, 1998, the Operating Partnership issued
794,656 common units of the Operating Partnership in connection with property
and undeveloped land acquisitions (see Note 3). For the eleven months ended
December 31, 1997, the Operating Partnership issued 3,406,212 common units of
the Operating Partnership of which 2,652,374 were issued in connection with
the Company's Formation Transactions on January 31, 1997 (see Note 1), and
753,838 were issued in connection with property acquisitions (see Note 3). As
a result of the aforementioned transactions, the Company owned an 86.8% and
87.8% general partnership interest in the Operating Partnership as of December
31, 1998 and 1997, respectively.

9. Stockholders' Equity

In January 1998, the Company filed a "shelf" registration statement on Form
S-3 with the SEC which registered $400 million of equity securities of the
Company. The registration statement was declared effective by the SEC on
February 11, 1998. Through December 31, 1998, the Company completed four
underwritten offerings aggregating 3,012,326 shares of common stock and two
direct placements aggregating 161,884 shares of common stock with aggregate
net proceeds of $81.8 million. As of March 10, 1999, an aggregate of
$313 million of equity securities were available for issue under the
registration statement. The Company, as general partner of the Operating
Partnership and as required by the terms and conditions of the Operating
Partnership's partnership agreement, contributed the net proceeds of the
offerings to the Operating Partnership, which used the net proceeds to repay
borrowings under the Credit Facility.

In October 1998, the Company adopted a Preferred Stock Purchase Rights Plan
(the "Rights Plan") under which common stockholders of record on October 15,
1998 received one Right for each share of the Company's outstanding common
stock. Each Right, which entitles its holder to buy one one-hundredth of a
share of voting preferred stock at an exercise price of $71.00, becomes
exercisable, subject to limited exceptions, if a person or group acquires 15%
or more of the Company's common stock or announces a tender offer for 15% or
more of the Company's common stock. Upon such event, each Right entitles its
holder to purchase, at the Right's then exercise price, a number of shares of
the Company's common stock equal to the market value at that time of twice the
Right's exercise price. Rights held by the acquirer will become void and will
not be exercisable upon the announcement of the acquisition. In the event that
the Company is acquired in a merger or other business combination, each Right
entitles its holder to purchase, at the Right's then current exercise price, a
number of shares of the acquiring company's common stock equal to the market
value at that time of twice the Right's exercise price. The Rights Plan
expires October 2, 2008. The Board may elect to redeem the Rights at $.001 per
Right.

In February 1999, the Company filed a registration statement on Form S-3
with the SEC which registered the potential issuance and resale of up to
2,817,476 shares of the Company's common stock to the identified holders of
2,817,476 common units of the Operating Partnership. The 2,817,476 common
units, previously issued in connection with two 1997 transactions, may be
exchanged, at the Company's option, on a one for one basis, into shares of the
Company's common stock on or after January 31, 1999. Of the total previously
issued 2,817,476 common units, 2,652,374 common units were issued in
connection with the Company's Formation Transactions on January 31, 1997 (see
Note 1), and 165,102 common units valued at approximately $4.0 million were
issued in connection with property acquisitions in June 1997 (see Note 3). The
Company and the Operating Partnership will not receive any of proceeds form
the issuance of the common stock to the identified common unitholders. The
registration statement has not yet been declared effective by the SEC.

F-17
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

In August 1997, the Company completed a follow-on public offering of
10,000,000 shares of common stock (the "August Offering"). The offering price
was $25.50 per share resulting in gross proceeds of $255 million. The
aggregate proceeds to the Company, net of underwriter's discounts and offering
costs, were approximately $241 million. The proceeds were used to pay
outstanding indebtedness and to fund acquisitions.

Accrued distributions at December 31, 1998 and 1997, consisted of the
following amounts payable to registered common stockholders of record holding
24,639,210 shares and 24,475,000 shares of common stock, respectively, and
common unitholders holding 4,200,868 and 3,406,212 common units of the
Operating Partnership, respectively:

<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------- -------
(in thousands)
<S> <C> <C>
Distributions payable to:
Common stockholders....................................... $11,194 $ 9,484
Common unitholders........................................ 1,701 1,320
------- -------
Total accrued distributions............................. $12,895 $10,804
======= =======
</TABLE>

F-18
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

10. Future Minimum Rent

The Company has operating leases with tenants that expire at various dates
through 2013 and are either subject to scheduled fixed increases or
adjustments based on the Consumer Price Index. Generally, the leases grant
tenants renewal options. Leases also provide for additional rents based on
certain operating expenses. Future minimum rent under operating leases,
excluding tenant reimbursements of certain costs, as of December 31, 1998, are
summarized as follows:

<TABLE>
<CAPTION>
Year Ending
----------- (in thousands)
<S> <C>
1999....................................................... $115,544
2000....................................................... 105,200
2001....................................................... 87,735
2002....................................................... 74,682
2003....................................................... 68,572
Thereafter................................................. 189,171
--------
Total.................................................... $640,904
========
</TABLE>

11. Employee Retirement and Stock Option and Incentive Plans

Retirement Savings Plan

Effective November 1, 1997, the Company adopted a retirement savings plan
designed to qualify under Section 401(k) of the Internal Revenue Code (the
"401(k) Plan"). The 401(k) Plan allows participants to defer up to twenty
percent of their eligible compensation on a pre-tax basis, subject to certain
maximum amounts allowed by the Internal Revenue Code. The 401(k) Plan provides
for a matching contribution by the Company in an amount equal to fifty-cents
for each one dollar of participant contributions up to a maximum of five
percent of the participant's annual salary. Participants vest immediately in
the amounts contributed by the Company. Employees of the Company are eligible
to participate in the 401(k) Plan when they meet certain requirements
concerning minimum period of credited service. For the years ended December
31, 1998 and 1997, the Company contributed $0.2 million and $28,000,
respectively, to the 401(k) Plan.

Stock Option and Incentive Plan

The Company has established a stock option and incentive plan (the "Stock
Plan") for the purpose of attracting and retaining officers and key employees,
under which restricted shares or stock options may be granted. The Stock Plan
authorizes the issuance of 3,000,000 shares of common stock of the Company. As
of December 31, 1998 and 1997, 100,000 shares have been issued as restricted
shares of common stock and options to purchase 2,344,000 and 1,185,000 shares
of common stock, respectively, have been granted to Directors, officers and
employees under the Stock Plan. At December 31, 1998, 355,000 of the options
were exercisable and had a weighted average exercise price of $23.59. There
were no options exercisable at December 31, 1997. The weighted average
exercise price of the options outstanding at December 31, 1998 and 1997 were
$23.37 and $23.80, respectively, with a weighted average remaining contractual
life of 9.1 and 9.2 years, respectively. Stock options vest at 33 1/3% per
year over three years beginning on the first anniversary date of the grant and
are exercisable at the market value on the date of the grant. The term of each
option is ten years from the date of the grant.

F-19
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

The Company's stock option activity is summarized as follows:

<TABLE>
<CAPTION>
Number of Weighted Average
Options Exercise Price
--------- ----------------
<S> <C> <C>
Outstanding at February 1, 1997.................. 0 --
Granted........................................ 1,185,000 $23.80
---------
Outstanding at December 31, 1997................. 1,185,000 23.80
Granted........................................ 1,339,000 23.28
Cancelled...................................... (180,000) 26.30
---------
Outstanding at December 31, 1998................. 2,344,000 $23.37
=========
</TABLE>

Restricted stock is subject to restrictions determined by the Company's
Compensation Committee. The Compensation Committee, comprised of two Directors
who are not officers of the Company, determines compensation, including awards
under the Stock Plan, for the Company's executive officers. The shares of
restricted stock which have been granted, were sold at a purchase price equal
to $0.01 and vest 20% per year over a five-year period. Restricted stock has
the same dividend and voting rights as common stock and is considered to be
currently issued and outstanding. Compensation expense is determined by
reference to the market value of the Company's common shares and is being
amortized on a monthly basis over the five-year vesting period. In connection
with the IPO in January 1997, 100,000 shares of restricted stock were issued
to an executive officer of the Company for a price of $1,000. Compensation
expense relating to these shares was approximately $0.5 million and $0.4
million for the year ended December 31, 1998 and the eleven months ended
December 31, 1997, respectively.

The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123") and will continue to use the intrinsic value
based method of accounting prescribed by Account Practice Bulletin opinion No.
25, "Accounting for Stock Issued to Employees." Accordingly, no compensation
cost has been recognized for the options granted under the Stock Plan. Had
compensation cost for the Company's Stock Plan been determined based on the
fair value at the grant date consistent with the provisions of SFAS No. 123,
the Company's net income and net income on a per share basis would have been
adjusted to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
Year Ended February 1, 1997
December 31, to December 31,
1998 1997
------------ ----------------
(in thousands, except per
share amounts)
<S> <C> <C>
Net income:
As reported.................................. $38,822 $22,060
Pro forma.................................... 36,415 20,981
Net income per common share--basic:
As reported.................................. 1.44 1.20
Pro forma.................................... 1.35 1.14
Net income per common share--diluted:
As reported ................................. 1.43 1.19
Pro forma.................................... $ 1.35 $ 1.13
</TABLE>

The fair value of each option grant issued in 1998 and 1997 is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted average assumptions (amounts shown as 1998 and 1997,
respectively): (a) dividend yield of 6.31% and 6.00%, (b) expected volatility
of the Company's stock of 26.2% and 21.8%, (c) risk free interest rate of
4.73% and 5.44%, (d) expected option life of seven years. The effects of
applying SFAS No. 123 may not be representative of the effects on disclosed
pro forma net income for future years because options vest over several years
and additional awards can be made each year.

F-20
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

12. Commitments and Contingencies

Escrow deposits--At December 31, 1998, the Company had escrow deposits of
$0.4 million for the contemplated acquisition of one office building with
approximately 50,000 aggregate rentable square feet. The aggregate acquisition
cost of the land and building is estimated to be approximately $9.0 million.
At December 31, 1997, the Company had escrow deposits of $5.1 million for
contemplated acquisitions of approximately 886,000 aggregate rentable square
feet of office and industrial buildings and 133 acres of undeveloped land. The
Company acquired approximately 600,000 aggregate rentable square feet of
office and industrial buildings for $94.7 million.

Operating leases-- The Company has noncancelable ground lease obligations on
Kilroy Airport Center, Long Beach, California with an initial lease period
expiring July 2035; the SeaTac Office Center in Seattle, Washington expiring
December 2032, with an option to extend the lease for another 30 years; 12312
W. Olympic Boulevard in Santa Monica, California expiring in September 2011;
and 9455 Towne Center in San Diego, California expiring in October 2043. On
the Kilroy Airport Center and the SeaTac Office Center ground leases, rentals
are subject to adjustments every five years based on the Consumer Price Index.
On the 12312 W. Olympic Boulevard ground lease, rentals are subject to
adjustments every year based on the Consumer Price Index. On the 9455 Towne
Center ground lease, rentals are subject to 5% annual increases.

The minimum commitment under these leases at December 31, 1998 was as
follows:

<TABLE>
<CAPTION>
Year Ending
----------- (in thousands)
<S> <C>
1999....................................................... $ 1,734
2000....................................................... 1,879
2001....................................................... 1,889
2002....................................................... 1,899
2003....................................................... 1,909
Thereafter................................................. 74,292
-------
Total.................................................... $83,602
=======
</TABLE>

Purchase agreement-- In connection with an agreement signed in October 1997
with The Allen Group, the Company is committed to purchase two office
properties totaling 254,000 rentable square feet for an aggregate purchase
price of $40.1 million. The Company intends to finance these acquisitions with
borrowings under the Credit Facility and the issuance of approximately $11.0
million of common units of the Operating Partnership. In addition, the
original agreement contemplated the acquisition by the Company of two
industrial buildings in San Rafael, California and Las Vegas, Nevada,
respectively, and one office building in Redwood City, California for an
aggregate purchase price of $22.8 million. Based on the current amended
agreement, the Company is no longer obligated to purchase these three non-
strategic properties.

The transaction with The Allen Group also provides for the development of
two office projects in San Diego, California with up to 1.0 million aggregate
rentable square feet for an estimated aggregate development cost of
approximately $150 million. The Company has agreed to purchase a 50% managing
interest in the two projects upon completion of all necessary entitlements and
infrastructure and is expected to manage the development of both projects.
Construction of phase 1 of both office projects commenced in the fourth
quarter of 1998.

In January 1999, the Company purchased a managing interest in phase 1 of the
first office project with The Allen Group for an aggregate purchase price of
$2.1 million. The 2 acres of undeveloped land were acquired

F-21
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

from an entity controlled by Richard S. Allen, a member of the Company's Board
of Directors at December 31, 1998, with borrowings under the Credit Facility
and the issuance of 7,771 common units of the Operating Partnership valued at
$0.2 million. An Executive Vice President of the Company who was previously a
member of The Allen Group received 5,400 of the total 7,771 common units. The
acquisition was based upon terms which the Company believes were similar to
arms length negotiations. The 7,771 common units were valued based upon the
closing share price of the Company's common stock. The Company has the option
to purchase The Allen Group's remaining interest in both projects for a
purchase price to be determined upon completion of the projects.

Litigation--Neither the Company nor any of the Company's Properties are
presently subject to any material litigation nor, to the Company's knowledge,
is any material litigation threatened against any of them which if determined
unfavorably to the Company would have a material adverse effect on the
Company's cash flows, financial condition or results of operations. The
Company is party to litigation arising in the ordinary course of business,
none of which if determined unfavorably to the Company is expected to have a
material adverse effect on the Company's cash flows, financial condition or
results of operations.

Environmental Matters--The Company follows the policy of monitoring its
Properties for the presence of hazardous or toxic substances. While there can
be no assurance that a material environmental liability does not exist, the
Company is not currently aware of any environmental liability with respect to
the Properties that would have a material effect on the Company's financial
condition, results of operations and cash flows. Further, the Company is not
aware of any environmental liability or any unasserted claim or assessment
with respect to an environmental liability that the Company believes would
require additional disclosure or the recording of a loss contingency.

13. Related-Party Transactions

During 1998, the Operating Partnership issued 703,869 common units of the
Operating Partnership, recorded by the Company at approximately $18.1 million,
in connection with the acquisition of four office buildings located in San
Diego, California and one industrial building located in Reno, Nevada from
entities controlled by Richard S. Allen, a member of the Company's Board of
Directors at December 31, 1998. An Executive Vice President of the Company who
was previously a member of The Allen Group received 303,316 of the total
703,869 common units. The acquisitions of the five buildings were based upon
terms which the Company believes were similar to arms length negotiations. The
703,869 common units were valued based upon the closing share price of the
Company's common stock.

In April 1998, the Company acquired 18 acres of undeveloped land in
Calabasas, California from a partnership controlled by John B. Kilroy, Sr. and
John B. Kilroy, Jr. in exchange for $0.4 million in cash and the issuance of
90,787 common limited partnership units of the Operating Partnership valued at
$2.5 million. The acquisition was based upon terms which the Company believes
were comparable to arm's-length negotiations. The 90,787 common units were
valued based upon the closing share price of the Company's common stock. The
land is part of a 66-acre development site in Calabasas, California which is
presently entitled for over 1.0 million rentable square feet of office, retail
and hotel development. In February 1999, the Company sold 8 of the total 18
acres it acquired to the City of Calabasas for a total sales price of $1.4
million. The Company presently plans to develop 210,000 rentable square feet
of office property on the remaining 10 acres it currently owns. The
infrastructure improvements on the land were financed with public facility
bonds sponsored by the County of Los Angeles which were refinanced in February
1999. In connection with the refinancing, the portion of the original
obligation balance that related to the 8 acres the Company sold to the City of
Calabasas was defeased. The refinanced bonds, which were sponsored by the City
of Calabasas, currently have a principal balance of $12.5 million and consist
of: $5.9 million in serial bonds that mature annually beginning on
September 1, 2000 through September 1, 2012 with annual principal payments
ranging from $0.4 million to $0.6 million and interest rates ranging from
4.00% to 5.55%; $3.4 million of 5.65% Term Bonds due

F-22
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

September 1, 2020; and $3.2 million of 5.75% Term Bonds due September 1, 2028.
Principal and interest on the public facility bonds are to be charged to the
Company and the other property owners through special property tax bills
through 2028. The bonds do not contain cross-collateralization provisions and
therefore if one property owner defaulted on their special tax payments, the
other property owners would not be obligated to repay the defaulted taxes.
Based on the planned development of the total site, the Company's maximum
obligation for its portion of the development site is estimated at $5.5
million but may decrease depending on the actual size and number of buildings
built. Because the assessment on each individual property owner is dependant
upon the rate of development of the entire development site and therefore is
not fixed and determinable, the obligation was not recorded by the Company at
December 31, 1998. The periodic assessments are currently capitalized as
development costs and will be charged to operations upon the completion of
construction.

In May 1998, the Company entered into an agreement to loan up to $8.5
million to a limited partnership controlled by Richard S. Allen, a member of
the Company's Board of Directors at December 31, 1998. Advances on the note
will be used for infrastructure improvements on undeveloped land in San Diego
that secures the note. Pursuant to a separate agreement with the borrower, the
Company will acquire a 50% interest in the land upon the completion of all
infrastructure improvements. Interest accrues on all outstanding borrowings at
a rate of LIBOR plus 1.85% (7.48% at December 31, 1998) and the note and
accrued interest are due upon the acquisition of the 50% interest in the land
by the Company. At December 31, 1998, $6.5 million was outstanding on
the note.

In May 1998, the Company entered into an agreement to loan up to $2.3
million to a limited liability company also controlled by Richard S. Allen.
Advances on the note will be used for tenant improvements and upgrades to a
building in San Diego. The note is secured by the pledge of membership
interests in the limited liability company. Pursuant to a separate agreement
with the borrower, the Company will acquire the building on or before June 30,
1999, subject to the completion of improvements. The note and accrued interest
are payable upon the acquisition of the building by the Company. Interest
accrues on all outstanding borrowings at a rate of Prime plus 1.00% (8.75% at
December 31, 1998). At December 31, 1998, $2.3 million was outstanding on the
note.

Pursuant to management agreements, the Operating Partnership provides
management and leasing services, and KSI provides development services with
respect to two properties, each of which is beneficially owned by John B.
Kilroy, Sr. and John B. Kilroy, Jr. The Operating Partnership recorded fees of
$0.2 million and $0.1 million for year ended December 31, 1998 and the eleven
months ended December 31, 1997, respectively, relating to the management and
leasing services. KSI recorded fees of $0.1 and $0.2 million for year ended
December 31, 1998 and the eleven months ended December 31, 1997, respectively,
related to the development services.

On January 31, 1997, the Operating Partnership issued 2,652,374 common units
to John B. Kilroy, Sr., John B. Kilroy, Jr., certain Kilroy family members and
certain entities owned by them in connection with the Company's Formation
Transactions (see Note 1).

During 1997, the Operating Partnership issued 588,736 common units of the
Operating Partnership, valued by the Company at approximately $15.3 million,
in connection with the acquisition of four office buildings located in San
Diego, California and four industrial buildings located in Las Vegas, Nevada
from The Allen Group. An Executive Vice President of the Company who was
previously a member of The Allen Group, received 118,721 of the total 588,736
common units. The acquisition of the eight buildings was based upon terms
which the Company believes were similar to arms length negotiations. The
588,736 common units were valued based upon closing share price of the
Company's common stock.

In October 1997, KSI entered into a management agreement to manage the
development of certain properties owned by entities under the common control
of Richard S. Allen. At December 31, 1998 and 1997, KSI had a receivable
balance of $0.2 million and $0.3 million, respectively, for management fees
earned. The 1998 fees were paid in March 1999 and the 1997 fees were paid in
January and February 1998.

F-23
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

In December 1997, the Company purchased construction materials and
architectural and engineering plans from John B. Kilroy, Sr. and John B.
Kilroy, Jr. for approximately $3.0 million.

Through January 31, 1997, KI provided management, legal, accounting and
general administrative services pursuant to agreements that provide for
management fees based upon a percentage of gross revenues from the properties
and reimbursement of other costs incurred by KI in connection with providing
the aforementioned services. Kilroy Company ("KC"), an affiliated entity,
provided marketing and leasing services through January 31, 1997. Charges by
KC include leasing commissions paid to employees and outside leasing brokers
as well as fees to cover its general administrative costs. Management fees are
expensed as incurred and are included in property expenses. Leasing fees are
capitalized and amortized over the life of the related leases. In addition, KI
was a tenant at the Kilroy Airport Center, El Segundo and Kilroy Airport
Center, Long Beach, under month-to-month basis leases. Charges for services
provided by KI and KC and rental income from KI are summarized as follows:

<TABLE>
<CAPTION>
1996
--------------
(in thousands)
<S> <C>
Management fees............................................. $1,220
Leasing fees................................................ 1,878
Rental income............................................... 524
</TABLE>

14. Fair Value of Financial Instruments

The carrying amounts of the Company's cash and cash equivalents, restricted
cash and accounts payable approximate fair value due to their short-term
maturities. The carrying amounts of the Company's notes receivable from
related parties, variable rate mortgage debt, and outstanding borrowings on
the Credit Facility and Unsecured Credit Facility approximate fair value since
the interest rates on these instruments are equivalent to rates currently
offered to the Company.

For fixed rate mortgage debt, the Company estimates fair value by using
discounted cash flow analyses based on borrowing rates for similar types of
borrowing arrangements. The fair value of the Company's fixed rate mortgage
debt was $121 million and $117 million at December 31, 1998 and 1997,
respectively.

For the Series A and Series C Preferred units, the Company estimates fair
value by using discounted cash flow analyses based on borrowing rates for
similar types of fixed rate financial instruments. The fair value of the
Series A and Series C Preferred units were $99.2 million at December 31, 1998.

For interest rate cap agreements, the carrying amount of $0.1 million, which
is comprised of the unamortized premium the Company paid to enter into the
agreements, approximates fair value since at December 31, 1998, the cap rates
exceeded the market rate of the contractually specified interest rate indices.

15. Segment Disclosure

The Company's reportable segments consist of the two types of commercial
real estate properties for which management internally evaluates operating
performance and financial results: Office Properties and Industrial
Properties. The Company also has certain corporate level activities including
legal, accounting, finance, and management information systems which are not
considered separate operating segments.

The Company evaluates the performance of its segments based upon net
operating income. Net operating income is defined as operating revenues
(rental income, tenant reimbursements and other property income) less property
and related expenses (property expenses, real estate taxes, and ground leases)
and does not include interest income and expense, depreciation and
amortization, and corporate general and administrative expenses.

F-24
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

The accounting policies of the reportable segments are the same as those
described in the Company's summary of significant accounting policies (see
Note 2). There is no intersegment activity.

The following tables reconcile the Company's segment activity to its
consolidated results of operations and financial position as of and for the
year ended December 31, 1998 and the period February 1, 1997 to December 31,
1997, and reconciles the Kilroy Group's segment activity to its combined
results of operations for the period January 1, 1997 to January 31, 1997 and
the year ended December 31, 1996.

<TABLE>
<CAPTION>
Kilroy Realty Corporation Kilroy Group
------------------------- ------------------------
February 1, January 1,
Year Ended 1997 to 1997 to Year Ended
December 31, December 31, January 31, December 31,
1998 1997 1997 1996
------------ ------------ ----------- ------------
(in thousands)
<S> <C> <C> <C> <C>
Revenues and Expenses
Office Properties:
Operating revenues(1)......... $ 95,662 $47,179 $2,555 $33,034
Property and related expenses. 23,805 11,476 752 8,597
-------- ------- ------ -------
Net operating income, as
defined...................... 71,857 35,703 1,803 24,437
-------- ------- ------ -------
Industrial Properties:
Operating revenues(1)......... 38,924 16,530 515 5,816
Property and related expenses. 6,278 2,431 28 632
-------- ------- ------ -------
Net operating income, as
defined...................... 32,646 14,099 487 5,184
-------- ------- ------ -------
Total Reportable Segments:
Operating revenues(1),(2)..... 134,586 63,709 3,070 38,850
Property and related expenses. 30,083 13,907 780 9,229
-------- ------- ------ -------
Net operating income, as
defined...................... 104,503 49,802 2,290 29,621
-------- ------- ------ -------
Reconciliation to Consolidated
Net Income:
Total net operating income, as
defined, for reportable
segments..................... 104,503 49,802 2,290 29,621
Other unallocated revenues:
Interest income............. 1,698 3,571
Development services........ 14 698
Other unallocated expenses:
General and administrative
expenses................... 7,739 4,949 78 2,383
Other expenses.............. 46 3,800
Provision for potentially
unrecoverable
pre-development costs...... 1,700
Interest expense............ 20,568 9,738 1,895 21,853
Depreciation and
amortization............... 26,200 13,236 787 9,111
-------- ------- ------ -------
Net income before equity in
income of
unconsolidated subsidiary,
minority
interests and extraordinary
gains........................ 49,994 25,450 $ (502) $(6,828)
Equity in income of
unconsolidated subsidiary.... 5 23
Minority interests............ (11,177) (3,413)
-------- ------- ------ -------
Net income (loss) before
extraordinary gains.......... $ 38,822 $22,060 $ (502) $(6,828)
======== ======= ====== =======
</TABLE>
- --------
(1) All operating revenues are comprised of amounts received from external
tenants.

(2) Total consolidated revenues equals total operating revenues from
reportable segments plus interest income and development services income.

F-25
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
---------- ---------
(in thousands)
<S> <C> <C>
Assets
Office Properties:
Land, buildings and improvements, net..................... $ 599,771 $ 425,711
Undeveloped land and construction in progress, net........ 79,924 11,034
Total assets.............................................. 697,352 446,784
Industrial Properties:
Land, buildings and improvements, net..................... 336,717 252,528
Undeveloped land and construction in progress, net........ 32,435 23,637
Total assets.............................................. 378,975 283,449
Total Reportable Segments:
Land, buildings and improvements, net..................... 936,488 678,239
Undeveloped land and construction in progress, net........ 112,359 34,671
Total assets.............................................. 1,076,327 730,233
Reconciliation to Consolidated Assets:
Total assets for reportable segments...................... 1,076,327 730,233
Other unallocated assets:
Cash and cash equivalents............................... 6,443 8,929
Restricted cash......................................... 6,896 5,680
Notes receivable from related parties................... 8,798
Escrow deposits......................................... 350 5,114
Deferred financing costs, net........................... 4,318 3,097
Prepaid expenses and other assets....................... 2,796 4,601
---------- ---------
Total consolidated assets............................. $1,105,928 $ 757,654
========== =========
<CAPTION>
December 31,
--------------------
1998 1997
---------- ---------
(in thousands)
<S> <C> <C>
Capital Expenditures(/1/)
Office Properties:
Building acquisitions and expenditures for completed
development.............................................. $ 177,641 $ 329,213
Recurring capital expenditures and tenant improvements.... 8,347 5,866
Industrial Properties:
Building acquisitions and expenditures for completed
development.............................................. 90,722 237,376
Recurring capital expenditures and tenant improvements.... 5,196 227
Total Reportable Segments:
Building acquisitions and expenditures for completed
development.............................................. 268,363 566,589
Recurring capital expenditures and tenant improvements.... $ 13,543 $ 6,093
</TABLE>
- --------
(1) Total consolidated capital expenditures are equal to the same amounts
disclosed for total reportable segments.

F-26
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

16. Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted-
average number of common shares outstanding for the period. Diluted earnings
per share is computed by dividing net income by the sum of the weighted-
average number of common shares outstanding for the period plus the assumed
exercise of all dilutive securities. The Company does not consider common
units of the Operating Partnership to be dilutive securities since the
exchange of common units into common stock is on a one for one basis and would
not have any effect on diluted earnings per share. The following table
reconciles the numerator and denominator of the basic and diluted per-share
computations for net income for the year ended December 31, 1998 and the
eleven months ended December 31, 1997:
<TABLE>
<CAPTION>
Year Ended December 31, 1998
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(in thousands, except share and per
share amounts)
<S> <C> <C> <C>
Basic.................................... $38,822 26,989,422 $1.44
Effect of dilutive securities:
Stock options granted.................. 70,566 (.01)
------- ---------- -----
Diluted.................................. $38,822 27,059,988 $1.43
======= ========== =====

<CAPTION>
Period From February 1, 1997 to
December 31, 1997
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
(in thousands, except share and per
share amounts)
<S> <C> <C> <C>
Basic.................................... $22,060 18,445,149 $1.20
Effect of dilutive securities:
Stock options granted.................. 94,150 (.01)
------- ---------- -----
Diluted.................................. $22,060 18,539,299 $1.19
======= ========== =====
</TABLE>

17. Quarterly Financial Information (Unaudited)

Summarized quarterly financial data for the year ended December 31, 1998 and
the eleven months ended December 31, 1997 was as follows:
<TABLE>
<CAPTION>
1998 Quarter Ended
----------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- -------- ------------- ------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Total revenues............ $28,951 $33,520 $34,519 $39,294
Income before minority
interests and
extraordinary gains...... 10,789 12,771 12,886 13,553
Net income................ 8,879 9,785 9,985 10,173
Net income per common
share (basic and
diluted)................. $ 0.35 $ 0.36 $ 0.36 $ 0.37
<CAPTION>
Period from
February 1, 1997 1997 Quarter Ended
to -----------------------------------
March 31, 1997 June 30, September 30, December 31,
---------------- -------- ------------- ------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Total revenues............ $ 9,040 $14,738 $19,467 $24,035
Income before minority
interests and
extraordinary gains...... 3,138 4,876 7,457 10,002
Net income................ 2,652 4,108 6,480 8,820
Net income per common
share (basic and
diluted)................. $ 0.18 $ 0.28 $ 0.34 $ 0.36
</TABLE>

F-27
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

Primarily due to the issuance of 10,000,000 additional shares of common
stock in connection with the August Offering, the sum of the quarterly
earnings per share in 1997 varies from the annual earnings per share.

18. Subsequent Events

On January 6, 1999, dividends of $12.9 million were paid to common
stockholders and common unitholders of record on December 31, 1998.

In January 1999, the Company purchased a 50% managing interest in the first
phase of the first of two office development projects with The Allen Group for
an aggregate purchase price of $1.9 million in cash and 7,771 common units of
the Operating Partnership valued at approximately $0.2 million (see Note 12).

In January 1999, the Company issued a $1.0 letter of credit in connection
with a signed commitment letter for a $95.0 mortgage loan (see Note 6).

In February 1999, the Company filed a pre-effective registration Statement
on Form S-3 with the SEC which registered the potential issuance and resale of
up to 2,817,476 shares of the Company's common stock to the identified holders
of 2,817,476 common units of the Operating Partnership (see Note 9).

In February 1999, the Company sold 8 acres of undeveloped land located in
Calabasas, California for a total sales price of approximately $1.4 million
(see Note 13).

In February 1999, the City of Calabasas refinanced the public facility bonds
used to finance the infrastructure improvements on 10 acres of undeveloped
land the Company owns in Calabasas, California. The interest rates on the
bonds decreased from a range of 6.25% to 7.6% to a range of 4.0% to 5.75%. The
term of the bonds increased from 17 years to 28 years. (see Note 13).

In February 1999, the Company acquired 3 acres of undeveloped land in San
Diego, California for an aggregate purchase price of approximately
$0.4 million in cash and 119,460 common units of the Operating Partnership
valued at approximately $2.5 million from entities controlled by Richard S.
Allen, a member of the Company's Board of Directors at December 31, 1998. An
Executive Vice President of the Company received 42,564 of the total 119,460
common units. The acquisition was based upon terms which the Company believes
were similar to arms length negotiations. The 119,460 common units were valued
based upon the closing share price of the Company's common stock.

In March 1999, the Company filed a pre-effective registration statement on
Form S-3 with the SEC which, in connection with the adoption of the Company's
Dividend Reinvestment and Direct Purchase Plan, registered 1,000,000 shares of
the Company's common stock (see Note 9).

F-28
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

19. Unaudited Pro Forma Condensed Consolidated Financial Information

The accompanying unaudited pro forma information for the years ended
December 31, 1998 and 1997 are presented as if the 1998 Office and Industrial
Acquisitions described in Note 3 had occurred on January 1, 1998 and as if the
IPO and Formation Transactions described in Note 1, the August Offering
described in Note 9, and the 1997 Office and Industrial Acquisitions described
in Note 3 had occurred on January 1, 1997. Such pro forma information is based
upon the consolidated financial statements of the Company for the year ended
December 31, 1998 and the period from February 1, 1997 to December 31, 1997
and the combined financial statements of the Kilroy Group for the period
January 1, 1997 to January 31, 1997.

This unaudited pro forma condensed consolidated information does not purport
to represent what the actual results of operations of the Company would have
been assuming the 1997 and 1998 Office and Industrial Acquisitions had been
completed as set forth above, nor do they purport to predict the results of
operations for future periods.

Pro Forma Income Statement
(unaudited, in thousands, except share and per share data)

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
----------- -----------
<S> <C> <C>
Total revenues........................................ $ 139,586 $ 114,926
========== ==========
Net income before extraordinary items................. $ 38,947 $ 28,265
========== ==========
Net income............................................ $ 38,947 $ 28,265
========== ==========
Net income per share of common stock--basic........... $ 1.44 $ 1.15
========== ==========
Net income per share of common stock--diluted......... $ 1.44 $ 1.15
========== ==========
Weighted average number of shares of common stock
outstanding-- basic.................................. 26,989,422 24,475,000
========== ==========
Weighted average number of shares of common stock
outstanding-- diluted................................ 27,059,988 24,569,150
========== ==========
</TABLE>

F-29
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

20. Schedule of Rental Property

<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------------------
Initial Cost Costs Gross Amounts
--------------------- Capitalized at which Carried Net
Buildings Subsequent to at Close of Period Date of Rentable
and Acquisition/ -------------------------- Accumulated Acquis.(A)/ Square
Property Location Land Improvements Improvement Land Building Total Depreciation Constrc.(C)(1) Feet
----------------- -------- ------------ ------------- -------- -------- -------- ------------ -------------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Office Properties:
Kilroy Airport
Center, El Segundo
El Segundo,
California....... $ 6,141 $ 69,195 $19,828 $ 6,141 $ 89,023 $ 95,164 $ 51,687 1983(C) 701,307
Kilroy Airport
Center, Long
Beach--Phase I
Long Beach,
California....... 23,689 23,689 23,689 1,293 1997(A) 225,217
Kilroy Airport
Center, Long
Beach--Phase II
Long Beach,
California....... 47,387 8,461 55,848 55,848 20,872 1989(C) 395,480
La Palma Business
Center
4175 E. La Palma
Avenue
Anaheim,
California....... 1,518 2,612 167 1,518 2,779 4,297 146 1997(A) 42,790
2829 Townsgate Road
Thousand Oaks,
California....... 5,248 8,001 228 5,248 8,229 13,477 442 1997(A) 81,158
181/185 S. Douglas
Street
El Segundo,
California....... 525 4,687 1,910 628 6,494 7,122 3,998 1978(C) 60,000
SeaTac Office
Center
Seattle,
Washington....... 25,993 16,556 42,549 42,549 25,295 1977(C) 532,430
23600-23610 Telo
Avenue
Torrance,
California....... 2,636 3,975 2,636 3,975 6,611 180 1997(A) 79,967
2100 Colorado
Avenue
Santa Monica,
California....... 5,474 26,087 14 5,476 26,099 31,575 1,118 1997(A) 94,844
5151-5155 Camino
Ruiz
Camarillo,
California....... 4,501 19,710 7 4,501 19,717 24,218 892 1997(A) 276,216
111 Pacifica
Irvine,
California....... 5,165 4,653 182 5,165 4,835 10,000 206 1997(A) 67,344
2501 Pullman
Santa Ana,
California....... 6,588 9,050 6,588 9,050 15,638 388 1997(A) 124,921
701-741 E. Ball
Road
Anaheim,
California....... 2,484 5,475 2 2,484 5,477 7,961 262 1997(A) 113,735
26541 Agoura Road
Calabasas,
California....... 1,979 9,630 3 1,979 9,633 11,612 459 1997(A) 90,878
9451 Toledo Way
Irvine,
California....... 869 28 897 897 37 1997(A) 27,200
1633 26th Street
Santa Monica,
California....... 2,080 6,672 330 2,041 7,041 9,082 298 1997(A) 43,800
4351 Latham Avenue
Riverside,
California....... 307 1,555 172 307 1,727 2,034 56 1997(A) 21,356
4361 Latham Avenue
Riverside,
California....... 764 3,577 37 764 3,614 4,378 128 1997(A) 30,842
601 Valencia Avenue
Brea, California.. 3,518 2,900 21 3,518 2,921 6,439 112 1997(A) 60,891
3750 University
Avenue
Riverside,
California....... 2,909 19,372 116 2,913 19,484 22,397 661 1997(A) 124,986
6220 Greenwich
Drive
San Diego,
California....... 4,796 15,863 58 4,805 15,912 20,717 530 1997(A) 141,214
6055 Lusk Avenue
San Diego,
California....... 3,935 8,008 22 3,943 8,022 11,965 267 1997(A) 93,000
</TABLE>

F-30
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------------------
Initial Cost Costs Gross Amounts
--------------------- Capitalized at which Carried Net
Buildings Subsequent to at Close of Period Date of Rentable
and Acquisition/ -------------------------- Accumulated Acquis.(A)/ Square
Property Location Land Improvements Improvement Land Building Total Depreciation Constrc.(C)(1) Feet
----------------- -------- ------------ ------------- -------- -------- -------- ------------ -------------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
6260 Sequence
Drive
San Diego,
California...... $ 3,206 $ 9,803 $ 24 $ 3,213 $ 9,820 $ 13,033 $ 327 1997(A) 130,000
6290 Sequence
Drive
San Diego,
California...... 2,403 7,349 17 2,407 7,362 9,769 245 1997(A) 90,000
8101 Kaiser Blvd.
Anaheim,
California...... 2,369 6,180 28 2,377 6,200 8,577 192 1997(A) 60,177
3130 Wilshire
Blvd.
Santa Monica,
California...... 8,921 6,579 2,387 9,187 8,700 17,887 265 1997(A) 88,338
12312 W. Olympic
Blvd.
Los Angeles,
California...... 3,325 12,202 197 3,325 12,399 15,724 180 1997(A) 78,000
Pacific Park Plaza
Aliso Viejo,
California...... 6,281 8,314 38 6,287 8,346 14,633 240 1997(A) 134,667
Anaheim Corporate
Center
Anaheim,
California...... 5,305 10,149 146 5,310 10,290 15,600 319 1997(A) 154,776
525 N. Brand Blvd.
Glendale,
California...... 1,360 8,771 101 1,373 8,859 10,232 253 1997(A) 43,647
Olympic/Bundy
Los Angeles,
California...... 7,628 (7,628) 90 1998(A) 48,356
Fullerton Business
Center
Fullerton,
California...... 4,155 6,482 52 4,155 6,534 10,689 187 1998(A) 145,522
501 Santa Monica
Blvd.
Santa Monica,
California...... 4,547 12,044 140 4,547 12,184 16,731 318 1998(A) 70,000
1240-1250 Lakeview
Blvd.
Anaheim,
California...... 2,851 4,295 10 2,851 4,305 7,156 102 1998(A) 78,903
5770 Armada Drive
Carlsbad,
California...... 2,626 7,880 2,626 7,880 10,506 169 1998(A) 81,712
6340-6350 Sequence
Drive
San Diego,
California...... 7,375 22,126 7,375 22,126 29,501 474 1998(A) 200,000
4880 Santa Rosa
Road
Camarillo,
California...... 2,389 2,641 2,389 2,641 5,030 58 1998(A) 41,131
15378 Avenue of
Science
San Diego,
California...... 3,565 3,796 3,565 3,796 7,361 72 1998(A) 68,910
10398-10421
Pacific Center
Court
San Diego,
California...... 14,979 39,634 14,979 39,634 54,613 849 1998(A) 411,402
3990 Ruffin Road
San Diego,
California...... 2,467 3,700 2,467 3,700 6,167 62 1998(A) 45,634
2231 Rutherford
Road
Carlsbad,
California...... 1,006 4,155 1,006 4,156 5,161 69 1998(A) 39,000
9455 Town Center
Drive
San Diego,
California...... 3,936 3,936 3,936 72 1998(A) 45,195
Carmel Valley
Corporate Center
San Diego,
California ..... 3,207 18,176 3,207 18,176 21,383 132 1998(A) 115,513
Kilroy Airport
Long Beach--
Phase III & IV(2)
Long Beach,
California ..... 4,997 4,997 4,997 2,583 1989(C)
-------- -------- ------- -------- -------- -------- -------- ---------
TOTAL OFFICE
PROPERTIES ...... $142,905 $501,111 $72,340 $143,301 $573,055 $716,356 $116,585 5,600,459
-------- -------- ------- -------- -------- -------- -------- ---------
</TABLE>

F-31
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------------------
Initial Cost Costs Gross Amounts
--------------------- Capitalized at which Carried Net
Buildings Subsequent to at Close of Period Date of Rentable
and Acquisition/ -------------------------- Accumulated Acquis.(A)/ Square
Property Location Land Improvements Improvement Land Building Total Depreciation Constrc.(C)(1) Feet
----------------- -------- ------------ ------------- -------- -------- -------- ------------ -------------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Industrial
Properties:
2031 E. Mariposa
Avenue
El Segundo,
California....... $ 132 $ 867 $ 2,698 $ 132 $ 3,565 $ 3,697 $ 3,105 1954(C) 192,053
3340 E. La Palma
Avenue
Anaheim,
California....... 67 1,521 2,830 67 4,351 4,418 3,800 1966(C) 153,320
2260 E. El Segundo
Blvd.
El Segundo,
California....... 1,423 4,194 1,402 1,703 5,316 7,019 3,402 1979(C) 113,820
2265 E. El Segundo
Blvd.
El Segundo,
California....... 1,352 2,028 645 1,571 2,454 4,025 1,716 1978(C) 76,570
1000 E. Ball Road 1956(C)/
Anaheim,
California....... 838 1,984 921 838 2,905 3,743 2,045 1974(A) 100,000
1230 S. Lewis Road
Anaheim,
California....... 395 1,489 2,058 395 3,547 3,942 2,665 1982(C) 57,730
12681/12691 Pala
Drive
Garden Grove,
California....... 471 2,115 2,829 471 4,944 5,415 3,176 1980(A) 84,700
2270 E. El Segundo
Blvd.
El Segundo,
California....... 361 100 125 419 167 586 78 1977(C) 6,362
5115 N. 27th Avenue
Phoenix, Arizona.. 125 1,206 15 125 1,221 1,346 1,168 1962(C) 130,877
12752-12822 Monarch
Street
Garden Grove,
California....... 3,975 5,238 219 3,975 5,457 9,432 288 1997(A) 277,037
4155 E. La Palma
Avenue
Anaheim,
California....... 1,148 2,681 14 1,148 2,695 3,843 147 1997(A) 74,618
4125 E. La Palma
Avenue
Anaheim,
California....... 1,690 2,604 14 1,690 2,618 4,308 150 1997(A) 69,472
Brea Industrial
Properties
Brea, California.. 1,263 13,927 1,263 13,927 15,190 630 1997(A) 276,278
Garden Grove
Industrial
Properties
Garden Grove,
California....... 1,868 11,894 314 1,868 12,208 14,076 568 1997(A) 275,971
821 S. Rockefeller
Ontario,
California....... 2,189 3,272 2,189 3,272 5,461 148 1997(A) 153,566
17150 Von Karman
Irvine,
California....... 4,848 7,342 4,848 7,342 12,190 350 1997(A) 157,458
7421 Orangewood
Avenue
Garden Grove,
California....... 612 3,967 612 3,967 4,579 161 1997(A) 82,602
5325 East Hunter
Avenue
Anaheim,
California....... 1,728 3,555 1,728 3,555 5,283 169 1997(A) 109,449
184-220 Technology
Drive
Irvine,
California....... 7,464 7,621 961 7,464 8,582 16,046 433 1997(A) 158,070
9401 Toledo Way
Irvine,
California....... 8,572 7,818 8,572 7,818 16,390 335 1997(A) 244,800
12400 Industry
Street
Garden Grove,
California....... 943 2,110 35 943 2,145 3,088 93 1997(A) 64,200
Walnut Park
Business Center
Diamond Bar,
California....... 2,588 6,090 34 2,588 6,124 8,712 218 1997(A) 165,420
2055 S.E. Main
Street
Irvine,
California....... 772 2,343 4 772 2,347 3,119 89 1997(A) 47,583
201 North Sunrise
Avenue
Roseville,
California....... 2,622 11,741 2,622 11,741 14,363 447 1997(A) 162,203
</TABLE>

F-32
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
December 31, 1998
----------------------------------------------------------------------
Initial Cost Costs Gross Amounts
------------------- Capitalized at which Carried Net
Buildings Subsequent to at Close of Period Date of Rentable
and Acquisition/ ----------------------- Accumulated Acquis.(A)/ Square
Property Location Land Improvements Improvement Land Building Total Depreciation Constrc.(C)(1) Feet
----------------- ------ ------------ ------------- ------ -------- ------- ------------ -------------- --------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
14831 Franklin Avenue
Tustin, California..... $1,112 $ 1,065 $ 3 $1,112 $ 1,068 $ 2,180 $ 41 1997(A) 36,256
6828 Nancy Ridge Drive
San Diego, California.. 1,914 1,110 1,914 1,110 3,024 42 1997(A) 39,669
1961 Concourse Drive
San Jose, California... 5,112 6,549 5,112 6,549 11,661 249 1997(A) 110,132
1710 Fortune Drive
San Jose, California... 3,362 5,750 3,362 5,750 9,112 219 1997(A) 86,000
1675 MacArthur
Costa Mesa, California. 2,076 2,114 2,076 2,114 4,190 81 1997(A) 50,842
3130-3150 Miraloma
Anaheim, California.... 3,335 3,727 27 3,335 3,754 7,089 133 1997(A) 144,000
3125 E. Coronado Street
Anaheim, California.... 3,669 4,341 3,669 4,341 8,010 155 1997(A) 144,000
1951 E. Carnegie
Santa Ana, California.. 1,830 3,630 800 1,845 4,415 6,260 129 1997(A) 100,000
5115 E. La Palma Avenue
Anaheim, California.... 2,462 6,675 4,217 2,462 10,892 13,354 159 1997(A) 291,146
3735 Imperial Highway
Stockton, California... 764 10,747 18 764 10,765 11,529 359 1997(A) 164,540
41093 County Center
Drive
Temecula, California... 1,709 2,841 7 1,712 2,845 4,557 95 1997(A) 77,582
1840 Aerojet Way
Las Vegas, Nevada...... 727 3,792 7 727 3,799 4,526 127 1997(A) 102,948
1900 Aerojet Way
Las Vegas, Nevada...... 644 4,093 7 644 4,100 4,744 137 1997(A) 106,717
4880 Colt Street
Ventura, California.... 1,488 3,919 131 1,500 4,038 5,538 124 1997(A) 125,511
Gothard Business Park
Huntington Beach,
California............ 1,812 1,819 40 1,814 1,857 3,671 53 1997(A) 56,638
Dimension Business Park
Lake Forest,
California............ 1,606 1,945 43 1,606 1,988 3,594 58 1997(A) 45,257
Giltspur Building
Garden Grove,
California............ 854 3,843 1,048 854 4,891 5,745 197 1997(A) 110,220
Alton Business Center
Irvine, California..... 5,130 7,465 63 5,130 7,528 12,658 224 1998(A) 143,117
Fortune Business Center
San Jose, California... 9,544 18,424 379 9,544 18,803 28,347 481 1998(A) 234,317
795 Trademark Drive
Reno, Nevada........... 1,731 5,193 1,731 5,193 6,924 136 1998(A) 75,257
1250 N. Tustin Avenue
Anaheim, California.... 2,098 4,158 2,098 4,158 6,256 79 1998(A) 84,185
2911 Dow Avenue
Tustin, California..... 1,124 2,408 1,124 2,408 3,532 40 1998(A) 54,720
5759 Fleet Street
Carlsbad, California... 3,112 7,702 3,112 7,702 10,814 6 1998(A) 82,100
892/909 Towne Center
Drive
Foothill Ranch,
California............ 3,334 12,352 4,949 10,737 15,686 133 1998(C) 303,327
</TABLE>

F-33
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED
AND KILROY GROUP COMBINED

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)

<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------------------------
Initial Cost Costs Gross Amounts
--------------------- Capitalized at which Carried Net
Buildings Subsequent to at Close of Period Date of Rentable
and Acquisition/ ---------------------------- Accumulated Acquis.(A)/ Square
Property Location Land Improvements Improvement Land Building Total Depreciation Constrc.(C)(1) Feet
- ----------------- -------- ------------ ------------- -------- -------- ---------- ------------ -------------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
3250 E. Carpenter
Avenue
Anaheim,
California..... $ 2,297 $ 2,297 $ 2,297 $ 14 1998(C) 41,225
-------- --------- -------- -------- -------- ---------- -------- ----------
TOTAL INDUSTRIAL
PROPERTIES(3).. $107,995 $ 221,017 $ 36,557 $110,199 $255,370 $ 365,569 $ 28,852 6,043,859
-------- --------- -------- -------- -------- ---------- -------- ----------
TOTAL ALL
PROPERTIES(3).. $250,900 $ 722,128 $108,897 $253,500 $828,425 $1,081,925 $145,437 11,624,318
======== ========= ======== ======== ======== ========== ======== ==========
</TABLE>
- -------
(1) Represents date of construction or acquisition by the Company, or the
Company's Predecessor, the Kilroy Group.

(2) These costs represent infrastructure costs incurred in 1989.

(3) This table does not include one industrial property with an aggregate
113,248 rentable square feet which was occupied at December 31, 1998. This
property is part of a three building complex that was constructed by the
Company. As substantial tenant improvements still needed to be completed
at December 31, 1998, the complex was included in construction in progress
at December 31, 1998.

The aggregate gross cost of property included above for federal income tax
purposes, approximated $1.0 billion as of December 31, 1998.

The following table reconciles the historical cost of the total investment
in real estate, net from January 1, 1996 to December 31, 1998:

<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1998 1997 1996
---------- -------- --------
(in thousands)
<S> <C> <C> <C>
Land, building and improvements, beginning of
year........................................ $ 800,019 $227,337 $224,983
Additions during period--
Acquisition, improvements, etc........... 281,906 572,682 2,354
---------- -------- --------
Land, building and improvements, end of
year........................................ 1,081,925 800,019 227,337
---------- -------- --------
Undeveloped land and construction in
progress, net, beginning of year............ 34,671
Change in undeveloped land and construction
in progress, net.......................... 77,688 34,671
---------- --------
Undeveloped land and construction in
progress, net, end of year.................. 112,359 34,671
---------- -------- --------
Total investment in real estate, net, end
of year................................. $1,194,284 $834,690 $227,337
========== ======== ========
</TABLE>

The following table reconciles the accumulated depreciation from January 1,
1996 to December 31, 1998:

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Beginning of year............................... $121,780 $109,668 $101,774
Additions during period--
Depreciation and amortization for the year.. 23,657 12,112 7,894
-------- -------- --------
End of year..................................... $145,437 $121,780 $109,668
======== ======== ========
</TABLE>

F-34
<PAGE>

KILROY REALTY CORPORATION CONSOLIDATED AND KILROY GROUP COMBINED

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

Year Ended December 31, 1998,
Period from February 1, 1997 to December 31, 1997,
Period from January 1, 1997 to January 31, 1997 and the
Year Ended December 31, 1996
(in thousands)

<TABLE>
<CAPTION>
Charged to
Costs and
Balance at Expenses Balance
Beginning or Rental at End
of Period Revenue Deductions of Period
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Year ended December 31, 1998--
Allowance for uncollectible tenant
receivables and unbilled deferred
rent.............................. $1,136 $1,107 $ (787) $1,456
====== ====== ======== ======
February 1, 1997 to December 31,
1997--Allowance for uncollectible
tenant receivables and unbilled
deferred rent..................... $1,675 $1,028 $(1,567) $1,136
====== ====== ======== ======
January 1, 1997 to January 31,
1997--Allowance for
uncollectible tenant receivables
and unbilled deferred rent........ $1,628 $ 50 $ (3) $1,675
====== ====== ======== ======
Year Ended December 31, 1996--
Allowance for uncollectible tenant
receivables and unbilled deferred
rent.............................. $1,837 $1,266 $(1,475) $1,628
====== ====== ======== ======
Year Ended December 31, 1998--
Allowance for
potentially unrecoverable pre-
development costs................. $1,700 $1,700
====== ======
</TABLE>

F-35
<PAGE>

EXHIBIT INDEX
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ----------- ------------
<C> <S> <C>
3.1 Articles of Amendment and Restatement of the
Registrant(1)
3.2 Amended and Restated Bylaws of the Registrant(1)
3.3 Form of Certificate for Common Stock of the
Registrant(1)
3.4 Articles Supplementary of the Registrant designating
8.075% Series A Cumulative Redeemable Preferred
Stock(10)
3.5 Articles Supplementary of the Registrant, designating
8.075% Series A Cumulative Redeemable Preferred
Stock(13)
3.6 Articles Supplementary of the Registrant designating
its Series B Junior Participating Preferred Stock (to
be filed by amendment)
3.7 Articles Supplementary of the Registrant designating
its 9.375% Series C Cumulative Redeemable Preferred
Stock(15)
4.1 Registration Rights Agreement, dated January 31,
1997(1)
4.2 Registration Rights Agreement, dated February 6,
1998(10)
4.3 Registration Rights Agreement, dated April 20, 1998(13)
4.4 Registration Rights Agreement, dated November 24,
1998(15)
4.5 Registration Rights Agreement, dated as of October 31,
1997(7)
4.6 Rights Agreement, dated as of October 2, 1998 between
Kilroy Realty Corporation and ChaseMellon Shareholder
Services, L.L.C., as Rights Agent, which includes the
form of Articles Supplementary of the Series B Junior
Participating Preferred Stock of Kilroy Realty
Corporation as Exhibit A, the form of Right
Certificate as Exhibit B and the Summary of Rights to
Purchase Preferred Shares as Exhibit C(16)
10.1 Fourth Amended and Restated Agreement of Limited
Partnership of Kilroy Realty, L.P., dated November 24,
1998(15)
10.2 Omnibus Agreement, dated as of October 30, 1996, by and
among Kilroy Realty, L.P. and the parties named
therein(1)
10.3 Supplemental Representations, Warranties and Indemnity
Agreement by and among Kilroy Realty, L.P. and the
parties named therein(1)
10.4 Pledge Agreement by and among Kilroy Realty, L.P., John
B. Kilroy, Sr., John B. Kilroy, Jr. and Kilroy
Industries(1)
10.5 1997 Stock Option and Incentive Plan of the Registrant
and Kilroy Realty, L.P(1)
10.6 Form of Indemnity Agreement of the Registrant and
Kilroy Realty, L.P. with certain officers and
directors(1)
10.7 Lease Agreement, dated January 24, 1989, by and between
Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase I(1)
10.8 First Amendment to Lease Agreement, dated December 28,
1990, by and between Kilroy Long Beach Associates and
the City of Long Beach for Kilroy Long Beach Phase
I(1)
10.9 Lease Agreement, dated July 17, 1985, by and between
Kilroy Long Beach Associates and the City of Long
Beach for Kilroy Long Beach Phase III(1)
10.10 Lease Agreement, dated April 21, 1988, by and between
Kilroy Long Beach Associates and the Board of Water
Commissioners of the City of Long Beach, acting for
and on behalf of the City of Long Beach, for Long
Beach Phase IV(1)
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ----------- ------------
<C> <S> <C>
10.11 Lease Agreement, dated December 30, 1988, by and
between Kilroy Long Beach Associates and City of Long
Beach for Kilroy Long Beach Phase II(1)
10.12 First Amendment to Lease, dated January 24, 1989, by
and between Kilroy Long Beach Associates and the City
of Long Beach for Kilroy Long Beach Phase III(1)
10.13 Second Amendment to Lease Agreement, dated December 28,
1990, by and between Kilroy Long Beach Associates and
the City of Long Beach for Kilroy Long Beach Phase
III(1)
10.14 First Amendment to Lease Agreement, dated December 28,
1990, by and between Kilroy Long Beach Associates and
the City of Long Beach for Kilroy Long Beach Phase
II(1)
10.15 Third Amendment to Lease Agreement, dated October 10,
1994, by and between Kilroy Long Beach Associates and
the City of Long Beach for Kilroy Long Beach Phase
III(1)
10.16 Development Agreement by and between Kilroy Long Beach
Associates and the City of Long Beach(1)
10.17 Amendment No. 1 to Development Agreement by and between
Kilroy Long Beach Associates and the City of Long
Beach(1)
10.18 Ground Lease by and between Frederick Boysen and Ted
Boysen and Kilroy Industries, dated May 15, 1969, for
SeaTac Office Center(1)
10.19 Amendment No. 1 to Ground Lease and Grant of Easement,
dated April 27, 1973, among Frederick Boysen and
Dorothy Boysen, Ted Boysen and Rose Boysen and Sea/Tac
Properties(1)
10.20 Amendment No. 2 to Ground Lease and Grant of Easement,
dated May 17, 1977, among Frederick Boysen and Dorothy
Boysen, Ted Boysen and Rose Boysen and Sea/Tac
Properties(1)
10.21 Airspace Lease, dated July 10, 1980, by and among the
Washington State Department of Transportation, as
lessor, and Sea Tac Properties, Ltd. and Kilroy
Industries, as lessee(1)
10.22 Lease, dated April 1, 1980, by and among Bow Lake,
Inc., as lessor, and Kilroy Industries and SeaTac
Properties, Ltd., as lessees for Sea/Tac Office
Center(1)
10.23 Amendment No. 1 to Ground Lease, dated September 17,
1990, between Bow Lake, Inc., as lessor, and Kilroy
Industries and Sea/Tac Properties, Ltd., as lessee(1)
10.24 Amendment No. 2 to Ground Lease, dated March 21, 1991,
between Bow Lake, Inc., as lessor, and Kilroy
Industries and Sea/Tac Properties, Ltd., as lessee(1)
10.25 Property Management Agreement between Kilroy Realty
Finance Partnership, L.P. and Kilroy Realty, L.P.(1)
10.26 Environmental Indemnity Agreement(1)
10.27 Option Agreement by and between Kilroy Realty, L.P. and
Kilroy Airport Imperial Co.(1)
10.28 Option Agreement by and between Kilroy Realty, L.P. and
Kilroy Calabasas Associates(1)
10.29 Employment Agreement between the Registrant and John B.
Kilroy, Jr.(1)
10.30 Employment Agreement between the Registrant and Richard
E. Moran Jr.(1)
10.31 Employment Agreement between the Registrant and Jeffrey
C. Hawken(1)
10.32 Employment Agreement between the Registrant and C. Hugh
Greenup(1)
10.33 Noncompetition Agreement by and between the Registrant
and John B. Kilroy, Sr.(1)
10.34 Noncompetition Agreement by and between the Registrant
and John B. Kilroy, Jr.(1)
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ----------- ------------
<C> <S> <C>
10.35 License Agreement by and among the Registrant and the
other persons named therein(1)
10.36 Form of Indenture of Mortgage, Deed of Trust, Security
Agreement, Financing Statement, Fixture Filing and
Assignment of Leases, Rents and Security Deposits(1)
10.37 Mortgage Note(1)
10.38 Indemnity Agreement(1)
10.39 Assignment of Leases, Rents and Security Deposits(1)
10.40 Variable Interest Rate Indenture of Mortgage, Deed of
Trust, Security Agreement, Financing Statement,
Fixture Filing and Assignment of Leases and Rents(1)
10.41 Environmental Indemnity Agreement(1)
10.42 Assignment, Rents and Security Deposits(1)
10.43 Form of Mortgage, Deed of Trust, Security Agreement,
Financing Statement, Fixture Filing and Assignment of
Leases and Rents(1)
10.44 Assignment of Leases, Rents and Security Deposits(1)
10.45 Purchase and Sale Agreement and Joint Escrow
Instructions, dated April 30, 1997, by and between
Mission Land Company, Mission-Vacaville, L.P. and
Kilroy Realty, L.P.(2)
10.46 Agreement of Purchase and Sale and Joint Escrow
Instructions, dated April 30, 1997, by and between
Camarillo Partners and Kilroy Realty, L.P.(2)
10.47 Purchase and Sale Agreement and Escrow Instructions,
dated May 5, 1997, by and between Kilroy Realty, L.P.
and Pullman Carnegie Associates(4)
10.48 Amendment to Purchase and Sale Agreement and Escrow
Instructions, dated June 27, 1997, by and between
Pullman Carnegie Associates and Kilroy Realty, L.P.(4)
10.49 Purchase and Sale Agreement, Contribution Agreement and
Joint Escrow Instructions, dated May 12, 1997, by and
between Shidler West Acquisition Company, LLC and
Kilroy Realty, L.P.(3)
10.50 First Amendment to Purchase and Sale Agreement,
Contribution Agreement and Joint Escrow Instructions,
dated June 6, 1997, between Kilroy Realty, L.P. and
Shidler West Acquisition Company, L.L.C. and Kilroy
Realty, L.P.(3)
10.51 Second Amendment to Purchase and Sale Agreement,
Contribution Agreement and Joint Escrow Instructions,
dated June 12, 1997, by and between Shidler West
Acquisition Company, LLC and Kilroy Realty, L.P.(3)
10.52 Agreement of Purchase and Sale and Joint Escrow
Instructions, dated June 12, 1997, by and between
Mazda Motor of America, Inc. and Kilroy Realty,
L.P.(4)
10.53 Amendment to Agreement of Purchase and Sale and Joint
Escrow Instructions, dated June 30, 1997, by and
between Mazda Motor of America, Inc. and Kilroy
Realty, L.P.(4)
10.54 Agreement for Purchase and Sale of 2100 Colorado
Avenue, Santa Monica, California, dated June 16, 1997,
by and between Santa Monica Number Seven Associates
L.P. and Kilroy Realty L.P.(4)
10.55 Second Amendment to Credit Agreement and First
Amendment to Variable Interest Rate Indenture of
Mortgage, Deed of Trust, Security Agreement, Financing
Statement, Fixture Filing and Assignment of Leases and
Rent dated August 13, 1997(5)
10.56 Purchase and Sale Agreement and Joint Escrow
Instructions, dated July 10, 1997, by and between
Kilroy Realty, L.P. and Mission Square Partners(6)
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ----------- ------------
<C> <S> <C>
10.57 First Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated August 22, 1997(6)
10.58 Second Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated September 5, 1997(6)
10.59 Third Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated September 19, 1997(6)
10.60 Fourth Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated September 22, 1997(6)
10.61 Fifth Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated September 23, 1997(6)
10.62 Sixth Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated September 25, 1997(6)
10.63 Seventh Amendment to the Purchase and Sale Agreement
and Joint Escrow Instructions, dated July 10, 1997, by
and between Kilroy Realty, L.P. and Mission Square
Partners, dated September 29, 1997(6)
10.64 Eighth Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated October 2, 1997(6)
10.65 Ninth Amendment to the Purchase and Sale Agreement and
Joint Escrow Instructions, dated July 10, 1997, by and
between Kilroy Realty, L.P. and Mission Square
Partners, dated October 24, 1997(6)
10.66 Contribution Agreement, dated October 21, 1997, by and
between Kilroy Realty, L.P. and Kilroy Realty
Corporation and The Allen Group and the Allens(8)
10.67 Purchase and Sale Agreement and Escrow Instructions,
dated December 11, 1997, by and between Kilroy Realty,
L.P. and Swede-Cal Properties, Inc., Viking Investors
of Southern California, L.P. and Viking Investors of
Southern California II, L.P.(9)
10.68 Amendment to the Contribution Agreement, dated October
14, 1998, by and between Kilroy Realty, L.P. and
Kilroy Realty Corporation and The Allen Group and the
Allens, dated October 21, 1997(15)
10.69 Amended and Restated Revolving Credit Agreement, dated
as of October 8, 1998 among Kilroy Realty, L.P.,
Morgan Guaranty Trust Company of New York, as Bank and
as Lead Agent for the Banks, and the Banks listed
therein.(14)
10.70 Amended and Restated Guaranty of Payment, dated as of
October 8, 1998, between Kilroy Realty Corporation and
Morgan Guaranty Trust Company of New York.(14)
21.1 List of Subsidiaries of the Registrant(17)
*23.1 Consent of Deloitte & Touche LLP
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description Page
------- ----------- ------------
<C> <S> <C>
*24.1 Power of Attorney (included in the signature page of
this Form 10-K)
**27.1 Financial Data Schedule
</TABLE>
- --------
*Filed herewith

**Previously filed

(1) Previously filed as an exhibit to the Registration Statement on Form S-11
(No. 333-15553) as declared effective on January 28, 1997 and
incorporated herein by reference.

(2) Previously filed as exhibit 10.11 and 10.12, respectively, to the Current
Report on Form 8-K, dated May 22, 1997, and incorporated herein by
reference.

(3) Previously filed as exhibit 10.57, 10.58 and 10.59, respectively, to the
Current Report on Form 8-K, dated June 30, 1997, and incorporated herein
by reference.

(4) Previously filed as exhibit 10.54, 10.59, 10.60, 10.61 and 10.62,
respectively, to the Current Report on Form 8-K, dated June 30, 1997, and
incorporated herein by reference.

(5) Previously filed as an exhibit to the Registration Statement on Form S-11
(No. 333-32261), and incorporated herein by reference.

(6) Previously filed as an exhibit on Form 10-Q, for the quarterly period
ended September 30, 1997, and incorporated herein by reference.

(7) Previously filed as an exhibit to the Current Report on Form 8-K/A, dated
October 29, 1997, and incorporated herein by reference.

(8) Previously filed as exhibit 10.70 and 10.71, respectively, to the Current
Report on Form 8-K, dated November 7, 1997, and incorporated herein by
reference.

(9) Previously filed as exhibit 10.70 to the Current Report on Form 8-K,
dated December 17, 1997, and incorporated herein by reference.