KILROY REALTY CORP, 10-Q, 1999-08-16

KILROY REALTY CORP
10-Q, 1999-08-16
REAL ESTATE INVESTMENT TRUSTS

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

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 1999

[_] 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)

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

As of August 13, 1999, 27,629,210 shares of common stock, par value $.01 per
share, were outstanding.

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KILROY REALTY CORPORATION

QUARTERLY REPORT FOR THE THREE MONTHS ENDED JUNE 30, 1999

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
PART I--FINANCIAL INFORMATION

<C> <S> <C>
Item 1. FINANCIAL STATEMENTS (unaudited)

Consolidated Balance Sheets as of June 30, 1999 and December 31,
1998............................................................ 3

Consolidated Statements of Operations for the six months ended
June 30, 1999 and 1998.......................................... 4

Consolidated Statements of Operations for the three months ended
June 30, 1999 and 1998.......................................... 5

Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 1998.......................................... 6

Notes to the Consolidated Financial Statements.................. 7

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 13

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...... 27

PART II--OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS............................................... 29
Item 2. CHANGES IN SECURITIES........................................... 29
Item 3. DEFAULTS UPON SENIOR SECURITIES................................. 29
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 29
Item 5. OTHER INFORMATION............................................... 29
Item 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 29
SIGNATURES...................................................... 30
</TABLE>

2
<PAGE>

PART I--FINANCIAL INFORMATION

ITEM 1. Financial Statements

KILROY REALTY CORPORATION

CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share data)

<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------- ------------
<S> <C> <C>
ASSETS

INVESTMENT IN REAL ESTATE (Note 2):
Land and improvements................................ $ 274,452 $ 253,500
Buildings and improvements........................... 907,145 828,425
Undeveloped land and construction in progress, net... 129,615 112,359
---------- ----------
Total investment in real estate..................... 1,311,212 1,194,284

Accumulated depreciation and amortization............ (158,503) (145,437)
---------- ----------
Investment in real estate, net...................... 1,152,709 1,048,847

CASH AND CASH EQUIVALENTS.............................. 9,044 6,443
RESTRICTED CASH........................................ 5,422 6,896
TENANT RECEIVABLES, NET................................ 17,669 15,630
NOTES RECEIVABLE FROM RELATED PARTIES.................. 8,798
DEFERRED FINANCING AND LEASING COSTS, NET.............. 20,295 16,168
PREPAID EXPENSES AND OTHER ASSETS...................... 3,402 3,146
---------- ----------
TOTAL ASSETS........................................ $1,208,541 $1,105,928
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES:
Mortgage debt (Note 3)............................... $ 237,798 $ 133,383
Unsecured line of credit (Note 3).................... 252,500 272,000
Accounts payable and accrued expenses................ 15,848 16,791
Accrued distributions (Note 8)....................... 13,567 12,895
Rents received in advance and tenant security
deposits............................................ 15,939 14,460
---------- ----------
Total liabilities................................... 535,652 449,529
---------- ----------
COMMITMENTS AND CONTINGENCIES..........................

MINORITY INTERESTS (Note 4):
8.075% Series A Cumulative Redeemable Preferred
unitholders......................................... 73,716 73,718
9.375% Series C Cumulative Redeemable Preferred
unitholders......................................... 34,471 34,410
Common unitholders................................... 80,302 72,372
Minority interest in Development LLCs................ 9,733
---------- ----------
Total minority interests............................ 198,222 180,500
---------- ----------
STOCKHOLDERS' EQUITY (Note 5):
Preferred stock, $.01 par value, 27,200,000 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, 27,629,210 and 27,639,210 shares issued
and outstanding, respectively....................... 276 276
Additional paid-in capital........................... 488,737 487,467
Distributions in excess of earnings.................. (14,346) (11,844)
---------- ----------
Total stockholders' equity.......................... 474,667 475,899
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......... $1,208,541 $1,105,928
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.

3
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KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except share and per share data)

<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
REVENUES (Note 6):
Rental income......................................... $ 66,982 $ 54,448
Tenant reimbursements................................. 8,316 7,077
Interest income....................................... 621 883
Other income.......................................... 932 867
---------- ----------
Total revenues...................................... 76,851 63,275
---------- ----------
EXPENSES:
Property expenses..................................... 10,463 9,037
Real estate taxes..................................... 5,861 4,558
General and administrative expenses................... 4,515 3,702
Ground leases......................................... 671 595
Interest expense...................................... 11,919 9,379
Depreciation and amortization......................... 14,677 12,419
---------- ----------
Total expenses...................................... 48,106 39,690
---------- ----------
INCOME BEFORE EQUITY IN LOSS OF UNCONSOLIDATED
SUBSIDIARY AND MINORITY INTERESTS...................... 28,745 23,585
EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARY............. (14) (25)
---------- ----------
INCOME BEFORE MINORITY INTERESTS........................ 28,731 23,560
---------- ----------

MINORITY INTERESTS:
Distributions on Cumulative Redeemable
Preferred units...................................... (4,669) (2,254)
Minority interest in earnings......................... (3,356) (2,642)
---------- ----------
Total minority interests............................ (8,025) (4,896)
---------- ----------

NET INCOME.............................................. $ 20,706 $ 18,664
========== ==========
Net income per common share--basic (Note 7)............. $ 0.75 $ 0.71
========== ==========
Net income per common share--diluted (Note 7)........... $ 0.75 $ 0.71
========== ==========
Weighted average shares outstanding--basic (Note 7)..... 27,630,867 26,324,554
========== ==========
Weighted average shares outstanding--diluted (Note 7)... 27,673,500 26,466,797
========== ==========
</TABLE>

See accompanying notes to consolidated financial statements.

4
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KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except share and per share data)

<TABLE>
<CAPTION>
Three Months Ended
June 30,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
REVENUES (Note 6):
Rental income......................................... $ 34,164 $ 28,988
Tenant reimbursements................................. 4,193 3,852
Interest income....................................... 221 409
Other income.......................................... 723 673
---------- ----------
Total revenues...................................... 39,301 33,922
---------- ----------
EXPENSES:
Property expenses..................................... 5,329 5,066
Real estate taxes..................................... 2,852 2,470
General and administrative expenses................... 2,201 2,143
Ground leases......................................... 334 290
Interest expense...................................... 6,160 4,593
Depreciation and amortization......................... 7,460 6,565
---------- ----------
Total expenses...................................... 24,336 21,127
---------- ----------
INCOME BEFORE EQUITY IN LOSS OF UNCONSOLIDATED
SUBSIDIARY AND MINORITY INTERESTS...................... 14,965 12,795
EQUITY IN LOSS OF UNCONSOLIDATED SUBSIDIARY............. (14) (24)
---------- ----------
INCOME BEFORE MINORITY INTERESTS........................ 14,951 12,771
---------- ----------

MINORITY INTERESTS:
Distributions on Cumulative Redeemable
Preferred units...................................... (2,335) (1,554)
Minority interest in earnings......................... (1,820) (1,432)
---------- ----------
Total minority interests............................ (4,155) (2,986)
---------- ----------

NET INCOME.............................................. $ 10,796 $ 9,785
========== ==========
Net income per common share--basic (Note 7)............. $ 0.39 $ 0.36
========== ==========
Net income per common share--diluted (Note 7)........... $ 0.39 $ 0.36
========== ==========
Weighted average shares outstanding--basic (Note 7)..... 27,629,210 27,406,618
========== ==========
Weighted average shares outstanding--diluted (Note 7)... 27,713,291 27,520,681
========== ==========
</TABLE>

See accompanying notes to consolidated financial statements.

5
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KILROY REALTY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------
1999 1998
-------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 20,706 $ 18,664
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization............................ 14,677 12,419
Provision for uncollectable tenant receivables and
deferred rent........................................... 1,310 740
Restricted stock compensation............................ 254 230
Minority interest in earnings............................ 3,356 2,642
Gain on sale of undeveloped land......................... (539)
Other.................................................... (216) 25
Changes in assets and liabilities:
Tenant receivables...................................... (3,349) (3,126)
Deferred leasing costs.................................. (1,674) (1,733)
Prepaid expenses and other assets....................... (164) (113)
Accounts payable and accrued expenses................... (19) 890
Rents received in advance and tenant security deposits.. 1,479 1,731
Accrued distributions to Cumulative Redeemable
Preferred unitholders.................................. 58 1,514
-------- ---------
Net cash provided by operating activities.............. 35,879 33,883
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for operating properties.................... (23,977) (213,009)
Expenditures for undeveloped land and construction in
progress................................................ (72,483) (37,583)
Proceeds from sale of undeveloped land................... 5,051
Cash paid for note receivable to related party........... (2,153)
Increase in escrow deposits.............................. 2,969
Net advances to unconsolidated subsidiary................ (1,016) (69)
-------- ---------
Net cash used in investing activities.................. (92,425) (249,845)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuances of common stock.............. 82,192
Net proceeds from issuances of Cumulative Redeemable
Preferred units......................................... 72,966
Net (repayment) borrowings on unsecured line of credit... (19,500) 81,000
Proceeds from issuance of mortgage debt.................. 125,000 5,000
Principal payments on mortgage debt...................... (20,585) (1,918)
Financing costs.......................................... (780) (1,151)
Decrease (increase) in restricted cash................... 1,474 (15)
Distributions paid to common stockholders and common
unitholders............................................. (26,462) (23,190)
-------- ---------
Net cash provided by financing activities.............. 59,147 214,884
-------- ---------
Net increase (decrease) in cash and cash equivalents...... 2,601 (1,078)
Cash and cash equivalents, beginning of period............ 6,443 8,929
-------- ---------
Cash and cash equivalents, end of period ................. $ 9,044 $ 7,851
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized interest...... $ 11,133 $ 8,599
======== =========
Distributions paid to Cumulative Redeemable Preferred
unitholders............................................. $ 4,596 $ 740
======== =========
NON-CASH TRANSACTIONS:
Accrual of distributions payable (Note 8)................ $ 13,567 $ 12,815
======== =========
Issuance of common units of the Operating Partnership to
acquire operating properties and undeveloped land (Note
2)...................................................... $ 9,915 $ 16,031
======== =========
Minority interest recorded in connection with Development
LLC undeveloped land acquisitions (Notes 2 and 4)....... $ 9,733
========
</TABLE>
See accompanying notes to consolidated financial statements.

6
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KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 1999 and 1998
(Unaudited)

1. Organization and Basis of Presentation

Organization

Kilroy Realty Corporation (the "Company") develops, owns, and operates
office and industrial real estate, primarily in Southern California. The
Company, which operates as a self-administered real estate investment trust
("REIT"), commenced operations upon the completion of its initial public
offering in January 1997. The Company is the successor to the real estate
business of the Kilroy Group, which had been engaged in the acquisition,
operation, financing and construction of principally class A suburban office
and industrial properties in select locations in key suburban submarkets,
primarily in Southern California. As of June 30, 1999, the Company's
stabilized portfolio consisted of 83 office properties and 86 industrial
properties, which encompassed approximately 5.8 million and 6.2 million
rentable square feet, respectively, and was 95.6% occupied. The Company's
stabilized portfolio consists of all of the Company's office and industrial
properties excluding properties recently developed by the Company that have
not yet reached 95.0% occupancy ("lease-up" properties) and projects currently
under construction or in pre-development. As of June 30, 1999, the Company had
seven office properties under construction which when completed are expected
to encompass an aggregate of 871,600 rentable square feet and had recently
completed construction on two office and three industrial properties
encompassing an aggregate of 175,400 and 769,200 rentable square feet,
respectively, which were in lease-up at June 30, 1999. Lease-up properties are
included in land and improvements and building and improvements on the
consolidated balance sheet upon building shell completion. The Company owns
its interests in all of its properties through Kilroy Realty, L.P. (the
"Operating Partnership") and Kilroy Realty Finance Partnership, L.P. and
conducts substantially all of its operations through the Operating
Partnership. The Company owned an 85.5% general partnership interest in the
Operating Partnership as of June 30, 1999.

The majority of the Company's 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 and industries in which the tenants operate.

Basis of Presentation

The accompanying interim financial statements have been prepared by the
Company's management in accordance with generally accepted accounting
principles and in conjunction with the rules and regulations of the Securities
and Exchange Commission ("SEC"). Certain information and footnote disclosures
required for annual financial statements have been condensed or excluded
pursuant to SEC rules and regulations. Accordingly, the interim financial
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, the interim financial statements presented herein
reflect all adjustments of a normal and recurring nature which are considered
necessary for a fair presentation of the results for the interim periods
presented. The results of operations for the interim period are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1999. These financial statements should be read in conjunction
with the audited consolidated financial statements and the notes thereto
included in the Company's Annual Report on Amendment 1 to Form 10-K on Form
10K-A for the year ended December 31, 1998.

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

7
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KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Six Months Ended June 30, 1999 and 1998
(Unaudited)

2. Acquisitions and Dispositions

Acquisitions

In February 1999, the Company acquired three acres of undeveloped land in
San Diego, California for $0.4 million in cash and 119,460 common units of the
Operating Partnership valued at $2.5 million based upon the closing share
price of the Company's common stock as reported on the New York Stock Exchange
("NYSE"). The undeveloped land was acquired from The Allen Group, a group of
affiliated real estate development companies based in Visalia, California. An
Executive Vice President of the Company received 76,896 of the total 119,460
common units issued in connection with the acquisition. The acquisition was
based upon terms that the Company believes were comparable to terms obtainable
from third-parties based on arm's-length negotiations and was funded primarily
with existing working capital.

In March 1999, the Company acquired one office property containing 126,000
aggregate rentable square feet in San Diego, California for $17.5 million in
cash and 168,402 common units of the Operating Partnership valued at $3.6
million based upon the closing share price of the Company's common stock as
reported on the NYSE. The office property, which is 100% leased through
February 2014, was acquired pursuant to an existing agreement executed by the
Company and The Allen Group in October 1997. In connection with this
anticipated transaction, the Company entered into an agreement in May 1998 to
loan up to $2.3 million to a limited liability company controlled by Richard
S. Allen, a former member of the Company's Board of Directors, to finance
tenant improvements to this property. The $2.3 million balance of the note and
the related interest, which accrued at a rate of Prime plus 1.00%, were repaid
to the Company in connection with the acquisition. An Executive Vice President
of the Company received 98,476 of the total 168,402 common units issued in
connection with the acquisition. The acquisition was based upon terms that the
Company believes were comparable to terms obtainable from third-parties based
on arm's-length negotiations and was funded primarily from existing working
capital and borrowings on the Company's revolving credit facility.

During the first quarter of 1999, the Company acquired a 50% interest in 55
acres of undeveloped land in San Diego, California for $16.1 million and
184,172 common units of the Operating Partnership valued at $3.8 million based
upon the closing share price of the Company's common stock as reported on the
NYSE. The undeveloped land was acquired pursuant to an existing agreement
executed by the Company and The Allen Group in October 1997 that provided for
the joint development of two office projects with approximately 1.1 million
aggregate rentable square feet over the next five years. Both the Company and
The Allen Group contributed their respective 50% interests in the undeveloped
land to two limited liability companies (the "Development LLCs") upon the
completion of the acquisition. In connection with this anticipated
transaction, the Company entered into an agreement in May 1998 to loan up to
$8.5 million to a limited partnership controlled by Richard S. Allen to
finance infrastructure improvements on the undeveloped land. The $8.5 million
balance of the note was assumed by one of the Development LLCs in connection
with the undeveloped land acquisition. The related interest, which accrued at
a rate of LIBOR plus 1.85%, was paid to the Company by the limited
partnership. An Executive Vice President of the Company received 69,694 of the
total 184,172 common units issued in connection with the acquisition. The
acquisition was based upon terms that the Company believes were comparable to
terms obtainable from third-parties based on arm's-length negotiations and was
funded primarily from existing working capital and borrowings on the Company's
revolving credit facility.

In April 1999, the Company acquired nine acres of undeveloped land in San
Diego, California from an unaffiliated third party for $4.3 million in cash.
The Company acquired the undeveloped land by exercising an option obtained in
connection with the acquisition of the adjacent office property in April 1998.
Prior to the acquisition, the Company had leased the undeveloped land from the
seller under a ground lease. The acquisition

8
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KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Six Months Ended June 30, 1999 and 1998
(Unaudited)

of the undeveloped land was funded primarily from existing working capital and
borrowings on the Company's revolving credit facility.

In May 1999, the Company acquired the 12.5% minority interest in a three-
building office complex in Los Angeles, California for $1.2 million in cash.
The Company had originally purchased its 87.5% interest in the office complex
in September 1997. The acquisition of the minority interest was based upon
terms that the Company believes were comparable to terms obtainable from
third-parties based on arm's length negotiations and was funded primarily from
existing working capital and borrowings on the Company's revolving credit
facility.

Dispositions

In February 1999, the Company sold eight acres of its 18-acre undeveloped
land parcel in Calabasas, California to the City of Calabasas for a total
sales price of $1.4 million. The land is part of a 66-acre development site
which is presently entitled for over 1.0 million rentable square feet of
office, retail and hotel development. The Company presently plans to develop
213,000 rentable square feet of office space on the remaining ten acres it
currently owns. The infrastructure improvements on the land were financed with
public facility bonds which were refinanced in February 1999. In connection
with the refinancing, the portion of the original obligation that related to
the eight 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. 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 currently 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 dependent 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 June 30, 1999. The periodic
assessments are currently capitalized as development costs and will be charged
to operations upon the completion of construction. The gain on sale of $0.1
million from the sale of the eight acres of undeveloped land is included in
other income in the consolidated statements of operations.

In May 1999, the Company sold five acres of undeveloped land in San Diego,
California to an unaffiliated third party for a total sales price of $3.7
million in cash. The gain on sale of $0.4 million is included in other income
in the consolidated statements of operations.

3. Unsecured Line of Credit and Mortgage Debt

As of June 30, 1999, the Company had borrowings of $253 million outstanding
under its revolving unsecured line of credit (the "Credit Facility") and
availability of approximately $78.6 million.

In March 1999, the Company borrowed $95.0 million under a mortgage loan that
is collateralized by nine office and industrial properties, requires monthly
principal and interest payments based on a fixed annual interest rate of
7.20%, amortizes over 25 years and matures in April 2009. The Company used the
proceeds from the mortgage loan to repay borrowings under the Credit Facility
and to fund development expenditures.

9
<PAGE>

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Six Months Ended June 30, 1999 and 1998
(Unaudited)

loan to repay an existing variable rate mortgage loan with an outstanding
balance of $19.0 million, to repay borrowings under the Credit Facility and to
fund development expenditures.

Total interest capitalized for the three months ended June 30, 1999 and 1998
was $2.6 million and $2.3 million, respectively. Total interest capitalized
for the six months ended June 30, 1999 and 1998 was $4.6 million and $3.7
million, respectively.

4. Minority Interests

Minority interests represent the preferred and common limited partnership
interests in the Operating Partnership and interests held by The Allen Group
in the Development LLCs.

During the six months ended June 30, 1999, the Operating Partnership issued
472,034 common limited partnership units in the Operating Partnership in
connection with operating property and undeveloped land acquisitions (see Note
2). As a result, the Company owned an 85.5% general partnership interest in
the Operating Partnership as of June 30, 1999.

During the first quarter of 1999, the Company became a 50% managing member
in each of the Development LLCs as a result of the acquisition of certain
undeveloped land and the simultaneous contribution of such land to the
Development LLCs (see Note 2). The Development LLCs are consolidated for
financial reporting purposes because the Company holds a 50% ownership
interest combined with the ability to control all significant development
decisions.

5. Stockholders Equity

The Company has filed a registration statement on Form S-3 with the SEC
which, when declared effective, will register the potential issuance and
resale of up to 3,660,201 shares of the Company's common stock to the
identified holders of 3,660,201 common limited partnership units of the
Operating Partnership that were previously issued in connection with
acquisitions during 1997 and 1998. The common units may be exchanged at the
Company's option, on a one-for-one basis, into shares of the Company's common
stock. Neither the Company nor the Operating Partnership will receive any of
the proceeds from the issuance of the common stock to the identified common
unitholders.

In March 1999, the Company filed a registration statement on Form S-3 with
the SEC to register 1,000,000 shares of the Company's common stock in
connection with the adoption of the Company's Dividend Reinvestment and Direct
Purchase Plan (the "Plan"). 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 or from the
open market or from privately negotiated transactions,

10
<PAGE>

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Six Months Ended June 30, 1999 and 1998
(Unaudited)

except for transactions executed under the WDP which will be purchased only
from previously unissued shares of common stock. Participation in the Plan is
entirely voluntary, and can be terminated at any time. The registration
statement has not yet been declared effective by the SEC.

In May 1999, the Company filed a registration statement on Form S-8 with the
SEC that registered the potential issuance and resale of up to 1,500,000
shares of the Company's common stock in connection with shares of the
Company's common stock issuable to the Company's employees and directors under
the 1997 Stock Option and Incentive Plan.

6. Segment Disclosure

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. All operating
revenues are comprised of amounts received from external tenants.

<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
1999 1998 1999 1998
--------- --------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Revenues and Expenses:
Office Properties:
Operating revenues................. $ 27,210 $ 24,323 $ 52,768 $ 44,181
Property and related expenses...... 6,621 6,394 13,245 11,496
--------- --------- -------- --------
Net operating income, as defined... 20,589 17,929 39,523 32,685
--------- --------- -------- --------
Industrial Properties:
Operating revenues................. 11,870 9,190 23,462 18,211
Property and related expenses...... 1,894 1,432 3,750 2,694
--------- --------- -------- --------
Net operating income, as defined... 9,976 7,758 19,712 15,517
--------- --------- -------- --------
Total Reportable Segments:
Operating revenues................. 39,080 33,513 76,230 62,392
Property and related expenses...... 8,515 7,826 16,995 14,190
--------- --------- -------- --------
Net operating income, as defined... 30,565 25,687 59,235 48,202
--------- --------- -------- --------
Reconciliation to Consolidated Net
Income:
Total net operating income, as
defined, for reportable segments.. 30,565 25,687 59,235 48,202
Other unallocated revenues:
Interest income.................. 221 409 621 883
Other unallocated expenses:
General and administrative
expenses........................ 2,201 2,143 4,515 3,702
Interest expense................. 6,160 4,593 11,919 9,379
Depreciation and amortization.... 7,460 6,565 14,677 12,419
--------- --------- -------- --------
Net income before equity in loss of
unconsolidated subsidiary and
minority interests................ 14,965 12,795 28,745 23,585
Equity in loss of unconsolidated
subsidiary........................ (14) (24) (14) (25)
Minority interests................. (4,155) (2,986) (8,025) (4,896)
--------- --------- -------- --------
Net income......................... $ 10,796 $ 9,785 $ 20,706 $ 18,664
========= ========= ======== ========
</TABLE>

11
<PAGE>

KILROY REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Six Months Ended June 30, 1999 and 1998
(Unaudited)

7. 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 number of
common shares issuable assuming the exercise of all dilutive securities. The
Company does not consider common units of the Operating Partnership to be
dilutive 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.

<TABLE>
<CAPTION>
Three Months Ended June 30, 1999 Three Months Ended June 30, 1998
----------------------------------- -----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
(in thousands, except share and per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Basic................... $10,796 27,629,210 $0.39 $9,785 27,406,618 $0.36
Effect of dilutive
securities:
Stock options
granted.............. 84,081 114,063
------- ---------- ----- ------ ---------- -----
Diluted................. $10,796 27,713,291 $0.39 $9,785 27,520,681 $0.36
======= ========== ===== ====== ========== =====
</TABLE>

<TABLE>
<CAPTION>
Six Months Ended June 30, 1999 Six Months Ended June 30, 1998
----------------------------------- -----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
(in thousands, except share and per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Basic................... $20,706 27,630,867 $0.75 $18,664 26,324,554 $0.71
Effect of dilutive
securities:
Stock options
granted.............. 42,633 142,243
------- ---------- ----- ------- ---------- -----
Diluted................. $20,706 27,673,500 $0.75 $18,664 26,466,797 $0.71
======= ========== ===== ======= ========== =====
</TABLE>

At June 30, 1999, Company employees and directors held options to purchase
2,147,900 shares of the Company's common stock that were antidilutive to the
diluted earnings per share computation. These options could become dilutive in
future periods if the average market price of the Company's common stock
exceeds the exercise price of the outstanding options.

8. Subsequent Events

On July 23, 1999, the Company acquired one office property located in San
Diego, California totaling approximately 50,000 rentable square feet for a
purchase price of approximately $9.3 million in cash. The property was
acquired from an unaffiliated third-party and was funded primarily from
working capital and borrowings on the Credit Facility.

On July 9, 1999, distributions of $13.6 million were paid to common
stockholders and common unitholders of record on June 30, 1999.

On August 13, 1999, the Company sold one office property located in Ventura,
California totaling approximately 125,500 rentable square feet to an
unaffiliated third party for a sales price of approximately $5.4 million in
cash.

12
<PAGE>

ITEM 2. 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 should be read in conjunction with the financial statements
and notes thereto appearing elsewhere in this report. 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

Results of Operations

During the six months ended June 30, 1999, the Company acquired one office
property encompassing 126,000 rentable square feet, for a total purchase price
of $21.1 million. During 1998, the Company acquired 25 office and 16
industrial buildings totaling 1.4 million and 674,000 aggregate rentable
square feet, respectively, for an aggregate acquisition cost of approximately
$254 million. Operating results for acquired properties are included in the
consolidated financial statements of the Company subsequent to their
respective acquisition dates.

As a result of the properties acquired and the projects developed by the
Company subsequent to June 30, 1998, rentable square footage in the Company's
portfolio of stabilized properties increased 1.0 million rentable square feet,
or 8.5% to 12.0 million rentable square feet at June 30, 1999 compared to 11.0
million rentable square feet at June 30, 1998. As of June 30, 1999, the
Company's portfolio of stabilized properties was comprised of 83 office
properties (the "Office Properties") encompassing 5.8 million rentable square
feet and 86 industrial properties (the "Industrial Properties" and together
with the Office Properties, the "Properties") encompassing 6.2 million
rentable square feet. The Company's stabilized portfolio consists of all of
the Company's Office and Industrial Properties excluding properties recently
developed by the Company that have not yet reached 95.0% occupancy ("lease-up"
properties) and projects currently under construction or in pre-development.
The stabilized portfolio occupancy rate at June 30, 1999 was 95.6%, with the
Office and Industrial Properties 93.1% and 98.0% occupied, respectively.

During the six months ended June 30, 1999, the Company completed
construction on two office and three industrial buildings encompassing an
aggregate of 175,400 and 769,200 rentable square feet, respectively, which
were in lease-up at June 30, 1999. At June 30, 1999, the Company had seven
office properties under construction which when completed are expected to
encompass an aggregate of 871,600 rentable square feet.

13
<PAGE>

Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998

<TABLE>
<CAPTION>
Three Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental income............................. $34,164 $28,988 $5,176 17.9%
Tenant reimbursements..................... 4,193 3,852 341 8.9
Interest income........................... 221 409 (188) (45.9)
Other income.............................. 723 673 50 7.5
------- ------- ------
Total revenues.......................... 39,301 33,922 5,379 15.9
------- ------- ------
Expenses:
Property expenses......................... 5,329 5,066 263 5.2
Real estate taxes......................... 2,852 2,470 382 15.5
General and administrative expenses....... 2,201 2,143 58 2.7
Ground leases............................. 334 290 44 15.2
Interest expense.......................... 6,160 4,593 1,567 34.1
Depreciation and amortization............. 7,460 6,565 895 13.6
------- ------- ------
Total expenses.......................... 24,336 21,127 3,209 15.2
------- ------- ------
Income before equity in loss of
unconsolidated subsidiary
and minority interests..................... $14,965 $12,795 $2,170 17.0%
======= ======= ======
</TABLE>

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 three months ended June 30, 1999 and 1998.

Office Properties

<TABLE>
<CAPTION>
Three Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating revenues:
Rental income.............................. $23,561 $20,669 $2,892 14.0%
Tenant reimbursements...................... 2,966 2,989 (23) (0.8)
Other income............................... 683 665 18 2.7
------- ------- ------
Total.................................... 27,210 24,323 2,887 11.9
------- ------- ------
Property and related expenses:
Property expenses.......................... 4,661 4,457 204 4.6
Real estate taxes.......................... 1,626 1,647 (21) (1.3)
Ground leases.............................. 334 290 44 15.2
------- ------- ------
Total.................................... 6,621 6,394 227 3.6
------- ------- ------
Net operating income, as defined............. $20,589 $17,929 $2,660 14.8%
======= ======= ======
</TABLE>

Total revenues from Office Properties increased $2.9 million, or 11.9% to
$27.2 million for the three months ended June 30, 1999 compared to $24.3
million for the three months ended June 30, 1998. Rental income from Office
Properties increased $2.9 million, or 14.0% to $23.6 million for the three
months ended June 30, 1999

14
<PAGE>

compared to $20.7 million for the three months ended June 30, 1998. Of this
increase, $0.6 million was generated by the one office property acquired
during 1999 (the "1999 Office Acquisition"), $0.6 million was generated by the
Office Properties acquired during 1998 (the "1998 Office Acquisitions") and
$0.9 million was generated by the Office Properties developed by the Company
in 1998 and in 1999 (the "Office Development Properties"). The remaining $0.8
million of the increase was generated by the stabilized office properties
owned at January 1, 1998 and still owned at June 30, 1999 (the "Core Office
Portfolio"), and represented a 5.1% increase in rental income for the Core
Office Portfolio. Average occupancy in the Core Office Portfolio remained
consistent for the three months ended June 30, 1999 compared to the same
period in 1998. The increase in rental income generated by the Core Office
Portfolio was primarily attributable to increases in rental rates.

Tenant reimbursements from Office Properties remained consistent for the
three months ended June 30, 1999 compared to the three months ended June 30,
1998. An increase of $0.1 million in tenant reimbursements generated by the
1999 Office Acquisition, the 1998 Office Acquisitions and the Office
Development Properties was offset by a decrease of $0.1 million in tenant
reimbursements generated by the Core Office Portfolio due to a decrease in
total expenses for this portfolio. Other income from Office Properties
remained consistent for the three months ended June 30, 1999 compared to the
same period in 1998. However, for the three months ended June 30, 1999, other
income from Office Properties included a $0.4 million gain on the sale of five
acres of undeveloped land in San Diego, California and for the three months
ended June 30, 1998, other income from Office Properties included a $0.5
million consulting fee for assisting an existing tenant with potential
expansion plans. The remaining amounts in other income from Office Properties
for both periods consisted primarily of lease termination and management fees.

Total expenses from Office Properties increased $0.2 million, or 3.6% to
$6.6 million for the three months ended June 30, 1999 compared to $6.4 million
for the three months ended June 30, 1998. Property expenses increased $0.2
million, or 4.6% to $4.7 million for the three months ended June 30, 1999
compared to $4.5 million for the same period in 1998. The total increase of
$0.2 million in property expenses from Office Properties was attributable to
the 1998 Office Acquisitions and the Office Development Properties. Property
expenses for the Core Office Portfolio decreased $42,000, or 1.3% for the
three months ended June 30, 1999 compared to the same period in 1998 due to
management's implementation of cost saving measures. Real estate taxes
remained consistent for the three months ended June 30, 1999 as compared to
the same period in 1998. An increase in real estate taxes of $0.1 million
attributable to owning the 1998 Office Acquisitions for a full quarter in 1999
was offset by a decrease in property taxes for the Core Office Portfolio due
primarily to lower than anticipated acquisition-related reassessments on
properties acquired by the Company during 1997. Ground lease expense from
Office Properties remained consistent for the three months ended June 30, 1999
compared to the same period in 1998.

Net operating income, as defined, from Office Properties increased $2.7
million, or 14.8% to $20.6 million for the three months ended June 30, 1999
compared to $17.9 million for the three months ended June 30, 1998. Of this
increase, $1.7 million was generated by the 1999 Office Acquisition, the 1998
Office Acquisitions, and the Office Development Properties. The remaining
increase of $1.0 million was generated by the Core Office Portfolio and
represented a 6.5% increase in net operating income for the Core Office
Portfolio.

15
<PAGE>

Industrial Properties

<TABLE>
<CAPTION>
Three Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating revenues:
Rental income............................... $10,603 $ 8,319 $2,284 27.5%
Tenant reimbursements....................... 1,227 863 364 42.2
Other income................................ 40 8 32 400.0
------- ------- ------
Total..................................... 11,870 9,190 2,680 29.2
------- ------- ------
Property and related expenses:
Property expenses........................... 668 609 59 9.7
Real estate taxes........................... 1,226 823 403 49.0
------- ------- ------
Total..................................... 1,894 1,432 462 32.3
------- ------- ------
Net operating income, as defined.............. $ 9,976 $ 7,758 $2,218 28.6%
======= ======= ======
</TABLE>

Total revenues from Industrial Properties increased $2.7 million, or 29.2%
to $11.9 million for the three months ended June 30, 1999 compared to $9.2
million for the three months ended June 30, 1998. Rental income from
Industrial Properties increased $2.3 million, or 27.5% to $10.6 million for
the three months ended June 30, 1999 compared to $8.3 million for the three
months ended June 30, 1998. Of this increase, $1.0 million was generated by
the Industrial Properties acquired during 1998 (the "1998 Industrial
Acquisitions") and $1.1 million was generated by the Industrial Properties
developed by the Company in 1998 and 1999 (the "Industrial Development
Properties"). The remaining $0.2 million of the increase was generated by the
stabilized industrial properties owned at January 1, 1998 and still owned at
June 30, 1999 (the "Core Industrial Portfolio") and represented a 3.0%
increase in rental income for the Core Industrial Portfolio. Average occupancy
in the Core Industrial Portfolio remained consistent for the three months
ended June 30, 1999 compared to the same period in 1998. The increase in
rental income generated by the Core Industrial Portfolio was primarily
attributable to increases in rental rates.

Tenant reimbursements from Industrial Properties increased $0.4 million, or
42.2% to $1.2 million for the three months ended June 30, 1999 compared to
$0.8 million for three months ended June 30, 1998. Of this increase, $0.3
million was attributable to the 1998 Industrial Acquisitions and the
Industrial Development Properties. The remaining $0.1 million was generated by
the Core Industrial Portfolio and was primarily attributable to an increase in
real estate taxes reimbursable by tenants. Other income from Industrial
Properties remained consistent for the three months ended June 30, 1999
compared to the same period in 1998.

Total expenses from Industrial Properties increased $0.5 million, or 32.3%
to $1.9 million for the three months ended June 30, 1999 compared to $1.4
million for the three months ended June 30, 1998. Property expenses from
Industrial Properties remained consistent for the three months ended June 30,
1999 compared to the three months ended June 30, 1998. An increase of $0.1
million attributable to the 1998 Industrial Acquisitions and the Industrial
Development Properties was offset by a decrease of $55,000, or 11.9% for the
Core Industrial Portfolio due to management's implementation of cost saving
measures. Real estate taxes from Industrial Properties increased $0.4 million,
or 49.0% to $1.2 million for the three months ended June 30, 1999 compared to
$0.8 million for the three months ended June 30, 1998. Of the total increase
in real estate taxes, $0.2 million was attributable to the 1998 Industrial
Acquisitions and the Industrial Development Properties. The remaining $0.2
million increase was generated by the Core Industrial Portfolio and was
primarily attributable to acquisition-related reassessments on properties
acquired by the Company in 1997.

Net operating income, as defined, from Industrial Properties increased $2.2
million, or 28.6% to $10.0 million for the three months ended June 30, 1999
compared to $7.8 million for the three months ended June 30, 1998. Of this
increase, $2.1 million was generated by the 1998 Industrial Acquisitions and
the Industrial

16
<PAGE>

Development Properties. The remaining $0.1 million was generated by the Core
Industrial Portfolio and represented a 1.8% increase in net operating income
for the Core Industrial Portfolio.

Non-Property Related Income and Expenses

Interest income decreased $0.2 million, or 45.9% to $0.2 million for the
three months ended June 30, 1999 compared to $0.4 million for the three months
ended June 30, 1998. The Company had higher outstanding cash balances during
the second quarter of 1998 due to proceeds received from equity offerings and
preferred unit issuances transacted during the first quarter of 1998.

General and administrative expenses remained relatively consistent at $2.2
million for the three months ended June 30, 1999 compared to $2.1 million for
the three months ended June 30, 1998.

Interest expense increased $1.6 million, or 34.1% to $6.2 million for the
three months ended June 30, 1999 compared to $4.6 million for the comparable
period in 1998, primarily due to a net increase in aggregate indebtedness. The
Company's weighted average interest rate decreased 0.3% to 7.1% at June 30,
1999 as compared to 7.4% at June 30, 1998.

Depreciation and amortization increased $0.9 million, or 13.6% to $7.5
million for the three months ended June 30, 1999 compared to $6.6 million for
the comparable period in 1998. The increase was due primarily to a full
quarter of depreciation on properties acquired during 1998.

Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998

<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Rental income............................ $66,982 $54,448 $12,534 23.0%
Tenant reimbursements.................... 8,316 7,077 1,239 17.5
Interest income.......................... 621 883 (262) (29.6)
Other income............................. 932 867 65 7.5
------- ------- -------
Total revenues......................... 76,851 63,275 13,576 21.5
------- ------- -------
Expenses:
Property expenses........................ 10,463 9,037 1,426 15.8
Real estate taxes........................ 5,861 4,558 1,303 28.6
General and administrative expenses...... 4,515 3,702 813 22.0
Ground leases............................ 671 595 76 12.8
Interest expense......................... 11,919 9,379 2,540 27.1
Depreciation and amortization............ 14,677 12,419 2,258 18.2
------- ------- -------
Total expenses......................... 48,106 39,690 8,416 21.1
------- ------- -------
Income before equity in loss of
unconsolidated subsidiary
and minority interests.................... $28,745 $23,585 $ 5,160 21.9%
======= ======= =======
</TABLE>

17
<PAGE>

Rental Operations

Office Properties

<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating Revenues:
Rental income.............................. $46,102 $38,097 $ 8,005 21.0%
Tenant reimbursements...................... 5,784 5,310 474 8.9
Other income............................... 882 774 108 14.0
------- ------- -------
Total.................................... 52,768 44,181 8,587 19.4
------- ------- -------
Property and related expenses:
Property expenses.......................... 9,084 7,931 1,153 14.5
Real estate taxes.......................... 3,490 2,970 520 17.5
Ground leases.............................. 671 595 76 12.8
------- ------- -------
Total.................................... 13,245 11,496 1,749 15.2
------- ------- -------
Net operating income, as defined............. $39,523 $32,685 $ 6,838 20.9%
======= ======= =======
</TABLE>

Total revenues from Office Properties increased $8.6 million, or 19.4% to
$52.8 million for the six months ended June 30, 1999 compared to $44.2 million
for the six months ended June 30, 1998. Rental income from Office Properties
increased $8.0 million, or 21.0% to $46.1 million for the six months ended
June 30, 1999 compared to $38.1 million for the six months ended June 30,
1998. Of this increase, $0.6 million was generated by the one office property
acquired during 1999 (the "1999 Office Acquisition"), $4.1 million was
generated by the Office Properties acquired during 1998 (the "1998 Office
Acquisitions") and $1.7 million was generated by the Office Properties
developed by the Company in 1998 and 1999 (the "Office Development
Properties"). The remaining $1.6 million of the increase was generated by the
stabilized office properties owned at January 1, 1998 and still owned at June
30, 1999 (the "Core Office Portfolio"), and represented a 4.9% increase in
rental income for the Core Office Portfolio. Average occupancy in the Core
Office Portfolio remained consistent for the six months ended June 30, 1999
compared to the same period in 1998. The increase in rental income generated
by the Core Office Portfolio was primarily attributable to increases in rental
rates.

Tenant reimbursements from Office Properties increased $0.5 million, or 8.9%
to $5.8 million for the six months ended June 30, 1999 compared to $5.3
million for the six months ended June 30, 1998. This increase was attributable
to tenant reimbursements from the 1999 Office Acquisition, the 1998 Office
Acquisitions and the Office Development Properties. Tenant reimbursements from
the Core Office Portfolio remained consistent for the six months ended June
30, 1999 compared to the same period in 1998. Other income from Office
Properties increased $0.1 million, or 14.0% to $0.9 million for the six months
ended June 30, 1999 compared to $0.8 million for the same period in 1998. For
the six months ended June 30, 1999 other income from Office Properties
included a $0.1 million gain on the sale of eight acres of undeveloped land in
Calabassas, California and a $0.4 million gain on the sale of five acres of
undeveloped land in San Diego, California. Other income from Office Properties
for the six months ended June 30, 1998 included a $0.5 million consulting fee
for assisting an existing tenant with potential expansion plans. The remaining
amounts in other income from Office Properties for both periods consisted
primarily of lease termination and management fees.

18
<PAGE>

Total expenses from Office Properties increased $1.7 million, or 15.2% to
$13.2 million for the six months ended June 30, 1999 compared to $11.5 million
for the six months ended June 30, 1998. Property expenses from Office
Properties increased $1.2 million, or 14.5% to $9.1 million and real estate
taxes from Office Properties increased $0.5 million, or 17.5% to $3.5 million
for the six months ended June 30, 1999 compared to $7.9 million and $3.0
million, respectively, for the six months ended June 30, 1998. Of the
collective increase of $1.7 million in property expenses and real estate
taxes, $1.8 million was attributable to the 1999 Office Acquisition, 1998
Office Acquisitions and the Office Development Properties. This increase was
offset by a $0.1 million decrease at the Core Office Portfolio, primarily due
to management's implementation of cost saving measures. Ground lease expense
from Office Properties increased $0.1 million, or 12.8% for the six months
ended June 30, 1999 compared to the same period in 1998 primarily due to a
full six months of ground lease expense at one of the 1998 Office
Acquisitions.

Net operating income, as defined, from Office Properties increased $6.8
million, or 20.9% to $39.5 million for the six months ended June 30, 1999
compared to $32.7 million for the six months ended June 30, 1998. Of this
increase, $5.0 million was generated by the 1999 Office Acquisition, the 1998
Office Acquisitions, and the Office Development Properties. The remaining
increase of $1.8 million was generated by the Core Office Portfolio and
represented a 6.5% increase in net operating income for the Core Office
Portfolio.

Industrial Properties

<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------- Dollar Percentage
1999 1998 Change Change
------- ------- ------ ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Operating Revenues:
Rental income.............................. $20,880 $16,351 $4,529 27.7%
Tenant reimbursements...................... 2,532 1,767 765 43.3
Other income............................... 50 93 (43) (46.2)
------- ------- ------
Total.................................... 23,462 18,211 5,251 28.8
------- ------- ------
Property and related expenses:
Property expenses.......................... 1,379 1,106 273 24.7
Real estate taxes.......................... 2,371 1,588 783 49.3
------- ------- ------
Total.................................... 3,750 2,694 1,056 39.2
------- ------- ------
Net operating income, as defined............. $19,712 $15,517 $4,195 27.0%
======= ======= ======
</TABLE>

Total revenues from Industrial Properties increased $5.3 million, or 28.8%
to $23.5 million for the six months ended June 30, 1999 compared to $18.2
million for the six months ended June 30, 1998. Rental income from Industrial
Properties increased $4.5 million, or 27.7% to $20.9 million for the six
months ended June 30, 1999 compared to $16.4 million for the six months ended
June 30, 1998. Of this increase, $2.0 million was generated by the Industrial
Properties acquired during 1998 (the "1998 Industrial Acquisitions") and
$2.3 million was generated by the Industrial Properties developed by the
Company in 1998 and 1999 (the "Industrial Development Properties"). The
remaining $0.2 million increase was generated by the stabilized industrial
properties owned at January 1, 1998 and still owned at June 30, 1999 (the
"Core Industrial Portfolio") and represented a 1.1% increase in rental income
for the Core Industrial Portfolio. Average occupancy in the Core Industrial
Portfolio remained consistent for the six months ended June 30, 1999 compared
to the same period in 1998. The increase in rental income from the Core
Industrial Portfolio was primarily attributable to increases in rental rates.

Tenant reimbursements from Industrial Properties increased $0.8 million, or
43.3% to $2.5 million for the six months ended June 30, 1999 compared to $1.7
million for the six months ended June 30, 1998. Of this increase, $0.6 million
was attributable to the 1998 Industrial Acquisitions and the Industrial
Development Properties. The remaining $0.2 million was generated by to the
Core Industrial Portfolio and was primarily due to an increase in

19
<PAGE>

real estate taxes reimbursable by tenants. Other income from Industrial
Properties remained consistent for the six months ended June 30, 1999 compared
to the same period in 1998.

Total expenses from Industrial Properties increased $1.1 million, or 39.2%
to $3.8 million for the six months ended June 30, 1999 compared to $2.7
million for the six months ended June 30, 1998. Property expenses from
Industrial Properties increased $0.3 million, or 24.7% to $1.4 million for the
six months ended June 30, 1999 compared to $1.1 million for the six months
ended June 30, 1998. This entire increase was attributable to the 1998
Industrial Acquisitions and the Industrial Development Properties. Property
expenses for the Core Industrial Portfolio remained consistent for the six
months ended June 30, 1999 compared to the comparable period in 1998. Real
estate taxes from Industrial Properties increased $0.8 million, or 49.3% to
$2.4 million for the six months ended June 30, 1999 compared to $1.6 million
for the six months ended June 30, 1998. Of the total increase in real estate
taxes, $0.4 million was attributable to the 1998 Industrial Acquisitions and
the Industrial Development Properties. The remaining $0.4 million increase was
generated by the Core Industrial Portfolio and was primarily due to
acquisition-related assessments on properties acquired by the Company in 1997.

Net operating income, as defined, from Industrial Properties increased $4.2
million, or 27.0% to $19.7 million for the six months ended June 30, 1999
compared to $15.5 million for the six months ended June 30, 1998. This
increase of $4.2 million in net operating income from Industrial Properties
was generated from the 1998 Industrial Acquisitions and the Industrial
Development Properties. Net operating income from the Core Industrial
Portfolio remained consistent for the six months ended June 30, 1999 compared
to the same period in 1998.

Non-Property Related Income and Expenses

Interest income decreased $0.3 million, or 29.6% to $0.6 million for the six
months ended June 30, 1999 compared to $0.9 million for the six months ended
June 30, 1998. The Company had higher outstanding cash balances during 1998
due to proceeds received from equity offerings and preferred unit issuances
transacted during the first quarter of 1998.

General and administrative expenses increased $0.8 million, or 22.0% to $4.5
million for the six months ended June 30, 1999 compared to $3.7 million for
the six months ended June 30, 1998 due to increased management, administrative
and personnel costs associated with the Company's increased portfolio size.

Interest expense increased $2.5 million, or 27.1% to $11.9 million for the
six months ended June 30, 1999 compared to $9.4 million for the comparable
period in 1998, primarily due to a net increase in aggregate indebtedness. The
Company's weighted average interest rate decreased 0.3% to 7.1% at June 30,
1999 as compared to 7.4% at June 30, 1998.

Depreciation and amortization increased $2.3 million, or 18.2% to $14.7
million for the six months ended June 30, 1999 compared to $12.4 million for
the comparable period in 1998. The increase was due primarily to a full six
months of depreciation on properties acquired during 1998.

Liquidity and Capital Resources

The Company has a $350 million Credit Facility which bears interest at a
rate of either LIBOR plus 1.00%, LIBOR plus 1.13%, LIBOR plus 1.25% or LIBOR
plus 1.38% (6.25% at June 30, 1999) depending on the Company's leverage ratio
at the time of borrowing, and matures in February 2000 with the lender's
option to extend for one year. As of June 30, 1999, the Company had borrowings
of $253 million outstanding under the Credit Facility and availability of
$78.6 million.

20
<PAGE>

interest rate of 7.20%, amortizes over 25 years and matures in April 2009. The
Company used the proceeds from the mortgage loan to repay borrowings under the
Credit Facility and to fund development expenditures.

In April 1999, the Company borrowed $30.0 million under a mortgage loan that
is collateralized by one office property and the related ground leases,
requires monthly principal and interest payments based on a fixed annual
interest rate of 7.15% and matures in May 2017. The Company used the proceeds
from the mortgage loan to repay an existing variable rate mortgage loan with
an outstanding balance of $19.0 million, to repay borrowings under the Credit
Facility and to fund development expenditures.

In March 1999, the Company filed a registration statement on Form S-3 with
the SEC to register 1,000,000 shares of the Company's common stock in
connection with the adoption of the Company's Dividend Reinvestment and Direct
Purchase Plan (the "Plan"). 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 DRIP, the COPP and 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 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.

In January 1998, the Company filed a "shelf" registration statement on Form
S-3 with the SEC that registered $400 million of equity securities of the
Company. As of August 13, 1999, an aggregate of $313 million of equity
securities were available for issuance under the registration statement.

Capital Expenditures

As of June 30, 1999, the Company had approximately 871,600 rentable square
feet of office space under construction at a total budgeted cost of
approximately $171 million. The Company has spent an aggregate of $56.1
million on these projects as of June 30, 1999. The Company intends to finance
the presently budgeted $115 million of remaining development costs with
additional mortgage financing, borrowings under the Credit Facility and
working capital. In addition, as of June 30, 1999, the Company has spent $73.5
million on land and pre-development costs for phased development projects
which are planned for the next five years.

At June 30, 1999, the Company had escrow deposits of $0.4 million for the
contemplated acquisition of one office building in San Diego, California with
50,000 aggregate rentable square feet. The Company acquired the property in
July 1999 for an aggregate acquisition cost of $9.3 million which was financed
with borrowings under the Credit Facility and working capital.

In connection with an agreement signed with The Allen Group in October 1997,
the Company has agreed to purchase one office property encompassing 128,000
rentable square feet, subject to the property meeting certain occupancy
thresholds. The purchase price for this property will be determined at the
time of acquisition based on the net operating income at that time. The
Company expects that in the event that this acquisition does occur, it would
be financed with borrowings under the Credit Facility and the issuance of
common limited partnership units of the Operating Partnership.

21
<PAGE>

The agreement with The Allen Group also provides for the development of two
office projects in San Diego, California with approximately 1.1 million
aggregate rentable square feet for an estimated aggregate development cost of
approximately $150 million. During the first quarter of 1999, the Company
purchased a 50% managing interest in both of the development projects. 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 I of both office projects commenced in the
fourth quarter of 1998 and construction on phase II on one of the office
projects commenced in the second quarter of 1999. The total budgeted
investment of $65.1 million for these projects is included in the total
budgeted cost of $171 million discussed above. In addition, the Company has
spent an aggregate of $31.7 million on the development of these projects as of
June 30, 1999, which is included in the aggregate expenditures of $56.1
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, the issuance
of debt or equity securities or the issuance of common or preferred units of
the Operating Partnership.

Building and Lease Information

The following tables set forth certain information regarding the Company's
Office and Industrial Properties at June 30, 1999:

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 2,297,473 120,866 95.0%
Orange County............... 27 1,021,882 814,684 207,198 79.7
San Diego................... 23 1,660,352 1,606,040 54,312 96.7
Other....................... 6 709,614 688,833 20,781 97.1
--- ---------- ---------- -------
83 5,810,187 5,407,030 403,157 93.1
--- ---------- ---------- -------
Industrial Properties:
Los Angeles................. 8 679,736 667,067 12,669 98.1
Orange County............... 62 3,946,531 3,836,883 109,648 97.2
San Diego................... 3 199,351 199,351 -- 100.0
Other....................... 13 1,326,557 1,325,676 881 99.9
--- ---------- ---------- -------
86 6,152,175 6,028,977 123,198 98.0
--- ---------- ---------- -------
Total Portfolio............. 169 11,962,362 11,436,007 526,355 95.6%
=== ========== ========== =======
</TABLE>

22
<PAGE>

Lease Expirations by Segment Type

<TABLE>
<CAPTION>
Percentage
of Total
Leased Annual Base
Total Square Square Feet Rent Under
Number of Footage of Represented Expiring
Expiring Expiring by Expiring Leases
Year of Lease Expiration Leases(1) Leases Leases(2) (in 000's)(3)
- ------------------------ --------- ------------ ----------- -------------
<S> <C> <C> <C> <C>
Office Properties:
Remaining 1999................ 43 272,919 5.0% $ 6,364
2000.......................... 83 382,368 6.9 7,337
2001.......................... 85 1,048,008 19.0 15,211
2002.......................... 55 583,378 10.6 8,892
2003.......................... 35 218,413 4.0 3,755
2004.......................... 31 607,472 11.0 13,485
--- --------- ---- -------
332 3,112,558 56.5% 55,044
--- --------- -------
Industrial Properties:
Remaining 1999................ 39 224,084 3.9% 1,465
2000.......................... 80 975,146 16.8 7,376
2001.......................... 58 911,871 15.7 5,433
2002.......................... 24 176,047 3.0 1,599
2003.......................... 28 779,872 13.4 5,508
2004.......................... 11 520,280 8.9 3,878
--- --------- ---- -------
240 3,587,300 61.7% 25,259
--- --------- -------
Total Portfolio............... 572 6,699,858 59.2% $80,303
=== ========= =======
</TABLE>
- --------
(1) Represents the total number of tenants. Some tenants have multiple leases.
Excludes leases for amenity, retail, parking and month to month tenants.

(2) Based on total leased square footage for the respective portfolios as of
June 30, 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 July 1, 1999.

Leasing Activity by Segment Type

<TABLE>
<CAPTION>
Weighted
Number of Average
Leases Square Feet Lease
----------- --------------- Retention Term (in
New Renewal New(1) Renewal Rate months)
--- ------- ------- ------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
For the Three Months Ended June
30, 1999:
Office Properties.............. 21 19 122,569 63,619 18.4% 80
Industrial Properties.......... 19 15 278,389 120,096 66.5 58
--- --- ------- -------
Total Portfolio................ 40 34 400,958 183,715 37.9% 65
=== === ======= =======
For the Six Months Ended June
30, 1999:
Office Properties.............. 39 40 335,075 324,204 49.1% 71
Industrial Properties.......... 43 30 388,191 270,365 58.6 53
--- --- ------- -------
Total Portfolio................ 82 70 723,266 594,569 53.0% 62
=== === ======= =======
</TABLE>
- --------
(1) The lease-up of 400,958 and 723,266 square feet to new tenants for the
three and six months ended June 30, 1999, respectively includes re-leasing
of 259,655 and 435,868 square feet, respectively and first generation
leasing of 141,303 and 287,398 square feet, respectively.

23
<PAGE>

Historical Cash Flows

The Company's net cash provided by operating activities increased $2.0
million, or 5.9% to $35.9 million for the six months ended June 30, 1999
compared to $33.9 million for the six months ended June 30, 1998. The increase
was primarily due to the increase in net income resulting from the 1998 Office
and Industrial Acquisitions and the Office and Industrial Development
Properties and an increase in net operating income, as defined, generated by
the Core Office and Industrial Portfolios. The increase was partially offset
by increased interest expense and general and administrative expenses.

Cash used in investing activities decreased $157 million, or 63.0% to $92.4
million for the six months ended June 30, 1999 compared to $250 million for
the six months ended June 30, 1998. Cash used in investing activities for the
six months ended June 30, 1999 consisted primarily of the purchase of one
office property for $15.2 million (net of $3.6 million of contributed value in
exchange for which the Company issued common units of the Operating
Partnership and the repayment of an existing $2.3 million note receivable),
the purchase of the minority interest in one office complex for $1.2 million,
the purchase of 12 acres of undeveloped land for $4.7 million (net of $2.5
million of contributed value in exchange for which the Company issued common
units of the Operating Partnership), the acquisition of a 50% interest in 55
acres of undeveloped land for $16.1 million (net of $3.8 million of
contributed value in exchange for which the Company issued common limited
partnership units of the Operating Partnership), the sale of 13 acres of
undeveloped land for $4.5 million (net of $0.5 million gain on sale),
expenditures for construction in progress of $51.7 million, and $7.2 million
in additional tenant improvements and capital expenditures. Cash used in
investing activities for the six months ended June 30, 1998 consisted
primarily of the purchase of 38 office and industrial properties for $208
million (net of $13.5 million of contributed value in exchange for which the
Company issued common units of the Operating Partnership), the purchase of 41
acres of undeveloped land for $16.0 million (net of $2.5 million of
contributed value in exchange for which the Company issued common units of the
Operating Partnership), disbursements for notes receivable from related
parties of $2.2 million, expenditures for construction in progress of $21.6
million, $4.5 million in additional tenant improvements and capital
expenditures and $3.0 million for escrow deposits.

Cash provided by financing activities decreased $156 million, or 72.5% to
$59.1 million for the six months ended June 30, 1999 compared to $215 million
for the six months ended June 30, 1998. Cash provided by financing activities
for the six months ended June 30, 1999 consisted primarily of $104 million in
net proceeds from the issuance of mortgage debt, partially offset by $19.5
million in repayments to the Credit Facility and $26.5 million in
distributions paid to common stockholders and common unitholders. Cash
provided by financing activities for the six months ended June 30, 1998
consisted of net proceeds of $82.2 million from common stock offerings, net
proceeds of $73.0 million from the issuance of 8.075% Series A Cumulative
Redeemable Preferred units, and $84.1 million in net proceeds from the
issuance of mortgage debt and borrowings under the Credit Facility, partially
offset by $23.2 million in distributions paid to common stockholders and
common unitholders.

Funds from Operations

Industry analysts generally consider 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
interests 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 historical
operating results of the Company, Funds From Operations should be examined in
conjunction with net income 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

24
<PAGE>

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 for the
three and six months ended June 30, 1999 and 1998.

<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
--------------- ---------------
1999 1998 1999 1998
------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C>
Net income..................................... $10,796 $ 9,785 $20,706 $18,664
Add:
Minority interest in earnings.............. 1,820 1,432 3,356 2,642
Depreciation and amortization.............. 7,460 6,565 14,677 12,419
Other...................................... 127 112 254 230
------- ------- ------- -------
Funds From Operations.......................... $20,203 $17,894 $38,993 $33,955
======= ======= ======= =======
</TABLE>

Inflation

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

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 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. In addition, management performed additional testing
during 1999 by setting the dates in the operating system and the accounting
and property management system ahead to the year 2000. Management believes
there is no material Y2K exposure with respect to its information technology
systems.

25
<PAGE>

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 Y2K compliant or will need to be
modified or replaced. Management has completed the discovery and assessment
phase and determined the Company's state of readiness as to building
management systems in early 1999. Management expects to complete the
remediation and implementation phase by September 1999 and the testing and
verification phase 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 public 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 approximately 10% of their annual
working hours over a 2 to 3 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 reimbursed 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 or
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. Regardless, the
Company is in the process of surveying significant tenants, vendors, suppliers
and other relevant third parties to investigate whether any of these third
parties have identified Y2K system exposure within their systems that would
interrupt the Company's normal operations. 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.

26
<PAGE>

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
September 1999.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in Primary Risk Exposures

In March 1999, the Company entered into a fixed rate mortgage loan with a
principal balance of $95.0 million, monthly principal and interest payments
based upon a fixed interest annual rate of 7.20% and a 25-year amortization
schedule, and a maturity date of April 2009. The Company used a portion of the
proceeds from this fixed rate mortgage loan to repay borrowings under its
existing variable rate Credit Facility. In April 1999, the Company entered
into a second fixed rate mortgage loan with a principal balance of $30.0
million, monthly principal and interest payments based upon a fixed annual
interest rate of 7.15% and a maturity date of May 2017. The Company used the
proceeds from this $30.0 million fixed rate mortgage loan to pay off an
existing $19.0 million variable rate mortgage loan and to repay borrowings
under its existing variable rate Credit Facility. As a result of the execution
of the two new mortgage loans totaling $125 million and the simultaneous
repayment of a portion of borrowings outstanding under the Credit Facility and
a $19.0 million variable rate mortgage loan, the Company's ratio of fixed rate
debt to total debt (excluding Cumulative Redeemable Preferred units) increased
23.3% from 28.2% at December 31, 1998 to 51.5% at June 30, 1999.

The tabular presentation below provides information about the Company's
interest rate sensitive financial and derivative instruments as of June 30,
1999. All of the Company's interest rate sensitive financial and derivative
instruments are designated as held for purposes other than trading.

For the Credit Facility, the table presents the assumption that the
outstanding principal balance at June 30, 1999 will be paid upon the Credit
Facility's maturity in February 2000, and that the lenders option to 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 fixed rate mortgage debt, the table presents the assumption that the
outstanding principal balance at June 30, 1999 will be paid according to
scheduled contractual 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. The Company had no
outstanding variable rate mortgage debt at June 30, 1999.

For the Series A and Series C Cumulative Redeemable Preferred units (the
"Preferred units"), the table presents that the Company is not contractually
obligated to repay the outstanding balance of the Preferred units since the
Preferred units will either remain outstanding or be converted 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 2003 and thereafter.

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 June 30, 1999.

27
<PAGE>

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

<TABLE>
<CAPTION>
Maturity Date
---------------------------------------------
There- Fair Value at
1999 2000 2001 2002 2003 after Total June 30, 1999
------ ------ ----- ----- ----- ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities:
Line of credit:
Variable rate......... $252.5 $252.5 $252.5
Average interest rate LIBOR LIBOR
index................ +1.38% +1.38%
Mortgage debt:
Fixed rate............ $ 2.2 $ 4.8 $ 5.1 $ 5.6 $ 6.1 $214.0 $237.8 $236.7
Average interest rate. 7.79% 7.79% 7.79% 7.79% 7.79% 7.79%
Series A and C Preferred
units:
Fixed rate............ $ 98.3
Average interest
rate................. 8.49% 8.49% 8.49% 8.49% 8.49% 8.49%
</TABLE>

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

<TABLE>
<CAPTION>
Maturity Date
-----------------------------------------
There- Fair Value at
1999 2000 2001 2002 2003 after Total June 30, 1999
----- ------ ---- ---- ---- ------ ------ -------------
<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>

28
<PAGE>

PART II--OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

During the three months ended June 30, 1999, no legal proceedings were
initiated against or on behalf of the Company, which if determined unfavorably
to the Company, would have a material adverse effect upon the financial
condition, results of operations and cash flows of the Company.

ITEM 2. CHANGES IN SECURITIES--None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES--None

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

At the Company's annual meeting of its stockholders on May 17, 1999,
stockholders elected John B. Kilroy, Sr. (22,303,827 votes for and 5,325,383
votes against or withheld) as a director of the Company for a term expiring in
the year 2002. The stockholders also elected Matthew J. Hart (22,638,300 votes
for and 4,990,910 votes against or withheld) as a director of the Company for
a term expiring in the year 2002.

ITEM 5. OTHER INFORMATION--None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
*27.1 Financial Data Schedule.
</TABLE>
- --------
* Filed herewith.

(b) Reports on Form 8-K

The Company filed a Report on Form 8-K, dated April 10, 1998, which included
the audited statements of certain revenues and certain expenses for one office
property acquired in April 1998, since during 1998, the Company consummated a
series of transactions to acquire 34 operating buildings in 14 separate
transactions for a total purchase price of $175 million, which in aggregate
were significant pursuant to Rule 3-14 of Regulation S-X under the Securities
Exchange Act of 1934.

29
<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 13,
1999.

Kilroy Realty Corporation

By: /s/ John B. Kilroy, Jr.
-------------------------------------
John B. Kilroy, Jr.
President and Chief Executive
Officer
(Principal Executive Officer)

By: /s/ Richard E. Moran Jr.
-------------------------------------
Richard E. Moran Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)

By: /s/ Ann Marie Whitney
-------------------------------------
Ann Marie Whitney
Vice President and Controller
(Principal Accounting Officer)

<PAGE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> JUN-30-1999 JUN-30-1998
<CASH> 9,044 7,851
<SECURITIES> 0 0
<RECEIVABLES> 19,063 12,493
<ALLOWANCES> (1,394) (587)
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 1,311,212 1,101,231
<DEPRECIATION> (158,503) (133,037)
<TOTAL-ASSETS> 1,208,541 1,015,122
<CURRENT-LIABILITIES> 0 0
<BONDS> 490,298 357,445
0 0
0 0
<COMMON> 276 276
<OTHER-SE> 474,391 477,351
<TOTAL-LIABILITY-AND-EQUITY> 1,208,541 1,015,122
<SALES> 0 0
<TOTAL-REVENUES> 76,851 63,275
<CGS> 0 0
<TOTAL-COSTS> 36,187 30,311
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 11,919 9,379
<INCOME-PRETAX> 28,745 23,585
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 28,745 23,585
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 20,701<F1> 18,664
<EPS-BASIC> 0.75 0.71
<EPS-DILUTED> 0.75 0.71
<FN>
<F1>Net income includes ($8,025) of minority interests and ($14) equity in loss of
unconsolidated subsidiary.
</FN>

</TABLE>