Q1 2022 Corporate Office Properties Trust Earnings Call
Yeah.
Okay.
Welcome to the corporate office properties Trust first quarter, 2022 result conference call.
As a reminder, today's call is being recorded.
This time I would like to turn the call over to Stephanie Krewson Kelly C. O P T Vice President Investor Relations Ms. Krewson Kelly. Please go ahead.
Thank you Valerie good afternoon, and welcome to Copts conference call to discuss first quarter results with me today are Steve <unk>, President and CEO , Todd Hartmann Executive Vice President and COO, and Anthony Mifsud, EVP and CFO reckon.
Reconciliations of GAAP and non-GAAP financial measures that management discusses are available on our website.
In the results press release and presentation and in our supplemental information package. As a reminder, forward looking statements made during today's call are subject to risks and uncertainties, which are discussed at length in our SEC filings.
Actual events and results can differ materially from these forward looking statements and the company does not undertake a duty to update them.
Steve.
Afternoon, and thank you for joining us.
Yesterday, we announced another strong quarter.
With continued progress on our growth strategy.
Our successful performance and execution since 2018.
<unk>, our company to deliver reliable annual <unk> growth and long term shareholder value.
Over the past decade cut as deeply concentrated its invested capital in the property supporting priority U S defense missions and select mission critical assets in regions that we collectively referred to as defense 80 locations.
These locations they'll generate 90% of our annualized rental revenue.
Our concentration of leases to the U S government.
And high credit tenants supporting National Defense, and cyber security Cyber security is the foundation of our ability to generate resilient high quality cash flow regardless of the broader economy.
Our external growth strategy is driven by our achievement of pre lease.
Low risk development at these proven defense it locations.
We have an advantage position and this unique market as the go to landlord for specialized space.
That's fine government security requirements.
We continue to experience strong leasing demand is up.
March 31.
Our portfolio was 94% leased.
92% occupied.
And generating steady high quality cash flow.
Our active development pipeline.
Haynes, one 7 million square feet, both projects at defense 80 locations.
These projects are 96% leased.
And one placed in service, we will produce incremental thoughtful there will augment the growth from our stable operating portfolio.
We have a strong balance sheet to support growth.
The debt refinancing activities, we completed in 'twenty, 'twenty and 2021 enhanced our investment grade balance sheet.
Meaningfully lowered our interest expense and extended our debt maturities.
Accordingly, 97% of our total debt is fixed rate.
Predominantly in the form of long term unsecured notes largely insulated results from interest rate increases.
And providing a solid foundation for growth.
Our solid first quarter results show the strength of the strategy and execution.
<unk> per share of <unk> 58 cents.
We exceeded the high end of guidance.
Making this the eighth quarter out of the past nine there we have met or exceeded the midpoint of guidance.
Leasing remains strong and our operating and development portfolios.
We completed 871000 square feet.
Total leasing.
And this volume included 265000 square feet of development leasing or about 40% of the target for the year.
And we are on track to achieve 700000 square feet development leasing goal.
We achieved better than average vacancy leasing volume in the quarter.
The 157000 square feet, we completed is 60% higher than the trailing five year first quarter average.
And virtually all of the vacancy leasing occurred at defense it locations.
Additionally, and as discussed on our last call.
We completed the sale of D C. Six in January .
Which recycled equity to fund development and.
And further concentrated our capital allocation to defense it locations.
We continue to see the benefits of defense spending growth that began in fiscal year 2017.
Spec nearly 6% increase in the Dod's fiscal year 2022 base budget.
To further drive demand in our portfolio.
Historically, our defense portfolio benefits from strong demand and industry, leading tenant retention and is generating consistent steady financial growth.
Between 2018 in 2021.
<unk> per share compounded at four 4%.
Our guidance suggests two 2% growth in 2022 coming off the strong 8% growth in 2021 .
Beginning in 2023, we expect growth to compound.
4% or more through 2026.
So in summary, we had another strong quarter and we're well positioned for continued growth.
With that I'll hand, the call over to Anthony Thanks, Steve.
<unk> per share of <unk> 58 exceeded the high end of our guidance by <unk> <unk>.
Due to stronger than expected same property results and the timing of development fees.
We continue to expect same property cash NOI to be flat to down 2% for the year.
It should grow between 50, and 100 basis points and our regional office segment, which now represents only 10% of our annualized rental revenues will decline, 20% to 25%, reflecting the transamerica vacancy that occurred on January one and the roll down in rent associated with the 15 year care first renewal executed.
In December .
Same property occupancy of 92, 2% was in line with our guidance range and we expect same property occupancy to be between 91 and 93% at year end.
NOI from development placed in service, we will continue to drive growth.
Developments recently placed into service contributed $1 million in the first quarter and we expect the total cash NOI contribution for the year of $15 million to $17 million all of which is contractual.
In terms of capital the sale of DC six provided $223 million of proceeds which further strengthened our balance sheet.
Based on projected development investments, we expect to recycle out of existing assets toward the end of the year to maintain our conservative leverage.
As Steve touched on between September 2020, and November 2021, we issued $1 $8 billion of new senior notes with a weighted average term of eight nine years and retire debt carrying a weighted average term of just two one years.
As a result of this proactive refinancing we increased the weighted average maturity of our consolidated debt portfolio from three years to seven years today and.
Lowered our exposure to variable rate debt.
Over 11% to less than 3%.
Lastly, as detailed on pages 12, and 13 of our slide deck, we are narrowing our full year range of <unk> per share to reflect first quarter results.
The $2.34 midpoint continues to imply two 2% growth over 2021 <unk> per share results as adjusted for comparability and reflects about two percentage points of dilution from the January sale of DC six.
And now I'll hand, the call over to Todd. Thank you Anthony.
Our future results will benefit from the strong leasing volumes achieved in the first quarter total leasing volume was 871000 square feet or nearly 150% of the first quarter five year average.
Ah 64% tenant retention ratio reflects transamerica is 141000 square foot non renewal at 100 Light Street and was included in our full year retention guidance of 70% to 75%.
Excluding transamerica, we renewed 78% of expiring leases in the quarter and we remain on track to achieve our retention guidance for the year.
Cash rents on renewals rolled down five 7%, which was anticipated and is included in our full year guidance for cash rent spreads to roll down 1% to 3%.
The 157000 square feet of vacancy leasing we completed was very strong.
This result was 60% higher than the trailing five year average for first quarter and represents the third consecutive quarter that we have exceeded our five year average.
96% of the quarter's vacancy leasing was in defense it locations. Additionally.
Additionally, nearly 75% of this lease space, we will have secured compartmentalized information facilities, creating high barriers to exit for the tenants who will be investing in additional two and a half to three times. The Ti allowances, we provide to complete the build outs.
Development leasing was strong as well we executed a 265000 square foot build to suit for a cloud computing customer in northern Virginia.
We are tracking one 2 million square feet of potential build to suit and major pre lease demand and our development leasing pipeline, which supports our objective of leasing 700000 square feet in developments this year.
Finally, we are encouraged by the activity on our larger vacancies at.
1200, Redstone Gateway, we are working with more than 300000 square feet of demand or nearly three times the building's availability and expect to have the former Boeing space leased well before the end of the year.
At 2100 L Street in Washington D C. The volume and pace of activity has markedly improved we are working with 165000 square feet of prospects or more than double the building 74000 square feet of availability.
Similarly activity strengthened at 100 light Street in Baltimore, where we are tracking a 145000 square feet of prospects.
Representing an 82% activity ratio.
We look forward to announcing progress on that this activity in coming quarters with that I'll hand, the call back to Steve.
To summarize.
We delivered another strong quarter.
We are on track to meet or exceed our 2022 business plan.
Vacancy leasing remains strong.
First quarter results significantly exceeded our five year quarterly average.
We are on track to achieve our full year guidance for development leasing and we expect strong second quarter results.
Our one 7 million square feet of active developments are 96% leased.
<unk> incremental NOI from these properties that will drive <unk> growth in coming years.
Our development leasing pipeline as well.
One 2 million square feet of opportunities.
Which we believe will translate into strong future development leasing.
Congress appropriated the fiscal year 2022.
National Defense Authorization Act in March.
Providing the department of defense with a five 8% increase in its base budget.
The largest annual increase since.
Fiscal year 2018.
Suggesting leasing demand will remain strong into 2024.
Lastly, we've delivered strong growth over the past three years.
And we expect to continue to deliver both <unk> and NAV growth in the coming years.
Operator, please open up the call for questions.
Thank you Mr Bedard, ladies and gentlemen, if you'd like to ask a question. Please press Star then one on your touch tone telephone again, if you would like to ask a question. Please press Star then one.
Our first question comes from Manny Korchman of Citi. Your line is open.
Hey, everyone. Good afternoon.
Thanks for sharing the pipelines on those three.
Big targeted lease ups just.
How is your confidence level on on getting those done now versus maybe a few months ago I know you've sort of broken it down to how much demand you have for each in their multiples.
That's sort of what's the probability of actually getting leases done in one timeframe.
Well, we're very encouraged by the activity increase at all of the assets.
Over the quarter.
We've seen increases in DC increases in Baltimore and increases down in Huntsville and.
The probability of getting a lease that is hard to predict we're very confident that we will get leasing done in the coming quarters, but I hesitate to put a timeframe on it.
But you feel better now than you did a little while ago it sounds like.
Yes, I think activity overall is increasing we have seen as we said increasing levels of activity in DC and increasing levels, increasing tour activity in Baltimore, increasing tour activity in D. C. So, yes, I would characterize activity is increasing.
We are extremely confident in Huntsville.
Right and then in terms of the same store NOI growth guidance.
Thank you guys exceeded your own plan for for the first quarter.
But that didn't lead to a lift in the year is there an offset somewhere or is it just kind of already accounted for in the range.
If you look at the.
The actual outperformance in the first quarter.
The actual total cash NOI increase versus our midpoint of guidance range was about $550000. So it wasn't a lot. It wasn't a lot of incremental NOI that drove the percentage outperformance first of all and then as you look at the quarterly cadence of cash NOI.
The first quarter benefited from the burn off of free rent on several large leases.
Which offset the impact of the Boeing and Transamerica.
Vacancies and we don't have the benefit of that in the second and third and fourth quarter, because that free rent had turned into cash rent in 2021 already.
Anthony I guess I guess the question more is if you look at slide 11 of the presentation.
You had a range of zero to 1% you came in at one 2%.
Let's see you exceeded your own range, but the midpoint of your own range by 70 basis points.
I guess the question is why doesn't that flow through to the rest of the year. If you if all those things you just named.
Or should have been I guess known to you. When you put out this initial guidance. So what changed that wont remain sort of I guess more permanent for the rest of the year.
Versus where your initial expectations were.
I guess, what I was trying to point out is that the half a million dollars outperformance in the first quarter.
Would increase where are the midpoint of our.
Of our total range, but not by enough to change the total range for the year.
So.
It's just not enough to move it from zero.
Flat to down 2% to something that's 50 basis points higher so.
Yes.
Nothing nothing else has really changed.
Got it I appreciate that thank you.
Yeah.
Thank you. Our next question comes from Blaine Heck of Wells Fargo. Your line is open.
Great. Thanks, Good afternoon, just related to <unk> question on vacancy leasing and specifically with respect to Red stand 100 light in 'twenty 100 L is there anything included in guidance related to leasing at any of those properties.
No I don't believe there is no.
Okay great.
And then just a switch.
Switching gears here just thinking about the inflation we've seen this year, Steve maybe can you can you talk about how that might be affecting development cost and whether your yields are being affected on that side of the business.
Yes, that's a great question so.
Actually did an exercise this last quarter.
We're benchmarking our 808000 series.
Developments, which are the easiest like for like comparison that we have in our portfolio.
<unk> 8000 to our most recent development costs actually increase over two years about 22%.
But our.
Our rental rates that we achieved are about 22% as well so we've been able to increase our rent because of the strength of demand in defense.
To preserve our targeted development yields.
You realize is.
Rents continue.
Costs continue to escalate.
That'll that will pick up with each and every asset.
Okay. That's helpful and then Steve sticking with you in more of a big picture question here.
What effect do you geopolitical tension like like what we're seeing now with Russia have on increasing government and contractor demand for new space in your key markets are there any prior instances you can point to where new military conflict or rising geopolitical stress seem to lead to increased space needs with.
In your portfolio and maybe help us understand how that played out.
What was the timeframe and what was the scope of the increase in demand.
So I haven't heard anything occur quite like this.
I've been with the company, but the.
As I described the prices so I think it will be clear.
No.
When the government response to <unk>.
Needs in the Defense Department.
So through Congress through increased spending.
That spending ends up.
Into our NDA appropriation.
That appropriation is.
Flows into the Dod.
Were they conceptualize.
The things that they need the structure them in contracts.
Have competitions, the contractor or is awarded a victory.
Then the need for space manifest in our portfolio.
So it's generally.
At least 12 and 18 to 24 months after.
The increase in the defense spending.
That will realize the benefit of leasing which is why my comments conveyed confidence in demand through 2024.
Great very helpful. Thanks, guys.
Thank you. Our next question comes from Brian <unk> of Evercore ISI. Your line is open.
Hi, Steve So you talked about 4% annual compounding <unk> growth beginning in 2023.
Could you, maybe just walk us through the components of that.
And what Youre, assuming in terms of regional office.
Regional asset sales there.
To what degree with.
With these forecasts to be effected by a recession.
Well. So that's great question I don't want to get into specific components.
This be misconstrued as some sort of guidance what I can.
<unk> management is conveying strong confidence in the company is positioned to generate good growth and then confidence really comes from our five year modeling.
So we completed at the beginning of each year.
Their most recent modeling process.
With the 22 to 26 period.
It was robust we were in 10 different scenarios and then stress those scenarios.
So to give you. An example, we had four different capital recycling alternatives.
We modeled three different development spend.
Scenarios.
We modeled in the impact of.
Deep recession, starting in the end of 2023.
And then we stress them all for higher labor rates in response to the change in interest rates that have occurred.
And that exercise gives us confidence.
Thereafter, the dilutive year from the sale of DC, six that we can generate 4% or better growth.
Okay and Anthony your comment about recycling out of some assets at the end of this year I assume that was directed toward them.
D C shell sales is that right.
That is that is one of the options that we have to generate approximately $75 million to $80 million worth of capital that we're projecting to need by the end of the year.
Okay.
What extent are you exploring or having conversations regarding regional office.
Sales in.
How is that activity changed at all in light of the recent move in bond yields.
Well, we monitor the capital market.
For office properties in Baltimore, and in Northern Virginia, and our data center shells.
Yes.
Each quarter I.
I would say that all of our regional assets or potential recycling candidates.
Some point in time as an alternative to the.
The shelves.
And when we see an opportunity.
That is optimal for you one of those to market.
It's a definite possibility.
Okay alright, thank you.
Thank you. Our next question comes from Jamie Feldman of Bank of America. Your line is open.
Hi, everyone.
Jamie Thanks for taking my question.
Going along the lines of the last question could you talk a little bit more about the investor appetite for your assets, whether it's data center shells or the regional office portfolio.
Cap rates or buyer pool changed with the rising interest rate environment.
Well demand for our data center shows has been extraordinary.
I don't believe demand has changed at all.
I have no comparable sales.
To provide indication that cap rates have crept higher.
Higher on those assets.
With regard to some of our regional assets there is sales activity in both.
The Baltimore market Northern Virginia.
They're active.
Processes being conducted so.
So we don't have the outcome from a cap rate perspective.
But I will say that the.
Selling entities.
We have pretty high expectations for attractive cap rates.
Okay.
Okay, great. Thank you very helpful and then.
Rising rates recession concerns or economic concerns in general slowed tenant lease decision, making or not really considering your tenant mix.
No, we really haven't seen a slowing in.
The pace and progress of our leasing and is reported out in our remarks.
The first quarter virtually all of our leasing was in the regional I'm, sorry defense segment.
So we just don't see that impacting that.
Matt.
Really speaks to the strength of our strategy.
Our markets are driven by defense budgets more than there, but the overall economy.
Okay, great. Thank you that's helpful.
Thank you. Our next question comes from Rich Anderson at MDC. Your line is open.
First question is on DC six no just kidding.
Yes.
Yes.
So.
Yes.
I can do this math myself developer.
Development assets as a percentage of total assets.
Are you at right now.
10%.
On a square foot basis, it's probably 9%.
Okay. So, let's say, 9%, 10% is that your is that your comfort zone to maintain it there. The reason why I ask is as you complete development and put them into the operating portfolio.
<unk> growing for you and producing cash.
NOI.
That's more valuable part of the story from the standpoint of the stock market. I know you guys are development and its vital to continue that going but from just from the standpoint of.
No.
Higher stock forms I think the same store portfolio in the in the production of cash.
Rents.
As more valued by the market.
And so do you see development.
Staying there or declining as the operating portfolio gets bigger.
That would be my first question.
As a percentage I would say it would probably diminish a bit.
Remember, we're a low risk developer with a strong preference to build to the.
A significant pre lease or a build to suit.
So we're not going to introduce more product than we see demand in our markets to remain to maintain targeted square footage ratio, but we've.
We've delivered on average over 1 billion one square feet of development leasing for a decade, we have no reason.
On average over a longer period of time, we think that would materially change.
I think you should never changed our stripes as a developer, but I do think the stock market has immediate gratification mentality. When it comes to development Thats just my opinion.
So balancing that with what you need to do long term is I guess.
Essence of my question.
The second question is the spread 200 basis points spread between the leased percentage in the occupied percentage 94 versus 92 I'm wondering how.
How that might change in the future.
That seems tighter than I think I'd normally seen and maybe you could just comment on that.
Tighter yeah.
But normally 200 basis I've always thought it was a little bit wider than 200 basis.
I think it's.
I don't studies.
Yes.
Why don't we follow up with you.
Rich.
Stumping is Steve it's so much fun.
So we did get a lot of vacancy back in the last quarter with Transamerica.
Transition with Boeing.
Good demand behind it.
We expect that would create some opportunity for nice growth next year.
Okay.
And then my last question is with everything Thats going on in Ukraine, and you just walk through the process of congressional approval to leasing I thought that was very interesting perspective. So thank you for that but in the office.
Business, you, obviously run a niche and theres other niches in office like life Science, and you've seen a lot of conventional office player players trying to get themselves intertwined into life Science World.
That's similar dynamic happening in your neck of the woods or is it the reverse that people kind of.
Hesitate to work directly with the government because theres. So much that goes into having to do that you guys have your clearances and all that sort of stuff. So is it are you are you seeing more or less in the way of competition for your specific niche in the current environment.
So we haven't seen a change.
Yes.
Recent years overall, I would say I thought there was more competition.
In Maryland from 2012 to 2014 or 15.
We experienced today.
There were some projects that were started with.
A desire to compete head to head with some of our better assets.
<unk> succeed them.
No longer exists.
But we don't see elevating competition and remember one of the unique advantages of our franchise has not only the clearances and the capabilities. The 25 year history of working on secure assets for the government. We have advantage land positions they tend to die.
Dominate when competitions recur.
No.
I think our competitive posture is as good as it's ever been.
Okay, great. So all I have thanks.
Thanks.
Thank you.
Next question comes from Tom Catherwood of <unk>. Your line is open.
Thanks, so much and good afternoon, everyone.
Yes.
So Todd I wanted to just kind of loop back on your comments on 'twenty 100, L Street, just with the demand improving their commentary last quarter was.
Say muted at best to somewhat negative on the DC market can you talk a bit about the improvement that you saw in the first quarter and kind of what's driving that uptick in demand and maybe what specific tenant sectors.
Sure well.
Activity has increased dramatically over the quarter as DC overall has emerged from the pandemic and its more and more in the rearview mirror keeping.
Keep in mind.
<unk> thousand $100, a trophy asset well located in the western edge of the CBD, which is one of the more popular submarkets in D C.
And I think as a flight to quality continues with tenants coming back into the market, we're going to see increased demand.
Over the long haul for $2100. So I think largely it's people returning to the market pursuing a flight to quality and as a result, 100 L is seeing the benefit of that activity.
Got it and then Steve maybe along those same lines last quarter. You had drawn this kind of comparison between D. C proper and your markets at MVP in Columbia Gateway and kind of the stark difference in demand and maybe dimension that it felt like Covid was over at that point in time in your Columbia, Maryland.
Markets.
With the pickup in D. C has that come at the expense of your other markets like MVP in Columbia Gateway or do those how does the demand trend in those other markets.
There is no scenario, where our markets overlap for demand.
Yes.
Completely unrelated.
Demand is very strong.
Fort Meade area.
Some great leases that we executed this last quarter expect strong full year leasing there.
We're just.
Unrelated.
Plenty of opportunity for D C to approve improve.
No impact on our activity.
Understood.
And then.
Going back to the defense portfolio last quarter, you'd also talked about potentially shifting to two regional assets into the defense portfolio as the tenant base was changing it looks like that happened. This quarter. When you make that shift is there kind of a marked change you have to make.
Marketing a building is there additional capital you have to put into it to make it defense I T ready.
Is there anything else or is it really just a.
We are moving from one bucket to the next.
Well, it's really an evolution in the tenant.
Yeah.
Occupancy and the nature of the tenants in the building those two buildings are in Sunrise really drove there.
Near Dulles Airport.
Over the last really three years.
Yes, it started attracting more defense and cyber contractors.
And this quarter, we signed a major lease four very important tenants is going to be doing.
D O D work.
Creating a full scale facility.
And it occurred to us to look at our concentration of defense versus non and that buildings now 80% defense tenant.
So its its.
Its appeal to the market that we desire.
<unk>.
Evolve naturally tour, we consider to different.
Different portfolio than when I set those segments back in 2014.
And Tom in addition to that the it's not just our two buildings. It's also the location the buildings around them that have also had the same kind of changes in their tenancy.
And that sort of both sub market in terms of the defense tenants and contractors who have.
Migrated towards that area.
Got it got it and it seems like it's the clustering effect then.
As more demand kind of or there's more demand is concentrated in that area.
These contractors tend to group together is that a fair statement.
It is.
And then last one for me.
Kind of putting all the pieces together and as you are talking about the potential for 4% plus growth going forward. How do you think about the dividend strategy as it ties into that I mean, obviously, you're growing your asset base through development spending each year.
But with those rolling into the portfolio what are the thoughts on strategically managing the dividend going forward.
Well, we've maintained a posture of the.
Constant dividend.
Any surplus cash flow funding their development.
We're not planning to change that philosophy.
But as we look forward.
We have to balance that against our taxable income and there will be a point in time.
The future.
Well.
<unk>.
The growth in our text, we willing to commit to start moving our dividend.
But I don't want to put out a firm date.
I totally get it that's it from me thanks, everyone.
Thank you Tom.
Thank you again, ladies and gentlemen, if you'd like to ask a question. Please press Star then one on your Touchtone telephone. Our next question comes from Bill Crow with Raymond James Your line is open.
Hey, good afternoon all.
From a macro pumped the increased budget defense budget is clearly good news, but on a micro basis when it really comes down to your portfolio, it's more about the specific contracts.
Contractors win or lose.
Also M&A within the contractor space and I'm, just curious whether there was anything on the renewals expansions nonrenewals or M&A that we should consider as we think about the next year.
No Theres no big M&A.
Sure.
There were aware of currently that would have any kind of a negative or positive effect on us.
In terms of renewals.
But for our transamerica in the Boeing renewals, we've disclosed over the next two years, we expect a very strong renewals.
With.
A brief bridge to the nature of our.
Leasing.
Todd made the point that 75% of the space.
We leased in this quarter all require skilled facilities.
And Thats a characteristic in the demand right now.
A lot of tenants looking to either add attain our expanse gift.
And their leasing objectives.
It wasn't I wasn't really big.
20 years ago, and then did it did it just kind of phase out a little bit now it's coming back.
Think about it.
<unk> always been vitally important.
And hard to get its complicated process.
A long time to build with escalation in construction costs.
That was very expensive to build scale.
It's a bit of a catch 22 you'd need to contract to get a <unk> you need to do the contract.
So skip is extremely valuable and it always has been.
Okay. Thank you.
Thank you Bill.
Thank you I'm showing no further questions at this time I will turn the call back over to Mr. <unk> for any closing remarks.
So thank you all for joining the call today.
We will be in our offices. So please coordinate any follow up questions with Stephanie if you.
If you have any thank you.
Thank you for your participation today and corporate office properties Trust first quarter 2022 without conference call. This concludes the presentation. You may now disconnect good day.
Yes.
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