Q2 2022 Corporate Office Properties Trust Earnings Call
Okay.
Welcome to the corporate office properties Trust second quarter 2022 results Conference call. As a reminder, today's call is being recorded at this time I will turn the call over to Michel Alain C. O P. Ts manager of Investor Relations MS Lake. Please go ahead.
Thank you Catherine good afternoon, and welcome to conference call to discuss second quarter results and updated guidance for the year with me today are Steve the Dor, President and CEO , Todd Hartmann Executive Vice President and C. L O and Anthony Mifsud Executive Vice President and C F.
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 in our SEC filings actual events and results can differ materially from those forward looking statements and the company does not undertake a duty to update them.
Yeah.
Good afternoon.
Thank you for joining us.
We achieved another strong quarter.
With continued progress on our 2022 business plan.
Successful performance and execution of our growth strategy.
Since 2018, we have positioned our company to deliver reliable annual preferred growth.
And long term shareholder value.
Yeah.
Over the past decade deeply concentrated investment in the property sporty priority U S defense missions and so on.
Mission critical assets in regions that we collectively referred to as.
As defense it locations.
At the end of the quarter.
There are cases generated 90%.
Our annualized rental revenue.
These locations is driven by a correlated with national security spending and largely immune from conditions in the overall economy.
Our concentration of leases to the U S government and high credit contractors supporting National Defense and cyber security missions is the foundation of our ability to generate resilient high quality cash flow.
Our external growth strategy continues to be driven by successful pre leased and low risk development at these proven defense 80 locations.
We have an advantage position and this unique market as the go to landlord for specialized space satisfying government security requirements.
Okay.
We wisely protected our balance sheet and as a result, the current interest rate environment poses limited risk star performance.
The $1 $8 billion of refinancing completed in 2020 in 2021 provide a solid foundation for us to deliver future growth from our operating and development portfolios.
Our second quarter results show, the strength of our strategy and execution.
<unk> per share of <unk> 59 cents matter.
The high end of guidance.
This is the ninth quarter rather than the.
Past 10.
We met or exceeded the midpoint of guidance.
As a result, we are increasing the midpoint of our full year guidance and narrowing the range.
We've seen remained strong and our operating and development portfolios.
As of June 30, our portfolio was 93, 6% leased.
And 91, 6% occupied.
We completed 558000 square feet of total leasing during the quarter.
We achieved a solid vacancy leasing volumes with 120000 square feet, we executed equally in our five year average for the second quarter.
Additionally, we have a large volume of leases pending execution.
That suggests our third quarter volume will be exceptional.
With total volume included 211000 square feet of development leasing primarily from a 186000 square foot full building pre lease.
This activity brings our year to date achievement.
The 68% of our 700000 square foot objective.
Okay.
Travel in this quarter's development leasing success, our active development pipeline now contains one 9 million square feet of projects all of which translate to your locations.
These 91% leased projects are 91% leased.
With a high level of demand in the <unk> space.
The projects will deliver between 2022 and 2024.
And when placed into service.
<unk> produced $47 million of incremental annualized NOI that will drive further growth in <unk> per share.
For fiscal year 2022 National Defense Authorization Act passed through the base budget increase of five 8% Rep.
Representing the largest increase since 2018.
We expect demand from this budget to manifest in our leasing pipeline in mid to late 2023.
Recall that following the 14% increase in the defense budget that occurred in 2018.
We achieved record leasing levels in new development and vacancy leasing in 2019.
Moreover, our current actions and the defense committees of the house and Senate suggest another healthy increase in the 2023 NDA.
These events give his character is leasing demand will remain strong through at least 2024.
Turning to inflation.
Severe and rapid escalation of material prices over the first half of the year impacted developed requests increasingly.
Increasing the year over year hard costs.
Like for like development projects by approximately 18%.
The demand in our defense portfolio was driven by National security needs and funded mission priorities and we have been able to renegotiate rents that maintain.
Historical development yields.
Our defense portfolio benefits from strong demand for new space and industry, leading tenant retention and the current economic conditions have not impacted our demand or achievement.
Positioning our portfolio to continue to generate consistent steady financial growth.
Between 2018 and 2021.
<unk> per share compounded at four 4%.
Coming off the strong 8% growth in 2021 arrive.
Our revised guidance suggests two 6% growth in 2022 after absorbing the dilutive effect of the sale of DC six.
Beginning in 2023.
We continue to expect growth to compound at 4% or more through 2026.
So in summary, we had another solid quarter.
Our strong pipeline.
<unk> and our fortified balance sheet reinforce our confidence for continued growth.
With that I'll hand, the call over to Anthony.
Thanks, Steve.
Quarter results continue to show the strength and resiliency of our portfolio. Despite the uncertain economic environment.
<unk> per share for the quarter at <unk> 59 was.
It was at the high end of our guidance range.
The one San achieving above the midpoint was due to lower than forecasted G&A expenses and the timing of repairs and maintenance projects that we expect to complete in the second half of the year.
The timing of the R&M projects produce same property cash NOI results that were slightly better than our forecast and our other property portfolio metrics for the quarter were in line with our expectations.
Since we expect to complete the delayed R&M projects later in the year. We continue to forecast same property cash NOI to be flat to down 2% for the year.
This guidance assumes that the defense it locations are flat to up 2%, while the regional office portfolio impacted primarily by the transamerica and care for our transactions.
<unk> to be down just over 20%.
Stronger than budgeted leasing activity has resulted in an increase in our forecasted same property occupancy at year end and as a result, we are tightening the range of guidance and increasing the expected midpoint by 50 basis points to 92, 5%.
NOI from development placed into service, we will continue to drive growth.
We continue to expect between 15 and $17 million of cash NOI in 2022 from completed development projects at the midpoint, 100% of this NOI is contractual.
With respect to the impact of the current interest rate environment at the end of the quarter, 86% of our debt was fixed rate and another 11% was variable rate debt swapped to fixed through year end.
The $1 $4 billion of fixed rate bonds issued last year, which have an average interest rate of two 6% and a weighted average term of issuance of just under 10 years significantly extended our debt maturities.
Prior to these transactions at year end 2020, we had $1 6 billion or almost 80% of our debt maturing between 2022, and 2025, which included almost $1 billion maturities in 2022 and 2023.
This refinancing activity took advantage of the historically low interest rate environment and pushed our first bond maturity into the first quarter of 2026.
<unk>, our exposure to the current increasing rate environment.
The only debt maturing prior to 2026 is a $100 million term loan later this year and our line of credit which has an initial maturity in the first quarter of next year.
We are working with our bank group on a new term loan and an extension of the maturity of our $800 million line of credit.
New term loan, which is expected to mature in 2028 will fund the repayment of the $100 million term loan and pay down a portion of the outstanding balance on our line of credit.
We expect these financing transactions will close before the end of the year.
With respect to the equity capital needed to fund our development investments and maintain our balance sheet strength roughly 25% of this year's investment will be funded by cash from operations with the remaining equity capital coming from the proceeds from the sale of DC, six and recycling out of existing assets towards the end of the year.
Finally, we are narrowing our range and increasing the midpoint of <unk> per share from our prior range of $2 31 to $2 37.
To a new range of $2 33 to $2 37.
As a reminder, our guidance includes <unk> <unk> of dilution from the sale of DC six and the increased midpoint of $2 35 per share implies two 6% growth over 2021 peso per share results.
Now ill hand, the call over to Todd Thank.
Thank you Anthony leasing activity remains strong and we are confident that we will meet or exceed our objectives for the year.
We completed 228000 square feet of renewal leasing during the quarter for a retention rate of 58%.
The retention rate was anticipated and heavily influenced by two non renewals and.
In Huntsville at 1100, Redstone Gateway, we negotiated a 48000 square foot reduction with Boeing providing much needed second generation capacity to meet market demand. We are currently negotiating a lease with a defense contractor for the entire vacancy and expect to have that space leased and occupied in the third quarter.
In Baltimore at our Canton crossing property, we experienced a 28000 square foot non renewal during the quarter, we executed a new lease for 15000 square feet of this space.
Occupancy expected in early 2023.
Cash rents for the quarter rolled down eight tenths of a percent and straight line rents increased seven 8%.
We expect renewal activity for the balance of the year to be very strong and heavily weighted to the fourth quarter and that our annual renewal volume will reach our historical average of 2 million square feet by year end.
As a result, we are increasing the midpoint of our retention guidance to 75%.
Looking forward to 2023 and 2024, we expect our strong retention rates to continue during.
During 2023 and 2024, we have 21 expiring leases larger than 50000 square feet totaling $2 4 million square feet, we expect to renew more than 95% of that space. These 21 leases represent 50% of all the expiring footage in 2023 and 2024 and <unk>.
12 full building leases for highly improved buildings, including six secured buildings leased to the United States government.
Three buildings leased to defense contractors, and three data shell properties with significant tenant investment.
The mission critical nature of these properties and the priority missions. They support in the form of our estimate of this high retention rate and supports our confidence in our projections for future growth.
Regarding vacancy leasing volume of 120000 square feet was consistent with our five year average for the second quarter demand was broad based across all of our markets with transactions completed across our defense markets as well as in regional office.
277000 square feet year to date is 23% higher than our five year average and we remain on track to meet or exceed our annual vacancy leasing goal.
Steve mentioned, we have a large volume of leases pending execution that suggest our third quarter volume will be exceptional.
Development leasing totaled 211000 square feet and our year to date total is 476000 square feet during.
During the quarter, we executed a 186000 square foot 11 year build to suit lease with a defense contractor at the National business Park.
Is the second full building long term defense contractor lease executed at the MVP and a little over a year.
Our development leasing pipeline of $1 2 million square feet gives us confidence we will achieve our 700000 square foot development leasing objective for 2022.
Lastly in terms of our remaining large vacancies we are encouraged by activity levels in our regional office segment, we are tracking more than 100000 square feet of activity at 100 Light Street in Baltimore, and 140000 square feet at 2100 L Street in Washington D C.
Activity is strong, but given competitive pressures in our regional office markets, we anticipate a slower pace of lease executions.
At 1200, Redstone Gateway, we are close to executing a lease with a defense contractor for the full 121000 square foot vacancy with commencement expected to occur close to year end.
Additional demand from contractors for space at Redstone led us to commence construction on our next 125000 square foot inventory building 8100, Redstone Gateway and we look forward to announcing leasing progress on this project in the coming quarters with that I'll hand, the call back to Steve.
To wrap up.
We completed the first half of the year ahead of plan.
And we are on track to meet or exceed our 2022 business plan.
Vacancy leasing remains strong.
First half vacancy leasing results exceeded our five year average by 23%.
Our one 9 million square feet of active developments or 91% leased.
And incremental NOI from these projects that will drive <unk> growth in coming years.
Our development and leasing pipeline is one 2 million square feet of opportunities, which we believe will translate into continued development achievements.
Congress appropriated in 2022 defense base budget with a five 8% increase.
The largest annual increase since fiscal year 2018, suggesting leasing demand will continue through calendar year 2023 and beyond.
Our prior year financing activities locked in historically low interest rates and minimize our exposure to the current volatile environment.
Lastly, we've delivered strong growth over the past three years.
We expect to continue to deliver growth and NAV growth in the coming years.
With that operator, please open the call for questions.
Yes.
Thank you as a reminder to ask a question press Star one one please standby, while we compile the Q&A roster.
Okay.
Okay.
Sure.
Okay.
Our first question comes from Michael Griffin with Citi. Your line is open.
Hey, Thanks for taking the question Todd maybe getting back to your comments on the demand at 100 line in 'twenty, one 'twenty one.
100 al can you add any additional color on sort of why you're seeing I guess marginally less demand relative to last quarter was it any specific tenants that you might've been tracking or just less demand youre seeing in those markets I mean any color there would be great.
Sure.
As it relates to a 100 light.
We had.
At least one state tenant that we are working with last quarter that.
<unk> was offered space at a much lower rate and another building and elected to go that direction by.
My remaining.
Activity at the building is strong and we're very encouraged by it and at 2100 al.
I think it's just the vagaries of the market and we had one tenant that.
We are tracking again.
Did you renew in the building and so that kind of dropped off our list.
Okay.
That's helpful and then kind of coming back maybe big picture I have Steve you kind of mentioned this repaired remarks, but just as it relates to defense spending.
The article earlier this week about the Senate Appropriations Committee seeking more funding for defense spending than the White house kind of requested some of that might've been related to the effects of inflation and whatnot. I guess is there a worry maybe as we get into election season. If there ends up being a divided government that you could see kind of a slowdown in that defense spending and maybe kind of what that translate.
So for your business.
No.
Let's talk about.
<unk> spending volume.
We're very confident that there'll be a substantial increase for the 23 NDA as well as potential for some supplemental.
Increases to deal with the impact of inflation.
And that confidence really comes from.
High level of unity in the Senate and House Armed Services Committee votes. Both of those committees are seeking funding well above the presidential request. So we think the magnitude is going to be high and potentially further increase for inflation.
Timing could be difficult, it's likely that this NDA won't be passed by the end of September .
It will end up in a continuing resolution.
Each could be delayed until after the election.
Time will tell.
In the last decade, I think we've only had one NDAA paths.
With that came to a resolution.
Okay. That's it for me appreciate the color.
Thank you <unk>.
Okay.
We have a question from Blaine Heck with Wells Fargo. Your line is open.
Thanks, Good afternoon.
Starting with Anthony just on same store NOI are there any do offset to the outperformance in the first half that meet you reluctant to kind of increase the full year guidance, especially given that it seems like occupancy and retention are ahead of expectations and an occupancy comps from last year could get a little bit more favorable as the year progresses.
Yeah.
No.
Variances that we've experienced to date.
Especially in the second quarter were more timing as it related to the same impact on same office cash NOI. We did have some variances in the first quarter that were more permanent in nature, but still the impact of those fell within the range of guidance and Thats, what we had discussed on our first quarter call.
With respect to the changes in occupancy and the impact on same office cash NOI.
A majority of the changes in.
That led us to increase the mid point of occupancy at year end really occur later in the fourth quarter. So they benefit occupancy at year end, but don't contribute to this year same office cash NOI will get the benefit of that into next year.
Got it Thats helpful.
And then maybe for Steve or Todd.
The data center REIT recently commented on potential challenges related to the power supply in northern Virginia from Dominion energy and delays that they could cause in the construction of new data center properties. So just wondering if you guys are dealing with any issues related to that and any potential delay that could cause on your.
Data center shell projects.
Yeah, that's a good question.
The comment really refers to the construction.
Of new.
Transmission lines and expansion of Substations beyond capacity that exists today.
All of our development sites will be serviced by components of either Dominion or Novak that are built and our customer has.
Our commitment for that power. So we don't believe it will affect the timing of our lease execution.
Okay very helpful. Lastly, just thinking about the inflation we've seen this year, Steve can you talk about how that might be affecting development cost and whether your yields are.
Being affected at all on that side of the business.
We made a comment in our prepared remarks.
Sure.
MBP.
550, which we just announced yesterday if you look at our supplement is 14, 4%.
<unk> hundred 50, which we locked in the pricing on just over a year ago.
Yes.
The material component of the hard costs increased 18% year over year.
<unk> been able both in the MVP in Redstone gateway to move our rents in harmony with those increases in costs and preserve our historic yields on those assets.
But each development will be.
We will face a new set of market conditions and it'll be a.
Challenge each and every time, we negotiated deal.
Very helpful. Thanks, guys.
Okay.
Thank you we have a question from James.
James Feldman with Bank of America. Your line is open.
Alright. Thank you I guess following up to <unk> question.
It sounds like you can keep you can still hit your development yields with higher rents on the development, but.
Are you able to push rents in your in service portfolio around those same assets.
Well, particularly at the MVP revenue.
Very good success.
Locking in existing portfolio rents that are very near our new development and rental rate.
We don't have as much second generation space.
In Redstone gateway for both of the leases for second Gen space that we're leasing.
Significant roll ups from the expiring rents that they had that are very close to our development and rental rates.
Okay.
Okay.
And then.
Going back to the budget you had talked about confidence confidence on the 23 budget growth.
Any any early indication of just how strong that uptick could be is it more or less than the five 8% for <unk>.
Okay.
So some of the information we saw was 10% overall.
Without more until it's hard for us.
Handicap, how that hits the base budget, the <unk> based budget, which is really what funds the leases that we negotiate.
But I would expect it to be in at least five.
<unk>.
7% if not higher.
Okay.
And then finally I appreciate the color on the large black explorations through 'twenty four.
I think you said you expect to renew 90% now.
No. Good deed goes unpunished. So can you talk about the other 10%.
We said above 95%.
And.
<unk>.
We just had some probability that.
One of the trends contractor.
Full buildings may not quite renew.
<unk> you.
Moving back a small portion.
<unk>.
A downsize in one of the regional office leases.
That is in that set of leases above 5000 square feet over the next two years.
Okay. So it sounds like one lease is really what you're worried about.
Sure.
Okay.
And by no means all of it we expect both leases to renew.
The regional office, we expect or we released built in probability that it could contract.
Up to about 50%.
And the defense contractor building, maybe a small component like 10 or 15000 square feet.
Okay.
And where when do those expire.
I believe both of those are in 'twenty three.
24 24, Sir.
Okay.
'twenty three with no concerns it sounds like.
Okay.
Okay, great. Thank you.
Great.
Okay.
We have a question from Steve <unk> with Evercore ISI.
ISI Your line is open.
Thanks, Good afternoon.
I guess one question for Anthony just to go back to what you talked about on the dispositions and the funding for the development needs. You said you have a couple of assets that youre going to sell by year end can you just sort of talk about the types of assets those are and given the dislocation we've seen in the <unk>.
<unk> market and where do you think cap rates are for those dispositions.
So our current forecast assumes that later this year, we venture two data center shells.
Pre currently wholly owned.
It generates about $80 million worth of proceeds.
Cap rates for shelves continue to seem like Theyre holding up.
Area close to where we executed back in June of last year.
So.
As of what we've seen right now we really haven't seen cap rates for those types of assets come under some of the kind of pressure that some of the other.
CBD and other office markets have.
Great. Thanks, that's it for me.
We have a question from Dave Rodgers with Baird. Your line is open.
Yes. Good afternoon, just sticking with the data center shelves just for a moment.
You said that you've got with three data shells that will come up for renewal in the next couple of years are those wholly owned or if you sold those and I was curious if they were still kind of on the balance sheet. The way I read it was there a reason you haven't sold those in was there something interesting about those particular assets that they hadn't been pushed into a JV.
No.
Three are in a JV.
And they and they expire in 2020 for all three of them.
Okay.
That answered that and then maybe final question just for Steve I don't know those of us that have followed it a long time.
MVP was a very strong part of the story seem to for a while the b a little bit weaker in terms of demand and the ability to sign deals and now it seems to be back in terms of the health of that part for you guys.
Is that is there a change in the spending and the funding for programs like cyber are there additional programs that have been added and it really I guess, what I'm trying to get at is that tail is going to be substantially more consistent or grow over the next couple of years in your mind around what's really been a marquee property for you guys.
Well, a big component of the success, we're having is being fueled both cyber spending unquestionably.
And we don't see that changing in the near term.
So same thing narrative nothing really added to that just finally, the money is getting spent the space is being committed.
And no real changes kind of on campus that either threatened or help that.
Well, there's certainly enough and campuses threatened.
And the increased challenges.
The cyber.
Defense.
Warfare environment.
Lead us to believe the spending will continue to be strong for quite some time.
Alright, thank you.
We have a question from Tom.
Tom Catherwood with BT AIG your line is open.
Thanks, so much and good afternoon, everyone.
Steve have already answered this question with response to Dave's question, but.
As Todd mentioned this is obviously your second build to suit in a year at niche National business Park.
Is the driver behind this kind of recent increase in in large space demand for cyber that you were mentioning or is it some other demand driver or Dod funding source that really contributed to this demand.
I think so.
First of all for us to know for sure.
When we do these build to suits with.
Defense contractors, they're very secretive about their business.
But overall.
The market has really been.
Supported by <unk>.
Expanded spending either U S cyber command.
Got it and is there an expectation that there could be more demand beyond that or does it just kind of come in fits and starts.
Certainly for leasing generally I see no abatement in.
Demand from the cyber contractors doing business both in the MVP in Columbia Gateway.
Cynthia Cyber command has been stood up.
Great accounts and source of growth and expansion.
Tenants that are.
Nearing.
Leaving their own building that started with 8000 square feet.
The spirit of steady state of.
Demand in growth.
Over eight years.
Got it I appreciate that Steve and then last one from me is on.
Those three data center shell leases that roll I think these are the ones that were.
Kind of in your first generation with your largest data center shell tenant and the question. When you first started was always what does that second generation lease look like.
What how do we rent change you need to do you need to invest incremental dollars do you have an expectation or at least an early read of kind of what that renewal might look like when you get to that point.
Well, it's couple of years.
So I don't want to.
But I would expect rents to increase.
For no other reason.
Then the value of the land.
That those assets sit on is at least tripled.
Got it I appreciate it thanks, everyone.
Okay.
We have a question from Bill Crow with Raymond James Your line is open.
Good afternoon.
Steve I'm curious, whether the dislocation we are seeing in the market and maybe some of the delays in leasing.
Has altered your thinking on selling some of the regional office assets particular Baltimore.
Well we are.
We routinely keep an eye on markets.
Are those assets.
And like we did with DC six.
If we see an opportunity to get good shareholder value in the market the capital market that exists we reconsider it.
But right now I don't see that.
Market condition being strong enough.
Sure.
To bring one of those assets to market.
How much do you think cap rates have increased on that sort of asset.
So I think there is a dearth of capital investing in CBD is right now.
You look across our portfolio.
We're literally no comps deploying too except for D C.
We're at 900 and sold at a four five cap rate to a foreign investor.
And I think the buyers that are sitting looking at somebody of the markets are rather opportunistic.
Looking to pay maybe a 100 basis points.
Get a cap rate at 100 basis points or more higher than they were say six months ago.
Yes makes sense.
Thats It from me.
Okay. Thanks Bill.
Okay.
Thank you and Thats all the questions. We have today I would like to turn the call back to Mr. <unk> for closing remarks.
Thank you for joining our call.
We will be in our offices. This afternoon. So if she'd like follow up conversation. Please coordinate through Michelle Thank you very much.
Thank you for your presentation today for your participation.
Today in the corporate office properties Trust second quarter 2020 results Conference call. This concludes the presentation. You may now disconnect everyone have a great day.
The conference will begin.
Sure.
Raise your hand during Q&A, you can dial star one one.
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