Corporate Office Properties Trust Q1 2023 Earnings Call
Yeah.
Welcome to the corporate office properties Trust first quarter 2023 results conference call.
Today's conference is being recorded at this time I will turn the call over to <expletive> Cat Co Minetti C. O P T as vice President of Investor Relations Mr. Coming any please go ahead.
Thank you Michelle good afternoon, and welcome to <unk> Conference call to discuss first quarter results with me today are Steve <unk>, President and CEO , and Anthony Mifsud Executive Vice President and CFO reconciliations of GAAP and non-GAAP financial measures that management discusses are available on our website and the <unk>.
<unk> 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.
Events and results can differ materially from these forward looking statements and the company to start undertaking do you need to update that.
Sure.
Good afternoon, and thank you for joining us.
Before turning to results for the quarter I'd like to start by highlighting a few.
Few important themes.
The fundamentals of our business remain very strong.
Does the outlook for defense spending.
We continue to see demand for new leasing and renewals that are defense like T locations as evidenced by our 95% portfolio lease Street.
Defense tenants working on secure programs can't work from home.
It is resulting in our tenants retaining space in our portfolio.
And as a result, we expect to achieve a tenant retention rate in 2023 that is at or above our 10 year record high of 81% in 2017.
We have good visibility into demand for our current and future development projects.
We continue to project that fish oil per share growth of roughly 4% on a compound basis between 2020, three and 'twenty 'twenty six.
And we completed the JV equity raise earlier in the year.
And we now have capacity to self fund the equity component of our anticipated development of best way going forward.
And lastly.
Just on the strength of our business our board approved a three 6% increase in our dividend in February .
Now, let's discuss results from the quarter.
We reported first quarter after four per share as adjusted comparability.
59 cents, which is two times higher than the midpoint of our guidance.
Our core portfolio remains well leased at 95, 1%, which represents 100 basis point increase year over year.
Our defense segment 76, 7% leased.
Which is the highest level since we began disclosing in the segment in 2015.
Our first quarter operating metrics were strong.
Same property cash NOI increased eight 3% year over year, which.
Which is the highest level in over a decade.
Leading us to raise full year guidance by 100 basis points at the midpoint.
We executed 99000 square feet of vacancy leasing, which is right on track with our full year target of 400000 square feet.
Our overall retention rate was 64%.
With our defense like T locations at 78%.
Total leasing volume of 788000 square feet in the quarter.
Included 194000 square feet of renewals.
Cash rent spreads were slightly positive GAAP.
GAAP rent spreads were up four 2% driven by annual rent increases of two 4%.
Measuring the starting cash rents of the tenants expiring lease to the starting cash rent the new lease.
The annual compound growth rate achieved on lease renewal leases was three 3%.
With a weighted average lease term of three years.
First quarter retention rate of 64%.
It was influenced by the impact of 55000 square feet.
<unk> non renewals in our regional office portfolio. However.
However.
Based on our activity and discussions with customers, we raised the midpoint of our full year retention guidance rate.
250 points to 80% to 85%.
In addition, we expect a retention rate.
Of over 95% and the $2 3 million square feet of large leases, which we define as least as over 50000 square feet.
Barring through year end 2024.
Included in this total is $1 1 million square feet of large leases that expire in 2023 through which we expect a 100% renewal rate.
Okay.
Yeah, the first quarter, we completed 99000 square feet of vacancy leasing.
The weighted average lease term of nearly eight years.
Recall, our expected leasing volumes in 2023 or lower.
Due to our diminished space available for lease.
In our defense portfolio, we have less than 700000 square feet of inventory available.
Which is the lowest level since 2017.
Despite the fact that that portfolio has increased by nearly 6 million square feet.
In that period.
Our vacancy leasing activity ratio remained strong at 75%.
With the pipeline of 950000 square feet of prospects.
Our $1 5 million square feet of active developments are 92.
So at least with a total estimated cost of $478 million.
<unk> seen a dine projects located in Maryland, Northern Virginia and.
<unk>, Alabama.
As previously announced we signed 464000 square feet.
Development leases in January .
Consistent with two build to suit data center shell leases for our cloud computing customer in Northern Virginia.
Totaled 418000 square feet.
And a 46000 square foot build to suit lease for Davidson technologies for their new headquarters at Redstone Gateway.
Since then we signed an additional 41000 square feet of development leases, which included a 27000 square foot lease with frontier technology.
And 8100 right out road.
Bringing that property to 20% lease.
And a 14000 square foot expansion with KBR.
1000, Redstone gateway, bringing that property to 78% leased.
In total we've completed 495000 square feet of leasing during the quarter, which represents about 70% of our full year goal of 700000 square feet.
Our development pipeline, which we define as projects, we consider 50% likely to win or better within two years or less.
Currently stands at 700000 square feet.
Beyond the pipeline, we are tracking another one 7 million square feet of potential future opportunities.
Which gives us carefully so it will be able to maintain a healthy development pipeline in the near and medium term.
Turning to the defense budget.
Last month, the administration's submitted the fiscal year 2020 for budget request, which calls for a three 6% year over year increase to $827 billion.
Between fiscal year, 2021 and 2023.
The base defense budget increase by roughly $100 billion.
Nearly 15%.
We expect demand from the 2023 budget increase will materialize in our portfolio starting in 2024.
Growth from the 2020 for budget will benefit us thereafter.
Including these budget assumptions or further investments in our offensive and defensive cyber related programs.
The department of Defense has committed over $13 billion to cyber activities in 2024.
Which is a $2 billion increase from the prior year.
TLD cyber programs have driven 2 million square feet of cyber leasing in our portfolio over the last 24 months, which equates to 55% of the total new leasing achievement.
In February 2023.
Office of the director of National Intelligence published a sobering threat assessment revealed China, probably represents the broadest cyber espionage threat to our country.
And.
If China throughout the major conflict with the U S were imminent.
It would be highly likely to undertake aggressive <unk>.
Labour operations against critical U S infrastructure and military assets.
Clearly the cyber threat environment continues to represent a significant security threat and must remain a priority investment choice.
The continued need for investment in cyber security should support strong demand from cyber tenants in our portfolio.
With that I'll hand, the call over to Anthony Thank you Steve.
We reported first quarter <unk> per share as adjusted for comparability of <unk> 59.
Which is <unk> <unk> higher than the midpoint of our guidance over half of the upside came from lower net seasonal related expenses and the remainder from the timing of repairs and maintenance expense.
As a result of these expense variances results exceeded our expectations. Our same property cash NOI increased eight 3% year over year, while same property GAAP NOI increased by three 7% year over year.
<unk> in our same property cash NOI results was the benefit of free rent burn off of two large tenants in the first quarter.
Excluding this impact same property cash NOI increased three 9% year over year.
We expect same property growth will moderate during the remainder of the year. However, driven by the first quarter's outperformance we are increasing the midpoint of our same property cash NOI guidance by 100 basis points to 3% to 5%.
The composition of the same property pool changed with the addition of nine new development properties, which are 92% occupied and the removal of three fully leased data center data shells, which were joint ventured.
Same property occupancy ended the quarter at 92, 1% and is expected to increase increase throughout the year as leases executed in 2020 to commence including over 160000 square feet at the National business Park during the second and third quarters, which includes 126000 square feet of new space with the <unk>.
S government and 121000 square foot lease with Lockheed Martin at 1200, Redstone gateway into third quarter.
These gains will be partially offset by a previously reported 54000 square foot contraction in our regional office segment by Carefirst at Canton crossing in the second quarter.
The location of our defense it assets has driven our exceptional leasing results, which translates into resilient and growing NOI.
Our three largest concentrated defense locations, which consists of the national business Park Redstone Gateway in Huntsville, and Lackland Air Force space and San Antonio are 98, 4% leased in aggregate and account for roughly 45% of our core annualized rental revenue.
Adding our fully leased data center shell portfolio, 50% of our core annualized rental revenue comes from assets that are 99, 1% leased and have rock solid stability for years to come.
Our balance sheet is well positioned to navigate the current volatility in the capital markets environment.
We have no significant debt maturities until March 2026.
During the quarter, we paid off a $16 million mortgage which matured in February with our line of credit and unencumbered $77 40 milestone Parkway.
Our unencumbered portfolio now represents 96% of total NOI from real estate operations.
As a result of the interest rate swaps, we entered into effective February one our variable rate debt exposure declined to 2% at quarter end compared to 15% at the end of 2022.
We expect our floating rate debt exposure to increase slightly over the remainder of the year as we fund development on our line of credit, but will remain below 10% throughout the year.
As previously announced in early January we closed on a 90 10 joint venture with affiliates of Blackstone for three single tenant data center shells, raising $190 million of equity proceeds.
Proceeds from this transaction were used to pay down the line of credit at the end of the quarter, we have 80% of the capacity of our line available.
Following the completed JV in January we have no need to sell or joint venture any additional assets to fund our expected $250 million to $275 million in annual development investment.
Looking forward, we anticipate self funding our equity requirements for expected development investments through cash flow from operations, while maintaining our strong balance sheet and conservative leverage metrics.
In February we announced a three 6% increase in our quarterly dividend, which is our first dividend raise in over a decade.
The dividend increase illustrates our confidence in strong <unk> and <unk> growth.
This increase we expect our full year <unk> dividend payout ratio will still be roughly 70%.
Turning to 2023 guidance, we are narrowing the range of <unk> <unk> per share by one penny at the low and high end and maintaining the midpoint at $2 38 per share.
Although our results exceeded expectations in the first quarter and the fundamentals of our portfolio continued to be very strong at this point in the year, we are being conservative and not changing the midpoint of our annual <unk> per share guidance for the.
Second quarter, we are establishing a guidance range for <unk> as adjusted for comparability of <unk> 57 to <unk> 59 per share.
With that I'll hand, the call back to Steve.
Thank you.
Summarizing our key messages.
We delivered a strong quarter with <unk> per share two cents above the midpoint of our guidance.
Our defense segment is 96, 7% leased which is the highest rate since we started reporting this segment in 2015.
We raised the midpoint full year same property cash NOI guidance by 100 basis points, driven by a great first quarter.
We raised the midpoint of our full year retention rate guidance by 250 basis points to 82, 5%.
Demonstrating our confidence in our renewal leasing.
We executed 99000 square feet of vacancy leasing and we are on track to achieve our full year target.
Our leasing pipeline remains strong with a vacancy leasing activity ratio at 75%.
And as Robyn leasing pipeline at 700000 square feet.
Our $1 5 million square feet of active developments, which are 92% lease provides a strong trajectory for NOI growth over the next few years.
The administration's fiscal year 2020 for budget request proposed an additional three 6% year over year increase ordinarily $30 billion.
Which trials are near 15% increase over the prior two years.
We are on track to deliver modest <unk> per share growth in 2023.
But expect compound annual <unk> growth of roughly 4% between 2023 and 2026.
And we raised our dividend by three 6%.
And we expect to self fund the equity component of our development pipeline.
Going forward.
So let me finish with an anecdote before we open up the line for questions.
Earlier this month I attended a ribbon cutting ceremony down at Redstone Gateway.
For a two building build to suit campus, which we developed for a defense contractor.
The properties totaled 262000 square feet.
They were delivered in the fourth quarter of 2022.
Total cost of over $100 billion.
$100 million sorry.
Well, we often discuss the mission critical nature of the work our tenants perform at our facilities. It's trips like these that really reinforces the importance of our tenants work through our national security.
This campus will be home to over 1000 employees, whose primary mission is to expand our nation's missile watch and missile defense capabilities.
Buildings contain office space.
<unk> facilities program management, and engineering design space and.
And integration Laboratory data center, and a 350 person auditorium.
This is a great example of mission critical work that requires specialized secure space. There is adjacent to a government demand driver that it supports.
And work that cannot be performed from home.
We're incredibly proud to play a role in the creation and advanced with a such a vital facility supporting critical defense missions of our country.
We are greatly appreciative of our relationships with our government and defense contractor tenants, providing them critical facilities and infrastructure to support their national security missions.
With that operator, please open up the call for questions.
Thank you Mr. Patrick to ask a question at this time. Please press star one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one again, one moment, while we compile our Q&A roster.
Alright.
Okay.
Our first question comes from the line of Anthony Pallone with Jpmorgan. Your line is open. Please go ahead.
Thank you.
So you talked about and outlined the about half of your expirations being over 50000 square feet and the high retention. There can you talk about just roughly.
Roughly either half thats smaller tenants and just any trends there that might be different than what youre seeing more broadly or things that we should watch with that half of the explorations.
So the.
The overall target.
Expectation with the midpoint of 82, 5%.
Suggest that we have just as high a retention.
Performance on smaller tenants and event defense.
As we do for the larger.
But do bear in mind, we've got 50000 square feet of regional office back year to date, and we're going to get another black 50 later in the year and that regional office.
As a significant factor in the 82, 5% retention rate.
Okay got it and then just.
The other question in terms of thinking about starts for the rest of this year.
And the planning or how should we think about that because it seems like your development goal you would need to start something.
The existing pipeline is pretty full.
That's correct.
A little over 100000 square feet in our available inventory.
There's multiple scenarios that could put us over the 700000 square feet.
One of which is another data center shell build to suit and.
And the alternative is some additional starts in the defense.
Locations, most likely Redstone Arsenal.
Okay. Thank you.
Thank you and one moment for our next question.
Our next question comes from the line of Blaine Heck.
With Wells Fargo. Your line is open. Please go ahead.
Great. Thanks, Good afternoon, just starting on guidance. It seems like there was room to move that capital guidance up given the movement in same store NOI and retention expectations.
That it's early in the year, but I guess I'm just wondering if there were any other factors other than interest rates that kind of kept you guys conservative at this point.
They are worried I think what we were trying to communicate with the changes that we did make as a result of the performance in the first quarter was the strength in the same office portfolio.
As well as in the retention of our expiring leases I think the one component of the forecast that we really have no control over is variable rate interest.
When you look at the change in projected so far from where it is at the beginning it will be at the beginning of May through the end of the year, it's projected to go down almost 75 basis points.
If that doesn't occur.
That would impact our interest expense every 50 basis points change in interest expense for the balance of the year is about an additional $600000 of interest expense. So at this point of the year.
We're not at a point, where we can be confident that that those rate reductions that are assume later in the year will actually happen.
And generally we like to put out conservative numbers.
And so there is still two quarters left to adjust that expectation.
If the first quarter results flowed through and interest rates remain stable.
Okay, that's fair.
Steve I was hoping you could talk a little bit about how you're approaching capital allocation decisions are broadly in this kind of volatile environment as you are.
Evaluate different investment opportunities from acquisitions do development and maybe even thinking about share repurchases do you think any of these investments revise the much more attractive risk reward profile at this point.
Well, we continue to believe that our incremental capital allocation.
He is best placed in new development at high priority defense locations and it has been for the last seven years since I took over as CEO .
There've been a few opportunities to look at some.
Somewhat interesting acquisitions in the marketplace.
But the value creation, we can deliver to shareholders through our development is superior to that of what we could do through an acquisition.
And we will continue to remain very disciplined looking.
Looking to maximize shareholder value through the development process.
That's very helpful. Steve and I guess to that point can you give us your latest thoughts around data center development in and whether land costs and power availability continued to be issues that could maybe impede your ability to develop more on that side of the business in the future.
So unquestionably the.
Availability of land, but more so the availability of power.
It's going to limit the overall opportunity to grow the data center capacity in the market that we serve which is northern Virginia.
And principally I'm currently.
So I think the rate of continuing progress will be lower than it was say five years ago.
But we continue to identify opportunities.
And.
Work in harmony with our customer to see if we can find solutions.
Two.
Continuing to developing for them.
And we're pretty confident we're going to have.
Additional development.
We will book in <unk>.
Secure for our shareholders.
Great. Thanks, everyone.
Thank you.
Thank you and one moment for our next question.
Okay.
Our next question comes from the line of Michael Griffin with Citi. Your line is open. Please go ahead.
Great. Thanks.
So you don't want to go back to prepared remarks around the defense budget.
Do you have any.
The impact of the budget negotiations that pet will clip.
If they can't reach an agreement in Congress.
Berkeley impact.
You are talking about it in 2024.
So it's going to be a roller coaster ride getting through to September unquestionably.
And we're in no position to project.
To predict exactly what the.
The fencing is going to look like between the house.
And the Senate and the president.
Awesome.
Crystal clear that.
But the one area of broad consensus is that defense spending has to continue to increase.
And when I say defense spending and I'm not referring to anything.
Pertaining to Ukraine.
The global threat environment.
That we face today.
So it'll be interesting that in the budget I can't tell you what things will be in place, but there is broad consensus of defense has to be invested in.
Gotcha, that's helpful. Maybe turning to Redstone I noticed you've been winning business from kind of a Greenfield park.
Against this opportunity set and then with the scale behind the fence I know you've got some entitlement for dealt there any update on that as well.
And maybe kind of in there.
So.
Overall, we have.
Over 3 million square feet of additional development capacity.
Inside and outside of the defense I would characterize about a third of that is inside the fence.
We continue to see opportunities of significant size.
Four new facilities to meet new missions.
Or enhanced capabilities in the marketplace timing of those.
Crystal clear in some respects.
With regard to the base seem decision for space command.
That's really in the hands of the.
Senior commander of the Air Force at this point from what we understand.
The decision was made probably going on four years ago, It's been challenged three times in.
And each and every.
Challenge and review.
Redstone Arsenal it comes out as the number one choice.
It's a matter of time.
It's a very political decision.
There are multiple states that wood.
We would prefer to go there.
So I can't predict timing I think it'll be.
<unk>.
If it's finalized in Alabama it'll be.
A big benefit to that market overall.
I think there'll be quite a bit of opportunity for our company there.
Gotcha.
Lastly on the regional office portfolio, Anthony I think you talked about 96% of your property being unencumbered or any of the regional office assets encumbered with mortgages.
I can hand back to Keith on it from shell.
All of the assets in our regional office portfolio are unencumbered, so theres no mortgage on any of those properties.
Alright, that's helpful.
Greg Thanks for the time.
Thanks, Michael.
Thank you and one moment for our next question.
Our next question comes from the line of <unk> with Bank of America. Your line is open. Please go ahead.
Hi, just following up on an earlier question around guidance.
<unk> was the driver of the SFO change on the upper range driven by the interest rate.
The ability or can you speak to.
What was driving this James.
Okay.
The Penny reduction at the top end was really driven by.
In fact, we've got a quarter in the books that we.
Even if interest rates were to Dod.
Don't expect interest rates to decline.
That dramatically that would get us to the higher end of that that range, which would be one of the drivers that would get us there.
Okay. Thank you most of my questions have been also okay. Thank you.
Thanks.
Thank you and one moment for our next question.
And our next question comes from the line of Tom Catherwood with <unk>. Your line is open. Please go ahead.
Thanks, and good afternoon, everyone.
Maybe sticking with Redstone, Steve in the past you've added some small mixed use components.
The build out kind of across the whole campus continues to accelerate is there any thought to carving off parcels for some other complementary uses I think you did some of this with with the hotel that was added back in I think it was either 2015 or 2016.
Good question. So we're.
We did do a second hotel land lease.
That hotel is under development.
It should deliver I think around year end.
Which will be good for the rest of the retail that we are invested in.
We also did a land lease with a daycare facility.
To support ultimately the employees of our customers on the base.
We'll do some relevant support more retail oriented lease seem to enrich the value of our development to our customers, but beyond that.
Beyond convenience service, we have no plans to use any of that land for anything but.
Defense contractor and U S government development.
Got it I appreciate that Steve and then maybe pivoting over to the data center shells.
I think your first round of second generation leasing is coming up soon when do those leases roll and did some of those re leasing expectations factor into the higher same store NOI guidance.
Well we have.
Negotiations ongoing on their first.
<unk>.
And I'll, just say stay tuned.
But it.
It did not factor into our change in same same office NOI, Firstly as Tom that matures as at the end of this year.
So any impact of a renewal would be wouldn't be until 2024 and from an NOI standpoint.
That property is one of the one that is in one of the Blackstone ventures said the impact of that for us would only upbeat.
The change in rent and are 10%.
Got it got it understood.
We will follow up on that.
Then last one for me and this is probably doesn't impact you guys, but obviously lots of distress and talks about distressed opportunities. When it comes to office now that office is very very different than your portfolios and I wouldn't expect there to be distressed per se and items leased to Dod.
Contractors, but are there any opportunities in your markets, whether it's to kind of add some tuck in acquisitions or some additional land that youre tracking or that you think may be opportunistic within the next year or so.
Great question so.
Keeping our eyes peeled for such an opportunity.
We have yet to find one that.
Fits our requirements.
Got it I appreciate it guys thats it from me.
Thanks, Tom.
Thank you and again to ask a question at this time. Please press Star then one one.
And our next question.
Comes from the line of Steve <unk> with Evercore ISI. Your line is open. Please go ahead.
Yes, thanks, good afternoon.
So Steve a lot of focus obviously on the defense sector, which is.
Doing very well as you pointed out almost 97% leased unfortunately, the six regional assets are only 78, 5% Lee. So I was just hoping that you guys could talk a little bit about the demand you're seeing in the regional assets and I know that that's kind of the catalyst to ultimately try and get these sold.
Which in today's environment on exactly the easiest thing to do but maybe speak to the demand side of what youre seeing on the regional office.
Sure.
We did sign two leases the regional office in the quarter that added about 11000 square feet.
Brinci when when the space is built.
Believe it or not our pipeline for regional office is at 76, 5%.
So there have been some larger users that are now in the marketplace canvassing.
Some buildings that we can compete for them.
It's too early to be overly optimistic.
But there's opportunity out there that we compete for which is a good sign.
We're down to.
A final decision with the tenant.
Considering 2100 out.
Think we're competing.
Effectively for that tenant.
We anxiously await their decision.
We'd love, we love Glenn that lease.
And would you sense that the demand is a little stronger in Washington D. C are up in Baltimore.
Or.
Any thoughts Greg.
The Dcs demand profile is pretty ugly.
For the Trophy office segment.
And in the Trophy office segment, there is diminishing supply.
I think it was below 13% availability right.
Right now.
Yes.
We believe Rs it competes very favorably.
Other availabilities to that segment.
From a volume perspective, <unk> got quite a bit of prospect activity in Baltimore.
I don't expect those deals to move quickly.
But we have a couple of larger opportunities.
Very interesting.
Okay.
Then on the development side I know, you've historically said that your yield to some extent at least on the data center shells might float with cost, but can you just kind of remind us to the extent that you move forward with another.
Data center.
Shell development or some of the.
It depends what kind of yields are you looking at today on cost and maybe what is happening with costs on the development side.
So costs have stabilized.
Materially over the last.
Call it two quarters.
Two quarters ago, we're reporting that our year over year development.
This building was.
Well 21, 22%.
We have been able to drive our rents up to maintain.
<unk> in our target range with the change in cost.
We did one build to suit in defense.
Year to date and I would say are our cash yield is 50 bps higher than it was say 12 months ago.
And we've elevated our targets try to achieve.
Commensurately better cash return.
With our increased cost of capital.
Data center shells are really want to discuss yields but.
So we look at the opportunity with the same.
Trying to achieve returns that are commensurate with our increased trust capital.
And I guess, maybe just last question I know, we sort of talked about this during the trip in D C, but given the power issues in Loudoun County today do you see your ability to find other are.
Yes larger locations in the northern Virginia area to help supplement your customers' needs for for data centers.
We're working on a couple right now and through preliminary.
Talk about them, because we're not under contract but.
I don't think youre going to see large land availabilities, it's going to be more moderate.
Moderate size parcels that required a little more creativity.
But we are working on several.
Okay.
Great that's it for me thanks.
Alright, thank you.
Thank you I would now like to turn the conference back over to Mr. <unk> for closing remarks.
Thank you all for joining our call today.
We are in our offices. So please coordinate through Venkat. If you would like follow up call. Thank you very much for joining us.
Thank you for participating in today's corporate office properties Trust first quarter 2023 results Conference call. This concludes the presentation. You may now disconnect have a good day.
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