Q2 2023 Corporate Office Properties Trust Earnings Call
Okay.
Welcome to the corporate office properties Trust quarter 2023 results conference call. At this time, all participants are in a listen only mode.
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As a reminder, today's call is being recorded.
At this time I'd like to turn the call over to Venkat coming any Copt's Vice President of Investor Relations. Mr. <unk>. Please go ahead.
Thank you Joe and good afternoon, and welcome to Cops conference call to discuss second quarter results with me today are Steve <unk>, President and CEO , and Anthony Mifsud Executive Vice President and CFO .
Conciliations 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.
Really from these forward looking statements and the company does not undertake a duty to update them Steve.
Good afternoon.
Thank you for joining us.
Our investment strategy and differentiated portfolio.
Really to generate strong operating results.
And support our positive outlook for our business for the coming years.
The $100 billion increases to the department of defense budget that had been appropriated since March 2022.
And the roughly $25 billion increase said that's expected to occur later this year.
And we'll continue to drive strong demand throughout our defense portfolio.
Our capital allocation decisions are deeply concentrated our assets.
The locations adjacent to or in some instances containing high priority missions.
Defense contractors benefit greatly by locating offices proximate to these high priority missions. These.
These ratios requires secure office environments.
Misha work cannot be performed from home.
The secure environments for these visions are difficult to get approval to construct.
Pensive to create.
And requiring significant tenant co investment.
And they're not transportable these.
These are the major factors that drive our industry, leading retention rates.
Accordingly.
Competitive advantages of the best locations adjacent to these high priority defense missions.
Our unique portfolio with significant security improvements.
Readily developable land sites to support midstream growth.
A 30 year track record of performance excellence.
And our franchisee relationships and security credentials.
Continues to provide strong results.
Proving resilient cash flows and asset growth.
We reported second quarter <unk> per share as adjusted for comparability of <unk> 62.
Two cents higher than the midpoint of our guidance.
Our portfolio is 95% leased.
Which represents 130 basis point increase year over year.
Our defense segment is 96, 8% lease which is the highest level since we began disclosing segment in 2015.
And represents a 190 basis point year over year increase.
Same property cash NOI increased five 8% over the second quarter of last year.
And increased 7% during the first half of the year.
We executed 88000 square feet of vacancy leasing where the weighted average lease term of nearly seven years.
Which brought our total for the six months ended 287000 square feet.
Adding the first few weeks of July <unk>.
We've executed 218000 square feet of vacancy leasing year to date, which puts us right on track to achieve our full year target of 400000 square feet.
Recall, our expected vacancy leasing volumes in 2023 are lower than 2022 due to the diminished inventory available to lease in our defense locations.
The National business Park is now 99.3% lease.
Which represents a 550 basis point increase.
Since the end of last June with only 31000 square feet of run lease space in the 4.1 million square foot Park and the largest vacant space is only 7800 square feet.
In our defense a key portfolio, we have 670000 square feet of inventory available, which is the lowest level since 2017.
Despite the fact that the portfolio has increased by nearly 6 million square feet during that period.
Our overall portfolio leasing activity ratio remained strong at 75%.
With a pipeline of 915000 square feet of vacancy prospects.
Total leasing volume of 891000 square feet in the quarter.
Included 803000 square feet of renewals.
Our overall retention rate for the quarter was 89%.
With our defense it locations at 93%.
And year to date, our overall retention rate is 83%.
Cash rent spreads were up one 3% for the quarter GAAP rent spreads were up seven 4% driven by annual rent increases of two 6% with a weighted average lease term of five years year.
Year to date rent spreads are up one 1% on a cash basis and six 9% on a GAAP basis, the weighted average lease term of four and a half years.
Measuring the starting cash rent tenants expiring lease.
So the starting cash rent of the renewal lease the annual compound growth rate achieved on these leases was three 4% for both the quarter and year to date.
Yeah.
On page 22 of our flipbook, we expanded our large lease disclosure to include our view of renewals through 2025.
We continue to expect portfolio retention to be extremely strong.
Looking forward over the next 10 quarters.
We have $7 1 million square feet of leases expiring.
Which includes $3 9 million square feet of large leases defined as leases over 50000 square feet.
We expect the retention rate of roughly 95% and these large leases.
So the balance of 2023, and we expect to renew 100% of the large leases that are included in this total.
Our $1 5 billion square feet of active developments or 92% leased with a total estimated cost of $480 million and consisting of nine projects located in Maryland.
Northern Virginia, and Huntsville, Alabama <unk>.
We expect to place 800000 square feet of developments into service over the remainder of 2023 that we expect to be 99% leased when delivered.
During the first six months of the year, we executed 495000 square feet of development leases.
Including three full building build to suits.
And 30000 square feet of development visa.
Our development pipeline.
Which we'd find its opportunities, we consider 50% likely to win or better within two years or less.
Currently stands at a million square feet.
Up from 700000 square feet last quarter.
Beyond that.
We're tracking another one 2 million square feet of potential future opportunities.
Should allow us to maintain a solid drummer and pipeline in the near and medium term.
Yes.
With the National business Park essentially full.
We are in the planning stage for our next contractor and government buildings and have commenced pre development and pre leasing activities.
We remain confident in achieving our 700000 square foot development leasing goal for the year.
The success, we've achieved during the first six months of the year has compelled us to increase the projected midpoint for <unk> per share and we remain confident we can achieve our <unk> per share growth expectations through 2026.
That I will hand call over to Anthony.
Steve We reported second quarter <unk> per share as adjusted for comparability of <unk> 60.
<unk> <unk> higher than the midpoint of our guidance.
<unk> outperformance was primarily driven by lower than expected net operating expenses, a portion of which was the timing of certain repairs and maintenance projects that we now expect to be completed in the second half of the year and slightly lower interest expense.
We have generated very strong increases in our same property cash NOI with the results that have exceeded our initial expectations.
Driven by the year to date outperformance that is not timing related we are increasing the midpoint of our same property cash NOI guidance by 100 basis points for a revised range of four five to five 5%.
This represents a 200 basis point increase in the midpoint for same property cash NOI growth from our initial guidance target.
Same property occupancy ended the quarter at 92, 8%, which is up 70 basis points sequentially from last quarter and up 170 basis points year over year, and we expect occupancy to continue to increase throughout the remainder of the year as executed leases commence including 70000 square feet Lockheed.
Martin at 1200, Redstone Gateway in the third quarter after taking occupancy of 52000 square feet in the second quarter and.
70000 square feet in our Fort Meade BW corridor subsegment during the third quarter.
Our core portfolio is 95% leased with our defense it locations, finishing the quarter at 96, 8% leased.
Our three largest concentrated defense locations, which consist of the National business Park Redstone Gateway in Huntsville, and Lackland Air Force base in San Antonio Our 98, 8% 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 revenues are generated from assets that are 99, 3% leased.
The strength of these property occupancy operations and cash flows are emblematic of our defense portfolio.
Year to date, we have renewed 997000 square feet with cash rent spreads up one 1%.
Based on our performance year to date and lease negotiations underway, we are increasing the midpoint of our our cash rent spread guidance by 50 basis points to a revised range of flat to up 1%.
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.
Our unencumbered portfolio now represents 96% of total NOI from real estate operations.
Additionally, at the end of the quarter, we had over 70% of the capacity on our line of credit available.
Our variable rate debt exposure was just under 5% at quarter end.
Although we expect our floating rate debt to increase slightly over the remainder of the year as we fund development on our line of credit our projections continue to have it below 10% at year end.
Turning to 2023 guidance given our outperformance for the first six months of the year, we are increasing the midpoint of our <unk> per share guidance by <unk> <unk>.
From $2 38 to $2 40.
This revised midpoint represents a 2% increase in <unk> per share over 2020 two's results.
For the third quarter, we are establishing a guidance range for <unk> as adjusted for comparability of <unk> 59 to 61 per share.
The resulting guidance for the fourth quarter implied implies <unk> per share between 60 and 62.
With that I'll hand, the call back to Steve.
Thank you.
<unk> in our key messages.
We delivered another strong quarter with <unk> per share <unk> <unk> above the midpoint of our guidance.
Our defense segment is 96, 8% leased the highest rate since we started reporting segment in 2015.
We raised the midpoint of full year same property cash NOI guidance by.
100 basis points, driven by a great first half.
We are on track to achieve our full year goals for vacancy and development leasing.
Our one 5 million square feet of active developments.
92% lease provide a strong trajectory for NOI growth over the next few years.
Our liquidity is very strong and we continue to expect to self fund the equity component of our expected development investment going forward.
We raised the midpoint full year <unk> per share guidance by <unk>, <unk> and now expect to deliver <unk> per share growth of 2% in 2023, 1% higher than our initial expectations.
And.
We continue to expect compound annual <unk> per share growth.
Roughly 4% between 2023 and 2026 from the midpoint of our original 2023 guidance.
Okay.
Before wrapping up the call I wanted to share some interesting current perspectives.
Agencies within U S government and become increasingly vocal about the cyber espionage threats to our country.
On last quarter's call, we shared threat assessment published by the director of the National Intelligence are DNI regarding China.
Recently, the office of the DNI. It drives Congress that Russia is focused on improving its ability to attack our infrastructure networks in China.
<unk> capable of attacks that could disrupt our infrastructure.
This quarter.
Five eyes, which drove the intelligence operations.
Added States, United Kingdom, Canada, Australia, and New Zealand.
Just issued a warning that a Chinese state sponsored entity is targeted networks across critical U S infrastructure sectors.
And last week.
It reports emerge the China based hackers infiltrated email accounts at the state Department and the Department of Commerce.
The center for strategic International Studies.
Or.
<unk> maintains a log of significant cyber events that have occurred since 2006.
Defined as state actions espionage.
And cyber attacks, where losses exceeded $1 million.
Since 2010 were in the U S. Cyber command was established the number of annual significant cyber incidents.
<unk> has reported globally.
It's escalated at a compounded annual rate of 16%.
And has averaged 11 significant cyber attacks per month over the past 36 months.
Our government's reaction to these threats has resulted in increased cyber related investments, which has led to increased demand for our portfolio and a record level of leased inventory.
Our portfolio is well positioned to continue to benefit from this investment given our advantage locations and expertise in providing secure space.
Year to date over 50% of our executed vacancy leasing supports cyber activities, primarily in the Fort Meade BW corridor.
Over the past three years, we've completed 730000 square feet of cyber leasing in both our development and operating portfolios.
Today, we have 465000 square feet of demand seeking new and expansion space.
<unk> skiff or secure facilities, primarily to support cyber mission growth.
The National Business Park is 99, 3% lease.
The highest level in the past 15 years.
And we're preparing new development options, primarily sport cyber mission growth for both the U S government and defense contractors.
These facilities will require security enhancements.
Ill address the asymmetric cyber threat, there will persist indefinitely.
Thus deepening the durability of our unique property portfolio and the resulting cash flows.
We're extremely proud to have played an important role in providing valuable leases to our cyber tenants and we look forward to the inherent expansion opportunities that will emerge from the critical defense needs of our country.
So operator with that please open up the call for questions.
Thank you Mr. Dark as a reminder to ask a question you will need to press star one on your telephone.
Your question. Please press star one again.
Please standby, while we compile the Q&A roster.
And I show. Our first question comes from the line of Blaine Heck from Wells Fargo. Please go ahead.
Great. Thanks, Good afternoon, maybe just a high level question to start out the government Accountability office just did a study on federal buildings that concluded that the utilization at those buildings with very low obviously the study covered a much different set of assets and what our OFC owns but can you just talk.
About your portfolio and how you'd characterize the utilization amongst your U S government tenants.
Sure. So first let me talk to study, which we read.
That primarily deals with the GSA the large GSA leases within the beltway and indeed, theyre very lately use some estimates are 20% or less.
And they've allowed a lot of work from home and that employee base has gotten pretty comfortable with that arrangement.
So learn that their 15th separate labor unions that represent the various U S government employee basis.
The kind of return to work.
Efforts are going to take a long time, because the fraction.
<unk> representation of those employees.
But turn it into our portfolio.
Our.
Our government customer assets are not included in that report.
Government customers.
Predominantly are in the defense and intelligence community.
Because of the security requirements of their mission work.
They are required to work in the office.
So really going all the way back to October of 2020.
The attendance at our government leased buildings has been normal.
Our full.
And just.
It just doesn't pertain to our portfolio.
Great. Thanks, Dave.
And then switching gears, a little bit to the data centers power issues that become an impediment that we've talked about consistently and northern Virginia data datacenter business do you see those power issues subsiding at any point and if not I guess would you consider developing data centers than any other market. If your customer was willing to.
Kind of planet will AG elsewhere.
So let me deal with the power.
Exactly and expert.
What's happening there but.
The two power companies to northern Virginia are working to increase the overall power capacity and our understanding is it's going to deliver in roughly thirds in 'twenty four 'twenty five and 26. So I think we're more than 12 months away from.
Seeing new power supply that can be pushed through the local distribution network.
With regard to our appetite to follow our customer to a new market, we absolutely would do that.
Provided the market was a.
Substantial data center market with long term.
Confidence in.
The assurance of high demand level.
Sure.
Great. Thanks, Steve.
Thank you.
And I show. Our next question comes from the line of Michael Griffin from Citi. Please go ahead.
Great. Thanks, maybe just touching on the leasing front I appreciate the disclosure around the large lease renewals through 2025 can you talk about 95% of these about 4 million expected to be or needed that for the remainder of that $7 million that expire what should we expect in terms of retention rates and any color you can give around that would be helpful.
Sure. So we're not going to put out a statistical number but it's extremely strong growth.
We expect very little non renewal in our portfolio.
I would say if you just handicap the rest of it at call it roughly 80%, we'd be at or maybe better than that.
Great. Thanks, and then I know the topic, that's been coming in for the past at the Redstone its potential moving of space demand from Colorado. There I'm curious if you can give any update on timing or anything about around that matter.
I wish I had one but I don't.
For those people who are less familiar.
Space Command was.
Through our process identified Redstone gateway is the best location.
To stand up this new combatant command.
Theres been a lot of politics in the Senate level in the house.
Other states have protested the decision.
<unk> gone through a reassessment twice in all three cases.
Redstone Gateway has been the prevailing selection it seems to be in.
Politically charged.
Environment, where the final decisions not been made.
We continue to await the outcome as well.
A lot of people in Redstone gateway.
Great. That's it for me thanks for the time.
Thank you.
And I show. Our next question comes from the line of <unk> from Bank of America. Please go ahead.
Hello, Anthony could you please share the latest thoughts on how the company is thinking about its payout ratio.
As we head towards the second half, but yes, it looks like Africa will be improving.
Your payout ratio will trend towards low 60%. So what's the sweet spot for you and does the company have a target for the medium term.
Our target for our payout ratio of <unk> has always been in.
The 70% range our projection for this year is that for the full year will be.
More in the mid <unk> of our total payout ratio based off of.
Our remaining improvement our results for the year and the remaining improvements that we expect to make to our properties. So R.
Our ratio is always sort of been in that sort of 65% to 70% range.
Okay great.
And on the operating expense side it looked like it outperformed in the quarter, but operating margins went down slightly was that more onetime in nature.
It was I think there was there is there operating expenses were favorable for the quarter.
Some of that related to some R&M projects that were.
The completion of which were pushed into the third and fourth quarter of this year.
But there was really no no sort of noise around our margins.
Okay.
Do you expect to see that interbank.
Sure.
Yes.
Okay.
It for me thank you.
Thank you.
And our next question comes from the line of Tom Catherwood from <unk>. Please go ahead.
Thanks, and good afternoon, all Steve.
Steve maybe going over to the vacancy leasing pipeline.
Could you provide some more color around that and specifically thinking are there certain regions of yours that are stronger than others.
What's really driving some of these tenant requirements is it exploration expansions is it winning new contracts are there some kind of general themes that you can pull out of the demand that youre seeing.
Sure.
So I would say probably the two strongest.
The areas in the development pipeline.
It's one of the two but collectively the beta.
W. Fort Meade quarter is extremely strong.
And I spoke a little bit to the amount of.
Tenant demand for new or expanded skiff capacity.
In the VW market.
That is heavily aligned with their associated with new contracts and expanded opportunities.
Cyber related.
Activity.
Closed my comments with the other areas Northern Virginia and again most of that demand is includes a need for expansion of skiff because of expansion.
New contract and expansion opportunities.
Route 28 corridor.
When youre talking about the increased.
Is that.
Is the cost for that base building is the cost of that covenant Ti as are.
Are the tenants putting in when you look at those leases.
On a net effective basis is that more beneficial to you or just over the long term does it make the tenant stickier.
Okay.
So the.
Going in lease we give a market level of tenant improvement.
So, it's no better or worse than a non skiff tenant.
The tenant itself has to invest incremental capital to complete the skiff.
And with the escalation in cost set of occurred you'll have to budget at least $150 a foot if that $200 a square foot to complete the <unk> component of that suite.
So.
That heavy co investment.
And the fact that skips they're not portable.
You can't pick them pick them up and move them to a new building is a major factor in our record or industry, leading retention rates. So it does accrue to our benefit over the long term.
Yes.
Got it got it and then just with all the talk around.
Increased demand expansion of tenants expansion of government budgets.
Are you seeing in terms of new entrants in your specific area, providing real estate solutions to these tenants and are you seeing any uptick in competitive supply.
We really haven't.
Okay.
We tend to dominate the market in and around Fort Meade.
I will say with the extremely high level of.
Yeah.
Inventory at least at the MVP were kind of guiding some of that demand into Columbia Gateway and we've got a rapidly escalating.
Kind of inventory of skiff or skip demand in the park, which is really good for their portfolio of long term.
In Northern Virginia.
Through 'twenty quarter has been more competitive.
For us because there are multiple landlords, but there's certainly no new entrants no new development.
Inventory in and around the demand drivers is largely.
Well leased and stable and of course, if you jumped Alabama, we have the best location period.
The incremental demand to come to us.
Understood really helpful. Thanks, everyone.
Thanks, Tom.
Thank you.
As a reminder to ask a question you would need to press star one on your telephone.
And I show. Our next question comes from the line of Jay <unk> from Evercore ISI. Please go ahead.
Hey, Thanks, Good afternoon, I'm, just curious what you what you have baked into guidance in the back half of the year from a macroeconomic perspective now you mentioned that interest expense came in a bit better than you expected. So just curious your thoughts for the macro environment and also the rate environment in the back half of the year.
So from the from a rate environment built into our forecast for the balance of the year as the current so far curve.
That came up that is sort of the most immediate one after the impact of any changes from the most recent fed increase earlier this week.
So it has it has.
The current projections for where the market is.
I would say.
A 25 basis point change in that.
In that curve.
The remaining six months of the year is only about $200000 increase in interest expense for the six months ended.
Just because such a large portion of our debt is fixed at this point fixed or swapped.
That's helpful. Thank you and then just I was wondering if theres any update on the regional office leasing activity.
Well.
Sure.
So our leasing activity ratio.
For the regional office the five regional office assets is about 68%, but I will say, it's largely preliminary opportunities except for lease that we're competing for in downtown D. C for 'twenty 100 out so that.
The sharp contrast between the timing in the sense of urgency and the demand.
In our defense business, which is over 90% of our revenue and that 10%, which is regional office <unk>.
And I would that work for.
Meaningful.
Progress in the leasing environment through the end of the year with the exception of the <unk>.
One lease we're competing for 'twenty 100.
Great. Thanks, that's all for me.
Thanks.
Thank you.
I'm showing no further questions in the queue at this time I will now turn the call back to Mr. <unk> for closing remarks.
Well, thank you all for joining us today.
Our in our offices. So please coordinate through Venkat, if you would like follow up call.
Thanks again for joining us.
Yes.
Thank you for your participation today in the corporate office properties Trust second quarter 2023 results Conference call. This concludes the presentation. You may now disconnect good day.
Yes.
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