COPT Defense Properties (CDP) 2003 Q4 法說會逐字稿

Good day, everyone, and welcome to the Corporate Office Properties Trust fourth-quarter 2003 earnings release conference call. As a reminder, this today's call is being recorded.

At this time, I would like to turn the conference over to Ms. Mary Ellen Fowler, Vice President of Finance and Investor Relations. Ms. Fowler, please go ahead.

Thank you, and good afternoon, everyone. Yesterday, our earnings press release was faxed or e-mailed to each of you. If there is anyone on the call who needs a copy of the release, or would like to get our quarterly supplemental package, please contact me after the call at 410-992-7324, or you can access both documents from the investor relations section of our Website at www.COPT.com. Within the supplemental package, you'll find a reconciliation of non-GAAP financial measures to the GAAP measures referenced throughout this call. Also, under the investor relations section of our Website, you'll find a reconciliation of our first-quarter and annual 2004 guidance.

With me today is Clay Hamlin, our CEO; Rand Griffin, our President and COO; and Roger Waesche, our CFO. In just a minute, they will review the results of the fourth quarter and 12 months of 2003. Then the call will be opened up for your questions.

First, I must remind all of you at the outset that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based upon what is believed to be reasonable assumptions, actual results may differ from those projected. These factors that could cause actual results to differ materially include, without limitation, the ability to renew or re-lease space under favorable terms, regulatory changes, changes in the economy, the successful and timely completion of acquisitions and development projects, changes in interest rates and other risks associated with the commercial real estate business, as detailed in our filings from time to time with the Securities and Exchange Commission.

Now, I would like to turn the call over to Clay Hamlin.

Thanks, Mary Ellen. Good afternoon, everyone. We are pleased to report that our team achieved another solid year of consistent growth and performance. This has been reflected in our stock price. For the year 2003, our total shareholder return was 58 percent. Looking at our performance over the past five years, we achieved a total return of 329 percent. This is based on data compiled by NAREIT. This was the highest among office REITs, and the second-highest among all REITs. We believe that this price appreciation really reflects the fact that we have achieved consistent stable growth year after year. For example, FFO for 2003 increased 8.3 percent on a diluted per-share basis, from $1.44 to $1.56, meeting consensus estimates. Our performance continues to be driven predominantly by a combination of strategic acquisitions, new development opportunities, consistent leasing activity, a favorable interest rate environment and reduction in our operating costs.

For the second year in a row, we surpassed our acquisition goal of $100 million, and we continued to ramp up our development pipeline, based on solid tenant demand. As you may recall, during the year, we closed on the purchase of Phase II at National Business Park. That's a 108-acre parcel that can support another 1.3 million square feet of office space to meet the next round of demand at National Business Park.

Along with growing our portfolio, we continued to enhance our balance sheet and our financial flexibility. We funded the majority of our 2003 investment activities by raising a total of $184 million in the public markets, consisting of both preferred and common equity. And we have excess financial capacity now to fund a portion of our anticipated growth in 2004.

Our debt to market cap, at 42 percent, is a record low for the Company, and our fixed-charge coverage has remained steady. At the same time, we continue to adhere to our debt strategy of locking in historically low interest rates on long-term fixed rate financing when possible, which Roger will discuss in a moment.

Our challenges for 2004 will be as follows. First, we have to take advantage of opportunities to increase occupancy in an improving market. Second, to uncover attractive acquisition opportunities in a competitive market. Third, to strategically position our development pipeline to take advantage of tenant growth and, fourth, to conservatively manage our balance sheet, particularly as it relates to interest-rate risks in a potentially increasing interest-rate environment.

In terms of our FFO for the year 2004, we remain comfortable with our previously-stated guidance of achieving FFO per share in the range of $1.66 to $1.71 per share. This is in line with current consensus, which is $1.69 per share for the year.

With regard to AFFO, we expect a bit slower growth than FFO, as a result of higher capital expenditures incurred as we ramp up occupancy over the year.

In summary, we are pleased with our results for 2003, and we are excited about the opportunities and the activity we see so far in 2004.

And now, with that, I'd like to turn the call over to Roger and Rand to take you through additional details.

Thanks, Clay. As a note, all per-share amounts are presented on a fully-diluted basis, and take into account the effects of FAS 141 and 145. And, as Mary Ellen noted, we provide a reconciliation of non-GAAP numbers to GAAP numbers in our press release and supplemental package.

FFO for the year 2003 totaled $61.3 million or $1.56 per diluted share, compared to $52.9 million or $1.44 per diluted share for the year 2002, as adjusted for FAS 141, representing a 16 percent increase in total FFO and an 8.3 percent per-share increase.

Looking at our GAAP earnings, for the year, the Company recorded earnings of 27 cents per diluted share, as compared to 56 cents per diluted share for the year ended 2002. The decrease in earnings resulted from an $11.2 million or 39 cent charge to earnings associated with our repurchase of the Series C convertible preferred units. Without the impact of the Series C preferred units, our EPS would have increased 18 percent on a per-share basis.

After adjusting for capital expenditures, straight-lining of rents and FAS 141 revenue, our adjusted funds from operations for the year totaled $43.2 million, as compared to $41.5 million in 2002. This represents a 4 percent increase in total AFFO. FFO for the quarter ended December 31 totaled $16.2 million or 40 cents per share, as compared to FFO for the fourth quarter of 2002 of $14.3 million or 39 cents per diluted share, as adjusted for FAS 141. This represents a 13 percent increase in total FFO, and a 2.6 percent per-share increase.

For our GAAP earnings for the fourth quarter, the Company recorded 14 cents per diluted share, even with the 14 cents per diluted share for the fourth quarter of 2002. After adjusting for capital expenditures, straight-lining of rents and FAS 141 revenue, our adjusted funds from operations for the fourth quarter totaled $11.1 million, as compared to AFFO of $11.6 million for the fourth quarter of 2002, representing a decrease of 4.4 percent.

During 2003, the Company distributed 91 cents per share of common dividends, representing a 5.8 percent increase over 2002. This equated to a 56.8 percent FFO payout ratio for the year.

For the fourth quarter, the Company distributed 23.5 cents per share, resulting in a low FFO payout ratio of 55.8 percent. Although capital expenditures have generally increased across the board, our AFFO payout ratios consistently remained comfortably below 85 percent, ending at 81.6 percent for the fourth quarter 2003 and 80.6 percent for the year.

Looking at the fourth quarter 2003, for the 107 same properties comprising 85 percent of the total square footage owned, cash NOI decreased by 6.6 percent, as compared to the fourth quarter of 2002, largely due to a $2.8 million decrease in lease termination fees. Excluding lease termination fees, same-property cash NOI increased 4 percent over fourth quarter 2002.

Turning to the balance sheet, at December 31st, the Company had a total market cap of over $1.75 billion, with $739 million of debt outstanding, resulting in a debt to total market cap of 42 percent. During the year, we continued to execute our debt strategy of locking in long-term fixed rate financing. Taking advantage of the low interest rate environment, in the fourth quarter, we closed on a $52 million long-term nonrecourse loan fixed at 5.36 percent. Currently, 81 percent of our debt is fixed-rate debt, including a $50 million swap agreement. Our floating-rate debt represents only 8 percent of our total market capitalization. Our weighted average cost of debt for the fourth quarter was a low 5.75 percent, down from 6.4 percent for the fourth quarter of 2002. With regard to our short-term debt and reflecting the Company's growth, we are in the process of replacing our secured $150 million revolving line that matures on March 31st, and several short-term floating-rate loans with an unsecured line in the range of $250 to $300 million, at more favorable terms. We have received more than sufficient commitments to close on the new lines from our existing banks, as well as new lenders, and anticipate an early March closing.

Lastly, a change to our balance sheet resulted from our purchase of the remaining interest in two joint ventures at the end of the fourth quarter. Upon completion and lease-up of 140 NBP, we purchased the remaining 50 percent interest for $5.3 million, as well as the 20 percent interest in a joint venture owning a land parcel and two operating properties located in Columbia, Maryland, for $857,000.

In terms of coverage ratios, for the fourth quarter, the Company's EBITDA-to-interest-expense ratio increased to a strong 2.9 times. With the repurchase of our Series C 9 percent convertible preferred, the issuance of our Series G 8 percent preferred and Series 8 7.5 percent preferred, our fixed charge coverage ratio remained a healthy 2.2 times.

In terms of our interest expense, as we mentioned in our third-quarter call, our guidance assumes that interest rates will increase 25 basis points per quarter throughout 2004. Lastly, with respect to FFO guidance for this year, we are confirming our previous guidance of $1.66 to $1.71 per share. As we mentioned last quarter, our FFO guidance is based upon comparable accounting treatments year over year. In addition, given the current interest rate environment, we anticipate redeeming our Series B 10 percent preferred stock issue that is callable in July of this year. Our guidance excludes the 4 cent accounting charge to FFO that would be required upon redemption.

In terms of our first-quarter guidance -- we expect FFO to be in the 38 to 40 cent per share range. There are primarily three factors that will affect FFO for the first quarter. First, although we believe we are on track to meet our acquisition goals for the year, acquisitions will have little FFO impact for the first quarter. Second, we raised $50 million from the issue of our Series 8 7.5 percent preferred during December, which has not yet been deployed, resulting in a 1.4 cent impact to FFO. And third, we will write off the unamortized loan costs associated with our existing secured revolver and several short-term secured loans, as a result of closing on the new unsecured revolver.

With that, I will turn the call over to Rand.

Thanks, Roger, and good afternoon, everyone. We currently have 119 suburban office properties in operation, totaling 10 million square feet. We ended the fourth quarter at 91.2 percent occupied and 92.8 percent leased. Occupancy decreased slightly for the fourth quarter, and although we did not reach the 92 percent occupancy we projected for year end, leasing activity has picked up, which will translate to increased occupancy as we move through the balance of the year. We still expect occupancy to reach 94 percent by year end 2004.

In terms of leasing activity, we had another good year, renewing 76 percent of the 1.2 million square feet that expired during 2003, at an average capital cost of $3.68 per square foot. In addition, we re-tenanted another 703,000 square feet. Our average per-square-foot capital costs for renewed and re-tenanted space was $6.90. Additionally, during 2003, we continued to focus on meeting the growing demand for space from our larger tenants, particularly the government and a number of key defense contractors. As an example, during 2003, we executed 23 leases totaling 589,000 square feet, with our existing top 20 tenants. Of these 23 leases, eight leases were with the government, four leases with Booz Allen Hamilton, three with General Dynamics and three with Titan Corporation. We also took advantage of the strong demand from these tenants to downsize certain tenants such as Genuity and Corvis. A significant portion of the leasing activity for the year was for new space with existing tenants, with a total of 365,000 square feet leased to the U.S. government, Titan Corporation and The Aerospace Corporation, each one taking an entire building. And we continue to see solid demand, which I will discuss in more detail in a minute.

As a result of this leasing activity, the percentage of total revenue that we derived from the government and defense contractors continued to grow during 2003, increasing to 40 percent at year end, as compared to 26 percent several years ago. We expect this percentage to continue increasing throughout the year.

During the fourth quarter, we renewed 88 percent of leases expiring, at an average capital cost of a low $2.61 per square foot. We renewed and re-tenanted space totaling 553,000 square feet, with base rent and total rent on a cash basis, decreasing slightly at 4 and 5 percent, respectively. As is the case with most of the office REITs, our re-tenanting costs are increasing. During the fourth quarter, our renewal and re-tenanting costs, including tenant improvements and leasing commissions, averaged $5.18 per square foot, versus $4.49 for the fourth quarter of 2002. However, these costs remain very low, in comparison to other office REITs.

Looking at our lease expiration schedule in 2004, we have 87 leases scheduled to expire, totaling 858,000 square feet, equating to 9 percent of our revenue. We expect to renew about 70 percent of the space rolling. Only 3 percent of these leases are over 50,000 square feet, and 55 percent of the square footage expiring is in our strong B/W Corridor. The average total rent for all expiring space is $18.56 per square foot, which remains below market.

With respect to market conditions and trends, despite the improving economy, office market conditions nationally remain challenging in 2003, and are not projected to dramatically improve in 2004. In contrast, each of our markets actually experienced a drop in vacancy rates from the beginning of 2003 through the end of the year.

Looking specifically at each of these submarkets, first we see fairly steady improvement within the entire BWI airport submarket in Anne Arundel County, which totals 4.4 million square feet. Direct and subleased vacancy totaled 11.2 percent for the fourth quarter 2003, versus 13.6 percent at the beginning of 2003. Our portfolio, which represents 78 percent of this entire market, was 92 percent leased at year end. As of December 31st, the Class A vacancy portion of this BWI airport submarket, including sublease, dropped to a very low 5.6 percent, as compared to 6.2 percent at the beginning of 2003.

Howard County and the B/W Corridor has a vacancy rate, including sublease space for all office, totaling 14.9 percent, down from 20.4 percent at the beginning of 2003. Our Howard County portfolio, consisting of 1.6 million square feet, is currently 91 percent leased.

Overall, Northern Virginia's total office vacancy rate, including sublease space, dropped again this quarter to 13.2 percent from 16 percent at the start of 2003. There was positive net absorption of 2.1 million square feet this quarter, the third quarter in a row that this market has had positive absorption. Our portfolio, consisting of 1.6 million square feet, is currently 97.5 percent leased.

Turning to acquisitions, during 2003, we acquired seven suburban office properties, encompassing 993,000 square feet that were 98 percent occupied upon acquisition, for an aggregate investment of $165 million. This total exceeded our stated objective of acquiring a net $100 million after the disposition of $41 million of properties. We increased our presence in two of our targeted Northern Virginia submarkets, with $147 million of total investment, as we continued to execute on our strategy of expanding our portfolio in this region. We expect most of our acquisition growth this year to, once again, be in the Greater Washington region. We have targeted $100 million ratably for acquisitions through 2004 and, although no acquisitions have closed so far, we have over $200 million of offers out, and are under a hard contract for a $22 million acquisition that we anticipate closing by the end of the first quarter.

With respect to development, during 2003, we completed and put into service four buildings totaling 276,000 square feet that were 73 percent leased at year end. This included 140 NBP, that was 100 percent leased to the U.S. government and placed into service right at year end. In terms of development activity, we currently have three buildings under construction, for a total of 301,000 square feet. These buildings are 90 percent preleased, and we would expect initial unleveraged cash yields in the 11 to 12 percent range.

Beyond these three projects, we have under pre-development an additional three projects totaling 393,000 square feet at National Business Park that, based on demand from both the government and defense contractors, we would expect to break ground on this spring, with delivery in 2005.

Specifically, these three projects are, first, 191 NBP, a 98,000-square-foot building, which will be located on the existing parking lot of 201 NBP. And along with that, we will do a parking deck to accommodate the parking needs for both buildings. Second will be 304 NBP, a 160,000-square-foot building. And third will be 318 NBP, a 125,000-square-foot building, both in Phase II of NBP.

Additionally, with respect to our Westfields properties in Northern Virginia, given that we are virtually 100 percent leased, and we are still seeing strong demand, we are permitting the second phase of WTP II, which is a 210,000-square-foot expansion of Washington Technology Park, and we would anticipate starting this project this spring, subject to pre-leasing discussions which are ongoing.

In total, we have under control 264 acres in additional development sites that are all located adjacent to existing COPT buildings, and can support a total of 4.2 million square feet of additional space. Also, we anticipate acquiring additional land this year adjacent to our existing locations, to position ourselves for future accelerating tenant demand.

Lastly, with regard to our management team, we recently announced a number of key promotions. We continue to add debt strategically to support our growth, and anticipate announcing in the first quarter the addition of an asset manager for our Northern Virginia portfolio that will position the Company to capitalize on the opportunities in that market.

In summary, we continue to work diligently to execute our business strategy while staying focused in our core markets. Our growth projections are based on our ability to meet increasing demand for new space from our existing tenants, and to seek out acquisition opportunities. We firmly believe that we have the platform and strategy to take advantage of these opportunities that we are seeing across our core markets, and to continue growing our business while delivering strong results. With that, we would be happy to answer any questions that you may have.

(OPERATOR INSTRUCTIONS). Paul Adornato, Cobblestone Research.

Looking at page 38 of the supplemental information, developments placed into service last year, it looks like two of the properties had little or no lease-up activity during the whole year. I was wondering if you could talk about those.

Paul, those properties are located in Columbia Gateway Business Park; they are two single-story office flex buildings. And if you look at our market as a whole, our Columbia market is probably the one where the supply and demand are the most out of balance. We obviously have very a favorable supply and demand situation in the B/W Corridor as a whole, particularly in Anne Arundel County. But in Columbia, there is a lot of competing product against those two buildings. We are seeing activity, and we would anticipate that those buildings will have no problem leasing up during calendar 2004.

And what about return expectations now, versus when you started those projects?

A couple of things. We had originally anticipated about 11.25 yields, stabilized yields. Now, I would say we're down to about 10.5 percent. And that is really as a result of rental rates being about $1 lower than we had anticipated. Also, we had anticipated much higher interest costs, so our carrying of these buildings obviously has been a lot less problematic than had interest rates been a lot higher.

Okay, and could you remind us of your accounting policies on developments? What is capitalized, and at what point you would begin expensing?

We start expensing all operating costs and interest the earlier of 60 percent occupancy or one year from shell completion -- certificate of occupancy from getting the shell.

And on the two assets that are less than 60 percent, are you --?

We have been carrying them since January 1 of '03.

Ken Weinberg, Legg Mason.

Rand, could you touch on any interest you are seeing in the VeriSign space in Northern Virginia?

As you know, and for the benefit of people that may not have been on other calls, that building was 100 percent leased to VeriSign. However, they really only occupy 172,000 square feet, and we actually structured two leases, one that would be a 12-year lease for that square footage. The other would be after two years, they would start to ratably, every six months, decrease that space. So, in effect, we had the opportunity to go out and take them out of the 270-plus thousand square feet on their nickel over the next several years. And one thing that we did do, as part of our initial lease and acquisition from them for the building, was to also get permission where, if required, with some notice, we could actually take them out of the building and be able to market the entire 404,000-square-foot building. That is the only building in Northern Virginia of that size, and so we have had quite a bit of interest from a number of groups -- three groups, specifically looking at the whole building, the whole 404,000. And then we have had different sizes of demand at 250, 270 and down to 100 and so on. So we are very optimistic. I think that the activity is strong. It looks like the lease rates are a little higher than what we had originally forecast when we purchased the building, and so we would expect this year, sometime during the year, to actually eliminate that potential future leasing exposure.

If I did my math right here, it looks like you could potentially be starting about 600,000 square feet this year, between NBP and Westfields.

Right.

Can you give me an estimated cost basis there?

It's about $100 million.

And you're comfortable with your funding sources there?

Well, as you know, we do construction loans for about 75 percent of the cost, and the land is paid for. And that, in effect, becomes your equity. So we are comfortable we've got that with no problem.

And then you mentioned that only 3 percent of the space that you expect to renew as rolling in '04 is over 50,000 square feet.

It's not 3 percent; it's actually 3 --

It's actually three leases?

Yes.

Can you give us a little color on what your expectations are there, and where they are located?

Of the three leases, one is for 84,000 square feet, and that will not renew, but it has already been re-tenanted. So in the second quarter, when it would have otherwise matured, we won't have a renewal situation, but we won't have our occupancy go down. And that represents about 10 percent of the year's expirations.

The second two, one is at the National Business Park for 69,000 square feet, and we are highly confident that that tenant will renew. And the third is at the airport, a single-story, 57,000-square-foot building to one of our top 20 tenants. And we are also confident that they will renew. So we feel like all three of those situations will work out positively.

Timothy Goebel (ph), R. Reese (ph).

Roger, the land that you are acquiring -- are you going to capitalize the interest on any of that? How much are you capitalizing interest on at this point?

Well, our land, I guess, is broken down into two components. We have what I'll call long-term land holdings that we are not actively developing or constructing. And on that land, we are expensing both the capital costs and the operating costs related to that. We've been do have land that is under active development or construction, where we are capitalizing certain costs, and that would include the land at the National Business Park. But, for instance, the land at Westfields -- all that land is just being expensed through our income statement.

How much is the breakdown, in dollar terms?

Well, the only land that we are capitalizing on would be at the National Business Park, and that would be about $27 million worth, because we are currently ready to start, as Randall mentioned, the three buildings.

About half the land banked right now?

Correct.

And how much are you looking to spend on land acquisitions, near term?

Near term, or this year? Probably this year would be, if all things worked out, roughly $20 million.

Chris Haley, Wachovia Securities.

It's Greg Carundi (ph), actually. I was wondering if you guys have any disposition volume built into '04 projections?

I think on our third-quarter call, we mentioned that we felt we would do $100 million net of investment for the year, which included about 125 gross of acquisitions and 25 million of dispositions. And I think we would still hold to those numbers at this point.

Any change to yield expectations on Phase II at NBP?

No, not really. I think, in that particular park, we're probably very, very close if not over 12 percent, going in unleveraged cash-on-cash yields.

(OPERATOR INSTRUCTIONS). Frank Greywhit (ph), McDonald Investments.

I was just wondering if you could go over some of the vacancy that you saw in Northern Virginia and Harrisburg during the quarter?

In the case of Harrisburg, it was just several small tenants that matured that we did not renew. In the case of Northern Virginia, when we bought an acquisition this year, one of the tenants was called Bond, and they had leased 65,000 square feet. A large amount of that was sublet to five tenants. We have now entered into direct leases with those five tenants, and are taking back the Bond space, and included in that is about 18,000 square feet of vacancy that we are getting back from them. So it's really just a one-tenant situation.

Anything in Northern New Jersey?

We had one or two just very small tenants.

Minor. Pretty minor.

As far as Magellan Health, they have a pretty large expiration. How do you feel about them renewing?

Well, we're in discussions with them. They have two leases, one that matures August 31st that's 42,000 square feet, and then one that matures next May of '05 that is 107,000 square feet. And at this point, it's too early to tell what will happen, but we are optimistic on our '04 and '05 expirations as a whole. We have already, with what we have talked about, handled about 18 or 19 percent of our 2004 expirations, at this point have already been either renewed or re-tenanted. So we're confident that, as Rand mentioned, that we will renew about 70 to 75 percent of our tenants for this year.

Just a little bit about your '04 mark to market. I was wondering if you could quantify that a little bit more. And then in '05, based upon current market rents, are you above or are you below market?

We think, for calendar '04, we're about 5 to 10 percent below market, with our 18 and change per-square-foot leases maturing on average this year. And for '05, if you looked at it today, it would be flat to up 5 to 7 percent. And hopefully, by then, it will be a better situation as supply and demand comes back into balance.

And do you feel pretty comfortable on the -- one swap agreement expired; are you going to put another swap agreement on that, or --?

Well, in December, we issued $50 million to preferred that sort of took the place of that $50 million swap. So at this point, as we mentioned, only about 8 percent of our capital structure is floating-rate interest. And we will be looking at that as the year goes on. What I think we would anticipate in lieu of that is doing some more permanent financing. We're looking at doing another package of assets in the $50 to $75 million range, that we would probably execute in the first half of this year.

And then two quick -- do you have what capitalized interest was for the quarter?

For the fourth quarter, we had a total of $682,000 capitalized. And that is made up of external third-party loans of $318,000, and then internal capitalized interest on things that we're funding out-of-pocket of 364,000.

Were there any lease term fees in the quarter?

We had $700,000 of lease termination fees in the fourth quarter of '03.

Paul Puryear, Raymond James.

A couple of questions. Could you take us through again sort of the rationale for how you manage your balance sheet, from a total debt capacity standpoint, the ratios that you key on? And the dry powder, I guess, that you think you have here?

Currently, today, on our line of credit, we have about $115 million of availability, and then we have some assets that have no debt associated with them. I think we're managing, obviously, a lot of things, including fixed-charge coverage, I would say is the first thing that we're managing. Second is we're managing debt service coverage, and we are obviously always looking at the three elements of our capital structure -- debt, common and preferred -- and trying to determine which of those is the cheapest at any one time, and trying to balance those three. And at this time, obviously, all three of those elements are very favorable, whether it be debt, preferred or common. And I think what you'll see is that we will continue to run the Company in the 50 to 55 percent leverage from a market cap standpoint, and the balance would be preferred and common.

And then the fixed-charge coverage ratio? I mean, you're --

What we said on our call is that we have always maintained above a 2.0 fixed-charge coverage.

I guess the second question -- you said, I think, in your opening comments that you thought AFFO would grow at a little slower rate than FFO because of a lease-up. Could you just talk about that a little bit? Do you envision -- certainly, it looks like you're expecting some occupancy gains. So that figures into that, but what are your views on the leasing costs themselves?

I think our leasing costs are still somewhat under pressure in some of our markets, and will continue to be for the next 12 to 24 months. But still, relative to other markets and our other peers, we still have very low costs per square foot. We are anticipating that occupancy will go up by 2 percent this year over the year, and if you take that times 10 million square feet, that's 200,000 square feet. And if you do, on a re-tenanting basis, $10 a square foot times that, we would anticipate that our capital costs could be approximately $2 million higher than normal, as our occupancy ramps up.

So you're still seeing pressure on leasing costs? You've not seen a turn in any of the submarkets?

No. clearly, in certain parts of the Baltimore/Washington Corridor, particularly the BWI district, where we have a large portion of our portfolio, Airport Square and the National Business Park, we're not having pressure in that market. We are having pressure in Columbia and surrounding areas, and then we're having some pressure in Harrisburg and New Jersey.

I think, Paul, part of that, if you look at the other aspect of it that is going to help is that, as I've mentioned, the markets have been improving fairly rapidly. And so we see during the year that those vacancy rates are going to continue to come down. And we expect that pressure to ease as the product gets absorbed. And we are already starting to see that somewhat, that pricing has certainly firmed up. And we would expect that the costs of the deals, as well, will firm up very well in those markets that are a little bit weaker during the year.

Richard Anderson, Maxcor Financial.

My first question is on your comment about government and government contractors representing 40 percent of your business, at this point. What is the number that you sort of view as nirvana, that you would like to get to and wouldn't want to go too much higher than that, in terms of your percentage of your total portfolio?

I don't know if you ever achieve nirvana. But I think we bounce around sort of a 50 percent number. There is nothing magical about that, because these are long-term leases, generally. They are very strong credit, obviously, and it does ebb and flow. During the year, for example, we started closer to 39. Then we bought a big building, the VeriSign building, that was non-government. And that dropped that percent to 37, and then it came back up to 40, and we would expect that to continue moving up from there. So a very healthy situation, when you're seeing significant, you know, 100 leases being signed with long-term, with bumps every year, with very good turns. That is very advantageous for us. You're not seeing that, really, in a lot of places in the country -- that unique growth sector of the (technical difficulty) economy right now that is --

Any new observations on the impact or lack thereof of the merger with Lockheed and Titan?

As I think we said on the last call, these are contract-related. They are not headquarters-related. So the leases that we have are -- is associated with that for Titan is specifically tied to contracts that they have with government agencies. And those are not being duplicative at all of Lockheed. There is no indication of any reductions whatsoever.

Okay. In September, you mentioned that you had $178 million of offers out for potential acquisitions, and you mentioned a number today of 200 million offers out, the difference being, coincidentally, 22 million, which is the number you're identified as being the one that you feel like you have a firm commitment on at this point. Is that just a coincidence, or did that one sort of pop in suddenly and move faster faster than you thought the other ones did?

I think that's just a coincidence. We do have $22 million under firm contract, and we do have -- $200 million is a round number. We have got a little over $200 million of offers out.

Are you disappointed that none of the 178 million that you're identified in September have yet to come to fruition? Or has it taken longer than you thought it was going to?

Not really. These particular acquisitions always take a long time. It's a competitive market, and we are constantly in the market. So in our experience, we continue to work on them, and we think we're doing pretty well, to date.

My last question is, has there been any thought about getting out of some of your tertiary markets such as Harrisburg or Northern New Jersey?

I think we always look at those opportunities. It's difficult to exit a market that some of the other REIT brethren have found, and to do it on the right time and the right pricing. So we always are looking at that as a strategy, but today we have no explicit desire or intention to be exiting any of those markets. Harrisburg is mentioned as something that logically would make sense; it's a decreasing percentage, constantly, of our portfolio. And it's not at a point where it's sufficiently leased, in our opinion, where you could exit it. So in the meantime, as you see, 70 plus percent of what we own is concentrated in Greater Washington. And we continue to add that as a percentage through both development and acquisition.

Jay Habermann, CSFB.

Good afternoon. Just a quick question. If 94 percent occupancy gets you to the high end of your guidance range, what are you assuming at the low end for occupancy? Or what keeps you within the range?

93 percent.

93? So you still are assuming an increase?

Yes.

For next year, as well, can you just run through your same-property NOI assumption, I guess, on a cash basis?

We're assuming a 1 to 2 percent increase in same-store cash NOI for calendar '04. That sounds a little low relative to a 2 percent occupancy increase, but we're assuming that that occupancy increase will happen over the 12-month period.

So you are going to experience some pressure on rents, is what you're factoring in?

A little bit.

Chris Haley.

I was hoping you could run over the Q1 guidance a little bit more. Are you expecting any lease-up between Q4 numbers into Q1? And then I have a follow-up on that.

We did mention that our leased percentage was 92.8 percent, versus occupied of 91.2. So yes, we are assuming that our occupancy percentage will start to go up in the first quarter of '04.

Would you care to quantify some of the deductions that are coming out? Looking at the fourth-quarter run rate of 40 cents, and adding some occupancy in Q1 automatically gets you above the range --

We mentioned two things. First of all, the preferred offering that we did in December, which we utilized to pay down our line -- there's a 4.5 percent interest rate differential there. So we are suffering about 1.4 cents in the first quarter of '04. Secondly, the write-off of the loan costs that we're going to repay, in connection with the issuance of our new unsecured line of credit, will total about $300,000, or 0.75 cents. And finally, we expect that G&A will have some pressure, like all public companies are having now, as the result of complying with new regulations, et cetera.

So a sequential increase in G&A?

Yes.

Any magnitude?

We're probably looking at an additional $100,000 in the first quarter.

And currently, there are no further questions remaining in our queue. Mr. Hamlin, I would like to turn things back over to you for any additional or closing remarks.

Sure. Thank you very much. I'd like thank everybody for joining us today, and we appreciate your participation. I'd like to mention that Rand, Roger, Mary Ellen and I are available to answer any questions you may have, and I wanted to also mention that we intend, at this point, to hold our first-quarter conference call on Thursday, April 29th. Thank you, everyone, and good day.

That will conclude today's conference. We thank you for joining us and have a great day.