COPT Defense Properties (CDP) 2004 Q2 法說會逐字稿

Welcome to the Corporate Office Properties Trust second-quarter earnings release conference call. As a reminder, today's call is being recorded. At this time I will turn the call over to Mary Ellen Fowler, Vice President of Finance and Investor Relations. Please go ahead, ma'am.

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 on the investor relations section of our website at www.copt.com. Within the supplemental package you will find a reconciliation of non-GAAP financial measures to GAAP measures referenced throughout this call.

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 second quarter. 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 on what we believe 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 release 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 will turn the call over to Clay Hamlin.

Thank you Mary Ellen. Good afternoon everyone.

We're reporting another excellent quarter. Total FFO for this quarter grew to 50 cents per share. That's 44 percent over the second quarter of last year. This represents a 32 percent increase on a per-share basis.

Most of the 10 cent increase above our previous guidance of 40 cents for the quarter resulted from a $4 million termination fee from VeriSign recognized during the quarter. Although Roger will walk you through the accounting for the lease termination fee in a few minutes, the main take away from this transaction is that we received a termination fee, we had no down time and leasing the space and ended up with a long-term lease with an expanding, strong credit tenant.

AFO increased 25 percent from the second quarter one year ago, and our pay out ratio advanced to a low 71 percent, compared to 81 percent for the same quarter last year.

From a macro viewpoint, we've experienced a pick up in our leasing activity over the past 90 days. This is particularly true in some of our softer submarkets such as Howard County. We have seen the leasing increase at properties such as our 6731 Columbia Gateway building that have been sitting at 67 percent occupied and is now 99 percent leased. A large portion of this activity continues from the defense sector.

As we discussed last quarter, we are tracking four components that will provide our growth as we move through 2004.

First, we set the benchmark that our occupancy would be 94 percent by year-end. We have made additional progress toward that goal. As of June 30th, our overall occupancy is 92.9 percent and leasing at 94.4 percent. In addition, we had solid portfolio performance, good renewal activity with positive marked-to-market lease rates and a 2.5 percent increase in same property cash NOI.

Second, with regard to our acquisition activity we have closed on one of the remaining buildings we purchased in the St. Mary's portfolio, and we're continuing to work towards closing the last building. You also recognize the $16 million, 179,000 square foot building located in Hunt Valley in Baltimore County, adding to our presence there.

Even though interest rates are ticking up, which we had hoped might impact certain purchasers, and our pipeline is large, acquisitions continue to be very competitive. That's especially true in our targeted submarkets like Northern Virginia.

We have stayed the course for with regard to our underwriting policy on acquisitions, however; that of looking at replacement costs as being a governor on purchase price. Nonetheless, with $96 million in building acquisitions completed so far this year, we are ahead of our projected $25 million per quarter goal for the year.

In addition to building acquisitions, we have purchased land such as the parcel adjacent to One Dulles Tower that will position us for growth over the next several years. We have enough ground at our existing parcel to support five more years of development growth. However, we're also bidding on several parcels of land to expand our development potential that we hope to announce by year-end. And those could position us even better for long-term growth.

Third, we continue to be very active on the development front. We have two buildings that will be acquired this fall, and we're achieving excellent returns on those buildings which should be very accretive. In addition, we have four new buildings that have started construction and two others that are in the development process. We're seeing an anomaly in the market where it is cheaper to build in Northern Virginia than to buy, which highlights the importance of our development capabilities of having sufficient ground control.

Fourth, from a balance sheet perspective we've improved the cost of debt by retiring a $26 million loan that had a rate of 7.8 percent and executing a commitment for $115 million long-term loan with a fixed rate of 5.5 percent. In addition, subsequent to the quarter end we have redeemed our 10 percent Series B Preferred Shares.

Turning to our earnings guidance, we're increasing our annual 2004 FFO guidance to a range of $1.70 to $1.74 per diluted share to reflect the VeriSign lease termination fee and our overall progress other key areas. Roger will go through the guidance in more detail.

Summarizing, our team is working exceptionally hard this year to deliver on our stated objectives. As evidenced by at our recent acquisition activity, we're continuing to look for opportunities that fit within our focused strategy of serving the government and defense industries. The defense contractor sector is one of the real growth areas of the US economy. We are uniquely positioned to take advantage of this opportunity.

Our concentration of government and defense tenancies continues to increase. We are now at 45 percent of our annualized revenues. With new leases coming online with Titan Corporation and Aerospace Corporation we expect that number to move towards 50 percent as we move to the end of the year.

With that, I'd like to turn the call over to Roger.

Thanks Clay. I will start with our funds from operations.

As a note, all per-share amounts are presented on a fully diluted basis and include the effects of FAS 141.

FFO for the second quarter totaled $21.4 million or 50 cents per share, as compared to FFO for the second quarter last year of $14.9 million or 38 cents per share, representing a 44 percent increase in total FFO and a 32 percent increase on a per-share basis.

Most of the 10 cent increase in FFO for the quarter above our guidance of 40 cents was due to a $4 million termination fee paid by VeriSign, contributing 9 cents to FFO with 1 cent realized from other improvements in operating performance. In an effort to make this more easily understood I will first go through the details of transaction that generated the VeriSign termination fee and then go through the accounting.

You may recall that the Company acquired the 404,000 square foot One Dulles Tower building in June 2003, and that it was 100 percent leased to VeriSign with 172,000 square feet expiring in 2014 and 232,000 square feet expiring in portions between June 2005 and September 2006.

In 2004, the Company signed a new 242,000 square foot lease with Booz Allen Hamilton for all the VeriSign short-term space and 10,000 square feet of the long-term space, and executed a concurrent lease termination with VeriSign. Booz Allen has an option to expand into the balance of the building and we have the right to move VeriSign totally out of the balance of their space.

As part of the termination, VeriSign agreed to continue paying their contractually obligated rent on the terminated space through December 2004, the day before Booz Allen's rent commences.

I will walk everyone through the accounting associated with the lease termination which is impacted by the accounting rules for FAS 141.

There are two revenue components to the lease termination. The first component is the $4 million that represents the acceleration of rent that was due from April through December of 2004. The $4 million was recognized in the second quarter and equates to 9 cents of FFO per share. The second revenue component is $3.5 million that is the real termination fee that we're recognizing on a straight line basis through May 2007, the date that VeriSign is anticipated to vacate totally from the building. Offsetting most of this term fee will be accelerated lease-specific charges like straight line rent and FAS 141 lease value. The net effect to FFO will be a nominal amount per quarter.

One further item to note is that the write-off and acceleration of FAS 141 deferred charges related to the space that VeriSign gave up is reflected in increased depreciation expense on our income statement. If VeriSign stayed in the lease we would have taken those charges over the original term of the lease. This charge is not included in FFO. The VeriSign lease still has approximately $13.5 million of FAS 141 assets that would be written off net of continued amortization if Booz Allen expands into the balance of the building. The write-off would not impact FFO, but would impact net income.

The bottom line is that REIT's will experience volatility in net income and FFO to a lesser extent as the result of FAS 141. In the case of One Dulles Tower transaction, we would not have terminated the VeriSign lease without the Booz Allen lease in hand. Even so, the FAS 141 assets have to be written off.

We have improved an asset by back-filling unoccupied space with a long-term lease to a strong credit tenants without down time or loss of rent. We're refinancing this asset with a very attractive long-term fixed-rate loan of 5.5 percent. We achieved an excellent economic outcome for our shareholders.

Turning to AFFO, after adjusting for capital expenditures and straight-lining of rent, our adjusted funds from operations increased 25 percent for the second quarter compared to the second quarter of 2003. We experienced higher CapEx resulting from increased occupancy of 1.7 percent since year-end.

During the quarter, the Company distributed 23.5 cents per share in common dividends, equating to 46 percent FFO pay out ratio as compared to a 60 percent FFO pay out ratio for the second quarter of 2003. AFFO pay out ratio was 71 percent compared to 81 percent at the end of June 2003.

Looking at GAAP earnings, for the second quarter we recorded earnings of 13 cents per share versus a net loss of 30 cents per share for the second quarter of 2003. Included in the second quarter of 2003 was and accounting charge of $11.2 million recognized upon the repurchase of convertible preferred units. Without the repurchase our net income diluted would have been 14 cents per share.

In terms of same property net operating income, for the 110 comparative properties representing 81 percent of our portfolio same property cash NOI increased by 2.5 percent over the second quarter of '03.

Turning to our balance sheet, at June 30th our total market capitalization was approximately $2.1 billion with $820 million of debt outstanding, resulting in our lowest level so far at 39 percent debt to total market cap ratio.

During the quarter we repaid a $26 million permanent loan with an interest rate of 7.8 percent. At June 30th, 28 percent of our debt was floating and 72 percent was fixed. We expect the floating rate debt percentage increase to approximately 14 percent by October of this year when we close on a $115 million seven-year nonrecourse loan fixed at 5.5 percent.

Turning to equity, during the quarter we issued 2.8 million shares of common stock, generating proceeds of $58.4 million. During July, we redeemed our 10 percent Series B Preferred Stock. The (indiscernible) 2 cents dilutive for the second quarter, but will be 2 cents accretive annually going forward with the Series B redemption and mortgage repayment. We plan to fund our development pipeline through construction loans using the land as equity for the transactions.

For the second quarter 2004, the Company's EBITDA to interest expense was 3.5-to-1 and our fixed charge EBITDA coverage 2.5-to-1.

Lastly, our previous 2004 FFO guidance was $1.66 to $1.70 per share, which did not take into account 4 cents per share charge for the Series B redemption. We are now projecting that FFO for 2004 will be in the $1.70 to $1.74 per share range. This guidance reflects the VeriSign termination fee recognition and includes the 4 cent per share write-off of origination costs resulting from the Series B Preferred redemption that we will incur in the third quarter.

In addition, our 2004 guidance assumes 94 percent occupancy by year-end, three buildings now under construction placed into service, $25 million in additional acquisitions, and a 25 basis point per quarter increase in interest rates by year-end.

Now I will turn the call over to Rand.

Thanks Roger and good afternoon everyone.

At June 30th our portfolio ended the quarter at 92.9 percent occupied and 94.4 percent leased. Our gain in occupancy includes half of the space we recently leased to Northrop Grumman at Airport Square One, as well as a number of smaller leases. We view our percentage leased as the lead indicator for portfolio occupancy, and as such believe that we're well on track to reaching our 94 percent occupancy target by year-end.

In terms of leasing statistics, we renewed and retenanted a total of 427,000 square feet for the quarter. Of this total, renewed space was 288,000 square feet, equating to a 70 percent renewal rate at an average capital cost of $9.50 per square foot. We expect our renewal rate to be in the 70 percent range at a minimum for the year.

Average rental rates for the renewed and retenanted space increased by about 9.7 percent for base rent and 5.6 percent for total rent on a straight line basis. And rents remain flat on a cash basis. These numbers indicate the relative strength of our markets. For renewed and retenanted space the average capital cost was $11.60 per square foot.

Looking at our lease expiration schedule across our portfolio for the remainder of this year, we have substantially reduced our renewal exposure from 9 percent at the beginning of the year to only 4.2 percent of our revenues at June 30th, which represents about 464,000 square feet. We have also proactively managed our lease expirations for 2005 down from 10.3 percent to 9.2 percent for our portfolio.

Clay summarized our acquisitions for the year, but I wanted to provide some more information on our recent press release regarding an executed contract for approximately 600 acres comprising the former Fort Ritchie Army Base located in Washington County, Maryland.

Fort Ritchie is located about an hour drive from our Columbia headquarters and is right on the Maryland/Pennsylvania border. It is our policy to announce acquisitions only when we close on the transaction. However, in this case we modified our policy since the execution of the contract needed to be disclosed publicly by the PenMar Development Corporation, which is the public entity overseeing the redevelopment of the site.

We're now in 90-day due diligence period during which we will be conducting our own due diligence on the site, including environmental review and finalizing a development plan. The site currently has a total of 222 buildings, consisting of approximately 1.3 million square feet of office buildings and support buildings and 341 residential units, along with recreational and woodland areas. If you go to PenMar’s website at www.penmar.com you will see pictures of the site, and it is really a sensational site.

We believe the developable acreage is in the 330 to 380 acre range, including the area encompassed by existing buildings. As part of the Base Realignment Act, or BRAC laws as they are called, we will be seeking input from the local community to incorporate into our development plans. We intend to hold meetings with the local residents together feedback on the project.

Our commitment to this project will be to create jobs in the area, generate economic development, increase the Washington County tax revenues, and serve the needs of the local community. Therefore, formulating a plan to successfully accomplish all of these goals is our next step.

We do think at this point that the property will have a mix of office and residential components. The office will be of the nature that we typically build, and we do have interest from the government sector, as well as the private sector, for this site.

Our view is that this property could be a very strategic one for us, fitting in very well with our existing tenant base and growth strategy. However, we want to make it very clear that this will be a long-term 10 to 15 year project that will not have any immediate earnings impact. We do have the development, leasing and management expertise, as well as the tenant relationships, however to make this a very successful project.

With respect to market conditions, in general in the BWI submarket as of June 30th vacancy including sublease is a very strong 6.7 percent, of which 5.3 percent was direct vacancy, down from 13.3 percent and 11 percent respectively in the second quarter of 2003. Our BWI portfolio totaling 3.5 million square feet and representing 77 percent of the BWI submarket, improved by 4.7 percent during the quarter to reach 96.3 percent leased at June 30th.

Turning next to the Columbia submarket in Howard County, at June 30th vacancy with sublease was 14.7 percent, of which 10.9 percent was direct vacancy. This overall vacancy has continued to improved and has declined from 18.2 percent and 13.3 percent one year ago. Our properties in the Columbia market total 1.6 million square feet and are currently 94.4 percent leased.

Lastly in the Dulles South submarket in Northern Virginia, the vacancy rate continues to decrease, ending the first quarter at 13 percent, of which 11.6 percent was direct vacancy, down from 17 percent and 12.8 percent respectively one year ago. Our operating portfolio of six buildings totaling just over 1 million square feet is 99.4 percent leased and occupied.

Turning to our development activity for a moment, we are very active with 530,000 square feet under construction at June 30th. We've already put into service a portion of 4230 Forbes Boulevard, and expect this fall to place into service both 220 NBP fully leased to the Titan Corporation and Greens III fully leased to the Aerospace Corporation.

New buildings added to our active construction for this quarter in National Business Park are 318 NBP, a 126,000 square foot building, and 191 NBP, a 104,000 square foot building. We have a full building leased out for signature on 191 NBP and have a verbal commitment for all of 318 NBP. Completion of 318 and 191 NBP is scheduled for third quarter of 2005. Subsequent to quarter end we also started construction on 304 NBP, a 162,000 square foot building that has a projected completion date of first quarter 2006. And we have a lease out on this building for the entire building.

This brings the total square footage under construction to 549,000 square feet at the National Business Park. In addition to this square footage, we anticipate an additional 288,000 square feet will be started later this year at National Business Park based on existing tenant demand. This additional 288,000 square feet consists of two buildings and is shown on the development page of our supplemental listed as 322 NBP and 306 NBP. We anticipate that both of these buildings will be complete between second quarter and third quarter of 2006. All of these buildings are very accretive to the Company.

Along with the buildings in National Business Park, based on tenant demand we have started subsequent to the quarter end the construction of Washington Tech Park II, a 216,000 square foot expansion of our Washington Tech Park I building located in Westfields Corporate Center in northern Virginia. So total square footage under construction NBP and Westfields totals 765,000 square feet today.

Based on market conditions and tenant demand, it is clear to us that we also need to start a new building in both St. Mary's County and Howard County later this year. We're moving quickly to line up building designs and permits for these two buildings.

Looking ahead at the new buildings that will start, and not including the three that will come online later this year, we project to have over 1 million square feet under construction by year-end. The sheer volume of development coming along, coupled with our acquisition activity, should result in our growth accelerating very nicely over the next two years.

In summary, we are pleased with our performance this quarter and are looking ahead to new opportunities that will further accelerate our growth.

And with that we will open up the call for your questions.

(OPERATOR INSTRUCTIONS) Chris Haley, Wachovia Securities.

Roger, I'm sorry, could you go through the parasite VeriSign accounting again and maybe address a little more in terms of the cash impact? My apologies; I wasn't able to keep up with everything.

Neither have I been able to for a long time.

VeriSign owes us rent contractually between -- first of all, we terminated the VeriSign lease at the end of March, and we signed the lease with Booz Allen Hamilton at the end of March. VeriSign as part of the termination agreement agreed to continue to pay us its contractually obligated rent between that termination period and 12-31-04, the time at which Booz Allen Hamilton's rent starts. In addition to that -- and that rent amount totals $4 million. In addition to that, there is another $3.5 million that they're specifically paying to us as a penalty to terminate the lease.

We recognize this quarter the $4 million in rent that was due between now and the end of the year. The other $3.5 million is being deferred because we made some adjustments to the long-term lease. And so they were tied together, and therefore the termination penalty got tied into that lease, and so it is being amortized over the expected balance of the occupancy for the long-term space for VeriSign.

I'm sorry, so the amortization of the $3.5 million penalty is over what time period?

We're assuming -- again, this is based on an estimate -- that they will be out of the space by May of 2007. So we've begun amortizing the 3.5 million into income between now and May 2007 on a straight line basis.

And that is in other or --?

That would go into rental income. But offsetting that is some straight line rent that's on the books and some FAS 141 lease value. If you remember, when we entered into the -- or bought the building, the leases or above market. And so therefore, we set up a deferred charge on our books which has to be accreted down to zero by the expected lease term. So those two will sort of offset each other. From a cash standpoint we are $3.5 million better off, but from accounting standpoint we're going to be about even.

So you have $3.5 million in pocket today?

Correct.

And you have $4 million of remaining rent. You're recognizing that now, but when do you receive that?

Ratably as they would otherwise pay contractually between now and the end of year.

But you recognized the $4 million in this quarter?

Correct.

What was the average term in terms of years of the leases signed in the quarter?

Just over 5, about 5.1 years.

And that is new and renewal?

Correct.

Great. Thank you.

Rich Anderson, Maxcor Financial.

Could you comment, if anything, on the nature of your conversations with Titan subsequent to some of the news on that company?

We've had conversations with Titan. And as a matter-of-fact, they continue to expand in this market. The buildings that we have under lease to them serve specific contracts that they have with an agency right across the street from our business park and other agencies in the community. They've actually come to us and asked for additional space since the Lockheed Martin merger abortion.

So at this point we feel very good about Titan. We have done a lot of research on their credit; their bank debt is trading at par and their bonds are trading similar to other bonds for their credit rating. So we feel comfortable about the company and its ability to go forward and pay us rent. And we also feel very good about the real estate which they lease from us.

Switching gears to CapEx, it jumped up from the first quarter. I was wondering how much of that was a function of the back-filling of the VeriSign space?

The short-term space for the VeriSign lease, we had set aside monies when we bought the property to spend actually $40 a square foot for the 232,000 square feet of space that would ultimately be back-filled if they left the building. So that will not be included in recurring CapEx. As a matter-of-fact, we haven't spend that money yet. Booz Allen is starting to build out their space now, and they will take drills (ph) from us over the next six month period of time. So there was no impact from the VeriSign lease.

But what's the reason then for the $9.5 per square foot of CapEx this quarter?

Some of it has to do with a little longer lease maturities on the -- historically our average renewal period has been about four years. It extended to about 5.1 this time.

With regard to the lease termination fee, the recognition, just from a modeling standpoint should we have in the top -- you have that in the topline revenue, the 4 million, I assume. Is that correct?

Correct.

And so we should sort of back that out when we are modeling forward. You won't recognize any of that on a go-forward-basis, so really the run rate from a topline revenue basis should be the number recorded during the quarter less 4 million?

That's correct.

Thank you very much.

(OPERATOR INSTRUCTIONS) Frank Greywitt, Key McDonald Investments.

I was wondering if you could comment a little bit more on Fort Ritchie, and if you can try to explain the true strategic -- what's the strategic significance behind it. Is it something that's currently in place in the area? Is an agency moving to the region?

Fort Ritchie has a very interesting and long history starting back in the 1880s, and then from a military standpoint sort of becoming involved in the 1920s. And it evolves when the government actually purchased it from the National Guard in the 1950s. Over time it's evolved into sort of a communications-type facility, as well as phased out of being a munitions training facility. And it was obviously a victim of the 1997 BRAC base closings decisions. And it's hurt area of Washington County pretty significantly with a loss of 1200 jobs on-site and about 350 jobs off-site. So it's been sitting there languishing.

And we believe that when you look at it, it is directly in the path of growth that is coming out of the Washington D.C. area. You look at where Frederick is, and kind of acceleration of values, and the type of firms and agencies that are there, and that growth is just continuing north of there. This situation, this site, is not that far from Frederick. As I said in my comments, Frank, we think that it fits very strategically with the type of tenants and the kinds of buildings that we do. It does have some existing buildings, as I said, that we will be able to retain and rehab. And then we would expect to be able to build some new buildings as well.

And so we look at this as a long-term play. We do have expressions of interest from a number of our existing-type tenants, but are not in a position to really go into detail at this time.

Can you indicate how much actual office square footage can be built on the developable acreage?

There is 1.3 million square feet there today that's an assortment of office and support buildings. We're in the process as part of our planning process, and meeting with the community, and then going through our various plans. So I don't think we're in a position really today to give you a number that I can count on. It's obviously a sizable figure with the size of the fort and the developable acreage that we've given. But we're still in that process of going through the development plan.

It's a 90-day period that probably after that 90 days you would have a little better idea?

Right. At the end of 90 days, which started on Monday of this week, we need to present a development plan to the PenMar Development Corporation for their approval. Subsequent to that we would obviously submit that to the Washington County Commissioners and go over it with the local community and a number of interested constituents. And that plan would then become sort of our obligation going forward with some flexibility obviously as market conditions adjust. So that's the process we are in.

Can you give us any idea on the total price of the land?

It's public. It was released yesterday. PenMar actually released the contract details. It is out, so I will give you that briefly, although you look in the press and I think even on their web site.

But the purchase price is $9 million for the site, and it's comprised of $5 million -- 3 million paid at closing, $1 million a year after that and $1 million two years after closing. The remaining $4 million is to be sort of tallied up at the end of nine years from closing. And whether or not we have to pay that depends on the amount of jobs that we've created in the timeframe that's sort of a sliding scale. If we get to 1400 jobs in that timeframe created, then we have no further obligation. If we have fewer than, then it's a sliding scale of obligation.

In addition, the contract specifies that we are taking over the obligation for infrastructure improvements on the property, and these range from bringing the roads up to acceptable standards to upgrading the electrical systems and so on like that.

We need to spend at a minimum $7.5 million during the initial five-year period. And that was there as a desire on the part of PenMar to make sure we had activity under way and we're just sitting on the property. PenMar has estimated originally, although we can't verify that number, that the total cost of infrastructure, which would be spread over a long period of time obviously, would be 20 to $25 million. But we're in the process during our timeframe of verifying that. And that will be dependent somewhat on the characteristics of the plan we develop.

Are there any tips or any sort of compensation for those improvements? Or are those all you guys?

They are ours, although the intricacies of the expenditures is that any money that's paid needs to be spent on the property. Any money that PenMar has accumulated from their past history also needs to be spent on the property. That area designated as a foreign tax zone, foreign trade zone. It is eligible for historic tax credits. So it has a lot of benefits from that perspective.

I heard there's a tenant currently on the site. Are you getting any yield at all in the beginning from that? Can you quantify that at all?

There are a number of tenants on the site, ranging from residential to other tenants. And we're going through the verification of just how much that will be in-place. Our expectation in that yes there would be some minimal FFO help to offset the $3 million initial investment and any other investment that we would make.

I appreciate that. Just another question on your development costs on your portfolio. There's a pretty substantial reduction. Is this going to be corresponding with the returns? Are you expecting to have the lower rents? What do you expect there?

I'm not sure what you're pointing at to say reductions.

Just on individual projects. It appears that the total cost --

(multiple speakers) date versus total.

Excuse me?

Are you looking at cost to date versus total?

I thought it was estimated. I can get back to you on that.

Why don't you do that? The costs have not gone down, per se.

Thank you very much.

Chris Haley, Wachovia Securities.

Sorry for the follow-up. On this project, who owns the acreage at this time?

Are you referring to Fort Ritchie?

Yes.

The property is under a lease by PenMar Development Corporation. PenMar was set up -- as is a typical process with base closings -- was set up by the Maryland Legislature as a legislative entity to deal with the redevelopment and eventual disposition of the site.

Unfortunately, there are several procedures that the Department of Defense need to go through. They have to do the environmental, for example, and verify that that's complete. They have to post potential uses of property and advertise that. And when they did that one entity came forward, leased some of the property, never used the property, and then filed suit when they were kicked off the property. And that has held up the actual transfer of title from the Department of Defense to PenMar.

We understand that recently the Department of Education ruled that that entity called Role Models of America did not have good standing, and the Department of Defense has proceeded with a request for a court date to have the injunction that was in-place lifted so that they can proceed with the sale of the property or the donation of the property to PenMar Corporation.

So we're hopeful that by the time we have finished our due diligence and are headed for closing, which should be right towards the end of the year, that this situation would be complete and we would take a clear title on the property. If it's not, then our contract calls for entering into a long-term lease with PenMar which requires that the Army Corps of Engineers extend their current lease, which they are in the process of discussing.

There is 100 acres of the 600 acres that is finishing up its remediation process, and that would be closing about a year later than the first portion.

That 100 acres is not related to, adjacent to, the 330, the 380 that you think you could develop on?

It's included in part of it.

So is this a kind of a -- my apologies if I'm not completely understanding this -- a land lease structure with an option? Trying to understand exactly who you're purchasing from or what exactly kind of agreement are you signing if you were to develop office space on this.

We actually have a sales contract that would have a fee simple. So we will own the entire fort. Again, we've got to get clear title (multiple speakers) but we would actually own the fee simple, the entire 600 acre plus fort, and then would proceed accordingly to develop. So if we built a new building and entered into a lease, the entities leasing would be from Corporate Office Properties and we would be owning those buildings.

So when you look at the capital outlay and the return on this capital versus putting more capital to work in Northern Virginia or the Baltimore/Washington Corridor, what does this signal to me in terms of -- or what should this signal to me about your hurdle rates or your investment opportunities in your existing markets?

I don't think you can make the correlation that the existing hurdle rates in our markets should go up or down or that we're worried or anything about that. We're very comfortable with that. We view this just as we sort of did with St. Mary's County when we invested there; this is just another excellent opportunity to expand our franchise that we have in this area. And we think that we've got the right kind of tenant mix and expertise to just continue to add to the overall development pace of the Company.

What would be the next one or two announcements from you about this project in your mind?

The first announcement most likely would be -- well, we may not announce it but it will get out in the public -- would be kind of our intended plan for the property. The second announcement most likely would be closing on the property. And then I would expect that sometime next year you'll start to see lease activity coming forth as we start to create some momentum on the property.

And again, this is a good 10, 15 year project. We think it will take a little while to kind of ramp up. Doesn't require a lot of expenditures, so that's nice from that perspective. When you do go to build new buildings, obviously using the land as equity and so you're just doing normal construction loans. And we think we can accomplish very comparable hurdle rates on this property to what we are achieving on places like National Business Park.

Looking at the dollars out the door to kind get things moving in terms of infrastructure, could you provide any range in terms of -- maybe a question rehashing an earlier question -- could you provide kind of dollars out the door before you start building?

It's too early to tell that. It's not a lot, but PenMar estimated for the entire redevelopment 20, 25 million. We don't really have a handle on that number and the phasing of it. So a lot of what we're doing in this 90-day period is sort of examining our view of the infrastructure against the projected costs and kind of developing that model.

You should come up and see it sometime (multiple speakers)

I think I will have to. It sounds like a --

I know you love to look at properties; this is a beautiful one.

Thank you very much and congratulations.

Glenn Pullard (ph), Legg Mason.

I apologize if I missed this, but could you just comment on any additional redevelopment opportunities as you did at Airport Square?

We don't have a lot of those kinds of buildings. The one we did at Airport Square, which was Airport Square One, was the oldest building in the portfolio. When we purchased we knew that we had a low basis in it and we knew that it needed some rehabbing. So we have completed that rehab and we were fortunate enough to lease it to Northrop Grumman for the entire building. And in June they occupied half of that, and we complete up another expansion then they occupy the second half later in the year.

Beyond that, we just don't really have other buildings in our portfolio that would require redevelopment at this point in time. Obviously when we're looking at purchases, if we can find redevelopment opportunities we're happy to take advantage of those. Some people would say the building we just did up on the York Road (ph) would be redevelopment, but it's 70 plus percent occupied; there's a lot of leasing activity and it's really not going to require a so-called redevelopment at that (inaudible). It's just some tenant (ph) finish some investment and some minor improvements to bring it up to current modern standards.

Just switching gears real quick, where do you think current marked-to-market -- '05 marked-to-market is on a portfolio-wide basis?

Based on the facts and circumstances that exist today, I'd say we were 7 to 10 percent. And obviously if the market tightens up we would hope that the difference would be greater by this time next year.

Thanks guys.

(multiple speakers) 7 to 10 percent under so there is growth. We want to differentiate from others in the country that are not so fortunate.

Thank you.

(OPERATOR INSTRUCTIONS) Rich Anderson, Maxcor Financial.

Sorry for the follow-up, but just a quick question on dispositions. Does your business strategies not lend itself to disposition since you are sort of building business parks and increasing your presence there as opposed to reducing? Do you have no plans to dispose of assets at this point?

No, that's not true. Normally it is true that with regard a lot of the business parks in our prime locations we're not looking to dispose of properties because of the fact that when you have a number of properties together there's a lot of benefit to that in both leasing and performance over time. However, there are properties in different locations which may not be targeted in our portfolio or which get to certain point and we look to dispose of them.

We currently have a property under contract, and we will see if that closes. And I think we projected 25 million in dispositions this year. And there are a few properties in our portfolio that are not core that we would consider from time to time putting on the market, sort of in line with what you've seen if you look at our history over the past four or five years.

Thank you.

Chris Haley, Wachovia Securities.

Clay, why not more? You have got all this stuff (technical difficulty) the development pipeline and your yields are pretty good, why not -- my perception is given the marketplace that you could get some pretty strong pricing for these assets, even non-core assets. Given your leverage ratio today, why not do more sales and really juice the numbers in terms of recycling, and therefore not dilute a year or two out?

Well, we do that. But one of the things we're looking at is determining when a property is ready for sale or not ready for sale. And we are opportunistic in that regard. If the property is not ready for sale because for instance it may not be leased appropriately or whatever, we're not going to actively market it until such time as it is. But we are certainly interested in recycling, and there are a lot of things going on in that department all the time.

Thank you.

That is all the questions we have. I will turn the conference back to you for any additional or closing remarks.

Thanks everybody for joining us and we appreciate your participation. Rand, Roger, Mary Ellen and I are available to answer other questions you might have, and wanted to say at this point that we intend to hold our third quarter conference call on November 4, 2004. Thanks everybody, and have a good day.

That does conclude today's teleconference. Thank you for your participation. Have a wonderful day. You may now disconnect.