COPT Defense Properties (CDP) 2004 Q3 法說會逐字稿

Welcome to the Corporate Office Properties Trust third-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, the Company's Vice President of Finance and Investor Relations. Please go ahead.

Thank you and good afternoon everyone. Yesterday our earnings press release was faxed or e-mailed to each if you. If there's 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, or you can access both documents from 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 the GAAP measures referenced throughout this call. Please refer to our Form 8-K or to our website for definitions of certain financial terms referred to on 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 third quarter and 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 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 will turn the call over to Clay Hamlin.

Thank you, Mary Ellen. Good afternoon, everyone. We have many positive details to share with you today. First, let me provide a couple of general comments.

As you are hearing on many of the quarterly earnings calls, the recovery in the office sector in most major markets around the country is slower than originally projected. Many of the office REITs are now thinking it will be 2006 before they see significant improvement in occupancy. For most of the major markets nationwide, rental rates are continuing to roll downward someone at renewal.

In contrast, our properties are in some of the best markets in the country, where occupancy rates are improving faster, as in the Baltimore/Washington corridor for example. So far this year, we have been able to increase our occupancy 180 basis points and we have been able to maintain or increase rents and our renewal rate is strong. We believe that this performance will continue through the year 2005 and beyond.

We have been asked recently whether the outcome of the election will affect the rate of demand we are seeing from our government and defense tenants. The answer is not materially. While we believe that either candidate must deal with the budget deficit, we do not believe that the defense spending related to intelligence activities will slow at all. One example is the recent NSA announcement that it will add 1500 jobs each year for the next five years in our market in Maryland, with 700 replacing retirees and 800 being net new jobs asset. In addition, NSA plans to double its annual contract or awards in Maryland, from $2 billion to $4 billion by 2008. We are seeing similar trends from the NRO in Northern Virginia.

Turning to our current results, we are firing on all cylinders. We generated 39 cents in FFO per diluted share in the quarter, or 43 cents if you ignore the 4 cent accounting charge for the Series B preferred share redemption. The 43 cents represents a 4.9 percent increase in FFO over the prior quarter a year ago. Based on our earnings, our board approved an 8.5 percent increase in our common dividend. That's the seventh year in a row of progressively increasing dividends.

We have made good progress on leasing, ending the quarter 94.9 percent leased and 93 percent occupied. We have surpassed our acquisition goal for the year by $100 million, with building acquisitions totaling 230 million year-to-date. We have effectively competed for properties in situations where properties have not been on the market, other situations where sophisticated tax structuring is required, or situations where there is unattractive long-term debt on the asset. We are also becoming well-known in Northern Virginia as we are now viewed as a credible buyer who can move quickly to close.

We continue to press forward on construction that will add over $175 million in asset value over the next two years and close to 1 million square feet of office space. As this development is completed, it will have a small impact on 2005 earnings and a much more significant impact on 2006 earnings. As we have recently announced, we are seeing the new space lease up, with three of the five buildings under construction already fully leased to single-tenant users.

During this quarter, we closed on a $115 million 7-rate (ph) fixed rate loan that increased our percentage of fixed-rate debt to 82 percent. We have permanently financed as many of our stabilized properties as possible, locking in long-term fixed rates in anticipation of rates rising. This of course creates a negative arbitrage in the short run, given the fact that short-term floating rates are still significantly below long-term rates. However, this adheres to the prudent strategy that this company has always followed.

Looking at year end, we are tightening our range for our 2004 FFO guidance to $1.72 to $1.74 range per diluted share. This guidance includes the 4 cent charge for our Series B preferred redemptions.

When we look forward to 2005 and analyze our projections for that year, we have a number of challenges that we are facing. During 2004 we have worked to expand through acquisitions, growing the portfolio by 13 percent so far, and through construction of new buildings, which equals another 6 percent. In addition, we are purchasing land that does not add to earnings today, which Rand will discuss. Between acquisitions and development, we are thus expanding our asset base by 19 percent from the start of 2004.

For us to continue growing the Company at the same pace, we have increased our staff, primarily in the accounting and development areas. With those new employees on board, we have the infrastructure to support our future growth. In addition, we have increased costs associated with Sarbanes Oxley and greater vesting of performance-based compensation. The combination of these factors will increase our G&A by about 20 percent for 2005.

Similar to other office REITs at this stage in the recovery, we do not believe that we will see tenants downsizing to the same extent as over the past 18 months. Therefore, lease termination fees -- which we have little control over -- will not be anywhere near the abnormally high level that we experienced this year. That being said, our initial 2005 annual FFO guidance range is $1.78 to $1.85 per share. This projection takes into consideration the above factors, rising interest rates, and a few other components. Roger will go through our assumptions in more detail.

In summary, this company is focused on long-term growth. We are making investments today, including development and land control, which we believe will lead to strong earnings growth in the future. An example of this strategy is our potential investment in Fort Ritchie, where we are investing today in what we project will be a strong generator of earnings over the next five to 10 years.

We are very confident in our business model because we are in the right markets, we have the right tenants, and we possess a unique franchise that will support our growth well into the future. With that, I'd like to turn the call over to Roger.

Thanks, Clay. I'll start 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 third quarter totaled $17.4 million, or 39 cents per share, as compared to FFO for the third quarter last year of $16.7 million, or 41 cents per share, representing a 4.9 percent decrease on a per-share basis. Included in FFO for the quarter is recognition of a $1.8 million accounting charge representing the write-off of initial offering cost for the Series B preferred share which was recorded at the time it was redeemed.

Without the accounting charge, our FFO diluted would have been 43 cents per share, representing a 4.9 percent increase. As a side note, the consensus estimate of 40 cents for the third quarter includes estimates from eight analysts, some of whom have included the 4 cent charge and some of who have ignored the charge.

Turning to AFFO, after adjusting for capital expenditures and straight lining of rents, our adjusted funds from operations decreased 1.7 percent for the third quarter compared to the third quarter of 2003. The decrease in AFFO is twofold. First, we experienced higher straight line rent of about $1.6 million in the quarter coming from the Booz Allen Hamilton lease at the former VeriSign space at 1 Dulles Tower. This will end when Booz Allen takes occupancy in January of 2005. Second, higher CapEx resulting from tenant leasing costs incurred from increasing occupancy by 1.8 percent since year-end 2003. We expect CapEx to be at a similar run rate over the next few quarters as we convert leasing to occupancy.

With regard to dividends, we increased our common dividend 8.5 percent during September and paid out 25.5 cents per share for the quarter ending September 30. This equated to a 65.8 percent FFO payout ratio, as compared to 53.9 percent for the third quarter of 2003. AFFO payout ratio was 97.3 percent compared to 75.4 percent at the end of September 2003. For the nine months ended September 30, our FFO and AFFO payout ratios were 56 percent and 81 percent, slightly below those for the comparable 2003 period.

Looking at GAAP earnings for the third quarter, we recorded earnings of 12 cents per share versus a net income of 18 cents per share for the third quarter of 2003. Included in the third quarter of 2004 was the $1.8 million accounting charge mentioned previously. Without the charge, our net income diluted would have been 17 cents per share. In terms of same-property net operating income for the 111 comparative properties representing 79 percent of our portfolio, same-property cash NOI decreased slightly by 1 percent and GAAP NOI increased by 2.3 percent over the third quarter 2003.

Turning to our balance sheet, at September 30th, our total market capitalization was approximately $2.3 billion with $947 million of debt outstanding, resulting in a 41.1 percent debt to total market cap ratio. During the quarter, we closed on a $115 million 7-year mortgage loans fixed at 5.47 percent. At September 30th, 18 percent of our debt was floating and 82 percent was fixed. We also closed on a $63 million secured loan to finance the construction of three buildings at the National Business Park.

Turning to equity, during the quarter we issued 2.3 million common shares, generating net proceeds of $57.3 million. During July we redeemed at par 100 percent of our 10 percent Series B preferred stock for $31.3 million. For the third quarter 2004, the Company's EBITDA to interest expense was 3.2 to 1 and our EBITDA to fixed charge coverage was 2.4 to 1.

With regard to earnings guidance, for our 2004 FFO guidance, we started the year with a range of $1.66 to $1.70 per diluted share, which did not take into account the 4 cent charge for the Series B redemption. Subsequently, we increased our range to $1.70 to $1.74, which included the 4 cent Series B charge and the 9 cent lease termination fee from VeriSign. We are now tightening the range to $1.72 to $1.74 per share. Overall, we are still above the top-end of our initial range and projecting 10.3 to 11.5 percent growth in FFO per share for 2004.

In looking at our growth for 2004, prior to the accounting charge and the extraordinary term fee, we projected FFO growing in 2004 from $1.56 to $1.68 per share, or 8.3 percent. We view both the 4 cent Series B accounting charge and the 9 cent VeriSign term fee as extraordinary and not reflective of our normalized FFO run rate. If we net out the 4 and 9 cents, we are really looking at a normalized calendar year 2004 run rate of $1.68 per share. Given that, our FFO guidance range for 2005 of $1.78 to $1.85 per share reflects 6 percent to 10 percent growth per share over our normalized run rate.

The assumptions for our guidance include --

First, occupancy starting the year at close to 94 percent and dropping to approximately 92 percent at the end of the first quarter, then increasing about 100 basis points per quarter, ending close to 95 percent by year-end. The initial occupancy drop is attributable to AT&T vacating 143,000 square feet at our Ridge Road building in New Jersey during the first quarter, which we mentioned on our first quarter call this year. This equates to over 120 basis points of occupancy and up to 6 cents in FFO on an annualized basis. We project it will take most of the year to release this space.

Second, term fees will be in the 3 to $4 million range, of which 1.4 million is identified today versus the nearly 10 million that we will have for 2004.

Third, $230 million of acquisitions for 2004 and $200 million in acquisitions with 50 million of dispositions for 2005. Acquisitions are projected ratably per quarter through the year.

Fourth, development coming online consisting of 220 NBP and (indiscernible) 3 for the entire year, and 191 and 318 NBP, all back-end loaded, with both buildings renting sometime in the third quarter.

Fifth, 2.8 million shares of common equity raised to midyear

Sixth, increase in G&A expense of about $2 million, $700,000 related to vesting of restricted stock and the balance from higher payroll due to new hiring that took place in the later part of 2004 and Sarbanes Oxley-related costs.

Seventh, costs associated with land positions purchased over the past year and anticipated to be acquired in 2005, which Rand will discuss in a minute.

And finally, increase in short-term interest rates of 25 basis points per quarter, with an initial LIBOR rate of 2.25 percent.

To summarize all of the above, we start with an approximate current quarterly FFO run rate of 44 cents per diluted share, or $1.76 annually. From our current run rate, increased G&A will cost 2 to 3 additional cents per share annually. Increased interest rates will cost 3 cents annually. The Ridge Road AT&T vacancy will cost between 4 to 6 cents in 2005, depending on timing of re-leasing. Same-store NOI other than the Ridge Road AT&T property is forecasted a positive 6 to 8 cents. Development is projected to be 2 to 3 cents positive, and acquisitions are projected to be 6 to 7 cents positive. The aggregate of these assumptions when added to our run rate creates an FFO per-share range of $1.78 to $1.85 per-share.

This is our initial look at 2005, and we expect to further refine the details next quarter and as we move through the year. With that, I'll turn the call over to Rand.

Thanks, Roger, and good afternoon everyone. At September 30 our portfolio consisted of 136 properties totaling 11.6 million square feet. As Clay indicated, we ended the quarter at 93 percent occupied and 94.9 percent leased. We are projecting that occupancy will be close to 94 percent at year end. As Roger mentioned, subsequent to year end we will lose 143,000 square feet that AT&T occupies in New Jersey, resulting in over a 120 basis point drop in portfolio occupancy. We've been working with a potential tenant for the entire building; however, our projections are based on a conservative lease-up for this space.

In addition we have some retenanting that has taken place this quarter that will not occupy until at least the end of the first quarter of 2005. Together, these changes will reduce occupancy to about 92 percent by the end of the first quarter of 2005. Thereafter, as Roger mentioned, we expect occupancy to increase about 100 basis points in the second and third quarter and reach a strong 95 percent by year-end 2005.

In terms of leasing statistics, we renewed and retenanted a total of 404,000 square feet for the quarter. Of this total, renewed space was 198,000 square feet, equating to a 77 percent renewal rate at an average capital cost of $2.52 per square foot. We expect our renewal rate to be in the 70 percent range for the year.

Average rental rates for the renewed and retenanted space increased by about 9.5 percent for base rent and 6.4 percent for total rent on a straight line basis. And base rents increased 3 percent on a cash basis. For renewed and retenanted space, the average capital cost was $10.15. We continued to successfully retenant spaces in a number of locations, including downsizing Ciena and Lucent Technology during the quarter and backfilling with the U.S. government and Booz Allen Hamilton.

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 3.8 percent of our revenues at September 30, representing about 455,000 square feet. We have also proactively managed our lease expirations for 2005 down, from 10.3 percent at the beginning of 2004 to 8.8 percent at September 30.

Turning to acquisitions, we had a very productive quarter. First we closed on a $112 million acquisition of the Pinnacle Towers, two office towers that total 440,000 square feet that are located in Tysons Corner. These buildings are very strategic for us as they are 89 percent occupied with several credit tenants, and establish our presence in a third targeted submarket in Northern Virginia for the Company. We have the ability to expand on this site by 150,000 square feet. With this acquisition, Wachovia Bank becomes our tenth-largest tenant, and we were able to win the bid on this property by successfully dealing with the seller's tax impact. As a result, we issued 352,000 Series I convertible preferred units for a total of $8.8 million, and also by assuming a low-leveraged fixed-rate loan.

Also this quarter, we closed on 114,000 square foot Class A building known as Corporate Point 3 located on the east side of Westfields' corporate center in Northern Virginia. This building is 100 percent leased with strong tenants. This is the first property that we have purchased on the east side of Westfields' corporate center and we do see a tightening of market conditions on this side of the park.

Turning to the market conditions, in general in the BWI submarket as of September 30th, vacancy including sublease stood at 6.2 percent, of which 5.1 percent was direct vacancy, down from 13.1 percent and 10.9 percent, respectively, in the third quarter of 2003. Our BWI portfolio, totaling 3.6 million square feet and representing 77 percent of the BWI submarket, improved by 1.1 percent to reach 97.4 percent leased at September 30th.

Turning the next to the Columbia submarket in Howard County, at September 30th, vacancy with sublease was 12.6 percent, of which 10.2 percent was direct vacancy. This overall vacancy has decreased from 18.2 percent and 13.7 percent, respectively, one year ago. Our properties in the Columbia market now total 1.5 million square feet and are currently 97.2 percent leased.

Lastly, in the Dulles South submarket in Northern Virginia, the vacancy rate continues to decrease, ending the third quarter at 12 percent, of which 7.8 percent was direct vacancy, down from 17 percent and 12.2 percent, respectively, one year ago. Our operating portfolio of seven buildings totaling just over 1.1 million square feet is 99.4 percent leased and occupied.

Turning to our development activity, we continued to progress with 696,000 square feet under construction at September 30th, totaling $120 million. At National Business Park, we have 191, 304 and 318 NBP, all under construction. This quarter we announced a lease with Northrop Grumman for the entire 191 NBP building and a lease with Booz Allen Hamilton for the entire 304 NBP building.

With these two buildings leased and the third committed, and in response to strong tenant demand, we are poised to move forward with another 286,000 square feet, 322 and 306 NBP, both currently under development. Subsequent to quarter-end, we signed a 65,000 square foot lease with Cadmus for a new building to be built in Columbia Gateway in Howard County. Cadmus is an existing tenant of ours in Airport Square and we were able to move Cadmus into a new build-to-suit that we'll deliver fourth quarter 2005. We will then have the opportunity to renovate and potentially expand the Airport Square building they will vacate, re-leasing this space at a much higher rental rate.

At Westfields in Northern Virginia we have Washington Tech Park 2 under construction, and even though we have no signed leases currently for this space, we are very comfortable with the tenant demand as all of our buildings at Westfields are full. The 100 percent pre-leased Greens III building at Westfields will be placed into service by the end of the year as the Aerospace Corporation takes occupancy.

This quarter we placed into service the balance of space at 4230 Forbes Boulevard, which is 50 percent leased, and all of 220 NBP, a 157,000 square foot building which is fully leased to the Titan Corporation.

In regard to our ongoing negotiations Fort Ritchie in Washington County, Maryland, we have submitted our plan for approval to the PenMar board and our due diligence was extended until November 12th. Prior to that time we expect to iron out the details of our development agreement. We have worked closely with the community and the PenMar board to generate a plan that will address the needs of the community as well as the requirements established by the PenMar board.

I don't know if you've seen the plan; it is on our web site. The mixed-use plan includes 1.7 million square feet of office space, 673 residential units and ancillary retail and business support space. Half the office space will be in a restricted area with secured space to meet the needs of our type of tenants. There will be about 20 acres of community area, including a community center, recreational fields and a museum. We are planning on saving 64 of the 68 historical buildings on the site. And as we move through the process, we are seeing increasing interest from an assortment of potential tenants. As we have discussed in the past, we view Fort Ritchie as a long-term project with a 10-year buildup.

Similar to Fort Ritchie and Patuxent River Naval Air Station, we are looking at a contiguous -- a number of contiguous market opportunities, including large park acquisitions. In addition, we are looking at opportunities outside of our core markets to meet the needs of specific tenants.

Another focus has been to position the Company for future growth with land inventory. We have been working very heart on this strategy throughout the year, and have quietly added through acquisitions 770,000 square feet of building capacity so far this year. We are well on our way to announcing on the next earnings call land control that could add approximately 5 million square feet to the almost 4 million square feet of building capacity we have today. We will provide -- this will provide the land inventory to be developed over the next five to 10 years as an important component of our future growth.

In summary, we are making great strides increasing the portfolio leasing close to the 95 percent mark, surpassing our acquisition goal for the year by a wide margin, moving new buildings through the construction phase rapidly, and positioning the Company with ground control that will provide inventory for us over the next five to 10 year timeframe. We have some challenges ahead in 2005 that we need to deal with, but believe the Company is positioned for solid growth in 2005 and accelerated growth in 2006 and beyond.

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

(OPERATOR INSTRUCTIONS). David Fick, Legg Mason.

You already batted down most of my questions, thank you, but I do have one for Roger I suppose. Could you talk a little bit more about the Sarbanes Oxley 404 implementation, specifically what kind of cost you have entailed, how much time it's taken internally, and sort of what you have learned through the process?

I'm probably too frustrated to answer that question. In terms of cost, I would say from an external standpoint our costs are going to be approximately $500,000 this year. That includes a consultant that we had come in and help us document and test our systems, and then our external auditor's review of that process. And that doesn't account all the countless hours of our internal people in terms of their documentation and testing, checking to make sure that the tests -- their systems worked.

I think what we have learned through this process is that we were a small company growing to a medium-sized company, and we had a lot of volume going through our structure and processes. So it actually happened at a good time and it allowed us to step back and look at our processes and see where we needed to embellish them and create new controls and processes to help us grow from the $1.5 billion size to the $3 billion size. So there has been some benefit to all of this, but there has been a lot of pain and suffering, mainly by many of the accounting people in our organization.

I would add to that, David, we have gone through a lot of the testing and are in pretty good shape. And of course when you talk to the external accountants, they are all scrambling as well to try and look at other firms and go through this. So I think it's a little bit of a wild card for the entire industry on how they are going to be positioned in terms of meeting the testing and full compliance.

Do you think you'll have any significant disclosures you will have to make, or will it be pretty clean?

No, it's very clean. And if anything, when you go through the testing there's a couple of minor procedural things that were put into place and then they test to see if you're in compliance, and you have the opportunity to do so small adjustments. But no, there's been nothing major at all come out of this, other than a huge amount of time and work on the part of the team, and externally.

You did a good job, I thought, of explaining the dilution next year and the assets that aren't going to be as productive while they're being banked. Could you perhaps give us a little bit more color on what you view your long-term earnings growth rate to be, given you really are sitting on a pretty premium multiple now?

We think the multiple is based on justified based on the historic growth that we have put up. I think if you look at 2005, we're saying the 6 to 10. I think that will move up. Certainly we still view ourselves as a 10 percent growth company. 2006 becomes interesting for us because of the amount of development that's underway and we anticipate starting later this year that will have a very nice impact in 2006. So I think that overall, you would look at it pretty consistently where we have said 10 percent and potentially accelerating beyond that.

A dividend increase is a strong message sort of supporting that view. Okay. Well, thank you very much.

Frank Greywitt, Key McDonald.

Just a couple of questions on the Fort Richie deal. Are you having any conversations with a significant tenant for that space?

We're having conversations with a lot of tenants. I know there are a lot of people out there who believe we have a large tenant locked up, and that is not -- we're not in a position to discuss that at this time until we are hard on the contract and proceed accordingly. So I will say that there is a lot of interest. This is a very timely project for us given the overall needs of the kinds of tenant that we deal with. And we'll just leave it at that.

And that's November 12th you're going hard on it?

Yes. It was November 25, and the requirement of the original contract was that there be a development agreement tied into our plan, and that was not completed PenMar. And so at the board meeting on the 25th they voted to extend that due diligence time until November 12.

Do you think the local community could affect your ability to acquire this property?

No, they're not really in a jurisdictional capacity there. They don't have a seat on the board. This is not a vote per se. We're taking that into consideration a lot in terms of the plan. It incorporates their desires. At the same time, PenMar -- first and foremost the Board was looking at job creation and then our company picking up the financial burden of the infrastructure improvements, and then thirdly putting the property on tax rolls, and then finally, being somebody that will deal with the community. So we are very cognizant of the prioritization of those objectives and we're working very hard to accomplish all of them.

Fort Ritchie aside, traditionally you've used options on land to mitigate any balance sheet impact or earnings impact. Can you talk about how you might implement that, or are you planning on owning this land outright on your balance sheet. It sounds like you are.

I think it's a mixture, Frank. We will, we are required by the sellers that own the property. As you move towards larger properties, we have been fortunate to be in discussions on several of the properties that we're in discussions on, where the landowners would be entering into joint ventures with us that provides very economical long-range control. Fort Ritchie, of course, is an ownership position, but the costs are reasonable enough that they will not be a burden for us. So we're always cognizant of not burdening the Company to much, but as I said on my part of the call, in this case we are trying to line up the future inventory. And this is sort of our raw product, if you want view it, of the company. So if it costs us 2 or 3 cents of FFO impact for next year through the carry that can be capitalized, then we're willing to take that hit in order to position the Company for just outstanding loan growth, long-range growth opportunities.

Do you have a dollar value of what you think the land acquisitions would be?

It's hard to say. Roger, if you want to take a stab at that.

I think we're looking at $50 million worth of land.

A couple of more. Do you have the lease term average, or the average lease term on leases that you signed during the quarter? Do you have that number?

5.1 years.

The Cadmus space, that seems new as far as -- when are they the planning to move out of Airport Square and into your developed building?

The early fourth quarter of 2005.

And that development is going to be starting very soon?

Yes.

Anymore acquisitions planned for this year do you think? What is the acquisition outlook?

I think the acquisition outlook is pretty good. We do have some things that in the pipeline, but nothing that is firm at this point. So there may be an acquisition or two, but nothing overly significant. And if it happens it would happen towards the end of the year.

Finally, on the operating expense front, it looked like operating margins were down a bit. Was there a onetime thing? Can you talk about a trend and where you see things going there?

Our operating expenses have what I would call a fixed component and a variable component. The 6 is the normal monthly maintenance of cutting the grass and maintaining the elevators, cleaning the, space. And then a variable component, which is special projects that we do seasonally -- and I think what happened is that most of those projects got pushed into the third quarter this year. So it was really just a timing thing.

Jessica Tully (ph) Credit Suisse First Boston.

Good afternoon. I had a couple of questions. One, I know one of the things that you thought about is trying to work towards a bond rating, and I just wanted what your thoughts are on that.

I think at this point the Company does not have a near-term desire to be rated. We still believe we have a lot of growth in front of us, and we think we can best execute that growth through having what we consider to be flexibility in our capital structure, the ability to do mortgage debt. So I think for the next round of growth taking the Company to the 2.5 to $3 billion level, we don't have a program or a plan to get the Company rated. I can't predict what we might desire out in the future, but for the near-term there is no plan.

I had a couple of accounting questions. On your land held for development, because I think you've got about 75 million, you should be able to capitalize the carry on most of that, shouldn't you?

We're capitalizing on approximately half of that, and then there's another half that is just sort of sitting and is not active. So there is nothing, no active development going on. So we are carrying that through our P&L.

What kind of overall rate are you using for interest capitalized for your (multiple speakers)

Roger Waesche, Jr: The way it works is we use our blended average interest rate for the whole company.

I had just one final question accounting-wise, and that was on the recent acquisition on -- the two that you announced in late September. Did you get any material accretion revenues from that, due to -- I guess that's the Accounting Standard 141, if you had below market?

Roger Waesche, Jr: Actually, both of those had nominally above-market rents, and so we will have some eat into our current FAS 141 revenues, to the point where starting out in '05 our FAS 141 is about zero. It will be nominally positive. So if you take the blend of all our acquisitions from the beginning of that pronouncement, July 1 of '01 through what we have acquired to date, it all nets out to about zero now going forward.

Chris Haley, Wachovia.

You're getting in the land business. Tell me about these other markets you're looking at where you might be interested in doing big developments.

I think two things, as I said on my section, Chris. The first is that just as we have done with the Patuxent River acquisition and then with the contract with Fort Ritchie, we believe that there are still some very important fill-in markets or expansions of our existing parks that we need to lock up. And so we started a program in the beginning of the year of looking at each of our landholdings. And to the extent that we felt that we were in danger of running out over the next two to five years, we have gone about and very strategically positioned additional land control that's in various stages of documentation here, all pretty far advanced. And so we think we'll be able to discuss that on the next call. But that's all within the -- sort of our contiguous markets.

The other component of it which are not typically large land, are more specific, is that several of our specific tenants have come to us and said that they like what we are doing. We fill a very important need for their infrastructure and would we consider looking to meet their needs elsewhere in the country. And so we have been in discussions with those tenants trying to understand those requirements, and would expect to start to make some moves in that direction? And we'll just have to wait and see how that falls out. But we believe that that will be an important expansion initiative for the company in the upcoming years.

Will that be through your ownership or will you JV the assets typically or sell the assets to the owner or the occupant?

It would not be so much land as specific buildings. We may JV it although, it's important that we stay involved in a portion of the ownership. It would not typically be a sale.

So most of this would be tenant land to a new market?

Exactly.

In terms of your larger complex projects, meaning multi-site complexes, you're still thinking of the Northern Virginia to Wilmington Carter?

The greater Washington region, really.

And you mentioned -- I'm sorry. Maybe I missed this. Was there a dollar number associated with any costs related to Ritchie, in terms of capital outlays that have yet to hit the balance sheet?

The contract -- just to refresh you -- it's a $9 million land acquisition, 3 million of which would be the first year, a million the second year, another million the third year -- so 5 million. And then at the end of year nine, if we have not accomplished the creation of 1400 permanent jobs on that site, then there will be -- it kind of does a stair stepping -- would be an additional $4 million payment. So those are out quite extended. In addition, we have the obligation for a minimum of $7.5 million of infrastructure improvements that we need to do in the first five years, and those most likely would be tied to specific phasings or leases that would be going into the facilities. And that is over -- while the property is 592 acres, the developable portion when you really cut through it all is about 350 acres.

The 7.5 million -- is that grant? Can you get grant money or is that going to out of your own pocket?

It's our money. I presume we could get it, but that's not our intention. It's our money but it's more geared to very specific improvements that would typically be tied to existing buildings that would be rehabbed or the infrastructure to service those buildings. There are some very attractive buildings that will work immediately for occupancy, and then our anticipation is we would still end up building about 16 additional office buildings on the site.

The last question has to do with you mentioned of your existing capacity of somewhere around 4 million. Could you in the interest of time do your best to give me a quick synopsis as to where that capacity is?

We added a new -- in the supplement, which you may not have had a chance to look at -- on page 30 we've added a new component now to the supplement which details the land inventory in each of the submarkets, the developable square feet, the acreage and the ownership of it. So I think for this point going forward you'll see that will be pretty helpful.

And that was going to 5 million? Where is (multiple speakers)

It's 4 million -- it's actually 3.8 million square feet right now, and we believe we will add an additional 5 million square feet of capacity.

So you're going to add five more?

Five more. Yes.

Rich Anderson, Maxcor Financial.

With regard to operating expenses, if I can just get back to that for a second. Cash rents were up during the quarter, occupancy was up. Could you put a percentage on how much expenses increased to drive cash same-store NOI down during the quarter?

Roger Waesche, Jr: Expenses were up 12.9 percent from the quarter '03 to the quarter '04. Revenues were up on a --

How much of that was sort like pushed into the third quarter. What would be a sort of normalized operating expense in your mind?.

Roger Waesche, Jr: About $1 million was pushed into the quarter.

Could you comment on cap rates on your acquisition activity?

Roger Waesche, Jr: The smaller acquisition that we made in the third quarter, the cash cap rate is about 8.8 percent, the GAAP is about 9.5. And then the larger acquisition, cash is about 8 and GAAP is about 8.5.

Dave Aubuchon, AG Edwards.

Looking at the supplemental, the 4 million square feet that you have right now to develop, plus the 5 million square feet you're working on, and then potentially Fort Ritchie -- it's a little bit over 10.5 million square feet of buildable product. Do you feel like right now you're maxing out your development capability with -- right now I think you have about 1 million square feet under development right now?

One of the things that we have done is to add people in that area, and we haven't done that in the past. We ran very, very lean. We're still very lean. But when you have that kind of actual physical construction underway, plus the development, and you're anticipating it ramping up, these are really record levels for our company. So we have added people this year in the development area, the construction area. We continue to do that. We think that we're well positioned to handle this. Everybody is working very, very hard in area.

Fortunately a lot of these are repeat tenants, repeat buildings, and so it's a little easier for us once you get the first building and the first lease through to kind of do these on a repeat basis. The Fort Ritchie for example, those take a lot more time. You have community involvement, and that's a little bit more unique. So those absorb more time, a little bit more difficult. But again, that's a long-range kind of project. So this square footage that we talked about really is over a long period of time. It just gives you that kind of nice solid growth that's locked in, but we're not going to rush out and do 8 or 10 million square feet in a year sort of thing. Our typical pattern, what we see happening is the million, 1.5 million square feet (technical difficulty)

So I guess you feel the opportunity with, obviously, Fort Ritchie, but the additional land that you're talking about is just too good to pass up at this point?

No. I think it comes from lots of years of experience sitting around the table here and in the company. And there's a point in time when you want to own land and control that. That is the (indiscernible) the raw material for, for the development part of this company. And we consciously did not go out and get a lot of land over the last three years because we didn't want to be in a position of holding it. But we see the markets turning and improving pretty rapidly here, and now is the time to be controlling that for the future. And he who can control the land will be in a position to deliver the product in the future very importantly. And so that is the position that we've taken, and we've been pretty aggressive in terms of lining these up. And you'll see that turn into building opportunities out into the future.

Has the competition to attract tenants to a development site increased over the past, just over the recent past? I mean, obviously there's other competitors in the market right now who are also ramping up development significantly, both public and private. Are you seeing any type of I guess squeezing of the margins there that (indiscernible) to be able get, or just the tenants that you'll be able to talk to in the competition just increasing?

I think you can't generalize; it varies by market. If you're over in the BWI submarket (indiscernible) county, there's very little under construction except our product. And so we have a pretty dominant position. And the tenants that want to be in that market really want to be at our park because of the major agency that they're servicing and that connectivity that is required for their contracts.

If you come over to Columbia Gateway, that's probably where there's the most pressure because there's still a lot of single-story product that will compete in the recessionary time and in rate-sensitive markets. But that capacity is pretty well being filled up here, and we see ourselves in a very good position going forward. Northern Virginia, interestingly, very strong demand. I think Northern Virginia year-to-date has close to 7 million square feet of net positive absorption for the whole market, and yet there's very little new construction going on. There's been enough square footage there to absorb that. We feel very strongly about the Westfields market, and so we have two buildings under construction, one, of course, fully leased and the other one speculative, but we feel very comfortable about that. And that's the only building in that market that is under construction, and yet there's strong demand. So we don't see that kind of competition in that market. Fort Ritchie will be an animal unto itself.

Roger, on the three cents increase in G&A for '05, how much is that kind of onetime ramp-up of the development staff so to speak, if any?

Roger Waesche, Jr: I think it's structural at this point. So what we're adding is permanent.

Last question is variable rates about 18 percent. Roger, do you have a specific strategy to reduce that exposure, or what are you thinking right now on that?

Roger Waesche, Jr: I think our goal is to keep our floating rate debt under 20 percent of total debt.

David Fick, Legg Mason.

Roger, you were pretty cautious in your projection for acquisitions. But I'm wondering what you are including in terms of potential equity. You may have answered that already and I missed it, and I apologize if that is the case.

Roger Waesche, Jr: We mentioned 2.8 million common shares in the middle of 2005.

I'm sorry I missed that. Lastly for Rand, could you comment on the Rouse situation and GGP (technical difficulty) they're looking potentially to offload that portfolio of office and land that they have?

We have not had any discussions with GGP at this point. There was an article in the local paper, as you saw probably, indicating that General Growth was desirous of selling the office sometime fairly early in the cycle next year. But again, they have got their hands full with a number of very complex issues to solve, and what I think is a very tight timetable to complete a major acquisition. So I think once that all settles in, maybe there will be that opportunity. But again, that office complex that they have in total is a very complex grouping of properties. And it will be interesting to see how they approach that sale, whether it's breaking it down by pieces or trying to do it in total or what. So we'll be interested in the part that we should be interested in, but we'll just have to wait and see.

Rich Anderson, Maxcor Financial.

I knew I had one other. With regard to the AT&T vacancy, that 6 cents -- you might have said this, but when are you assuming that that gets re-leased, reoccupied?

Roger Waesche, Jr: November 1st.

November 1st '05. So what is the best case? I mean, if you were to sign something now, could you get someone in there six months early? Or is that too quick?

Roger Waesche, Jr: That's probably too quick. I think midway through the year would be the best case.

Frank Greywitt, Key McDonald.

Two more questions. As far as you issued -- you indicated 2.8 million common shares, do you have any assumptions for preferred equity?

Roger Waesche, Jr: We do not.

What was your capitalized interest number for the quarter? I did not see it in the supplemental.

Roger Waesche, Jr: That was $1.42 million.

Chris Haley, Wachovia.

I have a question for Clay. Why are we not selling more assets to help fund this growing pipeline, versus selling new equity of capital?

That's a very good question, Chris. As you know, our stated goal as a company has been fairly consistent in trying to sell about 5 percent of our assets every year in terms of value, for a variety of reasons. Number one, it keeps us honest. (indiscernible) go through your portfolio. You regenerate capital for more accretive acquisitions. And we just think it's a good discipline.

It's been a little harder for us to do because we, obviously, don't want to sell particular assets out of our core business parks in the Baltimore/Washington area for example, because -- to break up your critical mass is not good in terms of your long-term performance. But what we have done and are doing consistently, even though you don't see it, is to work hard to sell those properties that are not core assets. And those are the ones we have been focusing on.

We are always investigating that at different times in the cycle. You're right; this is a great time to sell, and we are looking at a lot of different alternatives, as we have in the past. In some cases we have had assets that -- where the leasing isn't where it should be, and we have leased those assets up and are now attempting to do something with those. And we have a couple of those situations now. And so we are continuing to pursue that aggressively. And I would assume this year that we would have more -- or really early next year that we would have a more -- something more positive to announce on that front. Because I agree with you; there are situations that while you may have a little bit of short-term dilution from a sale, we will be able to reinvest the proceeds. And in the long-term, our goal is to build up our core markets to improve our franchise. Because we think in the long-run, number one, the markets are better, and number two, it certainly improves our performance. And it improves our performance not only with regard to the properties that we're holding but with the development that we do contiguous to those properties as our tenants grow.

We do have, Chris, in the plan 50 -- as Roger said -- $50 million in sales next year. We had 25 million this year and haven't done a good job of executing that.

But the year is still not over.

What is the assumption I should make for your first-year development yields?

Roger Waesche, Jr: 11 to 12 percent.

Cash?

Roger Waesche, Jr: Yes.

And if you were to do a development for one of your customers in a non-COPT market, what would my development yield be, or my return on capital be?

Roger Waesche, Jr: 11 percent.

Pretty much the same.

And why would you do it at the same rate of return versus trying to get an excess return by going out of market?

I think, Chris, because we're very happy with those returns. We think -- the only reason we're doing development is that if we think the returns are higher than buying properties.

I would be non-risk. It's not like you take on a higher risk through (multiple speakers). Those are pre-leased and very good credit-solid kind of deals that are important to the tenants that we execute. So we're not going to gouge them when it's not needed really.

But they're asking you to go to a different market. And granted you have "developed spec buildings", and most every one of your developments for the last three or four years has been a single-tenant building that has been let before construction is done. So you have a pretty good feel that it's really not a (indiscernible) development. I'm just trying to understand why you would not want a higher rate of return going out of market, or unless you feel as though the rates of return in your existing markets are too high.

Roger Waesche, Jr: I think some of it is just relative to our cost of capital. You've got to remember, we have a long-term relationship with these tenants and we're trying to satisfy their needs over a 15 or 20-year period, and so we don't want to get greedy. We're willing to do development on a pre-lease basis at 11 percent all day long, good credit.

That's all the time we have for questions today. At this time I'd like to turn the conference back to our speakers for any additional or closing remarks.

Thanks again, everybody, for joining us today and we appreciate your participation and support. Rand, Roger, Mary Ellen and me, myself, are available to answer any questions you might have. In addition, we want to let you know that we intend to hold our fourth quarter conference call on February 10, 2005. We look forward to updating you at that time. Thanks to everyone and have a good day.

That does conclude today's conference. Once again, thank you for joining.