COPT Defense Properties (CDP) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the Corporate Office Properties Trust third-quarter 2006 earnings conference call. As a reminder, today's call is being recorded.

At this time, I will turn the call over to Ms. Mary Ellen Fowler. Ms. Fowler, please go ahead.

Thank you and good afternoon everyone. Yesterday, our earnings press release was faxed or e-mailed to each of you. If there'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 GAAP measures referenced throughout this call. Please refer to our Form 8-K or to our website for definitions of other -- of certain financial terms referred to on this call.

With me today are Rand Griffin, our CEO; Roger Waesche, our COO; and Steve Riffee, our CFO. In just a minute, they will review the results of the third (technical difficulty), 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 or future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based upon what 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 Rand.

Thanks Mary Ellen. Good afternoon everyone. Happy Halloween Day. We've been very busy this quarter laying the groundwork for 2007. As we have done in past years, we continue to build our land inventory for future development.

Recently, we announced the closing on Fort Ritchie, a former US Army base located in Washington County, Maryland. This property has an existing portfolio of usable buildings totaling about 400,000 square feet and is approved for 1.7 million square feet of office space and 673 residential units. That brings our total land under control to over 1200 acres and a potential 11.2 million square feet of future office development over the next 5 to 10 years.

Other highlights so far this year include -- first, we're closing in on our $100 million disposition goal with $88 million in office buildings sold so far this year.

Second, with our recent announcement on Fort Ritchie, we have closed on $179 million in acquisitions including land. Despite the competitive market, we continue to find value-added acquisition opportunities, both within our core markets and in our new tenant-driven market locations. We have been patient in this process, and it's been difficult given the current pricing.

We're behind year-to-date on acquisitions, which has put some pressure on projected 2006 FFO. But we have a strong pipeline that we expect to close that will allow us to exceed our stated $300 million goal for the year. With these acquisitions closed by year-end, we should be well-positioned for 2007.

Third, we continue to make progress on leasing our development pipeline with 55,000 square feet signed this quarter and subsequently another 60,000 square feet signed for a new build-to-suit in Colorado Springs, bringing our total to 583,000 square feet signed so far this year.

Fourth, we improved our capital structure, redeeming two high coupons at 10.25% and 9.875% series of preferred shares, issuing a lower coupon preferred at 7.625% and also issuing $200 million in unsecured exchangeable notes at a fixed coupon of 3.5% for five years.

And lastly, based on our earnings and our continued growth, our Board approved a 10.7% increase in our common dividend, the ninth year in a row of progressively increasing dividends. Looking at year-end, we're tightening our range for our 2006 FFO guidance to $1.99 to $2.01 per diluted share before the two write-offs for the preferred share redemptions. Steve will discuss some of the factors contributing to our revisions in a few minutes.

Our initial 2007 annual FFO guidance was $2.18 to $2.27 per share, which positions us for an AFFO per share growth rate range of 8.5% to 13% next year based on our 2006 range as a starting point. Steve will go through our assumptions in more detail. With that, I will turn the call over to Steve.

Thanks Rand. It's a pleasure to be joining COPT's quarterly conference call for the first time. As you may imagine, I've spent my first 10 weeks learning about the Company and getting to know the team. I'm very excited to be on board to support the team and to further strengthen the platform to continue to grow the Company.

Turning to our results for the quarter, FFO for the third quarter totaled $24.3 million or $0.46 per diluted share. Comparable quarter FFO for 2005 was $22.1 million or $0.47 per diluted share, representing a 2.1% decrease on a per-share basis. Results for the quarter included an accounting charge of $1.8 million, equating to $0.04 of diluted FFO per share for the write-off of original issuance costs for the Series E preferred shares that were redeemed on July 15.

We also incurred costs related to the Company's move to its new headquarters in our 6711 Columbia Gateway Drive property. And we wrote off unamortized loan fees related to the early repayment of debt. Combine these additional costs, reduced FFO by another $0.01. And excluding these costs, our third-quarter FFO per share would've been $0.51, meeting consensus and reflecting an increase of 8.5% over the third quarter of 2005.

Now, looking at earnings per share for the third quarter, we recorded $0.33 per share versus $0.18 per share for the third quarter of 2005. With respect to net income for the quarter, the Company recognized a $12.7 million gain on sales of real estate, net of minority interest, and recorded the $1.8 million accounting charge for the Series E preferred shares redemption. The impact of the accounting charge results in a $0.04 reduction to earnings per share. For the third quarter, we recorded $1.3 million in lease termination fees compared to $1.1 million for the third quarter of 2005 and a total of $2.3 million so far this year.

Turning to AFFO, after adjusting for capital expenditures and the straight lining of rents, our adjusted Funds from Operations increased 20.6% from $15.9 million for the third quarter of last year to $19.2 million for the third quarter of 2006.

With regard to dividends, we increased our common dividend 10.7% in September and paid out $0.31 per share for the quarter ending September 30. Our FFO payout ratio was 65.4% for the quarter as compared to 60.6% FFO payout ratio for the third quarter of 2005. The AFFO payout ratio was 83% compared to 84.4% for the third quarter of 2005.

In terms of same-property net operating income, for the 120 comparative properties representing approximately 74% of our portfolio, same-property cash NOI increased slightly by $231,000 for the quarter or an increase of 0.006% over the same quarter last year. Items impacting same stores is the 97,000 square feet at Pinnacle Towers now leased but not yet occupied and high seasonal operating expenses, some of which will be recoverable upon the full-year [CAM] reconciliation process.

Turning to our balance sheet, at September 30, our total market capitalization was approximately $3.9 billion with $1.4 billion of debt outstanding, resulting in a 35.7% debt to market cap ratio.

With regard to our capital structure, during the quarter, we increased our revolving line from $400 million to $500 million. In addition, we closed on a $200 million exchangeable note offering with a 3.5% coupon fixed for five years. This transaction is highly accretive to the Company as we pay down construction loan financing as well as our revolver with a blended interest rate of 6.7%.

We project $0.10 of accretion in each of the first two years, decreasing over time to about $0.01 a year five -- at the end of five years, the notes may be redeemed at par value to be paid in cash with any premium over the conversion price to be paid at our option in cash for stock. We believe that this is a great layer of capital for the Company, as it's unsecured debt with no financial covenants and with a fixed interest rate of 3.5% for in essence, a 5-year term. As a result of the exchangeable note offering, our floating-rate debt was reduced to 16% at September 30 versus 27% last quarter.

Turning to equity, in addition to the redemption of our 10.25% Series E redeemable preferred shares of $28.8 million, we also issued 3.4 million preferred shares through our 7.625% Series J redeemable preferred offering. The offering generated net proceeds of $82.1 million, which we used to pay down our revolving line of credit. We had previously borrowed under the revolver to pay off a $60 million loan with a fixed rate of 7.8%.

Subsequent to quarter-end on October 15, we redeemed our 9.875% Series F redeemable preferred shares for $35.6 million. We expect to recognize a $2.1 million non-cash reduction to both net income and FFO for the original issuance costs in the fourth quarter of this year, resulting in a projected decrease of $0.04 per share to FFO and $0.05 to earnings per share.

For the third quarter of 2006, the Company's EBITDA -- interest, expense, coverage ratio -- was 3.6 times. And our EBITDA at the fixed charge coverage was a strong 2.9 times. With regard to our 2006 FFO guidance, on the second quarter, we gave a range of $1.99 to $2.05 per share. And now, we are tightening the range to $1.99 to $2.01 per share.

The tightening of the upper end of the range is due to a few items. We have some impacts in the back-end timing of acquisitions, while the dispositions have been slightly ahead of schedule during 2006.

Second, within the operating portfolio, VeriSign has terminated the remaining space at One Dulles Tower. Booz Allen will not commence rent until the spring of 2007.

Third, Washington Tech Park II has been placed into service, but rent has not commenced on a majority of the space. In the fourth quarter, we subsequently had an additional write-off of $200,000 of loan fee amortization related to the prepayment of additional debt.

Lastly, our projected term fees for the fourth quarter are less than half the fees generated for the third quarter of 2006. Both EPS and FFO 2006 guidance exclude the impact of the non-cash accounting charges for both the Series E and the Series F preferred share redemption.

As Rand mentioned, our initial FFO guidance for 2007 is $2.18 to $2.27 per diluted share. The assumptions for our 2007 guidance are as follows. First, for our existing portfolio, occupancy remains flat on average at 94% for the year. Average rental rates are estimated to increase 8% on maturing and new leases.

Third, lease termination fees will be in the $3 million range, similar to what we project for 2006. Fourth, we project 2006 net acquisitions to contribute $0.06 to $0.07 per share year-over-year with no additional acquisitions in 2007.

Fifth, our development coming online projections are outlined on pages 32 and 33 of our supplement and are estimated to be 80% preleased on average when delivering. Sixth, we will benefit about $0.02 per share year-over-year for the full year impact of having redeemed the higher coupon Series E and Series F preferred stock and having the lower coupon Series J preferred stock outstanding.

Seventh, we will receive the full-year benefit of having the 3.5% exchangeable notes outstanding in place of higher-cost, floating-rate debt. Eighth, we anticipate no new equity issuance during 2007.

Ninth, we expect G&A expenses to increase by about $2.5 to $3 million. Finally, we have not included any increase in short-term interest rates in these estimates.

So, to summarize all of the above, from our 2006 estimate of $1.99 to $2.01 per diluted share of FFO, same-office NOI is forecasted a positive $0.05 to $0.07 per share in 2007, representing a 6.5% increase in same-store NOI.

Development is projected to be $0.05 to $0.08 accretive net of interest expense. Net 2006 acquisitions occurring late in 2006 are projected to contribute an additional $0.06 to $0.07 year-over-year net of interest expense. This plan does not include any contributions from 2007 acquisitions.

Exchangeable notes replacing higher cost debt are $0.10 accretive for the full year and make an additional $0.07 per year per share year-over-year contribution. Lower coupon Series J preferred stock less the cost of higher coupon preferred redeemed and the variable debt refinanced in 2006 will contribute $0.02 per share year-over-year. And increased G&A will cost $0.05 to $0.06 per share annually.

The aggregate of these assumptions create an FFO per share guidance range, $2.18 to $2.27 per share. This is our initial look at 2007. We expect to further refine the details next quarter and throughout the year. With that summary, I will turn the call over to Roger.

Thanks Steve and good afternoon everyone. Turning to our operating portfolio at September 30, our wholly-owned portfolio consisted of 168 properties totaling 14.6 million square feet that were 94% occupied and 95.3% leased.

With regard to leasing, we see steady demand in development leasing from government tenants and defense contractors and in our operating portfolio from other industry tenants. We have brought our occupancy back to 94% where we started the year.

In terms of leasing statistics, we renewed 60.7% of expiring leases at an average capital cost of $3.53. Rental and renewals increased 18.2% on a straight line basis and 10.2% on a cash basis. Total rent for the renewed and retenanted space increased 2.9% on a straight line basis and decreased 3.4% on a cash basis.

The decrease in cash rent resulted from the final takedown of space, in this case, 100,000 square feet by Booz Allen from VeriSign at our One Dulles Tower project in Herndon, Virginia. This was expected, but Booz Allen controlled the timing. For all of renewed and retenanted space, the average capital cost was $18.17. This is a higher number than normal but largely reflects a higher amount of retenanting leasing that bears higher CapEx than renewals.

It is important to note that with regard to Northern Virginia, where we believe the potential for oversupply exists, we've improved our leasing in both our development pipeline and our operating portfolio. With regard to development, our only project under construction and lease-up, Washington Tech Park II, was 100% leased as of September 30.

With regard to our Northern Virginia operating portfolio, we have signed leases to retenant 227,000 square feet of space this quarter, including 100,000 square foot Booz Allen Hamilton retenanting and an 81,000 square foot lease in Pinnacle Towers. We are now 99.3% leased overall in our Northern Virginia portfolio.

Looking at our lease expiration schedule across our portfolio for the remainder of this year, at September 30, we have only 3.2% of our revenues expiring, representing about 358,000 square feet. For 2007, we have 11.8% of our revenues expiring, down from 12.9% at the beginning of 2006.

Turning to acquisitions, we had no closings during the quarter. However, since quarter-end, as Rand mentioned, we have closed on Fort Ritchie, the 591 acre former US Army base located in Washington County, Maryland. We expect to begin demolition of old Army barracks this fall and commence infrastructure work -- sewer, water and electric -- in the spring. We're not projecting any earnings impact in 2007.

So far this year, we have closed on $129 million of building acquisitions and close to $50 million in land. We have underwritten and bid on over $1.5 billion of real estate so far this year. We have been very selective and have not been successful in bidding on properties where we are unable to create value for our shareholders based on the low yields and above-replacement cost prices in the market today.

Based on our acquisition pipeline, we expect to surpass our $300 million acquisition goal for the year. Although cap rates still continue to be aggressive, particularly in the Northern Virginia submarkets, we're starting to see some effect from rising interest rates as measured by an acceleration of deals coming to market.

With regard to dispositions, during the quarter, we disposed of six buildings for approximately $61 million. This included our Brown's Wharf Building located on the Baltimore Inner Harbor; three New Jersey assets, one of which was in a joint venture; and one of the buildings in Hunt Valley that was acquired through the former Rouse office portfolio acquisition. In reviewing some of the Hunt Valley and Rutherford assets acquired at the end of last year, we have determined a few are non-core and the strong market has provided an opportunity to sell some assets at a profit.

During 2007, we continued working on our plans to dispose of our Blue Bell campus and continue marketing our remaining New Jersey properties. As expected, one of our tenants in Princeton Technology Center will acquire our three building complex between 2007 and 2009, completing our exit strategy for New Jersey.

With respect to marketing conditions in general, in the BWI submarket as of September 30, vacancy stood at 8.7%, up from the previous quarter as a result of several new buildings coming online. There is 374,000 feet under construction in this market. Our BWI portfolio totaling 4.1 million square feet and representing 71.9% of the BWI submarket was 95.8% leased and 94.9% occupied at September 30.

Turning next to the Columbia submarket in Howard County at September 30, vacancy was 9.8%. The overall vacancy has decreased slightly from second-quarter level of 10.5%. Our properties in the Columbia market totaled 2.6 million square feet and are currently 95.1% leased and 94.9% occupied.

Lastly, in the Dulles South submarket in Northern Virginia, the vacancy rate continues to decrease, ending the third quarter at 8.5%, down from 10% at the end of the second quarter. Our operating portfolio of eight buildings totaling just over 1.2 million square feet is 99.9% leased.

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

Thank you Roger. Turning to our development activity at September 30, we had 10 buildings with 1.2 million square feet under construction for a total cost of $253 million. Our construction pipeline is 67.4% leased as of September 30.

During the quarter, we placed a 50,000 square foot fully-leased building into service in Colorado Springs. And since quarter-end, we have placed two fully-leased buildings into service -- 322 NBP and Washington Tech Park II -- for a total of 349,000 square feet.

Looking ahead through 2007, we will deliver another eight buildings for 719,000 square feet that we expect will be close to fully leased as they come online. The largest of these buildings will be the $54 million Northrop Grumman VITA building in Richmond.

Our development pipeline has nine buildings with a total of 1 million square feet for a cost of $216 million. The majority of these buildings will move to under construction during the first half of 2007.

Looking at our land inventory with the addition of Fort Ritchie, we now control a total of 1200 acres that can support approximately 11.2 million square feet of office space. Additionally, we're pursuing land control and close proximity to Aberdeen Proving Grounds and Fort Detrick that along with National Business Park will position us to meet a portion of the demand from an estimated 60,000 jobs coming into Maryland as a result of the BRAC.

So far, in 2006, we have ramped up our ownership in Colorado Springs with 767,000 square feet in operating properties. We've placed our first fully-leased building into service. We've signed a 60,000 square foot build-to-suit and started development of the next 90,000 square foot building. And we're now the largest office owner in Colorado Springs.

In summary, we've laid out a conservative 2007 plan. We have a strong acquisition pipeline through the end of 2006 that when closed and combined with development activity coming online and with strong same-store capacity will generate double-digit FFO growth during 2007 that is not dependent on additional 2007 acquisition activity.

At the beginning of 2006, we had several goals. One was to move the Company to larger office space, which we did in July. This move provided the opportunity to meet our second goal of selectively adding new positions needed to support our growth. During August, we promoted Roger Waesche to Chief Operating Officer in order to focus on new strategic opportunities and added depth to the management team with several key hires -- Steve Riffee as CFO, Colleen Crews as Controller, and Steve Kutzer as Chief Information Officer.

Since that time, we have been building our technology team and plan over the next two years to upgrade our technology platform to support the operation of a larger operating portfolio and development pipeline as well as the addition of more cornerstone offices.

The third goal was to create our vision for the future and determine the core values that will sustain the Company over the next 20 years. We believe the core values define the COPT way, how we operate every day with our customers, our vendors, our shareholders, everyone we deal with. The core values were named ISITE and are defined as operating with the highest level of "I" for integrity, "S" for service, "I" for innovation, "T" for teamwork, and "E" for excellence. By living these core values, we have grown the Company into one of the top-performing office REITs for the past eight years.

We expect that financial performance to continue as we deliver on our core purpose, which is defined as to create environments that inspire success. This core purpose gives us the flexibility to adapt to future requirements, yet recognizes that we are instrumental to the success of our tenants, the communities that we live and work in and our shareholders.

With that, we will open up the call for your questions.

(Operator Instructions). John Guinee, Stifel Nicolaus.

A few quick housekeeping questions. First, KSI, the big deal in Tyson's, what are the terms and when does that hit earnings?

It's a -- they are taking five floors. One floor will be leased late this year, and the other floor will be leased late in the first quarter of '07. It's a 10-year term and the rates are at market, which means they are right around $30 a square foot.

What kind of operating expenses and what kind of TI/dollars?

On operating expenses, that building is running a little over $8 a square foot. And TI is in the $40 range.

Plus commissions??

Yes.

Another one -- it looks like your year-over-year FFO growth is about $0.18 to $0.27 a share. And per what was just an exceptionally good breakdown of how you get that growth by Steve, it comes out to $0.12 of that $0.18 to $0.27 is just from the accretion of the convertible notes and the accretion of the preferreds. Is it correct to say that the underlying property fundamentals plus development and acquisition is going to deliver between $0.06 and $0.15 a share?

Just one correction, I think. The preferreds I think outline -- contributed about $0.02 year-over-year and the convertibles $0.07 year-over-year. So, the full year of '07, that's $0.09. And then we can take the rest of your call.

Okay, so you're saying $0.09 of the $0.18 to $0.27 is cost of capital reduction.

Yes.

Okay, perfect.

Rich Anderson, BMO Capital.

I just have a question on the Booz Allen situation and where they had sort of controlled the timing. How did that proceed over the past three months? Did they sort of indicate that they would go sooner and then sort of pull the rug a little bit? And second, where else do you have situations like this where you sort of are out of control relative to the timing of someone taking space?

I think it's our only big existing lease where a tenant has an opportunity to bump another tenant out of the space, and they had the right to do it through the third quarter of '07. They elected to do it early because of a need for the space.

So, from a leasing perspective, do you see any sort of potential challenges that might sort of slow the process a little bit beyond maybe that specific circumstance? Are there any trouble issues in front of you that you are sort of monitoring?

No, no credit issues. No other tenants trying to get out of their space.

Then, on Fort Ritchie, the buildings that currently exist there, will you -- will those continue to operate as is as office buildings?

Partially office and partially mixed-use, Rich. This is really a community that we have purchased. And along with the residential, it will be a community center where we are taking a gymnasium for example and converting that and expanding that into a community center. We do expect there to be some service retail in some of those buildings and the bulk of them will be office.

And then last question, for '07, you mentioned all the sort of $0.06 to $0.07 of accretion from the acquisition activity in 2006 and nothing more in '07 in terms of acquisition activities at least in the guidance. Is that -- is it fair to assume that moving into new markets is not on the immediate radar screen for 2007?

I think that is fair to assume. And if we did move into new markets, it would be late in the year. And, we aren't assuming that there would be any FFO impact for '07. Again, it's a tough environment out there. We tried to be very conservative on this plan by not trying to just push acquisitions, even though they may be slightly accretive. We were trying to go to the opposite side and be very conservative.

Chris Lucas, Robert W. Baird.

Just a quick question on housekeeping. What was the capitalized interest for the quarter?

It was about $4.4 million.

Okay and then just as a follow-up on the question related to the acquisitions. You guys have never as far as I can remember ever gone through a year without acquisitions. Is that -- what does the guidance tell us about your thought process on the acquisition environment and where you see it heading for next year?

I think we may be guilty, Chris, of being a little bit old-fashioned. We still look very closely at replacement costs. I'm not going to buy above replacement costs. We want to buy where it's strategic for the Company. Usually, either we're expanding our market share. We're adding new tenancy, or we're adding a key submarket.

When we look at the environment out there, we're just a little bit cautious that I think the lower cap rates are not going to necessarily improve. We think interest rates are stable, and there's an awful lot of liquidity chasing deals out there. And so, we're just trying to be very conservative. You're right. It's the first year in our eight years of being a REIT that we will not have programmed in acquisitions. And yet, we're still hitting double-digit FFO growth.

So, we think that we were in a great position to do that. We will take our time. It doesn't say we're not going to keep looking. We will keep looking at a lot of things. But we're going to be very, very careful on those acquisitions.

I think one of the thoughts is just that you always want to be careful when you are buying something that you aren't sort of buying it at the peak. And we think that 2007 is sort of that year, where as you get towards the end of that year and into 2008, we think things will change. And so, we're going to be very cautious about particularly next year.

Then my last question has to do with just the mark-to-market on expiring leases for next year. The quarter was very good in the BWI corridor. What sort of exposure do you have in your various markets and what sort of mark-to-market do you think you have on expiring leases for next year?

63% of our renewals next year are in the BW corridor. 9% is in Northern Virginia, 17% is in St. Mary's and King George County, and 7% in Colorado Springs. That makes up 96% of our expiring leases.

And then the mark-to-market?

Mark-to-market, as Steve mentioned, we're assuming 8% on average mark-to-market.

Improvement?

Improvement.

Was there a -- in the current quarter, was there anything specific in the leases that were old or that you renewed in the BWI corridor that was unique or to create such a big pop in rent?

Well, we did have one lease that had some age to it that when it got mark-to-market was very favorable.

Then, down in St. Mary's, what sort of activity are you seeing down there? It seems to be softer from a same-store NOI basis. What do you see going on in that market?

I think things are steady from a demand standpoint, and there's not a lot of excess space down there. There's nobody building, so we feel very good about our renewals. What you saw in terms of same store had to do with operating expenses increasing. We did go in and revamp the way we operated in that market to get our customer satisfaction ratings up to ensure our long-term franchise in that market.

(Operator Instructions). Chris Haley, Wachovia.

The ISITE acronym, could you go through that again? What are kind of the motivational factors behind this?

We started out in March of this year, Chris, really to do the mission vision values for the Company. I think part of it -- we have a Disney customer service course that everyone in the Company goes through. We were starting to get ready to do a leadership course. And as we looked at leadership, we sent a couple of people down to another Disney course on leadership. When they came back, they really looked at the Company and said, "We can't really talk about leadership and succession planning and things like that without first defining what we stand for on our values and our mission/our vision of the future."

So we really took that heart and put a small group together of 24 people and spent about 40 hours off and on with an adviser going over that. So, the whole mission/vision values we call COPT Way.

And the core values really identify five items. Integrity is the first one, the "I" of ISITE. And of course, we operate under the very strictest levels of integrity, particularly with the kinds of clients that we have. So we thought that was appropriate it would be first.

Service is second with the "S." And service, we've been teaching that for a number of years. That's why we are number one in the country in customer service on the CEL surveys for two years in a row. And service is pay attention to details and exceed expectations.

The third one was innovation, "I" for innovation. You don't normally see that in a real estate company. But, one of the things that we thought about and Roger was the one pushing this about our Company is that we are very creative. We are very nimble. And so, innovation became something that we thought was one of our core values.

Teamwork, we very much -- the "T" part of it emphasized teamwork. We are a matrix company, and teamwork became that element of it.

And then excellence is the final -- "E" for excellence. It is really not just saying we want to be the best at everything we do, but we really have emphasized there's excellence in everything that we do. And so, these are the core values.

It was interesting when we did the core purpose, which is the mission -- creating environments that inspire success. It doesn't necessarily say we will be an office REIT in the future. It doesn't say we have to be public. But what we will be doing is creating environments. You can interpret that as Green buildings or beautiful buildings or nice interiors or improving communities that we live and work in as part of our environment. So, it's a fairly broad impactful definition.

And then inspiring success, we surveyed a lot of our tenants and brokers and stakeholders. All of them said that we are a key part of their success. We have a number of tenants, which started with 2500 square feet that are now 300,000, 400,000, 500,000 feet. And they have definitively said we are a key factor in their success. So, that's how it's all come about.

Just from an analytical perspective, does this have any monetary bite to it to the employees? Are there metrics or measures being applied to this?

Well, certainly, we are in the process of defining -- we give out awards -- service awards in terms of things that [imaginatarian] and things that people have done above and beyond the call of duty. And there are awards that are being established relating to the ISITE.

I think the more important aspect of it is really just that we have performed the highest level of the REITs for the last 10 years. We expect to sustain a very strong performance level. And to the extent that people are receiving options when they come into the Company and according to their performance and restricted shares, they are the top 30 group. They're participating in that success.

They just feel proud about it. We're not trying to tie specific monetary actions to these as much as to say this is what the Company stands for. This is what we're going to talk about when we're hiring people. This is why people stay here. We think over time, this will help define us as an outstanding company.

Steve, welcome aboard. It's nice to have a good balance sheet, isn't it?

Yes, and thanks Chris.

I was interested in your layout of year-over-year comparisons. If I listened to try and add up the building acquisitions so far in 2006, not land, what is the dollar value of building acquisitions?

128.

128, 128.

Plus the land and so you're going to get above a $300 million building plus land number by year-end?

Yes, we think we're going to hold to beating our guidance in total for building acquisitions for the year.

Will most of the last two months' acquisitions for this year be buildings or land?

They are buildings.

Buildings, okay. So that's going to contribute -- that's going to be a big plus to '07. You're not -- you mentioned a couple planned dispositions. Are they relatively minor as part of your guidance or are you assuming any matched funding?

Roger mentioned a tenant that has two or three years to buy. We have not assumed any acquisitions or dispositions in the number for 2007.

For the balance of '07, Chris, we do have $42 million of dispositions targeted to get out the door '06.

'06.

And they roll into '07 a little bit.

On the leveraged at year-end '07, so I'm just simply going to take incremental debt to incremental build-out for the development and then add in $150 million worth of acquisitions less $40 million worth of sales; is that about right?

Yes.

What is your comfort level at year-end '07 on your leverage ratios when you look at fixed charge coverage or debt to gross assets?

We have historically programmed the Company to have a minimum two times fixed-charge coverage. We don't look at debt to gross assets or debt to market value. We look at fixed charge.

Which was 2.9 at the end of the quarter, so we've got a little bit of room there.

Great, okay. And then specifically on the capital expenditure side, in relation to your same-store NOI assumptions, capital expenditures, whether on a per-foot basis or per-foot per-lease year in relation to -- which have been trending up in relation to the trend downward in same-store cash NOI, could you give us your thoughts on why that might -- why is that happening so far in '06, given the relative strength of your markets and what we might expect going into '07?

The second and third quarters were negatively impacted by the PwC lease, 97,000 square feet we lost at Pinnacle Towers. When that comes back on, that's really significant and that's why Steve talked about $0.05 to $0.07 of positive same-store NOI for next year.

We were also very much impacted this quarter by seasonality of operating expenses, particularly electric, that we didn't get fully reimbursement for. And we're hoping when we do our CAM reconciliations at year-end, we will do that.

To go back to your question about CapEx, again, largely this quarter, 57% of our leasing in the quarter was retenanting, 43% was renewals. Whereas in the first quarter, we only had 14% retenanting and 86% renewals in the second quarter. We had about 40% retenanting and 60% renewals. So part of it has to do with the composition of the leasing that happened during the quarter. We would admit that there is inflation going on and tenant improvements, so we would expect that our costs will go up. But on balance, they are still very low on a relative basis to the marketplace or to our peers.

I think, Chris, it's also a factor of where the leases are located. So, if you have like this last quarter, we had a higher percentage of leases that were retenanted in Northern Virginia. Northern Virginia is going to cost you more dollars. It's just the nature of that market.

As you heard Roger say outlook for next year, if you look at the leases rolling, 60-plus%, 65% are in the Baltimore/Washington corridor. Very few are in Northern Virginia. So you're going to see a stronger trend for next year.

Great. If you had to break down the composition of same store year-to-date and same store next year, Steve, what would that be between top-line revenue and expense levels?

Well, year-to-date, I think the biggest impact in the third quarter for same store was our operating expense spiked. We had $1 million more of utility expense in the third quarter. We had --

What would you say the percentage change is year-over-year on nine month same-store revenue and same-store expenses?

For this quarter, I don't know that I have in front of me the year-to-date. But, the revenue was up 3.7% on a same-store basis, and expenses were up 10.7%. Utilities were most of that. We had also an increase in grounds, so we had a spike higher than normal.

Even when I went back and worked with others in terms of what's happened in the third quarter on the utilities, it was very high. We also had some key tenants whose base years were being set this year. So, there was I think from what I can tell an unusual trend in the operating margin related to this quarter that I don't project to happen going forward.

Okay, so on same store going into '07, if I just roll my leases up 8% and that is GAAP NOI up 6.5%, so my rents are up 8%, not much of adjustment on the straight line. So I get a big up. I hopefully get more recoveries on reimbursements and I bring my expense levels down?

If you are using the third quarter as a run rate, you absolutely are bringing your expenses down.

Paul Puryear, Raymond James.

Rand, in your comments earlier, I think you alluded to a changing outlook for acquisitions in 2007/2008. Could you share some of that thought process with us?

Well, I think we always look at deals. We're very -- as Roger said, we looked at $1.5 billion in transactions this year. We purchased nothing in Northern Virginia. It just to us is not making sense when you look at the replacement costs and some of these transactions are empty buildings and still going 20% above replacement costs plus the TI and lease-up and leasing commissions and so on.

And so, we've been very cautious. We've been fortunate. We were able to buy a lot in Colorado Springs at very good cap rates this year. We think we've been fortunate in having some other niche plays that as they finish up this year will be very accretive for us.

But, when we sat down to look at next year, we said you know in contrast to previous years where we've been running hard to make sure we kept that growth going with acquisitions as a key component of it, we've got so much development going on this next year -- next few years that the growth can really handle that without having to be running hard on acquisitions.

You and I have been around a lot of these cycles for a while. I was out at Urban Land Institute two weeks ago, and we had the opportunity to listen to a lot of economists. And when they sat there and forecasted the sweet spot for office is this year and a little bit into next year. They start looking at recessions and potential recession in 2009.

So you sort of look at it and you say, "This is coming up; 2007 is the dangerous year." That might be the year when if you bought something and you were trying to stretch to get it, you found yourself buying at the peak. And then, you find things moving downward after that.

And so, we just sort of philosophically said we are going to be very conservative as a company. We still have double-digit growth going on. We will be opportunistic. But, we're not going to try and put in there on guidance and then end up like as we are to date behind for the year. And people kind of scratching their heads, trying to figure out the numbers. So, that's the thought.

How do you feel about the local economic outlook and in particular the government spending. And what do you see happening there for the next 12--?

Well, the local outlook is great. I mean in the Baltimore/Washington corridor area and even in greater Washington with the potential concern only on Northern Virginia for the overbuilding. I mean I think it's very, very strong. It's in balance. We see continuing demand that hasn't slackened at all on the government and the defense side. There is clearly some budget pressures on the government as a result of that Iraqi war, and that's actually been helping us because we see increasingly where they have to do leases instead of trying to do it on [no con], where they pay for everything themselves.

And so, we see that demand just steadily there. And with BRAC, 60,000 jobs coming into Maryland starting in 2008. So we see that as a very significant push. That's why we've been buying some land, trying to get some more land in those key markets. We will be very well-positioned to play a key part in that role. So, government spending is not slowing down at all. We need to make sure we are accelerating some of our development next year to be in place for that.

(Operator Instructions). Michael McGowan, Kensington Investments.

I had a question about Green buildings. I don't know if you had touched on this before. But I see that Peter Garver is going to be at NAIOP tomorrow speaking about Green buildings.

Yes.

So I assume that you're active in that somehow and was wondering three quick questions. Do you do any Green buildings on a spec or build-to-suit basis? And if so, are the development yields the same? And last is, do you have any plans to retrofit any of your existing buildings to be Green or somewhat Green?

Yes, we made a commitment two years ago as a company that we -- going forward, all new buildings would be Green. As you know, in the lease certification, there's LEED, then silver, gold and then platinum. We've targeted silver and last year actually were the first-ever winners of the Green Building Award by NAIOP.

We actually -- to answer your second question, we actually built a spec building. It ended up being a gold-rated building, LEED certified and we won an award for the first ever.

We have currently a lot of office buildings under way that are all certified and are expected to be certified for LEED. So, we do have some rehab going on. It also we expect would be LEED certified. We also have some buildings that we've purchased that are older buildings. And as we retrofitted for those interiors, we are going for LEED certification on the silver.

The building that last year that we won the award on, the gold-rated building was $2.87 a square foot extra cost. We were able to drop the operating costs an estimated $0.50. So, on a payback, it's a little over five years. We did it on a capitalization basis. It's actually making money.

What we found on that building now after a year of operation is the water consumption is down 40%. The electrical consumption is down 34%. And it's a great building. So, we find that yes, it's costing us a little bit more. But economically, it really pays for itself.

We have perfected this through so many of these buildings, and it's just a commitment of what we'll do. And it ties -- you heard me talk about the creating environments that inspire success. It ties very, very well to our newly-defined core purpose.

Great. And then, for the one you built back -- so you didn't have to charge anything extra in the lease rate at all? It's just the regular market rates?

Typically what we're doing anyways is looking at a return on costs. But when you look at a return on costs, you also are looking at what's your -- if you have a $30 stated gross rental rate and a $7 expense top with some of our markets here, that's where we are.

What this allows you to do is still charge the $30. But, instead of having $7, you're able to drop the expenses to $6.50. So you are really getting a return on the costs, the same return as you would without the additional expenditures.

We have no further questions.

Okay, well, thank you very much for joining us today, especially since it was Halloween. And we did move it up an hour to try and accommodate you all for that. As always, we do appreciate your participation and support. We are available to answer any other questions.

We haven't yet defined when our next earnings call will be, but we would expect it to be mid-February. With that, have a great day. Thank you.

This concludes today's conference call. Thank you everyone for joining us. You may now disconnect.