COPT Defense Properties (CDP) 2008 Q2 法說會逐字稿

Welcome to the Corporate Office Properties Trust second quarter 2008 earnings conference call. As a reminder, today's call is being recorded. At this time I will turn the call over the Mary Ellen Fowler, the Company's Vice President and Treasurer. Please go ahead.

Thank you and good morning everyone. Today we will be discussing our second quarter 2008 results. With me today are Rand Griffin, our CEO, Roger Waesche, our COO, and Steve Riffee, our CFO. As they review the results for the second quarter, the management team will be referring to our quarterly supplemental information package. You can access our supplemental package as well as our press release on the investor relations section of our website, www.COPT.com.

Within the supplemental package you'll find a reconciliation of GAAP financial measures to non-GAAP measures referenced throughout this call. Also under the investor relations section of our website you'll find a reconciliation of our annual 2008 guidance. At the conclusion of this discussion the call will be opened up for your questions.

Before we begin I must remind all of you that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based upon what 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, 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. Please note the Company assumes no obligation to update any forward-looking statements. Now I would like to turn the call over Rand.

Good morning everyone. We're pleased to report a strong second quarter for the Company, achieving FFO of $0.61 per diluted share which hits the top end of our guidance. Total FFO for this quarter grew by 7% on a diluted per share basis over the second quarter of last year.

We're comfortable with our performance for the quarter and believe we are on track to deliver a strong 8 to 11% FFO per diluted share growth for the year. We believe our strategy and customer relationships allow us to be able to deliver this level of growth despite an increasingly difficult economic environment.

Similar to last quarter the top two questions on investors' minds are capital availability and development leasing. We've addressed our capital needs through a number of financings. Let me go through those in detail.

Starting last fall we've increased our unsecured revolver to $600 million and revised the covenants to provide more capacity. In early May we closed on a $225 million construction revolver that can be increased to $325 million that will fund our wholly-owned construction and development pipeline for both 2008 and 2009.

Then, subsequent to quarter end, we closed on a 221 million dollar permanent loan that will refinance the balance of our permanent debt maturing this year, as well as pay down our revolver. Steve will provide details of these financings in a moment. As a result of these financing activities we've taken care of our capital requirements through for 2008.

With regard to the second question, development leasing, we've made excellent progress during the quarter, signing leases for 369,000 square feet of development space. Included in this total are two leases, each over 100,000 square feet for full building users. We will provide more specifics on these large leases in a few minutes.

Subsequent to quarter end we signed an additional 62,000 square feet in two leases, both over 25,000 square feet, bringing our development leasing to over 430,000 square feet since last quarter. We continue to see strong demand from our core tenants and in our core parks, where a majority of our new construction is located. As a result, we feel good about our pace of development leasing and believe we are on target for our buildings under construction and ahead of schedule for buildings under development.

We have also heard some questions from our investors recently regarding the impact of the presidential election on our company. We believe that regardless of the political party that wins, we will continue to see demand for space from our strong tenant base.

Our defense tenants are not producing ships or tanks, but rather are involved with communications and technology that support the government's war on terrorism. These activities have not slowed down and we believe will be accelerated if more money becomes available as a result of shifting expenditures from Iraq.

With regard to BRAC, we're pleased to see earlier than anticipated discussions for space at both Aberdeen Proving Ground and Fort Meade. We have two leases under discussion for our Northgate Project adjacent to Aberdeen Proving Ground, and one lease at NBP. The land control we've assembled at these two locations will be very important to furthering our strategy of growing government defense, IT and data sectors.

Turning to our strategy, we continue to work to differentiate our Company as a specialty office REIT focused on meeting the needs of government, defense IT and data sector tenants as opposed to a mostly market-driven suburban office REIT. As a result of our plan to further differentiate, we have set goals to grow our revenue from our core tenant base and core locations over the next three years.

Our core tenant base includes the government, defense IT and data sectors and our core locations are business parks adjacent to government demand drivers or in growth quarters. Typically we are the dominant owner in these parks and have land capacity to expand our market share.

For the six months ending June 30, our assets containing tenants within these sectors generated 53% of our total real estate revenues. Our goal is to grow this percentage to 65% by the end of 2010. Similarly, the real estate revenue stream from assets containing these three tenant sectors plus our core business parks was 79% of our total real estate revenues and we plan to grow this to 85% by the end of 2010.

The remaining 21% of the real estate revenue today is comprised of both strong real estate opportunistic projects and noncore holdings. Our plan is to shrink this category to 15% by the end of 2010. Achieving these goals, COPT will further strengthen its revenue stream and continue to differentiate itself from the suburban office sector with a focused commitment to our core activities, the strategy should produce continued growth and a higher quality of earnings.

In summary we're pleased with our results through the first half of the year and believe we are on pace with our plan for the year. And with that, I will turn the call over to Roger.

Thanks Rand. Turning to our portfolio at June 30, our wholly-owned portfolio ended the quarter at 93.4% occupied and 94.2% leased. Both percentages are higher than last quarter and one year ago.

As you may have noted, we did lose some occupancy in our Colorado Springs portfolio as Northrop Grumman relocated from 30,000 square feet in Patriot Park 1 consolidating into their new building at Colorado Springs Airport Park which we then purchased in late June. We have made good progress backfilling the Northrop space signing 15,000 square feet to date.

With regard to Baltimore County, we have improved occupancy from 83.8% last quarter to 85.5% or 170 basis points at June 30 and leasing is up from 86.6% to 87.2%. The six months ended June 30, for our suburban Baltimore County portfolio we have about a 67% renewal rate.

With regard to our renewals overall, we believe it's important to focus on the year-to-date leasing statistics as the first quarter included 720,000 square feet of leasing and the second quarter had only 275,000 square feet of leasing. For the six months ending June 30, we renewed 781,000 square feet or 76% of our expiring leases with an average capital cost of $4.58 per square foot.

For our renewed space, total rent increased 10.1% on a GAAP basis and 4% on a cash basis. For our renewed re-tenanted space of 995,000 square feet, total rent increased 7.2% on a GAAP basis and 1.5% on a cash basis.

The average capital cost for renewed and re-tenanted space for the six months totaled $7.75 per square foot. For the quarter, we renewed 193,000 square feet or 60.4% of our expiring leases at an average capital cost of $7.06.

As of June 30, our lease expirations for the balance of 2008 equate to 5.3% of our total annualized revenue down from 11.2% at the beginning of the year. Our lease expirations for 2009 equate to 15.4% of our revenue. Of this amount, 3% of the revenue is derived from our Unisys campus in Bluebell, Pennsylvania.

As you may recall, the Unisys campus comprises three buildings totaling 960,000 square feet all leased to Unisys. The leases mature June 30, 2009. The campus generates approximately $10.2 million of annualized NOI.

Unisys did not elect to exercise its option to renew the leases. One of the buildings totaling 220,000 square feet has been subleased by Unisys to Merck for many years. We have been negotiating with Merck and believe we will have a lease signed this quarter for their building.

The second building of approximately 208,000 square feet has been vacated by Unisys and we're planning core and shell renovation work in early 2009. We're actively marketing the building with some activity for fill building users.

The third building totaling 530,000 square feet has two parts -- the executive building of 114,000 square feet and a single-story building totaling 416,000 square feet. We're currently negotiating with Unisys to remain in the executive building. The outcome of peace negotiations should be finalized this quarter.

We are also designing the park for additional FAR of about 500,000 to 600,000 square feet. We will keep you updated as we make progress over the next year.

We continued to see fairly good but uneven demand for space. As Rand will detail, we have good demand for much of our development space which continues today. In our existing portfolio, certain submarkets are stronger such as Columbia and [NBP] than others such as the BWI Airport.

We have experienced some but not significant pressure on rental rate compression, free rent or TI packages. It is more deal specific than market specific.

With regard to tenant credit we have minimal exposure to the financial sector. We manage the business to portfolio and transaction cash flow with a view to the Company's overall lease maturity schedule, risks and opportunities inside the portfolio. We expect to deliver good overall 2008 leasing statistics.

Turning to our markets, with regard to the BWI submarket as of June 30 within the total market of 6.6 million square feet, vacancy including sublease stood at 14.2% up slightly from 14.1% one year ago and up from 12.4% in the first quarter of 2008. Our BWI portfolio totaling 4.6 million square feet and representing 70% of the submarket was 92% leased at June 30.

Turning next to the Columbia submarket in Howard County, at June 30 vacancy [was] sublease was 13.9% down from 14.2% one year ago and up slightly from 12.7% in the first quarter 2008. Our properties in the Columbia submarket total 3.1 million square feet and are currently 95% leased.

Within COPT's Northern Virginia submarkets, the direct vacancy rate was up to 14.1% versus 9.4% one year ago and 13.9% last quarter. Quarterly absorption was a positive 864,000 square feet versus an a negative 198,000 square feet last quarter. Our portfolio of 2.5 million square feet is 99.3% leased at June 30.

Looking just at the Dulles South submarket in Northern Virginia, the direct vacancy rate ended the second quarter at 18.3% or flat with the first quarter. Within the Dulles South submarket there was approximately 95,000 square feet added to the market as of June 30, down from the approximately one million square feet added in the first quarter 2008.

Our operating portfolio of nine buildings totaling 1.5 million square feet is 99.6% leased. Within the Colorado Springs submarket there's demand for new construction and leasing activity continues to increase and is ahead of last year.

Office vacancies were up in the second quarter to 10.8% compared to 7.5% one year ago. Our properties in the Colorado Springs submarket total 1.1 million square feet and are currently 95.3% leased.

Turning to acquisitions, we closed on three buildings, two located in San Antonio and one in Colorado Springs for a total of $40.5 million. In Colorado Springs, we purchased a 124,000 square foot building located in the Colorado Springs Airport Park known as Cresterra that is adjacent to Peterson Air Force Base.

As you may recall, COPT was chosen to be the master developer for all future development in this park. This is the first building in the park and is fully leased to Northrop Grumman as their Colorado Springs headquarters.

We believe this is a strategic acquisition for us since Northrop Grumman is our second-largest tenant. COPT will control the balance of the land to be developed at Cresterra with this building being located at the entrance to the park and we have the opportunity to build two additional buildings on their site.

We also purchased two buildings totaling 123,000 square feet in San Antonio for $17.3 million that are located in close proximity to our core tenant driven location. The buildings are currently leased to Sears Air Force Federal Credit Union and AFNI. The site can support an additional 120,000 square feet.

Our core tenant in San Antonio continues to expand and need additional space and will be absorbing for their use a majority of the land we originally identified for defense contractors. As a result, we have been looking at locations in close proximity to our sites that can support future demand from defense contractors. In that regard, subsequent to quarter-end we purchased 31 acres of land adjacent to our main location in San Antonio that we need to support office demand from the defense contractors.

With regard to dispositions during the quarter, we sold two small non-core buildings totaling 80,000 square feet for $8.3 million. And with that, I will turn the call over to Steve.

Thanks Roger. Turning to our results, diluted FFO for the second quarter of 2008 totaled $34.2 million or $0.61 per diluted share. In the second quarter of 2007, we reported diluted FFO of $31.8 million or $0.57 per diluted share representing a 7% increase on a per-share basis.

Second quarter FFO results of $0.61 per diluted share exceeded the top-end of our guidance by $0.01 per share primarily due to lower than projected short-term interest rates partially offset by lower than expected lease termination fees and slightly higher G&A costs. The contributions from development placement service were on target for the quarter.

We reported net income available to common shareholders for the second quarter of $8.8 million or $0.18 per diluted share compared to $3.9 million or $0.08 per diluted share for the second quarter of 2007. Turning to AFFO, after adjusting for capital expenditures and the straight lining of rents, our adjusted funds from operations of $25.1 million represents an increase of 16.4% from the $21.6 million in the second quarter of 2007.

This AFFO growth reflects continued strong cash flows, good renewal economics, well controlled capital expenditures and operating expenses. Our payout ratios also remain strong. Our diluted FFO payout ratio was 55.5% for the second quarter as compared to the 54% diluted FFO payout ratio for the comparable 2007 quarter. The diluted AFFO payout ratio was a strong 75.4% in the second quarter of 2008 compared to 79.5% in the second quarter of 2007.

Looking at our same-office cash NOI for the second quarter of 2008, for the 217 properties or 92.4% of the consolidated portfolio square footage, same-office cash NOI increased by 3.1% excluding the effect of an $863,000 reduction in lease termination fees. Including the effects of the lower lease termination fees, same-office property cash NOI increased by 1.5% for the quarter.

Turning to the balance sheet, at June 30 the Company had a total market cap of $4 billion with $1.9 billion of debt outstanding which equates to a debt to market cap ratio of 47.1%. A weighted average cost of debt for the second quarter was 5.1%, down from 5.9% a year ago. 74% of our total debt was at fixed interest rates.

Our coverage ratios remain strong with a second quarter EBITDA to interest expense coverage ratio of 3.1 times and a fixed charge coverage ratio of 2.55 times. With regard to our debt as we mentioned on our last call, we closed a $225 million revolving construction facility that will be used to fund our wholly-owned development pipeline.

The facility provides for funding of 85% of the construction cost on top of our 15% equity which is provided by our land and our predevelopment costs. The term of the facility is three years with a one-year extension option and we have an opportunity to increase the facility from $225 million to $325 million at a future date. Repayment terms are interest only and the interest spread starts at 160 basis points over LIBOR and is dependent on the Company's overall average.

Subsequent to quarter-end, we closed a $221.4 million four-year secured term loan requiring interest-only payments for the term at LIBOR plus 225 basis points. We have an option to extend the term by an additional year. We used approximately $64 million of the proceeds to repay construction loans that were maturing in 2008, $12 million to repay borrowings under our construction revolver and most of the balance to repay borrowings under our revolving credit facility.

To summarize, for our debt maturing in 2008, we have repaid $140 million, extended $41 million of debt for one year and the remaining $102 million will be repaid using the line capacity created by the new term loan proceeds. With these loan transactions we've addressed our major financing needs for the year, which is a key issue for most REITs in this credit environment. And at this point, we still do not anticipate a need to raise equity to the balance of 2008.

With respect to our FFO per diluted share guidance for 2008, although there have been few changes in our underlying assumptions, we are tightening both ends of the range by $0.01 per share to a range of $2.42 to $2.48 of FFO per diluted share which represents an 8 to 11% year-over-year FFO growth. Favorable changes in our assumptions since our last call principally relate to the contributions from acquisitions net of interest of approximately $1 million and given the current short-term interest rate environment, another slight reduction in our assumed interest expense.

These changes are partially offset by a further reduction in estimated lease termination fees which was originally forecasted to contribute approximately $4 million and now is estimated to contribute only $1 million for the year and slightly higher G&A expenses for the year which we now project will run approximately $6 million per quarter for the balance of the year. Development placed into service during 2008 is still expected to contribute approximately $4 million in 2008 and for the year we now expect to exceed our 70% lease renewal rate in our original guidance.

We plan to address our 2009 FFO guidance on our next call. As a reminder, our Board typically considers a dividend raise at the September Board meeting. And with that, I'll turn the call back over to Rand.

Turning to our construction pipeline at June 30, we had 11 buildings under construction for $241 million. The changes for the quarter include adding two buildings totaling 235,000 square feet from development into construction with no leasing and placing into service two buildings totaling 148,000 square feet that were 70% leased.

Even with these changes, we were 26.8% leased at the end of the quarter. Subsequent to the end of the quarter, we leased 62,000 square feet in two buildings. That moved us to 32% leased currently and with leases in final stages of negotiation, we will be 42% leased on our buildings under construction.

With regard to construction activity specifics, in Colorado Springs since Patriot Park 6 is fully leased to ITT, we have begun construction on our next building; Patriot Park 7, a 90,000 square foot building that we expect will be primarily leased by ITT and their contractors as part of the FAA contract. We have also started construction of our first multistory building at InterQuest Park, a 146,000 square foot building and subsequent to quarter-end signed a lease with Lockheed Martin for 34,000 square feet in this building.

With regard to our Hybrid buildings at InterQuest at Hybrid II we signed a lease for 44,000 square feet or 81% of the building. So we have good leasing momentum and are very pleased with our progress in Colorado Springs so far this year.

With regard to our buildings under construction within the BW quarter, we signed a 131,000 square foot lease with Integral Systems Inc. for the entire building under construction at 6721 Columbia Gateway Drive adjacent to our headquarters. We would like to provide a little color on how we were successful in winning this lease.

As you may know, there are currently three other newly constructed buildings in the Columbia Gateway Business Park. All three of these buildings started construction before our building and are currently all vacant. The possibility to win this lease was a result of our existing relationship with Integral Systems in Colorado Springs and was further reinforced by our long-term ownership strategy, excellent customer service and quality of building construction, [hard scape] and campus design.

Turning next to the National Business Park, we have under construction the next building for defense contractors at 300 NBP and are in advanced discussions with a potential tenant looking at taking a significant portion of this building. This is the first BRAC related discussion at NBP.

Turning to the University of Maryland Baltimore campus subsequent to quarter-end, we signed the first lease in our 106,000 square foot building at 5520 Research Park Drive for 28,000 square feet and have good leasing activity. At Arundel Preserve in which we have a 50% joint venture interest, we're close to signing our first small lease in this newly completed building. However, we do expect a little slower leasing as this is the first building in a new mixed-use park.

With regard to the University of Maryland at College Park or the M Square project as we call it, at our first building under construction for 116,000 square feet we signed a lease for 41,000 square feet or 36% of the building. Our second building at M Square is under development for 123,000 square feet and we signed a lease for the entire building during the quarter.

In San Antonio we have two small buildings for 90,000 square feet under construction to expand our existing campus for our major tenant in this region that should be completed by the fourth quarter of this year. We also have two buildings totaling 250,000 square feet in the development phase that will become the next expansion to this campus.

Turning to the remaining buildings under the development pipeline, we have interest from several defense contractor tenants related to BRAC for a portion of the first two buildings at Northgate Business Park adjacent to Aberdeen Proving Ground. We also have good leasing activity for space in our first new building at White Marsh at 8130 Corporate Drive.

In regard to our 1 million square feet of development that we intend to start this year, we have leased or have strong expressions of interest for 65% of the space. And importantly, 87% of our starts, all but one building this year, are for the government and defense IT sectors thus reinforcing the continued strong demand we see from these core tenants.

In summary, we are in good shape of this year, we've made great strides in our development leasing and have executed on our financing plan in a very difficult environment. So we continue to be on track for another year of strong FFO and AFFO growth. And with that we will open up call for your questions.

(OPERATOR INSTRUCTIONS) John Guinee.

Very nice quarter. A handful of quick questions. First, great articulation of the strategy out through 2010 (inaudible) down to 15% noncore. I guess I would say why still 15%?

I think, John, that this sort of a maximum. What we have tried to do is give assurance to our investors that we're staying very focused on our core and as we would approach 15% out into the future, we would be either selling or joint venturing properties. So I would expect it probably would be below 15 but that's sort of our maximum.

Okay, second question -- I was out at Fort Ritchie over the weekend. How much money do you have invested there and what is the plan?

Well we bought it for $5 million, as you know. We have a future commitment. We don't produce 1400 jobs in nine years, then we have another $4 million or we can do that pro rata. If you saw -- I don't know if you saw it be more subsequent to the purchase, what we have been spending our time on is demoing the older barracks, cleaning up the site and we have under construction just about finished a community center that we did promise the community we would do. It's about 50% funded by [Penmar] who needs to reinvest the money we paid for the site back onto the site or back into the community.

So if you add the five, we probably have $12 million to date. That includes the retrofits of some of the existing buildings where some of the leases have occurred to date.

Gotcha. And then the third question I guess probably for Roger is can you walk through the Unisys redevelopment? It looks like to me like you've got 208,000 square feet vacant plus the most likely the single-story building for 416. It looks to me like it's maybe 13 or $14 a square foot for the office product now net and $5 or $6 net for the single story but that's just a guess. What kind of numbers can you get for those buildings on a net basis once you redevelop?

The multistory building of 208,000 square feet has a net rent today of $14 per square foot that will roll off June 30 of '09. We think the market today is probably $18 net. We will have to spend some money to get there.

The single-story product is leased today at a little over $10 a square foot net. We think that product is probably in the 16 to $17 net range build out as office which it largely is today and again we will have to spend some money to get those rental rates.

Do you have to gut the space down to the shell or is it paint and carpet?

No, we're going to do some core and shell renovation work in both cases in addition to TI and commissions.

Great, all right. Thank you.

Irwin Guzman.

Can you talk about the leasing that was done in suburban Baltimore and Baltimore Washington corridor? Were there any sort of big onetime leases that drove the drove the dip in net effective rents?

We did have a couple of what I will call anomalies this quarter. We had a lease in Columbia that we really wanted to make given a certain space and a tenant was in the market and we had the ability to make the deal and stretch it a little bit to make that deal. And then up in Baltimore County, we -- General Growth who sold us the building had signed a lease many, many years ago that rolled off at a higher rent that we have now re-tenanted at a lower rent at market and it was those two leases that really drove the the statistics if you will for the quarter.

And then regarding the decrease in noncore exposure to 15%, I am assuming there is some dispositions that you would look to do. Are there certain assets that you're sort of just waiting for the right time to get rid of or maybe some markets that you are looking to reduce in?

We have only two remaining buildings in New Jersey. Those are under contract to the existing tenant and that sale should occur next fall in 2009. Subsequent also we back in 2005 said besides exiting Harrisburg in New Jersey, we would over time be exiting our ownership at Unisys. And so we think that would be accomplished by the 2010 timeframe and that's included in that number.

Beyond that, it's really some scattering of small buildings that we picked up as part of our last two major acquisitions with the Hunt Valley and the Nottingham portfolio. And that pretty what well makes up the getting down to or below the 15%.

What was the yield on the properties you bought this quarter?

They were approximately in the 8% range.

Is that cash?

Yes.

Just one other question on the development pipeline. I saw that some of the assets that you're planning on delivering in 2010 look like they got pushed out by one quarter. Is that just a demand issue or were you sort of reevaluating construction time?

No, I think it's just the giving -- it's not really the demand. It's really we're trying to in all cases allow at least a year for protection purposes for the lease up and so in some instances if the starts were delayed then automatically the full lease up is delayed. So (inaudible) very minor adjustments and you'll do that as you're looking at situations you may accelerate -- like the M Square building, that is a huge win and we didn't really anticipate that building, the second building would have started until next year. And now we are accelerating that from development in the next quarter. That will move from development into construction and 100% leased at 123,000 square feet.

So you are going to have some movements like that to go on. And that's why I tried to say in the construction part, I mean people should really look closely at our performance because we did move two buildings out of construction into the lease up and added two more buildings that we have now started but still have the lease up to go. And so it sort of distorts the lease up numbers and that's why we try to give some more details.

Bill Crow.

A couple of questions here. The current development -- I don't want to call it pipeline -- but activity is what, $500 million, 2.6 million square feet? Where or when will that peak? Is that a late 2009 peak as you get ready for BRAC and maybe go into some other markets or when do you think you see the peak in that?

Well I think the peak is not in that timeframe. We really expect to accelerate those starts in 2010 and probably into 2011 based on BRAC. Of all the buildings listed in development they're really the two Northgate buildings up at Aberdeen Proving Ground roughly 80,000 feet each are the only two buildings directly related to BRAC. You do have the one at Thomas Johnson Drive adjacent to Fort Dietrich and Frederick which also you could say is BRAC. So we really haven't seen the real surge yet on BRAC and that is sort of the I would say a 2009 story as we start to look at those coming online starting in 2009 for 2010 and 2011 deliveries.

All right and then the second question is just kind of the construction environment out there, what you're seeing as far as cost trends. Are you starting to get any breaks from that perspective and what are you seeing as far as competitors go in your markets?

On the competitors, we're not really seeing a lot of new construction. I think it's a combination of some concerns on their part on the markets but probably more so the financing environment and just almost daily in our markets you're seeing projects go on hold as a result of lack of financing opportunities.

So we think that bodes very well for firms like ours that have the financial capacity to proceed and have that core tenant demand. On the construction cost side, things dip down really as a result of the residential slowdown and probably the Olympic slowdown of construction finally being completed in China.

But I have to say that the second quarter we've now seen those costs start to accelerate partially because of the oil surge and cost and so concrete is back up, steel is back up, leadtimes are starting to extend there. Carpet has gone through additional cost increases as has asphalt which has doubled in the last year and so on. So there is some pressure there. Fortunately we've been able to still pretty much maintain our margins.

Final question for me is on the data center space and kind of what your strategic intent is going forward, how much do you want to grow that? Is that going to be opportunistic or what are your thoughts there?

We're continuing to grow it. We feel very fortunate that we're not in a position of having to go out and try and finance $1500 a square foot facilities. That's a very challenging situation I think in today's environment.

So our data, we do expect to still have some additional data [buildings] starting this year but they are by and large for specific tenants. The tenants put it in the bulk of the additional dollars. Maybe we have $280 a foot instead of $240 a foot in the buildings. We get the return on that.

But the tenants, which are single-tenant facilities are putting in the bulk of the dollars. So we are at 1.5 million, still seeing some growth there but it's a small component of our overall growth as part of the next three-year strategy.

Thanks Rand.

Rich Anderson.

Just so I understand the core and the core including business parks (inaudible) got to 85% by 2010, that includes conventional assets that are intermingled with sort of core assets within a business parks? Is that right? Am I thinking about it right?

Right, well let's take Columbia Gateway. Columbia Gateway we own 2.4 million square feet. We own about 72% of that park and 35% of those leases are government and defense. The balance are non-defense. But it is a core park. It's in a growth quarter and we continue to see excellent growth.

So you'll have that mixture but the important thing for us is within that defined 85% you have the three -- the government, the defense IT and data along with these four business parks. Now some of them like NBP, maybe 100% the first three core elements but still also be a park that we in a growth quarter that happens to be adjacent to a government demand driver. So to us, Whitemarsh is also core as is our Northern Virginia holdings and so on like that.

So it's either core or touched by core (multiple speakers) business park concept?

And then within the 15% you might have a nongovernment building that is out by itself somewhere and would view that as non-core within the (multiple speakers)

Now the 65% number of the core not including business parks, how much of that would you characterize as buildings with the sort of secured architecture associated with them?

It's probably all but 3 or 4%. Even there -- yes, I would guess that's about right.

Now you mentioned Nottingham, White Marsh. Did that not though take you in the wrong direction from this movement to sort of a core strategy at least temporarily?

Well, I don't think so because it perfectly fits that definition and that's why we tried to elaborate that on the call today. It's in a growth corridor. We are the dominant owner. We have all of the submarket which is 1.6 million square feet today. We have adjacent ground that we own to expand that and over time we will end up with about a 5 million square foot submarket and we will be the dominant owner of almost all (multiple speakers)

But it's not really a whole lot of core like government defense IT or data centers there right?

That's the fourth component. You have the three core -- you have government, defense IT, data and then you have the parks. And so to us that would fit the definition of the parks as sort of one of the four core components that would make up the 85%.

Now interestingly, we didn't buy it for that but we are starting to see some expression of interest from BRAC related tenants at Aberdeen Proving Ground who are a little trouble by the lack of services and the little bit lesser quality schools in Hartford County and are gravitating down towards Baltimore County which has more available housing, better schools and has that sort of mixed-use component. And so we do think we will end up with some component of our square footage expansion at Whitemarsh being BRAC related which then fits to that core 65% of our strategy.

Now in terms of the leasing activity, I know you ran through a lot of numbers there and you said that you are sort of on track with where you want to be or even better than on track. But I mean when I look at 26 or 27% lease for your under construction portfolio and that is about flat with last quarter although I know there were some moving parts between the two quarters, you would agree that the process this much slower in this environment. I don't know if it's -- you're saying it's meeting your expectations. But would you agree that leasing is sort of -- when things were really peaking, it wasn't quite as -- this is not quite as impressive activity?

I don't agree with that. I think if you look at the 26% and you look at where we were at the end of the first quarter and you said let's keep that static not counting the buildings that we moved out or in, you would be at 31%. And then if you took those buildings and added in the additional leasing that we have done, you would have moved up to 40%, 41% and if you added in the other leases that are in final stages of negotiations we would be right up close to 50%.

So I think that's right on track. And I think what people kind of forget and Steve said in his section, is that our buildings under construction this year only are producing $4 million of NOI. The buildings that we brought online last year, this year are producing $11 million of NOI. So they tend to be back-end loaded. It's just the construction cycle of when we started those buildings.

So that $4 million we anticipate grows to $13 million of NOI next year and when it's stabilized it's $14.3 million. So we think it's on track and exactly where we thought it would be for this year. And then as I said, what's really been surprising and encouraging has been the activity in the development area and that's very, very strong and very healthy and that bodes well for its impact on 2009.

That $4 million to $13 million is the entire development pipeline or just that under construction?

Just under construction currently.

And then Northern Virginia, obviously you don't have a whole lot of leasing exposure currently but you do eventually. Late 2009 I believe, certainly in 2010 27% of your leasing activity will be out of Northern Virginia. Obviously there's some pockets of weakness there. What are you doing today to sort of address that issue that will become an issue say 1.5 year down the road from now?

In terms of the 09 and 2010 Northern Virginia lease maturities, fortunately both of them are back-end loaded. In the case of '09, 64% is in the fourth quarter and in the case of 2010, 75% is in the fourth quarter. We are in contact with both tenants that represent the majority of our lease maturities in 2009 and 2010 and I think we feel good about our prospects to maintain them.

In both cases we have buildings that are below market rents that were signed a long time ago and the buildings have a lot of investment by the tenant and they also happen to have very strong amenities and they're both tenants that we have good long-term relationships with. So I think we feel relatively good. Yes, we will probably be impacted a little bit on the market dynamics but in terms of maintaining those tenants I think we feel comfortable.

Last question is just any sort of any big picture comment on where cap rates have moved in the world around you?

We really haven't seen much movement. If you're looking at acquisitions, there's just not a lot on the market that is of interest to us currently and the deals that have been getting done are still I think fairly pricey. So we fully expect that cap rates would move as the capital costs have gone up. But that hasn't occurred yet.

And I think it's a combination that the sellers are worried about anybody's ability to finance and so they are not putting things on the market or they still are holding out for their price expectations sort of from last year and we just haven't seen that capitulation stage that you usually see in a cycle like this. So therefore, we really don't expect any acquisitions for the balance of year. It is sort of turning more towards an '09 potential we think now.

Chris Lucas.

Just I guess a follow-up here Rand just on that last topic. Earlier in the year you had talked about your expectations see more opportunities to either invest more in the existing markets or potentially into an additional market. Are you suggesting now that maybe that is going to be more of an '09 story just generally?

No, I think it related to acquisitions of existing buildings. We're seeing a few scattered ones, obviously [we did] the three acquisitions last quarter. But I think where we are seeing the opportunities and that is consistent with comments we have made previously, is really in the development area where developers are coming to us with entitled projects that are very interesting opportunities that are very core to us, they fit our strategy exactly and that is where we think we will be putting our efforts in for the balance of the year rather than sort of existing buildings. Now some may come along but so far we haven't seen that.

Okay and then just as a follow-up on the acreage that you acquired in San Antonio, how much FAR does not have associated with it?

We think it's probably about 500,000 square feet.

Given your expectations for that market, what sort of buildout would you expect for that timeframe-wise? How long do you think it will take you to build that 0.5 million feet out?

We think that the contractors, the defense contractors need to start to be in occupancy in late 2010 on through say 2012. So I think that we will start to see some construction activity late next year, early 2010 and I would guess that would be a four, five-year buildout on the 500,000 feet.

And what are your preliminary thoughts -- is that a three or four building buildout?

Typically we're thinking of 125,000 square feet per building, so say four buildings there.

And then I guess, Steve, a couple of quick questions. On the term loan that you guys entered into subsequent to quarter-end, are you planning on hedging that all or are you just going to let it float at this point?

We're evaluating when to (inaudible) it to fix but right now we haven't made a decision as to when we will do that. It's likely we would probably do that at some top point over its term. But we may have more color for you on that on the next call. We're going to let it float for right now.

Is that priced off of the shorter or a mid-term maturity?

It's LIBOR based.

It's LIBOR based.

So is it on a 30-day or 180 day or --?

Yes, 30-day (multiple speakers)

30-day, okay. And then on the service revenue for the quarter and just sort of over the balance of the year, are you guys on pace for what your expectations were and if Steve, you could give us a little more color on what you expect for the second half of the year?

We are on pace and Roger can talk about what's coming up.

I think from a development fee standpoint, we will probably see an increase in the second half of the year and into '09.

And then I guess, Roger, just on Bluebell, if we could just kind of go back through that. It sounded like you were more optimistic on your direct lease with Merck but not so much on Unisys. Can you give us some color on what your expectations are for Unisys in terms of how that is going to play out?

Well to go back to that, one building we think will be taken care of by Merck. One building Unisys has already vacated. That's the one that has the $14 net rent and so we'll get that building back July 1 of '09. We are already out marketing it. We plan to do core and shell renovations to that building in early '09 to make sure it's positioned for leasing when Unisys lease matures or we can probably do it sooner.

And then in terms of the other building where Unisys is not leasing, that's a single-story building. The rent is $10 net and we will be probably breaking that building up into two parts because 400,000 is pretty big for a single-story building and so that will cost us some money and we will be doing some core and shell renovations there. We think net rents -- I think I quoted 16 to 17 before. Maybe it is 15 to 17 net. And we will be marketing that almost immediately for delivery in the second half of '09.

And the multistory building there, are you expecting the renewal or are you not sure at this point?

Well, there is the Merck building, yes. And then there's the multistory building -- there's the executive building and the answer is yes. We are expecting a renewal.

Okay and then, Rand, last question just on -- I guess Steve had mention that you guys -- the Board reviews the dividend in the September Board meeting. Given the capital markets today, what's your expectation generally in terms of whether it would be sort of towards the low -- would it be at the low end or at midpoint of where you have traditionally raised the dividend at this point? What would your thoughts be?

That's hard to speculate and it's really up to the Board. I am obviously a Board member but we will consider it at that point. I mean we clearly have the financial capacity. If you look at the payout ratios currently they are very healthy. We had a 16% plus AFFO growth for the quarter and that's really what we focus on is the AFFO component of our earnings as it relates to the dividend decision. So, the meeting is the 18th and we would expect to have the announcement right after that effective the end of September.

Chris Haley.

Rand and Roger, just a couple of questions if I may. First on the amount of square footage that you view as non-core or as potential liquidity over the next 24 months, would you care to give us a range as to how much that might be?

Well it's really -- we deal with it in terms of percentage of revenue. And you know if you look at it, it's probably on the lower end of per square foot rentals just through its nature. So as I said, non-core to us it's really the two buildings at Princeton Technology Center in New Jersey, it's the Unisys campus of 960,000 feet, and then a few other buildings. So it's probably when you are all said and done, 2 million square feet at the most.

Related to that, there has been some discussion in the past or at least (inaudible) recall from our notes that you have looked at partnerships ventures in the past either in a fund structure -- a programmatic fund structure or a drop-down structure. Is there any update on that? And have you thought about that as a way to monetize or exhibit the value in your government defense assets?

We haven't, Chris, from that standpoint. I mean obviously we have some joint ventures and are looking at a few others. But typically those relate to the land where the landowner is looking for us to be the partner in the equity there or where an individual may have a very specific expertise.

But if you're sitting there trying to say let's monetize our core government activities, I think when we had the meetings with the Board and we were rolling out and refining our strategy, what differentiated us from other REITs and I think that's particularly important right now in today's environment is that we are not a transactional company. We're not dependent upon the promotes and the generation of earnings that relates to contributing properties and then trying to run on the fees and look at the sales as a way to boost earnings.

We can produce our 10% plus earnings on a consistent basis doing a core strategy of paying attention to our tenants, growing with the tenants, helping the tenants be successful and continuing to develop. So we don't see ourselves as needing to go in that direction and we are fortunate I think to be able to have that sustained growth without having to go into kind of an asset management monetizing strategy.

The structure of those leases does provide a little bit of up. At the term you still take the risk of re-tenanting etc. Maximizing the value though upon development completion and stabilization would appear to me to be a way to minimize the equity return, probably the equity need that may not be necessary this year but is necessary down in the future, possibly what we think in 2009. All of that would go to boost ROE, boost returns and I think that would be a very well thought of, well -- strategy to make your equity less scarce over the next (multiple speakers)

You know it's interesting though the specific tenants that make up that core do not typically require a lot of CapEx as we go to renewals. And in fact if you look at your own chart year after year, we are the lowest on the CapEx of all of the office companies.

And so we think that from a capital expenditure -- so we think that it's a sustainable strategy. We don't need it -- certainly if we can go out and perform that and probably gets some more credit for it. But I think that it puts at risk those relationships over time and creates a potential conflict of interest situation as you start to parcel out parts of parks and so on. And currently we just don't need to do that and yet we're still at the top end of the sector, certainly one of the top two or three on FFO growth and probably top on AFFO growth and the strategy is holding well.

I appreciate that comment and I would agree with you that currently statistically your concession ratios are lower than many of your other suburban peers. And we think that is largely due to a high amount of your development activity over the last several years that has been under long-term lease agreement therefore requiring less turnover capital.

Yet that has shifted a little bit to include more multitenant projects in your pipeline today than where it was three to four years ago. I'm just trying to think of a long-term strategy to minimize equity issuance to boost the ROE of your Company and therefore regain a premium valuation.

I think -- we appreciate those thoughts. I think that the long-term as Steve said, we don't see the equity requirement at this point in time for this year. The divestiture in the moving from the 22% down to the 15% produces additional equity that should further mitigate any of the equity requirements out into the future. And I think we've got excellent core growth.

I would say that the secure buildings -- that's the component that maybe you're missing -- that aren't just a recent component of our development but have been there for quite a long time continue to have minimal investments in them as you go towards renewal. So that is a large percentage of our core components there in that when we look long-term we think that will continue to maintain that strategy.

But we're always looking very carefully at our long-term. We are long-term company on the thinking. We're not going to do something for short-term kind of gains. And as we think long-term so far we're very comfortable with the strategy and that's what we've tried to articulate.

Some people I think as yourself for example where you have got us as an underperform and not comfortable with our growth, it would seem to me that maybe you should look more closely at what we are consistently putting out quarter after quarter and answering those questions such as development leasing and some of the other things you have raised as concerns.

I appreciate that. And if I could just ask two very brief questions. You had mentioned, Rand, that your preleasing on your 2008 starts if I understood correctly were 60% or preleasing and/or commitment levels or (multiple speakers) soft sign levels we're seeing (multiple speakers)

Leased already and/or strong expressions of interest and negotiations is 65%.

Thank you. And then Roger and Steve, how do you expect to treat the potential re-tenanting of the Unisys campus? Are you going to view that as a redevelopment asset or will that be -- how that will impact your income statement?

I don't know that we have fully thought that through yet. Clearly the Merck, we're just going to have a leasing commission. We will run through normal operations and in terms of the buildings where we have got to expend more significant dollars, we haven't focused yet on whether that's occurring on nonrecurring. We will talk to the investors in the next couple of months on that.

(OPERATOR INSTRUCTIONS) [Michael Knotts].

Can you just clarify that 65%? Is that a total between page 31 and 32 of your supplemental or does it just relate to page 32?

32.

And then also you talked a little bit about development cost. Can you just talk about whether your yields on development are still holding firm at around 10% in terms of what you anticipate?

I think they have -- it's hard to know yet, Michael, in terms of those because we're just in the process of us bidding some of those buildings. It will be around the 10% range maybe slightly under, maybe it's under a little bit of pressure for 10 or 20 basis points.

But I still think we're pretty comfortable with it. Some are little lower in some markets and others are significantly above 10%. But we're comfortable with what we have been accomplishing. It's still above our peer group.

And then there had been prior discussions about landfills. Is that right? Is that something that you are still thinking about or is that sort of not on the front burner now?

We have a few that over time will occur. There's something much on the radar screen I would say for the balance of the year. We have a fair amount of land leases related to some of our multi-use developments that will be going on at Whitemarsh. And as Fort Richie goes through its next phase of development, we will start to see some land sales on a very consistent basis there as we start to do the lot sales for the residential. But you know it's a fraction of -- if there is that kind of activity it's a fraction of our overall picture.

And then I think on prior calls you had mentioned the possibility of seeing some distress potentially investment type situations in some of your specific markets? Have you -- is that something that's continuing to develop?

As I said previously, we're not really seeing that on existing product. I think that sellers are just either worried about the ability of people to finance or they're just trying to hold out until the investment climate strengthens. Where we are seeing the opportunities I wouldn't call them distressed.

It's really been more in the development where people are looking to firms like ourselves with strong balance sheets and with expertise to step in and either buy their projects or joint venture them. And so there are some very interesting opportunities there and we should have some further discussions of that in the next couple of quarters.

And then lastly, are you still looking at underwriting new markets and investigating new geographic regions?

Some of those development opportunities are in fact in new markets that sort of dovetails with that strategy. I think we had held off on that because we had to absorb Colorado Springs and San Antonio. We think that's comfortably on track as you see from our discussions today.

And we think that we have comfortably absorbed the Nottingham acquisition that we did in early '07. So as a Company we're ready to take that on. We have got the systems and the personnel and it's just been matching up the opportunities. We are now seeing those opportunities come forth and so stay tuned.

So that's likely maybe an '09 event and if so would it be sort of one to two markets or would it be more than that or just a single market? How should we think about it?

I don't know. We'll see. Usually it's one at a time. Stay tuned.

Wilkes Graham.

Rand, as I'm looking at page 34 with the land inventory and thinking about where the development opportunities will come from, you just talked about maybe there might be a couple of new markets. But if it's $1 billion and maybe that's 5 million square feet of starts, obviously big slugs of that will come at NBP and Arundel. Where else should I think -- I guess what I'm trying to get to is I think part of the negative perception that some people have with Whitemarsh is that the development opportunities that are there may be further down the road. But how much of that 1.5 million square feet or so that's at Whitemarsh kind of fits into the 2010 plan?

What's interesting in Whitemarsh is we think we made a great buy on the land component, certainly on the whole portfolio but particularly the land component. And some of the land as we have gotten into it is more appropriately utilized from mix use and so we are into the county for two planned unit development [puds] that are progressing nicely and those go to more mixed use. And so that will accelerate some of that land use.

On the office component, we're getting ready to start 8130 Corporate Place which -- and as I had said on the call, we have got good leasing activity there. We virtually have no multistory space available at Whitemarsh and so we need to produce that product. The tenants want larger footprints and higher quality properties. So we do see that continuing.

When I look at the land inventory otherwise, clearly the Northern Virginia activity is probably on hold through that timeframe although there are some RFPs for very large square footage campus kind of square footage that's out there. NBP as you said will be accelerating as will Arundel related to the continuing demand from Fort Meade as well as the new BRAC requirements.

Gateway, we have accelerated there so we are out of inventory already at Gateway and are looking at when do we start that next building. So in that timeframe that certainly will be utilized. Northgate will probably be started in its entirety in that timeframe and through the 2010 as would the Rockville -- I mean as would the Thomas Johnson Drive property related to the BRAC up at Fort Dietrich.

Then Colorado Springs is proceeding pretty nicely on InterQuest and Patriot Park and so we have properties under way there and as they lease up we will continue to produce that. San Antonio is virtually proceeding as we've talked about very well and then Fort Richie os starting to get through the infrastructure and start to proceed. So I think that it will -- you will see an acceleration of our land use over the next three years as a result of this demand and particularly the BRAC demand.

There are no further questions. I'd like to turn the call back to Mr. Griffin for closing remarks. You may proceed sir.

Thank you. This is our longest call on record. So we are in good shape for the year and we thank you for joining us today. As always we appreciate your participation and support and we are available to answer any other questions off-line that you might have. Thank you and have a great day everyone.

Thank you for attending the Corporate Office Properties Trust second-quarter 2008 earnings conference call. This concludes your presentation. You may now disconnect. Good day.