COPT Defense Properties (CDP) 2009 Q3 法說會逐字稿

Welcome to the Corporate Office Properties Trust third quarter 2009 earnings conference call.

As a reminder, today's call is being recorded.

At this time, I will turn the call over to Mary Ellen Fowler, the Company's Senior Vice President and Treasurer.

Ms.

Fowler, please go ahead.

Thank you and good morning, everyone.

Today we'll be discussing our third quarter 2009 results.

With me today are Rand Griffin our President and CEO; Roger Waesche our COO; and Steve Riffee, our CFO.

As they review the results of the third quarter the management team will be referring to our quarterly supplemental package.

You can access our supplemental package as well as our press release on the investor relations section of our website at www.copt.com.

Within the supplemental package you'll find reconciliations of GAAP financial measures to non-GAAP measures referenced throughout this call.

Also on the investor relations section of our website you'll find a reconciliation of our annual 2009 and 2010 guidance that was posted at the start of this call.

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.

Those answers that could cause actual results to differ materially include without limitations.

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 is detailed in our filings from trim to time with the Securities & Exchange Commission.

Please note the Company assumes no obligation to update any forward-looking statements.

Now I would like to turn the call over to Rand.

Thank you, Mary Ellen, and good morning, everyone.

We're pleased to report our quarterly FFO results of $0.60 per diluted share and $1.94 in FFO year-to-date.

These results reflect our continued efforts to maintain occupancy and same office net operating income through leasing activity combined with continuing operating costs controls.

During the quarter we increased our dividend by 5.4%.

One of the few REITs to do so so far this year, and we continue to pay our dividend in cash.

Our capital plan this year calls for replacing low cost revolver debt with higher priced long-term debt, a decision that would increase interest expense for the third and fourth quarter of this year and for 2010 thus putting some pressure on FFO growth.

In addition to raising the debt capital we opportunistically raised a small amount of equity in April at the time of our inclusion into the S&P 400 midcap.

We chose a capital strategy that would provide the necessary liquidity and at the same time result in minimal dilution to our shareholders while positioning the Company for future growth.

In contrast many REITs have raised large amounts of dilutive equity capital this year that will make it difficult for those companies to grow FFO per share in 2010 and possibly 2011.

Turning to our performance for 2009, we believe we are on track to deliver 4 to 5% FFO per diluted share growth in the year where there has been declining FFO per share results in our industry.

In addition to our FFO growth, our AFFO has remained very strong to date as we have been able to renew leases with low capital costs.

Turning to next year, we believe 2010 will be another difficult year for the REIT industry due to increasing pressures on fundamentals.

FFO per share declines will be the norm with flat being the new high.

We also will have challenges in 2010 and therefore we have set our 2010 FFO per share diluted guidance range at $2.35 to $2.53 per share representing a range in FFO from our 2009 guidance of a decline of 5% at the low end to a positive 1% at the high-end high-end.

Steve will provide 2010 guidance assumptions in a minute.

We believe our FFO per share results for 2010 relative to 2009 will still be among the highest for the office sector.

While we recognize that this guidance range reflects a difficult 2010 operating environment, we are very well-positioned to exceed accelerated FFO growth in 2011 and beyond.

We believe this sector leading growth will result from our BRAC and government leasing demand that is anticipated to significantly increase our development activity in 2010 and early 2011.

Now I will turn the call over to Steve.

Thanks, Rand, and good morning, everyone.

Turning to our results, FFO for the third quarter of 2009 totaled $42.4 million or $0.60 per diluted share.

These results represent a 3% decrease on a per share basis from the $0.62 per diluted share for the third quarter of 2008 although FFO exceeded the $39.5 million of FFO for the third quarter of 2008 by 7%.

For the nine months ended September 30, 2009, we reported FFO of $134.1 million or $1.94 per diluted share compared to the $113.2 million or $1.77 per diluted share for the nine months ended September 30, 2008.

That represents a per share increase of 10%.

2009 third quarter FFO results were impacted by higher interest expense than the first two quarters of 2009 due to the closing of secured fixed rate long-term debt and paying down variable rate short-term debt.

The third quarter also was impacted by the end of the original Unisys lease in Bluebell, Pennsylvania as of June 30, 2009, and the commencement of the plan to reposition these assets.

Year-to-date we renewed 72% of our expiring office leases and our wholly-owned portfolio ended the quarter 90.9% occupied and 91.4% leased.

We reported diluted earnings per share for the third quarter of $0.18 compared to $0.17 for the third quarter of 2008 and year-to-date diluted earnings per share of $0.62 increased by 32% over the comparable period prior year results of $0.47 per share.

Turning to AFFO, our third quarter adjusted funds from operations of $27.8 million represents an increase of 9% from $25.5 million in the third quarter of 2008.

For the nine months ended September 30, 2009, our AFFO of $97.4 million represents an increase of 31% over the $74.5 million for the first nine months of 2008.

We continue to carefully manage our leasing and our building capital expenditures while maintaining our high quality standards which coupled with our strong FFO results benefited AFFO.

Our year-to-date FFO payout ratio is 59%, and our year-to-date diluted AFFO payout ratio is 73%.

Looking at our same office cash NOI for the third quarter of 2009, for the 230 properties or 91% of the consolidated portfolio square footage, same office cash NOI increased by 5.2% over the third quarter of 2008.

Excluding gross lease termination fees, same office cash NOI increased by 3.9% over the third quarter of 2008.

For the nine months ended September 30, 2009, same office property cash NOI increased by 6.3% compared to the prior year.

Again, excluding gross lease termination fees, same office property cash NOI increased by 3.5% over the prior year nine months.

Turning to the balance sheet, at September 30, our weighted average cost of debt for the third quarter was 4.85%.

That's down from 5.11% a year ago.

Approximately 85% of our total debt was at fixed interest rates as of September 30.

Our coverage ratios remain strong with a third quarter EBITDA to interest coverage ratio of 3.2 times and a fixed charge coverage ratio of 2.64 times.

With regard to capital, we completed the secured financings that we had planned, and we paid down the remaining $22 million of debt maturities for 2009 and we had $372 million of availability on our revolving line of credit as of September 30.

During the quarter we closed a $90 million 7.25% secured five year loan in July and a $185 million 7.25% secured seven year loan at the end of the quarter.

Again, we have no remaining debt maturities in 2009, and we only have $65 million of debt maturing in 2010.

With the revolving line of credit capacity available to us as well as the availability under our $225 million construction revolver, we expect to continue to have ample liquidity to fund our development pipeline and have the capacity for acquisitions when they become available.

As a reminder, we can extend both the $600 million revolving line of credit and the construction revolver from 2011 to 2012 for minimal fees.

Now turning to our diluted FFO per share guidance for the remainder of 2009, we are tightening our range of guidance to a new range of $2.47 to $2.50 of FFO per diluted share excluding any acquisition closing costs that would now be required to be expensed under new accounting rules.

As Rand mentioned this represents FFO per share, diluted per share growth of 4 to 5% over the comparable $2.38 per share result for 2008 that 2008 result to be comparable excludes gains when debt extinguishment and has been adjusted for the accounting changes required for exchangeable notes in the FFP for AP 14-1.

The few assumptions of our 2009 guidance that we are updating at this time are as follows.

First, same office cash NOI for the year excluding termination fees is projected to be approximately 2.5% positive and that's indicating that the benefits for continued expense saving initiatives are offsetting some of the market pressure on leasing.

Second, subsequent to the quarter end, we closed on two acquisitions acquisitions that Roger will discuss in a few minutes.

Any additional acquisitions would not likely have a significant impact on 2009 results due to timing.

The accounting rules have been revised and transaction closing costs for acquisitions will be expensed.

Our guidance will exclude estimates for closing costs as they will vary significantly depending on local taxing jurisdictions, fees, and customer and local practices.

Third, gains from other than operating assets are now estimated to be approximately $0.03 per share for the year at the high-end of our range of guidance.

Finally, our floating rate debt as a percentage of total debt is 15% as we begin the fourth quarter and will rise to be between 20 to 25% as we complete acquisitions.

Based on the annual guidance assumptions that I just reviewed and the results for the first nine months of 2009, results for the fourth quarter are expected to be lower than those of the third quarter.

Interest expense is expected to increase by approximately $0.04 per share for the quarter as a result of executing our capital plan and fixing debt at higher interest rates through the secured financings and paying down our line of credit.

Turning to 2010, as Rand mentioned our initial FFO guidance range for 2010 is from $2.35 to $2.53 per diluted share which represents a decline of 5% at the low end to growth of 1% at the top end of our range compared to the comparable guidance for 2009.

The assumptions for our initial 2010 guidance are as follows.

First, for our 2010 same office portfolio, we expect occupancy to be flat for most of 2010 and then to grow to approximately 92% by the end of 2010.

Given market uncertainties, we are conservatively projecting our retention rate for 2010 to average 60%.

Second, same office cash NOI is projected to be flat to 1% positive compared to 2009 levels for the full year.

However it may fluctuate in certain quarters.

Third, we estimate development projects opening during 2010 to contribute $3 million of NOI growth.

The 2010 deliveries are expected to come online in the second half of the year.

Fourth, lease termination fees are projected to be in the range of 4 million to $5 million.

Fifth, the range includes anticipated acquisitions assuming some attractive opportunities become available.

We have assumed a weighted average new investment level of approximately $170 million for the year at the middle of our range of guidance and $200 million at the high-end.

Closing costs for potential acquisitions would be expensed and our guidance excludes estimates of those initial transaction costs.

Sixth, net service income primarily third party development fees and gains on sales of nonoperating assets including opportunistic investments are assumed to contribute between $3.5 million at the low end of the range and up to $12 million at the top end of the range.

Seventh, G&A is projected to average approximately $6.2 million per quarter at the middle of the range of our guidance.

Eighth, we estimate that approximately 20 to 25% of our outstanding debt will be floating on average throughout the year although it may fluctuate in certain quarters.

Finally, interest expense in our 2010 guidance is expected to increase year-over-year due to the financing and projected acquisitions and development as well as the annual impact of higher rates on fixed rate debt issued in 2009 compared to debt paid down in 2009.

In addition, 2010 will include one additional quarter of outstanding shares from the April 1, 2009, index inclusion offering.

We are not providing quarterly guidance.

However, these assumptions indicate that we expect revenue growth through the development place and service and acquisitions to increase quarterly results for FFO in the second half of 2010 as compared to our implied quarterly run rate for the fourth quarter of 2009.

This is our initial look at 2010.

We expect to further refine the tails at the year end call and then through the year.

With that I will turn the call over to Roger.

Thanks, Steve.

At quarter end our wholly-owned portfolio consisted of 246 properties totaling 18.4 million square feet that were 90.9% occupied and 91.4% leased.

Our occupancy was down 1.4% quarter over quarter.

This decrease was largely the result of bringing two development projects into service, one in Colorado Springs and one in the Baltimore, Washington, corridor that had a total of 157,000 square feet of unoccupied space.

During the third quarter we leased 761,000 square feet of which 529,000 square feet were renewals, 141,000 square feet was retenanting, and 65,000 square feet was first time lease up of previously acquired space and 25,000 square feet was development.

Year-to-date we have leased over 1.9 million square feet of which 1.35 million square feet were renewals, 340,000 square feet was retenanting, 177,000 square feet was first time leaseup of previously acquired space and 79,000 square feet was development space.

For the quarter we renewed 68% of expiring leases at an average capital cost of $5 per square feet, rents on renewals decreased 3.6% on a straight line basis, and 7.7% on a cash basis.

Total rent for renewed and retenanted space decreased 6% on a straight line basis and 12% on a cash basis.

For all renewed and retenanted space the average capital cost was $6 per square foot.

Year-to-date we have renewed 72% of expiring leases with an average capital cost of $6.14 per square foot.

We have averaged $7.67 per square foot in capital costs for renewed and retenanted space.

Looking at our lease expiration schedule across our portfolio for the balance of 2009, we have 3.3% of our revenues expiring down from 13.6% at year end representing 792,000 square feet.

We still expect a 2009 renewal rate of approximately 70%.

As we forecasted on the last two calls, our leasing metrics have deteriorated and we expect that to continue into 2010 with occupancy under pressure and renewal and retenanting rents rolling down somewhat.

To date our leasing capital costs have been low but we would expect them to increase in 2010.

We are pursuing some funds and extend transactions to mitigate future revenue risk from an overall portfolio management standpoint.

We are seeing significant top down pressure from Corporations to lower operating expenses including occupancy costs.

Most tenants do not want to make long-term commitments for space given the overall economic back drop.

We are seeing increasing back related leasing activity both at Fort Meade and Aberdeen, and we should see that activity convert to leases in the next six months.

Overall leasing inquiries and proposals are inconsistent across our portfolio although we would categorize the activity as steady overall.

On June 30, the Unisys leases expired.

As of July 1, the status of our Bluebell Pennsylvania campus is as follows.

A 219,000 square foot building is 100% leased to Merck, a 209,000 square foot building is being renovated for the Unisys headquarters in which they will occupy 156,000 square feet with the balance to be leased to others and two buildings, 114,000 square foot old headquarters building and a 418,000 square foot administration building are being partially occupied by Unisys until their new building is available.

We will renovate these two buildings in the second half of 2010 when Unisys moves into their new headquarters building.

The results of the third quarter fully reflect the reduction in NOI from this campus.

Given the challenging leasing environment we are aggressively pursuing operating expense reductions, working with our staff and vendors.

This was reflected in our second and third quarter results and allowed us to maintain positive same store results in the face of leasing challenges.

We expect this trend to continue into 2010 with our budget goals including the full-year impact of these efforts.

The credit quality of our top 50 tenants who represent almost 70% of our revenues remain strong.

We have experienced and do expect some modest credit issues over the next 24 months coming from outside of our top 50 tenants.

As we mentioned on our last call, the industry we're most exposed, to federal information technology, is doing reasonably well.

The outlook for contractors well-positioned with intelligence agencies is positive.

There is a continuing demand for intelligence, surveillance, and reconnaissance products and services.

President Obama has nominated national security agency director lieutenant general Keith Alexander to be promoted to the rank of general and assigned as commander of the new United States cyber command.

The cyber command will be in charge of cyber warfare and the security of military networks.

It will be based at Fort Meade, Maryland, and will be part of US strategic command which should drive demand for space around Fort Meade.

Our overall portfolio and investment strategy consists of a super core component that is focused on US government, defense contractor, and data center tenancy and we have a 65% target waiting on this central strategy.

Secondly, we are focused on core business parks located in growth corridors which when combined with our super core will account for 85% waiting in our target core portfolio.

Third, we have a 15% target for opportunistic office investments that do not fit in either of the first two strategies but provide the opportunity for higher returns by taking on additional calculated leasing or market risk.

Our super core currently accounts for approximately 58% of our NOI.

We intend to grow this portion of the portfolio to our target level through our development at the national business park at North Gate in Aberdeen and San Antonio where demand is driven by the government and defense contractors.

We intend to acquire core properties in our existing markets that fit the strategy as well.

Our targeted core portfolio currently accounts for approximately 81% of our NOI.

And in order to move toward our targeted portfolio composition we will selectively dispose of non-core properties.

As we proceed with our development and acquisition strategies, we intend to upgrade our portfolio in terms of overall quality, age, and tenancy.

During the third quarter the Company made no acquisitions.

Subsequent to quarter end the Company has made two acquisitions, both acquisitions are high quality assets that had weak capital structures.

The first is 156,000 square foot newly constructed office building adjacent to BWI airport and our airport square portfolio.

The building is 100% leased for ten years to Northrop Grumman, our second largest tenant and a key defense contractor.

The building is adjacent to and an expansion of the headquarters location for their electronic systems division thus we expect them to remain in place over the long-term.

We acquired the building from the receiver on behalf of a bank which took the building over just prior to the developer's bankruptcy filing.

We paid $38 million, and the site includes a retail pad.

This acquisition fits well with our super core strategy.

Northrop Grumman is completing their move in over the next few days and the lease commencement will be next week.

Given the circumstances surrounding the sale and our ability to complete due diligence and take ownership Briar to lease commencement we were able to achieve a favorable risk adjusted deal excluding the retail pad site costs that will provide additional value.

Secondly, we acquired a 474,000 square foot Class A plus office building, a parking lot, four adjacent water front lots totaling approximately 10 acres and a power plant that provides HVAC, electric, and back up generation to the existing building and that can support additional development.

These properties are located in the Canton area of Baltimore City.

The building and land are known as Canton Crossing, a plan unit development approved for 1.5 million square feet of office of which 474,000 square feet is built, a 450 room hotel, 150,000 square feet of retail, 500 residential units, and a marina.

The land acquired does not include the land for the residential units which along with other retail lands is still owned by the seller.

The building is 91% leased with very little lease rollover prior to 2016.

Tenants include Care First, Pro Metric, First Mariner Bank, Johns Hopkins and Comcast.

In August 2008 COP made an initial $15 million mezzanine loan to the owner of the project which through additional draws prior to the acquisition totaled approximately $30 million.

The capital market environment did not allow the owner to refinance the project.

This month we acquired the first mortgage and subsequently acquired the ownership position.

COP does not plan to build the hotel or retail products.

Our total investment in the project is approximately $125 million of which approximately $104 million is allocated to the building.

Prior to the acquisition of this building we recognized interest income on our mezzanine loan.

Subsequent to the acquisition the building will be wholly owned in our portfolio and we'll recognize net operating income.

The Canton Crossing transaction upgrades the quality of our assets included in the 15% opportunistic segment within our portfolio strategy and creates the opportunity for upside in the development land.

As we noted in last quarter's call, there is ample capital available for real estate and in particular for high quality well leased properties.

It is notable that multiple solid offers were received for the nursery road building that we just acquired and other offerings that we are aware of have received similar levels of investors interests.

While the deals that have been completed demonstrate that cap rates have moved up significantly from the market peak in 2006 and early 2007, they're not as high as we and perhaps many investors had previously anticipated.

However, we believe we'll be able to find core properties at favorable risk adjusted returns and our strong capitalization and ability to close on an all cash basis will it continue to make COX competitive for those assets we choose to pursue.

Now I will turn the call back to Rand.

Thank you, Roger.

Turning to our construction pipeline at September 30 we had 9 buildings totaling 1.2 million square feet under construction at a total cost of $250 million.

All of these buildings are being built for the government or defense IT tenants.

The pipeline is 26% leased at quarter end.

However, if we include space that we believe will be absorbed by the government, our leasing level would be close to 60%.

As previously discussed, since October 1st and the new government fiscal year we have seen an acceleration of leasing activity and feel very comfortable that most of these buildings will be leased to stabilization levels within the next six months.

Our development pipeline currently includes seven buildings totaling 709,000 square feet all being built for the government or defense IT tenants primarily at MBP, Aberdeen or San Antonio.

We anticipate starting three of these buildings totally approximately 290,000 square feet before the end of this year based upon expressed demand.

These buildings are 316 MBP, North Gate building C in Aberdeen, and military drive business park building A in San Antonio.

Given the projected space needs for the BRAC at MBP and Aberdeen and the cyber security at Fort Meade that Roger discussed and future expansion at San Antonio, we expect building starts to increase from the 1.2 million square feet under construction this year to a range of 1.5 million to 1.7 million square feet during 2010.

This development activity is important for FFO growth since we have seen our unlevered cash on cash yields on new development projects move from around 10% towards 11% due to decreased building costs.

While a number of the REITs have taken steps to down size development activity, cut overhead through layoffs to reduce costs, we have taken the opposite approach.

Despite the recessionary pressures, we are working hard to improve our platform for accelerated growth.

We have upgraded positions, added team depth, and invested heavily in new systems and processes.

In addition, we have worked over the past year to add depth to our Board of Trustees and recently announced the addition of two new Board members that will add development and defense sector expertise, two key areas of growth as we move forward with our plans.

In summary, as we look out to 2011 and beyond, we're excited about the opportunities ahead of us.

We recognize the challenges that we will face as we move through 2010 but believe we are well positioned to deal with both the long-term opportunities and the short-term challenges.

We appreciate the support of our investors, our employees, and our Board as we set the course for future growth.

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

(Operator Instructions) The first question is from Bill Crow with Raymond James.

Please proceed.

Good morning, guys.

A couple of questions for you.

Rand, the Canton Crossing acquisition, is this something you would have bid on had you not had $30 million invested in it?

I think always, Bill, we are looking for opportunities.

This is as we enter this cycle this is when you do want to be opportunistic and we made the original $25 million investment with an eye towards that potentially, and under the program that we have that was approved by the Board.

So we think that it was the appropriate thing to be doing, and it was as I said in the paper that came out today was sort of a win-win for all parties involved, and I think it will be very good for our shareholders.

I missed the cap rate on that.

Did you give the cap rate?

Give it, but, Roger, do you want to talk about that?

It is in the about 9% going in cash yield on our $105 million investment that we allocated towards the building.

Okay.

And then, Rand, nobody knows Baltimore better than you do in my opinion.

What do you think the outlook is for the future development?

It just seems like that market doesn't need much in the way of new office space, certainly not in need of hotel space.

Well, you're the expert on hotels, certainly, Bill, so we'll defer to that, but I think what you're seeing in Baltimore is really the water front continues to be dominant.

You have seen a shift from sort of the inner harbor to the inner harbor east with the Legg Mason tower and the Morgan Stanley buildings and so on, and we think that the growth will continue around the harbor to Canton Crossing.

As it turns out as you get that development there is significance traffic congestion downtown.

It is very difficult to get to those buildings and that's the advantage of Canton Crossing with close proximity to I-95, it's the one of the reasons Care First chose to select that building for the corporate headquarters, so we think there is a strong demand there.

Currently the difficulties in the sellers situation made it difficult to finish leasing up the building although it is in good cash flow position currently, and we think there will be future growth opportunities, particularly as we come out of this cycle and you continue to see water front demand.

Great.

One final question.

You talked about the change in the fiscal year and certainly we had been anticipating more announcements once that occurred.

Can you talk about the velocity, whether that leasing decision has lived up to your expectations thus far?

I know we're early into the new fiscal year.

We don't normally do the leasing announcements as they occur, and of course it is now into the fourth quarter, Bill, but we are seeing pick up.

We are starting to see the -- just the contractors show up around the Fort Meade area, and in addition we have seen an acceleration of leasing in anticipation of the cyber command that Roger talked about, so at MBP specifically and now starting to spread to our other near by projects, we are very pleased with that demand, and at Aberdeen I think we said we're getting ready to start the second building up there, and are aggressively designing the other buildings, and we do see that demand accelerating very good traffic.

The C4 ISRs move is ahead of schedule, and scheduled for March of 2011, and the first thousand people are really moving the end of this year, so you are seeing things on track and we have three to five showings a week up there, and so I think that -- I know everybody has been anxious and they have heard about the BRAC for quite a few years since 2005 now, but it is now reality and coming to fruition, and I think you will see a lot of that demonstrated over the next six months.

Great.

Thank you very much.

The next question comes from the line of Michael Bilerman with Citi.

Please proceed.

Good morning, guys, this is David Shamus here with Michael.

For the developments that delivered during the quarter you mentioned there was quite a bit of vacancy there.

Can you just talk about your prospects for leasing that space?

Both of those buildings have some pretty significant prospects at this point, but it is like everything with the economy it is taking longer than we would expect to take, and so although I would like to tell you that it will be done in the next 90 days, I think the interest will ultimately translate into leases, but it may be early 2010 before we have finalized leases on that space.

Okay.

And it looked like you had about 400 basis points of occupancy loss from your same store pool in Colorado Springs.

Was that something that was expected or can you talk about that a little bit?

In Colorado Springs we were just fully occupied originally, and it went -- in Colorado Springs we only have a 1.5 million square feet, so 4% is about 60,000 square feet, but the majority of the vacancy that we took on in that market was simply by adding 74,000 square feet of space to the denominator because of one building that we delivered.

And just shifting over to rent declines, looks like you guys posted many pretty big declines this quarter.

Is that something that's expected to continue and for how long?

We're forecasting for 2010 that our rental rates on renewals and retenanting on average will be negative in the very low single digits.

For the third quarter of 2009 to be fair we do have pressure on us both in the renewal sector and the retenanting of our space, but we did have a couple of anomalies.

The first is in Colorado Springs we had a 43,000 square foot tenant go bankrupt on us.

That business was bought by another company, and that company did stay in the space, and but we were forced to give them a phased in rent over the first year, and so for the first year we're showing about a minus 40% decrease in rent on that space.

Likewise, in suburban Maryland we had an empty space, and we have a pretty sizable renewal coming up next year, and we elected to convert some office space to flex space in order to secure that that tenant would renew and expand in that location and given what they're doing they're one of our top customers that they would stay there for the long-term.

So if you take just those two spaces alone, and pull those out of our quarterly statistics, it would have the impact of improving the cash NOI by about 4% and GAAP by about 2.5%.

In addition, we did have a few tenants that have been extending for short-term and their rents because of that kept rolling up above market and then they decided to do a permanent extension on their lease and as a result of that we had rollback, and that occurred a couple of times in the BW corridor, so I think I would say on balance we're under pressure, but maybe the statistics that we had for the third quarter were a little escalated over what we would expect.

Thank you.

Just finally, you talked about doing some non-core dispositions.

Any of that in your guidance for 2010?

It is not specifically in our guidance.

It will be based on building by building analysis, but we are trying to pursue some dispositions.

And what is the scale of that approximately?

It would probably be about $50 million.

Thank you.

The next question comes from the line of George Auerbach RSI Group.

Please proceed.

Good morning.

Roger, wonder if you can give the cap rate on the Northrop Grumman acquisition?

The cap rate if you include the additional retail pad is approximately above 8.5 and less than 9.

If you pull out a fair value for the land, it is approximately 9%, and the rent escalates by 3% annually for ten years.

Okay.

And just to clarify, in the investment in Canton Crossing, the $125 million already includes the 30 you had in the deal, so you paid an incremental 95?

That is correct.

Okay.

And are there other mez investment that is you're currently holding of any size?

We don't have any mez investments.

Okay.

I guess just finally, in terms of timing, on the developments, if you were to start an asset in the third quarter of 2010, when should we expect that hits both GAAP and cash NOI streams?

It is taking us about nine months to finish a building, core and then six months from that point to put these very sophisticated tenants into place, so you're looking at the first rent deliveries in twelve months, and the bulk of it in kind of a 15 months from that standpoint.

For projections just to be conservative, we normally show a year lease up from a year of construction, and that's what our projections include.

Great.

Thank you.

The next question comes from the line of Aslakson with Stifel.

Please proceed.

Good morning, guys.

How are you?

Hi, Erin.

Quick questions, sounds like you did not receive any kind of a discount on any interest mortgage.

I think, Erin, we have agreed among all the parties involved in the transaction not to disclose the details of the components of our investment.

We can just say that again we had $30 million invested in the project, 25 -- some of that was accrued interest, and then we invested another $95 million.

Okay.

Can I ask what value you placed on the land portion of the Canton Crossing?

We have 10 acres of water front land which is has PUD approval for really a million square feet of office.

We're planning on 500,000 square feet.

150,000 square feet of retail, and a 450 room hotel and marina.

In addition, the power plant that we acquired as part of the transaction has the ability from an HVAC and electric and back up generation standpoint to be sufficient to build the office on that acreage so all of that we allocated about $20 million to.

Okay.

In your comments I thought that I heard though, correct me if I'm wrong I thought I heard you were not planning it build the hotel portion.

That's correct.

Our options are to sell the land or do land leases or JV, some or all of the project.

Okay.

Do we know the status of First Bank as a tenant in the building and also is the condo that apparently tentative?

The condo lease matures at the end of the year, and we will be retenanting that space, and the bank has capital issues, but it is in the market to try to raise capital, and we're confident that they will be able to do that and stay in our building for the long-term.

Did I also hear in terms of the construction pipe that you guys have out there seems like it is either leasing up slowly or some sort of demand that's just not being I guess published by you guys.

What is the case there?

I mean, are we to be expecting to see several of these buildings go from 0 to 100% in one quarter or are we also expecting kind of slow lease up of these?

I think as is typical it is lumpy, and we had said for a while that the demand was being in effect held up until they have started validating the contracts from DISA as relates to the move to Fort Meade, and that was affecting some of the leasing.

That's now broken loose for MBT, and our surrounding developments and at Aberdeen I think it was really a little bit of just people starting to realize the timing of the move and looking around the market and finding that there was really very little product available and so that is accelerating, so we do think that you will see a lot of leasing occurring on those portfolios over the next six months, and it is not inconceivable to have some of the buildings being 100% leased still this year.

How about the Colorado Springs developments?

Is there a lot of demand there?

I would say it is inconsistent.

We do have one deal that we have been focused on that we're trying to get done in the next 60 days or so that would take us out of a lot of the vacancy that we delivered this quarter, but on balance it is sort of like we said overall steady but not robust.

Okay.

Thank you, guys, very much.

Thank you, Erin.

The next question comes from the line of Brendan Maiorana with Wells Fargo.

Please proceed.

This is [Yun Ku] here with Brendan.

In regards to your forward investments you stated you're not really looking to scale back your developments going to 2010 and 2011, and since yields are approaching 11%, we're just wondering why you guys are also looking to invest in acquisitions to say about $170 million in 2010?

Well, I think you want to take advantage of cycles, and for the last several years we really haven't purchased anything, cycle didn't allow that, and we're now entering the cycle where you do have the opportunity to be somewhat opportunistic, and we wanted to take advantage of that.

I think that you use acquisitions as the chance to expand your presence in particular submarkets that we're interested in grabbing some more market share or in entering into new geographic submarkets where in the past we may have been blocked out because of pricing and frankly, I think that in our Company's history when you look over the last 11 years of being on the New York Stock Exchange, we have always taken advantage of these cycles and helped to accelerate the growth of the Company, and so we will do that accordingly, and I think that development yields should have a higher cap rate requirement and IRR just because of some inherent risk and year-and-a-half or two years of tied up capital that it takes to really produce those where as you can turn an immediate impact on your earnings and your FFO with appropriate investments, so that balanced approach is I think a good one to take, and we have worked hard to lineup the excess cash this year to be ready to take advantage of those opportunities and you saw the first of those subsequent to the quarter close.

Okay.

But going forward we can actually expect the level to go up a little bit in the near term?

It moves slightly, but it is still well below our 50% sort of threshold that we would not want to go over.

It is 43% today and doesn't get close to that level through all of our future projections.

Okay.

Got you.

And can we get your releasing spread assumptions for year 2010 guidance?

What we said is that they will be negative on single-digit basis.

Got you.

And finally, the yield assumptions for your potential acquisitions in 2010?

We don't really have specific forecasts for those.

Obviously we with do it such that I that it made sense from a cost to capital standpoint and a long-term IRR standpoint.

Got it.

Thank you.

The next question comes from the line of Chris Lucas with Robert W Baird.

Please proceed.

Good morning, guys.

Hi, Chris.

On the, I guess following up on the lease expirations, what's the status on some of the larger ones that you have end of this year going into next year?

I know Computer Science is one and General Dynamics next year or I might have them reversed are two of the larger ones.

What's your comfort level on those?

CSC does not mature until 12/31/2010, and which is about 300,000 square feet and then General Dynamics is a little over 100,000 square feet.

They've extended their lease term short-term into 2010, but we do expect they would leave and the reason they would leave is simply because we have two tenants competing for space in one building and they're both growers, and we can't -- they can't cohabitate given the fact that they both need more space and we can't provide it to both of them.

And then just in terms of your guidance on the acquisition side for next year, you mentioned that $170 million was sort of at the midpoint of guidance.

What's the low end on your acquisition side?

It is not too much less than the 170, but it really depends on timing, so maybe the range depending upon timing an yield could be about as far away from the bottom, the midpoint as the top is, but we are assuming that some of the money gets out ratably over the course of the year, so it is not that different from the midpoint.

And then just in terms of the expenses associated with the fourth quarter acquisitions that are not part of guidance, what kind of numbers should we be thinking about in terms of our models?

Closing costs?

What we have so far and is approximately $2 million, and we will report those every quarter after we've completed them.

And then just in terms of going forward, Steven terms of the models for those expenses for next year, is there a percentage number that we should be thinking about or how do we want to model those numbers?

I specifically said I would exclude them because I don't know where they will be yet because they're place holders for investment levels.

It varies significantly based on customer and local practices, closing costs, transfer taxes very differently, so I am saying that we'll just model without what those are and report the transactions and recorders as they become specifically identified and we incur them.

Okay.

And then what was the capitalized interest for the third quarter?

Approximately $3 million.

That's it for me.

Thanks.

(Operator Instructions) Our next question comes from the line of Michael Knott with Green Street Advisors.

Please proceed.

Thanks.

Hey, guys, it is [Lucas Horowitz] in for Michael Knott, I have a couple of questions.

Firstly, $175 million of acquisitions next year, I am just curious if you can kind of give us your viewpoint on where those acquisitions will be and are they going to be in the 65% of your core strategy or is it going to be more the Canton Crossing type acquisition in that 15% bucket?

If you can kind of break that out for us.

I think the bulk will be in what we call the 85%, so super core and core.

We will reserve the right clearly to do like we have done in the Canton Crossing, and do opportunistic acquisitions within that category, but as Roger said, when we do that, it gives us the opportunity to upgrade that category with improved properties and then over time sell out of our dispose of others within that category, keeping it towards the 15% level, so we may find that bumping up within a period of time then coming back down.

Meanwhile everything that we're starting this year and next year is in the -- really in the super core and we would expect that most of the acquisitions would also fall into that, so we're well on our way.

When you're 81% currently out of our goal of 85%, we're on track to accomplish where we thought we wanted to be.

All right.

Thanks.

Second question is on the dispositions that you noted, are you guys thinking about exiting any certain markets or how are you thinking about those dispositions?

It would really be selling off some lower quality assets that we picked up as part of the bigger portfolio.

For instance, in our Baltimore County portfolio we have some product that we would like to sell.

Okay.

Thanks.

And then the last question is I am just curious with rents rolling down and your same store occupancy dropping 130 basis points year-over-year, how is cash NOI up 4%?

Is it the burn off of free rents or what's going on there?

We have really gone after the expenses pretty significantly, so, for instance, so far year-to-date we have taken a net debt to revenue of about $3.5 million to our tenants just for operating expenses they get back and on top of that we were able to achieve operating expense savings that fell to our bottom line where we either didn't have expense stops in place yet or where we had vacancy, and so it really had to do with expense control, so in this quarter our same store expenses increased 1% over the comparable 2008 portfolio and that includes a pretty significant 15% increase in electric rates, so if you accept that electric rates all other categories were down very significantly.

Okay.

I guess I am still a little confused.

You said expenses are up year-over-year?

Were down.

Down?

Sorry.

Didn't you say up 1%?

Up 1%, but our revenues were up by in the case of cash our revenues were up by 3.7% in GAAP, they were up 1.6%.

And so is that different burn off of free rented or what?

Just rent bumps.

All right.

That's it for me.

Thanks, guys.

Thank you.

The next question comes from the line of Dave Rogers with RBC Capital Markets.

Please proceed.

Hey, Rand, real quick on the cyber security, now that it sounds like you're final any in negotiations with regard to maybe what's there for land and space needs over the course of the next year or so, is your sense that demand is going to be ratable or do you think that you're going to see a spike in demand at some point in thyme, and is that estimated in 2010 at this point?

No, Dave, what's interesting is the order that Secretary Gates established in June that set up the command really had some interesting facets of it, the first was that they would be initially operational in October of this year and fully operational in October of next year which is very, very rapid acceleration of setting up a major command, so for them to do that they need to really take space that doesn't exist on Fort Meade, move some other people out, and so we're seeing some potential movement there short-term coming to properties like ours, and then longer term the nature of that particular command relies a lot on outside expertise on a very nimble basis, and looking around the world for the very best of the best in terms of innovations for cyber security, and that will bring in additional contractors beyond BRAC into the area, they will need to be close to Fort Meade, and so we see that as something that will over the next five years be fairly significant but have a fairly quick acceleration here with some of the leases occurring in 2010.

I think you said the average under -- average square footage construction would be a 1.5 million to 1.7 million next year.

Was that the right number?

Yes.

Starts weighted earlier in the year?

Pretty much I think you're going to see a lot of indication of that in the first six months of next year as we start seeing buildings filling up and also anticipating some of that, so we will -- we anticipate starting that amount between 1.5 million and 1.7 million next year, and it is scattered on the projects that I mentioned.

And any particular weighting for that related to MBP?

I don't know yet exactly how.

We do have the north expansion of MBP.

We will be in a position to start the first buildings there in March of next year, and are currently getting those finished up the design and permitting to be ready to do that, the road work starts this fall, so we think that there is a good three, four buildings that will easily start there and in addition to what we anticipated already starting this year.

Aberdeen we really probably need to start three or four buildings there in the first half of next year in addition to the one that we're starting the balance of this year.

It just goes on and on.

It is pretty strong demand really.

Thank you for the color.

Thanks, Dave.

Ladies and gentlemen, this concludes today's question and answer session.

I will now turn the call back to Mr.

Griffin for closing remarks.

Thank you, everyone, for joining us today, and it was a really busy earnings season, and lots going on with 2010 guidance from everyone, and so I appreciate you being on the call.

As always, we appreciate your support and participation and all of us will be available to answer any other questions you might have.

Thank you and good day.

Ladies and gentlemen, thank you for your participation today in the Corporate Office Properties Trust third quarter 2009 earnings conference call.

This concludes the presentation.

You may now disconnect.

Have a good day.