COPT Defense Properties (CDP) 2010 Q3 法說會逐字稿

Welcome to the Corporate Office Properties Trust third-quarter 2010 earnings conference call.

My name is Luanne and I will be your operator today.

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 will be discussing our third-quarter 2010 results and annual 2010 and 2011 guidance.

With me today are Rand Griffin, CEO; Roger Waesche, President and COO; Steve Riffee, CFO; and Wayne Lingafelter, Executive Vice President of Development and Construction.

As they review our financial results 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 at www.COPT.com.

Within the supplemental package you will find a reconciliation of GAAP measures to non-GAAP financial measures referenced throughout this call.

Also, under the Investor Relations section of our website you will find a reconciliation of our 2010 and 2011 annual guidance.

At the conclusion of this discussion, the call will be opened up for your questions.

First, I must remind all of you at the outset that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Although such statements and projections are based upon what we believe to be reasonable assumptions, actual results may differ from those projected.

These factors that could cause actual results to differ materially include without limitation the ability to renew or release space under favorable terms, regulatory changes, changes in the economy, the successful and timely completion of acquisitions and development projects, changes in interest rates, and other risks associated with the commercial real estate business as detailed in our filings from time to time with the Securities and Exchange Commission.

Now I'll turn the call over to Rand.

Thank you, Mary Ellen, and good morning everyone.

We are reporting FFO excluding acquisition costs of $0.58 per diluted share for the quarter, a 3% decline compared to the same quarter last year.

Portions of our existing operating portfolio continue to be challenged, but we have seen signs of bottoming and are experiencing heavy leasing volume.

Also, we have steady BRAC leasing demand for our construction pipeline and have good momentum on acquisitions.

As we indicated last quarter, we are starting to see some acquisition opportunities in our markets.

We believe we have a window of opportunity to buy well-leased, Super Core and core product at attractive yields.

As Roger will discuss in detail during the quarter, we closed on two wholly-owned acquisitions totaling $238 million.

So far this year we have closed on $275 million in acquisitions and expect to acquire over $300 million for the year.

We have the capacity on our line to fund the remaining acquisitions.

With regard to dispositions, during the quarter we sold the last two buildings and a contiguous land parcel in our New Jersey portfolio for $23.9 million, and are now completely out of that market.

During the quarter we raised our dividend 5.1%, the 13th year in a row, continuing our long history of increasing our dividend each year since being public, and continuing to pay our dividend in cash.

In fact, we have averaged a 9.4% compounded annual dividend increase over that time period, totaling 222%, the largest increase among public REITs.

Also, during the quarter as part of the Company's ongoing personnel development and succession program, the Board of Trustees appointed Roger to President, in addition to his current role as COO.

We congratulate Roger on this significant promotion, and look forward to his continuing leadership role in the success of the Company.

We are also adding Wayne Lingafelter to our earnings calls as he is responsible for all of our development and construction activities, a very important part of our business.

During recent meetings with investors we have received several questions regarding potential cuts in defense spending and their impact on the Company.

This is a normal process as the Pentagon begins to look towards peacetime reprioritization of spending.

There certainly will be cuts, but Secretary of Defense Gates has clearly indicated that he is trying to extract efficiencies from the budget in order to fund the new priorities.

And these new priorities will be on cybersecurity, intelligence and data storage.

Some weapons systems and soft combat support will be at risk.

But by and large our defense contractor tenants concentrate in areas of priority that should provide future growth opportunities for us.

Our strategy of locating adjacent to five expanding BRAC locations, Aberdeen Proving Ground, Fort Meade, Fort Belvoir, San Antonio and Redstone Arsenal, allows the Company to continue to grow as the command moves occur next year and our buildings deliver.

BRAC will be a meaningful growth driver for the Company.

In addition, we have started to expand our data center strategy with our Power Loft acquisition.

These six drivers will provide growth for the Company over a number of years.

And finally, we are tightening our 2010 FFO per diluted share guidance to a new range of $2.32 to $2.36.

We are also providing initial 2011 FFO per diluted share guidance in a range of $2.35 to $2.57, representing growth of 1% at the low end and 9% at the high end as compared to our revised 2010 guidance range.

The office REITs reporting to date that have provided 2011 guidance reflect industrywide that next year will continue to be a difficult year.

The recovery is tepid at best, and continues to be pushed out into the future.

Most of the office REITs will report flat to slight FFO growth next year.

Our 2011 guidance, which represents a 5.1% increase at the midpoint, stands in contrast and reflects the impact of our development activity and acquisitions.

With that I will turn the call over to Steve to discuss our results and guidance in detail.

Thanks, Rand, and good morning everyone.

Turning to our results.

FFO, excluding acquisition costs, for the third quarter of 2010 totaled $41.7 million or $0.58 per diluted share.

These results represent a 3% decrease on a per-share basis from the $0.60 per diluted share or $42.4 million of FFO for the third quarter of 2009.

This decline was primarily a result of an increase in interest expense, lower GAAP NOI from our same-office portfolio, and a decrease in net construction fees, partially offset by NOI increases from developments placed in service, and acquisitions, as well as gains from land sales.

The development placed in service and land sales were in line with our expectations and previous guidance.

The acquisitions occurred later than we assumed in our prior guidance.

We reported net income attributable to common shareholders for the third quarter of $4.8 million or $0.08 per diluted share compared to $10.4 million or $0.18 per diluted share for the third quarter of 2009.

Turning to AFFO.

Our adjusted funds from operations of $29.5 million represents an increase of 6% from $27.8 million for the third quarter of 2009.

Our third-quarter AFFO payout ratio was 89%, and our diluted FFO payout ratio was 71%, excluding property acquisition costs.

Our year-to-date AFFO payout ratio was 93%, and our diluted FFO payout ratio was 73%.

Looking at our same-office cash NOI for the third quarter of 2010.

For the 230 properties, or 85%, of the consolidated portfolio of rentable square footage, same-office cash NOI, excluding lease termination fees, increased by $2 million or 3% compared to the third quarter of 2009.

Same-office cash NOI included the prepayment of approximately $3 million of rent by a large tenant, which also impacted the quarter straight-line rent adjustments.

Including gross termination fees, same-office property cash NOI increased by $1.2 million or 2% for the quarter.

For the nine months ended September 30, same-office cash NOI, excluding gross termination fees, decreased by $1.3 million or 1%.

Turning to the balance sheet.

At September 30 our weighted average cost of debt for third-quarter was 5.1% compared to 4.9% a year ago.

72% of our debt was at fixed interest rates as of September 30.

Our coverage ratios remain strong, with a third-quarter EBITDA to interest expense coverage ratio of 2.85 times and a fixed charge coverage ratio of 2.42 times.

We have repaid all 2010 debt maturities.

Our revolving line of credit and our construction revolver mature in September and May 2011, respectively, and each can be extended for one year.

We are currently in the planning stages for 2011.

We are starting discussions with our banks regarding the extension and refinancing options.

We have secured debt of $102 million maturing in 2011, which we plan to refinance.

The first five-year put date for the $162.5 million of the 3.5% exchangeable notes is September 2011.

We are making plans to ensure that we have adequate liquidity to fund the notes if investors choose to put them.

The recently completed acquisitions were funded using our line of credit capacity and through the assumption of a $70 million 5.35% fixed-rate mortgage that matures in 2014.

As we have in the past, we expect to replenish our line capacity by obtaining proceeds from secured borrowings and other capital sources, paying down the line with the proceeds.

Turning to our diluted FFO per share guidance for 2010.

With one quarter remaining, we are tightening the range for the full year 2010 to a range of $2.32 to $2.36 per diluted share.

As previously noted, this guidance excludes any initial property acquisition costs that have been or would be expensed as incurred.

Here is an update regarding the guidance assumptions that we are refining at this point in the year.

First, same-office cash NOI, excluding term fees, is projected to be negative 2% to flat for the fourth quarter.

Second, lease termination fees for the fourth quarter are expected to be approximately $1 million.

Third, we estimate development projects opening during 2010 to contribute approximately $4 million of NOI for the year.

$1.4 million of this has been earned through September 30.

We have now completed $275 million of acquisitions, and could possibly close on additional acquisitions late in the fourth quarter of approximately $50 million.

Fifth, in other income the gain on our investment in KEYW as a result of its IPO that was completed in October, is approximately $6 million, and will be recognized in the fourth quarter.

In addition, for the fourth quarter gains on nonoperating assets are expected to contribute between $200,000 and $750,000.

Third-party development fees are expected to be approximately $300,000.

That is our updated outlook for 2010.

Now turning to our initial 2011 FFO per share guidance.

As Rand mentioned, our initial FFO guidance for 2011 is a range from $2.35 to $2.57 per diluted share, which represents an increase of 1% at the low end to 9% at the top end of our range compared to the revised and updated guidance for 2010.

This guidance excludes any initial property acquisition costs that would be required to be expensed as incurred.

Here are some of the initial assumptions for our 2011 guidance.

First, for our 2011 same-office portfolio we expect occupancy to bottom by the first quarter of 2011, and then grow steadily during the second, third and fourth quarters, and in 2011 up 1 percentage to 3 percentage points from the beginning of the year levels.

We are projecting our retention rate for 2011 to average 65%.

Second, same-office cash NOI, excluding term fees, is projected to be between negative 2% to flat for the year, declining through much of the first three quarters until the impact of leasing generates anticipated NOI growth for the fourth quarter.

Third, lease termination fees for the year are expected to be approximately $3 million.

Then, forth, we estimate NOI from development placed in service during 2010 and 2011, excluding the Power Loft data center to contribute between $13 million and $14 million of NOI for the year, most of which it is in place.

All of the 2011 deliveries are expected to open later in 2011 and contribute more in subsequent years.

Fifth, we assume that the development and lease-up of the Power Loft data center will contribute NOI of approximately $8 million at the midpoint of guidance.

Most of this NOI is weighted toward the later months of 2011.

We expect to finish the year slightly over 50% occupied at the center.

Sixth, we assume no acquisitions at the bottom end of the range, and up to $175 million at the top end of the range of guidance.

Seventh, in other income we are estimating a range of approximately $6 million to $11.5 million coming from the combined gains on land sales and on our investments, including our investment in KEYW during 2011.

Eighth, fee income, primarily for third-party development fees is expected to average approximately $600,000 for each of the first two quarters and then decline for the rest of the year.

Ninth, capitalized interest is assumed to average approximately $6 million per quarter with a year-over-year increase primarily due to the Power Loft and Patriot Ridge construction.

Tenth, G&A costs are expected to average approximately $6.3 million per quarter with the first quarter higher than the remaining quarters.

And, then, finally, our 2011 guidance assumes we maintain our balance sheet and capital to meet our coverage and leverage target levels.

This is our initial outlook at 2011.

We expect to refine it and update it after the 2010 year-end and then throughout the year.

And with that, I will now turn the call over to Roger.

Thanks, Steve.

At quarter end our wholly-owned portfolio consisted of 249 properties totaling 19.9 million square feet that were 87.4% occupied and 88.7% leased.

We forecast occupancy to bottom at the end of this year to early in the first quarter of 2011, with occupancy slowly building from that point.

With minimal new supply in our markets, modest employment growth is slowly translating to space demand, and along with increased BRAC and cybersecurity activity, should increase occupancy.

During the third quarter we leased 822,000 square feet, of which 428,000 square feet were renewals, 96,000 square feet was re-tenanting, 45,000 square feet was first-time lease-up of previously acquired space, and 253,000 square feet was development.

For the quarter we had a renewal rate of 54% at an average of capital cost of $3.62 per square foot.

Rents on renewals increased 1% on a straight-line basis and decreased 9% on a cash basis.

Total rent from renewed and re-tenanted space decreased 2% on a straight-line basis and decreased 10% on a cash basis.

For all the renewed and re-tenanted space the average capital cost was $8 per square foot.

Year-to-date we have executed 2.7 million square feet of leasing, with rents increasing on renewed and re-tenanted space by 1% on a GAAP basis, and declining 7% on a cash basis.

CapEx has averaged $9 from renewed and re-tenanted space.

Looking at our lease expiration schedule across the portfolio for the balance of 2010, we have 4.7% of our revenues expiring, representing 887,000 square feet.

We expect a mid-60% 2010 renewal rate, which is down modestly from prior expectations, but not far off from our ten-year historical average.

Although business sentiment is somewhat improved, we continue to see top-down pressure from corporations to lower operating expenses, including occupancy costs.

We continue to see many renewals accompanied with a space downsizing that has pressured our occupancy.

Leasing for vacant space that we expect to re-tenant has been slower to materialize.

Tenants are still being cautious about taking space.

For example, during the third quarter we had two leases out for signature totaling 121,000 square feet that were declined at the last minute when presented for approval to the tenant's executive committees.

Many tenants are looking for flexibility and do not want to make long-term commitments for space given the overall economic backdrop.

However, leasing activity has increased overall in our portfolio.

We have either signed or have under negotiation over 1 million square feet of leases in the fourth quarter.

We believe overall fundamentals have bottomed, but demand, excepting our BRAC locations, has not increased to the point where leasing metrics will improve measurably.

To date our leasing capital cost per square foot have been low during the downturn, but we caution that they could increase as we build occupancy in 2011 and 2012.

During the downturn we have worked hard to maintain operating cash flow.

We have foregone big CapEx deals and have generally, where needed, negotiated lower rent instead of giving away our cash.

Demand for our development projects is steady.

During the third quarter we executed over 250,000 square feet of development leasing.

Since the beginning of the year we have signed development leases totaling 800,000 square feet in eight different buildings in our Fort Meade, San Antonio, Colorado Springs and Aberdeen markets.

We continue to see good BRAC and cybersecurity related leasing activity both at Fort Meade and Aberdeen.

The moves of C4ISR from Fort Monmouth, New Jersey to Aberdeen and DISA from Northern Virginia into Fort Meade are on track for 2011.

Many contractors that support the government are active and physically repositioning themselves to serve their customers.

We do see BRAC contractor relocations extending out as far as the beginning of 2014.

The Company earns nearly 60% of its revenues from the government defense IT and data sectors.

The defense budget has had an unabated 12-year upswing since 1999, and really accelerated after 9/11, which prompted Secretary Gates to issue his DoD efficiency initiatives on August 16.

We do believe the base defense budget will maintain its existing levels of funding, but we will likely see some modest secondary effects for defense contractors from overall belt-tightening.

However, our positioning creates a greater likelihood for more positive opportunities on balance than negative issues for our Company.

We expect that the defense budget priorities will be recast with cyber, intelligence and data protection growing.

The Company is well-positioned to serve these priorities.

For example, US Cyber Command is still ramping up at Fort Meade.

Soon the command will reach full operations, and its staff level will be at a minimum 1,100 employees.

US Cyber Command will be supported by its service commands from the Army, Navy, Air Force and Marine Corps.

These subordinate commands are expected to be headquartered in the Fort Meade area with the Air Force component, 24th Air Force, headquartered in San Antonio.

Cyber Command will leverage NSA cyber expertise and capabilities and receive support from DISA, all located at Fort Meade.

Our BRAC positions will benefit from new programs moving to these areas -- C4ISR to Aberdeen; Defense Information Services Agency, DISA, to Fort Meade; National Geospatial Intelligence Agency, NGA, to Fort Belvoir; and Army Material Command to Redstone Arsenal.

We also believe that IT budgets should show more growth than overall defense spending over the next cycle, similar to the last cycle, as IT is used to reduce costs and improve efficiency.

While we will lose some user groups, we believe our overall position still provides for significant future growth.

Turning to acquisitions, we are seeing increased competition and more aggressive pricing for high-quality, well-leased core properties from a growing number of active institutional investment groups, many of which are bidding cap rates down and taking advantage of historically low interest rates to boost their overall yields.

Lately we have even seen increasing interest in value-added opportunities in historically strong office markets, such as metropolitan Washington.

The Company has made three operating asset purchases year-to-date, totaling $275 million.

In the second quarter we acquired a 152,000 square foot building in Tysons Corner, for $40 million.

The building was built in 2002 and is 100% leased to the MITRE Corporation.

MITRE is a tenant of ours in our Fort Meade and Aberdeen markets.

This acquisition represented a strategic investment for the Company of high-quality real estate and allows us to expand the customer relationship.

In September we acquired for $115 million 100% ownership in a newly constructed 233,000 gross square footage data center property known as Power Loft@Innovation located in Manassas, Virginia.

Separate from the asset, we established a controlling interest in the joint venture with the original developer that will be responsible for the leasing, management and development of the property.

The data center was 17% leased on the date of acquisition to two tenants, who have a combined initial power commitment of 3 megawatts of power, and expansion rights up to a combined 5 megawatts.

We expect to complete development of the property to an initial stabilization critical load of 18 megawatts by late 2012 for additional development costs of up to $166 million.

The facility can be ramped-up to 30 megawatts of critical load based on tenant needs.

Power Loft is located in Northern Virginia, a top-tier market and one of the strongest wholesale data center markets in the country.

Current demand for data center space relative to existing or near-term supply creates a favorable imbalance expected to continue for the near term.

We are currently tracking over 13 proposals totaling 64 megawatts of critical load demand.

As expected, with our ownership we are seeing increased traffic from our Super Core tenants.

We are forecasting full lease-up by January 2013.

Power Loft design supports the current industry standard of 150 to 160 watts of power per square foot, but can be increased to 300 watts per square foot with minimal disruption to an operating tenant.

Power Loft design without in-space coolers or cracks allows tenants a greater utilization of the space and a higher density of racks on the raised floor space than more traditional designs.

The design supports highly efficient UPS mechanical and distribution systems to minimize the cost of operation.

And Power Loft features an industry-leading power usage effectiveness rate in the Northern Virginia market.

These efficiencies result in an expected 35% savings in operating costs over most other data centers, which allow for higher base rents than the market.

The facility is LEED Silver certified.

The site can support government users who require setbacks with a controlled, secured perimeter.

Additionally, in September we acquired leasehold interests in two office properties totaling 362,000 square feet at 1201 M Street SE and 1220 12th Street SE, known as Maritime Plaza I and II, in the Capitol Riverfront submarket of Washington DC for $119 million.

The ground leases for Maritime Plaza I and II are with Washington Gas and expire in 2099 and 2100 respectively.

The buildings have parking ratios of about 2.5 per 1,000 square feet, which is high for the area.

The buildings are 100% leased with over 50% of the space leased to investment-grade tenants, of which most are Super Core tenants, such as CSC, General Dynamics and SAIC.

The buildings were adjacent to the Washington Navy Yard, home to the Naval Sea Systems Command, or NAVSEA.

The Washington Navy Yard was a major beneficiary of the 1995 BRAC, and by 2001 NAVSEA relocated approximately 4,000 employees to the Navy Yard.

Most recently the Navy announced its intent to hire close to another 1,000 employees by 2011, with an additional 2,400 employees by 2015, positioning Maritime Plaza well for future demand.

NAVSEA's 2009 budget was $25 billion.

The Capitol Riverfront submarket of DC is a unique submarket centered on defense contractor operations.

It totals 3.3 million square feet of office space.

There has been no new product delivered to the submarket since the second quarter of 2009.

At the end of the third quarter 2010 the total vacancy rate was 12.4%, down significantly in the past year.

And asking rental rates of about $46 per square foot full-service, which are nominally higher that our in-place average.

On the disposition side, in September we sold two office properties in Dayton, New Jersey, totaling 201,000 square feet and a contiguous land parcel for $23.9 million.

This concludes our exit from New Jersey market.

We have a strategy of divesting older, smaller, less strategic assets over time.

Now with that, I will turn the call over to Wayne.

Thanks, Roger.

Looking at our construction pipeline, at quarter end we had eight buildings under construction for a total of 845,000 square feet at a projected cost of $180 million, even after placing 751,000 square feet of construction into service this year.

The development pipeline has 10 buildings under development with close to 1.4 million square feet at a total projected cost of $340 million.

Two buildings under development, totaling 211,000 square feet, are for our largest tenant.

And all 10 buildings are either for government or defense contractors.

With regard to leasing, our construction pipeline ended the quarter at 40% leased.

As we mentioned last quarter and Roger has discussed, leasing at the National Business Park has been strong.

300 NBP that was fully placed into service this quarter is now essentially 100% committed, and 308 NBP is now 98% leased.

As a result of this leasing activity, we started construction last quarter on our next building, 430 NBP in the next phase of the Park.

This represents a strategic decision to prioritize the development in this new phase of NBP ahead of the remaining building sites in the existing portion of the Park.

The majority of the infrastructure work will be funded by a $30 million [TIP], which was closed in early August.

During the quarter we also began construction on an 80,000 square foot build-to-suit at Pax River in St.

Mary's County, that is 100% leased to SAIC.

At North Gate Business Park, adjacent to Aberdeen Proving Grounds, 209 Research Blvd.

is 100% leased, and 210 Research Blvd.

is 35% leased.

We therefore started construction on a 127,000 square foot building, 206 Research Blvd., in the last quarter.

As shown on page 34 of the supplement, buildings completed in 2009 and completed, or anticipated to be completed in 2010, are 81% leased as of September 30.

And development continues to generate strong returns at close to 11% cash-on-cash unleveraged deals, which are very accretive to our overall business performance.

Construction, material and labor pricing in each of our submarkets have stabilized over the past several quarters, and remains well below their historic high point reached in 2007 and 2008, which has played an important role in these results.

We continue to aggressively pursue the development of our two most recently announced projects.

Earlier this month we closed on the purchase of the final parcel for the Patriot Ridge development, which is located adjacent to Fort Belvoir and the new headquarters for the National Geospatial Intelligence Agency.

We are finalizing the design and pursuing a building permit for the first 240,000 square foot office building in the Patriot Ridge complex that will ultimately contain approximately 1 million square feet of development.

We expect construction to begin later this year on this first office building that will be delivered in the first quarter of 2012 to meet the demand from the contractors serving this 2.4 million square foot facility.

Leasing demand is very robust, and exceeds the building size, all from Super Core tenants.

We are also very active on several fronts in Huntsville, Alabama.

Our infrastructure planning is well underway, and we will begin bidding the first phase of the mass earthwork, roads and sewers shortly, with the work on the nonsecured site targeted to begin prior to the end of this year.

Our development pipeline has two office buildings projected to start construction in late 2010 or early 2011 in Redstone Gateway.

Now I will turn the call back to Brand.

Thanks, Wayne.

I hope it is evident from this call that despite a difficult economy the team has been working very hard on positioning the Company for future growth.

The 2011 guidance provides a realistic view of this growth, which is primarily coming from development leasing, placed in service and acquisitions, both largely in place by year-end 2010.

The dividend increase reflects our confidence in this growth.

We truly appreciate your continued confidence and support of the Company.

And with that, we would be happy to address any questions you may have.

(Operator Instructions).

George Auerbach, ISI Group.

I was wondering if you could just reconcile a couple of things.

Roger, in your commentary you said the tenants are cautious of taking new space.

But at the same time the guidance for next year assumes a pretty healthy ramp-up in occupancy.

I guess are there tenants or conversations that you're having that are sort of outside the, I guess, broader tenant groups that you are seeing better activity from?

Some of that occupancy, obviously, will come over the extended period of a year.

We are currently in the fourth quarter tracking 400,000 square feet of leases under negotiation or signed for vacant space in our portfolio.

So that translates into 2% of our portfolio, but don't get 100% excited about that, because we will not have 100% renewal rate next year.

But I think it is somewhat of an indication that there is reasonably good activity for space in some of our submarkets that have been weak, like White Marsh and a little bit in Colorado Springs, but certainly in the BW corridor.

So I think we are feeling a little better.

The other thing we should say is that leases are just taking forever to get done.

And so we had anticipated a lot more leasing to have gotten done in the third quarter that has slipped to the fourth quarter.

So we are hopeful that we will have a big fourth quarter in leasing and get back on track.

George, I would add -- this is Rand -- I would add to that that typically what happens in a recession, and we're just about at that point, is that tenants all of a sudden recognize that it has bottomed out and they start to move very aggressively to take space at the lowest rates in the market and move up on the quality chain to the very best quality space.

That is what has happened in the last six or seven recessions that I have been involved in, and we really expect to see that happening again here.

Jordan Sadler, KeyBanc Capital Markets.

It is Craig Mailman here with Jordan.

Roger, I think in your comments you said there is about 120,000 square feet of leases that got killed by executives at certain tenants.

Can you maybe go into the characteristics of those tenants?

Was that your Super Core or is that more of the traditional suburban guys?

One of them was a defense contractor, who just got nervous about pulling the trigger at that time.

Hopefully, they will pull it in the future.

The other was a commercial tenant that was about to lease a part of the building -- a development building that we have placed in service already.

It is in our operational statistics, but that lease did not go forward.

And the defense contractor, was that more in the development pipeline or in the existing?

Yes.

It was development.

Then I guess just moving on to the data center in Northern Virginia, you guys expect to be 50% occupied, or at least that is what you are assuming in guidance.

Can you maybe talk about the activity level that you are seeing there, any big requirements and --.

So there are a lot of proposals out.

And actually, the proposals exceed the total capacity of the data center.

But the revenue cycle in data centers is longer than it is for traditional office.

So our expectation is that it will take a while longer to -- for those proposals and demand to translate into leases and then into revenue.

But we're feeling pretty good about that.

Again, we have showcased this data center to all of our key customers and we are getting pretty good response.

We are comfortable that we will have good activity on this beginning in 2011.

Sri Nagarajan, FBR Capital Markets.

Why don't you move on, operator.

Sorry, guys.

Sorry about that.

I had a question on margins, the expenses.

Are there any one-time expenses in the quarter or was it just a matter of sequentially higher expenses?

Generally the third quarter is our highest quarter for operating expenses, and it comes about for two reasons.

Number one, it is our cooling season and so our electric costs are higher.

Then, secondly, the third quarter, because of the weather tends to be the quarter in which we do the most of the Company's discretionary R&M.

So the second quarter tends to be our lightest quarter in terms of OpEx; the fourth quarter, the second.

First quarter is a little tough because of cold weather and snow.

Then the third quarter is generally our worst quarter, again, because of electric and discretionary R&M.

I just didn't see the same pattern in '09, which is what my question was.

My second question has to do with your renewal or retention rate of 54%.

Just following up on the previous question, is the loss of the (inaudible) due to your Super Core tenants or what is the mix of tenants leaving your space?

And could you also give as a flavor of what kind of space is it?

Is this some of the newer developments as in two, three years of development or these are older buildings?

The majority of the loss in the third quarter came about as a result of a tenant in Northern Virginia that was in the building with another one of our core tenants, and both of them were growing in the building, and one of them had to leave.

So the one tenant did leave and go to another building.

So we lost over 100,000 square feet of occupancy as a result of us not being able to fulfill the space needs of this particular tenant.

We had one other defense contractor leave that was modest.

But the balance of the tenants were commercial tenants.

And in terms of renewal percentage, we would expect the fourth-quarter renewal percentage to be higher.

And again, that is because of a lot of our renewal leasing that we had anticipated to be complete by the third quarter will get done in the fourth quarter.

John Guinee, Stifel Nicolaus.

A quick question for you.

I am looking at your development pipe.

You've got $180 million under construction, 845,000 square feet.

That equates to about $212 a square foot.

If you get an 11% cash yield on that, forgetting credit loss and vacancy, that translates to about $23 net.

Are these kind of tenant just not very price sensitive or is that the going rate in most of these submarkets?

I would say that your math is working to the average.

We have a range of price sensitivities, but your math has worked to the average.

Of course, the National Business Park is where we have the strongest tenant demand that allows us to achieve the economics you have outlined.

Great, thank you.

Dave Rodgers, RBC.

Maybe either Wayne or Steve, could you address the development starts that you are planning in the fourth quarter, and then maybe either by quarter, or by half in 2011 and what the resulting capital spend might be on those?

I am essentially trying to get at what the acceleration in that pipeline might look like today.

This is Wayne.

I will take that question.

We have several projects that we expect to still get started yet in 2010, including the Patriot Ridge project, which is a fairly sizable investment for us at 240,000 square feet.

Then in terms of 2011, we've got a range of properties that are scheduled there are actually backloaded a bit in the year, so we do accelerate as we go through that development pipeline.

And the projects are across the portfolio.

Brendan Maiorana, Wells Fargo.

I just wanted to ask a little bit more about the Power Loft deal, and I apologize if this was answered already; I had some difficulties.

But it strikes me that a lot of the investment activity that you guys have done over the years has been tenant driven, whether it be some of the market expansions that you have done.

But is this deal being done?

And the move to doing more of a data center for third parties -- is that driven by your tenants asking you to do that or is this driven by your expectations that you see a market opportunity and this is a good investment in a market opportunity that may be underserved and where you can get outsized returns?

This is a Rand.

I think it is actually both.

The tenants that are in our Super Core grouping have seen what we have done for the government and some of the select other defense contractors, and they appreciate our quality and the 24/7 operation of critical mission facilities.

So they know our capabilities.

So I think increasingly they have looked at us as a standard that perhaps could be applied to the more typical wholesale data facilities.

At the same time, I think, we were not getting credit compared to some of our data competitors in the REIT space for having the amount of data space that we do have.

So we saw an opportunity to really take advantage of our expertise and start to get these larger returns, which we do think will be in the 12% to 14% cash-on-cash unleveraged levels as we complete the buildout of the spaces.

We have been studying this -- we have been in this business six years -- been studying it for the last several years on the best way to enter.

And we are very excited about the design that Power Loft represents, the state-of-the-art and significant operating efficiencies in one of the strongest markets, as Roger mentioned.

So this is -- it is not a huge part of what we do, certainly, but we think it is an important growth driver.

You saw that from the initial NOI coming out of that project next year, which will significantly expand in 2012.

Michael Knott, Green Street Advisors.

Just to follow-up on your data center comment.

It looked like there was a new page in the supplemental on page 36.

I'm just curious, maybe you could give a little more detail on some of the other data centers, if you can, to the extent you think the market should give you more credit?

I appreciate that, but unfortunately the nature of the other data centers that we have precludes us from going into this sort of detail.

Clearly, they don't want it identified by location or load or so on.

So what we tried to do on page 36 of the supplement, as you noted, is start to identify what will be a future emphasis in this part of the data business, the wholesale data center.

This will provide the updates, both in terms of the square footage and the critical load percentages and any other details.

And as we add others in the future this will become a page that you can go to in looking at that part of the business.

Christopher Lucas, Robert W.

Baird.

Just one more follow-up on the data center.

What sort of return expectations do you have for that, and how do you get to that range based on the power density?

I will let -- it is a 12% to 14% unleveraged, and I think as you -- that is up for the 18 megawatt.

And as you go beyond the 18 megawatt towards the 30 megawatts those returns can tend to be at the high end and even beyond the 14%.

Then I will let Roger go over some details of that.

Well, I think, obviously with expandability data centers become cheaper, so adding the next megawatt of power is at a lot lower cost than the first one, because you have paid for so much of the elements of the data center.

So I think that is -- all we are trying to say is that there is some price reduction economies as you expand the data center.

Michael Bilerman, Citi.

It is Josh Attie with Michael.

For the 2011 guidance can you talk more specifically about the refinancing assumptions to turn out the line of credit?

And also from a leverage perspective do you feel that should be termed out with debt or -- with permanent debt or with equity?

This is Steve.

We are -- we have the option on the lines -- we will try to take your questions in part -- to extend to one extra year for 12.5 basis points in the case of one line, and 15 on the other.

We may do that, but we are also in discussion with our bank group about what the longer timeframe would look like for the lines, and haven't made a decision at this point which option we will choose.

With regard to, I guess, capital in the line, we will make sure that as we continue to grow, because we have confidence in our growth plans, that we can access all the types of capital that we have traditionally used and invest it accretively.

And that we will maintain our capital stack according to the targets that we have managed to.

As I have said on prior calls, we really watch our coverage and our leverage, and we feel good about our fixed charge coverage ratio.

We have always try to keep it above 2.

We have performed above that.

And we watch our leverage as well.

And we do that on a debt to gross assets basis.

We target to be around 50% or below.

And we have been in the high 40%s recently for that.

So we are -- but we will access, as we get growth opportunities, all types of capital at appropriate times, because fortunately we have growth to invest in it.

Steve Benyik, Jefferies.

I guess regarding the 3Q same-store cash NOI.

I know it turned positive.

Obviously, occupancy a bit lower, negative mark-to-markets on leasing.

I know you mentioned the $3 million prepayment of rent in the quarter.

I was hoping you can give a little more color on that and whether you would expect anything similar in 2011?

That had to do with a customer who wanted to, for budgeting reasons, to pay some of their future rent in advance.

We recognized obviously, more gap rent than we had cash rent on that particular tenant.

So by paying that amount in cash that had a reversal of straight-line rent that we had recognized in the past, and will have also the impact of reducing the cash rent for that particular lease going forward.

It is possible that we could have a little bit of that in 2011, but it is not something that we see from most of our tenants, and we don't expect it to be a regular occurrence.

Brendan Maiorana, Wells Fargo.

Thanks, just a follow-up with Steve.

Steve, can you just give us an update what you think your capacity for additional mortgage debt is?

And then just as it relates to guidance, I think you mentioned that your guidance assumes keeping the capital ratios in check.

But I wasn't sure whether or not that may have included a potential equity raise if you have acquisitions towards the top end of your guidance range.

Well, we won't comment specifically on any capital assumptions that we haven't finalized or planned.

But our plan does assume that we maintain those capital target ratios that we shoot for.

And if we get more growth opportunities than less, that means we will proportionally have to raise more different types of capital.

With regard to capacity, we have -- within those ratios we are not necessarily finished with all of our development.

So as development stabilizes and comes in and increases our unencumbered asset pool, from time to time that increases our capacity to put [to debt] on our asset.

So, as you can see, we are delivering more and more lease, so that moves up over time.

And that is basically the guidance that we are giving at this point in time.

Michael Knott, Green Street Advisors.

Roger, I guess this question is probably for you.

Looking on page 25 of your supplemental, and I apologize if someone asked about this earlier, or if you talked about it, but it looked like the Virginia occupancy or percentage leased book fell a fair bit sequentially.

And I was just curious if you can remind us what that was attributable to, and if any of that was a surprise or not?

That was a tenant in a building in Northern Virginia who had as a co-tenant another defense contractor.

And they both had that building 100% leased.

So they were both still growing, and one of them had to leave the building, unfortunately, and so they left that building.

It was over in excess of 100,000 square feet and went to another building.

So it is unfortunate.

It had nothing to do with not needing the space.

It had to do with our inability to grow them in that particular building.

Christopher Lucas, Robert W.

Baird.

Just a quick question on the disposition side.

There is nothing in guidance, and given capital issues, where do you see dispositions over the next year?

Well, I think we are -- we have as a general guiding principle to try to sell some of our portfolio.

Again, those assets that are older or smaller or strategic, those assets that we acquired maybe when our strategy was a little different as a company.

But it is something that we are going to do over time.

It is something we're going to do as the market allows us to execute that and get fair value for those assets.

I think over the year we will probably firm up some more plans and get out to the investors our intent with respect to that particular program.

Jordan Sadler, KeyBanc Capital Markets.

Just two quick follow-ups.

Given the delay and the need for some of these contractors to move down for BRAC, is the 1.5 million square feet of development starts per year is still a good run rate, or is maybe that going to be scaled back a bit?

Then the other one, just on the Power Loft, how much speculative risk are you guys willing to take on building out pods to have it ready for any potential leasing?

I'll take that.

This is Rand.

So it is not necessarily that the defense contractors are delaying.

I think that the demand -- and it varies by location and it matches up to the specific customer.

So at Aberdeen I think there the customer is ahead of schedule.

The tenants are generally small, 140 companies moving from Fort Monmouth, and generally they are smaller and have not had experience in real estate relocations, and so their decision making process is slightly behind.

It has not been the case with, certainty, the cybersecurity, which is ahead of what we would had have expected at Fort Meade.

But there DISA specifically said because of the proximity of Northern Virginia, where a lot of these tenants are located, that they will give them a little more time to relocate.

So we are in discussions with a fair amount of tenants, but they have a little bit more time and need to finish that up by the end 2013.

Very strong demand, and hence the need for really pushing product at Fort Belvoir.

And then we are in the same kind of discussions down at the -- for the time frame on the BRAC at Redstone Arsenal.

So I think that we are in pretty good shape there.

We are not building buildings just to build them, we are building them in anticipation of the demand that is there.

And sometimes that might be slightly slower, or will accelerate on us.

And we have to try to prejudge the timeframe for that demand just because of the leadtime on building those buildings.

But the good news is that very strong demand collectively, and it is just the question of matching the timeframe.

On the speculative risk for building out, as soon as we purchased the Power Loft facility we did go ahead and authorize the next 3 megawatts of ordering of equipment and pre-build, and we are going to try and stay ahead of that demand wherever possible.

They are big numbers, so we are cautious about it, but we do want to take advantage of that 64 megawatts of demand that is there with the proposals that we have out in front of us.

So we are pre-ordering equipment to take advantage of that, and try to be first to the market on delivery.

We think we are first in that space now in Northern Virginia based on any other starts that are there.

So that should be good for leasing.

Steve Benyik, Jefferies.

Regarding the 2011 guidance when you look at what is underpinning the same-store NOI growth assumption, can you talk a little bit about cash mark-to-market expectations on signed leases in 2011, as well as regarding the development NOI, how much square footage needs to be leased to get that $13 million to $14 million number?

Well, the $13 million to $14 million refers to development leasing for buildings that we placed in service in 2010.

The majority of that leasing has been done.

In terms of same-store NOI, we are assuming that our rents on average are nominally negative to positive for 2011.

Dave Rodgers, RBC.

If you didn't address it already, if you could please, on the acquisitions for the fourth quarter and in the 2011 guidance, could you talk about whether that is land or buildings, core or opportunistic, contiguous geographies, and whether that is targeted tenant demand or more market-driven, and what the thought is on the outlook there?

I think, as I said in my comments, we do see a window there for trying to find core and Super Core properties in our existing locations.

So we have been pursuing those, although I must say that pricing is changing pretty rapidly on us.

We are starting to look at some building of marketshare in some of the other locations, and so we are trying to move aggressively on that front.

That does not include land -- that we think we are in pretty good shape with almost 22 million square feet of land capacity in the Company that is entitled and ready to go.

And we will just see.

It is a very difficult thing to look at next year and see whether if interest rates stay where they are, and pricing continues to be pretty aggressive, and I think that will knock a lot of people out of the market from the acquisition standpoint.

There are discussions that we have had earlier in the year that are taking advantage of those different rates, and we just have to see if those materially can get closed or not.

There are no further questions.

I will now turn the call back to Mr.

Griffin, for closing remarks.

Mr.

Griffin, please

So thank you for joining us today.

I am sorry it went a little bit longer, but lots of questions.

And we appreciate your participation and support, and certainly are available to answer any other questions that you might have.

Thanks, and have a great day.

Ladies and gentlemen, thank you for your participation today in the Corporate Office Properties Trust third-quarter 2010 earnings conference call.

This concludes the presentation.

You may now disconnect.

Good day.