COPT Defense Properties (CDP) 2011 Q2 法說會逐字稿

Welcome to the Corporate Office Properties Trust's second quarter 2011 earnings conference call.

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

At this time I will turn the call over to Stephanie Krewson, the company's Vice President of Investor Relations.

Ms.

Krewson, please go ahead.

Thank you, [Crystalline].

Good morning and welcome to COPT's second 2011 earnings conference call.

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

As management reviews our financial results, they will refer to our quarterly supplemental information package and associated press release, both of which can be found 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 2011 annual and quarterly guidance.

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

Before turning the call over to management, let me remind you all 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.

Factors that could cause actual results to differ materially include, without limitation, the ability to renew or re-lease space under favorable terms, regulatory changes, changes in the economy, the success and timely completion of acquisitions and development projects, and changes in interest rates, and other risks associated with the commercial real estate business as detailed in our filings with the SEC.

I would now turn the call over to Rand for his formal remarks.

Thank you, Stephanie, and good morning everyone.

I'm going to cover a few highlights from the second quarter and update you on the status of defense spending and how leasing at COPT has been affected.

Although the tepid economic recovery in the US continues to present significant leasing challenges for the office sector, COPT performed well in the second quarter.

Our FFO per share of $0.57 after adjustments was a penny above the high end of our guidance range.

Second quarter results were driven primarily by higher NOI margins, partially offset by a lack of acquisitions and nominal lease fee termination fees.

Pertaining to acquisitions, a flood of capital from private and all-cash buyers continues to drive down cap rates on acquisitions, especially for well-leased, high-quality assets in growth markets, such as the Greater DC-Baltimore region.

While we competed for several buildings, we were outbid by aggressive buyers.

Still we believe our disciplined underwriting and focus on strategic super-core assets will serve the company and its shareholders well in the long run.

During the second quarter, we leased just over 1 million square feet, despite the lingering effects of the delayed passage of the 2011 federal budget.

Roger will discuss COPT's leasing achievements in the market for property transactions in greater detail.

Although the 2011 federal budget was passed on April 15, it is taking time for appropriated moves and monies to translate into signed leases.

We anticipated this delay.

Let me briefly explain the process for those of you listening who may not be as familiar with it.

Once the 2011 budget was passed in April, the appropriated funds then needed to be allocated by the Office of Management and Budget, or OMB.

The OMB gives agencies, including the Department of Defense, budget guidance for the fiscal year.

Once funds are allocated and therefore available, contracts can be bid, or re-bid as appropriate, and awards made.

This whole process obviously does not happen overnight.

So we were not surprised by the soft demand for new space in our second quarter.

For the remainder of the year, we do expect incremental leasing to come from government agencies that must either commit to space before September 30, when the 2011 federal budget year ends or forfeit uncommitted funds.

We also expect defense contractors who are awarded contracts prior to September 30 to seek space to be occupied within 6 months in order to fulfill their contract obligations.

We believe that defense contractor demand will increase in the second half of this year because, with some limited exceptions unrelated to COPT's portfolio, all government agencies impacted by the 2005 BRAC need to be in their new locations by September 15 of this year.

Importantly, physical move-ins into the federally funded developments that create our government demand drivers are almost complete at all four of COPT's BRAC locations.

Starting with the National Business Park, the ribbon-cutting for the new Defense Information Systems Agency headquarters building at Fort Meade occurred on April 15.

Approximately 90% of the 5,800 government employees are already in place.

The anticipated contractor tail for DISA and Cyber Command is between 16,000 and 20,000 workers who, by extension, will need approximately 4 million square feet of office space.

Similarly, at Aberdeen Proving Ground where C4ISR is the major government demand driver, 6,200 of the anticipated 8,300 government employees have already moved to APG, leaving only 300 more to move and 1,800 new employees to be hired.

The expected contractor tail of 7,500 to 10,000 contractor employees will require between 2 million and 2.5 million square feet of office space.

In Northern Virginia, the National Geospatial Intelligence Agency's new 2.4 million square foot, $1.7-billion headquarters, is now open.

And 5,100 of the 8,500 government employees have moved in.

The expected contractor tail to serve the NGA is 9,000 workers, which implies an office space need of between 1 million and 2 million square feet.

Fourth, but by no means last, roughly 3,800 of the anticipated 4,700 new government workers are in place at Redstone Arsenal in Huntsville, Alabama.

The contractor tail of 7,000 workers will require up to 2 million square feet of office space.

The timing of contractor moves at each of our four BRAC locations will vary according to the agency being supported.

It is expected that most of these moves will occur before the end of 2014.

So 10 million square feet of demand from contractors moving to support the new government agency locations is coming to our four BRAC locations over the next few years.

With our strong locations, we are well positioned to get our fair share of this demand.

And with that, I'll turn the call over to Roger.

Thanks, Rand.

I'm going to go over our leasing results for the quarter and provide an update on progress we've made on the strategic reallocation plan we announced on the last earnings call.

At quarter end, our wholly- owned portfolio of 249 buildings encompassed 20 million square feet, they were 87.3% occupied and 89.4% leased.

Our occupancy increased 30 basis points from first quarter 2011.

The percentage leased, which is a leading indicator, increased 20 basis points in the quarter.

Despite the uncertain economic environment in which many tenants are operating, we leased 1,035,000 square feet during the second quarter.

That, combined with the 1.2 million square feet of leases in the first quarter, keeps us on pace to reach our 2011 leasing goal of 4 million square feet.

Recall we began the second quarter with only 300,000 square feet of leases scheduled to expire.

Of the space leased in the second quarter, 768,000 square feet were renewals, 202,000 square feet of which related to 2011 expirations, and 566,000 square feet related primarily to 2012 lease expirations.

We re-tenanted 143,000 square feet, executed 64,000 square feet in development or re-development projects, and we also signed 61,000 square feet of vacant first-generation space.

Even though the protracted continuing resolution surrounding the 2011 federal budget negotiations caused development leasing to fall short of our initial expectations for 2011, we expect demand to pick up in the coming months as money for fiscal 2011 is freed up and, as Rand mentioned, must be committed prior to September 30.

Although we don't yet have signed leases, we are in active discussions with prospects for about 600,000 square feet of our development pipeline.

For the quarter, we had a renewal rate of 89% at an average capital cost of $11.49 per square foot.

Rents on renewals increased 1.7% on a straight line basis and decreased 7.7% on a cash basis.

Total rent from renewed and re-tenanted space increased 2.1% on a straight line basis and decreased 7.3% on a cash basis.

For all renewed and re-tenanted space, the average capital cost was $13.21 per square foot.

Year-to-date, we had a renewal rate of 76% at an average capital cost of $11.

Rental and renewals increased 3.6% on a straight line basis and decreased 4.2% on a cash basis.

Total rent from renewed and re-tenanted space increased 3.2% on a straight line basis and decreased 4% on a cash basis.

For all renewed and re-tenanted space, capital cost averaged $14.47 per square foot.

While rental rates continued to be under pressure from tenants wanting to lower operating expenses, rental rates on leases executed thus far in 2011 are declining at a lower rate relative to 2010 levels.

So things are less negative than they were last year.

But supply and demand fundamentals, except in a few sub-markets, still modestly favor tenants.

A positive during the first half of the year and hopefully for the beginning of the trend was that only 6 out of 74 renewal transactions were accompanied by a downsizing.

We continue to believe same office occupancy bottomed in the first quarter of this year.

For the third quarter, we have about 112,000 square feet of known move-outs, which will be more than compensated for by 427,000 square feet of space that's leased, and will become occupied before year-end.

Accordingly, we project that same office occupancy sequentially will improve modestly each quarter for the remainder of the year.

Turning now to the property transaction market, while we have actively pursued a number of acquisition opportunities in 2011, we made no acquisitions this year.

Moreover, the acquisition environment remains extremely competitive, particularly for high-quality stabilized properties.

The cap rate compression that began last year in CBD markets has spread to many of the suburban office markets we target because the significant amount of capital is pursuing stabilized deals that pose little near-term risk.

We continue to pursue acquisitions both on- and off-market.

But our expectations for total acquisition volume this year have been tempered by the pricing and returns we have seen thus far.

Now let's review the progress on our strategic reallocation plan.

During the second quarter, the company sold a small 3-building complex that was retail in nature for $3.8 million or about $100 per square foot.

The buildings were 89% occupied at closing.

Details of these asset sales are on page 22 of the supplemental information package.

We have assets under contract for a little over $20 million and another set of buildings that should be under contract in the next week or two.

We expect these asset sales to close this year.

This would put us on track to meet or exceed the $55 million of assets sales we projected to occur in 2011 as part of our plan.

In addition, we are evaluating unsolicited offers or are in various phases of marketing for another $120 million of assets sales that could close late this year or in the first quarter of 2012.

The dispositions in the strategic reallocation plan took time to ramp up.

But we believe we now have momentum, and we'll ultimately sell the entire $260 million of targeted assets earlier than the original forecast of year-end 2013.

With that, I'll turn things over to Steve.

Thanks, Roger, and good morning, everyone.

For the second quarter of 2011, we reported FFO available to common shareholders of $41.5 million or $0.57 per diluted share, $0.01 above the high end of our guidance range.

This result excludes a $40-million, or $0.55 per diluted share, non-cash impairment charge net of tax related to our strategic reallocation plan that we announced last quarter.

Including the non-cash impairment, our FFO per diluted share was $0.02.

For the second quarter of 2011, net loss attributable to common shareholders was $28.3 million, and diluted loss per share was $0.42 compared to net earnings attributable to common shareholders of $4.4 million and $0.07 per diluted share for the second quarter of 2010.

Our diluted FFO payout ratio as adjusted was 76% and our diluted AFFO payout ratio, excluding capital expenditures invested at properties that are part of the disposition plan, was 111%.

We view our common dividend on a long-term basis and we believe it is sustainable.

As we lease up vacancy and assuming capital expenditures revert to more normalized levels, our dividend coverage should return to the company's historical level.

As of June 30, our same-office portfolio consisted of 190 properties representing 81% of the consolidated portfolio square footage and excluded all of the properties we intend to dispose of as part of the strategic reallocation plan.

Same-office cash NOI, excluding termination fees, increased by $5.5 million, or 10%, in the first quarter and was down $350,000, or 60 basis points, compared to the second quarter of 2010.

Same-office occupancy averaged 89.1% in the second quarter of 2011 versus 89.6% in the second quarter of 2010.

Turning to the balance sheet, at June 30, the company had $2.3 billion of debt outstanding at a weighted average cost of 4.9%, 81% of our debt was at fixed interest rates.

For the quarter, our adjusted EBITDA-to-interest-expense-coverage-ratio was 3.1 times, and our fixed charge coverage ratio was 2.6 times.

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Our debt to adjusted EBITDA ratio adjusting for construction in progress was 6.4 times at quarter end.

During the second quarter, we raised approximately $146 million in an offering of 4.6 million common shares.

With these net proceeds, we paid off a $102-million secured loan that was scheduled to mature in September.

We also began syndicating a new $1-billion line of credit to replace our existing line.

The new line will have a three-year term that could be extended for another year.

Commitments from our bank group exceed this facility, and we expect to close by September 1.

We are working on closing a construction loan to fund our first building at the Patriot Ridge Development and are negotiating financing for our Redstone Gateway project.

We expect both construction loans to close during 2011.

We anticipate issuing between $200 million and $250 million of ten-year fixed rate debt by year-end, which will allow us to extend roughly 10% of our debt for 10 years.

Now turning to our revised guidance, we are tightening our prior 2011 FFO per share guidance range to a new range of $2.23 to $2.35.

Our prior guidance range was $2.20 to $2.40.

Our guidance excludes non-cash impairments and acquisition costs, the latter of which vary by jurisdiction and are difficult to predict.

Having said that, let me walk you through the fundamental assumptions behind our 2011 outlook.

First, for the same-office portfolio, occupancy improved 40 basis in the first quarter when we believed it bottomed, and should modestly improve the next two quarters to end the year 40 to 100 basis points higher.

We continue to project a tenant retention ratio -- rate of 65% to 70% for 2011.

We project same office NOI to be between negative 1% and negative 3% for the entire year, but ending the year stronger in the fourth quarter.

Second, our prior guidance anticipated $750,000 of lease termination fees for the second quarter.

As shown on page 3 of the supplement, we've recognized only $342,000 in the first half of the year.

At the midpoint of our guidance range, lease termination fees for the second half of 2011 are expected to be approximately $1.5 million.

Third, there is no change to our forecast of cash NOI from development placed in service during 2010 and 2011.

Excluding the Power Loft data center, we expect $13 million to $14 million of cash NOI for the year from these properties.

Virtually all of this is already in place.

Fourth, we still expect cash NOI from Power Loft to be approximately $1.2 million to $2 million for the year.

Fifth, our guidance assumes no acquisitions at the bottom end of the range and up to $80 million at the top end -- a reduction from prior guidance.

Sixth, our guidance assumes we will sell approximately $55 million of assets under the strategic reallocation plan.

But as Roger mentioned, we may exceed that level before year-end.

Seventh is other income.

Year-to-date, we've recognized $5.2 million, or $0.06 per diluted share of gains on land sales and our investment in KEYW.

In the second quarter, we sold 500,000 of KEYW and recognized gains of $2.2 million or $0.03 per share.

Upon Rand's resignation from KEYW's board in the third quarter, we no longer account for this investment using the equity method.

Instead, we will begin marking the investment to market.

Assuming KEYW's closing prices as of yesterday, July 27, of $11.31, less our $7.45 basis per share, the gain on our remaining 2.6 million share investment will be an additional $9.9 million.

So we are not going to predict KEYW stock price.

So COPT's unrealized gain of $0.13 per diluted share is included in both the bottom and the top ends of our guidance range.

In summary, we now expect other income, including gains on KEYW, to contribute between $18 million and $20 million in 2011.

Finally, capitalized interest is assumed to average approximately $4.8 million per quarter for the last two quarters of 2011.

Moving on to our third quarter guidance, we expect FFO to be between $0.62 and $0.65 per diluted share.

As with our full year guidance, our quarterly guidance excludes acquisition costs.

The guidance range for the third quarter includes the same $0.13-gain for our investment in KEYW at the bottom and the top of the range.

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

Thanks, Steve.

My comments will focus on information presented on pages 25 and 26 of the supplement.

As Roger discussed, second quarter pre-leasing in the construction portfolio was modest.

NBP 430, our first office building in the north section of the National Business Park, had just over 60,000 square feet in lease commitments in the quarter.

The construction pipeline overall saw no net change in the total occupancy level from last quarter.

Looking at starts and completions, which are on page 25 of the supplement, during the second quarter, we did not start construction on any new office buildings.

We did place 209 Research Boulevard into service at North Gate Business Park in Aberdeen.

The building is now accounted for in our operating portfolio and is 100% leased to several key contractor customers.

Next, when reviewing our re-development projects on page 26, there are two changes since last quarter.

First, 801 Lakeview Drive in our Arborcrest Park is 100% leased and therefore was placed into the operating portfolio in the second quarter and removed from the re-development schedule.

We've also removed the 7468 Candlewood Road project.

Our re-development program converted this asset to warehouse/flex condominiums and is being marketed for sale as part of our strategic reallocation plan.

We have made several changes to our under development pipeline that represent projects on which we expect to start construction within the next 12 months.

Properties under development are detailed on page 26.

Second quarter changes were made in response to anticipated customer demand for our office space.

The net result was a modest increase in the size of the development pipeline from 991,000 square feet at the end of the first quarter to just over 1 million square feet at the end of the second quarter.

Here are the major changes.

First, in the National Business Park, we have 3 buildings under construction in support of the move of DISA from Northern Virginia to Fort Meade and the standup of Cyber Command at Fort Meade.

However, we elected to accelerate the development of NBP 560, which is located in the northern section of the park, and push back the anticipated start date for NBP 310.

At 260,000 square feet, NBP 310 is a signature building and represents one of the last development sites in the original section of NBP.

We have seen strong interest in the new north section of NBP, and believe we should take advantage of that momentum by beginning another neighborhood in the park.

Second, we have added the second office building in Patriot Ridge to our under development pipeline.

Recall that Patriot Ridge is located in Springfield, Virginia, just south of Washington, DC, along the I-95 Corridor, adjacent to both Fort Belvoir and the NGA.

And that we currently have 7770 Backlick Road, a 240,000 square foot office building under construction there.

Because leasing demand from the contractors serving the NGA continues to be very robust, we believe it is prudent to begin development on the second office building, which will also be 240,000 square feet.

Third, our North Gate Business Park, and the entire office market serving the Aberdeen Proving Ground, continues to see rather modest leasing activity.

Accordingly, we have removed the next building from the development pipeline as we believe current inventory is adequate to meet anticipated market demand for at least the next 12 months.

Finally, Redstone Gateway is our fourth BRAC location.

The first phase of the park is master planned for approximately 2 million square feet, and the site development work is underway.

Construction on our first office building of 115,000 square feet is scheduled to be completed at the end of this year.

Interest from the contractors in the market for the first phase of office space is growing.

In addition to the second office building previously listed in the under development schedule, we have added a flex office building with an anticipated start date in the fourth quarter of 2011.

With that, I'll turn the call back to Rand.

Thanks, Wayne, and thank you all for joining us today.

In summary, we are seeing a gradual improvement in the business as demonstrated by the continued leasing activity and same-office occupancy gains.

We are strengthening the balance sheet and progressing well on development and construction activities.

On a personal note regarding the status of my potential retirement, we expect to discuss this timing at the upcoming September Board meeting as appropriate, an announcement will be made subsequent to that meeting.

Roger, Steve, Wayne, Stephanie and I are available to answer any questions you might have.

And, Crystalline, if you could open up the call now for questions.

Thank you, Mr.

Griffin.

(Operator Instructions)

Our first question comes from the line of Craig Mailman with KeyBanc Capital Markets.

Please proceed.

Hi, good morning.

Jordan Sadler is on the phone with me as well.

Roger, maybe you can just talk about the leasing pace.

I know you had mentioned that you guys feel good about getting to the 4 million square foot target for the year.

But as I'm looking at the lease expirations for the balance of the year and kind of putting the 65% to 70% retention rate on that, let's call it 650,000 and 700,000 square feet.

You talked a little bit about 600,000 square feet of active requirements in the development pipeline.

Can you maybe just give a little bit of color on how much of a pickup you guys are expecting in new leasing to kind of offset the big retention that you guys had in the 2Q?

I think overall, we currently have about 700,000 square feet of leases that are out under negotiation.

A lot of that is towards the 1 million square feet that we have renewing for the -- maturing for the balance of the year.

And then we've got the 600,000 square feet of other negotiations going on with -- on the development portfolio.

And so as Steve said, our thinking is that with the 65% renewal rate for the rest of the year and the other re-tenanting leasing we're doing that we'll be able to bring our same-store up and plus eat into our -- unleased under construction pipeline by some pretty good amount before year end.

Are you getting a sense of just talking to tenants that there's a pretty big shadow demand on -- once these contracts get signed?

Do you have any kind of pipeline there that you could discuss?

Well I don't think we can be specific.

But I would say that at four locations, really, the only location that we don't have activity on development leasing is up in Aberdeen, Maryland.

But the other locations, we've got a pretty good activity that we think will be realized over the next so many months.

Great.

And I'm just wondering if there's, in your recent conversations with tenants, sort of the inability of Washington to get their consensus on deficit reduction and just spending overall.

Are people starting to get worried that we might have the same situation in '12 with the budget resolution being delayed that we had in '11 and kind of how are they positioning for that and how are you guys positioning for that from the development start standpoint?

This is Rand, Craig and Jordan.

No, I think clearly, given how difficult it is for both parties to get agreement on something that's been in discussions for 8 months on the debt ceiling increase, we now think that the 2012 budget will certainly go into a continuing resolution and be a delay just like it occurred at the end last year and this year.

So how contractors are really approaching that is that the awards that are being done now and the government leasing that will occur prior to September 30 becomes very, very important.

Because under continuing resolution, what they're able to do is to continue to spend at the 2011 levels, just not go into new obligations as they approach into the 2012.

So the velocity that needs to get done between now and the end of September 30 is very, very important for both contractors and the government.

And then we will see that velocity be able to continue as it relates to the 2011.

But we do -- we anticipate again, just like we've experienced this year, then a lull for new obligations that would occur until that gets resolved.

And we think it's probably going to run about the same time into April or so of 2012.

Now earlier in the year, they said absolutely, Congress did not want to be in this situation going into an election year.

And yet, you can tell by the difficulties under the negotiations that we're clearly projected to be that way.

And how does that affect kind of the way you guys are looking at starts?

I know 1.2 million is a pretty good number for you guys.

Do you think that could be aggressive heading into late '11, early '12?

No, I think what happens, Craig, is that the leasing that Roger mentioned, the 600,000 square feet of development leasing that we think will get done over the next 6 months, that really brings those existing construction projects up to sufficient levels to then require that we get going on the next round of starts.

And generally, we'd like to be 50% leased or so on a building before we start the next one.

Or in some cases, like at Redstone Arsenal where we have decent activity on the first one, we have a full-building tenant, negotiating for a second building.

And we would like to also have the flex office product -- there's quite a bit of interest in that -- starting as well.

So there you'd start a little bit extra just to be meeting the anticipated demand.

So the starts that Wayne mentioned that are in the supplement really are, I think, very comfortable dictated on the leasing that will take place on the existing construction, and so we feel that's quite conservative and comfortable.

Hey, it's Jordan.

I just have one quick followup for Steve.

There's an income tax benefit of about $5 million, I see, in the P&L.

I might have missed any commentary on that.

Can you just enlighten me?

That is related to some condo sales as part of our strategic reallocation charge, and that -- those go through our TRS.

So there's a tax effect to those.

And is there -- so is there a gain that offsets that?

It looks like it's included in FFO, right?

No, it's part -- there's an impairment charge --

I mean, is there a loss?

(inaudible)

There's an impairment charge related to the strategic reallocation plan that affects assets held in a TRS.

So therefore, there is a tax offset to that -- benefit of that.

Okay, so they should be netted.

And they're both in FFO.

They're both in the strategic reallocation, $0.55-number.

That's net number that I've given you.

Okay.

Thank you.

Our next question comes from the line of John Guinee with Stifel.

Please proceed.

Hi, John Guinee here.

Sort of back of the envelope, Rand, Roger, guys, Stephanie, about 50% plus or minus of your portfolio is -- this might be an oxymoron, but unique suburban office space due to the tenancy or the location.

And about 50% of your portfolio is fairly generic stuff.

So my question is, if you were really going to think big in terms of your reallocation plan, how much could you actually move up in addition to this relatively mundane $55-million number that's been quoted oftentimes?

Well, John, we continue to evaluate the balance of our portfolio.

What we announced in the strategic reallocation plan was our -- what I'll call first phase.

And then there are other designated properties behind that.

But at this point, we're not prepared to lay out where those properties are or the size.

But we understand that by the time there's another downturn, that we want to have our portfolio positioned differently with --it much more tied to the government and defense spending and less to generic commercial tenants.

So you're thinking about thinking big?

Yes.

Thanks a lot.

Also, John, you're at 50%-50%.

The number is more like 60%-40%.

And as we said, that will move by 2013 now and probably a little earlier than that, as Roger mentioned, from the timing of the sales -- Roger and Steve -- to 67%.

So right there you can see the generic -- so called generic or commodity percentages continuing to move and contract pretty dramatically.

All right.

Thank you very much.

Thank you, John.

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

Please proceed.

Thanks.

Hi, good morning.

So I wanted to follow up on Craig's question about just the development pipeline and the starts for next year.

I guess if I'm understanding the comments correctly from Roger and Rand, it's -- the development that will be started as you kind of go into next year, if we get the continuing resolutions that happen again, I mean, will the leasing -- I guess the pace of leasing, is the expectation that it'll get kind of delayed in '12 the way that it's been in '11?

And are you guys kind of comfortable with that in '12 just given that there is a pent-up demand and it's just a timing issue?

Or do you think you can adjust the level of starts to maybe have less delayed leasing as you go into '12?

I think, Brendan, it will be somewhat cyclical and fall into a similar pattern where we'll get a -- so we think we'll get a surge of leasing the balance of this year.

That would bring up the percentage of lease under construction to our historically pretty healthy levels.

And that then requires that new buildings get started to meet the continued demand.

We don't expect then that the first half of 2012 would have a lot of leasing on those projects.

But that's fine because they're just -- they will have just started and they'll be underway.

And we do think then the second half of '12, you'll catch back up as the continuing resolution is finished, the budget is finished in mid '12 and they start once again executing contracts and awarding leases.

So, I think it's somewhat into that pattern.

It's unfortunate that the government can't get their act together.

But it doesn't affect us that much.

And some people have -- in other sectors have commented well, they're worried about the overall demand, I think because of our niche with the government and because of the four BRAC locations that have to move as I detailed in my comments, we think we're pretty uniquely protected and should experience continued strong demand, albeit it might be cyclical within a year.

Okay, that's helpful.

And then -- I mean, is there any concern or any consideration that the budget and the -- just kind of the scale-back may put a little bit of pressure on the contractor margins and then in turn, that could put a little bit of pressure on the yields or on the lease rates that you guys are getting?

Or do you still feel pretty comfortable that the returns on the new development will be in the, kind of, 10% to 11% cash-on-cash yield?

No, I don't think it's really affecting our yields.

And thankfully, the construction cost, Wayne and his team do a very good job at keeping that down.

So we are able to continue to increase the rental rates.

And there really are no concessions in the development of the construction.

So I think we're in good shape there.

I think the overhang of the potential budget cuts in the Department of Defense and the military, which relate primarily to weapons or support contractors, that does affect the psyche of the contractors.

It doesn't affect the contracts where we're dealing, but it does affect the overall sort of viability and growth of the companies.

And so the side effect of that, I think we've commented on the last call, is that they're a little more cautious to make decisions.

They want to have leases executed as opposed to going speculatively on that.

And yet they have this dilemma where once they've executed it, they need to be operationally within 6 months.

And so that's why we have to pre-suppose and kind of anticipate their requirements and build ahead of that schedule because it takes us a year to build buildings and another 6 months to a year to outfit them.

But we don't see a decrease per se in our particular sector.

If you were dealing in the weaponry or in the actual support of the force sizes, like some of the defense contracts are doing, directly supporting Iraq and Afghanistan, there you could expect, over the next several years, to see some reduction in their contracts.

But that will have really very minimal impact on us.

Okay, that's helpful.

And then just lastly, Steve, the guidance, if I strip out the $0.13 in Q2, I think that brings the number to kind of $0.49 to $0.52, or call it $0.50 or $0.51 at the midpoint.

That would imply, just to get to the midpoint of your overall guidance, that the fourth quarter is probably somewhere around $0.57 to $0.58 a share of FFO without any big KEYW gains in there.

What -- is that increase just driven by the signing on the leases on the development pipeline and the NOI coming online in the fourth quarter or is there something else that would drive that number up?

There's definitely improved occupancy.

But also, if you look at our pattern, the third quarter, from an operating expense standpoint seasonally, has a little bit higher level of net operating expenses because of the heat wave that we've anticipated, a little bit higher electricity cost in the third quarter relative to the fourth.

Okay, great.

Thank you.

Our next question comes from the line of Michael Knott with Green Street Advisors.

Please proceed.

Hey, Steve.

I was just curious if you had kind of a ballpark same-store number if the 2 million feet or so of shrinkage from last quarter or this quarter was included.

Michael, we analyze that [and] there really wasn't much of a change between the new same-store portfolio composition and the old.

And our occupancy actually went up as you can see quarter-over-quarter, and it actually went up some in the portfolio that will be divested.

And then, Rand, on your comments about the '12 budget going to continuing resolution, does that -- should the inference be then that you would expect another slow patch in say first part of '12 like happened this year with this year's impasse in the spring?

If you do have -- Michael, if you have the continuing resolution then where you would normally have a pretty steady flow of both government and contractor leasing, yes, we would expect that the first part of the year, as it relates to new commitments, would be somewhat slower and then you'd catch that back up in the second part.

But we would have very strong momentum carrying into that year and into the first part of the year from leasing that will have occurred as a result of people -- contractors and government trying to hurry to get commitments in before September 30.

So the government, they have to sign leases to commit.

And on the contractor side, they have to sign contracts.

Contractors then go out seeking space.

And so we'll get the balance of the next 6 months after that leasing related to the '11 budget.

And then we've got to of course get them in occupancy, and that will boost the NOI related to that.

So I think the impact will be a little less than this year, but still there somewhat in the similar pattern.

Okay.

Thank you.

Our next question comes from the line of Nicholas Yulico with Macquarie Capital.

Please proceed.

Hi, thanks.

What was the TIs and free rent on the second quarter leases and where are they trending in the marketplace today?

TIs averaged $13 per square foot for our renewed and re-tenanted space.

And in terms of free rent, our average free rent was less than a month for the leases that we signed during the second quarter.

Okay.

And how does that compare to recent quarters?

The $13 is higher than what we experienced in the 2008, '09 and '10 period.

It's down off of last quarter.

On a per square foot basis it works out to about $2.75 per square foot of lease year.

That's lower than the first quarter and about the same as the last three quarters of last year.

So I don't think it's getting worse.

But I think it's still going to be a little more time before we see some improvement there.

Okay.

And on the assets held for sale on the balance sheet, does that include all of the assets targeted for sale?

No, it's just the ones that we think will sell in the next -- really the balance of this year.

Okay.

So that's -- so their listed at more than the $55 million sale that you expect this year?

I'm just -- is that right or -- I'm trying to--

Well, included in there is the warehouse condominiums that Steve mentioned.

And so that's why it's an elevated number.

And that'll probably take the balance of this year to sell.

Okay, thanks.

That's all I have.

Our next question is from the line of Sri Nagarajan with FBR.

Please proceed.

Thanks.

Roger, just following on your remarks of accelerating the disposition plan, obviously, is there significant leasing goals that you need to get rid of and to come to in terms of getting rid of these assets, specifically with the commentary that we're hearing that obviously prospective buyers are interested more in stable assets versus value-add assets?

Thanks.

Sure.

The $120 million that I mentioned of assets that we're either getting unsolicited offers on or in the [market] somehow do not require that we do additional leasing.

We think we're in a position to move those pretty quickly.

And most of those are relatively stable.

They had a little bit of leasing opportunity for a prospective buyer, but we're not selling them at 70% or 75% leased.

Thanks.

That's helpful.

Our next question is from the line of Dave Rodgers with RBC Capital Markets.

Please proceed.

Hey, good morning.

Steve, a question on the data center.

Following the '11 budget approval, have you seen better traction there?

Thank you for the guidance on full year NOI contribution from data.

But given your thoughts about the 2012 budget, can you kind of give us thoughts about the ability to stabilize that going into 2013, how the budget resolution this next year might impact that leasing?

Well, I would say similar to -- as Roger described at some of the parks where we have activity, we've seen an increase in multiple trip activity at the data center, but has not resulted in signed leases right now.

I do -- we are hopeful that some of that will turn into leases as we get into early '12 just from the activity that's already circling.

In terms of new requirements that might come, it might have the same kind of lumpiness during in 2012 as Rand described for additional demand beyond that, which is circling right now.

Do you have any additional plans to build out more space there at that facility?

What we've done is try to build some capacity ahead of demand so that we're touring and can get people in.

So we have 6 -- at the end of the second quarter, we delivered and have 6 megawatts available and plan to add -- I mean, a total, of which 3 megawatts is [leased] plan to add another 3 megawatts by the end of the year.

And that's what's been in all our numbers and projections and costs and all.

Okay, great.

And then, Roger, a question on the acquisitions that you looked at.

I think both you and Rand had maybe said that you were getting outbid in the market.

Can you give us a sense of what you were looking at, core or super-core assets, were these assets contiguous with existing parks or facilities that you have?

Just a little more color would be interesting.

Yes.

They were in markets that we're already in and they were leased to our super-core tenants.

And they went for cap rates that were in the 6% something range and with IRRs that we felt were in the 7% and something range.

And we thought at the end of the day, we're value creators.

We're not about trying to arbitrage money.

And so we didn't pursue those opportunities.

But I think as people start to get their pricing, more assets will come to market.

And because we're always in the market, a few things will find their way to COPT.

Great.

Last question then, I go back to Steve, on your debt refinancings on the line of credit, did you have any color to provide on the costs or where the direction might be for fees, et cetera?

Sure.

Well, at today's leverage levels, we would expect pricing to be at 200 basis points over LIBOR, versus the 95 that we're borrowing at today.

Okay.

Thank you.

Thanks, Dave.

Our next question is from the line of Chris Lucas with Robert W.

Baird.

Please proceed.

Good morning.

Just a couple of follow-up questions.

Steve, on the data center activity, there have been, I guess, closures among the various federal facilities and obviously more slated to close.

Are you -- have you seen any awards that reflect that activity at this point or is that still in the shopping stage?

I think there's some shopping going on that we're lining up to participate and trying to fulfill some of the needs.

We also had some government tours among the activity, even at Power Loft along with contractors, along with commercial demand there.

Okay.

And then just can you give us a sense as to what the -- on the assets that are put into the discontinued operations, what the level of NOI that is for the quarter?

I don't have -- do you have that?

I don't have that with me, Chris.

Okay.

We can follow up on that.

Okay.

And then, Wayne, it sounded like you were shifting the product mix at Redstone a little bit.

I guess if you could maybe provide some color on how you're thinking about the demand there and whether they're a little more price sensitive than maybe the original thinking.

Chris, we've added -- to the portfolios I described, I wouldn't necessarily characterize that as a shift at all.

I think we still feel strongly about the role that the traditional suburban office will play in that market.

So we've added the single-story flex product.

But the portfolio, the plan still has a significant suburban multi-story component to it, which we think will do quite well.

And I think the margins are holding up well.

Certainly, with new product, we're really the only ones with any new product coming on the market and we'll be at the high end of that market comparable to the most recent new buildings.

And when you have a large park like that, approaching 5 million square feet, I think you want to have multiple price points.

There are some contractors who have a different kind of requirements that don't fit as well on the multi-story high Class A office buildings that will work well.

We also are in discussions on -- behind the fence on some security, [TFP] facilities that will be also a different kind of requirements.

So --

Yes, Chris, the plan has always had that flex product in it.

We just have moved to it to give ourselves some diversity in the market.

Okay, great.

Thanks guys.

Thank you.

(Operator Instructions).

Our next question is from the line of Steve Sakwa with ISI Group.

Please proceed.

Hi, it's Steve Sakwa.

Good morning.

This is for Steve Riffee.

I just want to make sure I understand.

Three numbers, in terms of fiscal year, full year '11, term fees, stock sale and then land sale gains, I just want to make sure I have those down for the full year.

All right.

Let's see if I can address them.

The term fees, we've only had $340,000 year-to-date and are projecting $1.5 million for the second half of the year.

And we would just typically split it in half and say $750,000 a quarter.

In terms of the KEYW gain, so everything that I've reported that we've done year-to-date -- which was $5.2 million -- happened through 6 months.

Then Rand resigned from their board on July 1.

So we've moved from equity accounting from -- because of the criteria of significant influence, to mark-to-market accounting.

And so it now is -- depends on the change in their stock price.

And I gave you a calculation -- I'm looking for the basis here -- that if you take the stock price last night, it would be -- minus our basis, it would be $0.13.

And our basis is on 2.6 million shares.

It's $7.45 a share.

So we just put that gain locked in at both ends of our range of guidance and we'll just report the actual results based on that.

But your expectation is to sell all that by the end of this year.

Well, what we've done is we suspended the 10b5-1 plan as of the beginning of the quarter.

And then 90 days after Rand's resignation, which I believe was July 1, then he is no longer deemed an insider, which allows us to execute sales more freely than under the restrictions of a 10b5-1 plan.

So we therefore plan not to sell during the 90-day period, which is this next quarter, and then be in the -- capable of being in the market to continue to sell shares.

And I don't think, Steve, that necessarily presumes that we would sell all of it before year-end.

Oh, and then land sale, let's see.

Well that would make up the balance of the $18 million to $20 million that I gave.

Let me do the math here.

$2.5 million year-to-date.

$2.5 million.

Yes.

Year-to-date.

Okay.

Our next question is a followup from the line of John Guinee with Stifel.

Please proceed.

John Guinee again.

(inaudible).

I hadn't anticipated asking this.

But basically what you guys are saying in response to the previous question, if you add up your lease term fees year-to-date, your KEYW $5.2 million and land sales, you basically have booked, in other income, $8 million.

And you have another, I guess, $10 million of mark-to-market for KEYW and another $1.5 million for lease term fees?

That's right.

Okay.

Those numbers make sense.

Okay.

All right, Rand, just out of curiosity, you're a pretty smart guy.

Why are you leaving the board of this company?

Well I think as they -- we invested early on when they were in the formative stages.

And we -- Len Moodispaw from his previous ramp-up at Essex, and I have a lot of confidence in him.

So I think our primary role was to give guidance to help them get public.

That's been accomplished.

I think increasingly, the demands of time of that board, I just didn't want to spend the time there.

I think that they viewed it as they were anxious to make sure that I got off the board.

And sometimes, when you're the largest owner in the company sitting there on the board, sometimes that can be potentially a concern for them.

And so we were able to just, on a very friendly basis, separate off.

It doesn't mean we don't have influence as the largest owner, but I'm just not involved in [the] board activities.

And we do think it does give us a little bit more freedom, not being an insider.

Great.

Thank you.

Thanks, John.

Our next question comes from the line of Michael Knott with Green Street Advisors.

Hey, Rand, you've obviously been leading this company day-to-day for a long time.

And as you think about retiring potentially next year, is being Chairman something that you would be personally interested in?

And if so, is that or shouldn't that be something that's on the table at the board meeting when this topic is discussed?

Well I think, first off, I -- it is my expectation that if I do, if and when I retire, I would continue to be active on the Board and play a meaningful role.

I think it's up to the Board and the dynamics of that certainly as to whether or not they would want to move me into that position.

I don't think I'm in a position to speculate on those dynamics.

I think I can play a meaningful role and help the company irregardless of what title I have on the Board.

And certainly, we've worked very hard as a team on succession planning.

We think we're in great shape if and when that occurs.

And so I think you'll see continued strong performance from the company, accelerating really out into the future.

Thank you.

Thanks.

Our final question is a followup from the line of Brendan Maiorana with Wells Fargo.

Please proceed.

Thanks.

Just a quick one for Steve just to follow up on a couple of previous questions, so I guess if I'm looking at the numbers correctly on guidance, it seems like the additional $0.07 a share related to the higher other income, which is primarily KEYW, mark-to-market, that's effectively pulling forward the gain on that, on your basis relative to where the share price is into 2011, whereas the prior expectation was that all of that was not going to be sold in 2011 and would be recognized in '12.

That's correct.

It would --

Okay.

All right, great.

I mean that's the effect of it.

Yes, yes.

So -- okay.

I mean, obviously, if those shares keep going up, you guys will recognize more in the latter half of the year into '12.

But, okay, if it's the same, then no gains into 2012.

Yes, you understand how it works.

Okay, great.

Thank you.

Thank you.

Thank you.

That concludes our question-and-answer session.

I would now like to turn the call back to Mr.

Griffin for closing remarks.

Well thank you very much.

We appreciate it.

And we are available for any additional calls or questions you might have.

And we look forward to our next call at the end of October.

Thank you for your participation today in the Corporate Office Properties Trust's second quarter 2011 earnings conference call.

This concludes the presentation.

You may now disconnect, and good day.