COPT Defense Properties (CDP) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Corporate Office Properties Trust fourth-quarter and year-end 2012 earnings conference call.

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

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

Ms. Krewson, please go ahead.

Thank you, Latasha.

Good afternoon, and welcome to COPT's conference call to discuss the company's fourth-quarter and year-end 2012 results.

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

As management discusses guidance for GAAP and non-GAAP measures, you'll find a reconciliation of such financial measures in the press release issued earlier this morning and under the Investor Relations section of our website.

At the conclusion of management's remarks the call will be opened up for your questions.

Before turning the call over to management, let me remind you certain statements made during this call regarding anticipated 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 release space under favorable terms, regulatory changes, changes in the economy, the successful and timely completion of dispositions, acquisitions and development projects, changes in interest rates, and other risks associated with the commercial real estate business, as detailed in our filings with the SEC.

I will now turn the call over to Roger.

Thank you, Stephanie, and good afternoon, everyone.

2012 was a year of strong execution by the COPT team, and of outperforming our Company goals, which were to lease space, to sell non-strategic assets, to continue making disciplined capital allocation decisions, and to improve our financial flexibility.

On the leasing front, 2012 was the best year in the Company's history as measured by the 1.2 million square feet of development leasing, 675,000 of which was leased to strategic tenants in our government defense IT niche.

The fact that we achieved a record volume of development leasing during a time when customers in the defense IT niche continue to operate in such an uncertain budgetary environment is, in our view, validation of our decision to concentrate our Business around serving this specialized niche.

The government agencies conducting intelligence in cyber activities, and many of the contractors supporting them, need to lease a strategically located space, despite budgetary uncertainties.

In terms of selling non-strategic assets, during 2012 we disposed of 35 buildings containing 2.3 million square feet for an aggregate value of over $310 million.

Our average exit cap rate on these transactions was 8%.

To date, we have disposed of nearly $400 million of the $512 million of properties in the strategic reallocation plan, or SRP.

We also made progress in titling land that represents an additional $50 million of the SRP, and expect to sell as much as $20 million of it in 2013.

In terms of making disciplined capital allocation decisions that enhance both our franchise related to our strategic tenant niche, and the quality of our future earnings, we recycled sale proceeds into development projects with tangible demand, as evidenced by the four build-to-suit transactions we executed in 2012, and investments in key locations such as our parks serving Fort Meade, and Annapolis Junction, Maryland, our Patriot Ridge project that supports Fort Belvoir in northern Virginia and our Redstone Gateway project where we are currently constructing a three building local headquarters complex for Boeing.

These and other projects that are adjacent to critical government demand drivers have a clear competitive advantage over other locations in their sub-markets.

We also recycled sale proceeds into McLaren Center, a highly strategic 200,000 square foot Class A office building located in the Herndon sub-market of Northern Virginia.

The building is located in close proximity to government demand drivers in this strategic market, and is 100% leased.

During 2012, we executed several initiatives designed to improve our balance sheet flexibility and capital structure with the capital we raised in the debt and equity markets, and with proceeds from asset sales, we decreased our total debt outstanding by over $400 million and redeemed $55 million of 8%-yielding preferred stock.

As a result, we lowered our debt to gross asset value ratio from 49.8% at the beginning of 2012 to 42.7% by year-end, and improved our debt to adjusted EBITDA ratio from 8.6 times in 2011 to 7.1 times for 2012.

In summary, 2012 was a transformative year for the Company.

The strategic initiatives we accomplished have strengthened our platform, so that in 2013, we will complete the reset of our Company's portfolio and earnings and be in a position to grow NAV and FFO.

Lastly, I'll summarize our current thinking about the Federal budget issues.

Not a lot has changed since we spoke on our January 15th call, but I will discuss the three possible outcomes.

First, sequestration, mandated by the 2011 Budget Control Act could go into effect as written, triggering across-the-board cuts, including roughly $50 billion of annual reductions to the DoD, which would lower the base budget and eat into the current fiscal year base budget of $527 million.

Second, Congress could kick the can down the road another few months to allow more time to negotiate.

This option would be a de facto spending cut, as the current continuing resolution already has resulted in lower government and defense spending, because the continuing resolution limits the flexibility of the use of funds.

Third, a grand bargain, which we believe would result in moderately lower defense spending, creating certainty and not materially impacting our strategic customer segment.

Given that March 1 is only three weeks away, we believe scenarios one or two are the most likely.

Until a grand bargain on spending is reached we expect our Company and many others will have to endure a lot of headline noise while the Federal budgetary issues are debated.

Furthermore, our tenants have been operating under four years of continuing resolutions rather than budgets, so if Congress kicks the can again, that outcome would not represent a change in the way business has been done.

Although business is not easy to win, we have managed to do pretty well, including our record leasing achievements in 2012.

If sequestration were to go into effect, we believe it would be only for a few months, enough time to force serious and responsible budget cutting decisions to be made.

Under this scenario, leasing would become more challenging, but our franchise will still be intact.

Our confidence stems from the fact that we have shed most of the non-strategic properties that acted as a drag on our past results.

The portfolio we now have is both lean and well aligned with demand drivers that support missions the nation cannot afford to cut, or at least not cut materially.

Finally, whenever a grand bargain is struck, we certainly are prepared to handle the additional flow of demand for space that would likely follow over time.

Until that longer-term solution is reached, we'll focus on what we can control, which is to be the preferred provider of real estate solutions to the government and defense IT communities.

We feel strongly about our competitive position, regardless of the outcome.

With that, I'll turn things over to Steve Riffee to discuss our 2012 results.

Steve?

Thanks, Roger, and good afternoon, everyone.

Before reviewing our 2012 results, I'd like to highlight one new disclosure item that relates to expense reclassification.

In order to conform our property operating expense and G&A line items to industry standard, and to further improve our disclosure on the components of our corporate overhead, we reclassified certain operating expenses during 2012.

In the first quarter of 2012, we reclassified land carry costs from property operating expense into the G&A line, called business development expenses and land carry costs.

We completed our expense reclassification process in the fourth quarter, by allocating expenses of our leasing and marketing teams to G&A, and now present them in the line item entitled leasing expenses for all periods presenting.

Owing to these reclassifications, investors now have a clear line of sight on the Company's NOI margins and the overhead associated with our Business.

Now, turning to our 2012 results.

FFO as adjusted for comparability for the full year-ended December 31, 2012, was $190.5 million, or $2.11 per diluted share, representing a 1% decrease on a per-share basis from the $2.14 per diluted share, or $177.7 million of FFO for 2011.

The decrease in FFO per share versus 2011 was due to the dilutive effects of selling non-strategic properties, and the higher share count.

2012 FFO per share, as defined by NAREIT was $2.13 as compared to $0.72 in 2011.

For 2012, we reported a net loss attributable to common shareholders of $1.7 million and diluted loss per share of $0.03 compared to a net loss of $135.5 million and a loss per share of $1.97 for 2011.

At December 31, 2012, our same office portfolio included 177 properties, representing 84% of our total consolidated square feet.

The 177 properties were fully operational in both 2011 and 2012 and exclude our project in Blue Bell, Pennsylvania and the properties that were part of the strategic reallocation plan.

For the year, and excluding gross lease termination fees, same-office cash NOI increased by $5.9 million or 2.3% for 2011.

Including gross lease termination fees, same-office property cash NOI increased by $7.1 million or 2.8%.

Same-office occupancy averaged 88.6% during 2012 compared to 89.1% for 2011 and ended 2012 at 89.1%.

For the fourth quarter of 2012, same-office occupancy averaged 88.8%, which was only 10 basis points below the fourth-quarter average in 2011.

In the fourth quarter, same-office cash NOI excluding lease termination fees decreased by 1.4% over the fourth quarter of 2011.

Including gross lease termination fees, same-office property cash NOI decreased 0.7% from the prior-year fourth quarter.

These same-office NOI results were impacted by a $1.4 million rent prepayment received in the fourth quarter of 2011.

Adjusting for this rent prepayment, same office cash NOI, excluding lease termination fees, for the fourth quarter, actually increased 0.8%.

Adjusting for this rent prepayment and an additional large prepayment received in the third quarter of 2011, annual same office cash NOI, excluding lease termination fees, increased 4.4%.

Within the same-office pool, buildings that are adjacent to government demand drivers, as well as those primarily leased to government and defense IT tenants, represented 74% of the total same-office cash NOI, and were 93.6% occupied on average, and ended the year 95.4% leased.

Turning to the balance sheet, as of December 31, the Company had a total market cap of $4.5 billion, with $2 billion of debt outstanding.

At year-end, 80% of our total debt was at fixed interest rates, and our weighted average cost of debt was 4.4%.

Our debt to gross asset value ratio, as calculated according to our bank loan covenants, was 42.7% at the end of 2012, down 7.1 percentage points from its year-end 2011 level.

Our debt maturities remain manageable with approximately $105 million of debt maturing in the remainder of 2013, and $160 million maturing in 2014, and as I discussed on our 2013 guidance call, we expect to issue at least $250 million of long-term debt in 2013 to extend our debt maturities ladder.

Last but not least, in this morning's press release, we have affirmed our previously issued guidance for 2013 diluted FFO per share of between $1.83 and $1.93.

As a reminder, the $1.88 midpoint of our FFO per share guidance range is our base case.

We currently only have $17.3 million of revenue at risk, down from the $19.5 million that was at risk on our January 15th call, and of the $17.3 million, $12.9 million is in various stages of negotiation.

Our guidance is built on the fact that we have 24 tenants that lease 25,000 or more square feet from us and whose leases expire this year.

These 24 tenants aggregate 1.65 million square feet, or 67% of all 2013 lease expirations.

As of today, we have a high degree of confidence that 78% of them are going to renew.

We also know that 13% are going to move out, including the two Ciena buildings at Airport Square totaling 164,000 square feet, leaving only 9% of these lease renewals this year, where the tenant is undecided.

And with that, I'll now turn the call over to Steve Budorick.

Thanks, Steve, and good morning, everyone.

Market conditions in Greater Washington DC and Baltimore region continue to be challenging, with vacancies in the 15% range and sluggish overall demand.

The Federal budget impasse and the threat of sequestration continue to drive caution, consolidation, and short-term behaviors in tenant decisions, particularly from the larger more diversified defense contractors.

Notwithstanding these overall conditions, northern Virginia, suburban Maryland and Baltimore markets each experienced positive absorption in the fourth quarter, and the Maryland markets experienced mildly positive absorption for the full year 2012.

A thorough analysis of the statistics reveals that each of these major markets have sub-markets that are experiencing disproportionate leasing success and tenants migrating to higher-quality opportunities and toward demand drivers.

The sub-markets adjacent to Fort Meade have tightened, and we're experiencing steady demand, scarcity of large blocks of available space, and positive GAAP and cash rent spreads on renewals during the fourth quarter.

The cyber command activity at Fort Meade continues to drive demand from small, mid size and large contractors who are receiving contract awards.

At the National Business Park, we signed a 58,000 square foot lease after year-end, with a cyber contractor for all of the remaining vacancy at MBP410, which brought the property to 100% leased and the park to over 99% leased.

In Virginia, concessions remain high but we have realized reasonably strong demand in Tyson's Corner, Westfield and Springfield sub-markets, once again confirming the validity of our strategy to invest in properties adjacent to knowledge-based defense IT demand drivers.

We expect that overall conditions in the region will remain challenging, as Congress grapples with the fiscal dilemma.

However, we also have good visibility to additional demand in many of our sub-markets, and we remain confident we will achieve continued leasing success in coming quarters.

In terms of COPT's properties, our consolidated operating portfolio occupancy increased 160 basis points during the year to end 2012 at 87.8%.

We attribute the increase in occupancy to disposing of non-strategic properties, that on average, were 82.7% occupied and to the impressive volume of leasing achieved.

During the year, we leased 3.3 million square feet, including 1.2 million square feet of new leases at our construction and redevelopment projects.

As Roger mentioned, despite the budget condition or uncertainties in DC, approximately 675,000 square feet of our development leasing was to strategic tenants, and the Government Defense IT niche.

Our leasing statistics for the fourth quarter and the full year are detailed on pages 17 and 18 of our supplement, but let me mention a few things worth highlighting.

First, we have simplified our leasing presentation into three basic categories.

Renewing leases, development and redevelopment leases, and other new leases representing leases signed for vacant space that we acquired and/or second-generation space that has been retenanted.

Also, on renewing leases, we now provide the GAAP and cash rents for the expiring and renewing leases.

This spread should serve as a better proxy for a mark-to-market analysis.

Having said that, here is some color behind the fourth-quarter leasing stats.

The renewal rate for the fourth quarter in our in-service portfolio was 86%.

The average length of renewing leases signed in the Baltimore Washington corridor and in Colorado Springs averaged roughly five years.

The overall fourth quarter renewal lease term was skewed by two tenants that executed short-term renewals, the 220,000 square foot user in northern Virginia and 100,000 square foot user in St.

Mary's County.

This is a short-term tenant reaction to the Federal budget uncertainty.

Excluding the effect of these two large renewals, the weighted average term of renewing leases in our fourth quarter was 3.2 years, and for the year, was 4.0 years.

The impact of the short-term renewal activity is threefold.

First, the shorter leases require minimal leasing costs.

Second, our 2014 and 2015 lease expirations reflect slightly higher rollover levels than a year ago, and third, we have a higher percentage of northern Virginia leases to negotiate in 2014.

However, 70% of our 2013 rollover is in the Baltimore Washington corridor, where we have the best pricing power relative to other sub-markets.

One final thing to note about the fourth quarter leasing is the 342,000 square feet of new leasing executed in northern Virginia.

The majority of this activity related to the two data center build-to-suit deals in Ashburn we signed late last year.

Those leases are triple net and we're obligated to deliver only shell buildings.

Accordingly the leasing costs per square foot on these deals and the rental rates are much lower than our average office deal.

For 2012, our cash roll down on renewing leases was 4% which was in line with our expectations laid out a year ago.

Looking at the fourth quarter, cash rents on renewing leases actually rolled up 1%, owing to the 7.9% cash roll-ups we achieved in the Baltimore Washington corridor, modest roll-ups on the 250,000 square feet we renewed in northern Virginia and 1.7% cash increases we realized on 110,000 square feet of renewing space in St.

Mary's and King George's County.

A final comment on our leasing in 2012 involves capital spending.

Consistent with past years, our Company once again managed to lease space with some of the lowest capital commitments in the office sector.

For the full year, our average committed cost per square foot lease of only $6.35 compares favorably to our office REIT peers' leasing costs.

Our ability to manage our leasing costs continues to enable us to invest more proactively in building improvements, which bolsters future leasing efforts and gets us ahead on our three-year capital plan.

So in the fourth quarter of 2012, you will also notice an increase in our quarterly CapEx, which is associated with our accelerating some of the capital spending.

Turning to COPT DC 6, our wholesale data center in Manassas, Virginia we continue to track significant wholesale demand, and the users behind that demand continue to be methodical in their decision-making.

The wholesale demand in the market today represents more than 133% of the remaining capacity of our facility.

The supply and balance in northern Virginia has improved and there's currently 11 megawatts of competitive supply available, reduced from 33 megawatts in mid-2012.

During the fourth quarter of 2012, we initiated a program to provide a co-location leasing structure to augment our wholesale offering, in order to provide an effective solution to a more active demand segment in the data market, which includes many defense contractors and government requirements.

We're encouraged by the interest we are experiencing from the defense and government contractor segment, and our high-density capability is a competitive advantage in this segment.

In January, we executed our first co-location transaction, with a high credit international commercial tenant providing an initial deployment of 120-kilowatts, scalable to 300-kilowatts at tenant's option.

This tenant's initial deployment is configured at a high density of 175 watts per square foot and we're working with additional prospects to provide deployment scaled above 250 watts per square foot.

We continue to be optimistic regarding both our wholesale and our co-location leasing opportunities as we progress in the 2013.

With that, I'll turn the call over to Wayne.

Thanks, Steve.

Before discussing our major projects, I'd like to highlight a change we made to our supplemental disclosure, related to land and pre-construction costs which are presented on page 27.

We have separated out the non-strategic land and provided the associated book values.

These book values include infrastructure and other pre construction costs, which do add value for future development or resale purposes, and in the case of our strategic parks keep us well positioned to respond quickly when new demand for office space materializes.

Some of the non-strategic land was in the SRP and we intend to dispose of it as opportunities present themselves over the next several years.

In the meantime, we believe this additional disclosure will help you firm up your valuations of our Company.

Having said that, I'll now provide a quick recap of our 2012 activity, and touch on our current development pipeline for 2013.

During 2012, we completed shell construction on five buildings, including one redevelopment, aggregating to 624,000 square feet and representing $148 million of value.

At year-end, these five buildings were 62% leased.

During the year, three office development properties were fully placed into service, including two properties at MBP.

These three properties contain 348,000 square feet, representing a total projected investment of $76.6 million of stabilization, and are 59% leased as of January 31, 2013.

As we begin 2013, our pipeline is 66% pre-leased, and only four buildings have uncommitted space.

One of these four buildings is a small flex property we recently completed at Redstone Gateway where there has been demonstrated demand for this product type.

The second one is our initial building at Patriot Ridge in Springfield, Virginia which is now 49% leased.

We see good interest in the market from contractors supporting the National Geospatial Intelligence Agency.

The other two uncommitted buildings are at MBP.

The first building, MBP312, is adjacent to our secure campus and therefore targeted for government use.

The second building, MBP420, will be delivered to the market in the second quarter.

Now that our latest building to deliver, MBP410, is 100% leased we are directing interest from our contractor base to MBP420.

Given the strong, fairly steady demand generated by Fort Meade and the cyber initiatives, we believe our investment in MBP312 and 420 will generate attractive returns.

In closing, I would like to highlight the strong demand driven build-to-suit activity we closed in the fourth quarter.

As previously announced, we have commenced construction on four new base building projects which are fully leased to high-quality credit customers in strategic markets.

Two of these properties are in Huntsville, Alabama, and two are located in Ashburn, Virginia.

We believe the build-to-suit activity, as well as the pre-leasing achieved in the rest of the pipeline, demonstrate our commitment and ability to derisk our Development business while still providing attractive returns to our shareholders.

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

Thanks, Wayne.

Let me conclude by highlighting our leasing situation.

In terms of square feet that are leased but not yet occupied, our in-service portfolio has 263,000 square feet of leased space that will begin cash flowing this year.

We have more than 900,000 square feet of development and redevelopment space that is pre-leased, and which will begin cash flowing later this year or in 2014.

That leaves us only 575,000 square feet of development space to be leased in our development and redevelopment pipelines.

We currently are tracking over 500,000 square feet of development demand in our markets.

It's these supply and demand fundamentals, combined with the value our franchise provides for our customers, that gives us confidence about the Company's ability to execute our plan in 2013.

I'm not saying things will be easy.

We are expecting turbulence on the government defense spending front while the budget issues are negotiated and hopefully resolved, but we also expect 2013 to present us with plenty of opportunity, in particular because one piece of certainty that Washington D.C. DC is able to project is that cyber defense and the intelligence aspects of national security are and will remain top priorities for the DoD.

For 2013, we are clear about our mandate, finish what we started, work hard to capture new demand in our markets, and position the Company for growth.

With that, operator, please open up the call for questions.

(Operator Instructions)

Your first question comes from the line of Brendan with Wells Fargo.

Please proceed.

So, Steve Riffee, just wanted to start with you.

I appreciate the commentary about the leasing expenses being reclassified.

I was just hopeful that you could provide a little bit more color about the nature of these expenses, and why it's appropriate to have them as corporate expenses and not operating expenses.

Well, they're, in essence, the cost of internal personnel for unsuccessful leasing.

So, what our team finished was a study, and concluded that most REITs now classify those leasing costs in G&A, so we've made that reclass, put them on a separate line item so you can see them for leasing purposes.

So it would be the cost of internal space design people and leasing people for deals that don't go through and those get expensed.

Otherwise successful leases are capitalized and amortized over the lease.

Okay, so there's leasing personnel in there, but to the extent that they pursue leases that aren't successful it goes in that line, but the leasing commissions -- any internal leasing commissions or salary would get allocated to the operating expense line?

No.

All internal leasing costs are either capitalized as part of the successful lease, or they're expensed.

And, what we've done is break out anything that's expensed for an unsuccessful lease and put it on a separate line item.

Okay, that's helpful.

Thank you.

The second question I had was for Wayne.

The land allocation, I do think that's helpful looking at that.

If I look at the breakout of your strategic land, there's 1.8 million square feet of NBP, that's about 15% of your total developable land.

It strikes me that, that's probably a much higher percentage of that total cost.

Do you have a sense of how much the cost is related to the NBP land?

No, I think be would have to get back to you with that answer, Brendan.

Or maybe if I could put it in a different way, if you guys look at development projects that you do there and you think about the stabilized value of those assets upon stabilization, what does that imply for the land value underneath -- the land value per square foot underneath those buildings?

Brendan, it's Roger.

I think the land for NBP, given what land for instance sells at Columbia Gateway Business Park, which is seven miles away, and does participate in the government contractor business at Fort Meade, would -- considering land here sells for $35 to $40 a foot I think the NBP land would probably be $50 or so.

Our allocation is approximately $30 a square foot at the National Business Park.

But it's a little misleading in that it includes moneys we spent to design some buildings and get permits and it also includes a little bit of a parking garage for future building.

So, embedded in our land values are other costs other than specifically land.

Okay, that's helpful.

And last one, Roger, you have done a really great job over the past couple of years selling the non-strategic assets and focusing more on what I think you used to call sort of super core properties.

As you look out over the next year or couple of years, what do you think that the non-defense and government-related portion of the portfolio looks like?

Is it data center, and is it something like Canton Crossing, or does that actually get down significantly less than what it is today or do you always think that's a portion of your portfolio and business?

I think by the nature that we are a sharpshooter in certain sub-markets of the Greater Washington Baltimore region, we will always have a portion of our portfolio that isn't 100% aligned with adjacency to government demand drivers or with strategic customers that support those demand drivers.

So, for instance, you're right, Canton Crossing and assets like that would be in our local sharpshooter bucket, and we think that, that will probably be about 30% of our business, with the strategic adjacency and strategic customers being about 70%.

Okay, and which bucket would the data centers fall in, the 30% or the 70%?

Well, most of our data centers are four strategic customers, and they are already embedded in the strategic bucket.

We have one data center outside of that.

Sure.

Okay, thanks.

Your next question comes from the line of Josh Attie with Citi.

Please proceed.

I know you changed the presentation and the supplemental, but can you tell us what the cash rent spreads would have been on the re-tenanted space in the fourth quarter?

Josh, we don't have that broken out.

I think we could go back and calculate it and talk to you but we're just taking the re-tenanted space and we're lumping it in with the vacant space that we acquired, and treating that as other new leasing.

Okay, so you don't have that number separately?

No.

Separately, can you update us on what you think the average cash yield might be for the projects in the pipeline today?

I know composition has changed over the last few quarters, with some things being delivered and other projects being started.

Can you give us an expectation for what's in the pipeline today, what you think the initial cash yield might be?

Are you asking what the cash spreads are on a mark-to-market basis over the next year or two?

Or are you on the development?

No, no, on the development pipeline, what the cash yield you expect for the projects in the pipeline today.

Right, so this is Wayne.

We've been working towards high single digits on that.

Some of the recent data center leasing we've done is modestly below that, but we're still working towards the higher end of the range.

So like 9% to 10% do you think, or 8% to 9%?

We're over 9%, less than 10%, I would say that we average around 9.25%.

Including the data center?

Not including COPT DC6.

Just other development.

Okay, and not including the build-to-suit data center?

Including the build-to-suit data center, it wouldn't impact the 9.25% number I mentioned very much.

Okay.

And, my last question, do you expect to start additional spec development at NBP this year?

As you just spoke about that's where you have a lot of land and it sounds like you only have one more building to lease up there.

When you look out, do you see demand on the horizon that could support more development starts this year?

Well, as we've said in the past, we like to have one building that's available for commercial demand and one building that's available for government demand, which is how we're positioned today with NBP420 and NBP312.

So, it's really subject to the demand that materializes in the second half of the year.

We will be ready to start additional development there if the demand does materialize.

Okay, thank you.

Your next question comes from the line of Craig Mailman with KeyBanc.

Please proceed.

Just a quick follow-up on the comments on the build-to-suit data centers and the yields.

I'm just looking in the supplemental and the cash rents you are breaking out versus the price per square foot.

It looks like it's closer to 10, not high -- I mean is that high-single digits in your view or am I looking at that wrong?

Well, there is a few operating expenses that are embedded into the rents, and so the net, the NOI, is a high-single digit number.

Okay.

And then, just moving on to leasing.

Steve, can you just give a little bit more flesh around the color about the good visibility into additional sub-markets?

Where are you seeing best demand here?

Any specific examples you may have would be helpful.

Sure.

In the Columbia area, in and around Fort Meade, we have known tenants that have leased all the space that we can make available to them and are looking for other solutions.

In Columbia, there are tenants seeking consolidation or new offices where there is not sufficient supply to meet their requirements, so they're evaluating build-to-suit opportunities.

Additionally, in Virginia, in the Westfields market, there's a significant amount of activity interested in that market.

And, in the 2014-2015 time frame, there's active tenants representing somewhere between 1.1 million and 1.4 million square feet, looking for opportunities to plant the flag in that market.

And also down in Springfield, we have tenants we've been talking to for some time working on contracts with the NGA that we anticipate being successful, and they have -- they are planning to take space in our buildings, if and when contracts are awarded.

And then, frankly, Tyson's Corner -- there's a reasonably high amount of vacancy in the Corner, but tenants are starting to behave and look forward to the situation when the transit stations are open, and so we're getting some pretty strong interest in that building --1751 Pinnacle.

And when you say the Columbia, that's outside of NBP, right?

That's more Columbia Gateway?

Yes, Columbia Gateway, in and around the headquarters building that we occupy.

Okay.

And then, on the 70% of 2013 expirations in the BWI, how much of that is NBP, and where are rents relative to where you think you'd price them today?

I haven't really broken down by park, Craig.

I'd have to take a look at that again.

But I think if you look at our leasing statistics for the fourth quarter, you see we're getting pretty good results in that BW corridor.

Okay.

And then, just lastly, for Steve Riffee.

Can you just go through your capitalization policy?

Just as regards to the Patriot Ridge, I know part of it came online, but looks like you're capitalizing the balance of it.

Just a refresher on how you guys look at that.

On Patriot Ridge in Northern Virginia, we've got one building that's come online and the garage associated with that is online at this point.

So, Craig, the way our capitalization policy works is we capitalize on development assets to the earlier of when they're leased or one year after shell completion.

And so, that building was shell complete in September and so, in September of 2013, we will be fully expensing the costs on that asset.

Okay, great.

Thank you.

Consistent with industry policy.

Great, thank you.

Your next question comes from the line of Dave Rodgers with Robert W. Baird.

Please proceed.

Roger, in your prepared comments you talked about pent-up demand, and I think that comment was meant more as a longer-term comment.

But, I guess as you think about this year playing out, and then you tied in about 0.5 million square feet in your final comments on the call, how should we tie those numbers together?

The pent-up demand that you're seeing -- will there be a fairly sizeable chunk that comes in after any type of approvals, and how have you guys kind of modeled that in your own guidance in preparation for the year?

When we gave guidance for the year we only assumed an additional $3 million of development NOI from what we already had in place to meet our 2013 numbers.

In terms of the 500,000 square feet, that's 500,000 square feet of specific tenants that we're speaking to about space needs in our specific markets.

There's a lot of other soft interest, but we don't know how to handicap that, given the uncertainty that exists out there.

So, as Wayne said, in terms of building starts and dollars spent this year, it will depend on how soon things get resolved with the government spending situation, and then tenants come forward and are willing to sign leases.

Maybe, Steve Budorick, going back to your average lease term comments -- a year or 1.7 years of average on the renewal, you said that was two specific tenants.

If the sequestration continues to get kicked down the road for a sizeable period of time, do you see additional tenants doing this, further building up that 2014 backlog?

I'm not sure that's necessarily the fair way to look at it.

The larger of the two tenants in particular is engaged in a very complicated reassessment of the way they want to do business in the future, kind of changing their standards and the entirety of their real estate occupancy strategy.

They were simply looking for additional period of time to work through the strategic situation, and have given indication that they want to stay in the building long term, they were just unable to make a commitment or identify exactly what they needed, particularly in terms of identifying their occupancy.

The other tenant, I think that was related more to concern about contracts and the award -- the continued funding and award of contracts.

And, that's in St.

Mary's County, it's kind of a different, much more specific occupancy for a large group than one in Virginia.

So, I think occasionally, but not sweepingly, will we be running into those shorter terms.

Okay.

Last question, in Huntsville, I think, you lost a tenant that was 20,000 or 25,000 square feet, not a huge impact to the business, of course.

But, can you talk about whether there was a broader impact to any programming down there or what might have drove this move out?

Ironically, it's the same tenant that we referred to in Virginia, who's reassessing its long-term real estate strategy and densifying its occupancy.

So, they exercised the right to terminate a floor in that building.

And the good news is, that is the best building in Huntsville outside of our new development, and we have good interest on it already.

Okay, thank you.

Your next question comes from the line of Bill Crow with Raymond James.

Please proceed.

One quick big picture question for me, which is, all the budget talk and sequestration talk seems to have rekindled the idea of another round of BRAC, and it's early in the process, but can you handicap at all whether that would be a positive or a negative as you sit and look at your portfolio today?

We believe it would be a positive, and that's because the government has already relocated and consolidated many groups into the knowledge base defense installations that we're tied to.

And there's a lot of infrastructure that's been spent and we're embedded in a environment where there's a highly-educated workforce and a lot of higher education, so the infrastructure is all there.

So, we think actually the basis that we're tied to would actually be additional winners if there was a new BRAC in 2015.

Okay, just want to get out a little bit ahead of the issue in case it comes up.

That's it for me, thanks.

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

Please proceed.

Can you just revisit the prospects for selling the last $160 million in the SRP?

How much are you targeting for this year?

We're in the market to sell our Colorado Springs portfolio, which would effectively close out the SRP.

We're also, as we mentioned in our comments, getting entitlements for some of our land to retool it to retail and residential, and we hopefully see some sales from that this year.

So, the $160 million is really Colorado Springs and a little bit of land sales this year.

It sounded like some of the land will dribble out past 2013.

That's correct.

We think it's the best value proposition for the Company to reposition it for alternative uses and get a much higher value.

A definitional question on the page 27 that you pointed out, the breakout of land between strategic and non-strategic, the non-strategic has a book value of $97 million, but you're only looking to sell $50 million.

Can you help us parse through the difference?

Sure, so when we set up the SRP back in 2011, we weren't confident that we could sell $97 million worth of land before the end of 2013, so we took part of it and put it into the plan, with the balance outside of the plan.

But the goal is to try to sell that $100 million as fast as we can.

And you'd previously taken some writedowns going into the SRP, and that included some of the land, right?

That's correct.

Okay, and then kind of a housekeeping question.

Of your defense IT segment of your portfolio, what ballpark percent is cyber today, and where do you think that might go in the future?

Michael, we don't know exactly because many of the tenants do both intel work and other program work along with cyber, so it's really impossible for us to break that out exactly.

Okay, and then just going back, you pointed out that your business has been operating under the continuing resolution format for a number of years.

If you were to go back to the beginning of that period and have told yourself that there would be this stretch of no real budgets, and then all this talk about sequestration, et cetera, would you have guessed that the leasing in your business over that stretch would have been better or worse than what's actually happened?

Probably in the beginning about the same, but I think we would have been surprised for instance in 2012 that we did 1.2 million square feet of development leasing.

Okay, thanks.

Your next question comes from the line of Michael Carroll with RBC Capital markets.

Yes, since you guys prefer to have some inventory in your markets, do you have any plans to start another project in Huntsville since you only have one small flex building currently under development?

Michael, this is Wayne.

We're in the process right now of going through our development to design and have a building that's on the shelf, as was referenced earlier, we do have inventory in the market with the Bridgepoint building.

So, in combination with that and the single story, we're probably well positioned in the short term.

And, as the year unfolds, as we do in all the markets, we'll continue to monitor the demand and be ready to react accordingly.

Would you do that spec, if you thought the demand was there or would you want to have another build-to-suit kind of like the deals you're able to complete recently?

We haven't gotten to that point.

Pre-lease would be an important step for us I think.

Not necessarily 100% of the building, but a pre-lease.

Okay, and then my final question is, why were the tenant improvements or the CapEx accelerated in the quarter?

It wasn't tenant improvements.

It was base building CapEx.

We were running pretty favorable on our leasing costs in the year.

We managed that capital plan every quarter for the next 12 quarters.

We identified projects of two types that would be helpful to accelerate, since we had capacity -- one, our largely mechanical system upgrades that allow us to run more efficiently and reduce our energy costs and were in need and scheduled; and the others were opportunities to enhance the lease-ability of assets with interior upgrades, and we pulled those out of 2013 and, in some cases '14, and brought them into 2012 to gain those efficiencies and improve our ability to lease.

Okay, thank you.

Your next question comes from the line of Tayo Okusanya with Jefferies.

Please proceed.

I wanted to make sure I understand plans for land sales going forward, so it sounds like there's $97 million up for sale, but that, in 2013, you really have $20 million built in.

Is that correct?

That's correct.

So a lot of the land is not yet specifically held for sale.

It's just designated to be as non-core, non-strategic, and as we get the land entitled for residential or retail, we will sell it off, and that's going to take several years to realize.

Okay.

And of the $20 million that spills into 2013 numbers, what kind of gains do you expect from that, and if that gain number is built into guidance?

The book value should, we believe, is fine at this point.

There's no gains in guidance and we wouldn't include it in as adjusted for comparability.

Okay, that's helpful.

And then, in regards to just -- your overall liquidity at this point with the SRP sales, your line of credit, you have a massive amount of liquidity.

I'm just wondering, going forward, what could we potentially see you do with all that liquidity?

Well, we have a development plan to continue to build assets in our business parks where we have defense communities that we're creating adjacent to government demand drivers, and that will materialize as demand presents itself and then we will also look to do some selective value-add acquisitions like we did the one in 2012.

Okay, that's helpful.

And then, one for Roger.

Since we've had all the sequestration stuff pushed out to March 1, that at least a reprieve, a temporary reprieve from some of this fiscal cliff stuff come January 1, have you really seen tenants change behavior in the last 60 days, versus how they were behaving last year?

Not really.

I think its been more of the same people have felt the concern and the uncertainty for an extended period of time, so I think people have been acting about the same.

There are certain programs where contractors are deeply embedded and they know their work will continue on and they move forward, as if there's no change in circumstances.

And then there are others where they feel they're more at risk and they move slower.

Okay.

And then, between a sequestration scenario and the kind of continued resolution scenario that you described, which of those two do you think is actually better, in regards to the better scenario for you?

Well I think, again, as we said, if sequestration kicks in we don't believe it will be for a long period of time.

We do believe that the government will create an adjustment to sequestration that will allow the DOD to spend money on a targeted basis as opposed to cutting across the board.

So, I think, on the one hand, the uncertainty would go away I guess if sequestration hit, but it would be -- the consequences of that wouldn't be favorable for spending patterns so I think, under either scenario, it's short lived and we're going to get to a resolution some time later in 2013.

Okay, that's helpful.

Thank you very much.

Great quarter.

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

Please proceed.

Great.

Thanks, guys.

Just a lot of little housekeeping questions, some quick ones.

On page 6, about $4 million of interest and other income, is that anything unusual there?

Well, we had the track manager gain which is the reason that we upped the guidance on the last call, John, about $0.03 a share.

And, what's a good run rate for that line item going forward?

I think on the last call we gave guidance, see if I can find it here real quick.

$4 million of which is interest income and about $6.5 million or so of other income in total.

Got you.

Then on page 11, which is really well laid out, thank you, you've got, Roger, I think Airport Square, Commons, those are fairly old entire-built portfolios and they tend to be bouncing around 70% to 80%.

Is the market such that, as we have austerity, those buildings will be more competitive in the future, or less competitive for the sort of the second-tier defense contractors?

I think the answer is that it's both.

I think there will be some tenants who want a lower-cost alternative and who want to go to the airport because it does serve the Fort Meade area, it's not too far away.

And, there's a lot of infrastructure up around the airport that will remain, and tenants can take advantage of that.

But, I think others will want to be in newer and fresher product and will pay up for that.

So, I think Airport Square is a balance of some newer assets that compete favorably in the market and then some older buildings with tenants that are deeply embedded, and we think they will stay there for a long time.

And then, we have other older buildings that we'll either have to redevelop or we'll have to lease them at lower price points in order to clear the market.

Okay.

Then, on Northgate, has there been any leasing there in the last year or so, and what's going on with the big sale of the gate?

We have not had any additional leasing in the past year, and in terms of the gate, I'm not exactly sure what's going on there.

It was taken to market and there was not a sale, and I think they've pulled back from active marketing for the time being.

And then on -- there's been a lot of odd questions on the Ashburn Crossing DC8 and DC9.

Essentially, did you own that land before and, therefore, you're just providing the core and shell for about $110 a square foot, so the tenant that I'm assuming is putting in $500 to $1,000 of additional cost.

What's the whole sort of mentality that a tenant would just have you build the core and the shell and they would take care of all of the improvements?

I think it's a execution situation, where they need a developer who can move quickly and execute on their behalf, and so they're willing to pay reasonable returns in order to have that.

And then they're going to step in and build-out the improvements?

That's correct.

Right.

So, all the data center investment will be on the tenant's investment.

Got you, okay.

And then, if I look at page 27, 12.7 million square feet of development strategic land, 10-year supply, is that a good way to look at it?

It's all over the place, right?

Huntsville, we could probably be 20 years and National Business Park could be 5 years, so it's -- I think it depends, but if you're saying in general terms, that's a good number.

And then, for Stephanie, I think you have set a record -- pages 38 to 44 are six pages of definitions, and you are the only IR person I know who's actually written a book, so my question is, is there anything in these six pages that would strike us as unusual if we actually read the definitions?

No, John.

We also made the reconciliation pages in a larger font so that they are not ant tracks and they are more legible.

But, no, in fact, as management has highlighted, any of the changes that we have made to disclosures have been to conform to industry best practices, so I would submit to you that there is nothing strange there.

Great.

Have a nice weekend, thanks.

(Operator Instructions)

Your next question comes from the line of Todd Lukasik with Morningstar.

Please proceed.

Just on the cash releasing spreads, it looked like they were up about 1% in the fourth quarter.

I think your expectation for 2013 was down in the low-single digits.

Is that still in line with your thinking?

Yes, it is in line with our thinking and our guidance.

We had a good quarter, and it had quite a bit of activity in the Baltimore Washington corridor, and we anticipate good results there, but we're not changing our guidance overall.

Okay, and anything from quarter to quarter where you may see today that there might be one quarter or two significantly higher or lower than the low-single digit area?

No, and the problem with that is you never know when the tenant is going to sign the lease, so people that have third quarter maturities sign in the second quarter and some that have third quarter maturities don't sign until then, and sometimes they even -- the documents don't get signed until the fourth quarter, so it's hard for us to predict quarter to quarter.

So, what we're saying is that, over the 12-month period, we feel good about a low-single digit drop in cash rents for the year.

Okay, got you.

And then, you mentioned I think $160 million still in the SRP.

Is that all Colorado Springs or is Colorado Springs just a portion of that, and do you have a particular number for Colorado Springs?

Well, we're in the market for Colorado Springs, so we don't want to put a cap rate or a dollar amount on that.

But it's a large part of the $160 million.

Okay.

And then, just coming back to sort of the federal budgeting process over the last few years and the change in the leasing environment due to that.

The -- rethinking about the assets and which ones you guys want to hold strategically long term is probably the biggest part of it, but is there anything else on a -- with regards to your business, on a day-to-day basis, that you've changed to better cope with or deal with the federal budgeting process and the negative knock-down effect that, that has on the areas leasing and the uncertainty around that, and is that something that we should think is kind of a new normal going forward, or do you see it getting better in future years?

Well, at some point, the government spending situation will get resolved, and then there will be certainty with respect to the baseline, and the growth off of that, and then people will be able to act more normally.

So, we expect that.

And then, in terms of our business, we've also spent the past 1.5 years reducing our commodity space, so that we are not a collection of disparate assets and so that we've focused our assets around our franchise locations, so that we don't have quite the market ups and downs that a normal suburban office has.

All right, thank you.

Your next question comes from the line of Josh Attie with Citi.

Please proceed.

Just a quick follow-up.

Can you tell us if any equity has been issued through the ATM program so far this year?

There has been none.

Okay, thank you.

There are no further questions in the queue.

I would now like to turn the call back over to Mr. Waesche for closing remarks.

Thank you all, again, for joining us today.

If your question did not get answered on this call we're all in the office and able to speak with you later today.

Thanks.

Thank you for your participation in today's Corporate Office Properties Trust fourth-quarter and year-end 2012 earnings conference call.

This concludes the presentation.

You may now all disconnect.

Good day.