COPT Defense Properties (CDP) 2013 Q4 法說會逐字稿

Welcome to the Corporate Office Properties Trust fourth-quarter and year-end 2013 earnings conference call.

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

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

Ms. Krewson, please go ahead.

Thank you, Gwen.

Good afternoon, and welcome to COPT's conference call to discuss the Company's fourth-quarter and year-end 2013 results and 2014 guidance.

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

As management discusses GAAP and non-GAAP measures, you will 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.

I'd like to highlight a few improvements we've made to our supplemental disclosure.

First, we enhanced our disclosure related to redevelopment projects listed on page 25 to carve out the carryover basis of assets under redevelopment.

Second, we are continuing to use the term core related to our portfolio on a temporary basis, and will discontinue its use once the two buildings securing $150 million of nonrecourse indebtedness have been resolved later this year.

Third, on page 12 of the supplemental, our Arborcrest project in the greater Philadelphia market is listed below the core subtotal.

Recent leasing activity at the project will allow us to redevelop a fourth building that is 79% preleased, and we also intend to redevelop the building that Merck is vacating.

Accordingly, beginning in the first quarter of 2014, two of the five Arborcrest buildings will be back in our same office portfolio.

Hillcrest II will be in our core portfolio, but not in same office.

Hillcrest III will be under redevelopment, and Woodlands I, which many refer to as the Merck building, will be classified into our redevelopment pipeline.

Before turning the call over to management, let me remind you that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

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 time of 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.

Good afternoon, everyone.

Our primary goals for 2013 were to complete the strategic reallocation plan, create value-enhancing development projects, and strengthen the balance sheet.

We accomplished all three of these objectives.

Today our story is much simpler.

I would like to highlight the following three takeaways.

First, our same office and core portfolios are well leased and trending positively.

Second, we continue to create significant value with our development pipeline.

And third, 2014 is the inflection year for our FFO per share.

Specifically, we forecast that the second quarter will mark the bottom for our quarterly FFO per share, and that quarterly results will rebuild thereafter.

The following observations support this forecast.

The operating property sales associated with the SRP initiated in April 2011 are complete.

By the end of 2013, we disposed of 5.9 million square feet of older, smaller buildings and buildings that were in submarkets viewed to be less growth oriented.

This included reducing our exposure to suburban Baltimore by 63% and completely exiting Colorado Springs.

In total, we disposed of approximately 30% of the square footage we owned when the SRP began.

Our 2014 guidance includes $150 million disposition of two buildings that will no longer contribute to our results, effective April 1. This transaction will be the final major disposition of our three-year repositioning, and upon its completion, related FFO dilution will cease.

Going forward, we will seek opportunities to further enhance our portfolio quality and returns by selectively harvesting value from mature buildings in our regional office portfolio.

During the last three years we also upgraded our portfolio by placing 2.2 million square feet of new development into service and acquiring 300,000 square feet of class A office buildings in our most strategic submarkets.

Our current development pipeline consists of seven new development properties and three properties under redevelopment, for a total of 1.4 million square feet that are 75% leased.

Steve Budorick will walk you through the future NOI we expect from our recently completed and current development activity.

Additionally, we lowered leverage by over 700 basis points versus 2011.

Last year we obtained investment grade ratings from Fitch, Moody's and S&P, and accessed the unsecured bond market.

Accordingly, we have ample balance sheet flexibility to continue to fund our development pipeline.

Last, and with respect to our existing portfolio occupancy, we are confirming a favorable outlook for this year, and expect same office occupancy to build modestly throughout the year.

Although we expect some turnover in our portfolio, we have good visibility on strong levels of demand to backfill space.

Our business environment has recently improved and supports our positive outlook.

The recent bipartisan budget act of 2013 restores $22 billion of spending to the DOD's FY14 budget, and brings a measure of stability that should improve our tenants' ability to plan for the future.

As a result of the act, the DOD's base budget for FY14 and FY15 will be approximately $500 billion.

Defense spending levels will be flat these two years relative to FY13, and thereafter likely grow with inflation.

Importantly, the act has removed defense spending from the political chessboard for the foreseeable future.

Just as important, the law removed the across-the-board spending cuts, and now allows government agencies the flexibility to reallocate funds to priority programs, such as cyber security.

Our portfolio is clustered around defense installations whose missions are aligned with the DOD's high-tech spending priorities.

Accordingly, we expect our projects that serve such installations will benefit in the coming months from increased demand from defense contractors chosen to support key missions.

New demand likely won't materialize until late this year.

Nonetheless, it feels good to finally have some wind at our backs.

With that, let me turn the call over to Steve Budorick to update you on our leasing and development activity.

Steve?

Thanks, Roger.

Leasing results in 2013 were strong.

During the year, we leased 3.8 million square feet, including 1.1 million square feet in the fourth quarter.

In 2013, we completed 900,000 square feet of new development and redevelopment leasing, which I'll refer to collectively as development leasing.

When combined with the 1.2 million square feet accomplished in 2012, we have completed 2.1 million square feet of development leasing in the last 24 months.

For the fourth quarter, our renewal rate was 74%, and for the year, it was 70%, consistent with our historical averages.

We are encouraged that tenants are committing to longer lease terms.

As you can see on page 17 and 18 of the supplement, on renewals, we averaged six-year terms in the fourth quarter.

And for the year, the average term was over four years.

For the year, we realized average lease terms of over 10 years on the 900,000 square feet of development leasing.

Fourth quarter statistics included leasing 100,000 square feet of stubborn vacancy.

For the full-year our inventory management efforts have resolved over 350,000 square feet of stubborn vacancy, with average lease length of 5.5 years.

At the end of the year, our 2013 same office pool was 89.8% occupied and 91.2% leased.

We will be adding six properties to the 2014 same office pool.

Five of these buildings are 93% occupied, on average; however, the sixth building, located in Aberdeen, Maryland is vacant.

Due to the inclusion of the Aberdeen property, the 2014 same office pool was 89.3% occupied at the beginning of the year.

During the year, we expect same office occupancy to increase modestly.

We continue to forecast a renewal rate for our core portfolio of approximately 60% in 2014.

Based on the 1.6 million square feet of space scheduled to expire this year, our forecasted retention rate implies we have to lease 650,000 square feet to maintain occupancy.

Our leasing pipeline currently exceeds this amount and underpins our expectation for higher year-end occupancy.

Our leasing pipeline is defined as lease negotiations for existing space, where we have a 50% or greater probability of success.

On our last call in October, our leasing pipeline stood at 725,000 square feet.

Today, our leasing pipeline stands at 775,000 square feet.

When we issued 2014 guidance, our revenue at risk to achieve the midpoint of that guidance was $19.3 million.

And we had transactions in progress for $8.2 million, leaving just over $11.1 million in unidentified revenue at risk.

Today, our unidentified revenue at risk is down to $10.2 million.

The depth of our leasing pipeline and the progress we are making supports our confidence that we can meet or exceed our occupancy goals.

Turning to our development pipeline, we continue to see strong demand in many of our submarkets.

The results of our development activity will positively affect future NOI and FFO in three ways.

First, we have $21 million of stabilized cash NOI from 10 highly leased recent development projects that are not yet fully cash flowing.

These projects will generate about $9 million of cash NOI in 2014, and incremental amounts to full stabilization in 2015 and 2016.

This $21 million of NOI is not speculative.

It's associated with executed leases.

Second, we have five recently completed buildings that have roughly 300,000 square feet of unleased space.

When stabilized, these buildings should provide an incremental $9 million of annualized NOI beyond 2014 levels.

Third, we are optimistic about our chances to secure new development leases in the next year, with multiple tenants in four separate locations throughout our portfolio.

If we secure all of this demand, these four buildings will total approximately 625,000 square feet and would generate about $14 million of annual cash NOI.

On that note, I'll turn things over to Steve Riffee.

Thanks, Steve, and good afternoon, everyone.

Fourth-quarter and full-year diluted FFO per share, as adjusted for comparability, were $0.48 and $1.97, respectively.

Both results were within our guidance.

For the year, our AFFO payout ratio was a strong 70%.

For the quarter, the same office portfolio represented 91% of our core square footage and core NOI.

Excluding lease termination fees, same office cash NOI was flat with the fourth quarter of 2012, and grew by 2.3% for the full year.

Same office operating expenses in the fourth quarter of 2013 were negatively impacted by nonrecurring operating expenses of over $1 million.

By incurring these one-time expenses, we created energy cost savings to benefit future same office NOI margins.

Within the same office pool, buildings serving our strategic tenant niche, which are those that are adjacent to government demand drivers, as well as those primarily leased to government and defense IT tenants, represented 77% of same office cash NOI.

During the fourth quarter of 2013, these buildings were 93.8% occupied on average, and ended the quarter 94.5% leased.

For the fourth quarter, these properties' same office cash NOI, excluding lease termination fees, increased 2% over the fourth quarter of 2012.

2013 was a watershed year for our balance sheet.

We raised $120 million in equity through our public offering in March, and accessed our ATM for $39 million in July.

Also in March, we redeemed all $85 million of our series J preferred shares.

We earned investment grade ratings from all three major US rating agencies and then completed two bond offerings, issuing $600 million of 10-year bonds at an average interest rate of 4.3%.

Finally, we extinguished $146.5 million of nonrecourse secured debt by transferring 14 properties, worth significantly less than the loan amount, to the lender.

Our debt-to-adjusted-book ratio at December 31, 2013 was 43.6%, more than two percentage points less than the 45.8% level at which we began the year.

The net debt to in place EBITDA improved from 7.2 times to 6.8 times.

Also, we improved our fixed charge coverage ratio to 2.8 times from 2.6 times.

We expect to further enhance our financial flexibility by resolving a $150 million nonrecourse loan that is secured by two buildings in northern Virginia.

Although these buildings were 94% occupied at the end of 2013, we forecast their occupancy will decline to below 50% on April 1. And that quarterly cash NOI will decrease from the current run rate of $2.8 million to only $700,000.

Because the loan amount greatly exceeds our estimate of the fair value of these two properties, we will work with a special servicer to restructure this loan.

However, based on our recent experience attempting to resolve similar debt, we believe the most likely outcome will be for us to convey the properties to the lender.

Our 2014 guidance reflects this assumption.

I'll finish my remarks with some color on our 2014 guidance, which we provided in a press release dated January 7. For the full year, we expect FFO per share as adjusted for comparability to be between $1.84 and $1.92.

We are establishing our first-quarter 2014 range of FFO per share at $0.45 to $0.47.

To get from our fourth-quarter 2013 diluted FFO per share as adjusted for comparability of $0.48 to the midpoint of our first-quarter 2014 range of $0.46, subtract $0.03 to reflect the dilutions in the mid-December sale of our portfolio properties in Colorado Springs, and then add back $0.01 related to lower interest expense.

We expect second quarter FFO per share will be the low point of our quarterly results.

The April 1 removal of the NOI and interest expense associated with the two properties to be conveyed, plus the move out of Merck from Arborcrest at the end of February, will cause our second quarter FFO per share as adjusted for comparability, (technical difficulty) approximately $0.02 lower than our expected first quarter.

The midpoint of our annual guidance of $1.88 implies $0.98 of FFO per share for the second half of the year.

In the third and fourth quarters, we expect occupancy gains in our same office pool to increase our FFO per share to levels modestly higher than the first quarter results.

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

Thanks, Steve.

In summary, this year marks a positive inflection point for our Company.

We are confident this will be the case because our same office portfolio is stable to improving, demand for newly developed space in our strategic tenant niche and in select submarkets is strong and growing, and occupancy gains from leases already executed or in the process of being completed will drive FFO higher beginning in the second half of the year.

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

(Operator Instructions)

Craig Mailman, KeyBanc Capital Markets.

I just want to clarify on the occupancy.

I think, Steve, last time we talked, same-store was projected to be in like the 90.6% range.

And maybe you needed one million square feet of new leasing to get there.

I'm just curious, because you said 650,000 to maintain.

Just wanted to make sure that those assumptions haven't changed.

No.

They haven't changed, Craig.

We're benchmarking off the 2014 same office pool, which has an adjustment because of the six buildings we added.

And then 650,000 is the minimum we need to stay where we're at, but we're anticipating modest improvement from that level.

So it sounds like it's changing a little bit from the 90.6%.

Where's the target with the new, same-store pool?

Craig, that was based on the 2013 pool, so when we added the six buildings, we went backwards by a 0.5%, so you've got to adjust that old target for the add of six new buildings to the pool.

All right.

So it's 50 basis points then.

The drag.

Okay.

That's helpful.

And then I heard your comments about the new demand coming from the budget deal, back half of the year, but just curious at sites like Patriot Ridge.

Are you hearing any chatter from tenants that the NGA's in the process of looking to put out contracts, and maybe -- are you seeing more showings at that project than you have seen more recently?

There are three locations where I would say that, generally, there's more optimism among contractors in improvements and activities.

One of them is Patriot Ridge.

The other is Huntsville.

And a little bit at 3120 Fairview Park in Merrifield.

Okay.

The last question.

Blue Bell, you guys got the build to suit done there.

Does that change your long-term view on that market?

I know that had been one you guys had been -- put on the non-core list.

It's still long-term a source of funds for the Company.

What we're separating out is the concept that we're going to have to stay in it a little longer to complete the value creation and then sell into a good market.

All right.

Great.

Thank you.

Jamie Feldman, Bank of America Merrill Lynch.

I guess you're thinking about some of your non-core submarkets are outside the strategic portfolio.

Can you talk a little bit about conditions there?

We're seeing a general recovery in the office market, and I'm curious what kind of upside you're seeing in those submarkets.

Our more commercial markets include the White Marsh in Baltimore.

We've had good leasing activity in that market for the last couple quarters.

Columbia is really one of the -- about half our portfolio there is commercial.

It's one of the stronger markets in the BW corridor, and we continue to see good activity.

And then if you think about Arborcrest, we've had tremendous demand for that project.

And even beyond the lease that we announced that created a 70% pre-leased building, we recently signed another 34,000 square foot lease there in this quarter.

And then we have some activity behind it.

So it remains strong.

Okay.

And then I think you had said in your comments, if I heard you right, there's four big leases or four buildings that you're focused on that would really move the numbers.

Can you talk a little bit more about those, or did I not hear you correctly?

Jamie, it's Wayne.

No.

You heard the remarks correctly.

We do have a total of 625,000 square feet of new projects that we're tracking closely.

That actually includes three projects that were not started at year-end and the one that we did announce as a fourth-quarter start, which is in San Antonio.

So those projects, we have good line of sight on the demand.

It is -- they're geographically diverse.

They're targeted to the tenants in our strategic niche, and the construction is generally set to commence in the first half of the year.

It looks like the incremental investment will be in the $100 million to $125 million over a 18 to 24 month spend.

Okay.

So I think in the past you guys have talked about a 750,000 number.

How does that compare?

The 750,000 was a number that we referenced over the last quarter.

When you backed out the lease that Steve just referred to that was done up in Blue Bell, it takes you to the 625,000 number that we are now referencing as our shadow pipeline.

It backed out because we signed it.

Right.

Right.

That's a good knockdown.

In terms of potential upside to that, how should we think about that?

We have five buildings that have 300,000 square feet of development leasing, or development vacancy.

And we're feeling better about all of those.

We have about 138,000, 140,000 square feet of deals working in those buildings right now.

And then we continue to work a variety of locations to create opportunities for future development, and we've had good success.

Okay.

And then finally for Steve Riffee, can you talk a little bit about the sensitivity to the guidance?

What would take you higher or lower?

The largest pieces?

Quite frankly, if you look at the guidance, a big number in the year is the development incomes that's placed in service.

And most of that's already signed up and in place, so there's not much variability there.

We don't -- if you look at the guidance assumptions, it's not a heavy transactional year, so there's not a lot of acquisitions and dispositions.

So it's pretty much based on just leasing up the portfolio and hitting the leasing numbers that we have high confidence in for the year.

I just don't see as much variability as perhaps there possibly was earlier in prior years.

Okay.

Great.

Thank you.

Joshua Attie, Citibank.

Steve, on the large data center asset, COPT DC-6, it sounded like you had good activity last year.

But it doesn't seem like there's been much leasing since the summer.

Can you give us an update on that asset and what the tenant activity has been like?

Sure.

We did have good progress through July, where we signed 2.3 megawatts last year.

We did not sign any through the end of the year.

What I can tell you right now is we have -- we're tracking about 20 megawatts of demand that we are engaged with at some level.

We have working deals where we're involved in multiple rounds with those tenants that represent 7 to 13 megawatts, and I consider five days of those promising.

Okay.

Thanks.

And on the shadow development pipeline, can you tell us what yields you expect on those new projects that could be added?

I know what's being placed in service this year is 8% to 10%, but what about the new projects?

I think that's a good range to reference on those new projects as well.

Okay.

And can you also discuss funding sources and uses?

I know you have some debt capacity following the CMBS givebacks.

But just remind us, how much debt capacity you have relative to what your capital needs are if all of these new developments start.

We have zero outstanding on our lines, just in terms of liquidity.

If you look at the January 7 press release, we gave our investment activity source and use assumptions.

So the way we laid it out was that our development and redevelopment spend for the year will be between $200 million and $250 million, no acquisitions.

And then when we look at the main disposition as extinguishing the $150 million debt, we're saying we will be able to do that, handle all of our source and uses, and our metrics won't change.

So that's the way we've been characterizing our capacity on the balance sheet.

Okay.

Thanks.

And then just one last question.

I think you mentioned in response to an earlier question that your traditional suburban office markets are improving, you're seeing better activity.

But I'm looking at the occupancy trends in the supplemental and so in greater Baltimore, it looks like occupancy has kind of been flat to down and declined again in the fourth quarter.

Is the activity just not translating into occupancy growth yet or is it still very early?

It's kind of timing, Josh, as we talked before.

We had some known moveouts that were going to happen in the fourth quarter, with not enough time left in the quarter to replace them.

Many of those spaces we had backfilled tenants identified that will occupy later in the year.

And we've mentioned in the stats, we're getting longer lease terms and we'll resolve the tail end of the rationalization of space we've experienced from the last two years in 2014.

So when you think about four quarters from now, the occupancy, in call it greater Baltimore, it should be -- if it's 83% today, you're forecasting that to be higher three or four quarters from now?

Yes.

We'll start gaining ground.

Okay.

Thank you.

Brendan Maiorana

Steve Budorick, I'm sorry if I missed this before, but when we -- last quarter you had between the fourth quarter of 2013 through the end of 2014, 2.5 million square feet of expirations.

I think you expected your retention rate to be 60%, so that was 1 million square feet of moveouts, and that was at 725,000 square foot pipeline of tenants to backfill.

It looks like retention was better in Q4.

Is there an update on what you think retention is likely to be in 2014?

Is that likely to stay better now, as well, because you're feeling a little bit better about the market?

We're still forecasting it at 60%.

So the magnitude has come down.

It's about 1.6 million square feet remaining.

We're still anticipating 60% of that to be retained.

And that was driving the numbers of roughly 650,000 square feet of leasing, our occupancy needed to break even on the year, and we tempered that against the pipeline of 775,000 that we're seeing today.

Right.

So I guess part of the question is that 725,000 pipeline last time, presumably there were some deals that got signed that got taken out of that pipeline and then you've backfilled that, and then some, with some new prospects.

Is that right?

That's right.

Okay.

Great.

Thank you.

Steve Riffee, in the quarter, and the year, I think your prior guidance on same store was 2.5% to 3%.

It came in a little below that.

Was that solely attributable to the $1 million of expenses that you highlighted in the quarter?

Yes.

It was -- there was discretion there, but it was making some expense decisions, so revenue was where we wanted it to be for the quarter.

Okay.

Great.

And then last one, bigger picture question for Roger.

You mentioned this is -- 2014 as the inflection point-year.

You've got some challenges early part of the year with some of the tenant moveouts, the CMBS give-back, and the like.

And you guys were very detailed in that growth outlook and the FFO outlook for the back half of the year.

As we think bigger picture, when you think about COPT, what do you think the FFO growth outlook should be if you've got a fairly stabilized same-store pool and all the development activity that you're seeing in it?

Where do you think you can be on a year-over-year basis over the next few years?

I think mid-single digits would be a number that we would be comfortable with, given same store and given our ability to create growth opportunities for the Company.

And do you think that the growth outlook that's there is -- do you think you have enough non-core asset sales that are likely to fund the growth on the development pipeline?

Or do you think at some point equity issuance would be more likely because you've gotten rid of most of the non-core stuff?

I think for the next couple of years, we think we have enough sale opportunities in our portfolio that we can fund new development.

And beyond that, we'll just see where the stock is and where our opportunity set is.

Okay.

Great.

Thank you.

John Smith, Stifel.

John Guinee here.

I just didn't have the energy.

(laughter) Just so we get the ramping of the hockey stick here, should we look at 2014 as, say, $0.47, $0.45, $0.48, $0.49?

Or should we look at it as, say, $0.46, $0.44, $0.48, $0.50?

Quarterly FFO?

Well, we said $0.46 and $0.02 less, $0.44, so that leaves the other $0.98 in the last two quarters.

We haven't given you the split between the two quarters, but it's building up, John.

Okay.

And then Steve, if I look at this wonderful summary on page 11, it's kind of a tale of two markets, where National Business Park, Columbia Gateway, San Antonio, very, very strong.

Airport Square, Commons Parkway, White Marsh, I-83 corridor, bouncing around 80%.

And it just so happens that if you do the quick math, Airport Square, average building size 76,000 feet.

Commons, average building size 43,000 square feet.

White Marsh, and 83, average building size 46,000 square feet.

Which sort of implies, and I may be wrong about this, so correct me, but it sort of implies one- and two-story value office.

Is that a correct assessment of those markets, and do you think you can gain occupancy in those specific submarkets?

Your characterization of the assets is correct.

And yes, we do think we can gain ground there.

Much of the stubborn vacancy activity that we referred to exists in those buildings.

We've put a lot of effort into punching up both the buildings, common areas, and the suites.

The conditions of the suites to make it more marketable, and we're encouraged that we can gain ground.

Okay.

And then I guess Roger, if I look at the regional office portfolio, 5 million square feet, 66 assets, again, 75,000 square feet per building, is this something that we should expect to sell $100, $110 a foot, or is this a $150-a-foot product?

I think going forward, we are a financial seller of assets versus a strategic seller, meaning we're going to be more patient and try to optimize values to sell.

But as assets mature, we get them leased, try to sell them into hopefully a better market, and get the first square foot that you had suggested, your latter number of $140 to $150 a square foot.

Okay.

And then the last question, the way this whole on-base/off-base thing seems to work is in some of the big defense-oriented locations, such as Fort Meade and Quantico, you have new development.

Others you don't.

Can you talk a little bit about what's going on at NSA in terms of what they have under construction and their plans to then redevelop other buildings, as well as what's going on with the Army's Cyber Com at Fort Meade?

Well, it's public out there that they are building a computing center on the campus that's 400,000 square feet and that Cyber Command is looking to build a headquarters on the campus, but that's all that's in the near-term works there at this point.

Great.

All right.

Thank you.

Jonathan [Pauling], Robert W. Baird.

It's Steve Rogers.

Steve Budorick, question to start with you.

Can you talk a little bit more about leasing economics?

Two sides of that, concessions, TIs, LCs.

Can you give us a color if that will stay at a run rate of the $4 per square foot that you've been quoting?

Will that get better?

And then on the leasing spread side, you gave guidance for the full year, but I thought maybe in prior calls, or at some other prior time you had given some color that maybe those spreads would turn positive as you moved into the third and fourth quarter.

I don't want put words in your mouth, so correct me or give me some color on the leasing spreads, as well.

Sure.

Let me start with the spreads, because that's the last thing you talked about.

The most pressure on those spreads, really, we're feeling in Virginia, where we've had some longer leases that are rolling through a softer market.

And we're rolling -- you can see even in this quarter, we rolled down 11% on the few deals that we did.

But on average, we've been rolling about 3% negative.

And I'd point out, if you look at the Baltimore-Washington corridor this quarter, our cash flow up mildly.

And that's really the trend I was talking to you in the BW quarter, where we've got better leverage and more than half of our deals over the last three quarters have rolled positively.

And then in this quarter we actually rolled, on average, positively.

So in the BW quarter, over time, we expect it to continue to strengthen.

Now, what was the first half of the question?

Just the concession that you're seeing in the market in terms of TI build (technical difficulty) [fees] for rent, et cetera.

Very stable in the BW quarter, more pressure in Virginia.

No question.

Representatives are seeking very high tenant improvements.

We've been able to find opportunities where we don't need to meet some other landlords, but there's more pressure on the Virginia side.

I wouldn't say it's worsened, but it's more extreme on that side of the river.

Okay.

Steve Riffee, when did you model the give-back of the assets after the tenant moves out?

And then maybe second to that, is there any variability in the earnings if you were to have to give it back, either sooner than you guided or later, given the NOI versus the interest expense?

Well, in our -- if you look at our reconciliation table from earnings per share, the FFO per NAREIT, and to FFO as adjusted for comparability, and also read the footnotes there, when you refer back, you'll see the timing and the assumptions.

But what happens, is when the loan goes in default in April, the NOI from that point forward belongs to the lender.

We will also accrue interest at a default interest rate, but we won't be paying it.

So in terms of FFO as adjusted for comparability, we are taking out the two sets of net operating income that is associated with those assets from April 1 to the end of the year.

And we're taking up to $0.14 of accrued interest that will be accruing, but we won't be paying.

And then, our guidance is assuming for showing you the math, that the debt would be extinguished at the end of the year.

And if all of that happens, that would be a $0.68 gain.

We won't count the NOI once the property's in default.

NOI is adjusted for comparability.

We won't count the default interest that we won't be paying.

And we will not be counting the gain on extinguishment.

So that's -- we've laid that out, and that timing's all in the footnotes of the reconciliation as well, Dave.

Essentially no impact to your guidance?

That's helpful.

And Roger, last bigger picture question is, I think with regard to some of the US -- let's call it, quote-unquote spying issues and leaks that have happened.

There were some bills that had been floated in Congress about limiting cyber security power or at least diversifying that power into multiple organizations.

Wondering if, one, if you believe that even anything happens there, and two, is it kind of detriment or a benefit if that gets spread out a little bit more across these key locations?

Well, there's a lot of talk in the media.

And if you follow the politicians and the political banter about this whole situation, I think at the end of the day, our message to investors is that we have the government in our buildings, and that we believe that the missions that they serve are stable and will continue, and that we have to let all the other noise just be noise.

Okay.

Thank you.

Michael Knott, Greenstreet Advisors.

John Bejjani here.

First question, given the recent budget agreement, do you still see there being risk for -- from an upcoming debt ceiling debate, or do you feel political risk as behind you guys now?

It's just a educated guess on our part, but it appears that they'll work something out with the budget ceiling.

I don't think any of the politicians want to go through what we did in early October, so our sense is that something will get worked out, and that this will just be noise and not have any impact on, not just COPT, but the whole United States of America.

Okay.

And then on re-leasing spreads, so you guys talked about expecting down 3% or so for the year.

Would you say that's reflective of your portfolio overall, or is there -- is 2014 a bit different than what you expect your overall mark to market to be?

Well, I think it's a good representation of the current condition of the average of our leases.

And if you think about it, our leases tend to escalate 2.5% to 3% each and every year over a longer period of time.

And on average, we're giving back about 3% on a cash basis for the first year of the renewal and then growing from there.

Thanks.

And one last question.

So right now, your core portfolio is sitting at about 90% leased.

Longer-term, where do you guys see stabilized occupancy ending up, and over what horizon do you feel you can get there?

We see it stabilizing in the 93% range.

And we see it taking about 24 months to get there.

Great.

Thanks, guys.

Paul Puryear, Raymond James & Associates.

This is Bill.

Bill Crow with a question here.

Roger, a bigger picture.

If I go back 10 years and I listen to you on the road, talking about the attributes of the Company, we talked about two things in particular -- the top-secret access and what that did to your consumer base.

And then the second thing was that you had barriers to exit from your tenants based on linkages to government installations, or the amount of money that the tenants invested in the properties.

And when I look at your new core portfolio and a 60% retention rate expectation for this year, I guess my question is twofold.

As we look forward longer term, will you get any benefit for tenant retention based on the old formula of who your tenants are and where they're located?

And does the top-secret access and all that matter anymore, or have you morphed into something that would be more pure like to the suburban office rates?

Right.

Our 11- or 12-year average occupancy retainage is 70%, and so last year we did that again.

This year, the 60% is really a reflection of the finalization of the rationalization of the defense community, in particular, the defense contractors, to get their business models and their people and the right amount of space to fit the new equilibrium in the defense budget.

And so we do think that we're at the tail end of that and that our occupancy should stay very high, and our normal retainage rates should stay very high.

Our business is tied to our customers' proximity to their customers.

It's about co-location with national assets.

It's about the ecosystem, the synergy, critical mass.

It's all that collaboration.

And so the assets that we've been able to create meet that model, and then we have some secure space to go with it.

And so we don't think that our model is being upended by what's going on.

It's just that we needed to go through this digestive period where the DOD's budget was getting retooled and repositioned the last couple of years.

Okay.

Thank you.

(Operator Instructions)

Tayo Okusanya, Jefferies.

Just a couple of quick ones.

First of all, a development question in regards to the old Merck space.

I was hoping you could walk us through the thought process of why redevelop it versus try to re-lease it?

Tayo, this is Wayne.

We've been engaged for a while now that the Merck building will be coming back to us.

And so we've been engaged in looking at how that building can be repositioned in the same manner that the successes we've had at the Hillcrest campus are.

Frankly, we've really created what we think is a very branded campus there, one that's been well received in the market.

The Merck building is a slightly different configuration than the other assets we've worked on.

But we still, at this point, feel like there's a strong path to a redevelopment play there that can have the same type of success that we've been able to enjoy with the four buildings that are now fully -- three buildings that are redeveloped and one that's under development.

And those four buildings are 90.7% leased as we sit here today.

And there continues to be demand in that marketplace for more product that's similar, which would support a redevelopment strategy.

Okay.

That makes sense to me.

Then second question, just more on the data center.

And it doesn't seem like there was any additional lease-up this quarter.

Just curious what you're seeing in regards to that market demand for space and also pricing.

You're right.

We did not sign any leases in the quarter, like I told Josh.

The entire northern Virginia market was relatively slower in the fourth quarter.

But we continue to have optimism.

We're attracting about 20 megawatts of activity that we're engaged with at some level.

Consider 7 to 13 of those megawatts as working deals, where we're negotiating actively.

And then five to eight of those megawatts I consider promising.

So we're hoping that 2014 has some more good news like we brought in 2013.

Okay.

And what about pricing-wise?

Is pricing remaining steady?

Is there more pricing pressure?

Pricings remain steady.

I don't feel further pressure.

Got it.

Last thing, that's going forward.

I know we've had a lot of conversations about development and redevelopment, but from an acquisition perspective, just curious what the Company's thinking.

If you were to acquire something, what general characteristics would that asset have?

Well right now, acquisition opportunities are very scarce.

There are opportunities available, but they're scarce in terms of being able to make acquisitions that make financial sense.

For us to make an acquisition, we would have to balance that against our very strong development pipeline and put a higher priority on that, since we're taking care of existing customers.

But if we found an acquisition that was forward-looking, that was the 21st century building of the future, that was very well located and we thought it would enhance our franchise and we could make economic sense out of it, we would look at it.

We're constantly in the market, underwriting opportunities, but we haven't been able to make sense of any.

As we mentioned on the call, in the last three years we've only made two acquisitions.

We made one in 2011, one in 2012 and we've really made none in 2013, except for buying a warehouse that we were renovating for a customer.

All right.

Great.

Thank you very much.

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

Thank you all again for joining us today.

If your question has not been answered on this call, we are all in the office and able to speak with you later.

Thank you very much.

Good day.

Thank you for your participation in the Corporate Office Properties Trust fourth quarter and year-end 2013 earnings conference call.

This concludes your presentation.

You may now disconnect.

Good day.