COPT Defense Properties (CDP) 2015 Q3 法說會逐字稿

Welcome to the Corporate Office Properties Trust Third Quarter 2015 Earnings Conference Call. As a reminder, today's conference is being recorded. At this time, I will turn the call over to Stephanie Krewson-Kelly, COPT's Vice President of Investor Relations. Ms. Krewson-Kelly, please go ahead.

Thank you, (inaudible). Good afternoon and welcome to COPT's conference call to discuss the company's third quarter 2015 results and our updated guidance for the year. With me today are Roger Waesche, President and CEO, Steve Budorick, Executive Vice President and COO, Wayne Lingafelter, EVP of Development and Construction, and Anthony Mifsud, EVP and CFO.

In addition to our supplemental package and press release related to third quarter results, please note that we have posted a flip book titled 3Q15 results to our website that accompanies management's remarks this morning. We also have issued two press releases earlier this week related to the sale of One Dulles Tower in Northern Virginia for $84 million and to two new 100% pre-leased development projects in our strategic niche.

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 on the Investor section of our website. At the conclusion of management's remarks, the call will be opened up for your questions.

We remind you that statements made during this call may be forward-looking within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995 and that actual results may differ materially due to a variety of risks, uncertainties and other factors. Please refer to today's press release and our SEC filings for a detailed discussion of forward-looking statements.

With that, I will turn the call over to Roger.

Thank you, Stephanie, and good afternoon everyone. Since our last call, we have been extremely productive, particularly as it relates to capital allocation. During the quarter, we placed 447,000 square feet of development that are over 93% leased into service, bringing our year-to-date total to 1.1 million square feet that are 97% leased. We have sold $130 million of assets this year and before year-end expect to sell or have, under binding contract, another $145 million.

Total proceeds of $275 million will capitalize the acquisitions we completed earlier this year and solidify our balance sheet. Additionally, because of these capital allocation decisions and the strength of leasing across our portfolio, we are on track to grow our same-office cash NOI in 2016 by 3%. Since our last call, we have also spent a lot of time on the road meeting with investors. As we've been doing in those meetings, I want to reiterate the Company's objectives and strategies. Like every public company, our number one goal is to produce attractive returns for shareholders. By generating high-quality NOI growth and increasing NAV per share, we will achieve this goal. Slides 3 and 4 summarize our capital allocation strategy for meeting our objectives and goals. Our strategy is pretty straightforward.

Direct capital to our 14 strategic niche locations to strengthen our position as the preeminent provider of real estate and services to hi-tech defense segments of the US Government. Properties in our strategic niche include buildings whose locations are priority government missions. We also direct capital to upgrade the quality and growth potential of our regional office assets. While the majority of our tactics have involved selling regional office assets, we will very selectively buy or develop buildings, provided they are in urban or urban-like locations, we are robust and varied set of amenities combined with transportation advantages to create a vibrant live-work-play community.

Strategically, we will continue to focus our time and capital on these two types of locations because scarcity of land keeps competing supply in check.

As slide 5 details, in our strategic niche, we control the prime developable land and therefore create a barrier to new supply. In the niche and in our regional office locations, several factors exist to compel demand. Such demand drivers include proximity to a government customer whose mission involves national defense, access to the right labor force and transit -- mass-transit alternatives were simply the best location with the [Harvard deal]. Our strategic niche has never been more important driver of the company's growth than it is today. Parks like the National Business Park are uniquely positioned to compete for new opportunities and we'll continue to benefit from the strength of their government tenancy, diverse contractor base and an irreplaceable location. The point is, tenants not only want to be there, they must be there for their businesses to thrive.

So everything we have done and are going to do will be in pursuit of refining our portfolio along strategic locations. Within our niche, we will continue allocating capital to mission critical locations. In our regional office portfolio, we will allocate capital to locations that offer the best lifestyles and support strong commercial demand. By concentrating our capital in our most strategic markets to what we build, buy and sell, we will optimize our portfolio NOI and value for shareholders. The tactics we use to execute on our strategy are equally straightforward. Develop and redevelop at risk attracted adjusted returns, acquire assets opportunistically, recycle proceeds from selling lower growth assets to fund growth and to maintain our investment grade rating. Slides 6 and 7 summarize how our strategy has grown and improved both parts of our portfolio. By recycling proceeds from the sale of 7.3 million square feet of suburban properties since 2012, we have developed 3.6 million square feet and acquired 1.3 million square feet in strategic locations and earned an investment grade credit rating.

By doing so, we have increased the size of our strategic niche from 59% of revenues in 2010 to 75% today. We also improved the quality of revenues generated by our regional office portfolio by increasing the concentration of square feet that are urban or urban-like locations from less than 10% in 2010 to about 65% by the end of this year. We regularly get asked what percentage of the portfolio will be niche in the future versus regional offices. I think it's important to understand that the percentages will flex modestly over time depending on where the most attractive risk-adjusted returns can be earned. When we complete the dispositions planned for this quarter and next year, approximately 85% of our buildings will be in locations that directly support a government demand driver and about 15% will constitute our regional office portfolio. On that note, I'll turn the call over to Steve.

Thanks, Roger. I'll start with an update on our development business beginning on slide 8. Development leasing has been solid based on strong demand from customers in our strategic niche. During the quarter, we signed 300,000 square feet of build-to-suit developments bringing our year-to-date development leasing to 650,000 square feet. Virtually, all of which was for strategic niche customers. Through the third quarter, we placed 1.1 million square feet of development into service that are 97% leased, demonstrating our ability to create value through low-risk development. We have executed on 25 development projects. They will generate up to $55 million of annualized cash NOI. As slide 9 details, $40 million of this annual NOI is contractual and therefore has no risk. Only $17 million flows through our 2015 results and another $20 million will benefit 2016 results. We have $3 million of additional contractual NOI occurring in 2017 and we are making good progress on the $13 million to $15 million of NOI associated with future leasing.

Slide 10 illustrates the strong demand we see across all of our strategic locations. Niche and regional office continues to grow. Note that our shadow development pipeline of up to 1.5 million square feet is actually a few hundred thousand square feet larger than last quarter despite harvesting 300,000 square feet of build-to-suits in the third quarter. The increase reflects the new potential projects that have already emerged from customers in our strategic niche. Accordingly, we expect to exceed our 700,000 square foot target for development leasing this year.

I want to spend a few minutes discussing our disposition pipeline since we are funding our growth by recycling suburban assets. Year-to-date, we've sold $18 million of land and $112 million of suburban buildings at an average unlevered IRR of 8.8% and an average price per square foot of $204. We have another $69 million of operating properties under contract to sell for $182 a foot. We also have $13 million of land under contract that will close late next year and we have another $176 million of operating properties under letter of intent or being marketed that we expect to sell before the end of June next year.

Whereas we typically allocate disposition proceeds, the paying down debt and funding development, this year we are recycling proceeds in a well Lease Strategic Development and into three separate market opportunities that significantly upgrade the growth profile of our operating portfolio.

Slide 11 shows how we are recycling proceeds from the sale of low-rise suburban office buildings from the White Marsh and Timonium submarkets of Baltimore County into two Class-A office towers we purchased in Baltimore's Pratt Street quarters submarket in the Ann Arbor. We are completing the suburban to urban trade for approximately the same cap rates without diluting NAV. When the suburban Baltimore sales are complete in the next few months, our Baltimore investment will represent about 8% of total square feet which is slightly lower than at the beginning of the year. But our expected NOI growth from that 8% is now higher, which translate into NAV growth.

Slide 12 summarizes how we improve the future NOI of our portfolio in Northern Virginia by recycling capital from the sale of the Mitre and Booz Allen buildings into Metro Place II, a Class A building that is 100% leased to strategic tenants and is located on the Dunn Loring Metro in an urban-like micro market of Merrifield. Based on leases in place, we expect Metro Place II to generate 2.5% to 3.5% NOI growth.

Please turn to slide 13 and let me walk through our recent sale of One Dulles Tower. The 397,000 square-foot building on the Toll Road in Herndon, Virginia. We purchased that asset in June of 2003 for $71 million or $179 a foot. We earned NOI net of tenant and building capital of $85 million during our hold period. We sold the building for $84 million or $212 a foot earning an unlevered IRR of 9.4%. Booz Allen is vacating the building on January 1 and we do not expect that will be re-tenanted primarily by defense contractors. By selling the building, we avoided re-tenanting costs, which we estimate will exceed $40 million or $110 a foot and $2 million in annual operating expenses that we would have absorbed until the building release. Selling One Dulles Tower was prudent capital allocation.

I want to conclude my portion of the call by discussing how we have de-risk our future lease expiration schedule even since the last call and our expectations for 2016 metrics.

Please turn to slide 14 for an update on our large tenant renewal forecast. On our last call, we listed nine leases of 100,000 square feet or more that were scheduled to expire between then and the end of 2017. Since then, we fully renewed two of those leases and we sold One Dulles Tower leaving only six large lease expirations in the next 26 months. We have one large expiration this quarter. That lease is with the government at a secured location and we expect it to renew next month.

The 2016 large lease expirations with the government in a secure location as are two of the 2017 leases. We expect a 100% renewal rate on all three leading just two contractor leases that expire in 2017. One of those leases is with a contractor in Northern Virginia, given the nature of the mission being supported in that building, we expect a full renewal. The other 2017 lease is with a contractor of Maryland. We expect the tenants to retain between 50% and 100% of their current space. Assuming we renew only 50% of this last lease, the average renewal rate on these six large lease expirations will be 91%. So as you can see, our largest tenant renewal environment has stabilized nicely. Another important thing to note about our expirations is that in 2016, we only have 6.7% of our annualized revenue scheduled to roll. This level is about half the rollover we typically manage in any given year. We expect a renewal rate of 65% to 70% in 2016, and in 2017, we have 11.7% of our annualized revenues scheduled to expire and forecast that our retention rate will improve back to pre-2010 average levels of 70% to 75%.

Lastly, please turn to slide 16, which summarizes our preliminary forecast of 2016 operating metrics. Based on rent bumps embedded in our leases plus incremental leasing and netting the minor effect of minus 2 to minus 3% cash roll downs on renewals, we expect our same-office cash NOI to grow by 3% in 2016. The 2016 same-office cash NOI growth of 3% will set the stage for continued growth into 2017. With that, I'll turn the call over to Anthony.

Thanks, Steve. We had another solid quarter as summarized on slide 17 with diluted FFO per share as adjusted for comparability of $0.52, which was in line with the midpoint of our guidance as were occupancy and same-office tax. Lower recurring CapEx supported a strong AFFO payout ratio of 74% in the quarter and 70% year-to-date. Dispositions, which are summarized on slide 18, have strengthened our balance sheet and credit metrics, as will EBITDA from the 1.1 million square feet of development projects we placed into service this year. As slide 19 shows after the $145 million of dispositions we expect to complete by or shortly after year-end, our debt to EBITDA and debt to adjusted book will approximate 6.4 times and 41% respectively.

I want to highlight that during the quarter, we completed the transfer of the 2 WTP properties to the lender, extinguishing $150 million mortgage. This transaction resulted in the large gain on debt extinguishment in the third quarter and was the major difference between our FFO according to NAREIT and our FFO as adjusted for comparability. If you turn to slide 20, you'll see our debt maturity schedule is well laddered with a weighted average debt maturity of 5.9 years. In 2016, we have $162 million of secured debt that is pre-payable at par beginning on July 1. The loan bears interest at 7.25% and we have several alternatives for refinancing that debt when it comes due.

Slide 21 summarizes our updated guidance. Our forecasted diluted FFO per share as adjusted for comparability for the fourth quarter is $0.51 to $0.53 and for the full year is $2 even to $2.02. We are narrowing both prior ranges to reflect the earlier than expected completion dates on fourth quarter asset sales.

One brief comment on cash renewal rates. Renewing leases rolled down 4.1% on a cash basis in the third quarter and 3.7% year-to-date. Based on renewals already completed in the fourth quarter plus those forecasted, we expect renewal rates on leases in the fourth quarter to roll flat to down 1%, which will bring our average cash rent roll down on renewals for the full year to within our original forecast of 2% to 3%.

Lastly, we anticipate providing full year guidance for 2016 in early January. In the meantime, the forecasted operating metrics that Steve referenced on slide 16 and the sources and uses information we provide on slide 22 give you a clear line of sight into next year. The sales we have under LOI or contract will improve our leverage and credit metrics to levels that are more comparable with our long-term balance sheet goals and the planned sales of approximately $200 million in 2016 will fund next year's development investment.

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

Thank you, Anthony. I want to ask you to please step back and not over-complicate what you've heard today, our objective strategy and tactics are simple, increased value for our shareholders by growing NAV, maintain an investment grade balance sheet, and grow primarily by executing on low-risk developments. How that translates into our vision for our current portfolio is equally simple, with every property we build, acquire and sell, we are concentrating our portfolio around our most strategic locations. Growing our 14 strategic niche locations as one avenue of growth that produces attractive risk-adjusted returns.

Upgrading a regional office portfolio to generate higher more durable NOI is another. We are confident that the combined growth of both portfolios will produce attractive returns for shareholders.

Before opening up the call to your questions, I would encourage those of you who have not visited us in the last year to schedule a date to see how we have transformed in growing our portfolio along our two strategic lines. The next Baltimore tour we are coordinating with the sell side is on November 10. Please email Stephanie if you're interested in attending. We would love to share you the strength of our niche and the value we've captured in Baltimore's Inner Harbor. With that, operator, please open up the call for questions.

(Operator Instructions) Gabriel Hilmoe, Evercore ISI.

Thanks, good afternoon guys. Maybe Steve, just on the initial outlook for 2016 for same-store NOI growth in occupancy, just on the five assets, 310 Bridge, 3120 Fairview in Patriot Ridge. Now those have been somewhat of a drag to operations for bid and I know you made some leasing progress there, but when you think about going into next year, can you maybe frame up kind of what's embedded for lease-up in those assets when we think about NOI growth in occupancy for next year?

I think our projections are more conservative than we could achieve. With regard to 310 The Bridge, we're at about 85% right now (inaudible) with leases, in negotiation, we will push that up to about 94%. We've two small center spaces left to lease. So, that'll be stabilized next year. With regard to 15049 or the aerospace building, we concluded one lease and we have two being negotiated that represent about third of the building and we have good demand behind it representing all the sufficient to fill the building. So, we think we're going to make good progress. The timing of those leases will be later in 2016.

We're very confident we're making progress. Our demand profile of Maritime has improved measurably and we are very confident we're going to put some leasing scores on the board shortly. Generally, across all of our portfolio, contractor demand has been improving for the last quarter or two, and we feel like we're in good shape.

Okay and then just maybe switching gears to the development side, you announced the 300,000 square feet last night, but when I look at the spend for 2016, I think that the numbers, the $200 million to $225 million kind of stayed the same. I'm assuming those numbers include some more build-to-suits potentially coming. Can you just give us a sense of what that $200 million to $225 million of development spend is comprised of?

It's a budget that we're taking year-to-year and it could be a combination of the four types of projects we listed on page 10. We do expect additional data shells development. We have a major customer evaluating the build-to-suit campus in Huntsville. The timing of that could be more towards 2017 or 2018 delivery. We have multiple customers looking for space in the Fort Meade area and we are pretty good likelihood of signing a lease to kick off another building at the NBP and then we've got very strong demand up in Plymouth Meeting at our very successful urban class project. So, it could be a combination of all those.

Okay.

One thing to remind is that the majority of the capital that we have for the two data centers that we just announced is being invested in the fourth quarter of this year. So, the land was purchased in the fourth quarter, which was the most significant component of that investment.

Okay and then just maybe one last quick one. See there's a couple assets on the market in Baltimore, any thoughts around those buildings and I guess would you have any interest in those?

They're good buildings. No, we have no interest. We repositioned our Baltimore portfolio from suburban to urban, but we are very interested in watching those sales as the cap rates and the pricing, I think, are going to be very supportive of the investments we made. Under these guidance, pricing is about $350 a foot compared to $190 across the street, and the expectations for Legg Mason building are in excess of $500 a foot.

Jamie Feldman, Bank of America.

I hope you can talk a little bit about just the pricing environment and rent environment? Your negative cash leasing spread this year and negative cash leasing spread next year, maybe talk to us about how GAAP leasing spreads like shape up for next year, and then just generally are you in a position to push rents here or what are the expectations?

Well, let me deal with the ability to push rents and then I am going to turn it over to Anthony for the GAAP. With regard to this quarter, we had a couple outlier deals that we elected to complete for strategic reasons. In Greater Baltimore, we locked on the lease to position to [building to sell] that had a negative impact. In Columbia, we incentivized the tenant to retain all of their space rather than contracting a bit and avoiding a lot of capital that was a contributor to our result and then we jumped out in front of maturities for 2016 with two leases in Virginia to solidify that portfolio. If you strip those four leases out, we are really more like 1.2% negative, Jamie. In Columbia Gateway, Fort Meade, generally in our Maryland and now downtown Baltimore we're pushing rents. Northern Virginia is still very competitive. So, we're not in a position to do that and we have driven our rates up in Huntsville pretty heavily on the lease-up of three tenants. So, that environment has improved greatly from two years ago.

And then with respect to our expectation of the GAAP rent roll ups, the 2% to 3% cash roll downs based on our leasing structures that we believe will be part of the renewals would roll GAAP rents up 5% to 6% next year on those renewing leases.

And then just maybe bigger picture, can you talk about your thoughts on the budget and the cyber defense bill or cyber bill that's in Congress and what you think that might mean for leasing demand next year?

Right. I'll start with the cyber bill. The cyber bill is largely about sharing of information between the private sector and the government. It's about protecting each other from a legal standpoint. So, I'm not sure that we'll get a lot of benefit from that particular bill, we'll get a lot of benefit just because of the continued cyber incursions that are happening throughout our land. On the budget, we're really excited about the two-year budget agreement passed by the House yesterday because it creates two years of defense spending clarity for the current fiscal year, which just started October 1, defense spending will increase by 5% that's a $25 billion increase over a base of about $496 billion current base. And then in 2017, defense spending will increase by 3%. So, that's a very significant improvement over being flat for the last three years after having a one-time $30 billion reduction in defense spending. We read the earnings transcripts of the big five defense contractors and then some of the smaller contractors who are tied to high tech defense and contract awards across the board are increasing. So, we think that the combination of the budget agreement and increasing contract awards gives us confidence, we will see growth in our customer segment and in space needs later this year and into next year.

And are your tenants already starting to talk about it and plan for, what's the lag before you think it actually starts to affect you guys?

Well, as Steve mentioned, there has been a higher incidence of contract awards. Again, we're seeing that in the earnings calls of the defense contractors and then we're experiencing it through the space demand at locations that have been soft for a number of years. So, I think it's already manifesting itself and we believe that the momentum will continue.

Okay and then finally, you've guided to 92% to 93% occupancy next year. That compares to the 91.6% at the end of the third quarter. And if so, can you just walk us through, like what are your expectations of how that will flow?

The guidance that we gave out for next year is our 2016 same office pool. So, it's benefiting from the leasing activity that Steve mentioned as well as some of the projects that will be going into the pool for next year.

I was just asking how do you, if you think here we are -- you're looking at September 30 number, I think, of 91.6%. Do you think it just goes up gradually at the year-end 2016?

It does.

Okay. All right, thank you. And I appreciate the presentation that was helpful.

Craig Mailman, KeyBanc Capital Markets Inc.

Hey, guys, just curious the 3% cash is shown up for 2016, what would that have been if you guys hadn't sold Mitre and Booz?

Well, Mitre would not have impacted it because that lease goes out until October 31, 2016 and we would have a roll-up for 10 months and then the roll-down. In the case of Booz, things would have rolled down about 4%, but when you layer it into our existing portfolio, we would have been about flat for next year on same office.

Okay. Sounds like going to be a smart pick-up. Okay. And then just quickly on the sales here. Thanks for the color on that. Just curious you guys continue to sign Shell datacenter leases. Are any of the contemplated sales for 4Q in 2016, kind of a recycling on some of the earlier deals that you did?

We are going to market with a couple of data centers and we'd rather not talk about which ones because we don't want to get caught in the market situation, but data, because we do have stability, we think we've created a lot of value and we think it's one of the cheapest sources of capital that we can raise, we are going to test the market on some data centers.

Brendan Maiorana, Wells Fargo.

Thanks Anthony, just a follow up on Jamie's question. The occupancy target for the end of next year. So I get that the pool's changing, but I think the same office pool as it stands today was, or at the end of September was 90.5% occupied. I think average was 90.3%. So, the pool is going to change. So, do we compare that to the total portfolio of 91.6% today or the same office pool of 90.5%?

You can essentially compare to the total company portfolio.

Okay, so your occupancy pickup is reasonable for next year, but it's not quite as big if you are comparing it to the overall same-store pool. Steve, how much would you say your kind of overall in-place bumps are for the portfolio sort of average?

2.5%.

2.5%. Okay, So thinking about the 3% for next year, you've got occupancy growth that's in there and you've got very little in terms of roll as you pointed out, only 6.7% of the portfolio rolls with spreads that are down sort of nominally. Kind of feels like, can you beat 3% if you actually end the year at the occupancy target that you've got?

Yes, we can. Remember we're generating new leasing to make contribution to that. The timing of the leasing is important, often there's free rent associated with that. So, the cash impact is not immediate.

Okay, that's helpful. And then just for the dispositions, I gather the Booz building was about 9 cap kind of rough numbers, how should we think about just the total in terms of exit cap rate on the roughly 230 that's expected for the fourth quarter and then maybe that sort of 150 to 200 million of disposition proceeds that you expect in the first half of next year.

On the Booz building, the two-month exit cap rate is 12%. The cap rate beginning January 1 would be at minus 2.5%. In terms of the balance of the sale, they will be done between 7% and 8% and I think probably a little closer to 8% on average.

Okay. And so offsetting that, it looks like I'm just going to back on the last page of your [flip book] there and maybe this is for Anthony. So it looks like in the fourth quarter, your developments are going to add on a GAAP basis about $8 million of NOI. So you got $16 million year-to-date, you're going to get $24 million for the year GAAP and so that's $8 million in the quarter and those projects are going to give us $36 million of total NOI for 2016. So, relative to kind of year $0.52 guidance. Is it fair to think there's not a whole lot of incremental pickup on the development projects for 2016?

I think that's a fair way to look at it, because of the annualized impact by the fourth quarter of next year over the dispositions, that will be completed.

And then how do you guys feel, last one, how do you guys feel just about the 13 million to 15 million of additional leasing on the development pipeline? Is there a meaningful amount of that that could contribute to 2016 or is that more likely to be 2017 and thereafter event?

Yes. Quite a bit, these represented by the two large government leases. We expect those to move towards contract documentation in 2016. I would not expect cash NOI from either one because of the nature of those building, the construction cycle is extremely long.

Tom Catherwood, Cowen and Company.

This question is for Steve. I was looking back at the 2Q presentation slide deck, and in that deck, it included $350 million to $400 million of additional planned sales. And in the 3Q deck, and when you add up all the planned sales, I mean, it could be coming up, it's anywhere from $417 million to $442 million or potentially more. Kind of trying to figure out what the driver is of the upsize disposition program whether it's some sort of the push/pull, whether it's that you just have more uses for the funds, you are going to go to sell more or whether you think pricing is so good right now that you're going to go ahead and sell more non-core. What's the driver there?

Well, certainly pricing that we are achieving we're very pleased with, but the flex upward would really reflect our optimism in our development, our shadow development pipeline.

And as you increase that disposition program, I know, Roger, you obviously mentioned in the testing the waters with the data centers, but is there any of that additional sales that could be harvesting a value from core assets or is it still non-core mainly?

It's suburban Baltimore. It's one-offs here and there and it's [data].

Okay. And then jumping over to the straight-line of rent this quarter, jumped up, it was the highest level it has been during this cycle. Is that being driven by the 1.1 million square feet of development completions this year or are there other contributing factors that are pushing that up?

The vast majority of it relates to the combination of the development that was placed in service in the quarter as well as the impact of the acquisitions.

Okay. And then should we expect it at a slightly above your average run rate level or whether would that come down over the next quarter or two.

Yes, the run rate should moderate down to $3.5 million to $4 million.

Okay. That's it for me. Thanks guys.

John Guinee, Stifel.

Great. Thank you. This is just a really big picture question on how the GSA is thinking and how the Department of Defense is thinking. And we keep track of all the GSA relocations which we can send you, and the general thought process is that we're in the early innings and the GSA themes are pretty consistent. State-of-the-art new buildings or 100% gut rehabs, metro centric, turn-key deals, very painful economics, all of which bodes pretty poorly for the whole DC Metro area, not to mention the whole freeze the footprint as well as 25%, 30% decrease in square foot per person which gives us concern about the entire DC metro area. So, that's sort of one point which we'd love to have you opine on. And then the second is, while we are big believers that cyber warfare is the real deal and the Department of Defense is going to free up a lot of capital. It appears to us that there is a clear focus on state-of-the-art buildings, highly secure buildings, which means that continued migration to on-base facilities rather than leasing facilities, which obviously scares us about the niche we're talking about today. Can you address both of those sort of big picture concerns we have.

Sure. Well, let me take the GSA first. I would not argue with the point that you've made in the GSA -- certainly looking to capture some significant economies in the way they have leased space by consolidating, densifying, moving to different usage patterns. And so I would suggest that it will be tough for second-tier buildings in Washington DC that have had a lot of GSA occupancy over the years. It's going to be a tough experience for them. But I do want to remind you that we don't really have GSA leases. Our leases with the government come from a different procuring source and the way they have used their space is the antithesis of what GSA has used, they are highly efficient, very dense, very modern. So we don't anticipate any of that overall drive affecting our government tenancy by any means.

With regard to the on-base construction of additional campus, there is some construction at Ford Mead. It's going to support the stand-up of a new Four Star Command. That Four Star command has a force base of 6100 employees that it needs to build, to enter into the new era of cyber warfare. That building will hold maybe 15% to 20% of the new requirement. There are needs to upgrade facilities generally on most of the military bases, because they're older facilities and much of that construction that you see is going to be to support improved occupancy of existing tenancy.

With regard to collapsing out of the buildings that we have, I don't anticipate that happening at all and our conversations with our customers lead us to believe that we are a strategic component in their long-term plan, because our developments have provided the secure environment that they do need as other landlords may or may not have. So, we feel pretty good about our position.

And then just one little comment on our government business niche. Since 2011, we have grown our government customer business by 34.5% and that is compounded at 8% per year. And since the sequester, the end of 2013, we've grown our revenue by 26.4%, and it's compounded at 13.6%. So, we feel like we're a vital component of solving problems and providing good space for the government and we don't see that changing.

Dave Rogers, Robert Baird.

Roger, I don't want to put words in your mouth. I guess when you took over initially, you had kind of talked about growing the strategic niche of the business was truly done through development and through dispositions together. I felt like over the last couple of quarters, maybe you started to communicate that you wanted to even that pie out a little bit with some of the larger Baltimore acquisitions. In this quarter, kind of when you look at the disposition plan and kind of what you've said and the move back into strategic development, it seems like maybe you are not evening the pie out, I guess I just wanted to kind of ask that as directly as I could in terms of kind of how you view the breakdown between the strategic niche, the regional office business and really kind of what your goal is, intermediate and longer term in terms of balancing that out?

The company's primary focus is its strategic niche and that's because of the assets we bring to the table every day, we bring 14 locations, we bring a lot of land, unique advantaged land. We bring credential people to work with the government, we bring 20 years of operating and development expertise building special buildings, 20 years of customer relationships and so that's the emphasis of the Company. What we've done most recently was to trade as Steve laid out in his remarks and by the pitch book that we put out for this quarter to trade our suburban Baltimore assets for urban assets.

We do think that there is a place in our portfolio, a small place for what we call our regional portfolio because it does allow us to leverage our local expertise into a second growth platform and we think it's complementary to our existing business, but our core competency is our niche.

I guess as you look at the 2016 sales and I know you're not done with those yet, but in terms of the ability to put that into something else, I mean it looks like development is really your only focus at this point. So, I guess there's nothing really on that regional office perspective that we should be thinking about moving into 2016?

Now we're 100% focused on development, low-risk development.

Okay. And then answer me the last question along those lines. When you think about the spread between the sales this year, next year, which you talked about, I think, to Brendan's question if I remember right, what you see on the development yield side for some of the strategic deals that you're working on now and kind of how that will play into 2016 as well?

Well, on the low end, we're in the 7.5% range on the data deals and then we we're still upwards of 10%, but more in the 8.5% to 8.75% range for our traditional bread and butter niche development deals.

Maybe a last one for Anthony. In terms of selling 200 million and putting that into development, you're comfortable kind of continuing to sell $200 million plus or minus kind of going forward and the ability to absorb that and any potential gains that you would have and put that into development without [10.31] or dividend or anything like that?

We have managed three of the sales this year through a reverse 10.31. So we have managed that both through one of the acquisitions that we executed as well as one of the land purchases and developments. So we're continuing to use some of those transactions to manage that. So, we don't see an issue with that going forward.

Chris Lucas, Capital One Securities.

Just a couple of small questions. On the Dulles Tower sale, Roger, could you maybe give us a little background or color on the wholesale decisions related to how you are thinking about underwriting the lease up of that building as part of the juxtaposition to actually the sales price that you got?

Sure. Well, to start with obviously, we needed capital and we thought the sale of One Dulles tower was cheap capital for the Company to raise, but we did look at it on a marginal basis, that is, we looked at the marginal benefits and the marginal costs, we took our sale price and took the opposite view of that that we were re-buying at $84 million. We added the $100 a square foot of re-tenanting costs that's TI commissions and a little bit of building improvements. As Steve mentioned, there is some OpEx carry of that $2 million a year we assumed for about 18 months and then we looked at the opportunity cost of investing the $84 million for a year and a half, and then we looked at where we thought rents would be when the building was leased up minus $11 in operating expenses and we determined that we would be recreating the value at about a 7% to 7.25% yield and we can invest today for 7% and 7.25% and take a lot less risk because we don't have to deal with the Northern Virginia leasing market and the potential for free rent and extra TI, et cetera.

Okay, and then Steve, you mentioned a little bit about the timing for NOI from both, I guess, it is 3.10 and (inaudible), can you maybe give a little more color as it relates to sort of what your expectations would be as it relates to the build-out of those to actually start the collection of cash rent?

Well, we expect to move into a contracting cycle mid to third quarter next year on the two buildings and I would [handicap] a full year of tenant improvement process for both of them. So I wouldn't expect cash rental later in 2017.

Manny Korchman, Citi Group.

If we just look at your renewal forecast on large box page, what would have to change in either the macro environment or otherwise that you would lose confidence especially once you marked a 100% at this point?

Well, as Steve pointed out, four of the six renewals are with a government customer behind-the-fence in the very secure buildings that have built ATFT standards that are high mission. So, we're highly confident in those four and the other two are very -- are contractors that have a number one position at the agencies that they currently represent. So we think there is a good probability that their contracts continue on and that we expect either 100% renewal in one and 50% to 100% renewal on the second. So, we think it's all about specific circumstances and not about a budget environment.

And with regard to the smaller leases for the fourth quarter, Manny, we are 40% done with what we expect to achieve and we're well into documentation with a large portion of the 60%, we're still working on. So, we have pretty good visibility into what the rent and the renewal achievement is going to be.

And then just switching to the data centers for a second, what types of lease terms are you getting on those deals?

They are 10-year deals with extension terms for another 20.

Thank you. I will now turn the call back to Mr. Waesche for closing remarks.

Thank you all again for joining us today. If your question did not get answered, we're available to speak with you later today. Good day.

Thank you for your participation today in the Corporate Office Properties Trust third quarter 2015 earnings conference call. This concludes the presentation. You may now disconnect. Good day.