COPT Defense Properties (CDP) 2016 Q4 法說會逐字稿

Welcome to the Corporate Office Properties Trust fourth-quarter and year-end 2016 earnings conference call. As a reminder, today's call is being recorded.

At this time I'll turn the call over to Stephanie Krewson-Kelly, COPT's Vice President of Investor Relations. Ms. Krewson-Kelly, please go ahead.

Thank you. Good afternoon, and welcome to COPT's conference call to discuss the company's fourth-quarter and full year results for 2016. With me today are Steve Budorick, President and CEO; Paul Adkins, Executive Vice President and COO; and Anthony Mifsud, EVP and CFO. In addition to the supplemental package and press release related to our results, we have posted slides on the investor section of our website to accompany management's remarks.

As management discusses GAAP and non-GAAP measures you'll find a reconciliation of such financial measures in the press release and on our website. At the conclusion of management's remarks we will open up the call for your questions.

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 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.

I'll now turn the call over to Steve.

Thank you, Stephanie, and good afternoon.

We're pleased with our performance in 2016. We executed well on all aspects of our plan and capitalized on the rising demand for space throughout our portfolio.

As highlighted on slide 4, FFO per share of $0.51 in the fourth quarter and $2.01 for the year were both in line with the midpoints of guidance. We achieved same office cash NOI growth of 4.1% for the year, slightly exceeding the high end of our guidance range. We sold $344 million of assets during the year, completed another $14 million in January, and based on what's under contract expect to close between $39 million and $49 million more this quarter. With these closings, we will have achieved 90% of our disposition goal.

We achieved our deleveraging goal, finishing the year with debt to EBITDA ratio below 6 times and we outperformed our development leasing goal of 700,000 square feet last year, executing 843,000 square feet. For the past five years, through a difficult defense spending environment, we have averaged over 900,000 square feet of development leasing annually. In addition to achieving our goals, 2016 was an important year because it marked the completion of three Company milestones and the beginning of a new outlook first time spending.

I'll discuss the changes in the outlook for defense spending first, since defense IT locations now account for 87% of our core business. According to industry experts and prime defense contractors, US defense spending has emerged from its multi-year recession and is gearing up for new growth.

For the first time since the budget control act of 2011 was passed, there is bipartisan support in Congress to increase defense spending. Equally as important, the five-year space utilization right sizing by defense contractors has run its course within our portfolio.

Demand from contractors was in a healthy recovery throughout the year and we are encouraged by the increase in activity we have seen in the fourth quarter. We see a growing trend of contractors seeking additional space in our locations to service new contracts for which they are competing.

On their most recent earning calls, the prime contractors forecast increased defense spending. While early enthusiasm was based largely on sentiment and anticipated increases in defense spending, the President's national security memorandum on rebuilding the US Armed Forces, issued on January 27, and the memo Secretary of Defense Mattis issued four days later make it clear that defense spending will increase.

Furthermore, the Secretary instructed the DoD to submit its FY17 supplemental budget request to the OMB no later than March 1. If adopted into law, such a supplemental request would increase the DoD's base budget above the $543 billion number already approved but not yet appropriated in the national defense authorization act for FY17.

Until late April, when the current continuing resolution expires, we are awaiting patiently and hoping to see Congress approve and appropriate a FY17 budget. The bottom line from our perspective is that after five years of tacking into the wind we finally expect to enjoy some tailwinds.

The first Company milestone achieved in 2016 relates to our portfolio. Between 2011 and 2016, we disposed of $1.5 billion of mostly commodity suburban office assets containing 9 million square feet. Our portfolio is now concentrated in the most desirable locations which we are growing through well-leased development. During these years, we deployed $1.1 billion into defense IT developments.

Today, our properties and land are adjacent to or near growing United States defense installations or they are in transit-served urban-like locations. Having completed these major refinements, we are highly confident in our portfolio's ability to generate reliable same office cash NOI growth of 3%. We now have the right portfolio and a focused strategy for growing it.

The second milestone is our balance sheet. We have reduced debt and outstanding preferred shares by nearly $0.5 billion and earned an investment grade rating. As mentioned on slide 4 and detailed on slide 9, we have approved our debt plus preferred to EBITDA leverage ratio from a high of nearly 10 times in 2011 to 6.3 times at year-end and expect to lower it to 6 times by the end of this year, by redeeming nearly $200 million of preferred shares. So we also now have a balance sheet with flexibility to support our development franchise.

Our third and final milestone relates to our organization and the changes we have made in the past year, realigning our organizational structure to enhance business development and leasing. Our new Chief Operating Officer, Paul Adkins, joined the Company at the end of November and has a proven track record in capturing business.

In total, we have added six new positions in business development, the cost of which is more than offset by cost reductions elsewhere. These personnel changes will enable us to identify and capture opportunities to deliver more product, faster, and more profitably. All four strengths, our portfolio, balance sheet, organizational structure, and industry outlook position us to capitalize on an expanding set of growth opportunities.

On that note, I'm happy to introduce Paul Adkins, our new Chief Operating Officer. Paul?

Thank you, Steve. It's great to be here and I'm really excited to be part of the team.

I'll start by providing an overview of our major sub-markets and then touch on our shadow development pipeline, which tracks deals where we believe we have a 50% or better chance of winning the business. Our core portfolio was 94.4% leased at the end of 2016 which represented a 50 basis point increase during the year. Demand throughout our portfolio is increasing and should accelerate with higher defense spending.

Our largest sub-segment is the Fort Meade BW corridor which consists of 7.8 million square feet that were 95.4% leased at year-end. The majority of the sub segment is represented by four office parks that support demand at Fort Meade: the National Business Park, Arundel Preserve, Columbia Gateway, and Airport Square. In this sub segment, we also own land that can support an additional 4 million square feet of future development.

The NBP remains the dominant office park in the BW corridor with its unique adjacency to Fort Meade commanding premium rents and occupancies. The NBP contains 3.5 million square feet that are 96.4% leased and the park has consistently been at least 95% leased, even during the recent years of constrained defense spending. The US government is in the process of leasing additional space at 310 NBP which is being Incorporated into their secure campus. We expect 310 to be fully leased before year-end.

Columbia Gateway in Howard County is seven miles away from Fort Meade and serves as an alternative locations for contractors who need to be proximate but not adjacent to Fort Meade. Currently our Columbia Gateway and Howard County properties are 94.3% leased, predominantly to defense IT tenants. Over the past several years, Columbia Gateway has attracted a substantial number of cybersecurity firms and most recently Howard County designated Columbia gateway as a business innovation district.

Airport Square is a 3.9 million square foot office market that surrounds the BWI Airport located 10 miles north of Fort Meade. The market has a wide building quality range and during the past few years, we pared back our office presence to just eight buildings that contain 564,000 square feet and at year-end were 97% leased, 89% to the government and defense contractors associated with missions at Fort Meade.

Demand throughout our defense IT portfolio in northern Virginia rebounded in 2016 and should continue to improve with the passage of the federal budget. At our Westfields location, 10 minutes from Dulles Airport, our 922,000 square feet were 87% leased at the end of the year.

The majority of our vacancy in the sub-market is concentrated at 15049 Conference Center Drive which Aerospace vacated at the end of 2014. Since repositioning the building for multi-tenant use we have leased 86,000 square feet and are experiencing strong demand for the remaining 60,000 square feet.

Patriot Ridge in Springfield is a development project built to support demand from contractors serving the relocated headquarters of the National Geospatial Intelligence Agency or NGA in 2011. Our lease up was delayed by the budgetary environment that existed when we completed the shell and the building has had significant vacancy for a few years. In 2016, demand improved and we leased 10,000 square feet and we are currently negotiating with an NGA contractor that needs 11,000 square feet and who wants expansion rights for up to an additional 40,000 square feet.

In our Navy support portfolio, demand throughout our three locations improved dramatically in 2016 as evidenced by the 740 basis point increase in leasing. Given the new administration's desire to enhance the Navy's capabilities, we are encouraged about our ability to continue to restabilize this unique sub segment of our portfolio.

Our Redstone Gateway project is located in Huntsville, Alabama on land we control pursuant to an EUL. Similar to NBP in it's adjacency to the government demand driver Redstone Gateway offers contractors the only opportunity to relocate into modern, efficient buildings in an office park that is located en route to the government's missions at red stone arsenal, one of which is based in missile defense, which the President highlighted as a funding priority in his January 27 memorandum.

Our project's adjacency to the arsenal translates into cost savings for contractors and its visibility affords them branding opportunities that are unparalleled in that market. Lastly, the seven Class A office buildings in urban and urban-like locations that we refer to as our regional office segment were 95.3% leased at the end of 2016 and continue to outperform the relative competitive sets.

Rising demand in our markets and a strong renewal forecast support our expectation that same office cash NOI will grow between 3 and 3.5% this year. Recovering demand also supports the size and geographic diversification of our shadow development pipeline that now includes up to 1.6 million square feet of mostly build-to-suit projects.

Typically our shadow development pipeline exceeds 1 million square feet and translates into 750,000 to 1 million square feet of projects under construction each year. As slide 8 illustrates, since 2012 we have averaged 920,000 square feet of development leasing annually. This newly developed space we place into service each quarter tends to be significantly pre-leased.

In 2015, we delivered 1 million square feet that was 97% leased and as slide 7 shows the 700,000 square feet we placed into service during 2016 were 93% leased. This high degree of pre leasing translates into future growth. We currently have $19 million of annualized cash NOI associated with executed leases which will contribute to future results and grow NAV.

With that, I'm handing the call over to Anthony.

Thanks, Paul.

FFO per share of $0.51 in the fourth quarter and $2.01 for the year were in line with the midpoints of our guidance. Same office cash NOI increased 4.2% in the quarter and 4.1% during the year, slightly outperforming guidance.

During the fourth quarter, we sold $54 million of suburban office properties and non-strategic land, bringing our total sales for the year to $344 million. Our 2017 guidance includes selling the final $100 million to $110 million of assets, $14 million of which have already closed and another $39 million of which is hard with deposits at risk. We have another $47 million to $57 million in contract negotiations which when executed will complete the programmatic asset sales.

In the fourth quarter, we issued $110 million of common shares under our ATM at an average price of $29.56. We chose this course and the associated dilution in the first half of 2017 in order to raise the remaining long term capital necessary to redeem up to $200 million of preferred shares that are callable this year. We have already redeemed all $26.6 million of our outstanding Series K preferred shares in January and likely will redeem the $172.5 million of Series L preferred shares which have a 7 3/8% dividend when they are callable at the end of June.

As shown on slide 9, we modestly exceeded our debt target debt to EBITDA ratio for the year due to issuing common shares from our ATM. If we had not issued the common equity we still would have ended the year with the debt to EBITDA ratio of 6 times. Our goal for the year is to lower our comprehensive leverage ratio, measured as debt plus preferred to EBITDA, from 6.3 times at the end of 2016 to 6 times at the end of this year.

As slide 10 depicts our debt maturity schedule at the end of the year, please note we have no debt maturities until 2020.

Slide 11 of our presentation summarizes our guidance and the major assumptions that support it. We are maintaining our initial guidance for the year of $2 to $2.08 and establishing guidance for FFO per share as adjusted for comparability for the first quarter of $0.44 to $0.46. We forecast same-office occupancy to increase between 40 and 80 basis points in the quarter which is based on executed lease commencements in the first quarter.

To reconcile the $0.45 mid point of our first quarter guidance versus the $0.51 we reported for the fourth quarter, subtract $0.02 of dilution from the $110 million of common shares we issued late in 2016 that won't be deployed until mid-year; subtract $0.02 for net weather related expenses, $0.01 for lower development fee income, and another $0.01 to account for dilution from asset sales.

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

Thank you, Anthony.

Our primary objective is to deliver competitive total returns to our shareholders. We are doing this by aggressively pursuing defense IT business and by managing our portfolio and balance sheet risk to ensure stable, predictable growth through out the economic cycle. The four strengths I spoke about earlier: our portfolio, our balance sheet, our organization, and our industry outlook should combine to produce very attractive risk-adjusted returns for shareholders.

Going forward, our strategy will produce same-office growth which, when combined with our development yields and at least $200 million of well leased projects, should generate annual FFO growth of around 5% to 6%. Even assuming no multiple expansion, such levels of steady growth in conjunction with our secure dividend should translate into total annual returns of 8% to 9%.

In conclusion, after years of being on defense, we are excited to shift to offense. Our 2016 achievements and the years of change that preceded them have provided a strong foundation for future success.

Defense spending bottomed in 2015 and has begun a multi-year upturn. Our defense IT locations are aligned with the US government spending priorities and intelligence, surveillance, reconnaissance, missile defense, Navy force, and cybersecurity. We are optimistic about our future prospects and ready to capitalize on them for shareholders.

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

Thank you, ladies and gentlemen.

(Operator Instructions)

Your first question comes from the line of Emmanuel Korchman with Citigroup.

Hi. Good afternoon, everyone.

Good morning, Manny.

Could we just talk about the leasing and occupancy pace for a second? I think, Anthony, you mentioned that 60 basis points was occupancy gain was accounted for through executed leases. But at the same time it looks like your lease-to-occupied rate or the gap between those two rates was also compressed, so is that to say that you're going to get an even bigger compression between those two rates by the end of Q1?

Not at all.

It's just to say that there's a significant amount of space that's leased but not occupied that will come on line in the First Quarter. That accounts for the increase in same office occupancy for the quarter that we're projecting, but we'll continue to execute leases that will maintain if not continue to increase the lease percentage.

Got it. And then, Paul, maybe a question for you. Welcome to your first call.

Thank you.

You mentioned that you're speaking to one contractor taking 11,000 square feet or looking to take 11,000 square feet with 40,000 with an option for 40,000 feet.

Additional space, yes.

Of additional space. What would give them the clarity to take that big of an increase on sort of that incremental space?

I'm sure it would be related to a contract with the US government.

That tenant is a NGA contractor and they elected to move their executive team into the building. And they are also seeking or seriously considering consolidating other functions to the building, because they are pretty excited about coming into it.

And then one last one for me. Would you consider using your ATM to fund developments as well, or was that more one-time to take out the preferred?

In our guidance for 2017, we're assuming that balance of the proceeds from the dispositions will fund our development needs and will maintain the balance sheet where it is with not only the proceeds from dispositions, but also the incremental EBITDA that's coming on from our development projects. So we'll use the ATM to match fund development and to maintain the balance sheet over time, but for 2017 our plan is really based off of EBITDA from developments coming online as well as proceeds from dispositions.

Great thanks, everyone.

Thank you.

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

Hi, guys. Just a question on some of the leases you were talking about. Just curious, were those kind of under way pre-election or those kind of ramp post-election?

Then maybe on top of that, just could you give us a sense historically how it's kind of trended from the increase in defense budget to when contracts are actually awarded and then the delay when leasing actually comes through?

Sure. So the activity that we've signed in the Fourth Quarter was all underway, if you will, prior to the election, so remember the FY16 budget defense budget added 5.23% to the FY15 budget and it took months for that to translate through distribution within government, in contracts and contract awards.

So the excitement that we realized in the Fourth Quarter and the increase in our demand is really based on the continuing 2016 budget with no impact yet from the 3.8 percent increase we expect to have at the end of April, at a minimum, when the FY17 budget gets approved, so I think I've answered the question.

It takes a little while, and any increase in spending from here should translate into increased demand near the end of 2017.

Then separately, DC6, you guys have more space expiring this year -- I think another megawatt. Kind of what's the expectation there?

And just bigger picture you guys have a fair amount of capital tied up in this building. I thought maybe NOI would reach 19 million and now we're at 15 million. Just curious what the long term plan is. And why not just sell this thing? And you can almost fund the year development with the proceeds.

So with regard to the contraction, we had a renewal where the tenant had over-procured and not realized the full capacity that they had the need for the full capacity they leased. So they gave us back a megawatt, but I can tell you, we increased the rate about 40% on the renewal so it's a good thing for us.

In addition to what you see in the supplement there's another megawatt of co-location deals that are directly have been assigned directly to us that we're looking to transfer to a new tenant in a two-megawatt lease. And we actually have some pretty interesting activity on the remaining almost four megawatts of capacity we have. And we like to -- if we're going to consider selling the asset we want to realize full value.

That's fair. And just lastly, point of clarification. You guys included the 125,000 square foot renewal that was post year-end into the numbers this year. Are you guys going to pull that from the leasing statistics from Q1, so not to double count the benefit?

Well I think what we're going to do, Greg is we're going to continue to show it will be counted as a 2017 renewal based on how we define renewals. So we'll show it in our four supplements for 2017 with and without just like we showed it at year-end, so you'll be able to see how the portfolio is performing with and without the benefit of that lease.

Great thanks guys.

Thanks, Craig.

Your next question comes from the line of Jed Reagan with Green Street Advisors.

Good morning guys. If we do see a sustained uptick in defense related to demand in your Markets, do you think you will benefit from that primarily for more build-to-suit opportunities? Or are you anticipating a material pick up in market rents?

I think it will be a little about both. Already our conversations about build-to-suites in defense locations are higher than they were a year ago as reflected in the increased shadow development pipeline. I also think it's going to drive through drive further progress in parts of the portfolio that have vacancy.

They were particularly excited about gaining ground in the Navy support group. Just to remind you, the Navy got hit disproportionately hard on funding cutbacks and short-term contract awards, so we think that will be pretty exciting.

Then as occupancy improves, generally in the areas around the demand drivers I think we're in a position to be more firm on rate and less defensive on capturing renewals. This could take 12-18 months to realize it.

Have you seen rent spikes in the past in your core sub markets, say the Fort Meade area, or is it typically pretty steady?

Considering I joined the Company a little over five years ago, we haven't seen it in the last five years. My understanding before that per idea of time is we had steady growth but not spikes.

Okay and you mentioned an improved tempo of build-to-suit conversations over the last year, have you seen a noticeable change in the trends even just since the election? And if you've averaged 900,000 square feet or so of development leasing over the last five years in what were softer conditions, how are you feeling about kind of reaching or exceeding that target in the coming year or two?

It's really too early to say that we've seen an uptick since the election. We have had some casual conversations that lead us to believe we should be more optimistic, but until we see that translate into demand, we would be remiss to project higher levels. But we have some significant build-to-suit opportunities that occurred or were introduced before the election, based on contractors' comfort with just the increase from the 2015 to 2016 level of spending and their confidence in planning longer-term about their business needs.

Okay, but just to be clear as far as kind of recent activity are you noticing tenants defense more active in the market generally? I know one of your peers was talking about a noticeable uptick even just in the last six weeks or so?

Yes, we don't like to over promise, but I can tell you we've had some conversations with people in the community looking for resources that would imply some significant growth. But they are just conversations.

Got it, and just the last one for me. In terms of a disposition progress, are you finding that deals are taking longer to close than expected? And do you feel like pricing is meeting your initial expectations, or have you guys seen some softening in recent months?

I would say some of the suburban -- commodity suburban product has taken longer than we expected, and we have not found buyers who were willing to take on a significant amount of that product in an individual transaction.

So that's led us to breakup some of those portfolios into much smaller bite-size pieces. So because of that it's taken longer, once we get into the right level we have had good demand from buyers and it's gone through the normal closing process once its gotten to a size that the buyers are comfortable with.

To put it in context, Jed, last year's activity represented 17 separate sales, and then we have one closed this year and a couple more coming.

Okay, appreciate the color guys.

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

Hi good afternoon guys. Steve I just wanted to follow-up maybe on the tone overall of what you're seeing from government defense activity.

It sounded in your comments, you talked a lot about later in the year, being able to get started on a number of projects or feeling good later in the later half of the year. But when you look at your development spend guidance for the year, you only have about 125 left to spend on the existing pipeline, which implies 130 plus of new projects to get to work. So I guess a couple of questions in there.

What's getting started early in the year to get you to such a large incremental spend number? And am I reading your comments correctly?

So a lot of what's in their development spend for the year is leasing up the existing assets that we await leasing on. And it reflects the timing of when we anticipate realizing leases and moving out with improvement spend. And the uptick that we're notionally implying for the end of the year won't have much spend associated with it.

So I guess overall what are you anticipating being the development start number for the year? Did you give that? And if you did I missed it.

We didn't give that guidance. Let us take a look at that and we'll call you back direct.

Okay that's fine. I guess with regard to Redstone, it sounds like the product is going to be there and ready. How much of the Redstone activity do you anticipate to be contract driven versus how much of it is market lease expiration driven? And what is that activity look like?

So all of the build to suit activity that we've talked about or that we are engaged in pertains to contractors needing new facilities for current business.

No conversation down there is contingent upon contract awards.

Great that's helpful. Maybe just two more for me. Anymore clarity or timing on when you'll have clarity with that one remaining larger lease that's outstanding in NBP?

Of 310?

No, I'm sorry. The renewal that's pending still.

It will be the end of the year. The Fourth Quarter. I want to say that the contract is scheduled to be awarded in late August and have no reason to leave it will be awarded earlier and skeptical feeling it might be awarded later, just because the complexity of it. So I think Fourth Quarter is the soonest we'll understand who the winner is.

Great okay, and lastly to Anthony, we seen a number of one-time items severance charges impairments etc. Are we done with those? Are those mostly behind us if you taken what you need to continue to reposition the portfolio?

Absolutely with respect to impairments. We will have some sort of final transition costs flowing through the First Quarter for some changes that were implemented in the Fourth Quarter the cost switch will go over year-end. And we will have the write-off of the up- front preferred costs when we redeem those Series K, and Series L. Aside from that, it should be a regular run rate.

Okay, great. Thank you, guys.

Thanks.

Your next question comes from the line of Tom Catherwood with BTIG.

Thanks. Good afternoon, everybody.

How you doing Tom?

Good thanks. Steve, a question. And the theme for this is really risk of too much of a good thing. When I think about it, the Company scaled down over the past few years to handle a slower growth defense spending environment. If that reverses like you expect and demand is this strong or potentially even better, is there more that you need to do to ensure you can service the demand and not miss out on a large upcoming opportunity?

It's a good question. It would be a hell of a problem to have.

In our reorganization, we put a lot of thinking around our development capabilities. And I believe we have the resources we need to handle what we've been used to with some expansion and when we think about that team, we think about it in the context of having the capabilities to meet the needs of our customers and not necessarily on the incremental penny of cost. So my guess is we're pretty well-positioned for an uptick, and my final comment is based on recruiting activities. If we needed to ramp up our team, I'm quite certain we would get good talent very quickly.

Got it. Switching over to the sales, kind of following up on Jed's question previously. So you're projecting $100 million to $110 million of operating asset sales this year, you finished $53 million so far in the First Quarter, think Steve you said there's another $39 million to $49 million. The $53 million that are done and the $39 million to $49 million that could come this quarter, is that all baked into that $100 million and $110 million for the year?

It is.

Okay. So if you complete what you expect to complete in the First Quarter, there's very little left throughout the end of the year; correct?

That's right.

Does this get you kind of portfolio-wise through the end of your non core assets? Or are there a few more hanging around?

This is the final year of programmatic repositioning.

Got it. Then following on that, this is maybe more of a methodology question, but taking a look at your core portfolio it looks like this quarter it grew by 6 assets to 152 in total.

I figured these were developments coming online, but it looks like you only stabilized three developments this quarter. So what made up the balance of these additional core assets that were kind of moved into that part of the portfolio?

There were four assets that we had previously held for sale, that in the Fourth Quarter based on the progress we had made on some of the other transactions, we moved them back into the same office pool. Back into the core portfolio.

Got it. That's it for me. Thanks, guys.

Thanks, Tom.

Your next question comes from the line of Rich Anderson with Mizuho Securities.

Thanks, good afternoon. So Steve, one of my questions I had written down before you started talking was the idea of sentiment over realistic and reality. And you're kind of starting to walk over to the cusp of reality in terms of defense spending, which is great. But I'm curious. Does that ultimately mean that the firepower of your portfolio being something greater than 3% when you're actually getting hard dollars to your contractors? So, in other words, what's 2018 guidance?

Well, I'm going to duck that question shamelessly, but let me give you something to hang your hat on.

If you break down the National Defense Authorization act of 2017, which has been approved but not funded, set forth in it are strengths, 14 strength priorities for the DOD. When we look at those strength priorities, 10 of the 14 have some element of that priority adjacent to our portfolio.

If you dig deeper into the specific objectives set forth in those 10, there are 17 specific objectives that have priorities that are related to our portfolio in some way. So that's the best I can tell you on expectations.

Over time, if that builds as it could, then there could be upside, but we aren't going to--

So, but 3 kind of feel like a floor at least in the current environment?

I think yes, we've said since last year that we believe we can do 3% or better.

Okay, when did cash rent stop rolling down?

Well, we faced some pretty big risks in the third quarter by getting some early renewals out of the way. I think that's going to mitigate the overall impact, depending on the mix.

We still have some properties with older leases that were in tight markets, that when they renew they will roll down. So specifically, in Washington D.C. at the Navy yard, we suffered some big roll downs and in northern Virginia as well.

I guess a year or two more and we should be mark-to-market and start seeing some incremental growth.

Lastly, I know everyone's very excited about the prospects for defense spending, but you do have we do have a President that is inclined to change his mind quickly. And I'm curious, not to make a political statement, but are you underwriting any of that type of uncertainty, or do you think your tenants are underwriting any uncertainty about what direction Trump might take?

He isn't your typical President, so to speak, so what are you putting in place your Company and what do you think your tenants are putting in place to make sure that you don't get a little bit too over your skis on what may or may not come down the road despite what it feels like today?

That's a good question, and it lets us reveal the way we look at our business plan for 2017 and 2018. We haven't handicapped a huge uptick. We've left that as upside.

We based our plan on what we could see based on FY2016 funding being continued through a continuing resolution in FY17, so we've been pretty conservative. If the uptick were less than we anticipated or that the market is anticipating, unquestionably we can still deliver our plan and continue to make good progress based merely on the $523 billion that's been continued into April. With regard to our customers, I don't speak for them.

Okay, but the 3.8% that you referenced the next uptick in defense, you have that but nothing more. Is that right?

No, our leasing plan is based on the activity we saw under the 523 before the 3.8 uptick to 543. So as that uptick materializes, which we don't really expect to happen if it gets funded until Fourth Quarter next year, based on the pattern of demand building this year. It would be upside, but we've been pretty conservative.

Okay fair enough, thank you. It's all I've got.

Your next question comes from the line of Jamie Feldman with Bank of America.

Great, thank you. I think, Paul, you'd mentioned that you think you'll see a lease as [$3.10 in away]. Can you talk about the timing of that in terms of when we might see the NOI contribution for FFO?

Well, we are currently negotiating a lease for 7400 square feet right now and by mid year -- and then there's also verbal intent for another floor, but we think that with the passage of the federal appropriations bill, that maybe by mid year 2017 we would expect to be moving towards a lease for a substantial stabilization of that asset.

Jamie, that wouldn't show up in our results until probably the first or Second Quarter of next year. Because the space still needs to be built out based on the tenant specification.

So you get both of those leases. What's left in the building, how much space?

Well we have 176,000 square feet right now, 7400 square feet under negotiation, so that would leave 170,000 square feet left in the building.

Okay and then what about Nova B. What are your thoughts there in terms of conversations?

We've had some very specific conversations that tell us the approval to proceed with the lease is tied to the FY17 funding approval. So until that gets determined on the current schedule at the end of April, we don't see any activity happening there, but we expect to move to a lease shortly thereafter.

Okay and then you talked about six new people on the Business Development side. Can you maybe talk to us, bigger picture, about what we should expect to see in the organization and maybe a change in strategy than what we've seen in the past, as we think about the next couple years?

Well I don't anticipate changing our strategy at all. We worked for two years to hone the strategy to what it is now. Happily the defense industry outlook is perfectly situated for that strategy to succeed.

What we did do was put some additional resources -- and by the way, Paul is one of the six so I'm pretty happy to have him on Board -- to effectuate a better Business Development capability than we've had in the past.

So I guess more specifically, are they like market focused or are they like type of tenant focused, where are you really beefing up capacity?

So a little bit in development, two positions in leasing, one position in Business Development oriented towards government tenants and data, a better leader, Paul. Who am I missing? We've made a change in our investment professional, and we hired a full time Vice President to be full time on the build to suit activities in Huntsville, Alabama.

Okay great that's helpful, thank you.

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

John Guinee here, how are you? Can you talk -- if you look at page 18 on your leasing in the Fourth Quarter and then you do the math for your 125,000 square foot government renewal -- Can you tell us a little bit about the building, about the location? What the new gross rents, are that sort of thing?

Well, the building is a -- you're talking about the building, the lease we signed after year-end?

Exactly, yes Steve.

So it's a modern ATFP building in the secure campus in the Fort Meade area. Rents were probably $24 to $25 net.

I did the math, because it's pretty easy to subtract one from the other. It looks to me like your expiring rent is about 37 gross and your new rents about 47 gross which is a 27% up. Looks like your cash rent went from 40 to 43, which is about a 7% increase looks like about a $20 per square foot TI package and a 10-year lease term does that all sound pretty good?

Sounds about right.

How many of those can you do? The rest of the page is and not too inspiring, but that one lease is stunningly good.

Well you do them when they mature, I can tell you that about 44% of the renewal activity we expect in 2018 will have similar characteristics.

How many square feet in your portfolio is ATFP secured behind the fence? And, by the way, I already know the answer.

Well then I'm not going to answer the question. I'd prefer not to.

Second, looks like you had a $7.2 million land gain? Is that correct?

That's correct.

What kind of dirt, can you tell us a little bit more about it's a pretty impressive number.

The majority of that was -- in the quarter we sold a couple of parcels of land, two of which were in Colorado that didn't relate to that. We had the largest component of the gain related to a piece of dirt in Nottingham Ridge. We sold a majority of that parcel to Paragon two years ago, but we retained 17 acres in the front of that parcel for future development to sort of coattail their development and increase the value. We decided that as part of the strategy of eliminating non strategic land, that we would take that to market and we got a really good price from the market from a couple of folks, and we closed on that.

And was that before or after Paragon announced they weren't going to build the outlet mall?

That was before.

Wow. Well, congratulations. That's, for people that don't know, the White Marsh mall which owned by GGP, and Paragon has been trying to build an outlet mall for four or five years now.

Last question. When I talk to other people who lease to the Federal Government through the Army Corps of Engineers, they tell me that it's a 100% price based RFP process. And then when I talk to people about the defense contracting world, they tell me it's basically technically competent lowest cost, defense contractor has to eat the Real Estate operating expenses. Very different than a decade ago. Are those accurate statements?

Yes, I think they are.

Great. Thank you.

Your next question comes from the line of Chris Lucas with Capital One Securities.

Hi, good afternoon, everyone. Just a couple of quick follow-up questions. Steve, going back to the organizational conversation that was held earlier. Is there any plans to backfill the role that Wayne Lingafelter being held? Or how is that responsibility being managed today and will it be managed going forward?

It's already filled. The candidate started on January 30. It's a lower title, but we have an excellent candidate with the kind of experience that we wanted. And by the way, as part of the restructuring, that position now reports to Paul. So Paul is responsible for government development, commercial development, data center development, and all of the Business Development related to get a better integrated operation.

Paul, do you want to say anything about it?

I think we have a really talented business focused professional on Board who has deep experience to complement mine in the D.C. - Baltimore area, so I'm really excited. As Steve said, we have a Business Development focus along with a great degree of experience working in both D.C. and Baltimore and in between.

Okay. And then, just again, another follow-up, maybe a simpler way to ask it. On the 310 NBP stabilization and Nova B lease, sort of how much time should we expect to elapse between sort of lease signature to GAAP rent beginning and then cast rent beginning?

So from the signature to GAAP, maybe 7 months, and to cash as much as 12 months.

So 12 additional months or 12 months from the lease signature?

Twelve from the signature.

Okay. Great that's all I have, thank you.

Thanks, Chris.

(Operator Instructions)

Your next question is a follow-up from the line of Jed Reagan with Green Street Advisors.

Hi, guys. You've got the development site in D.C. that you tied up a year or so ago. Just curious what the latest is there and how you think about the future of that project. And just to be clear, could it be a defense related tenant potentially?

Hi, Jed. It's Paul Adkins. No, that's a basically a trophy office development site, we're doing a joint venture with the Akridge Company. We are negotiating some final details as it relates to the site, which involves the renovation of a historic school. But we have a 190,000 square foot 10-story trophy office building planned. We have and are currently marketing and in discussions with potential pre lease tenants. And downtown D.C. has nothing to do with defense. These are most likely lawyers.

Understood. What kind of pre-lease threshold would you be targeting?

I would say roughly 40, 50, 60. Somewhere in there.

Okay, and timing wise? Maybe a year or so out?

A year or more, but roughly a year in terms of the hunt before we start the project in order to find the pre-lease.

Okay thank you.

Sure.

Your next question is a follow-up from the line of Tom Catherwood with BTIG.

Thank you very much. Just a quick one for me. The data center shell business -- it looks like you guys only have 21 acres of land left that earmarked for that business. Is it something where you plan to add more land to keep the platform growing, or can you utilize your other land holdings to build at those shells?

Well, we work in harmony with our customers to find the right land for the use they want, and we tend to put that land under contract concurrent with the first pre-lease for it. So no, the summary point is we're not going to land bank. We don't want to take risk on buying land. We are going to time it with the opportunity.

Got it. Thanks.

At this time we have no further questions. I'll now turn the call back to Mr. Budorick for closing remarks.

Thank you all for joining our call today. We are in our offices this afternoon, so please coordinate through Stephanie if you'd like to follow-up. Call later today. Thank you.

Thank you for your participation today in the Corporate Office Properties Trust Fourth Quarter and year-end 2016 earnings Conference Call.

This concludes the presentation. You may now all disconnect. Have a great day.