COPT DEFENSE PROPERTIES Q3 FY2024 earnings call

• Executed two strategic acquisitions in Q3: a 365-acre land parcel near Des Moines for data center development and 3900 Rogers Road in San Antonio.
• FFO per share as adjusted for comparability was $0.65, $0.01 above quarterly guidance midpoint. Increased 2024 FFO per share annual guidance midpoint to $2.57, implying over 6% year-over-year growth.
• Same property cash NOI increased 9.4% quarter-over-quarter and 8.8% year-to-date; increased midpoint of same property cash NOI growth guidance.
• Vacancy leasing exceeded target, with broad-based leasing activity across markets. Tenant retention improved, with midpoint of tenant retention guidance increased to 85% based on strong renewal leasing results.

FFO per share as adjusted for comparability was $0.65, $0.01 above the midpoint of quarterly guidance. Same property cash NOI increased 9.4% for the quarter and 8.8% year-to-date. Occupancy ended the quarter at 93.6%, with the overall portfolio at 93.1% and Defense/IT portfolio at 95%. Vacancy leasing was strong with total portfolio at 94.8% and Defense/IT at 96.5%, with year-to-date leasing exceeding targets. Year-to-date vacancy leasing was 431,000 square feet, exceeding the 400,000 square foot annual target, and vacancy leasing target was increased to 475,000 square feet.

• Increased 2024 FFO per share midpoint to $2.57, up $0.01 from prior guidance, implying over 6% year-over-year growth.
• Increased midpoint of same property cash NOI growth guidance, tenant retention guidance to 85%, and capital investment guidance to $240 million.
• Anticipate compound annual FFO per share growth of at least 4% between 2023 and 2026.

• Market uncertainties related to defense spending and political outcomes.
• Refinancing risks for the $400 million bond maturing in 2026.
• Timing variability in infrastructure development for the Des Moines data center project, affecting construction and delivery timelines.

Q: Maybe just a couple of questions around the Des Moines land acquisition. Just maybe help us think through the timing of getting, I guess, all the infrastructure in place in order to kind of start construction? And then what does that mean from a delivery perspective and then maybe touch on how kind of the leasing for that asset is going to work with your major customer?

A: Well, I'll take that in phases. There's still some timing variability we have to work out. We are awaiting the response of our formal request for a phase power delivery of 1 gigawatt. We'll get that timing in November and then we can react to a Mid-American response to our request with the notion being that if that takes too long, we might be able to self perform some of the development necessary to bring that power to the site. So our thoughts are '25 and part of '26, we'll complete the infrastructure. We expect in all likelihood signed leases in that time period at least the initial leases and then delivery, hopefully in '27, but could possibly slip to '28. With regard to the leasing, we anticipate this will be -- this project will be consistent with our long term program that we will execute pre-leases for data ccenter shells in series of one, two or maybe even three at a time. We'll execute those developments, deliver the space fully leased with rent commencing on the day of delivery and will progress from there.

Q: And not to get sort of ahead of things since you haven't -- don't want yet or leased it, but as you think about the long term ownership, I know on some of the prior projects that you did, you were willing to sell large chunks of those into different vehicles and pull money out. Would you think about that similarly, or do you have a different kind of long term ownership structure for this project?

A: Well, it's our intent and desire to retain 100% ownership of that portfolio as we develop it, as well as the 2 million square feet that we'll have that we continue to fully own. When we did harvest the value of some of these assets through joint ventures, we did it as a financing mechanism when we are not in a position to self fund our development and needed to recycle capital to continue our development program. So to the extent we can manage the pace of this development within our self funding capacity, we will continue to own them. Should the pace of development exceed it then we certainly have the option to bring those to market. We have a tremendous joint venture partner who's expressed interest in expanding that relationship, and we could do that very predictably and profitably.

Q: Just to follow up on Des Moines. As you stand here today, do you have any ballpark figures you can give us on total spend on the project? And then on funding options, Anthony, I think I heard you say you're looking to fund everything through retained cash and debt. But I guess, given the size of this, do you think this will require any equity or at least property sales to fund?

A: Well, it depends on timing. We anticipate this will be a longer term development and we think we can self fund it with our own threshold. We would spend the capacity we've created and we expect to expand as our business situation improves further. But as I said, if that pace exceeds our ability to self fund we're really well positioned to bring in a joint venture partner someplace and recycle capital.

Q: And anything you can say on total spend or too early for that?

A: On total spend, over the life of the development, probably $1.2 billion or more.

Q: I wanted to first ask about leasing and wondering if you can give us a sense on kind of if you have a greater ability to push rental rates for your private sector tenants, just given the more limited availability in a lot of your markets. And then do you have a sense if there is more pricing power on the vacancy leasing side, because tenants might be expanding or you might be adding newer tenants to the portfolio? And how might that compare to pricing power on renewals?

A: Yes, I mean, I would say probably in terms of where the pricing power is, is probably more on the renewal side but certainly seeing opportunities on vacancy as well. But again, as I mentioned in my remarks, it's all about balancing the relationship of what we have with the customers and tenants that we have versus being overly aggressive trying to jack rent. So I think it's -- we just have to look at every case and see where the opportunities are. And as we've said on past calls, looking at opportunities to push down those concessions is really the first opportunity to do that. And then if we can move to Phase III, we can, we will. But it's all about the relationship. If we are too aggressive and stick -- sharp stick in someone's eye then they may agree to this lease but then we won't have them for 10 or 20 years. So it's just something we need to balance with our customers. But to answer your last question it really is more on the renewal side, I would say, at this point because the amount of impact -- the amount of investment they've made in those spaces is significant and it's really hard for them to leave.

Q: Maybe Anthony, starting just looping back on a prior question. On your self funding strategy, can you remind us how much development can you fund the year between retained earnings and the additional leverage capacity as projects stabilize?

A: On a gross basis, it's $250 million to $275 million. So we can fund the equity component of that $250 million to $275 million and essentially maintain our current leverage levels of plus or minus 6 times.

Q: And then, Britt, on the 1.3 million square foot development leasing pipeline, if I back out the two Iowa data center shells that you mentioned are in there, it looks like the pipeline still increased 115,000 square feet or so compared to Q2. Is that directionally correct? And if so, what types of opportunities drove that increase?

A: I mean, directionally, it is correct. It is spread out, though across the portfolio. It's not in one specific area. I will say that, as I mentioned, our Navy Support, we have seen the increased activity there quite a bit, a lot of it relating to the Navy lease that we signed at Maritime. There's additional activity there, which we're very encouraged by even beyond what I just mentioned. So we are seeing some additional activity and tours down in Huntsville as well related to missile offense and defense and the cyber activity here in Columbia Gateway continues to be very, very strong. So it's kind of spread out but directionally correct.

Q: On Rogers Road, is there a SCIF element to that asset?

A: Yes, it will be fully SCIF'd.

Q: And I guess I asked the same question that I asked about Franklin Centers. Like why was it vacant, if it's a nice building given its proximity? Is it similar to, in terms of like, you happen to have this local relationship set that maybe the prior owner didn't. I just -- I'm just curious as to what caused to be vacant and now suddenly fully leased in the dark of night type of thing?

A: Trade secrets, my man. It had been a call center building very heavily occupied. I mean, very densely occupied. The building is in great shape. This was a defense need. And I can't speak for the objectives or capabilities of the people we bought it from. But we identified an opportunity, we moved in, we -- kind of deal that was good for our shareholders.

Q: Given the success there, pretty immediate and also the success that you're seeing at Franklin Center. Does that give you any confidence to start moving the needle on regional office sales? I know 2100 is closed. You've described the capital markets is not there yet. But do you start to get at least a little bit more confident to move the needle on that and take those last remaining sort of issues off the table or at least start to do it, because of some of the successes elsewhere?

A: Well, actually, no. It doesn't make me more excited. And the issue is we're going out and buying assets basically all cash. We finance it internally. For the market to support good value on those sales is going to have to be fairly cost effective, debt capacity to invest in office buildings, and that's not there today. So I don't want to mislead shareholders to think we can create magic because we bought a couple of buildings. The financial markets are going to have to support office investment with that to get good value out of those assets, and we're not there yet.

Q: So you had pretty strong leasing spreads, particularly in the data center shell segment this quarter. But also just noticed that in Fort Meade and BW corridor, particularly on trade line basis was pretty strong as well. So could you just comment any sort of onetime results in there that drove that up? And then is that an indication of how we should think about pricing power on a straight line basis going forward in that sub market?

A: I think your final comment is -- let me address that first. I think, yes, you could think about that as what you can expect in that submarket. Clearly, it's our strongest sub-segment with the MVP representing the biggest component of it and our conditions or our accuracy is so -- our vacancy is so limited there that we've got great power, pricing power.

Q: Just going back to -- I think, you guys alluded to some of the data center renewals that you guys signed had a, call it, 30 basis -- 130% mark-to-market spread on that. I mean are you guys seeing the ability to be able to push rent bumps as you come up on some of those renewals?

A: Well, those -- we are -- the rent bumps on those renewals were 3% each year. I think that compares to -- on two of the leases 2.25% rent bumps and on one 2.5%. So there are higher increases.

Q: I think the one unknown in -- the one item that's in the 2026 math for us is the refinancing rate for our $400 million bond that comes due in the first quarter of 2026, that bond is currently at 2.25%. We know that's not replaceable at that rate. So I think the ability for that to increase is really geared -- gauged off of interest -- the refinancing interest rate on that bond.

A: And lastly, we put that benchmark of, I think, at the end of ‘22 and we're going to report on the benchmark we gave our investors until we get there. So it could possibly be better. But we said we're going to generate at least 4% and we're going to report it that way until we give you the final result.