Welcome to the Corporate Office Properties Trust Second Quarter 2021 Results Conference Call. As a reminder, today’s call 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, Terry. Good afternoon and welcome to COPT’s conference call to discuss second quarter 2021 results and updated full year guidance. With me today are Steve Budorick, President and CEO; Todd Hartman, Executive Vice President and COO; and Anthony Mifsud, EVP and CFO.

Good afternoon and thank you for joining us. Our unique investment strategy of clustering assets around U.S. defense installations supporting national security activities continues to generate strong, high-quality earnings. Second quarter FFO per share, as adjusted for comparability, of $0.58 exceeded the high end of guidance by $0.01 and was driven primarily by same-property results. Additionally, NOI from real estate operations in the quarter was up 8% and AFFO increased 17% from a year ago. Through the second quarter, we completed a total leasing of 1.7 million square feet, which included 815,000 square feet of renewals, 205,000 square feet of vacancy leasing and 641,000 square feet of development leasing. So far, in the third quarter, we have executed 53,000 square feet of development leasing. And we are in advanced negotiations on another 250,000 square feet that should close this quarter. Based on this activity, we are highly confident we will achieve our 1 million square foot goal for the year. Regarding our large renewal at DC6, we have not finalized the lease yet. We reached agreement on business terms in June and expected documentation would follow quickly. The tenant is controlling the pace and progress of the actual lease document preparation and that process continues to labor. Based on their deployment, power usage and the nature of other activities we are conducting with them, we have every confidence they will remain in our building. During the quarter, we placed 197,000 square feet of development projects in the service, including Project EL, a 107,000 square foot specialized facility we built for a defense contractor in San Antonio. We completed this project a full quarter earlier than forecasted and we expect to deliver two additional projects ahead of schedule later in the year, thereby accelerating lease commencements. We expect to deliver Nova C and 610 Guardian Way earlier than planned, which combined with Project EL, are adding nearly $0.03 to this year’s FFO per share. Stronger same-property operations and accelerated development completions drive us to once again increase the midpoint of our full year guidance for FFO per share as adjusted for comparability. The $2.26 midpoint of updated 2021 guidance is $0.07 above our original midpoint and 6.6% higher than 2020 results.

Thank you, Steve. Metrics and trends in our defense IT locations exhibit strength and we continue to capture strong demand as shown in our lease accomplishment to-date. In the second quarter, we leased 1.4 million square feet, including 661,000 square feet of renewals for a very strong retention rate of 89%. Cash rents and renewals rolled up 0.1% and annual escalations averaged 2.6%. For the 6-month period, we completed 815,000 square feet of renewal leasing, with a 78% retention rate, an average lease term of 4.3 years and cash rents rolling down 0.2%. Late in the quarter, we learned that a tenant at Redstone Gateway did not win the recompete of a large contract and at the end of the year, will vacate RG 1200, a 121,000 square foot building. This will be our first opportunity in 10 years to demonstrate the strength of demand for second generation space at the park. We already have strong interest from multiple defense contractors looking to move to Redstone Gateway, including 2 that have 2022 occupancy requirements and want to gain control of the full building. The strength of demand we continue to see demonstrates Redstone Gateway’s position in the market is the essential location for serving government customers on Redstone Arsenal. In terms of vacancy leasing, we completed 111,000 square feet in the quarter, representing 10% of our available space at the beginning of the period. For the first half of the year, we completed 205,000 square feet of vacancy leasing. Our leasing activity ratio was 105%, the highest level since well before the pandemic, demonstrating continued growth in demand across our portfolio. As such, we expect to accomplish healthy volumes of vacancy leasing in the remainder of this year. Regarding development leasing, second quarter achievement was a robust 630,000 square feet and consisted of a 265,000 square foot data center shell in Northern Virginia for our cloud computing customer and 179,000 square feet at Redstone Gateway in the form of two major pre-leases with KBR Wyle. We also executed a 183,000 square foot build-to-suit at the National Business Park. The tenant is a Fortune 100 company and an important defense contractor that provides secure infrastructure, artificial intelligence and cloud computing services to U.S. defense and intelligence agencies. Their selection of the National Business Park for their local headquarters further reinforces the dominance of our location for serving the missions at Fort Meade.

Thanks, Todd. Second quarter FFO per share as adjusted for comparability of $0.58 exceeded the high end of guidance by $0.01, driven primarily by stronger same-property results. Lower operating costs due to effective expense management and the timing of R&M projects boosted second quarter same-property cash NOI by nearly $0.02 above our second quarter forecast. We expect to complete these R&M projects in the third and fourth quarters, which will impact quarterly same-property cash NOI and FFO per share, as shown on Page 18 of the results deck. That being said, for the second consecutive quarter, operating savings and better than expected leasing outcomes are pushing our same-property cash NOI forecast higher. We now expect same-property cash NOI for the year to either be flat or increase as much as 1%, which at the midpoint is a 150 basis point increase relative to our original guidance. We are maintaining our full year occupancy guidance of 90% to 92%, which continues to incorporate the negative impact of joint venturing fully occupied, wholly owned data center shells to raise equity as well as the unexpected vacancy of the 121,000 square foot contractor building at Redstone Gateway in December. In early June, we sold 2 data center shells to a new 90:10 joint venture with Blackstone Real Estate, which generated proceeds of $107 million. The assets were valued at $119 million, which represented a 48% profit and demonstrated the value we create through development. Including 3 properties under development, we wholly owned 10 data center shells that we estimate represent more than $750 million of equity value we can monetize to fund the equity component of future development. Lastly, and for reasons already discussed, we are increasing our full year guidance from a previously elevated range of $2.19 to $2.25 to a new range of $2.24 to $2.28. Our updated guidance range implies 5.7% to 7.5% growth over 2020 results and 6.6% at the midpoint. It is important to note that early development deliveries are driving most of the increase to guidance and that the NOI from these developments expected in 2022 remains unchanged.

Thank you. At midyear, our FFO achievement has outperformed our business plan significantly. This quarter’s FFO result is the fifth time in the past six quarters that we exceeded our plan and the third time in which we elevated full year FFO guidance. Our key performance metrics such as vacancy leasing and development leasing are tracking at or above plan. Clearly, our strategy of concentrating investments adjacent to priority Department of Defense missions and creating value through low risk developments at these locations is delivering FFO growth and lowering our cost of capital. Our strategy continues to provide over 1 million square feet of new development opportunities annually and by expansion, high-value defense IT assets that benefit our shareholders long-term. This year, our development capability excellence is not only delivering projects on budget and on time. In several instances, we are completing projects ahead of schedule and accelerating our bottom line results. Our property operations excellence is wringing out additional performance from our portfolio and improving our same-property results. Our highly durable operating portfolio, strong balance sheet and reliable low-risk development program, combine to create the very visible growth we are delivering. We have a strong set of development and leasing opportunities before us and the balance sheet and access to capital to seize upon them. With that, operator, please open up the call for questions.

Your first question comes from the line of Manny Korchman from Citi. Your line is open.

Hey, everyone. Good afternoon. You guys spoke about the demand at Redstone Gateway, especially for backfilling that this space is going to be vacated. Do you think that, that excess demand is going to lead to new developments there as well or are you just more confident refilling that space that you didn’t expect to get back the NOR?

Well, as Todd mentioned, we have two contractors vying to replace that tenant in RG 1200, only one of them is going to fit. So by expansion, yes, we think we take the other one to a new development.

I guess, Steve, the question is more, were you already in development conversations with them and now one of those is going to get satisfied by this existing building backfill or you just – are you in new conversations with them since the tenant vacated?

These are pretty fast breaking opportunities. So, we had not planned a development for them. It may have occurred had this not happened. But certainly, with the inventory, they see an attractive opportunity to make a move quicker.

And then back to our favorite topic, DC6. It sounds like you are frustrated with the process. Investors are certainly frustrated with the process. Is there anything else here that may change from – within your conversations or is it literally just waiting for somebody to pick up the pen and finalize the deal?

It’s really waiting for the point of contact to put some time and effort in finalizing the documents.

Are you offering a new best guess as to when that gets done or are you going to stay away from that?

I am out of that business. I have been two to three times in a row. Manny, in June, we are pretty excited that we thought we would wrap it up and literally nothing happened through July. So, we continue to wait.

Are they being responsive, Steve or are they – is it literally just silence?

How will I say, they pretend to be responsive, but then they fail to deliver.

Thanks very much.

Your next question comes from the line of Craig Mailman from Keybanc. Your line is open.

Thanks. Yes. I guess, we will continue to beat the dead horse of DC6 for a second. You guys had said down 10% to 15% on rent. Is that still kind of the expectation? And also, are these guys trying to get anything like early outs from you guys or anything that could potentially kind of impact scalability if you guys go to bring this to market eventually?

So we have reached – we believe we have reached business terms back in June. And I don’t want to reveal all the elements of their lease. But I would say the structure is almost identical to the original lease we had.

Okay. And is that mark-to-market still pretty much in the ballpark?

Yes.

Okay. And they didn’t have any early outs in the first lease, right?

Well, they had a right to terminate early, but there was significant penalty associated with it.

Okay. And then just on, I guess development, in general you guys are signing a lot of leases. Are you guys having any trouble getting materials given kind of the shortages of different building products going on or do you guys feel like you can maintain the similar pace of deliveries that you guys have historically done?

Well, as our comments pointed out, we are finishing a couple of these projects earlier than we thought. We have had no problem getting the materials and the labor we needed to deliver. Two of those projects were just signed last year. So, the bulk of the development progressed through that period of time when there is a lot of narrative about shortages. We have had no issue.

Okay. And then just last one for me. Update on 310 NBP, I think you guys have said part of it would be leased by 2Q and the rest end of year. Kind of what’s the updated timing on that one?

No. I think your comments a little off. We said two floors would be leased by the end of the government fiscal year, which is 9/30. And we expect the remaining two by the end of the calendar year, which is 12/31.

Okay. Is that still the expected timing?

It is.

Okay, great. Thank you, guys.

Thanks Craig.

Your next question comes from the line of Steve Sakwa of Evercore ISI. Your line is open.

Thanks. Anthony, I was wondering if you could just help us think through the same-store occupancy target of 90% to 92%. I appreciate the RG 1200 project that put some additional vacancy into the portfolio. And I can kind of see maybe where the high end or midpoint could come into play. But can you help us think through how the low end would come into play at this point given that we are kind of sitting here in August or just about August?

Well, the low end is – contemplates the impact of one to two transactions or additional data center shell sales that are in our results for 6/30 as 100% leased transactions. We – if each of those transactions has about a 20 basis point impact on same office – year end, same office occupancy results. So, to the extent we execute both of those we are sort of managing each based on the timing of our development capital needs. So, it’s really the question as to whether we execute the second of those data center shell sales.

And I realize you don’t provide kind of overall kind of occupancy trends. But if you were to sort of just think about where your overall occupancy is today, any sense for kind of maybe where that bottoms? And when do you think is the bottom kind of put in after Transamerica is out or how do you sort of think about overall occupancy?

Yes. The bottom on a total occupancy basis is probably the end of the first quarter of next year when Transamerica will have moved out, and we will have the impact of the non-renewal at Redstone. The total is – the total occupancy number is just so you are – just you are aware for the second quarter versus the first quarter were impacted by us placing the balance of 2100 L into service, that was formally not part of the denominator. So, now that it was 12 months from its place in-service date, that 81,000 square feet was placed into service during the quarter, second quarter.

Got it. And then maybe just last question. Since you mentioned 2100 L, any – just kind of update on the leasing and sort of what are your thoughts around monetizing that asset, maybe once you lease it up?

Well, Todd, why don’t you handle the leasing?

Sure. DC was hit particularly hard during the pandemic, and it’s emerging slowly. But we have seen an increase in activity in tours and have about 100,000 square feet for the 80 – active prospects for the 80,000 square feet of vacancy. Several of those are in proposal stage and several of those are – the proposals are being drafted. So, increase in activity, we feel good that we are seeing more people and expect some leasing to emerge.

Regarding our thoughts, we fully intend when we have delivered the value we expected to, to take that asset to market, recycle it.

Got it. Thanks.

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

Great. Thank you very much. I am just curious if you have a sense of any kind of price discovery on where cap rates are for your different products – different markets – for your product in different markets?

So, we have a whole research piece on that. And I would recommend maybe rather than trying to remember exactly what’s in that piece on the call that we follow-up with you and we – with Stephanie, our Head of IR, and we give you some support on those cap rates.

Okay. It sounds good. And then can you talk about the Baltimore office market. Just what your thoughts are on backfilling the space you are getting back early next year and just what that pipeline looks like?

Sure. Well, Todd, why don’t you handle this?

Sure. Well, since the market became aware of the impending vacancy at 100 Light, the response has been very favorable. We have about 120,000 feet of active prospects for that vacancy with about 80,000 of it needing a 2020 occupancy. So, we have been pretty encouraged by the market’s reception to that space. It’s a pretty unique space being the highest in the market. So, we feel encouraged by the activity so far.

Okay, great. Thank you.

Thank you.

Our next question is from the line of Anthony Paolone from JPMorgan. Your line is now open.

Okay. Thank you. Maybe for Anthony, you have guidance out there with like – it looks like a year ending run rate about $0.57 at the midpoint, and you talked about .

Hello, anybody there?

It’s Tony Paolone. I am here, if you can hear me.

Tony, we lost you right after you got started. So, why don’t you take it from the top?

Yes, sure. Thanks. So Anthony, and the question surrounds just run rate going into ‘22, because your fourth quarter looks like about $0.57 midpoint in terms of ending the year, but you have got more visibility now on some leases that are occurring or not, the roll outs going into next year. Just any way to bottom line kind of what the step down may be starting Jan 1, given what you know to that run rate?

Yes. I think the – well, the impact for the two large non-renewals in the first quarter, their annual revenue totals about $8 million. So, on a quarterly basis, that would be about $0.02 per share, assuming that there is no – because those happen at the beginning of the year. We are not assuming any backfill for those spaces. But then we also get the benefit of full quarters element placed in service from the fourth quarter. So, it might be $0.01 or $0.02 lower than the run rate at the end of – the number at the end of the fourth quarter.

Okay, got it. Thanks. And then just can you talk about the data center shell pipeline as we start to look out for the next 18 months roughly?

Sure. We have land positions to accommodate roughly another 1 million square feet. We do expect leasing next year. The timing of that leasing has really been driven by the availability of critical power as the market really – the availability in the market got consumed over the last couple of years, robust development. But in total, it’s about 1 million in what we own today and potentially more thereafter.

Okay. Do you think there is any sensitivity on yields on those types of projects, just given where cap rates seem to have gone and also just materials costs and so forth?

Well, it’s more of the cap rate than the material cost. The structure of the deals is a yield on cost. So, when costs go up, the rent will go up with them. It’s more pressure on the negotiated yield, given that the cap rates have continued to compress.

Okay. And then just last one for me. Just you all been able to raise guidance and you’ve put up growth, any thoughts on the dividend? And when maybe we could see a change there at some point?

Go ahead.

Yes. We continue to view the dividend as a capital allocation decision. And since our development opportunities continue to remain very robust and we have no sort of tax structure need to increase the dividend right now. We’re using that additional net operating cash flow to just manage the amount of equity that we need to raise each year for capitalizing the development pipeline. So at this point, our dividend – our payout ratio is incredibly strong, and we have room to move it up when we either need to from a tax standpoint or we believe that there is – we don’t have the development opportunities to invest in.

Got it. Okay, thank you.

Next question is from the line of Dave Rodgers from Baird. Your line is now open.

Yes. Hi, good morning or good afternoon. You guys have answered a lot already, but maybe, Steve, can you talk about the more recent JEDI announcement and the impact or the reaction in the defense community and whether that opens or closes any doors for you guys in the near-term that you’d previously planned on?

Well, I have to say that there is not great visibility into that space yet. But all along, we really did not believe that JEDI was going to be a material boost to our company, because our data center shell customer had not really talked about the impact of it. It’s our belief that with a multi-vendor opportunity, our potential opportunity set would be higher based on some of the great locations that we have. But it’s pretty early yet to see a clear path.

That’s helpful, Steve. I appreciate that. And then maybe one for Anthony, if you had addressed this earlier and I missed it, just let me know, the impact of the lease in Baltimore that you’ll get back the space in the third quarter of ‘22, but it looks like you’ll reset the gap rent in the third quarter of ‘21, any meaningful impact from that, that we should think about?

That rent is rolling down about 10% from the current rent. And that would start the month after we execute the renewal with the tenant. So right now, we forecast – our current forecast and guidance has that effective as of September 1.

Okay. Thanks, everyone.

Next is Bill Crow from Raymond James. Your line is now open.

Hi, good afternoon. Thanks. Steve, and maybe it’s just my perception, but my thought was that you viewed 1 million square feet of development leasing as readily achievable and maybe even a low bar. And I’m just wondering whether – and again, maybe that’s just misperception on my part, but your confidence level in maybe doing much better than 1 million square feet this year?

It’s timing issue, Bill. There are several projects that we expect to win that could occur by the end of the year, which would push us above – materially above. But the timing is – I don’t have enough confidence in the timing to put that into a forward-looking statement.

Alright. Understood. Appreciate that. And then one quick question, I apologize, on DC6, but what are market rents doing over the past year in competitive projects?

So our renewal rate is in line with other large deployment renewals that have occurred in the last, call it, 6 to 12 months. New leasing, those rates are materially lower, maybe as much as $15 a kilowatt a month. But the renewals, we’re right in the range of the market.

And the reason for the new lease, the roll downs on pricing is just too much space, not enough demand, cheaper to build the competitive nature. What’s driving the rents down?

Well, I think it’s a speculative development that needs to put some income into those assets.

Yes. Okay. Appreciate it. Thanks you.

Sure, Bill.

Next is Tom Catherwood from BTIG. Your line is now open.

Excellent. Thank you, good afternoon everyone. Todd, in your prepared remarks, you mentioned leasing activity ratio of 105%, which I think you said was a high for the company. How does that compare to prior periods, maybe last quarter or a year ago? And then do you also track the time it takes for the leases to go from kind of initial activity and interest through documentation and then to execution? Because that period seems like it’s been taking longer and longer over recent years.

Well, the ratio is obviously affected during the pandemic. We’re at levels now that approximate pre-pandemic levels. But throughout the pandemic it dropped and it’s been steadily increasing since late last year and now post pandemic, it’s – I don’t know that it’s at an all-time high, but it’s a high that we haven’t seen in at least 18 months, I’ll say. As far as the time of leasing, we don’t track that officially, but in conversations with our leasing teams and our asset managers, it’s clear that the deal cycles have extended, something that might have been a 4-month cycle before is now 5 or 6 and 6 months might be 8. It’s a function of tenants having a lot of opportunity, where they are looking at a lot of different spaces and taking their time to make their decisions. So the good news is people are moving through the pipeline, just seems to be taking a little bit longer than it used to.

Understood. And then it was good to see the pickup of, obviously, leasing across the board this quarter, but you also had a pickup in Northern Virginia, and that’s a market that’s – seems like it’s been a little slower over recent years. Can you kind of comment on recent activity there? And is there an expectation that you get some more vacancy leasing there in the near-term?

Well, it is one of the markets where we have seen a recent uptick in activity. Its activity ratio is very strong, and it’s been coming on strong over the last 3 months. Again, we would anticipate closing some of that activity, but I can’t really comment on when that would happen.

Got it. Thanks, Todd. And then last one for me, maybe for Steve. You’d mentioned finishing the project early in San Antonio. You have a handful of assets there around Lackland. Obviously, they have all been fully leased for years. What kind of opportunity do you have to maybe expand your portfolio down there, anything else in the near-term?

I wouldn’t expect anything in the near-term. We’ve now consumed all the land that we’ve held on our balance sheet. And ultimately, we do expect the mission to continue to grow. And we have capacity inside the fence to accommodate the government and as opportunity presents with contractors, we have to source some new land, but I wouldn’t expect anything in the next 12 to 18 months.

Got it. That’s it for me. Thanks everyone.

Next is Chris Lucas from Capital One Securities. Your line is now open.

Hi, good afternoon everybody. Hey, Steve. Just wanted to follow-up on your comment about the prospective development leasing deals in Redstone, I am just curious as to whether those deals would be part of the exterior – outside defense land or inside the fence or is it a combination perhaps?

So the things we’re working to close now, and a start that we contemplate we might add are all outside the fence. There is longer term opportunity inside the fence.

Okay. And then, Anthony, I guess on the data shell capital raises. I think you had, I think, earlier in the year, it suggested you would see a series of deals done second quarter, third quarter, fourth quarter. It doesn’t sound like you’re as confident or maybe that the – all of the deals that you had previously guided to necessarily have to close this year. What – can you give us your latest thinking on the datasets shell JV process?

Sure. The current – our current forecast assumes that we execute another joint venture by the end of the third quarter. And at least based on our current thinking and really driven by the fact that we have sort of incremental EBITDA from the operations of the portfolio to maintain our overall leverage levels. At this point, we don’t think we need that additional transaction in the fourth quarter. So right now, we would contemplate a JV on potentially two data center shells by the end of the third quarter, and that would be the balance – that would be all for the balance of the year.

Okay, thank you. That’s all I had.

Thanks, Chris.

No further questions. I will now turn the call back to Mr. Budorick for closing remarks.

Thank you all for joining our call today. We will be in our offices this afternoon, so please coordinate through Stephanie if you’d like a follow-up call.

Thank you for your participation today in the Corporate Office Properties Trust second quarter 2021 results conference call. This concludes the presentation. You may now disconnect. Good day.