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Corporate Office Properties Trust (NYSE:OFC)

Q4 2012 Earnings Call

February 08, 2013, 12:00 pm ET

Executives

Stephanie Krewson - VP, Investor Relations

Roger Waesche - President & CEO

Steve Riffee - EVP & CFO

Steve Budorick - EVP & COO

Wayne Lingafelter - President, Development & Construction Services

Analysts

Brendan Maiorana - Wells Fargo

Josh Attie - Citi

Craig Mailman - KeyBanc

Dave Rodgers - Robert W. Baird

Bill Crow - Raymond James

Michael Knott - Green Street Advisors

Michael Carroll - RBC Capital Markets

Tayo Okusanya - Jefferies

John Guinee - Stifel Nicolaus

Todd Lukasik - Morningstar

Operator

Good day ladies and gentlemen, and welcome to the Corporate Office Properties Trust Fourth Quarter and Year-End 2012 Earnings Conference Call. As a reminder, today’s conference is being recorded. At this time, I will turn the call over to Stephanie Krewson, COPT's Vice President of Investor Relations. Ms. Krewson, please go ahead.

Stephanie Krewson

Thank you, Natasha and good afternoon and welcome to the COPT’s conference call to discuss the company's fourth quarter and year-end 2012 results. With me today are, Roger Waesche, COPT’s President and CEO; Steve Riffee, our Executive Vice President and CFO; Steve Budorick, our EVP and COO and Wayne Lingafelter, EVP of Development and Construction.

As management discusses guidance for GAAP and non-GAAP measures, you will find a reconciliation of such financial measures in the press release issued earlier this morning, and under the Investor Relations section of our website. At the conclusion of management's remarks, the call will be opened up for your questions.

Before turning the call over to management, let me remind you that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although, such statements and projections are based upon what we believe to be reasonable assumptions, actual results may differ from those projected.

Factors that could cause actual results to differ materially include, without limitation, the ability to renew or re-lease space under favorable terms, regulatory changes, changes in the economy, the successful and timely completion of dispositions, acquisitions and development projects, changes in interest rates and other risks associated with the commercial real estate business as detailed in our filings with the SEC.

I will now turn the call over to Roger.

Roger Waesche

Thank you Stephanie and good afternoon everyone. 2012 was a year of strong execution by the COPT team and of outperforming our company goals which were to lease space, to sell non-strategic assets, to continue making disciplined capital allocation decisions and to improve our financial flexibility.

On the leasing front, 2012 was the best year in the company’s history as measured be the 1.2 million square feet of development leasing, 675,000 of which was leased to strategic tenants in our government defense IT niche. The fact that we achieved a record volume of development leasing during a time when customers in the defense IT niche continue to operate in such an uncertain budgetary environment is in our view validation of our decision to concentrate our business around serving this specialized niche. The government agencies conducting intelligence and cyber activities and many of the contractors supporting them need to lease strategically located space despite budgetary uncertainties.

In terms of selling non-strategic asset, during 2012, we disposed 35 buildings containing 2.3 million square feet for an aggregate value of over $310 million. Our average exit cap rate on these transactions was 8%. Today, we have disposed nearly $400 million of the $512 million of properties in the Strategic Reallocation Plan or SRP. We also made progress in titling land that represents an additional $50 million of the SRP and expect to sell as much as $20 million of it in 2013.

In terms of making disciplined capital allocation decisions that enhance both our franchise related to our strategic tenant niche and the quality of our future earnings, we recycle sale proceeds into development projects with tangible demand. As evidenced by the four Build-to-Suit transactions, we executed in 2012 and investments in key locations such as our park serving Fort Meade in Annapolis Junction, Maryland, our Patriot Ridge project that supports Fort Belvoir in Northern Virginia and our Redstone Gateway project where we currently are constructing a three building local headquarters complex for Boeing. These and other projects that are adjacent to critical government demand drivers have a clear competitive advantage over other locations in their submarkets.

We also recycled sale proceeds into McLearen Center, a highly strategic 200,000 square foot Class A office building that is located in the Herndon submarket of Northern Virginia. The building is located in close proximity to government demand drivers in this strategic market and is a 100% leased.

During 2012, we executed several initiatives designed to improve our balance sheet flexibility and capital structure with the capital we raised in the debt and equity markets and with proceeds from asset sales we decreased our total debt outstanding by over $400 million and redeemed $55 million of 8% yielding preferred stock. As a result, we lowered our debt to gross asset value ratio from 49.8% at the beginning of 2012 to 42.7% by year-end and improved our debt to adjusted EBITDA ratio from 8.6 times in 2011 to 7.1 times for 2012.

In summary, 2012 was a transformative year for the company. The strategic initiatives we accomplished have strengthen our platform, so that in 2013, we will complete the reset of our company’s portfolio and earnings and be in a position to grow NAV and FFO.

Lastly, I will summarize our current thinking about the federal budget issues. Now a lot has changed since we spoke on our January 15th call, but I will discuss the three possible outcomes. First, sequestration mandated by the 2011 Budget Control Act could go into effect as written triggering across the board cuts including roughly $50 billion of annual reductions to the DoD which would lower the base budget and eat into the current fiscal year base budget of $527 billion.

Second, Congress could kick the can down the road another few months to allow more time to negotiate. This option would be a de facto spending cut as the current continuing resolution already has resulted in lower government and defense spending because the continuing resolution limits the flexibility of the use of funds.

Third, a grand bargain which we believe would result in moderately lower defense spending creating certainty and not materially impacting our strategic customer segment. Given that March 1st is only three weeks away, we believe scenarios one or two are the most likely, until grand bargain on spending is reached, we expect our company and many others will have to endure a lot of headline noise, while the federal budgetary issues are debated.

Furthermore, our tenants have been operating under four years of continuing resolutions rather than budgets. So if Congress kicks the can again that outcome would not represent a change in the way business has been done, although business is not easy to win, we have managed to do pretty well including our record leasing achievements in 2012.

If sequestration were to go into affect, we believe would be only for a few months enough time to for serious and responsible budget cutting decisions to be made. Under this scenario, leasing will become more challenging, but our franchise will still be intact. Our confidence stems from the fact that we have shed most of the non-strategic properties that acted as a drag on our past results, the portfolio we now have is both lean and well aligned with demand drivers that support missions that the nation cannot afford to cut, or at least not cut materially.

Finally, whenever a grand bargain is struck, we certainly and prepared to handle the additional flow of demand for space that would likely follow overtime. Until that longer-term solution is reached, we will focus on what we can control which is to be the preferred provider of real estate solutions to the government and defense IT communities. We feel strongly about our competitive position regardless of the outcome.

With that, I will turn things over to Steve Riffee to discuss our 2012 results.

Steve Riffee

Thanks Roger and good afternoon everyone. Before reviewing our 2012 results, I would like to highlight one new disclosure item that relates to expense reclassification. In order to conform our property operating expense and G&A line items to industry standards and to further improve our disclosure on the components about our corporate overhead, we reclassified certain operating expenses during 2012.

In the first quarter of 2012, we reclassified land carry cost from property operating expense into the G&A line called business development expenses and land carry cost. We completed our expense reclassification process in the fourth quarter by allocating expenses of our leasing and marketing teams to G&A. And I will present them in the line item entitled leasing expenses for all periods presenting. Owing to these reclassifications, investors now have a clear line of sight on the company's NOI margins and the overhead associated with our business.

Now turning to our 2012 results, FFO was adjusted for comparability. For the full year ended December 31, 2012 was $190.5 million or $2.11 per diluted share representing a 1% decrease on a per share basis from the $2.14 per diluted share or $177.7 million of FFO for 2011.

The decrease in FFO per share versus 2011 was due to the dilutive effects of selling non-strategic properties and the higher share count. 2012 FFO per share as defined by [annuity] was $2.13 as compared to $0.72 in 2011.

For 2012, we reported a net loss attributable to common shareholders of $1.7 million and diluted loss per share of $0.03 compared to a net loss of $135.5 million and a loss per share of $1.97 for 2011. At December 31, 2012 our same office portfolio included 177 properties representing 84% of our total consolidated square feet.

177 properties were fully operational in both 2011 and ’12 and exclude our project in Blue Bell, Pennsylvania and the properties that were part of the strategic reallocation plan. For the year and excluding gross lease termination fees, same office cash NOI increased by $5.9 million or 2.3% for 2011.

Including gross lease termination fees, same office property cash NOI increased by $7.1 million or 2.8%. Same office occupancy averaged 88.6% during 2012 compared to 89.1% for 2011 and ended 2012 at 89.1%. For the fourth quarter of 2012, same office occupancy averaged 88.8% which was only 10 basis points below the fourth quarter average in 2011.

In the fourth quarter, same office cash NOI excluding lease termination fees decreased by 1.4% over the fourth quarter of 2011. Including gross lease termination fees, same office property cash NOI decreased 0.7% from the prior year fourth quarter. This same office NOI results were impacted by $1.4 million risk prepayment received in the fourth quarter of 2011.

Adjusting for this rent prepayment, same office cash NOI excluding lease termination fees for the fourth quarter actually increased 0.8%. Adjusting for this rent prepayment and an additional large prepayment received in the third quarter of 2011, annual same office cash NOI excluding lease termination fees increased 4.4%. Within the same office pool, buildings that are adjacent to government demand drivers as well as those primarily leased, the government and defense IT tenants represented 74% of the total same office cash NOI and were 93.6% occupied on average and into the year 95.4% leased.

Turning to the balance sheet, as of December 31, the company had a total market cap of $4.5 billion with $2 billion of debt outstanding. At year-end, 80% of our total debt was at fixed interest rates and a weighted average cost of debt was 4.4%. Our debt-to-gross asset value ratio was calculated according to our bank loan covenants was 42.1% at the end of 2012, down 7.1 percentage points from a year end 2011 level.

Our debt maturities remain manageable with approximately $105 million of debt maturing in the remainder of 2013 and $160 million maturing in 2014 and as I discussed in our 2013 guidance call, we expect to issue at least $250 million of long-term debt in 2013 to extend our debt maturities ladder.

Last but not least, in this morning's press release, we've affirmed our previously issued guidance for 2013 diluted FFO per share of between $1.83 and $1.93. As a reminder, the $1.88 midpoint of our FFO per share guidance range is our base case. We currently only have $17.3 million of revenue at risk down from the $19.5 million that was at risk on our January 15 call and out of the $17.3 million, $12.9 million is in various stages of negotiations.

Our guidance is built on the fact that we have 24 tenants, at least 25,000 or more square feet from us and whose leases expire this year. These 24 tenants aggregate 1.65 million square feet or 67% of all 2013 lease explorations. As of today, we have a high degree of confidence that 78% of them are going to renew it. We also know that 13% are going to move out including the two buildings at Airport Square totaling 164,000 square feet, leaving only 9% of least lease renewals this year with the tenant is undecided.

And with that, I will now turn the call over to Steve Budorick.

Steve Budorick

Thanks Steve and good morning everyone. Market conditions in Greater Washington DC and Baltimore region continue to be challenging with vacancies in the 15% range and sluggish overall demand. The federal budget impasse and the threat of (inaudible) continue to drive caution, consolidation and short-term behaviors in tenant decisions, particularly from the larger more diversified defense contractors.

Notwithstanding these overall conditions, Northern Virginia, suburban Maryland and Baltimore markets each experienced positive absorption in the fourth quarter and the Maryland markets experienced mildly positive absorption for the full year of 2012. A thorough analysis of the statistics reveals that each of these major markets have submarkets that are experiencing disproportionate leasing success and tenants migrating the higher quality opportunities and to our demand drivers.

The submarkets adjacent to Fort Meade have tightened and we are experiencing steady demand, scarcity of large blocks of available space and the positive GAAP and cash lend spreads and renewals during the fourth quarter. The cyber command activity at Fort Meade continues to drive demand from small, mid-sized and large contractors who are receiving contract awards.

At the National Business Park, we signed a 58,000 square foot lease after year end. Where the cyber contractor for all of the remaining vacancy had MVP [four times] which brought the property to 100% lease and the part to over 99% lease.

In Virginia, concessions remained high, but we have realized reasonably strong demand in Tysons Corner, Westfields and Springfield submarkets. Once again, confirming the [volatility] of our strategy to invest in properties adjacent to knowledge based defense IT demand drivers.

We expect that overall conditions in the region will remain challenging, as Congress grapples with the fiscal dilemma, however we also have good visibility to additional demand in many of our submarkets and we remained confident that we will achieve continued leasing success in coming quarters.

In terms of COPT’s properties our consolidated operating portfolio occupancy increased to 160 basis points during the year to end 2012 at 87.8%. We attribute the increase on occupancy to disposing of non-strategic properties that on average were 82.7% occupied and to the impressive volume of leasing achieved.

During the year, we leased 3.3 million square feet including 1.2 million square feet of new leases at our construction and redevelopment projects. As Roger mentioned, despite the budget conditions around certainties in DC, approximately 675,000 square feet of our development leasing with the strategic tenants and government defense IT niche.

Our recent statistics for the fourth quarter and the full year are detailed on pages 17 and 18 of our supplement. So let me mention a few things worth highlighting.

First, we have simplified our leasing presentation in the three basic categories; renewing leases, development and redevelopment leases; and other new leases representing leases assigned for vacant space that we acquired and/or second generation space that has been re-tenanted. Also on renewing leases, we now provide the GAAP and cash rents through the expiring and renewing leases. These spreads can serve as a better proxy for a mark-to-market analysis.

Having said that here's some color behind the fourth quarter leasing stats; the renewal rates for the fourth quarter in our in-service portfolio was 86%. The average length of renewing leases signed in the Baltimore, Washington corridor and in Colorado Springs averaged roughly five years. The overall fourth quarter renewal lease terms was skewed by two tenants that executed short term renewals. The 220,000 square feet user in Northern Virginia and a 100,000 square feet user in St. Mary’s County. This is a short term tenant reaction to the federal budget uncertainty.

Excluding the effect on these two large renewals, the weighted average term of renewing leases in our fourth quarter was 3.2 years and for the year was 4.0 years. The impact of the short term renewal activity is threefold. First, the shorter leases require minimal leasing costs; second, our 2014 and 2015 lease expirations reflect slightly higher roll over levels than a year ago; and third, we have a higher percentage of Northern Virginia leases to negotiate 2014. However 70% of our 2013 rollover is in the Baltimore Washington quarter, where we have the best pricing power relative to other sub markets.

One final thing to note about the fourth quarter leasing is the 342,000 square feet of new leasing executed in Northern Virginia. The majority of this activity related to the two datacenter, build-to-suit deals in Ashburn we signed late last year. Those leases are triple net and we are obligated to deliver only shell buildings. Accordingly, the leasing costs per square foot on these deals and the rental rates are much lower than our average office deal.

For 2012, our cash flow on renewing leases was 4%, which was in line with our expectations laid out a year ago. Looking at the fourth quarter, cash rents on renewing leases actually rolled up 1% owing to the 7.9% cash rollups we achieved in the Baltimore Washington corridor minus rollups on the 250,000 square feet we renewed in Northern Virginia and 1.7% cash increases we realized on 110,000 square feet of renewing space in St. Mary’s and King George’s County.

Our final comment on our leasing in 2012 involves capital spending. Consistent with past years, our company once again managed to lease space with some of the lowest capital commitments in the office sector. For the full year, our average committed costs per square foot leased of only $6.35, compares favorably to our office repairs leasing cost. Our ability to manage our leasing costs continues to enable us to invest more proactively in building improvements, which bolsters future leasing efforts and gets us ahead on our three year capital plan.

During the fourth quarter of 2012, you will also notice an increase in our quarterly CapEx, which is associated with our accelerating some of the capital spending. Turning to COPT DC-6 our wholesale datacenter in Manassas, Virginia, we continue to track significant wholesale demand and the users behind that demand continue to be methodical in their decision making. The wholesale demand in the market today represents more than 133% of the remaining capacity of our facility. The supply and balance in northern Virginia has improved and there is currently 11 megawatts of competitive supply available, reduced from 33 megawatts in mid 2012.

Turning to the fourth quarter of 2012, we initiated a program to provide a co-location leasing structure to augment our wholesale offering. In order to provide an effective solution to a more active demand segment in the data market, which includes many defense contractors and government requirements. We're encouraged by the interest we're experiencing from the defense and government contractor segment and our high density capability is the competitive advantage in this segment.

In January, we executed our first co-location transaction with a high credit international commercial tenant, providing an initial deployment of 120 kilowatts scalable for 300 kilowatts at tenant [auction]. This tenant’s initial deployment is configured at a high density of 175 watts per square foot, and we're working with additional prospects to provide deployments scaled above 250 watts per square foot. We continue to be optimistic regarding both our wholesale and our co-location leasing opportunities as we progress in to 2013.

With that, I'll turn the call over the Wayne.

Wayne Lingafelter

Thanks, Steve. Before discussing our major projects, I would like to highlight a change we made to our supplemental disclosure related to land and pre-construction cost, which are presented on page 27. We've separated out the non-strategic land and provided the associated book values. These book values include infrastructure and other pre-construction cost which do add value for future development or resale purposes, and in the case of our strategic parts, keep us well positioned to respond quickly when new demand for office space materializes. Some of the non-strategic land was in the SRP and we intend to dispose off it as opportunities present themselves over the next several years. In the meantime we believe this additional disclosure will help you firm up the evaluations of our company.

Having said that, I will now provide a quick recap of our 2012 activity and touch on our current development pipeline for 2013. During 2012, we completed shelf construction on five building, including the one redevelopment aggregating to 624,000 square feet and representing $148 million of value. At year-end, these five buildings were 62% leased.

During the year, three office development properties were fully placed into the service, including two properties at NBP. These three properties contain 348,000 square feet, representing total projected investment of $76.6 million of stabilization and are 59% leased as of January 31, 2013. As we begin 2013, our pipeline is 66% pre-leased and only four buildings have on committed space. One of these four buildings is a small flexed property we recently completed at Redstone Gateway where there has been demonstrated demand for this product type.

The second one is our initial building at Patriot Ridge in Springfield Virginia, which is now 49% leased. We see good interest in the market from contractors supporting the National Geospatial-Intelligence Agency. The other two on committed buildings are at NBP. The first building NBP 312 is adjacent to our secure campus and therefore targeted for government use. The second building NBP 420 will be delivered to the market in the second quarter. Now that our latest building to deliver NBP 410 is 100% leased, we are directing interest from our contractor based to NBP 420.

Given the strong fairly steady demand generated by Fort Meade and the cyber initiatives, we believe our investment in NBP 312 and 420 will generate attractive returns. In closing, I would like to highlight the strong, demand-driven, build-to-suit activity we closed in the fourth quarter. As previously announced we have commenced construction on four new based building projects which are fully leased to high quality credit customers in strategic markets. Two of these properties are Huntsville, Alabama and two are located in Ashburn, Virginia. We believe the build-to-suit activity as well as the pre-leasing achieved in the rest of the pipeline demonstrates our commitment and ability to de-risk our development business while still providing attractive returns to our shareholders.

With that I will turn the call back to Roger.

Roger Waesche

Thanks Wayne. Let me conclude by highlighting our leasing situation. In terms of square feet that are leased that not yet occupied, our in-service portfolio has 263,000 square feet of lease space that will begin cash flowing this year. We have more than 900,000 square feet of development and redevelopment space that is pre-leased and which will begin cash flowing later this year or in 2014.

That lease is only 575,000 square feet of development space to be leased in a development and redevelopment pipelines. We currently are tracking over 500,000 square feet of development demand in our markets. As these supply and demand fundamentals combined with the value our franchise provides for our customers, it gives us confidence about the company’s ability to execute our plan in 2013.

We are not saying things will be easy, we are expecting turbulence on the government defense spending front while the budget issues are negotiated and hopefully resolved, but we also expect 2013 to present us with plenty of opportunity in particular because one piece of certainty that Washington DC is able to project is that cyber defense and the intelligence aspects of national security are and will remain top priorities for the DoD. For 2013, we are clear about our mandate, finish what we started, work hard to capture new demand in our market and position the company for growth.

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

Question-and-Answer Session

Operator

Thank you Mr. Waesche. (Operator Instructions) Your first question comes from the line of Brendan [Brendan Maiorana] with Wells Fargo. Please proceed.

Brendan Maiorana - Wells Fargo

So, Steve Riffee, just wanted to start with you, I appreciate the commentary about the leasing expenses being reclassified. I just was hopeful that you could provide a little bit more color about the nature of these expenses and why its appropriate to have them as corporate expenses and not operating expenses?

Steve Riffee

Well, they are in essence, the cost of internal personnel for unsuccessful leasing. So what our team finished was a study and concluded that most REITs now classify those leasing costs in G&A so we made that reclassify and put them on a separate line item so you can see for (inaudible). So it would be the cost of internal space design people and leasing people for deals that don't go through and those get expensed. Otherwise, successful leases are capitalized and amortized over those.

Brendan Maiorana - Wells Fargo

Okay. So there's leasing personnel in there, but to the extent that they pursue leases that aren't successful that goes in that line, but the leasing commissions, any internal leasing commissions or salary would get allocated to the operating expense line?

Steve Riffee

No. All internal leasing costs are either capitalized as part of a successful lease or they are expensed and what we've done is breakout anything that's expensed for an unsuccessful lease and put it on the separate line item.

Brendan Maiorana - Wells Fargo

The second question I had was for Wayne, the land allocation, you know I do think that's helpful looking at that, if I look at the breakout of your strategic land there's 1.8 million square feet at NBP, that's about 15% of your total developable land. It strikes me that that's probably a much higher percentage of that total cost; do you have a sense of how much the cost is related to the NBP land?

Wayne Lingafelter

No, I think we got to get back to you with that answer, Brendan.

Brendan Maiorana - Wells Fargo

Well, or maybe if I could put it in a different way, if you guys look at development projects that you do there and you think about the stabilized value of those assets, upon stabilization, what does that sort of imply for the land value underneath the land value per square foot underneath those buildings?

Roger Waesche

Brendan, it’s Roger, I think the land for NBP given what land for instance sells, at Columbia Gateway Business Park which is seven miles away and does participate in the government contractor business at Fort Meade, considering land here sells for $35 to $40 a foot I think the NBP land would probably be $50 or so. Our allocation is approximately $30 a square foot at the National Business Park, but it's a little misleading in that, it includes monies we spent to design some buildings and get permits and it also includes a little bit of a parking garage for future building. So embedded in our land values are other cost other than specifically land.

Brendan Maiorana - Wells Fargo

Okay, that’s helpful. And then last one, Roger, you guys have done a really great job over the past couple of years, selling the non-strategic assets and focusing more on, what I think you used to call for super core properties. As you look out over the next year or a couple of years, what do you think that the non-defense and government related portion of the portfolio looks like; is it datacenter and is it something like Canton Crossing or does that actually get down significantly less than what it is today or do you always think that that’s a portion of your portfolio on business?

Roger Waesche

I think by nature we're sharpshooter in certain submarkets of the greater Washington, Baltimore region. We’ll obviously have a portion of our portfolio that isn’t 100% aligned with adjacency to government demand drivers or with strategic customers that support those demand drivers. So for instance, you are right, Canton Crossing and assets like that would be in our local sharpshooter bucket and we think that that will probably be about 30% of our business with the strategic adjacency and strategic customers being about 70%.

Brendan Maiorana - Wells Fargo

Okay. And which bucket would the datacenter is falling, the 30% or the 70%?

Roger Waesche

Well, most of our datacenters are for strategic customers and they are already embedded in the strategic bucket. We have one datacenter that’s outside of that.

Operator

Your next question comes from the line of Josh Attie with Citi. Please proceed.

Josh Attie - Citi

Thanks, good afternoon. I know you changed the presentation in the supplemental, but can you tell us what the cash rent spreads would have been on the re-tenanted space in the fourth quarter?

Steve Budorick

Josh we don’t have that broken out. I think we could go back and calculate it and talk to you, but we are just taking the re-tenanted space and we are lumping in with the vacant space that we acquired and treating that as other new leasing.

Josh Attie - Citi

Okay. So you don’t have that number separately.

Steve Budorick

No.

Josh Attie - Citi

Separately, can you update us on what you think the average cash yield might be for the projects in the pipeline today; I know composition has changed over the last few quarters with something is being delivered and other projects being started. Can you give us an expectation for what’s in the pipeline today, what you think your initial cash yield might be?

Wayne Lingafelter

Are you asking what the cash spreads are on the mark-to-market basis over the next like year or two?

Josh Attie - Citi

No, on the development pipeline, what the yield, the cash yield do you expect for the projects in the pipeline today?

Wayne Lingafelter

Right, so this is Wayne. We have been working towards high single-digits on that; some of the recent datacenter leasing we have done is modestly below that, but we are still working towards those higher end of the range.

Josh Attie - Citi

So, like 9% to 10% you think or 8% to 9%?

Wayne Lingafelter

We are over 9%, less than 10% I would say that we average around 9.25%.

Josh Attie - Citi

Okay. Including the datacenter?

Wayne Lingafelter

Not including CPOT DC-6, just other development.

Josh Attie - Citi

Okay. And not including the Build-to-Suit datacenter?

Wayne Lingafelter

Including the Build-to-Suit datacenter, it wouldn’t impact the 9.25% number I mentioned very much.

Josh Attie - Citi

Okay. And my last question, do you expect to start additional respective element at NBP this year, I mean as you just spoke about that’s where have a lot of land and it sounds like you only have one more building to lease up there; when you look out, do you see demand on horizon that could support more development starts this year?

Roger Waesche

Well, as we’ve said in the past we like to have one building that’s available for commercial demand and one building that’s available for government demand which is how we’re positioned today with NBP 420 and NBP 312. So its really subject to the demand that materializes in the second half of the year; we will be ready to start additional development there if demand does materialize.

Operator

Your next question comes from the line of Craig Mailman with KeyBanc. Please proceed.

Craig Mailman - KeyBanc

Hey, guys. Just a quick follow-up on the comments on the Build-to-Suit datacenters and the yield; I am just looking in the supplemental, the cash runs you guys are breaking out versus the price per square foot, it looks like closer to 10, I mean is that high single digit in your view or am I looking at that wrong?

Steve Riffee

Well, there is a few operating expenses that are embedded into the rents and so the net, the NOI is a high single digit number.

Craig Mailman - KeyBanc

Okay. And then just moving on to leasing, Steve can you just give a little bit more flash around the color about the good visibility in traditional submarkets, kind of where are you seeing the best demand here, any specific examples you may have would be helpful?

Steve Budorick

Sure in the Columbia area in and around Fort Meade. We have known tenants that have leased all the space that we can make available to them and are looking for other solutions. In Columbia, there are tenants seeking consolidation or new offices where there is not sufficient supply to meet their requirements. So they are evaluating both through opportunities.

Additionally, in Virginia in the Westfields market, there's a significant amount of activity interested in that market and in the 2014 to 2015 timeframe, there's active tenants representing somewhere between 1.1 million and 1.4 million square feet looking for opportunities to plant the flag in that market, and also down at Springfields, we have tenants we've been talking to for some time working on contracts with the NGA that we anticipate being successful and they are planning to take space in our buildings if and when contracts are awarded. And then frankly, Tysons Corner there's a reasonably high amount of vacancy in the Corner, but tenants are starting to behave and look forward to the situation when the transit stations are opened and so we are getting pretty strong interest in that building, the 1751 Pinnacle.

Craig Mailman - KeyBanc

And when you say the Columbia that's outside of MVP right, that's more Columbia Gateway?

Steve Budorick

The Columbia Gateway in and around the headquarters building that we (inaudible).

Craig Mailman - KeyBanc

Okay, then on the 70% of 2013 expirations in the BWI how much of that is MVP and kind of where are rents relative to where you guys think you price them today?

Steve Budorick

I haven't really broken down by part Craig, I would have to take a look at that again but I think if you look at our leasing statistics for the fourth quarter you see we are getting to a pretty good results in that BW quarter.

Craig Mailman - KeyBanc

Okay and then lastly for Steve Riffee, can you just go through your capitalization policy, and just as regards to Patriot Ridge, I know part of it came online but it looks like your cap lies in the balance of it, just a refresher on how you guys look at that?

Steve Riffee

On Patriot Ridge in Northern Virginia, we've got one building that's come online and the garage associated with that is online at this point.

Roger Waesche

And so Craig the way our capitalization policy works is we capitalize on development assets to the earlier of when they are leased or one year after shell completion, so that building with shell complete in September and so in September of 2013 we will be fully expensing the cost on that asset with industry policy, right.

Operator

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

Dave Rodgers - Robert W. Baird

Roger, in your prepared comments you talked about pent up demand and I think that comment was meant more as a longer term comment but I guess as we think about this year playing out and then you tied in about half a million square feet I think in your final comments on the call you would, how should we tie those numbers together, the pent up demand that you are seeing will there be a fairly sizeable chunk that comes in after any type of approval and how are you guys going to model that in your own guidance and preparation for the year?

Roger Waesche

When we gave guidance for the year, we only assumed an additional $3 million of development NOI from what we already have in place to meet our 2013 numbers. In terms of the 500,000 square feet, that’s 500,000 square feet of specific tenants that we're speaking to about, space needs in our specific market. There is a lot of other soft interest but we don’t know how to handicap that given the uncertainty that exist out there. So as Wayne said, in terms of building starts and dollar spent this year, it will depend on how soon things get resolved with the government spending situation and then tenants coming forward or willing to sign leases.

Dave Rodgers - Robert W. Baird

And maybe Steve Budorick, go back to your average lease term comments 1.7 years of average on the renewal. So that was two specific tenants, if the sequestration continues, it get kicked down the road for a sizeable period of time, do you see additional tenants doing this as further building up that 2014 backlog?

Steve Budorick

I am not sure that's necessarily the fair way to look at it. The larger of the two tenants in particular is engaged in a very complicated, reassessment of the way they want to do business in the future, kind of changing their standards and the entirety of the real estate occupancy strategy. They are simply looking for additional period of time to work through a strategic situation and have given indication that they do want to stay in the building long-term; they were just unable to make a commitment or identify exactly what they needed particularly in terms of identifying their occupancy. The other tenant I think that was related more to concerned about the contracts and the award, the continued funding in award of contracts and that’s at St. Mary’s County it’s kind of a different, a very much more specific occupancy for large group than the one in Virginia. So I think occasionally but now sweepingly well, we will be running into the shorter terms.

Dave Rodgers - Robert W. Baird

Okay, now last question in Huntsville I think you lost a tenant that was 20,000 or 25,000 square feet not a huge impact to the business of course, but can you talk about whether there was a broader impact to any programming down there or what might have drove this move out?

Steve Budorick

Ironically, it’s the same tenant that we referred to in Virginia who is reassessing its long-term real estate strategy intensifying its occupancy. So they exercise the right to terminate eight floor in that building and the good news is it's the best building in Huntsville outside of our new development and we have good interest (inaudible) already.

Operator

Your next question comes from the line of Bill Crow with Raymond James. Please proceed.

Bill Crow - Raymond James

One quick and big picture question from me which is all the budget talk and sequestration talk seems to have rekindled all the idea of another round of BRAC and it’s early in the process but can you handicap at all whether that would be a positive or negative as you look at your portfolio today?

Roger Waesche

We believe it would be a positive and that’s because the government is already relocated and consolidated many groups into the knowledge based defense installations that were tied to and there is a lot of infrastructure that’s been spend and were embedded in environment where there is a highly educated workforce and lot of higher education, so the infrastructure is all there, so we think actually the basis that were tied to would actually to be additional winners, if there was a new BRAC in say 2015.

Operator

Your next question comes from the line of Michael Knott with Green Street Advisors. Please proceed.

Michael Knott - Green Street Advisors

Can you just revisit the prospects for selling the last $160 million in the SRP, and how much are you targeting for this year?

Roger Waesche

We are in the market to sell our Colorado Springs portfolio would which will effectively close out the SRP. We are also as we mentioned in our comments getting entitlements for some of our land to retool it to retail and residential and we hopefully will see some sales from that this year. So the 160 is really Colorado Springs and a little bit of land sales this year.

Michael Knott - Green Street Advisors

You sound like some of the land will dribble out past 2013?

Roger Waesche

That is correct, we think it’s the best value proposition for the company to reposition it for alternative uses and get a much higher value.

Michael Knott - Green Street Advisors

And definitional question on the page 27 that you pointed out to break out of land between strategic and non-strategic, the non-strategic has a book value of $97 million but you are only looking to sell $50 million, can you help us march through the difference?

Roger Waesche

Sure, so when we (inaudible) up the SRP back in 2011, we weren't confident that we could sell $100 million or $97 million worth of land before the end of 2013, so we took part of it and put it into the plan with the balance outside of the plan, but the goal is to try to sell that $100 million as fast as we can.

Michael Knott - Green Street Advisors

And you had previously taken some write-downs going into the SRP and that included some of the land, right.

Roger Waesche

That's correct.

Michael Knott - Green Street Advisors

Okay, and then kind of a house keeping question, of your defense IT segment of your portfolio what ballpark percent is cyber today and where do you think that might go in the future.

Roger Waesche

Michael we don't know exactly because many of the tenants do both Intel work and other program work along with Cyber. So its really impossible for us to break that out exactly.

Michael Knott - Green Street Advisors

And then just I guess going back you pointed out that your business has been operating under the continuing resolution format for a number of years. If you were to go back to the beginning of that period and have told yourself that there would be the stretch of no real budgets and then all this talk about sequestration etcetera. Would you have guessed that the leasing in your business over that stretch would have been better or worse than what's actually happened.

Roger Waesche

Probably in the beginning about the same, but I think we would have been surprised for instance in 2012 that we did 1.2 million of square feet of development leasing.

Operator

Your next question comes from the line of Michael Carroll with RBC Capital Markets.

Michael Carroll - RBC Capital Markets

Since you guys prefer to have some inventory in your markets, do you have any plans to start another project in Huntsville since you only have one small flex building currently under development.

Wayne Lingafelter

Michael this is Wayne, we are in the process right now of going through our development to design and have a building that's on the shelf as was referenced earlier. We do have inventory in the market with the Bridge Point building. So in combination with that in the single story, we are probably well positioned in the short term and as the year unfolds as we do in all the markets we will continue to monitor the demand and be ready to react accordingly.

Michael Carroll - RBC Capital Markets

Would you do that back if you thought the demand was there or would you want to have another built-to-suit, kind of like the deals you are able to complete recently?

Wayne Lingafelter

We haven't gotten to that point, you know pre-lease would be important step for us I think. And that's necessarily a 100% of the building but a pre-lease.

Michael Carroll - RBC Capital Markets

And then my final question is why weren’t the tenant improvements or the CapEx accelerated in the quarter.

Steve Riffee

It wasn’t tenant improvement, it was based on the CapEx. We are running pretty favorable on our leasing cost in the year. We manage that capital plan every quarter for the next 12 quarters. We identified projects of two types that would be helpful to accelerate since we had capacity. One, our largely mechanical system upgrades that allow us to run more efficiently and reduce our energy costs, and we are in need and schedule and the others were opportunities to enhance the lease-ability of assets with interior upgrades and we pulled those out of 2013 and in some cases ’14 and brought them into 2012 to gain those efficiencies and improve our ability to lease.

Operator

Your next question comes from the line of Tayo Okusanya with Jefferies.

Tayo Okusanya - Jefferies

I just want to make sure I understand plans for land sales going forward. So it sounds like there is $97 million up for sale but that in 2013, you really have 20 million built in. Is that correct?

Roger Waesche

That’s correct. A lot of the land is not yet specifically held for sale. It's just designated to be as non-core, non-strategic, and as we get the land entitled for residential, for retail, we will sell it off and that’s going to take several years to realize.

Tayo Okusanya - Jefferies

Okay, and then of the 20 million, that's build in to the 2013 number, what kind of gain do you expect from that and if that gain number is built in to guidance?

Steve Riffee

The book value, we believe, is fine at this point. There is no gain in guidance and we wouldn't include it in as adjusted for comparability.

Tayo Okusanya - Jefferies

And then in regard to, I mean, the overall liquidity at this point with the SRP sale, your line of credit, I mean you guys have a massive amount of liquidity. I am just wondering, going forward, what could we potentially see you do with all that liquidity?

Wayne Lingafelter

Well, we have a development plan to continue to build assets in our business parks, where we had defense communities that were creating adjacent to government demand drivers and that will materialize as demand presents itself and then we will also look to do some selective value-add acquisitions like we did the one in 2012.

Tayo Okusanya - Jefferies

That’s helpful and then one for Roger, I mean since we’ve had all the sequestration stuff pushed out to March 1 at least a reprieve, temporary reprieve from some of this fiscal cliff stuff come January 1, have you really seen tenants change behavior in the last 60 days versus how they were being last year?

Roger Waesche

Not really. I think it’s been more of the same who felt the concern and the uncertainty for an extended period of time, so I think people who have been acting about the same. There are certain programs where contractors are deeply embedded and I know their work will continue on and they move forward as if there is no change in circumstances and then there are others where they feel they are more risk and they lose [slower].

Tayo Okusanya - Jefferies

And then between the sequestration scenario and the kind of continued resolution scenario that you described, which of those do you think is actually better in regards to what is the better scenario for you guys.

Roger Waesche

Well I think again as we said if sequestration kicks in, we don’t believe it will be for long period of time. We do believe that the government will create an adjustment to sequestration that will allow the DoD to spend money on a targeted basis as oppose to cutting across the board. So I think on the one hand the uncertainty would go away I guess if sequestration hit, but it would be, the consequences of that wouldn’t be favorable for spending patterns. So I think under either scenario it’s short lived and we are going to get to a resolution sometime later in 2013.

Operator

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

John Guinee - Stifel Nicolaus

Just a lot of little housekeeping question some quick ones. On page six about 4 million of interest and other income is that anything unusual there?

Wayne Lingafelter

Well we have a track manage gain, which was the reason that we up the guidance on the last call John about $0.03 a share.

John Guinee - Stifel Nicolaus

Okay, and what a good run rate for that line item is going forward?

Steve Riffee

I think that on the last call we gave guidance. So $4 million of which is interest income and about $6.5 million so of other income in total.

John Guinee - Stifel Nicolaus

Then on page 11, which is really well laid out, thank you. You have got, Roger I think airport square comments, those are fairly old entire build portfolios and they tend to be bouncing around 70% to 80%/. Is the market such that as we have austerity those buildings will be more competitive in the future are less competitive for the sort of the second here defense contractors?

Roger Waesche

I think the answer is that, its both. There will be some tenants who want to lower cost alternative and who want to go to the airport because it does serve the Fort Meade it’s not too far away and there is a lot of infrastructure up around the airport that will remain and tenants can take advantage of that. But I think others will want to be in newer and fresher product and we will pay up for that. So I think airport square is a balance of some newer assets that compete favorably in the market and then some overbuilding with tenants that are deeply embedded and we think it will stay there for a long time, and then we have some other older buildings that will either have to redevelop or we’ll have to lease then at lower price points price points in order to clear the market.

John Guinee - Stifel Nicolaus

Okay, and then on the North Gate has there been any leasing there in last year or so and what's going on with the big sale of the Gate?

Roger Waesche

We have not had any additional leasing in the past year and in terms of the Gate, I'm not exactly sure what's going on there. It was taken to market and there was not a sale and I think they pull back from active marketing for the time being.

John Guinee - Stifel Nicolaus

And then on there's been a lot of odd questions on the Ashburn Crossing in DC8 and DC9, essentially did you own that land before and therefore you are just providing the core end of the shell for about $110 a square foot. For the tenant I'm assuming it's putting in $500 to a $1,000 of additional costs. What's the whole sort of mentality that a tenant would just have you build a core shell and they would take care of all the improvements?

Roger Waesche

I think its execution situation where they need a developer who can move quickly and execute on their behalf and so they are willing to pay reasonable returns in order to have that.

John Guinee - Stifel Nicolaus

And that they are going to step in and build out the improvements?

Roger Waesche

That's correct. Right, so all the data center investment will be on the tenants investment.

John Guinee - Stifel Nicolaus

Got you, okay and then if I look at page 27, 12.7 million square feet of development of strategic land, 10 year of supply, is that a good way to look at it?

Roger Waesche

It’s all over the place right. I mean Huntsville, we could probably be 20 years and National Business Park could be five years. So I think it depends but if you are saying in general terms that's a good number.

John Guinee - Stifel Nicolaus

Okay, and then for Stephanie, I think you have set a record, pages 38 through 44, are six pages of definitions and you already the only IR person I know who has actually written a book. So my question is, is there anything in the six pages that would strike us as unusual if we actually read the definitions?

Stephanie Krewson

No John. We also made the reconciliation pages in the larger font so that they are not (inaudible) and they are more legible. But no in fact as management has highlighted any of the changes that we have made to disclosure have been to conform to industry best practices. So I would submit to you that there is nothing strange there.

Operator

(Operator Instructions) Your next question comes from the line of Todd Lukasik with Morningstar. Please proceed.

Todd Lukasik - Morningstar

Just on the cash releasing spreads, it looks like they are up about 1% in the fourth quarter, I think your expectation for 2013 was down in the low single-digits, is that still in line what you are thinking?

Steve Budorick

Yeah, it is in line with our thinking and our guidance. We had a good quarter, had quite a bit of activity in the Baltimore, Washington quarter and we anticipate good results there but we are not changing our guidance overall.

Todd Lukasik - Morningstar

Okay, and anything from quarter-to-quarter where there, you may see today that there might be one quarter or two significantly higher or lower than sort of low single digit area?

Roger Waesche

No, and the problem with that as you never know when the tenant is going to sign the lease. So people that have third quarter maturity signed in the second quarter and some that have third quarter maturities don’t sign until then and sometime even the documents don’t get signed until the fourth quarter. So it's hard for us to predict quarter-to-quarter. So what we're saying is that over the 12 month period, we feel good about a low single-digit drop in cash rents for the year.

Todd Lukasik - Morningstar

You mentioned, I think 150 million still in SRP. Is that all Colorado Springs, or is Colorado Springs just a portion of that and do you have a particular number for Colorado Springs?

Roger Waesche

Well, we're in the market for Colorado Springs so we don’t want to put a cap rate or $1 amount on that but it's a large part of $160 million.

Todd Lukasik - Morningstar

Just coming back to sort of the federal budgeting process over the last few years, and sort of the change in leasing environment due to that. What are you thinking about the asset and which ones you guys want to hold strategically long-term is probably the biggest part of it. But is there anything else, with regards to your business, sort of on a day-to-day basis that you’ve changed to better cope with or deal with the federal budgeting process and the negative knock down effect that kind of has on the areas leasing and the uncertainty around that. Is that something that we should think is kind of a new normal going forward or do you see getting better in future years?

Roger Waesche

Well, at some point the government spending situation will get result and then there will be certainty with respect to the base line and the growth off of that and then people will be able to act more normally, and so we expect that. In terms of our business, we've also spent the past year and half reducing our commodity space, so that we're not a collection of desperate assets and so that we’ve focused our assets around our franchise locations so that we don’t have quite the market, ups and downs that normal suburban office has.

Operator

Your next question comes from the line of Josh Attie with Citi. Please proceed.

Josh Attie - Citi

Just a quick follow up, can you tell us if any equity has been issued through the ATM program so far this year.

Steve Riffee

There has been none.

Operator

There are no further questions in the queue. I would now like to turn the call back over to Mr. Waesche for closing remarks.

Roger Waesche

Thank you all again for joining us today. If your question did not get answered on this call, we are all in the office and able to speak with you later today thanks.

Operator

Thank you for your participation in today’s Corporate Office Properties Trust fourth quarter and year-end 2012 earnings conference call. This concludes the presentation, you may now all disconnect. Good day.

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