Corporate Office Properties Trust's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb. 7.14 | About: Corporate Office (OFC)

Corporate Office Properties Trust (NYSE:OFC)

Q4 2013 Earnings Conference Call

February 07, 2014 12:00 PM ET

Executives

Stephanie Krewson - Vice President of Investor Relations

Roger Waesche - President and CEO

Steve Riffee - Executive Vice President and CFO

Steve Budorick - EVP and Chief Operating Officer

Wayne Lingafelter - EVP of Development and Construction

Analysts

Craig Mailman - KeyBanc Capital Markets

Jamie Feldman - Bank of America

Joshua Attie - Citibank

Brendan Maiorana - Wells Fargo

John Guinee - Stifel

Dave Rodgers - Robert W. Baird

John Bejjani - Green Street Advisors

Bill Crow - Raymond James Associates

Tayo Okusanya - Jefferies

Operator

Welcome to the Corporate Office Properties Trust Fourth Quarter and Year-End 2013 Earnings Conference Call. As a reminder, today’s call 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, Glen. Good afternoon, and welcome to COP’s conference call to discuss the company’s fourth quarter and year-end 2013 results and 2014 guidance. With me today are Roger Waesche, President and CEO; Steve Riffee, Executive Vice President and CFO; Steve Budorick, EVP and COO; and Wayne Lingafelter, EVP of Development and Construction.

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

I’d like to highlight a few improvements we have made to our supplemental disclosure. First, we enhanced our disclosure related to redevelopment projects listed on page 25 to carve out the carry over basis of assets under redevelopment. Second, we are continuing to use the term core related to our portfolio on a temporary basis and will discontinue its use once the two buildings securing $150 million of non-recourse indebtedness have been resolved later this year.

Third on page 12 of the supplemental our Arborcrest project in the Greater Philadelphia market is listed below the course subtotal. Recently leasing activity at the project will allow us to redevelop a fourth building that is 79% pre-leased and we also intend to redevelop the building that Merck is vacating.

Accordingly, beginning in the first quarter of 2014, two to five Arborcrest buildings will be back in our same office portfolio. Hillcrest II will be in our core portfolio, but not in same office. Hillcrest III will be under redevelopment. And Woodlands I which many refer to as the Merck building will be classified into our redevelopment pipeline.

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 in the economy, the success 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. Good afternoon, everyone. Our primary goals for 2013 were to complete the strategic reallocation plans, create value enhancing development projects and strengthen the balance-sheet. We accomplished off three of these objectives.

Today our story is much simpler. I would like to highlight the following three takeaways. First, our same office and core portfolios are well leased and trending positively. Second we continue to create significant value with our development pipeline. And third 2014 is the inflection year for our FFO per share.

Specifically, we forecasted the second quarter will mark the bottom for our quarterly FFO per share and the quarterly results will rebuild thereafter. The following observations support this forecast. The operating property sales associated with the SRP initiated in April 2011 are complete. By the end of 2013 we disposed of 5.9 million square feet of older smaller buildings and buildings that were in submarkets seemed to be less growth oriented. This included reducing our exposure to suburban Baltimore by 63% and completely exiting Colorado springs. In total we disposed of approximately 30% of the square footage we owned when the SRP began.

Our 2014 guidance includes $115 million disposition of two buildings that will no longer contribute to our results effective April 1st. This transaction will be the final major disposition of our three year repositioning and upon its completion related FFO dilution will cease. Going forward we will seek opportunities to further enhance our portfolio quality and returns by selectively harvesting value from mature buildings in our regional office portfolio.

During the last three years we also upgraded our portfolio by placing 2.2 million square feet of new development into service and acquiring 300,000 square feet of Class A office buildings in our most strategic submarkets. Our current development pipeline consists of seven new development properties and three properties under redevelopment for a total of 1.4 million square feet that are 75% leased.

Steve Budorick will walk you through the future NOI when we expect from our recently completed and current development activity. Additionally we lowered leverage by over 700 basis points versus 2011. Last year we obtained investment grade ratings from Fitch, Moody’s and S&P and accessed the unsecured bond market. Accordingly, we have ample balance sheet flexibility to continue to fund our development pipeline.

Last and with respect to our existing portfolio occupancy we’re confirming a favorable outlook for this year and expect same office occupancy to build modestly throughout the year. Although we expect some turnover in our portfolio we have good visibility on strong levels of demand to back those spaces.

Our business environment has recently improved and supports our positive outlook. The recent Bipartisan Budget Act of 2013 we sourced $22 billion of spending to the DoD’s fiscal 2014 budget and bring some measure of stability that should improve our tenant’s ability to plan for the future. As a result of the act the DoD’s base budget for fiscal ‘14 and ‘15 will be approximately $500 billion. Defense spending levels will be flat these two years relative to fiscal ‘13 and thereafter likely grow with inflation. Importantly the act has removed defense spending from the political chessboard for the foreseeable future.

Just as important the law remove the across the board spending cuts and now allows government agencies the flexibility to reallocate funds to priority programs such as cyber security. Our portfolio is clustered around defense installation missions or allying with the DoD’s high-tech spending priorities. Accordingly we expect their projects it serves such installations will benefit in the coming months from increased demand from defense contractors chosen to support team missions. New demand likely won’t materialize until late this year, nonetheless, it feels good to finally have some wins at our backs.

With that let me turn the call over to Steve Budorick to update you on our leasing and development activity, Steve?

Steve Budorick

Thanks Roger. Leasing results in 2013 were strong, during the year, we leased 3.8 million square feet including 1.1 million square feet in the fourth quarter. In 2013, we completed 900,000 square feet of new development and redevelopment leasing which I’ll refer to collectively as development leasing.

When combined with the 1.2 million square feet accomplished in 2012, we have completed 2.1 million square feet of development leasing in the last 24 months. For the fourth quarter, our renewal rate was 74% and for the year we were 70%, consistent with our historical averages. We are encouraged that tenants are committing the longer lease terms.

As you can see on page 17 and 18 in the supplement, on renewals we averaged six year terms in the fourth quarter and for the year, the average term was over four years. For the year we realized average lease terms of over 10 years and the 900,000 square feet of development leasings.

Fourth quarter statistics included leasing 100,000 square feet of stubborn vacancies. For the full year our inventory management efforts have resolved over 350,000 square feet of stubborn vacancies with average lease length of 5.5 years. At the end of the year our 2013 same office pool was 89.8% occupied and 91.2% leased. We will be adding six properties to the 2014 same-office pool, five of these buildings are 92% occupied on average, however the sixth building located in Aberdeen, Maryland is vacant. Due to the inclusion of the Aberdeen property, the 2014 same-office pool was 89.3% occupied at the beginning of the year. During the year, we expect same-office occupancy to increase modestly.

We continue to forecast the renewal rate for our core portfolio of approximately 60% in 2014. Based on 1.6 million square feet of space scheduled to expire this year, our forecasted retention rate implies we have to lease 650,000 square feet to maintain occupancy. Our leasing pipeline currently exceeds this amount and underpins our expectation for higher year-end occupancy. Our leasing pipeline is defined as lease negotiations for existing space where we have a 50% or greater probability of success.

On our last call in October, our leasing pipeline stood at 725,000 square feet. Today, our leasing pipeline stands at 775,000 square feet. When we issued 2014 guidance our revenue at risk to achieve the mid-point of that guidance was $19.3 million and we had transactions in progress for $8.2 million leaving just over $11.1 million in unidentified revenue at risk. Today our unidentified revenue at risk is down to $10.2 million.

The depth of our leasing pipeline and the progress we are making supports our confidence that we can meet or exceed occupancy goals.

Turning to our development pipeline, we continue to see strong demand in many of our submarkets. The results of our development activity will positively affect future NOI and FFO in three ways. First, we have $21 million of stabilized cash NOI from 10 highly lease recent development projects that are not yet fully cash flowing. These projects would generate about $9 million of cash NOI in 2014, an incremental amount to full stabilization in 2015 and 2016. This $21 million of NOI is not speculative; it's associated with executed leases.

Second, we have five recently completed buildings that have roughly 300,000 square feet of unleased space. When stabilized, these buildings should provide an incremental $9 million of annualized NOI beyond 2014 levels.

Third, we are optimistic about our chances to secure new development of leases in the next year with multiple tenants in four separate locations throughout our portfolio. If we secure all of this demand, these four buildings would total approximately 625,000 square feet and would generate about $14 million of annual cash NOI.

On that note, I'll turn things over to Steve Riffee.

Steve Riffee

Thanks Steve and good afternoon everyone. Fourth quarter and full year diluted FFO per share as adjusted for comparability were $0.48 and $1.97 respectively. Both results were within in our guidance. For the year, our AFFO payout ratio was a strong 70%. For the quarter, the same office portfolio represented 91% of our core square footage and core NOI.

Excluding lease termination fees, same office cash NOI was flat with the fourth quarter of 2012 and grew by 2.3% for the full year. Same office operating expenses in the fourth quarter of 2013 were negatively impacted our non-recurring operating expenses of over $1 million. By incurring these one-time expenses, we created energy cost savings to benefit future same office NOI margins.

Within the same office pool, building, serving our strategic tenant niche which are those that are adjacent to government demand drivers, as well as those primarily leased to government and defense IT tenants, represented 77% of same office cash NOI. During the fourth quarter of 2013, these buildings were 93.8% occupied on average and ended the quarter 94.5% leased. For the fourth quarter, these properties, same office cash NOI excluding lease termination fees increased 2% over the fourth quarter of 2012.

2013 was a watershed year for our balance sheet. We raised $120 million in equity through a public offering in March and accessed our ATM for $39 million in July. Also in March, we redeemed all $85 million of our Series A preferred shares. We earned investment grade ratings from all three major U.S. rating agencies and then completed two bond offerings, issuing $600 million of 10 year bond at an average interest rate of 4.3%. Finally, we extinguished $146.5 million of non-recourse secured debt by transferring 14 properties more significantly [lessening] the loan amount to the lender. Our debt to adjusted book ratio at December 31, 2013 was 43.6%, more than 2 percentage points less than the 45.8% level at which we began the year.

A net debt to in-place EBITDA improved from 7.2 times to 6.8 times. Also we improved our fixed charge covering ratio to 2.8 times from the 2.6 times. We expect to further enhance our financial flexibility by resolving a $150 million non-recourse loan that is secured by two buildings in Northern Virginia.

Although these buildings were 94% occupied at the end of 2013, we forecast their occupancy will decline to below 50% on April 1st, and that quarterly cash NOI will decrease from the current run rate of $2.8 million to only $700,000. Because the loan amount greatly exceeds our estimate of the fair of these two properties, we will work with the special servicers to restructure this one.

However, based on our recent experience attempting to resolve similar debt, we believe the most likely outcome will be for us to convey the properties to the lender. Our 2014 guidance reflects this assumption. I’ll finish my remarks with some color on our 2014 guidance, which we provided in a press release dated January 7th.

For the full year, we expect FFO per share as adjusted for comparability to be between $1.84 and $1.92. We are establishing our first quarter 2014 range of FFO per share at $0.45 to $0.47. We get from our fourth quarter 2013 diluted FFO per share as adjusted for comparability of $0.48 to the mid-point of our first quarter 2014 range of $0.46, so in fact $0.03 to reflect the dilutions in the mid December sale in our portfolio of properties in Colorado Spring, and then add back $0.01 related to lower interest expense.

We expect second quarter FFO per share will be the low point of our quarterly results. The April 1 removal of the NOI and interest expense associated with the two properties to be conveyed, plus the move out of Merck from Arborcrest at the end of February will cause our second quarter FFO per share as adjusted for comparability to be approximately $0.02 lower than our expected first quarter.

The mid-point of our annual guidance of $1.88 implies $0.98 of FFO per share for the second half for the year. In the third and fourth quarters, we expect occupancy gains in our same office pool to increase our FFO per share to levels modestly higher than the first quarter results.

And with that I will now turn the call back to Roger.

Roger Waesche

Thanks Steve. In summary, this year marks a positive inflection point for our company. We are confident this will be the case, because our same office portfolio is stable to improving, demand for newly developed space in our strategic tenant niche and in select sub-markets is strong and growing, and occupancy gains from leases already executed or in the process of being completed will drive FFO higher beginning in the second half of the year.

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

Question-and-Answer Session

Operator

Thank you, Mr. Waesche. (Operator Instructions). Our first question comes from the line of Craig Mailman with KeyBanc Capital Markets. Please proceed.

Craig Mailman - KeyBanc Capital Markets

Hi guys. I just wanted to clarify on the occupancy. I think Steve last time we’ve talked, same-store was projected to be in the 90.6% range and maybe you needed 1 million square feet of new leasing to get there. I am just curious because you said 650 to kind of maintain, just want to make sure that those assumptions haven’t changed?

Steve Riffee

No they haven’t changed, Craig. We’re benchmarking off the 2014 same-office pool. We have some adjustments because of the six buildings we added. And then 650 is the minimum we need to stay where we are at, but we are anticipating modest improvement from that level.

Craig Mailman - KeyBanc Capital Markets

So, isn’t sound like it’s changing a little bit from the 90.6% sort of where is the target maybe with the same-store pool?

Steve Riffee

Craig that was based on the 2013 pool, so when we added the six buildings we went backwards by a 0.5% so you have got to adjust that old target for the add of six new building to the pool.

Craig Mailman - KeyBanc Capital Markets

Alright so it’s [50 basis point] that you are at. Okay that’s helpful. And then I heard your comments about kind of the new demand coming from the budget deal maybe back half of the year, but just curious at sites like Patriot Ridge are you hearing any chatter from tenants that the NGA is in the process of looking to put out contracts and maybe are you seeing more showings at that projects that we have seen more recently?

Roger Waesche

There are three locations where I would say that generally there is more optimism among contractors in improvements and activities. One of them is Patriot Ridge, the other is Huntsville and a little bit at 3120 Fairview Park in Merrifield.

Craig Mailman - KeyBanc Capital Markets

Okay. And then just last question. Blue Bell you guys got the build to suite done there, does that change your kind of long-term view on that market, I know that had been one you guys had been put on the non-core list?

Roger Waesche

It's still long-term source of funds for the company. What we're separating out is the concept that we're going to have to stay in it a little longer to complete the value creation and then sell into a good market.

Craig Mailman - KeyBanc Capital Markets

Great. Thank you.

Operator

Your next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch. Please proceed.

Jamie Feldman - Bank of America

Great, thank you. I guess you're thinking about some of your non-core submarkets outside the strategic portfolio. Can you talk a little bit about conditions there? We're seeing a general recovery in the office market and I'm curious what kind of upside you're seeing in those submarkets?

Roger Waesche

Our more commercial markets include White Marsh in Baltimore. We’ve had good leasing activity in that market for the last couple of quarter. Columbia is really one of the -- half of portfolio there is commercial. It's one of the stronger markets in B/W Corridor and we continue to see good activity. And then if you think about Arborcrest, we've had tremendous demand for that project. And even beyond the lease that we announced that created a 70% preleased building, we recently find another 34,000 square foot lease there in this quarter and then we have some activity behind it. So it remains strong.

Jamie Feldman - Bank of America

Okay. And then I think you said in your comments if I heard you right there is four big leases or four buildings that you’re focused on that would really move the numbers. Can you talk a little bit more about those, did I hear you correctly?

Wayne Lingafelter

Jamie it’s Wayne. No, you heard the remarks correctly. We do have a total of 625,000 square feet of new projects that we’re tracking closely that actually includes three projects that were not started at year-end and the one that we did announce at the fourth quarter start, which is in San Antonio. So those projects we have good line of site on the demand, it is -- they’re geographically diverse. They’re targeted to the tenants and our strategic niche and the construction is generally set to commence in the first half of the year. It looks like the incremental investment will be in the $100 million to $125 million over 18 to 24 month span.

Jamie Feldman - Bank of America

Okay. So I guess I think in the past you guys have talked about [750] number; how does that compare?

Wayne Lingafelter

The 750 was a number that we referenced over the last quarter. When you backed out the lease that Steve just referred to that was done up in Blue Bell, it takes you to the 625 number that we’re now referencing as our shadow pipeline.

Roger Waesche

And that’s out because we’re trying to.

Jamie Feldman - Bank of America

Thanks. That’s a good [number]. And then in terms of potential upside for that, how should we think about that?

Roger Waesche

We have five buildings that have 300,000 square feet of development leasing or development vacancy. And we're feeling better about all of those. We have about 138,000 or 140,000 square feet fields working in those buildings right now. And then we continue to work a variety of locations to create opportunities for future development and we've had good success.

Jamie Feldman - Bank of America

Okay. And then finally for Steve Riffee, just can you talk a little bit about the sensitivity to the guidance, what would take you higher or lower, the largest pieces?

Steve Riffee

Yes, quite frankly, if you look at the guidance, a big number in the year is the development income that’s placed in service to most of that already timed up and then placed. So, there is not much variability there. We don't -- if you look at the guidance assumptions, it's not a heavy transactional year for those lot of acquisitions and disposition. So, it's pretty much based on just leasing up the portfolio and hitting the leasing numbers that we have high confidence in for the year. So, I just want to see as much variability as perhaps there possibly was early in prior year.

Jamie Feldman - Bank of America

Okay, great. Thank you.

Operator

Your next question comes from the line of Joshua Attie with Citibank. Please proceed.

Joshua Attie - Citibank

Thank you. Steve, on the large data center asset, COPT DC-6, it sounded like you had good activity last year and it doesn't seem like there has been much leasing since the summer. Can you give us an update on that asset and what the tenant activity has been like?

Steve Riffee

Sure. We did have good progress through July where we signed 2.3 megawatts last year. And we did signing through the end of the year. What I can't tell you right now is we have -- we're tracking above 20 megawatts of demand that engage with it some level. We have working deals where we're involved in multiple rounds with those tenants that represent 7 to 13 megawatts and I consider five days ago is promising.

Joshua Attie - Citibank

Okay thanks. And on the shadow development pipeline, can you tell us what yields you expect on those new projects that could be added, I know what’s being placed in service this year is 8% to 10%, but what about the new projects?

Steve Riffee

I think that's a good range to reference on those new projects as well.

Joshua Attie - Citibank

Okay. And can you also discuss funding kind of sources and uses. I know you have some debt capacity following you see on the (inaudible) get back, but just remind us how much debt capacity have relative to what your capital needs are all of these new development start?

Roger Waesche

We have zero outstanding on our lines just in terms of liquidity. If you look at the January 7th press release, we gave our investment activity source and used [assumptions]. So, the way we laid it out was that our development and redevelopment spend for the year will be between $200 million and $250 million, no acquisitions.

And then when we look at the main disposition is extinguishing is a $150 million debt, which thing we’ll be able to do that handle all of our sources and uses on our metrics for a change. So that's the way we've been characterizing on capacity on the balance sheet.

Joshua Attie - Citibank

Okay thanks. And then just one last question, I think you mentioned in response to an earlier question that your traditional suburban office markets are improving, you’re seeing better activity, but I’m looking at the occupancy trends in the supplemental and so in Greater Baltimore it looks like occupancy has kind of been slacked down and declined again in the fourth quarter. Is the activity just now translating into occupancy growth you had or is it still very early?

Roger Waesche

It’s kind of timing Josh as we talked before we hit some no move outs that are going to happen in the fourth quarter with not enough time left in the quarter replacing many of those basins we have to actual kind of identified that will occupy later in the year. And we kind of mentioned in the stats we are getting longer lease terms and will resolve the tail-end of the kind of rationalization of space we’ve experienced from the last few years in 2014.

Joshua Attie - Citibank

So when we think about kind of four quarters from now the occupancy and like Greater Baltimore it should, if it’s 83% today you here forecasting going to be higher three or four quarters from now.

Steve Budorick

Yeah. We’ll [stock 80 grands].

Joshua Attie - Citibank

Okay thank you.

Operator

The next question comes from the line of Brendan Maiorana. Please proceed.

Brendan Maiorana - Wells Fargo

Thanks good afternoon. Steve Budorick I am sorry if I missed this before but when we last quarter you guys had between the fourth quarter of ‘13 through the end of ‘14, 2.5 million square feet of expirations I think you expected your retention rate to be 60% so that was 1 million square feet of move out and that was kind of a 725,000 square foot pipeline of tenants to backfill. It looks like retention was better in Q4 and has there an update on what you think retention is likely to be in 2014, is that likely to stay better now as well because you are feeling a little bit better about the market?

Steve Budorick

We are still forecasting it at 60%. So the magnitude is coming down it’s about 1.6 million square feet remaining we’re still anticipating 60% of that to be retained and that was dragging the numbers of roughly 650,000 square feet of leasing or occupancy needed to breakeven on the year and we comfort that against pipeline of 775 that we’re seeing today.

Brendan Maiorana - Wells Fargo

Right. So, I guess that being a part of the question is that 725 pipeline last time presumably, there are some deals that got signed, that got taken out of that pipeline. And then you have backfilled that and then with some new prospects. Is that right?

Steve Budorick

That's right.

Brendan Maiorana - Wells Fargo

Okay, great. Thank you. Steve Riffee in the quarter and the year, I think your prior guidance on same-store was 2.5 to 3, it came in a little below that. Was that solely attributable to the million dollars of expenses that you highlighted in the quarter?

Steve Riffee

Yes. It was, there was discretion there, but it was making some expense decisions. So, revenue was where we wanted to be for the quarter.

Brendan Maiorana - Wells Fargo

Okay, great. And then just last one and a bigger picture question for Roger. You mentioned that this is 2014 is the inflection point year, you've got some challenges early part of the year with some of the tenant move outs the CMBS get back and alike. And you guys are very detailed in that growth outlook and the FFO outlook for the back half of the year. As we just kind of think bigger picture, when you think about COP, what do you think the FFO growth outlook should be if you got a fairly stabilized same-store pool and all the development activity that you're seeing in it. Where do you think you could be on it year-over-year basis over the next few years?

Roger Waesche

I think mid-single digits would be a number that we would be comfortable with given same-store and given our ability to create growth opportunities for the company.

Brendan Maiorana - Wells Fargo

And do you think that the growth outlook that's there is, do you think you have enough kind of non-core asset sales that are likely to fund the growth on the development pipeline or do you think at some point equity issuance would be more likely because you’ve gotten rid of most of the non-core stuff?

Roger Waesche

I think for the next couple of years we think we have enough sale opportunities in our portfolio that we can fund new developments and beyond that we’ll just see where the stock is and where our opportunity set is.

Brendan Maiorana - Wells Fargo

Okay, great. Thank you.

Operator

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

John Guinee - Stifel

Great. Actually John Guinee here, I just didn’t have the energy. Just till we get the ramping of the hockey stick here. Should we look at 2014 as a $0.47, $0.45, $0.48, $0.49 or should we look at it as say $0.46, $0.44, $0.48, $0.50 quarterly FFO?

Steve Budorick

Well we said $0.46 and Steve said plus $0.44. So that leads the other $0.98 in the last two quarters given the split between the two quarters, but it’s building up John.

John Guinee - Stifel

Okay. And then Steve, if I look at this wonderful summary on page 11, it’s kind of a tell of two markets where National Business Park, Columbia Gateway, San Antonio very, very strong, Airport Square, Commons Parkway, White Marsh, 83 Corridor kind of bouncing around 80%. And if just so happens, but if you do the quick math Airport Square average building size 76,000 feet; Commons average building size 43,000 square feet; White Marsh and 83, average building size 46,000 square feet, which sort of implies and I maybe wrong about this so correct me, but it sort of implies one and two storey value office. Is that correct assessment of those markets and do you think you can gain occupancy in those specific submarkets?

Steve Budorick

Your characterization of the assets is correct. And yes, we do think we can gain ground there, much of this to our vacancy activity that we refer to exists in those building, so we put a lot of effort into punching up both the buildings common areas and the suites. The conditions of the suites is to more marketable and we’re encouraged that we can gain ground.

John Guinee - Stifel

Okay. And then I guess Roger, if I look at the regional office portfolio 5 million square feet, 66 assets, again sort of 75,000 square feet per building; is this something that we should expect to sell $100, $110 a foot or is this $150 a foot product?

Roger Waesche

Well, I think going forward we are a financial seller of assets versus a strategic seller, meaning we are going to be more patient and try to optimize values to sell but as assets mature, we get them leased, we try to sell them into hopefully a better market and get the per square foot that you suggested your latter number of 140 to 150 a square foot.

John Guinee - Stifel

Okay. And then the last question, the way this whole on base, off base things seems to work in some of the big defense oriented locations such as Fort Meade and Quantico, you have new development, others you don’t. Can you talk a little bit about what’s going on at NSA in terms of what they have under construction and their plans to then redevelop other buildings as well as what’s going on with army’s Cyber Command Fort Meade?

Roger Waesche

Well, it’s publicly out there that they are building a computing center on the campus, the 400,000 square feet and that Cyber Command is looking to build the headquarters on the campus but that’s all that in the near-term works there at this point.

John Guinee - Stifel

Great, all right. Thank you.

Operator

Your next question comes from the line of Jonathan Pong with Robert W. Baird. Please proceed.

Dave Rodgers - Robert W. Baird

Hey everybody, it’d Dave Rodgers. Steve Budorick, question, maybe to start with you, can you talk a little bit more about leasing economics, two sides of that I guess, concessions TIs, LCs can you give us the color that kind of will stay at a run rate of $4 per square foot that you’ve been quoting, will that get better? And then on the leasing spread side, you gave guidance for the full year, but I thought maybe in prior calls or in some of the prior time you had given some kind of color that may be those spreads would turn positive as you moved into the third quarter and fourth quarter. So I don’t want to put word in your mouth, so may be correct me or give me some color on the leasing spreads as well?

Steve Budorick

Sure. Well, let me start with spreads because that’s what I think you talked about. The most pressure on those spreads really we are feeling in Virginia, were we have some longer leases that are rolling to software market and rolling you can see even in this quarter, we rolled out 11% on the few deals that we did. But on average we've been rolling about 3% negative, and I’d point out, if you look at the Baltimore/Washington Corridor this quarter, our cash flow up mildly. And that’s really the trend I was talking to in the BW Corridor where we've got better leverage and more of and half of our deals over the last three quarters have rolled positively and then in this quarter we actually rolled on average positively, so in BW Corridor over time, expected to continue to strengthen.

Now, what was the first half of the question?

Dave Rodgers - Robert W. Baird

Just the concessions that you’re seeing in the market in terms of TIs and LCs et cetera.

Steve Budorick

Very stable in the BW Corridor, more pressure in Virginia, no question, I mean tenant representatives are seeking very high tenant improvements. We've been able to find opportunities where we don’t need to meet some other landlords but there is more pressure on the Virginia side. I wouldn’t say it’s worsened but it’s more shrink, on that side of the [rumor].

Dave Rodgers - Robert W. Baird

Okay. Steve Riffee, when did you model to give back the assets after the tenant moves out? And then I guess maybe second to that is, is there variability in the earnings if you were have to give it back either sooner than you guided or later, given kind of the NOI versus the interest expense?

Steve Riffee

Well, in our -- if look at our reconciliation table from earnings per share, FFO per NAREIT and FFO as adjusted for comparability and also read the footnote when you refer back, you will see the timing and the assumptions. But what happens is when the loan goes in default in April, the NOI from that point forward belongs to the lender. We will also accrue interest at our default interest rate, but we won’t be paying it. So what in terms of FFO is adjusted for comparability, we are taking out the two sets of net operating income that is associated with those assets from April 1 to the end of the year and we are taking out the $0.14 of accrued interest that we’ll be accruing but we won’t be paying. And then our guidance is assuming for showing you the math that that would be extinguished at the end of the year. And if all of that happens that would be a $0.68 gain. We won’t calculate NOI once the properties in default and are as adjusted for comparability, we won’t count the default interest that won’t be paying and we will not be counting the gain on extinguishment. So that’s how -- and we have laid that out in that timings, all in the footnote of the reconciliation as well there.

Dave Rodgers - Robert W. Baird

Okay. So, essentially no impact to your guidance, that’s helpful. And then Roger, maybe last bigger picture question is I think with regard to some of the U.S. let’s call “spying issues and the leaks that have happened, there were some bills maybe that had been floated in Congress about limiting cyber security power or at least diversifying that power in multiple organization. Wondering what if you believe that even anything happens there and was it kind of a detriment or a benefit if kind of that gets spread out a little bit more across these key locations?

Roger Waesche

Well, there is a lot of talk in the media and if you follow the politicians and the political venture about this whole situation. I think at the end of the day, our message to investors is that we have the government in our buildings and that we believe that the missions that they serve are stable and will continue and that we have to let all the other noise, just be noise.

Dave Rodgers - Robert W. Baird

Okay. Thank you.

Operator

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

John Bejjani - Green Street Advisors

Hey guys, it's John Bejjani here. First question, given the recent budget agreement, do you still see there being risk from an upcoming debt ceiling debate or do you feel political risk is sort of behind you guys now?

Roger Waesche

I mean, it's just a educated guess on our part, but it appears that they will work something out with the budget ceiling. I don't think any of the politicians want to go through what we did in early October. So, our sense is that something will get worked out and that this will just be noise and not have any impact on not just cost but the whole United States of America.

John Bejjani - Green Street Advisors

Okay. And then on re-leasing spreads. So you guys talked about expecting down 3% or so for the year. Would you say that's reflective of your portfolio overall, or is there -- is ‘14 a bit different than what you expect your overall mark-to-market to be?

Roger Waesche

Well, I think it’s a good representation of the current condition of the average of our leasings. And if you think about it, our leasing spend escalate 2.5% to 3% each and every year over the period of time and on average we’re giving back about 3% on a cash basis for the first year of the renewal and then growing from there.

John Bejjani - Green Street Advisors

Thanks. And one last question. So right now, your core portfolio is sitting at about 90% leased. I guess longer-term, where do you guys see stabilized occupancy ending up and over what horizon do you feel you can get there?

Roger Waesche

We see it stabilizing in the 93 range and we see it taking about 24 months to get there.

John Bejjani - Green Street Advisors

Great. Thanks guys.

Roger Waesche

Thank you.

Operator

Your next question comes from the line of Paul Puryear with Raymond James and Associates. Please proceed.

Bill Crow - Raymond James Associates

It’s Bill Crow with the question here. Roger, bigger picture, if I go back 10 years, right, I was with you on the road talking about the attributes of the company. We talk about two things in particular, the top secret access and what that did to your consumer base. And then the second thing was that you had barriers to exit from your tenants based on linkages to government installations or the amount of money that the tenants invested in the properties. When I look at your new core portfolio and a 60% retention rate expectation for this year, I guess my question is two-folds. As we look forward longer-term, will you get any benefit from tenant retention based on the old the formula of who your tenants are and where they’re located? And does the top secret access and all that matter anymore or have you kind of morphed into something that would be more appear like to the suburban office rates?

Roger Waesche

Right, so our 11 or 12 year average occupancy retainage is 70% and so last year we did that again. This year the 60% is really a reflection of the finalization of the rationalization of the defense community in particular the defense contractors to get their business models and their people in the right amount of space to fit the new equilibrium in the defense budget. And so we do think that we are at the tail-end of and that our occupancy should stay very high and our normal retainage rate should stay very high.

Our business is tied to our customers’ proximity to their customers, it’s about co-location with national assets, it’s about the ecosystems, the synergy, critical mass, it’s all about collaboration. And so the assets that we have been over create meet that model and then we have some secure space to go with it. And so we don’t think that our model is being up ended by what’s going on, it’s just a -- we needed to go through this digestive period where this budget was getting retooled and repositioned in the last couple of years.

Bill Crow - Raymond James Associates

Okay, thank you.

Operator

(Operator instructions). And your next question comes from the line of Tayo Okusanya with Jefferies. Please proceed.

Tayo Okusanya - Jefferies

Hi guys, good afternoon. Just a couple of quick ones, first of all a development question in regards to the old Merck space. I was hoping you could just kind of walk us through the thought process of why we develop that versus try to release it?

Wayne Lingafelter

Tayo, this is Wayne.

Tayo Okusanya - Jefferies

Hey Wayne.

Wayne Lingafelter

We've been engaged for a while now that the Merck will be coming back to us. And so we've been engaged in looking at how that building can be repositioned in the same manner that the success as we've had at the Hillcrest Campus are. And frankly we've really created what we think is a very branded campus there, one that’s been well received in the market. The Merck building is a slightly different configuration than the other assets we've worked on. But we still at this point feel like there is a strong path to a redevelopment play there that can have the same type of success that we've been able to enjoy with the four buildings that are now fully -- well three buildings are redeveloped and one that's under development.

Roger Waesche

And most of our buildings are mainly 90.7% leased we sit here today. And there continues to be demand in that marketplace for more products, which will support the redevelopment strategy.

Tayo Okusanya - Jefferies

Okay. That makes sense to me. And then second question just more on the data center and does it seem like are there any additional lease up this quarter, just curious what you are kind of seeing in lots of that market demand for space and also pricing?

Roger Waesche

You’re right, we did that signing in leases in the quarter, like I told Josh, the entire Northern Virginia market was relatively slower in the fourth quarter, but we continue to have optimism. We’re tracking about 20 megawatt electricity that were engaged with at some level, consider 7 to 13 of those megawatts as working deals where we’re negotiating actively and then 5 to 8 of those megawatts are considered promising. So we’re hoping that 2014 has more good news like we brought in 2013.

Tayo Okusanya - Jefferies

Okay. And then what about pricing wise, is pricing kind of remaining steady is there more pricing pressure?

Roger Waesche

Pricing remains steady, I don’t feel further pressure.

Tayo Okusanya - Jefferies

Got it. And then lastly just kind of going forward, I know we’ve had a lot of conversations about development and redevelopment, but from an acquisition perspective just kind of curious what company is thinking if you were to acquire something what general characteristics would that asset have?

Steve Riffee

Well, right now acquisition opportunities are very scares, I mean there are opportunities available, but they are scares in terms of being able to make acquisition that make financial sense for us. To make an acquisition we would have to balance that against our very strong development pipeline for the higher priority on that since we are taking care of existing customers. But if we found an acquisition that was forward-looking that was the 21st century building of the future that was very well located and we thought it would enhance our franchise and could make economic sense out of it, we would look at it.

We’re constantly in the market underwriting opportunities, but we haven’t been able to make sense of any. So we mentioned on the call in the last three years we’ve only made two acquisitions. We made one in 2011 one in 2012 and we really make none in 2013 except for buying up a warehouse that we were renovating for a customer.

Tayo Okusanya - Jefferies

All right. Thank you very much.

Operator

I would now like to turn the call over to Mr. Waesche for closing remarks.

Roger Waesche

Thank you all again for joining us today; if your question has not been answered on this call, we are all in the office and able to speak with you later. Thank you very much. Good day.

Operator

Thank you for your participation in the Corporate Office Properties Trust fourth quarter and year-end 2013 earnings conference call. This concludes the presentation. You may now disconnect. Good day.

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