Corporate Office Properties Trust CEO Discusses Q2 2011 Results - Earnings Call Transcript

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 |  Includes: OFC
by: SA Transcripts

Corporate Office Properties Trust (NYSE:OFC)

Q2 2011 Earnings Call

July 28, 2011 11:00 am ET

Executives

Stephanie Krewson – Vice President, Investor Relations

Randall M. Griffin – Chief Executive Officer

Roger Waesche – President and Chief Operating Officer

Stephen E. Riffee - Executive Vice President and Chief Financial Officer

Analysts

Craig Mailman – KeyBanc Capital Markets

John Guinee – Stifel Nicolaus & Company, Inc.

Brendan Maiorana – Wells Fargo Securities

Michael Knott – Green Street Advisors

Nicholas Yulico – Macquarie Capital

Sri Nagarajan – FBR

David Rogers – RBC Capital Markets

Chris Lucas – Robert W. Baird & Co., Inc.

Steve Sakwa – Isi Group Inc

Brendan Maiorana – Wells Fargo

Operator

Welcome to the Corporate Office Properties Trust Second Quarter 2011 Earnings Conference Call. As a reminder, today's call is being recorded. At this time, I will turn the call over to Stephanie Krewson, the company’s Vice President of Investor Relations. Ms. Krewson, please go ahead.

Stephanie Krewson

Thank you, Krystalline. Good morning and welcome to second quarter 2011 earnings conference call. With me today, are Rand Griffin, COP’s CEO; Roger Waesche, our President and COO; Steve Riffee, our Executive VP and CFO; and Wayne Lingafelter, Executive Vice President of Development and Construction.

As management review their financial results, they will refer to our quarterly supplemental information package and associated press release. Both of which can be found on the Investor Relations section of our website at www.copt.com.

Within the supplemental package, you will find a reconciliation of GAAP measures to non-GAAP financial measures referenced throughout this call. Also under the Investor Relations section of our website, you will find a reconciliation of our 2011 annual and quarterly guidance. At the conclusion of this discussion, the call will be opened up for your questions.

Before turning the call over to management, let me remind you all 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 release space under favorable terms, regulatory changes, changes in the economy, the success and timely completion of acquisitions and development projects, and changes in interest rates and other risks associated with the commercial real estate business, as detailed in our filings with the SEC.

I would now like to turn the call over to Rand for his formal remarks.

Randall M. Griffin

Thank you, Stephanie, and good morning, everyone. I’m going to cover a few highlights from the second quarter and update you on the status of the defense spending and how leasing and cost has been affected. Although, the tepid economic recovery in the U.S. continues to present significant leasing challenges for the office sector, COP performed well in the second quarter.

Our FFO per share of $0.57 after adjustments was a $0.01 above the high end of our guidance range. Second quarter results were driven primarily by higher NOI margins, partially offset by a lack of acquisitions and nominal lease fee termination fees.

Pertaining to acquisitions, a flood of capital from private and all cash buyers continues to drive down cap rates on acquisitions. Especially, for well leased high quality assets in growth markets, such as the greater DC, Baltimore region. While we competed for several buildings we were outbid by aggressive buyers. Still we believe our disciplined underwriting and focus on strategic super core assets will serve the company and its shareholders well in the long run.

During the second quarter, we leased just over 1 million square feet despite the lingering effects of the delayed passage of the 2011 federal budget. Roger will discuss COPT’s leasing achievements in the market for property transactions in greater detail.

Although the 2011 federal budget was passed on April 15, it is taking time for appropriated moves and monies to translate into signed leases. We anticipated this delay, but we briefly explain the process for those of you listening who may not be as familiar with it.

Once the 2011 budget was passed in April, the appropriated funds then needed to be allocated by the Office of Management and Budget or OMB. The OMB gives agencies including the Department of Defense, budget guidance for the fiscal year. Once funds are allocated and therefore available, contracts can be bid or rebid as appropriate and awards made. This whole process obviously does not happen overnight. So we were not surprised by the soft demand for new space in our second quarter.

For the remainder of the year, we do expect incremental leasing to come from government agencies that must either commit to space before September 30th, when the 2011 federal budget year-end or forfeit uncommitted funds.

We also expect Defense contractors who are awarded contracts prior to September 30th to seek space to be occupied within six months in order to fulfill their contract obligations.

We believe the Defense contractor demand will increase in the second half of this year because with some limited exceptions unrelated to COPT’s portfolio all government agencies impacted by the 2005 BRAC need to be in their new locations by September 15th of this year.

Importantly, physical move-ins into the federally funded developments that create our government demand drivers are almost complete at all four our COPT’s BRAC locations. Starting with the National Business Park, the ribbon-cutting for the new Defense Information Systems Agency headquarters building at Fort Meade occurred on April 15th. Approximately 90% of the 5,800 government employees are already in place.

The anticipated contractor tail for DISA and Cyber Command is between 16,000 and 20,000 workers who buy extension will need approximately 4 million square feet of office space. Similarly, at Aberdeen Proving Ground, where C4ISR is the major government demand driver, 6,200 of the anticipated 8,300 government employees have already moved to APG, leaving only 300 more to move and 1,800 new employees to be hired. The expected contractor tail of 7,500 to 10,000 contractor employees will require between 2 million and 2.5 million square feet of office space.

In Northern Virginia, the National Geospatial-Intelligence Agency’s new 2.4 million square foot and $1.7 billion headquarters is now open and 5,100 of the 8,500 government employees have moved in. The expected contractor tail to serve the MGA is 9,000 workers, which implies an office space need of between 1 million and 2 million square feet.

Fourth, but by no means last, roughly 3,800 of the anticipated 4,700 new government workers are in place at Redstone Arsenal in Huntsville, Alabama. The contractor tail of 7,000 workers will require up to 2 million square feet of office space. The timing of contractor moves at each of our four BRAC locations will vary according to the agency being supported, it is expected that most of these moves will occur before the end of 2014.

So 10 million square feet of demand from contractors moving to support the new government agency locations is coming to our four BRAC locations over the next few years. With our strong locations, we are well positioned to get our fair share of this demand.

And with that, I will turn the call over to Roger.

Roger Waesche

Thanks, Rand. I'm going to go over our leasing results for the quarter and provide an update on our progress we’ve made on the strategic reallocation plan we announced on the last earnings call.

At quarter end, our wholly-owned portfolio of 249 buildings encompassed 20 million square feet that were 87.3% occupied and 89.4% leased. Our occupancy increased 30 basis points from first quarter 2011. The percentage leased, which is a leading indicator increased 20 basis points in the quarter.

Despite the uncertain economic environment in which many tenants are operating, we leased 1.35 million square feet during the second quarter that combined with the 1.2 million square feet of leases in the first quarter keeps us on pace to reach our 2011 leasing goal of 4 million square feet.

Recall, we began the second quarter with only 300,000 square feet of leases scheduled to expire. Of the space leased in the second quarter, 768,000 square feet were renewals, 202,000 square feet of which related to 2011 expirations. And 566,000 square feet related primarily to 2012 lease expirations. We returned at a 143,000 square feet, executed 64,000 square feet in development or redevelopment projects, and we also signed 61,000 square feet of vacant, first generation space.

Even though the protracted continuing resolutions surrounding the 2011 federal budget negotiations caused development leasing to fall short of our initial expectations for 2011, we expect demand to pick up in the coming months as money for fiscal 2011 is freed up and as Rand mentioned, must be committed prior to September 30th. Although, we don't yet have signed leases, we are in active discussions with prospects for about 600,000 square feet of our development pipeline.

For the quarter, we had a renewal rate of 89% at an average capital cost of $11.49 per square foot. Rents from renewals increased 1.7% on a straight line basis and decreased 7.7% on a cash basis.

Total rent from renewed and re-tenanted space increased 2.1% on a straight line basis and decreased 7.3% on a cash basis. For all renewed and re-tenanted space the average capital cost was $13.21 per square foot. Year-to-date, we had a renewal rate of 76% at an average capital cost of $11.

Rents from renewals increased 3.6% on a straight line basis and decreased 4.2% on a cash basis. Total rent for renewed and re-tenanted space increased 3.2% on a straight line basis and decreased 4% on a cash basis. For all renewed and re-tenanted space capital cost averaged $14.47 per square foot. While rental rates continued to be under pressure from tenants wanting to lower operating expenses, rental rates on leases executed thus far in 2011 are declining at a lower rate relative to 2010 levels.

So things are less negative then they were last year, both supply and demand fundamentals except in a few submarkets still modestly favor tenants. A positive during the first half of the year and hopefully for the beginning of the trend was that only six out of 74 renewal transactions were accompanied by downsizing.

We continue to believe same office occupancy bottomed in the first quarter of this year. For the third quarter, we have about 112,000 square feet of no move outs, which will be more than compensated before by 427,000 square feet of space that’s leased and will become occupied before year-end. Accordingly, we projected shape office occupancy sequentially will improve modestly each quarter for the remainder of the year.

Turning now to the property transaction market, while we have actively pursued a number of acquisition opportunities in 2011, we made no acquisitions this year. Moreover, the acquisition environment remains extremely competitive particularly for high quality stabilized property.

The cap rate compression that began last year in CVD market have spread to many of the suburban office markets we target because of significant amount of capital is pursuing stabilized deals that close little near-term risk. We continue to pursue acquisitions both on and off market, but our expectations for total acquisition volume this year have been tampered by the pricing and returns we have seen thus far.

Now let's review this progress on our strategic relocation plan. During the second quarter, the company sold a small three building complex that was retail in nature for $3.8 million or about $100 per square foot. The buildings were 89% occupied at closing. Details of these asset sales are on page 22 of the supplemental information package.

We have assets under contract for a little over $20 million and another set of buildings that should be under contract in the next week or two. We expect these asset sales to close this year, this would put us on track to meet or exceed the $55 million of assets sales we projected to occur in 2011 as part of our plan.

In addition, we are evaluating unsolicited offers or in various phases of marketing for another $120 million of asset sales that could close late this year or in the first quarter of 2012. The dispositions in the strategic relocation plan took time to ramp up, but we believe we now have momentum and will ultimately sell the entire $260 million of targeted assets earlier than the original forecast of year end 2013.

With that, I’ll turn things over to Steve.

Stephen E. Riffee

Thanks, Roger, and good morning everyone. For the second quarter of 2011, we reported FFO available to common shareholders of $41.5 million or $0.57 per diluted share, a $0.01 above the high-end of our guidance range. This result excludes a $40 million or $0.55 per diluted share non-cash impairment charge, net of tax related to our strategic relocation plan that we announced last quarter. Including the non-cash impairment, our FFO per diluted share was $0.02.

For the second quarter of 2011, net loss attributable to common shareholders was $28.3 million and diluted loss per share was $0.42 compared to net earnings attributable to common shareholders of $4.4 million and $0.07 per diluted share for the second quarter of 2010.

Our diluted FFO payout ratio as adjusted was 76% and our diluted AFFO payout ratio, excluding capital expenditures invested at properties that are part of the disposition plan was 111%. We view our common dividend on a long-term basis and we believe it is sustainable. As release of vacancy and assuming capital expenditures revert to more normalized levels, our dividend coverage should return to the company’s historical levels.

As of June 30, our same office portfolio consisted of 190 properties representing 81% of the consolidated portfolio square footage and excluded all of the properties we intend to dispose of as part of the strategic reallocation plan. Same office cash NOIs excluding termination fees, increased by $5.5 million or 10% from the first quarter and was down $350,000 or 60 basis points compared to the second quarter of 2010. Same office occupancy averaged 89.1% in the second quarter of 2011 versus 89.6% in the second quarter of 2010.

Turning to the balance sheet, at June 30, the company had $2.3 billion of debt outstanding at a weighted average cost up 4.9%, 81% of our debt was at fixed interest rates. For the quarter, our adjusted EBITDA to interest expense coverage ratio was 3.1 times and our fixed charge coverage ratio was 2.6 times. Our debt-to-adjusted EBITDA ratio adjusting for construction and progress was 6.4 times at quarter end.

During the second quarter, we raised approximately $146 million in an offering of 4.6 million common shares with these net proceeds we paid of $102 million secured loan that was scheduled to mature in September. We also began syndicating a new $1 billion line of credit to replace our existing line. The new line will have a three year term that could be extended for another year. Commitments from our bank group exceed this facility and we expect to close by September 1.

We are working on closing a construction loan to fund our first building at the Patriot Ridge development and are negotiating financing for our Redstone gateway project. We expect both construction loans to close during 2011. We anticipate a swing between $200 million and $250 million of ten year fixed rate debt by year-end, which will allow us to extend roughly 10% of our debt for ten years.

Now turning to our revised guidance, we are tightening our prior 2011 FFO per share guidance range to a new range of $2.32 to $2.35; our prior guidance range was $2.20 to $2.40. Our guidance excludes non-cash impairments and acquisition cost to that of which vary by jurisdiction and are difficult to predict.

Having said that let me walk you through the fundamental assumptions behind our 2011 outlook. First, in the same office portfolio occupancy improved 40 basis in the first quarter when we believe at bottom and should modestly improve the next two quarter to end the year 40 to 100 basis points higher. We continue to project a tenant retention ratio rate of 65% to 70% for 2011.

We project same office NOI to be between negative 1% and negative 3% for the entire year, but ending the year stronger in the fourth quarter. Second, our prior guidance anticipated $750,000 in lease termination fees for the second quarter. As shown on page three of the supplement, we’ve recognized only $342,000 in the first half of the year. At the midpoint of our guidance range, lease termination fees for the second half of 2011 are expected to be approximately $1.5 million.

Third, there is no change to our forecast, our cash NOIs and development placements service during 2010 and 2011. Excluding the Power Loft data center, we expect $13 million to $14 million of cash NOI for the year for these properties, virtually all of this is already in place.

Fourth, we still expect cash NOI from Power Loft to be approximately $1.2 million to $2 million for the year. Fifth, our guidance assumes no acquisitions at the bottom end of the range and up to $80 million at the top end, a reduction from prior guidance.

Sixth, our guidance assumes we will sell approximately $55 million of assets under the strategic reallocation plan. But as Roger mentioned, we may exceed that level before year-end. Seventh, is other income, year-to-date, we recognized $5.2 million or $0.06 per diluted share of gains on land sales and our investments in KEYW.

In the second quarter, we sold 500,000 shares of KEYW and recognized gains of $2.2 million or $0.03 per share. Upon Ran’s resignation from KEYW’s board in the third quarter, we no longer account for this investment using the equity method, instead we will begin marketing the investment to market.

Assuming KEYW’s closing prices of yesterday, July 27th of $11.31 less are $7.45 basis per share, the gain on our remaining $2.6 million share investment will be in an additional $9.9 million. And we're not going to predict KYW stock price for COPT’s unrealized gain of $0.13 per diluted share is included in both the bottom and the top ends of our guidance range.

In summary, we now expect other income including gains on KEYW to contribute between $18 million and $20 million in 2011. Finally, capitalized interest is assumed to average approximately $4.8 million per quarter for the last two quarters of 2011. Moving on to our third quarter guidance, we expect FFO to be between $0.62 and $0.65 per diluted share. As with our full year guidance, our quarterly guidance excludes acquisition costs. The guidance range for the third quarter includes the same $0.13 gain for investment in KEYW at the bottom and the top of the range.

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

Wayne Lingafelter

Thanks, Steve. My comments will focus on information presenting on pages 25 and 26 of the supplement. As Roger discussed, second quarter pre-leasing in the construction portfolio was modest. NBP 430, our first office building in the northern section of the National Business Park had just over 60,000 square feet in lease commitments in the quarter. The construction pipeline overall saw a no net change in the total occupancy level from last quarter.

Looking at starts and completions, which are on page 25 of the supplement, during the second quarter, we did not start construction on any new office buildings. We did play 209 Research Boulevard into service at Northgate Business Park in Aberdeen. The building is now accounted for in our operating portfolio and is 100% lease to several key contractor customers.

Next, when reviewing our free development projects on page 26, there are two changes since last quarter. First 801 Lakeview Drive in our Arborcrest Park is 100% leased and therefore was placed into the operating portfolio in the second quarter and removed from the redevelopment schedule.

We've also removed the 7468 Candlewood Road project, our redevelopment program converted this asset to warehouse flex condominium and has been marketed for sale as part of our strategic reallocation plan.

We've made several changes to our under development pipeline that represent projects on which we expect to start construction with in the next 12 months. Properties under development are detailed on page 26. Second quarter changes were made in response to anticipated customer demand for our office space. The net result was a modest increase in the size of the development pipeline from 991,000 square feet at the end of the first quarter to just over 1 million square feet at the end of the second quarter.

Here are the major changes. First, in the National Business Park, we have three buildings under construction in support of the move of (inaudible) from northern Virginia to Fort

Meade, and a stand up of Cyber Command at Fort Meade. However, we elected to accelerated the development of NBP 560, which is located in the northern section of the park and push back the anticipated start date for NBP 310. At 260,000 square feet, NBP 310 is a signature building and represents one of the last development site in the original section of NBP.

We have seen strong interest in the new North section of NBP and believe we should take advantage of that momentum by beginning another neighborhood in the park.

Second, we have added the second office building at Patriot Ridge to our under development pipeline. Recall that Patriot Ridge is located in Springfield, Virginia, just south of Washington DC along the I-95 Corridor adjacent to both Fort Belvoir and the NGA. And then we currently have 7770 Backlick Road, a 240,000 square foot office building under construction there. Because leasing demand from the contractors serving the NGA continues to be very robust, we believe it is prudent to begin development on the second office building, which will also be 240,000 square feet.

Third, our Northgate Business Park and the entire office market serving the already improving ground continues to see rather modest leasing activity. Accordingly, we have removed the next building from the development pipeline as we believe current inventory is adequate to meet anticipated market demand for at least the next 12 months.

Finally, Redstone Gateway is our fourth BRAC locations. The first phase of the park is master planned for approximately 2,000,000 square feet and the site development work is underway. Construction on our first office building of 115,000 square feet is scheduled to be completed at the end of this year. Interest from the contractors in the market for the first phase of office space is growing. In addition to the second office building previously listed in the underdevelopment schedule, we have added a FLEX office building with an anticipated start date in the fourth quarter of 2011.

With that, I will turn the call back to Rand.

Randall M. Griffin

Thanks, Wayne, and thank you all for joining us today. In summary, we are seeing a gradual improvement in the business as demonstrated by the continued leasing activity in same office occupancy gains. We are strengthening the balance sheet and progressing well on development and construction activities.

On a personal note regarding the status of my potential retirement, we expect to discuss this timing at the upcoming September Board meeting. As appropriate an announcement will be made subsequent to that meeting. Roger, Steve, Wayne, Stephanie and I are available to answer any questions you might have. And Crystalline, if you could open up the call now for questions.

Question-And-Answer Session

Operator

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

Craig Mailman – KeyBanc Capital Markets

Hi, good morning, George in the phone with me as well. Roger, may be you can just talk about the leasing pace? I know you had mentioned that you guys are still good about getting to the 4 million square foot target for the year, but as I'm looking at the lease expiration for the balance of the year and kind of putting the 65% to 70% retention rate on that that costs 650,000 to 700,000 square feet, you’ve talked a little bit about 600,000 square feet of actual requirements on the development pipeline. Can you may be just give us a little bit color how much of a pickup you guys are expecting in new leasing to kind of offset the big retention that you guys had in the 2Q?

Stephen E. Riffee

I think overall we currently have about 700,000 square feet of leases that are out under negotiation, a lot of that is towards the million square feet that we have renewing, maturing for the balance of the year. And then we’ve got the 600,000 square feet of other negotiations going on with one of the development portfolio. And so, as Steve said, our thinking is that with the 65% renewal rate for the rest of the year and the other retananting leasing we're doing that we’ll be able to bring our same store up and plus eat into our unleashed, underconstruction pipeline by some pretty good amount before year-and.

Craig Mailman – KeyBanc Capital Markets

Are you getting a sense of just talking to tenants that there is a pretty big shadow demand on once these contract get signed? Do you have any kind of pipeline there that you could discuss?

Stephen E. Riffee

I don't think we can be specific, but I’d say that at four locations really the only location that we don't have activity on development leasing is up in Maryland, but the other locations we’ve got a pretty good activity that we think will be realized over the next so many months.

Craig Mailman – KeyBanc Capital Markets

Great. And just wondering in your recent conversations with tenants, sort of inability the of Washington to get census on deficit reduction, when you just spending overall. Are people starting to get worried that we might have the same situation in ’12 with the budget resolution being delayed that we have in ’11 and kind of how are they positioning for that and how are you guys positioning for that from the development start standpoint?.

Randall M. Griffin

This is Randall Griffin, Jordan. No, I think clearly given how difficult it is for both parties to get agreement on something that’s been in discussions for eight months on the debt ceiling increase, we now think that the 2012 budget will certainly go into a continuing resolution and be a delay just like it occurred end of last year and this year. So how contractors are really approaching that is that the awards are being done now and the government leasing that will occur prior to September 30, becomes very, very important because, under continuous dilution what they are able to do is continue to spend up to 2011 levels, just not go into new obligations as they approached into the 2012. So the velocity that needs to get done between now and the end of September 30 is very, very important for both contractors and the government. And then we will see that velocity be able to continue as relates to the 2011, but we anticipate again just like we have experienced this year than a law for new obligations that would occur until that gets resolved and we think it’s probably going to run about the same time into April or so of 2012.

Now, earlier in the year they said absolutely the Congress did not want to be in this situation going into an election year and yet you can tell by the difficulties under the negotiations that we clearly projected to be that way.

Craig Mailman – KeyBanc Capital Markets

And how does that affect kind of the way you guys are looking at starts and that $1.2 million, is a pretty good number for you guys? Do you think that can be aggressive heading into late '11, early '12?

Randall M. Griffin

No, I think what happens Craig is that the leasing that Roger mentioned the 600,000 square feet of development leasing that we think will get done over the next six months that really brings also the existing construction projects up to sufficient levels to then require that we get going on the next round of starts. And generally we like to be 50% leased or so on a building before we start the next one or in some cases like the Redstone Arsenal where we have decent activity on the first one, we have a full building tenant negotiating for the second building and we would like to also have the Flex office product is quite a bit of interest in that starting as well. So there you would start a little bit extra just to be meeting the anticipated demand. So the starts that Wayne mentioned that are in the supplement, really I think very comfortable dictated on the leasing that will take place on the existing construction. And so we feel it’s quite conservative and comfortable.

Craig Mailman – KeyBanc Capital Markets

Hey, it’s Jordan. I just have a one quick follow-up for Steve. There is an income tax benefit of about 5 million I see in the P&L, you might have missed in the commentary on that. Can you put some lighting?

Stephen E. Riffee

That is related to some condo sales, part of our strategic reallocation charge and that those goes to our TRS so there is a tax effect for those.

Craig Mailman – KeyBanc Capital Markets

So is there a gain that offsets that. It looks like it’s included in FFO, right?

Stephen E. Riffee

No, it’s part, it is an impairment charge related to the strategic reallocation plan that affects assets held in the TRS, so therefore there is a tax offset to that benefit of that.

Craig Mailman – KeyBanc Capital Markets

Okay. So it should be netted and they’re both in FFO.

Stephen E. Riffee

They’re both in the strategic reallocation $0.55 number that’s net number that I’ve given you.

Craig Mailman – KeyBanc Capital Markets

Okay, thank you.

Operator

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

John Guinee – Stifel Nicolaus & Company, Inc.

Hi, John Guinee here. Sort of back the Envelope Rand, Roger, guys, (inaudible), about 50% plus or minus of your portfolio is this might be an auction run, but you need suburban office space due to the tenancy or the location. And about 50% of your portfolio is fairly generic stuff. So my question is if you're really going to think big in terms of your reallocation plan, how much could you actually move up in addition to this relatively mundane $55 million number that’s been quoted often times?

Randall M. Griffin

Well, John, we continue to evaluate the balance of our portfolio, what we announced in the strategic reallocation plan was there what I will call first Steve and then there are other designated properties behind that, but at this point we’re not in a prepared layout, whether these properties are of the size but we understand that by the time there is another downturn we want to have our portfolio positioned differently with between much more tied to the government and defense spending in the last two generic commercial tenants?

John Guinee – Stifel Nicolaus & Company, Inc.

So you’re thinking about thinking big.

Randall M. Griffin

Yes,

John Guinee – Stifel Nicolaus & Company, Inc.

Thanks a lot.

Randall M. Griffin

Also John you are at 50-50, that number is more like 60-40 and as we said that will move by 2013 and probably little earlier than that as Roger mentioned on the timing of the sales (inaudible) to 67%. So rate there you can see the generics, so-called generic our commodity percentages continuing to move and contract pretty dramatically.

John Guinee – Stifel Nicolaus & Company, Inc.

All right, thank you very much.

Randall M. Griffin

Thank you, John.

Operator

Our next question comes from the line of Brendan Maiorana with Wells Fargo. Please proceed.

Brendan Maiorana – Wells Fargo Securities

Thanks good morning. I wanted to follow-up on Craig’s question about just the development pipeline and the starts for next year. I guess, if I’m understanding the comments correctly from Roger and Rand, it’s the development that will be started as you kind of go into next year, if we get continuing resolution that happen again. I mean will the leasing, I guess the pace of leasing is the extrication that it will get kind of delayed in 2012 the way that it has been in 2011 and are you guys kind of comfortable with that in 2012 just given that there is the pent-up demand and it is just the timing issue or do you think you can adjust the level of starts to maybe have less delayed leasing as you go into 2012?

Randall M. Griffin

I think, Brandon, it will be somewhat cyclical and fall into a similar pattern where we will get a, so we think we will get a surge of leasing the balance of this year that will bring up the percentage leased comp under construction to our historically pretty healthy levels. And that then requires the new buildings to get started to meet the continued demand. We don't expect then the first half of 2012 would have a lot of leasing on those projects, but that’s fine because they will have just started and they will be underway. And we do think then in the second half of 2012, you will catch back up as the continued resolution has finished, the budget's finished in mid-2012 and they start once again executing contracts and awarding leases.

So I think it’s somewhat into that pattern. It’s unfortunate that the government can get their act together, but it doesn't affect the stock margin and some people have in other sectors have commented while they are worried about the overall demand. I think because of our niche with the government and because of the four bright locations that have to move as I detailed in my comments, we think we are pretty uniquely protected and should experience continued strong demand, albeit it might be cyclical within a year.

Brendan Maiorana – Wells Fargo Securities

Okay, that’s helpful. And then, I mean, is there any concern or any consideration that the budget and just kind of scale-back may put a little bit of pressure on the contractor margins and then in turn that could put a little bit of pressure on the yields or on the lease rates that you guys are getting or do you still see a pretty comfortable at the returns and the new development will be in the kind of 10 to 11 cash on cash yield?

Randall M. Griffin

I don't think it’s really affecting our yields and thankfully the construction cost went and this team did a very good job on keeping that down. So we are able to continue to increase the rental rates and there really are no concessions in the development of the construction. So I think we’re in good shape there. I think the overhang of the potential budget cuts in the Department of Defense and Military, which relate primarily to weapons or support contractors that does affect the psyche of the contractors, it doesn't affect the contracts what we are dealing, but it does affect the overall sort of viability and growth of the company's and so the side-effect of that because I think we commented on the last call is that they are little more cautious to make decisions, they want to have leases executed as opposed to going speculatively on that And yet they have this dilemma where once they’ve executed it, they need to be operationally within six months.

So that's why we have to free suppose and kind of anticipate their requirements and build ahead of that schedule because it takes us a year to build (Inaudible) and another six months to a year to out fit them. But we don't see a decrease per se in our particular sector, if you were dealing in the weaponry or in the actual support of the force sizes like some of the Defense contractor's are doing directly supporting Iraq and Afghanistan. There you could expect over the next several years to see some reduction in their contracts, but that will have really very minimal impact on us.

Brendan Maiorana – Wells Fargo Securities

Okay, that's helpful, and just lastly Steve, the guidance if I strip out the $0.13 in Q2, I think that brings the number to kind of $0.49 to $0.52 or call it $0.50 or $0.51 to mid-point that would imply just to get the mid-point of your overall guidance that the fourth quarter is probably somewhere around $0.57 to $0.58 a share of FFO without any of the KEYW gains in there, what – is that increase just driven by the signing on the leases on the development pipeline and the NOI coming online in the fourth quarter or is there something else that would drive that number up.

Randall M. Griffin

It’s definitely improved occupancy, but also if you look at our pattern the third quarter from an operating expense standpoint seasonally has a little bit higher level of net operating expenses, because of the [heat wave] that we’ve anticipated a little bit higher electricity costs in the third quarter relative to the fourth.

Brendan Maiorana – Wells Fargo Securities

Okay great, thank you.

Operator

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

Michael Knott – Green Street Advisors

Steve, I was just curious if you had kind of a ballpark same-store number of 2 million feet or so of shrinkage from last quarter, this quarter was included?

Stephen E. Riffee

Michael, we analyzed that if there wasn't really much of a change between the new same-store portfolio composition, our occupancy actually went up as you can see quarter over quarter, and it actually went up, some in the portfolio that will be divested.

Michael Knott – Green Street Advisors

And then Rand on your comments about the ’12 budget going to continuing resolution does that – should the inference be then you would expect another slow patch in say first part of ’12 like happened this year with this year’s impact in the spring?

Stephen E. Riffee

If you do have Michael, if you have the continuing resolution, then where you would normally have a pretty steady flow of both government and contractor leasing. Yes, we would expect that the first part of the year as it relates to new commitments would be somewhat slower and then you would catch that back up in the second part. We would have very strong momentum going into that year and into the first part of the year, from leasing that will have occurred as a result of people, contractors and government trying to hurry to get commitments in before September 30th. So the government, they have to sign leases to commit – on the contractor side they have to sign contracts. Contactors then go out seeking space. and so we'll get the balance of the next six months after that leasing related to the ’11 budget and then we’ve got to of course get them in occupancy and that will boost the NOI related to that. So, I think the impact will be a little less than this year, but still they are somewhat in the similar pattern.

Michael Knott – Green Street Advisors

Okay, thank you.

Operator

Our next question comes from the line of Nicholas Yulico with Macquarie Capital. Please proceed.

Nicholas Yulico – Macquarie Capital

Hi, thanks. What were the TIs and free rent on the second quarter leases and where are they trending in the marketplace today?

Stephen E. Riffee

Well, TIs averaged $13 per square foot for our renewed and retentive space. And in terms of free rent, our average free rent was less than a month for the leases that we signed during the second quarter.

Nicholas Yulico – Macquarie Capital

Okay. And how does that compare to recent quarters?

Stephen E. Riffee

The $13 is higher than what we experienced in the 2008, ’09 and ’10 period. It’s down off of last quarter on a per square foot basis, it works out to that $2.75 per square foot of lease year that’s lower than the first quarter and about the same as the last three quarters of last year. So, I don’t think it’s getting worse, but I think it’s still going to be a little more time before we see some improvement there.

Nicholas Yulico – Macquarie Capital

Okay. And on the assets held-for-sale on the balance sheet, does that include all of the assets targeted for sale?

Stephen E. Riffee

No. it’s just the ones that we think we’ll sell in the next really the balance of this year.

Nicholas Yulico – Macquarie Capital

Okay. So that’s sort of [listed] at more than just a $55 million sale that you expect this year. Is that right?

Stephen E. Riffee

Included in there is the warehouse condominiums that Steve mentioned. And so that’s why it’s an elevated number that will probably take the balance of this year to sell.

Nicholas Yulico – Macquarie Capital

Okay. Thanks that’s all I have.

Operator

Our next question is from the line of Sri Nagarajan with FBR. Please proceed.

Sri Nagarajan – FBR

Thanks. Roger just following on your remarks of accelerating the disposition plan. Obviously is there significant leasing goals that you need to get rid off and get that to come to in terms of getting rid of these assets, specifically with the account that we are hearing that obviously prospective buyers are interest more in stable assets towards value added assets? Thanks.

Stephen E. Riffee

Sure. The $120 million that I mentioned of assets that were either getting on of course this office owner or somehow did not require that we do additional leasing, we think we are in a position to both pretty quickly and most of those are relatively stable. They have a little bit of leasing opportunity for a perspective buyer but we are not selling them at 70% or 75% lease.

Sri Nagarajan – FBR

Thanks, that’s helpful.

Operator

Our next question is from the Dave Rogers with RBC Capital Markets. Please proceed.

David Rogers – RBC Capital Markets

Good morning. Steve question on the data center, following the ’11 budget approval, have you seen better traction there? Thank you for the guidance on full year NOI contribution from data. But given your thoughts about the 2012 budget can you kind of give us thoughts about the ability to stabilize that going into 2013? How the budget resolution that next year might impact that leasing?

Stephen E. Riffee

Well, I would say similar to as Roger described at some of the parts where we have activity, we’ve seen an increase in notable trip activity at the data center, but it has not resulted in signed leases right now. I do we are hopeful that some of that will turn into leases as we get into early twelve disciplinary activity that’s already circling. In terms of new requirements that might come it might have the same kind of lumpiness during 2012 as Rand described for additional demand beyond that which is circling right now.

David Rogers – RBC Capital Markets

Do you have any additional plans to built out more space there at that facility.

Stephen E. Riffee

What we’ve done is try to build some capacity ahead of demand, so that we are touring and can get people in. So we have six at the end of the second quarter we delivered and have six megawatts available and plan to add a total of which three at least and plan to add another three megawatts by the end of the year, and that what building all our numbers and projections and talks.

David Rogers – RBC Capital Markets

Okay. Great and then Roger, question on the acquisition that you looked at, I think both you and Rand may be said that you were getting out there in the market. Can you give us a sense of what you were looking at your core or super core assets, where these assets continuos with the existing parts or facilities that you have. Just a little more color, it will be interested.

Roger Waesche

Yes, they were in markets we are already in and they were leased to our super core tenants and they went for cap rates, that were in the 6% something range, and with IRRs that we thought were in the 7 and some percentage range and we thought at the end of the day, we are value creators, we’re not about trying to arbitrage money until we didn’t pursue those opportunities, but I think as people start to get their pricing more assets will come to market and because we always in the market a few things will find our way to come.

David Rogers – RBC Capital Markets

Great. Last question I would like to see on your debt refinancings on the line of credit, do you any color to provide on the costs or what the direction might be for fees et cetera.

Roger Waesche

Well at today’s leverage levels we would expect pricing to be at 200 basis points over LIBOR versus the 95 that we’re borrowing out today.

David Rogers – RBC Capital Markets

Okay. Thank you.

Roger Waesche

Thanks (inaudible).

Operator

Our next question is from the line of Chris Lucas with Robert W. Baird. Please proceed.

Chris Lucas – Robert W. Baird & Co., Inc.

Just a couple of follow up questions, Steve on the data center activity there have been like closures among the various federal facilities and obviously more slated to closure. Have you seen any awards that reflect that activity at this point or is that still in the shopping stage.

Stephen E. Riffee

I think there is some shopping going on that were lining up to participate and trying to fulfill some of those needs we also had some governments towards among the actual liberty even along with contractors, along with commercial demand there.

Chris Lucas – Robert W. Baird & Co., Inc.

Okay. And then just can you give us a sense us to what the assets that are putting to the discontinued operation, what the level of NOI that is for the quarter.

Stephen E. Riffee

I don’t have that, with me Chris. We can just follow up on that.

Chris Lucas – Robert W. Baird & Co., Inc.

And then Wayne, it sounded like are shifting to product mix at Redstone a little bit, I guess we could may be provide some color on, how you’re thinking about the demand there and whether they are a little more price sensitive than may be the original thinking.

Wayne Lingafelter

Chris we’ve added to the portfolio I just described I wouldn’t necessarily quite heard that it shifted at all I think we still feel strongly about the traditional role at the suburban office will play in that market. So we’ve added the single storey FLEX product, but the portfolio of the plan still has a significant suburban multi-storey component to it, which I think will do quite well.

Randall M. Griffin

And I think the margins are holding up well. Certainly with new products, we were the only ones with any new product coming on the market and we’ll be at the high end of that market comparable to the most recent new buildings. When you have a large park like that streaching 5 million square feet, I think you want to have multiple price points. There are some contractors who have different kind of requirements that don't fit as well on the multi-storey high-class A office buildings that will work well. We also are in discussions on, behind the fence on some security facilities that will be also different kind of requirements.

Wayne H. Lingafelter

Yes, Chris, the plan has always have that FLEX product in it, we just have moved to it to give ourselves some diversity in the market.

Chris Lucas – Robert W. Baird & Co., Inc.

Okay, great. Thanks, guys.

Randall M. Griffin

Thank you.

Operator

(Operator Instructions) Our next question is from the line of Steve Sakwa with ISI Group, please proceed

Steve Sakwa – Isi Group Inc

Hi, Steve Sakwa, good morning. This is for Steve Riffee, I just want to make sure I understand three numbers, in terms of a fiscal year full year ‘11 term fees, stock sale and land sales gains, I just want to make sure I have those down for the full year?

Stephen E. Riffee

The turn keys, we’ve only had $340,000 year-to-date and are projecting $1.5 million for the second half of the year. We would just typically split it in half and say $750,000 a quarter. In terms of KUYW gain, so everything that I have reported that we’ve done year-to-date $5.2 million happen through six months. Then Rand resigned from their Board on July 1, so we move some equity accounting criteria significant influence to mark-to-market accounting and so it now is depends on the change in their stock price. And I gave you a calculation looking for the basis here that if you take the stock price last night, it would be minus, it would be $0.13 an hour basis is 2.6 million shares $7.45 a share. So we just took that gain, locked in at both ends of our ranges of guidance and would this report be actual results based on that.

Steve Sakwa – Isi Group Inc

But your expectation is to sell all that by the end of this year.

Stephen E. Riffee

Well, what we’ve done is we suspended the 10b5-1 plan as of the beginning of the quarter. And then 90 days after Rand’s resignation, which I believe is July 1st then he is no longer being inside, which allows us to execute sales more freely than sections of the 10b5-1 plan. So we – so therefore, plan not to sell during the 90-day period, which is this next quarter and then be capable – being in the market to continue to sell shares.

Randall M. Griffin

I don’t think Steve that necessarily presumes that we would tell all of that before you’re in.

Stephen E. Riffee

Well, and then land sales. Say that would make up the balance of the $18 million to $20 million that I gave.

Wayne H. Lingafelter

$2.5 million.

Stephen E. Riffee

That’s year-to-date.

Operator

Our next question is a follow-up from the line of John Guinee with Stifel. Please proceed.

John Guinee – Stifel Nicolaus & Company, Inc.

John Guinee, again. I hadn't anticipated asking this. But basically what you guys are saying in response to the previous question, if you add up your lease term fee here today, your KEYW $5.2 million and land sales, you basically have booked, in other income, $8 million. And you have another, I guess, $10 million of mark-to-market for KEYW and then another $1.5 million for lease term fees?

Randall M. Griffin

I’ll try.

John Guinee – Stifel Nicolaus & Company, Inc.

Okay. Those numbers make sense.

Randall M. Griffin

Okay.

John Guinee – Stifel Nicolaus & Company, Inc.

All right. Rand, just out of curiosity you’re a pretty smart guy. why are you leaving the Board of this company?

Randall M. Griffin

Well, I think as they – we invested early on when they were in the formular stages and we (inaudible) from his previous ramp up at SX and had a lot of confidence in himself. I think our primary role is to give guidance to help them get public, that’s been accomplished I think increasingly the demands of time of that board, I just didn’t want to spend the time there, I think that they view this as they were anxious to make sure that I got off the board and it sometimes when you’re the largest owner in the company sitting there on the board, sometimes that can be potentially concerned for them. And so we were able to just on a friendly basis separate off. It doesn’t mean we don’t have influence, it’s the largest owner, but I am just not involved in that sort of activities. And we do think it does give us a little bit more freedom not being an insider.

John Guinee – Stifel Nicolaus & Company, Inc.

Great. Thank you.

Randall M. Griffin

Thanks, John.

Operator

Our next question comes from the line of Michael Knott with Green Street Advisors.

Michael Knott – Green Street Advisors

Hey, Rand you’ve obviously have been leading this company day-to-day for a long time and as you think about retiring potentially next year as being Chairman something that you would be personally interested in, and if so is that are shouldn’t that be something that’s on the table at the Board meeting when this topic is discussed?

Randall M. Griffin

Well, I think, first of it is my expectation that if I do is, when I retire I would continue to be active on the Board and play meaningful role. I think it’s up to the Board and the dynamics of that certainly is to whether or not they would want to move me into that position and I don’t think I am in a position to speculate on those dynamics. I think I can play a meaningful role and help the company regardless of what title I have on the Board and certainly we’ve worked very hard as a team on succession planning with great shape you know if when not occurs and so you know I think you will continued strong performance from the company, it’s accelerating really out into the future.

Michael Knott – Green Street Advisors

Thank you.

Randall M. Griffin

Okay.

Operator

And our final question is a follow-up from the line of Brendan Maiorana with Wells Fargo. Please proceed.

Brendan Maiorana – Wells Fargo

Thanks. Just a quick one for Steve. Just a follow-up on couple of previous questions. So I guess if I am looking at the numbers correctly on guidance, it seems like the additional $0.07 of share related to the higher other income which is primarily KEYW mark-to-market, that’s effectively pulling forward the gain on that, on your basis relative to where the share price is into 2011 whereas the prior expectation was what that all of that was not going to be sold in 2011 and will be recognized in 12.

Stephen E. Riffee

That’s correct.

Brendan Maiorana – Wells Fargo

Okay, great.

Stephen E. Riffee

I mean that will be effect of it.

Brendan Maiorana – Wells Fargo

Yeah, so okay. I mean obviously if the shares keep going up you guys will recognize more in the latter half of the year in the ’12, but okay as it’s same and [hoping] into 2012.

Stephen E. Riffee

Yeah, you understand how it works.

Brendan Maiorana – Wells Fargo

Okay, great thank you.

Stephen E. Riffee

Thank you.

Randall M. Griffin

Thank you.

Operator

That concludes our question-and-answer session. I would now like to turn the call back to Mr. Griffin for closing remarks.

Randall M. Griffin

Well, thank you very much, we appreciate it, and we are available for any additional calls or questions you might have. And we look forward to our next call in the end of October.

Operator

Thank you for your participation today in the Corporate Office Properties Trust second quarter 2011 earnings conference call. This concludes the presentation. You may now disconnect and good day.

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