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Executives

Stephanie Krewson - VP, IR

Rand Griffin - CEO

Roger Waesche - President

Steve Riffee - EVP & CFO

Steve Budorick - EVP & COO

Wayne Lingafelter - President, COPT Development & Construction Services

Analysts

Craig Mailman - KeyBanc Capital Markets

Michael Knott - Green Street Advisors

Joshua Attie - Citi

Dave Rogers - RBC Capital

John Guinee - Stifel

Jamie Feldman - Bank of America/Merrill Lynch

Brendan Maiorana - Wells Fargo

Rich Anderson - BMO Capital Markets

Paul D. Puryear - Raymond James

Chris Lucas - Robert W. Baird

Corporate Office Properties Trust (OFC) Q4 2011 Earnings Call February 9, 2012 11:00 AM ET

Operator

Welcome to the Corporate Office Properties Trust fourth quarter and yearend 2011 earnings conference call. As a reminder, today’s conference 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, Laura and good morning and welcome to COPT’s conference call to discuss the company’s fourth quarter and yearend 2011 results. With me today are Rand Griffin, COPT’s CEO; Roger Waesche, our President; Steve Riffee our Executive Vice President and CFO; Steve Budorick our EVP and COO; and Wayne Lingafelter, EVP of Development and Construction.

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

Before turning the call over to management, let me remind all of 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 up on 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 successful and timely completion of dispositions, acquisitions and development projects, changes in interest rates and other risks associated with the commercial real estate business as detailed in our filings with the SEC.

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

Rand Griffin

Thank you, Stephanie and good morning everyone. As you are all aware last September the Board approved my retirement effective March 31st of this year. So this is my final earnings call with COPT. I’ve had a leadership role at COPT and its predecessor companies for over 18 years and will remain on the board of trusties. While the past few years have been challenging, our record over the past 13 years as a publicly traded company places us close to the top of all office REITs in terms of total shareholder return.

During that timeframe I have enjoyed my interactions with all of you. It’s been my distinct honor to serve the board and our shareholders and to build and lead such an exceptional team. Together, we’ve devised a strategy niche unique among REITs that serves the specialized needs of the US government focused on cyber security and intelligence and the defense contractors serving those functions.

These tenants and the missions they carry are critical to our nation’s safety. So although the Department of Defense is facing budgetary cuts, we’re confident that agencies and contractors focused on the cyber security and intelligence aspects of national security will emerge relatively unscathed. Furthermore although COPT’s unique tenant niche has recently been out of favor due to the Washington DC morass. We remain confident that this strategic niche will provide outstanding growth opportunities for COPT over the long term.

During the past 12 months, our management team and the board have made a lot of tough strategic decisions. We felt that it was important as a team to get these decisions behind us so that COPT could move ahead into 2012 with a clean slate and the best opportunity for success. I know that I am leaving the day to day management of COPT in the capable hands of Roger and the team that we have built.

I am confident that you will see COPT continue to perform the next years, regaining the confidence of investors as the best-in-class office REIT. Now I will turn the call over to Roger.

Roger Waesche

Thank you, Rand. 2011 was yet another year of challenges and the year of transition owing to the weak economic recovery and a continuing resolution that lasted beyond many people’s expectations. Our 2011 FFO per share as adjusted for comparability was $2.17 or 8% below the $2.36 of FFO per share we achieved in 2010. But 2011 was also a year of positioning for future success. The difficult operating environment precipitated a reevaluation of the company’s strengths and some difficult, but necessary strategic choices were made. The strategic repositioning included first, we are resetting the portfolio through the commitment to sell $562 million of assets in our strategic reallocation plan or SRP in order to decrease our exposure to non-strategic assets in markets.

Second, I have curtailed our development pipeline until such time as demand for new space that each project merits new construction. In the meantime, our development team headed by Wayne is making sure that entitlements and permits remain intact so that we can be first to market when the time is right.

And lastly, we have cut the dividend by 33% beginning with the first quarter of 2012. Cutting the dividend was a capital allocation decision that enables COPT to retain over $40 million of free cash flow each year which will improve the company’s financial flexibility. As you read in this morning’s press release, we are reiterating our 2012 FFO per share guidance with a range of $2.02 to $2.18.

Before turning the call over to Steve Riffee to discuss results and guidance, let me give a quick update on our progress with the SRP asset sales and our major strategic initiatives. As we detailed in our February 2nd press release, so far in 2012, COPT has sold five properties in White Marsh at an exit cap rate of 7.6% netting $18.5 million. In aggregate, the buildings were 83.2% leased and contained 55 leases.

In that same press release, we also announced the opportunistic sale of a 95,000 square foot property in San Antonio, Texas. Sentry Gateway 100 was shell complete in late 2010 and was vacant at the time of sale. In negotiating at least with the prospect of single tenant late last year, it became clear that the best solution for us and the customer was to sell the building and an adjacent four acre land parcel.

This sale allowed us to cede the park with a long-term user without having to invest the $4 million of tenant improvements. We will recognize a modest gain on the sales of building in the first quarter.

What’s important to take away from that transaction, however, is that we remain committed to San Antonio and our Sentry Gateway project. Ultimately, we can develop over 1.1 million square feet there and continue to view San Antonio as a strategic market for COPT.

The other takeaway is that while we are focused primarily on executing sales of assets in the SRP, we will not shy away from other asset sales if they make sense. Since announcing the SRP in April of 2011, COPT has executed a $111 million of total asset sales including opportunistic sales like San Antonio at an average cap rate of just below 8%. Net proceeds received on these sales totaled approximately a $105 million

The total assets sold so far aggregate 1.2 million sq ft that were 76% occupied at time of sale. From a property management perspective, the property sold contained a 154 leases representing 17% of the total leases that were in place at March 31st of 2011 with only 6% of our consolidated square feet. Combined with operating efficiencies rolled out by management during 2011 and early 2012, the shedding of these smaller more-management intensive property should translate into higher NOI margins by year end.

Looking at our disposition pipeline, we currently have another $57 million of assets under contract and an additional $116 million of assets actively being marketed for sale. But we are on track to meet our goal of selling $205 million of operating properties this year.

In summary, COPT has four major strategic initiatives; leasing space, selling non-strategic assets, making disciplined capital allocation decisions and improving our financial flexibility. I want to emphasize the prioritization of these objectives. The number one consideration we currently are adjusting is COPT’s return on invested capital. That is why our main objectives are to lease space and sell non-strategic assets. We are aware that our leverage levels are higher than those of the average office rate which was one of the reasons we made the tough capital allocation decisions to curtail development and acquisitions and cut the dividend. We will bring our ratios more in line with industry averages over time by improving our occupancy levels from recessionary lows, paying down debt with about half the anticipated proceeds from the SRP asset sales and remaining disciplined on our development and infrastructure spend.

Now I will turn things over to Steve Riffee to discuss our 2011 results and provide guidance for the first quarter of 2012.

Steve Riffee

Thanks Roger and good morning everyone. Before getting into more substantive matters, I would like to highlight some changes we've made to our supplemental disclosure. The first of which relates to how we present portfolio occupancy. Beginning with our December 31, 2011 financials we have changed our reporting method from just wholly owned to consolidated properties. To help you maintain models on the company and to bridge the difference in how we will be reporting portfolio occupancy, we will continue to include the information contained on page 4 of the supplemental package, which reports both the wholly owned and the consolidated occupancy for our operating portfolio.

Consolidated occupancy for the fourth quarter of 2011 declined 120 basis points sequentially from the third quarter. The decline in occupancy is not due to tenant move outs, but rather to the inclusion of four unstabilized buildings being added to the operating portfolio during the fourth quarter that previously were accounted for as under-construction and under redevelopment. Detail on these unstabilized properties can be found on page 15 of the supplemental. These unstabilized properties were only 15% occupied and 37% leased at December 31, 2011 resulting in lower overall percentage occupied and lease statistics. Economically there's been virtually no change from September 30, 2011.

The second major change in our disclosure that I like the highlight is the additional information we are now provide on our government and defense IT niche. On page nine, we carved out major business parts, such as MBP and provide you with percentage of leased and occupied statistics as well as the building count and total square footage.

On page 18, we now provide a lease exploration analysis for a government and defense IT niche. Which at year end accounted for 60% of our annualized rents in place and then our average rent for square foot was $29.12.

Now turning to our 2011 results. FFO as adjusted for comparability, for the full year ended December 31, 2011 was $179.8 million or $2.17 per diluted share representing an 8% decrease on a per share basis from the $2.36 per diluted share or $171.7 million of FFO for 2010.

The decrease in FFO per share versus 2010 was due to a modest decrease in same officer NOI, a $0.09 decline in earnings related to our investment in KEYW and a higher share count. Including impairments on unappreciative real estate, through revenue losses, losses on the early extinguishment of debt and acquisition costs, 2011 FFO per share as defined by NAREIT was $0.76 as compared to $2.30 in 2010.

Our 2011 FFO per share included $0.97 of impairment of losses with unappreciative real estate and $0.40 of derivative losses. Note also that are our full year FFO per share for 2011 restates our second quarter 2011 results to $0.44 from a previously reported $0.02 to confirm to NAREIT’s revise standard accounting for impairment losses on depreciated real estate. For the full year, we reported a net loss attributable to common shareholders for 2011 of $133.8 million and diluted loss per share $1.94 compared to net earnings of $26.7 million and EPS of $0.43 for 2010.

In terms of safe-office results, cash NOI reserves were in lined with our expectation. Our same-office portfolio excludes properties included in the strategic reallocation plan. As of December 31, 2012 the same-office pool of assets consisted of 160 properties and represented 72% of our consolidated square footage. For the year and excluding gross lease termination fees, same-office cash NOI declined by $4.2 million or 1.9% from 2010. Including gross lease termination fees same-office property cash NOI declined by $5.9 million or 2.6% from 2010. Same-office occupancy averaged 89.9% for all of 2011 compared to 91% for 2010 and ended 2011 at 89.9%.

Turning to the balance sheet, pages 29 to 31 of our supplement present debt ratios that measure financial flexibility. At December 31, the company had a total debt to market capital of $4.3 billion with $2.4 billion of debt outstanding, for a debt to mark total mark cap ratio of 57%. As we think about leverage one of our key metrics is debt to gross asset value as calculated according to our bank loan covenants. As of December 31, 2011 our debt to gross asset value ratio was 49.8%. Additionally at year end 2011 80% of our total debt was at fixed interest rates and our weighted average cost to debt for 2011 was 4.5%, down from 4.75% for 2010.

For the fourth quarter ended December 31, 2011, adjusted EBITDA to interest expense coverage ratio was 3.3 times. Adjusted EBITDA fix charge coverage ratio was 2.8 times and our adjusted debt to adjusted EBITDA ratio was 6.7 times. Our debt maturities were very manageable with only $66 million of debt maturing in 2012 and $163 million in 2013.

As I discussed in our 2012 guidance call in January 12, we expect to issue $200 million of five-year term debt in the first quarter of the year, the proceeds of which will be used to pay down our lines of credit.

In terms of guidance, we’re reiterating our recently announced annual 2012 FFO per share guidance range of $2.02 to $2.18, and we’re initiating first quarter FFO per share guidance at a range of $0.49 to $0.51.

Our first quarter 2012 guidance assumes no acquisitions and approximately $90 million of asset sales, including the White Marsh and San Antonio sales that closed in January.

We assumed a tenant retention rate of between 65% and 70% and project same-office occupancy will be approximately 90% for the quarter.

For the quarter, we also assumed no incremental leasing at Power Loft. G&A in the first quarter is expected to be between $7 million and $7.5 million and new business costs are expected to be approximately $1 million. This was consistent with the guidance we gave you back on January 12.

In general, our first quarter G&A is usually higher due to the front end timing of payroll taxes. Additionally, in the first quarter of 2012, we eliminated a number of positions resulting in severance costs. There are also executive transition costs in the first quarter that are not expected to recur.

Our final assumption for the quarter is that we expect approximately $1.5 million of other income which will be generated by development fees and interest income on existing loans. Note that other income excludes any gain or loss from our remaining $1.8 million share investment in KEYW. And with that I will now turn the call over to Stephen Budorick.

Steve Budorick

Thank you Steve. Our same office portfolio was at 89.9% at year end 2011 down very modestly from 90.1% at the end of third quarter. During the fourth quarter we released a total of 729 sq ft of which that 400,200 sq ft were renewals and 66,000 sq ft were re-tenanted, a 192,000 sq ft was related to development or redevelopment projects and 70,000 sq ft represented other first generation space leased at properties we acquired with existing vacancies.

Our economics on leasing continue to improve and provide evidence that we are rebounding, albeit slowly. In the fourth quarter we had a renewal rate of 64% at an average capital cost of $5.64 per sq ft. Rental renewals increased 8.1% on a straight line basis and were flat on a cash basis. The renewed and re-tenanted spaces, total rent increased 7.5% on a straight line basis but decreased 1.4% on a cash basis.

Our average capital commitment on second generation leases was a low $6.88 per sq ft. For the full year we signed 3,850,000 sq ft of leases; 2,530,000 sq ft for renewals equating to a 75% renewal rate. 505,000 square feet was re-tenanting previously occupied space, 544,000 square feet related to leasing, development and redevelopment properties and 267,000 square feet was leasing or other first generation space.

For 2011, rental rates for all second generation space increased 5.2% on a GAAP basis and decreased 3.2% on a cash basis and leasing costs averaged $11.85. By comparison, in 2010 second generation run rates increased by 2.3% on a GAAP basis, declined 5.6% on a cash basis and leasing cost averaged $11.72 per square foot.

Moving on to an update of our major markets. Broadly speaking, all of our markets continue to experience uneven demand from the dual impact of uncertainty regarding the federal budgets and concerns relating to the financial markets and lagging economic recovery. Some tenants remained cautious and price sensitive seeking to minimize financial exposures. Most markets are dominated by renewal transactions and frequently for shorter term.

Northern Virginia in particular is experiencing continued decline as BRAC-related move-outs grew negative net absorption of 1.9 million square feet in 2011. The looming possibility of defense cuts has caused large defense contractors become highly cautious of consolidating offices and exercising early termination. That being said, we are experiencing packets of demand in the small defense contractor segment. At Patriot Ridge in Springfield and select other locations.

The Baltimore/Washington Corridor continues to experience amounts of pressure at rental rates and concessions for the 15.2% overall vacancy. However, unemployment rates continue to improve modestly and we are starting to see some tenants expanding in the quarter. So we are optimistic that we have turned the corner and are moving into a better leasing environment.

Activities surrounding Fort Meade is robust; there was strong demand in the National Business Park and Arundel Preserve and improved activity in Columbia generally related to Cyber and Intel contracts, but also in Healthcare and business services.

At North Gate Business Park in Aberdeen, vacancy remains very high into the delayed contract of BRAC relocations from the Fort Belvoir area. Contracts are being awarded in everyday improving ground in local groups are compelled to make the leasing commitments. Longer term, we expect improved demand from future contract awards. Improved marketing activity resulting from leasing contracts in Huntsville including those with the Missile Defense Agency continues to make us optimistic of our price less Redstone Gateway.

And finally, Power Loft which is our wholesale data center in Manassas, Virginia. Market conditions continue to be stable; data center operations and significant capital investments for federal and commercial data centers and therefore a major a decision to have better visibility in the business. Accordingly, current activities come in by smaller users, below 1 megawatt and we are aggressively pursing them. We continue to call opportunities in the federal space.

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

Wayne Lingafelter

Thanks, Steve. Before discussing developments at our major projects, I would like to highlight some of the changes we have made to our supplemental disclosure. All of which I would categorize as streamlining.

Beginning on page 21, we’ve re-categorized what used to be pre-construction projects as land. Once again, emphasizing the more discipline approach we are taking before starting future developments. Pages 22 through 24 provide detail on projects under construction, redevelopment and Power Loft. Page 25 presents a summary of land held for future development or sale grouped by major market and by business parks.

At the bottom on page 25, we have also included COPT’s current book value of our land holdings which consist of what we originally paid for the land, any improvements and soft cost such as master planning, design and engineering and entitling the land less any impairment charges. At year end 2011 our total bases in land was $361.7 million. As demand merits new construction in the future, we will transfer projects off of the land schedule and after the construction schedule.

Now I will provide a brief update of activities at our major development projects beginning with the National Business Park. We completed shell construction of NBP 410 in the fourth quarter. This is the second property served by the NBP parkway extension and is adjacent to the previously delivered NBP 430. We are in final lease negotiations with the tenant who would lease approximately 50% of the property and have made proposals to prospective tenants for the remaining space in the building.

At NBP 430 executed leases increased from 73% at year end 2011 to 89% as of the end of January. The continued strong interest at NBP from our contractor base, positions us well to consider starting construction this year on the next building in the 400 neighborhood.

We also placed NBP 316, a building in our secured campus into service with 63% of the property leased, but not yet occupied by a government tenant. We are responding to additional interest from another secured customer who would lease the balance of this building.

Similar to our state of readiness in the 400 neighborhood of NBP, we have NBP 312 designed, permitted and have the steel purchased, so we can begin construction in an expedited manner once the leasing on the balance of NBP 316 is finalized.

Second, at Patriot Ridge in Springfield, our construction activity and the first building and associated parking garage continued as planned, with Shell construction, completion target for late in the second quarter. During the fourth quarter, we announced the execution of a lease with a defense contractor for 44% of the building.

Third, at Sentry Gateway in San Antonio and as Roger described, we sold the first building we constructed in the contractor park as well as an adjacent land parcel to a well established San Antonio corporation. We remain committed to this business park and will begin pre-construction work associated with the next parcel. We will closely monitor leasing activity in the submarket and anticipate being positioned to commence construction as contractor demands warrants.

Fourth and finally, in Huntsville, Alabama, our Redstone Gateway project continues to advance well. Our first building’s construction completion was delayed by about 30 days and therefore is now a first quarter 2012 completion. The large infrastructure work to support the park is progressing well and the park is very much taking shape and able to be presented to our prospective tenants.

With that, I’ll turn the call back to Roger.

Roger Waesche

Thanks Wayne. In summary, we expect 2012 to be a challenging year, but also a year in which we execute along four major strategic lines; leasing space, executing our strategic reallocation plan, allocating capital prudently and strengthening our balance sheet.

Before opening up the call for questions, on behalf of senior management and the employees at COPT, I want to thank you Rand for your many years of service and the strong leadership you have provided us all. We look forward to your continued stewardship at the Board level.

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

Question-and-Answer Session

Operator

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

Craig Mailman - KeyBanc Capital Markets

I guess I’d just like start by echoing Roger’s sentiments Rand that you will be missed. But turning now, just to the disposition Roger on the $205 million I know you are kind of expecting an 8% cap rate for the sales this year. Just curious on the $57 million under contract where the cap rates might be and just relative to all the activity you are playing this year, the 8% range, so there is going to be some above and some below. Just trying to get a better sense of, if you think the sales are going to come earlier in the year could be trending well below that 8% and maybe the assets are a little bit tougher are going to be above the 8%. Just trying to get a better run rate maybe for the sales.

Roger Waesche

Well you are very astute because that is sort of how the portfolio bifurcates and trifurcates when we think about selling it. The asset sales that we have in the first quarter are at pretty low cap rates because the biggest one we are selling is an asset that's very stabilized and has long-term leases. But as some of the assets we are selling for the balance of the year have lower occupancy and aren't quite the quality of what we are selling in the first quarter. So I do expect that some of the cap rates later in the year could be at higher yields. We still I think look favorably as we go down asset by asset and analyze that we will be able to be in the 8% range.

Craig Mailman - KeyBanc Capital Markets

But maybe the spectrums like low 7s to high 8s is probably a good way to think about it.

Roger Waesche

Yeah or even could be 9, could be 7 to 9.

Craig Mailman - KeyBanc Capital Markets

And then just the comments surrounding Power Loft. Is it safe to say that you guys are really looking to multi tenants that now bringing some of the more predominant tenancy in Northern Virginia, just given the continued piece of what you guys are seeing on the demand side from the super core tenants?

Roger Waesche

I think we will lease it to commercial or government and defense niche tenants whoever, whoever we can make a deal, but we still are trying to focus the attention of our marketing on our niche tenant to government and defense contractors. That’s challenging because of were the defense budget is and the cautiousness of all their core customers at this point. But I still think the asset positions itself well for that niche but we won’t we preclude leasing it to traditional commercial tenants.

Craig Mailman - KeyBanc Capital Markets

Then just one last one on the balance sheet. I know Stevie, you talked about the GAV, just curious as you guys think longer term, do you guys have any goalpost of where you want to bring the leverage to maybe debt to GAV and debt to EBITDA, maybe not you know by the end of this year but as you think of a five years type plan?

Steve Riffee

Our long-term goal to maybe put it in terms of what you would typically compare it to all REITs who don’t necessarily have the covenant package would be to get our debt to undepreciated book value down to the mid 40s. So that would be down from where we are today. As we do that we’re going to also be delevering and our typical measures of debt to GAV improve. I see that in low 40s to mid 40s and we’ve a very strong fixed charge coverage ratio of well above the bottom goalpost that we have expressed before. I think it will continue to strengthen as we delever. I think we’ll probably be covering slightly higher interest rates because it’s our goal over the next couple of years to continue to term out our debt ladder when we get opportunities to do that. So that’s how we think about our balance sheet long term.

Operator

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

Michael Knott - Green Street Advisors

I guess my first question would be, I read recently in one of the real estate rags that you guys were marketing properties in the St. Mary’s, King George county and I previously understood that that was not going to be part of the sales. My understanding is that’s mostly government tenants, can you just comment on sort of the thought include some of those in the SRP or may be those outside the SRP?

Roger Waesche

Michael, in St. Mary’s county, we have our portfolio breaks down that, the largest part of it is right outside of the main gate to Patuxent river naval air station, but we do have six smaller properties that are north of the main gate, a couple of miles and what we are trying to do is keep the highest quality assets and sell off the lower quality assets and so it just falls into that category. Those buildings are strategic from the standpoint of the tenancy, but in terms of making sure that we have the A assets in locations, it’s really about that in this case.

Michael Knott - Green Street Advisors

Okay. So is that part of what you are talking about, I think you mentioned may be being willing to sell some assets outside of the SRP if I heard that right?

Roger Waesche

That’s right.

Michael Knott - Green Street Advisors

So that would fit into that category. Is there much else beyond, I guess there will be similar situations or may be is there any magnitude of sales in addition to the 560 I think for SRP. That would be sort of outside the SRP that you would think about over the next couple of years?

Roger Waesche

Yes. Again, back to the context of wanting to have A assets in A locations adjacent to our government demand drivers, we would sell assets that are further away from the mother ship if you will.

Michael Knott - Green Street Advisors

Okay. And then should we presume that the same store pool is different now that you’ve recharacterized that in terms of it’s a smaller group of properties going forward?

Roger Waesche

It’s down to the 160 properties. So, what's been excluded are the assets that we specifically identify as part of the SRP, Michael.

Michael Knott - Green Street Advisors

Okay. But that change is effective January 1. That’s not part of the 2011 same store reporting, right?

Roger Waesche

Every year you redefine same store, so that its assets even since the beginning of 2011, all the way through the end of 2012 and the 2012 pool. The prior year, it was comparing to 2010 and 2011 years.

Michael Knott - Green Street Advisors

You happen to have a sense for how the same store in 2011 would have looked under this new pool compared to what your reported same store was?

Roger Waesche

I don’t have that number in front of me. I don’t think we’re seeing any core business, significant shifts, you know, just because we change the pool, Michael.

Operator

Your next question comes from the line Joshua Attie from Citi. Please proceed.

Joshua Attie - Citi

Thanks a follow up on Greg’s question on Power Loft. It sounds like there is a small strategy shift. Can you talk about what the impact is on the yield and if you’re still targeting high single digits?

Roger Waesche

Josh, I think, yes on the earnings guidance call a month ago, we mentioned that we saw, we could realize a yield in the high single digits to maybe double digit if we are very fortunate. And I think that’s, one, we were speaking at that time, we were acknowledging the rent that we were going to be realize were going to be lower, whether they are to our government and defense constituency or two commercial tenants and so nothing has changed since that call. So it think that we were hoping to stabilize in the high single digits.

Joshua Attie - Citi

Thanks and you added some new information in your SRP on the asset you have dedicated to government and defense IT. Can you remind us what the long-term target is for those assets as a percentage of total NOI and has that changed at all recently?

Roger Waesche

I think the near term goal is to get it to two thirds of our business and then as we execute our SRP plan, we will see what evolves out of that over the next 18 months.

Operator

Your next question comes from the line of Dave Rogers from RBC Capital. please proceed.

Dave Rogers - RBC Capital

Steve Budorick, a question, you had some terminations perhaps in the government contract side and I think we have talked about those for sometime but it brought a thought to me that perhaps with the purgatory we have seen with some of these defense contracts that that might allow them to be able to increasingly terminate or consolidate and I was interested in your view on that or may be Roger yours as well and what risk you see to the 2012 occupancy numbers based upon that if in fact it can occur.

Steve Budorick

Those comments were really made with respect to the broader Virginia market which is a 170 million plus sq ft. That was not really pertaining to our portfolio. We have not experienced that in the last quarter.

Dave Rogers - RBC Capital

And any risk that you can see some of that in 2012 with some of those contracts as we are getting more and more clarity on them.

Steve Budorick

It really pertains to different niches within the defense. We are not seeing that with our kind of customers and there is a big distinction in the way they are behaving because kind of the cyber oriented world is well funded and continuing to grow where other parts have less clarity in their future. And so it’s really different customer base.

Dave Rogers - RBC Capital

With regard to data center I think you had talked about some small one megawatt deals, do you think as a company COPT is in a position today to be a more active manager of that space going down into the one megawatt size or sub one meg. Are you prepared to do that today from a structural perspective or would that add some potential added costs or would you consider using a third party manager of the facility to do that.

Steve Budorick

No we've already developed a plan to accommodate some of the users and it will not represent a material change in our cost structure.

Dave Rogers - RBC Capital

And Rand I recently saw a presentation by Roger [Starbuck] and he had said since the merger of JLL he has the title of Executive Chairman and he spends a lot of time with his lab but he always look forward to the fourth quarter and I think with that I think you certainly deserved it. I wish you a strong fourth quarter as well. And thanks for all your help and guidance for the year.

Rand Griffin

I am still in the first half, not the fourth quarter Dave.

Dave Rogers - RBC Capital

I don't want to be dire about it, but good luck to you.

Operator

Your next question is coming from the line of John Guinee from Stifel. Please proceed.

John Guinee - Stifel

Rand we are going to miss you but I hope you come up to the center club and take me out for lunch pretty soon.

Rand Griffin

That will be on schedule.

John Guinee - Stifel

Actually all three. Okay. I guess this is for Wayne. Wayne I am looking at the land on page 21 and page 25 and these are back at the envelope, there's much more detail to it but Baltimore Washington quarter 26 per FAR Northern Virginia 30 per FAR and San Antonio per FAR Greater Philadelphia 34 per FAR. These are pretty big numbers. How should we look at the real value of the land on page 25?

Wayne Lingafelter

John, I think we feel like they are fairly priced. They do include, keep in mind that in many cases, we’ve invested in the land. So it’s beyond just your simply your all-acquisition cost, whether it would be an allocation of infrastructure, architectural work and the like. Those costs are inclusive of some development work that’s already been done. So when you consider that we think that they are fairly positioned.

John Guinee - Stifel

No, I actually asked the question is because there were the significant amount of soft cost loaded into the land that your wrote off Fort Ritchie a while ago. Are you still capitalizing interest on this page 25?

Wayne Lingafelter

John the only asset that we’re capitalizing interest on is the NBP where we were extending it into the phase II and up the route 175. So there is some capitalization on the NBP north land going on.

John Guinee - Stifel

Okay. and then the on the same vein also for Wayne I am looking at total project cost for Aberdeen about $201 a square foot I think its still about 184 I think that’s on a ground ways which is maybe the reason they are different. But 200 a square for this sort of product in these kind of locations seems like a big number is there are big TI component or lot of carrying there how should be look at that kind of number?

Wayne Lingafelter

I think they got market based what we think its market based tenant improvement allowances John. So I think we are comfortable with both of those bases. If you look across the portfolio, there are properties that have a bit higher bases. We know that we want to be targeted at a lower point in both of the markets you mentioned. But I think we are comfortable with the bases.

John Guinee - Stifel

Okay. And to keep up a good work on the dispositions, all the local brokers are very happy with your plan? Thanks.

Operator

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

Jamie Feldman - Bank of America/Merrill Lynch

Great, thank you. And Rand congratulations and best to you in the future as well.

Rand Griffin

Thank you Jamie.

Jamie Feldman - Bank of America/Merrill Lynch

So in terms of the acquisition or the disposition market, can you talk about may be any kind of changes and sentiments from buyers or may be just a buyer pool and pricing, now that we have stared a new year and you had some optimism in the stock market?

Roger Waesche

I think overall sentiment is very positive. I think when the Fed said that there we keep short-term interest rates low through 2014, that gave a little buoyancy to the market and we are seeing more active buyers, who now are willing to buy just spread invest for a couple of years and as long as they feel like they are getting a pretty good price per pound. So I think it actually does interject some positive energy into our sales momentum and I think we are experiencing that now.

Jamie Feldman - Bank of America/Merrill Lynch

And so where are these buyers, were they on the sideline or they were focusing more on core?

Roger Waesche

I think they were there. I just think that they got more confidence with the ability to borrow money and the fact that again they can borrow money extremely cheaply and they know they can do it for pretty extended period of time and lock in a good yield for, a good spread for a reasonable period of time.

Jamie Feldman - Bank of America/Merrill Lynch

Okay. And a focus more on fully leased, not really value added at this point?

Roger Waesche

No, it’s both. I think there is different character of buyer. Some like to buy core, stable and without taking risk and others like the value-add where they can lease up a building to stabilization and make a profit that way.

Jamie Feldman - Bank of America/Merrill Lynch

And were you seeing a spread in their pricing? What kind of yields they want?

Roger Waesche

I think for highly stabilized properties, we’re in the 7% going in yield in for those things that are or have a perception of maybe some structural vacancy that’s where the yields are in the 8.5% to 9% area.

Jamie Feldman - Bank of America/Merrill Lynch

Okay. And then turning to operations, in terms of where you said there are pockets of demand, can you give a little color on, is that a change that you’ve seen so far this year or is that the same pockets of demand you’ve seen throughout the downturn? And if it’s a change, kind of, was it meant for the future?

Stephen Budorick

No. It doesn’t really represent a change but certain of our properties have activity and that is encouraging, very encouraging relative to the overall market.

Jamie Feldman - Bank of America/Merrill Lynch

Okay. So, you’re not really seeing any shift and the dynamics of who actually needs space within the government and the contractor sectors in terms of their type of business?

Stephen Budorick

No. We’re not.

Jamie Feldman - Bank of America/Merrill Lynch

And then, finally, if you look at your cash leasing spreads, there is still negative. If you look at your GAAP there, pretty sharply positive, can you just talk about the dynamics in your contracts that are letting you do that. Is it something with where the all leases were priced or is it just your ability to get bumps. How should we think about that and whether that’s sustainable?

Steve Riffee

Well, I think it is, the answer to that, again 60% of our business is our government and contractor business that has more stability because the tenants have invested more money in that particular location and have a need to stay where they are. So in those cases we have been able to get positive cash rent growth and GAAP growth. Where that was being offset is in our portfolio that is subject to the anomalies of the market demand up and down and so the two have been offsetting each other largely speaking and our spreads are better than the traditional suburban office player out there but we still not where we would like them but that why we are attacking the portfolio with our strategic reallocation plan.

Jamie Feldman - Bank of America/Merrill Lynch

I guess in terms of your GAAP leasing spread what kind of bumps have been able to built into leases and is it dependant on the tenant or depends on the market or you getting it across the board?

Roger Waesche

We are in the market we operate and we are able to get generally speaking 3% bumps on rents once they have been reset to the market rate.

Jamie Feldman - Bank of America/Merrill Lynch

Across the entire portfolio

Roger Waesche

Yes annually too

Operator

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

Brendan Maiorana - Wells Fargo

Thanks. Certainly for Rand congratulations and thank you for all the help over the years and we will catch up for cup of coffee or lunch or something before the end of March. The first question I had is the 192,000 sq ft of leasing that you guys did in the quarter your referenced in the last call I think 400 70000 sq ft of prospects that you are chasing on the development pipeline. Is the 192 part of the 470 and can kindly give us an update of what the prospect list looks like today?

Roger Waesche

Well, when we had the call in January a little over 100,000 square feet of that had already been signed, so there is a little bit of overlap there but I would still say we have prospects for 400,000 square feet of space that's in specific Columbia building that we have under construction at NBP down in Huntsville and also a little bit up in Aberdeen and also some modest specific known demand down in Fort Belvoir. So I think there are designated tenants for 400,000 square feet of space. It is going a lot slower than we would like it to go, but we are confident we will get to the finish line, but I can't tell you exactly what quarter that's going to be.

Brendan Maiorana - Wells Fargo

That was helpful. On the same store, I think Michael Knott was asking about the change in the pool, is the guidance for the year is eroded to, is that on the new pool and if so what do you think the same store numbers are for the SRP properties that I guess is about $500 million to kind of start the year?

Roger Waesche

I don't think it’s that much different because they were the properties that were lower occupied and we had taken a little bit of dollars out of our cost structure. So I think that even if those properties were included, because they are in lease up along the way that our same store would be in the same range.

Brendan Maiorana - Wells Fargo

It would be in the same range; so as we think about like the sale of those assets overtime in the cap rates that you guys have provided, because I think its around 8% for this year 8.5% for next year, there is not a kind of same store leakage in the ’13 so that 8.5% is still on kind of today's level of NOI; it’s not going to go down?

Steve Riffee

Right, and one of the reasons that we’ve excluded it is so that you can see the assets that we intend to hold on long term and see the where they were down negative 1.9% and 11% we’re saying flat to positive too. So we’re saying that the buildings, that are core that we’re going to hold on to, relatively stronger in ‘12 than were in ‘11.

Roger Waesche

The other thing Brendan is that, our assets in the SRP only relate to about 11% of our revenues. So it’s not like it’s a significant part of our portfolio. Our same store portfolio is 76% and then a lot of assets we’ve put into service from our construction, pipeline or acquisitions we made that haven’t yet hit the same store represent the difference.

Brendan Maiorana - Wells Fargo

And then just the assets that, I guess are less strategic but not part of the SRP, so I think some of the ones that you referenced in the King George and St. Mary’s county, why are those are not part of the SRP; is that just the magnitude of assets that you plan to dispose off over the next couple of year, so it would just be too large and maybe if there is you know SRP too that would be sometime thereafter?

Roger Waesche

Well, the assets down in Pax River Naval Air Station, those six small building are part of the SRP. But you are right, there are other assets that are not in I’ll call it the existing SRP plan that we probably will continue to sell. So I think the company going forward will be much more turning its portfolio more than we have in the past even beyond the SRP plan.

Brendan Maiorana - Wells Fargo

Is it sort of like kind of 5% your type of number or is it something larger?

Steve Riffee

I think that’s probably a good number.

Operator

Your next question comes from the line of Rich Anderson from BMO Capital Markets. Please proceed.

Rich Anderson - BMO Capital Markets

And Rand, I think I probably pretty much annoyed you when I first started covering the company 10 years ago but I also think you warmed up to me and for me that is?

Rand Griffin

Warmed up.

Rich Anderson - BMO Capital Markets

That is may be my top success as an analyst for someone of your caliber. So wish you the best of luck and hopefully your past will continue to cross in the future.

Rand Griffin

Thank you. We have always enjoyed your headlines.

Rich Anderson - BMO Capital Markets

Thank you. Hope you read the research still but, so just a couple of quick ones for following the call here, but can you kind of quantify, we all know you’re kind of curtailing your development effort at this point, what would you say, may be this is written at some place and I haven’t seen yet, but what would you say as a percentage or in dollars that you kind of decided to walk away from or at least postpone working on at this point. What would have otherwise had it not been for all the things that are going on around you?

Roger Waesche

I think first I’ll step back and put it in broad context, we spent 2010 and 2011 seeding all of the business products related to BRAC and also those other government campuses that are BRAC like and so by the middle of 2010 we had already started all the buildings we needed to make sure we had a position in each of those locations. So our sort of peak speculative development, if you will, had already evolved naturally from wanting to be where we were with the product that we developed. Now beyond that, it’s really a matter of leasings before we start other buildings. And I think the point we’ve been making the last couple of calls is that we are going to have a higher standard of analyzing revenue and risk of revenue before we do new starts going forward.

Rich Anderson - BMO Capital Markets

So you think it could have been, like I don’t know, $200 million of new starts that you would have done, that you are not doing now or I am just trying to get a sense of how much you’re putting the brakes on in dollar terms?

Roger Waesche

Well, I guess, to start of put a broad framework around it, if you say that we have six sort of locations that are BRAC or BRAC-like and each building is a 100,000 to 120,000 square feet and so if you wanted to have one building at all times, that’s you know, 700,000 square feet and if our average cost is $200 a foot, that’s $140 million would be probably the most we would have and that’s if we had all of our buildings without any leasing. So I think that exposure will come down.

Rich Anderson - BMO Capital Markets

Okay. That’s helpful. And then Power Loft, you guys, in the interest of kind of simplifying and deleveraging and kind of just kind of getting back to your core strengths, have you thought about, maybe this is an asset that you would eventually sell and not go down the path of running Power Loft?

Roger Waesche

Certainly, that’s one of the options and we are trying to lease it up to our strategic tenants. Secondarily, we’ll lease it to commercial tenants and if we don’t make the asset, strategic asset with our customer constituency we would likely sell those assets.

Operator

Your next question comes from the line of D. Puryear from Raymond James. Please proceed.

Paul D. Puryear - Raymond James

Hi Rand, again thanks for the passion you brought to the company and I’ll let Brendan buy you a coffee, but I think I can do better down here next time. I think we may have one or two sit around with your name on it. My question is kind of bigger picture, has the number of prospective tenants associated with the movement of BRAC in private sector contractors, has that changed materially over the past year or two years and has the housing market inability to relocate impacted to that as well?

Roger Waesche

I do think the housing downturn has impacted the relocation of companies and their employees to BRAC locations and I think that’s why they went to the government and got relief from having to comply with their circumference obligation under the contracts they have with the government.

So I do think that has been an impact, but I think the number of tenants is probably still the same as it was before; it’s just that they are slower to move. I do think some smaller tenants in some of the locations maybe up in New Jersey will find other work and never move to for instance Aberdeen, stand the ground. But I think others will supplant them as new contracts are issued.

So I think in general, we will get to the same spot. It’s just going to take longer than we thought. I remember years and years ago after the BRAC that really made St. Mary’s County, Pax River Naval Air Station what it is and it started off very slow and a lot of us were very circumspect about whether or not it would ever materialize, but it did, just that it took five or six years to materialize, but when it did, it really was a robust amount of growth for that area. And I think that's what we are going to see at Aberdeen, that's what we are going to see with Belvoir and around Fort Meade and also down in San Antonio.

Rand Griffin

But we’re also seeing interestingly are people that are selling their houses and moving to apartments or condo sort of is it downsizing for a while and so and of course the government people had move tend to also to hit apartments. So you see a very robust activities in our area with apartments and record kind of setting rates, record kind of absorptions, a lot under construction. So that's sort of one of the positives that I think is offsetting the other part of the housing questions.

Operator

Your next question comes from the line of Chris Lucas from Baird. Please proceed.

Chris Lucas - Robert W. Baird

Rand, just wanted to echo the sentiments of the others and congratulations and best of luck and thank you for all of the years of help and access. My question, a follow-up on Bill’s question, on proximity requirements, are those, the laxness on those is that broad or is that specific to certain BRAC locations?

Roger Waesche

I think it’s broad, but I think it also depends on if you’re a prime contractor or a secondary contractor and what level of work you are doing for either your prime or for the government and so I think it has to do with the contract by contract and depends on what the mission is and the criticality and the need for those customers to be really near the government customer.

Chris Lucas - Robert W. Baird

Okay. And then just again another broad question just as this relates to the sentiment within the contracting business we’ve seen. Obviously, we’ve got a budget, there is appropriation. So that’s the positive. The negative you’re seeing a fair amount of high profile lay offs and some real downsizing that is going on, what is your sense about their commitment level or the confidence about their business for the next couple of years?

Roger Waesche

And Chris, what’s happening is the contractors are cycling to where the contracts are. So they see the weapons part of their business going down. They see that they have been supporting like (inaudible) and some of those supporting the actual combat operations. They see that being curtailed and so they are making the appropriate downsize moves which is not unusual in that part of the business and in both in the current conditions and in the dissipation of where the cuts have come from. Conversely what’s interesting is that they are seeing where they have won contracts and where they are continuing to win in cyber and intelligence areas and so on and they are both taking space there and also you’re seeing an increased M&A activity where the larger firms are starting to move to increase their revenues through buying other people and so we see that is a continuing trend and even if a contractor says well we going to downsize somewhat. We are backfilling that instantly with the kind of locations that we have. So and we can’t get this across to the analyst very well. It seems like you know in terms of this is something that and even to a degree the investors. I mean you can’t generalize on the problem of defense. You got to understand the specifics of it related to the niches that they are in. So, hence we are still doing development leasing, still seeing nice demand.

Chris Lucas - Robert W. Baird

And then Steve Riffee, just a couple of specific questions. On Power Loft, are you capitalizing interest in carrying expenses on that asset at this point and if so far how much longer is that possible?

Steve Riffee

Only on small piece. Chris we substantially built out the nine megawatts. So our capital spending for this year is primarily just for the TI finish and there is just a little bit of time that is still left on the spend that we spent you know at Power Loft, so it’s not a big number.

Chris Lucas - Robert W. Baird

Okay. But as far as the interest expense and operating expense carries, is that being capitalized or is that spinning expensed?

Steve Riffee

A portion of it is being capitalized.

Chris Lucas - Robert W. Baird

Okay. And then just trying to understand on again a pretty specific question. On AFFO adjustments, added back the derivative loss for fourth quarter, but my understanding, that is a cash expense, is that correct?

Steve Riffee

It is, it’s one that was settled in 2012 also.

Chris Lucas - Robert W. Baird

Okay. So the add-back occurs for fourth quarter, will it be a deduct against AFFO in the first quarter or how are you thinking about that?

Steve Riffee

No, I think we just look at the financing type derivative items as expense and it will not be an add back.

Chris Lucas - Robert W. Baird

Okay. It wont be an add back in the first quarter. I mean, what if that is, you added it back to get to the AFFO number that you reported in your results for this quarter.

Steve Riffee

And that’s the year that we accounted for the FFO and AFFO. So that won’t be an item, an adjustment in ’12.

Chris Lucas - Robert W. Baird

Okay. Well, I am just trying to understand why as a cash, there was a cash expense, why was it added back? Just trying to understand that.

Steve Budorick

We’re just excluding derivative gains and losses from AFFO.

Operator

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

Michael Knott - Green Street Advisors

Hey guys. Just a couple of questions on sort of a new disclosure, still kind of digesting it. Thanks for trying to improve some of that. I think some of the development disclosure was a little confusing before I think it’s a little more streamlined now.

But one question I have, it seems like there is no longer, any specific or dedicated pages to measuring the performance of properties that were recently placed in service. I guess, there is the one line on page 10. Is that where we should look now where you have the line properties place and service. That’s where we should look to see how properties that were recently developed or recently completed, I guess, are performing, and then I was going to ask what the cost basis is for that 1.5 million square feet, that’s shown on that page.

Roger Waesche

We will get you that number, Michael. The other place you could look is also on page 15 where we have a schedule of unstabilized office properties. That’s all development that we placed in service that has less than 90% occupancy and so in that case we have nine assets, totaling a million square feet that we placed in the service, that are in our occupancy count, that are only, at year end, were 23% occupied and they were 40% leased

Michael Knott - Green Street Advisors

Okay thanks for that and just follow up on terms of your comment what will be the difference between that 1 million sq ft versus the 1.5 million that is on page 10?

Roger Waesche

In that case it is assets that are stable that greater than 90% leased, but having gone into the same-store pool again.

Michael Knott - Green Street Advisors

Got you okay and then the other disclosure question would be if I can log in a request for consideration for the future, it might be helpful to have a same-store income and expense page like most of the companies provide and one reason I ask is just curiously when you look at the income statement for 2011 it looks like total operating expenses were 10% higher. Obviously that is not same-store and I am just curious how you are thinking about operating expenses for 2012 as part of your 0 to 2% same-store guidance?

Steve Riffee

I think operating expenses will be up nominally nil and I should mention that 10% is skewed because we have certain customers that escalate the amount of service they want in certain locations and so the expenses go up and there is reimbursement like expenses.

Operator

I will now turn the call back over to Mr. Waesche for closing remarks.

Roger Waesche

Thank you all for joining us today if your questions did not get answered on this call we are in our offices and available to speak with you. Thank you.

Operator

Thank you for your participation in the Corporate Office Properties Trust fourth quarter and year end 2011 earnings conference call. This concludes the presentation. You may now disconnect.

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