COPT Defense Properties (NYSE:CDP) Q4 2023 Earnings Call Transcript

Operator: One moment for our next question. Our next question comes from Tom Catherwood with BTIG. Your line is open.

Tom Catherwood: Thank you and good afternoon everybody. Steve, I know there’s no acquisition in guidance, but you’ve talked in the past about maintaining liquidity for potential investment opportunities. Are you seeing any early movement in the transaction markets and kind of, given your focus on specific submarkets and tenants, what criteria would you be keying on if you were to pursue a deal?

Steve Budorick: So that’s a great question. To pursue a deal, it has to be an asset with current or expected occupancy that serves the missions that we typically serve, geographically would have to be very closely located to the assets we own currently, and then the return that we’d have to get on that asset would have to be competitive with our development yields. And so that creates pretty small set of opportunities. We’re always diligent to look at opportunities that come up, but we haven’t found many that meet that criteria.

Tom Catherwood: Gotcha. Appreciate that. And then maybe sticking with your commentary about the inventory building at NBP, given that the park is 99.4% leased and that inventory building doesn’t deliver with 18 months – 24 months, whatever it may be, what are tenants doing when they need expansion space? And is that demand having any impact on your other Howard County business parks?

Steve Budorick: We’ve been able to push quite a bit of demand that would have otherwise gone to the MBP into our portfolio in Columbia and Gateway. And we’ve got a prospect ratio that’s about 160% for our vacancy in that park. So it’s very positive for us long term because we’re adding quite a bit of skiff facilities in Columbia Gateway that typically would have favored the MBP.

Tom Catherwood: Got it. And then last one for me, Britt, first off, congratulations on your first call. And second off, you had mentioned a handful of lease renewals that were delayed because of the continuing resolution. How does the mechanics of that work? Did the leases expire and the tenants are now month to month or is there still term left on the lease? How does that kind of all come together?

Britt Snider: Yes, no, it just gets put into, if it approaches expiration, then it just goes into holdover. But I mean we feel great. Like I said about those leases, it’s going to happen in 2024, just some things are out of our control, but, yes, they would stay in the space. Obviously, we have no intention of moving them out or asking them to move, they’re long-term partners of ours.

Steve Budorick: To be clear, we use a different term, it’s standstill not holdover. Holdover implies that we could put penalties on them and kind of jack up rent; there’s just provisions in the lease that allow them to keep paying what they were paying. We true up when they get a lease.

Tom Catherwood: And that’s perfect. See, that was what I was worried about, was that there would be some sort of a roll-down if they were on a holdover lease. So it would be just no change in the rent while you’re coming through the continuing resolution.

Steve Budorick: Yes, standstill. Correct.

Tom Catherwood: Got it. All right. That’s it for me. Thanks, everybody.

Operator: One moment for our next question. Our next question comes from Richard Anderson with Wedbush Securities. Your line is open.

Richard Anderson: Thanks. Good afternoon. So on Slide 17, what about the other 2.9 million square feet that isn’t 50,000 square feet or greater, what’s the status of those situations?

Steve Budorick: If you look at our overall guidance, it’s impossible for me to go lease-by-lease. It’s very comparable. Maybe, there’ll be some non-renewal, but we’re getting to a midpoint of 80 and we’re very confident we’re going to deliver that.

Richard Anderson: Okay. You mentioned the statistic 89% demand to space available in your Defense/IT segment, I guess that’s a good number. I think you’d like it to be above 100%. Is there a line of sight into how that number might change over the passage of time based on what you’re seeing today? And am I asking for too much for it to be over 100%?

Steve Budorick: Yes, over 100% is pretty rare. We actually have a graph. We track that statistic and anything over 70% is pretty strong; 60% is not unusual in a submarket. But remember that spot demand for your inventory. So, it changes with every ebb and flow of a deal. But 70 and up is very strong. Over 100 is great and we are over 100 in the BW corridor, which includes Columbia Gateway.

Richard Anderson: Right. 6% same-store NOI growth for this coming year at the midpoint, a little bit less than 4% FFO growth. Anthony said, maybe a little bit more AFFO growth, but still, the common theory is if you get X internal growth, you should get X plus Y at the bottom line, it’s not the case here with you. Actually, your FFO growth is actually lower. Is that just a condition of the fact that you’re a big-time developer and you’ll never kind of really see 6% equal 8% FFO growth or 4% equal 6% FFO growth? I’m just curious if that’s just sort of a function of the way CDP operates.

Anthony Mifsud: No, I think it’s the function of no one, none of us are immune from the changes in interest rates and the full-year impact of the exchangeable note offering that we did in September of last year is in 2024’s math. And that 5.25% is higher than the debt portfolio interest rate that we had prior to that transaction. So, some of that, both internal and external growth — EBITDA growth is being absorbed by an increase in interest expense.

Richard Anderson: I guess I would have thought that interest rates last year versus this year, almost a wash, if not an opportunity. But I hear your point, you have more stuff to deal with. So interest expense goes up. But in theory, you should see what I described, right? If holding all else constant, that shouldn’t be any reason why you shouldn’t get more FFO growth than you get same-store growth. Is that a fair statement?

Anthony Mifsud: Yes. All capital costs being equal, that’s a fair statement.

Richard Anderson: Okay, last question…

Steve Budorick: When interest rates come down, there’s some pretty interesting growth that could come back, stay tuned.

Richard Anderson: And then the last question is, I’m just thinking you mentioned cyber and how important it is to your business. I wonder about AI these days and whether that is being weaponized, certainly it is. Is that like a demand driver for cyber demand as well? And how do you see AI impacting your business, either positively or negatively, whether it’s a demand or a competitive threat to CDP? I’m just riffing a little bit, but I’m curious if you have any thoughts on that.

Steve Budorick: Well, the answer is you got to be highly speculative. So, if we understand the speculative, eventually the AI technology is going to reach some level of competency where it will have to be evaluated for use in the DoD environment. And I don’t think we’ve seen — we have no evidence that we’ve seen any increased activity and contracts related to AI as of current. So could be potentially upside, but it’s a little early to tell.

Richard Anderson: Okay, fair enough. Thanks very much.

Operator: One moment for our next question. Our next question comes from Dylan Burzinski with Green Street. Your line is open.

Dylan Burzinski: Good afternoon, guys. Thanks for taking the question. I guess just going back to some of the comments on cash release and spread guidance, being potentially conservative in ’24, but I guess just as we think about the business over the next five years, given portfolio occupancy is at historically high levels, and given your comments on being able to push higher yields on costs and new Defense and IT developments, I guess at what point does that give you guys the ability to continue to push rents in the operating portfolio. I mean, is the zero — call it the flat mark to market, sort of a low baseline as we think about the business over the next five years?

Steve Budorick: Well, I do recall, one of the interesting dynamics of our business is, we have embedded growth in our leases and that’s why we give you the compound annual growth rate from the original lease to the renewal lease because we capture growth in all of our leases and the mark-to-market is really on the renewal is — we a little below the market growth in rent or we are a little above. And the zero guidance says the internal growth, we expect is about what the market has grown and if we beat it, we were able to push up a little higher or not. But it’s not a measure of no growth, it’s a measure of deviation of the mark-to-market growth from the embedded growth.

Dylan Burzinski: Right. So I guess the question really is like over the next few years you continue to expect that market rent growth will keep pace with called the 2.5% annual escalators. Is that fair to say then?

Steve Budorick: Yes. And remember, the 2.5% escalators generate a higher growth than 2.5% because 2.5% on a gross rent with an expense stop, which allows us to pass through increases of expenses. So the average of 2.5% on the gross rents produces 3.2% to 3.45% compound growth over the term, depending on the length.

Dylan Burzinski: Great. Appreciate the comment, Steve. Thanks.

Operator: [Operator Instructions] Our next question comes from Steve Sakwa with Evercore ISI. Your line is open.

Steve Sakwa: Great, thanks. Good afternoon. Steve, I think in your prepared remarks you guys talked about the lease-up of 2100 L Street, which I know is kind of in the non-core, non-Defense/IT bucket. Where does that sit in terms of potential disposition candidates in ’24?

Steve Budorick: That’ll be market-dependent. So Britt alluded to some more news that could be positive in the leasing front. And I think if we’re able to achieve what he alluded to, the occupancy will be positioned well for a disposition. And then it’s a question of what does the capital market look like to bring that asset to market? Currently, our belief is there’s very little demand for investment in even a trophy asset like this. There’s a lot of uncertainty around interest rates and what the Fed’s going to do. The cuts that were expected have been delayed. I think that’s all creates a difficult backdrop for investors to move ahead. But I will say we will maintain a very nimble position, and when the market supports an efficient sale, we intend to sell it.

Steve Sakwa: Great. And then on the data center shells, you basically said you’ve got no land, I think, and no starts penciled in. Just how are you thinking about that business at this point with kind of the major customer you have? Are you looking for additional sites outside of the northern Virginia kind of core market that you had or that whole business is on hold? And how do you think about the retention of that business long term if it doesn’t grow from here?

Steve Budorick: So we are working actively to find additional opportunities to develop. Our market is further impaired by a lack of clarity of power availability. And so until there’s clarity on power, and then from that demand, we just have to be an observer of the conditions, looking for opportunities and moving forward when conditions will allow us to do a lease.

Steve Sakwa: Well, maybe ask a little differently. Are you kind of locked into the one submarket or one area where you develop with them, or could that sort of expand geographically within the broader Virginia market?