Welcome to the Corporate Office Properties Trust First Quarter 2023 Results Conference Call. As a reminder today's conference is being recorded. At this time, I will turn the call over to Venkat Kommineni, COPT's Vice President of Investor Relations. Mr. Kommineni please go ahead.

Thank you, Michelle. Good afternoon and welcome to COPT's conference call to discuss first quarter results. With me today are Steve Budorick, President and CEO; and Anthony Mifsud, Executive Vice President and CFO. Reconciliations of GAAP and non-GAAP financial measures that management discusses are available on our website in the results press release and presentation and in our supplemental information package. As a reminder forward-looking statements made during today's call are subject to risks and uncertainties, which are discussed in our SEC filings. Actual events and results can differ materially from these forward-looking statements and the company does not undertake a duty to update them. Steve?

Good afternoon, and thank you for joining us. Before turning to results for the quarter I'd like to start by highlighting a few important themes. The fundamentals of our business remained very strong, as does the outlook for defense spending. We continue to see demand for new leasing and renewals at our Defense/IT locations, as evidenced by our 95% portfolio lease rate. Defense tenants working on secured programs can't work from home and that's resulting in our tenants retaining space in our portfolio. And as a result, we expect to achieve a tenant retention rate in 2023 that is at or above our 10-year record high of 81% in 2017. We have good visibility into demand for our current and future development projects. We continue to project FFO per share growth of roughly 4% on a compound basis between 2023 and 2026. And we completed the JV equity raise earlier in the year and we now have capacity to self-fund the equity component of our anticipated development investment going forward. And lastly, based on the strength of our business, our Board approved a 3.6% increase in our dividend in February. Now let's discuss results from the quarter. We reported first quarter FFO per share as adjusted for comparability of $0.59, which is $0.02 higher than the midpoint of our guidance. Our core portfolio remained well leased at 95.1%, which represents 100 basis point increase year-over-year. Our Defense/IT segment is 96.7% leased, which is the highest level since we began disclosing the segment in 2015. Our first quarter operating metrics were strong. Same property cash NOI increased 8.3% year-over-year, which is the highest level in over a decade, leading us to raise full year guidance by 100 basis points at the midpoint. We executed 99,000 square feet of vacancy leasing, which…

Thank you, Steve. We reported first quarter FFO per share as adjusted for comparability of $0.59, which is $0.02 higher than the midpoint of our guidance. Over half of the upside came from lower net seasonal related expenses and the remainder from the timing of repairs and maintenance expense. As a result of these expense variances results exceeded our expectations, as same-property cash NOI increased 8.3% year-over-year, while same-property GAAP NOI increased by 3.7% year-over-year. Included in our same-property cash NOI results was the benefit of free rent burn-off of two large tenants in the first quarter. Excluding this impact same property cash NOI increased 3.9% year-over-year. We expect same property growth will moderate during the remainder of the year. However, driven by the first quarter's outperformance, we are increasing the midpoint of our same-property cash NOI guidance by 100 basis points to 3% to 5%. The composition of the same property pool changed with the addition of nine new development properties which are 92% occupied and the removal of three fully leased data shells which were joint ventured. Same-property occupancy ended the quarter at 92.1% and is expected to increase throughout the year, as leases executed in 2022 commence, including over 160,000 square feet at the National Business Park during the second and third quarters, which includes 126,000 square feet of new space with the US government and 121,000 square foot lease with Lockheed Martin at 1200 Redstone Gateway in the third quarter. These gains will be partially offset by a previously reported 54,000 square foot contraction in our regional office segment by CareFirst at Canton Crossing in the second quarter. The location of our Defense/IT assets has driven our exceptional leasing results, which translates into resilient and growing NOI. Our three largest concentrated defense locations which consist of…

Thank you. Summarizing our key messages, we delivered a strong quarter with FFO per share $0.02 above the midpoint of our guidance. Our Defense/IT segment is 96.7% leased which is the highest rate since we started reporting the segment in 2015. We raised the midpoint of full year same property cash NOI guidance, by 100 basis points driven by a great first quarter. We raised the midpoint of our full year retention rate guidance by 250 basis points to 82.5% demonstrating our confidence in our renewal leasing. We executed 99,000 square feet of vacancy leasing and we are on track to achieve our full year target. Our leasing pipeline remains strong, with a vacancy leasing activity ratio at 75% and a development and leasing pipeline at 700,000 square feet. Our 1.5 million square feet of active developments which are 92% leased provides a strong trajectory for NOI growth over the next few years. The administration's fiscal year 2024 budget request proposed an additional 3.6% year-over-year increase or nearly $30 billion, which follows a near 15% increase over the prior two years. We are on track to deliver modest FFO per share growth in 2023, but expect compound annual FFO growth of roughly 4% between 2023 and 2026. And we raised our dividend by 3.6% and we expect to self-fund the equity component of our development pipeline going forward. So let me finish with an anecdote, before we open up the line for questions. Earlier this month, they attended a ribbon-cutting ceremony down at Redstone Gateway, for a two building build-to-suit campus, which we developed for a top defense contractor. The properties totaled 262,000 square feet, and they were delivered in the fourth quarter of 2022 at a total cost of over $100 billion -- $100 million, sorry. While we often discuss the mission-critical nature of the work our tenants perform at our facilities it trips like these that really reinforce the importance of our tenants work to our national security. This campus will be home to over 1,000 employees whose primary mission is to expand our nation's missile watch and missile defense capabilities. The buildings contain office space, skip facilities, program management and engineering design space an integration, laboratory, a data center and a 350-person auditorium. This is a great example of mission-critical work that requires specialized secure space that is adjacent to a government demand driver that, it supports and work that cannot be performed from home. We're incredibly proud to play a role in the creation in advance with such a vital facility, supporting critical defense missions of our country. We are greatly appreciative of our relationships with our government and defense contractor tenants providing them critical facilities and infrastructure, to support their national security missions. And with that, operator, please open up the call for questions.

[Operator Instructions] Our first question comes from the line of Anthony Paolone with JPMorgan. Your line is open. Please go ahead.

Thank you. So you talked about and outlined about half of your expirations being over 50,000 square feet the high retention there. Can you talk about just the roughly other half that's smaller tenants? And just any trends there that might be different than what you're seeing more broadly or things that we should watch with that half of the expirations?

No. The overall target or expectation with the midpoint at 82.5% suggests that we have just as high retention performance on smaller tenants in Defense/IT, as we do for the larger. But do bear in mind we got 50,000 square feet of regional office back year-to-date and we're going to get another block of 50 later in the year. And that regional office is a significant factor in the 82.5% retention rate.

Okay. Got it. And then just other question, in terms of thinking about starts for the rest of this year, what's in the planning, or how should we think about that? Because it seems like, to take your development goal, you need to start something that the existing pipeline is pretty full.

That's, correct. We've got a little over I think 100,000 square feet, in our available inventory. There's multiple scenarios that could put us over the 700,000 square feet, one of which is another data center shell build-to-suit and the alternative is some additional starts in the Defense/IT locations most likely Redstone Arsenal.

Okay. Thank you.

Thank you and one moment for our next question. Our next question comes from the line of Blaine Heck with Wells Fargo. Your line is open. Please go ahead.

Great. Thanks. Good afternoon. Just starting on guidance. It seems like there was room to move FFO guidance up given the movement in same-store NOI and retention expectations. I guess that it's early in the year. But I guess, I'm just wondering if there were any other factors other than interest rates that kind of kept you guys conservative at this point?

There weren't. I think what we were trying to communicate with the changes that we did make as a result of the performance in the first quarter, was the strength in the same office portfolio, as well as in the retention of our expiring leases. I think the one component of the forecast that we really have no control over is, variable rate interest. When you look at the change in projected SOFR from where it is at the beginning of -- will be at the beginning of May through the end of the year, it's projecting to go down almost 75 basis points, if that doesn't occur that would impact our interest expense. Every 50 basis points change in interest expense, for the balance of the year is, about an additional $600,000 of interest expense. So at this point of the year, we're not at a point where we can be confident that that -- those rate reductions that are assumed later in the year will actually happen.

In general, we like to put out conservative numbers. And so there's still two quarters left to adjust that expectation, if the first quarter results flow through and interest rates remain stable.

Okay. That's fair. Steve, I was hoping you could talk a little bit about, how you're approaching capital allocation decisions more broadly in this kind of volatile environment, as you evaluate different investment opportunities from acquisitions to development and maybe even thinking about share repurchases. Do you think any of these investments provide a much more attractive risk reward profile, at this point?

Well, we continue to believe that our incremental capital allocation is best placed in new development at high priority defense locations, and it has been for the last seven years, since I took over as CEO. There have been a few opportunities to look at some, somewhat interesting acquisitions in the marketplace. But the value creation, we can deliver to shareholders through our development, is superior to that of what we could do through an acquisition and we'll continue to remain very disciplined, looking to maximize shareholder value through the development process.

That's very helpful, Steve. And I guess to that point, can you give us your latest thoughts around data center development and whether land costs, and power availability continue to be issues that could maybe impede your ability to develop more on that side of the business in the future?

So, unquestionably the availability of land, but more so the availability of power is going to limit the overall opportunity to grow the data center capacity in the market that we serve which is Northern Virginia and Prince William County. So, I think the rate of continuing progress will be lower than it was say five years ago. But we continue to identify opportunities and work in harmony with our customers to see if we can find solutions to continue developing for them and we're pretty confident we're going to have additional development that we will book and secure for our shareholders.

Great. Thanks everyone.

Thank you.

Thank you. Our next question comes from the line of Michael Griffin with Citi. Your line is open, please go ahead.

Great. Thanks. Steve I want to go back to the prepared remarks around the defense budget. Do you have any sense the impact of the budget negotiations, the debt filling fiscal clip? I mean if they can't reach kind of an agreement with Congress, could that adversely impact that growth that you're talking about in 2024?

So, it's going to be a roller coaster ride getting through to September unquestionably. And we're in no position to project -- or to predict exactly what fencing is going to look like between the House and the Senate and the President, but it's crystal clear that the one area of broad consensus is that defense spending has to continue to increase. And when I say defense spending, I'm not referring to anything pertaining to Ukraine to meet the global threat environment that we face today. So, it will be interesting on the budget, I can't tell you what things will be in place. But there is broad consensus that defense has to be invested in.

Got you. That's helpful. Maybe turning to Redstone. I noticed you've been winning some business from [indiscernible]. How big is this opportunity set? And then we just go behind the fence? I know you've got some entitlements to build there. Any update on this as well as space demand may be coming there?

So, overall, we have over 3 million square feet of additional development capacity inside and outside of defense I would characterize about a third of that is inside the fence. We continue to see opportunities of significant size for new facilities to meet new missions or enhanced capabilities in the marketplace. Timing of those is crystal clear in some respects. With regard to the basin decision for Space Command, that's really in the hands of the senior commander of the Air Force at this point from what we understand. The decision was made probably going on four years ago. It's been challenged three times and each and every challenge and review Redstone Arsell comes out as the number one choice. And I think it's a matter of time. But it's a very political decision and there are multiple states that would prefer to go there. So I can't predict timing. I think it will be a -- if it's finalized in Alabama, it will be a big benefit to that market overall and I think there'll be quite a bit of opportunity for our company there.

Got you. And then just lastly on the regional office portfolio. Anthony, I think, you talked about 96% of your properties being unencumbered. Are any of the regional office assets encumbered with mortgages and like you hand back keys on it as if the potential?

All of the assets in the regional office portfolio are unencumbered. So there's no mortgages on any of those properties.

All right. That’s it from me. Thank you for your time.

Thanks, Michael.

Thank you. And moment for our next question. Our next question comes from the line of Camille Bonnel with Bank of America. Your line is open. Please go ahead.

Hi. Just following up on an earlier question around guidance. To clarify was the driver of the FFO change on the upper range driven by interest rate variability, or can you speak to what was driving this change?

The penny – the reduction at the top end was really driven by the fact that we've got a quarter in the books that we even if interest rates were to -- we don't expect interest rates to decline that dramatically that would get us to the higher end of that range which would be one of the drivers that would get us there.

Okay. Thank you for clarifying it. Most of my questions have been asked. So it that's for me.

Thanks.

Thank you. And one moment for our next question. And our next question comes from the line of Tom Catherwood with BTIG. Your line is open. Please go ahead.

Thanks and good afternoon, everyone. Maybe sticking with Redstone, Steve in the past you've added some small mixed-use components now that the build out kind of across the whole campus continues to accelerate, is there any thought to carving off parcels for some other complementary uses. I think you did some of this with the hotel that was added back in I think it was either 2015 or 2016.

Good question. So we're -- we did do a second hotel land lease. That hotel is under development. It should deliver I think around year end, which will be good for the rest of the retail that we had invested in. We had also -- did a land lease with a daycare facility to support ultimately the employees of our customers on the base. And we'll do some relevant support more retail-oriented leasing to enrich the value of our development to our customers. But beyond that -- beyond convenience service we have no plans to use any of that land for anything but defense contractor and U.S. government development.

Got it. I appreciate that Steve. And then maybe pivot over to the data center shells I think your first round of second-generation leasing is coming up soon. When do those leases roll? And did some of those re-leasing expectations factor into the higher same-store NOI guidance?

I don't -- well we have negotiations ongoing on our first renewals. And I'll just say stay tuned, but it did not factor into our change in the same office NOI.

The first lease on that matures is at the end of this year. So any impact of our renewal would be -- wouldn't be until 2024. And from an NOI standpoint, that property is one that is in one of the Blackstone ventures. So the impact of that for us would only be the change in rent and our 10%.

Got it. Understood. We will follow-up on that. And then last one for me, and this is probably doesn't impact you guys but obviously, lots of distress and talks about distressed opportunities when it comes to office. Now that office is very, very different than your portfolios, and I wouldn't expect there to be distress per se in items leased to DoD or contractors. But are there any opportunities in your markets, whether it's to kind of add some tuck-in acquisitions or some additional land that you're tracking or that you think may be opportunistic within the next year or so?

Great question. So we are keeping our eyes peeled for such an opportunity. We have yet to find when that fits our requirements.

Got it. Appreciate it, guys. That’s it for me.

Thanks, Tom.

Thanks, Tom.

Thank you. [Operator Instructions] And our next question comes from the line of Steve Sakwa with Evercore ISI. Your line is open. Please go ahead.

Yes. Thanks. Good afternoon. So Steve, a lot of focus obviously on the defense IT sector, which is doing very well, as you pointed out almost 97% leased. Unfortunately, the six regional assets are only 78.5% lease. So, I was just hoping that you guys could talk a little bit about the demand you're seeing in the regional assets. And I know that that's kind of the catalyst ultimately try and get these sold, which in today's environment is not exactly the easiest thing to do, but maybe speak to the demand side of what you're seeing on the regional office.

Sure. We did sign two leases in the regional office in the quarter that added about 11,000 square feet of occupancy when the space is built. Believe it or not our pipeline for regional office is at 76.5%. So there have been some larger uses that are now in the marketplace canvasing some buildings that we can compete for them. It's too early to be overly optimistic, but there's opportunity out there that we can compete for, which is a good sign. We're down to a final decision with the tenant that's considering $2,100. We think we're competing effectively for that tenant. We anxiously await their decision and we'd love to land that lease.

And would you sense that the demand is a little stronger in Washington D.C. or up in Baltimore or any thoughts on that or price of tenant.

So D.C.'s demand profile is pretty ugly except for the trophy office segment. And in the trophy office segment, there's diminishing supply, I think it's below 13% availability right now. And we believe our asset competes very favorably with other availability to that segment. From a volume perspective, we've got quite a bit of prospect activity in Baltimore. I don't expect those deals to move quickly. But we have a couple of larger opportunities that are very interesting.

Okay. And then on the development side, I know you've historically said that your yields to some extent at least on the data center shells might float with costs. But can you just kind of remind us to the extent that you move forward with another data center shell development or some of the IT, defense IT. What kind of yields are you looking at today on cost and maybe what is happening with costs on the development side?

So costs have stabilized pretty materially over the last call it two quarters. Two quarters ago we were reporting that our year-over-year development on office buildings was about 21%, 22% and we have been able to drive our rents up to maintain yields in our target range with that change in cost. We did one build-to-suit and Defense/IT year-to-date. And I would say our cash yield is 50 bps higher than it was say 12 months ago. And we've elevated our targets to try to achieve a commensurately better cash return with our increased cost of capital. Data center shells, I don't really want to discuss yields. But we look at that opportunity with the same lens trying to achieve returns that are commensurate with our increased cost of capital.

And I guess maybe just last question. I know we sort of talked about this during the trip in D.C., but given the power issues in Loudoun County today, do you see your ability to find other I guess larger locations in the Northern Virginia area to help supplement your customers' needs for data centers?

We're working on a couple right now. It's a little preliminary talk about them because we're not under contract but I don't think you're going to see large land availabilities. It's going to be more moderate – moderate-sized parcels that require a little more creativity but we are working on several.

Great. That’s it for me. Thanks.

Thank you.

Thank you. I would now like to turn the conference back over to Mr. Budorick for closing remarks.

Thank you, all for joining our call today. We are in our offices. So please coordinate through Venkat, if you would like a follow-up call. Thank you very much for joining us.

Thank you for participating in today's Corporate Office Properties Trust first quarter 2023 results conference call. This concludes the presentation. You may now disconnect. Have a good day.