FEATURED COMPANY
COPT Defense Properties:
A Unique Specialty Real Estate Franchise Supporting National Defense
COPT Defense Properties (COPT Defense) (NYSE: CDP) is an equity real estate investment trust (REIT) whose 22.2 million square foot portfolio of office and data center properties was 96.5% leased on September 30, 2024. Classified by Nareit as an “Office REIT,” COPT Defense’s specialized capability to provide real estate solutions to the U.S. Government and its defense contractors, most of whom are engaged in national security, defense, and information technology (IT) related activities (collectively referred to as the Defense/IT Portfolio) is unique in the REIT industry and makes COPT Defense more of a specialty REIT.
The Defense/IT Portfolio is adjacent to defense installations that execute high-tech and knowledge-based defense missions encompassing intelligence, surveillance and reconnaissance (ISR), research and development (R&D), missile attack and defense systems, Naval weapons and systems development, space exploration and defense, cybersecurity, and cloud computing. Accordingly, COPT Defense’s business is not correlated with the broader economy or traditional office fundamentals, and the Company strongly outperformed other office REITs during the COVID-19 pandemic shutdowns and the subsequent shift to flexible work-from-home policies. In fact, the Company grew its compound annual FFO (funds from operations) per share, as adjusted for comparability, by 4.5% from 2019 to 2023.
For 2024, COPT Defense expects to grow FFO per share, as adjusted for comparability, by another 6.2%, despite the elevated interest rate environment. This track record of reliable growth through tumultuous economic events, combined with its secure, annualized dividend yield of ~3.6%, makes COPT Defense an attractive investment opportunity. COPT Defense has raised the dividend by 7.3% since February 2023, which illustrates confidence in its ability to generate strong levels of AFFO, as COPT Defense is only one of two Office REITs to have raised the dividend in 2023 and 2024 to date.
Moreover, management believes the Company is on track to generate at least 4% compound FFO per share growth from 2023 to 2026. Underpinning this expectation are the following points:
- Healthy defense spending environment in the United States continues to drive strong demand for COPT Defense’s locations. The Defense/IT Portfolio, which accounts for ~90% of annualized rental revenue, is 96.5% leased, which is just shy of the 97.2% record achieved in 4Q 2023, and well above the Office REIT average occupancy of ~86%. Through the third quarter of 2024, the Company completed 2.5 million square feet of total leasing, with a tenant retention rate of 84%, which is ahead of the 10-year average of 76%, and well ahead of other office REITs. Because demand for COPT Defense locations is not correlated to the macroeconomic environment or general office fundamentals, COPT Defense raised the full year target for vacancy leasing by nearly 20% driven by the strength of leasing to date.
- COPT Defense owns and controls over 1,000 acres of land in its Defense/IT Properties, which limits competing supply and can accommodate roughly 11 million square feet of future mission growth.
- On September 30, 2024, over $330 million of specialized office and data centers were under construction totaling 830,000 square feet, all of which are at Defense/IT locations; ~80% of that space is pre-leased and will support growth in the coming quarters.
- An investment grade-rated balance sheet supports future growth through development and ensures dividend safety. As of September 30, 2024, COPT Defense’s market capitalization is $5.9 billion, composed of $3.5 billion in equity capitalization and $2.4 billion in total debt. The debt portfolio is primarily composed of long-term unsecured senior notes with attractive interest rates, and maturities that occur in 2026, 2028, 2029, 2031 and 2033. The Company has no refinancing exposure until 2026.
Advisor Access spoke with Stephen E. Budorick, president and CEO of COPT Defense Properties.
Advisor Access: How would you describe COPT Defense Properties’ niche position among REITs?
Stephen Budorick: COPT Defense’s business model focuses on owning properties and developable land (Defense/IT Properties) near key United States defense installations whose missions have been and continue to be Department of Defense spending priorities such as Intelligence, Surveillance and Reconnaissance, Missile Defense, R&D, Space, Cybersecurity and Cloud Computing.
Over 90% of our rental revenue comes from properties in Defense/IT locations. Our largest tenant is the United States Government, generating 36% of annualized rental revenue. The next 51% of annual rental revenue is generated from the Defense Contractor industry, conducting work to support the priority missions of our United States Government tenants in proximate or adjacent properties we own.
Our unique portfolio of assets, along with our specialized development and operating expertise, offer a distinct competitive advantage in the REIT space. We are the dominant landlord, public or private, for secured, specialized space, including sensitive compartmented information facilities (SCIF), anti-terrorism force protection (ATFP), and other secure facility requirements. In addition to owning concentrations of properties and entitled land adjacent to these mission-critical defense installations, we also have the credentialed personnel required to develop and operate properties occupied by these U.S. Government missions and their defense contractors.
Our U.S. Government customers possess their own procurement authority from Congress and are exempt from the regulations and activities of the General Services Administration (GSA). Their authorities recognize the importance of their specific needs to address national security challenges and established information security protocols. Our defense tenants, both government and defense contractors, require specialized security improvements that compel them to make significant co-investment in the design and function of their leased space.
In many instances, our tenants have invested more capital improving our properties than we have invested to construct them. Moreover, the government regulates the creation of these specialized conditions, often requiring years to obtain approvals and complete construction, creating a scarcity of real estate supply meeting those requirements and severely limiting competition.
These three factors—the need to be proximate to the missions we support, the significant tenant co-investment in the leased space, and the scarcity of competing supply—create very high barriers-to-exit and have translated into our decades-long track record of extremely high renewal rates. This year we expect to renew approximately 85% of expiring leases.
AA: COPT Defense announced strong 3Q 2024 results. What are some of the highlights?
SB: We delivered excellent results in 3Q 2024 and expect to deliver FFO per share growth of ~6% in 2024, which is ~2.5% higher than our initial expectations, and well ahead of peers, as the majority expect FFO per share to decline in 2024. Based on consensus estimates, we are forecasted to generate the second highest FFO per share growth in our sector in both 2024 and in 2025.
We outperformed our initial full year vacancy leasing target of 400,000 square feet, based upon our solid achievement to date, with broad-based activity across our markets, and increased our target to roughly 475,000 square feet.
Our Defense/IT Portfolio is 96.5% leased and 95.0% occupied, which is roughly 10 percentage points higher than our peer group. We expect full year same property Cash NOI (net operating income) will increase 8.5% year over year, which is the highest level in over a decade.
We forecast tenant retention in the 82.5–87.5% range in 2024, which is above our five-year historical average of 77%, and is expected to be the highest level in over two decades. We expect to renew over 95% of our large leases (over 50,000 square feet) scheduled to expire through year-end 2026, which provides a high level of earnings visibility in the near and medium-term.
We have met our capital commitment to new investments target for 2024, with $212 million committed year-to-date to two development projects, two acquisitions, and one land acquisition for future data center shell development, all within our Defense/IT Portfolio.
In September, we acquired a 365-acre land parcel near Des Moines, Iowa, for $32 million to expand our highly successful data center shell program. We are incredibly excited about the opportunity as our initial plans indicate that the site can accommodate approximately 3.3 million square feet of development, supported by an estimated 1 gigawatt of power capacity. Des Moines is the fifth largest hyperscale market in the U.S. and is already home to several of the largest hyperscalers in the world, including Microsoft, Meta, and Apple.
The anticipated benefits of this investment are as follows:
- It increases our wholly-owned data center shell program from 2 million square feet today, to nearly 5.5 million square feet at full build-out,
- It capitalizes on the explosive growth in data center capacity, driven by advancements in cloud computing and AI,
- It expands our data center shell program to a market with access to power, a supportive municipality, attractive land values, and long-term growth potential, and
- Finally, and most importantly, it will result in significant value creation for our shareholders.
Also in September, we acquired an 80,000 square foot building in San Antonio, Texas, for $17 million, which is located just five miles from our approximately 1.0 million square foot campus, which is 100% leased and occupied. We acquired the vacant building at a roughly 50% discount to replacement cost, and subsequently leased the entire building to the U.S. Government. This investment adds another strategic Defense/IT asset to our portfolio, and expands our relationship with our most important tenant—the U.S. Government. With this transaction, our U.S. Government portfolio, which now includes 35 fully leased buildings and on a pro forma basis as of September 30, 2024, accounts for 36.5% of our annualized rental revenue.
Our investment-grade rated balance sheet is well positioned to take advantage of such opportunities, with limited near-term refinancing risk as we have no significant debt maturities until March 2026. Bond investors continue to value the strength of our performance and quality of our cash flows, as our bonds are currently trading at the tightest spreads to Treasuries of any equal or higher-rated Office peer. In November, Moody’s affirmed their Baa3 credit rating, and revised their outlook from Stable to Positive, which reflects their expectation that we will continue to grow cash flows driven by developments, fund new investments on a leverage-neutral basis, and pre-lease data center shell development projects.
AA: What competitive advantages does COPT Defense have in providing secured, specialized space?
SB: Our competitive advantage is based on four pillars:
First, our operating platform. Our teams of managers have specialized skills and credentials required to handle the complex space and security needs of tenants at our Defense/IT Properties—a distinct competitive advantage over non-credentialed landlords.
Second, our development expertise. We’ve developed millions of square feet of advanced properties including SCIF, anti-terrorism force-protected, data center and mission-specific critical facilities.
Third, our track record and customer relationships. We have over a 30-year track record serving the highest secure functions of the U.S. Government.
And finally, our unique and advantaged land positions. We have properties and entitled land adjacent to mission-critical knowledge-based defense installations.
AA: How is COPT Defense positioned for long-term growth and value creation?
SB: Our playbook to accomplish our strategy is to execute low-risk highly leased development, coupled with opportunistic acquisitions, while maintaining a strong, investment grade rated balance sheet. Internal growth is achieved by continued uplift in occupancy, high tenant retention, low capex on renewal leasing, and contractual rent escalators.
Development is the key to our external growth. We are an active developer of specialized properties for our tenants and are currently developing 830,000 square feet that is ~80% leased, with a total estimated cost of $335 million, consisting of five projects located in Maryland, Northern Virginia, and Huntsville, Alabama.
When completed, these low-risk projects, along with those completed in 2023 and 2024, will add nearly $50 million of future Cash NOI on an annual basis, ignoring any future development starts.
Over the next three years, we have the capacity to self-fund capital invested in development and acquisitions in the range of $250 to $275 million, on a leverage neutral basis, which will further contribute to Cash NOI and FFO growth in the medium-term.
We have a high level of earnings visibility driven by these factors, which will drive at least 4% FFO growth on a compound annual basis from 2023 to 2026.
AA: Is there anything else you would like investors to know about COPT Defense?
SB: I’d like to quickly recap the major points for investing in COPT Defense Properties.
First, we have a unique specialty real estate franchise supporting national defense. The missions our buildings support—including Signals and Human Intelligence, Missile Defense, Space Activities, Law Enforcement, and Cyber Security—are driven by national and global security needs.
Second and very importantly, these missions are supported by strong and growing defense budgets, and our portfolio operations are not correlated with traditional office fundamentals, or the broader economic cycle. National security work cannot be performed outside of secure office facilities, and our tenants’ employees generally cannot work from home.
Third, following six years of strategic portfolio realignment and refinement, COPT Defense entered a period of FFO growth in 2018. Between 2019 and the midpoint of 2024 guidance, we expect to deliver 5.1% compound annual FFO per share growth. Our $335 million development pipeline for our unique tenant base, in addition to development deliveries in 2023 and 2024, drives the 4% growth we expect to achieve from 2023 to 2026.
Fourth and finally, we outperformed our REIT sector during the pandemic shutdowns, and continue to outperform in the current period of economic uncertainty and elevated interest rate environment.
Between 2019 and 2023, we generated the second highest FFO per share growth in the Office REIT sector, a period when a majority of peers saw FFO per share decline. In both 2024 and 2025, we are expected to generate the second highest FFO per share growth based on consensus estimates.
Despite our outperformance, proven resilience and the strength of our outlook, our current stock price represents a compelling value and entry point for new investors.
AA: Thank you for your insights.
Stephen E. Budorick is President and Chief Executive Officer of COPT Defense Properties (COPT Defense). Mr. Budorick was elected Trustee in May 2016 and was COPT Defense’s Executive Vice President and Chief Operating Officer from September 2011 through May 2016.
Before his tenure at Callahan Capital Partners, he was Executive Vice President in charge of Trizec Properties, Inc.’s Central Region from 1997–2006, and Executive Vice President in charge of third-party management and leasing at Miglin Beitler Management Company from 1991–1997. Mr. Budorick also worked in asset management at LaSalle Partners, Inc. from 1988–1991 and in facilities management and planning at American Hospital Association from 1983–1988.
Mr. Budorick earned a B.S. in Industrial Engineering from the University of Illinois and an MBA in Finance from the University of Chicago in 1982 and 1988, respectively. He was elected a member of the Nareit Advisory Board of Governors in November 2017 and serves on the Board of Directors of the Greater Baltimore Committee and the United Way of Central Maryland.
Analyst Commentary
“Given the continued strong performance, a strong balance sheet and low leverage, we increased our PT [price target] from $33 to $36 and maintain our Outperform rating as intelligence spending shouldn’t change regardless of who wins the White House or which party controls Congress.”
—Steve Sakwa, Evercore ISI
October 29, 2024
“Additionally, the Des Moines land acquisition creates a long term value creation opportunity within CDP’s data center shell development business, particularly given the strong demand we’ve seen in the data center space recently.”
—Michael A. Griffin, CFA, Citi Research
October 28, 2024
“The company has now recorded 23 straight quarters of positive YOY normalized FFOps growth. At its guidance midpoint, CDP’s 2024 normalized FFOps will be 27% higher than what it posted pre-pandemic in 2019. The only other REIT in our office coverage universe to post positive growth over that period is Highwoods Properties (HIW, Buy) at just 3%.”
—Michael Lewis, CFA, Truist Securities
October 28, 2024
“With bipartisan support for growing defense spending, we view CDP as an attractive way to gain office REIT exposure absent the lingering questions around hybrid office use, etc.”
—Richard Anderson, Wedbush Securities
September 27, 2024
“We continue to favor the defensive nature of CDP’s strong balance sheet and specialized/secure assets, which lead to a stickier tenant base and high retention.”
—Blaine Heck, CFA, Wells Fargo Securities
August 30, 2024
Disclosures
Investors and others should note that COPT Defense Properties posts important financial information using the investor relations section of the COPT Defense Properties website, https://www.copt.com/, and Securities and Exchange Commission filings.
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