A Unique Office REIT Delivers Growth and Safe Income Throughout the Cycle, Plus Downside Protection

Corporate Office Properties Trust (COPT) (NYSE: OFC) is an office REIT headquartered in Columbia, Maryland, equidistant between Baltimore and Washington, D.C. As of Sept. 30, 2020, COPT’s core portfolio of 174 office and data center properties encompassed 20.2 million square feet and was 94.6% leased. COPT is differentiated from other office REITs because: 1) it has a unique franchise of office properties and land positions that serve priority U.S. Government defense activities, such as information technology and hyperscale cloud computing, collectively referred to as Defense/IT Locations, and 2) its impressive track record of completing an average of 1 million square feet of developments annually at its Defense/IT Locations, which are highly leased and create significant shareholder value.

These Defense/IT Locations are adjacent to defense installations that execute high-tech and research-oriented defense missions encompassing intelligence, surveillance and reconnaissance (ISR), research and development (R&D) for unmanned drones, missile defense, space, and cybersecurity. Accordingly, COPT’s business is not correlated with the broader economy or traditional office fundamentals, and the Company has strongly outperformed the REIT market during the pandemic.

  • Healthy defense spending environment in the United States continues to drive strong demand for COPT’s locations. In 2019 the Company completed over 2 million square feet of development leasing—an all-time record. Because demand for COPT locations is not correlated to the economy, COPT is on track to complete another 1 million square feet of development leasing in 2020. Additionally, this year’s tenant retention is on track to set a 20-year record of 80%-85%.
  • COPT owns and controls over 850 acres of the most relevant land locations, which limits competing supply and can accommodate over 10 million square feet of future mission growth.
  • 1.6 million square feet are under construction; 84% of that space is pre-leased and should support impressive growth in the coming quarters.
  • A secure common dividend yields 4.8%—an attractive premium to the yield from 10-year U.S. Treasuries.
  • An investment grade-rated balance sheet supports future growth through development, and ensures dividend safety.
  • The Company continues to meet or exceed its 2020 plan objectives and operates largely unimpeded by pandemic-related restrictions, shutdowns, or tenant credit issues.

Advisor Access spoke with Corporate Office Properties’ President and CEO, Steve Budorick, about the trust’s business model and growth strategy.

Advisor Access: COPT fills a unique niche in the REIT space. Please describe your business model.

Steve Budorick: As of Sept. 30, 2020, we derived 88% of our business from Defense/IT Locations, which encompass 20.2 million square feet of office space and more than 850 acres of strategic developable land. Our buildings and land positions are unique, as is our decades-long track record of successful execution and mutual trust with our U.S. Government customers. An important distinction is that the defense and intelligence locations we support are not involved with weapons manufacturing or in the training and deployment of troops; rather, the missions involve high-tech, R&D, cloud computing and cybersecurity aspects of national defense.

COPT’s business model focuses on owning properties and developable land (Defense/IT Locations) near key defense installations whose missions have been and continue to be U.S. Department of Defense (DOD) spending priorities, such as intelligence, surveillance and reconnaissance (ISR), missile defense R&D, cybersecurity, and cloud computing. Our unique portfolio and operating expertise have distinct competitive advantages in the REIT space. We are the “go-to” landlord for secured, specialized space, including sensitive, compartmented information facilities (SCIF), anti-terrorism force protection (ATFP), and other secure facility requirements. We own concentrations of properties and entitled land adjacent to mission-critical defense installations, and we also have the credentialed personnel required to collaborate with the U.S. Government and defense customers in their secure spaces.

These defense customers have very specific location requirements for executing their missions, and also heavily co-invest in the space they lease from us. These two factors create very high barriers-to-exit, and have translated into our decades-long track record of extremely high renewal rates. In fact, this year we expect our renewal rates to set a 20-year record of 80%–85%.

High tenant retention, in turn, leads to more robust cash flow, as we avoid the downtime and capital expenditures incurred when a tenant vacates. Our stable operations support solid same-property growth, typically between 2%–3% each year.

In terms of external growth, we pursue low-risk development opportunities at our proven strategic locations. Demand for our Defense/IT Locations is driven by defense spending and mission growth, which continue to advance irrespective of election outcomes or the broader economic environment.

The massive 14% defense spending increase in fiscal year 2018 fueled our record development leasing volume in 2019, when we executed over 2 million square feet of development leases. Defense spending continues to be well funded and supported by both chambers of Congress, and we are on track to complete at least 1 million square feet of development leasing this year.

Our development activity is low-risk because we pursue fully or highly pre-leased opportunities. Through the third quarter, we placed 1.2 million square feet of fully leased development into service this year and, before year-end, we expect to place 600,000 additional fully leased square feet into service. These 1.8 million square feet increase our portfolio by nearly 10%. Further, our ability to place large volumes of stabilized development projects in service generates highly visible, low-risk cash flows that maintain our strong balance sheet and support our dividend.

AA: Looking back on 2020, are there specific properties or innovations you’d like to highlight?

SB: Our newest and fastest growing park is Redstone Gateway, which we are developing on a land lease from the U.S. Government at the main gate of Redstone Arsenal in Huntsville, Alabama. That park consists of nearly 1.2 million square feet of operating properties that are 100% leased, and we have another 330,000 square feet under development, including 100 Secured Gateway, a 250,000-square-foot facility and our first project in the Redstone Gateway’s secure campus behind Redstone Arsenal’s security fence. 100 Secured Gateway is 84% pre-leased today, and should be 100% leased when fully operational in 2021.

AA: In November, COPT announced its 92nd consecutive common dividend. Tell us how you’ve been able to sustain this remarkable record even in the face of unprecedented economic, social, and political headwinds. Do you anticipate being able to continue the run?

SB: One of the main reasons investors buy REIT shares is for dividend income. We manage our operations to ensure the safety of our dividend, regardless of economic, social, political, or capital market trends.

In addition to generating 88% of our revenues from Defense/IT Locations, where demand for facilities remains solid regardless of the broader economy, we operate with very conservative levels of debt, and have been investment grade-rated by all three major rating agencies since 2013. Operating with conservative leverage ensures the growth from our pipeline of 1.6 million square feet of highly leased developments is responsibly funded, and our dividend is well covered. To this end, our 2020 plan forecasts a dividend-to-adjusted funds from operation payout of 65%-70%.

AA: The coronavirus pandemic, and the resulting emphasis on employees working remotely from their homes, has had a significant effect on office occupancy. How have COPT’s properties—and bottom-line funds from operation (FFO) per share results—been impacted, and how have you addressed these impacts?

SB: Throughout this pandemic, our operations and rent collection rates have been minimally impacted. In strong contrast to other office REITs, we not only have maintained and outperformed our quarterly guidance for three consecutive quarters, but we also increased our full-year guidance for FFO per share, as adjusted for comparability.

Operationally, none of our office and data center properties were subject to pandemic shutdowns. Because the vast majority of our buildings either are located on secure campuses, contain high-security SCIF environments, or operate pursuant to high security standards, the preponderance of our tenants required employees to work in our properties, allowing only a small proportion to work from home (WFH). The defense missions being executed at our locations absolutely cannot be performed remotely.

In terms of utilization rates, half our portfolio is back to normal pre-pandemic levels, another 40% is running at or above 50%, with a current weighted average estimate of 63%, and only 10% of our portfolio is lightly utilized, with daily attendance of roughly 25%. Rent accommodations remain below 1% of annualized rental revenues, and what rent relief we did grant went primarily to tenants that provide food service, fitness centers, and other amenities within our office parks. Lastly, our rent collection rates in the second and third quarters—without adjusting for rent relief granted—were above 99.5%.

Our strategy of concentrating assets around the U.S. Government demand drivers we support was designed to create a portfolio that would generate highly durable and growing cash flows for shareholders, regardless of the broader economic environment. The shutdowns and economic challenges brought about by the pandemic have clearly evidenced the strength of our franchise.

AA: The pandemic will likely continue to affect all markets, including REITs, for months to come. What steps has COPT taken to weather what could be a rocky start to 2021, and beyond?

SB: We actually do not expect a rocky start to 2021, and are not making any adjustments to our proven strategy. We have consistently outperformed on many metrics throughout 2020—bottom-line results, and our stock price, to name two—and are highly confident in our ability to grow FFO per share growth by 3%–6% in 2021.

AA: Thank you, Steve.

Stephen E. Budorick is President and Chief Executive Officer of Corporate Office Properties Trust (COPT). Mr. Budorick was elected trustee in May 2016 and was COPT’s executive vice president and chief operating officer from September 2011 through May 2016. Prior to joining COPT, Mr. Budorick served as executive vice president of asset management at Callahan Capital Partners LLC, beginning in 2006. 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 Co. 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 2018 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

“We have long appreciated COPT’s niche focus on the ownership of office parks located nearby key defense/IT/cyber installations. Its development acumen and relationship with key defense contractors has consistently delivered value creation …”

—William A. Crow, Raymond James
Oct. 27, 2020

“We like the company’s core defense IT and data center shell business in this environment. The company’s high credit quality tenant base is driving strong rent collections near-term, and we think the nature of the work done within its buildings insulates the company from work-from-home dynamics that could pose a risk to long-term conventional office demand.”

—Anthony Paolone, J.P.Morgan
July 20, 2020

“Overall higher defense and intelligence spending increased space demand meaningfully, leading to the best outlook in OFC’s portfolio in more than 10 years for key operating metrics.”

—Chris Lucas, Capital One Securities
Feb. 3, 2020


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