Corporate Office Properties Trust Earnings Call Insights: Reclassified Leasing Expenses and Re-tenanted Space

Corporate Office Properties Trust, Inc. (NYSE:OFC) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Reclassified Leasing Expenses

Brendan Maiorana – Wells Fargo: So Steve Riffee just wanted to start with you. I appreciated the commentary about the leasing expenses being reclassified. I just was hopeful that you could provide a little bit more color about the nature of these expenses and why its appropriate to have them as corporate expenses and not operating expenses?

Stephen E. Riffee – EVP and CFO: They are in essence the costs of internal personnel for unsuccessful leasing. What our team finished was a study and concluded that most REITs now classified those leasing costs in G&A. So we have made that re-class, put them on the separate line item so you can see them for buildings and processes. So it would be the cost of internal space design people and leasing people for deals that don’t go through and those get expensed. Otherwise successful leases are capitalized and amortized over the lease.

Brendan Maiorana – Wells Fargo: So there is leasing personnel in there but to the extent that they are – that they pursue leases that aren’t successful that goes in that line but the leasing commissions, any internal leasing commission or salary would get allocated to the operating expense line?

Stephen E. Riffee – EVP and CFO: No. All internal leasing cost are either capitalized as part of the successful lease or their expense and what we’ve done is breaking out anything that’s an expense for an unsuccessful lease and put it on a separate line item.

Brendan Maiorana – Wells Fargo: Second question I had was for Wayne, the land allocation; I do think that’s helpful. Looking at that, if I look at the breakout of your strategic land, there’s 1.8 million square feet at NBP that’s about 15% of your total developable land. It strikes me that that’s probably a much higher percentage of that total cost. Do you have a sense of how much the cost is related to the NBP land?

Wayne Lingafelter – President, Development & Construction Services: No, I think we’d have to get back to you with that answer Brendan.

Brendan Maiorana – Wells Fargo: Or maybe if I could put it in a different way, if you guys look at development projects that you do there and you think about the stabilized value of those assets upon stabilization, what does that sort of imply for the land value underneath – the land value per square-foot underneath those buildings?

Roger A. Waesche, Jr. – President and CEO: Brendan, it’s Roger. I think the land for NBP given what land for instance sells at Columbia Gateway Business Park which is 7 miles away and does participate in the government contractor business at Fort Meade would — considering land here sells for $35, $40 a foot, I think the NBP land would probably be $50 or so. Our allocation is approximately $30 a square foot at the National Business Park, but it’s a little misleading in that it includes monies we spent to design some buildings and get permits and it also includes a little bit of parking garage for a future building, so embedded in our land values are other costs other than specifically land.

Brendan Maiorana – Wells Fargo: Then just, last one Roger. You guys have done a really great job over the past couple of years selling the non-strategic assets and focusing more on what I think you used to call super core properties, as you look out over the next year or couple of years what do you think that the non-defense and government related portion of the portfolio looks like? Is it data center and is it something like Canton Crossing or does that actually get down significantly less than what it is today? Or do you always think that that’s a portion of your portfolio owned business?

Roger A. Waesche, Jr. – President and CEO: I think by the nature that we are sharpshooter in certain submarkets of the greater Washington Baltimore region. We will always have a portion of our portfolio that isn’t 100% aligned with adjacency to government demand drivers or with strategic customers that support those demand drivers. Though for instance, you’re right Canton Crossing and assets like that would be in our local sharpshooter bucket, and we think that that’ll probably be about 30% of our business with the strategic adjacency and strategic customers being about 70%.

Brendan Maiorana – Wells Fargo: Which bucket would the data center is following, the 30% or the 70%?

Roger A. Waesche, Jr. – President and CEO: Most of our data centers are four strategic customers and they are all already embedded in the strategic bucket. We only have one data center that’s outside of that.

Re-tenanted Space

Joshua Attie – Citi: I know you changed the presentation in the supplemental, but can you tell us what the cash rent spreads would have been on the re-tenanted space in the fourth quarter?

Stephen E. Budorick – EVP and COO: Josh we won’t have that broken out. I think we could go back and calculate it and talk to you but we are just taking the re-tenanted space and we are lumping, it in with the vacant space that we acquired and treating that as other new leasing.

Joshua Attie – Citi: Obviously you don’t have that number separately?

Stephen E. Budorick – EVP and COO: No.

Joshua Attie – Citi: Separately, can you update us on what you think the average cash yield might be for the projects in the pipeline today? I know the composition has changed over the last few quarters with some things being delivered and other projects being started. Can you give us an expectation for what’s in the pipeline today, what you think the initial cash yield might be?

Roger A. Waesche, Jr. – President and CEO: Are you asking what the cash spreads on a mark to market basis over the next like year or two or you are on the development.

Joshua Attie – Citi: No. On the development pipeline what the cash yield do you expect for the projects in the pipeline today?

Wayne Lingafelter – President, Development & Construction Services: Right so this is Wayne. We’ve been working towards high single digits on that. Some of the recent data center leasing we’ve done is modestly below that. But we are still working towards those of the higher end of the range.

Joshua Attie – Citi: So like 9% to 10% do you think or 8% to 9%?

Wayne Lingafelter – President, Development & Construction Services: We are over 9% less than 10%. I would say that we average around 9.75%.

Joshua Attie – Citi: Including the data center?

Wayne Lingafelter – President, Development & Construction Services: Not including COPT DC6, just other developments.

Joshua Attie – Citi: Not including the Build-to-Suit data center?

Wayne Lingafelter – President, Development & Construction Services: Including the Build-to-Suit data center it wouldn’t impact the 9.75% number I mentioned very much.

Joshua Attie – Citi: My last question, do you expect to start additional spec development at NBP this year? I mean as you just spoke about, that’s where you have a lot of land and it sounds like you only have one more building to lease up there. When you look out, do you see demand on the horizon that could support more development starts this year?

Wayne Lingafelter – President, Development & Construction Services: As we’ve said in past, we like to have one building that’s available for commercial demand and one building that’s available for government demand, which is how we are positioned today with NBP 420 and NBP 312. So it’s really subject to the demand that materializes in the second half of the year. We will be ready to start additional development there if the demand does materialize.