Welcome to the Corporate Office Properties Trust First Quarter 2021 Results Conference Call. As a reminder, today's call is being recorded. At this time, I will turn the call over to Stephanie Krewson-Kelly, COPT's Vice President of Investor Relations. Ms. Krewson-Kelly, please go ahead.

Thank you, Paul. Good afternoon, and welcome to COPT's conference call to discuss first quarter 2021 results. With me today are Steve Budorick, President and CEO; Todd Hartman, Executive Vice President and COO; and Anthony Mifsud, EVP and CFO.

Good afternoon. Our unique strategy of concentrating assets around U.S. defense installations, executing priority missions continues to produce highly resilient, growing cash flows as demonstrated by our strong first quarter results, representing a great start towards shaping up to be another strong year. Driven by solid operations and interest savings from our recent bond financing, first quarter FFO per share as adjusted for comparability of $0.56 met the high end of guidance and is 10% higher than the first quarter results in 2020. Additionally, NOI from real estate operations in the quarter was up 6% from a year ago. And AFFO increased an impressive 26%. As these year-over-year comparisons demonstrate, we are clearly on a path of sustainable and highly visible growth. First quarter leasing results were solid totaling 258,000 square feet and second quarter leasing is off to a blistering start. In April, we've completed 662,000 square feet of renewals and vacancy leasing, eclipsing first quarter volume by 2.5x. Better-than-planned outcomes on vacancy and renewal leasing are driving our increased guidance for same-property results for the year. Development leasing in the quarter totaled 11,000 square feet. However, we're in advanced negotiations on nearly 900,000 square feet that should close in the coming months. Bridging to financing activities, we completed a second landmark bond offering last month. The $600 million 10-year issuance has a 2.75% coupon and was the strongest debt financing in the Company's history. The bonds priced a full notch higher than our current ratings, reflecting the market's growing recognition of the durability of our portfolio, our strategy and our cash flows. So for the second time in six months, the fixed income investor community unequivocally recognized and rewarded our company with robust demand for and exceptional pricing on our bond offerings. The improved outlook for same-property cash NOI and interest savings from the bond refinancing are driving the $0.03 increase in the midpoint of 2021 guidance for FFO per share as adjusted for comparability, which at the midpoint, implies 4.7% growth over the elevated 2020 results.

Thank you, Steve. First quarter total leasing of 258,000 square feet included 154,000 square feet of renewals. Renewal economics were in line with expectations, with cash rents rolling down 2.2%, annual escalations averaging 2.6% and leasing capital being only $1.93 per square foot per year of term. This month, we renewed 596,000 square feet of expiring leases, achieving an 88% renewal rate. Cash rents on April renewals rolled up 0.5% and carried an average lease term of 4.8 years. To date, we have completed 750,000 square feet of renewal leasing with a 77% retention rate and an average term of 4.5 years and cash rents rolling flat. Based on our renewal achievement to date, we are increasing our full year retention guidance to a new range of 70% to 75%. We completed 93,000 square feet of vacancy leasing in the quarter and 66,000 square feet in April, bringing our total to 159,000 square feet, and our leasing activity ratio remains strong. One lease to highlight from the quarter was a two-floor, 55,000 square foot lease at 6721 Columbia Gateway with Systems, a provider of real-time technology to enable AI-driven decision-making. Recall that the nonrenewal of that building's anchor tenant a year ago left it 20% leased. We took the opportunity to reposition the asset, creating amenity areas, which appeal to a growing list of high tech and cyber companies in the market. This property is now 80% leased with strong demand remaining for the availability. In April, we completed a 7,000 square foot expansion with a cybersecurity defense contractor at 6950 Columbia Gateway, bringing that 2020 redevelopment to 100% leased. We believe our leasing success at both properties demonstrates the value we add by repositioning buildings as well as Columbia Gateway's growing importance as a preferred location for cyber and high-tech companies. Development leasing in the quarter was light at 11,000 square feet at Redstone Gateway. So far in the second quarter, we have 265,000 square feet of development leasing out for signature and are in advanced negotiations for another 610,000 square feet. Our development leasing pipeline remains deep and diversified across our IT locations and customer base. We are tracking up to 2.1 million square feet of development opportunities and are confident we will meet or exceed our 1 million square foot development leasing goal. During the quarter, we placed 7,100 square feet at Redstone Gateway into service. The building is a build-to-suit for aerospace. Our pipeline of active developments totals 1.4 million square feet that are 85% leased. During the remainder of the year, we expect to place 789,000 square feet of these projects into service, bringing our total for the year to 785,000 square feet.

Thanks, Todd. First quarter FFO per share as adjusted for comparability of $0.56 met the high end of guidance, driven primarily by operations and interest savings from the recent bond refinancing. Similar to our transaction last fall, our March bond deal was an enormous success. Our original plan and guidance for 2021 assumed a $450 million bond issuance to repay or refinance some higher coupon debt. On March 3, we launched a new 10-year offering at initial price talk on credit spreads of 175 basis points. The offering was 8x oversubscribed with an order book that totaled close to $3.5 billion. Strong demand from many high-quality investors allowed us to upsize the offering to $600 million and significantly drive down the credit spread. The deal priced at 140 basis points over the 10-year treasury resulting in a 2.75% coupon and a 1% discount. We used the proceeds to retire two higher-cost issuances, locking in annual interest savings of $7 million. The fixed income investors were highly focused on our ability to deliver large volumes of highly leased, low-risk development to continue to grow EBITDA and FFO. They also appreciated our strategy of concentrating assets around mission-critical defense locations, which greatly insulates our cash flows from the impact of any work-from-home trends. The March bond issuance represented the fifth most oversubscribed book of all time in the office sector and the seventh lowest coupon of any length note ever issued by an office REIT. This offering reset our credit spreads, which now are well within the band of spreads of peers who are rated one notch higher. Fixed income investors have addressed their views with their wallets, and clearly value the performance of our portfolio, the resiliency of our cash flows and our growth from low-risk developments. Regarding operations, same property cash NOI was roughly in line with the low end of our first quarter range. As forecasted, weather-related expenses were at normal levels compared to extremely light levels in the first quarter of 2020, and parking income continued to be lower than last year as employees start to return to our urban locations. Based on current negotiations, we expect several positive leasing outcomes that increase our forecast of same-property cash NOI from our original midpoint of negative 1% to a new range that is flat at the midpoint.

Thank you. Our central strategy of value creation through low-risk development deeply concentrated adjacent to Department of Defense priority missions that support the U.S. government and its contractors has and continues to provide an average of 1 million or more square feet of new development opportunities, and by extension, high-value defense IT assets each year. Our strategy also has created a portfolio of high credit tenants, whose business cycles are not correlated to the general economy. We have durable and growing business demand, and are supported by healthy defense spending on priority national defense programs. These attributes allow both our company and our tenants' businesses to outperform during the pandemic shutdowns and continue now during the emerging recovery. Our 2021 business plan had a great first quarter and has accelerating achievement and demand levels thus far into the second quarter. Our recent experience in the debt markets, achieving landmark results for our company, combined with our stock's relative outperformance last year, demonstrate that the investment community recognizes the strength of our strategy, our assets and tenants that result in the strength of our franchise. Our increased midpoint of full year FFO guidance of $2.22 implies 4.7% growth over the elevated 2020 results and 4.8% compound growth from 2019. We're firmly on a path of sustainable growth, driven by a durable operating portfolio, a strong balance sheet and a reliable low-risk development program that is producing incremental NOI annually. We look forward to capitalizing on the growing set of impressive opportunities we have before us. With that, operator, please open up the call for questions.

Our first question is from the line of Manny Korchman with Citi. Your line is open.

Looking at your investor presentation, it looks like the retention rate on the 2022 expirations is now more of a firm number. Does that imply that you have more conviction in getting those leases retained at that number? Or is there something else driving sort of that minor change in reporting?

The minor change in reporting was we had two tenants that are large regional office users in Baltimore. In our previous math, we had one tenant with a partial renewal and staying in the building for about 30,000 square feet. Our expectation now is that they will totally vacate. The second tenant's contraction ended up not being as large as what we had forecasted, which resulted in the net change.

Thank you. And then maybe sticking to regional office for a second. Others in the space have accelerated their noncore or nonstrategic disposition programs. You certainly sold nonstrategic assets in the past. But have you given any renewed thought to selling the regional office assets? And maybe I'll wrap that with—you made a comment on working from home and being protected within your current portfolio. How do you feel about the work-from-home trends with your regional office portfolio?

Well, I'll take the second part of that first. There's clearly one large tenant—the one that is renewing—that is implementing a significant work-from-home strategy. The other large tenant that we're renewing is not, and their contraction is less severe than we anticipated before the pandemic, which is good news for our shareholders. With regard to recycling those assets, we have always maintained that there are future opportunities for recycling. We don't anticipate doing it this year in particular, because we need to renew those tenants or reestablish the occupancy that we're going to lose, but there are certainly candidates for recycling in future years.

Our next question is from the line of Craig Mailman with KeyBanc Capital Markets. Your line is open.

Just curious, Anthony, on the timing of potential JV sales. Is the slower development leasing out of the gate impacting that timing at all? Or is the kind of what you guys assumed in guidance standing pat?

No. What we're assuming in guidance is standing pat. When you think about the investment of our development capital into the development projects, what we've projected for this year is the majority of it is an investment in projects that are currently under construction and then the commencement of some of the projects that we expect to lease this year later in the year. So the leasing pace has not correlated to the timing of our development investment for the year.

And for the record, Craig, the 11,000 square feet we did lease is 11 more than last year in the first quarter. Development leasing is lumpy, and it doesn't average out by quarter.

Fair enough. It's infinite off of 0, right? And then just another quick one. On DC-6, I think previous guidance had assumed kind of a $331 renewal and new lease on that. Now it looks like it's going to take longer. Does that materially impact earnings at all getting the higher rent for another quarter or two? Can you kind of just remind me the order of magnitude?

Sure. The incremental benefit per quarter is about $0.5 million.

Okay. And then as we— it sounds like you guys have good momentum in the development pipeline. Could you just kind of go through the 875,000 square feet that's in advanced negotiations? Just break it down by either geography or office versus shell data centers. Just give us a sense of who is kind of more active these days?

Sure. So first, by breakdown, it's about 70% defense IT office and 30% shell. By location, it's diversified. It includes the NBP land that we own in Northern Virginia and Redstone Gateway.

And does that 30% totally exhaust your remaining data center land?

Not at all. We have at least four additional shells that we can add on the land we own.

The next question is from Jamie Feldman with Bank of America. Your line is open.

I guess to start with Anthony, can you talk about the next refi opportunity or the next potential rate you might do? It sounds like this one was so successful. How are you thinking about maybe more?

Well, in terms of debt maturities, we have a $1 million term loan that comes due in December of 2022. That's our next maturity. And currently, that term loan is priced at a BBB flat credit spread based on the renegotiated deal we did with our banks last March. So that's very competitive capital right now in terms of pricing. And then our next sort of maturity after that is the 2025 bond issuance that comes due. So I think we'll continue to monitor the bond markets and see if there's an opportunity to continue to take advantage of where our bonds are trading and refinance that out to extend our debt ladder.

Okay. And when you think about the leasing pipeline pickup, is there anything new, news-wise, or that you're seeing in the market that's driving this beyond kind of what was expected and kind of pent-up demand? Like, are there any of the data breaches we've seen or anything else that's kind of driving it or the new administration perhaps? Or is this all kind of what you thought it was—just pent-up demand?

Well, I can't really tie it to the administration by any means. But it is clear that the need for SCIF space in the Fort Meade area is at a very high level of demand and much of the leasing that I think we're going to do in that subsegment is driven by new contracts, driving need for new or expanded SCIFs.

Okay. And then if you look at the portfolio occupancy quarter-to-quarter, you did see a slip in Fort Meade, BW corridor and Defense is actually much—or is only 10 basis points in office. Can you just talk about what happened in those two submarkets? And is that more temporary or is that stuff you're going to backfill? How should we think about that?

Well, particularly in Fort Meade, I would expect it to be backfilled in the next 6 to 12 months. The space we did get back had to do with either merger-and-acquisition activity in the past that resulted in surplus space or similar consolidation and reorganization. But demand where we did get that space back is pretty high.

Okay. And then just any more detail on DC-6 in terms of how the conversations are going and your expected timeline?

Well, they're going well, but they're painfully slow. Our client is extremely busy. Our tenant, their team getting on their schedule to drive the negotiation of the document forward has been slow. I read through the redline status—current status in the agreement. It feels like we're very close on the open issues. There are a couple more levels of documents that need to be settled, and I would hope we could do it this quarter.

Okay. What's included in your latest guidance? I think last time you said maybe April, if I remember correctly.

Our latest guidance assumes the end of the second quarter.

The next question is from the line of Steve Sakwa with Evercore ISI. Your line is open.

A lot of my questions have been asked and answered. But Steve, I was just curious, as you're talking to new tenants, both for development and for your existing vacancy, is there anything that you're seeing different in the density, receiving or how they're laying out the space versus kind of current configurations?

So interestingly, and I touched on this on the last call, one of the customers we're working to complete a build-to-suit for their density requirement at Redstone Gateway is higher than typical density requirements and therefore requires more parking. The full 1.5 million we've built over the last, call it, nine years. Everything else is kind of normal. In this particular case, we're investing additional money and using more land because the parking ratio is higher than normal.

Okay. So they're actually fitting more people in—kind of going in the opposite direction of what we would have thought would happen?

Well, certainly, it's not a work-from-home situation. That's for sure.

Okay. And then I know when you've talked about sort of buying land positions for the data center shells, you sort of suggested you've kind of done it in concert with your partner and you've kind of let them drive the process a bit. Is that still the case? Are you looking to kind of broaden out with other partners? And would you be looking to take down any land for potentially other JV partners?

Well, certainly, we have no plan to buy land with a JV partner. From time to time having conversations with other potential tenants, our interest in buying land would have to be tied to some pretty advanced negotiations for development. With regard to our current customer, we've always worked in harmony with them, and we continue to have 800,000 to 1 million square feet of development capacity on land we've already bought.

Okay. And then just last question. I know you've kind of tightened up the footprint over the last couple of years. Are there any new potential locations that could emerge that would fit the current defense IT profile that you're not currently in?

None that we've identified to date, Steve.

The next question is from the line of Tom Catherwood with BTIG. Your line is open.

I want to stick with the data center shells for a second. Just thinking more about development funding in general. When we think about your pipeline going forward, as you stabilize properties, the additional NOI allows you to borrow against that on a leverage-neutral basis and redeploy that into development. And then the data center shell contributions provide a nice source of low-cost equity. Do you have a sense of the runway that you could get or the number of years of development you could fund just from the contributions of the data center shells you wholly own right now and the ones that are kind of close to being developed?

So Tom, at the end of the year, the portfolio of wholly-owned data center shells that were operational, plus the two that were under development had a gross value based on the cap rate that we achieved in 2020's joint venture of about $650 million. And that doesn't include any incremental development projects that we would expect to do this year or next year. Based on our current pipeline as well as what we expect to do, we have modeled out that that capital would be able to continue to fund the development pipeline on a leverage-neutral basis over the next four to five years.

Got it. And then, Todd, just wanted to check. I thought I heard you say that the April leases were done at cash leasing spreads of positive 0.5%. Did I hear that right?

That's correct. The renewal leasing, yes.

Got it. So it sounds like those rents held in a little better than we had expected. Can you talk more broadly about rent trends in your markets? And along with that, it also seems like the leasing that was done in 1Q, the bumps are a little higher—the annual bumps are a little higher than we're used to. Was that just a leasing mix? Or are you able to push those more in your leases?

Well, I would say generally rents are tracking to where they were last year. We haven't seen any material decline in face rates. In terms of the annual bumps, I think that's probably mix-based rather than a sign of a market shift.

Got it. And then you mentioned certainty on the one regional office expiration in 2022. You've put capital into a lot of those, especially your Baltimore buildings over the past few years. Other than leasing capital to get that space backfilled, are you expecting any incremental capital to put into that asset in order to get it stabilized again?

No. No, we're not.

Great. And then last one for me. Last quarter, you had mentioned that there was an opportunity—or expectation—of leasing some of 310 NBP in 2021. Is that still the expectation?

Yes. It is still our expectation with a portion of the space midyear and the balance of it by the end of the year.

The next question is from the line of Rich Anderson with SMBC. Your line is open.

On DC-6, you described it as moving slowly—that's an obvious statement. But maybe is there a plan B, like are you engaging potential third parties in case this doesn't come through to the finish line? One potential third party I'm thinking about is a customer of yours in the shell business. I'm wondering if there's any fit there for this 11-megawatt space?

Our confidence is very high. The current tenant over the five now, call it, six-year term has adopted new documentation standards, and we've been working to translate our form into their structure. We've moved through that. Last year, there was a lot of what-ifs and further upgrades to things like security and fire control, which we've moved through and resolved. At this point in time, we feel like we're in a mop-up. We just need to get the contract wrapped up and executed. I would not compromise our relationship by putting that space on the market given the confidence we have.

Okay. That's quite fair. On the growth profile of the Company, you described the negative 2.7% same-store cash NOI is consistent with guidance. I guess defined consistent, but it was outside of the range. Yet you did better than we thought from the renewal rates during the quarter. So what happened there? Maybe I missed something obvious.

The result for the quarter was driven by two things. One was weather-related expenses, both snow and energy, that were significantly higher than the first quarter of 2020 and slightly higher than our forecast on a net basis. And then parking revenue from our urban locations—primarily Baltimore and Maritime—was clearly lower than the first quarter of last year, which was pre-pandemic, and that reduction was slightly higher than what we were expecting.

Okay. Fair enough. So then looking longer term, once you get through these remaining nuances and are in a steady-state operating environment, what do you see as the growth profile of the Company when you take into consideration same-store growth, leverage, the development pipeline—all those things together? Is it like a 5% type growth model, or greater?

I think over a longer period, a good number to rely on is roughly 5%—about 2% to 2.5% from same-office growth and the balance being incremental growth from development.

The next question is from the line of Dave Rodgers with Baird. Your line is open.

Between Todd and Anthony, I think you guys have talked about several positive leasing outcomes that you hadn't anticipated. I wanted to dive into those a little bit more. Can you talk about whether that was on the vacancy renewal side or on rate overall? And then, Anthony, on the lease term fee in the quarter, will that continue to be amortized or was that a one-time fee?

In terms of the better-than-expected leasing activity, it was both renewals that occurred where we were expecting non-renewals and some additional vacancy leasing—both additional square footage and sooner than we had forecasted. With respect to the termination fees, a portion of the termination fees that we recognized in the first quarter will continue to be amortized through the balance of the year with that tenant expiring at the end of 2021.

Okay. And then Steve, you haven't really talked too much about Washington and the government and any potential issues there. You've been pretty positive over the past several quarters in terms of the budget. Is there anything in the pipeline now as you talk and have these advanced negotiations that is a risk in your mind to executing these transactions in the near term?

Certainly, the near term negotiations are active—we wouldn't have identified them if we weren't working on lease documents. Regarding the government outlook, it looks to be status quo with 1% to 2% growth on a very high defense budget base. I think that will be stable and promising for our portfolio.

Any issues as Congress battles and fights other issues in terms of funding that would put this on the back burner from a timing perspective, not necessarily cancel it?

The timing is driven by the appropriation of an annual budget. We've only had one budget appropriated on time in the last nine years. I would fully expect this year to be another year where there's a continuing resolution that pushes the appropriation from the scheduled September outcome to November or December. That's kind of become the norm.

The next question is from the line of Daniel Ismail with Green Street. Your line is open.

I'm just curious to see if there's been any update on 2100 L Street. I believe on the last call, you mentioned some early-stage prospects. How have those conversations evolved?

Those conversations are ongoing. We have more prospects now for the space than we had last quarter. But no real advancement in the discussions other than the lease process—that deal process is going to take its time.

Any anticipation for that being done this year? Or is that still pretty hard to say?

Fifty-fifty. We're certainly trading paper with a couple of prospects. There's at least a 50% likelihood we could win one of those deals.

Great. And then two questions on development costs—development costs are moving higher. Has there been any impact on the pipeline? And second, assuming replacement costs are moving higher in conjunction with construction costs, should we see that translate into better longer-term rent growth for either the defense or regional office portfolio?

Certainly there's short-term pressure on costs. Throughout the last 12 months, we have not had difficulty completing our developments. We're hearing some material segments that are under significant cost increases right now, like drywall. With regard to longer-term elevation of replacement costs, it would follow that we could drive rates into higher long-term replacement costs. But I'm not convinced this is a permanent shift in the cost structure as much as a short-term supply-and-demand issue.

The next question is from the line of Omotayo Okusanya with Mizuho. Your line is open.

I just wanted to focus on the regional office portfolio, the nonrenewal and also the renewal of the two tenants you talked about. Could you just kind of talk about mark-to-market prospects on both the renewal and the possibility of when you get a new tenant for the space that wasn't renewed?

So mark-to-market on rents would probably be negative 8% to 10% for a long-term renewal. For the empty space, it's similar—around negative 8% to 10%. For the tenant that is renewing, the mark-to-market is similar.

Okay, great. And then again, if you could indulge me: I know the bigger driver for you is the Department of Defense budget, specifically around security and related areas. But the large amount of spending that the administration is trying to do across major bills—COVID relief, infrastructure, education—do you expect that to have any meaningful impact on tenant demand, specifically for you or even in the general D.C. area?

With regard to our portfolio of defense IT assets or priority missions, I don't see any correlation with the bulk of our portfolio. More spending in D.C. could drive broader real estate demand in the DC market, and if that happens, we'd welcome it, particularly when finishing development.

The next question is from the line of Bill Crow with Raymond James. Your line is open.

Going back to Baltimore quickly. Does the outcome of those two leases change in any way the prospective timing of selling those assets?

Potentially. Certainly, a successful outcome in the one we're expecting could change our thoughts. We're presuming an unsuccessful outcome on the other. We prefer to bring a building to market for lease as opposed to with significant vacancy.

We have an additional question from the line of Manny Korchman with Citi. Your line is open.

Yes. In response to an earlier question about new markets, you gave a very, very quick 'no.' I was just wanting to dig into that and figure out what's driving that now. Is that because you don't have a presence in new markets now? Is it because you don't think tenants are expanding quickly enough in those markets? Are there others that are just more entrenched? What's driving that very firm 'no'?

Well, there are certainly some markets that we've evaluated from time to time. We're just not in a position where I'd want to start indicating that we're ready to make a new-market move until we're more certain. But we continue regularly to evaluate opportunities that have come up from time to time to open up in a new market.

The next question is from the line of Steve Sakwa with Evercore ISI. Your line is open.

Yes. Sorry, my questions have all been asked; I just couldn't get out of queue. Sorry about that.

Thank you for joining our call today. We will be in our offices this afternoon. Please coordinate with Stephanie if you'd like a follow-up call.

Thank you for your participation today in the Corporate Office Properties Trust first quarter 2021 results conference call. This concludes the presentation. You may now disconnect. Good day.