Copt Defense Properties Q3 FY2021 Earnings Call

Welcome to the Corporate Office Properties Trust Third Quarter 2021 Results Conference Call. As a reminder, today's conference 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, Blue. Good afternoon, and welcome to COPT's conference call to discuss third quarter 2021 results and updated guidance. With me today are Steve Budorick, President and CEO; Todd Hartman, Executive Vice President and COO; 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 at length 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. The company delivered another fantastic quarter with better-than-expected results, another record-setting bond deal, and excellent achievement in all areas of leasing. Third quarter FFO per share as adjusted for comparability of $0.57 outperformed the high end of guidance by $0.01 and represented the sixth time in the past seven quarters that we outperformed expectations. We also exceeded our guidance two of the last three quarters. For the third time this year, we're increasing the midpoint of our full-year guidance for FFO per share as adjusted. The $2.27 midpoint of updated 2021 guidance is $0.08 above our original midpoint and represents an increase of 7.1% over 2020 results. We completed another record bond financing in the quarter. In August, we issued $400 million of senior unsecured notes with a 2% coupon, which tied as the second-lowest coupon ever issued among office REITs. Our growth strategy targets owning and developing specialized office in data center shells and mission-critical defense IT locations. This strategy continues to deliver excellent results. In the quarter, we achieved a total of 1 million square feet of leasing, which included extremely strong vacancy leasing of 215,000 square feet. This vacancy leasing volume represented the highest achievement in two years; it was 67% above the trailing eight-quarter average volume. Vacancy leasing also included the 68,000 square foot lease with the United States government for two floors at 310 NBP. In the quarter, we also completed 274,000 square feet of development leasing, all at defense IT locations, including a full-building lease with the U.S. government. Lastly, we renewed 553,000 square feet delivering a 76% retention rate, at lease economics that were consistent with our expectations. Leasing fundamentals for the nine months continue to strengthen, with customers making long-term commitments to new space. We completed 2.7 million square feet of total leasing, which included 420,000 square feet of vacancy leasing at an average lease term of 8.6 years. We completed 1.4 million square feet of renewals at a 75% retention rate and we executed 915,000 square feet of development leasing with an average initial term of 14.1 years. After the quarter, we leased another 263,000 square feet bringing our total development leasing for the year to just under 1.2 million square feet with an average lease term of 13.4 years. As a result of these transactions, our active developments totaled 1.8 million square feet that are 94% leased. Development leasing to date exceeds our 2021 goal by 18% and represents the fourth consecutive year we've achieved over 1 million square feet of development leasing. Our excellent leasing performance continues to translate into impressive operating results, including the impact of assets sold to fund development. For the nine-month period, NOI from real estate operations increased 7%, FFO per share as adjusted for comparability grew 10% and AFFO is up 16% from one year ago. Our unique defense IT portfolio, strong balance sheet and reliable low-risk development program continue to generate high-quality FFO per share and cash flow growth that are extremely durable, because demand is driven by defense spending and national security requirements rather than traditional office fundamentals. Importantly, demand at our defense IT locations is not impacted by work-from-home and other trends that may affect office demand in the future. We continue to have a strong set of leasing and development opportunities before us and the balance sheet to seize upon them. With that, I'll hand the call over to Todd.

Thank you, Steve. Continued strong demand in our markets has driven outstanding lease achievement this year. Third quarter vacancy leasing was exceptionally strong at 215,000 square feet representing 18% of our available space at the beginning of the quarter. To put this achievement in perspective, since defense spending began rebounding in 2016, our quarterly vacancy leasing has averaged 132,000 square feet. There were two major transactions from the quarter worth highlighting. The first of which was a 68,000 square foot lease with the U.S. government at 310 NBP, leaving two floors to lease to bring that building to 100%. The customer continues to indicate their intent to lease the remaining space, but because the government is operating under a continuing resolution, we now project lease execution during 2022. The second major vacancy lease was for 63,000 square feet at 6740 Alexander Bell Drive in Columbia Gateway. The new tenant is consolidating multiple offices and executed a 16.5-year lease for the entire building with lease commencement expected in July 2022. Although we had intended to redevelop this asset, we backfilled the full building in just four months and accordingly have moved it back into our same-property pool. For the nine months, our 420,000 square feet of vacancy leasing represented 114% of the trailing five-year average through nine months and was the second-highest nine-month volume in the past five years. Our current leasing activity ratio is 101% and since the start of the second quarter has averaged 90%, underpinning much of the third quarter's vacancy leasing success and our expectation for strong lease achievements continuing into the fourth quarter. During the third quarter, we renewed 553,000 square feet translating into a 76% tenant retention rate. Cash rents on renewals rolled down six-tenths of a percent and GAAP rents grew 1%. Excluding an 89,000 square foot renewal where the tenant was rolling off a 10-year lease that had escalated above market, cash and GAAP rents increased 1% and 5% respectively in the quarter. For the nine-month period, we completed 1.4 million square feet of renewals with a 75% retention rate, cash rents rolling down three-tenths of a percent with annual escalations averaging 2.4%, and average initial lease terms of 3.8 years. Excluding the two Boeing buildings in Redstone Gateway that are still on one-year renewals, the lease term for the nine months averaged 4.7 years. We continue to advance negotiations to renew the 11.25 megawatt user at DC6. The customer's process remains slow and methodical and we are confident they will renew; given we cannot control their pace, we are not putting a timeframe on its completion. The tenant's original lease remains in effect and they continue to pay their escalated rent. During the quarter, we executed 274,000 square feet of development leasing at Redstone Gateway. The largest transaction was a 205,000 square foot full-building lease with the U.S. government. Lease commencement is scheduled for early 2024. This development represents our second building in the secured campus, which upon completion of this project will total 460,000 square feet. The remaining 69,000 square feet of development leasing was with two defense contractors who leased space at 8000 Rideout Road. That development was started because of the contractor demand we are tracking and is now 88% leased. We are working to close a lease for the remaining 12,000 square feet. Earlier this month, we executed leases with Northrop Grumman for two build-to-suit office buildings along Rideout Road at Redstone Gateway. The two-building campus totals 263,000 square feet of highly visible Class A office space with one of the world's largest defense contractors just outside Redstone Arsenal's main gate. We are on track for lease commencement in the second half of next year. Once the active projects under development at Redstone Gateway are placed into service, the park will total 2.2 million square feet making it our second largest concentration of defense IT assets and equal to slightly more than half the size of the National Business Park. The Northrop leases brought our year-to-date development leasing total to nearly 1.2 million square feet, making 2021 the 10th straight year we have exceeded our development leasing goal. Based on the 1.5 million square feet of opportunities we are tracking in our development leasing pipeline, we expect continued strong development leasing. Lastly, in the first nine months, we've raised 709,000 square feet of developments into service that were 89% leased. We expect to place another 74,000 square feet into service in the fourth quarter bringing our total for the year to roughly 800,000 square feet. With that, I'll turn the call over to Anthony.

Thanks, Todd. Third quarter FFO per share as adjusted for comparability of $0.57 exceeded the midpoint of guidance by $0.02 driven by $0.01 of deferred R&M projects and $0.01 of other outperformance. We expect to complete the deferred R&M projects in the fourth quarter, which will impact same-property cash NOI and FFO per share. Incorporating this change, we are adjusting the midpoint of our fourth quarter guidance to a new range of $0.55 to $0.57. The timing of R&M projects drove 165 basis points of outperformance in same-property cash NOI, which increased 4.8% in the quarter. Given the year-to-date results, we are increasing our full-year guidance for same-property cash NOI growth again from a prior range that was flat to up 1% to a new range that is up 50 to 100 basis points. At the 75 basis point midpoint, our revised full-year guidance for same-property cash NOI growth is 175 basis points above the midpoint of our original guidance. We are also narrowing our full-year guidance for same-property occupancy from the prior range of 90% to 92% to a new range of 90% to 91.5%. Our revised guidance continues to incorporate the 20 basis point negative impact of joint venturing fully occupied, wholly-owned data center shells to raise equity in the fourth quarter and has been adjusted to include the 40 basis point negative impact of placing 6740 Alexander Bell Drive back into service, back into the same-property pool. In August, we issued $400 million of seven-year senior unsecured notes priced at 2% and used the proceeds to retire floating rate debt. Specifically, we prepaid $100 million of our 2022 term loan, retired the $89 million construction loan at 2100 L Street, and paid down amounts on our line of credit with the remainder. The August deal was more than 5 times oversubscribed and priced at 105 basis points over the seven-year Treasury, which was 25 to 30 basis points below initial price talk. The 2% coupon ranks as the lowest among office REITs for seven-year paper and ties as the second-lowest overall face rate of any duration among office REITs. Our credit spreads compare favorably to peers who are rated one notch higher by the rating agencies. Clearly fixed income investors appreciate the durability of our cash flow, the high quality credit of our tenants and their in-office work requirements. Also of note, since September of 2020, we have issued $1.4 billion of senior notes with an average term of over eight years and used the proceeds to retire debt carrying an average term of 1.8 years. Lastly, incorporating the items addressed earlier, we are increasing our full-year guidance from a previously elevated range of $2.24 to $2.28 to a new range of $2.26 to $2.28. At the midpoint, our updated guidance range implies 7.1% growth over 2020 results and is $0.08 higher than the midpoint of our original guidance. It is important to note that placing several development projects into service earlier than originally planned drove nearly $0.02 of this year's outperformance and pulling that NOI forward into 2021 tempers 2022 growth by approximately 1%. With that, I'll hand the call back to Steve.

Thank you. I'll close the call with a recap of our key message points. Our company's investment strategy is supported by the defense economy, which is funded by the United States defense budget and aligned with providing national security needs of the United States. The U.S. defense budget has been well funded since fiscal year 2016 and has bipartisan support for continued growth to address the increasingly risky global threat environment. Our portfolio office usage levels remain very high, as high-security defense work cannot be performed from remote locations. Our defense tenants are not experiencing diminished office usage, significant contractions or seeking short-term lease extensions. Rather, they continue to require densely configured office space to accommodate mission growth and as our results continue to evidence, they're making long-term commitments to our defense IT locations. So our development, vacancy and renewal leases remain at or above pre-pandemic levels demonstrating our tenants' commitment to working in their offices for the long term and their confidence in the outlook for the defense industry. Our company has exceeded its business plan throughout the pandemic year. And this year, we're experiencing further strengthening of business fundamentals and achievements suggesting continued strength and performance in coming years. Clearly, our strategy of investing in priority defense mission locations and creating value through new low-risk development at these locations is very different from other office companies and continues to deliver high-quality FFO per share and cash flow growth, regardless of broader economic trends. Operator, with that, please open up the call for questions.

Thank you, Mr. Budorick. The first question comes from the line of Manny Korchman from Citi. Your line is now open.

Hey, good afternoon, guys. Maybe it's a question for either Todd or Anthony, but you've got a pretty good leasing backlog that's built up. How should we think about that translating into an increase in physical occupancy just from a timing perspective?

In terms of occupancy, it’s probably a second- to third-quarter occupancy for next year. Typically, it's a five to six-month period from execution to occupancy.

Does that hold for the NBP lease as well, Anthony?

It does.

Okay. And then just looking at the leasing stats, concessions continue to be pretty high, especially in the new leases. Is there any relief coming there? Was an agent-specific item that went into that that drove those numbers as high as they were?

Well, on our new leasing for the quarter, we had one lease that was an outlier on the high side due to the fact that it was shell space. It was a 68,000 square foot lease. So the TI on that deal was a little higher than the rest. Overall, as that deal was removed, our quarterly number was $6.71, which tracks very nicely with our five-year average for the quarter.

Yes, Manny, to be clear, that's a U.S. government lease at 310 NBP. Although it's a five-year lease term on paper, that tenant will occupy that building for an extremely long period of time.

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

Hello, Craig.

Hey, Craig.

Craig?

Craig, your line is open.

He's not answering. Sir, he might have fallen out of the call. Can you go on to the next question, please?

Thank you. Your next question comes from the line of Jamie Feldman from Bank of America. Your line is now open.

Thanks and good morning. Maybe just to start, can you talk about some of the Baltimore explorations and where you stand on backfilling those, tenant interest?

Well, there's two large events. Transamerica vacates January 1, and we have marketing activity. Todd, you want to talk about the volume?

Yes. We have about 100,000 square feet of prospects that we're working with currently for the 140,000 square feet that we expect to get back as Steve said, January 1st. Progress is slow but methodical on those as well, and we're very encouraged by the response. Once the space was put on the market, it is the top of the building, it's unique space in Downtown Baltimore and I think the current level of interest indicates overall interest in that space. As far as the other large renewal, CareFirst over at 1501 Clinton, we continue to progress the renewal and expect that to happen very soon.

Okay, great. Thank you. And then, I guess just that DC6, I know you're — it sounds like it's certainly not on your end. As you guys look ahead to next year, do you think you'll still do the same thing? Just kind of keep it in or assume late in the year for guidance. What's a realistic expectation to set here about when that could actually get done?

Well, I think our word is we are no longer in the business of projecting finishing dates. There's absolutely no reason why it can't get done quicker. Over the next quarter, it's just been amazingly frustrating the change in personnel and the lack of progress. It's interesting to note we have relationship on the renewal side. We also have regular activity on the operating side. Our activity from the operating side makes it crystal clear they're going to stay in the building. I don't know why it's not a higher priority for them, but we continue to await their more affirmative schedule from them.

And with respect to guidance for next year, when we come out with that, we will be clear about what we've assumed in the low- and high-end of our range and therefore the midpoint with respect to 2022, so that we can report off of that once the transaction is completed.

Okay. Thank you. And then thinking about data centers in general, do you think you could ramp up development more? And if you look at the land bank, I think you've got room for maybe three or four more on your current land. How should we think about that as an avenue of growth?

Well, we have over 1 million square feet of capacity on the land we have, and I think you'll see some substantial leasing on that land next year.

And that's based on discussions today?

Yes.

Okay. And then, on the development pipeline, can you talk about the College Park development and how you're making progress there? I think you only have a couple of projects that are around 50% leased at this point. How is that trending?

We have two tenants that are negotiating the closeout of that building and frankly might require additional space in the future, which could trigger the next building. One of those may get signed by the end of the year. The other one is a government-funded cyber program and because of the funding process, it may not get done by the end of the year, but we've stopped marketing that space to anybody else.

Do you see expanding a lot more in that submarket or would this be one or two buildings and that's it?

We have significant capacity beyond what we're doing. I would expect one building in the next couple of years and then we'll see what happens. We build to demand. So as demand rises, we have additional capacity to deliver.

Okay. But you're comfortable sitting on that land longer term?

We will—the land really has no cost to us because it's part of the joint venture with the University of Maryland. So when the land gets contributed into each of the individual building developments that land value becomes part of their equity balance. So there's really no cost to the company of carrying that land.

Your next question comes from the line of Steve Sakwa from Evercore ISI. Your line is now open.

Yes. Thanks. Good afternoon. First, I was just wondering if you could provide a little bit more of a breakdown on the 1.5 million square foot development pipeline. How does that break out between office and data centers? And then maybe within the office component, is there any flavor for where that is in Huntsville? Is that up in NBP? Other parts of the portfolio?

Sure. Because we've just signed a bunch of defense IT leases, it's currently about 60% data center shell and 40% defense IT, and that 40% is split between NBP and Redstone Gateway.

Okay. And I guess when you look at your occupied and leased percentages, most of your submarkets are in the low to mid-90s. The only real two standouts are what you label as Howard County and Northern Virginia. Can you speak to what you're seeing in those two markets which are the laggards within the portfolio?

I'll jump in on Virginia and Howard County. We do have one asset with about 90,000 square feet vacant in Northern Virginia in Merrifield. Velocity in that submarket is fairly slow. We signed one lease this quarter and we have some opportunities in the front, but that's a market-driven velocity challenge. Columbia Gateway is pretty exciting and I'll let Todd talk about it.

Our activity in Columbia Gateway is very strong as it is generally in the Baltimore corridor. Recent activity in the market—several large transactions have occurred and the activity ratio for the Columbia Gateway area is about 125% of the available space. So I would anticipate our Howard County numbers to increase very soon.

Your next question comes from the line of Blaine Heck from Wells Fargo. Your line is now open.

Thanks. Good afternoon. Todd, you mentioned in your prepared remarks that Redstone would be 2.2 million square feet by the time everything under construction is completed. Can you talk about how much additional capacity to build you had left there after those projects are done and whether there's any need or ability to acquire more land to build there?

Yes. We have about 2.3 million square feet of additional capacity after these are completed. We have the ability to expand down there and are currently considering our options. Right now we're about halfway done with the available capacity.

Great. That's helpful. And then, Anthony, your updated guidance calls for 50 to 100 basis points of same-store NOI this year. Year-to-date you're sitting at roughly 1.5% implying a dip in the fourth quarter. Can you talk us through the drivers there? I'm assuming the Redstone move-out might have something to do with that, but anything else we should be thinking about? Also any color on what the lower result in the fourth quarter means for same-store going forward and any levers you might be able to pull to increase that in the future?

The fourth quarter will be lower relative to the year-to-date results because of two things. One is the timing of the R&M projects that we discussed earlier; those drove one-tenth of the current quarter's outperformance and will be executed in the fourth quarter. Second, there are some incremental net operating expenses in the fourth quarter compared to the fourth quarter of last year because of the increase in attendance at some of our regional office properties. Those are the two primary drivers for the fourth quarter. With respect to next year, we'll provide guidance when we're ready, and we'll be clear about assumptions. There are anomalies like these quarter-to-quarter swings that we'll discuss if necessary, but nothing right now indicates we would be outside of what we've historically talked about as our internal growth expectations.

Your next question comes from the line of Tom Catherwood from BTIG. Your line is now open.

Thanks so much, and good afternoon, everyone. Steve, in the past you've mentioned that office requirements and layouts have not materially shifted for your new developments. What are you seeing in terms of specialized building features in new projects—things like SCIF rooms, force protection or physical setbacks? Are tenants' needs changing and are you seeing additional development spend going to those specialized features?

With regard to development spend, we negotiate a market TI allowance and we meet the market. How the tenant uses it is up to them; we don't fully fund all tenant-specific build-outs. Demand for SCIFs is extremely high right now. There's a pent-up set of contractors seeking SCIFs in and around the NBP that can't be fulfilled with the existing inventory, so we expect it will drive continued demand in the future. With regard to how spaces are being used in new development, the recently executed two-building build-to-suit is very interesting because as part of the development costs we're going to have to go to partial structured parking to accommodate the density that Northrop Grumman's going to put in those buildings. The delivery of space is somewhat slower than we could have normally done because of the extreme technology they're adding to the buildings including SCIFs and other high-computing environments. So I think that addresses your questions.

That was perfect, Steve. Along those lines, do you have any idea how much more tenants are putting into their space on average over and above the TIs you're allocating for these new projects?

This is a guess, but on average I would say tenants are putting in almost 50% of the TI we give them.

Appreciate that. One more: looking at your land bank, it looks like this quarter there's a delta of about 24 acres in NBP between prior quarter and this quarter, but you didn't start anything this quarter in that area. Are you accounting for the land differently there or did you sell some off? What was driving that change in land?

You get a cookie for that one, Tom. That is just an adjustment for the assumed density on one of the parcels as we look at laying that parcel out for the different kinds of uses that we believe tenants are going to need in NBP. It was an adjustment to how the team is looking at that parcel for future layout and use; it wasn't about putting anything into service or selling any land.

Your next question comes from the line of Dave Rodgers from Robert W. Baird. Your line is now open.

Yes, good afternoon. Steve, I wanted to ask about the long lease durations on some of the developments you announced during the quarter—13 to 16 years. Can you talk about how the development returns came out on those longer-duration leases? And did the tenants have termination options? That seems like a pretty long lease compared to what we're used to seeing.

No, they don't have outs. Our threshold return in defense IT is an 8% cash yield. These deals have been around that neighborhood and some slightly better.

So these aren't necessarily tied to a specific contract, and the capital that tenants are spending is likely the reason they'd want to lock in for that long. Is that the right way to think about it?

That's correct. Remember many of the leases we've done are at our new headquarters locations and they're investing heavily because that's where they're going to center their business operations in service to Redstone Arsenal in the future.

Got you. That's helpful. Anthony, maybe update us on the disposition plan. You mentioned it in your comments for the fourth quarter and continued dispositions—amount, timing for the quarter, and any thoughts into next year?

For the fourth quarter, we have two data center shells that we're focusing on that would raise a little over $70 million worth of equity capital using our 90/10 structure that we've done in the past. Looking into next year, as we've consistently said, if our stock price is at a point where we believe we're getting fair value and we can issue equity at fair value, our first choice would always be to issue under the ATM to match-fund the development investment that we're making. To the extent that isn't an option, after the transaction we're contemplating for the fourth quarter we would still have over $700 million of gross value of data center shells that are either operating or currently under development that we could tap into to fund equity requirements for continuing to invest in the development pipeline.

Your next question comes from the line of Rich Anderson from SMBC. Your line is now open.

Thanks. Good afternoon, everyone. I have a theory that your occupancy is sort of capped at 93%. If you have about 2 million square feet expiring and your retention is 75%, then 25% is about 500,000 square feet of new vacancy coming at you. If you're doing about that much vacancy leasing in any given year, it's kind of a treadmill. Is that a reasonable way of looking at the future for the company?

With respect to the operating portfolio, one thing that will impact that in the future is how well the development pipeline adds to the overall portfolio as those projects are placed into service. Right now we've got almost 2 million square feet under development—roughly 10% of the existing portfolio—and they're 94% leased today. We expect by the time they're fully placed into service, they'll be 100% leased. So on the margin, continued low-risk, highly leased development will help improve the dynamic you're referring to.

Okay, good enough. What is the difference in the retention rate of regional office versus your core defense IT business?

Historically it's been pretty consistent, but some upcoming items will make the numbers look different next year. There's one large example with Transamerica where we're getting back a significant block. The dynamics between regional office and defense IT have varied over time, but overall the defense IT demand has been stable and strong.

Last question on DC6: is this a tenant that you would hesitate to do business with in the future given the drawn-out renewal? How is the relationship?

Our relationship is great. We work with them across multiple levels—operating and leasing. They are the kind of tenant every data center owner would love to have, and we're grateful to have them. This renewal has been a little frustrating with changes in personnel and fits and starts, but we'll get through it. It's a great tenant and we're thrilled to have them in our building.

Your next question comes from the line of Rob Simone from Hedgeye Risk Management. Your line is now open.

Hey guys, how's it going? Thanks for taking the question.

Hey Rob.

Anthony, a high-level long-term strategic question for COPT. One of the things that came up on this call was the thought of tapping the ATM to match fund development. Is there a case to be made that with the nature of your tenants and longer-term leases you could consider taking leverage up a turn or so, terming out some longer debt, pulling capital forward to fund development as opposed to issuing equity? The portfolio is cleaner than it was four or five years ago, so theoretically those long-term contracts and tenant mix could support that. Any thoughts?

Reasonable people could make that argument. Given the performance and credit quality, one could argue for higher leverage. However, we've run the company in a highly risk-averse manner and prefer having less debt than more. Over time we hope to develop our way to lower leverage and continue to create meaningful shareholder value. We're comfortable with the current debt level.

Makes sense. Specifically, you have the $300 million term loan coming due late next year. What's the plan for that? Refinance with unsecured notes or a bank facility?

We have a few options. We could go back to the public unsecured market to refinance, or the bank-term loan market is open again so we could refinance with our bank group. That particular loan is funded by six banks within a 12-bank group, and we have the capacity to refinance it with the bank group or even increase the facility if we wanted to. We think the market is there to do that.

Your next question comes from the line of Manny Korchman from Citi. Your line is now open.

Hi, Steve. I wanted to follow up on the answer you gave earlier. You said that TIs were high because the leasing at NBP was at 310 NBP. I thought that was in October, not in the 3Q numbers, or are the 3Q numbers inclusive of that lease?

No, it's in the 3Q numbers, Manny. We just announced it with the earnings call; it was quite significant enough to put out individually. So that number is in there. It's a $60 TI on a five-year deal, which drives up your cost per year of committed term. But in our business that tenant will be in that building for more than 20 years.

Your next question comes from the line of Chris Lucas from Capital One Securities. Your line is now open.

Hi, good afternoon everybody. Steve, a couple of follow-ups on the renewal at DC6. What is the term for that renewal, just trying to understand how long you've been dealing with it versus what the actual duration is for the deal?

That's a good question. We've been negotiating it for two years and it's a three-year term.

And going back to the commercial vacancy issues, what level of interest is there in terms of space available? Are you seeing interest across the board for all spaces or are some spaces more promising competitively? I'm trying to understand the competitive dynamics.

If you're talking about the regional office, our largest concentration of vacancy is in downtown Baltimore. The demand we see is financial services, law, and business services—high-quality tenants seeking a premier building with great views. The top-of-building space is attractive to that tenant type.

Regarding the Merrifield office building you mentioned earlier that was vacated by a defense contractor, is that now general space or still defense contractor-oriented?

It was defense contractor space. It was given back because of an M&A event. Part of it was contraction as well. That building fits the needs of defense contractors that need access to the Pentagon—it's connected by a metro rail and is convenient to the Pentagon.

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

Hey, good morning. Thanks for taking the questions. I've got three, but hopefully they're quick. How much new supply not being driven by COPT is under construction in your submarkets?

Very little, really none. At the NBP there isn't relevant competing development active within our service radius. In Alabama there is other development that serves industrial and manufacturing relocation activity, but our defense IT business is not competing meaningfully with external spec development. In Northern Virginia, market conditions show 18% to 20% vacancy in most submarkets, except the Route 28 corridor where we're located, which is one of the strongest markets in NOVA.

So the tenant retention: you've got 20% to 25% of expiring defense and IT leases that don't get renewed. Is that M&A, program funding, or what's the primary reason they aren't sticking around?

There's a seesaw with contract awards and re-competes; it's fairly routine. For example, in Redstone Boeing gave back space tied to a contract and another defense contractor won it, and we leased the space to the replacement. Over the long term about a third of turnover in the last few years has been M&A-driven where consolidation results in space coming back.

Last one on DC6: what's going on with market rents there? They had been trending down—have they stabilized?

I would say rents have stabilized. The compression we saw in 2019 and 2020 was developer-driven with spec development that bid down power rates. That dynamic has stabilized and there's a lot of demand now compared to the inventory in those years. We've been settled on the renewal economics for some time.

There are no further questions at this time. I will now turn the conference back to Mr. Budorick for closing remarks.

Thank you all for joining our call today. We're in our offices, so please coordinate any follow-up questions through Stephanie. And thank you for attending.

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