All right, good morning, everyone. Rich Anderson here with Wedbush Securities. Welcome to day two of NAREIT. Happy to be moderating the panel discussion with COPT Defense Properties, CDP. I still want to say OFC, but I promise I won't. I'm trying my hardest. But yeah, a great, really unique niche story in the office space. I won't steal CEO Steve Budorick's thunder, so I'll let him sort of kick off the discussion, and we'll go right into Q&A. I have a bunch of questions here, but the floor is really yours, so please chime in. Let's make it as interactive as possible. So I'll let you start it off, Steve. Thanks.
Thank you, Rich. So COPT Defense Properties is a specialized REIT, deeply concentrated in mission-critical assets that support national defense activity of the United States government. The vast majority of our 201 properties are located adjacent to, or in some cases occupied by, priority defense missions, generally involving knowledge-based defense activities. Some of the missions we support include intelligence and surveillance, cybersecurity and network activities, naval sea and air technology, missile attack and defense systems, army aviation and enhancements, and of course, cloud computing. Our property locations are not typical for an office company. They're adjacent to the United States defense installations in Maryland, Virginia, Alabama, and Texas. Our properties are approved for top-secret mission work. 85% of our portfolio contains high security operations.
That includes 8 U.S. government campuses that comprise about 4 million sq ft that are anti-terrorism force protected and contain SCIF, which is an acronym for Secured Compartmentalized Information Facilities. We have another 1.4 million sq ft of U.S. government high-security leases outside those campuses that are SCIF and access controlled. We have 15 cloud computing campuses that contain 6 million sq ft that are fenced with limited access, and we have 9 million sq ft of defense contractor leases that contain SCIF. Additionally, an important factor of our business is defense tenants for these missions must work in their office due to the security requirements of the mission. Today, 90% of our annualized rental revenue, or ARR, is derived from our defense IT properties. Our defense IT segment is 96.8% leased.
Our three largest concentrated defense locations include the National Business Park in Maryland, Redstone Gateway in Huntsville, Alabama, and a campus adjacent to Lackland Air Force Base in San Antonio. Combined, those three are 99% occupied in aggregate. They account for 45% of our annualized rental revenue. Adding to that, our fully leased data center shell portfolio, we have 13.5 million sq ft, that's 99.5% leased, and accounts for over half of our annualized rental revenue. The U.S. Government is our largest tenant by revenue. They have 95 separate leases, 69 different properties across four separate states and the District of Columbia. They total 5.5 million sq ft of occupancy, and that occupancy produces 36% of our annualized revenue. Our defense contractor tenants lease over 14 million sq ft.
This is roughly 2.5 million sq ft includes 2.5 million sq ft of cyber defense contractor tenants, and 15 of our top 20 tenants are defense contractors. Non-defense locations provide about 10% of our annualized rental revenue. This now consists of just 5 regional office assets located in Baltimore on the waterfront, Tysons Corner in Washington, D.C., in the CBD. Our tenants in these assets have excellent credit postures as well, and we plan to recycle these assets as markets support reasonable sale values. Our strategy is straightforward and simple. We allocate capital to durable demand locations adjacent to priority defense installations and missions. Since May of 2016, when I took over as CEO, 100% of our incremental capital allocation has been directed to defense IT locations. The playbook is also straightforward.
We execute low risk, highly pre-leased development. On occasion, we execute redevelopment or repositioning of assets, and we maintain a strong investment-grade balance sheet. Development is our primary external growth activity. Over the past ten years, we've delivered over $2.5 billion of successful developments, averaging over $250 million a year and exceeding 12 million sq ft of development. We're currently developing six projects with a total cost of $380 million. They're 74% pre-leased, and they represent just under 1 million sq ft. When completed, these low-risk development projects, along with those completed in 2023, will add an incremental $37 million of future contractual cash NOI on an annual basis, and that is driving the roughly 4% compound growth we've been projecting to the street between 2023 and 2026.
We also are in a position to self-fund the equity component of our development using cash flow from operations after the dividend. The debt component is funded currently by cash on hand. We have roughly $95 million of cash in the bank, and then incrementally on our line of credit to the point where we have a balance that's index eligible, and then we'll issue unsecured long-term financing. Our competitive advantage starts with our operating platform. We have over a third of our employees are experienced and credentialed, cleared to work in the most secure facilities of the United States of America. Our development expertise is vast, and it includes building anti-terrorism force protected buildings and secured compartmentalized information facilities. We've also constructed data centers and specialized mission-critical facilities for the U.S. government.
We have a 30-year track record of building for the government and the defense contractors, and we, of course, have advantaged land positions that are proximate to these priority missions, so we have the best locations to develop our property. So in summary, we're a specialized REIT that is not correlated to the broader economy. Our assets have strategic features and locations. There's little risk from work from home affecting our business, and there's strong demand for new developments and vacancy leasing. There's four main points we want to leave with the crowd today. We continue to project FFO per share growth of roughly 4% between 2023 and 2026, irrespective of where interest rates go. We've achieved self-funding of the equity requirements of our development investments on a leverage neutral basis.
We commenced our dividend increases in 2023 for the first time in over a decade, and we increased the dividend again by 3.5% last month. We're one of only 2 office REITs that have raised the dividend in both 2023 and 2024 year-to-date. And finally, the outlook for defense spending remains incredibly strong. The base budget increased by $100 billion, or over 15% over the prior 2 years, and we expect it to increase another 4% this year. And lastly, the global threat environment continues to escalate, so we don't see any change in the defense need for defense spending. With that, back to you.
Okay, so that's all the questions I have. Just kidding. Great, great summary. I think, you know, maybe kicking off with a question, and please just raise your hand and, I'll defer to the audience. But you mentioned, you know, 100% of your... or most of your external growth is through development channels. But what I do know about CDP is you mentioned 74% pre-leased, but oftentimes, you might start a project at 0% pre-leased. You just have an absolute necessity because there's so much demand, right? Can you talk about those optics?
So if someone looks at your development pipeline, they might see a couple of zeros, but you're so confident just based on the demand that's going on in those installations that, you know, it's again a necessity to start in some cases.
Yeah. We routinely will build a building to what we call an inventory building without a pre-lease. When we get to the point where the operating portfolio in and around that mission has insufficient vacancy to handle what we expect the growth to be. So, for instance, this year, we started a 138,000 sq ft building at the National Business Park. If you look at that park overall, it's 4.3 million sq ft, 99.1% leased. In total, we have 37,000 sq ft of vacancy, and the biggest contiguous block is only 7,000 sq ft. So we need to build a building to defend our franchise and make sure that we can handle the internal and external demand from the park that wanna come there and support the missions at Fort Meade.
Similarly, in Huntsville, Alabama, we have two buildings, one started with a 20% pre-lease. It's a high bay research and development asset that has strong demand in Redstone. We expect that building to be fully leased by the end of the summer, and we have another building where we built on spec, if you will. It was inventory. We're 40% leased, and we expect that to be leased by the end of the year. And then on top of that, there are times when we have deep understanding of what the government's needs are, and one of the idiosyncrasies of building for the government is you have to start that building without a pre-lease-
Yeah
... typically.
Mm-hmm.
We call that informed demand. When we understand the government has demand, we'll build the building to make sure that we can fulfill it. It's part of our competitive advantage, not only the interoperability of our teams with the government, but our willingness to take financial risk and start building on spec to fulfill their needs.
Yep. Good problem to have. You know, one, one of the things you mentioned was the defense budget sort of on a steady climb, I think. I don't remember the number. I think it, this year it's up 4%. Is that the right number?
That's correct.
But how does that ultimately translate into a leasing event for CDP? So, you know, you typically start a year of Continuing Resolution, and then you get a real budget done. I think that actually just happened in March, if I remember correctly. Correct me if I'm wrong.
No, you're right.
Okay, and then there's a process of, you know, pushing out those capital and contract awards, and there's a lot of steps before it gets to the point where there's a leasing event for CDP. Can you just sort of walk through the basic steps from continuing resolution onto the end game for you, which is a lease within your portfolio?
Sure. So usually, Continuing Resolution occurs from September to early December, sometimes as late... Well, in 2000—fiscal year 2016, as late as, May of 2000-
Have they ever started a year recently without a Continuing Resolution?
In 13 years that I've been at the company, only one time-
Okay
... was, NDAA appropriated as required on September thirtieth.
Right.
So it's a rarity. Once there is an appropriated NDAA, there are two scenarios that can lead to leasing for us. In the event that it's a U.S. government lease, typically that money's been allocated in a fiscal year, and it needs to be committed by the end of that fiscal year. So in this current appropriation, we have two locations where we expect to do leases with the U.S. government for needs that we've discussed with them in the past, and some of that will occur in the National Business Park, and some should occur in Redstone Gateway. But those have to happen during that fiscal year-
Oh, interesting
... to make the appropriation. So typically, August to September are pretty active months for leasing when the government is leasing space. With regard to defense contractors, it's more of a passive activity. Money flows into programs, and programs are completed by contractors. Contractors compete in a competitive bidding process to win a program, and if they win, since 2012, the norm is that the losers are gonna protest-
Mm-hmm
... and object to the award. And then, that process has to be adjudicated with a very defined process. Once the adjudication is completed, then you have a final winner, who's the defense contractor, and typically, they've been working with us in preparation of winning that award because they have to understand what their cost basis is gonna be to perform it.
Mm-hmm.
That includes the rent. And then, when they've won the award, then we can proceed and move to a lease and-
In summary-
Yes
... government is measured in months, and contractor could be measured in a year plus.
Yeah, we like to say that the contractor demand materializes 12-18 months-
Okay
... after an appropriation.
Perfect. Any quest-
So to that point, we're having great vacancy leasing. I'm sure you'll ask me about that, but this year. If you don't, we're having great vacancy leasing this year. But that's really all being driven off of the prior year-
Right
... NDAA with defense contractors.
Rolling forward, so it's,
Right
... ongoing. Any questions? So maybe something that's a little bit different from, from CDP, very recently, isn't a development, but you, you've acquired Franklin Center in, in the vicinity of your headquarters. 56% leased asset to a single, contractor, that we don't know the name of, but maybe we could find that out. Do we know it?
I can tell you.
Oh, go ahead, tell me.
It's Leidos.
Okay. Um-
Very successful defense contractor.
A lease that's expiring soon, though. So what is it about this asset that is so appealing to you? Because it is, you know, a bit of a departure for CDP to be an acquirer, so there must have been something very special here.
Well, it is the second newest office property in the park. It was developed in 2008. It was initially leased as a single-tenant, fully leased building by SAIC, which ultimately split into two companies, and Leidos is the remaining component. And about seven years ago, Leidos exercised a contraction option, and they've had this 95,000 sq ft vacant for about seven years. Unfortunately for them, they were owned by a triple-net private entity on the West Coast. They don't have an operating franchise in Maryland. They don't have expertise or the deep relationships that we have with defense contractors, and they were unable to lease the space for a long period of time. They had a need to redeploy capital. They brought it to market. We observed where the market was gonna price the asset.
We stepped in, and we bought it. They suffered because they had to compete with our franchise. Our shareholders will benefit by that strength because we now own the asset at extremely cheap price. We bought a, you know, a new seven-story building for $74 and some change a foot. Since we've acquired the asset, demand from defense contractors has accumulated to about 280,000 sq ft of opportunities-
Wow
... over the last 2 months. So we have a almost 3-to-1 ratio, or over 3-to-1 ratio with our vacancy, and we expect that to lease up, incrementally, say over the next 12 months.
Great.
So it's a great value creation opportunity for our tenants. And from time to time, we will buy an asset that makes sense, but it's got to meet the criteria that we have. It has to be proximate to a defense mission with permanence. It has to have a locational advantage, a good quality asset defense contractors can invest in. And then ideally, a tenant in place like Leidos, which is a very successful business serving Fort Meade, Fort Belvoir.
What are the prospects of them renewing?
Oh, I would say 100% on whether they will stay in the building. We've handicapped, they could contract some of their non-classified space, but the bulk of this suite is heavily invested in SCIF. If the SCIF process is hard to get, and once you get it, you can't move it, and I'm quite certain they'll, they'll retain it.
Okay, great. Questions from the audience?
With your specialization, have you thought about going to Europe and building for NATO mission-critical facilities?
Just repeat the question.
Um, I-
Can you repeat the question? Can you repeat the question one more?
So the question is, with our expertise, have we thought about going to Europe and building for NATO? I haven't. I mean, notionally, we explored it with another country that was one of the Five Eyes. I'll leave the country out, but their program would have required us to build the property on a fee and turn it over to their government. That's just not the business we're in. We're not a fee developer, so we passed. I haven't seen an opportunity to go to Europe. I'd be very interested to find that opportunity if it exists, so I'll think about it. Thank you.
Questions? Here you go. Yeah.
Can you talk a little bit about the tenant improvements, and what makes the tenant want to stay there over time?
Sure. So the question is, can I tell them a little bit about the tenant improvements and what makes the tenant want to stay? By the way, shameless plug, we have extraordinarily high retention in our portfolio. Over the last decade, we've averaged 70%, above 70% retention. Over the last three or four years, we've been closer to 80%. We guided from 75%-85% retention this year. We expect to be at the upper end of that guidance. Among the reasons our retention is so high, location has a lot to do with it. We have buildings proximate to priority missions that are national defense priorities that will always be funded, and there's no better place to go. So that's one factor.
The second is to do the kind of work that these contractors are doing for the government. It requires a high security environment to handle the mission work, and that requires this condition I described as SCIF. So SCIFs are the catch-22 of the defense contracting world. You can't win a contract if you don't have a SCIF to conduct it in, but you can't get a SCIF unless you have a contract to work in it. So they're very hard to get. Small contractors have to, in essence, sublease SCIFs until they win enough business where they can build one. To build a SCIF, you have to have a sponsoring agency. They have requirements that have to be fulfilled.
It has to be constructed in a way with third-party observers watching every element of the construction to make sure this doesn't end up like the Soviet Embassy in Moscow back in the day, where when we finished building it, it was one big microphone. And then it takes 12 to sometimes as much as 24 months to complete and get a SCIF certified. Once SCIF is certified, if it's ever breached, it's garbage. It has to be turned out, so torn down. So a SCIF has to be guarded and secured. There are systems in place to monitor that. And then once you've built it, you can't move it. So once they get invested... And by the way, current costs to construct SCIF is about $300-$350 a foot. It's comparable to the cost of building a base building.
So once and we don't fund that. We'll give a market tenant improvement allowance. So once that tenant is invested in that facility, they need it to continue their business, they can't move it, and if they were to allow it to be breached, then they're out of business till they get another one. So that SCIF is a big part of why our retention is so high.
That build-out belongs to you?
Ultimately, yeah.
Yeah.
If we ever do get SCIF back, we have credentials with the government to maintain the integrity of the SCIF and then lease it to another contractor with the certification to use the SCIF, and we can lease those at will.
Great. Questions? So, your guidance for internal growth this year is 6%-6.5%? Same store NOI growth.
Correct.
And that's a, it's a big number, impressive number, but how sustainable of a number is it? I mean, you talked about 4% FFO growth through to 2026 per year. Does that imply, you know, that this is not a number that people should be thinking of as re-- as terribly repeatable? Still a good number, but maybe not as high as 6.5%.
So the 6.5% is assisted by the last couple years, we've had some remarkable vacancy leasing. So there's, you know, we're elevating our occupancy, and that certainly has a contribution on a same-store basis as an asset that was 93% leased is now 96% leased, is kicking off more income. If you look at our first quarter results, our same-store was 6.1%. But if you looked at the prior year's pool, it was 4.8%.
Okay.
So the other benefit we get is once we've delivered a completed development, and it's operated for a full calendar year, it gets added to the same-store pool, and so that's that extra, call it 1.3%, from new developments coming online. Neutralizing those things and looking at the portfolio over the longer term, it's really structured to grow 3-4, maybe a little bit more, from internal growth on leasing year in and year out. So we'll have some good years with development contributions or gains in occupancy, and then, of course, if we lose occupancy, it's gonna break the other way.
Right. Right.
I think that 3-4 is something you can rely on internally and incremental from development activities.
Okay, and then speaking of vacancy leasing, 'cause you told me I have to ask the question, what is... What's the target for this year? I think you're almost halfway there already, if I recall. You know, how jazzed up are you about, you know, essentially beating what's embedded in your guidance right now?
I'm gonna let Britt answer this, 'cause it's his responsibility.
Yeah, so we had a target of 400,000 sq ft of vacancy leasing for the year. We're already at about 220,000 before halfway through the year, so feeling great about that target. Again, the demand for this kind of space continues to increase for secure space, and yeah, we feel great about the prospects that are out there both the U.S. Government and government contractors who continue to be very interested in this kind of space.
Okay. Questions, anybody? So maybe flipping the conversation a little bit away from your defense IT core, you have, you have what you call other, no longer regional office, and, you know, that's, essentially, eventually, you know, up for sale at some point in the future. I think that's clear, but probably not at the moment. However, L Street got some, in D.C., got some nice leasing. I think you're over 90% leased there. To what extent could we start seeing some asset sales out of this non-core bucket happening sooner rather than later?
So, first, can I provide some backdrop-
Sure, sure.
on, L Street?
Yeah.
My predecessor committed to an urban development at 2100 L Street in 2015. We completed that development somewhere around 2018, 2019, and we've just recently stabilized it at 92%. It's trophy. It's a wonderful building. It's got a, you know, great value inherent in it. But currently, the capital markets for office properties don't really support buyer financing, and so I think if we were to bring that to market today, we'd leave shareholder value on the table at where it would trade. So we will patiently await the recovery in the capital markets. We've got very long in-place lease terms, plenty of time to wait and allow free rent to burn off, and when we can get great shareholder value out of the asset, we will sell it.
Similarly, we have four other assets, one concentration in Tysons Corner and three in downtown Baltimore. We do intend to exit those, but similarly, we're gonna do it in a way where we get reasonable value from the asset, and we have no particular deadline, and so we just have to be patient.
Okay. Questions? Let's talk about Huntsville. So a lot of people in this room may not know much about Huntsville. I think it's one of the fastest-growing cities in the country, probably because of Redstone. But can you kinda, sort of frame Huntsville and how it compares in your mind to NBP, in terms of the opportunity set for CDP?
So the military installation in Huntsville is the Redstone Arsenal, and it's a multi-governmental agency facility hosted by the U.S. Army. But with BRACs and other activities, it has a very high concentration of activities involving missiles, space, all of Army procurement, what's called Army Materiel Command, is located on the base. Foreign weapon sales is located on the base. There's a very advanced research and development command that sits on that base, and it's multi-funded. It has elements of the FBI, the FBI Terrorist Explosive Device, TEDAC, Command, I believe, where they literally dissect every terrorist bomb that the U.S. can get possession of to try to fingerprint who made the bomb and learn how to defeat it. Oh, I'm out of time. So anyway, it's a very rich environment.
Our development after 11 years is at 2.5 million sq ft. We've got capacity to go to 5.5 million sq ft, and its growth rate is actually faster than the NB P was.
Outstanding. We are gonna stop there. Thank you very much, Stephen.
Is there overtime? No overtime.
Thanks very much. Enjoyed it.
All right. Thank you.