Welcome to the Corporate Office Properties Trust Quarter 2023 Results Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Venkat Kommineni, COPT's Vice President of Investor Relations. Mr. Kommineni, please go ahead.
Thank you, Dylan. Good afternoon, and welcome to COPT's conference call to discuss second quarter results. With me today are Stephen Budorick, President and CEO, 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 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. Thank you for joining us. Our investment strategy and differentiated portfolio continue to generate strong operating results and support our positive outlook for our business for the coming years. The $100 billion increases to the Department of Defense budget that have been appropriated since March 2022, and the roughly $25 billion increase that is expected to occur later this year, has and will continue to drive strong demand throughout our defense IT portfolio. Our capital allocation decisions have deeply concentrated our assets in locations adjacent to, or in some instances, containing high-priority missions. Defense contractors benefit greatly by locating offices proximate to these high-priority missions. These missions require secure office environments, and the mission work cannot be performed from home. The secure environments for these missions are difficult to get approval to construct, expensive to create, and requiring significant tenant co-investment, and are not transportable.
These are the major factors that drive our industry-leading retention rates. Accordingly, our competitive advantages of the best locations adjacent to these high-priority defense missions, a unique portfolio with significant security improvements, readily developable land sites to support mission growth, a 30-year track record of performance excellence, and our franchise of relationships and security credentials continues to provide strong results, including resilient cash flows and FFO growth. We reported second quarter FFO per share as adjusted for comparability of $0.60, $0.02 higher than the midpoint of our guidance. Our core portfolio is 95% leased, which represents a 130 basis point increase year-over-year. Our defense IT segment is 96.8% leased, which is the highest level since we began disclosing the segment in 2015 and represents a 190 basis point year-over-year increase.
Same property, cash NOI increased 5.8% over the second quarter of last year and increased 7% during the first half of the year. We executed 88,000 sq ft of vacancy leasing with a weighted average lease term of nearly 7 years, which brought our total for the six months ended to 187,000 sq ft. Adding the first few weeks of July, we've executed 218,000 sq ft of vacancy leasing year to date, which puts us right on track to achieve our full year target of 400,000 sq ft. Recall, our expected vacancy leasing volumes in 2023 are lower than 2022 due to the diminished inventory available to lease in our defense locations.
The National Business Park is now 99.3% leased, which represents a 550 basis point increase since the end of last June, with only 31,000 sq ft of unleased space in the 4.1 million sq ft park, and the largest vacant space is only 7,800 sq ft. In our defense IT portfolio, we have 670,000 sq ft of inventory available, which is the lowest level since 2017, despite the fact that the portfolio has increased by nearly 6 million sq ft during that period. Our overall portfolio leasing activity ratio remains strong at 75%, with a pipeline of 915,000 sq ft of vacancy prospects. Total leasing volume of 891,000 sq ft in the quarter included 803,000 sq ft of renewals.
Our overall retention rate for the quarter was 89%, with our defense IT locations at 93%. Year to date, our overall retention rate is 83%. Cash rent spreads were up 1.3% for the quarter, while GAAP rent spreads were up 7.4%, driven by annual rent increases of 2.6%, with a weighted average lease term of 5 years. Year to date, rent spreads are up 1.1% on a cash basis and 6.9% on a GAAP basis, with a weighted average lease term of 4.5 years. Measuring the starting cash rent of the tenant's expiring lease to the starting cash rent of the renewal lease, the annual compound growth rate achieved on these leases was 3.4% for both the quarter and year to date.
On page 22 of our flip book, we expanded our large lease disclosure to include our view of renewals through 2025. We continue to expect portfolio retention to be extremely strong. Looking forward, over the next 10 quarters, we have 7.1 million sq ft of leases expiring, which includes 3.9 million sq ft of large leases, defined as leases over 50,000 sq ft. We expect a retention rate of roughly 95% on these large leases. For the balance of 2023, we expect to renew 100% of the large leases that are included in this total. Our 1.5 million sq ft of active developments are 92% leased, with a total estimated cost of $480 million, consisting of nine projects located in Maryland, Northern Virginia, and Huntsville, Alabama.
We expect to place 800,000 sq ft of developments into service over the remainder of 2023, that we expect to be 99% leased when delivered. During the first six months of the year, we executed 495,000 sq ft of development leases, including three full building build-to-suits and 30,000 sq ft of development lease up. Our development pipeline, which we define as opportunities we consider 50% likely to win or better within two years or less, currently stands at 1 million sq ft, up from 700,000 sq ft last quarter. Beyond that, we're tracking another 1.2 million sq ft of potential future opportunities, which should allow us to maintain a solid development pipeline in the near and medium term.
With the National Business Park essentially full, we are in the planning stage for our next contractor and government buildings and have commenced pre-development and pre-leasing activities. We remain confident in achieving our 700,000 sq ft development leasing goal for the year. The success we've achieved during the 6 months of the year has compelled us to increase the projected midpoint for FFO per share. We remain confident we can achieve our FFO per share growth expectations through 2026. With that, I'll hand the call over to Anthony.
Thank you, Steve. We reported second quarter FFO per share as adjusted for comparability of $0.60, which is $0.02 higher than the midpoint of our guidance. The quarter's outperformance was primarily driven by lower than expected net operating expenses, a portion of which was the timing of certain repairs and maintenance projects that we now expect to be completed in the second half of the year, and slightly lower interest expense. We have generated very strong increases in same-property cash NOI, with results that have exceeded our initial expectations. Driven by the year-to-date outperformance that is not timing related, we are increasing the midpoint of our same-property cash NOI guidance by 100 basis points, for a revised range of 4.5%-5.5%.
This represents a 200 basis point increase in the midpoint for same-property cash NOI growth from our initial guidance target. Same-property occupancy ended the quarter at 92.8%, which is up 70 basis points sequentially from last quarter and up 170 basis points year-over-year. We expect occupancy to continue to increase throughout the remainder of the year as executed leases commence, including 70,000 sq ft by Lockheed Martin at 1,200 Redstone Gateway in the third quarter, after taking occupancy of 52,000 sq ft in the second quarter, and 70,000 sq ft in our Fort Meade BW corridor subsegment during the third quarter. Our core portfolio is 95% leased, with our defense IT locations finishing the quarter at 96.8% leased.
Our three largest concentrated defense locations, which consist of The National Business Park, Redstone Gateway in Huntsville, and Lackland Air Force Base in San Antonio, are 98.8% leased in aggregate and account for roughly 45% of our core annualized rental revenue. Adding our fully leased data center shell portfolio, 50% of our core annualized rental revenues are generated from assets that are 99.3% leased. The strength of these properties' occupancy, operations, and cash flows are emblematic of our defense IT portfolio. Year to date, we have renewed 997,000 sq ft, with cash rent spreads up 1.1%. Based on our performance year to date and lease negotiations underway, we are increasing the midpoint of our cash rent spread guidance by 50 basis points to a revised range of flat to up 1%.
Our balance sheet is well positioned to navigate the current volatility in the capital markets environment. We have no significant debt maturities until March 2026. Our unencumbered portfolio now represents 96% of total NOI from real estate operations. Additionally, at the end of the quarter, we had over 70% of the capacity on our line of credit available. Our variable rate debt exposure was just under 5% at quarter end. Although we expect our floating rate debt to increase slightly over the remainder of the year as we fund development on our line of credit, our projections continue to have it below 10% at year-end. Turning to 2023 guidance.
Given our outperformance for the first 6 months of the year, we are increasing the midpoint of our FFO per share guidance by $0.02, from $2.38 to $2.40. This revised midpoint represents a 2% increase in FFO per share over 2022's results. For the 3rd quarter, we're establishing a guidance range for FFO, as adjusted for comparability of $0.59-$0.61 per share. The resulting guidance for the 4th quarter implies FFO per share between $0.60 and $0.62. With that, I'll hand the call back to Steve.
Thank you. Summarizing our key messages, we delivered another strong quarter, with FFO per share $0.02 above the midpoint of our guidance. Our defense IT segment is 96.8% leased, the highest rate since we started reporting the segment in 2015. We raised the midpoint of full-year same-property cash NOI guidance by 100 basis points, driven by a great first half. We're on track to achieve our full-year goals for vacancy and development leasing. Our 1.5 million sq ft of active developments, which are 92% leased, provide a strong trajectory for NOI growth over the next few years. Our liquidity is very strong, and we continue to expect to self-fund the equity component of our expected development investment going forward.
We raised the midpoint full-year FFO per share guidance by $0.02, now expect to deliver FFO per share growth of 2% in 2023, 1% higher than our initial expectations. We continue to expect compound annual FFO per share growth of roughly 4% between 2023 and 2026 from the midpoint of our original 2023 guidance. Before wrapping up the call, I wanted to share some interesting current perspectives. Agencies within the U.S. government have become increasingly vocal about the cyber espionage threats to our country. On last quarter's call, we shared the threat assessment published by the Director of National Intelligence, or DNI, regarding China. More recently, the office of the DNI advised Congress that Russia is focused on improving its ability to attack our infrastructure networks, and China is likely capable of attacks that could disrupt our infrastructure.
This quarter, the Five Eyes, which are the intelligence operations of the United States, United Kingdom, Canada, Australia, and New Zealand, just issued a warning that a Chinese state-sponsored entity has targeted networks across critical U.S. infrastructure sectors. Last week, reports emerged that China-based hackers infiltrated email accounts at the State Department and the Department of Commerce. The Center for Strategic and International Studies, or CSIS, maintains a log of significant cyber events that have occurred since 2006, defined as state actions, espionage, and cyberattacks, where losses exceeded $1 million. Since 2010, when the U.S. Cyber Command was established, the number of annual significant cyber incidents CSIS has reported globally has escalated at a compound annual rate of 16% and has averaged 11 significant cyberattacks per month over the past 36 months.
Our government's reaction to these threats has resulted in increased cyber-related investments, which has led to increased demand for our portfolio and our record level of leased inventory. Our portfolio is well positioned to continue to benefit from this investment, given our advantage, locations, and expertise in providing secure space. Year to date, over 50% of our executed vacancy leasing supports cyber activities, primarily in the Fort Meade BW corridor. Over the past three years, we've completed 730,000 sq ft of cyber leasing in both our development and operating portfolios. Today, we have 465,000 sq ft of demand, seeking new and expansion space requiring SCIF, or secure facilities, primarily to support cyber mission growth.
The National Business Park is 99.3% leased, the highest level in the past 15 years. We're preparing new development options to primarily support cyber mission growth for both the U.S. government and defense contractors. These facilities will require security enhancements. They'll address the asymmetric cyber threat that will persist indefinitely, thus deepening the durability of our unique property portfolio and the resulting cash flows. We're extremely proud to have played an important role in providing valuable leases to our cyber tenants. We look forward to the inherent expansion opportunities that will emerge from the critical defense needs of our country. Operator, with that, please open up the call for questions.
Thank you, Mr. Budorick. As a reminder, to ask a question, you will need to press star one one on your telephone. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. I show our first question comes from the line of C . Please go ahead.
Great, thanks. Good afternoon. Maybe just a high-level question to start out. The Government Accountability Office just did a study on federal buildings that concluded that the utilization at those buildings was very low. Obviously, the study covered, you know, a much different set of assets than what COPT owns, but can you just talk about your portfolio and, and how you'd characterize the utilization amongst your U.S. government tenants?
Sure. First, let me talk to that study, which we read. That primarily deals with the GSA, the large GSA leases within the Beltway, and indeed, they are very lightly used. Some estimates are 20% or less. They've allowed a lot of work from home, and that employee base has gotten pretty comfortable with that arrangement. I've also learned that there are 15 separate labor unions that represent the various U.S. government employee bases, and the kinda return to work efforts are gonna take a long time because of the fractional representation of those employees. Turning to our portfolio, our government customer assets are not included in that report. Our government customers predominantly are in the defense or intelligence community, and because of the security requirements of their mission work, they are required to work in the office.
Really going all the way back to October of 2020, the attendance in our government-leased buildings has been normal or full. It just doesn't pertain to our portfolio.
Great. Thanks, Steve. Switching gears a little bit to the data centers. Power issues have become an impediment that we talked about consistently in the Northern Virginia data center business. Do you see those power issues subsiding at any point? If not, I guess, would you consider developing data centers in any other market if your customer was willing to kinda plant a flag elsewhere?
Let me deal with the power, and I'm, I'm not exactly an expert of, what's happening there. The two power companies in Northern Virginia are working to increase the overall power capacity, and our understanding is it's gonna deliver in roughly thirds in 2024, 2025, and 2026. I think we're more than 12 months away from seeing new power supply that can be pushed through the local distribution network. With regard to our appetite to follow our customer to a new market, we absolutely would do that, provided the market was a substantial data center market with long-term confidence and assurance of, of, a high demand level.
Great. Thanks, Steve.
Thank you. I show our next question comes from the line of Michael Griffin from Citigroup. Please go ahead.
Great, thanks. Maybe just touching on the leasing front. Appreciate the disclosure around the large lease renewals through 2025. You talk about 95% of these, you know, about $4 million expected to be renewed. For the remainder of that $7 million that expire, what should we expect in terms of retention rates, and any color you can give around that would be helpful.
Sure. We're not gonna put out a statistical number, but it's extremely strong, Griff. We, we expect very little non-renewal in our portfolio. I would say if you just handicapped the rest of it at, call it, roughly 80%, we'd be at or, or maybe better than that.
Great, thanks. Then I know a topic that's been coming up in the past with Redstone is the potential moving of Space Command from Colorado there. I'm curious if you can give any update on timing or anything around that matter?
Well, I, I wish I had one, but, but I don't. For those people who are less familiar, you know, Space Command was through a process, identified Redstone Gateway as the best location, to stand up this new combatant command. There's been a lot of politics in the Senate level, in the House, where other states have protested the decision. They've gone through a reassessment twice. In all three cases, Redstone Gateway has been the prevailing selection. It seems to be in a politically charged-... environment where the final decision's not been made, and we continue to await the outcome, as does a lot of people in Redstone Gateway.
Great. That's it for me. Thanks for the time.
Thank you. I show our next question comes from the line of Camille Bonnell from Bank of America. Please go ahead.
Hello. Anthony, could you please share the latest thoughts on how the company is thinking about its payout ratio? As we head towards the second half of the year, it looks like AFFO will be improving, implying your payout ratio will trend towards low 60%. What's the sweet spot for you, and does the company have a target for the medium term?
Our target for our payout ratio of AFFO has always been in the 70% range. Our projection for this year is that for the full year, we'll be more in the mid-60s of our total payout ratio, based off of our remaining improvement-- our results for the year and the remaining improvements that we expect to make to our properties. Our, our ratio has always sort of been in that sort of 65%-70% range.
Okay, great. On the operating expense side, it looked like it outperformed in the quarter, but operating margins went down slightly. Was that more one time in nature?
It was. I think there's, the operating expenses were favorable for the quarter. Some of that related to some R&M projects that were, the completion of which were pushed into the 3rd and 4th quarter of this year. There was really no sort of noise around our, our, our margins.
Okay. You expect to see that, improving from here?
Yes.
Okay. That's it from me. Thank you.
Thank you. Our next question comes from the line of Tom Catherwood from BTIG. Please go ahead.
Thanks. Good afternoon, all. Steve, maybe going over to the vacancy leasing pipeline, could you provide some more color around that? I'm specifically thinking, are, are there certain regions of yours that are stronger than others? What's really driving some of these tenant requirements? Is it expirations, expansions? Is it winning new contracts? You know, are there some kind of general themes that you can pull out of the demand that you're seeing?
Sure. I, I would say probably the two strongest areas in the development pipeline. Well, it's more than two, but collectively, the BW, BW Fort Meade corridor is extremely strong. I spoke a little bit to the amount of tenant demand for new or expanded SCIF capacity in the BW market, and that is heavily aligned with or associated with new contracts and expanded opportunities in that cyber-related activity that I closed the my comments with. The other areas, Northern Virginia, and again, most of that demand is, includes a need for expansion of SCIF because of expansion opportunity or new contract and expansion opportunities in the Route 28 corridor.
When you're talking about the increased SCIF, is that, is the cost for that base building, is the cost for that covered in TIs? Are the, are the tenants putting in? You know, when, when you look at those leases, is, on a net effective basis, is that more beneficial to you, or just over the long term, does it make the tenant stickier?
On, on the going-in lease, we give a market level of tenant improvement, still better or worse than a non-SCIF tenant. The tenant itself has to invest the incremental capital to complete the SCIF. With the escalation in costs that have occurred, you'll have to budget at least $150 a foot, if not $200 a square foot, to complete the SCIF component of that suite. That heavy co-investment and the fact that SCIFs are not portable, you can't pick them, pick them up and move them to a new building, is a major factor in our record or industry-leading retention rates. It does accrue to our benefit over the long term.
Got it. Got it, and then, you know, just with all the talk around increased demand, expansion of tenants, expansion of government budgets, what are you seeing in terms of new entrants in your specific area, providing real estate solutions to these tenants? Are you seeing any uptick in competitive supply?
We really haven't, Tom. You know, we, we tend to dominate the market in and around Fort Meade. I will say, with the extremely high level of inventory leased at the NBP, we're kind of guiding some of that demand into Columbia Gateway, and we've got a rapidly escalating kind of inventory of SCIF or SCIF demand in the park, which is really good for that portfolio long term. In Northern Virginia, it's, it's always Route 28 corridor has been more competitive for us because there are multiple landlords. There are certainly no new entrants, no new development. The inventory in and around the demand drivers is largely, you know, well leased and stable. Of course, you know, if you jump to Alabama, we have the best location, period, and the incremental demand tends to come to us.
Understood. Really helpful. Thanks, everyone.
Thanks, Tom.
Thank you. As a reminder to ask a question, you would need to press star one one on your telephone. I show our next question comes from the line of Jay Poskitt from Evercore ISI. Please go ahead.
Hey, thanks. Good afternoon. I'm just curious what you, what you have baked into guidance in the back half of the year from a macroeconomic perspective. Just curious your thoughts for the macro environment and also the rate environment in the back half of the year?
From the, from a rate environment built into our forecast for the balance of the year is the current SOFR curve, that came-- that is, you know, sort of the most immediate one after the impact of any changes from the most recent Fed increase earlier this week. It has, it has the current projections for where the market is. I'd say a 25 basis point change in that, in that curve for the remaining six months of the year is only about a $200,000 increase in interest expense for the six months ended, just because such a large portion of our debt is, is fixed at this point, fixed or swapped.
That's helpful. Thank you. Then just I was wondering if there's any update on the regional office leasing activity?
Our, our leasing activity ratio for the regional office, the 5 regional office assets, is about 68%. I will say it's largely preliminary opportunities except for a lease that we're competing for in downtown D.C. for 2100 L. That, the sharp contrast between the timing and the sense of urgency and the demand in our defense business, which is over 90% of our revenue, and that 10%, which is regional office, it's pretty lethargic, and I would not look for meaningful progress in the leasing environment through the end of the year, with the exception of the 1 lease we're competing for at 2100 L.
Great, thanks. That's all for me.
Thanks.
Thank you. I'm showing no further questions in the queue at this time. I'll now turn the call back to Mr. Budorick for closing remarks.
Well, thank you all for joining us today. We are in our offices, so please coordinate through Venkat if you would like a follow-up call. Thanks again for joining us.
Thank you for your participation today in the Corporate Office Properties Trust Second Quarter 2023 Results Conference Call. This concludes the presentation. You may now disconnect. Good day.