COPT Defense Properties (Corporate Office Properties Trust) — FY 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. COPT is a REIT whose operating business is conducted primarily through Corporate Office Properties, L.P. (COPLP). The company owns, manages, leases and develops office and data center properties, with a strategic focus on U.S. Government and contractor tenants in Defense/IT markets. At year-end, its portfolio included 163 office and data center shell properties totaling 18.1 million square feet, one wholesale data center, and 10 properties under construction or redevelopment.
Financial and operating performance
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $578.1 million | $612.8 million |
| Real estate operations revenue | $517.3 million | $510.0 million |
| Net income | $78.6 million | $74.9 million |
| Net income attributable to COPT common shareholders | $72.3 million | $55.7 million |
| Basic and diluted EPS | $0.69 | $0.56 |
| NOI from real estate operations | $321.0 million | $323.8 million |
| Operating cash flow | $180.5 million | $230.1 million |
| Investing cash flow | $(232.9) million | $(89.4) million |
| Debt at year-end | $1.824 billion | $1.828 billion |
| Cash and cash equivalents at year-end | $8.1 million | $12.3 million |
| Diluted FFO per share | $1.97 | $1.94 |
| Common dividend per share | $1.10 | $1.10 |
Annual total revenue fell 5.7%, primarily because construction and other service revenue declined to $60.9 million from $102.8 million as tenant-related construction activity slowed. Real estate operations revenue increased 1.4%. Net income rose $3.7 million, including a $12.8 million reduction in impairment losses that was partly offset by lower gains on property sales. Diluted FFO per share increased modestly; management cautions that FFO is a supplemental, non-GAAP measure and is not a substitute for operating cash flow or net income.
Cash provided by operating activities decreased $49.6 million, mainly because the company paid construction costs in 2018 on a contract that a customer had pre-funded in prior years. Investing cash outflow increased as property-sale proceeds were absent in 2018, compared with $180.8 million in 2017. Financing cash flow was positive $49.6 million, supported by $202.1 million of net common-share proceeds and partly offset by distributions and debt payments.
Material changes versus the prior comparable period
- Year-end office and data center shell occupancy was 93.0%, down from 93.6% in 2017. The decline mainly reflected unoccupied space in a newly completed property intended for U.S. Government use that took longer than expected to lease. Same-property occupancy was 93.0%, versus 92.1% a year earlier.
- Same-property NOI decreased $2.9 million. Defense/IT same-property NOI increased $3.7 million, while Regional Office same-property NOI fell $5.7 million, chiefly due to weaker Northern Virginia occupancy and higher net operating costs in Baltimore City.
- Leasing volume reached 4.2 million square feet, including 1.1 million square feet of construction and redevelopment space. Tenant retention was 78.4%. Renewals averaged approximately 2.0% lower annualized cash rents but 6.8% higher GAAP rents than the prior leases.
- Construction and development spending recorded as cash outlays was $160.0 million. COPT issued 5.9 million shares through forward equity agreements and approximately 992,000 shares through its ATM program, raising net proceeds used primarily to repay revolving-credit borrowings.
- Impairment losses declined to $2.4 million from $15.1 million. The 2018 charge related to abandoned redevelopment plans; the 2017 charges were primarily associated with the Aberdeen portfolio and land.
Outlook, risks and unusual items
- Management expected 2019 construction and development spending of $250–$300 million, plus approximately $65 million for operating-property improvements and leasing costs. Planned funding sources included revolving-credit borrowings, forward equity proceeds and operating cash flow.
- The $800 million revolving credit facility matures in March 2023 and had $587 million available at year-end. Debt had a weighted-average effective interest rate of approximately 4.1%; a 1 percentage-point rise in applicable LIBOR was estimated to increase 2018 interest expense by $1.7 million, including the effect of swaps.
- Debt maturities include approximately $304 million in 2021, $268 million in 2022 and $630 million in 2023, including amounts potentially extendable subject to conditions. The company reported compliance with its financial covenants and investment-grade ratings on senior unsecured debt.
- Tenant and mission concentration is material: the U.S. Government represented 32.7% of annualized rental revenue, and the 10 largest tenants represented 61.7%. Government shutdowns, funding delays or reductions in defense and other knowledge-based spending could affect rent, renewals and demand. Many Government leases are structured as consecutive one-year terms and may be terminated in certain circumstances.
- Other disclosed risks include regional office-market weakness, development cost and leasing risks, refinancing and interest-rate exposure, tenant credit, cybersecurity, environmental and climate-related liabilities, and the specialized nature and potential obsolescence of data center assets. Management reported no material litigation and no material off-balance-sheet arrangements.
- The 2018 fourth-quarter impairment charge was $2.4 million. A 2017 property sale was recognized for accounting purposes in 2018 after a buyer-related financial guaranty expired; the company reported no losses under that guaranty.
Most important facts for investors to verify
- Whether the newly completed Government-targeted space is leased and whether occupancy and leasing trends remain stable.
- Tenant concentration, Government lease renewal and termination terms, and exposure to federal budget actions or shutdowns.
- Progress, leasing, completion timing and remaining cost for the approximately 1.3 million square feet under construction or redevelopment.
- Liquidity and refinancing plans for the 2021–2023 maturities, covenant headroom, and the cost and availability of equity or debt funding.
- Cash generation after recurring capital, tenant improvements and distributions; reported FFO should not be treated as cash flow available for debt service or dividends.
- Regional Office performance, especially Northern Virginia occupancy, and the assumptions supporting property valuations and any future impairment assessments.