Business context and reporting period
Corporate Office Properties Trust (COPT), a REIT focused on office properties serving U.S. government, defense and defense IT tenants, filed this Form 10-K for the year ended December 31, 2010. It also operates real estate services businesses and entered the wholesale data center market in 2010. At year-end, its wholly owned office portfolio comprised 252 properties and 20.0 million square feet, 88.2% occupied; it also held development assets and a partially operational data center.
Financial and operating performance
| Metric | 2010 | 2009 |
|---|---|---|
| Total revenue | $564.5 million | $767.1 million |
| Real estate operations revenue | $459.8 million | $424.0 million |
| Operating income | $131.3 million | $137.9 million |
| Net income attributable to COPT common shareholders | $26.7 million | $40.2 million |
| Diluted EPS | $0.43 | $0.70 |
| Diluted FFO per share | $2.30 | $2.46 |
| Cash flow from operations | $156.4 million | $194.8 million |
| Year-end debt | $2.324 billion | $2.054 billion |
- NOI from continuing real estate operations rose to $280.4 million from $266.8 million. Same-office NOI fell $8.0 million, while acquisitions and newly placed properties added NOI.
- Operating cash flow declined $38.4 million, which management attributed mainly to timing of third-party construction cash flows and higher interest paid. Investing activities used $479.2 million; financing activities provided $324.6 million.
- Year-end cash was $10.1 million. The $800 million revolving credit facility had $503.1 million available; the $225 million revolving construction facility had $82.7 million available.
- EBITDA interest coverage was 3.01x and fixed-charge coverage was 2.54x, versus 3.40x and 2.78x, respectively, in 2009. About 22% of debt had variable rates, including swaps.
- Common dividends declared were $1.61 per share, up from $1.53. The diluted FFO payout ratio, excluding acquisition costs and the debt-extinguishment gain, increased to 69.6% from 61.8%.
Fourth quarter: Revenue was $151.4 million, operating income $35.1 million, net income attributable to common shareholders $11.5 million and diluted EPS $0.18. In fourth-quarter 2009, these were $178.3 million, $32.1 million, $5.1 million and $0.08, respectively.
Material changes versus the prior comparable period
- Total annual revenue fell 26%, primarily because construction and other service revenue dropped to $104.7 million from $343.1 million as a large construction contract neared completion. Real estate operations revenue increased 8%.
- Common-shareholder net income declined 34%. Interest expense rose $19.7 million, and operating income fell $6.6 million; higher gains associated with COPT’s KEYW investment partly offset these decreases.
- Interest expense increased to $101.9 million from $82.2 million, reflecting higher average debt and a higher weighted-average debt rate (5.01% versus 4.86%).
- Wholly owned office occupancy fell to 88.2% from 90.7%; management cited weak leasing demand, tenant downsizing and new space not yet leased. Average contractual annual rent per square foot rose to $25.56 from $24.63.
- Debt increased by $269.8 million and total assets by $464.5 million. COPT issued $240 million of 4.25% exchangeable notes due 2030 and 7.475 million common shares, raising $245.8 million net of underwriting discounts but before offering expenses.
Outlook, management commentary, risks and contingencies
- Management expected the challenging leasing environment to continue at least through 2011, but believed office leasing fundamentals were at or near bottom by year-end 2010. It cited anticipated demand near BRAC-related government installations and Fort Meade’s Cyber Command, while acknowledging uncertainty around defense spending.
- No specific earnings, FFO, occupancy or dividend guidance is provided. Management expected to fund 2011 maturities and planned construction through credit facilities and access to secured debt, unsecured debt and/or public equity markets; it said liquidity was adequate but remained dependent on capital-market access.
- Scheduled debt payments were $733.7 million in 2011 and $271.4 million in 2012. In January 2011, $142.3 million of maturities were extended to 2012; an additional $311.8 million could be extended subject to conditions. The revolving credit facility matured in September 2011, with a one-year extension option; management expected to extend it or arrange a replacement.
- Development exposure is substantial: the company reported estimated remaining costs of $152.1 million to complete the data center to an 18 MW initial stabilized load; it was 17% leased at year-end. COPT acknowledged less experience with wholesale data centers and risks of cost overruns, delayed completion, leasing shortfalls and obsolescence.
- Tenant and market concentration are material: the U.S. Government represented 21.1% of annualized rental revenue from wholly owned office properties; government/defense-related tenants represented 58.7%. The Greater Washington, DC region and neighboring Greater Baltimore generated 85.4%. Government leases can have one-year terms or early termination rights, including funding-related termination risk.
- Fort Ritchie development remained subject to a court order pending additional Army environmental documentation. The property’s carrying value was $27.7 million; an unfavorable outcome could impede development and impair recovery of the investment. The Army’s appeal was dismissed in January 2011, but the matter remained unresolved.
- Other disclosed exposures include a maximum approximately $66 million of guarantees for an unconsolidated joint venture, a $3.5 million estimated tax-increment-financing shortfall liability, and capped environmental indemnities. Management reported compliance with debt covenants at year-end and no other material litigation. Management and the auditor concluded internal control over financial reporting was effective.
Most important facts for investors to verify
- Whether the 2011 debt extensions and refinancing plans were completed on acceptable terms, and the resulting liquidity and covenant headroom.
- Actual occupancy, lease renewals and rental rates against the 88.2% year-end occupancy and the 2011–2015 lease expirations, particularly government leases with termination provisions.
- Data center construction spending, leasing progress, power-load delivery and stabilization assumptions versus the remaining-cost estimate and 18 MW target.
- Resolution of the Fort Ritchie court and Army documentation process, and any resulting impairment or development-plan changes.
- Underlying recurring performance apart from volatile construction-service revenue and KEYW-related gains; reconcile GAAP earnings with FFO and cash available for dividends.
- Effects of higher debt and interest costs, continued equity issuance/dilution, and the REIT’s ability to sustain distributions while funding development.