Business context and reporting period
Corporate Office Properties Trust (COPT; NYSE: OFC) filed this combined 10-K with its operating partnership, Corporate Office Properties, L.P. (COPLP), for the fiscal year ended December 31, 2017. COPT is a REIT and owned 96.9% of COPLP’s common units; COPLP conducts substantially all operations. The company owns, leases, manages and develops office and data-center properties, primarily serving U.S. government and defense/IT tenants in the Mid-Atlantic region.
At year-end, the portfolio included 159 office and data-center-shell properties totaling 17.3 million square feet, plus a wholesale data center with 19.25 MW of critical load. Approximately 87.4% of office and data-center-shell annualized rental revenue came from Defense/IT Locations.
Financial and operating results
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $612.8 million | $574.3 million |
| Real-estate operations revenue | $510.0 million | $526.0 million |
| Operating income | $135.8 million | $52.4 million |
| Net income | $76.3 million | $15.7 million |
| Net income attributable to COPT common shareholders | $57.0 million | $(2.9) million |
| Diluted EPS | $0.57 | $(0.03) |
| Diluted FFO per share | $1.95 | $1.82 |
| Adjusted diluted FFO per share | $2.03 | $2.01 |
| Cash flow from operations | $230.7 million | $232.5 million |
| Cash and cash equivalents at year-end | $12.3 million | $209.9 million |
| Debt at year-end | $1.83 billion | $1.90 billion |
| Common dividend per share | $1.10 | $1.10 |
Office and data-center-shell occupancy was 93.6%, up from 92.1%; same-property average occupancy rose to 92.5% from 91.5%. Same-property NOI increased $5.9 million to $274.2 million, while total real-estate NOI declined $6.5 million to $324.2 million, primarily reflecting dispositions. Renewal leasing covered 81.0% of expiring space; renewal annualized rents decreased approximately 0.7% on average, while GAAP rental revenue for those leases increased approximately 9.5%.
Real-estate operations revenue fell $16.0 million year over year, while construction and other service revenue rose $54.5 million to $102.8 million; service operating margins remained small, with service NOI of $3.2 million. Operating income and net income improved substantially as impairment losses decreased to $15.1 million from $101.4 million. Net income also reflected $9.9 million of real-estate sale gains. Interest expense declined to $77.0 million from $83.2 million; the weighted-average effective debt rate was 4.1% in both years.
Material changes and capital position
- COPT placed 1.2 million square feet in newly constructed or redeveloped properties into service; these properties were 97.8% leased at year-end.
- The company reported selling 13 operating properties totaling 992,000 square feet and other land for $184.2 million. It also repaid $200 million on a term loan and redeemed all its outstanding Series K and Series L preferred shares for an aggregate $199.1 million.
- Common shares issued through an ATM program and forward equity agreements generated $69.5 million of net proceeds in 2017. At year-end, 7.5 million shares remained available under forward equity agreements, with an indicated settlement value of $221.9 million.
- Cash used in investing activities was $89.7 million, versus $71.4 million provided in 2016, reflecting lower disposition proceeds and higher development spending. Financing activities used $338.5 million, including preferred-share redemptions, distributions and net debt repayments.
- Liquidity included $12.3 million cash and $674 million available under the $800 million revolving credit facility, which matures in May 2019 and has two optional six-month extensions subject to conditions. COPT reported compliance with debt covenants and investment-grade ratings for COPLP’s senior unsecured debt.
Outlook, risks and unusual items
Management expected to spend approximately $320 million on construction and development and $60 million on improvements to operating properties in 2018. Funding was expected to come initially primarily from revolver borrowings and forward-equity proceeds, with operating cash flow funding property improvements. The filing provides no formal earnings or FFO guidance. Management said it expected liquidity and capital resources to meet near- and longer-term needs without requiring property sales.
Management cited improved defense leasing conditions and a 14% increase in the FY2018 Defense Department discretionary base-budget authority versus the prior year, but noted that Congress had not yet appropriated the funding as of mid-February 2018 and the government was operating under a continuing resolution. Key risks include government shutdowns or spending reductions, dependence on government and defense-contractor tenants, regional and tenant concentration, leasing and development execution, interest rates, refinancing access, and REIT qualification. The U.S. Government represented 31.7% of annualized rental revenue; the four largest tenants together represented 47.0%.
In the fourth quarter, COPT recorded $13.7 million of impairment losses on Aberdeen operating properties and land amid weak leasing prospects and expected prolonged vacancy; it also recorded $1.6 million of impairments on properties held for sale during the year. A 2017 property sale for $44 million was accounted for as a financing arrangement, not a completed accounting sale, because COPT provided an indemnity of up to $20 million for a defined capital event through June 30, 2019. The company reported the proceeds as a liability and said it did not expect losses under the guarantee. Separately, the Tax Cuts and Jobs Act was enacted in December 2017; management expected a generally favorable effect for REITs but said the full impact remained uncertain.
Lease rollover is also relevant: 13.8% of total annualized rental revenue was scheduled to expire in 2018 and 17.7% in 2019. Management expected temporary occupancy pressure in Regional Office properties during 2018 and said 61% of wholesale data-center annualized rental revenue was scheduled to expire in 2020.
PricewaterhouseCoopers issued unqualified opinions on the financial statements and internal control over financial reporting; management reported effective controls. The filing said there was no material litigation and no material off-balance-sheet arrangement during 2017.
Important facts for investors to verify
- Track federal appropriations, government shutdown exposure and tenant concentration, particularly the U.S. Government’s 31.7% share of annualized rental revenue.
- Review the 2018–2020 lease expirations, renewal assumptions and expected Regional Office occupancy softness.
- Assess financing needs against the May 2019 revolver maturity, debt maturities, interest-rate sensitivity and the company’s planned 2018 development spending.
- Confirm the final proceeds and dilution from outstanding forward equity agreements, and the status of the $20 million property-sale indemnity.
- Distinguish GAAP earnings from FFO and adjusted FFO; 2017 results were affected by impairments, dispositions, preferred-share redemption costs and the deferred property sale.