COPT Defense Properties (Corporate Office Properties Trust) — Q3 2018 Form 10-Q
Business context and reporting period
Unaudited quarter and nine months ended September 30, 2018; comparisons are to the same 2017 periods. COPT is a REIT and owns approximately 98.8% of Corporate Office Properties, L.P. (COPLP), which conducts substantially all operations. The portfolio focuses largely on U.S. government, defense and IT-related tenants, alongside regional office and data center assets. At quarter-end, it included 161 properties totaling 17.9 million square feet and a wholesale data center with 19.25 MW of critical load.
Financial and operating highlights
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $137.4 million | $157.0 million | $439.6 million | $448.3 million |
| Net income | $20.3 million | $22.3 million | $60.2 million | $63.9 million |
| Net income per common share, diluted | $0.18 | $0.21 | $0.54 | $0.46 |
| Operating income | $37.4 million | $38.9 million | $111.5 million | $111.0 million |
| Real estate NOI | $80.9 million | $82.1 million | $240.3 million | $242.4 million |
| Diluted FFO per share | $0.50 | $0.54 | $1.51 | $1.47 |
| Diluted FFO per share, adjusted for comparability | $0.50 | $0.53 | $1.51 | $1.50 |
Amounts are in U.S. dollars. Q3 revenue fell 12.5%, principally because construction and other service revenue declined to $8.4 million from $29.8 million; these activities generally have small operating margins. Rental revenue was nearly unchanged at $102.1 million. For the nine months, real estate revenue increased $4.1 million, but service revenue decreased $12.8 million. Net income comparisons also reflect the prior-year $5.4 million real estate sale gain; nine-month 2017 common-share earnings included preferred-share dividends and redemption costs, affecting the per-share comparison.
Same-property NOI was $71.6 million in Q3, essentially flat year over year, and $213.4 million for nine months, down $2.0 million. Management attributed the year-to-date decline mainly to higher snow, utility and real estate tax costs. Portfolio occupancy was 92.1% at September 30, down from 93.6% at December 31, 2017, primarily due to newly completed space not yet occupied. Average same-property occupancy for the first nine months was 91.2%, versus 93.5%.
At September 30, total assets were $3.65 billion, debt net of financing items was $1.81 billion (versus $1.83 billion at December 31, 2017), and cash and cash equivalents were $9.5 million. Cash plus restricted cash was $12.9 million. Nine-month operating cash flow was $121.7 million, down from $169.4 million; investing cash use was $152.7 million, versus $52.5 million, largely reflecting lower property-sale proceeds. Financing provided $29.1 million, including $162.2 million of net common equity proceeds, partly offset by distributions, debt repayments and capital lease payments.
Material changes, outlook and risks
- COPT issued 4.5 million shares through forward equity agreements for $132.5 million net proceeds and 991,664 shares through its ATM program for $29.8 million net proceeds. Proceeds primarily repaid revolver borrowings used for development. Further forward equity capacity was 3.0 million shares; ATM capacity was $39.8 million gross.
- On October 10, 2018, COPLP replaced its revolving facility with an $800 million facility maturing March 2023, with two optional six-month extensions and a potential commitment increase to $1.25 billion subject to lender approval. At September 30, $701 million was available under the prior facility. The company reported compliance with debt covenants.
- Management expected to spend approximately $120 million on construction and development and $25 million on operating-property improvements and leasing during the remainder of 2018. It stated liquidity was adequate for near- and longer-term needs without requiring property sales. No specific earnings or FFO guidance was provided in the filing text.
- Development and redevelopment obligations totaled $163.1 million; operating-property capital expenditure commitments were $39.7 million. Lease obligations, primarily ground leases, extended to 2100. Expected contractual debt balloon payments included $99 million in 2019 under the former facility; the new facility changes the revolving-credit maturity, subject to its terms.
- Interest-rate exposure remains relevant: a 1 percentage-point increase in LIBOR would have increased nine-month interest expense by an estimated $1.4 million. Interest-rate swaps had a $10.9 million fair value asset; approximately $2.5 million of gains were expected to reduce interest expense over the next 12 months.
- Principal risks cited include government shutdowns or budget reductions affecting tenants and demand, real estate and financing conditions, development execution and costs, joint-venture risks, dilution from equity issuance, REIT tax requirements and environmental matters. Management reported no material change to the risk factors in its 2017 Form 10-K and no material litigation known to it.
- A data center shell property sale was treated as a financing arrangement through September 30 because of a buyer guaranty; the guaranty expired October 1, 2018 without loss, and accounting recognition of the sale followed. The company also retrospectively adjusted 2016 and comparative periods after adopting real estate derecognition guidance, recognizing an additional $18 million of income in 2016.
Most important facts for investors to verify
- Whether occupancy and leasing improve as newly completed space is occupied, especially in Northern Virginia and the Fort Meade/Baltimore-Washington corridor.
- Development delivery, leasing, cost estimates and funding needs against the $163.1 million of remaining development commitments and planned spending.
- Debt maturities, borrowing availability and covenant headroom under the replacement revolving facility, including the 2019 maturity presentation.
- Cash-flow conversion and recurring operating performance apart from variable construction-service revenue and prior-period property-sale gains.
- Government tenant exposure and any budget, shutdown or mission-related changes that could affect leasing, renewals or collections.
- Equity issuance and share-count growth, and the effect on per-share FFO and distributions.