Business context and reporting period
Corporate Office Properties Trust (COPT; NYSE: OFC), a REIT focused on office properties serving U.S. government and defense information technology customers, filed this Form 10-K for the year ended December 31, 2011. The filing provides annual results; it does not present a separate full-year-comparable Q4 financial summary. At year-end, COPT had 238 operating office properties totaling 20.5 million square feet, 86.2% occupied, plus seven properties under construction or redevelopment and a partially operational wholesale data center.
Financial and operating performance
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $556.8 million | $537.6 million |
| Real estate operations revenue | $472.5 million | $432.9 million |
| Operating income | $4.1 million | $124.5 million |
| Net income (loss) attributable to common shareholders | $(133.8) million | $26.7 million |
| Diluted EPS | $(1.94) | $0.43 |
| NOI from real estate operations | $299.8 million | $282.0 million |
| Diluted FFO per share | $0.76 | $2.30 |
| Diluted FFO per share, adjusted for comparability | $2.17 | $2.36 |
| Cash provided by operating activities | $152.1 million | $156.4 million |
| Cash used in investing activities | $260.4 million | $479.2 million |
| Cash provided by financing activities | $103.7 million | $324.6 million |
Total revenue grew 3.6%, led by real estate operations; service revenue declined as a large construction contract wound down. Real estate NOI increased 6.3%, primarily from new construction and acquisitions, while Same Office NOI fell $4.5 million. Same Office occupancy declined to 89.9% from 90.1%; overall portfolio occupancy fell to 86.2% from 87.6%. The reported common-share loss largely reflected $151.0 million of impairment charges and a $29.8 million loss on interest-rate derivatives. Adjusted EBITDA was $286.7 million; interest coverage was 3.08x and fixed-charge coverage 2.61x.
Year-end assets were $3.87 billion, total equity $1.22 billion, and debt $2.43 billion, up from $2.32 billion in 2010. Cash and cash equivalents were $5.6 million; restricted cash and marketable securities were $36.2 million. The $1.0 billion revolving facility had $329.6 million available at year-end. Approximately $1.14 billion of debt was variable-rate; management estimated that a 1 percentage-point increase in short-term rates would have increased 2011 interest expense by $3.8 million. COPT reported compliance with debt covenants, but disclosed default on a $15.2 million nonrecourse mortgage secured by a property with estimated fair value of about $9 million.
Material changes versus prior comparable period
- Common-shareholder results moved from $26.7 million income to a $133.8 million loss; operating income fell to $4.1 million from $124.5 million.
- Impairments totaled $151.0 million, including charges on assets slated for strategic disposition and a $27.7 million Fort Ritchie property write-down. The Fort Ritchie charge followed Army disclosures about historical herbicide use and increased uncertainty over development rights and future demand.
- COPT recognized a $29.8 million derivative loss after forecast borrowings underlying swaps were no longer expected to occur; it cash-settled the related swaps for $29.7 million in January 2012.
- Overall occupancy declined, though Same Office occupancy was nearly stable. Same Office leasing rents decreased by about 3.2% on average, while GAAP revenue on those leases increased about 5.2% relative to prior leases.
- Debt increased by $102.6 million. COPT established a new $1.0 billion unsecured revolver and borrowed $400 million under a term loan, repaid prior facilities and $270.3 million of variable-rate secured loans, and repurchased $162.5 million of 3.5% exchangeable notes.
- COPT issued 4.6 million common shares for net proceeds of approximately $145.7 million before offering expenses. Cash dividends declared rose to $1.65 per share for 2011 from $1.61 in 2010, but a 2012 quarterly dividend reduction was announced.
Outlook, risks and unusual items
Management described leasing conditions as challenging: the economic recovery was tepid, tenants remained cautious, and uncertainty over defense spending and federal budget actions delayed leasing. COPT expected the late-2011 defense budget approval to release some delayed leasing, while anticipating continued pressure from possible defense spending reductions. Government and defense IT tenants represented 59.9% of office annualized rental revenue; the U.S. Government alone represented 22.2%. The 20 largest tenants generated 60.3% of annualized office rental revenue, and the Greater Washington, DC/Baltimore region represented 84.7%.
The Strategic Reallocation Plan covered land and 83 operating properties with estimated fair value of $562 million at year-end. COPT expected to complete office dispositions by the end of 2013; 2011 sales under the plan totaled $76.7 million. Management estimated net proceeds after property-secured debt repayment of approximately $441 million. For 2012, COPT expected more than $200 million of property sales, over $200 million in construction and development spending, and approximately $80 million of operating-property improvements. It expected to arrange $175–$200 million of unsecured long-term borrowing in the first half of 2012, principally to reduce revolver borrowings. Management expected to be less likely to begin construction before more definitive leasing prospects were in place.
The first-quarter 2012 common dividend was cut 33% to $0.275 per share, from $0.4125, with management expecting the lower rate to continue at least through the remainder of 2012. Risks include federal budget cuts or shutdowns, short government lease terms and termination rights, tenant and geographic concentration, refinancing and interest-rate exposure, execution of property sales and developments, data-center leasing and obsolescence, and environmental and development uncertainty at Fort Ritchie. The filing reports no other material litigation; routine claims were expected to be substantially covered by insurance. A joint-venture guarantee exposure could reach approximately $65 million, subject to specified indemnity recovery.
Most important facts for investors to verify
- Progress and actual net proceeds from the Strategic Reallocation Plan, including whether dispositions occur on schedule and at expected values.
- Occupancy, renewal rates, rental-rate trends, and the effect of federal budget decisions on government and defense contractor leasing.
- Debt refinancing needs, particularly 2014–2015 maturities, variable-rate exposure, revolver availability, and the disclosed mortgage default.
- Whether recurring cash generation and adjusted FFO support the reduced dividend and planned capital expenditures.
- Further impairment, development-rights, environmental, or litigation developments concerning Fort Ritchie and other properties.
- Leasing progress, remaining capital requirements, and realized returns for the wholesale data center, which had no new leases signed in 2011.