COPT Defense Properties (Corporate Office Properties Trust) — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The company is a REIT focused primarily on office properties and data center shells in U.S. Government/defense and IT locations, alongside a regional office portfolio.
Business and operating context
- At quarter-end, the portfolio comprised 188 properties totaling 22.1 million square feet; 12 properties were under development, with an estimated 1.9 million square feet upon completion. Approximately 710 acres were controlled for future development.
- Portfolio occupancy was 92.7% and leasing was 94.9%. Defense/IT occupancy was 93.9%; Regional Office occupancy was 81.5%, down from 87.3% at year-end 2021.
- During the first nine months, COPT leased 2.3 million square feet, including 1.2 million square feet of renewals and a 72.0% tenant retention rate. Three new developments totaling 363,000 square feet entered service and were 98.6% leased.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total revenue | $182.5 | $166.9 | $563.8 | $478.5 |
| Income from continuing operations | $32.3 | $28.3 | $97.2 | $64.7 |
| Net income | $32.3 | $28.8 | $126.7 | $66.6 |
| Net income attributable to COPT common shareholders | $30.9 | $27.1 | $122.6 | $62.8 |
| Diluted EPS | $0.27 | $0.24 | $1.08 | $0.56 |
| Diluted FFO per share | $0.58 | $0.56 | $1.75 | $1.19 |
| Diluted FFO per share, adjusted for comparability | $0.58 | $0.57 | $1.75 | $1.71 |
- Q3 lease revenue was $146.5 million, up from $138.0 million. Construction and other service revenue was $34.8 million, up from $28.0 million; related costs were nearly equal to revenue, leaving $1.3 million of service NOI.
- Nine-month operating cash flow was $187.1 million, compared with $199.9 million. Investing activities used $82.4 million and financing activities used $105.6 million. Cash and cash equivalents were $12.6 million at September 30; cash plus restricted cash was $16.4 million.
- Real estate NOI was $91.1 million in Q3, up $0.6 million year over year; nine-month NOI was $268.5 million, down $1.9 million. Same-property NOI declined $2.0 million in Q3 and $6.2 million year to date.
- Debt, net, was $2.270 billion at September 30, versus $2.272 billion at December 31, 2021. Q3 interest expense was $15.1 million; nine-month interest expense was $44.4 million, down from $49.2 million. The quarterly common dividend was $0.275 per share.
Material changes and unusual items
- Total revenue growth included a sharp increase in construction and service activity, which carries low margins. Nine-month construction/service revenue rose $66.0 million, with related expenses increasing $64.5 million.
- Nine-month net income included a $28.6 million gain from the January 2022 sale of the wholesale data center for $222.5 million. The property is presented as discontinued operations. The prior-year comparison included a $39.7 million gain on sale and a $59.6 million loss on early debt extinguishment; these items make reported net income comparisons less representative of recurring operations.
- Same-property NOI was pressured by lower occupancy in Regional Office, including the expiration of a 140,000-square-foot lease, and by a 121,000-square-foot Redstone Arsenal property vacated in late 2021. The Redstone space has since been fully leased, with occupancy expected in 2023. New developments helped offset same-property weakness.
- Investing receivables, net, rose to $102.6 million from $82.2 million; the allowance for credit losses increased to $3.7 million from $1.6 million. Management attributed higher credit loss expense largely to newly issued investing receivables.
Liquidity, outlook, risks and contingencies
- At September 30, the existing $800 million revolver had $273 million drawn and $527 million available. On October 26, 2022, COPT entered into a new credit agreement providing a $600 million unsecured revolver and a $125 million unsecured term loan. The term-loan proceeds repaid the remaining $100 million on the prior term loan and reduced revolver borrowings. Management said this left no significant debt maturity until 2026.
- Management expected approximately $80 million of development spending during the remainder of 2022, most contractually committed, and approximately $40 million for tenant and capital improvements. It expected to fund ongoing requirements primarily from operating cash flow and borrowing capacity, with anticipated data center-shell joint venture interest sales and other financing or property transactions as potential sources to replenish capacity.
- No specific earnings or FFO guidance was provided in the filing. Management said Defense/IT leasing demand remained strong, while Regional Office leasing conditions remained challenging. Inflation and supply constraints had not significantly affected execution to date, but further cost increases could reduce development yields or delay improvements. Higher rates and volatile capital markets could also impede property sales and raise future borrowing costs.
- Approximately $200 million of variable-rate debt had been hedged by swaps fixing one-month LIBOR at about 1.9%; those swaps expired December 1, 2022. Management reported that a 1% increase in LIBOR would have increased nine-month 2022 interest expense by $0.8 million. Most debt was fixed-rate, and the company was compliant with its financial covenants at quarter-end.
- Management considered a loss of up to $3.9 million on certain municipal tax claims reasonably possible; it did not expect a material effect on financial position or liquidity, though results of operations could be affected. The company also disclosed environmental indemnifications capped at $19 million in aggregate, with insurance intended to mitigate much of any potential loss, and a roughly $29 million tax-increment financing obligation for which it did not expect to fund future shortfalls.
- Management stated there were no material changes to the risk factors in its 2021 Form 10-K. It also reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Key facts for investors to verify
- Execution and cost of the October 2022 refinancing, including borrowing rates, facility availability and the effect of expiring interest-rate hedges.
- Whether Regional Office occupancy improves and the expected 2023 occupancy of the re-leased Redstone property.
- Delivery, leasing, costs and yields for the development pipeline, and the timing and proceeds of planned data center-shell joint venture transactions.
- Credit performance and allowance adequacy for investing receivables, including the Huntsville-related loans and newly originated balances.
- Resolution of the municipal tax claims and any change in the company’s assessment of contingencies or liquidity needs.