COPT Defense Properties (CDP) Earnings Call Transcript & Summary

Thank you all for joining us for the final roundtable of the Bank of America's 2025 Global Real Estate Conference. I'm Jana Galan, and I cover the office REITs at BofA. We're very pleased to have with us COPT Defense Properties CEO and President, Steve Budorick here today. Steve will introduce his team and provide some opening remarks, and then we'll open it up for questions.

So with me is our Chief Operating Officer, Britt Snider; and our Chief Financial Officer, Anthony Mifsud and we're pleased to be here. So thank you. So COPT Defense Properties is a specialized REIT, deeply concentrated mission-critical assets that support the national defense activity in the United States government. The vast majority of our 204 properties are located adjacent to are sometimes occupied by priority defense missions generally involving knowledge-based defense activities. Missions that we support include intelligence, surveillance, reconnaissance, cybersecurity and network activity, naval sea and air technology development, missile attack and defense systems, drone aviation technology, development cloud computing and others. Our property locations are not typical for an office company because they are proximate to important United States defense installations in Virginia, Maryland, Washington, D.C., Alabama and Texas. Our properties are unique in that they are approved for top secret mission work. 80% of our defense portfolio contains high security operations and that 80% includes 8 U.S. government secured campuses, representing over 4 million square feet that are built to antiterrorism force protection and SCIF standards. SCIF is an acronym for secured compartmentalized information facility. We have another 1 million square feet of U.S. government leases that our SCIF and access controlled outside campuses. We have over 6 million square feet of defense contractor leases that contains SCIF in them. And we have 15 cloud computing campuses representing over 6 million square feet that's fenced and has limited access. An additional nuance of our business is our defense tenants have to work from their office. And they did so throughout the pandemic environment because if they take their work home, it's [ SBNage ] and they go to jail. So it's a big differentiator. Today, over 90% of our annualized rental revenue is derived from our defense IT properties. Our pre-leased developments that are available in our supplement, we'll increase that figure in coming years. And our Defense/IT segment was 96.8% leased at quarter end, well above our peer average. The U.S. government is our largest tenant by revenue. We have over 100 separate leases and 70 different properties. That totals 5.6 million square feet and produces 36% of our annualized rental revenue. Defence contractor tenants lease 15 million square free for us. This includes 3 million square feet of cyber defense contractor tenants and defense contractors contribute 51% of our annualized rental revenue, 15 of our 20 top tenants are defense tenants. Our nondefense locations provide just 10% of annualized rental revenue. And they consists of 5 properties, 3 in downtown Baltimore on the waterfront, one in Downtown D.C. and one in Tysons Corner. Our tenants and these assets also have excellent credit, but we do plan to recycle these assets as market opportunities support reasonable sale values. Our strategy is straightforward and pretty simple. We allocate capital to durable demand locations adjacent to priority defense missions and we do that primarily through low-risk, highly pre-leased development. Occasionally, we get an opportunity to redevelop an asset or reposition, but development is our major strategy. And of course, we maintain a strong investment-grade rated balance sheet. So our competitive advantage really falls in 4 pillars. We have an operating platform with experience and credential workforce. We've been serving the U.S. government has a landlord for over 30 years. And over that 30-year period, over 40%, we've reached the point where over 40% of our employees are cleared to design, build and operate the highest security level assets in the U.S. DoD. Over those years, we've also accumulated immense development experience, that includes SCIFs, antiterrism force protection, data center and other specialized mission-critical facilities for the U.S. government. As I mentioned, we have a 30-year track record of not only designing, building, but the important distinction is we actually operate the properties. So our teams are embedded with their secure customers as part of the delivery vehicle for the mission. And this is all built upon advantaged land positions that we identified years ago, made investments in land and we continue to develop on land we primarily own. So to wrap it up, we are a specialized REIT. We're not correlated with the broader economy because we're deeply correlated with the defense industry. Our assets have strategic features and locations. There's little risk of work from home across our portfolio, and we've enjoyed strong demand for new development and vacancy and leasing for years. There's 4 main points. I'd like you to leave with today. First, we have strong underlying tailwinds from the growth in the defense budget, the funding for the Golden Dome, defense shield for the United States and the relocation recently announced relocation of Space Command headquarters from Colorado Springs to Huntsville. I might add, it will go on the land that we control and we will develop the properties. Second point is growth. In 2025, we're forecasting nearly 4% FFO per share growth at the midpoint of our guidance, and that would mark our seventh consecutive year of FFO growth. And we've increased the dividend nearly 11% over the last 3 years. And we are the only office REIT to raise the dividend in both '23 and '24, and we did it again in '25. Third key point is leasing. We're very confident we'll meet or exceed our leasing targets, we set an initial goal of 400,000 square feet of vacancy leasing. We achieved over 350,000 in the first half. We elevated our guidance modestly, and we're very confident we'll deliver that. And then fourth, we set a guidance of committing $225 million to new developments over the year. At midyear, we're at $50 million. We are in advanced negotiations with 6 different tenants for build-to-suit solutions, 3 of which we think will secure during the remaining part of the year, and that will achieve our objective. And finally, I'd like to point out we're still a great value at $30.44, trading at a mere 11.4x FFO and only 2 turns above our 10-year low. We have a 4% dividend yield, and we trade at a 9% discount to our NAV. It's a good time to buy our shares. With that, back to you, Jana.

Thank you, Steve. So following up on the correlation with the defense industry, if you could help us with your defense budget outlook and what's -- what are the key takeaways from big beautiful bill and then the President's budget request for fiscal '26?

So big beautiful bill is really unusual in that the Congress preappropriate at $150 billion for the next 5 years. But within that pre-appropriated amount, $113 billion will occur in fiscal year '26, which starts on October 1. So that adds $150 billion to the current base defense budget of, call it, $833 billion. So it represents a 13% increase, the largest nominal increase in defense spending in a single year over the last 25 years and the second biggest percentage increase. So it sets a strong backdrop for our ability to generate business out of that funding. We guide investors to expect incremental leasing and development opportunities from defense budget increases trailing 12 to 18 months as that money has to get matriculate its way through the government program of procuring new contracts, issuing those contracts to contractors, finalizing awards and then we lease space. So it's a pretty exciting thing.

And on the President's budget?

So the President's initial budget is right on top of last year's budget. So it's $831 billion. That's what's been submitted to Congress. It's not unusual. It's almost common that by the time it makes its way through the House and Senate, it actually grows. So base case is flat base budget from last year, it wouldn't surprise me at all if it increases by a couple of percent.

And this morning, we had a policy panel, and they kind of talked to the potential risks of a government shutdown. Does that in any way potentially impact or delay rent payments or...

No. But it usually represents a good time to time our stock. Because people think it's going to hurt us and it doesn't. And if we lose a little bit on our price, you should time your buy to that. So our leases are covered -- I forget the act, but the government is required to pay our leases. The missions we support are all essential missions. And so they will work through any shutdown that does occur. The last time we had a shutdown, at one of our locations, the only impact that occurred is the line of cars waiting to get on base got longer because they deem the security access point is not essential and reduce it by half. But government shutdowns are not a factor for our company.

And there was some big, exciting news last week with the relocation of Space Command HQ to Huntsville, you mentioned this could be a great opportunity. If maybe you can give us some more color and details around this?

Yes. So to give you some history, Space Force was initiated by President Trump. By the end of his term, there was competition that occurred to identify the best place for the unified combatant command for space called Space Command and it was determined that Huntsville was the best location on the Redstone Arsenal. When President Biden came into office, it was contested several times by locations that didn't win the contest. In each case, it was readjudicated for Huntsville and Redstone Arsenal. And then through a presidential order it was maintained in Colorado Springs, but it was never funded properly to create facilities they need. That decision was reversed last Tuesday. Appropriations have been set aside to build a new command for Space Command. It's been publicly announced that it will be on the enhanced used lease that COPT defense properties has on Redstone Arsenal land and we will be the developer. It looks like that development will represent three buildings, 450,000 square feet to 480,000 square feet to move the entirety of the command to the Arsenal in 2 years or less. We're the only solution that can get them the facilities they so badly need have been politicized for 5 years and get the mission in its proper form. Beyond the command, the command has led us to expect that the contractor support tail that they currently expect to follow them, could be twice as big as the area required for the command. So it would apply another 1 million square feet of development opportunity over the coming years as the new facility is constructed. The SCIFs are completed and certified, the commands relocated and the contractors file.

And can you let us know maybe the time line around that initial 3 buildings?

Well, we're ready to start. We've been planning these buildings for a long time. We had developed this plan over 5 years ago. We are -- we've prepared the land with utilities and we're ready to commence. We'll start one building very shortly, be willing to start that building without a signed lease and then as we get a lease document formulated, we sequentially developed the next 2 right behind it.

Great, any questions in the room?

I mean when you personally leave the company, what kind of knowledge do they take [indiscernible]

Our company?

Yes

[indiscernible]. You got to have a little fun, is the last conference here. No. We've got an amazing history of long-term service of the company through retirement. It's staggering. Over 1/3 of our employees have been with us for like 20 years or more. Those that tend to retire, they stay pretty involved with us. We maintain very good relationships with them and rarely do we see anybody leave to go to a competitive company. Not that there is one that's directly compatible.

The 1 million square feet of contractor [indiscernible]. What's your thought about how much of that you will directly see [indiscernible]

So it's a little less clear, Jordan. First of all, how much will we see? To the extent it comes is a guidance from the government for our expectations. We started our Redstone development with our first building in 2011. And we've grown that to 24 buildings and 2.5 million square feet not quite half the capacity that we can develop. We have rarely lost a new tenant to another location in Huntsville because the advantages of being on our development. So my expectation is we will get the lion's share. And by that, it wasn't over 90%, I'd be surprised. When it comes, this is -- these are contractors supporting the mission. And so until the mission is ready to move, I don't think they're going to relocate. Now certainly, if they're going to require SCIF, they're going to have to build in a lot of time to have that SCIF created and provisioned and that's a very time-consuming, very technical process. So my guess is we'd start to see firm commitments to relocate lease space and start SCIF process in roughly a year.

[indiscernible]

It's too early for me to know that. I don't think it will -- we expect our delivery from building 1 to 3 to be a matter of a month or so, not longer periods of time. And what their actual strategy is to populate, I can't speak to that.

[indiscernible] Is there any [indiscernible] cost for that development?

So we've routinely developed our defense contractor buildings over the last 3 years at 8.5% cash on cash and often by the time we punch out the project, it accretes up.

Is that a cash [indiscernible]

No, it's just cash on cash, initial, not average, not GAAP cash.

[indiscernible] open to change the economics given the patent [indiscernible] was strong side and [indiscernible] is pretty high.

Well, we're always looking to do better than I say we do. But I'd now like to make statements. I can't back up.

Great. Maybe turning over to the Golden Dome, the opportunity and kind of just overview what exactly that entails?

So the Golden Dome is a fascinating initiative, maybe 1 of the biggest DoD has committed to in 30 years. But it represents creating an anti-missile defense shield for the United States of America, the entire country. Currently, we're protected by what's called GMD ground missile defense and ground-based missile defense. And that program is run out of the Redstone Arsenal and the contractors in our buildings at Redstone Gateway. But this is elevating that from just a defends against intercontinental ballistic to any missile of any form. So initially, we're advised that it will be an enumeration of disparate technologies from a wide variety of contractors, combined and integrated into a cohesive defense structure distributed across the country. But then eventually, new technology will have to be advanced and created to both improve identification of threats and potentially target them from space. The initial budget is estimated to be $175 billion, and they would like it to be operational by 2029 or 2030. The one big beautiful bill Act appropriated $25 billion for a down payment on system, and that is in the fiscal year '26 spend. And that implies $150 billion of incremental investment over, call it, the next 4 years to integrate current technology, advance improve our new solutions and deploy it. So it's pretty exciting. The Missile Defense Agency is at Redstone Arsenal and that will be the primary vehicle for coordinating all this activity. So beyond Space Command, this development of a new system will be paralleled to it. So we expect that will be a strong driver of leasing demand as well.

So over the last, I'm not sure what the right time frame is 10 years, whatever you've done a very good job of transitioning from a company that describes itself as a defense provider of defense space to an actual company that provides defense largely predominant defense contractors. Do you have any -- what's the amount of space left that would be considered either government less mission-critical or not defense related? And is any of that subject to the kind of review -- overall review that's gone on relative to real estate space used by the government?

So first of all, a point of clarification. I did join the company 14 years ago, and we were more than 50% defense tenancy, we were less disciplined in concentrating into defense. And in the 9 years I've been CEO, every incremental investment has been into the Defense/IT space, and we're now at 90%. So it went from roughly to 50% to 90%. What's left is that in our Defense/IT portfolio. It was just 5 buildings, their legacy assets that we were unable to recycle when the market would support that efficiently and we've identified them as recycling targets as interest rates provide a more attractive way to do that. Within our Defense/IT portfolio, I made this comment in our remarks, 80% of the space has high security improvements. So there is some defense contractor space that is not SCIF, but it's a very small fraction. I think I answered the question. Did I miss any?

So you're saying, essentially, there's nothing at risk relative to the quarter review of government?

Yes, I missed that nuance. Yes. Those really had no impact on our company at all. And if you really go back and read Pete Hisut's comments. He wanted to find 15% savings in administrative and overhead costs. He didn't want to cut spending. He wanted to reallocate that money to support mission. The one thing we've been extraordinarily disciplined at is when we build and lease or buy a building and what we elected to sell is corollary, we want mission work. We don't want headquarters work. We don't want back office. We don't want executives. We want the mission work in our buildings. And so the movement in this efficiency environment is to get more money to the mission, and that plays right to our portfolio.

You touched on the strength in leasing and you almost met your full year target at the half point of the year. Maybe if you could just kind of give an overview now of the demand out there in the market, what you're seeing, how the leasing pipeline is shaping up?

Yes. So we maintain every week, a leasing pipeline that probability ranks all our prospects, and then it measures that as a percentage of vacant space left in our portfolio. So that pipeline currently is just over 70%. So that means we have prospects for over 70% of the space that we have vacant. So that's a very strong level. From a timing standpoint, we expect second half volume to be a little less strong as our first half because of the timing of the appropriation of the fiscal year 2025 defense budget. With the change in the presidency that budget, we experienced the longest continuing resolution in the history of the government. It was appropriated on July 4, and much of the demand we're working with is anticipating new contract awards that will allow them to expand their footprint. And so the timing of that will be more '26 oriented because it takes a long to get to the one big beautiful act and that appropriation done. But we will hit our full year elevated guidance of 450,000 square feet, which, by the way, represents more than 1/3 of the vacancy we had on January 1.

And how do you think about pushing [indiscernible]

Well, I like occupancy, and I love retention. That's a better question. We like to think -- when we get defense tenants in our buildings. They typically co-invest to create SCIF and specialize and that drives our just uniquely immensely high retention rate. So we're always looking for occupancy rate, we have to be sensitive of what the market rate is. And as a strategy, we want to be a business partner to our tenants, and we never want to be in a position where they feel like we've taken advantage of them because they need to be in our portfolio. So we get premiums, but we don't push them to outrageous levels and our simple comment is pigs get fat and hogs get slaughtered and we never want to be a hog and if you look at our tenancy, you take out our biggest 2 tenants, we average 4 to 6 leases with defense contractors in multiple locations. And it's that partnership that we're really driving for. So I think I kind of ducked it, but I talked about.

Could you give an update on [indiscernible]?

Sure. So I forgot the number, we have over 6 million square feet of data centers. A significant portion of those are in a joint venture, that we use to create -- to recycle capital and support our development in prior years where we need more capital to fulfill our development opportunities. Those were developed over a longer period of time. I can say this much. Many of them have mark-to-market on renewal and those mark-to-markets have been 100% or more increases in the rent. And although we extracted great development profit from those, their value has more than doubled since we joint venture them. And we continue to have about 2 million square feet that we've developed and retained full ownership of, including 2 that are going to develop this year. In terms of future development, we did acquire 365 acres outside of Des Moines, Iowa is a long-term investment in land for a new location to reenergize that development component of our business, but we expect it will be roughly 4 years before we start break ground. Because of the power constraints nationally and in particular, in that particular service area.

I'm sure you answered the question [indiscernible]

Well, it's the fifth biggest hyperscale market in the country, believe it or not. You got to get on a plane and fly there Jordan and drive around. I'd identify all the tenants that are there, but then by omission, I might imply what -- who our customer is. So I won't, but all the bigs are there. There's a significant amount of really impressive data center facilities in the area. And it was a place for us to bring a new idea and execution capability to a long-term customer that was compatible with their own objectives. So it's just a good fit for us, they do some quite a bit.

It seems a little outside of your [indiscernible]

Well, we're looking long term. The opportunity set in Virginia has become extraordinarily low. We spent $32 million on 366 acres. If we have bought that land, if we could find it, and buy it in Northern Virginia. It would have been $1.2 billion at the then current market value that existed last year when we made the investment. The communities in Northern Virginia, they become decidedly anti-development for data centers. They've kind of had their fill of it. One of the counties that is an opportunity, they're contemplating a new law that says for every acre you develop into a data center you have to set aside 5 acres for farmland, which suggests you'd have to -- for every acre you develop, you have to own 6 and the price per foot is now lower. So its becoming very difficult.

[indiscernible]

It will, but it's still -- it's an expensive game of poker. So we look long term. How do we set up a win-win for us and our customer in a new market that will allow us to support their business and thereby benefit our shareholders.

[indiscernible] market you're offering a [indiscernible]

So in our core defense world, competition tends to be local or fragmented ownership are probably most competitive market is Northern Virginia. It's a very big office market and we don't dominate the square footage in that market. We certainly have a dominating franchise where we tend to win more opportunities because of what we can offer those defense tenants. But in most of our locations is that strong competition. There's theoretical competition, and there's no company that touches as many markets as we touch.

What's the [indiscernible]

Yes. So the government buildings. They talked about 8 campuses. Those are in secure locations where they're clustered and they're fenced, and we've never -- in over 30 years of developing and leasing to the government, we've never had a full building not renew. Hypothetically be awkward if that building was behind the fense and it did not renew, but it's ever happened. In terms of non-fense buildings, their office buildings. So if we had to lease them to an non-fenced tenant, it's no different than any other building. The trend is really the contrary, one of our -- where our headquarters is Columbia Gateway. Traditionally, our tenancy has been roughly half defense tenants, half not. Over the last 4 years, that has really trended to the point where 75% of the same building set is defense tenants and almost all of that growth was cyber or we'll call it signals intelligence related and required SCIF facilities.

Unfortunately, we're out of time, but I'd like to conclude with a rapid fire questions. We've been asking all the REITs presenting at the conference. When the Fed starts to cut, do you expect rates for long-term debt to decline, stay flat or rise?

They will decline. We expect them to decline, but it's going to take 6 to 9 months.

Last year, the majority of companies stated they're ramping up spending on AI initiatives. How would you characterize your plans for the next year, spend more, flat or less?

Flat, which is virtually nothing.

And do you believe same-store NOI for your sector will be higher or lower or the same next year?

It will be lower. But ours will be higher.

Thank you very much.