Corporate Office Properties Trust

F:WX7

Earnings Call Analysis

Strong Q3 Performance with Raised NOI Guidance

The company reported a solid third-quarter FFO per share of $0.60, aligning with the midpoint of their guidance and showcasing an increase in occupancy and developments. This was somewhat offset by higher interest expenses. Encouraged by a strong year-to-date performance and lower free rent concessions, the company raised its same-property cash NOI guidance by 100 basis points to 6%, a total increase of 300 basis points from the beginning of the year. Occupancy increased to 93.4%, and while year-end occupancy projections reduced slightly to 93.25%, it only corresponds to a minor 50,000 square foot change. A recent $345 million debt issuance secured funding through 2026, minimizing risks in volatile markets and circumventing the need for external capital. Despite recognizing impairment losses of $253 million due to extreme market conditions, the company remains confident in the underlying value of its assets and its ability to navigate market uncertainties.

Financial Performance and Guidance Improvements

The announcement highlighted a third-quarter Funds From Operations (FFO) per share of $0.60, aligning with the midpoint of the company's guidance. This reflects benefits from increased occupancy and revenue from developments placed into service, though tempered by higher interest expenses. As a testament to robust year-over-year growth, same-property cash Net Operating Income (NOI) forecasts outperformed initial expectations, leading to a raised guidance midpoint by 100 basis points to 6%.

Occupancy and Lease Commencements

Properties ended the quarter with an occupancy rate of 93.4%, signifying an increase both sequentially and year-over-year, largely driven by significant lease commencements. Despite a 25 basis point decrease in year-end occupancy guidance due to certain leases slipping into the following year, the adjustment represents a minimal footprint change of 50,000 square feet.

Debt Issuance and Balance Sheet Strengthening

The company successfully issued debt, with the issuance of $345 million in exchangeable notes at a 5.25% coupon rate, maturing in 2028. This strategic move reduces execution and pricing risks in volatile markets, secures development funding through late 2026, and mitigates cash drag from proceeds. Additionally, proceeds improved the balance sheet by paying down the line of credit and funding anticipated annual development investments ranging between $250 million to $275 million over the next three years without external capital requirement.

Portfolio Restructuring and Asset Impairments

A rebranding initiative prompted the combination of reportable segments and reclassified certain assets ultimately leading to the recognition of impairment losses amounting to $253 million. These properties' valuations are reflective of the current challenging market conditions and carry the potential for improved sales prices if market conditions ameliorate.

Development Prospects and Underwriting Changes

Characterizing the company's approach to development, executives highlighted that targeted cash yields on new developments have increased, exemplifying prudent financial management amid changing market conditions. Management expects a continued steady range for rent spreads, indicating stability despite macroeconomic factors. The company is confident in its development pipeline, which is mostly filled with new business opportunities with defense contractors, comprising roughly 700,000 square feet of associated data center space and other defense projects spread across various locations.

Market Conditions and Strategic Positioning

The company's competitive differentiators were emphasized, including alignment with high-priority national defense missions, strategic land positions for growth, an industry-leading retention rate, strong tenant credit quality, and a robust balance sheet strategically positioned to fund developments through 2026 without incurring further debt or equity. The company awaits improvements in the functioning debt market before capitalizing on asset monetization opportunities.

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to the COPT's Defense Properties Third Quarter 2023 Results Conference Call. As a reminder, today's call is being recorded.

At this time, I will turn the call over to Venkat Kommineni, Cops Defense Vice President of Investor Relations. Mr. Kommineni, please go ahead.

[Venkat Kommineni, executive]

Thank you, Abigal. Good afternoon, and welcome to Comp Defense's conference call to discuss third quarter results.

With me today are Steve Budorick, President and CEO; and Anthony Mifsud, Executive Vice President and CFO.

Reconciliations of GAAP and non-GAAP financial measures that management discusses are available on our website in the results press release and presentation and in our supplemental information package. As a reminder, forward-looking statements made during today's call are subject to risks and uncertainties, which are discussed in our SEC filings. Actual events and results can differ materially from these forward-looking statements, and the company does not undertake a duty to update them.

Steve?

[Stephen E. Budorick, executive]

Good afternoon, and thank you for joining us. Our investment strategy and differentiated portfolio continue to generate strong operating results and support the positive outlook we have for our business for the coming years.

On September 15, the company adopted a new name, COPT Defense Properties, a new ticker CDP and a new logo, which combines some important symbols of our core customers. The Shield shape is assemble of military strength in defense activities. The Flag identifies the United States of America, which is not only the country we serve, but our #1 tenant.

The Eagle is a symbol of the U.S. Army. The Star, the symbol of the U.S. Navy and the Lightning Bolt, a symbol of both, the U.S. Air Force and U.S. Cyber Command. We rebranded to better inform investors of our capital allocation strategy, and portfolio quality and to provide investors with a loud reminder that we completed the transformation of our portfolio back in 2018.

Over the past 12 years, we sold over 10 million square feet. We acquired only 1.5 million square feet. We developed over 11 million square feet. And today, 70% of our portfolio has been developed by us.

These modern, efficient buildings were developed for the missions we serve and are located in the best Defense/IT locations. The key point is COPT Defense Properties is not the old Corporate Office Properties Trust, and that's why we changed the name. To provide clarity to investors, this is a different company, and we've created a unique REIT platform that is outperforming peers.

Turning to highlights from the quarter. We delivered strong results with FFO per share at the midpoint of our guidance. Our Defense/IT portfolio is 97% leased, which is the highest level since we began disclosing the segment in 2015 and represents a 70 basis point year-over-year increase. We raised the midpoint full year same-property cash NOI guidance by another 100 basis points, driven by another strong quarter and great performance year-to-date.

We remain on track to achieve our full year goals for vacancy and development leasing, replaced 443,000 square feet of development projects into service during the quarter, which are 98% leased.

Our 1 million square feet of active developments are 90% pre-leased. We raised $345 million in exchangeable notes in September. And once combined with our free cash flow, we now have the necessary capital to fund our expected development investment through late 2026. We narrowed the range of FFO per share guidance and expect to deliver FFO per share growth of 2% this year, which is 1% higher than our initial expectations.

Moving to specific results for the quarter. We reported third quarter FFO per share as adjusted for comparability of $0.60. The total portfolio is 95.1% leased and 94.1% occupied. Same-property cash NOI increased 4.5% over the third quarter of last year, and increased 6.2% during the first 9 months of the year.

We executed 151,000 square feet of vacancy leasing with a weighted average lease term of over 8 years, which brought our total for the 9 month ended to 337,000 square feet. Based on our pipeline of demand across our portfolio that is in advanced negotiations, we're highly confident meeting or exceeding our full year target of 400,000 square feet.

Our overall portfolio leasing activity ratio remained strong at 71%, with a pipeline of 861,000 square feet of vacancy prospects. In our Defense/IT portfolio, we have 695,000 square feet of available inventory and our activity ratio is an even more impressive, 104%.

Turning to quarterly leasing results, total leasing volume of 521,000 square feet included 370,000 square feet of renewals. Our retention rate was 82% and is 82.5% year-to-date.

In our Defense/IT portfolio, the retention rate was also 82% and is 87.3% year-to-date. Cash rent spreads were up 1.7%, while GAAP rent spreads were up 9.3%, driven by annual rent increases of 2.7% with a weighted average lease term of 4.2 years.

Year-to-date, rent spreads are up 1.2% on a cash basis and 7.5% on a GAAP basis with a weighted average lease term of 4.4 years. Measuring the starting cash rent of the tenant's expiring lease to the starting cash rent of the renewal lease, the compound annual growth rate achieved on these leases was 2.5% for the quarter and 3.1% for the 9 months ended.

On Page 21 of our float book, we provide our large lease disclosure, which details our view of renewals through 2025. And we continue to expect portfolio retention to be extremely strong.

Looking forward, over the next 9 quarters, we have 6.8 million square feet of leases expiring, which includes 3.8 million square feet of large leases, which we define as leases over 50,000 square feet. We expect a retention rate of roughly 95% on these large leases.

Our 1 million square feet of active developments are 90% leased with a total estimated cost of $337 million, consisting of 6 projects located in Maryland, Northern Virginia and Huntsville, Alabama, and we expect to place 380,000 square feet of these projects into service during the fourth quarter that are 100% leased.

Our development leasing pipeline, which we define as opportunities, we consider 50% likely to win or better within 2 years or less, currently stands at 700,000 square feet, down from the 1 million square feet reported last quarter. A figure declined as we removed opportunities associated with Space Command at Redstone Arsenal given the President's recent decision to maintain the command in Colorado Springs.

However, we do remain optimistic that future opportunities with Space Command may arise in the Redstone Gateway. Beyond that, we're tracking another 1.2 million square feet of potential future development opportunities, which should allow us to maintain a solid development pipeline in the near and medium term.

We achieved no development leasing during the third quarter. During the first 9 months of the year, we executed 495,000 square feet of development leases, including 3 full-building build-to-suits and 30,000 square feet of development lease-up. We are actively negotiating leases with several defense contractors, including one with our cloud computing customer, and remain confident in achieving our 700,000 square foot development leasing goal for the year.

Our consistent demand and high occupancy levels at the National Business Park and Redstone Gateway compel us to develop in advance to create inventory to accommodate this demand from U.S. government and contractors. The National Business Park is down 99.4% leased, with only 25,000 square feet of unleased space in the 4.3 million square foot park and the largest vacant suite is only 7,800 square feet.

Our operating portfolio at Redstone Gateway is 98% leased, and we have solid demand for the 100,000 square feet of development space at 8,100 right out road, which we expect to fully lease in coming months.

With the NBP essentially full, we commenced development of an inventory building during the fourth quarter. NBP 400 will cost roughly $65 million and will total 140,000 square feet. We have a healthy pipeline of activity with 180,000 square feet of tenant interest, and we're highly confident we will pre-lease the majority, if not all of this space during the construction period.

Similarly, at Redstone Gateway, we plan to commence our next inventory development early next year as the lease-up of 8,100 right out road is completed. With good visibility into year-end, we narrowed our FFO per share guidance range, while keeping the midpoint unchanged. Given the strength of our operating portfolio, our highly leased development pipeline and minimal interest rate exposure, we continue to expect compound annual FFO per share growth of roughly 4% between 2023 and 2026 from the midpoint of our original 2023 guidance.

And with that, I'll hand the call over to Anthony.

[Anthony Mifsud, executive]

Thank you, Steve. We reported third quarter FFO per share as adjusted for comparability of $0.60, which was at the midpoint of our guidance. The quarter benefited from an uptick in occupancy and revenue recognition from developments placed into service, partially offset by higher interest expense. We have generated excellent growth in same-property cash NOI with results that continue to surpass our initial expectations.

Driven by the year-to-date outperformance and our forecast for the remainder of the year, we are increasing the midpoint of our same-property cash NOI guidance by another 100 basis points to 6%. This represents a 300 basis point increase in the midpoint for same-property cash NOI growth from our initial guidance established at the beginning of the year. This increase is driven primarily by a reduction in free rent concessions and lower-than-expected net operating expenses.

Same-property occupancy ended the quarter at 93.4%, which is up 60 basis points sequentially from last quarter and up 120 basis points year-over-year, driven largely by the following lease commencements: 70,000 square feet by Lockheed Martin at 1,200 Redstone Gateway, after taking occupancy of 52,000 square feet in the second quarter and 90,000 square feet in our Fort Meade BW corridor subsegment.

We lowered the midpoint of our same-property year-end occupancy guidance by 25 basis points to 93.25%. The decline is driven by lease commencements that will slip into 2024. For context, the 25 basis point reduction in same property year-end occupancy only amounts to a 50,000 square foot timing change.

During the quarter, we also successfully issued debt in the public markets. Last month, we issued $345 million of exchangeable notes maturing in 2028 with a coupon of 5.25%. The rationale for the deal is simple. First and foremost, this eliminates the execution and pricing risk in a challenging market environment. Second, we are now able to fully fund our expected development through late 2026. And third, there is no cash drag from the proceeds.

We typically accumulate the debt component of our development investment on our line of credit and then replenish that capacity with a capital markets transaction. Our forecast at the beginning of the year assumed that we would need to access the capital markets in the fourth quarter of 2024 in order to reload the line of credit.

Given the uncertainty, volatility and risk in the capital markets, we reversed our sequence, locking in attractive rates in advance. With this structure, we were able to source debt capital at an interest rate that was roughly 200 basis points below where we could have priced 5-year unsecured bonds.

Given the fact that in just 7 weeks since the offering priced, the underlying 5-year U.S. treasury rate has increased over 40 basis points. We've clearly achieved our goal. The proceeds from this offering, coupled with the retained cash flow provides us the necessary capital to fund the $250 million to $275 million of expected annual development investment over the next 3 years without having to source outside capital.

We used a portion of the proceeds to pay down the line of credit, which given where SOFA rates are today, is accretive by over 120 basis points. Until funds are invested into development projects, we're able to invest the remaining proceeds at flat to slightly positive spreads relative to the debt coupon.

Given the fact that our development projects generate long-term growth in FFO and NAV, we never want to be in a position where we have to say no to one of these opportunities because of a lack of capital. This transaction serves to reinforce our fortress balance sheet is in keeping with our successful track record of sourcing attractively priced capital and sources -- and funds our expected development investment through late 2026.

As a result of our rebranding in September, we made a few disclosure changes. We combined 2 of our reportable segments, eliminating the regional office segment and reclassifying those assets to other. With this reclassification, we will no longer be reporting a core portfolio, and we'll report our assets as part of either our Defense/IT portfolio or other, reflecting our intention to sell these assets when functioning markets return. Based on those shortened hold periods, we determined that the carrying amounts of these properties were not recoverable from future undiscounted cash flows and sale proceeds. As a result, we recognized impairment losses of $253 million on these properties and a parcel of land, marking these assets down to their combined fair value of $311 million.

The magnitude of the impairment loss reflects valuations based on the current extreme market conditions. However, as we reach the point of sale, improvements in market conditions could lead to somewhat to significantly better sales prices.

Our balance sheet is well positioned to navigate the current volatility in the capital markets. We have no significant debt maturities until March 2026. Our unencumbered portfolio now represents 96% of total NOI from real estate operations.

At the end of the quarter, we had over 85% of the capacity on our line of credit available and over $200 million of cash on hand. We have no variable rate debt exposure as the proceeds from our exchangeable note offering were used to pay down the unhedged balance of our line of credit.

In February, we entered into interest rate swaps that capped SOFR at 3.75% for 3 years on our $125 million term loan and $75 million of the line of credit. This is over 150 basis points lower than the current 1-month term SOFR and provide significant protection in this higher for longer rate environment.

We expect 100% of our debt will be at fixed rates until late into 2024, as we initially fund development investment from our existing cash balance and subsequently funded from our line of credit. With only 2 months left in the year, we are maintaining the midpoint of FFO per share at $2.40, but narrowing the range by $0.01 at both the high-low and high end. This midpoint represents a 2% increase in FFO per share over 2022's results.

For the fourth quarter, we are affirming our guidance range for FFO as adjusted for comparability of $0.60 to $0.62 per share.

With that, I'll hand the call back to Steve.

[Stephen E. Budorick, executive]

Thank you. I typically close out the call by summarizing our key messages for the quarter. However, this quarter, I'd like to end by reminding investors of 10 key differentiators of our business, our strategy and our portfolio relative to peers, that we reviewed at our recent Investor Day.

One, our underlying economy is national defense and the missions we align with are high-priority knowledge-based national defense missions.

Two, these mission locations have permanence, and therefore, our building locations are irreplaceable.

Three, we have advantaged land positions to develop, which provides a clear path for future growth.

Four, our tenant relationships are built on decades of trust as our top 15 tenants have, on average [ 14 ] and are located in 3 to 4 of our markets.

Five, the mission work must be performed in secure working space, which protects us from work-from-home trends. Skip facilities are hard to procure and very expensive to construct, requiring significant tenant co-investment in our assets, which makes tenants unable or unlikely to relocate supporting our industry-leading retention rates.

Six, funds contracting is a very profitable business and financial distress is a major risk indicator for vulnerability to espionage. For this reason, we have extremely strong tenant credit quality.

And seven, our low-risk development pipeline drives reliable external growth. Over the last 7 years, we've allocated capital to over 7 million square feet of highly pre-leased Defense/IT projects.

Eight, our deeply experienced employees who carry high security credentials have a 30-year track record of both constructing and operating secured facilities, including full government campuses, skips and antiterrorism force protected properties.

Nine, our balance sheet is very strong, and we are prepositioned to fund incremental development through 2026, with no need for further debt or equity capital and no near-term debt maturities.

And finally, the global threat environment to our national security and that of our allies continues to escalate, virtually assuring continued strong investments in defense.

As we've watched the tragic events unfold over the past several weeks, it provides a stark reminder of the importance of having a strong defense posture and the significance of intelligence and surveillance to the security of our country.

Operator, please open up the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Camille Bonnell with Bank of America.

[Camille Bonnel, analyst]

There's been a lot of changes in the government, and we're heading into an election year. Just wondering if you still have confidence on the outlook for the DoD funding plans on 2024. And is there anything you foresee that could change there?

[Stephen E. Budorick, executive]

Well, that's a bit of a coin toss right now. There has been a pretty [indiscernible] last 3 weeks in the house. What I can tell you is both the House and Senate and services committees recommended roughly a 3% increase in defense. I think the worst-case scenario would be in an environment where they go to a continuing resolution and reduced defense by approximately 1%.

But remember, this reduction would be vastly different than the sequestrations that occurred years ago because it is not mandated ratably across the DoD, and the DoD can prioritize where those cuts go. And as I said in my 10 key points, the missions we support our high-priority knowledge-based missions that will be well funded.

[Camille Bonnel, analyst]

Appreciate that color. Can you talk next to the returns you're underwriting on the new development you've started this quarter? Has there been any significant change in hurdles compared to projects started 12 months ago?

[Stephen E. Budorick, executive]

So we've pushed up our targeted cash yield. I believe the targeted cash yield on that development is [ 8. 25% ].

[Camille Bonnel, analyst]

And last one for me. Can you talk to some of the third-party broker assumptions made that drove the impairment adjustments on your regional assets or now called the other bucket?

[Stephen E. Budorick, executive]

So I'll describe the process. We engaged 2 sets of investment sales teams, asked them to give us pricing on all those assets. In a spot market viewpoint, what would they sell for today. We amalgamated the data, and we apply that to the assets individually and result in that $251 million mark-to-market.

[Camille Bonnel, analyst]

I guess just trying to understand if the underwriting is conservative enough? Or could we see more adjustments down the road?

[Stephen E. Budorick, executive]

No. We wanted to make sure that we take a very realistic and kind of a foreview of value. So we -- there's no sugar coating in those numbers.

[Operator]

Our next question comes from Nick Joseph with Citi.

[Nicholas Joseph, analyst]

Maybe just following up on your first comments regarding the defense budget and what's happening in kind of Congress. You had mentioned negotiating with defense contractors for space right now. Are they more impacted by the uncertainty there relative to a more traditional DoD?

[Stephen E. Budorick, executive]

Not the current negotiations that we're engaged in by any means. I don't know what impact in the future might occur because of this budget, but all the deals that we're working on now, there's been no discussion by any concern about passage of budget.

[Nicholas Joseph, analyst]

And then just on the other bucket at this point. So you walked through the write-down. What are you looking for in terms of actually putting those assets on market or actually executing on a sale? Is it stability of interest rates? Is it something else as you talk to those brokers, when do you actually think you will look to move away from them?

[Stephen E. Budorick, executive]

Really, each asset has kind of a different story. I'll just deal with the one we have our eye on to monetize first, 2100, we'd like to get stabilized above 85% from a lease standpoint. Similarly, under light needs a bunch of leasing.

Some of the other assets are more stabilized. But I think most importantly, outside of D.C., it's the functioning of a healthy debt market for office investors, which will require some better pricing that's available today to engage into a procurement.

[Operator]

Our next question comes from Blaine Heck with Wells Fargo.

[Blaine Heck, analyst]

Steve, how do you feel about pricing power in general? I mean, you guys increased your expectations slightly for rent spreads last quarter, but you're still kind of hovering around flat. Are there any indications that you guys can continue to see improvement there? Or should we expect those kind of rent spreads to remain pretty range bound?

[Stephen E. Budorick, executive]

I'd expect them to remain reasonably range-bound. Remember, our quarter-to-quarter statistics can be somewhat misleading depending on how long the terms of the expiring leases work, with our compound growth embedded in our lease structures. When we get longer leases that have moved to a reset point, it's not uncommon for them to have grown above the current market, and that reduces the mark-to-market that we get. That's why we always remind you of what's the compound growth from start rent to start rent in the bucket of leases we complete in the quarter because our growth manifests itself in the structure and not on the mark-to-market.

[Blaine Heck, analyst]

That's helpful. I guess following up on that, can you just talk about what kind of annual rent increases or escalators you guys are putting into leases on newly signed deals? And how that kind of compares with historical averages? And then maybe remind us what the average escalator is in your portfolio?

[Stephen E. Budorick, executive]

So currently, we're seeking escalators in the 3% range, where typically we would have been at 2.5%. I would say the weight average embedded, this is entirely a guess, is somewhere around 2.7%.

[Anthony Mifsud, executive]

Yes. And Blaine, that's consistent with what we accomplished in the third quarter, the escalators on the renewal leases were 2.7%.

[Blaine Heck, analyst]

Great. That's helpful. And then maybe sticking with you, Anthony, just on guidance. The increase in same-store guidance was certainly a positive, but didn't flow through to an increase on FFO. So just wondering if that's a timing issue or whether that same-store improvement was kind of offset by higher interest expense or something else?

[Anthony Mifsud, executive]

It was really the -- what was creating the incremental cash. So we have had success renewing space within our portfolio with limited free rent concessions compared to what we had forecasted. So that results in increases in cash NOI from a GAAP basis. It's a pretty minor increase because the GAAP rent would have been included in our forecast. And with respect to interest expense, because we've essentially are fully fixed right now, there's really no interest rate exposure for the balance of the year that would have offset that. So it's mostly coming from the strength of the leasing activity we've had.

[Operator]

Our next question comes from Tom Catherwood with BTIG.

[William Catherwood, analyst]

Steve, just following up on one of your responses to DoD budget. You've highlighted this 14.7% increase in the budget since 2021. But when we get kind of under the hood on that, are there also reallocations amongst that budget giving more proceeds to priority missions that your clusters are serving? And do you have -- if that's the case, do you have a sense maybe -- if the whole budget is up 14.7%, do you have a sense of how much the missions that your properties are serving? How much are they up? Is it more than that? Is it flat with that? Or is that not something you track?

[Stephen E. Budorick, executive]

So it's hard to get into that level of detail because the Green Book doesn't tend to provide it. The one that is called out is cyber, and cyber is, I believe, up like 15% year-over-year. It's compounded at an extremely strong rate for the last decade. In the Fort Meade area, a lot of our leasing demand is cyber.

The other comment that you didn't ask, but I'll point out, it takes roughly 18 months after those increases to manifest itself in contractor demand. So from that 14% increase, we still think we have quite a bit of runway in demand notwithstanding what happens to this budget.

[William Catherwood, analyst]

Got it. I appreciate that. And then at the Investor Day, you guys had done a deep dive on skips and the costs and what it takes to certify them. From a tenant's perspective, who typically manages that skip build-out process? Are they going out and hiring the designer and consultants and contractor, similar to like they do for a regular office fit-out?

[Stephen E. Budorick, executive]

So it depends on the tenant. I think what you'll find is a few of the larger national platforms will handle that themselves with their own consultants. For instance, in the building [indiscernible] with us, which was 560 MEP. That particular tenant is managing that skip development themselves with their parties, more common with the small- and medium-sized contractors. They come to us because of our expertise and capability of managing them through that process, in getting them online as quickly as you can. So it's kind of split, but it's not -- it's not pure either way. A few will do it themselves.

[William Catherwood, analyst]

Understood. Understood. And last one for me. Over on 2100 L Street. Any updates on tenant activity or kind of near-term leasing expectations?

[Stephen E. Budorick, executive]

Well, I'm reluctant to be too assertive at this particular topic. We thought we were close to a deal in August that ended up being a no deal, which is pretty disappointing. We do have activity. As a percent of vacancy, our activity ratio is 58%. We've got one large prospect we're working with. We've got a couple of preliminaries behind that, but that market continues to move in a very slow and deliberate way.

[Operator]

Our next question comes from Richard Anderson with Wedbush Securities.

[Richard Anderson, analyst]

So on the new basis on the other assets, $311 million. What would that imply if you were to sell it the entirety of it today in terms of a cap rate sort of trying to get a sense of the sort of potential dilution from a transaction? Understand you're not doing at this moment, but I just want to sort of triangulate that a little bit.

[Anthony Mifsud, executive]

So Rich, if you take the annualized quarterly cash NOI from those properties and deduct the land component, the Canton land that's part of that $311 million, the cap rate is about 8.8%.

[Richard Anderson, analyst]

Were any of the people that helped you in the valuation interested themselves?

[Stephen E. Budorick, executive]

No, there are service firms...

[Anthony Mifsud, executive]

A few are interested in selling them when we're ready, but a few weren't interested in buying.

[Stephen E. Budorick, executive]

I think Wedbush would look great on top of one of those buildings. We have sites available in several spots.

[Richard Anderson, analyst]

Yes. Well, all those corporate office signs need to be dusted off maybe. So the other question I have is you talked about -- I would call spec development at NBP and Redstone. Understood, you want to be ready for demand. How large of a percentage of spec development are you comfortable having in its entirety within the development portfolio? And would there be any more outside of NBP in Redstone that you'd be willing to take that type of strategy?

[Stephen E. Budorick, executive]

Well, I'll answer the last component first. No, outside of NBP and Redstone, we'd be highly [ reluctant ] to start spec building. At both Redstone and NBP, we see the demand. And for us to capture, we need to get going. So we have more than 100% of the capacity of NBP 400 looking for Space Solutions now, roughly 1/3 of the building, we're actually negotiating lease terms on and there are multiple tenants.

So we're extremely confident that they'll be leased. And frankly, we're working on what's our next alternative as we get this one rolling, we want to make sure we can deliver another one as well.

[Richard Anderson, analyst]

And specifically for...

[Stephen E. Budorick, executive]

Our total is, one at a time and NBP and Redstone to be the evolving or emerging demand we see. If we didn't see the demand, we wouldn't start the building. And we don't use the words back we use inventory because we have nothing to lease.

[Richard Anderson, analyst]

Fair enough. And this might be in the range of a silly question, but I'll ask it anyway. NBP has been around for a while now. So you're building further and further away from the hub of activity. I mean, does that become an issue where just proximity is less appealing to people? Or are you just nowhere near that type of stress in terms of the development?

[Stephen E. Budorick, executive]

That's really never an issue. Because the advantages of being at the MEP are ubiquitous to the park, the comps run throughout the entirety of the park. The shuttle services run through the entirety of the park. And the ability to work in harmony with competitors or partners on contracts is not impaired by the short distance between MEP South and North. So it's really never been a factor.

[Richard Anderson, analyst]

And then last, Anthony, for you, I understand with the debt raise and having yourself covered through 2026, no need for outside capital. Does that mean dispositions? Or is it all just cash flow generation to cover the difference between what you raised and what you have to spend over the next 3 years? Or could there be a meaningful asset sale component to that financing activity over the next few years?

[Anthony Mifsud, executive]

No. It's all -- our base plan is built on sources that are the debt that we have raised and now have in the bank and the equity component of the development investment is funded from cash from operations after our dividend.

If we have the opportunity to take advantage of developments that are in excess of that amount, then we would look to different ways to capitalize that. But our base plan of $250 million to $275 million of development each year is effectively fully funded right now.

[Operator]

Our next question comes from Dylan Bazinsky with Green Street.

[Unknown Analyst]

Just on development leasing. You guys mentioned you're still likely to hit the 700,000 square foot mark for this year. But as we look out towards '24 and '25, I guess, -- what do you guys have baked into your estimates? Should we expect you guys to remain in that 700,000 square foot range or slightly lower? Or just how should we be thinking about that?

[Stephen E. Budorick, executive]

Well, I think about it more as dollars than square feet. And Anthony gave the range of $250 million to $275 million each year. One of the facts that you have to recognize as developments roughly 30% more expensive today than it was 2.5 years ago. And it's the money we invest that we generate the growth off of, not the square footage. So I don't want to give any guidance looking forward. But we do have 1.25 million square feet of projects that we have actively had discussions with customers on that we currently do not believe are 50% likely to win in 2 years or less. So we're pretty confident we'll have some substantial square footage numbers to guide to.

[Operator]

Our next question comes from Jay Poscott with Evercore ISI.

[Unknown Analyst]

I was wondering if you could just provide a little bit of color on the breakdown of the development leasing pipeline. Are they more focused on new needs, expansions, renewals? Any color there would be great.

[Stephen E. Budorick, executive]

So most of them, I would say, are new business opportunities with defense contractors. In the current pipeline, there's about 31% of the square footage that we said is roughly 700,000 square feet. It's associated with the data center show. The other 69% are defense contractors in a variety of locations in our park. And with regard to the 1.25 million square feet beyond that, it's only about 15% data center shell, 85% defense contract are pretty broad-based in 3 or more of our locations both the defense contractor and the U.S. government.

[Unknown Analyst]

That's helpful. And then just on the data center point there, can you just talk about your appetite for potentially going to new markets? I know Northern Virginia has a power constraint. So just curious your thoughts on potentially developing in a non, let's call it, core market for data centers?

[Stephen E. Budorick, executive]

Well, we'd be happy to follow our core customer to a new market, provided it was a established data center market with a strong expectation of long-term value. If it were a secondary tertiary market that is not well established, I don't think we put our capital into that.

[Operator]

This concludes the question-and-answer session.

I will now turn the call back to Mr. Budorick for closing remarks.

[Stephen E. Budorick, executive]

So first, welcome back, Rich. It's good to have you on the call, and thank you all for joining the call today. We're in our offices, so please coordinate through Venkat, if you'd like a follow-up.

[Operator]

Thank you for your participation today in the COPT Defense Properties Third Quarter 2023 Results Conference Call. This concludes the presentation. You may now disconnect. Good day.