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Welcome to the Corporate Office Properties Trust Fourth Quarter and Year End 2017 Earnings Conference Call. As a reminder, today's call is being recorded.
At this time, I will turn the call over to Stephanie Krewson-Kelly, COPT's Vice President of Investor Relations. Ms. Krewson-Kelly, please go ahead.
Thank you, Serena. Good afternoon and welcome to COPT's conference call to discuss our fourth quarter and year end 2017 results as well as our guidance for 2018. With me today are Steve Budorick, President and CEO; Paul Adkins, Executive Vice President and COO and Anthony Mifsud, EVP and CFO. In addition to the supplemental package and press release related to our results, we have posted slides on the Investors section of our website to accompany management's remarks. As management discusses GAAP and non-GAAP measures, you will find a reconciliation of such financial measures in the press release and on our website.
At the conclusion of management's remarks, we will open the call for your questions. Statements made during this call may be forward-looking within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties and other factors. Please refer to today's press release and our SEC filings for a detailed discussion of forward-looking statements.
I will now turn the call over to Steve.
Thank you, Stephanie and good afternoon. We had a very strong fourth quarter, which topped off a successful year. Our fourth quarter included the following significant achievements. We captured almost 700,000 square feet of new and development leasing. We sold $73.5 million from assets in non-core locations and by doing so, earned a 10% unlevered IRR, eliminated future vacancy risks and reinvested proceeds into development to create future value and we locked in our equity requirements to match fund accelerated development opportunities.
During the year, we achieved almost 1 million square feet of new development leasing, which was the second best volume in our history. We leased over 400,000 square feet of vacancy in our operating portfolio and achieved an 80% retention rate. That's the highest annual retention rate for our company since 1999. We completed programmatic asset sales in non-defense suburban like locations, thereby positioning our platform for sustained growth and most importantly, we now have advanced -- advancing activity on our two US government assets, which we fully expect to lease this year, as Paul will discuss.
Our ability to achieve near record volumes of development leasing last year during the recovery phase of government demand is a testament to our strategy of diversifying the mission critical demand drivers we serve. We've positioned our company to benefit from three complimentary avenues of growth. First, our US government franchise in multiple locations. Second, defense contractors who serve at the mission and third, government contractors that offer hyperscale cloud computing services, the demand for which is skyrocketing and is not correlated to the federal budget cycle.
Demand for secure your mission critical solutions for government customers is growing and we are in discussions at multiple locations for new facilities. By its nature, government procurement moves slowly and will build over the coming years. Our three sources of demand within defense IT broaden our ability to grow operating cash flows and NAV more consistently than in the past.
An essential step to securing these avenues of growth was to call the non-strategic assets that would be a drag on future results. Over the past 7 years, we methodically eliminated non-strategic locations by disposing of over 11 million square feet of assets for $1.6 billion. As a result, our non-strategic assets are now de minimus. The two assets we sold opportunistically in the fourth quarter are located outside our core markets and in our view, had a high risk of future vacancy and value loss. Their dispositions cleared the way for us to grow operating cash flows and NOI from strategic developments without further dilution.
In the past seven years, we also solidified our dominance around proven government demand drivers in high tech aspects of national security, namely surveillance, research and development, reconnaissance, missile defense and cyber security. Our newest high tech defense IT demand driver is data center shells for cloud computing government contractors. Demand for cloud computing is expanding rapidly and accounted for 75% of last year's development leasing. Our mission critical build-to-suit data center shells are all located in Northern Virginia, the largest and busiest network access point in the country.
Like other government contractor buildings, our tenants significantly co-invest in our facilities and we fully expect to realize very high renewal rates as a result. Since delivering our first data center shell in 2013, we've established a competitive advantage in developing these facilities and grown our platform to 2.3 million square feet of operating properties plus 450,000 square feet currently under construction.
Given the low risk nature of these build-to-suits, the high credit quality of our tenants and the accretion to our net asset value, we are very excited to identify 2 million square feet of new data shell demand last fall. We needed to procure multiple land parcels concurrently ahead of construction and did not want to be long on land and short on equity. In order to capture the value creation of this pipeline, while maintaining our balance sheet flexibility and eliminating market risk, we structured a forward equity transaction, which much like an ATM allows us to match fund development costs, but at a protected share price at locked in NAV accretion.
As summarized on slide 7, the DoD’s base budget authority bottomed in fiscal year 2015 and has increased 7% over the last two years. Early this morning, Congress passed and the President signed a two-year budget deal that lifted the spending caps for defense and non-defense discretionary spending for fiscal years ’18 and ’19 and extended the fiscal 2018 continuing resolution to March 23. The next steps are an omnibus appropriations bill for fiscal 2018 and then later this year one for 2019.
The budget agreement increases the DoD's base budget to $605 billion in fiscal 2018 and then to $625 billion in fiscal 2019. This 14% increase for 2018 will represent the largest single year increase to the DoD's base budget since 2002 and should ignite significant new demand in our markets. We’re excited at the prospects emerging from contractors and government users alike. Our shadow development pipeline tracks demand for new development opportunities up to 24 months out.
It currently contains up to 3 million square feet of mostly build-to-suit transactions that we believe we have at least a 50% chance of winning. Currently two-thirds of the pipeline deals are for datacenter shells and the remainder are with the government and other defense contractors in the BW corridor in Northern Virginia and at Redstone gateway in Huntsville, Alabama. Data center demand is the most robust currently, however, we have high visibility into a growing pipeline of development opportunities with the government and other defense contractors and expect these groups to represent a higher fraction of Shadow development pipeline activity in the future. With these trends, development will be our exclusive source of external growth for several years.
With that, I'll turn the call over to Paul.
Thank you, Steve. Demand in our operating properties and from new developments gained momentum during 2017 and continues to expand. Looking at the JLL market velocity chart on slide 8, among our defense IT submarkets, demand for cloud computing is the strongest and shows no signs of abating. And other markets like Columbia Gateway are seeing very solid demand. Among our subsegments, Navy support has seen the biggest recovery. In the third quarter of 2015, our Navy support portfolio was only 73.2% leased.
By the end of 2017, the portfolio was 88.7% leased, an increase of 15.5%. Furthermore, we increased the amount of space leased to the US government in this subsegment by 135%. We expect to experience solid demand from new and renewal leasing in our existing assets. We have about 1.2 million square feet of prospects against 1.4 million square feet of current and pending unleased vacancy in our 2018 same property portfolio. In terms of lease expirations, we expect to renew at least 70% of the 2.1 million square feet in leases scheduled to expire this year.
Looking further out, slide nine summarizes the 12 large leases rolling this year and next. These leases total 1.7 million square feet, 65% of which is in the BW corridor and 76% of which is leased to the US government. We forecast a 100% renewal rate on the government leases and overall expect to renew 98% of this footage. When we reset the same property pool of assets for 2018, we added 13 properties, including NoVA B and NBP 310. As a result, our 2018 same property occupancy on January 1 was 92.1%.
As slide 5 shows, in the first quarter, we anticipate 338,000 square feet of transitional vacancy that will temporarily decrease our same property occupancy to between 90% and 91%. We have already re-leased 100,000 square feet of this vacancy and expect same property occupancy to increase during the remaining three quarters ending the year between 93% and 94%. The first quarter transitional vacancies will also cause our same property cash NOI to decline between 1% and 2% in the first quarter relative to 2017 first quarter results and to be flat for the full year. These transitional vacancies are primarily with non-defense tenants. Given the strong fundamentals in our markets, we view them as opportunities to attract an even greater portion of high tech cybersecurity tenants to our portfolio.
The broad based demand emerging in our markets will translate into robust development activity in 2018. Slides 3 and 4 show that we expect to invest between $300 million and $325 million in new development activity, about a 50% increase over the past few years’ average development spend. This increase is due in part to the demand for data center shells and also the need for modern efficient space by other defense contractors to accommodate mission growth. We also expect strong development leasing this year, including the lease up of NoVA B and NBP 310. Processes on both buildings are advancing smoothly. We have an executed letter of intent for all 161,000 square feet of NoVA B and we are negotiating the lease currently.
At NBP 310, we are working with the customer on programming the uses and remain on track for lease action during the summer. We expect both buildings to fully lease this year and to contribute partial year results to same property cash NOI in 2019. Overall, the broad based demand in our market supports our goal of leasing 900,000 square feet of developments during 2018. I’d like to remind investors of our value proposition with the government.
Notwithstanding the unusual delays associated with NoVA B and NBP 310, once the government leases a building, they invest significantly in it and the asset then generates decades of reliable, durable cash flows with consistent annual rent growth and modest renewal capital requirements. The government's investment combined with the criticality of the buildings to the mission cert have supported the 25-year track record of 100% renewal rates we have enjoyed with the government in full building leases.
In 2017, we also placed 11 properties comprising 1.2 million square feet into service that were 98% leased. These 11 included NoVA B, a 240,000 square foot secure facility that is 100% leased to a US government user. As you can see on slide 4, we expect highly leased developments to contribute between $16 million and $17 million of cash NOI to this year's results. Our proven track record of delivering robust volumes of highly leased developments each year and increasing occupancy in our existing portfolio support future operating cash flow and NAV growth.
With that, I'll hand the call over to Anthony.
Thanks, Paul. Our fourth quarter results were strong as highlighted on slide 2. FFO per share of $0.53 in the quarter and $2.03 for the year were $0.01 below the midpoint of guidance due to the opportunistic asset sales we executed in the fourth quarter. These sales consisted primarily of two properties outside our core Northern Virginia footprint for $73.5 million. The properties are located in Richmond and Lebanon, Virginia, markets we no longer deemed to be strategic. Both single tenant buildings had significant non-renewal risk and uncertain demand conditions for future re-tenanting. We believe taking advantage of the unexpected opportunity to recycle capital from these assets into our strategic developments was a prudent and proactive asset allocation decision that created value.
Markets change and we will harvest value from our portfolio as appropriate. But as reflected on slide 4, we have no intention of selling any assets in 2018. Last year, we also simplified our balance sheet by redeeming $200 million of preferred shares. Additionally, we raised $20 million of equity using our ATM in the first half of the year and had $70 million of capacity left on that facility. Then, when presented with the opportunity to build 2 million square feet of 100% pre-lease data center shells for a government contractor. We completed a $285 million forward equity sale contract in November to lock in the approximate 3% increase in NAV associated with these projects. We already have acquired two land parcels for $43 million and commenced construction on three of these projects. Late in the fourth quarter, we issued 1.7 million common shares, pursuant to the forward agreement, representing $50 million of proceeds to fund this development activity.
Our balance sheet metrics continue to be strong as we ended the year with a debt plus preferred equity to EBITDA ratio of 6.1 times. We will continue to improve this ratio by placing highly occupied development projects into service and conservatively capitalizing our new development. We have no debt maturing until 2020, at which time we have a $100 million term loan maturing. This loan is prepayable without penalty and we intend to refinance it along with balances accumulated on our line of credit during 2018.
Accordingly, our guidance includes $300 million of refinancing to extend our debt ladder. Lastly, during the fourth quarter, we recognized a $14 million impairment on three buildings and associated land we own in Aberdeen, Maryland, decreasing our net book value there to just $5.5 million. Aberdeen plus two land parcels elsewhere in our portfolio collectively represent our entire non-strategic holdings, which total less than $8 million. We have no other non-strategic assets.
For 2018, we are establishing a guidance range for FFO per share of $1.95 to $2.05. Our guidance reflects dilution from 2017 asset sales, offsetting much of the incremental NOI from developments placed in service as well as the increase from the shares outstanding as we draw down proceeds from our forward equity facility to fund the equity component of our $300 million to $325 million of development spend throughout the year. Though the midpoint of our guidance is $0.03 below our 2017 results, we forecast a 4% to 6% increase in AFFO.
We are establishing first quarter FFO per share guidance of $0.48 to $0.50. The $0.49 midpoint is $0.04 below the fourth quarter 2017 results, reflecting the first quarter dip in same property cash NOI due to transitional vacancy, an incremental one-half cent of dilution from fourth quarter asset sales, net of interest expense savings, higher seasonal operating costs and dilution from the 1.7 million common shares we issued under the forward facility at the end of the fourth quarter.
With that, I'll turn the call back to Steve.
Thank you. In 2017, we accomplished near record levels of development leasing and healthy occupancy gains in our operating properties. Our dispositions are now complete and we're optimistic about our ability to generate annual FFO growth of at least 4% beginning in 2019. We're at the advent of a multi-year expansion in defense spending, which in conjunction with the demand for cloud computing facilities, from government contractors, will present multiple avenues for growth.
We are uniquely positioned among REITs to benefit from these defense related growth opportunities. Having solidified our competitive advantage in our government franchise and expanded that expertise into developing datacenter shells allows us to generate predictable incremental cash flows and value creation. We cast a much wider, much stronger net than ever before and are in a position of strength to capitalize on the growth opportunities present and emerging in our markets.
Operator, please open up the call for questions.
[Operator Instructions] And our first question will come from the line of Tom Catherwood with BTIG.
Steve, it seems like there is a government budget battle each time you have an earnings call. I appreciate the kind of outlook that the next step is 2018 omnibus bill. Could you provide a little more color on kind of the steps after the omnibus bill to get to the DoD and then to get to specific contracts and your contractors as far as funding for their projects?
So just like last year, the appropriations bill got passed in May. We had a little bit of an increase in the third quarter of leasing and then this fourth quarter was the best fourth quarter in the history of our company with really 46% of our annual leasing done a couple of quarters after the appropriation is passed. We still have good strength coming from the fiscal year 2017 activity that we’ll harvest in the first and second quarter and then with the appropriation of ’18, you'll start to see it in the third and fourth quarter.
And then also if we look back at the presentation from the third quarter earnings call, you guys have projected roughly $250 million of annual development investments through year end 2019. Now, we're looking at 300 million to 325 million for 2018, which is a pretty big ramp. Do you think that the 2018 level is sustainable for the next few years or can we see a reversion back to that $250 million of spending?
I think given the backdrop, the spending, the strength of our Shadow development pipeline and the significant amount of development we have and put on that pipeline, I’d say 300 to 325 is better run rate going forward.
And then just one last one for me, Steve, the 3 million square feet of Shadow that you mentioned in your prepared remarks. Does that include the 11 buildings that you laid out last quarter, the data center shells?
So we already signed three of those. And there are -- in the shadow development pipeline, there's another 8. And then of course beyond Shadow development pipeline, we work on sourcing land and solutions for additional beyond that.
And the next question will come from the line of Rich Anderson with Mizuho Securities.
So Steve, do you have an idea of, I think, you might have said and I might have missed it, the timing of the 2018 appropriations and then the 2019 appropriations and maybe we can kind of have this all resonated at one point next year where you’re kind of getting double-whammy in terms of tenant activity.
So, there's still some uncertainty about the appropriation for this year and that's really the DACA deal, which expires on March 5. I'd expect that there be some continued activity and challenge to the appropriation. But our source this morning was very confident that by the end of the continuing resolution, the deal would be worked out and we'd be moving forward at the end of March for fiscal year ’18. Fiscal year ’19, I could not predict. I know that General Mattis has been emphatic about the need to get the funding into the system early in the fiscal year. It is really emphasizing that we've got to return to a more predictable passage of the budget. So I would hope for a more timely appropriation for fiscal year ’19, but in advance of election year, who knows I guess is my point.
One of the things that occurred and I don't know if it's a direct hit to you, it probably isn't, but the deficit obviously is in at least optically skyrocketing, starting with tax reform and then followed up by this. I mean do you have any opinion about that in terms of whether or not, I know that the spending in the defense world is good for you, but is there any, I don't know, deal to double type of concern that you think might be out there in terms of the broader thesis on our economy and how the stock market might behave over the longer term because of all the spending.
I'm just going to tell you Rich, I think that’s over my pay grade. I want to talk about the company in the defense budget and I’ll duck that question.
Okay. Well, is it of your pay grade to go in to the Senate floor and start taking some names and pushing people around to get things done?
I look in the opportunity.
More than to the company, on the same store growth profile for 2018, obviously, you have some specific items that are bringing you back down for a temporary period of time. Do you guys have any sort of line of sight into what might be a similar turn of events next year that might slow down the same store profile again in ’19 or do you feel very confident that this is a one hit wonder type of event?
I’m very confident it's a one hit wonder. Just the leasing of the government buildings would have pushed us far higher than flat, but it got delayed. And then remember, this year, we're getting some space back for deals that were done in ’16, which kind of takes two years of contractions and piles them in a one year. And we've handicapped our renewal rates for the next three years and they're very strong. So we're very confident we can generate solid growth after this year.
And then last question on the shell business, it continues to go, I'm curious, what is your comfort level in terms of how big that can be as a percentage of the pie because while it's low risk, it's also lower return and I'm just wondering how you're handicapping all those moving parts?
So we've answered that question previously. As we sit here today, it's about 6% of revenue. When we complete the full 11 building project, it will be 10.5% of revenue and we’ll be comfortable getting that up into the 15% range. And Rich, the one thing I do want to point out is amazing NAV creation with this platform of development. So although the growth might be more 2.25% annually, the value creation is immediate, substantial and a great proposition for our shareholders.
And the next question comes from the line of Manny Korchman with Citi.
Maybe just a follow up on Rich's question, in terms of the data center development pipeline, can you talk about how your sort of competitive mode there is different than owning a cluster of assets would be lease side of the government or contractors and sort of the security clearances there versus owning land in the right place and then sort of doing a build-to-suit data center development program to a particular customer.
So I think what you're asking is what's our competitive advantage in that development space, is that really.
Sure. Or I guess what stops other people from doing it.
Well, the people do do it. Some of the industrial companies have captured segments of that demand. Speed and quality of execution is a competitive advantage and then some of the industrial companies tend to emphasize or impose design restrictions because they're fearful of data and we're not. So I think our ability to accommodate the customer and the amazing capability that the development team has just allowed us to capture a lot of business.
And then maybe a question on just leasing or occupancy, are there any more sort of forward vacancy holes similar to what you discussed about 2016 that we should worry about in the portfolio where you've signed leases that are currently occupying space, but when they roll they’ve been signed, but to lower amounts of space.
Good question and no.
And the next question will come from the line of Jamie Feldman with Ban of America.
So I wanted to focus on page 8 of your presentation where you talk about – you showed the property clock. Can you maybe just talk us through, I mean, you show your submarkets generally turning to the rising face. Maybe just talk us through like what that means for rent growth or what kind of gives you comfort that trajectory is going to be up until the right here, just more color on the market specific fundamentals if you could.
Sure. Well I think we've talked a lot about data center shells. So I’ll skip that. Columbia, we're getting some of that transitional vacancy back in Columbia. We've probably got the two to one prospect ratio on the amount of space that we have. Our redevelopment projects in that market have been highly successful, the most recent of which was 75% of pre-leased before we kicked it off. We've kind of developed a great technique to capture the growth in cyber and tech tenants by taking our existing properties and putting features in that make it very appealing for accruing young talent in that segment.
And it's probably the strongest pipeline we have on a square footage basis in the portfolio. We talked a little bit about maybe support, we've gained 15% increase in occupancy and importantly, we've more than doubled the square footage of leases with the US government after a long period, when the Navy was constrained in spending. They have pent up demand for seats and facilities and we continue to expect some improvement there and better pricing power as that market tightens than we've experienced in the past.
Huntsville's, at this point in time, entirely build-to-suit or new development driven and we have a great value proposition in the market. We're subject to some pricing pressure from existing assets, but really our value proposition is new facilities for a new era of defense spending. NBP and Fort Meade, we're speaking more to the velocity than the rent level. We've always commanded very strong rents.
We see that foreseeing or continuing in the foreseeable future and most importantly, new programs coming out of the Fort had got -- generated a lot of activity by contractors planning for wins when those contractors are awarded. By the way, Huntsville has amazing levels of defense contractors, defense contracts being released just in the last few months, $3.25 billion of contracts were issued for the current year and 4.21 billion had been awarded for future years and most importantly, a big component of that is for missile defense systems’ growth, modernization and then foreign sales. So we view that improving rapidly.
Getting back to Baltimore waterfront, this JLL really represents the overall market. There was a big development in a build-to-suit so vacancy ticked up to about 11% in Class A. It's back down to about 9% and really rents have accreted since we bought the properties. The NoVA defense and NoVA regional office, improving with a velocity standpoint, but still under heavy pricing pressure. But we expect our segment out there, the route 20 corridor to improve pretty rapidly with this increase in defense and intelligence spending.
Did I hit them all for you?
You did. Thank you. Just a big picture, summary of all, like what do you think rent growth can be or like if you think about, getting across to ’18, do they get still pretty flat or you see some growth.
So for ’18, we guided zero to minus 2 like this year. Remember, we have unique rent structures where we get high escalations or office escalations achieved in the fourth quarter were 2.6% a year. And so to some extent, that suppresses us a bit, but if we're taking down a percent and then starting a trend of 2.6% growth, it's more optics than reality.
And I think in response to an earlier – to Rich’s question about your confidence on ’18 or ’19 growth, I think you had mentioned the two development projects as part of that growth, like how much of those contribute to your ’19 growth rate when you think about it, the 310 and NoVA B.
For 2019, it will only be a small percentage because in terms -- based on our -- the timing of when those leases will be sort of GAAP revenue generating and then cash revenue generating, the cash component of that for the NoVA project is in the fourth quarter of -- beginning of the fourth quarter of 2019 and for the NBP project is later in the fourth quarter. So, it’s only a small component of ’19 and then will be a larger component in 20.
So the 2% to 3% in ’19 beyond is purely a true same store number in terms of, like there is no development, no properties in the development pipeline that are part of that growth.
Same office, the same property portfolio is only projects that have been placed in service for a full year before they're moved into that portfolio of properties. So there's no projects that are development projects that would be placed in service in 2018 or ’19 would be moved into the pool.
And the next question comes from the line of Rob Simone with Evercore ISI.
You guys kind of hammered it home that the portfolio is essentially 100% strategic at this point and there are no sales in ’18, but I was just wondering if you could talk maybe longer term about Baltimore and kind of how it fits in with the core defense IT strategy and whether or not those assets, once they're fully stabilized, could be sale candidates beyond ’18?
They absolutely could. We saw those as an opportunity to create shareholder value. We did with the acquisition of them in the opportunistic way we did, particularly the two we purchased I referenced. And we've got value added strategies in place on both. And in the future, as we've realized the value creation, they certainly give us optionality and I thought it is great -- excellent value and then we’ll harvest it and find another opportunity.
And Paul, just a quick follow-up on Jamie's question earlier, so the cash impact is in 2020, but what -- is there any meaningful or partial GAAP impact to NOI in ’19 from the commencements?
That is Anthony. There's a GAAP component to the NoVA building in late 2018 that will run through ’19 and then NBP building, we project would start in the second quarter of 2019.
Thank you. And the next question will come from the line of Craig Mailman with KeyBanc Capital Markets.
Just maybe another clarification on NoVA B and 310, so as we think about kind of getting from that 90% to 91% same store occupancy after the transitional vacancy, really we should just think the NoVA B will hit that number, but 310 NBP will not be part of the occupancy pick up this year?
That's correct.
Then Steve I know some of the good news today here on the bill getting passed, but still the continuing resolution, I guess I'm just trying to figure out what type of optimism you guys have baked in from a lease up perspective or maybe probabilities on when continuing resolution and then we can start to see some of the appropriation come in and contract awards picking up and I guess as part of that, as you look at your markets, you look at the tenant activity, how much of it just translates into better retention for you in the market versus kind of net expansion opportunities?
So I think we've got hampered optimism from this increase baked into 2018. Most of the activity that is in our leasing plan was visibility in new leasing from really last year's fiscal budget. So I think given the timing, there could be a little uptick in the fourth quarter beyond what we expect, but most of the impact from FY18, you'll see in FY19.
There's a second half of that question that I seem to forget. What was a second half?
Does this translate into just better retention for you and market peers or is it net expansion opportunities, just given kind of what the contractors have on the books from a space perspective versus your utilization?
It's really both and recently we went on an NDR and I looked through our pipeline of operating leases and we have several tenants are looking for expansions in multiple locations across our portfolio. As they capture additional business, they have need for additional space because during the down cycle on defense spending, certainly you would recall that we had a lot of contractions and they right size their footprint. Additionally, we're no longer experiencing those kind of contractions or retentions that are in incremental leasing is driven by incremental projects.
If you look at some of the statements by defense contractors, they're starting to worry about having the ability to capture the talent to handle the growth, which leads me to believe that they're going to need additional space for the talent that they hope to get to capture the growth that they know is coming.
And then just lastly big picture, you guys are through the strategic dispositions, you guys are funded for this year's investments, but as we start to get towards the end of ’18, the stock is trading at a pretty sizable discount to NAV on my numbers. How do you foresee if development continues at the pace it’s at? Are you guys thinking about funding in the near term? Do you have a queue of strategic assets that maybe are, you can maximize some value or do you kind of maybe harvest or JV some of the shell data centers again with GI or other partners?
So, we have a couple of levers we can pull. We continually reassess our contingency plans for a period of time or we have limited access to new equity. Certainly, our hope is the strength of our markets and our performance will provide access for that, but we have three or four different levers we could pull, one of which would be to bring additional JVs JV partners into some of the data center shell.
And what would the other two levers be?
So I think I just spoke to Rob Simone’s question. Given the choice between funding government and retaining regional office, we harvest regional office and fund government and defense contractors.
And just can you remind me when does the tax protection burn off on the Wells Fargo building?
It's September of 2019.
And the next question comes from the line of Dave Rodgers with Baird.
Maybe for Stephen and Paul to break this down, the 300 million to 325 million of capital spend this year, can you talk about how much of that you anticipate to go into the data shell business, how much would go into the more traditional defense IT segment and kind of where returns are coming out, now that you're kind of reaccelerating the outlook for the more traditional defense IT office.
In terms of where that capital is forecasted to be spent, about a little over half of it is going to be invested in the data center shell portfolio and another, call it 35% is going to be invested in completing what we have under construction today as well as funding the tenant improvements for the two government buildings. And then the balance is the commencement of construction on regional office building at 2100 L Street.
In terms of yields, we're seeing, I think, similar to what we've talked about in the past on the data center sells, sort of in the -- sort of 7% initial cash on cash yields on the shell portfolio and then on the other contractor and government investments, those deals range from 8% to probably a little north of 9%.
And then maybe for Paul on the 338,000 square feet, can you just remind us kind of when that 100,000 square feet moves back in or if it did already and kind of what the economic changes are related to the old leases versus the new.
The 100,000 square feet is represented in two deals, one of which is Magellan Health, which we were able to keep in the park here at Columbia gateway with a significant downsizing on their part. So that was 70,000 square feet. That begins in second quarter 2018 and then the other one was the expansion by CareFirst in downtown Baltimore in to 30,000 square feet that was relinquished by Prometric and a restructuring of their lease when they early renewal of building. So that’s 100,000 square feet against the 338 that's coming back in the first quarter.
From an economics standpoint, those new deals have very comparable rents to the expiring rent.
And then the activity on the remainder of that space. What do you think timing looks like?
I think that the vast majority of that space, we have activity on all that space and since there are ongoing pursuits of backfilling space, I expect 75% or more of that remaining 228,000 square feet of vacancy to be filled in 2018. The comment was that we’re really happy with, in general, the level of activity at Columbia Gateway has significantly ramped up in the last few quarters. So some of that 338 is focused within the park, so hope to be announcing another deal shortly.
Thank you. And the next question comes from the line of Chris Belosic with Green Street Advisors.
First one for me, I guess on the latest defense budget, it looks like there is an additional 30 billion planned there incremental to what you guys had forecasted last. So maybe just if you guys have a feel for, is that being targeted kind of specifically the incremental amount towards intelligence, cyber security or other programs that directly benefit your tenant base or is it towards other defense items.
So I don't have the pass appropriations bill or budget deal to break that down, in fact, it's just got passed this morning. But we'll follow up with you as we look at it, but I expect it to continue kind of broad based funding. Certainly, the intelligence community is going to get a big chunk in my expectation. Some of the contracts I referenced earlier in the call, that missile defense would get a significant plus up because of the escalating threat and then just weapon systems will also be well funded to both repair and start to replace much of the equipment that was start from funds in the last seven years.
And then maybe another one, so the shadow development pipeline that you guys talk about for projects with greater than 30% chance of achieving in your eyes, but what about you guys track a larger pipeline of Midwest specular prospects and if you do, maybe could you frame out how large that is and how it's been trending in recent months or quarters.
Well, it’s gotten bigger in identified opportunities that we excluded from Shadow development or another 1.5 million square feet.
And then just one last one for me. So in the presentation, where you guys have the large block renewals on page 9, when you have the high expectations there, nearly 100%, could you frame up for us in terms of overall leasing economic expectations on that or rent mark-to-market, maybe lease term and leasing cost as a percentage of rent.
This is Paul. So out of the 12 leases that comprise this year and next year, on the large leases, the 98% renewal likelihood we feel good about. The -- overall I think -- I don't have the math in front of me, but I would think that the rents, the new cash rents should be at or slightly above the in place rents at the end of the term. Again, a number of those leases are with the US government, consistent with the pattern we've had in the past. They rolled up slightly.
And typically Chris, the TI associated with the government renewals is just a nominal amount for typically a five to seven year renewal.
And the next question comes from the line of Chris Lucas with Capital One Securities. Your line is now open.
Just a couple of housekeeping items for me. Steve, just to be clear. As you think about your lease opportunities at both NoVA B and 310 NBP, NoVA B is the one that's most likely to occur first, but it still requires that the omnibus budget be approved before anything can move forward. Is that correct?
No. That’s incorrect. The required approval of the fiscal year 2017, but the funding is secured through, we have a letter of intent and we’re negotiation the document.
Okay. So that gives you confidence to have some component of GAAP income for this year?
Yes.
And then just as it relates to the impact of the lease resets from ’16 into the fourth quarter of ’17 and sort of carrying forward, was it a full impact in the fourth quarter or is there some sort of carry through that occurs in the first quarter of ‘18.
With respect to rents or occupancy, Chris?
Well, both, the NOI impact.
Yeah. The NOI is going to impact, will start impacting -- be some spread from transactions that happened in the fourth quarter that will also move in to the first quarter and then there are the impact of vacancies that happened after 1/1 that will fully impact the first quarter, but had no impact on the fourth quarter.
So the rental rate impact was realized, but not for full month and one of the -- full quarter and you'll see a full quarter impact on the rental rate and full impact on the contraction.
So, as I think about the complete impact, how much of the impact rent, was it one month, two months, three months that we got in the fourth quarter and then you're saying the occupancy impact actually doesn't happen until the first quarter.
Because it’s a combination of transactions, the rent and depending on which pieces of the transact -- which leases that are a component of what happened in the fourth quarter and what happened in the first quarter. The occupancy and the NOI follow that. So for transactions that happened in the fourth quarter that we’re downsizing, we had the occupancy and a partial NOI impact in the fourth quarter and then for the ones that are happening early in the first quarter, we'll have both the occupancy and NOI impact in the first quarter and so they’re re-laid.
And our final question will come from the line of John Guinee with Stifel.
I was touring up Fort Meade recently, a heck of a lot is going on there. Can you talk about what's under construction and what's planned in the near term and how that affects NBP positively and negatively?
So remember, the biggest component of that is recapitalization. There's the joint operation center, which is nearing completion, which had intended to combine an intelligence group with Cyber Command. Marine for cyber building is nearing completion and then I think I don't remember the exact delivery, but there's ECB 1 and ECB 2. ECB 1, I would expect finished this year. ECB2 is starting and will finish couple of years down the road. The bulk of that, well, everything but the jack and the Marine cyber building, a replacement for aged facilities, those two are new commands been set up by the base. Impact to NBP is zero from -- none of the uses of that development are programmed to be moved in from our properties.
And then you had mentioned defense contractors looking for the talent to handle the growth. As we all know, these defense contractors, they’re very price sensitive because I'm pretty sure the RFPs are technically competent, lowest cost RFP process and they can no longer pass through the overhead to the government they’ve got to eat it themselves and it appears to me that the location is less and less important. So where are the big picture perspective do you see defense contractors wanting to locate, given a very different landscape than a decade or two ago.
Well, the implications of that pricing really started in 2012 and the biggest impact were the rightsizing of the footprint. In terms of location, proximity to the customer is still of paramount importance and most contractors involve some interactivity with other defense contractors. So the location value proposition has not changed at all. And with regard to certain types of defense contracts, they’re required to be within tight radiuses of the customer they serve. So, there's really no change in that.
Thank you. I will now turn the call back to Mr. Budorick for closing remarks.
Thank you all for joining our call today. We will be in our offices this afternoon. So please coordinate through Stephanie if you’d like a follow-up call. We're happy to talk to you further in person.
Thank you for your participation today in the Corporate Office Properties Trust fourth quarter and year end 2017 earnings conference call. This concludes the presentation. You may now disconnect. Good day.