COPT Defense Properties 2026 Q3 Earnings Call

Hello. Welcome to COPT Defense Properties Third Quarter 2026 Results Conference Call. As a reminder, today's call is being recorded. At this time, I will turn the call over to Mr. Venkat Kommineni, COPT Defense's Vice President of Investor Relations. Sir, you may begin. Thank you, Towanda.

Good afternoon, and welcome to COPT Defense's conference call to discuss third quarter results. With me today are Steve Budorick, President and CEO, Britt Snider, Executive Vice President and COO, 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? Good afternoon, and thank you for joining us.

We had another great quarter with continued strength in demand and a robust underlying business environment, highlighted by our vacancy leasing achievements. It all translated into solid results, which I'll detail. For the third quarter, FFO per share was $0.71, which was $0.02 above the midpoint of guidance and represents 2.9% increase year over year. Same property cash NOI increased 3.2% year over year and 5.3% during the nine months. We had particularly strong quarter in terms of vacancy leasing, executing 222,000 square feet, which exceeded our trailing five-year quarterly average by 50%. This achievement brings vacancy leasing during the first nine months to 453,000 square feet, which amounts to 95% of our prior full-year target of 475,000 square feet, and over 110% of our initial target of 400,000 square feet.

We committed $88 million to two developments at Redstone Gateway, which we announced on our last call. The Huntsville operating portfolio is 98% leased and continues to see very strong demand, which led us to start these projects to provide the vital inventory we need to meet the demand we're seeing and to accelerate those lease commencements. Turning to guidance, we increased the midpoint of 2026 guidance for four metrics. FFO per share, as adjusted for comparability, increased to $2.80 per share. Same property cash NOI growth increased to 4.25%. Capital committed to new investments increased to $375 million, and capital invested in development and acquisitions increased to $240 million. Anthony will provide additional detail on what drove these increases.

We decreased the midpoint of our tenant retention guidance for a very good reason: to support the growth of core tenants and strengthen our tenant roster. Our tenant retention was actually tracking to 84%, but we created an opportunity to recapture space from three suboptimal tenants and re-lease those spaces to high-value tenants with strong long-term growth and credit profiles. As a result, we are reducing the midpoint of our tenant retention guidance by 250 basis points to a still very strong 80%. We made a corresponding change to our vacancy leasing target, increasing it to 625,000 square feet, because we have leased or expect to lease over 145,000 square feet of this nearly 160,000 square feet of space recaptured from the three tenants. The strong level of demand in our portfolio positioned us to proactively enhance our tenant growth profile while continuing to maintain a sector-leading tenant retention rate.

With the midterm elections just days away, I would like to remind everyone of the immense stability in our country's support for increased defense spending over the past 12 years, regardless of the shifts in control of the chambers of Congress and the presidency. First, over that period, there has been a balance between unified and split control of government, with six years of unified control, including the presidency in both chambers, four under the Republican Party and two under the Democrat Party, and six years of split control. Despite these control changes within the government, there has been strong bipartisan support for defense spending throughout the period. Since fiscal year 2015, the National Defense Authorization Act has, on average, passed the House by a margin of 3.5 to 1 and the Senate by over 7.5 to 1. During this period, the defense base budget grew by $285 billion, or 51%.

That equates to a compound annual growth rate of nearly 4%, with annual increases occurring in each of those 12 years. Second, our business is primarily driven off the Department of War base budget, which at $840 billion in fiscal year 2026, is the highest defense budget in history. Looking forward, the FY 2027 base budget request is $1.1 trillion. With the challenging global threat environment, we expect defense spending will continue to be a priority regardless of the election results. Finally, given the 12 to 18-month lag we generally experience between budget appropriation and leasing activity, there is embedded demand throughout our portfolio from funding that has already been appropriated. The FY 2025 and FY 2026 budgets, plus the $150 billion of funding appropriated in the One Big Beautiful Bill Act, will continue to produce demand in our portfolio through 2027.

The FY 2027 budget, when ultimately passed, will drive activity in 2028 and 2029. Notwithstanding the election, we have a very strong funding backdrop supporting our underlying industry. We are not the only company seeing growth opportunities created by the massive investments in technological advancement in support of national defense. There is a rising tide of private capital targeting the defense sector space, and in particular, emerging technologies. In fact, Blackstone has invested $20 billion in the sector over the past five years, with a recent investment of $1 billion to form a defense tech platform specializing in missile interceptor technology. Carlyle Group announced a $3 billion defense fund. They recently invested in a company developing low-cost hypersonic weapons.

JPMorgan announced a $1.5 trillion Security and Resiliency Initiative last year to finance and facilitate investments in key areas of economic and national security, including aerospace and defense, and frontier and strategic technologies such as cybersecurity and quantum computing. Clearly, the investment priorities of the Department of War are generating a strong response from the private sector to deploy capital to companies serving the same priority missions supported by our portfolio, which include intelligence, cybersecurity, and missile defense. Having touched on the highlights of the business, I will turn it over to Britt for additional detail.

Thank you, Steve. Before I walk through the operating performance during the quarter, I would like to highlight the strong leasing results driven by our unique strategy. We have executed 3 million square feet of total leasing during the first 9 months, which includes strong performance on the vacancy leasing front and very healthy demand. We are executing leases with tenants supporting broader missile defense missions in Huntsville and have a robust pipeline of additional prospects. We are also executing leases with tenants supporting US Cyber Command in Columbia Gateway, which accounts for nearly half of our vacancy leasing year-to-date. Finally, of the nearly 1 million square feet of combined vacancy and investment leasing executed year-to-date, roughly 80% is with existing tenants. This highlights one of our key strengths, our tenant relationships, as the leading defense contractors in the country have multiple leases with us in multiple markets.

At the end of the third quarter, our total portfolio was 95% leased and 94% occupied, while our Defense/IT portfolio, which accounts for 93% of our NOI, was 96.2% leased and 95.2% occupied. The 60 basis point decrease in the total portfolio's lease rate was primarily driven by 2 events. First, the law firm tenant that leased both its new and old space in Baltimore last quarter vacated their old space this quarter, which accounted for 30 basis points of the decrease. Second, as Steve discussed, a strategic early lease termination accounted for 20 basis points of the decrease. In Redstone Gateway, we recaptured 46,000 square feet from a defense tenant underutilizing their space.

We are in advanced negotiations to backfill the bulk of that space to Lockheed Martin to expand its presence in the park by nearly 30% and have several great prospects for the remainder of the space. This overall decline was mitigated by 50 basis points of offsetting occupancy by placing MBP 400, our 100% occupied inventory development at the National Business Park, into service during the quarter. As a result, total portfolio occupancy only declined by 10 basis points. Additionally, in Columbia Gateway, we recaptured 56,000 square feet from a non-defense tenant set to vacate in 2027. We fully backfilled that space to Frequentis, an existing and fast-growing defense contractor in the park, focused on both cyber and aviation. We expect that lease to commence in the first quarter of 2027.

Frequentis has more than doubled its footprint in Columbia Gateway since the beginning of the year, starting at 87,000 sq ft, then expanding by nearly 100,000 sq ft through four separate transactions. Both examples speak to a few of our key competitive advantages of proactive asset management scale, commitment to accommodate tenant growth throughout the portfolio, and a strong balance sheet and cash flow to fund tenant improvements. One additional point about Columbia Gateway, earlier this month, we also signed a 30,000 sq ft lease at Franklin Center, bringing that recent acquisition up to 87% leased. We executed 222,000 sq ft of vacancy leasing during the third quarter, and 504,000 sq ft year to date. This achievement equates to over 125% of our initial full-year target of 400,000 sq ft, and over 105% of our second quarter full-year target of 475,000 sq ft.

We have over 200,000 sq ft of prospects in advanced negotiations, which we define as over 90% likely to execute. Taken together, there are 710,000 sq ft of leases either executed or in advanced negotiations, which supports our decision to increase our target for vacancy leasing to 625,000 sq ft for the year. Our leasing activity ratio has grown to a very strong 83%, which is based on over 1 million sq ft of prospects on about 1.25 million sq ft of availability. Of the 710,000 sq ft of vacancy leasing executed or in advanced negotiations, approximately 55% or 390,000 sq ft leases space that was vacant at the beginning of the year. 25% or 175,000 sq ft leases non-renewing space in 2026 and 2027, and backfills nearly 20% of the forecasted non-renewals in 2026.