Feb 14, 2008
Executives
Mary Ellen Fowler - VP and Treasurer Rand Griffin - President and CEO Roger Waesche - COO Steve Riffee - CFO
Analysts
John Guinee - Stifel David Seamus - Citi Chris Haley - Wachovia Capital Markets Rich Anderson - BMO Capital Markets Ian Weissman - Merrill Lynch
Operator
Welcome to the Corporate Office Properties Trust fourth quarter and year-end 2007 Earnings Call. As a reminder, today's call is being recorded.
At this time, I would turn the call over to Mary Ellen Fowler, the company's Vice President and Treasurer. Ms.
Fowler, please go ahead.
Mary Ellen Fowler
Thank you and good morning, everyone. Yesterday our earnings press release was faxed or e-mailed to each of you.
If there is anyone on the call who needs a copy of the release, or would like to get our quarterly supplemental package, please contact me after the call at 443-285-5450. Or you can access both documents from the Investor Relations section of our website at www.COPT.com.
Within the supplemental package you'll find a reconciliation of non-GAAP financial measures to GAAP measures referenced throughout this call. Also under the investor relation section of our website, you will find a reconciliation of our first quarter and annual 2008 guidance.
With me today is Rand Griffin, our President and CEO; Roger Waesche, our COO; and Steve Riffee, our CFO. In just a minute they will review the results of the fourth quarter and the year 2007 and then the call will be opened up for your questions.
First I must remind all of you at the outset that certain statements made during this call regarding anticipated operating results and future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although such statements and projections are based on what we believe to be reasonable assumptions actual results may differ from those projected.
These factors that could cause actual results to differ materially include without limitation, the ability to renew or release space under favorable terms, regulatory changes, changes in the economy, successful and timely completion of acquisitions and development projects, changes in interest rates and other risks associated with the commercial real estate business as detailed in our filings from time-to-time with the Securities and Exchange Commission. Now, I will turn the call over to Rand.
Rand Griffin
Thank you, Mary Ellen. Good morning and Happy Valentine's Day to everyone.
As we look back at last year, 2007 was a great earnings year for COPT. We generated FFO of $2.24 per share, a 12.6% increase over 2006 results of FFO of $1.99 per share, which was prior to the write-off of $0.08 per share in 2006 for non-cash charges related to the redemption of our Series E and F preferred shares.
We believe that our FFO growth is among the highest in the Office REIT sector, and compares favorably to FFO growth for the REIT sector overall. As most of you know, 2007 was a difficult year for REIT stock performance.
Our stock price seemed to be negatively impacted more than most than most Office REITs. The factors that created turmoil in the market and the resulting poor stock performance, have little to no impact on the fundamental operating metrics of our company, and it was clearly a disconnect between operating fundamentals and our stock performance.
The fundamental operating dynamics of our company remained strong. In fact, we had one of our highest FFO growth years during 2007, and the fundamentals remained strong for 2008 and beyond.
We continue to experience steady occupancy, and no significant credit issues with our tenants. Our renewal rates continue to be strong, with steadily increasing rental rates, and we see additional demand to support new development from our locations, where we have strong government demand drivers.
As Steve will discuss in a moment, we project another strong year for 2008 with FFO per share growth in the 8% to 11% range. This projection reflects our realistic view of the year with detailed recession planning in place.
For example, we do not project any acquisitions nor do we expect or need to raise in the equity. Our balance sheet is in good shape with very little debt rolling, significant capacity on our newly enlarged line of credit and excellent payout ratios.
The majority of our growth comes from development initially placed into service in 2007, which is very well leased, and is providing $11 million of NOI in 2008. Also, we are continuing to experience excellent growth from our San Antonio and Colorado Springs locations.
We believe that we are well-positioned to weather a potential recession, due to our strong government and defense IT contractor niche, and manageable rollovers from our tenants and other sectors. Our company has performed well in past recessions due to our strong tenant base and close proximity to DC, a market that always holds up well in a recession, and due to our financial flexibility as we are not a rated company.
We've been meeting with our institutional share holders recently to determine what issues and concerns are on their minds. And from those discussions, we believe that there are four concerns of misconceptions about our company that I would like to address.
First, we have been incorrectly compared to other companies located in the suburban office sector. We believe that we are a specialty Office REIT for the government defense information technology and data focus.
We believe these sectors represent strong consistent growth, and are less susceptible to the impact of recessionary pressures than typical office product. Second, investors view development as more risky today than just six months ago.
We do agree that some office companies may struggle to get leasing accomplished on a timely basis. However, we continue to see good demand from our government and defense sector, as well as from our market demand driven locations.
With regard to our construction pipeline, we still have some leasing to do, but this will not affect our 2008 earnings, since most of the buildings will be completed toward the end of 2008. And we are not projected to lease up for 12 months.
With regard to our development pipeline, comprise of buildings that will start in 2008, 77% of the square footage is targeted at the Government and Defense Information Technology niche. Third, there may be concern about the Northern Virginia market.
We agree that there is over building in this market, but our portfolio is 99% leased and occupied, with little rollover until late 2009. But we are not expanding in Northern Virginia right now.
Through our customer focus strategy, we are expanding in both San Antonio and Colorado Springs. Those locations have strong demand which will support our growth as we wait for the Northern Virginia market to recover, and space in the market to be absorbed.
And fourth and finally, shareholders are concerned about the effect of a change in the political party and control of the White House, resulting from the presidential elections, as well as a potential reduction in defense spending. From a political perspective, we do not believe the outcome of the presidential election will have an impact on our government and defense contractor niche.
As you know, the democrats presently control congress, and Maryland has good representation from their delegation, who sit on the intelligence committees that oversee and continue to support defense spending. The need for the critical missions that our primary locations support have not decreased but in fact have increased in size and complexity.
This is the case with our expansion at San Antonio, with Patriot Park in Colorado Springs, and at the National Business Park in Maryland. As you may know, 13.7% of the defense budget is allocated to intelligence and IT.
The portion of the Federal budget allocated to this critical work, has averaged up to a 12.2% increase per year over the past 12 years, and shows no signs of slowing down. As a result, we have further identified our tenant base with defense, IT contractors, and the supplement.
We hope this description will remind our investors that our tenants do not produce guns, planes, and other hard products that are typically subject to cuts in defense spending, but rather deal with information, and communication technology. We believe that there will not be a slowdown in this type of defense spending regardless of administration.
Our plan for 2008 is to continue building and leasing our strong development pipeline. We'll monitor the acquisition market for opportunities to buy assets that meet our return hurdles.
With our portfolio, we'll focus on retaining our tenants as leases expire, increasing rents where possible but with the goal of retaining our historically high occupancy levels. And with that I'll turn the call over to Roger.
Roger Waesche
Thanks, Rand. At year end, our wholly-owned portfolio totaled 228 suburban office properties, with 17.8 million square feet in operation.
We ended the year 92.6% occupied and 93.4% leased. Subsequent to year end, we sold our vacant 142,000 square foot, 429 Ridge Road property in New Jersey to the adjacent tenant, which move portfolio occupancy up over 93%.
In terms of our niche, government and defense IT tenants, totaled 48% of their revenue, with the government at about 16% of revenues. We continue to expand these relationships.
In the fourth quarter, the government committed to an additional 91,000 square feet in our San Antonio location, and we expanded our relationship with ITT by signing a 75,000 square foot lease at our 104,000 square foot Patriot Park VI building in Colorado Springs. We expect that ITT will expand to take 100% of the building, and will occupy the initial phase during the second quarter of 2008.
ITT won the prime contract to upgrade the FAAs air traffic control system, and we expect subcontractors to borrow an adjacent building. In addition, we are starting to see some preliminary interest at NBP and Aberdeen Proving ground in Maryland.
It would support relocations associated with BRAC. We had not anticipated any BRAC related activity during 2008.
We are pleased to report that we are having some discussions with tenants to begin revealing their needs associated with BRAC. We are also starting to see some specific leasing activity at Fort Ritchie, although the requirements are complex, and will take some time to plan and execute.
With respect to leasing during 2007, we had an active year signing leases for 2.6 million square feet of space. This total includes 1.7 million square feet of renewed leases, equating to a 69% renewal rate for the year at an average, low cost of $5.93 per square foot.
Total rent for renewed space increased 9.5% on a straight line basis, and 2.5 on a cash basis. With regard to 2.2 million square feet of renewed and retenanted space for the year, total rent increased 7.3% on a straight line basis, and 1% on a cash basis.
For the renewed and retenanted space, our average per square foot capital cost was $9.58 down from $11.4 in 2006. For the fourth quarter of 2007, we renewed 301,000 square feet or 60% of expiring space.
Our renewed and retenanted space of 436,000 square feet total rent on a GAAP basis increased 8.5% and on a cash basis was 5%. Our average square foot capital cost for renewed and retenanted space for the quarter was $12.83.
Looking forward to 2008, about $1.9 million square feet equating to 11.2% of our revenue is scheduled to expire. About 23% of this total represents the government, which has a high probability of renewal.
In total, we have 26 leases maturing with greater than 20,000 square feet or 78% of renewals. We only have one space that we renew for certain, we'll not renew out of those 26 spaces.
The average total rent for the maturing space is $20.31 per square foot, which on average remains somewhat below margin. Turning to our markets with regard to the BWI submarket, as of December 31 within the total market of 6.4 million square feet vacancy including sublease stood at 14.2% up from 8.8% at one year ago.
Approximately 508,000 square feet has been delivered to the market in the past year. Our BWI portfolio totaling $4.5 million square feet and representing 64% of the BWI submarket was 94% leased at December 31.
Turning next to the Columbia submarket and Howard County at December 31, vacancy with sublease was 12.7% up from one year ago at 11.3%. In Columbia, 550,000 square feet of new development has been added to the market in the past year.
Our properties in the Columbia submarket totaled 2.9 million square feet, and a 92.1% leased as of December 31st. We will experience minimal rollover in this market in 2008.
We recall that we acquired the Nottingham portfolio that was 84% occupied with one-third of the space rolling in 2007. Our suburban Baltimore occupancy is 85%, an improvement from 81% one year ago.
We have experienced a lot of leasing activity and interest in this market for small and medium-size users. The market in suburban Baltimore has remained reasonably healthy due to the lack of new supply.
Within COPT's Northern Virginia submarkets, the direct vacancy rate was up to 13.2% versus 9.5% one year ago. Orderly absorption was a negative 173,000 square feet.
Approximately 2.2 million square feet was added over the past year. Our portfolio of 2.5 million square feet is 98.8% leased at December 31st.
Looking just at the Dulles South submarket in Northern Virginia, the direct vacancy rate ended the fourth quarter at 18.9% up from 12.1% one year ago. Within the Dulles South submarket there was 1.7 million square feet added to the market within the last year, a majority built on spec.
Our operating portfolio of nine buildings totaling approximately 1.5 million square feet is 98.6% leased, and we have no lease rollover until late 2009. Therefore, we believe we are well protected from the impact of any potential overbuilding in this submarket.
Within the Colorado Springs submarket, leasing activity is increasing, and office vacancies remain steady in the fourth quarter at 8.9% compared to one year ago at 6.8%. Our properties in the Colorado Springs submarket total 823,000 square feet and are currently 96.7% leased.
Asking rental rates were continuing to rise for Class A office due to demand without significant supply coming online. Turning to acquisitions for 2007 for our wholly-owned portfolio, we acquired the $362 million Nottingham office portfolio, adding 2.4 million square feet of office space, and a minimum of 2 million square feet of development capacity to our portfolio.
With this acquisition, we were able to become the dominant owner in the high growth of submarket of White Marsh, and we are working on a safe plan design for our future office and retail locations in the submarket. We sold $15 million of the portfolio in 2007, realizing a profit after-tax somewhat of approximately $3 million.
Moving to 2007, we also acquired 56 acre parcel at the north entrance to Aberdeen Proving Ground in Maryland, on which we can develop 800,000 square feet to support for BRAC relocations. Additional disposition during 2007 included the sale of two small buildings in New Jersey, and during the past months, we sold our 429 Ridge Road building in New Jersey for $17 million.
This leaves us only three buildings to sell in New Jersey, and we are expected to exit the market by mid-July 2009. Subsequent to yearend, we sold most of our warehouse condo units located at our Towerview Road property in Northern Virginia.
Moving to 2008, we will continue to analyze our portfolio for non-core assets, and then move to sell these assets. We expect to for account for $60 million in dispositions for 2008.
With the potential recession in line during 2008, we will be concentrating on early renewals and operating expense control in our portfolio. We will continue to be patient on the acquisition front expecting that opportunities will improve later in the year, but forecasting no acquisitions for the year.
And with that, I will turn the call over to Steve
Steve Riffee
Thanks, Roger. Turning to our results, FFO for the year 2007 totaled $125.3 million or $2.24 per diluted share.
In 2006, we reported FFO for the year of $98.9 million or $1.91 per diluted share representing a 17.3% increase on a per share basis. As you may recall, results for the 2006 year included an accounting charge of $3.9 million related to the write-off of original issuance costs for the redeemed Series E and Series F preferred shares.
Excluding these charges from 2006 results, FFO per share increased 12.6% per diluted share on a year-over-year basis. FFO for the fourth quarter of 2007 totaled $32.8 million or $0.59 per diluted share, as compared to $25 million or $0.48 per diluted share for the fourth quarter of 2006.
That represents an increase of 22.9% per diluted share. FFO for the fourth quarter 2006 included the accounting charge of $2.1 million related to the write-off of the original issuance cost for the redeemed Series F preferred shares.
And excluding those charges from the fourth quarter of 2006 results, FFO per diluted share increased 13.5% per share over the comparable quarter. Regarding earnings per diluted share for the year, we recorded $0.39 compared to the $0.69 per diluted share for 2006.
Net income for the year included $4.8 million of gains on the sale of real estate, net of minority interest and taxes, which is substantially below the $14.8 million of gains recognized during 2006. Turning to AFFO, after adjusting per capital expenditures in the straight lining of rents, our adjusted funds from operations increased 21.5% from $74.7 million in 2006 to $90.8 million in 2007.
During 2007, we again increased our common dividend by 10% in September and continue to remain strong payout ratios. Our FFO payout ratio was 57.5% for the year as compared to 60.3% FFO payout ratio for 2006.
The diluted AFFO payout ratio was 79.3% in 2007 compared to 79.9% for 2006. Looking at our same office result, for the fourth quarter of 2007 with the 162 properties or 81.3% of the total square footage out same office cash NOI increased by strong 6.6%.
The same office results were positively impacted by retenanting space in our Northern Virginia portfolio, and on that of the impact of a $600,000 reduction in termination fees. For the year 2007, our same office portfolio generated a 2.9% cash NOI increase for the full year and that was at the high end of our projection.
Turning to the balance sheet at December 31, the company hade a total market cap of approximately $3.8 billion with $1.8 billion of debt outstanding and that equates to a debt to market cap ratio of 48%. Our weighted average cost of debt for the fourth quarter was 5.74% down from 5.99% a year ago.
Our fourth quarter EBITDA interest expense coverage ratio was 2.95 times and our fourth quarter fixed charge coverage ratio was 2.45 times. As of September 30, 2007, we had approximately $623 million of debt outstanding that was scheduled to mature in 2008.
And a little over half of that maturing debt was the balance of our unsecured revolving line of credit. During the fourth quarter of 2007, we amended our revolving line to extend the term to September 2011, as well as increase the line by $100 to $600 million and then we added an accordion feature allowing further expansion to $800 million.
Currently, we have the remaining $283 million of loans for the maturing including $143 million of permanent loans maturing at an average fixed interest rate of 7.2% and about half of the permanent debt will mature in the last quarter of 2008. The loan balances have been amortizing over the 10 year term and the asset value of the collateral has appreciated resulting in about a 50% loan-to-value ratio against these assets.
We'll be in the market shortly with our first permanent loan package in the $80 million range to refinance a portion of this debt. We believe the aggressive underwriting and the pricing that we saw during 2007 is now returned to a more normalized level with loan-to-values decreasing from 80% to 60% or 65% for life insurance companies and 70% to 75% for the securitized market.
Even though the spreads have widened from 100 basis points in 2007, to the 200 to 300 basis point range being recorded today. Treasuries have fallen to the 3.7% range resulting on what we believe will be rates in the 6 in the quarter to 6 and 3 quarter percent range.
Still substantially below the interest rate than our permanent debt that's maturing this year. Our strategy over the past several years has been to bundle buildings together to create a collateral package that could support $100 million to $150 million of securitized debt.
While this strategy has been very efficient in our buildings, or other sides that could allow us to refinance the maturing debt by executing several permanent loans in the $25 million to $50 million range, a level that maybe more appealing to lenders today. We also have $140 million of construction and short-term debt maturing in 2008 of which $48 million will be extended for one year and $92 million will be refinanced initially to the revolving line, and subsequently to permanent loans or medium term bank debt.
Turning to our construction funding, we are working with our bank group to structure construction financing sufficient to fund the remaining costs for the under construction pipeline during 2008, as well as the under development pipeline that will be built in 2009. Once we have completed our refinancings, we project having sufficient land capacity for approximately $250 million still we need capital for acquisitions.
With regard to our interest rate structure, as of year end 19% of our total debt was financed at an affording interest rate. We executed a swap to fix $50 million affording rate debt at 4.33% for two years during the fourth quarter.
Turning to equity capital, we do not believe we need to raise equity through 2008, as we can continue to use the equity and our land inventory, coupled with the construction financing to fund development through 2008. And in addition, we de-levered in early 2007 through the issuance of stock and units for both the Nottingham and the Interquest acquisitions, at an average net stock or unit price of $49 per share.
And now, let's turn to our outlook for 2008 and our guidance. Our initial FFO guidance for 2008, which we announced in November was $2.40 to $2.49 per diluted share or an increase in the 7% to 11% range for 2008 based on the actual 2007 results of $2.24 per share.
Current market conditions resulted in the projection, as short-term interest rates will be lower than those rates assumed in our initial guidance. Therefore, we are increasing the bottom-end of the range from the $2.40 to $2.41 per share.
However, given the overall uncertainty in the marketplace, and the increase in spreads for the custom long-term debt capital, we think it would be just too early in the year to amend the top range of our guidance. As we explained in our last call, our 2008 results are estimated to back end loaded towards the third and the fourth quarters, when we expect to benefit from the NOI generated from our 2008 development projects placed on servers, as well as benefit from additional leasing activity in the existing portfolio that's currently underway.
Historically, we've not provided quarterly guidance. However, we feel that because of the expected trend in our 2008 results, we should give some color on the first quarter expectations.
We expect that we will generate between $0.56 to $0.58 of FFO per diluted share for the first quarter. Our first quarter and our full year expectations are based on the following assumptions.
First, for our wholly-owned portfolio, occupancy during the year, ended the year at 92.6%, and we expect occupancy to remain close to that level through the end of the first quarter. We continue to expect occupancy to build throughout the remainder of the year and approach 94% by the end of 2008.
Our retention ratio for 2008 is expected to average approximately 70% for the full year. Second, we estimate development initially placed in service in 2007, to contribute $2.6 million of NOI for the first quarter of 2008, and $11 million for the entire year.
Development that will be initially placed in service during 2008 is expected to contribute approximately $4 million of NOI with approximately $500,000 being generated in the first quarter. About 70% of the NOI generated by the 2008 deliveries is expected to come on line in the second half of the year.
Based on leases and commitments in place, we've substantially all this development and NOI committed for 2008. Third, same office cash NOI is projected to grow for 1.5% at the low-end of the range of guidance to 3% at the high-end using a projected annual 2008 same office pool.
The increase in same office results is estimated to be lowest in the first quarter, and grow over the year. Fourth, lease termination fees are projected to be less than $500,000 for the first quarter, and then in the $1 million per quarter range for the balance of the year.
But we have projected no 2008 acquisitions, but we will continue to underwrite opportunities. If these were to occur, they could move us beyond the upside range of our guidance.
Sixth, gains on sales on non-operating assets such as land or the Towerview condo units, or other non-operating assets could add up to $1.1 million for the first quarter. Our annual guidance estimated that these gains could go up to $4 million at the very top-end of the range of guidance during 2008.
Seventh, service activities are projected to generate approximately $500,000 in the first quarter, and we still anticipate an estimated total of $2.7 million for the entire year was about 70% expected to be coming in the last half of the year. Eighth, as we indicated in the fall, we continue to estimate G&A to run at a quarterly rate of approximately $6 million, but be slightly higher in the first quarter.
Ninth, our initial guidance for interest expense was based on a projected average LIBOR rate of approximately 5.5%. We decrease that assumption by 200 basis points to 50 basis points above LIBOR today, and 60 basis points above the average expected LIBOR for the balance of the year.
And with respect to the FFO results, it's important to remember that a portion of our assumed reduction in the floating rate interest expense is offset by reduction in the capitalized interest for our projects under development. And as I discussed earlier, we believe spreads on permanent debts have widened substantially.
And we've taken that into account in our projections as well. And once again, our guidance for 2008 at this point, does not quantify any impact of the anticipated accounting changes for the convertible securities via an additional non-cash interest expense increase.
So we simply do not have a final standard yet. And finally, we continue to anticipate no new equity issuance during 2008.
And with that, I'll turn the call back over to Rand.
Rand Griffin
Thanks Steve. Turning to development, during 2007, we placed into service six buildings totaling 550,000 square feet, that were 95.4% leased at yearend.
Four of the properties are leased by homebuilding users. This is a fourth time in a row that our development placed into service exceeded 95% leased, which is a testimony to the strength of our markets, and the depth of our tenant relationships.
Our cash on cash unleveraged returns on development are still in the 10% range making this a very accretive growth engine for the company. In terms of development activity at year end, we had 10 buildings under construction for a total of 846,000 square feet at a cost of $162 million that were 36% pre-leased or committed.
Three of these buildings have full building users. The leasing level at our 302 NBP building has remained at 51% due to holding space for the government mega-skip, which is secured space.
The mega-skip would be spaced and leased to defense contractor employees who were being asked to move off Fort Meade, adjacent to our NBP Park. Since, we have good leasing demand at the park, we'll move the mega skip requirement to another building that's about to be started, and expect to rapidly compete 302 NBP leasing in first half of 2008.
In addition at year end, we had under development close to 1.1 million square feet at a projected total cost of $233 million. These projects are in the design and permitting phase, but all are expected to start during 2008.
Several of our investors have asked about our ability to pre-lease our constructions prior to starting these projects. With regard to our construction pipeline, we have found that we need to have products available in most of our locations to capture demand from our government and defense contractor tenants.
This is certainly the case in Colorado Springs with our Patriot Park VL building that we leased to ITT. If you refer to pages 40 and 41 in our supplement, we have categorized the demand for the buildings in our construction and development pipeline into three sources.
The first is buildings being built based on demand from our government and defense IT contractor tenant base, which accounts for 49% of our construction pipeline and 77% of our anticipated starts this year. The second category is market demand accounting for 38% of the construction pipeline and 23% of development pipeline.
This category defines buildings located in markets, where we have no new product and demand exists. The last category is space being built in research parks that are affiliated with major universities that have their own distinct sources of demand driven by research and education.
As noted on page 4 of the supplemental, we recently completed our joint venture documents with the University of Maryland to develop, lease, and manage up to 750,000 square feet of office space located at M Square Research Park at College Park. Also included in the supplement for the first time are both a construction completion date, and the date of operation.
To summarize, the construction changes from the third to the fourth quarter two projects went into service -- out of construction into service, four projects went from development to under construction and two projects the delivery was slightly delayed, one by a month and one by a quarter. On the underdevelopment schedule, we look very carefully at the start schedule and the lease of schedule with the following changes occurring.
Two projects shifted to under construction, two projects were added to underdevelopment, and two projects were deferred and dropped off of the schedule for the time being. One project was switched within the park, and was delayed two quarters, and then, five projects, we added one to three quarters of lease up, generally allowing a year for lease up, to can be completed.
With regard to our land inventory, we increased from about 1400 acres and 12.5 million square feet of development capacity at year end 2006 to owning or controlling 1700 acres that can support 14.8 million square feet of development capacity at year end 2007. Of this total, 225 acres and 2.5 million square feet are owned with joint venture partners.
We want to thank our entire team of employees for all the effort, the creativity and perseverance that enabled our company to generate strong FFO growth for our shareholders during 2007. In summary, we have taken a cautious but reasoned approach to 2008 that takes into account the potential recession.
We believe that we are well protected due to our government and defense, IT niche and well positioned for continued strong growth. And with that we'd be happy to answer any questions that you may have.
Operator
(Operators Instructions). And your first question comes from the line of John Guinee with Stifel.
Please proceed.
John Guinee - Stifel
John Guinee. Mary Ellen, are you there?
Mary Ellen
Yes, I'm here John, how are you?
John Guinee - Stifel
Happy Valentines Day.
Mary Ellen Fowler
Same to you.
John Guinee – Stifel
A couple of questions, just on accounting issue we're looking at this for a lot of people. You've got $215 million worth of land inventory.
Can you walk through on both the interest query and the other query, what's your capitalizing and what's your expensing on that $250 million worth of land inventory?
Roger Waesche
John, we don't have in front of us project-by-project, but on average about 50% of our land is what is called from an accounting standpoint under active development. And therefore, we are capitalizing interest and property taxes on that.
And the other half, we are expensing the interest associated with that and expensing the property taxes.
John Guinee – Stifel
Okay. And then the second question.
This all makes perfect sense to me and you guys did a great job of explaining it, but one disconnect is only $60 million of disposed and there are two places that's a disconnect. One is your development is much more in excess of $60 million a year and then two, as you're trying to focus the story more on the specialty.
It seems as if there is a great opportunity to sell more than $60 million in 2008.
Roger Waesche
I think we were taking into consideration that reality for now, the sales market is pretty much frozen. You know nobody wants to buy, nobody wants to sell.
And so we agree with you that as we focused the company more around government, defense and data then we needed to be selling off or joint venturing non-core assets and we are focused on that. But we want it to be realistic given that 2007 the market -- the financial markets are in such as state of term loan.
Rand Griffin
I think John, we are trying to be conservative there. I mean we have gone through and identified more than that in terms of what we deemed sort of non-core properties or properties where we have opportunity to joint venture or so but we are rearing on the side for conservatism.
John Guinee – Stifel
Perfect. Thank you.
Rand Griffin
Thank you.
Operator
And you next question comes from the line of Michael Bilerman with Citi. Please proceed.
David Seamus - Citi
Good morning. This is [David Seamus] with Michael.
Just a couple of quick questions. First of all, in terms of the development pipeline it looks like -- I know you talked about some of the projects are getting push back.
I was hoping you can give a little bit more color why do they get pushed back, why do some of those projects fall off the list? Particularly, I saw that Interquest, so if could just talk about that a little bit?
Rand Griffin
Well, Interquest actually moved from -- it didn't actually move, it's moving to where we anticipated starting that in the first quarter. So it's still on the list.
Steve Riffee
We actually changed the name with that.
Rand Griffin
We changed the name it's called Epic One. We did move the two hybrid buildings that are also at Interquest and Colorado Springs.
In the third quarter, those were under development and the fourth quarter those did move to under construction. And if I go down on the development from the construction that there was really no change, I mean other than dropping a couple into service and adding to the four building.
So the four buildings that were added were in construction where the two buildings Hybrid I and II in Colorado Springs and then the two buildings that are in San Antonio for the government.
David Seamus - Citi
Okay.
Rand Griffin
And you look under development, the two buildings that were delayed that we really kind of decided to put them off were a Rockville and then in NBP, we moved up 300 NBP and are re-shifting 308 NBP, which is the other side of a parking garage that we're going to be constructing.
David Seamus - Citi
Got you
Rand Griffin
Two of the one shifted, as I said, out of under construction to the two Hybrid Is, out of from development to under construction. The two that were added for development were Patriot Park VI, as the result of the success in Colorado Springs with the lease to ITT, we do need to move that building up and so we anticipate starting that in the first quarter.
And then also Northgate, which is the first building that we anticipate starting later this year at our Northgate project at Aberdeen. The remaining of the five that were delayed, really, we just went back and looked at the lease of timeframe and generally just reflected 12 months.
And I would say that we did that last quarter looking at projects and that just simply looked at the timings of the starts and then looked at the timing of 12 months. And generally those are -- five of those were delayed, either a quarter, and one was delayed three quarters, mainly because of the permitting of start timeframes for that particular project.
David Seamus - Citi
And what is your expected yield on the developments?
Rand Griffin
Roughly 10% cash-on-cash.
David Seamus - Citi
Thanks. Also, you guys mentioned cutting your operating expenses, just wondering how you go about cutting them.
It looks like right now you are about 39% of revenues, what can you feasibly get that down do in 2008?
Steve Riffee
We think we can increase our margins by about 2%. Our margins have actually dropped over the past year or two and some of that is a manifestation of character of the leases we know how in our portfolio as we've have taken on more gross leases versus net leases.
Mathematically, your percentage margin goes down although as a practical matter than that rent, it stays the same but it just looks like your margins are spinning a little bit. But where we are focused on cost control is utilities and on labor and just some of the R&M elements of our business.
David Seamus - Citi
Okay. Great.
Thank you.
Operator
And your next comes from the line of Chris Haley with Wachovia, please proceed.
Chris Haley - Wachovia Capital Markets
Good morning.
Mary Ellen Fowler
Hi Chris.
Chris Haley - Wachovia Capital Markets
Couple of questions if I can. Steve, could you remind me of the occupancy guidance again throughout the year the start and the end range?
Steve Riffee
Well, we started at 92 -- we ended 2007 at 92.6% It actually went slightly above 92.6% to 93% by the sale of the building and we're going to be just under -- we're going to build up to just under 94% by the end of the year based upon our assembly sub-schedules.
Chris Haley - Wachovia Capital Markets
Okay. And do you, I don't hear anything but I'd appreciate any color you guys can provide in terms of where you believe your rents are either on the '08 escalations or just portfolio wide if that is easier on your major notes?
Steve Riffee
We think well, as we've mentioned for this year what's maturing is in the very low 20s and so we think we are 10% below market hopefully on a cash basis, but certainly on a GAAP basis. And in terms of market -- the market I'd say is on balance and our portfolio is about 10% below market.
It's not significant in any market so it's not like we're flat in one market and up 20 in another.
Chris Haley - Wachovia Capital Markets
Are the rents similar to Virginia or around BWI? You don't believe marginal rents have changed materially versus six months ago?
Steve Riffee
No not materially. We aren't seeing yet any significant rent crawl down or anything.
Chris Haley - Wachovia Capital Markets
Okay. And the last question is, I very much appreciate the additional disclosure, which is very helpful and the disclosure that you offer in your quarterly packet much like some meetings we've had previously about the mix of demand for your development projects.
First, do you anticipate providing that on a regular basis?
Rand Griffin
Yeah
Chris Haley - Wachovia Capital Markets
Thank you, Rand. Would you characterize how those three buckets have shifted over the last six months?
Rand Griffin
I'd say Chris that the government and the defense information technology sector has grown and you can see that we went from 49%, which is under construction currently to then starting 77%. So, our construction volume and what we're anticipating to start let's say fairly steady.
But it's been a pretty dramatic shift over to the government and the defense IT. And we think that's healthy.
Those are sort of somewhat recession proof and what's interesting is that's really not yet reflective of the BRAC. And as Roger said we're starting to see a little bit of the BRAC activity.
But the stars that we're anticipating this year none of them really well the one -- only the one would be averaging that reflects BRAC. So, we're pretty comfortable with where things look to be from a demand standpoint.
Chris Haley - Wachovia Capital Markets
And the other two so that the market based demand now?
Rand Griffin
Market demand will have gone down than as a percentage and really, where we'll look again. Riffee said on the definition of that if we look around in a market and we've no product available within our portfolio and we look at the demand and we look at the RFPs that we're receiving and the expressions of interest.
When we recognized that it's a 12-month timeframe to build a building, we'll then typically start that building if we're comfortable. Now clearly, when we looked around at the situation in Northern Virginia, we did not start there even though we're falling and there are now some deals floating around, we just are more comfortable with the overhang there.
But we've gone ahead on the market demand position here in Gateway and also at our Arundel Preserve, which you could say we'll end up really being our government defense that one is the first building in a park that's immediately North of Fort Meade and diagonal to NBP. So, those are the two key ones that really were in response to market demand.
Chris Haley - Wachovia Capital Markets
Thank you.
Operator
And your next question comes from the line of Rich Anderson with BMO Capital Markets, please proceed.
Rich Anderson - BMO Capital Markets
Thanks and good morning everybody.
Rand Griffin
Hi Rich.
Rich Anderson - BMO Capital Markets
Rand I mean that you or anybody I guess the development yield number of 10% is of course a very good number but it's also down from 11% in change that you are able to do in past years on average. What do you think is driving that number down?
Rand Griffin
Rich, I think the construction cost, while we're seeing them moderating somewhat still have been up a little bit. The other aspect, we're seeing that you just have to recognize in today's environment is that the IT packages, it's just more difficult to deliver a turnkey space for tenants on the newer buildings at -- we used to do $25.
That's now moved up into the $40 range and in some instances even the $50 range. So I think that that's moved it up a little bit and also for a while we had reflected in there a little bit higher soft costs, permitting -- in every municipality, we're seeing fairly significant increases in permitting fees and other impact fees, particularly as the states start to decrease their revenue, expected revenue they're putting the pressure on the local municipalities who are stepping it up by adding costs to development.
And that's starting to become almost, more of a percentage increase frankly than the construction costs increases as an absolute percentage. So it's come down a little bit, but we're very comfortable that those are still far and above, higher than most of our peers.
Rich Anderson - BMO Capital Markets
Understood. In terms of the questions for every year is new markets, Colorado Springs seems to be taking up a lot of your time now.
Do you feel like you haven't the right mix for 2008 in terms of your markets, or could you see the company getting into another San Antonio or Colorado Springs in the next 12 months?
Rand Griffin
As we've said on previous calls Rich, we did spend really 2007 both absorbing the impact of Colorado Springs where we now have that pretty well staffed and well under development on the properties that we control and we feel very comfortable about our position there. We also had to absorb the Nottingham acquisition, which is almost like in effect buying a city, in terms of buying an entire submarket of 1.6 million square feet for that portion in White Marsh and taking on 19 new employees.
We are at a point now I think where we are comfortable and are starting to reaccelerate our examination of other cities and also are kind of looking at specific requirements and data as well as in our other government and defense IT sectors. And in our plan there is nothing for 2008.
We think that will more of over a 2009 at the earliest, if it occurs that's an upside to…
Rich Anderson - BMO Capital Markets
Okay.
Rand Griffin
…our numbers.
Rich Anderson - BMO Capital Markets
And then last question, you seem like you have a fair amount of protection in the Dalles South marketplace with no meaningful expirations despite the weak market, but where would you say do have some exposure to supply if it's not Dalles South where -- what markets do you have that have your attention right now from that perspective?
Rand Griffin
I think the only other one would be Columbia gateway, where they've absorbed between 500,000 and high of above 1.2 million square feet over the past years and there are currently some other buildings that also started slightly ahead of us. We are again pretty full with our 2.6 million square feet or 2.3 million square feet and felt comfortable to start.
But we recognized that that might be slightly slower on the lease up. The BRAC will start to accelerate and we'll take care of it by the end of '09 certainly and into 2010.
The rest of the markets were in good shape and we just don't see any real risk at all.
Rich Anderson - BMO Capital Markets
Okay. Great.
Thanks very much.
Rand Griffin
Okay.
Operator
(Operator Instructions) And your next question comes from the line of Ian Weissman with Merrill Lynch. Please proceed.
Ian Weissman - Merrill Lynch
Yes, good morning.
Rand Griffin
Hi, Ian.
Ian Weissman - Merrill Lynch
Just given the way the stock currently trades, can you just talk to us a little bit about your thought process on the stock buybacks and maybe if you'd accelerate your dispositions this year. How do you waive additional development activity versus stock buybacks?
Roger Waesche
We look at that a lot and constantly and we've noticed that a certain number of our peers have been quite active on the stock buybacks. Our position has been that we're open to that.
Our Board stands ready to take that action upon our recommendations. Currently though we're at a point, where when we look at the numbers and we look at the development yields that we're getting in the 10% range and we look at the other people that maybe don't have that kind of ability to accomplish those types of development yields and don't have the development opportunities that we have.
I think our preference is to retain the liquidity both for the development activities as well as just to kind of look cautiously at the liquidity availability in the marketplace. So, today we have not recommended that to the Board and the stock price has of course recovered during January and hopefully we'll continue to see some upward movement.
Ian Weissman - Merrill Lynch
Care to give us a surprise on where the stock looks attractive to buyback?
Roger Waesche
No.
Ian Weissman - Merrill Lynch
Final question is, with respect to your lease up goals for the year, 94%, how much of that is Nottingham driven. Where do we end the year in Nottingham and what are your leasing goals at Nottingham this year?
Steve Riffee
White Marsh ended the year 86% occupied and our goal for the year is to take that up to 91%.
Ian Weissman - Merrill Lynch
And where is the additional demand coming from? What type of business sector do you think will drive that demand of 500 basis points?
Steve Riffee
Health primarily we have a medical center there and we've got MedStar Health anchored in that community and Johns Hopkins has a major presence here and they are looking to expand. So, I'd say that's the number one industry group, the second area a little bit of financial services.
Ian Weissman - Merrill Lynch
Okay, thank you very much.
Steve Riffee
Thank you.
Operator
There are no additional questions at this time. I'd now like to turn the call over to Rand Griffin for closing remarks.
Rand Griffin
Thank you for joining us today. As always we do appreciate your participation and support and input and enthusiasm throughout the past year.
We hope we can live up to your expectations of this year. We are available to answer any other questions you might have.
And thank you and everyone have a good Valentine's Day. Thank you.
Operator
Thank you for your participation in today's conference. This concludes the presentation.
You may now disconnect. Good day.