Corporate Office Properties Trust (OFC) Q2 2019 Earnings Call Transcript

Corporate Office Properties Trust (OFC 0.26%)
Q2 2019 Earnings Call
Jul 30, 2019, 12:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the Corporate Office Properties Trust second-quarter 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.

Stephanie Krewson-Kelly -- Vice President of Investor Relations

Thank you, Crystal. Good afternoon and welcome to COPT's second-quarter 2019 conference call. 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 posted slides on the Investors section of our website to accompany management's remarks.

On our website and in the results press release, you will find reconciliations of GAAP to non-GAAP financial measures management discusses. At the conclusion of management's remarks, we'll open the call for 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 yesterday's press release and our SEC filings for a detailed discussion of forward-looking statements.

I will now hand the call over to Steve.

Steve Budorick -- President and Chief Executive Officer

Thank you and good afternoon. We had a very productive first seven months, during which we achieved three high-priority strategic objectives. In development leasing, we signed 1.7 million square feet to date, a new record for a single year. We exceeded our prior record by over 0.5 million square feet and we still have five months remaining in the year.

As a result, we have more than doubled our expectation for full-year development leasing in 2019 from our initial guidance levels. Second, in the quarter, we tied our all-time quarterly record for vacancy leasing, and we're on pace to meet or exceed our best annual volume for the year. And third, we created a strategic joint venture arrangement with Blackstone to fund our 2019 development investment needs and most of the equity for our expected 2020 development spend. Importantly, the JV creates a valuable relationship we can rely on to generate future capital recycling, if necessary, in a highly cost-effective manner to ensure funding of our expanding development opportunities.

The healthy defense spending environment underpins the robust demand for our Defense/IT locations, and our ability to convert this broad-based demand and the strong leasing volumes bolsters the outlook for future FFO growth. Last week, Congress agreed on a two-year budget deal that, when appropriated, will continue to grow defense spending into fiscal '20 and '21. The House passed the agreement last week, and the Senate is expected to pass it this week. The two-year bipartisan agreement raises the final two years of spending caps put in place by the Budget Control Act of 2011, removing the possibility of future sequestration cuts and reducing the likelihood of Continuing Resolutions.

The very visible bipartisan support to restore and fund our national defense continues to instill confidence among government users and defense contractors to invest in growth, which includes facility planning. As demonstrated by our record leasing results in the quarter and year to date, we continue to benefit from being the preferred provider of real estate solutions to government users and defense contractors engaged in national security defense and IT-related activities, including cybersecurity. Moreover, we see strong growth in all five of the categories of demand we've outlined on prior calls. The first category is defense contractor incremental expansions, which continued to accelerate.

In the second quarter, we completed 245,000 square feet of vacancy leasing, matching our best ever quarterly volume. The vacancy leasing at our Defense/IT locations was 76% of the quarter's volume and exceeded the entire amount of vacancy leasing executed in the second quarter of 2018. The second category is deferred U.S. government leasing.

During the second quarter, 92,000 square feet of our vacancy leasing was with the U.S. government in the Fort Meade area. For the first half of the year, we completed five leases with the U.S. government totaling 126,000 square feet, representing 1/3 of our total vacancy leasing.

The third category is speculative development in markets where demand has absorbed the available inventory and supports modest speculative development. Redstone Gateway is one of the two markets where we see current speculative opportunity. The two spec buildings we started last year are both 100% leased. Every square foot of operating space in Redstone Gateway is leased, and the 440,000 square feet of contractor-built leads under development are 95% leased.

Since we have no uncommitted inventory later this quarter, we expect to break ground on our next 100,000 square foot spec building to capture highly visible defense contractor demand. The other market that supports speculative development is the Discovery District at the University of Maryland. Last quarter, we placed 5801 University Research Court, our most recent spec development in that business park, into service. That building is 100% leased, and given the strong demand we continue to see for this Metro-served location, we recently kicked off a 105,000 square foot spec development.

Among the many prospects we are pursuing, there's a fast-growing provider of cybersecurity training that we expect will prelease 25% of the project. The fourth category is build-to-suit and major preleases with defense contractors positioning for growth. Demand for preleases in full building build-to-suits emerged last year and continues. Excluding the data center shells, this year, we've completed more than 400,000 square feet of major prelease and build-to-suit leases with defense contractors for new facilities.

This activity includes a multi-building campus for Yulista, whose Defense Systems and Solutions division recently won a nine-year $4.7 billion contract from AMRDEC at our Redstone Arsenal. In our data center shell business, we've signed five leases this year. The first four completed the 11-facility pipeline we announced in 2017. In aggregate, that program encompassed 220,000 more square feet and committed $40 million more than originally planned, which roughly equals one extra data center shell.

The fifth lease is the first of another half dozen or so additional opportunities with this customer on land we already control. Demand for data center shells continues to be strong, and our recent joint venture transaction demonstrates the value proposition of that development platform. We monetized profits in seven of these assets and are recycling the proceeds into an expanding set of development projects, creating value for shareholders and providing a highly cost-effective capital source. The fifth demand driver is the government returning to long-term planning and expansion at our secured campuses.

Negotiations are advancing well with multiple government users to fill 100 Secured Gateway in Huntsville, and discussions are progressing with other government users that require new facilities elsewhere. In fact, approximately 1/3 of the transactions in our shell development pipeline involve new facilities for government users. So in summary, we're obviously in a rapidly expanding set of leasing opportunities resulting from the past few years of defense spending increases. The outlook for defense spending remains bright and should fuel strong demand for our Defense/IT locations for years to come.

Referring to Page 25 of our supplemental package, we have 2.1 million square feet of active construction projects under way. As we place this pipeline of highly preleased developments into service between now and the end of 2021, we expect the additional EBITDA to generate modest FFO growth in 2020 and impressive growth in 2021. With that, I'll turn the call over to Paul.

Paul Adkins -- Executive Vice President and Chief Operating Officer

Thank you, Steve. At the end of the second quarter, our 19 million square foot core portfolio was 94.1% leased, the highest level in 18 months and a 40 basis point increase from last quarter. We expect the strong leasing momentum to drive additional occupancy gains. Within our operating portfolio, in the second quarter and first half of this year, we've leased twice the vacant footage than we did during the same periods last year.

61% of second quarter's vacancy leasing was in the Fort Meade/BW Corridor subsegment, which was 92.5% leased at the end of the quarter. In the market, we are tracking 500,000 square feet of activity against these 600,000 square feet of unleased space. At the National Business Park, we are 91% leased, representing an increase of 140 basis points over last quarter. This 3.8 million square foot park contains only 365,000 square feet of unleased space, against which we are in various stages of pursuit with roughly 230,000 square feet of demand.

Looking in our other subsegments. In leasing executed in July, our 706,000 square feet of operational space in Huntsville is 100% leased. In San Antonio, our 953,000 square foot mission-critical campus remains 100% leased. Our 1.2 million square foot Navy Support portfolio was 93% leased at the end of the quarter, marking a 180 basis point increase over last quarter.

We are working 66,000 square feet of demand against the remaining 85,000 square feet of vacancy and expect to see more space absorbed before year-end. Our two million square foot NoVA Defense/IT portfolio was 88% leased at the end of the quarter, which is down relative to the first quarter due to expected return -- tenant turnover. We have already backfilled 25% of the nonrenewals and are in advanced negotiations with another 50%. For the subsegment as a whole, we have 245,000 square feet of unleased space, against which we are working an equal amount of demand.

Lastly, at our Regional office portfolio, with the 46,000 square feet of leases signed in the second quarter, our Baltimore portfolio of three Inner Harbor office towers is now 94% leased, and we are tracking 75,000 square feet of new demand. Our four Metro-serviced buildings -- served buildings in Northern Virginia were 84% leased at the end of the quarter, and we are in discussions with prospects to absorb up to 1/3 of the 100,000 square feet of unleased space. In terms of new construction, the 2.1 million square feet of projects under development are 83% preleased. When placed into service, this pipeline will increase our total portfolio by 11%.

Furthermore, we expect each project to be substantially or fully leased when they are placed into service between now and the end of 2021. In the second quarter, we placed 606,000 square feet into service that were 100% leased, bringing our total through June 30 to 787,000 square feet of fully leased space. Before year-end, we expect to place another 100,000 square feet of leased space into service for an annual achievement of nearly 900,000 square feet. Our ability to consistently deliver development projects that are highly leased supports cash flow growth and is the key to our value creation.

Our shadow development pipeline contains up to 2.3 million square feet of potential transactions. We have a high degree of confidence that we will execute on another 300,000 to 400,000 square feet of leases before year-end, which supports the increase of our development leasing goal for the year from the previously elevated target of 1.4 million square feet to the new goal of two million square feet. With that, I'll hand the call over to Anthony.

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Thanks, Paul. The continued strong demand for new developments and our elevated development leasing goal have resulted in a corresponding increase in our development spend guidance. We are increasing our estimated investment for the year by another $75 million to a new range of $400 million to $450 million. This is 1.5 times our initial expectation, which was to invest $250 million to $300 million in developments this year.

During the quarter, we contributed 90% interest in seven of our data center shell properties through a joint venture with Blackstone Real Estate Income Fund, raising gross proceeds of $238 million. Based on our average yield on cost of 7.2%, pricing on the seven assets equated to the profit margin of approximately 45%. In order to fund the increased level of development investment, we increased the percentage on the first seven assets contributed to the venture and have executed an agreement to contribute two additional data center shells in early December to our Blackstone JV. Selling a higher percentage interest and two extra assets increases our disposition guidance for the year to $300 million, which is twice the level of asset sales anticipated when we established guidance in February.

Second-quarter FFO per share of $0.52 exceeded the high end of guidance by $0.01 and was driven by stronger-than-anticipated same-property cash NOI growth of 4.5% and higher lease termination income. Same-property cash NOI exceeded our internal forecast and was driven in part by lower-than-expected operating expenses, which included the timing of R&M costs. Based on the 4.5% increase in same-property cash NOI for the first six months and our forecast for the remainder of the year, which includes investing to deferred R&M costs, we are increasing our same-property cash NOI growth for the full year from our prior range of 1.5% to 3% to a new range of 2.75% to 3.75%. Regarding year-end same-property occupancy, the closings on the Blackstone joint venture removes eight 100% leased assets from the same property pool and reduces year-end same property occupancy by 60 basis points.

Accordingly, we are tightening our guidance from a prior range of 92% to 94% to a new range of 92% to 93%. Tenant retention was 81% in the quarter and 78% for the six months, both of which exceeded our full-year guidance of 70% to 75%, and we are increasing our tenant retention target to a new range of 75% to 80%. Cash rents on renewals in the quarter rolled down 3.3%. Similar to the first quarter, the roll-down was driven by a couple of transactions where annual rent increases on long-term leases compounded in excess of market rent growth.

I want to discuss the impacts of tenant retention and renewal rates in more detail to keep the importance of these metrics in the proper context. Although we prefer market rents to keep pace with our embedded rent steps, the fact is that our higher retention rates more than offset the rate compression. I'll refer you to the analysis on Slide 11 of our deck. Without accounting for downtime, which would magnify these results, this analysis reveals that renewing 78% of expiring leases with a 4.6% roll-down produces 8.8% more revenue and avoids spending a minimum of $600,000 of capex relative to achieving a 65% retention rate and 5% cash rent growth.

Quite simply, our consistently high retention rates, as shown on Slide 10, reduced capex investment, avoid potentially lengthy downtimes and therefore, benefit AFFO in current and future periods. The structural rent growth in our leases will recapture the loss rate over time and the capex savings, which is a permanent benefit. In terms of renewing rents guidance for the balance of the year, we are in advanced negotiations on several large 2020 expirations that we expect to renew before the end of the year. These early renewals were not part of our initial guidance and the expiring rates have escalated above market.

Incorporating actual results with these renewals into our forecast, we now expect renewing cash rents to roll down between 4% and 5% for the year. Last but perhaps most important, we are reiterating our guidance for FFO per share for the full year in a range of $2.01 to $2.05. We are establishing third quarter guidance of $0.49 to $0.51. Even though we have doubled our expected dispositions for the year, which net of interest savings causes an additional $1.5 of dilution in 2019, we expect our existing operations to more than make up for this.

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

Steve Budorick -- President and Chief Executive Officer

Thank you, Anthony. Recapping today's call, we've had a great first half of 2019, and we're looking forward to finishing the year with strength. Our occupancy fundamentals are gaining ground. We're on pace to achieve our highest vacancy leasing level in our history.

We've already set a new record in annual development leasing, and we're guiding to a record-shattering two million square feet for 2019. We expect to invest about $425 million in our development activities or a 54% increase above the midpoint of our initial guidance. Our active development pipeline contains 2.1 million square feet of highly preleased projects that represent more than 10% growth on our portfolio size when delivered. We've recycled development capital, demonstrating impressive margins and valuations in our development activities.

And importantly, we've raised sufficient capital to fund 2019's development activity and most of 2020's expected investment. Clearly, the succession of the increased Department of Defense based budgets, commencing with the fiscal year 2017 budget passed in May of 2017, have materialized in a greater opportunity for both our operating portfolio and our development business and within the time frames we set forth in early 2018. We attribute the outstanding demand we're now experiencing for the fiscal year 2018 budget appropriated in March of '18, and that demand continues with strength into the second half of the year. Given that fiscal year 2019 defense budget was passed only 10 months ago and the recent two-year bipartisan agreement is in the process of being passed and the mission-critical nature of our Defense/IT locations is unique in our industry, we have great confidence that our shareholders will continue to benefit from the strength of the national security investments of our country for at least the next three to four years.

The strength of our capital recycling effort this year propels our company toward supporting elevated development investments with diminishing incremental equity capital needs and ultimately beyond an inflection point where we can sell fund development and deliver impressive annual FFO and cash flow growth. And with that, operator, please open up the call for questions.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Craig Mailman from KeyBanc Capital Markets.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Anthony, I think you touched on it with the R&M cost being diverted a little bit. But could you just break down the 75 basis point increase in guidance here into the components?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Well, the components are made up of some faster lease occupancy for leasing that was -- tenants into occupancy from leasing that was done last year. And there were some operating expenses that were lower than expected in the first and second quarter that are permanent, most of them relating to the net impact of weather-related expenses, both snow as well as energy.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

OK. And then I know the rent spreads are coming down because of some early renewals. If we were to think about just kind of rent spreads and commencements for this year versus 2020, kind of how would those two buckets look?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Not sure they'd look any different. I mean there is -- some of the early renewals that we're experiencing won't impact our cash NOI until next year, but there's -- I'd say there's 2/3 of our renewals that relate to expiring leases within the current year and roughly 1/3 that are early renewals. So some of -- it's probably roughly a 2/3, 1/3.

Steve Budorick -- President and Chief Executive Officer

Craig, to put a little finer point on that, where we stand year to date, 91% of our leases in aggregate rolls within the guidance we set forth for -- with cash rent roll-down less than 2%. Only four leases that we -- that included one early renewal renewed outside of our guidance. In total, they renewed at about 9.1% combined. The important point of those four deals, they are larger, they are coming off very long terms and had escalated higher.

We retained $10.5 million of rent by renewing them and we gave up one. But if you look at the big picture, we saved $10 million, $20 million from potential downtime. We avoided at least $8 million to $10 million of capex risk. So next year, the proponents of our leases will likely roll in that 0 minus 2%, but there may be an occasion where a bigger or longer-term lease comes to maturity or maybe early that could deviate from that.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

OK, that's helpful. And then just lastly, I know you guys have another $300 million to $400 million of dev leasing in the full year. And how much of that is related to like a potential JEDI award versus just the increased defense spend you guys are talking about on just the office side?

Steve Budorick -- President and Chief Executive Officer

So to the best of our knowledge, none of the planned developments we're doing in cloud computing anticipate the JEDI contract. That contract is expected to be awarded in August. There were only two competitors that are qualified to service it, and we'll understand I think in August how that turns out and what the implications are for our company or there -- or afterwards.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

So none of the $300,000 to $400,000 potential incrementally for year-end is related to data centers? It's more traditional just kind of the fee?

Steve Budorick -- President and Chief Executive Officer

That's absolutely true. We don't expect to sign another data center lease this year. So we're currently -- our current development mix with the two deals we just signed, our year-to-date achievement is about 70% data centers. As we look to the end of the year, that mix should be 60-ish percent and possibly as low as 50%.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

OK. And then just one last one. Anthony, on your ability to kind of continue to shelter gains on additional data center contributions, kind of how much more can you put into that before you run into some special dividend concerns, if any?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

We have a lot of sort of tax planning that's going on this year to eliminate the need for special dividend this year, and all of those are on track to get completed before the end of the year. We would continue to have some cushion beyond that, probably some significant cushion beyond that because we would still maintain most of, if not all of our fifth quarter dividend deduction.

Operator

Our next question comes from Manny Korchman from Citi.

Manny Korchman -- Citi -- Analyst

Anthony, you sort of touched on this in your closing remarks, but how do you think about continued sales or JVs versus tapping the public equity markets, especially since you guided to have an active ATM out there?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

I think as we -- as long as we continue to trade in the public markets below net asset value and we can harvest and recycle our data center shell assets in the kind of structure, the kind of pricing and kind of development margins that we executed in the second quarter, we would continue to do that in lieu of going to the market and issuing under our ATM. Getting that capital source was not only a goal to raise the capital for this year, but it was to find a partner who can become a programmatic partner for us going forward. And we're confident that we have found that partner.

Manny Korchman -- Citi -- Analyst

As we think about your -- the shadow development pipeline, I think you said of 2.3 million square feet, can you give us at least a rough breakdown of the makeup of the markets or asset types? How much of that is kind of builds versus office space?

Steve Budorick -- President and Chief Executive Officer

Roughly 50% is data center, 50% is defense contractor or other office space. It's distributed throughout our portfolio, but there is a strong concentration in Redstone Gateway. And then there's -- roughly 1/3 of volume represents U.S. government facilities that are working with the users to plan for the future.

Operator

Our next question comes from Blaine Heck from Wells Fargo.

Blaine Heck -- Wells Fargo Securities -- Analyst

Just a follow-up on that last one, Steve. It seems like thus far, you've built relatively small buildings at Redstone Gateway. But is there an opportunity to take advantage of the momentum there and maybe do some larger properties?

Steve Budorick -- President and Chief Executive Officer

Well, so we've had some discussions over and above larger properties in a build-to-suit or major prelease basis. In terms of our expectation of starting another building this quarter without a significant prelease, we would manage our speculative commitment to 100,000 square feet or so at a time. We've got ample land and with -- building to that size, we can fulfill the 4.5 million square feet of potential. So we're about managing shareholder risk.

Blaine Heck -- Wells Fargo Securities -- Analyst

All right, that's helpful. Then just digging into your top 20 tenants and those that are next roll, and maybe some of this is included in early renewals. But it looks like Kratos and Accenture are coming up within the next year and some larger ones, Northrop, Boeing, Booz Allen in say the next couple of years. Paul or Steve, is there any color you can give on the specific leases and your expectations or negotiations you might be having at this point?

Steve Budorick -- President and Chief Executive Officer

Well, the one I will call out is Kratos, which will be a nonrenewal. That lease was assigned to other users years ago so that we may retain the tenancy rulebook. Part or all of it, we'll book it as new leasing. The other ones, I think, are open issues.

Paul Adkins -- Executive Vice President and Chief Operating Officer

Yes. The other ones, the expectation is, as you can tell by our chart in the slide deck, we expect to renew those leases.

Blaine Heck -- Wells Fargo Securities -- Analyst

OK, helpful. And then on Page 8 of the presentation, you guys referenced 900,000 square feet of demand from defense contract awards that you're tracking. Can you just give us some more color on those requirements? And when were those contracts awarded? And how many contracts are actually driving that 900,000 square feet?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Well, the 900,000 square feet is an aggregate of the demand across all of our subsegments that are at Defense/IT locations. So there is -- that's just the summary of the active deals that we're pursuing. It's obviously numerous contracts that they're related to, but it's not a direct correlation of two, five contracts or something like that. That really represents the broad-based demand across our various locations.

Operator

Our next question comes from Jamie Feldman from Bank of America.

James Feldman -- Bank of America Merrill Lynch -- Analyst

I want to ask you a little bit about just the platform and your ability to manage all of this incrementals, developments should it continue to grow. I mean do you think that based on your current headcount and land bank and platform across your markets, what's your capacity to keep growing? Or do you think you need to beef up the company even more?

Steve Budorick -- President and Chief Executive Officer

Well, we made a decision in the last six months to beef up our Redstone Gateway team, so we've added one body and a second shortly. Beyond that, we have great scale in our data center shell development team so we're fine there. And we've got -- I don't think we'll have any material additions to our headcount to support this elevated demand or continue in the future.

James Feldman -- Bank of America Merrill Lynch -- Analyst

OK. And then for Anthony, as you think about funding with dispositions, especially to the data center JV, I mean do you -- are there any REIT limitations on how much you can contribute per year? And can you give a sense of pricing on the two assets that you guys are going to contribute or just how the pricing is structured for that JV?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Sure. There is really no limitation here. We have -- we've done a total -- we have a total of 26 either operating or under construction data center shells with the 13 that are in ventures today plus the two we expect to contribute at the end of the year. We'll have 11 that are -- continue to be wholly owned assets.

I think our only restriction is really time as we make sure that those assets have sort of reached their hold -- 24-month hold dates from placed in service from a tax standpoint. Other than that, there's really no restriction on the timing or the amount that we could sell. It's really how much we need to sell to not just meet the funding of our expected development investment but maintain and continue to marginally improve our leverage over time. So I think we're fine with respect to having a stable of assets that we can continue to tap into.

With respect to pricing, the cap rate on the two data center shells that were closed into the venture in December have a very small premium in cap rate to what we did in June because of the -- to get the commitment from our venture partner but still in that same low five range.

James Feldman -- Bank of America Merrill Lynch -- Analyst

OK. And then maybe an update on the Washington, D.C. development leasing?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Sure. At 2100 L, we currently have six active prospects totaling 260,000 square feet for the 90,000 -- 100,000 square feet of office space we have left. So we're 50% preleased. The building is pouring the seventh floor out of 10.

It will be topping off the next couple of months. And so with that activity, we remain optimistic that we will deliver substantially leased. The earliest that we can perform tenant work is April of next year. So kind of that's when we'll begin the Morrison & Foerster build-out.

But overall, the climate is competitive, but we're confident that the superior trophy attributes will -- they do compete well.

James Feldman -- Bank of America Merrill Lynch -- Analyst

OK. And then I guess just finally, the Blackstone JV seems like it's going pretty well. I mean what's your appetite to start similar structures with other investors for maybe more of the Defense/IT side assets?

Steve Budorick -- President and Chief Executive Officer

We don't have any appetite to joint venture our Defense/IT assets beyond the data center shells.

Operator

Our next question comes from Dave Rodgers from Baird.

Dave Rodgers -- Robert W. Baird and Co. -- Analyst

[Inaudible] along the way, any update on 310, timing, conversations, incremental leasing, et cetera?

Steve Budorick -- President and Chief Executive Officer

So we missed the first half of your sentence. Do you want to start from the beginning?

Dave Rodgers -- Robert W. Baird and Co. -- Analyst

Yes, sure. Sorry about my connection. Just on 310 NBP, I don't know if I named it -- either had a bad connection earlier and missed something along the way. Just any updates on leasing expectations there.

Steve Budorick -- President and Chief Executive Officer

So we expect our opportunity to fully lease the building to occur before year-end.

Dave Rodgers -- Robert W. Baird and Co. -- Analyst

Great. That's helpful. Steve, talk about kind of what gets you comfortable with spec development? It's been a while since you've done that. And would you do spec on the government side? Or is this purely defense contractors? Is it more location-driven? Kind of some thoughts around that.

Steve Budorick -- President and Chief Executive Officer

Well, first, let's just separate the government. Most of the government customers we serve, we have to start the buildings before it can be leased like 100 Secured Gateway at the Redstone Gateway development. We have a condition, we call them form demand. We understand there are needs available and where the funding sources are and we move forward as we typically have with that kind of development.

With regard to spec, it was pretty clear in our comments, there's only two developments we have currently where we're comfortable going spec. The first is the University of Maryland where we're completely leased. We do have some development achievement milestones and we've got great demand for product on there. It's a pretty exciting location.

And the second is Redstone Gateway. Literally, we have not a square foot in all of Huntsville that we can lease to a prospect, and we have significant demand in conversations ranging from modest to very large. So it's clearly a very comfortable bet to kick off a 100,000 square foot building on spec based on the numerous conversations we're having.

Dave Rodgers -- Robert W. Baird and Co. -- Analyst

That's helpful. Appreciate that color. And then maybe just lastly for you or for Anthony, Steve, with regard to your comments, you've been pretty consistently -- I think at the beginning, they're talking about 2021 FFO growth kind of starting. It looks though that with your development pipeline completion, stabilization, expectations that most of that growth should actually begin to occur in the second half of '20.

So I guess I just want ask a more pointed question of, do you expect some of the leases to take a little bit longer? Or is it more maybe solutions coming? Or is it really you're just looking at a full year versus kind of when that contribution really starts to kick in? Just want to kind of get a better sense for that second half of '20.

Steve Budorick -- President and Chief Executive Officer

It's -- well, you're going to see a ramp-up in the second half of 2020. You're going to see full-year impact in 2021. And do -- you do have to put in context that we doubled our capital raise, we've doubled our full-year dilution from that capital raise. We expect good growth next year and then the full impact to occur in 2021.

Operator

Our next question comes from Rich Anderson from SMBC.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

So the market -- or the consensus NAV number out there is $31. Do you have any comment about that number?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

I think our comment on that would be that we believe the value of the company is higher than that based on where we believe the cap rates for our assets are compared to the cap rates that are assumed in some of those valuations that make up consensus.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

OK. So not -- the stock clicks $31.01. We're not looking for an equity offering from you guys, I guess, is my point.

Steve Budorick -- President and Chief Executive Officer

Well, it's certainly not this year with what we've completed in -- we mentioned in our comments. We've put a substantial amount of the capital needs for 2020 away.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

Yes. So speaking of capital raising, and I would argue you have two programmatic partners in the shell business now. But I'm curious when you look now at your Inner Harbor assets in Baltimore, 94% leased. What is your thought about them long term, particularly now that we've learned that the city is rat infested?

Steve Budorick -- President and Chief Executive Officer

OK. All right. Well, I am not going to make any comment on the politics. I will say like every great city, Baltimore clearly has some issues and challenging neighborhoods, but it also has very solid business community with great organizations and citizens dedicated to the city.

So as for our three buildings in the Inner Harbor, we're very pleased with our performance and with our investment. Back in 2015, we invested into the reurbanization trend in and around the harbor, which continues to be very successful. All of the residential developments that we are anticipating back then has completed. They've all had great success, and that dynamic that supports the CBD and our investments continues to be strong.

So -- and my last comment is the buildings are 94% leased and it marks a new high in occupancy, so we're very satisfied with the buildings. Long term, they are nondefense assets. We do have value creation series and programs involved in all three that we're executing on. And there may be a day when the best move for our shareholders is to harvest that value, but it's not in the next 12 to 24 months.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

OK. Anthony maybe or whomever, is the $300 million of dispositions, is that -- just to clarify, that's entirely the Blackstone joint venture arrangements, correct?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

That's correct.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

OK. And then when you talked about the escalators exceeding market rent growth and hence, the rent roll-downs at expiration, how -- is that a condition that can stay in perpetuity? Or will -- at some point, you'll need to see escalators come down to better reflect what is happening in the marketplace?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

I think we continue to see a benefit from getting the escalators over time because we're -- even though we're having these rent roll-downs on our renewals, you compare our first year cash to first year cash on leases, we're still seeing rent growth over the life of the leases. And so we'd rather continue to get the -- and negotiate for those higher -- those continued high increases each year. But clearly, as we sort of outlined, the benefit of our higher tenant retention more than outweighs the impact of cash rent roll-downs even when those roll-downs are at market. And we'll continue -- we believe we'll continue to experience those high levels of retentions.

And by doing that, we avoid step-down options that could be undefinable in terms of how long it is as well as higher tenant allowance and in some cases, even building capital.

Steve Budorick -- President and Chief Executive Officer

And let me just throw a quick point. In our average leases, call it five to six years, 90% of our leases are rolling within our guidance of 0 to minus 2%. About 1/3 of them, roll-up, 1/3 to 40% is flat to positive and some are mildly negative. It's the rare lease that is compounded for eight or 10 years where we see a mark-to-market that's a bit painful, and it disproportionately shows on our annual guidance.

But we see no change in our ability to negotiate and capture good rent growth in our structure, which we've demonstrated creates start rents, start rent growth in our portfolio.

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

OK. And then lastly, Steve, why did you mention that you thought Continuing Resolution was probably off the tail? I don't remember exactly how you put it, but it wasn't a complete no? I'm curious, is there some language in there to that end?

Steve Budorick -- President and Chief Executive Officer

We did more than imply that. We stated that in our narrative. It really speaks to the activity that occurred last year that you see breaking lose right now with that bipartisan agreement. They start identifying and agreeing on components of the total budget and passing them individually.

Last year, before the end of the fiscal year, at least three of the budget sectors were already passed before we hit September 30. The narrative that we hear is that we'd like to see defense and several others pass before the end of September 30, if not all of them.

Operator

Our next question comes from Tom Catherwood from BTIG.

Tom Catherwood -- BTIG -- Analyst

Sticking with the leasing and the leasing roll-down questions. So either Anthony or Steve, is it correct to say that were it not for the early renewals that you did, the 2020 renewals, that leasing spreads would have been within the prior guidance? Is it just that dragging it down?

Steve Budorick -- President and Chief Executive Officer

Well, there's a big early renewal in the first quarter that set that quarter's roll-down. It would have been much closer to our guidance without them.

Tom Catherwood -- BTIG -- Analyst

OK. And is it...

Steve Budorick -- President and Chief Executive Officer

Like I say, it would have been at guidance, but it would have been plus or minus a point.

Tom Catherwood -- BTIG -- Analyst

OK. And is it -- it sounds like it's just the duration of those leases that causes that substantial roll-down, or is it market location? Is that factor in? Or is it pretty consistent across your markets as far as kind of how far below market these leases are?

Steve Budorick -- President and Chief Executive Officer

It's really duration.

Tom Catherwood -- BTIG -- Analyst

OK. And what I'm really trying to get at is you spoke a lot about the incredible demand. Paul spoke about kind of the demand that you're tracking against the vacancy. Obviously, leasing volumes are as high as they've ever been, but the market still remained relatively flat.

Is there's something in your markets that needs to change from a vacancy standpoint or just a competitive standpoint to start getting some positive momentum, not on the leasing front but I mean on the rent front? Or it's kind of just flat is the way it's going to be?

Steve Budorick -- President and Chief Executive Officer

Well, firstly, I can't talk about rent growth in all markets in the same way. Some of our markets were already experiencing rent growth from what we had 12 or 24 months ago, and others, less so. But in all instances in my career, when you see increases in the rates, it needs to be preceded by 12 to 24 months of strong absorption. When the supply availability drops, that's when you can see leverage to command higher rate, and we're at the front end of that recovery.

So 12 to 18 months, 24 months from now, we expect to be at a better spot than we are. In the meantime, we are managing to maximize cash flow growth from our assets. And as we demonstrated on our exhibit, the best way to do that is not lose our tenants. So if we have to, on occasion, take a roll-down to keep that retention, you can't grow a rent that you don't keep and the capital avoidance is really where the value comes in.

Effective rents are much better. So that's the way we look at it.

Tom Catherwood -- BTIG -- Analyst

Totally fair. And along those lines, Steve, do you then -- again, because there is more demand, even though we're not 12, 24 months down the road, do you get some more flexibility in your negotiation, whether it's being able to capture longer terms or higher annual bumps on these leases that you're doing now?

Paul Adkins -- Executive Vice President and Chief Operating Officer

Tom, it's Paul. I would say that we do get a little bit more leverage in our negotiations with the increased demand. And as Steve said, we're really -- this is just beginning to ramp up. There's a sort of the demand upkick from the FY '18 budget that we're seeing.

So we're focused mostly on the velocity of increasing our occupancy in our portfolio. The terms aren't moving demonstrably better for us nor are they obviously deteriorating. So it's just increased demand in what's minor improvements in select submarkets in terms of terms so that we can dictate slightly better terms.

Tom Catherwood -- BTIG -- Analyst

Got it. Got it. OK. And then last one from me, Steve, you mentioned something interesting at the end of your remarks.

I didn't hear it fully, but you mentioned getting toward self-funding. So you obviously set up this programmatic joint venture. You're going to have increasing cash flows as you deliver the developments that are in place right now. But how do you think about that comment you made with self-funding in terms of, a, what it might take to get you to that point; and b, kind of what level of annual investment you could support on just a self-funding basis?

Steve Budorick -- President and Chief Executive Officer

Well, I'm not going to let you pin me down on exact numbers or years. But as we model our business going forward, with the oversized capital raise this year, the pre-funding of significant amount of what we need next year to maintain higher development levels than we've averaged over the last eight years, we need increasingly less capital on a new capital for equity on the annual basis. And we project that day 1, we'll be able to support a very high level of development with our internal funding.

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

While maintaining our current, if not improving our current leverage levels.

Steve Budorick -- President and Chief Executive Officer

We're referring to an inflection point. We've come a long way to get our debt where it's at to create value. We've recycled on a few instances, but there's real leverage in the profitability of the development we've recycled. And as that leverage impacts future cash flow, we're gaining ground.

Operator

Our next question comes from Jon Petersen from Jefferies.

Jon Petersen -- Jefferies -- Analyst

So you had a little conversation earlier, I think with Rich, on NAV. So I'm curious if you could talk more about cap rates. So obviously, we've seen interest rates come down, but clearly, there's also some momentum in the business that you guys focus on. So I know a couple of years ago, you've put some research down on your page with some cap rate guidelines.

I was curious if you can comment on whether -- if you were to update that today, would those cap rates be down, up, the same?

Steve Budorick -- President and Chief Executive Officer

Well, the one thing I will say we demonstrated was the cap rate on our data center shells. And Anthony, do you want to take the rest of that?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Yes. We'll be updating that piece based -- to incorporate some other transactions that have occurred in our markets over the last 12 months. But our expectation is -- and based on transactions that have been executed, those cap rates would be sort of marginally lower than what they were in -- on the last piece we put out, I think the one area where we will continue to have a debate and conversations with investors and analysts around the value of our government buildings. We believe those government assets -- if we can demonstrate that our data center shell trend -- assets are valued in the range where that cap rate was priced, we're pretty confident that our government, secured government portfolio would price with a cap rate inside of where our data center shells are.

So I think that's where we will continue to mine for comparable transactions, whether just -- difficult to find to support where we believe the value of that portfolio resides.

Jon Petersen -- Jefferies -- Analyst

OK. And then yes, you guys have done a lot of work on leverage to bring it down. You're currently at BBB- kind of across all the rating agencies. But I think you've got positive outlooks, at least two of the three of them.

So I guess what do you still have to do to get upgraded to that BBB flat notch? And is it just a matter of waiting? And then I guess once you get there, I guess maybe what sort of different strategies will you take to extract those interest savings?

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Well, I think the -- it's different at each agency. Yes, I think that some of the -- one of the agencies, we need to maintain a lower leverage profile for a long extended period of time to offset what they see as geographic and tenant concentration concerns. I think at other agencies, they have clearly come around and come to appreciate the value of our franchise and the value of what that concentration means with respect to the stability of cash flows within our portfolio. So -- and I think with the two that we're on positive outlook on, there's the possibility over the next 12 to 18 months of moving those to BBB flat.

But again, there's -- every time we think we're there, somehow, the goal line moves. But I think we're clearly moving in the right direction, and all of the commentary we've received from the agencies is very, very positive. In terms of how we capitalize the company, how big we would -- I think we would continue to structure our debt portfolio in a similar manner to what we have to date where the vast majority of our debt is in a fixed income public market. And we would continue to tap that market to fund the debt component of our investment opportunities.

Operator

Our next question comes from Bill Crow from Raymond James.

Bill Crow -- Raymond James -- Analyst

Steve, real quick, does the success at Huntsville encourage you or embolden you to continue to put energy into looking for new markets?

Steve Budorick -- President and Chief Executive Officer

Well, we haven't done the new market research for a couple of years now. But when we've done in the past, they really made the conclusion that we picked the best markets for our shareholders, that there's long-term growth opportunities in all of them. And so we're not currently seeking an expansion market. With the environment that's accumulated since the increases in the defense budget, conversations with the government and defense contractors at our locations, we feel we're going to have significant opportunity growing in front of us.

Bill Crow -- Raymond James -- Analyst

You don't have your tenants coming to you telling you to start looking in a certain market or anything like that? There's no obvious next...

Steve Budorick -- President and Chief Executive Officer

From time to time, we've been asked by tenants to consider a one-off in a different market. Since 2013 or '14, we've refused those.

Operator

And our next question comes from Chris Lucas from Capital One Securities.

Chris Lucas -- Capital One Securities -- Analyst

Nice quarter, Steve. Just a couple of detailed questions, on 7500 and 7600 Advanced Gateway, the project scope increased. Just some color on the background on what happened between sort of when you got the lease signed in the second quarter to today.

Steve Budorick -- President and Chief Executive Officer

We're just advancing the planning for the campus. We've introduced a really talented design team to help plan for a long-term efficiency realization with that customer. And we're just refining the need as we get through the details of the design.

Chris Lucas -- Capital One Securities -- Analyst

Should we interpret this as a move toward a more dense campus based on the demand that you're seeing there?

Steve Budorick -- President and Chief Executive Officer

Well, certainly, this campus, this build-to-suit campus is going to be pretty compact as part of the efficiency. And in terms of the overall development, yes, I think you're going to start to see us creating more density than you would expect.

Chris Lucas -- Capital One Securities -- Analyst

OK, great. And then on the recent data center leases that were signed subsequent to end -- into the quarter, are the economics consistent with the prior set of deals? Or is there any change particularly given the fact that rates are down and the established cap rate for the value of those assets, et cetera?

Steve Budorick -- President and Chief Executive Officer

No change at all, Chris.

Chris Lucas -- Capital One Securities -- Analyst

OK. And then the last question from me. Just on the timing to deliver, you're moving from single story to multi-story. Just how does that extend the sort of start to finish time frame?

Steve Budorick -- President and Chief Executive Officer

Tough to answer. The team's extremely good at getting the building built once we have all the land conditions established. Our delay has been more in getting permits and stormwater issues. But I don't think it takes us a materially longer period of time, maybe a month actually to do a two-story over a one-story.

Chris Lucas -- Capital One Securities -- Analyst

OK. And then actually, let me ask one other question, which is -- you talked about spec in some markets. Have you given the dynamics of the -- particularly the Northern Virginia data center market, have you thought about doing spec development on data center shells?

Steve Budorick -- President and Chief Executive Officer

No, we have not considered that.

Operator

Thank you. And I am showing no further questions from our phone line. I'd now like to turn the conference back over to Mr. Budorick for any closing remarks.

Steve Budorick -- President and Chief Executive Officer

Thank you for joining our call today. We're in our offices this afternoon, so please coordinate any calls through Stephanie if you'd like to follow up with us. Thank you for participating.

Operator

[Operator signoff]

Duration: 63 minutes

Call participants:

Stephanie Krewson-Kelly -- Vice President of Investor Relations

Steve Budorick -- President and Chief Executive Officer

Paul Adkins -- Executive Vice President and Chief Operating Officer

Anthony Mifsud -- Executive Vice President and Chief Financial Officer

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Manny Korchman -- Citi -- Analyst

Blaine Heck -- Wells Fargo Securities -- Analyst

James Feldman -- Bank of America Merrill Lynch -- Analyst

Dave Rodgers -- Robert W. Baird and Co. -- Analyst

Rich Anderson -- SMBC Nikko Securities America Inc. -- Analyst

Tom Catherwood -- BTIG -- Analyst

Jon Petersen -- Jefferies -- Analyst

Bill Crow -- Raymond James -- Analyst

Chris Lucas -- Capital One Securities -- Analyst

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