UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q  
(Mark one)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
to
 
           
Commission file number 1-14023 (Corporate Office Properties Trust)
Commission file number 333-189188 (Corporate Office Properties, L.P.)
Corporate Office Properties Trust
Corporate Office Properties, L.P.
(Exact name of registrant as specified in its charter)
Corporate Office Properties Trust
 
Maryland
 
23-2947217
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
 
 
 
 
 
Corporate Office Properties, L.P.
 
Delaware
 
23-2930022
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
6711 Columbia Gateway Drive, Suite 300, Columbia, MD
21046
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (443) 285-5400
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Corporate Office Properties Trust
Large accelerated filer  ý
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company  o
Emerging growth company  o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

Corporate Office Properties, L.P.
Large accelerated filer  ý
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company  o
Emerging growth company  o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Corporate Office Properties Trust o
Corporate Office Properties, L.P. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Corporate Office Properties Trust o Yes   ý No
Corporate Office Properties, L.P. o Yes   ý No

As of July 20, 2018 , 103,263,449 of Corporate Office Properties Trust’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.
 
 
 
 
 

EXPLANATORY NOTE

This report combines the quarterly reports on Form 10-Q for the period ended June 30, 2018 of Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) and Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”). Unless stated otherwise or the context otherwise requires, “we,” “our,” and “us” refer collectively to COPT, COPLP and their subsidiaries.

COPT is a real estate investment trust, or REIT, and the sole general partner of COPLP. As of June 30, 2018 , COPT owned approximately 97.0% of the outstanding common units in COPLP; the remaining common units and all of the outstanding COPLP preferred units were owned by third parties. As the sole general partner of COPLP, COPT controls COPLP and can cause it to enter into major transactions including acquisitions, dispositions and refinancings and cause changes in its line of business, capital structure and distribution policies.

There are a few differences between the Company and the Operating Partnership which are reflected in this Form 10-Q. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the two operate as an interrelated, consolidated company. COPT is a REIT whose only material asset is its ownership of partnership interests of COPLP. As a result, COPT does not conduct business itself, other than acting as the sole general partner of COPLP, issuing public equity and guaranteeing certain debt of COPLP. COPT itself is not directly obligated under any indebtedness but guarantees some of the debt of COPLP. COPLP owns substantially all of the assets of COPT either directly or through its subsidiaries, conducts almost all of the operations of the business and is structured as a limited partnership with no publicly traded equity. Except for net proceeds from public equity issuances by COPT, which are contributed to COPLP in exchange for partnership units, COPLP generates the capital required by COPT’s business through COPLP’s operations, by COPLP’s direct or indirect incurrence of indebtedness or through the issuance of partnership units.

Noncontrolling interests, shareholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of COPT and those of COPLP. The common limited partnership interests in COPLP not owned by COPT are accounted for as partners’ capital in COPLP’s consolidated financial statements and as noncontrolling



interests in COPT’s consolidated financial statements. COPLP’s consolidated financial statements also reflect COPT’s noncontrolling interests in certain real estate partnerships and limited liability companies (“LLCs”); the differences between shareholders’ equity, partners’ capital and noncontrolling interests result from the differences in the equity issued at the COPT and COPLP levels and in COPT’s noncontrolling interests in these real estate partnerships and LLCs. The only other significant differences between the consolidated financial statements of COPT and those of COPLP are assets in connection with a non-qualified elective deferred compensation plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the plan’s participants that are held directly by COPT.

We believe combining the quarterly reports on Form 10-Q of the Company and the Operating Partnership into this single report results in the following benefits:
•
combined reports better reflect how management, investors and the analyst community view the business as a single operating unit;
•
combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
•
combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
•
combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.

To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
•
consolidated financial statements;
•
the following notes to the consolidated financial statements:
•
Note 4, Fair Value Measurements of COPT and subsidiaries and COPLP and subsidiaries; and
•
Note 15, Earnings per Share of COPT and subsidiaries and Earnings per Unit of COPLP and subsidiaries;
•
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPT”; and
•
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPLP.”

This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for each of COPT and COPLP to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that COPT and COPLP are compliant with Rule 13a-15 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.




TABLE OF CONTENTS
 
FORM 10-Q
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements


Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
 
June 30,
2018
 
December 31,
2017
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,760,632

 
$
2,737,611

Projects in development or held for future development
422,905

 
403,494

Total properties, net
3,183,537

 
3,141,105

Assets held for sale, net
42,226

 
42,226

Cash and cash equivalents
8,472

 
12,261

Investment in unconsolidated real estate joint venture
40,806

 
41,787

Accounts receivable (net of allowance for doubtful accounts of $811 and $607, respectively)
23,656

 
31,802

Deferred rent receivable (net of allowance of $423 and $364, respectively)
89,606

 
86,710

Intangible assets on real estate acquisitions, net
50,586

 
59,092

Deferred leasing costs (net of accumulated amortization of $29,546 and $29,560, respectively)
48,183

 
48,322

Investing receivables
54,427

 
57,493

Prepaid expenses and other assets, net
70,863

 
74,407

Total assets
$
3,612,362

 
$
3,595,205

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,871,445

 
$
1,828,333

Accounts payable and accrued expenses
88,885

 
108,137

Rents received in advance and security deposits
24,905

 
25,648

Dividends and distributions payable
29,449

 
28,921

Deferred revenue associated with operating leases
10,783

 
11,682

Deferred property sale
43,377

 
43,377

Capital lease obligation
640

 
15,853

Other liabilities
9,849

 
41,822

Total liabilities
2,079,333

 
2,103,773

Commitments and contingencies (Note 16)


 


Redeemable noncontrolling interests
24,544

 
23,125

Equity:
 

 
 

Corporate Office Properties Trust’s shareholders’ equity:
 

 
 

Common Shares of beneficial interest ($0.01 par value; 150,000,000 shares authorized; shares issued and outstanding of 103,260,495 at June 30, 2018 and 101,292,299 at December 31, 2017)
1,033

 
1,013

Additional paid-in capital
2,254,430

 
2,201,047

Cumulative distributions in excess of net income
(822,270
)
 
(802,085
)
Accumulated other comprehensive income
9,012

 
2,167

Total Corporate Office Properties Trust’s shareholders’ equity
1,442,205

 
1,402,142

Noncontrolling interests in subsidiaries:
 

 
 

Common units in COPLP
44,651

 
45,097

Preferred units in COPLP
8,800

 
8,800

Other consolidated entities
12,829

 
12,268

Noncontrolling interests in subsidiaries
66,280

 
66,165

Total equity
1,508,485

 
1,468,307

Total liabilities, redeemable noncontrolling interests and equity
$
3,612,362

 
$
3,595,205


See accompanying notes to consolidated financial statements.

3


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,121

 
$
101,347

 
$
201,955

 
$
201,962

Tenant recoveries and other real estate operations revenue
28,041

 
26,950

 
55,485

 
53,102

Construction contract and other service revenues
17,581

 
23,138

 
44,779

 
36,172

Total revenues
146,743

 
151,435

 
302,219

 
291,236

Expenses
 

 
 

 
 

 
 

Property operating expenses
49,446

 
48,628

 
100,397

 
97,147

Depreciation and amortization associated with real estate operations
33,190

 
32,793

 
66,702

 
65,852

Construction contract and other service expenses
16,941

 
22,315

 
43,157

 
34,801

Impairment losses
—

 
1,625

 
—

 
1,625

General, administrative and leasing expenses
7,628

 
7,859

 
14,920

 
16,470

Business development expenses and land carry costs
1,234

 
1,597

 
2,848

 
3,290

Total operating expenses
108,439

 
114,817

 
228,024

 
219,185

Operating income
38,304

 
36,618

 
74,195

 
72,051

Interest expense
(18,945
)
 
(19,163
)
 
(37,729
)
 
(38,157
)
Interest and other income
1,439

 
1,583

 
2,798

 
3,309

Loss on early extinguishment of debt
—

 
(513
)
 
—

 
(513
)
Income before equity in income of unconsolidated entities and income taxes
20,798

 
18,525

 
39,264

 
36,690

Equity in income of unconsolidated entities
373

 
370

 
746

 
747

Income tax expense
(63
)
 
(48
)
 
(118
)
 
(88
)
Income before gain on sales of real estate
21,108

 
18,847

 
39,892

 
37,349

Gain on sales of real estate
(23
)
 
12

 
(27
)
 
4,250

Net income
21,085

 
18,859

 
39,865

 
41,599

Net income attributable to noncontrolling interests:
 

 
 

 
 

 
 

Common units in COPLP
(608
)
 
(261
)
 
(1,152
)
 
(883
)
Preferred units in COPLP
(165
)
 
(165
)
 
(330
)
 
(330
)
Other consolidated entities
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Net income attributable to COPT
19,434

 
17,526

 
36,584

 
38,545

Preferred share dividends
—

 
(3,039
)
 
—

 
(6,219
)
Issuance costs associated with redeemed preferred shares
—

 
(6,847
)
 
—

 
(6,847
)
Net income attributable to COPT common shareholders
$
19,434

 
$
7,640

 
$
36,584

 
$
25,479

 
 
 
 
 
 
 
 
Earnings per common share:
 

 
 

 
 

 
 

Net income attributable to COPT common shareholders - basic
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Net income attributable to COPT common shareholders - diluted
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Dividends declared per common share
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

4


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
21,085

 
$
18,859

 
$
39,865

 
$
41,599

Other comprehensive income
 

 
 

 
 

 
 

Unrealized gain (loss) on interest rate derivatives
1,912

 
(1,800
)
 
6,588

 
(1,576
)
(Gain) loss on interest rate derivatives recognized in interest expense
(47
)
 
941

 
198

 
2,125

Equity in other comprehensive income of equity method investee
—

 
39

 
—

 
39

Other comprehensive income (loss)
1,865

 
(820
)
 
6,786

 
588

Comprehensive income
22,950

 
18,039

 
46,651

 
42,187

Comprehensive income attributable to noncontrolling interests
(1,708
)
 
(1,306
)
 
(3,498
)
 
(3,074
)
Comprehensive income attributable to COPT
$
21,242

 
$
16,733

 
$
43,153

 
$
39,113

 
See accompanying notes to consolidated financial statements.



5


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Preferred
Shares
 
Common
Shares
 
Additional
Paid-in
Capital
 
Cumulative
Distributions in
Excess of Net
Income
 
Accumulated
Other
Comprehensive Income ( Loss)
 
Noncontrolling
Interests
 
Total
Balance at December 31, 2016 (98,498,651 common shares outstanding)
$
172,500

 
$
985

 
$
2,116,581

 
$
(747,825
)
 
$
(1,731
)
 
$
72,267

 
$
1,612,777

Redemption of preferred shares (6,900,000 shares)
(172,500
)
 
—

 
6,847

 
(6,847
)
 
—

 
—

 
(172,500
)
Conversion of common units to common shares (187,000 shares)
—

 
2

 
2,562

 
—

 
—

 
(2,564
)
 
—

Common shares issued under at-the-market program (591,042 shares)
—

 
6

 
19,662

 
—

 
—

 
—

 
19,668

Exercise of share options (5,000 shares)
—

 
—

 
150

 
—

 
—

 
—

 
150

Share-based compensation (189,948 shares issued, net of redemptions)
—

 
2

 
3,045

 
—

 
—

 
—

 
3,047

Redemption of vested equity awards
—

 
—

 
(1,813
)
 
—

 
—

 
—

 
(1,813
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(514
)
 
—

 
—

 
514

 
—

Comprehensive income
—

 
—

 
—

 
38,545

 
568

 
1,934

 
41,047

Dividends
—

 
—

 
—

 
(60,922
)
 
—

 
—

 
(60,922
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(2,202
)
 
(2,202
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
(401
)
 
—

 
—

 
—

 
(401
)
Balance at June 30, 2017 (99,471,641 common shares outstanding)
$
—

 
$
995

 
$
2,146,119

 
$
(777,049
)
 
$
(1,163
)
 
$
67,339

 
$
1,436,241

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017 (101,292,299 common shares outstanding)
$
—

 
$
1,013

 
$
2,201,047

 
$
(802,085
)
 
$
2,167

 
$
66,165

 
$
1,468,307

Cumulative effect of accounting change for adoption of hedge accounting guidance
—

 
—

 
—

 
(276
)
 
276

 
—

 
—

Balance at December 31, 2017, as adjusted
—

 
1,013

 
2,201,047

 
(802,361
)
 
2,443

 
66,165

 
1,468,307

Conversion of common units to common shares (53,817 shares)
—

 
1

 
760

 
—

 
—

 
(761
)
 
—

Common shares issued under forward equity sale agreements (1,777,000 shares)
—

 
18

 
52,209

 
—

 
—

 
—

 
52,227

Share-based compensation (137,379 shares issued, net of redemptions)
—

 
1

 
3,399

 
—

 
—

 
—

 
3,400

Redemption of vested equity awards
—

 
—

 
(1,525
)
 
—

 
—

 
—

 
(1,525
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(702
)
 
—

 
—

 
702

 
—

Comprehensive income
—

 
—

 
—

 
36,584

 
6,569

 
2,269

 
45,422

Dividends
—

 
—

 
—

 
(56,493
)
 
—

 
—

 
(56,493
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(2,088
)
 
(2,088
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(7
)
 
(7
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
(758
)
 
—

 
—

 
—

 
(758
)
Balance at June 30, 2018 (103,260,495 common shares outstanding)
$
—

 
$
1,033

 
$
2,254,430

 
$
(822,270
)
 
$
9,012

 
$
66,280

 
$
1,508,485


See accompanying notes to consolidated financial statements.

6


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)  
 
For the Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
262,602

 
$
254,392

Construction contract and other service revenues received
18,411

 
39,917

Property operating expenses paid
(83,642
)
 
(79,683
)
Construction contract and other service expenses paid
(62,624
)
 
(31,996
)
General, administrative, leasing, business development and land carry costs paid
(15,148
)
 
(20,315
)
Interest expense paid
(36,155
)
 
(36,351
)
Lease incentives paid
(4,825
)
 
(9,375
)
Other
2,093

 
940

Net cash provided by operating activities
80,712

 
117,529

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(67,749
)
 
(85,926
)
Tenant improvements on operating properties
(18,352
)
 
(13,711
)
Other capital improvements on operating properties
(8,584
)
 
(11,780
)
Proceeds from dispositions of properties
—

 
54,798

Leasing costs paid
(3,838
)
 
(3,904
)
Other
1,715

 
1,746

Net cash used in investing activities
(96,808
)
 
(58,777
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
153,000

 
213,000

Repayments of debt
 
 
 
Revolving Credit Facility
(109,000
)
 
(19,000
)
Scheduled principal amortization
(2,101
)
 
(2,013
)
Other debt repayments
—

 
(200,000
)
Payments on capital lease obligation
(15,379
)
 
—

Net proceeds from issuance of common shares
52,277

 
19,835

Redemption of preferred shares
—

 
(199,083
)
Common share dividends paid
(55,950
)
 
(54,439
)
Preferred share dividends paid
—

 
(9,305
)
Distributions paid to noncontrolling interests in COPLP
(2,110
)
 
(2,274
)
Redemption of vested equity awards
(1,525
)
 
(1,813
)
Other
(5,370
)
 
(2,952
)
Net cash provided by (used in) financing activities
13,842

 
(258,044
)
Net decrease in cash and cash equivalents and restricted cash
(2,254
)
 
(199,292
)
Cash and cash equivalents and restricted cash
 

 
 

Beginning of period
14,831

 
212,619

End of period
$
12,577

 
$
13,327


See accompanying notes to consolidated financial statements.
 


7


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2018
 
2017
Reconciliation of net income to net cash provided by operating activities:
 

 
 

Net income
$
39,865

 
$
41,599

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
67,684

 
66,948

Impairment losses
—

 
1,618

Amortization of deferred financing costs and net debt discounts
1,648

 
2,613

(Increase) decrease in deferred rent receivable
(3,470
)
 
669

Gain on sales of real estate
27

 
(4,250
)
Share-based compensation
3,132

 
2,820

Other
(777
)
 
(1,861
)
Changes in operating assets and liabilities:
 

 
 
Decrease (increase) in accounts receivable
8,050

 
(8,304
)
Decrease in prepaid expenses and other assets, net
14,718

 
22,418

Decrease in accounts payable, accrued expenses and other liabilities
(49,422
)
 
(2,387
)
Decrease in rents received in advance and security deposits
(743
)
 
(4,354
)
Net cash provided by operating activities
$
80,712

 
$
117,529

Reconciliation of cash and cash equivalents and restricted cash:
 
 
 
Cash and cash equivalents at beginning of period
$
12,261

 
$
209,863

Restricted cash at beginning of period
2,570

 
2,756

Cash and cash equivalents and restricted cash at beginning of period
$
14,831

 
$
212,619

 
 
 
 
Cash and cash equivalents at end of period
$
8,472

 
$
10,606

Restricted cash at end of period
4,105

 
2,721

Cash and cash equivalents and restricted cash at end of period
$
12,577

 
$
13,327

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase (decrease) in accrued capital improvements, leasing and other investing activity costs
$
2,909

 
$
(4,927
)
Increase in property in connection with capital lease obligation
$
—

 
$
16,127

Increase in fair value of derivatives applied to accumulated other comprehensive income and noncontrolling interests
$
6,719

 
$
513

Equity in other comprehensive income of an equity method investee
$
—

 
$
39

Dividends/distributions payable
$
29,449

 
$
28,462

Decrease in noncontrolling interests and increase in shareholders’ equity in connection with the conversion of common units into common shares
$
761

 
$
2,564

Adjustments to noncontrolling interests resulting from changes in COPLP ownership
$
702

 
$
514

Increase in redeemable noncontrolling interests and decrease in equity to carry redeemable noncontrolling interests at fair value
$
758

 
$
401

 
See accompanying notes to consolidated financial statements.


8




Corporate Office Properties, L.P. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except unit data)
(unaudited)
 
June 30,
2018
 
December 31,
2017
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,760,632

 
$
2,737,611

Projects in development or held for future development
422,905

 
403,494

Total properties, net
3,183,537

 
3,141,105

Assets held for sale, net
42,226

 
42,226

Cash and cash equivalents
8,472

 
12,261

Investment in unconsolidated real estate joint venture
40,806

 
41,787

Accounts receivable (net of allowance for doubtful accounts of $811 and $607, respectively)
23,656

 
31,802

Deferred rent receivable (net of allowance of $423 and $364, respectively)
89,606

 
86,710

Intangible assets on real estate acquisitions, net
50,586

 
59,092

Deferred leasing costs (net of accumulated amortization of $29,546 and $29,560, respectively)
48,183

 
48,322

Investing receivables
54,427

 
57,493

Prepaid expenses and other assets, net
66,669

 
69,791

Total assets
$
3,608,168

 
$
3,590,589

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,871,445

 
$
1,828,333

Accounts payable and accrued expenses
88,885

 
108,137

Rents received in advance and security deposits
24,905

 
25,648

Distributions payable
29,449

 
28,921

Deferred revenue associated with operating leases
10,783

 
11,682

Deferred property sale
43,377

 
43,377

Capital lease obligation
640


15,853

Other liabilities
5,655

 
37,206

Total liabilities
2,075,139

 
2,099,157

Commitments and contingencies (Note 16)


 


Redeemable noncontrolling interests
24,544

 
23,125

Equity:
 

 
 

Corporate Office Properties, L.P.’s equity:
 

 
 

Preferred units held by limited partner, 352,000 preferred units outstanding at June 30, 2018 and December 31, 2017
8,800

 
8,800

Common units, 103,260,495 and 101,292,299 held by the general partner and 3,197,061 and 3,250,878 held by limited partners at June 30, 2018 and December 31, 2017, respectively
1,477,575

 
1,445,022

Accumulated other comprehensive income
9,235

 
2,173

Total Corporate Office Properties, L.P.’s equity
1,495,610

 
1,455,995

Noncontrolling interests in subsidiaries
12,875

 
12,312

Total equity
1,508,485

 
1,468,307

Total liabilities, redeemable noncontrolling interests and equity
$
3,608,168

 
$
3,590,589


See accompanying notes to consolidated financial statements.


9


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per unit data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,121

 
$
101,347

 
$
201,955

 
$
201,962

Tenant recoveries and other real estate operations revenue
28,041

 
26,950

 
55,485

 
53,102

Construction contract and other service revenues
17,581

 
23,138

 
44,779

 
36,172

Total revenues
146,743

 
151,435

 
302,219

 
291,236

Expenses
 

 
 

 
 

 
 

Property operating expenses
49,446

 
48,628

 
100,397

 
97,147

Depreciation and amortization associated with real estate operations
33,190

 
32,793

 
66,702

 
65,852

Construction contract and other service expenses
16,941

 
22,315

 
43,157

 
34,801

Impairment losses
—

 
1,625

 
—

 
1,625

General, administrative and leasing expenses
7,628

 
7,859

 
14,920

 
16,470

Business development expenses and land carry costs
1,234

 
1,597

 
2,848

 
3,290

Total operating expenses
108,439

 
114,817

 
228,024

 
219,185

Operating income
38,304

 
36,618

 
74,195

 
72,051

Interest expense
(18,945
)
 
(19,163
)
 
(37,729
)
 
(38,157
)
Interest and other income
1,439

 
1,583

 
2,798

 
3,309

Loss on early extinguishment of debt
—

 
(513
)
 
—

 
(513
)
Income before equity in income of unconsolidated entities and income taxes
20,798

 
18,525

 
39,264

 
36,690

Equity in income of unconsolidated entities
373

 
370

 
746

 
747

Income tax expense
(63
)
 
(48
)
 
(118
)
 
(88
)
Income before gain on sales of real estate
21,108

 
18,847

 
39,892

 
37,349

Gain on sales of real estate
(23
)
 
12

 
(27
)
 
4,250

Net income
21,085

 
18,859

 
39,865

 
41,599

Net income attributable to noncontrolling interests in consolidated entities
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Net income attributable to COPLP
20,207

 
17,952

 
38,066

 
39,758

Preferred unit distributions
(165
)
 
(3,204
)
 
(330
)
 
(6,549
)
Issuance costs associated with redeemed preferred units
—

 
(6,847
)
 
—

 
(6,847
)
Net income attributable to COPLP common unitholders
$
20,042

 
$
7,901

 
$
37,736

 
$
26,362

Earnings per common unit:
 

 
 

 
 

 
 

Net income attributable to COPLP common unitholders - basic
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Net income attributable to COPLP common unitholders - diluted
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Distributions declared per common unit
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

10


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)  
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
21,085

 
$
18,859

 
$
39,865

 
$
41,599

Other comprehensive income
 

 
 

 
 
 
 
Unrealized gain (loss) on interest rate derivatives
1,912

 
(1,800
)
 
6,588

 
(1,576
)
(Gain) loss on interest rate derivatives recognized in interest expense
(47
)
 
941

 
198

 
2,125

Equity in other comprehensive income of equity method investee
—

 
39

 
—

 
39

Other comprehensive income (loss)
1,865

 
(820
)
 
6,786

 
588

Comprehensive income
22,950

 
18,039

 
46,651

 
42,187

Comprehensive income attributable to noncontrolling interests
(878
)
 
(907
)
 
(1,799
)
 
(1,841
)
Comprehensive income attributable to COPLP
$
22,072

 
$
17,132

 
$
44,852

 
$
40,346

 
See accompanying notes to consolidated financial statements.

 

11


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Limited Partner Preferred Units
 
General Partner
 Preferred Units
 
Common Units
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interests in Subsidiaries
 
 
 
Units
 
Amount
 
Units
 
Amount
 
Units
 
Amount
 
 
 
Total Equity
Balance at December 31, 2016
352,000

 
$
8,800

 
6,900,000

 
$
172,500

 
102,089,042

 
$
1,419,710

 
$
(1,854
)
 
$
13,621

 
$
1,612,777

Redemption of preferred units resulting from redemption of preferred shares
—

 
—

 
(6,900,000
)
 
(172,500
)
 
—

 
—

 
—

 
—

 
(172,500
)
Issuance of common units resulting from common shares issued under COPT at-the-market program
—

 
—

 
—

 
—

 
591,042

 
19,668

 
—

 
—

 
19,668

Issuance of common units resulting from exercise of share options
—

 
—

 
—

 
—

 
5,000

 
150

 
—

 
—

 
150

Share-based compensation (units net of redemption)
—

 
—

 
—

 
—

 
189,948

 
3,047

 
—

 
—

 
3,047

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(1,813
)
 
—

 
—

 
(1,813
)
Comprehensive income
—

 
330

 
—

 
6,219

 
—

 
33,209

 
588

 
701

 
41,047

Distributions to owners of common and preferred units
—

 
(330
)
 
—

 
(6,219
)
 
—

 
(56,575
)
 
—

 
—

 
(63,124
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
—

 
—

 
—

 
(401
)
 
—

 
—

 
(401
)
Balance at June 30, 2017
352,000

 
$
8,800

 
—

 
$
—

 
102,875,032

 
$
1,416,995

 
$
(1,266
)
 
$
11,712

 
$
1,436,241

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
352,000

 
$
8,800

 
—

 
$
—

 
104,543,177

 
$
1,445,022

 
$
2,173

 
$
12,312

 
$
1,468,307

Cumulative effect of accounting change for adoption of hedge accounting guidance
—

 
—

 
—

 
—

 
—

 
(276
)
 
276

 
—

 
—

Balance at December 31, 2017, as adjusted
352,000

 
8,800

 
—

 
—

 
104,543,177

 
1,444,746

 
2,449

 
12,312

 
1,468,307

Issuance of common units resulting from common shares issued under COPT forward equity sale agreements
—

 
—

 
—

 
—

 
1,777,000

 
52,227

 
—

 
—

 
52,227

Share-based compensation (units net of redemption)
—

 
—

 
—

 
—

 
137,379

 
3,400

 
—

 
—

 
3,400

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(1,525
)
 
—

 
—

 
(1,525
)
Comprehensive income
—

 
330

 
—

 
—

 
—

 
37,736

 
6,786

 
570

 
45,422

Distributions to owners of common and preferred units
—

 
(330
)
 
—

 
—

 
—

 
(58,251
)
 
—

 
—

 
(58,581
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(7
)
 
(7
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
—

 
—

 
—

 
(758
)
 
—

 
—

 
(758
)
Balance at June 30, 2018
352,000

 
$
8,800

 
—

 
$
—

 
106,457,556

 
$
1,477,575

 
$
9,235

 
$
12,875

 
$
1,508,485


See accompanying notes to consolidated financial statements.

12


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
262,602

 
$
254,392

Construction contract and other service revenues received
18,411

 
39,917

Property operating expenses paid
(83,642
)
 
(79,683
)
Construction contract and other service expenses paid
(62,624
)
 
(31,996
)
General, administrative, leasing, business development and land carry costs paid
(15,148
)
 
(20,315
)
Interest expense paid
(36,155
)
 
(36,351
)
Lease incentives paid
(4,825
)
 
(9,375
)
Other
2,093

 
940

Net cash provided by operating activities
80,712

 
117,529

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(67,749
)
 
(85,926
)
Tenant improvements on operating properties
(18,352
)
 
(13,711
)
Other capital improvements on operating properties
(8,584
)
 
(11,780
)
Proceeds from dispositions of properties
—

 
54,798

Leasing costs paid
(3,838
)
 
(3,904
)
Other
1,715

 
1,746

Net cash used in investing activities
(96,808
)
 
(58,777
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
153,000

 
213,000

Repayments of debt
 
 
 
Revolving Credit Facility
(109,000
)
 
(19,000
)
Scheduled principal amortization
(2,101
)
 
(2,013
)
Other debt repayments
—

 
(200,000
)
Payments on capital lease obligation
(15,379
)
 
—

Net proceeds from issuance of common units
52,277

 
19,835

Redemption of preferred units
—

 
(199,083
)
Common unit distributions paid
(57,730
)
 
(56,383
)
Preferred unit distributions paid
(330
)
 
(9,635
)
Redemption of vested equity awards
(1,525
)
 
(1,813
)
Other
(5,370
)
 
(2,952
)
Net cash provided by (used in) financing activities
13,842

 
(258,044
)
Net decrease in cash and cash equivalents and restricted cash
(2,254
)
 
(199,292
)
Cash and cash equivalents and restricted cash
 

 
 

Beginning of period
14,831

 
212,619

End of period
$
12,577

 
$
13,327


See accompanying notes to consolidated financial statements.

13


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
(in thousands)
(unaudited)

 
For the Six Months Ended June 30,
 
2018
 
2017
Reconciliation of net income to net cash provided by operating activities:
 

 
 

Net income
$
39,865

 
$
41,599

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
67,684

 
66,948

Impairment losses
—

 
1,618

Amortization of deferred financing costs and net debt discounts
1,648

 
2,613

(Increase) decrease in deferred rent receivable
(3,470
)
 
669

Gain on sales of real estate
27

 
(4,250
)
Share-based compensation
3,132

 
2,820

Other
(777
)
 
(1,861
)
Operating changes in assets and liabilities:
 

 
 
Decrease (increase) in accounts receivable
8,050

 
(8,304
)
Decrease in prepaid expenses and other assets, net
14,296

 
21,126

Decrease in accounts payable, accrued expenses and other liabilities
(49,000
)
 
(1,095
)
Decrease in rents received in advance and security deposits
(743
)
 
(4,354
)
Net cash provided by operating activities
$
80,712

 
$
117,529

Reconciliation of cash and cash equivalents and restricted cash:
 
 
 
Cash and cash equivalents at beginning of period
$
12,261

 
$
209,863

Restricted cash at beginning of period
2,570

 
2,756

Cash and cash equivalents and restricted cash at beginning of period
$
14,831

 
$
212,619

 
 
 
 
Cash and cash equivalents at end of period
$
8,472

 
$
10,606

Restricted cash at end of period
4,105

 
2,721

Cash and cash equivalents and restricted cash at end of period
$
12,577

 
$
13,327

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase (decrease) in accrued capital improvements, leasing and other investing activity costs
$
2,909

 
$
(4,927
)
Increase in property in connection with capital lease obligation
$
—

 
$
16,127

Increase in fair value of derivatives applied to accumulated other comprehensive income and noncontrolling interests
$
6,719

 
$
513

Equity in other comprehensive income of an equity method investee
$
—

 
$
39

Distributions payable
$
29,449

 
$
28,462

Increase in redeemable noncontrolling interests and decrease in equity to carry redeemable noncontrolling interests at fair value
$
758

 
$
401

 
See accompanying notes to consolidated financial statements.



14


Corporate Office Properties Trust and Subsidiaries and Corporate Office Properties, L.P. and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
 
1.    Organization
 
Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a fully-integrated and self-managed real estate investment trust (“REIT”). Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”) is the entity through which COPT, the sole general partner of COPLP, conducts almost all of its operations and owns almost all of its assets. Unless otherwise expressly stated or the context otherwise requires, “we”, “us” and “our” as used herein refer to each of the Company and the Operating Partnership. We own, manage, lease, develop and selectively acquire office and data center properties. The majority of our portfolio is in locations that support the United States Government and its contractors, most of whom are engaged in national security, defense and information technology (“IT”) related activities servicing what we believe are growing, durable, priority missions (“Defense/IT Locations”). We also own a portfolio of office properties located in select urban/urban-like submarkets in the Greater Washington, DC/Baltimore region
with durable Class-A office fundamentals and characteristics (“Regional Office”). As of June 30, 2018 , our properties included the following:

•
159 properties totaling 17.7 million square feet comprised of 143 office properties and 16 single-tenant data center shell properties (“data center shells”). We owned six of these data center shells through an unconsolidated real estate joint venture;
•
a wholesale data center with a critical load of 19.25 megawatts;
•
nine properties under construction or redevelopment ( five office properties and four data center shells) that we estimate will total approximately 1.0 million square feet upon completion, including one partially-operational property; and
•
approximately 1,000 acres of land controlled for future development that we believe could be developed into approximately 12.3 million square feet and 150 acres of other land.
 
COPLP owns real estate directly and through subsidiary partnerships and limited liability companies (“LLCs”).  In addition to owning real estate, COPLP also owns subsidiaries that provide real estate services such as property management and construction and development services primarily for our properties but also for third parties. Some of these services are performed by a taxable REIT subsidiary (“TRS”).

Equity interests in COPLP are in the form of common and preferred units. As of June 30, 2018 , COPT owned 97.0% of the outstanding COPLP common units (“common units”); the remaining common units and all of the outstanding COPLP preferred units (“preferred units”) were owned by third parties. Common units not owned by COPT carry certain redemption rights. The number of common units owned by COPT is equivalent to the number of outstanding common shares of beneficial interest (“common shares”) of COPT, and the entitlement of all common units to quarterly distributions and payments in liquidation is substantially the same as those of COPT common shareholders. Similarly, in the case of any series of preferred units held by COPT, there is a series of preferred shares of beneficial interest (“preferred shares”) in COPT that is equivalent in number and carries substantially the same terms as such series of COPLP preferred units. COPT’s common shares are publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “OFC”.

Because COPLP is managed by COPT, and COPT conducts substantially all of its operations through COPLP, we refer to COPT’s executive officers as COPLP’s executive officers; similarly, although COPLP does not have a board of trustees, we refer to COPT’s Board of Trustees as COPLP’s Board of Trustees.
  
2.       Summary of Significant Accounting Policies
 
Basis of Presentation
 
The COPT consolidated financial statements include the accounts of COPT, the Operating Partnership, their subsidiaries and other entities in which COPT has a majority voting interest and control.  The COPLP consolidated financial statements include the accounts of COPLP, its subsidiaries and other entities in which COPLP has a majority voting interest and control.  We also consolidate certain entities when control of such entities can be achieved through means other than voting rights (“variable interest entities” or “VIEs”) if we are deemed to be the primary beneficiary of such entities.  We eliminate all intercompany balances and transactions in consolidation.

15



 We use the equity method of accounting when we own an interest in an entity and can exert significant influence over but cannot control the entity’s operations. We discontinue equity method accounting if our investment in an entity (and net advances) is reduced to zero unless we have guaranteed obligations of the entity or are otherwise committed to provide further financial support for the entity.
 
We use the cost method of accounting when we own an interest in an entity and cannot exert significant influence over its operations.

These interim financial statements should be read together with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2017 included in our 2017 Annual Report on Form 10-K.  The unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly state our financial position and results of operations.  All adjustments are of a normal recurring nature.  The consolidated financial statements have been prepared using the accounting policies described in our 2017 Annual Report on Form 10-K as updated for our adoption of recent accounting pronouncements discussed below.

Reclassification

We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity, including restricted cash and marketable securities that were reclassified to the line entitled “prepaid expenses and other assets, net” on our consolidated balance sheets after having been reported on a separate line in our Quarterly Reports on Form 10-Q filed in prior years and previous Annual Reports on Form 10-K.

Recent Accounting Pronouncements

We adopted guidance issued by the Financial Accounting Standards Board (“FASB”) effective January 1, 2018 regarding the recognition of revenue from contracts with customers (“Topic 606”). Under this guidance, an entity recognizes revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires improved disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. We determined that Topic 606 is applicable to our construction contract and other service revenues, which includes predominantly construction and design projects performed primarily for tenants of our properties. We used the modified retrospective method for contracts that were not completed as of January 1, 2018. Under this method, the cumulative effect of initially applying the guidance is recognized as an adjustment to the opening balance of retained earnings as of the date of initial application. Our adoption of Topic 606 effective January 1, 2018 did not affect our consolidated financial statements other than additional disclosure provided in accordance with the guidance. We did not elect to use any of the practical expedients provided for under the guidance. As discussed further below, once the new guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases goes into effect on January 1, 2019, Topic 606 may apply to executory costs and other components of revenue due under leases that are deemed to be non-lease components (such as common area maintenance and provision of utilities).

We adopted guidance issued by the FASB effective January 1, 2018 that requires entities to measure equity investments at fair value through net income, except for those that result in consolidation or are accounted for under the equity method of accounting. For equity investments without readily determinable fair values, the guidance permits the application of a measurement alternative using the cost of the investment, less any impairments, plus or minus changes resulting from observable price changes for an identical or similar investment of the same issuer. Our adoption of this guidance had no effect on our consolidated financial statements.
 
We adopted guidance issued by the FASB retrospectively effective January 1, 2018 that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The areas addressed in the new guidance relate to debt prepayment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned and bank-owned life insurance policies, distributions received from equity method investments, beneficial interest in securitization transactions and separately identifiable cash flows and application of the predominance principle. Our adoption of this guidance had no effect on our consolidated financial statements.


16


We adopted guidance issued by the FASB retrospectively effective January 1, 2018 that requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts described as restricted cash or restricted cash equivalents.  Under the new guidance, amounts described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the statement of cash flows.  As a result of our adoption of this guidance, the change in restricted cash is no longer reported as either operating or investing activities on our statements of cash flows. Our restricted cash primarily consists of cash escrowed under mortgage debt for capital improvements and real estate taxes and certain tenant security deposits. Our adoption of this guidance had the following effects on our consolidated statements of cash flows for the six months ended June 30, 2017 (in thousands):
 
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Net cash provided by operating activities
 
$
117,737

 
$
(208
)
 
$
117,529

Net cash used in investing activities
 
$
(58,950
)
 
$
173

 
$
(58,777
)
Net decrease in cash and cash equivalents and restricted cash
 
$
(199,257
)
 
$
(35
)
 
$
(199,292
)
Beginning of period cash and cash equivalents and restricted cash
 
$
209,863

 
$
2,756

 
$
212,619

End of period cash and cash equivalents and restricted cash
 
$
10,606

 
$
2,721

 
$
13,327


We adopted guidance issued by the FASB that clarifies the scope of provisions and accounting for nonfinancial asset derecognition, including partial sales of real estate assets, effective January 1, 2018 using the full retrospective method. The new guidance requires recognition of a sale of real estate and resulting gain or loss when control transfers and the buyer has the ability to direct use of, or obtain substantially all of the remaining benefit from, the asset (which generally will occur on the closing date); the factor of continuing involvement is no longer a specific consideration for the timing of recognition. The new guidance eliminates the need to consider adequacy of buyer investment, which was replaced by additional judgments regarding collectability and intent and/or ability to pay. The new guidance also requires an entity to derecognize nonfinancial assets and in-substance nonfinancial assets once it transfers control of such assets. When an entity transfers its controlling interest in a nonfinancial asset but retains a noncontrolling ownership interest, the entity is required to measure any non-controlling interest it receives or retains at fair value and recognize a full gain or loss on the transaction; as a result, sales and partial sales of real estate assets are now subject to the same derecognition model as all other nonfinancial assets. We had a transaction in July 2016 accounted for as a partial sale under the previous guidance that meets the criteria for immediate full gain recognition under the new guidance; as a result, we retrospectively recognized an additional $18 million in income in 2016 that was being amortized into income in subsequent periods under the previous guidance. The recognition pattern for our other sales of real estate were not changed by this new guidance. The full retrospective method requires adjustment of each reporting period presented at the time of adoption.






17


The tables below set forth the impact of the adoption of this guidance for amounts previously reported on the consolidated financial statements of COPT and subsidiaries (in thousands):
 
 
As of December 31, 2017
 
As of June 30, 2017
 
As of December 31, 2016
Consolidated Balance Sheets
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Investment in unconsolidated real estate joint venture
 
$
25,066

 
$
16,721

 
$
41,787

 
$
25,335

 
$
17,417

 
$
42,752

 
$
25,548

 
$
18,113

 
$
43,661

Cumulative distributions in excess of net income
 
$
(818,190
)
 
$
16,105

 
$
(802,085
)
 
$
(793,828
)
 
$
16,779

 
$
(777,049
)
 
$
(765,276
)
 
$
17,451

 
$
(747,825
)
Noncontrolling interests in subsidiaries
 
$
65,549

 
$
616

 
$
66,165

 
$
66,701

 
$
638

 
$
67,339

 
$
71,605

 
$
662

 
$
72,267

 
 
For the Three Months Ended June 30, 2017
 
For the Six Months Ended June 30, 2017
Consolidated Statements of Operations and Comprehensive Income
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Equity in income of unconsolidated entities
 
$
718

 
$
(348
)
 
$
370

 
$
1,443

 
$
(696
)
 
$
747

Income before gain on sales of real estate
 
$
19,195

 
$
(348
)
 
$
18,847

 
$
38,045

 
$
(696
)
 
$
37,349

Net income
 
$
19,207

 
$
(348
)
 
$
18,859

 
$
42,295

 
$
(696
)
 
$
41,599

Net income attributable to noncontrolling interests - Common units in COPLP
 
$
(273
)
 
$
12

 
$
(261
)
 
$
(907
)
 
$
24

 
$
(883
)
Net income attributable to COPT
 
$
17,862

 
$
(336
)
 
$
17,526

 
$
39,217

 
$
(672
)
 
$
38,545

Net income attributable to COPT common shareholders
 
$
7,976

 
$
(336
)
 
$
7,640

 
$
26,151

 
$
(672
)
 
$
25,479

Comprehensive income
 
$
18,387

 
$
(348
)
 
$
18,039

 
$
42,883

 
$
(696
)
 
$
42,187

Comprehensive income attributable to COPT
 
$
17,069

 
$
(336
)
 
$
16,733

 
$
39,785

 
$
(672
)
 
$
39,113

 
 
 
 
 
 
 
 
 
 
 
 
 
The tables below set forth the impact of the adoption of this guidance for amounts previously reported on the consolidated financial statements of COPLP and subsidiaries (in thousands):
 
 
As of December 31, 2017
 
As of June 30, 2017
 
As of December 31, 2016
Consolidated Balance Sheets
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Investment in unconsolid. real estate joint venture
 
$
25,066

 
$
16,721

 
$
41,787

 
$
25,335

 
$
17,417

 
$
42,752

 
$
25,548

 
$
18,113

 
$
43,661

Common units
 
$
1,428,301

 
$
16,721

 
$
1,445,022

 
$
1,399,578

 
$
17,417

 
$
1,416,995

 
$
1,401,597

 
$
18,113

 
$
1,419,710

 
 
For the Three Months Ended June 30, 2017
 
For the Six Months Ended June 30, 2017
Consolidated Statements of Operations and Comprehensive Income
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
 
As Previously Reported
 
Impact of Adoption
 
As
Adjusted
Equity in income of unconsolidated entities
 
$
718

 
$
(348
)
 
$
370

 
$
1,443

 
$
(696
)
 
$
747

Income before gain on sales of real estate
 
$
19,195

 
$
(348
)
 
$
18,847

 
$
38,045

 
$
(696
)
 
$
37,349

Net income
 
$
19,207

 
$
(348
)
 
$
18,859

 
$
42,295

 
$
(696
)
 
$
41,599

Net income attributable to COPLP
 
$
18,300

 
$
(348
)
 
$
17,952

 
$
40,454

 
$
(696
)
 
$
39,758

Net income attributable to COPLP common unitholders
 
$
8,249

 
$
(348
)
 
$
7,901

 
$
27,058

 
$
(696
)
 
$
26,362

Comprehensive income
 
$
18,387

 
$
(348
)
 
$
18,039

 
$
42,883

 
$
(696
)
 
$
42,187

Comprehensive income attributable to COPLP
 
$
17,480

 
$
(348
)
 
$
17,132

 
$
41,042

 
$
(696
)
 
$
40,346

 
 
 
 
 
 
 
 
 
 
 
 
 
Adoption of this guidance had no impact to cash provided by or used in operating, financing or investing activities on our consolidated statements of cash flows for the six months ended June 30, 2017.

18


We early adopted guidance issued by the FASB effective January 1, 2018 that makes targeted improvements to hedge accounting. This new guidance simplifies the application of hedge accounting and better aligns financial reporting for hedging activities with companies’ economic objectives in undertaking those activities. Under the new guidance, all changes in the fair value of highly effective cash flow hedges will be recorded in other comprehensive income instead of income. The new guidance also eases the administrative burden of hedge documentation requirements and assessing hedge effectiveness. We adopted this guidance using the modified retrospective transition method under which we eliminated $276,000 in previously-recorded cumulative hedge ineffectiveness as of January 1, 2018 by means of a cumulative-effect adjustment to our beginning balance of accumulated other comprehensive income (“AOCI”), with a corresponding adjustment to the beginning balance of: cumulative distributions in excess of net income for COPT and subsidiaries; and common units for COPLP and subsidiaries.

In February 2016, the FASB issued guidance that sets forth principles for the recognition, measurement, presentation and disclosure of leases.  This guidance requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. The resulting classification determines whether the lease expense is recognized based on an effective interest method or straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases. The guidance requires lessors of real estate to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases.  This guidance is effective for reporting periods beginning January 1, 2019 using a modified retrospective transition approach at the time of adoption. Early adoption is also permitted for this guidance. In addition, the guidance permits lessees and lessors to elect to apply a package of practical expedients that allow them not to reassess upon adoption: the lease classification for any expired or existing leases; their deferred recognition of incremental direct costs of leasing for any expired or existing leases; and whether any expired or existing contracts are, or contain, leases. While we are still completing our assessment of the impact of this guidance, below is a summary of the anticipated primary effects of this guidance on our accounting and reporting.

•
Real estate leases in which we are the lessor:
◦
Balance sheet reporting: We believe that we will apply an approach under the new guidance that is similar to the current accounting for operating leases, in which we will continue to recognize the underlying leased asset as property on our balance sheet.
◦
Deferral of non-incremental lease costs: Under the new lease guidance, we will no longer be able to defer the recognition of non-incremental costs in connection with new or extended tenant leases (refer to amounts reported in our 2017 Annual Report on Form 10-K for amounts deferred in 2017, 2016 and 2015). Upon adoption of the new guidance, we would expense previously deferred non-incremental lease costs for existing leases unless we elect the package of practical expedients, in which case such costs would remain deferred and amortized over the remaining lease terms.
◦
Lease revenue reporting: Under the issued and approved guidance, we believed that the new revenue standard would apply to executory costs and other components of revenue deemed to be non-lease components (such as common area maintenance and provision of utilities), in which case we would need: to separate the lease components of revenue due under leases from the non-lease components; and recognize revenue on the non-lease components as the related services are delivered, which could result in a change to our revenue recognition pattern. However, in March 2018, the FASB tentatively approved a practical expedient to provide lessors with an option to not separate lease components of revenue from non-lease components if: the timing and pattern of transfer of these components is the same as the related lease; and the lease would continue to be classified as an operating lease.
•
Leases in which we are the lessee:
◦
Our most significant leases as lessee are ground leases; as of June 30, 2018 , our future minimum rental payments under these leases totaled $89.4 million , with various expiration dates extending to the year 2100. While we are still in the process of evaluating these leases under the new guidance, we believe that we will be required to recognize right-of-use assets and lease liabilities for the present value of these minimum lease payments. We also believe that these types of leases most likely would be classified as finance leases under the new guidance, which would result in the interest component of each lease payment being recorded as interest expense and the right-of-use asset being amortized into expense using the straight-line method over the life of the lease; however, we expect to elect to apply the package of practical expedients under which we would continue to account for our existing ground leases as operating leases upon adoption of the guidance.

In June 2016, the FASB issued guidance that changes how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The guidance replaces the current incurred loss model with an expected loss approach, resulting in a more timely recognition of such losses. The guidance will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans,

19


held-to-maturity debt securities, net investments in leases, and off-balance-sheet credit exposures (e.g. loan commitments). Under the new guidance, an entity will recognize its estimate of expected credit losses as an allowance, as the guidance requires that financial assets be measured on an amortized cost basis and to be presented at the net amount expected to be collected. The guidance is effective for us beginning January 1, 2020, with early adoption permitted after December 2018. We are currently assessing the financial impact of this guidance on our consolidated financial statements.

3.       Revenue Recognition on Construction Contract and Other Service Revenues

We enter into construction contracts to complete various design and construction services primarily for our United States Government tenants. The revenues and expenses from these services consist primarily of subcontracted costs that are reimbursed to us by our customers along with a fee. These services are an ancillary component of our overall operations, with small operating margins relative to the revenue. We review each contract to determine the performance obligations and allocate the transaction price. We recognize revenue under these contracts as services are performed in an amount that reflects the consideration we expect to receive in exchange for those services. Our performance obligations are satisfied over time as work progresses. Revenue recognition is determined using the input method based on costs incurred as of point in time relative to the total estimated costs at completion to measure progress toward satisfying our performance obligations. We believe incurred costs of work performed best depicts the transfer of control of the services being transferred to the customer.

In determining whether the performance obligations of each construction contract should be accounted for separately versus together, we consider numerous factors that may require significant judgment, including: whether the components contracted are substantially the same with the same pattern of transfer; whether the customer could contract with another party to perform construction based on our design project; and whether the customer can elect not to move forward after the design phase of the contract. Most of our contracts have a single performance obligation as the promise to transfer the services is not separately identifiable from other obligations in the contracts and, therefore, are not distinct. Some contracts have multiple performance obligations, most commonly due to having distinct project phases for design and construction for which our customer is making decisions and managing separately. In these cases, we allocate the transaction price between these performance obligations based on the amounts separately set forth in the contracts for such obligations. Contract modifications, such as change orders, are routine for our construction contracts and are generally determined to be additions to the existing performance obligations because they would have been part of the initial performance obligations if they were identified at the initial contract date.

We have three main types of compensation arrangements for our construction contracts: guaranteed maximum price (“GMP”); firm fixed price (“FFP”); and cost-plus fee.

•
GMP contracts provide for revenue equal to costs incurred plus a fee equal to a percentage of such costs, up to a maximum contract amount. We generally enter into GMP contracts for projects that are significant in nature based on the size of the project and total fees, and for which the full scope of the project has not been determined as of the contract date. GMP contracts are lower risk to us than FFP contracts since the costs and revenue move proportionately to one another;
•
FFP contracts provide for revenue equal to a fixed fee. These contracts are typically lower in value and scope relative to GMP contracts, and are generally entered into when the scope of the project is well defined. Typically, we assume more risk with FFP contracts than GMP contracts since the revenue is fixed and we could realize losses or less than expected profits if we incur more costs than originally estimated. However, these types of contracts offer the opportunity for additional profits when we complete the work for less than originally estimated. Determining the estimated total costs for contracts under an FFP compensation arrangement may require significant judgment and has a direct effect on our revenue recognition pattern;
•
Cost-plus fee contracts provide for revenue equal to costs incurred plus a fee equal to a percentage of such costs but, unlike GMP contracts, do not have a maximum contract amount. We do not frequently enter into cost-plus fee contracts. Similar to GMP contracts, cost-plus fee contracts are low risk to us since the costs and revenue move proportionately to one another.

Construction contract cost estimates are based on various assumptions, such as performance of subcontractors and cost and availability of materials, to project the outcome of future events over the course of the project. We review and update these estimates regularly as a significant change could affect the profitability of our construction contracts. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method as the modification does not create a new performance obligation. Under this method, the impact of the adjustment on profit recorded to date on a contract is recognized in the period the adjustment is identified. Revenue and profit in future periods are recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter it is identified.


20


We disaggregate our construction contract and other service revenues by compensation arrangement and by service type as we believe it best depicts the nature, timing and uncertainty of our revenue. The table below reports construction contract and other service revenues by compensation arrangement (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Construction contract revenues:
 
 
 
 
 
 
 
GMP
$
9,539

 
$
18,317

 
$
30,025

 
$
24,906

FFP
6,288

 
4,587

 
12,723

 
10,785

Cost-plus fee
1,496

 
—

 
1,554

 
17

Other
258

 
234

 
477

 
464

 
$
17,581

 
$
23,138

 
$
44,779

 
$
36,172


The table below reports construction contract and other service revenues by service type (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Construction contract revenues:
 
 
 
 
 
 
 
Construction
$
16,668

 
$
21,078

 
$
42,583

 
$
31,169

Design
655

 
1,826

 
1,719

 
4,539

Other
258

 
234

 
477

 
464

 
$
17,581

 
$
23,138

 
$
44,779

 
$
36,172


We recognized revenue from performance obligations satisfied (or partially satisfied) in previous periods of $10,000 and $401,000 in the three months ended June 30, 2018 and 2017 , respectively; and $319,000 and $547,000 in the six months ended June 30, 2018 and 2017 , respectively.

Our timing of revenue recognition for construction contracts generally differs from the timing of invoicing to customers. We recognize such revenue as we satisfy our performance obligations. Payment terms and conditions vary by contract type. Under most of our contracts, we bill customers monthly, as work progresses, in accordance with the contract terms, with payment due in 30 days , although customers occasionally pay in advance of services being provided. We have determined that our contracts generally do not include a significant financing component. The primary purpose of the timing of our invoicing is for convenience, not to receive financing from our customers or to provide customers with financing. Additionally, the timing of transfer of the services is often at the discretion of the customer. We recognized no impairment losses on construction contracts receivable or unbilled construction revenue in the periods set forth herein.

Accounts receivable related to our construction contract services is included in accounts receivable, net on our consolidated balance sheets. The beginning and ending balances of accounts receivable related to our construction contracts were as follows (in thousands):
 
For the Six Months Ended June 30,
 
2018
 
2017
Beginning balance
$
4,577

 
$
4,131

Ending balance
$
4,805

 
$
11,946


Under most of our contracts, we bill customers one month subsequent to revenue recognition, resulting in contract assets representing unbilled construction revenue. Contract assets, which we refer to herein as construction costs in excess of billings, are included in prepaid expenses and other assets, net reported on our consolidated balance sheets. The beginning and ending balances of our contract assets were as follows (in thousands):
 
For the Six Months Ended June 30,
 
2018
 
2017
Beginning balance
$
4,884

 
$
10,350

Ending balance
$
4,158

 
$
3,620



21


Our contract liabilities consist of advance payments from our customers or billings in excess of construction contract revenue recognized. Contract liabilities are included in other liabilities reported on our consolidated balance sheets. Changes in contract liabilities were as follows (in thousands):
 
For the Six Months Ended June 30,
 
2018
 
2017
Beginning balance
$
27,402

 
$
32,650

Ending balance
$
515

 
$
40,209

Portion of beginning balance recognized in revenue during:
 
 
 
Three months ended June 30
$
7,999

 
$
16,762

Six months ended June 30
$
27,296

 
$
20,961


The change in the contract liabilities balance reported above for the six months ended June 30, 2018 was due primarily to our satisfaction of performance obligations during the period on a contract on which we previously received advance payments from a customer.

Revenue allocated to the remaining performance obligations under existing contracts as of June 30, 2018 that will be recognized as revenue in future periods was $16.1 million , virtually all of which we expect to recognize during the remainder of 2018.

We have no deferred incremental costs incurred to obtain or fulfill our construction contracts or other service revenues.

4.       Fair Value Measurements

Recurring Fair Value Measurements

COPT has a non-qualified elective deferred compensation plan for Trustees and certain members of our management team that permits participants to defer up to 100% of their compensation on a pre-tax basis and receive a tax-deferred return on such deferrals. The assets held in the plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the participants are measured at fair value on a recurring basis on COPT’s consolidated balance sheets using quoted market prices, as are other marketable securities that we hold. The balance of the plan, which was fully funded, totaled $4.2 million as of June 30, 2018 , and is included in the line entitled “prepaid expenses and other assets, net” on COPT’s consolidated balance sheets. The offsetting liability associated with the plan is adjusted to fair value at the end of each accounting period based on the fair value of the plan assets and reported in other liabilities on COPT’s consolidated balance sheets. The assets of the plan are classified in Level 1 of the fair value hierarchy, while the offsetting liability is classified in Level 2 of the fair value hierarchy.

The fair values of our interest rate derivatives are determined using widely accepted valuation techniques, including a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate market data and implied volatilities in such interest rates. While we determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our interest rate derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default. However, as of June 30, 2018 , we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivatives and determined that these adjustments are not significant. As a result, we determined that our interest rate derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, other assets (excluding investing receivables) and accounts payable and accrued expenses are reasonable estimates of their fair values because of the short maturities of these instruments.  As discussed in Note 7, we estimated the fair values of our investing receivables based on the discounted estimated future cash flows of the loans (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans with similar maturities and credit quality, and the estimated cash payments include scheduled principal and interest payments.  For our disclosure of debt fair values in Note 9, we estimated the fair value of our unsecured senior notes based on quoted market rates for publicly-traded debt (categorized within Level 2 of the fair value hierarchy) and estimated the fair value of our other debt based on the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans, or groups of loans, with similar maturities and credit quality, and the estimated future payments include scheduled principal and interest payments.  Fair value estimates are made as of a specific point in time, are subjective in nature

22


and involve uncertainties and matters of significant judgment.  Settlement at such fair value amounts may not be possible and may not be a prudent management decision.
 
For additional fair value information, please refer to Note 7 for investing receivables, Note 9 for debt and Note 10 for interest rate derivatives. 

COPT and Subsidiaries

The table below sets forth financial assets and liabilities of COPT and subsidiaries that are accounted for at fair value on a recurring basis as of June 30, 2018 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):
Description
 
Quoted Prices in
Active Markets for
Identical Assets (Level 1)
 
Significant Other
Observable Inputs(Level 2)
 
Significant
Unobservable Inputs(Level 3)
 
Total
Assets:
 
 

 
 

 
 

 
 

Marketable securities in deferred compensation plan (1)
 
 

 
 

 
 

 
 

Mutual funds
 
$
4,146

 
$
—

 
$
—

 
$
4,146

Other
 
48

 
—

 
—

 
48

Interest rate derivatives (1)
 
—

 
9,792

 
—

 
9,792

Total assets
 
$
4,194

 
$
9,792

 
$
—

 
$
13,986

Liabilities:
 
 

 
 

 
 

 
 

Deferred compensation plan liability (2)
 
$
—

 
$
4,194

 
$
—

 
$
4,194


(1) Included in the line entitled “prepaid expenses and other assets, net” on COPT’s consolidated balance sheet.
(2) Included in the line entitled “other liabilities” on COPT’s consolidated balance sheet.

COPLP and Subsidiaries

The table below sets forth financial assets and liabilities of COPLP and subsidiaries that are accounted for at fair value on a recurring basis as of June 30, 2018 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):
Description
 
Quoted Prices in
Active Markets for
Identical Assets (Level 1)
 
Significant Other
Observable Inputs(Level 2)
 
Significant
Unobservable Inputs(Level 3)
 
Total
Assets:
 
 

 
 

 
 

 
 

Interest rate derivatives (1)
 
$
—

 
$
9,792

 
$
—

 
$
9,792


(1) Included in the line entitled “prepaid expenses and other assets, net” on COPLP ’ s consolidated balance sheet.

5.      Properties, Net
 
Operating properties, net consisted of the following (in thousands): 
 
June 30,
2018
 
December 31,
2017
Land
$
469,494

 
$
455,680

Buildings and improvements
3,130,616

 
3,068,124

Less: Accumulated depreciation
(839,478
)
 
(786,193
)
Operating properties, net
$
2,760,632

 
$
2,737,611


Projects in development or held for future development consisted of the following (in thousands):
 
June 30,
2018
 
December 31,
2017
Land
$
232,758

 
$
240,825

Development in progress, excluding land
190,147

 
162,669

Projects in development or held for future development
$
422,905

 
$
403,494


23



Our property held for sale is 11751 Meadowville Lane, a property in our Data Center Shells sub-segment, the sale of which was not recognized for accounting purposes. We provided a financial guaranty to the buyer under which we provided an indemnification for up to $20 million in losses it could incur related to a potential defined capital event occurring on the property by June 30, 2019. We account for this transaction as a financing arrangement. Accordingly, we did not recognize the sale of this property for accounting purposes (and will not until the guaranty expires) and we reported the sales proceeds as a liability on the consolidated balance sheets as of June 30, 2018 and December 31, 2017 in the line entitled “deferred property sale.” We do not expect to incur any losses under this financial guaranty. The table below sets forth the components of this property’s assets as of June 30, 2018 and December 31, 2017 (in thousands):
Properties, net
$
38,670

Deferred rent receivable
3,237

Deferred leasing costs, net
319

Assets held for sale, net
$
42,226


2018 Construction Activities

During the six months ended June 30, 2018 , we placed into service 223,000 square feet in two newly-constructed properties and 13,000 square feet in one redeveloped property. As of June 30, 2018 , we had seven properties under construction, or which we were contractually committed to construct, that we estimate will total 880,000 square feet upon completion and two properties under redevelopment (including one partially-operational property) that we estimate will total 128,000 square feet upon completion.

6.      Real Estate Joint Ventures

Consolidated Joint Ventures

The table below sets forth information pertaining to our investments in consolidated real estate joint ventures as of June 30, 2018 (dollars in thousands):
 
 
 
 
Nominal
 
 
 
 
 
 
 
 
 
 
 
 
Ownership
 
 
 
June 30, 2018 (1)
 
 
Date
 
% as of
 
 
 
Total
 
Encumbered
 
Total
 
 
Acquired
 
6/30/2018
 
Nature of Activity
 
Assets
 
Assets
 
Liabilities
LW Redstone Company, LLC
 
3/23/2010
 
85%
 
Development and operation of real estate (2)
 
$
159,805

 
$
74,012

 
$
51,157

M Square Associates, LLC
 
6/26/2007
 
50%
 
Development and operation of real estate (3)
 
73,395

 
44,457

 
46,323

Stevens Investors, LLC
 
8/11/2015
 
95%
 
Development of real estate (4)
 
75,813

 
—

 
4,887

 
 
 
 
 
 
 
 
$
309,013

 
$
118,469

 
$
102,367

(1)
Excludes amounts eliminated in consolidation.
(2) 
This joint venture’s properties are in Huntsville, Alabama.
(3)
This joint venture’s properties are in College Park, Maryland.
(4) 
This joint venture’s property is in Washington, DC.

Unconsolidated Joint Venture

As of June 30, 2018 , we owned a 50% interest in GI-COPT DC Partnership LLC (“GI-COPT”), a joint venture owning six triple-net leased, single-tenant data center shell properties in Virginia, that we account for using the equity method of accounting. As of June 30, 2018 , we had an investment balance in GI-COPT of $40.8 million .

7.    Investing Receivables
 
Investing receivables, including accrued interest thereon, consisted of the following (in thousands):
 
 
June 30,
2018
 
December 31,
2017
Notes receivable from the City of Huntsville
$
51,386

 
$
54,472

Other investing loans receivable
3,041

 
3,021

 
$
54,427

 
$
57,493

 

24


Our notes receivable from the City of Huntsville funded infrastructure costs in connection with our LW Redstone Company, LLC joint venture (see Note 6) and carry an interest rate of 9.95% .

We did not have an allowance for credit losses in connection with our investing receivables as of June 30, 2018 or December 31, 2017 .  The fair value of these receivables approximated their carrying amounts as of June 30, 2018 and December 31, 2017 .

8.    Prepaid Expenses and Other Assets, Net
 
Prepaid expenses and other assets, net of COPT and subsidiaries consisted of the following (in thousands):
 
 
June 30,
2018
 
December 31,
2017
Lease incentives, net
$
18,376

 
$
19,011

Prepaid expenses
12,173

 
24,670

Interest rate derivatives
9,792

 
3,073

Furniture, fixtures and equipment, net
6,407

 
5,256

Non-real estate equity investments
5,076

 
5,056

Marketable securities in deferred compensation plan
4,194

 
4,616

Construction contract costs incurred in excess of billings
4,158

 
4,884

Restricted cash
4,105

 
2,570

Deferred tax asset, net (1)
1,774

 
1,892

Other assets
4,808

 
3,379

Prepaid expenses and other assets, net
$
70,863

 
$
74,407


(1) Includes a valuation allowance of $1.4 million .


25


9.    Debt, Net
 
Our debt consisted of the following (dollars in thousands):
 
 
Carrying Value (1) as of
 
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
Stated Interest Rates as of
 
Scheduled Maturity as of
 
 
 
 
June 30, 2018
 
June 30, 2018
Mortgage and Other Secured Debt:
 
 

 
 

 
 
 
 
Fixed rate mortgage debt (2)
 
$
148,950

 
$
150,723

 
3.82% - 7.87% (3)
 
2019-2026
Variable rate secured debt
 
12,943

 
13,115

 
LIBOR + 1.85% (4)
 
October 2020
Total mortgage and other secured debt
 
161,893

 
163,838

 
 
 
 
Revolving Credit Facility
 
170,000

 
126,000

 
LIBOR + 0.875% to 1.60% (5)
 
May 2019 (6)
Term Loan Facilities (7)
 
348,185

 
347,959

 
LIBOR + 0.90% to 1.85% (8)
 
2020-2022
Unsecured Senior Notes
 
 
 
 
 
 
 
 
3.600%, $350,000 aggregate principal
 
347,767

 
347,551

 
3.60% (9)
 
May 2023
5.250%, $250,000 aggregate principal
 
246,887

 
246,645

 
5.25% (10)
 
February 2024
3.700%, $300,000 aggregate principal
 
298,567

 
298,322

 
3.70% (11)
 
June 2021
5.000%, $300,000 aggregate principal
 
296,918

 
296,731

 
5.00% (12)
 
July 2025
Unsecured note payable
 
1,228

 
1,287

 
0% (13)
 
May 2026
Total debt, net
 
$
1,871,445

 
$
1,828,333

 
 
 
 

(1)
The carrying values of our debt other than the Revolving Credit Facility reflect net deferred financing costs of $4.5 million as of June 30, 2018 and $5.0 million as of December 31, 2017 .
(2)  
Certain of the fixed rate mortgages carry interest rates that, upon assumption, were above or below market rates and therefore were recorded at their fair value based on applicable effective interest rates. The carrying values of these loans reflect net unamortized premiums totaling $315,000 as of June 30, 2018 and $349,000 as of December 31, 2017 .
(3)
The weighted average interest rate on our fixed rate mortgage debt was 4.18% as of June 30, 2018 .
(4) 
The interest rate on our variable rate secured debt was 3.83% as of June 30, 2018 .
(5)
The weighted average interest rate on the Revolving Credit Facility was 3.19% as of June 30, 2018 .
(6)
The facility matures in May 2019, with the ability for us to further extend such maturity by two six -month periods at our option, provided that there is no default under the facility and we pay an extension fee of 0.075% of the total availability under the facility for each extension period.
(7)  
As of June 30, 2018 , we have the ability to borrow an additional $350.0 million in the aggregate under these term loan facilities, provided that there is no default under the facilities and subject to the approval of the lenders.
(8) 
The weighted average interest rate on these loans was 3.35% as of June 30, 2018 .
(9)
The carrying value of these notes reflects an unamortized discount totaling $1.5 million as of June 30, 2018 and $1.7 million as of December 31, 2017 .  The effective interest rate under the notes, including amortization of the issuance costs, was 3.70% . 
(10)
The carrying value of these notes reflects an unamortized discount totaling $2.8 million as of June 30, 2018 and $3.0 million as of December 31, 2017 .  The effective interest rate under the notes, including amortization of the issuance costs, was 5.49% . 
(11)
The carrying value of these notes reflects an unamortized discount totaling $1.1 million as of June 30, 2018 and $1.3 million as of December 31, 2017 .  The effective interest rate under the notes, including amortization of the issuance costs, was 3.85% . 
(12) The carrying value of these notes reflects an unamortized discount totaling $2.6 million as of June 30, 2018 and $2.7 million as of December 31, 2017 .  The effective interest rate under the notes, including amortization of the issuance costs, was 5.15% .
(13) 
This note carries an interest rate that, upon assumption, was below market rates and it therefore was recorded at its fair value based on applicable effective interest rates.  The carrying value of this note reflects an unamortized discount totaling $333,000 as of June 30, 2018 and $373,000 as of December 31, 2017 .
 
All debt is owed by the Operating Partnership. While COPT is not directly obligated by any debt, it has guaranteed the Operating Partnership’s Revolving Credit Facility, Term Loan Facilities and Unsecured Senior Notes.

Certain of our debt instruments require that we comply with a number of restrictive financial covenants.  As of June 30, 2018 , we were within the compliance requirements of these financial covenants.

We capitalized interest costs of $1.4 million in the three months ended June 30, 2018 , $1.6 million in the three months ended June 30, 2017 , $2.8 million in the six months ended June 30, 2018 and $3.1 million in the six months ended June 30, 2017 .


26


The following table sets forth information pertaining to the fair value of our debt (in thousands): 
 
June 30, 2018
 
December 31, 2017
 
Carrying
 
Fair
 
Carrying
 
Fair
 
Amount
 
Value
 
Amount
 
Value
Fixed-rate debt
 

 
 

 
 

 
 

Unsecured Senior Notes
$
1,190,139

 
$
1,220,040

 
$
1,189,249

 
$
1,229,398

Other fixed-rate debt
150,178

 
148,257

 
152,010

 
152,485

Variable-rate debt
531,128

 
530,968

 
487,074

 
485,694

 
$
1,871,445

 
$
1,899,265

 
$
1,828,333

 
$
1,867,577

 

10.    Interest Rate Derivatives
 
The following table sets forth the key terms and fair values of our interest rate swap derivatives, each of which was designated as a cash flow hedge of interest rate risk (dollars in thousands):
 
 
 



 

 

Fair Value at
Notional Amount
 
Fixed Rate

Floating Rate Index

Effective Date

Expiration Date

June 30,
2018

December 31,
2017
$
100,000


1.7300%

One-Month LIBOR

9/1/2015

8/1/2019

$
745


$
252

13,026

(1)
1.3900%
 
One-Month LIBOR
 
10/13/2015
 
10/1/2020
 
343

 
213

100,000

 
1.9013%
 
One-Month LIBOR
 
9/1/2016
 
12/1/2022
 
3,481

 
1,046

100,000

 
1.9050%
 
One-Month LIBOR
 
9/1/2016
 
12/1/2022
 
3,494

 
1,051

50,000

 
1.9079%
 
One-Month LIBOR
 
9/1/2016
 
12/1/2022
 
1,729

 
511

 

 
 

 

 

 

$
9,792


$
3,073


(1)     The notional amount of this instrument is scheduled to amortize to $12.1 million .
 
The table below sets forth the fair value of our interest rate derivatives as well as their classification on our consolidated balance sheets (in thousands):
 
 
 
 
Fair Value at
Derivatives
 
Balance Sheet Location
 
June 30,
2018
 
December 31, 2017
Interest rate swaps designated as cash flow hedges
 
Prepaid expenses and other assets, net
 
$
9,792

 
$
3,073

 
The table below presents the effect of our interest rate derivatives on our consolidated statements of operations and comprehensive income (in thousands):
 
 
Amount of Gain (Loss) Recognized in AOCI on Derivatives
 
Amount of Gain (Loss) Reclassified from AOCI into Interest Expense on Statement of Operations
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Derivatives in Hedging Relationships
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Interest rate derivatives
 
$
1,912

 
$
(1,800
)
 
$
6,588

 
$
(1,576
)
 
$
47

 
$
(941
)
 
$
(198
)
 
$
(2,125
)

Over the next 12 months, we estimate that approximately $1.9 million of gains will be reclassified from AOCI as a decrease to interest expense.

We have agreements with each of our interest rate derivative counterparties that contain provisions under which, if we default or are capable of being declared in default on defined levels of our indebtedness, we could also be declared in default on our derivative obligations. Failure to comply with the loan covenant provisions could result in our being declared in default on any derivative instrument obligations covered by the agreements. We are not in default with any of these provisions. As of June 30, 2018 , we did not have any derivatives in liability positions. As of June 30, 2018 , we had not posted any collateral related to these agreements.


27


11.    Redeemable Noncontrolling Interests

Our partners in two real estate joint ventures, LW Redstone Company, LLC and Stevens Investors, LLC (discussed further in Note 6), have the right to require us to acquire their respective interests at fair value; accordingly, we classify the fair value of our partners’ interests as redeemable noncontrolling interests in the mezzanine section of our consolidated balance sheets. We determine the fair value of the interests based on unobservable inputs after considering the assumptions that market participants would make in pricing the interest. We apply a discount rate to the estimated future cash flows allocable to our partners from the properties underlying the respective joint ventures. Estimated cash flows used in such analyses are based on our plans for the properties and our views of market and economic conditions, and consider items such as current and future rental rates, occupancy projections and estimated operating and development expenditures. The table below sets forth the activity for these redeemable noncontrolling interests (in thousands):
 
 
For the Six Months Ended June 30,
 
 
2018
 
2017
Beginning balance
 
$
23,125

 
$
22,979

Contributions from noncontrolling interests
 
143

 
—

Distributions to noncontrolling interests
 
(711
)
 
(789
)
Net income attributable to noncontrolling interests
 
1,229

 
1,140

Adjustment to arrive at fair value of interests
 
758

 
401

Ending balance
 
$
24,544

 
$
23,731


12.    Equity
 
During the six months ended June 30, 2018 , COPT issued 1.8 million common shares under its forward equity sale agreements for net proceeds of $52.3 million . COPT contributed the net proceeds from these issuances to COPLP in exchange for an equal number of units in COPLP. COPT’s remaining capacity under the forward equity sale agreements was 5.7 million common shares as of June 30, 2018 .

During the six months ended June 30, 2018 , certain COPLP limited partners converted 53,817 common units in COPLP for an equal number of common shares in COPT.

As of June 30, 2018 , COPT had remaining capacity under its at-the-market stock offering program equal to an aggregate gross sales price of $70.0 million in common share sales.

See Note 14 for disclosure of COPT common share and COPLP common unit activity pertaining to our share-based compensation plans.


28


13.    Information by Business Segment

We have the following reportable segments: Defense/IT Locations; Regional Office; Wholesale Data Center; and Other. We also report on Defense/IT Locations sub-segments, which include the following: Fort George G. Meade and the Baltimore/Washington Corridor (referred to herein as “Fort Meade/BW Corridor”); Northern Virginia Defense/IT Locations; Lackland Air Force Base (in San Antonio); locations serving the U.S. Navy (“Navy Support Locations”), which included properties proximate to the Washington Navy Yard, the Naval Air Station Patuxent River in Maryland and the Naval Surface Warfare Center Dahlgren Division in Virginia; Redstone Arsenal (in Huntsville); and data center shells (properties leased to tenants to be operated as data centers in which the tenants generally fund the costs for the power, fiber connectivity and data center infrastructure). As of June 30, 2018 and December 31, 2017 , our Regional Office segment included properties located in select urban/urban-like submarkets in the Greater Washington, DC/Baltimore region with durable Class-A office fundamentals and characteristics; during 2017, this segment also included suburban properties that did not meet these characteristics (that were since disposed).

We measure the performance of our segments through the measure we define as net operating income from real estate operations (“NOI from real estate operations”), which includes: real estate revenues and property operating expenses; and the net of revenues and property operating expenses of real estate operations owned through unconsolidated real estate joint ventures (“UJVs”) that is allocable to COPT’s ownership interest (“UJV NOI allocable to COPT”). Amounts reported for segment assets represent long-lived assets associated with consolidated operating properties (including the carrying value of properties, intangible assets, deferred leasing costs, deferred rents receivable and lease incentives) and the carrying value of investments in UJVs owning operating properties. Amounts reported as additions to long-lived assets represent additions to existing consolidated operating properties, excluding transfers from non-operating properties, which we report separately.


29


The table below reports segment financial information for our reportable segments (in thousands): 
 
Operating Property Segments
 
 
 
 
 
 
 
Defense/Information Technology Locations
 
 
 
 
 
 
 
 
 
Fort Meade/BW Corridor
 
Northern Virginia Defense/IT
 
Lackland Air Force Base
 
Navy Support Locations
 
Redstone Arsenal
 
Data Center Shells
 
Total Defense/IT Locations
 
Regional Office
 
Wholesale
Data Center
 
Other
 
Total
Three Months Ended June 30, 2018
 

 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

 
 

 
 

Revenues from real estate operations
$
61,993

 
$
13,118

 
$
12,382

 
$
8,127

 
$
3,652

 
$
5,955

 
$
105,227

 
$
15,296

 
$
8,105

 
$
534

 
$
129,162

Property operating expenses
(20,099
)
 
(4,909
)
 
(7,494
)
 
(3,431
)
 
(1,509
)
 
(799
)
 
(38,241
)
 
(7,169
)
 
(4,150
)
 
114

 
(49,446
)
UJV NOI allocable to COPT
—

 
—

 
—

 
—

 
—

 
1,202

 
1,202

 
—

 
—

 
—

 
1,202

NOI from real estate operations
$
41,894

 
$
8,209

 
$
4,888

 
$
4,696

 
$
2,143

 
$
6,358

 
$
68,188

 
$
8,127

 
$
3,955

 
$
648

 
$
80,918

Additions to long-lived assets
$
8,151

 
$
1,186

 
$
—

 
$
1,450

 
$
351

 
$
—

 
$
11,138

 
$
5,361

 
$
81

 
$
188

 
$
16,768

Transfers from non-operating properties
$
3,035

 
$
352

 
$
—

 
$
3

 
$
26

 
$
29,675

 
$
33,091

 
$
—

 
$
1,133

 
$
—

 
$
34,224

Three Months Ended June 30, 2017
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

 
 

Revenues from real estate operations
$
61,284

 
$
11,095

 
$
13,029

 
$
7,449

 
$
3,624

 
$
5,800

 
$
102,281

 
$
17,462

 
$
7,033

 
$
1,521

 
$
128,297

Property operating expenses
(20,129
)
 
(4,219
)
 
(8,130
)
 
(3,025
)
 
(1,491
)
 
(577
)
 
(37,571
)
 
(7,082
)
 
(3,501
)
 
(474
)
 
(48,628
)
UJV NOI allocable to COPT
—

 
—

 
—

 
—

 
—

 
1,198

 
1,198

 
—

 
—

 
—

 
1,198

NOI from real estate operations
$
41,155

 
$
6,876

 
$
4,899

 
$
4,424

 
$
2,133

 
$
6,421

 
$
65,908

 
$
10,380

 
$
3,532

 
$
1,047

 
$
80,867

Additions to long-lived assets
$
5,853

 
$
977

 
$
16

 
$
2,231

 
$
84

 
$
—

 
$
9,161

 
$
4,018

 
$
2,005

 
$
(29
)
 
$
15,155

Transfers from non-operating properties
$
18,159

 
$
218

 
$
—

 
$
466

 
$
1,709

 
$
26,215

 
$
46,767

 
$
(25
)
 
$
—

 
$
—

 
$
46,742

Six Months Ended June 30, 2018
 

 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

 
 

 
 

Revenues from real estate operations
$
124,775

 
$
25,679

 
$
23,825

 
$
15,997

 
$
7,285

 
$
11,786

 
$
209,347

 
$
30,580

 
$
16,182

 
$
1,331

 
$
257,440

Property operating expenses
(41,703
)
 
(9,632
)
 
(14,092
)
 
(6,735
)
 
(2,949
)
 
(1,593
)
 
(76,704
)
 
(15,047
)
 
(8,408
)
 
(238
)
 
(100,397
)
UJV NOI allocable to COPT
—

 
—

 
—

 
—

 
—

 
2,401

 
2,401

 
—

 
—

 
—

 
2,401

NOI from real estate operations
$
83,072

 
$
16,047

 
$
9,733

 
$
9,262

 
$
4,336

 
$
12,594

 
$
135,044

 
$
15,533

 
$
7,774

 
$
1,093

 
$
159,444

Additions to long-lived assets
$
15,272

 
$
3,126

 
$
—

 
$
2,558

 
$
430

 
$
—

 
$
21,386

 
$
9,245

 
$
117

 
$
315

 
$
31,063

Transfers from non-operating properties
$
20,221

 
$
693

 
$
—

 
$
—

 
$
470

 
$
30,789

 
$
52,173

 
$
—

 
$
2,145

 
$
—

 
$
54,318

Segment assets at June 30, 2018
$
1,269,525

 
$
396,139

 
$
126,956

 
$
190,537

 
$
106,374

 
$
330,622

 
$
2,420,153

 
$
396,847

 
$
221,239

 
$
4,213

 
$
3,042,452

Six Months Ended June 30, 2017
 

 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

 
 

 
 

Revenues from real estate operations
$
122,139

 
$
22,802

 
$
24,663

 
$
14,459

 
$
7,084

 
$
11,322

 
$
202,469

 
$
35,738

 
$
13,803

 
$
3,054

 
$
255,064

Property operating expenses
(40,649
)
 
(8,671
)
 
(14,932
)
 
(6,234
)
 
(2,862
)
 
(1,236
)
 
(74,584
)
 
(14,568
)
 
(6,866
)
 
(1,129
)
 
(97,147
)
UJV NOI allocable to COPT
—

 
—

 
—

 
—

 
—

 
2,400

 
2,400

 
—

 
—

 
—

 
2,400

NOI from real estate operations
$
81,490

 
$
14,131

 
$
9,731

 
$
8,225

 
$
4,222

 
$
12,486

 
$
130,285

 
$
21,170

 
$
6,937

 
$
1,925

 
$
160,317

Additions to long-lived assets
$
9,275

 
$
3,445

 
$
16

 
$
4,399

 
$
216

 
$
—

 
$
17,351

 
$
11,138

 
$
3,579

 
$
127

 
$
32,195

Transfers from non-operating properties
$
31,575

 
$
440

 
$
—

 
$
466

 
$
1,705

 
$
25,200

 
$
59,386

 
$
(25
)
 
$
8

 
$
18

 
$
59,387

Segment assets at June 30, 2017
$
1,267,635

 
$
357,747

 
$
130,431

 
$
195,732

 
$
109,586

 
$
247,974

 
$
2,309,105

 
$
435,399

 
$
229,224

 
$
19,350

 
$
2,993,078


30


The following table reconciles our segment revenues to total revenues as reported on our consolidated statements of operations (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Segment revenues from real estate operations
$
129,162

 
$
128,297

 
$
257,440

 
$
255,064

Construction contract and other service revenues
17,581

 
23,138

 
44,779

 
36,172

Total revenues
$
146,743

 
$
151,435

 
$
302,219

 
$
291,236

 
The following table reconciles UJV NOI allocable to COPT to equity in income of unconsolidated entities as reported on our consolidated statements of operations (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
UJV NOI allocable to COPT
$
1,202

 
$
1,198

 
$
2,401

 
$
2,400

Less: Income from UJV allocable to COPT attributable to depreciation and amortization expense and interest expense
(828
)
 
(827
)
 
(1,652
)
 
(1,651
)
Add: Equity in loss of unconsolidated non-real estate entities
(1
)
 
(1
)
 
(3
)
 
(2
)
Equity in income of unconsolidated entities
$
373

 
$
370

 
$
746

 
$
747

 
As previously discussed, we provide real estate services such as property management and construction and development services primarily for our properties but also for third parties.  The primary manner in which we evaluate the operating performance of our service activities is through a measure we define as net operating income from service operations (“NOI from service operations”), which is based on the net of revenues and expenses from these activities.  Construction contract and other service revenues and expenses consist primarily of subcontracted costs that are reimbursed to us by the customer along with a management fee. The operating margins from these activities are small relative to the revenue.  We believe NOI from service operations is a useful measure in assessing both our level of activity and our profitability in conducting such operations. The table below sets forth the computation of our NOI from service operations (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Construction contract and other service revenues
$
17,581

 
$
23,138

 
$
44,779

 
$
36,172

Construction contract and other service expenses
(16,941
)
 
(22,315
)
 
(43,157
)
 
(34,801
)
NOI from service operations
$
640

 
$
823

 
$
1,622

 
$
1,371



31


The following table reconciles our NOI from real estate operations for reportable segments and NOI from service operations to income before gain on sales of real estate as reported on our consolidated statements of operations (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
NOI from real estate operations
$
80,918

 
$
80,867

 
$
159,444

 
$
160,317

NOI from service operations
640

 
823

 
1,622

 
1,371

Interest and other income
1,439

 
1,583

 
2,798

 
3,309

Equity in income of unconsolidated entities
373

 
370

 
746

 
747

Income tax expense
(63
)
 
(48
)
 
(118
)
 
(88
)
Depreciation and other amortization associated with real estate operations
(33,190
)
 
(32,793
)
 
(66,702
)
 
(65,852
)
Impairment losses
—

 
(1,625
)
 
—

 
(1,625
)
General, administrative and leasing expenses
(7,628
)
 
(7,859
)
 
(14,920
)
 
(16,470
)
Business development expenses and land carry costs
(1,234
)
 
(1,597
)
 
(2,848
)
 
(3,290
)
Interest expense
(18,945
)
 
(19,163
)
 
(37,729
)
 
(38,157
)
Less: UJV NOI allocable to COPT included in equity in income of unconsolidated entities
(1,202
)
 
(1,198
)
 
(2,401
)
 
(2,400
)
Loss on early extinguishment of debt
—

 
(513
)
 
—

 
(513
)
Income before gain on sales of real estate
$
21,108

 
$
18,847

 
$
39,892

 
$
37,349

 
The following table reconciles our segment assets to the consolidated total assets of COPT and subsidiaries (in thousands):
 
 
June 30,
2018
 
June 30,
2017
Segment assets
$
3,042,452

 
$
2,993,078

Non-operating property assets
431,661

 
452,824

Other assets
138,249

 
146,402

Total COPT consolidated assets
$
3,612,362

 
$
3,592,304

 
The accounting policies of the segments are the same as those used to prepare our consolidated financial statements, except that UJV NOI allocable to COPT are not presented separately for segment purposes.  In the segment reporting presented above, we did not allocate interest expense, depreciation and amortization, impairment losses, loss on early extinguishment of debt, gain on sales of real estate and equity in income of unconsolidated entities not included in NOI to our real estate segments since they are not included in the measure of segment profit reviewed by management.  We also did not allocate general, administrative and leasing expenses, business development expenses and land carry costs, interest and other income, income taxes and noncontrolling interests because these items represent general corporate or non-operating property items not attributable to segments.

14.    Share-Based Compensation
 
Performance Share Awards (“PSUs”)
 
On January 1, 2018 , our Board of Trustees granted 59,110 PSUs with an aggregate grant date fair value of $1.9 million to our three executives.  The PSUs have a performance period beginning on January 1, 2018 and concluding on the earlier of December 31, 2020 or the date of: (1) termination by us without cause, death or disability of the executive or constructive discharge of the executive (collectively, “qualified termination”); or (2) a sale event.  The number of PSUs earned (“earned PSUs”) at the end of the performance period will be determined based on the percentile rank of COPT’s total shareholder return relative to a peer group of companies, as set forth in the following schedule:
Percentile Rank
 
Earned PSUs Payout %
75th or greater
 
200% of PSUs granted
50th
 
100% of PSUs granted
25th
 
50% of PSUs granted
Below 25th
 
0% of PSUs granted


32


If the percentile rank exceeds the 25th percentile and is between two of the percentile ranks set forth in the table above, then the percentage of the earned PSUs will be interpolated between the ranges set forth in the table above to reflect any performance between the listed percentiles.  At the end of the performance period, we, in settlement of the award will:

•
issue a number of fully-vested COPT common shares equal to the number of earned PSUs in settlement of the award plan; and
•
pay cash equal to the aggregate dividends that would have been paid with respect to the common shares issued in settlement of the earned PSUs through the date of settlement had such shares been issued on the grant date.
 
If a performance period ends due to a sale event or qualified termination, the number of earned PSUs is prorated based on the portion of the three -year performance period that has elapsed.  If employment is terminated by the employee or by us for cause, all PSUs are forfeited. PSUs do not carry voting rights.

We computed a grant date fair value of $31.97 per PSU using a Monte Carlo model. Significant assumptions for that model included the following: baseline common share value of $29.20 ; expected volatility for COPT common shares of 17.0% ; and a risk-free interest rate of 2.04% .  

We issued 13,328 common shares on February 22, 2018 to executives in settlement of PSUs issued in 2015, representing 75% of the target award for those PSUs.

Restricted Shares
 
During the six months ended June 30, 2018 , certain employees and non-employee members of our Board of Trustees were granted a total of 196,366 restricted common shares with an aggregate grant date fair value of $5.0 million (weighted average of $25.38 per share).  Restricted shares granted to employees vest based on increments and over periods of time set forth under the terms of the respective awards provided that the employee remains employed by us.  Restricted shares granted to non-employee Trustees vest on the first anniversary of the grant date, provided that the Trustee remains in his or her position. During the six months ended June 30, 2018 , forfeiture restrictions lapsed on 161,322 previously issued common shares; these shares had a weighted average grant date fair value of $29.72 per share, and the aggregate intrinsic value of the shares on the vesting dates was $4.1 million .

Deferred Share Awards

During the six months ended June 30, 2018 , non-employee members of our Board of Trustees were granted a total of 13,832 deferred share awards with an aggregate grant date fair value of $388,000 ( $28.08 per share). Deferred share awards vest on the first anniversary of the grant date, provided that the Trustee remains in his or her position. We settle deferred share awards by issuing an equivalent number of common shares upon vesting of the awards or a later date elected by the Trustee (generally upon cessation of being a Trustee). During the six months ended June 30, 2018 , we issued 5,515 common shares in settlement of deferred share awards; these shares had a grant date fair value of $29.32 per share, and the aggregate intrinsic value of the shares on the settlement date was $154,000 .

15.    Earnings Per Share (“EPS”) and Earnings Per Unit (“EPU”)
 
COPT and Subsidiaries EPS

We present both basic and diluted EPS.  We compute basic EPS by dividing net income available to common shareholders allocable to unrestricted common shares under the two-class method by the weighted average number of unrestricted common shares outstanding during the period.  Our computation of diluted EPS is similar except that:
 
•
the denominator is increased to include: (1) the weighted average number of potential additional common shares that would have been outstanding if securities that are convertible into COPT common shares were converted; and (2) the effect of dilutive potential common shares outstanding during the period attributable to COPT’s forward equity sale agreements and our share-based compensation using the treasury stock or if-converted methods; and
•
the numerator is adjusted to add back any changes in income or loss that would result from the assumed conversion into common shares that we added to the denominator.


33


Summaries of the numerator and denominator for purposes of basic and diluted EPS calculations are set forth below (in thousands, except per share data):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 

 
 

 
 
 
 
Net income attributable to COPT
$
19,434

 
$
17,526

 
$
36,584

 
$
38,545

Preferred share dividends
—

 
(3,039
)
 
—

 
(6,219
)
Issuance costs associated with redeemed preferred shares
—

 
(6,847
)
 
—

 
(6,847
)
Income attributable to share-based compensation awards
(117
)
 
(117
)
 
(234
)
 
(242
)
Numerator for basic and diluted EPS on net income attributable to COPT common shareholders
$
19,317

 
$
7,523

 
$
36,350

 
$
25,237

Denominator (all weighted averages):
 

 
 

 
 
 
 
Denominator for basic EPS (common shares)
101,789

 
99,036

 
101,397

 
98,725

Dilutive effect of share-based compensation awards
119

 
160

 
131

 
158

Denominator for diluted EPS (common shares)
101,908

 
99,196

 
101,528

 
98,883

Basic EPS
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Diluted EPS
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

 
Our diluted EPS computations do not include the effects of the following securities since the conversions of such securities would increase diluted EPS for the respective periods (in thousands):
 
Weighted Average Shares Excluded from Denominator
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Conversion of common units
3,197

 
3,405

 
3,208

 
3,425

Conversion of Series I preferred units
176

 
176

 
176

 
176

 
The following securities were also excluded from the computation of diluted EPS because their effects were not dilutive:
 
•
weighted average shares related to COPT’s forward equity sale agreements for the three and six months ended June 30, 2018 of 6.8 million and 7.1 million , respectively;
•
weighted average restricted shares and deferred share awards for the three months ended June 30, 2018 and 2017 of 458,000 and 455,000 , respectively, and for the six months ended June 30, 2018 and 2017 of 451,000 and 424,000 , respectively; and
•
weighted average options for the three months ended June 30, 2018 and 2017 of 47,000 and 61,000 , respectively, and for the six months ended June 30, 2018 and 2017 of 53,000 and 100,000 , respectively.

COPLP and Subsidiaries EPU

We present both basic and diluted EPU.  We compute basic EPU by dividing net income available to common unitholders allocable to unrestricted common units under the two-class method by the weighted average number of unrestricted common units outstanding during the period.  Our computation of diluted EPU is similar except that:
 
•
the denominator is increased to include: (1) the weighted average number of potential additional common units that would have been outstanding if securities that are convertible into our common units were converted; and (2) the effect of dilutive potential common units outstanding during the period attributable to COPT’s forward equity sale agreements and our share-based compensation using the treasury stock or if-converted methods; and
•
the numerator is adjusted to add back any changes in income or loss that would result from the assumed conversion into common units that we added to the denominator.


34


Summaries of the numerator and denominator for purposes of basic and diluted EPU calculations are set forth below (in thousands, except per unit data):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 

 
 

 
 
 
 
Net income attributable to COPLP
$
20,207

 
$
17,952

 
$
38,066

 
$
39,758

Preferred unit distributions
(165
)
 
(3,204
)
 
(330
)
 
(6,549
)
Issuance costs associated with redeemed preferred units
—

 
(6,847
)
 
—

 
(6,847
)
Income attributable to share-based compensation awards
(117
)
 
(117
)
 
(234
)
 
(242
)
Numerator for basic and diluted EPU on net income attributable to COPLP common unitholders
$
19,925

 
$
7,784

 
$
37,502

 
$
26,120

Denominator (all weighted averages):
 

 
 

 
 
 
 
Denominator for basic EPU (common units)
104,986

 
102,441

 
104,605

 
102,150

Dilutive effect of share-based compensation awards
119

 
160

 
131

 
158

Denominator for diluted EPU (common units)
105,105

 
102,601

 
104,736

 
102,308

Basic EPU
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

Diluted EPU
$
0.19

 
$
0.08

 
$
0.36

 
$
0.26

 
Our diluted EPU computations do not include the effect of 176,000 common units resulting from an assumed conversion of the Series I preferred units since such a conversion would increase diluted EPU for the three and six months ended June 30, 2018 and 2017 . The following securities were also excluded from the computation of diluted EPU because their effects were not dilutive:
 
•
weighted average units related to COPT’s forward equity sale agreements for the three and six months ended June 30, 2018 of 6.8 million and 7.1 million , respectively;
•
weighted average restricted units and deferred share awards for the three months ended June 30, 2018 and 2017 of 458,000 and 455,000 , respectively, and for the six months ended June 30, 2018 and 2017 of 451,000 and 424,000 , respectively; and
•
weighted average options for the three months ended June 30, 2018 and 2017 of 47,000 and 61,000 , respectively, and for the six months ended June 30, 2018 and 2017 of 53,000 and 100,000 , respectively.

16.    Commitments and Contingencies
 
Litigation and Claims
 
In the normal course of business, we are subject to legal actions and other claims.  We record losses for specific legal proceedings and claims when we determine that a loss is probable and the amount of loss can be reasonably estimated.  Management believes that it is reasonably possible that we could incur losses pursuant to such claims but do not believe such losses would materially affect our financial position, liquidity or results of operations. Our assessment of the potential outcomes of these matters involves significant judgment and is subject to change based on future developments.
 
Environmental
 
We are subject to various Federal, state and local environmental regulations related to our property ownership and operation.  We have performed environmental assessments of our properties, the results of which have not revealed any environmental liability that we believe would have a materially adverse effect on our financial position, operations or liquidity.

In connection with a lease and subsequent sale in 2008 and 2010 of three properties in Dayton, New Jersey, we agreed to provide certain environmental indemnifications limited to $19 million in the aggregate. We have insurance coverage in place to mitigate much of any potential future losses that may result from these indemnification agreements.
 

35


Tax Incremental Financing Obligation
 
In August 2010, Anne Arundel County, Maryland issued $30 million in tax incremental financing bonds to third-party investors in order to finance public improvements needed in connection with our project known as National Business Park North.  The real estate taxes on increases in assessed value of a development district encompassing National Business Park North are to be transferred to a special fund pledged to the repayment of the bonds. While we are obligated to fund, through a special tax, any future shortfalls between debt service of the bonds and real estate taxes available to repay the bonds, as of June 30, 2018 , we do not expect any such future fundings will be required.

Operating Leases

We are obligated as lessee under operating leases (mostly ground leases) with various expiration dates extending to the year 2100. Future minimum rental payments due under the terms of these operating leases as of June 30, 2018 follow (in thousands):
Year Ending December 31,
 
 
2018 (1)
 
$
644

2019
 
1,277

2020
 
1,270

2021
 
1,274

2022
 
1,158

Thereafter
 
84,611

 
 
$
90,234

 
(1) Represents the six months ending December 31, 2018 .

Capital Lease

On May 25, 2017, we entered into a ground lease on land under development in Washington, DC through our Stevens Investors, LLC joint venture. The lease has a 99 -year term, and we possess an option to purchase the property for one dollar (estimated to occur in 2020). Upon inception of the lease, we recorded a $16.1 million capital lease liability on our consolidated balance sheets based on the present value of the future minimum rental payments and have since paid down most of this liability. The remaining capital lease obligation as of June 30, 2018 was comprised of the following (in thousands):
Minimum rental payments due in 2020
 
$
660

Less: Amount representing interest
 
(20
)
Capital lease obligation
 
$
640


Contractual Obligations

We had amounts remaining to be incurred under various contractual obligations as of June 30, 2018 that included the following (excluding amounts incurred and therefore reflected as liabilities reported on our consolidated balance sheets):

•
new development and redevelopment obligations of $89.4 million ;
•
capital expenditures for operating properties of $41.5 million ;
•
third party construction of $4.5 million ; and
•
other obligations of $2.4 million .


36


Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
During the six months ended June 30, 2018 : 

•
we finished the period with our office and data center shell portfolio 91.4% occupied;
•
we placed into service an aggregate of 236,000 square feet in three newly-constructed or redeveloped properties that were 75.9% leased as of June 30, 2018 ; and
•
COPT issued 1.8 million common shares under its forward equity sale agreements for net proceeds of $52.3 million , which it contributed to COPLP in exchange for an equal number of units in COPLP. COPLP used the proceeds primarily to repay borrowings under our Revolving Credit Facility that funded development costs.

With regard to our operating portfolio square footage, occupancy and leasing statistics included below and elsewhere in this Quarterly Report on Form 10-Q, amounts disclosed:

•
include information pertaining to six properties owned through an unconsolidated real estate joint venture except for amounts reported for Annualized Rental Revenue, which represent the portion attributable to our ownership interest; and
•
exclude, for purposes of amounts reported as of June 30, 2018 and December 31, 2017, a property reported as held for sale that we sold in 2017 subject to our providing a financial guaranty to the buyer under which we indemnify it for up to $20 million in losses it could incur related to a potential defined capital event occurring on the property by June 30, 2019.  Accordingly, we did not recognize the sale of this property for accounting purposes, and we reported the sales proceeds as a liability on our consolidated balance sheets.

We discuss significant factors contributing to changes in our net income in the section below entitled “Results of Operations.” The results of operations discussion is combined for COPT and COPLP because there are no material differences in the results of operations between the two reporting entities.

In addition, the section below entitled “Liquidity and Capital Resources” includes discussions of, among other things:

•
how we expect to generate cash for short and long-term capital needs; and
•
our commitments and contingencies.
 
You should refer to our consolidated financial statements and the notes thereto as you read this section.
 
This section contains “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on our current expectations, estimates and projections about future events and financial trends affecting the financial condition and operations of our business. Forward-looking statements can be identified by the use of words such as “may,” “will,” “should,” “could,” “believe,” “anticipate,” “expect,” “estimate,” “plan” or other comparable terminology. Forward-looking statements are inherently subject to risks and uncertainties, many of which we cannot predict with accuracy and some of which we might not even anticipate. Although we believe that the expectations, estimates and projections reflected in such forward-looking statements are based on reasonable assumptions at the time made, we can give no assurance that these expectations, estimates and projections will be achieved. Future events and actual results may differ materially from those discussed in the forward-looking statements. Important factors that may affect these expectations, estimates and projections include, but are not limited to:

•
general economic and business conditions, which will, among other things, affect office property and data center demand and rents, tenant creditworthiness, interest rates, financing availability and property values;
•
adverse changes in the real estate markets, including, among other things, increased competition with other companies;
•
governmental actions and initiatives, including risks associated with the impact of a prolonged government shutdown or budgetary reductions or impasses, such as a reduction in rental revenues, non-renewal of leases and/or a curtailment of demand for additional space by our strategic customers;
•
our ability to borrow on favorable terms;
•
risks of real estate acquisition and development activities, including, among other things, risks that development projects may not be completed on schedule, that tenants may not take occupancy or pay rent or that development or operating costs may be greater than anticipated;
•
risks of investing through joint venture structures, including risks that our joint venture partners may not fulfill their financial obligations as investors or may take actions that are inconsistent with our objectives;

37


•
changes in our plans for properties or views of market economic conditions or failure to obtain development rights, either of which could result in recognition of significant impairment losses;
•
our ability to satisfy and operate effectively under Federal income tax rules relating to real estate investment trusts and partnerships;
•
possible adverse changes in tax laws;
•
the dilutive effects of issuing additional common shares;
•
our ability to achieve projected results; and
•
environmental requirements.

We undertake no obligation to update or supplement forward-looking statements.
 
Occupancy and Leasing
 
Office and Data Center Shell Portfolio
 
The tables below set forth occupancy information pertaining to our portfolio of office and data center shell properties:
 
June 30, 2018
 
December 31, 2017
Occupancy rates at period end
 

 
 

Total
91.4
%
 
93.6
%
Defense/IT Locations:
 
 
 
Fort Meade/BW Corridor
90.9
%
 
95.6
%
Northern Virginia Defense/IT
82.9
%
 
89.1
%
Lackland Air Force Base
100.0
%
 
100.0
%
Navy Support Locations
88.2
%
 
87.7
%
Redstone Arsenal
98.2
%
 
98.2
%
Data Center Shells
100.0
%
 
100.0
%
Total Defense/IT Locations
92.0
%
 
95.2
%
Regional Office
87.2
%
 
89.5
%
Other
82.2
%
 
34.4
%
Average contractual annual rental rate per square foot at period end (1)
$
30.09

 
$
29.84


(1) 
Includes estimated expense reimbursements. Amounts reported include the portion of six properties owned through an unconsolidated real estate joint venture that was allocable to our ownership interest.
 
Rentable
Square Feet
 
Occupied
Square Feet
 
(in thousands)
December 31, 2017
17,345

 
16,227

Vacated upon lease expiration (1)
—

 
(497
)
Occupancy for new leases (2)
—

 
205

Constructed or redeveloped (3)
566

 
200

Removed from operations (4)
(241
)
 
—

Other changes
(15
)
 
—

June 30, 2018
17,655

 
16,135


(1)
Includes lease terminations and space reductions occurring in connection with lease renewals.
(2)
Excludes occupancy of vacant square feet acquired or developed.
(3)
Includes 330,000 unoccupied square feet that were completed in 2016 but reported as construction projects through December 31, 2017 since they were held for future lease to the United States Government.
(4)
Includes the removal of one property for which we have no leasing plan or intention to allocate future capital and one property reclassified as redevelopment.

Total occupancy decreased from December 31, 2017 to June 30, 2018 due primarily to the addition of 404,000 unoccupied, newly-constructed square feet during the period, including: 243,000 in the Fort Meade/BW Corridor sub-segment; and 161,000 in the Northern Virginia Defense/IT sub-segment leased in June 2018 that we expect to be occupied by the end of the year.


38


During the six months ended June 30, 2018 , we completed 2.1 million square feet of leasing, including: renewed leases on 1.2 million square feet, representing 77.0% of the square footage of our lease expirations (including the effect of early renewals and excluding the effect of 108,000 square feet vacated in a property in the Fort Meade/BW Corridor sub-segment that was removed from service for redevelopment); 675,000 of construction and redevelopment space; and 187,000 in other leasing.

Wholesale Data Center
 
Our 19.25 megawatt wholesale data center had 16.86 megawatts leased as of June 30, 2018 and December 31, 2017 .

Results of Operations
 
We evaluate the operating performance of our properties using NOI from real estate operations, our segment performance measure, which includes: real estate revenues and property operating expenses; and the net of revenues and property operating expenses of real estate operations owned through unconsolidated real estate joint ventures (“UJVs”) that is allocable to COPT’s ownership interest (“UJV NOI allocable to COPT”).  We view our NOI from real estate operations as comprising the following primary categories:

•
office and data center shell properties:
•
continually owned and 100% operational throughout the current and prior year reporting periods, excluding properties held for sale.  We define these as changes from “Same Properties”;
•
constructed or redeveloped and placed into service that were not 100% operational throughout the current and prior year reporting periods; and
•
disposed (including a property reported as held for sale as of December 31, 2017, the sale of which in 2017 was not recognized for accounting purposes); and
•
our wholesale data center.

In addition to owning properties, we provide construction management and other services. The primary manner in which we evaluate the operating performance of our construction management and other service activities is through a measure we define as NOI from service operations, which is based on the net of the revenues and expenses from these activities.  The revenues and expenses from these activities consist primarily of subcontracted costs that are reimbursed to us by customers along with a management fee.  The operating margins from these activities are small relative to the revenue.  We believe NOI from service operations is a useful measure in assessing both our level of activity and our profitability in conducting such operations.
 
Since both of the measures discussed above exclude certain items includable in operating income, reliance on these measures has limitations; management compensates for these limitations by using the measures simply as supplemental measures that are considered alongside other GAAP and non-GAAP measures. A reconciliation of NOI from real estate operations and NOI from service operations to income before gain on sales of real estate reported on the consolidated statements of operations of COPT and subsidiaries is provided in Note 13 to our consolidated financial statements.

39



Comparison of Statements of Operations for the Three Months Ended June 30, 2018 and 2017

 
For the Three Months Ended June 30,
 
2018
 
2017
 
Variance
 
(in thousands)
Revenues
 

 
 

 
 

Revenues from real estate operations
$
129,162

 
$
128,297

 
$
865

Construction contract and other service revenues
17,581

 
23,138

 
(5,557
)
Total revenues
146,743

 
151,435

 
(4,692
)
Expenses
 

 
 

 
 

Property operating expenses
49,446

 
48,628

 
818

Depreciation and amortization associated with real estate operations
33,190

 
32,793

 
397

Construction contract and other service expenses
16,941

 
22,315

 
(5,374
)
Impairment losses
—

 
1,625

 
(1,625
)
General, administrative and leasing expenses
7,628

 
7,859

 
(231
)
Business development expenses and land carry costs
1,234

 
1,597

 
(363
)
Total operating expenses
108,439

 
114,817

 
(6,378
)
Operating income
38,304

 
36,618

 
1,686

Interest expense
(18,945
)
 
(19,163
)
 
218

Interest and other income
1,439

 
1,583

 
(144
)
Loss on early extinguishment of debt
—

 
(513
)
 
513

Equity in income of unconsolidated entities
373

 
370

 
3

Income tax expense
(63
)
 
(48
)
 
(15
)
Income before gain on sales of real estate
21,108

 
18,847

 
2,261

Gain on sales of real estate
(23
)
 
12

 
(35
)
Net income
$
21,085

 
$
18,859

 
$
2,226



40


NOI from Real Estate Operations
 
For the Three Months Ended June 30,
 
2018
 
2017
 
Variance
 
(Dollars in thousands, except per square foot data)
Revenues
 
 
 
 
 
Same Properties revenues
 
 
 
 
 
Rental revenue, excluding lease termination revenue
$
89,071

 
$
88,860

 
$
211

Lease termination revenue
558

 
517

 
41

Tenant recoveries and other real estate operations revenue
24,567

 
24,468

 
99

Same Properties total revenues
114,196

 
113,845

 
351

Constructed and redeveloped properties placed in service
6,476

 
1,879

 
4,597

Wholesale data center
8,105

 
7,033

 
1,072

Dispositions
5

 
4,899

 
(4,894
)
Other
380

 
641

 
(261
)
 
129,162

 
128,297

 
865

Property operating expenses
 
 
 
 
 
Same Properties
(43,461
)
 
(42,944
)
 
(517
)
Constructed and redeveloped properties placed in service
(1,666
)
 
(867
)
 
(799
)
Wholesale data center
(4,150
)
 
(3,501
)
 
(649
)
Dispositions
(8
)
 
(941
)
 
933

Other
(161
)
 
(375
)
 
214

 
(49,446
)
 
(48,628
)
 
(818
)
 
 
 
 
 
 
Same Properties UJV NOI allocable to COPT
1,202

 
1,198

 
4

 
 
 
 
 
 
NOI from real estate operations
 
 
 
 
 
Same Properties
71,937

 
72,099

 
(162
)
Constructed and redeveloped properties placed in service
4,810

 
1,012

 
3,798

Wholesale data center
3,955

 
3,532

 
423

Dispositions
(3
)
 
3,958

 
(3,961
)
Other
219

 
266

 
(47
)
 
$
80,918

 
$
80,867

 
$
51

Same Properties rent statistics
 
 
 
 
 
Average occupancy rate
91.0
%
 
91.5
%
 
(0.5
)%
Average straight-line rent per occupied square foot (1)
$
6.45

 
$
6.39

 
$
0.06

 
(1) 
Includes minimum base rents, net of abatements, and lease incentives on a straight-line basis for the periods set forth above.

Our Same Properties pool consisted of 147 properties, comprising 91.9% of our office and data center shell portfolio’s square footage as of June 30, 2018 . This pool of properties included the following changes from the pool used for purposes of comparing 2017 and 2016 in our 2017 Annual Report on Form 10-K: the addition of 14 properties placed in service and 100% operational on or before January 1, 2017 (including six unconsolidated real estate joint venture properties and two properties added to our rentable square feet in 2018 that were previously reported as construction projects since they were held for future lease to the United States Government); and the removal of one property in 2018 for which we have no leasing plan or intention to allocate future capital and one property reclassified as redevelopment.

41


Our NOI from constructed and redeveloped properties placed in service included 12 properties placed in service in 2017 and 2018 .

NOI from Service Operations
 
 
For the Three Months Ended June 30,
 
 
2018
 
2017
 
Variance
 
 
(in thousands)
Construction contract and other service revenues
 
$
17,581

 
$
23,138

 
$
(5,557
)
Construction contract and other service expenses
 
16,941

 
22,315

 
(5,374
)
NOI from service operations
 
$
640

 
$
823

 
$
(183
)

Construction contract and other service revenue and expenses decreased due primarily to a lower volume of construction activity in connection with several of our tenants. Construction contract activity is inherently subject to significant variability depending on the volume and nature of projects undertaken by us (primarily on behalf of tenants). Service operations are an ancillary component of our overall operations that typically contribute an insignificant amount of operating income relative to our real estate operations.

Comparison of Statements of Operations for the Six Months Ended June 30, 2018 and 2017

 
For the Six Months Ended June 30,
 
2018
 
2017
 
Variance
 
(in thousands)
Revenues
 

 
 

 
 

Revenues from real estate operations
$
257,440

 
$
255,064

 
$
2,376

Construction contract and other service revenues
44,779

 
36,172

 
8,607

Total revenues
302,219

 
291,236

 
10,983

Expenses
 

 
 

 
 

Property operating expenses
100,397

 
97,147

 
3,250

Depreciation and amortization associated with real estate operations
66,702

 
65,852

 
850

Construction contract and other service expenses
43,157

 
34,801

 
8,356

Impairment losses
—

 
1,625

 
(1,625
)
General, administrative and leasing expenses
14,920

 
16,470

 
(1,550
)
Business development expenses and land carry costs
2,848

 
3,290

 
(442
)
Total operating expenses
228,024

 
219,185

 
8,839

Operating income
74,195

 
72,051

 
2,144

Interest expense
(37,729
)
 
(38,157
)
 
428

Interest and other income
2,798

 
3,309

 
(511
)
Loss on early extinguishment of debt
—

 
(513
)
 
513

Equity in income of unconsolidated entities
746

 
747

 
(1
)
Income tax expense
(118
)
 
(88
)
 
(30
)
Income before gain on sales of real estate
39,892

 
37,349

 
2,543

Gain on sales of real estate
(27
)
 
4,250

 
(4,277
)
Net income
$
39,865

 
$
41,599

 
$
(1,734
)


42


NOI from Real Estate Operations
 
For the Six Months Ended June 30,
 
2018
 
2017
 
Variance
 
(Dollars in thousands, except per square foot data)
Revenues
 
 
 
 
 
Same Properties revenues
 
 
 
 
 
Rental revenue, excluding lease termination revenue
$
177,410

 
$
177,472

 
$
(62
)
Lease termination revenue
1,566

 
1,223

 
343

Tenant recoveries and other real estate operations revenue
48,678

 
48,389

 
289

Same Properties total revenues
227,654

 
227,084

 
570

Constructed and redeveloped properties placed in service
12,370

 
2,373

 
9,997

Wholesale data center
16,182

 
13,803

 
2,379

Dispositions
140

 
10,443

 
(10,303
)
Other
1,094

 
1,361

 
(267
)
 
257,440

 
255,064

 
2,376

Property operating expenses
 
 
 
 
 
Same Properties
(88,278
)
 
(85,686
)
 
(2,592
)
Constructed and redeveloped properties placed in service
(3,277
)
 
(1,520
)
 
(1,757
)
Wholesale data center
(8,408
)
 
(6,866
)
 
(1,542
)
Dispositions
(30
)
 
(2,191
)
 
2,161

Other
(404
)
 
(884
)
 
480

 
(100,397
)
 
(97,147
)
 
(3,250
)
 
 
 
 
 
 
Same Properties UJV NOI allocable to COPT
2,401

 
2,400

 
1

 
 
 
 
 
 
NOI from real estate operations
 
 
 
 
 
Same Properties
141,777

 
143,798

 
(2,021
)
Constructed and redeveloped properties placed in service
9,093

 
853

 
8,240

Wholesale data center
7,774

 
6,937

 
837

Dispositions
110

 
8,252

 
(8,142
)
Other
690

 
477

 
213

 
$
159,444

 
$
160,317

 
$
(873
)
Same Properties rent statistics
 
 
 
 
 
Average occupancy rate
91.0
%
 
91.4
%
 
(0.4
)%
Average straight-line rent per occupied square foot (1)
$
12.85

 
$
12.79

 
$
0.06

 
(1) 
Includes minimum base rents, net of abatements, and lease incentives on a straight-line basis for the periods set forth above.

The decrease in our Same Properties NOI from real estate operations reflected above was due primarily to higher snow and utilities expenses in the current period, as well as higher real estate taxes at certain properties resulting from increased property assessments.

Our NOI from constructed and redeveloped properties placed in service included 12 properties placed in service in 2017 and 2018 .

NOI from Service Operations
 
 
For the Six Months Ended June 30,
 
 
2018
 
2017
 
Variance
 
 
(in thousands)
Construction contract and other service revenues
 
$
44,779

 
$
36,172

 
$
8,607

Construction contract and other service expenses
 
43,157

 
34,801

 
8,356

NOI from service operations
 
$
1,622

 
$
1,371

 
$
251



43


Construction contract and other service revenue and expenses increased due primarily to a greater volume of construction activity in connection with several of our tenants.

Gain on Sales of Real Estate

We recognized a gain on sales of real estate of $4.3 million in the prior period in connection with a land sale.

Funds from Operations
 
Funds from operations (“FFO”) is defined as net income computed using GAAP, excluding gains on sales of, and impairment losses on, previously depreciated operating properties, plus real estate-related depreciation and amortization. When multiple properties consisting of both operating and non-operating properties exist on a single tax parcel, we classify all of the gains on sales of, and impairment losses on, the tax parcel as all being for previously depreciated operating properties when most of the value of the parcel is associated with operating properties on the parcel. FFO also includes adjustments to net income for the effects of the items noted above pertaining to UJVs that were allocable to our ownership interest in the UJVs. We believe that we use the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, although others may interpret the definition differently and, accordingly, our presentation of FFO may differ from those of other REITs.  We believe that FFO is useful to management and investors as a supplemental measure of operating performance because, by excluding gains related to sales of, and impairment losses on, previously depreciated operating properties, net of related tax benefit, and excluding real estate-related depreciation and amortization, FFO can help one compare our operating performance between periods.  In addition, since most equity REITs provide FFO information to the investment community, we believe that FFO is useful to investors as a supplemental measure for comparing our results to those of other equity REITs.  We believe that net income is the most directly comparable GAAP measure to FFO.
 
Since FFO excludes certain items includable in net income, reliance on the measure has limitations; management compensates for these limitations by using the measure simply as a supplemental measure that is weighed in balance with other GAAP and non-GAAP measures. FFO is not necessarily an indication of our cash flow available to fund cash needs.  Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing activities when evaluating our liquidity or ability to make cash distributions or pay debt service.
 
Basic FFO available to common share and common unit holders (“Basic FFO”) is FFO adjusted to subtract (1) preferred share dividends, (2) issuance costs associated with redeemed preferred shares, (3) income attributable to noncontrolling interests through ownership of preferred units in the Operating Partnership or interests in other consolidated entities not owned by us, (4) depreciation and amortization allocable to noncontrolling interests in other consolidated entities and (5) Basic FFO allocable to restricted shares.  With these adjustments, Basic FFO represents FFO available to common shareholders and common unitholders.  Common units in the Operating Partnership are substantially similar to our common shares and are exchangeable into common shares, subject to certain conditions.  We believe that Basic FFO is useful to investors due to the close correlation of common units to common shares.  We believe that net income is the most directly comparable GAAP measure to Basic FFO.  Basic FFO has essentially the same limitations as FFO; management compensates for these limitations in essentially the same manner as described above for FFO.
 
Diluted FFO available to common share and common unit holders (“Diluted FFO”) is Basic FFO adjusted to add back any changes in Basic FFO that would result from the assumed conversion of securities that are convertible or exchangeable into common shares.  We believe that Diluted FFO is useful to investors because it is the numerator used to compute Diluted FFO per share, discussed below.  We believe that net income is the most directly comparable GAAP measure to Diluted FFO.  Since Diluted FFO excludes certain items includable in the numerator to diluted EPS, reliance on the measure has limitations; management compensates for these limitations by using the measure simply as a supplemental measure that is weighed in the balance with other GAAP and non-GAAP measures.  Diluted FFO is not necessarily an indication of our cash flow available to fund cash needs.  Additionally, it should not be used as an alternative to net income when evaluating our financial performance or to cash flow from operating, investing and financing activities when evaluating our liquidity or ability to make cash distributions or pay debt service.
 
Diluted FFO available to common share and common unit holders, as adjusted for comparability is defined as Diluted FFO adjusted to exclude operating property acquisition costs; gains on sales of, and impairment losses on, properties other than previously depreciated operating properties, net of associated income tax; gain or loss on early extinguishment of debt; FFO associated with properties securing non-recourse debt on which we have defaulted and which we have extinguished, or expect to extinguish, via conveyance of such properties, including property NOI, interest expense and gains on debt extinguishment; loss on interest rate derivatives; demolition costs on redevelopment and nonrecurring improvements; executive transition costs;

44


and issuance costs associated with redeemed preferred shares.  This measure also includes adjustments for the effects of the items noted above pertaining to UJVs that were allocable to our ownership interest in the UJVs. We believe this to be a useful supplemental measure alongside Diluted FFO as it excludes gains and losses from certain investing and financing activities and certain other items that we believe are not closely correlated to (or associated with) our operating performance. We believe that net income is the most directly comparable GAAP measure to this non-GAAP measure.  This measure has essentially the same limitations as Diluted FFO, as well as the further limitation of not reflecting the effects of the excluded items; we compensate for these limitations in essentially the same manner as described above for Diluted FFO.
 
Diluted FFO per share is (1) Diluted FFO divided by (2) the sum of the (a) weighted average common shares outstanding during a period, (b) weighted average common units outstanding during a period and (c) weighted average number of potential additional common shares that would have been outstanding during a period if other securities that are convertible or exchangeable into common shares were converted or exchanged.  We believe that Diluted FFO per share is useful to investors because it provides investors with a further context for evaluating our FFO results in the same manner that investors use earnings per share (“EPS”) in evaluating net income available to common shareholders.  In addition, since most equity REITs provide Diluted FFO per share information to the investment community, we believe that Diluted FFO per share is a useful supplemental measure for comparing us to other equity REITs. We believe that diluted EPS is the most directly comparable GAAP measure to Diluted FFO per share. Diluted FFO per share has most of the same limitations as Diluted FFO (described above); management compensates for these limitations in essentially the same manner as described above for Diluted FFO.
 
Diluted FFO per share, as adjusted for comparability is (1) Diluted FFO, as adjusted for comparability divided by (2) the sum of the (a) weighted average common shares outstanding during a period, (b) weighted average common units outstanding during a period and (c) weighted average number of potential additional common shares that would have been outstanding during a period if other securities that are convertible or exchangeable into common shares were converted or exchanged.  We believe that this measure is useful to investors because it provides investors with a further context for evaluating our FFO results.  We believe this to be a useful supplemental measure alongside Diluted FFO per share as it excludes gains and losses from certain investing and financing activities and certain other items that we believe are not closely correlated to (or associated with) our operating performance. We believe that diluted EPS is the most directly comparable GAAP measure to this per share measure.  This measure has most of the same limitations as Diluted FFO (described above) as well as the further limitation of not reflecting the effects of the excluded items; we compensate for these limitations in essentially the same manner as described above for Diluted FFO.
 
The computations for all of the above measures on a diluted basis assume the conversion of common units in COPLP but do not assume the conversion of other securities that are convertible into common shares if the conversion of those securities would increase per share measures in a given period.


45


The table below sets forth the computation of the above stated measures for the three and six months ended June 30, 2018 and 2017 , and provides reconciliations to the GAAP measures of COPT and subsidiaries associated with such measures:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars and shares in thousands, 
except per share data)
Net income
$
21,085

 
$
18,859

 
$
39,865

 
$
41,599

Add: Real estate-related depreciation and amortization
33,190

 
32,793

 
66,702

 
65,852

Add: Depreciation and amortization on UJV allocable to COPT
564

 
563

 
1,127

 
1,126

Add: Impairment losses on previously depreciated operating properties
—

 
1,610

 
—

 
1,610

Less: Gain on sales of previously depreciated operating properties
23

 
(12
)
 
27

 
(31
)
FFO
54,862

 
53,813

 
107,721

 
110,156

Less: Noncontrolling interests-preferred units in the Operating Partnership
(165
)
 
(165
)
 
(330
)
 
(330
)
Less: FFO allocable to other noncontrolling interests
(753
)
 
(906
)
 
(1,697
)
 
(1,884
)
Less: Preferred share dividends
—

 
(3,039
)
 
—

 
(6,219
)
Less: Issuance costs associated with redeemed preferred shares
—

 
(6,847
)
 
—

 
(6,847
)
Basic and diluted FFO allocable to share-based compensation awards
(224
)
 
(185
)
 
(437
)
 
(401
)
Basic and diluted FFO available to common share and common unit holders
53,720

 
42,671

 
105,257

 
94,475

Gain on sales of non-operating properties
—

 
—

 
—

 
(4,219
)
Impairment losses on non-operating properties
—

 
15

 
—

 
15

Loss (gain) on interest rate derivatives
—

 
444

 
—

 
(9
)
Loss on early extinguishment of debt
—

 
513

 
—

 
513

Issuance costs associated with redeemed preferred shares
—

 
6,847

 
—

 
6,847

Executive transition costs
213

 
31

 
376

 
730

Demolition costs on redevelopment and nonrecurring improvements
9

 
72

 
48

 
294

Diluted FFO comparability adjustments allocable to share-based compensation awards
(1
)
 
(31
)
 
(2
)
 
(17
)
Diluted FFO available to common share and common unit holders, as adjusted for comparability
$
53,941

 
$
50,562

 
$
105,679

 
$
98,629

 
 
 
 
 
 
 
 
Weighted average common shares
101,789

 
99,036

 
101,397

 
98,725

Conversion of weighted average common units
3,197

 
3,405

 
3,208

 
3,425

Weighted average common shares/units - Basic FFO
104,986

 
102,441

 
104,605

 
102,150

Dilutive effect of share-based compensation awards
119

 
160

 
131

 
158

Weighted average common shares/units - Diluted FFO
105,105

 
102,601

 
104,736

 
102,308

 
 
 
 
 
 
 
 
Diluted FFO per share
$
0.51

 
$
0.42

 
$
1.00

 
$
0.92

Diluted FFO per share, as adjusted for comparability
$
0.51

 
$
0.49

 
$
1.01

 
$
0.96

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Denominator for diluted EPS
101,908

 
99,196

 
101,528

 
98,883

Weighted average common units
3,197

 
3,405

 
3,208

 
3,425

Denominator for diluted FFO per share measures
105,105

 
102,601

 
104,736

 
102,308



46


Property Additions
 
The table below sets forth the major components of our additions to properties for the six months ended June 30, 2018 (in thousands):
Construction, development and redevelopment
$
73,323

Tenant improvements on operating properties (1)
15,624

Capital improvements on operating properties
7,697

 
$
96,644

(1) Tenant improvement costs incurred on newly-constructed properties are classified in this table as construction, development and redevelopment.
 
Cash Flows
 
Net cash flow from operating activities decreased $36.8 million when comparing the six months ended June 30, 2018 and 2017 due primarily to our payment in 2018 of construction costs on a contract that the customer pre-funded to us in prior years.
 
Net cash flow from investing activities decreased $38.0 million when comparing the six months ended June 30, 2018 and 2017 due primarily to a decrease in property sales in 2018 relative to 2017 , which was offset in part by lower expenditures for development in 2018 relative to 2017.
 
Net cash flow provided by financing activities in the six months ended June 30, 2018 was $13.8 million , and included the following:

•
net debt borrowings of $41.9 million ; and
•
net proceeds from the issuance of common shares (or units) of $52.3 million ; offset in part by
•
dividends and/or distributions to equity holders of $58.1 million ; and
•
payments on a capital lease obligation of $15.4 million.

Net cash flow used in financing activities in the six months ended June 30, 2017 was $258.0 million , and included the following:

•
redemption of preferred shares (or units) of $199.1 million; and
•
dividends and/or distributions to equity holders of $66.0 million ; offset in part by
•
net proceeds from the issuance of common shares (or units) of $19.8 million .

Liquidity and Capital Resources of COPT

COPLP is the entity through which COPT, the sole general partner of COPLP, conducts almost all of its operations and owns almost all of its assets. COPT occasionally issues public equity but does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses in operating as a public company which are fully reimbursed by COPLP. COPT itself does not hold any indebtedness, and its only material asset is its ownership of partnership interests of COPLP. COPT’s principal funding requirement is the payment of dividends on its common and preferred shares. COPT’s principal source of funding for its dividend payments is distributions it receives from COPLP.

As of June 30, 2018 , COPT owned 97.0% of the outstanding common units in COPLP; the remaining common units and all of the outstanding preferred units were owned by third parties. As the sole general partner of COPLP, COPT has the full, exclusive and complete responsibility for COPLP’s day-to-day management and control.

The liquidity of COPT is dependent on COPLP’s ability to make sufficient distributions to COPT. The primary cash requirement of COPT is its payment of dividends to its shareholders. COPT also guarantees some of the Operating Partnership’s debt, as discussed further in Note 9 of the notes to consolidated financial statements included elsewhere herein. If the Operating Partnership fails to fulfill certain of its debt requirements, which trigger COPT’s guarantee obligations, then COPT will be required to fulfill its cash payment commitments under such guarantees. However, COPT’s only significant asset is its investment in COPLP.

As discussed further below, we believe the Operating Partnership’s sources of working capital, specifically its cash flow from operations, and borrowings available under its Revolving Credit Facility, are adequate for it to make its distribution payments to COPT and, in turn, for COPT to make its dividend payments to its shareholders.

47



COPT’s short-term liquidity requirements consist primarily of funds to pay for future dividends expected to be paid to its shareholders. COPT periodically accesses the public equity markets to raise capital by issuing common and/or preferred shares.

For COPT to maintain its qualification as a REIT, it must pay dividends to its shareholders aggregating annually at least 90% of its ordinary taxable income. As a result of this distribution requirement, it cannot rely on retained earnings to fund its ongoing operations to the same extent that some other companies can. COPT may need to continue to raise capital in the equity markets to fund COPLP’s working capital needs, acquisitions and developments.
 
Liquidity and Capital Resources of COPLP
 
COPLP’s primary cash requirements are for operating expenses, debt service, development of new properties, improvements to existing properties and acquisitions, to the extent they are pursued in the future.  We expect COPLP to continue to use cash flow provided by operations as the primary source to meet its short-term capital needs, including property operating expenses, general and administrative expenses, interest expense, scheduled principal amortization of debt, distributions to its security holders and improvements to existing properties.  As of June 30, 2018 , COPLP had $8.5 million in cash and cash equivalents.
 
COPLP’s senior unsecured debt is currently rated investment grade by the three major rating agencies. We aim to maintain an investment grade rating to enable COPLP to use debt comprised of unsecured, primarily fixed-rate debt (including the effect of interest rate swaps) from public markets and banks. COPLP also uses secured nonrecourse debt from institutional lenders and banks for joint venture financing. In addition, COPLP periodically raises equity from COPT when COPT accesses the public equity markets by issuing common and/or preferred shares.
 
COPLP uses its Revolving Credit Facility to initially finance much of its investing activities.  COPLP subsequently pays down the facility using cash available from operations and proceeds from long-term borrowings, equity issuances and property sales.  The lenders’ aggregate commitment under the facility is $800.0 million , with the ability for COPLP to increase the lenders’ aggregate commitment to $1.3 billion , provided that there is no default under the facility and subject to the approval of the lenders. The Revolving Credit Facility matures in May 2019, and may be extended by two six-month periods at COPLP’s option, provided that there is no default under the facility and it pays an extension fee of 0.075% of the total availability of the facility. As of June 30, 2018 , the maximum borrowing capacity under this facility totaled $800.0 million , of which $630.0 million was available.

As of June 30, 2018 , COPT had forward equity sale agreements in place with 5.7 million shares available for future issuance with a settlement value of $167.0 million that we expect to use to fund development costs.

We believe that COPLP’s liquidity and capital resources are adequate for its near-term and longer-term requirements without necessitating property sales. However, we may dispose of interests in properties opportunistically or when capital markets otherwise warrant.


48


The following table summarizes our contractual obligations as of June 30, 2018 (in thousands):
 
For the Periods Ending December 31,
 
 
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
Contractual obligations (1)
 

 
 

 
 

 
 

 
 

 
 

 
 

Debt (2)
 

 
 

 
 

 
 

 
 

 
 

 
 

Balloon payments due upon maturity
$
—

 
$
170,000

 
$
112,132

 
$
300,000

 
$
250,000

 
$
1,026,830

 
$
1,858,962

Scheduled principal payments (3)
2,138

 
4,387

 
4,024

 
3,875

 
4,033

 
6,647

 
25,104

Interest on debt (3)(4)
38,058

 
72,195

 
67,801

 
59,606

 
54,475

 
63,592

 
355,727

New construction and redevelopment obligations (5)(6)
88,630

 
797

 
—

 
—

 
—

 
—

 
89,427

Third-party construction obligations (6)(7)
3,076

 
1,378

 
—

 
—

 
—

 
—

 
4,454

Capital expenditures for operating properties (3)(6)(8)
13,360

 
18,990

 
9,158

 
—

 
—

 
—

 
41,508

Capital lease obligation (principal and interest)
—

 
—

 
660

 
—

 
—

 
—

 
660

Operating leases (3)
644

 
1,277

 
1,270

 
1,274

 
1,158

 
84,611

 
90,234

Other obligations (3)
379

 
434

 
254

 
182

 
178

 
977

 
2,404

Total contractual cash obligations
$
146,285

 
$
269,458

 
$
195,299

 
$
364,937

 
$
309,844

 
$
1,182,657

 
$
2,468,480


(1)
The contractual obligations set forth in this table exclude property operations contracts that may be terminated with notice of one month or less and also exclude accruals and payables incurred (with the exclusion of debt) and therefore reflected in our reported liabilities.
(2)
Represents scheduled principal amortization payments and maturities only and therefore excludes net debt discounts and deferred financing costs of $12.6 million . As of June 30, 2018 , maturities included $170.0 million in 2019 that may be extended to 2020, subject to certain conditions.
(3)
We expect to pay these items using cash flow from operations.
(4)
Represents interest costs for our outstanding debt as of June 30, 2018 for the terms of such debt.  For variable rate debt, the amounts reflected above used June 30, 2018 interest rates on variable rate debt in computing interest costs for the terms of such debt. We expect to pay these items using cash flow from operations.
(5)
Represents contractual obligations pertaining to new development and redevelopment activities.
(6)
Due to the long-term nature of certain construction and development contracts and leases included in these lines, the amounts reported in the table represent our estimate of the timing for the related obligations being payable.
(7)  
Represents contractual obligations pertaining to projects for which we are acting as construction manager on behalf of unrelated parties who are our clients.  We expect to be reimbursed in full for these costs by our clients.
(8)
Represents contractual obligations pertaining to capital expenditures for our operating properties.  We expect to pay these costs primarily using cash flow from operating activities.
 
We expect to spend approximately $200 million on construction and development costs and approximately $35 million  on improvements to operating properties (including the commitments set forth in the table above) during the remainder of 2018 .  We expect to fund the construction and development costs initially using primarily borrowings under our Revolving Credit Facility and proceeds from common shares issued under COPT’s forward equity sale agreements.  We expect to fund improvements to existing operating properties using cash flow from operating activities.

Certain of our debt instruments require that we comply with a number of restrictive financial covenants, including maximum leverage ratio, unencumbered leverage ratio, minimum net worth, minimum fixed charge coverage, minimum unencumbered interest coverage ratio, minimum debt service and maximum secured indebtedness ratio.  As of June 30, 2018 , we were compliant with these covenants.

Off-Balance Sheet Arrangements
 
 We had no material off-balance sheet arrangements during the six months ended June 30, 2018 .

Inflation
 
Most of our tenants are obligated to pay their share of a property’s operating expenses to the extent such expenses exceed amounts established in their leases, which are based on historical expense levels.  Some of our tenants are obligated to pay their full share of a building’s operating expenses.  These arrangements somewhat reduce our exposure to increases in such costs resulting from inflation.


49


Recent Accounting Pronouncements

See Note 2 to our consolidated financial statements for information regarding recent accounting pronouncements.

Item 3.            Quantitative and Qualitative Disclosures about Market Risk
 
We are exposed to certain market risks, one of the most predominant of which is a change in interest rates.  Increases in interest rates can result in increased interest expense under our Revolving Credit Facility and other variable rate debt.  Increases in interest rates can also result in increased interest expense when our fixed rate debt matures and needs to be refinanced.
 
The following table sets forth as of June 30, 2018 our debt obligations and weighted average interest rates on debt maturing each year (dollars in thousands):
 
For the Periods Ending December 31,
 
 
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
Debt:
 

 
 

 
 
 
 

 
 

 
 

 
 

Fixed rate debt (1)
$
1,946

 
$
3,991

 
$
3,718

 
$
303,875

 
$
4,033

 
$
1,033,477

 
$
1,351,040

Weighted average interest rate
4.37
%
 
4.36
%
 
3.96
%
 
3.70
%
 
3.98
%
 
4.48
%
 
4.30
%
Variable rate debt (2)
$
192

 
$
170,396

 
$
112,438

 
$
—

 
$
250,000

 
$
—

 
$
533,026

Weighted average interest rate (3)
3.83
%
 
3.19
%
 
3.44
%
 
—
%
 
3.34
%
 
—
%
 
3.31
%

(1)
Represents principal maturities only and therefore excludes net discounts and deferred financing costs of $12.6 million .
(2)
As of June 30, 2018 , maturities included $170.0 million in 2019 that may be extended to 2020, subject to certain conditions.
(3)
The amounts reflected above used interest rates as of June 30, 2018 for variable rate debt.

The fair value of our debt was $1.9 billion as of June 30, 2018 .  If interest rates had been 1% lower, the fair value of our fixed-rate debt would have increased by approximately $61 million as of June 30, 2018 .
 
See Note 10 to our consolidated financial statements for information pertaining to interest rate swap contracts in place as of June 30, 2018 and their respective fair values.

Based on our variable-rate debt balances, including the effect of interest rate swap contracts, our interest expense would have increased by $902,000 in the six months ended June 30, 2018 if the applicable LIBOR rate was 1% higher.
 
Item 4.            Controls and Procedures
 
COPT

(a)                                   Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of COPT’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2018 .  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that COPT’s disclosure controls and procedures as of June 30, 2018 were functioning effectively to provide reasonable assurance that the information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
 
(b)                                  Change in Internal Control over Financial Reporting
 
No change in the COPT’s internal control over financial reporting occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.
 
COPLP

(a)                                   Evaluation of Disclosure Controls and Procedures
 

50


Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of COPLP’s disclosure controls and procedures (as defined in Rule 15d-15(e) under the Exchange Act) as of June 30, 2018 .  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that COPLP’s disclosure controls and procedures as of June 30, 2018 were functioning effectively to provide reasonable assurance that the information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
 
(b)                                  Change in Internal Control over Financial Reporting
 
No change in the COPLP’s internal control over financial reporting occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

PART II: OTHER INFORMATION
 
Item 1.            Legal Proceedings
 
We are not currently involved in any material litigation nor, to our knowledge, is any material litigation currently threatened against the Company or the Operating Partnership (other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance).
 
Item 1A.  Risk Factors
 
There have been no material changes to the risk factors included in our 2017 Annual Report on Form 10-K.
 
Item 2.            Unregistered Sales of Equity Securities and Use of Proceeds
 
None.
 
Item 3.            Defaults Upon Senior Securities
 
(a)           Not applicable
 
(b)          Not applicable
 
Item 4.            Mine Safety Disclosures

Not applicable

Item 5.            Other Information
 
None

51


Item 6.            Exhibits
 
(a)           Exhibits:
 
EXHIBIT
NO.
 
DESCRIPTION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.INS
 
XBRL Instance Document (filed herewith).
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document (filed herewith).
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith).
 
 
 
101.LAB
 
XBRL Extension Labels Linkbase (filed herewith).
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document (filed herewith).
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document (filed herewith).

52


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the undersigned Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.
 
 
CORPORATE OFFICE PROPERTIES TRUST
 
CORPORATE OFFICE PROPERTIES, L.P.
 
 
 
By: Corporate Office Properties Trust,
 
 
 
its General Partner
 
 
 
 
 
/s/ Stephen E. Budorick
 
/s/ Stephen E. Budorick
 
Stephen E. Budorick
 
Stephen E. Budorick
 
President and Chief Executive Officer
 
President and Chief Executive Officer
 
 
 
 
 
 
 
 
 
/s/ Anthony Mifsud
 
/s/ Anthony Mifsud
 
Anthony Mifsud
 
Anthony Mifsud
 
Executive Vice President and Chief Financial Officer
 
Executive Vice President and Chief Financial Officer
 
 
 
 
Dated:
July 31, 2018
Dated:
July 31, 2018

53

Exhibit 3.1
CORPORATE OFFICE PROPERTIES TRUST

AMENDED AND RESTATED DECLARATION OF TRUST

(Reflecting amendments through May 15, 2018)

This DECLARATION OF TRUST is made as of the date set forth above by the undersigned Trustee (as defined herein):

ARTICLE I
FORMATION

The Trust is a real estate investment trust within the meaning of Title 8. The Trust shall not be deemed to be a general partnership, limited partnership, joint venture, joint stock company or a corporation (but nothing herein shall preclude the Trust from being treated for tax purposes as an association under the Code).
 
ARTICLE II
NAME

The name of the Trust is:

Corporate Office Properties Trust

Under circumstances in which the Board of Trustees of the Trust (the “Board of Trustees” or “Board”) determines that the use of the name of the Trust is not practicable, the Trust may use any other designation or name for the Trust.

ARTICLE III
PURPOSES AND POWERS

Section 3.1 Purposes . The purposes for which the Trust is formed are to invest in and to acquire, hold, manage, administer, control and dispose of property and interests (direct or indirect and of whatsoever nature) in and in respect of property, including, without limitation or obligation, engaging in business as a real estate investment trust under the Internal Revenue Code of 1986, as amended (the “Code”).

Section 3.2 Powers . The Trust shall have all of the powers granted to real estate investment trusts by Title 8 and all other powers set forth in the Declaration of Trust which are not inconsistent with law and are appropriate to promote and attain the purposes set forth in the Declaration of Trust.




ARTICLE IV
RESIDENT AGENT

The name of the resident agent of the Trust in the State of Maryland is James J. Hanks, Jr., whose post office address is c/o Ballard Spahr Andrews & Ingersoll, 300 East Lombard Street, Baltimore, Maryland 21202. The resident agent is a citizen of and resides in the State of Maryland. The Trust may have such offices or places of business within or outside the State of Maryland as the Board of Trustees may from time to time determine.

ARTICLE V
BOARD OF TRUSTEES

Section 5.1 Powers . Subject to any express limitations contained in the Declaration of Trust or in the Bylaws, (a) the business and affairs of the Trust shall be managed under the direction of the Board of Trustees and (b) the Board shall have full, exclusive and absolute power, control and authority over any and all property of the Trust. The Board may take any action as in its sole judgment and discretion is necessary or appropriate to conduct the business and affairs of the Trust. The Declaration of Trust shall be construed with the presumption in favor of the grant of power and authority to the Board. Any construction of the Declaration of Trust or determination made in good faith by the Board concerning its powers and authority hereunder shall be conclusive. The enumeration and definition of particular powers of the Trustees included in the Declaration of Trust or in the Bylaws shall in no way be limited or restricted by reference to or inference from the terms of this or any other provision of the Declaration of Trust or the Bylaws or construed or deemed by inference or otherwise in any manner to exclude or limit the powers conferred upon the Board or the Trustees under the general laws of the State of Maryland or any other applicable laws.

The Board, without any action by the shareholders of the Trust, shall have and may exercise, on behalf of the Trust, without limitation, the power to terminate the status of the Trust as a real estate investment trust under the Code; to determine that compliance with any restriction or limitations on ownership and transfers of shares of the Trust’s beneficial interest set forth in Article VII of the Declaration of Trust is no longer required in order for the Trust to qualify as a REIT; to adopt, amend and repeal Bylaws; to elect officers in the manner prescribed in the Bylaws; to solicit proxies from holders of shares of beneficial interest of the Trust; and to do any other acts and deliver any other documents necessary or appropriate to the foregoing powers.

Section 5.2 Number and Class . The number of Trustees (hereinafter the “Trustees”) is nine (9), which number may be increased or decreased pursuant to the Bylaws of the Trust. The Trustees shall be elected at each annual meeting of shareholders in the manner provided in the Bylaws or, in order to fill any vacancy on the Board of Trustees, in the manner provided in the Bylaws. It shall not be necessary to list in the Declaration of Trust the names and addresses of any Trustees.




Section 5.3 Resignation, Removal or Death . Any Trustee may resign by written notice to the Board, effective upon execution and delivery to the Trust of such written notice or upon any future date specified in the notice. Subject to the rights of holders of one or more classes or series of Preferred Shares to elect one or more Trustees, a Trustee may be removed at any time, only for cause and only at a meeting of the shareholders, by the affirmative vote of the holders of not less than two-thirds of the Shares then outstanding and entitled to vote generally in the election of Trustees.

ARTICLE VI
SHARES OF BENEFICIAL INTEREST

Section 6.1 Authorized Shares . The beneficial interest of the Trust shall be divided into shares of beneficial interest (the “Shares”). The Trust has authority to issue 175,000,000 shares of beneficial interest, consisting of 150,000,000 common shares of beneficial interest, $0.01 par value per share (“Common Shares”), and 25,000,000 preferred shares of beneficial interest, $0.01 par value per share (“Preferred Shares”). The Board of Trustees, without any action by the shareholders of the Trust, may amend the Declaration of Trust from time to time to increase or decrease the aggregate number of Shares or the number of Shares of any class that the Trust has authority to issue. If shares of one class of stock are classified or reclassified into shares of another class of stock pursuant to Sections 6.2, 6.3 or 6.4 of this Article VI, the number of authorized shares of the former class shall be automatically decreased and the number of shares of the latter class shall be automatically increased, in each case by the number of shares so classified or reclassified.

Section 6.2 Common Shares . Subject to the provisions of Article VII, each Common Share shall entitle the holder thereof to one vote on each matter upon which holders of Common Shares are entitled to vote. The Board of Trustees may reclassify any unissued Common Shares from time to time in one or more classes or series of Shares.

Section 6.3 Preferred Shares . The Board of Trustees may classify any unissued Preferred Shares and reclassify any previously classified but unissued Preferred Shares of any series from time to time, in one or more classes or series of Shares.

Section 6.4 Classified or Reclassified Shares . Prior to issuance of classified or reclassified Shares of any class or series, the Board of Trustees by resolution shall (a) designate that class or series to distinguish it from all other classes and series of Shares; (b) specify the number of Shares to be included in the class or series; (c) set, subject to the provisions of Article VII and subject to the express terms of any class or series of Shares outstanding at the time, the preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms and conditions of redemption for each class or series; and (d) cause the Trust to file articles supplementary with the State Department of Assessments and Taxation of Maryland (the “SDAT”). Any of the terms of any class or series of Shares set pursuant to clause (c) of this Section 6.4 may be made dependent upon facts ascertainable outside the Declaration of Trust (including the occurrence of any event, including a determination or action by the Trust or any other person or body) and may vary among holders



thereof, provided that the manner in which such facts or variations shall operate upon the terms of such class or series of Shares is clearly and expressly set forth in the articles supplementary filed with the SDAT.

Section 6.5 Authorization by Board of Share Issuance . The Board of Trustees may authorize the issuance from time to time of Shares of any class or series, whether now or hereafter authorized, or securities or rights convertible into Shares of any class or series, whether now or hereafter authorized, for such consideration (whether in cash, property, past or future services, obligation for future payment or otherwise) as the Board of Trustees may deem advisable (or without consideration in the case of a Share split or Share dividend), subject to such restrictions or limitations, if any, as may be set forth in the Declaration of Trust or the Bylaws of the Trust.

Section 6.6 Dividends and Distributions . The Board of Trustees may from time to time authorize and declare to shareholders such dividends or distributions, in cash or other assets of the Trust or in securities of the Trust or from any other source as the Board of Trustees in its discretion shall determine. The Board of Trustees shall endeavor to declare and pay such dividends and distributions as shall be necessary for the Trust to qualify as a real estate investment trust under the Code; however, shareholders shall have no right to any dividend or distribution unless and until authorized and declared by the Board. The exercise of the powers and rights of the Board of Trustees pursuant to this Section 6.6 shall be subject to the provisions of any class or series of Shares at the time outstanding. Notwithstanding any other provision in the Declaration of Trust, no determination shall be made by the Board of Trustees nor shall any transaction be entered into by the Trust which would cause any Shares or other beneficial interest in the Trust not to constitute “transferable shares” or “transferable certificates of beneficial interest” under Section 856(a)(2) of the Code or which would cause any distribution to constitute a preferential dividend as described in Section 562(c) of the Code.

Section 6.7 General Nature of Shares . All Shares shall be personal property entitling the shareholders only to those rights provided in the Declaration of Trust. The shareholders shall have no interest in the property of the Trust and shall have no right to compel any partition, division, dividend or distribution of the Trust or of the property of the Trust. The death of a shareholder shall not terminate the Trust. The Trust is entitled to treat as shareholders only those persons in whose names Shares are registered as holders of Shares on the beneficial interest ledger of the Trust.

Section 6.8 Fractional Shares . The Trust may, without the consent or approval of any shareholder, issue fractional Shares, eliminate a fraction of a Share by rounding up or down to a full Share, arrange for the disposition of a fraction of a Share by the person entitled to it, or pay cash for the fair value of a fraction of a Share.

Section 6.9 Declaration and Bylaws . All shareholders are subject to the provisions of the Declaration of Trust and the Bylaws of the Trust. Except as otherwise specifically required by law, the Trustees and the Shareholders shall each have the power to adopt, amend and modify the



Bylaws of the Trust in the manner set forth in the Bylaws as the same may be amended or modified from time to time.

Section 6.10 Divisions and Combinations of Shares . Subject to an express provision to the contrary in the terms of any class or series of beneficial interest hereafter authorized, the Board of Trustees shall have the power to divide or combine the outstanding shares of any class or series of beneficial interest, without a vote of shareholders.

ARTICLE VII
RESTRICTION ON TRANSFER AND OWNERSHIP OF SHARES

Section 7.1 Definitions . For the purpose of this Article VII, the following terms shall have the following meanings:

Aggregate Share Ownership Limit . The term “Aggregate Share Ownership Limit” shall mean not more than 9.8 percent in value of the aggregate of the outstanding Equity Shares. The value of the outstanding Equity Shares shall be determined by the Board of Trustees in good faith, which determination shall be conclusive for all purposes hereof.

Beneficial Ownership . The term “Beneficial Ownership” shall mean ownership of Equity Shares by a Person, whether the interest in Equity Shares is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 544 of the Code, as modified by Section 856(h)(1)(B) of the Code. The terms “Beneficial Owner,” “Beneficially Owns” and “Beneficially Owned” shall have the correlative meanings.

Business Day . The term “Business Day” shall mean any day, other than a Saturday or Sunday, that is neither a legal holiday nor a day on which banking institutions in New York City are authorized or required by law, regulation or executive order to close.

Charitable Beneficiary . The term “Charitable Beneficiary” shall mean one or more beneficiaries of the Charitable Trust as determined pursuant to Section 7.3.6, provided that each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under each of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Charitable Trust . The term “Charitable Trust” shall mean any trust provided for in Section 7.3.1.

Code . The term “Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Common Share Ownership Limit . The term “Common Share Ownership Limit” shall mean not more than 9.8 percent (in value or in number of shares, whichever is more restrictive) of the aggregate of the outstanding Common Shares. The number and value of outstanding



Common Shares shall be determined by the Board of Trustees in good faith, which determination shall be conclusive for all purposes hereof.

Constructive Ownership . The term “Constructive Ownership” shall mean ownership of Equity Shares by a Person, whether the interest in Equity Shares is held directly or indirectly (including by a nominee), and shall include interests that would be treated as owned through the application of Section 318(a) of the Code, as modified by Section 856(d)(5) of the Code. The terms “Constructive Owner,” “Constructively Owns” and “Constructively Owned” shall have the correlative meanings.

Declaration of Trust . The term “Declaration of Trust” shall mean this Declaration of Trust as filed for record with the SDAT, and any amendments thereto.

Equity Shares . The term “Equity Shares” shall mean all classes or series of Shares, including, without limitation, Common Shares and Preferred Shares.

Excepted Holder . The term “Excepted Holder” shall mean a Permitted Holder or a shareholder of the Trust for whom an Excepted Holder Limit is created by this Article VII or by the Board of Trustees pursuant to Section 7.2.7.

Excepted Holder Limit . The term “Excepted Holder Limit” shall mean, (i) in the case of Permitted Holders, the percentage limit established by the Board of Trustees prior to their becoming shareholders of the Trust, subject to adjustment pursuant to Sections 7.2.7 and 7.2.8 and (ii) in the case of any other Excepted Holder, provided that the affected Excepted Holder agrees to comply with the requirements established by the Board of Trustees pursuant to Section 7.2.7, and subject to adjustment pursuant to Section 7.2.8, the percentage limit established by the Board of Trustees pursuant to Section 7.2.7.

Initial Date . The term “Initial Date” shall mean the date upon which this Declaration of Trust containing this Article VII is filed for record with the SDAT.

Market Price . The term “Market Price” on any date shall mean, with respect to any class or series of outstanding Equity Shares, the Closing Price for such Equity Shares on such date. The “Closing Price” on any date shall mean the last sale price for such Equity Shares, regular way, or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, for such Equity Shares, in either case as reported in the principal consolidated transaction reporting system with respect to the securities listed or admitted to trading on National Market or Small Cap tier of the Nasdaq Stock Market (“Nasdaq-NM”) or, if such Equity Shares are not listed or admitted to trading on the Nasdaq-NM, as reported on the principal consolidated transaction reporting system with respect to the principal national securities exchange on which such Equity Shares are listed or admitted to trading or, if such Equity Shares are not listed or admitted to trading on the Nasdaq-NM or any national securities exchange, the last quoted price, or, if not so quoted, the average of the high bid and low asked prices in the over-the-counter market, as reported by the principal automated quotation system that may then be in use or, if such Equity Shares are not quoted by any such organization, the



average of the closing bid and asked prices as furnished by a professional market maker making a market in such Equity Shares selected by the Board of Trustees or, in the event that no trading price is available for such Equity Shares, the fair market value of Equity Shares, as determined in good faith by the Board of Trustees.

Permitted Holder . The term Permitted Holder shall mean Jay H. Shidler, Clay W. Hamlin, III, Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate Co. Investment Partnership I, L.P. and any corporation, partnership, trust, estate or other legal entity controlled by any of the foregoing persons (or jointly controlled by Messrs. Shidler and Hamlin).

Person . The term “Person” shall mean an individual, corporation, partnership, estate, trust (including a trust qualified under Sections 401(a) or 501(c)(17) of the Code), a portion of a trust permanently set aside for or to be used exclusively for the purposes described in Section 642(c) of the Code, association, private foundation within the meaning of Section 509(a) of the Code, joint stock company or other entity and also includes a group as that term is used for purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, and a group to which an Excepted Holder Limit applies.

Prohibited Owner . The term “Prohibited Owner” shall mean, with respect to any purported Transfer, any Person who, but for the provisions of Section 7.2.1, would Beneficially Own or Constructively Own Equity Shares, and if appropriate in the context, shall also mean any Person who would have been the record owner of Equity Shares that the Prohibited Owner would have so owned.

REIT . The term “REIT” shall mean a real estate investment trust within the meaning of Section 856 of the Code.

Restriction Termination Date . The term “Restriction Termination Date” shall mean the first day after the Initial Date on which the Board of Trustees determines that it is no longer in the best interests of the Trust to attempt to, or continue to, qualify as a REIT or that compliance with the restrictions and limitations on Beneficial Ownership, Constructive Ownership and Transfers of Equity Shares set forth herein is no longer required in order for the Trust to qualify as a REIT.

SDAT. The term “SDAT” shall mean the State Department of Assessments and Taxation of Maryland.

Transfer . The term “Transfer” shall mean any issuance, sale, transfer, gift, assignment, devise or other disposition, as well as any other event that causes any Person to acquire Beneficial Ownership or Constructive Ownership, or any agreement to take any such actions or cause any such events, of Equity Shares or the right to vote or receive dividends on Equity Shares, including (a) the granting or exercise of any option (or any disposition of any option), (b) any disposition of any securities or rights convertible into or exchangeable for Equity Shares or any interest in Equity Shares or any exercise of any such conversion or exchange right and (c) Transfers of interests in other entities that result in changes in Beneficial or Constructive



Ownership of Equity Shares; in each case, whether voluntary or involuntary, whether owned of record, Constructively Owned or Beneficially Owned and whether by operation of law or otherwise; provided, however, that the term Transfer shall not include the initial issuance of Equity Shares in connection with the indirect merger of Corporate Office Properties Trust, Inc., a Minnesota corporation, with and into the Trust. The terms “Transferring” and “Transferred” shall have the correlative meanings.

Trustee . The term “Trustee” shall mean the Person unaffiliated with the Trust and a Prohibited Owner, that is appointed by the Trust to serve as trustee of the Charitable Trust.

Section 7.2 Equity Shares .

Section 7.2.1 Ownership Limitations . During the period commencing on the Initial Date and prior to the Restriction Termination Date:

(a) Basic Restrictions .

(i) (1) No Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own Equity Shares in excess of the Aggregate Share Ownership Limit, (2) no Person, other than an Excepted Holder, shall Beneficially Own or Constructively Own Common Shares in excess of the Common Share Ownership Limit and (3) no Excepted Holder shall Beneficially Own or Constructively Own Equity Shares in excess of the Excepted Holder Limit for such Excepted Holder.

(ii) No Person shall Beneficially or Constructively Own Equity Shares to the extent that such Beneficial or Constructive Ownership of Equity Shares would result in the Trust being “closely held” within the meaning of Section 856(h) of the Code (without regard to whether the ownership interest is held during the last half of a taxable year), or otherwise failing to qualify as a REIT (including, but not limited to, Beneficial or Constructive Ownership that would result in the Trust owning (actually or Constructively) an interest in a tenant that is described in Section 856(d)(2)(B) of the Code if the income derived by the Trust from such tenant would cause the Trust to fail to satisfy any of the gross income requirements of Section 856(c) of the Code).

(iii) Notwithstanding any other provisions contained herein, any Transfer of Equity Shares (whether or not such Transfer is the result of a transaction entered into through the facilities of the Nasdaq-NM or any other national securities exchange or automated inter-dealer quotation system) that, if effective, would result in Equity Shares being beneficially owned by less than 100 Persons (determined under the principles of Section 856(a)(5) of the Code) shall be void ab initio , and the intended transferee shall acquire no rights in such Equity Shares.

(b) Transfer in Trust . If any Transfer of Equity Shares (whether or not such Transfer is the result of a transaction entered into through the facilities of the NYSE or any other national securities exchange or automated inter-dealer quotation system) occurs which, if



effective, would result in any Person Beneficially Owning or Constructively Owning Equity Shares in violation of Section 7.2.1(a)(i) or (ii),

(i) then that number of Equity Shares the Beneficial or Constructive Ownership of which otherwise would cause such Person to violate Section 7.2.1(a)(i) or (ii) (rounded to the nearest whole share) shall be automatically transferred to a Charitable Trust for the benefit of a Charitable Beneficiary, as described in Section 7.3, effective as of the close of business on the Business Day prior to the date of such Transfer, and such Person shall acquire no rights in such Equity Shares; or

(ii) if the transfer to the Charitable Trust described in clause (i) of this sentence would not be effective for any reason to prevent the violation of Section 7.2.1(a)(i) or (ii), then the Transfer of that number of Equity Shares that otherwise would cause any Person to violate Section 7.2.1(a)(i) or (ii) shall be void ab initio , and the intended transferee shall acquire no rights in such Equity Shares.

Section 7.2.2 Remedies For Breach . If the Board of Trustees or any duly authorized committee thereof shall at any time determine in good faith that a Transfer or other event has taken place that results in a violation of Section 7.2.1 or that a Person intends to acquire or has attempted to acquire Beneficial or Constructive Ownership of any Equity Shares in violation of Section 7.2.1 (whether or not such violation is intended), the Board of Trustees or a committee thereof shall take such action as it deems advisable to refuse to give effect to or to prevent such Transfer or other event, including, without limitation, causing the Trust to redeem Equity Shares, refusing to give effect to such Transfer on the books of the Trust or instituting proceedings to enjoin such Transfer or other event; provided , however , that any Transfers or attempted Transfers or other events in violation of Section 7.2.1 shall automatically result in the transfer to the Charitable Trust described above, and, where applicable, such Transfer (or other event) shall be void ab initio as provided above irrespective of any action (or non-action) by the Board of Trustees or a committee thereof.

Section 7.2.3 Notice of Restricted Transfer . Any Person who, as the result of a Transfer, attempted Transfer or intended Transfer acquires or attempts or intends to acquire Beneficial Ownership or Constructive Ownership of Equity Shares that will or may violate Section 7.2.1(a), or any Person who would have owned Equity Shares that resulted in a transfer to the Charitable Trust pursuant to the provisions of Section 7.2.1(b), shall immediately give written notice to the Trust of such event, or in the case of such a proposed or attempted transaction, give at least 15 days prior written notice, and shall provide to the Trust such other information as the Trust may request in order to determine the effect, if any, of such Transfer on the Trust’s status as a REIT.

Section 7.2.4 Owners Required to Provide Information . From the Initial
Date and prior to the Restriction Termination Date:

(a) every owner of more than five percent (or such other percentage as required by the Code or the Treasury Regulations promulgated thereunder) of the outstanding



Equity Shares, within 30 days after the end of each taxable year, shall give written notice to the Trust stating the name and address of such owner, the number of Equity Shares and other Equity Shares Beneficially Owned and a description of the manner in which such shares are held. Each such owner shall provide to the Trust such additional information as the Trust may request in order to determine the effect, if any, of such Beneficial Ownership on the Trust’s status as a REIT and to ensure compliance with the Aggregate Share Ownership Limit.

(b) each Person who is a Beneficial or Constructive Owner of Equity Shares and each Person (including the shareholder of record) who is holding Equity Shares for a Beneficial or Constructive Owner shall provide to the Trust such information as the Trust may request, in good faith, in order to determine the Trust’s status as a REIT and to comply with requirements of any taxing authority or governmental authority or to determine such compliance.

Section 7.2.5 Remedies Not Limited . Subject to Section 5.1 of the Declaration of Trust, nothing contained in this Section 7.2 shall limit the authority of the Board of Trustees to take such other action as it deems necessary or advisable to protect the Trust and the interests of its shareholders in preserving the Trust’s status as a REIT.

Section 7.2.6 Ambiguity . In the case of an ambiguity in the application of any of the provisions of this Section 7.2, Section 7.3 or any definition contained in Section 7.1, the Board of Trustees shall have the power to determine the application of the provisions of this Section 7.2 or Section 7.3 or any such definition with respect to any situation based on the facts known to it. In the event Section 7.2 or 7.3 requires an action by the Board of Trustees and the Declaration of Trust fails to provide specific guidance with respect to such action, the Board of Trustees shall have the power to determine the action to be taken so long as such action is not contrary to the provisions of Sections 7.1, 7.2 or 7.3.

Section 7.2.7 Exceptions .

(a) Subject to Section 7.2.1(a)(ii), the Board of Trustees, in its sole discretion, may exempt a Person from the Aggregate Share Ownership Limit and the Common Share Ownership Limit, as the case may be, and may establish or increase an Excepted Holder Limit for a Person (including a Permitted Holder) if:

(i) the Board of Trustees obtains such representations and undertakings from such Person as are reasonably necessary to ascertain that no individual’s Beneficial or Constructive Ownership of such Equity Shares will violate Section 7.2.1(a)(ii);

(ii) such Person does not and represents that it will not own, actually or Constructively, an interest in a tenant of the Trust (or a tenant of any entity owned or controlled by the Trust) that would cause the Trust to own, actually or Constructively, more than a 9.9% interest (as set forth in Section 856(d)(2)(B) of the Code) in such tenant and the Board of Trustees obtains such representations and undertakings from such Person as are reasonably necessary to ascertain this fact (for this purpose, a tenant from whom the Trust (or an entity owned or controlled by the Trust) derives (and is expected to continue to derive) a sufficiently



small amount of revenue such that, in the opinion of the Board of Trustees, rent from such tenant would not adversely affect the Trust’s ability to qualify as a REIT, shall not be treated as a tenant of the Trust); and

(iii) such Person agrees that any violation or attempted violation of such representations or undertakings (or other action which is contrary to the restrictions contained in Sections 7.2.1 through 7.2.6) will result in such Equity Shares being automatically transferred to a Charitable Trust in accordance with Sections 7.2.1(b) and 7.3.

(b) Prior to granting any exception pursuant to Section 7.2.7(a), the Board of Trustees may require a ruling from the Internal Revenue Service, or an opinion of counsel, in either case in form and substance satisfactory to the Board of Trustees in its sole discretion, as it may deem necessary or advisable in order to determine or ensure the Trust’s status as a REIT. Notwithstanding the receipt of any ruling or opinion, the Board of Trustees may impose such conditions or restrictions as it deems appropriate in connection with granting such exception.

(c) Subject to Section 7.2.1(a)(ii), an underwriter which participates in a public offering or a private placement of Equity Shares (or securities convertible into or exchangeable for Equity Shares) may Beneficially Own or Constructively Own Equity Shares (or securities convertible into or exchangeable for Equity Shares) in excess of the Aggregate Share Ownership Limit, the Common Share Ownership Limit or both such limits, but only to the extent necessary to facilitate such public offering or private placement.

(d) The Board of Trustees may only reduce the Excepted Holder Limit for an Excepted Holder: (1) with the written consent of such Excepted Holder at any time, or (2) pursuant to the terms and conditions of the agreements and undertakings entered into with such Excepted Holder in connection with the establishment of the Excepted Holder Limit for that Excepted Holder. No Excepted Holder Limit shall be reduced to a percentage that is less than the Common Share Ownership Limit.

Section 7.2.8 Increase in Aggregate Share Ownership and Common Share
Ownership Limits . The Board of Trustees may from time to time increase the Common Share Ownership Limit and the Aggregate Share Ownership Limit.

Section 7.2.9 Legend . Each certificate for Equity Shares shall bear substantially the following legend:

The shares represented by this Certificate are subject to restrictions on Beneficial Ownership, Constructive Ownership and Transfer for the purpose of the Trust’s maintenance of its status as a real estate investment trust (a “REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). Subject to certain further restrictions and except as expressly provided in the Declaration of Trust of the Trust (i) no Person may Beneficially Own or Constructively Own Common Shares of the Trust in excess of 9.8 percent (in value or number of



shares) of the outstanding Common Shares of the Trust unless such Person is an Excepted Holder or a Permitted Holder (in which case the Excepted Holder Limit shall be applicable); (ii) no Person may Beneficially Own or Constructively Own Equity Shares of the Trust in excess of 9.8 percent of the value of the total outstanding Equity Shares of the Trust, unless such Person is an Excepted Holder or a Permitted Holder (in which case the Excepted Holder Limit shall be applicable); (iii) no Person may Beneficially Own or Constructively Own Equity Shares that would result in the Trust being “closely held” under Section 856(h) of the Code or otherwise cause the Trust to fail to qualify as a REIT; and (iv) no Person may Transfer Equity Shares if such Transfer would result in Equity Shares of the Trust being owned by fewer than 100 Persons. Any Person who Beneficially Owns or Constructively Owns or attempts to Beneficially Own or Constructively Own Equity Shares which cause or will cause a Person to Beneficially Own or Constructively Own Equity Shares in excess or in violation of the above limitations must immediately notify the Trust. If any of the restrictions on transfer or ownership are violated, the Equity Shares represented hereby will be automatically transferred to a Trustee of a Charitable Trust for the benefit of one or more Charitable Beneficiaries. In addition, upon the occurrence of certain events, attempted Transfers in violation of the restrictions described above may be void ab initio . All capitalized terms in this legend have the meanings defined in the Declaration of Trust of the Trust, as the same may be amended from time to time, a copy of which, including the restrictions on transfer and ownership, will be furnished to each holder of Equity Shares of the Trust on request and without charge.

Instead of the foregoing legend, the certificate may state that the Trust will furnish a full statement about certain restrictions on transferability to a shareholder on request and without charge.

Section 7.3 Transfer of Equity Shares in Trust .

Section 7.3.1 Ownership In Trust . Upon any purported Transfer or other event described in Section 7.2.1(b) that would result in a transfer of Equity Shares to a Charitable Trust, such Equity Shares shall be deemed to have been transferred to the Trustee as trustee of a Charitable Trust for the exclusive benefit of one or more Charitable Beneficiaries. Such transfer to the Trustee shall be deemed to be effective as of the close of business on the Business Day prior to the purported Transfer or other event that results in the transfer to the Charitable Trust pursuant to Section 7.2.1(b). The Trustee shall be appointed by the Trust and shall be a Person unaffiliated with the Trust and any Prohibited Owner. Each Charitable Beneficiary shall be designated by the Trust as provided in Section 7.3.6.




Section 7.3.2 Status of Shares Held by the Trustee . Equity Shares held by the Trustee shall be issued and outstanding Equity Shares of the Company. The Prohibited Owner shall have no rights in the shares held by the Trustee. The Prohibited Owner shall not benefit economically from ownership of any shares held in trust by the Trustee, shall have no rights to dividends or other distributions and shall not possess any rights to vote or other rights attributable to the shares held in the Charitable Trust.

Section 7.3.3 Dividend and Voting Rights . The Trustee shall have all voting rights and rights to dividends or other distributions with respect to Equity Shares held in the Charitable Trust, which rights shall be exercised for the exclusive benefit of the Charitable Beneficiary. Any dividend or other distribution paid prior to the discovery by the Trust that Equity Shares have been transferred to the Trustee shall be paid with respect to such Equity Shares to the Trustee upon demand and any dividend or other distribution authorized but unpaid shall be paid when due to the Trustee. Any dividends or distributions so paid over to the Trustee shall be held in trust for the Charitable Beneficiary. The Prohibited Owner shall have no voting rights with respect to shares held in the Charitable Trust and, subject to Maryland law, effective as of the date that Equity Shares have been transferred to the Trustee, the Trustee shall have the authority (at the Trustee’s sole discretion) (i) to rescind as void any vote cast by a Prohibited Owner prior to the discovery by the Trust that Equity Shares have been transferred to the Trustee and (ii) to recast such vote in accordance with the desires of the Trustee acting for the benefit of the Charitable Beneficiary; provided, however, that if the Company has already taken irreversible trust action, then the Trustee shall not have the authority to rescind and recast such vote. Notwithstanding the provisions of this Article VII, until the Trust has received notification that Equity Shares have been transferred into a Charitable Trust, the Trust shall be entitled to rely on its share transfer and other shareholder records for purposes of preparing lists of shareholders entitled to vote at meetings, determining the validity and authority of proxies and otherwise conducting votes of shareholders.

Section 7.3.4 Sale of Shares by Trustee . Within 20 days of receiving notice from the Trust that Equity Shares have been transferred to the Charitable Trust, the Trustee of the Charitable Trust shall sell the shares held in the Charitable Trust to a person, designated by the Trustee, whose ownership of the shares will not violate the ownership limitations set forth in Section 7.2.1(a). Upon such sale, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner and to the Charitable Beneficiary as provided in this Section 7.3.4. The Prohibited Owner shall receive the lesser of (1) the price paid by the Prohibited Owner for the shares or, if the Prohibited Owner did not give value for the shares in connection with the event causing the shares to be held in the Charitable Trust ( e.g. , in the case of a gift, devise or other such transaction), the Market Price of the shares on the day of the event causing the shares to be held in the Charitable Trust and (2) the price per share received by the Trustee from the sale or other disposition of the shares held in the Charitable Trust. Any net sales proceeds in excess of the amount payable to the Prohibited Owner shall be immediately paid to the Charitable Beneficiary. If, prior to the discovery by the Trust that Equity Shares have been transferred to the Trustee, such shares are sold by a Prohibited Owner, then (i) such shares shall be deemed to have been sold on behalf of the Charitable Trust and (ii) to the extent that the Prohibited Owner received an



amount for such shares that exceeds the amount that such Prohibited Owner was entitled to receive pursuant to this Section 7.3.4, such excess shall be paid to the Trustee upon demand.

Section 7.3.5 Purchase Right in Shares Transferred to the Trustee . Equity Shares transferred to the Trustee shall be deemed to have been offered for sale to the Trust, or its designee, at a price per share equal to the lesser of (i) the price per share in the transaction that resulted in such transfer to the Charitable Trust (or, in the case of a devise or gift, the Market Price at the time of such devise or gift) and (ii) the Market Price on the date the Trust, or its designee, accepts such offer. The Trust shall have the right to accept such offer until the Trustee has sold the shares held in the Charitable Trust pursuant to Section 7.3.4. Upon such a sale to the Trust, the interest of the Charitable Beneficiary in the shares sold shall terminate and the Trustee shall distribute the net proceeds of the sale to the Prohibited Owner.

Section 7.3.6 Designation of Charitable Beneficiaries . By written notice to the Trustee, the Trust shall designate one or more nonprofit organizations to be the Charitable Beneficiary of the interest in the Charitable Trust such that (i) Equity Shares held in the Charitable Trust would not violate the restrictions set forth in Section 7.2.1(a) in the hands of such Charitable Beneficiary and (ii) each such organization must be described in Section 501(c)(3) of the Code and contributions to each such organization must be eligible for deduction under each of Sections 170(b)(1)(A), 2055 and 2522 of the Code.

Section 7.4 Nasdaq-NM Transactions . Nothing in this Article VII shall preclude the settlement of any transaction entered into through the facilities of the Nasdaq-NM or any other national securities exchange or automated inter-dealer quotation system. The fact that the settlement of any transaction is so permitted shall not negate the effect of any other provision of this Article VII and any transferee in such a transaction shall be subject to all of the provisions and limitations set forth in this Article VII.

Section 7.5 Enforcement . The Trust is authorized specifically to seek equitable relief, including injunctive relief, to enforce the provisions of this Article VII.

Section 7.6 Non-Waiver . No delay or failure on the part of the Trust or the Board of Trustees in exercising any right hereunder shall operate as a waiver of any right of the Trust or the Board of Trustees, as the case may be, except to the extent specifically waived in writing.

ARTICLE VIII
SHAREHOLDERS

Section 8.1 Meetings . There shall be an annual meeting of the shareholders, commencing with the calendar year 1999, to be held on proper notice at such time (after the delivery of the annual report) and convenient location as shall be determined by or in the manner prescribed in the Bylaws, for the election of the Trustees, if required, and for the transaction of any other business within the powers of the Trust. Except as otherwise provided in the Declaration of Trust or as specifically required by law, special meetings of shareholders may only be called in the manner provided in the Bylaws. If there are no Trustees, the officers of the



Trust shall promptly call a special meeting of the shareholders entitled to vote for the election of successor Trustees. Any meeting may be adjourned and reconvened as the Trustees determine or as provided in the Bylaws.

Section 8.2 Voting Rights . Subject to the provisions of any class or series of Shares then outstanding, the shareholders shall be entitled to vote only on the following matters: (a) election of Trustees as provided in Section 5.2 and the removal of Trustees as provided in Section 5.3; (b) amendment of the Declaration of Trust as provided in Article X; (c) termination of the Trust as provided in Section 10.3; (d) merger or consolidation of the Trust, or the sale or disposition of substantially all of the Trust Property, as provided in Article XI; and (e) such other matters with respect to which the Board of Trustees has adopted a resolution declaring that a proposed action is advisable and directing that the matter be submitted to the shareholders for approval or ratification. Except with respect to the foregoing matters, no action taken by the shareholders at any meeting or by consent shall in any way bind the Board of Trustees.

Section 8.3 Preemptive and Appraisal Rights . Except as may be provided by the Board of Trustees in setting the terms of classified or reclassified Shares pursuant to Section 6.4, no holder of Shares shall, as such holder, (a) have any preemptive right to purchase or subscribe for any additional Shares of the Trust or any other security of the Trust which it may issue or sell or (b), except as expressly required by Title 8, have any right to require the Trust to pay him the fair value of his Shares in an appraisal or similar proceeding.

Section 8.4 Extraordinary Actions . Except as specifically provided in Section 5.3 (relating to removal of Trustees), in Article X (relating to amendments to this Declaration of Trust), in Article XI (relating to mergers, consolidations or sales of trust property), and in Section 12.2 (relating to termination of the Trust) and except for any deletion or modification of the foregoing references in this Section 8.4, notwithstanding any provision of law permitting or requiring any action to be taken or authorized by the affirmative vote of the holders of a greater number of votes, any such action shall be effective and valid if taken or authorized by the affirmative vote of holders of Shares entitled to cast a majority of all the votes entitled to be cast on the matter.

Section 8.5 Board Approval . The submission of any action to the shareholders for their consideration shall first be approved by the Board of Trustees.

Section 8.6 Action by Shareholders without a Meeting . The Bylaws of the Trust may provide that any action required or permitted to be taken by the shareholders may be taken without a meeting by the written consent of all shareholders entitled to cast votes on the matter.

ARTICLE IX
LIABILITY LIMITATION, INDEMNIFICATION
AND TRANSACTIONS WITH THE TRUST

Section 9.1 Limitation of Shareholder Liability . No shareholder shall be liable for any debt, claim, demand, judgment or obligation of any kind of, against or with respect to the Trust



by reason of his being a shareholder, nor shall any shareholder be subject to any personal liability whatsoever, in tort, contract or otherwise, to any person in connection with the property or the affairs of the Trust by reason of his being a shareholder.

Section 9.2 Limitation of Trustee and Officer Liability . To the maximum extent that Maryland law in effect from time to time permits limitation of the liability of trustees and officers of a real estate investment trust, no Trustee or officer of the Trust shall be liable to the Trust or to any shareholder for money damages. Neither the amendment nor repeal of this Section 9.2, nor the adoption or amendment of any other provision of the Declaration of Trust inconsistent with this Section 9.2, shall apply to or affect in any respect the applicability of the preceding sentence with respect to any act or failure to act which occurred prior to such amendment, repeal or adoption. In the absence of any Maryland statute limiting the liability of trustees and officers of a Maryland real estate investment trust for money damages in a suit by or on behalf of the Trust or by any shareholder, no Trustee or officer of the Trust shall be liable to the Trust or to any shareholder for money damages except to the extent that (a) the Trustee or officer actually received an improper benefit or profit in money, property, or services, for the amount of the benefit or profit in money, property, or services actually received; or (b) a judgment or other final adjudication adverse to the Trustee or officer is entered in a proceeding based on a finding in the proceeding that the Trustee’s or officer’s action or failure to act was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding.

Section 9.3 Indemnification . The Trust shall have the power, to the maximum extent permitted by Maryland law in effect from time to time, to obligate itself to indemnify, and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to, (a) any individual who is a present or former shareholder, Trustee or officer of the Trust or (b) any individual who, while a Trustee of the Trust and at the request of the Trust, serves or has served as a director, officer, partner, trustee, employee or agent of another real estate investment trust, corporation, partnership, joint venture, trust, employee benefit plan or any other enterprise from and against any claim or liability to which such person may become subject or which such person may incur by reason of his status as a present or former shareholder, Trustee or officer of the Trust. The Trust shall have the power, with the approval of its Board of Trustees, to provide such indemnification and advancement of expenses to a person who served a predecessor of the Trust in any of the capacities described in (a) or (b) above and to any employee or agent of the Trust or a predecessor of the Trust.

Section 9.4 Transactions Between the Trust and its Trustees, Officers, Employees and Agents . Subject to any express restrictions in the Declaration of Trust or adopted by the Trustees in the Bylaws or by resolution, the Trust may enter into any contract or transaction of any kind with any person, including any Trustee, officer, employee or agent of the Trust or any person affiliated with a Trustee, officer, employee or agent of the Trust, whether or not any of them has a financial interest in such transaction.




ARTICLE X
AMENDMENTS

Section 10.1 General . The Trust reserves the right from time to time to make any amendment to the Declaration of Trust, now or hereafter authorized by law, including any amendment altering the terms or contract rights, as expressly set forth in the Declaration of Trust, of any Shares. All rights and powers conferred by the Declaration of Trust on shareholders, Trustees and officers are granted subject to this reservation. An amendment to the Declaration of Trust (a) shall be signed and acknowledged by at least a majority of the Trustees, or an officer duly authorized by at least a majority of the Trustees, (b) shall be filed for record as provided in Section 13.5 and (c) shall become effective as of the later of the time the SDAT accepts the amendment for record or the time established in the amendment, not to exceed 30 days after the amendment is accepted for record. All references to the Declaration of Trust shall include all amendments thereto.

Section 10.2 By Trustees . The Trustees may amend the Declaration of Trust from time to time, in the manner provided by Title 8, without any action by the shareholders, to qualify as a real estate investment trust under the Code or under Title 8 and as otherwise provided in the Declaration of Trust.

Section 10.3 By Shareholders . Except as otherwise provided in the Declaration of Trust, any amendment to the Declaration of Trust shall be valid only if approved by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter.

ARTICLE XI
MERGER, CONSOLIDATION OR SALE OF TRUST PROPERTY

Subject to the provisions of any class or series of Shares at the time outstanding, the Trust may (a) merge the Trust into another entity, (b) consolidate the Trust with one or more other entities into a new entity or (c) sell, lease, exchange or otherwise transfer all or substantially all of the Trust Property. Any such action must be approved by the Board of Trustees and, after notice to all shareholders entitled to vote on the matter, by the affirmative vote of a majority of all the votes entitled to be cast on the matter.

ARTICLE XII
DURATION AND TERMINATION OF TRUST

Section 12.1 Duration . The Trust shall continue perpetually unless terminated pursuant to Section 12.2 or pursuant to any applicable provision of
Title 8.




Section 12.2 Termination .

(a) Subject to the provisions of any class or series of Shares at the time outstanding, the Trust may be terminated at any meeting of shareholders, by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter. Upon the termination of the Trust:

(i) The Trust shall carry on no business except for the purpose of winding up its affairs.

(ii) The Trustees shall proceed to wind up the affairs of the Trust and all of the powers of the Trustees under the Declaration of Trust shall continue, including the powers to fulfill or discharge the Trust’s contracts, collect its assets, sell, convey, assign, exchange, transfer or otherwise dispose of all or any part of the remaining property of the Trust to one or more persons at public or private sale for consideration which may consist in whole or in part of cash, securities or other property of any kind, discharge or pay its liabilities and do all other acts appropriate to liquidate its business.

(iii) After paying or adequately providing for the payment of all liabilities, and upon receipt of such releases, indemnities and agreements as they deem necessary for their protection, the Trust may distribute the remaining property of the Trust among the shareholders so that after payment in full or the setting apart for payment of such preferential amounts, if any, to which the holders of any Shares at the time outstanding shall be entitled, the remaining property of the Trust shall, subject to any participating or similar rights of Shares at the time outstanding, be distributed ratably among the holders of Common Shares at the time outstanding.

(b) After termination of the Trust, the liquidation of its business and the distribution to the shareholders as herein provided, a majority of the Trustees shall execute and file with the Trust’s records a document certifying that the Trust has been duly terminated, and the Trustees shall be discharged from all liabilities and duties hereunder, and the rights and interests of all shareholders shall cease.

ARTICLE XIII
MISCELLANEOUS

Section 13.1 Governing Law . The Declaration of Trust is executed by the undersigned Trustees and delivered in the State of Maryland with reference to the laws thereof, and the rights of all parties and the validity, construction and effect of every provision hereof shall be subject to and construed according to the laws of the State of Maryland without regard to conflicts of laws provisions thereof.

Section 13.2 Reliance by Third Parties . Any certificate shall be final and conclusive as to any person dealing with the Trust if executed by the Secretary or an Assistant Secretary of the Trust or a Trustee, and if certifying to: (a) the number or identity of Trustees, officers of the Trust or shareholders; (b) the due authorization of the execution of any document; (c) the action or vote taken, and the existence of a quorum, at a meeting of the Board of Trustees or shareholders;



(d) a copy of the Declaration of Trust or of the Bylaws as a true and complete copy as then in force; (e) an amendment to the Declaration of Trust; (f) the termination of the Trust; or (g) the existence of any fact relating to the affairs of the Trust. No purchaser, lender, transfer agent or other person shall be bound to make any inquiry concerning the validity of any transaction purporting to be made by the Trust on its behalf or by any officer, employee or agent of the Trust.

Section 13.3 Severability .

(a) The provisions of the Declaration of Trust are severable, and if the Board of Trustees shall determine, with the advice of counsel, that any one or more of such provisions (the “Conflicting Provisions”) are in conflict with the Code, Title 8 or other applicable federal or state laws, the Conflicting Provisions, to the extent of the conflict, shall be deemed never to have constituted a part of the Declaration of Trust, even without any amendment of the Declaration of Trust pursuant to Article X and without affecting or impairing any of the remaining provisions of the Declaration of Trust or rendering invalid or improper any action taken or omitted prior to such determination. No Trustee shall be liable for making or failing to make such a determination. In the event of any such determination by the Board of Trustees, the Board shall amend the Declaration of Trust in the manner provided in Section 10.2.

(b) If any provision of the Declaration of Trust shall be held invalid or unenforceable in any jurisdiction, such holding shall apply only to the extent of any such invalidity or unenforceability and shall not in any manner affect, impair or render invalid or unenforceable such provision in any other jurisdiction or any other provision of the Declaration of Trust in any jurisdiction.

Section 13.4 Construction . In the Declaration of Trust, unless the context otherwise requires, words used in the singular or in the plural include both the plural and singular and words denoting any gender include all genders. The title and headings of different parts are inserted for convenience and shall not affect the meaning, construction or effect of the Declaration of Trust. In defining or interpreting the powers and duties of the Trust and its Trustees and officers, reference may be made by the Trustees or officers, to the extent appropriate and not inconsistent with the Code or Title 8, to Titles 1 through 3 of the Corporations and Associations Article of the Annotated Code of Maryland. In furtherance and not in limitation of the foregoing, in accordance with the provisions of Title 3, Subtitles 6 and 7, of the Corporations and Associations Article of the Annotated Code of Maryland, the Trust shall be included within the definition of “corporation” for purposes of such provisions.

Section 13.5 Recordation . The Declaration of Trust and any amendment hereto shall be filed for record with the SDAT and may also be filed or recorded in such other places as the Trustees deem appropriate, but failure to file for record the Declaration of Trust or any amendment hereto in any office other than in the State of Maryland shall not affect or impair the validity or effectiveness of the Declaration of Trust or any amendment hereto. A restated Declaration of Trust shall, upon filing, be conclusive evidence of all amendments contained therein and may thereafter be referred to in lieu of the original Declaration of Trust and the various amendments thereto.




EXHIBIT 12.1
Corporate Office Properties Trust
Ratio of Earnings to Combined Fixed Charges and Preferred Share Dividends
(Dollars in thousands)
 
 
Six Months Ended
June 30, 2018
Earnings:
 
 
Income before equity in income of unconsolidated entities and income taxes
 
$
39,264

Gain on sales of real estate
 
(27
)
Combined fixed charges and preferred share dividends (from below)
 
41,157

Amortization of capitalized interest
 
1,332

Distributed income of equity investees
 
749

Subtract:
 
 
Capitalized interest (from below)
 
(2,771
)
Preferred unit distributions included in fixed charges
 
(330
)
Preferred distributions of other consolidated entities
 
(7
)
Total earnings
 
$
79,367

 
 
 
Combined Fixed Charges and Preferred Share Dividends:
 
 
Combined fixed charges and preferred share dividends:
 
 
Interest expense
 
$
37,729

Capitalized interest (internal and external)
 
2,771

Interest included in rental expense
 
320

Preferred unit distributions
 
330

Preferred distributions of other consolidated entities
 
7

Total combined fixed charges and preferred share dividends
 
$
41,157

 
 
 
Ratio of earnings to combined fixed charges and preferred share dividends
 
1.93

 
 
 

For purposes of calculating the above ratios, earnings were computed by adding fixed charges (excluding capitalized interest), gain on sales of real estate, amortization of capitalized interest and distributed income of equity investees to income before noncontrolling interests, equity in income of unconsolidated entities and income taxes. Fixed charges consist of interest costs and capitalized amortization of debt issuance costs.




EXHIBIT 12.2
Corporate Office Properties, L.P.
Ratio of Earnings to Fixed Charges
(Dollars in thousands)
 
 
Six Months Ended
June 30, 2018
Earnings:
 
 
Income before equity in income of unconsolidated entities and income taxes
 
$
39,264

Gain on sales of real estate
 
(27
)
Fixed charges (from below)
 
40,827

Amortization of capitalized interest
 
1,332

Distributed income of equity investees
 
749

Subtract:
 
 
Capitalized interest (from below)
 
(2,771
)
Preferred distributions of other consolidated entities
 
(7
)
Total earnings
 
$
79,367

 
 
 
Fixed charges:
 
 
Interest expense
 
$
37,729

Capitalized interest (internal and external)
 
2,771

Interest included in rental expense
 
320

Preferred distributions of other consolidated entities
 
7

Total fixed charges
 
$
40,827

 
 
 
Ratio of earnings to fixed charges
 
1.94

 
 
 

For purposes of calculating the above ratios, earnings were computed by adding fixed charges (excluding capitalized interest), gain on sales of real estate, amortization of capitalized interest and distributed income of equity investees to income before noncontrolling interests, equity in income of unconsolidated entities and income taxes. Fixed charges consist of interest costs and capitalized amortization of debt issuance costs.




EXHIBIT 31.1  
CORPORATE OFFICE PROPERTIES TRUST
 
CERTIFICATIONS REQUIRED BY
RULE 13a-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
CERTIFICATIONS
 
I, Stephen E. Budorick, certify that:
 
1.             I have reviewed this Quarterly Report on Form 10-Q of Corporate Office Properties Trust;
 
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)              Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)             Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c)              Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)             Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.              The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)              All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)             Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:
July 31, 2018
 
/s/ Stephen E. Budorick
 
 
Stephen E. Budorick
 
 
President and Chief Executive Officer




EXHIBIT 31.2  
CORPORATE OFFICE PROPERTIES TRUST
 
CERTIFICATIONS REQUIRED BY
RULE 13a-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
CERTIFICATIONS
 
I, Anthony Mifsud, certify that:
 
1.             I have reviewed this Quarterly Report on Form 10-Q of Corporate Office Properties Trust;
 
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)              Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)             Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c)              Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)             Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.              The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)              All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)             Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. 

Date:
July 31, 2018
 
/s/ Anthony Mifsud
 
 
Anthony Mifsud
 
 
Chief Financial Officer




EXHIBIT 31.3  
CORPORATE OFFICE PROPERTIES, L.P.
 
CERTIFICATIONS REQUIRED BY
RULE 15d-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
CERTIFICATIONS
 
I, Stephen E. Budorick, certify that:
 
1.             I have reviewed this Quarterly Report on Form 10-Q of Corporate Office Properties, L.P.;
 
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)              Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)             Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c)              Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)             Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.              The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)              All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)             Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:
July 31, 2018
 
/s/ Stephen E. Budorick
 
 
Stephen E. Budorick
 
 
President and Chief Executive Officer
 
 
 
 




EXHIBIT 31.4  
CORPORATE OFFICE PROPERTIES, L.P.
 
CERTIFICATIONS REQUIRED BY
RULE 15d-14(a) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
CERTIFICATIONS
 
I, Anthony Mifsud, certify that:
 
1.             I have reviewed this Quarterly Report on Form 10-Q of Corporate Office Properties, L.P.;
 
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.             The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)              Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b)             Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c)              Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)             Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.              The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)              All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)             Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. 

Date:
July 31, 2018
 
/s/ Anthony Mifsud
 
 
Anthony Mifsud
 
 
Chief Financial Officer




EXHIBIT 32.1
 
CORPORATE OFFICE PROPERTIES TRUST
 
CERTIFICATIONS REQUIRED BY

RULE 13a-14(b) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
In connection with the Quarterly Report on Form 10-Q of Corporate Office Properties Trust (the “Company”) for the quarter ended June 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen E. Budorick, President and Chief Executive Officer of the Company, certify that to my knowledge:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
 
/s/ Stephen E. Budorick
Stephen E. Budorick
President and Chief Executive Officer
 
Date:
July 31, 2018





EXHIBIT 32.2
 
CORPORATE OFFICE PROPERTIES TRUST
 
CERTIFICATIONS REQUIRED BY

RULE 13a-14(b) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
In connection with the Quarterly Report on Form 10-Q of Corporate Office Properties Trust (the “Company”) for the quarter ended June 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Anthony Mifsud, Chief Financial Officer of the Company, certify that to my knowledge:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
 
/s/ Anthony Mifsud
Anthony Mifsud
Chief Financial Officer
 
Date:
July 31, 2018





EXHIBIT 32.3
 
CORPORATE OFFICE PROPERTIES, L.P.
 
CERTIFICATIONS REQUIRED BY

RULE 15d-14(b) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
In connection with the Quarterly Report on Form 10-Q of Corporate Office Properties, L.P. (the “Company”) for the quarter ended June 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen E. Budorick, President and Chief Executive Officer of the Company, certify that to my knowledge:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 

/s/ Stephen E. Budorick
Stephen E. Budorick
President and Chief Executive Officer
 
Date:
July 31, 2018





EXHIBIT 32.4
 
CORPORATE OFFICE PROPERTIES, L.P.
 
CERTIFICATIONS REQUIRED BY

RULE 15d-14(b) UNDER THE SECURITIES EXCHANGE ACT OF 1934
 
In connection with the Quarterly Report on Form 10-Q of Corporate Office Properties, L.P. (the “Company”) for the quarter ended June 30, 2018 , as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Anthony Mifsud, Chief Financial Officer of the Company, certify that to my knowledge:
 
(1)           The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
 
 

/s/ Anthony Mifsud
Anthony Mifsud
Chief Financial Officer
 
Date:
July 31, 2018