UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

 

For the transition period from                          to                      

Commission file number 1-14023

 

Corporate Office Properties Trust

(Exact name of registrant as specified in its charter)

 

 

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.

x Yes     Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

o Yes     Nox

On November 3, 2006, 42,821,762 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

 

TABLE OF CONTENTS

FORM 10-Q

			Page
PART I: FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005 (unaudited)		3
	Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 (unaudited)		4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 (unaudited)		5
	Notes to Consolidated Financial Statements		6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
Item 3:	Quantitative and Qualitative Disclosures About Market Risk		47
Item 4:	Controls and Procedures		48
PART II: OTHER INFORMATION
Item 1:	Legal Proceedings		48
Item 1A:	Risk Factors		48
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds		49
Item 3:	Defaults Upon Senior Securities		49
Item 4:	Submission of Matters to a Vote of Security Holders		49
Item 5:	Other Information		49
Item 6:	Exhibits		49
SIGNATURES			51

 

2

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)
(unaudited)

		September 30,			December 31,
		2006			2005
Assets
Investment in real estate:
Operating properties, net		$	1,740,326		$	1,631,038
Projects under construction or development		315,360			255,617
Total commercial real estate properties, net		2,055,686			1,886,655
Investments in and advances to unconsolidated real estate joint ventures		—			1,451
Investment in real estate, net		2,055,686			1,888,106
Cash and cash equivalents		10,810			10,784
Restricted cash		51,784			21,476
Accounts receivable, net		26,778			15,606
Investment in other unconsolidated entity		1,621			1,621
Deferred rent receivable		39,033			32,579
Intangible assets on real estate acquisitions, net		92,061			90,984
Deferred charges, net		40,091			35,046
Prepaid and other assets		27,684			29,255
Furniture, fixtures and equipment, net		10,374			4,302
Total assets		$	2,355,922		$	2,129,759
Liabilities and shareholders’ equity
Liabilities:
Mortgage and other loans payable		$	1,206,682		$	1,348,351
3.5% Exchangeable Senior Notes		200,000			—
Accounts payable and accrued expenses		55,487			41,693
Rents received in advance and security deposits		20,842			14,774
Dividends and distributions payable		19,810			16,703
Deferred revenue associated with acquired operating leases		12,074			12,707
Distributions in excess of investment in unconsolidated real estate joint venture		3,103			3,081
Fair value of derivatives		473			—
Other liabilities		5,526			4,727
Total liabilities		1,523,997			1,442,036
Minority interests:
Common units in the Operating Partnership		107,212			95,014
Preferred units in the Operating Partnership		8,800			8,800
Other consolidated real estate joint ventures		1,760			1,396
Total minority interests		117,772			105,210
Commitments and contingencies (Note 20)
Shareholders’ equity:
Preferred Shares of beneficial interest ($0.01 par value; shares authorized  of 15,000,000, issued and outstanding of 9,015,000 at September 30, 2006  and 6,775,000 at December 31, 2005) (Note 14)		90			67
Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued and outstanding of 42,810,978 at September 30, 2006 and 39,927,316 at December 31, 2005)		424			399
Additional paid-in capital		790,526			657,339
Cumulative distributions in excess of net income		(76,046		)	(67,697		)
Value of unearned restricted common share grants		—			(7,113		)
Accumulated other comprehensive loss		(841		)	(482		)
Total shareholders’ equity		714,153			582,513
Total liabilities and shareholders’ equity		$	2,355,922		$	2,129,759

 

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
(unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2006			2005			2006			2005
Revenues
Rental revenue		$	66,550		$	53,182		$	190,166		$	155,808
Tenant recoveries and other real estate operations revenue		11,586			7,826			29,686			21,317
Construction contract revenues		13,219			28,476			39,919			61,649
Other service operations revenues		1,572			1,308			5,321			3,696
Total revenues		92,927			90,792			265,092			242,470
Expenses
Property operating expenses		25,430			18,272			68,698			52,940
Depreciation and other amortization associated with real estate operations		21,680			17,522			58,631			45,943
Construction contract expenses		12,465			28,073			38,134			60,193
Other service operations expenses		1,495			1,253			4,991			3,499
General and administrative expenses		4,226			3,318			11,895			9,760
Total operating expenses		65,296			68,438			182,349			172,335
Operating income		27,631			22,354			82,743			70,135
Interest expense		(17,974		)	(13,894		)	(52,493		)	(39,960		)
Amortization of deferred financing costs		(736		)	(639		)	(1,899		)	(1,500		)
Income from continuing operations before equity in income (loss) of unconsolidated entities, income taxes and minority interests		8,921			7,821			28,351			28,675
Equity in income (loss) of unconsolidated entities		15			—			(40		)	—
Income tax expense		(202		)	(263		)	(623		)	(933		)
Income from continuing operations before minority interests		8,734			7,558			27,688			27,742
Minority interests in income from continuing operations
Common units in the Operating Partnership		(808		)	(752		)	(2,839		)	(3,216		)
Preferred units in the Operating Partnership		(165		)	(165		)	(495		)	(495		)
Other consolidated entities		38			19			96			58
Income from continuing operations		7,799			6,660			24,450			24,089
Income from discontinued operations, net of minority interests		12,191			3,870			14,458			4,413
Income before gain on sales of real estate		19,990			10,530			38,908			28,502
Gain on sales of real estate, net		597			59			732			247
Net income		20,587			10,589			39,640			28,749
Preferred share dividends		(4,307		)	(3,653		)	(11,614		)	(10,961		)
Issuance costs associated with redeemed preferred shares		(1,829		)	—			(1,829		)	—
Net income available to common shareholders		$	14,451		$	6,936		$	26,197		$	17,788
Basic earnings per common share
Income from continuing operations		$	0.05		$	0.08		$	0.29		$	0.36
Discontinued operations		0.29			0.11			0.35			0.12
Net income		$	0.34		$	0.19		$	0.64		$	0.48
Diluted earnings per common share
Income from continuing operations		$	0.05		$	0.08		$	0.27		$	0.35
Discontinued operations		0.28			0.10			0.34			0.11
Net income		$	0.33		$	0.18		$	0.61		$	0.46

 

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands)
(unaudited)

		For the Nine Months Ended September 30,
		2006			2005
Cash flows from operating activities
Net income		$	39,640		$	28,749
Adjustments to reconcile net income to net cash provided by operating activities:
Minority interests		6,471			4,806
Depreciation and other amortization		59,993			47,951
Amortization of deferred financing costs		2,032			1,508
Amortization of deferred market rental revenue		(1,326		)	(32		)
Equity in loss of unconsolidated entities		40			—
Gain on sales of real estate		(17,990		)	(4,674		)
Changes in operating assets and liabilities:
Increase in deferred rent receivable		(7,446		)	(4,570		)
Increase in accounts receivable, restricted cash and prepaid and other assets		(11,308		)	(3,504		)
Increase in accounts payable, accrued expenses, rents received in advance and security deposits		14,176			4,322
Other		2,304			1,666
Net cash provided by operating activities		86,586			76,222
Cash flows from investing activities
Purchases of and additions to commercial real estate properties		(227,592		)	(279,082		)
Proceeds from sales of properties		46,708			29,470
Proceeds from sale of unconsolidated real estate joint venture		1,524			—
Proceeds from contributions of assets to unconsolidated real estate joint venture		—			68,646
Investments in and advances from unconsolidated entities		127			36
Distributions from unconsolidated entities		367			—
Leasing costs paid		(6,106		)	(6,582		)
Decrease (increase) in restricted cash associated with investing activities		5,559			(110		)
Purchases of furniture, fixtures and equipment		(7,549		)	(1,850		)
Other		(182		)	(759		)
Net cash used in investing activities		(187,144		)	(190,231		)
Cash flows from financing activities
Proceeds from mortgage and other loans payable		368,259			423,699
Proceeds from 3.5% Exchangeable Senior Notes		200,000			—
Repayments of mortgage and other loans payable		(548,090		)	(334,890		)
Deferred financing costs paid		(5,402		)	(2,752		)
Acquisition of partner interests in consolidated joint ventures		(3,016		)	(1,208		)
Distributions paid to partners in consolidated joint ventures		(787		)	—
Net proceeds from issuance of common shares		88,622			78,260
Net proceeds from issuance of preferred shares		81,863			—
Redemption of preferred shares		(28,750		)	—
Dividends paid		(45,138		)	(38,968		)
Distributions paid		(7,614		)	(7,060		)
Other		637			455
Net cash provided by financing activities		100,584			117,536
Net increase in cash and cash equivalents		26			3,527
Cash and cash equivalents
Beginning of period		10,784			13,821
End of period		$	10,810		$	17,348

 

See accompanying notes to consolidated financial statements.

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Corporate Office Properties Trust and Subsidiaries

Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(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”) that focuses on the acquisition, development, ownership, management and leasing of primarily Class A suburban office properties in the Greater Washington, D.C. region and other select submarkets.  We have implemented a core customer expansion strategy that is built on meeting, through acquisitions and development, the multi-location requirements of our strategic tenants.  As of September 30, 2006, our investments in real estate included the following:

·                  168 wholly owned operating properties totaling 14.6 million square feet;

·                  17 wholly owned properties under construction or development that we estimate will total approximately 2.1 million square feet upon completion and two wholly owned office properties totaling approximately 115,000 square feet that were under redevelopment;

·                  wholly owned land parcels totaling 555 acres that we believe are potentially developable into approximately 6.9 million square feet; and

·                  partial ownership interests in a number of other real estate projects in operations or under development or redevelopment.

We conduct almost all of our operations through our operating partnership, Corporate Office Properties, L.P. (the “Operating Partnership”), of which we are the general partner.  The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies (“LLCs”).  A summary of our Operating Partnership’s forms of ownership and the percentage of those securities owned by COPT as of September 30, 2006 follows:

 

Two of our trustees controlled, either directly or through ownership by other entities or family members, an additional 14% of the Operating Partnership’s common units.

In addition to owning interests in real estate, the Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) and, either directly or through COMI, 100% of the consolidated subsidiaries that are set forth below (collectively defined as the “Service Companies”):

Entity Name		Type of Service Business
COPT Property Management Services, LLC (“CPM”)		Real Estate Management
COPT Development & Construction Services, LLC (“CDC”)		Construction and Development
Corporate Development Services, LLC (“CDS”)		Construction and Development
Corporate Cooling & Controls, LLC (“CC&C”)		Heating and Air Conditioning

 

Most of the services that CPM provides are for us.  CDC, CDS and CC&C provide services to us and to third parties.

2.                                      Basis of Presentation

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, certain information and disclosures

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required by accounting principles generally accepted in the United States for complete Consolidated Financial Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our Current Report on Form 8-K filed on August 31, 2006.  The interim financial statements on the previous pages reflect all adjustments that we believe are necessary for the fair statement of our financial position and results of operations for the interim periods presented.  These adjustments are of a normal recurring nature.  The results of operations for such interim periods are not necessarily indicative of the results for a full year.

3.             Earnings Per Share (“EPS”)

 We present both basic and diluted EPS.  We compute basic EPS by dividing net income available to common shareholders by the weighted average number of 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 our common shares were converted; and (2) the effect of dilutive potential common shares outstanding during the period attributable to share-based compensation using the treasury stock method; and

·                  the numerator is adjusted to add back any convertible preferred dividends and any other changes in income or loss that would result from the assumed conversion into common shares.

Our computation of diluted EPS does not assume conversion of securities into our common shares if conversion of those securities would increase our diluted EPS in a given period.  A summary of the numerator and denominator for purposes of basic and diluted EPS calculations is set forth below (dollars and shares in thousands, except per share data):

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2006			2005			2006			2005
Numerator:
Income from continuing operations		$	7,799		$	6,660		$	24,450		$	24,089
Add: Gain on sales of real estate, net		597			59			732			247
Less: Preferred share dividends		(4,307		)	(3,653		)	(11,614		)	(10,961		)
Less: Issuance costs associated with redeemed preferred shares		(1,829		)	—			(1,829		)	—
Numerator for basic and diluted EPS from continuing operations available to common shareholders		2,260			3,066			11,739			13,375
Add: Income from discontinued operations, net		12,191			3,870			14,458			4,413
Numerator for basic and diluted EPS on net income  available to common shareholders		$	14,451		$	6,936		$	26,197		$	17,788
Denominator (all weighted averages):
Denominator for basic EPS (common shares)		42,197			36,913			41,134			36,721
Dilutive effect of share-based compensation awards		1,649			1,667			1,785			1,595
Denominator for diluted EPS		43,846			38,580			42,919			38,316
Basic EPS:
Income from continuing operations		$	0.05		$	0.08		$	0.29		$	0.36
Income from discontinued operations		0.29			0.11			0.35			0.12
Net income available to common shareholders		$	0.34		$	0.19		$	0.64		$	0.48
Diluted EPS:
Income from continuing operations		$	0.05		$	0.08		$	0.27		$	0.35
Income from discontinued operations		0.28			0.10			0.34			0.11
Net income available to common shareholders		$	0.33		$	0.18		$	0.61		$	0.46

 

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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: 

		Weighted Average Shares in Denominator
		For the Three Months Ended September 30,				For the Nine Months Ended September 30,
		2006		2005		2006		2005
Conversion of weighted average common units		8,562		8,758		8,516		8,707
Conversion of weighted average convertible preferred units		176		176		176		176
Share-based compensation awards		—		191		—		175

 

4.             Recent Accounting Pronouncements

See Note 5 for disclosure associated with our implementation of recent accounting pronouncements relating to our accounting for share-based compensation.

In June 2005, the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) regarding EITF 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.”  The conclusion provided a framework for addressing the question of when a general partner, as defined in EITF 04-05, should consolidate a limited partnership.  Under the consensus, a general partner is presumed to control a limited partnership (or similar entity) and should consolidate that entity unless the limited partners possess kick-out rights or other substantive participating rights as described in EITF 96-16, “Investor’s Accounting for an Investee When the Investor has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.”  This EITF was initially effective for all new limited partnerships formed and for existing limited partnerships for which the partnership agreements were modified after June 29, 2005, and, as of January 1, 2006, for existing limited partnership agreements.  The EITF did not impact us in 2005.  The adoption of this EITF in 2006 for existing limited partnership agreements did not have a material effect on our financial position, results of operations or cash flows.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” (“FIN 48”).  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.”  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  We do not expect that the implementation of FIN 48 will have a material effect on our financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).   SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  The Statement does not require any new fair value measurements but does apply under other accounting pronouncements that require or permit fair value measurements.  The changes to current practice resulting from the Statement relate to the definition of fair value, the methods used to measure fair value and the expanded disclosures about fair value measurements.  SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with earlier application encouraged.  We do not expect that the adoption of this Statement will have a material effect on our financial position, results of operations or cash flows.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”), which addresses diversity in practice in quantifying financial statement misstatements and the potential under current practice for the build up of improper amounts on the balance sheet.  There have historically been two widely recognized methods for quantifying the effects of financial statement errors: the “roll-over” method and the “iron curtain” method.  The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements on the balance sheet.  Conversely, the iron-curtain method focuses primarily on the effect of correcting the period end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement.  SAB 108 establishes an approach that requires quantification of financial statement errors based on the effects of the

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error on each of the company’s financial statements and the related financial statement disclosures.  This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron-curtain and the roll-over methods.  SAB 108 is effective for financial statements for fiscal years ending after November 15, 2006.  We do not expect that SAB 108 will have a material effect on our consolidated financial position or results of operations.

5.             Share-Based Compensation

Share-based Compensation Plans

In 1993, we adopted a share option plan for our Trustees under which we have 75,000 common shares reserved for issuance.  These options expire ten years after the date of grant and are all exercisable.  Shares for this plan are issued under a registration statement on Form S-8 that became effective upon filing with the Securities and Exchange Commission.  As of September 30, 2006, there were no awards available for future grant under this plan.

In March 1998, we adopted a long-term incentive plan for our Trustees and employees.  This plan provides for the award of options to acquire our common shares (“share options”), common shares subject to forfeiture restrictions (“restricted shares”) and dividend equivalents.  We are authorized to issue awards under the plan amounting to no more than 13% of the total of (1) our common shares outstanding plus (2) the number of shares that would be outstanding upon redemption of all units of the Operating Partnership or other securities that are convertible into our common shares.  Trustee options under this plan become exercisable beginning on the first anniversary of their grant.  The vesting periods for employees’ options under this plan range from immediately to five years, although they generally are three years.  Options expire ten years after the date of grant.  Restricted shares generally vest annually in the following increments: 16% upon the first anniversary following the date of grant, 18% upon the second anniversary, 20% upon the third anniversary, 22% upon the fourth anniversary and 24% upon the fifth anniversary.  Shares for this plan are issued under a registration statement on Form S-8 that became effective upon filing with the Securities and Exchange Commission.  As of September 30, 2006, we had 743,683 awards available for future grant under this plan.

The following table summarizes share option transactions under the plans described above for the nine months
ended September 30, 2006:

		Shares		Weighted Average Exercise Price per Share			Weighted Average Remaining Contractual Term (in Years)				Aggregate Intrinsic Value
Outstanding at December 31, 2005		2,709,927		$	14.41
Granted		443,149		$	42.00
Forfeited		(41,978	)	$	32.11
Exercised		(561,568	)	$	11.16
Outstanding at September 30, 2006		2,549,530		$	19.63			6			$	64,172
Exercisable at September 30, 2006		1,771,197		$	12.64			5			$	56,886
Options expected to vest		739,416		$	35.52			9			$	6,922

 

The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $18,916.

We received $6,265 in proceeds from the exercise of share options during the nine months ended September 30, 2006.

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The following table summarizes restricted share transactions under the plans described above for the nine months ended September 30, 2006:

 

 

The total fair value of restricted shares vested during the nine months ended September 30, 2006 was $5,319.

We did not realize a windfall tax benefit for the 2006 periods on options exercised and restricted shares vested by employees of our subsidiaries that are subject to income tax due to the existence of a net operating loss carryforward on such subsidiaries.

Adoption of Statement of Financial Accounting Standards No. 123(R)

We have historically issued two forms of share-based compensation: share options and restricted shares.  Prior to January 1, 2006, when we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), our general method for accounting for these forms of share-based compensation was as follows:

·                  Share options: These awards were accounted for using the intrinsic value method.  Under this method, we recorded compensation expense only when the exercise price of a grant was less than the market price of our common shares on the option grant date; when this occurred, we recognized compensation expense equal to the difference between the exercise price and the grant-date market price over the service period to which the options related.

·                  Restricted shares: We computed compensation expense for restricted share grants based on the value of such grants, as determined by the value of our common shares on the applicable measurement date (generally the date of grant).  We recognized compensation expense for such grants over the service periods to which the grants related based on the vesting schedules for such grants.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123(R).  The statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, focusing primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.  The statement requires us to measure the cost of employee services received in exchange for an award of equity instruments based generally on the fair value of the award on the grant date; such cost should then be recognized over the period during which the employee is required to provide service in exchange for the award (generally the vesting period).  No compensation cost is recognized for equity instruments for which employees do not render the requisite service.  In 2005, the FASB also issued several FASB Staff Positions that clarify certain aspects of SFAS 123(R).  SFAS 123(R) became effective for us on January 1, 2006, applying to all awards granted after January 1, 2006 and to awards modified, repurchased or cancelled after that date.  We used the modified prospective application approach to adoption provided for under SFAS 123(R); under this approach, we recognized compensation cost on or after January 1, 2006 for the portion of outstanding awards for which the requisite service was not yet rendered, based on the fair value of those awards on the date of grant.

The primary effect of our adoption of SFAS 123(R) on our Consolidated Financial Statements is that beginning January 1, 2006 we are: (1) incurring higher expense associated with share options issued to employees relative to what we would have recognized under the intrinsic value method; (2) recognizing expenses associated with restricted common shares over the life of the grant using a straight line basis methodology over the service period; and (3) reporting the benefits of tax deductions in excess of recognized compensation costs as cash flow from financing activities (such benefits were previously reported as operating cash flows).

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Prior to our adoption of SFAS 123(R), we provided disclosures in our financial statements for periods prior to 2006 that summarized what our operating results would have been if we had elected to account for our share-based compensation under the fair value provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).  In computing the amounts that appeared in these disclosures, we accounted for forfeitures as they occurred.  SFAS 123(R) requires that share-based compensation be computed based on awards that are ultimately expected to vest.  As a result, future forfeitures of awards are to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  SFAS 123(R) also requires that companies make a one-time cumulative effect adjustment upon adoption of the standard to record the effect that estimated future forfeitures of outstanding awards would have on expenses previously recognized in the companies’ financial statements; we did not record such a cumulative effect adjustment since we determined that the effect of pre-vesting forfeitures on our recorded expense has historically been negligible.  The amounts included in our Consolidated Statements of Operations for share-based compensation in the three and nine months ended September 30, 2006 reflected an estimate of pre-vesting forfeitures of approximately 5%.

In the disclosures that we provided in our financial statements for periods prior to 2006 that summarized what our operating results would have been if we had elected to account for our share-based compensation under the fair value provisions of SFAS 123, we did not capitalize costs associated with share-based compensation.  Effective upon our adoption of SFAS 123(R), we began capitalizing costs associated with share-based compensation.

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.”  We elected to adopt the alternative transition method provided in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123(R).  The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of
SFAS 123(R).

We compute the fair value of share options under SFAS 123(R) using the Black-Scholes option-pricing model; the weighted average assumptions we used in that model for share options issued during the nine months ended September 30, 2006 are set forth below:

(1)             Ranged from 4.35% to 5.31%.

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.  The expected option life is based on our historical experience of employee exercise behavior.  Expected volatility is based on historical volatility of our common shares.  Expected dividend yield is based on the average historical dividend yield on our common shares over a period of time ending on the grant date of the options.

The table below sets forth information relating to expenses from share-based compensation included in our Consolidated Statements of Operations for the three and nine months ended September 30, 2006:

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We also capitalized share-based compensation costs of approximately $52 in the three months ended September 30, 2006 and $137 in the nine months ended September 30, 2006.

As of September 30, 2006, there was $1,492 of unrecognized compensation cost related to nonvested options that is expected to be recognized over a weighted average period of approximately two years.  As of September 30, 2006, there was $9,273 of unrecognized compensation cost related to unvested restricted shares that is expected to be recognized over a weighted average period of approximately three years.

Disclosure for Periods Prior to 2006, Including Pro Forma Financial Information Under SFAS 123

Expenses from share-based compensation reflected in our Consolidated Statements of Operations for the three and nine months ended September 30, 2005 were as follows:

The following table summarizes our operating results for the three and nine months ended September 30, 2005 as if we elected to account for our share-based compensation under the fair value provisions of SFAS 123 in that period:

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		For the Three Months Ended September 30, 2005			For the Nine Months Ended September 30, 2005
Net income, as reported		$	10,589		$	28,749
Add: Share-based compensation expense, net of related tax effects and minority interests, included in the determination of net income		437			1,239
Less: Share-based compensation expense determined under the fair value based method, net of related tax effects and minority interests		(432		)	(1,200		)
Net income, pro forma		$	10,594		$	28,788
Basic EPS on net income available to common shareholders, as reported		$	0.19		$	0.48
Basic EPS on net income available to common shareholders, pro forma		$	0.19		$	0.49
Diluted EPS on net income available to common shareholders, as reported		$	0.18		$	0.46
Diluted EPS on net income available to common shareholders, pro forma		$	0.18		$	0.47

 

The share-based compensation expense under the fair value method, as reported in the above table, was computed using the Black-Scholes option-pricing model.

6.             Commercial Real Estate Properties

Operating properties consisted of the following:

 

Projects we had under construction or pre-construction consisted of the following:

 

 

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2006 Acquisitions

We acquired the following office properties during the nine months ended September 30, 2006:

 

										Total
				Date of		Number of				Rentable
Project Name		Location		Acquisition		Buildings				Square Feet		Initial Cost
North Creek		Colorado Springs, CO		5/18/2006			3			324,549		$	41,508
1915 & 1925 Aerotech Drive		Colorado Springs, CO		6/8/2006			2			75,892		8,378
7125 Columbia Gateway Drive		Columbia, MD (1)		6/29/2006			1			611,379		74,168
							6			1,011,820		$	124,054

(1)             Located in the Baltimore/Washington Corridor.

The table below sets forth the allocation of the acquisition costs of the properties described above:

					1915 & 1925			7125
					Aerotech			Columbia
		North Creek			Drive			Gateway Drive			Total
Land, operating properties		$	2,735		$	1,113		$	17,126		$	20,974
Building and improvements		34,161			6,161			46,964			87,286
Intangible assets on real estate acquisitions		5,694			1,235			11,959			18,888
Total assets		42,590			8,509			76,049			127,148
Deferred revenue associated with  acquired operating leases		(1,082		)	(131		)	(1,881		)	(3,094		)
Total acquisition cost		$	41,508		$	8,378		$	74,168		$	124,054

 

Intangible assets recorded in connection with these acquisitions included the following:

					Weighted
					Average
					Amortization
		Cost			Period
Lease-up value		$	12,867		3
Tenant relationship value		3,345			6
Lease cost portion of deemed  cost avoidance		1,825			3
Lease to market value		851			5
		$	18,888		4

 

During the nine months ended September 30, 2006, we also acquired the following:

·                  a property located in Colorado Springs, Colorado containing a 60,000 square foot building that will be redeveloped and a four-acre parcel of land that we believe can support approximately 30,000 developable square feet for $2,602 on January 19, 2006;

·                  a 31-acre parcel of land located in San Antonio, Texas that we believe can support up to 375,000 developable square feet for $7,430 on January 20, 2006;

·                  a six-acre parcel of land located in Hanover, Maryland that we believe can support up to 60,000 developable square feet for $2,141 on February 28, 2006 (Hanover, Maryland is located in the Baltimore/Washington Corridor);

·                  a 20-acre parcel of land located in Colorado Springs, Colorado that we believe can support up to 300,000 developable square feet for $1,060 on April 21, 2006;

·                  a 13-acre parcel of land located in Colorado Springs, Colorado that we believe can support up to 150,000 developable square feet for $2,263 on May 19, 2006;

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·                  a 178-acre parcel of land located in Annapolis Junction, Maryland, located adjacent to the National Business Park, that we believe can support up to 1.25 million developable square feet for $26,833 on June 29, 2006 (Annapolis Junction, Maryland is located in the Baltimore/Washington Corridor);

·                  a five-acre parcel of land located in Columbia, Maryland that we believe can support up to 120,000 developable square feet for $3,361 on June 29, 2006; and

·                  a 28-acre parcel of land located in Chesterfield, Virginia on September 15, 2006 that was acquired under the terms of a lease for a 193,000 square foot building that we are constructing on the property (Chesterfield, Virginia, which is located in Greater Richmond, Virginia, is included in our “other” business segment).  The fair value of the land and closing costs associated with the title transfer totaled $1,303.

We also acquired a 50% interest in a consolidated joint venture called Commons Office 6-B, LLC that owns a land parcel located in Hanover, Maryland for $1,830 on February 10, 2006.  The joint venture is constructing an office property totaling approximately 44,000 square feet on the land parcel.

2006 Construction and Pre-Construction Activities

During 2006, we fully placed into service two properties totaling 212,000 (one located in the Baltimore/Washington Corridor and one in Colorado Springs, Colorado) and placed into service a portion of two properties totaling 179,000 square feet (both located in the Baltimore/Washington Corridor).

As of September 30, 2006, we had construction underway on six new buildings in the Baltimore/Washington Corridor (including the one 50% joint venture discussed above), one in Northern Virginia, one in St. Mary’s County, Maryland, one in Suburban Baltimore and one in Chesterfield, Virginia.  We also had pre-construction activities underway on four new buildings located in the Baltimore/Washington Corridor (including one through a 50% joint venture, the formation of which was pending at September 30, 2006), one in Suburban Maryland, one in King George County, Virginia, two in Colorado Springs, Colorado and one in Suburban Baltimore.  In addition, we had redevelopment underway on two wholly owned existing buildings (one is located in the Baltimore/Washington Corridor and one in Colorado Springs, Colorado) and two buildings owned by a joint venture (one is located in Northern Virginia and one in the Baltimore/Washington Corridor).

2006 Dispositions

We sold the following operating properties during the nine months ended September 30, 2006:

 

						Number				Total
				Date of		of				Rentable					Gain on
Project Name		Location		Sale		Buildings				Square Feet		Sale Price			Sale
Lakeview at the Greens		Laurel, Maryland (1)		2/6/2006			2			141,783		$	17,000		$	2,087
68 Culver Road		Dayton, New Jersey		3/8/2006			1			57,280		9,700			316
710 Route 46		Fairfield, New Jersey		7/26/2006			1			101,263		15,750			4,498
230 Schilling Circle		Woodlawn, Maryland (2)		8/9/2006			1			107,348		13,795			951
7 Centre Drive		Monroe, New Jersey		8/30/2006			1			19,468		3,000			684
Brown’s Wharf		Baltimore, Maryland		9/28/2006			1			104,203		20,300			8,565
							7			531,345		$	79,545		$	17,101

(1)             Located in the Suburban Maryland region.

(2)             Located in the Suburban Baltimore region.

During the nine months ended September 30, 2006, we also sold the following:

·                  a newly constructed property in Columbia, Maryland for $2,530 on January 17, 2006.  We recognized a gain of $111 on this sale; and

·                  a two-acre parcel of land located in Linthicum Heights, Maryland for $900 on September 7, 2006.  We recognized a gain of $165 on this sale.

7.                                      Real Estate Joint Ventures

Our investments in and advances to unconsolidated real estate joint ventures accounted for using the equity method of accounting included the following:

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Investment Balance at

Total

Maximum

September 30,

December 31,

Date

Owner-

Nature of

Assets at

Exposure

2006

2005

Acquired

ship

Activity

9/30/2006

to Loss (1)

Harrisburg Corporate  Gateway Partners, L.P.

$(3,103)

(2)

$(3,081)

(2)

9/29/2005

20 %

Operates 16 buildings

(3)

$76,827

—

Route 46 Partners

—

(4)

1,451

3/14/2003

20 %

Operates one building

(5)

N/A

N/A

(1)             Derived from the sum of our investment balance and maximum additional unilateral capital contributions or loans required from us.  Not reported above are additional amounts that we and our partner are required to fund when needed by this joint venture; these funding requirements are proportional to our respective ownership percentages.  Also not reported above are additional unilateral contributions or loans from us, the amounts of which are uncertain, that would be due if certain contingent events occurred.

(2)             The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $5,195 at September 30, 2006 and $5,204 at December 31, 2005 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation.  A difference will continue to exist to the extent the nature of our continuing involvement in the joint venture does not change.

(3)             This joint venture’s properties are located in Greater Harrisburg, Pennsylvania.

(4)             As discussed further below, we sold the property owned by this joint venture on July 26, 2006, after which the joint venture was dissolved.  The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $1,370 at December 31, 2005 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation.

(5)          This joint venture’s property was located in Fairfield, New Jersey.

On July 26, 2006, Rt. 46 Partners sold its property for $27,000.  After the sale, the joint venture was dissolved.  We recognized a gain of $563 on the disposition of our joint venture interest.

The following table sets forth condensed balance sheets for our unconsolidated real estate joint ventures:

 

 

The following table sets forth combined condensed statements of operations for the three and nine months ended September 30, 2006 for the two unconsolidated joint ventures we owned during the nine months ended September 30, 2006:

 

The table above includes net income from Rt. 46 Partners of $3,272 for the three month period and $3,501 for the nine month period.  Our joint venture partner in Route 46 Partners had preference in receiving distributions of cash flows for a defined return.  We were not entitled to receive distributions for a defined return until our partner received its defined return.  We did not recognize income from our investment in Route 46 Partners in the three and nine months ended September 30, 2006 and 2005 until the dissolution of the entity since the income earned by

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the entity in those periods did not exceed our partner’s defined return until that point in time.  Upon dissolution of the entity, we recognized income from our investment of $60, excluding the $563 gain on disposition of the joint venture interest discussed above.

Our investments in consolidated real estate joint ventures included the following:

				Ownership				Total			Collateralized
		Date		% at		Nature of		Assets at			Assets at
		Acquired		9/30/2006		Activity		9/30/2006			9/30/2006
COPT Opportunity Invest I, LLC		12/20/2005		92.5%		Redeveloping two properties(1)		$	39,130		$	—
Commons Office 6-B, LLC		2/10/2006		50.0%		Developing land parcel(2)		7,118			7,118
MOR Forbes 2 LLC		12/24/2002		50.0%		Operating building(3)		4,192			3,787
								$	50,440		$	10,905

(1)             This joint venture owns one property in Northern Virginia and one in the Baltimore/Washington Corridor.

(2)             This joint venture’s property is located in Hanover, Maryland (located in the Baltimore/Washington Corridor region).

(3)             This joint venture’s property is located in Lanham, Maryland (located in the Suburban Maryland region).

On January 17, 2006 we acquired our partner’s remaining 50% interest in MOR Montpelier 3 LLC, an entity that recently completed the construction of an office property, for $1,186.  We then sold the property to a third party for $2,530, as discussed in Note 6.

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 20.

8.             Intangible Assets on Real Estate Acquisitions

Intangible assets on real estate acquisitions consisted of the following:

		September 30, 2006									December 31, 2005
		Gross Carrying			Accumulated			Net Carrying			Gross Carrying			Accumulated			Net Carrying
		Amount			Amortization			Amount			Amount			Amortization			Amount
Lease-up value		$	105,719		$	34,608		$	71,111		$	92,812		$	20,824		$	71,988
Lease cost portion of deemed  cost avoidance		12,880			5,409			7,471			11,054			3,991			7,063
Lease to market value		10,623			6,802			3,821			9,772			5,277			4,495
Tenant relationship value		9,371			907			8,464			6,349			130			6,219
Market concentration premium		1,333			139			1,194			1,333			114			1,219
		$	139,926		$	47,865		$	92,061		$	121,320		$	30,336		$	90,984

 

Amortization of the intangible asset categories set forth above totaled approximately $15.9 million in the nine months ended September 30, 2006 and $10.2 million in the nine months ended September 30, 2005.  The approximate weighted average amortization periods of the categories set forth above follow: lease up value: 6 years; lease cost portion of deemed cost avoidance: 4 years; lease to market value: 3 years; tenant relationship value: 5 years; and market concentration premium: 36 years.  The approximate weighted average amortization period for all of the categories combined above is 5 years.  Estimated amortization expense associated with the intangible asset categories set forth above for the three months ended December 31, 2006 is $4.3 million, for 2007 is $15.1 million, 2008 is $13.4 million, 2009 is $11.5 million, 2010 is $8.5 million and 2011 is $6.7 million.

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