Gladstone Commercial Management Discusses Q4 2012 Results - Earnings Call Transcript

| About: Gladstone Commercial (GOOD)

Gladstone Commercial (NASDAQ:GOOD)

Q4 2012 Earnings Call

February 20, 2013 8:30 am ET


David J. Gladstone - Founder, Chairman, Chief Executive Officer, Chairman of Executive Committee, Chairman of Gladstone Management Corporation and Chief Executive Officer of Gladstone Management Corporation

Robert G. Cutlip - President and Senior Managing Director

Danielle Jones - Chief Financial Officer, Principal Accounting Officer and Treasurer


John M. Roberts - Hilliard Lyons, Research Division


Good morning and welcome to the Gladstone Commercial Fourth Quarter and Year-Ended December 31, 2012, Conference Call. [Operator Instructions] Please note this event is being recorded. Now, I would like to turn the conference over to David Gladstone. Please go ahead.

David J. Gladstone

All right. Thank you, Emily, and thanks to all of you for calling in. We always enjoy these times that we have with you on the phone and we certainly wish we had more time to talk to you. Please come and visit us if you're ever in the Washington D.C. area. We're located in the suburb called McLean, Virginia. You have an open invitation to stop by and see us if you're in this area. You'll see a great team in work. There's now about 57 members of the team. So, we're no longer a small company, we're sort of midsized. And, oh, we have a few puppy dogs out here as well that come into the office on a regular routine basis.

Let me just read the forward-looking statements that we read each time. This report that we're about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, including statements with regard to future performance of the company. These forward-looking statements involve certain risks and uncertainties and are based on our current plans, and we believe those plans to be accurate.

There are many factors that may cause our actual results to be materially different from any future results expressed or implied in these forward-looking statements, including those factors listed under the caption "Risk Factors" of our company's 10-Ks and 10-Q filings that we file with the Securities and Exchange Commission.

All those 10-Ks and 10-Qs and other documents can be found on our website at and also on the SEC website. The company undertakes no obligation to publicly update or revise any of the forward-looking statements, whether as a result of new information, future events or otherwise.

In our talk today, we plan to talk about funds from operation or FFO as we abbreviate it. Since FFO is a non-GAAP accounting term, I need to define FFO as net income excluding gains or losses from the sale of real estate plus depreciation and amortization of the real estate assets. The National Association of Real Estate Investment Trusts has endorsed FFO as one of those non-accounting standards that we can use in discussing our REIT. Please see our 10-K filed yesterday with the SEC and all of our financial statements for a detailed definition of FFO.

Now, we'll begin the call today by hearing from our President, Bob Cutlip. Bob is out in California looking at real estate. So Bob, why don't you come on the line and tell us about your section?

Robert G. Cutlip

Thank you, David. Good morning, everyone. Since we last spoke, the company has acquired 2 additional properties, issued or assumed long-term debt on both of these properties, refinanced our largest mortgage, issued common equity under our ATM program and extended the term on 3 of our upcoming expiring leases. Our pipeline remains robust and we hope to announce additional acquisitions in the near future.

Now, for some details. At December 31, 2012, all but 2 of our buildings continue to be occupied and all of the occupied buildings' tenants continue to pay as agreed. The 2 empty buildings constitute about 1.9% of our stabilized gross portfolio income and about 1.2% of the total square feet of space we own. We continue to take the appropriate action to re-tenant these properties.

We acquired 2 additional properties this quarter. The first property we acquired is an industrial facility with approximately 208,000 square feet, which was purchased for $20 million and is located in a large industrial business park in Fort Worth, Texas. We funded this acquisition through a combination of borrowings from our line of credit and the assumption of $14.2 million of mortgage debt on the property.

This property serves as a federal records center for the National Archives and Records Administration in the Southwest region and provides storage for records created or received by over 100 federal agencies located in Arkansas, Louisiana, Oklahoma and Texas, including U.S. district and bankruptcy courts and the Internal Revenue Service. National archives has leased the properties for 14 years and the lease is fully guaranteed by the U.S. government.

The second property we acquired this quarter is an office building with approximately 147,000 square feet, which is purchased for $29.2 million and is located in Columbia, South Carolina. We funded this acquisition through a combination of borrowings from our line of credit and the issuance of $19 million of mortgage debt on the property. This property serves as an operations center for Verizon Wireless and they have leased the property for 10 years, with three 5-year renewal options.

These 2 acquisitions, combined with earlier purchases, result in a total investment volume of $107.2 million for 2012, our second largest annual volume since the REIT was established in 2003.

Switching to mortgages, the market for long-term mortgages has improved. Mid- to long-term, that is 5- to 10-year mortgages are becoming much more obtainable. The collateralized mortgage-backed securities or CMBS market has made a comeback in recent months but it is still more conservative than it was prior to the credit crisis and the market remains somewhat volatile. Consequently, we also look to regional banks, insurance companies and other non-bank lenders as an alternative to finance our real estate activities.

During the quarter, we issued or assumed 2 new mortgages on both of our new acquisitions for $33.2 million, and we also borrowed $34 million collateralized by 7 of our properties in order to repay our $45.2 million mortgage, which with extension options would have been due October 1, 2013. We repaid the mortgage in full in October 2012 without incurring any exit fees.

These mortgages were issued at a weighted average interest rate of 4.8% and the weighted average loan-to-value obtained was 67%. Depending on several factors, including the tenant credit rating, the location of the facility and the terms of the loan, today we're seeing interest rates in the range from 4% to 5%, historically low rates.

Now let's address equity. We utilized our At the Market or ATM program during the fourth quarter and issued additional shares of common stock for gross proceeds of $2.5 million. We used this additional liquidity for working capital needs and to reduce the balance under our line of credit. Our stock price has been higher over the past several months, but this was a great opportunity for us to issue a small amount of equity to reduce our leverage without impacting our stock price. We continued the sales in January and we issued a small amount of common stock. We anticipate utilizing this program throughout 2013 as needed in order to continue our long-term goal of slowly reducing our leverage. We continue to only use our line of credit to make acquisitions that we believe can be financed with longer-term mortgage debt.

As you may recall, our customary business model calls for us initially to borrow from the line to buy properties. We then obtain longer-term, fixed-rate mortgages as soon as we can. In doing this, we were then able to secure the difference or the spread between the rent coming in and the mortgage payments going out, thus, locking in the profit for 5 to 10 years or in some cases, even longer. From a liquidity perspective, the proceeds from the mortgages then pay down our line of credit, thus, making the line available for the purchase of our next property.

We expanded our line from $50 million to $75 million this past January to give us more room to acquire additional properties. We also had one additional bank join the bank syndication group. Our line of credit matures in December 2013 and we are currently in discussions with both our existing lenders and various other lenders to either renew our existing line or to implement a new line of credit. We anticipate being able to extend or issue a new line well in advance of the maturity of our existing line.

The turmoil in the credit and equity markets over the past few years, our business model-adjusted so that we are matching as closely as possible long-term leases with longer-term credit. If we do not believe we'll be able to source attractive debt on new acquisitions, then we'll only buy properties that already have long-term mortgages on them. Currently, we have enough availability to fund our current operations and any upcoming improvement at certain of our properties. However, we will need to raise equity if we have a lot of deals closing.

Turning to our tenants. We continue to improve the value of our existing portfolio of properties by reviewing and renegotiating existing leases and performing improvements in our properties. To this end, we extended the term on 3 of our releases, 2 of which were expiring in 2013. However, the remaining existing tenant with a lease expiring in 2013 recently notified us of their intent not to renew. This lease represents less than 1% of our rent. The property is a 12,000 square foot medical facility and is favorably located next to a major hospital in Houston, Texas, and we have initiated re-leasing efforts. Locating new tenants and signing leases with the existing tenants for these buildings may require some capital outlays for tenant improvements and leasing commissions.

In summary, at year-end, all of our existing tenants are paying as agreed and our portfolio was 98% leased. At December 31, 2012, we had 2 buildings without tenants and subsequently, signed a lease pending lender approval for the entirety of one of these buildings and are aggressively pursuing tenant prospects for the other. We also are aggressively pursuing new tenant prospects for our partially leased building in Roseville, Minnesota in the Minneapolis market. The existing tenant renewed the lease but only took 1/3 of the building and we are looking to re-lease the remaining space. Our pipeline of possible acquisitions is strong today and we hope to close on more properties in the upcoming months. Please stay tuned.

And now, let's turn it back to David.

David J. Gladstone

All right. Thank you very much. Good presentation. Now let's turn to our Chief Financial Officer and Treasurer, Danielle Jones, for a report on the financial results.

Danielle Jones

Thanks, David. Good morning, everybody. Our quarterly and year-end results were strong and reflect our growth from our recent acquisitions. This is evidenced by our total assets increasing to $565 million, which is up 25% from 1 year ago. The amounts outstanding under long-term mortgages and our line of credit also increased to $384.2 million, which was a 26.3% increase from last year.

In addition, our stockholders' equity, including our term-preferred stock, increased by 18.9% to $160.9 million from our preferred equity offering in January of 2012 and issuance of common stock under our ATM program during the fourth quarter.

Reviewing our upcoming long-term debt maturities, we have mortgage debt in aggregate principal amount of $15.6 million payable during 2013, and $24.4 million payable during 2014. The 2013 and 2014 principal amounts payable includes balloon principal payments due in December of 2013 and June of 2014. However, we are initiating conversations with these lenders in advance of these maturities and anticipate being able to extend the maturity date or refinance with new lenders.

An investment-grade tenant at a property where our debt matures in December of this year recently extended their lease for an additional 10 years. Thus, we believe we will be able to refinance this mortgage relatively easily. We intend to pay the additional debt and amortization payments from operating cash flow and borrowings under our line of credit.

As Bob mentioned, we were able to refinance our largest mortgage, the $45.2 million GE mortgage, that originally matured in 2012 with KeyBank, which closed in October of 2012. The KeyBank mortgage was a $34 million 10-year mortgage on 7 of the 9 properties that have been originally financed under the GE mortgage. We placed the remaining 2 properties in our borrowing base on our line of credit. We funded the difference between the KeyBank mortgage and the GE payoff with existing cash on hand. We were able to reduce the weighted average interest rate in our existing mortgages by 10 basis points this quarter to 5.6% from the drop in interest rates from the new mortgages we placed on our properties.

Turning to our line of credit, we had $25 million outstanding under the line at the end of the year at a weighted average interest rate of approximately 3%. As Bob discussed, our line matures at the end of this year but we are actively working on extending or placing the line today. Our debt-to-equity ratio at the end of the quarter, excluding our new tranche of term preferred, was 3.1:1. We are focused on decreasing our debt-to-equity ratio in the next couple of years as we continue to issue common stock under our ATM program.

At February 15, our available liquidity was approximately $13.6 million, which is comprised of $3 million in cash and an available borrowing capacity of $10.6 million under our line of credit. The borrowing capacity on our line is limited to a percentage of the value of properties pledged as collateral to the line, less the amount outstanding under our line in our outstanding letters of credit. With the capacity under our line and current cash flow from operations, we have sufficient liquidity to continue to fund our operations, service our debt this year, perform any capital improvements we need at our properties and maintain our distributions to our common stockholders.

In addition, we continue to have the ability to raise $214 million of additional preferred or common stock equity through the sale of securities that are registered under our shelf registration statement in one or more future public offerings.

And now, I'll discuss the operating results. Please note that per share numbers referenced are fully diluted weighted average common shares. FFO available to common stockholders for the quarter was approximately $4.2 million or $0.38 per share and $16.4 million or $1.50 per share for the year. Which was about a 12% and 4% increase, respectively, when compared to the same periods last year for a total FFO.

Total FFO increased primarily because of a 20% increase in operating revenue derived from the 8 properties acquired in 2012, which was partially offset by a 24% increase in interest expense and the mortgage debt that we issued and assumed during 2012, coupled with the dividends paid on our Series C Term Preferred Stock, which was not outstanding in 2011. There was also an increase in property operating expenses during the quarter. Property operating expenses increased because of ground lease payments we are now responsible for at 2 of our properties, and overhead expenses and franchise taxes we are responsible for paying at our vacant properties.

Our funds from operations has not grown as we would have liked because of the additional preferred equity raised in January and the debt issued during 2012, which was not fully deployed until the latter half of the year. This lag between the time we raised the money and when we put it to work reduces funds from operations in the short term. We hope 2013 will be a better year for growth for us.

And now, I'll turn the program back over to David.

David J. Gladstone

All right. That was a good report, Danielle. We encourage all our listeners to read our press releases and our annual report, certainly the one that was filed yesterday with the SEC, called Form 10-K. There's a lot of good material in that document. You can find that and all the other documents at our website and also on the SEC website. To stay up-to-date on our latest news involving Gladstone Commercial and our other public companies, please follow us on Twitter using the name GladstoneComps, C-O-M-P-S; and on Facebook, the keyword is, The Gladstone Companies. And you can go to our general website and see more information about all the Gladstone entities, that's at

I think the main news today is that we're reporting really good numbers for the quarter, that we were able to acquire $50 million of additional properties, issued long-term debt on both of these acquisitions, refinanced our largest mortgage that came due, and for another 10 years, which just pushes that way out. We issued some common stock under the ATM program and certainly extended 3 of our leases. So this is all very positive news for all of our shareholders and those who are thinking about buying some stock.

We've built up a nice pipeline of potential properties. Bob came onboard during the summer and he's been instrumental in helping everyone move this along and we are interested in acquiring because that pipeline, we hope to be able to grow the asset portfolio even more during 2013. With the increase in portfolio of properties comes greater diversification and we certainly believe that's better.

We're still selling some of our Senior Common Stock. We've sold about $1.8 million of that. That's been designed for a specific marketplace. We have a new group in place that's marketing that now and I think that will pick up during 2013. So we'll get some additional equity coming into the company from that.

On another note, we've been able to find some attractive long-term mortgages to finance our unencumbered properties and these mortgages are market from banks and getting much better. We're now having long-term mortgages on 64 of our 80 properties that we own and most of the remaining properties are pledged as collateral on our line of credit and provides us with additional liquidity.

We also continue to look at properties with mortgages on them that we can assume when we buy the properties and just close or secure financing at the same time and close simultaneously as we have on the 2 properties that we acquired in 2012.

If we don't close on the debt simultaneously, then we've been able to successfully obtain debt on the properties just a few months later. So this is the way we operate, Bob explained that. As all of you know, the market for real estate properties is divided into what I consider 3 big categories. There is the one piece of the business that has sort of AAA and BBB rated. These are rated tenants that are located in high-quality real estate area. They are sought after by the large real estate investment trusts, insurance companies and pension funds. The cap rates continue to move around on this and today they are significantly lower than they were last year at this time, and are continuing to be out of the reach of companies like ours.

Small real estate properties is another category. These are the fast food locations or pharmacy chains. These are being purchased by individual investors at cap rates that yield about 6.5%. We've seen some of those move up a little bit, but we've seen some others move down. They do this, that is, the buyers do this for income. We purchased a couple of these in the last few years at somewhat normal market times. I'm not sure there's any available for us during this market cycle.

And then the third area is the one that we are in and we like the most. The area we most like to invest in is the middle market that we see. These are mostly non-rated tenants. Although we have a large number of rated tenants. We have unrated small and medium-sized businesses and commercial and office and industrial properties, as well as some medical properties.

Our competitive advantage here is the expertise that we have to underwrite non-rated business tenants in conjunction with the acquisition of real estate. Now we are in a good position to see a lot of opportunities here. Cap rates for this group are in the 8% to 9% range even today and with leverage that gives us an 11%, sometimes even as much as a 15% return on equity. We are focusing our efforts on finding good properties in this category with long-term financing that match our long-term leases. We are much more optimistic that things are going to be positive for us during this 2013 year. So while we proceed cautiously, as we always do, we're expecting some beneficial transactions in the near term.

So one of the things I need to mention here is that we may have to raise equity during the year. And as you know, the disconnect between the time that we raised the equity and finally get it invested, our FFO finally moved up from $0.34 to $0.38 a share, so we're up to $1.52. I'm hopeful that if we have to raise equity this year, we can use most of it to pay down debt and then come back into the marketplace to replace that. Much of the industrial base that rents industrial and commercial properties remains steady and most of them are paying their rents. So we've had good luck there and we've seen mostly good properties out there in the business world today. But there are still some businesses that are having problems in the economy and still not in good shape. However, we expect this 2013 year to be fine.

While I'm optimistic that our company will be fine in the future, we'll continue to be cautious in our acquisitions as we've done in past years. We've made it through the last recession without cutting the dividend or having a lot of problems from the tenants. And if there's another recession lurking on the horizon, I think, our portfolio will go through that easily, too.

We were successful in raising common equity twice in 2011 and preferred equity in 2012. We used the new equity to fund our acquisitions over the past couple of years. We also raised a little common equity with the ATM program in the fourth quarter and continue to use that in 2013. This ATM program during 2013 helps us fund our pipeline of acquisitions and even with that in place, I think, we're likely to raise some common or preferred stock during 2013.

In January 2013, the board voted to maintain the monthly distributions of $12.50 per common share for the January, February and March. So an annual run rate of about $1.50 a year. This is still a very attractive rate for such a well-managed REIT like ours. And we've now paid 102 consecutive common stock dividends since inception and we recently went through the recession without cutting that dividend. Because the real estate can be depreciated, and I say this each time, we are able to shelter the income that's coming in from the company on our rents and the distribution in 2012 was actually 100% return on capital and that, of course, is tax-free to those who are holding their stock.

This is a very tax-friendly stock. In my opinion, it's a very good one to put in personal accounts that is speaking income because of this depreciation shield. Remember, the return on capital is due to -- the return of capital is due to the depreciation of a real estate asset and other items, and that causes the earnings to remain extremely low after you apply the depreciation. And that's why we talk about FFO because that is adding back the real estate depreciation. Depreciation of a building is a bit of a fiction sense at the end of the depreciation period some 20, 25 years. The building is still really standing and if you own stock of a non-retirement account such as an IRA or a Keogh or one of those retirement plans, then you're not paying any tax on part that's sheltered by the depreciation, considered a return of capital. However, as we all know, the return of capital does reduce our cost basis in the stock which means that when you sell the stock, you have a larger capital gain, hopefully, down the road.

With the stock price now, yesterday closed about $19.23. The distribution yield on the stock is about 7.8%. I remind you each time I look at these -- all of these documents out there, many of the REITs are trading at much lower yields. I just read the -- looked at the entire REIT universe, it's trading at about 3.77% today. And my goodness, if we were trading at 3.77%, our stock would be at $40 a share and the triple net marketplace, which we are similar to in many ways, are at 5% cap rate. And certainly, if we were trading at a 5% yield, we'd be at $30 per share. There's really no reason for us not to be there other than we're smaller than some of the others and people see that as a bigger risk. Although, we certainly fared better than most during the last recession.

Anyway, the board will vote in early April during our regular scheduled quarterly board meeting on the declaration of the monthly distributions for April, May and June. So stay tuned for that.

And now, I'm going to stop and have some questions come in from our loyal shareholders and also the analysts who follow this wonderful REIT. Will the operator, please come on and help our listeners so they can ask some questions?

Question-and-Answer Session


[Operator Instructions] And our first question will come from John Roberts of Hilliard Lyons.

John M. Roberts - Hilliard Lyons, Research Division

Two questions. And you've sort of answered one, but let me have you expand on a bit. First, pipeline. What are your expectations for acquisitions this year? And second, you mentioned you're likely to raise some common and preferred, which obviously is needed given the leverage, but what's your touchstone as to which way you're going to go?

David J. Gladstone

Well, I'll answer the last one first. We always look at the marketplace for common and preferred and try to make a determination on which is best for shareholders. Obviously, preferreds are usually a little bit different in terms of yield than common, although the common stock has moved up some. Really hard to say that until the moment in time that we need the common or preferred or additional equity. And so, I can't give you much of an answer other than sit down and do the math. And the math usually tells you which is the best of the 2 to go with. On the pipeline, I'll just comment briefly and then I'll ask Bob to comment on it. Pipeline looks much stronger than it has in the past, only because I think the marketplace is shifting. A lot of different people have decided to sell their properties now. It's a -- we didn't see a big pile up of properties for sale coming at the end of the year even though the capital gains changed. It didn't change that much and I think a lot of people are thinking about selling their properties now rather than waiting for capital gains tax to go up again. But Bob, why don't you come on and just talk about the pipeline?

Robert G. Cutlip

Sure. John -- excuse me. The acquisition team, we've spent a lot of time over the last several months just kind of identifying where we're trying to go. But our ongoing strategy for us to achieve the goals that we achieved this year, we believe, requires us to have about, as a minimum, about $250 million in the pipeline. And by the pipeline, we mean, those that come into the categories of under initial review, letter of intent, negotiating the contract and the due diligence activities. And the emphasis is for all of us, who are sourcing these deals, to have something in each pot so that we have some consistent deal flow and closings. And today, we really exceed that minimum by about 20% to 25%. And I think we'll be able to keep that going -- subject to market conditions. We all know that we are going to be driven by what's going on economically as well as regionally in each of our markets. So we're hopeful that we can repeat the success that we had in 2012 and it looks at least, right now, at least our pipeline is strong, as David indicated.

John M. Roberts - Hilliard Lyons, Research Division

Well, great answer. Do you think you can close the same amount as you did last year? I mean is that your hope?

Robert G. Cutlip

Well, we're going to try. I mean our goal is -- when we set goals at the end of the fourth quarter, and the team is pretty pumped about being able to repeat what we did in 2012. And, of course, our goal, David and Danielle's and mine is to probably do a little bit better. But we'll see how things unfold over the next several months.

David J. Gladstone

Okay. Next question, please.


[Operator Instructions] At this time, I'm not seeing any further questions. I'd like to turn the conference back over to Mr. Gladstone.

David J. Gladstone

All right. Well, thank you very much. Obviously, I know John Roberts is asking the perennial question of how are you going to do next year? And we always love to dodge that question because it's really hard to answer and we don't like to give forward-looking statements in that much detail. I do think we're in good position to go forward and be very successful in 2013. Again, thank you all for calling in. And that's the end of this conference.


The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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