Gladstone Commercial's CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Gladstone Commercial (GOOD)

Gladstone Commercial Corp. (NASDAQ:GOOD)

Q1 2013 Earnings Call

April 30, 2013 8:30 am ET


David Gladstone - Chairman & CEO

Bob Cutlip - Cutlip


Dan Donlan - Ladenburg Thalmann


Good morning and welcome to the Gladstone Commercial Corp's First Quarter Conference Call. All participants will be in a listen-only mode. (Operator Instructions). After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Mr. Gladstone. Please go ahead, sir.

David Gladstone

Thank you, Denise, and thanks to all of you for calling in. We always enjoy these times that we have with you on the phone and wish we had a lot more of them but here we go. By the way, if you're ever visiting the Washington D.C. area we are located in a suburb called McLean, Virginia, and if you have an open – I want you to know that you have an open invitation to stop by and see us if you’re ever in this area. You'll see a great team at work here. We are now almost 60 members of the team and no longer a small business and by the way we have a few puppy dogs that come in every day to the office.

Now, let me read these forward-looking statements that's the report that I’m about to give that we are about to give include statements that may constitute forward-looking statements within the meaning of Securities Act of 1933 and Securities Exchange Act of 1934, including statements with regard to the future performance of our company. These forward-looking statements involve certain risks and uncertainties that are based on our current plans and we believe those plans to be reasonable.

There are many factors that may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements including those risk factors listed under the caption Risk Factors in our company’s 10-K and 10-Q filings that we filed with the Securities and Exchange Commission and those in the 10-Ks can be found in our website at and also on the SEC website. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

In the talk today, we plan to talk about funds from operation or as we refer to it, FFO. And since FFO is a non-GAAP accounting term, I need to define FFO and that is its net income excluding gains and losses from the sale of real estate plus depreciation and amortization of real estate assets. The National Association of Real Estate Investment Trust has endorsed FFO as one of those non-accounting standards that we can use in discussing our REIT as well as others use it for their REITs. And please see our 10-Q filed yesterday with the SEC and our financial statements for a detailed description of FFO.

Now, let’s get started with the call today by hearing from our President, Bob Cutlip. Bob, go ahead

Bob Cutlip

Thanks David. Good morning everyone. During the quarter we acquired one additional property and simultaneously placed long-term debt on this property, issued common equity under our ATM program, and extended the term on one of our upcoming expiring leases. After the end of the quarter we extended another of our upcoming expiring leases, funded an expansion at one of our properties and also extended that lease and signed a lease on one of our previously vacant property. Our pipeline is robust and we hope to announce additional acquisitions in the very near future.

Now, for some details. As I mentioned earlier we acquired one additional property this quarter. The property acquired is an office building with approximately 29,000 square feet which was purchased for $5.7 million and is located in Egg Harbor Township, New Jersey. We funded this acquisition through a combination of borrowings from our line of credit and the issuance of $3.7 million of mortgage debt on the property. This property includes both administrative and operational office space leased to AtlantiCare Health System, Inc., a not for profit health system consisting of 100 operating locations in Southern New Jersey. AtlantiCare has leased the property for 10 years.

At March 31, 2013 all the three of our buildings continue to be fully occupied and all of the occupied building tenants continue to pay as agreed. Two of these buildings are 100% vacant and one is partially vacant. One of the fully vacant buildings is located in Hazelwood, Missouri, a suburb of St. Louis. And the other building is located in Richmond, Virginia. The leases on these two vacant buildings comprised 1% of our annualized rental income as of March 31, 2013.

We are actively seeking new tenants for our Richmond, Virginia building and are happy to announce that we have executed a lease with a new tenant for the entire Hazelwood, Missouri building that will begin pending the due diligence period sometime in the next few months. Our building located in Roseville, Minnesota remains partially vacant and we continue to aggressively pursue new tenants for this building. In addition, the tenant in our Baytown, Texas 12,000 square foot office property notified us that they would not be renewing the lease that expires at the end of this month. We are aggressively pursuing new tenants for this building. This tenant comprised less than 1% of our annualized rental income as of March 31, 2013.

Switching to mortgages now, 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 and is expected to expand its lending levels in 2013. In addition, regional banks, insurance companies and other non-bank lenders have become quite competitive and are viable sources to finance our real estate activity.

During the quarter, we issued a new mortgage on our acquisition for $3.7 million. This mortgage was issued at an interest rate of 4.16% 10-year term 25-year amortization schedule. Depending on several factors including the tenant credit rating, location of building and the terms for the loan, we are seeing interest rates in the marketplace today ranging from the upper 3s to the upper 4% level. And we expect these rates to remain at these low levels over the next 12 to 18 months.

Now, let’s address equity. We utilized our at-the-market program or ATM during the first quarter and issued additional shares of common stock for growth proceeds of $5.6 million. We used this additional equity to fund our new acquisition and for other working capital needs. Our stock price has been much higher over the past several months and this is a great opportunity for us to issue a small amount of equity to reduce our leverage without impacting our stock price. We anticipate utilizing this program throughout 2013 as available in order to continue our long-term goal of slowly reducing our leverage.

Additionally, we completed an overnight common equity raise last week, which priced at $18.90 and raised about $22.6 million in net proceeds after paying underwriters and other offering expenses. We are planning to use the proceeds from this offering to fund a few deals in our pipeline in the next few weeks, but in the meantime, we will use the proceeds to pay down our outstanding balance under the line of credit. 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 could borrow from the line of credit to buy properties. We then obtain longer term fixed rate mortgages as soon as we can. By doing this, we are then able to secure the difference or 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.

Our line of credit matures in December 2013. We are currently in discussions with various lenders to implement a new line of credit. We anticipate being able to issue this new line well in advance of the maturity of our existing line, hopefully sometime this summer.

With the current aggressive credit and equity markets, our business model is adjusted so that we are matching it closely as possible long-term leases with longer term credit. If we do not believe we will be able to source attractive debt on new acquisitions then we’ll only buy properties that already have long-term mortgages in place which we can assume. Currently, we have enough availability to fund our current operations, the deals in our pipeline and any upcoming improvement at certain of our property.

Turning to our tenants, we continue to improve the value of our existing portfolio of properties by reviewing and re-negotiating existing leases and performing improvements at our property. To this end, we were able to renew six of the seven leases that were originally scheduled to expire in 2013. As I mentioned earlier in the presentation, the remaining existing tenant with the lease expiring in 2013 has 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 outpatient surgery center and is favorably located next to a major hospital in a Greater Houston submarket. We are aggressively attempting to release the property and are optimistic about our prospect.

Locating new tenants and signing leases for the existing tenants for these buildings may require some capital outlays for tenant improvement and for leasing commissions.

In summary, at quarter end, all of our existing tenants are paying as agreed and our portfolio was 96% leased. At March 31, 2013 we had two buildings without tenants but have subsequently signed a lease on 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. The existing tenants renew the lease that only took one-third of the building and we are looking to release the balance of the space.

We acquired a property this quarter, our sixth consecutive quarter of increasing our asset base, and our pipeline at possible acquisition is strong. We especially closed on more properties in the upcoming months, please stay-tuned.

And now, let’s turn it back to David.

David Gladstone

Alright, Bob, thank you, that was a good presentation. And now let’s turn it over to Chief Financial Officer and Treasurer, Danielle Jones, for a report on the financial results. Danielle?

Danielle Jones

Thanks David. Good morning everybody. Our quarterly results were strong and reflect our continued growth from our acquisitions, which is evidenced by our total assets increasing to $569 million from our acquisition during the quarter. Amounts outstanding under our long-term mortgages and our line of credit also increased to $387.4 million, a slight increase from the end of the year. In addition, our stockholders equity including our Term Preferred Stock increased slightly from the end of the year to $162.1 million from the issuance of common stock under our ATM program during the quarter.

Reviewing our upcoming long-term debt maturities, we have mortgage debt in the aggregate principal amount of $13.9 million payable during the remainder of 2013 and $24.5 million payable during 2014. The 2013 and 2014 principal amounts payable include the loan 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.

The tenant of the 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 amortization payments from operating cash flow and borrowings under our line of credit. The weighted average interest rate on our existing mortgage remains at 5.6%.

Turning to our line of credit we had $26.4 million outstanding under the line at the end of the quarter at a weighted average interest rate of approximately 3%. We will use the proceeds from our overnight rate that closed yesterday to repay a portion of this balance. As Bob discussed, our line of credit matures at the end of this year but we are actively working on extending or replacing the line today.

Our debt-to-equity ratio at the end of the quarter excluding our new tranche of Term Preferred Stock was 3.121. We are focused on decreasing our debt-to-equity ratio in the next couple of years as we continue to issue more common stock through those overnight offering and under our ATM program.

As of today, after receiving the proceeds from our overnight offering that closed yesterday, our available liquidity is approximately $33.5 million comprised of $27.6 million in cash and an available borrowing capacity of 5.9 under our line of credit. The borrowing capacity on our line of credit is limited to a percentage of the value of properties pledged as collateral to line plus the amount outstanding under the line and our outstanding letters of credit.

With the capacity under our line and our current cash flows from operations, we have sufficient liquidity to fund our operations, service our debt this year, perform necessary capital improvements to our properties and maintain our distributions to our common shareholders. In addition, we continue to have the ability to raise $184 million of additional preferred or common stock equity through the sale of securities that are registered under our self-registration statement in one or more future public offerings.

And now, I’ll discuss the operating results for the quarter. Per share numbers referenced are fully diluted weighted average common shares. FFO available to common stockholders for the quarter was approximately $4.3 million or $0.37 per share which was about a 2% increase when compared to the same period last year. Total FFO increased primarily because of the 16% increase in operating revenues derived from the eight properties acquired in the past 12 months which were partially offset by a 24% increase in interest expense due to the mortgage debt issued in during the last 12 months coupled with dividends paid on the Series C Term Preferred Stock which was not outstanding the full three months ended March 31, 2012.

There also was an increase in property operating expenses during the quarter. Property operating expenses increased primarily because of the partial vacancy at our Roseville, Minnesota property. This coupled with ground lease payments we are now responsible for two of our property and overhead expenses and franchise taxes we are responsible for paying all of our vacant properties.

We believe 2013 will be a better year of growth for FFO as our pipeline is very strong and we continue to work on releasing our vacant properties.

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

David Gladstone

Alright, that was a good report from Danielle. We encourage all of the listeners to read our press releases and our annual report -- quarterly report that was filed yesterday with the SEC on Form 10-Q. There is a lot of good material that goes into these documents and you can find them on our website and also on the SEC website.

To stay up to-date on the latest news involving Gladstone Commercial and our other public companies please follow us on Twitter using the name GladstoneComps and also on Facebook under The Gladstone Companies, and you can go to our general website and see more information about us at

The main news to report for this quarter is that we are able to acquire additional property, issue some long-term debt, issue some common stock under the ATM program and extend our leases that were scheduled to mature this year, all of this is very positive news for our shareholders. We built up a nice list of potential acquisitions and because of that list we hope to be able to grow the asset portfolio even more during 2013. With the increase in the portfolio of properties commence greater diversification and we believe that’s better earnings for our shareholders.

On another note we’ve been able to find some attractive long-term mortgages to finance our unencumbered properties. The mortgage market from banks and insurance companies and others is getting much better, and we have a long-term mortgage on 65 of our 81 properties that we own. Most of the remaining properties are pledged as collateral to our line of credit and provide us with additional liquidity. We also continue to look at properties with mortgages on them so we can assume the mortgages and not have to secure financing and close simultaneously on the properties in. So, if we don’t close that simultaneously we have been successful in obtaining mortgages on the properties in a few months later.

The market for real estate properties as I tell you each time is divided into three big categories tenants that have a AAA or even a BBB rating, a well located high quality real estate are being sought after by the large real estate investment trust, the insurance companies, and the yields continues to move around on those. I don’t know where they are and where they’re going to stop but they’re still extremely low so, these larger companies with lower cost capital can buy those.

Then there is another category which we call small real estate properties. These are the like the fast food locations, the pharmacy chain locations. These are being purchased by individual investors and they have yields in 6.5% to 7% rate sometimes much lower than that. Most of the buyers do this just for the income. We’ve actually purchased two of these in the past years that is - we’re somewhat out of the normal marketplace for these type of properties and we got them at very good rates of return.

And then, there is this third category that we had most like to invest in; this is called the middle market. We seek non-rated tenants small and medium-sized business and commercial office and industrial properties, as well as some medical properties. Our competitive advantage here is that we have the ability to underwrite the non-rated business tenants in conjunction with the acquisition of the real estate. As you all know, we run some companies that do investing in small and mid-sized businesses and we can use that technology there to underwrite these tenants.

We are in a good position to see a lot of opportunities here. Yield for this group of properties is in the 8% to 9% range, assuming once we have lower cost leverage on the properties the return on equity can be utilized 11% to 15% range.

Now, we are focusing our efforts on finding properties and long-term financing that match our long-term leases being able to lock in these long-term financing. So, with the long-term leases we were much more optimistic and things going to be positive for us in the next year. So, while we proceed cautiously, we’re expecting some beneficial transactions in the near term. Much of the industrial base that rents industrial and commercial properties like ours remain steady and most of them are paying their rents, so we feel good about what we’re doing in the next phase. There is still some businesses that are having problems and the economy still not in good shape and I would expect good growth for 2013 for this route.

Now, while I'm optimistic that our company will find a lot of good opportunities in the future, nevertheless we're continuing to be cautious in our acquisitions, as we've done in past years. We made it through last recession without cutting our distributions to stockholders and/or having a lot of problems with our tenants. And so, I think if there is another recession lurking on our horizon we’ll – I think our portfolio would stand very well again. We were successful in raising common equity last week and we’ll use this equity to fund our next couple of acquisitions that are coming up over the next couple of months.

In April 2013, the Board voted to maintain the monthly distribution at $0.125 per share their common share for April, May and June at an annual rate of $12.50 a year, so very attractive rate for such a well managed REIT. We now have paid a 105 consecutives stock – common stock dividend since inception and we went through the recent recession without cutting those distributions. Because the real estate can be depreciated we’re able to shelter the income of the company, the distributions are made from sheltered tax – sheltered from taxes because they’re mostly return of capital, and that’s tax free. This is a tax friendly stock and in my opinion is one of the good ones to hold in your personal accounts and see that income coming in. This return of capital is due to the depreciation of the real estate assets and other items and has caused earnings to remain low after depreciation, that’s why we talk about FFO funds from operation because it adds back the real estate depreciation.

Depreciation of a building is a bit of an IRS fiction since at the end of the depreciation period to building still standing. If you own stock and non retirement account as opposed to having an IRA or retirement plan, you don’t pay any taxes on these return of capital. It's sheltered by the depreciation and is considered the return on capital. However, as you all know the return of capital does reduce your cost basis on the stock which mat result in a larger capital when the stock is sold.

With the stock price now at $19.18 as it closed yesterday, the distribution yield on the stock is about 7.8% meaning the REITs are trading at much lower yields. I think that the entire universe is trading about 3.8% yield and if we were trading at that our stock will be almost $40 of share, and in the net real estate marketplace the yields are about 5% and if we were trading at 5% yield obviously we’d be a $30 stock. And we believe we should be trading at a much higher yield compared to our portfolio compared to some of the others that are out there.

The Board will vote in early July during the regular schedule quarterly board meeting on declaration of the monthly distribution for July, August and September, I think you will be happy with that distribution as well.

So let’s stop now and have Denise come on and have some questions from our loyal shareholders as well as some of the analysts that follow this wonderful REIT.

Operator, please come on.

Question-and-Answer Session


We will now begin the question-and answer-session. (Operator Instructions). We have a question from Dan Donlan from Ladenburg Thalmann. Please go ahead.

Dan Donlan - Ladenburg Thalmann

So, just can we talk a little bit about the lease roll in 2014; it’s all the way down to I think 5.5% of your rents. Any indications on what may happen at some of those properties and I think its either four or five properties that are coming up for renewal?

David Gladstone

Bob, do you want to speak to that please.

Bob Cutlip

Sure. Dan, we in fact had six leases that are scheduled to expire in 2014. We have already renewed two of those. We’re in negotiations with three others, and then the final one is a December expiration and we haven’t picked on that.

Dan Donlan - Ladenburg Thalmann


Bob Cutlip

I think we’re pretty confident. We did as you can tell, we did fairly -- I think, we did very well in 2013. In 2012, we had renewed all of our leases that came due. Of course, one of them reduced in space but the track record is good and we just try to stay out in front of it and stay close to the tenant during the term, and then of course initiate our conversions at least 18 months in advance because we’re seeing them at least quarterly anyhow.

Dan Donlan - Ladenburg Thalmann

Okay. And from a rent standpoint, are you expecting to see rollups on these tenants, on these leases and then what type of tenant improvements or any CapEx stars that you are looking at?

Bob Cutlip

I think it depends on the specific. I think to be clearly honest with -- when some of these leases were completed coming forward over let’s say the next two to three years, there maybe some - some minor cash roll downs. But I think when we look at our average straight line rent, I think we’re still going to have plus up. Most of the -- I do expect that we’ll have tenant improvements on the – on both the industrial and the office but there is going to be more cosmetic. At this point even this year, we only have -- we have two routes that we are replacing and some concrete porches at one location that have to be repaired but pretty much the responsibility for the maintenance and repair of the buildings belong to the tenants, and the tenant roster has done a very good job at maintaining the properties.

Dan Donlan - Ladenburg Thalmann

Okay. And then as far as your acquisition pipeline looks, could you maybe talk about how robust that is and maybe kind of give us some flavor what type of properties are you guys are looking at, is it office, is it some warehouse, what the type of properties you are looking at?

Bob Cutlip

Sure. We try to maintain the – we try to maintain I think somewhere from minimum of $250 million in the pipeline and that covers some an initial review, through issuing a term sheet letter of intent under contract and then of course due diligence and closing. And right now, our pipeline is in excess of $300 million, and that split pretty much evenly between office and industrial. We, in fact, have 11 industrial properties, two-thirds of which are more distribution type and then about a third of that industrial is more manufacturing a combination office and assembly.

And then the balance of the other nine are all strictly office. No medical office in the pipeline at this point other than maybe I think there's one small medical facility that we’re looking at in the Midwest but the others are predominately office. So, a pretty good split. And if you look at our - at really our current rent, we are split pretty much down the middle between office and industrial and we like that. I think we’ve more industrial space but the rents are pretty close.

Dan Donlan - Ladenburg Thalmann

Right, exactly. And then I guess lastly, David on the dividend you guys have done a good job obviously maintaining your dividend but we haven’t yet seen an increase form you guys in quite some time. What do you - we need to see from you guys in order to see that, that increase in the divined? Is it simply we – you need to have more acquisitions or is it kind of releasing some of the vacant space that you have? Is there any other thing that you are thinking about from a cost standpoint maybe that you can reduce on your end to maybe boost the divined?

David Gladstone

Well, that’s a perennial question. We talk about that every quarter. The biggest problem of course is that we raise money and then have to put it to work, and every time you do that you damage your ability to raise the dividend unless you can put the money to work quickly. We think we have a couple of properties that are going to close reasonably quick with this money raise, which will help us a lot. But if there is a long time between the day you raise the money and then when you put the money to work in a building it just damages our ability to increase the dividend.

So, we’ll see if these two get done in record time. We held out this IP - this offering until we felt like, we couldn’t wait anymore and that damaged a little bit in the marketplace by the price falling in the last couple of hours of the day. But right now, I think we’re in good shape to put this money to work and hopefully in the timeframe that we’re talking about, which is the July discussion by the board think about where we go from there. But I can’t make any promises we’re going to raise the dividend anytime soon only because every dividend is dependent on us increasing the assets and increasing them quickly when we have to raise capital.

Dan Donlan - Ladenburg Thalmann

Okay. So, it is definitely from the asset side, but you don’t think there is any type of expenses you guys could cut out at the current moment?

David Gladstone

I don’t know of any. We look at it and we sweat over it day-in and day-out. So, I think, we’re in good shape there.

Dan Donlan - Ladenburg Thalmann

And then sorry last question, Bob, your Roseville, Minnesota property I think if you’re able to lease that up that would be very, very useful to your earnings. You said you had some interest there but any type of more detail you could provide there?

Bob Cutlip

Well, we at this point have four very active prospects, two of them are office users and two of them are datacenter users. And they range in size from about 10,000 square feet to as much as 40,000 square feet. I can’t promise anything. All I can tell us is that our team, collective team, the brokers and our internal team are up there all the time pushing this. And the market has turned a bit now in Minneapolis so that we’re starting to see a bit more transaction velocity. So, we’re pressing and I agree with you the sooner we can get that released two-thirds of the properties are the better-off are going to be because of the – they get to on the OpEx side that we were absorbing. So, our projections are not assuming that we would kind of lease it up all up right away but we are assuming some lease up during this year.

Dan Donlan - Ladenburg Thalmann

Okay. Alright. Thank you very much.

David Gladstone

Just to take you back on Dan’s question there we do have the one property in Kansas that’s going to hopefully come online and they start paying rent this summer. So that will help us as well. Next question, Denise?


(Operator Instructions). I show no further questions at this time, so I would like to turn the call back over to Mr. Gladstone for closing remarks.

David Gladstone

Thank you, Denise. Thank you all for coming to our meeting and discussing some of the aspects. We wish we had more questions than just Dan’s but we’ve done a good job so I think as a result of that there aren’t a lot of questions could be asked. We’ll see you all next quarter. That’s the end of this conference call.


The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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