Gladstone Commercial's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Gladstone Commercial (GOOD)

Gladstone Commercial Corporation (NASDAQ:GOOD)

Q4 2013 Earnings Conference Call

February 19, 2014, 8:30 AM ET


David Gladstone - Chairman and Chief Executive Officer

Michael LiCalsi - Internal Counsel and Secretary

Bob Cutlip - President

Danielle Jones - Chief Financial Officer and Treasurer


John Roberts - Hilliard Lyons

John Massocca - Ladenburg Thalmann


Good morning and welcome to the Gladstone Commercial Corporation Fourth Quarter and Year Ended December 31, 2013, Shareholders' Conference Call. (Operator Instructions) Now I'd like to turn the conference over to David Gladstone. Mr. Gladstone, please go ahead.

David Gladstone

All right. Thank you, Keith, for that nice introduction. This is David Gladstone, Chairman. And thanks to all of you for calling in. We always enjoy the time we have with you on these phone calls and wish there was more time to talk about the company. Here in the Washington, D.C. area, we are located in a suburb called McLean, Virginia. And you have an open invitation to stop by and see us when you are in this area. There's a great team at work and there's about 60 members of the team now, so we're no longer a small business. And by the way, some of the people even bring their dogs to work, so you can see them when you come by here too.

To start off, we'll want to start with Michael LiCalsi. He is our current lawyer. He does a lot of the legal work here. He is also President of the Administrator that runs a lot of the services that we provide to the different funds. And he will present our statement regarding forward-looking statements.

Michael LiCalsi

Good morning, everyone. This report that is about to be given, they include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 or the Securities Exchange Act of 1934, including statements with regard to the future performance of the company. These forward-looking statements involve certain risks and uncertainties that are based on our current plan, which we believe 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 all those factors listed under the caption Risk Factors in our company’s Form 10-K and Form 10-Q filings that we file with Securities and Exchange Commission. Those Form 10-Q and 10-K filings can be found on our website at and on the SEC's website at 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, except as required by law.

In our talk today, we plan to talk about funds from operation or FFO. And since FFO is a non-GAAP accounting term, I need to define FFO as net income excluding the gains or losses from the sale of real estate and any impairment losses from property, plus depreciation and amortization of real estate assets. The National Association of REITs or NAREIT has endorsed FFO as one of the non-accounting standards that we and other REITs can use in our discussion of REIT. Please see our Form 10-K filed yesterday with the SEC and our financial statements for a detailed description of FFO.

We'll begin the presentation today from hearing from our President, Bob Cutlip.

Bob Cutlip

Thanks, Michael. Good morning, everyone. During the fourth quarter, we acquired two properties and closed long-term financing on both of these transactions, refinanced the mortgage on an existing property where the mortgage was maturing, commenced construction to expand one of our properties and simultaneously extended the lease through 2034 and issued additional common equity in an overnight raise.

We had a very good year in 2013. We deployed a total of $134 million in new acquisitions or expansions at our existing properties, exceeding our 2012 annual performance by about $27 million. We also acquired our first property in the west as we seek to expand our presence there. The fourth quarter marked our ninth consecutive quarter of closing acquisitions consistent with our objective of increasing our total asset base.

In the last few years, we've increased our total real estate assets by about 50%. The listed properties in our acquisition pipeline remains robust and we hope to announce additional acquisitions in the near future.

Now let's describe some details. During the quarter ended December 31st, we acquired two additional properties. The first property acquired was a 99,800 square foot office building located in Englewood, Colorado, a Southern submarket of Denver. The property is the The Class A, LEED Gold multistoried office building that's leased to ViaSat, an innovator in satellite and other wireless networking systems. The purchase price was $18.3 million, which equates to an average cap rate of 80.2% over the life of the lease.

We funded this acquisition with proceeds from our common equity raise in November and the issuance of $11.3 million of mortgage debt on the property. The assets has close to eight years remaining on the lease and has several renewal options.

The second property acquired was a 156,200 square foot industrial building purchased for $7.3 million with an average cap rate of 9.4% over the life of the lease. The property is leased for 10 years to Eberspaecher, a global German manufacturer of exhaust systems, heating and air conditioning systems for automotive and commercial vehicles. And this property is located in Novi, Michigan, which is the Western suburb of Detroit. We purchased this property with cash proceeds from our November 2013 common offering as well as the issuance of $4.4 million of mortgage debt on the property.

Shifting to our overall portfolio, as of today, all the three of our buildings continue to be fully occupied and all of the occupied buildings' tenants continue to pay as agreed. Two of these properties are vacant and one is partially vacant. The leases on these vacant buildings comprise less than 1% of our total square footage as of December 31, 2013. One of the vacant properties is located in Richmond, Virginia, and we have three active prospects for this property, each requiring the entire building. Two are call centers and one is a retail user.

We've seen activity increase dramatically over the past months, and this property as a completed retail development that's anchored by a Kroger megastore was completed nearby. The other vacant property is located in a Houston, Texas, submarket and is a 12,000-square-foot medical facility in close proximity to a hospital. We also have three active prospects at this building, and one of them is for the entire building and we've submitted our proposal to them recently for that facility.

Our building located in Roseville, Minnesota, remains partially vacant, and we continue to aggressively pursue new tenants for this building. To this end, we have three prospects for this building ranging from 30,000 to 50,000 square feet, two call centers and one state agency. The state agency has much more interest than the two call centers at this time, but we'll see as we're going forward. The loan on this property matures in June of this year, and we've begun discussions with existing lender.

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 at the properties. We continue to work diligently on the remainder of our leases that come due in 2014 and 2015, and to this end, have already renewed five of the six leases that were originally set to expire in 2014. The remaining 2014 lease expires in December, and this building is located in an industrial submarket of Chicago. We're actively marketing this property now and have two prospects, one of which has occupied the entire building. The existing tenant in this property has already vacated. They came to us in middle of last year and said we need to expand, we need to double in size, and of course we did not have any adjacent land to where we could expand them. So they did have to move on. However, they've prepaid the rent through the end of the term in December 2014.

We have 11 leases expiring in 2015, one of which is a building with two tenants in it. And we are in negotiations with tenants in nine of these buildings at this time. Locating new tenants and signing leases with existing tenants for these buildings usually require some capital outlays for tenant improvements and leasing commissions.

Switching to mortgages, debt financing is available for multiple sources. We've seen an increase in interest rates over the past several months, as the yields on U.S. Treasury securities and interest rate swaps increased and spreads widened once demand for higher rates in the CMBS marketplace took hold. Now recently, spreads have mulled somewhat, but regardless, we still believe interest rates remain historically low. And as you're aware, we continue to actively try to match fund our acquisitions for cost-effective mortgages.

Depending upon several factors, including the tenant credit rating, the location of the building, the configuration and the terms of the lease, we're seeing fixed interest rates in the marketplace today ranging from the upper-4% to the lower-5% level. To this end, we issued about $24 million in three new mortgage loans this quarter, two of which were fixed rate loans placed on new acquisitions with interest rates ranging from 4.7% to 5.3%. The third mortgage was a refinance of an existing loan and we placed a variable rate mortgage on this property with a rate of one-month LIBOR plus 2.15%. We also placed an interest rate cap on this mortgage to cap the LIBOR at 3%.

In summary, at year-end, all of our existing tenants are paying as agreed, and our portfolio is 96.8% leased. As noted, we acquired two additional properties during the quarter. We've consistently increased the acquisition volume over the past three years and we currently have approximately $22 million of potential acquisitions in due diligence. All of these properties may not close, but this number reflects our continued efforts always to have properties in the final stage of the transaction process. Our current pipeline also includes four properties total $63 million that are in the Letter of Intent stage and about $235 million under initial review.

All in all, the 23 properties in that pipeline, 40% of them industrial and 60% office. So a pretty good stint for us. Our objective is to have, as we've noted in the past, at lease $250 million to $300 million in the pipeline of new investments with the properties in each phase including the initial review period, the indication of interest, letters of intent and due diligence. At this point, we are exceeding that target, and our team is very active. We hope to close on additional properties in the upcoming months.

Now let's turn to our Chief Financial Officer and Treasurer, Danielle Jones, for a report on the financial results.

Danielle Jones

Good morning. As Bob mentioned we continued to grow asset and equity base in the fourth quarter. Our total assets increased to $690 million from our two new acquisitions during the quarter, which is a 4% increase from last quarter and a 23% increase in asset during 2013.

The amounts outstanding under long-term mortgages and our line of credit increased about $447 million as a result of the funding of our new acquisitions. Reviewing our upcoming long-term debt maturities, we have mortgage debt in the aggregate principal amount of $24.8 million payable during the remainder of 2014 and $22.4 million payable during 2015. The 2014 and 2015 principal amounts payable include balloon principal payments due in June of 2014 and three mortgages that mature in the second half of 2015. We're now working on the mortgage for 2014 and anticipate being able to refinance the mortgages that come due in 2015 with new mortgage debt. We now intend to increase the leverage on the new lease refinancing in order to continue our strategy of producing our overall leverage. 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 the new debt issued during 2013 was 4.5% plus the weighted average interest rate in all of our existing mortgages dropped 25 basis points during 2013 to 5.4% from the lower rates we were able to achieve on new mortgages during 2013. We also continued our strategy during 2013 of lowering our overall leverage by reducing our weighted average loan to value on new issued debt to 60% from 68% in 2012.

Now turning to equity, as Bob mentioned, we completed an overnight offering of common equity during the quarter. We issued 1.2 million shares of our common stock, which closed in November at the public offering price of $18.50 per share. And net proceeds after deducting offerings, expenses were $24.2 million. We used the equity raised in the fourth quarter to fund our fourth quarter acquisitions. In total, we received $80.8 million in net proceeds from common equity offering during 2013 in order to increase our total market cap and shares outstanding.

(inaudible) equity and overnight offering, we did not utilize our at-the-market program or ATM program during the fourth quarter. We will look to utilize the ATM in 2014 as it continues to be a great way for us to raise additional equity in a cost-effective manner.

Turning to our line of credit, as we discussed the last time we spoke, we closed on a new unsecured line KeyBanc in August. The new line is a $60 million line with a capacity to expand the line to $75 million. It's a three-year term and has a one-year extension option. We are excited about this new unsecured line as it gives us more flexibility and ease of use since we are no longer required to pledge assets to the line, which has already saved money in the costs we were incurring to add or remove properties to the borrowing base under our old line of credit.

We had $24.4 million outstanding under the line at end of the quarter at a weighted average interest rate of approximately 3.4%. We continue to only use our line of credit to make acquisitions that we believe can be financed with longer-term mortgage debt or that we believe are good additions to our unsecured property pool required under our new line of credit.

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. By doing this, we are able to secure the difference or spread between the rent coming in and the mortgage payments going out, thus locking in the profit for five to 10 years or in some cases 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. With the current aggressive credit and equity market, our business model adjusted, so that we are matching as closely as possible long-term leases with longer-term mortgages. If we do not believe that we'll be able to source attractive debt on new acquisitions, then we will only buy properties that already have long-term mortgages on them or are well-suited to be funded on our line. Currently, we have enough availability to fund our current operations, deals in our pipeline and any known upcoming improvements at certain of our properties.

Our debt-to-equity ratio at the end of the year, excluding our Term Preferred Stock, was approximately 2.4:1. We will focus on decreasing our debt-to-equity ratio for the next couple of years as we continue to issue more common stock to both overnight offerings and under our ATM program and reducing our loan-to-value on new and refinanced mortgages.

As of today, our available liquidity is approximately $24.6 million, comprised of about $4.5 million in cash and an available borrowing capacity of $20.6 million under our line of credit. The borrowing capacity in our line is limited to a percentage of the asset value of our unencumbered properties, thus both the amount outstanding under the line and our outstanding letters of credit. With the capacity under the line and our current cash flow from operations, we have sufficient liquidity to fund our operations, to service our debt this year, perform capital improvements to our properties and maintain our distribution to our common shareholders.

In addition, we have the ability to raise additional equity in preferred or common 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 $5.7 million or $0.38 per share, which is about a 3.8% increase when compared to the third quarter and was approximately $20 million or $1.49 per share year-to-date. FFO per share increased from 2012 primarily because of the additional revenue we achieved from new acquisitions. This was partially offset by vacancies in our portfolio coupled with additional shares issued during the year.

During 2013, we also managed the lost revenue and additional property operating expenses from our vacancies of $3 million. We did this for maintaining our dividend during the year. This is a good opportunity for us to increase our FFO during 2014 by releasing certain of these properties without significant capital investment.

Total FFO increased this quarter primarily because of the 2% increase in rental income derived from the two properties we acquired this quarter, which was partially by an increase in the base management and administrative fees and an increase in our total assets and equity.

We were not able to pay out a large portion of earned incentive fee this quarter because of the dilution from the equity offerings during. However, we believe our payout ratio will increase next quarter since we deployed these proceeds in the fourth quarter. We also believe 2014 will allow us to continue to grow our FFO as we continue to increase our asset base and work diligently to lease our vacant buildings and manage our property operating expenses.

I'll now turn the program back to David.

David Gladstone

Thank you, Danielle. That was a good report and certainly a good report from Bob Cutlip too. For those of you who want to keep up with everything, we encourage you all to listen to and read our press releases and annual report that was filed yesterday with the SEC called Form 10-K. There's just an abundant information. This is just a summary when we give you these reports every quarter, but there is a good material in those documents. And you can find them all on our website at And to stay up to date with the latest news, you can follow us on Twitter as well as on Facebook. Under Twitter, it's GladstoneComps, and on Facebook keywords The Gladstone Company. And you can go to our general website and see more information about all the Gladstone companies at

The main news to report for this quarter is obviously the acquisition of the two new properties and the closing on the long-term financing on these properties. We refinanced mortgage that was coming due and we raised additional common equity. All of these are very positive news for our shareholders, as we've added quality real estate to our portfolio, we shored up the existing investments and we've grown our asset base in excess of $130 million during 2013.

And as we continue to grow and our market capitalization increases, we hope to see higher trading volume in our stock and hope to see a corresponding uptick in the stock price. We continue to have a nice list of potential properties that we're interested in acquiring. And the list of properties, we hope to be able to grow the asset portfolio even more during 2014. And with the increase in portfolio of properties comes greater diversification, and certainly that's better for earnings to have more diversification.

On another note, we've been able to find some attractive long-term mortgages to finance our newly acquired properties. The mortgage marketplace from banks is much better now than it was even a year ago. We continue to look at properties with mortgages already on them that we can we can assume that as well. And secure financing for these acquisitions gives us much more opportunity out there for us to fund that kind of thing.

When we don't close debt simultaneously, we've been successful on obtaining the debt on the property a few months later or selecting those properties to remain unemcumbered and give necessary availability under the line of credit. We are focusing our efforts on finding good properties with long-term financing that match our long-term leases, being able to lock in the spread between the long-term financing and the rent that's coming in is what we pay our dividend. We are much more optimistic now that things are going to be positive for the next year, feeling pretty good about the economic outlook.

Much of the industrial base that rents industrial and commercial properties like the properties that we're buying remain steady and most of them are paying their rents. There's still some businesses that are having problems and the economy is still not in great shape. However, we expect the growth for 2014 for this REIT to be very good and strong.

While I'm optimistic that our company will be fine in the future, we continue to be cautious in our acquisitions. As we've done in past years, we made it through the last recession without cutting the dividend or having a lot of problems. And I think if there's a recession lurking on the horizon that our portfolio will continue to stand up against any kind of downturn.

We were successful in raising common equity this year, and we've put the new equity to work pretty quickly. And we've been able to fund some new acquisitions that can close on hopefully this quarter. We may seek to utilize the ATM program, as we didn't use as much in 2013, but we'll probably use it this first quarter and next couple of months.

In January this year, the Board voted to maintain the monthly distribution of $0.125 per common share for January, February and March at an annual run rate of $1.50 per share. This is a very attractive rate for a well-managed REIT like ours. We've now paid 114 consecutive common stock dividends. We went through the recent recession, as I mentioned before, not cutting our dividend. And here is a great reason to hold this stock in your personal account.

Because the real estate can be depreciated, we're able to partially shelter the income. The distributions in 2013, for example, was 82% return of capital. That portion is tax-free. This is a tax-friendly stock that in my opinion is a great one for personal accounts, the ones that are seeking income. The return of capital is due to the depreciation of the real estate assets and other items that has caused earnings to remain low after depreciation. And that's why we talk about FFO as funds from operation, because this FFO number is adding back the real estate depreciation.

Depreciation of a building is a bit of a fiction anyway since at the end of the depreciation period, the building is usually still standing and in pretty good shape. So if you own a stock in a non-retirement account as opposed to having an IRA or retirement plan, you don't pay any taxes on that part of the dividend that's sheltered by the depreciation. That's considered a return of capital. However, as you all know, the return of capital does reduce your cost bases on the stock, which may result in the larger capital gains tax when the stock is sold.

With the stock price about $17.74, the distribution yield on the stock is about 8.5%. So many of the REITs are trading at much lower yields today. I just read a REIT report that the REIT universe as a whole is trading at 4.3% yield. Certainly if we were doing that, we'd be almost up to $35 a share. And the triple-net REITs, which are similar to us in some ways, is trading at about 6%. And that would mean that if we traded at 6%, that would be $25 per share. So there's plenty of room for yield expansion. And we believe we should be in that range as well. As we continue to build our portfolio and increase our income, I think you should all notice there are more investors being attracted to this stock.

The Board will vote in early April during our regularly scheduled board meeting to determine and declare the monthly distribution for April, May and June. And I want to stop at this point in time and have some questions from our loyal shareholders, some of the analysts who are following this wonderful REIT. Would the operator please come on and help us get those questions?

Question-and-Answer Session


(Operator Instructions) And the first question comes from John Roberts with Hilliard Lyons.

John Roberts - Hilliard Lyons

Obviously, you've been pretty consistently waving your incentive fees. Can you talk a little bit about the strategy on that and what you anticipate doing going forward since you're not covering the dividend unless you're waving the fees?

David Gladstone

Sure. That's one of the things that we always look at when we're doing a new deal. Unfortunately when we raise capital and try to get it to work quickly, sometimes we're not as good at that as we'd like to be. And so as a result, in order to cover those new shares that have been issued, we need to use that by giving back some of our incentive comp. As time goes on, that will go away. As we get bigger and the new offerings have less dilutive effect on the earnings power, I think all of that will go away. We all understand that. People give up in the short range in order to get long-term benefits for us and our shareholders.

And I think it shows something to shareholders that we're willing to give that up in order to make sure that we continue to grow the asset base and the earnings base of the company. So not excited about giving it up, but at the same time, it's just a short-term give-up. We'll eventually get back to normal and be able to pay it all out.

John Roberts - Hilliard Lyons

Well, it shows some shareholder-friendliness, David.

David Gladstone

Yeah, we are friendly to shareholder. And as sitting around the table, we're all big shareholders. So what we give up on one side, we generally get on the other side.

John Roberts - Hilliard Lyons

Obviously you're not going to see any growth in FFO until that goes. Any timeframe that your expectations on when we might get by that?

David Gladstone

John, you're always asking for projections. It's really hard in this business. Until we get to about $1 billion in assets, I think it's going to take us that time to get there, John. We're about $680 million, $690 million. Probably another year before we get past that. And so we're looking at maybe 2015 to start to think about that. So that's where we are. But the good news is for all those shareholders, the dividend is very solid positioned, certainly in the preferred shares, but in the common shares very solid coverage ratio because of the ability to give back the incentive comps. So people who are buying that are buying it with a good deal of certainty that they're going to get their dividend. Nothing is guaranteed of course, but I think it's pretty well covered.


Next question comes from Dan Donlan with Ladenburg Thalmann.

John Massocca - Ladenburg Thalmann

This is actually John Massocca on for Dan Donlan. I noticed in the fourth quarter, you announced you're doing expansion at your Canton, North Carolina, property. Could you maybe give us a little more color on that deal? And then as kind of a follow-up, was any construction actually completed in the fourth quarter?

Bob Cutlip

Certain, John, that is the 230,000 square foot industrial facility. We were expanding by 150,000 square feet. The expansion is clearly infrastructure for additional circulation for their trucking as well as for distribution. The company has consolidated into this located from, I believe, it was one other location. And there was really no construction done in the fourth quarter we did. The design was completed and we began moving (inaudible), but weather turned bad on us. We're still anticipating that the building will be completed in August. And as this property as we place money into this transaction, the tenant actually began paying rent on the in-placed capital. And as I indicated earlier, with this transaction, we're extending a lease on the building to 2044.

John Massocca - Ladenburg Thalmann

One quick broader question, if you will. Have you seen kind of change in leasing demand particularly for suburban office properties? I mean have you kind of been improving here that affected in a positive way your ability to kind of lease and re-lease your suburban office properties?

Bob Cutlip

We are seeing more demand out there really across the board. As I indicated, most of the year, we were seeing more office opportunities and suburban market spend reversing industrial opportunity. And of course a lot of that relates to some of the institutions chasing industrial properties. But yes, we're seeing our ability (inaudible) for offices is not great. And if you look at the macro, everyone is saying that really from a space per employee standpoint, that's dropping from, let's say, 250 down into the 100 to 150 with a millennial. That could be a change. But with us picking facilities that we think really are mission-critical and therefore the people around it want to be there. We still feel confident long term with the movement that we're going into the secondary growth markets.


(Operator Instructions)

David Gladstone

It sounds like we don't have any more. All right, we again thank you all for calling in and look forward to you next quarter.


Thank you. That concludes today's teleconference. You may now disconnect your phone lines. Thank you for participating and have a nice day.

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