The Real Story For Gladstone Commercial Corporation

| About: Gladstone Commercial (GOOD)

Summary

The company hit expectations on FFO (not a surprise) and covered their dividend.

The real story for GOOD is primarily one of financing.

The company was able to lower their cost of debt and issue new preferred equity at a lower rate than existing preferred shares.

Paying off their C series of preferred stock improves financial flexibility.

Gladstone Commercial Corporation (NASDAQ:GOOD) had a deceptively good second quarter, if you will excuse the pun. The REIT declared FFO of $.39 per share, which matches analyst estimates. The FFO covers a strong monthly dividend of $.125 per common share. On a quarterly basis, that comes to $.375.

Triple Net Lease REITs

The business structure for GOOD is a simple triple net lease REIT. They own commercial real estate and lease it out to tenants on a "triple net" basis. The REIT receives the stated rental rate and it receives reimbursement for the expenses. The result is a REIT that is able to align the REIT's interest with the interest of the tenant. Tenants have a stronger incentive to take care of the property when they know they will be paying all of the operating and maintenance expenses.

The Real Story

While the REIT beat slightly on revenues and hit expectations on FFO, the real story for GOOD comes down to financing and acquisitions. During the quarter, the company was able to pay off some of their existing debts with a rate of 6.25% and refinance the properties at a rate of 3.2%. They also took out some new loans at 4.684%. Since the debts coming off the books had a higher rate than those that were left on the books, the net result should be a lower WACC (weighted average cost of capital). It should only be a moderate impact, but it is still positive.

The bigger story on financing is the company paying off their 7.125% C series of preferred stock. These preferred shares carried a mandatory redemption rate (which makes them more akin to a very junior level of debt than normal preferred shares), but the new shares issued carry a 7.0% rate. While the difference of .125% is not material, even on a par value of around $25 million, the ability to get the C series paid off means substantially more flexibility for GOOD. Prior to this, they needed to find a way to raise the $25 million. That issue is off the table now.

With the C series retired, they can continue to work on issues shares of the new 7.0% preferred stock, trading under the ticker GOODM. The proceeds should pay off the 7.75% series of GOODP and the 7.5% series of GOODO. I expect that to be an area of emphasis for management over the next couple of quarters.

They also completed another acquisition for the quarter. The new property comes fully occupied, costs $17 million, and carries a capitalization rate of 8.4%. That is a fairly high capitalization rate and compares favorably with the lower cost of funding for the portfolio.

The company has ATM (at the market) programs in place for issuing new common and preferred stock. Expect them to use the one to issue preferred stock whenever they get the opportunity. Consequently, it should not be too surprising if there are a couple other acquisitions during the year.

Conclusion

GOOD had a solid quarter. Due to the volatility on their common share price, I have no rating on the common equity. I see some favorable developments for the REIT as growth in their portfolio should encourage a lower WACC. The larger REITs appear safer for both shareholders and creditors. However, GOOD is unlikely to ever trade at the same lofty multiples as some of the other triple net lease REITs like Realty Income Corporation (NYSE:O). The market tends to favor internally managed triple net lease REITs, and GOOD has external management. That creates an inherent challenge in getting the lowest possible WACC.

I am personally long shares of GOODP, though I would look to end that position at the right price since they are callable and trade at a premium to call value.

You can read the entire earnings release here.

Disclosure: I am/we are long GOODP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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