Gladstone Commercial Corp (GOOD) 2020 Q4 法說會逐字稿

Greetings. Welcome to Gladstone Commercial Corporation's Fiscal year ended December 31, 2020, Earnings Call. (Operator Instructions) Please note, this conference is being recorded.

At this time, I'll turn the conference over to Mr. David Gladstone. Mr. Gladstone, you may begin. Mr. Gladstone, please go ahead.

Well, thank you all for tuning in, and thank you, Rob. Appreciate everybody coming in this morning. It's -- this is Gladstone Commercial's quarterly shareholders call for the year ending December 31, 2020, and we have a good time on these. We'll hopefully get some good questions at the end. And now we'll hear from Michael LiCalsi, our General Counsel and Secretary, to give the legal and regulatory matters concerned about this call. Michael?

Yes. Thanks, David, and good morning. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance, and these forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. And many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors in our forms 10-Q, 10-K. And other documents we filed with the SEC, and you can find these on our website at www.gladstonecommercial.com, specifically on the Investors page or on the SEC's website, which is www.sec.gov. Now we undertake no obligation to publicly update or revise any of these forward-looking statements whether as a result of new information, future events or otherwise, except as required by law.

But today, we will discuss FFO, which is funds from operations. Now FFO is a non-GAAP accounting term defined as net income, excluding the gains and losses from the sale of real estate and any impairment losses on property, plus depreciation and amortization of real estate assets. And we'll also discuss FFO as adjusted for comparability and core FFO, which are generally FFO adjusted for certain other nonrecurring revenues and expenses. And we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. And please take the opportunity to visit our website, once again, gladstonecommercial.com, sign up for our e-mail notification service. You can also find us on Facebook. Keyword there is The Gladstone Companies, and our Twitter handle is @GladstoneComps.

But today's call is an overview of our results, so we ask that you review our press release and Form 10-K, both issued yesterday for more detailed information. Again, you can find them on the Investors page of our website.

Now I'll turn the baton over to Gladstone Commercial's President, Bob Cutlip. Bob?

Thank you, Michael. Good morning, everyone. During the fourth quarter, we acquired 3 industrial properties totaling 674,000 square feet. And $46.9 million of investment volume in Pittsburgh, Pennsylvania; Montgomery, Alabama and Huntsville, Alabama. Sold a 3 property single-story office portfolio in Champagne, Illinois for $13.4 million, resulting in a gain of $4.1 million. Sold a 52,000 square foot single-story office property in Austin, Texas, for $8.6 million, resulting in a gain of $2.8 million. Extended the lease for our 21,000 square foot industrial tenant in Bolingbrook, Illinois, for an additional 7 years. Executed a lease for 21,000 square feet at our Akron, Ohio single-story office property for 7 years.

Extended and expanded the lease for 5 years for an office tenant in our Indianapolis anchored multi-tenant property, and collected 99% of scheduled rental income during 2020 with remaining 1%, representing deferred rent to be paid overtime. Subsequent to the end of the quarter, we acquired a 180,000 square foot distribution property in Finley, Ohio for $11 million with a GAAP cap rate of 8.4% and collected 98% of January cash base rents. No amounts have been abated through the pandemic.

As stated on earlier calls, we're continuing our investment strategy to increase our portfolio's industrial allocation, which we believe will improve our property operating efficiencies. During 2020, we acquired 9 properties, all industrial and a total investment of $130 million, with a weighted average lease term of 12.2 years and an average GAAP cap rate of 7.4%. Since January of 2019, our total investment volume has been just under $270 million, all of which is industrial, providing further evidence of that commitment. Our industrial allocation has increased from 33% in January of 2019 to 47% today with an objective of achieving a 60% allocation within the next 18 to 24 months. We will continue to overweight industrial acquisitions, and our primary focus has been and will be acquisition candidates ranging in size from 50,000 to 300,000 square feet.

Investment opportunities improved during the fourth quarter. And as I noted earlier, we acquired $46.9 million of industrial properties in targeted locations. A 241,000 square foot property along the I-65 corridor in Montgomery, Alabama. The total investment was $14.25 million with 7.2 years of remaining lease term and a GAAP cap rate of 7.3%, a 208,000 square foot property in Huntsville, Alabama, also along the I-65 corridor. The total investment was $19.9 million, with 9.2 years of remaining lease term and a GAAP cap rate of 7.5%. And we acquired a 155,000 square foot property in Pittsburgh, Pennsylvania. The total investment was $12.8 million with 10 years of remaining lease term and a GAAP cap rate of 7.9%.

Our asset management team continued to deliver on improving our same-store operations. During the fourth quarter, the team executed 2 lease extensions and 1 new lease, comprised of 2 office properties and one industrial property. For the full year, the team completed 20 lease transactions totaling 1.1 million square feet, 10 of which are office properties. The weighted average straight-line rent increased by 4.7%, and the overall tenant improvement allowance was approximately $3 per square foot.

Our asset management team continued our capital recycling program. We are focusing on selling our single-story office properties and redeploying the proceeds into industrial product in our target markets. We sold 3 such properties in Champagne, Illinois and 1 single-story office asset in Austin, resulting in gross proceeds of $22 million and a gain of $6.9 million. We will continue this program as disposition opportunities arise.

Our rent collection experience continues to be strong. 99% of fourth quarter cash rent collections were paid, and January collections were 98%. We're very pleased with our portfolio and tenant's performance during these challenging times for all industries.

We continue to stay closely connected to our tenants' operations. There have been, and we expect there will be, requests from tenants for rent relief, and we will address them as we are notified by the respective tenant. The key objectives for us are to offer rent deferrals and/or lease extensions to maintain or increase core FFO per share and to return cash flow to the proper previous level as soon as possible. We did have a daycare provider request additional interim rent relief, and we agreed to do so.

In return, they extended their lease an additional year. And during that extension period, their cash rent will increase by 10%. A 6,000 square foot medical office provider in Houston informed us they are closing their business, and we are now marketing that space for lease. Their rent represents 0.01% of our annual rental income.

Anticipating that many on the call are interested in lease expirations through 2021, I wanted to summarize the team's thoughts and activities. We're encouraged about our same-store performance over the next 2 years as we average about 5% lease expiration for each of those years. For 2021, we have $5.7 million of annualized straight-line rent expiring, and $3.7 million of that total expires at the end of November and the end of December. So future expiration issues should be quite manageable. Our largest vacancy is in Austin, as I have related previously, a property formerly leased to GM, who vacated at the end of August.

Our active marketing of the property with assistance from the local Chamber of Commerce has resulted in 5 viable current prospects for the building, ranging from 40,000 square feet to 250,000 square feet. Activity has increased since the beginning of the year, which is encouraging. And as I've noted earlier, our previous GAAP rent at the property of $14.50 per square foot compares quite favorably in the submarket with current space offerings in the low to mid-$20 per square foot on a triple-net basis.

Market conditions are worthy of comment, particularly with the adverse effects from the onset of the COVID-19 virus. Year-over-year through the fourth quarter, investment sales volume across all property types is down approximately 30% according to Real Capital Analytics. National research reports also reflect office property sublease space is on the rise. And Cushman & Wakefield is forecasting negative office absorption over the near term. However, the continued interest in industrial properties particularly those related to e-commerce and last mile, has resulted in no increase in cap rates for this product type in many markets, and in fact, compressed cap rates in select locations. And Cushman & Wakefield and CBRE both report the industrial space absorption is up during 2020 compared to 2019. And 2019 was the highest absorption for the industrial product.

As it relates to growth opportunities, investment sales listings have moderated with the pandemic, although we are seeing increased activity in the Midwest markets. Our current pipeline of acquisition candidates is approximately $280 million in volume, representing 16 properties, 1 of which is an office building and the balance are industrial. Of the 16 properties, 3 are in the letter of intent stage and the balance are under initial review. Our team is staying actively engaged in the markets as we believe acquisition opportunities will arise that we can and we will pursue.

So in summary, our fourth quarter activities reflected excellent leasing and rental collection success, continued active engagement to identify industrial acquisition opportunities, and we believe, collectively positions us well to pursue growth opportunities.

Now let's turn it over to Mike for a report on the financial results, including our capital markets' activities.

Thanks, Bob. Good morning. I'll start by reviewing our operating results for the fourth quarter of 2020. All per share numbers I reference are based on fully diluted weighted average common shares.

FFO and core FFO available to common stockholders were $0.37 and $0.38 per share for the quarter, respectively. FFO and core FFO available to common stockholders were $1.56 and $1.57 per share for the year, respectively. This performance demonstrates the accretive yet prudent growth of the company as well as the performance of the in-place portfolio. In addition to these accretive deals, our same-store cash rent continues to grow at 2% on an annualized basis. Our fourth quarter results reflected stable total operating revenues of $32.9 million as compared to total operating expenses of $24 million for the period, excluding 1 property impairment charge.

As Bob laid out, our team is actively engaged with every tenant of ours as we intend to maximize shareholder value through and beyond the COVID-19 pandemic. We're pleased with the teams and portfolios continued exceptional performance, but these are uncharted times. We continue to enhance our strong balance sheet as we grow our assets and focus on decreasing our leverage. We've reduced our debt to gross assets by nearly 15% to 49.9% over the past 5 years through refinancing maturing debt and financing new acquisitions at lower leverage levels. We believe that we are 1% to 2% away from our target leverage level, long term.

We continue to primarily use long-term mortgage debt to make acquisitions. As we grow through disciplined investments, we'll also expand our unsecured property pool with additional high-quality assets through efficiently utilizing our recently upsized credit facility, which I'll describe further. Over time, we expect this will increase our financing alternatives.

Looking at our debt profile as of today, our 2021 and 2022 loan maturities are manageable with $11 million coming due in '21 and [$99 million] coming due in '22. We will refinance these amounts at the appropriate time. The efficient upsizing of our credit facility this month continues to speak to lender recognition of the quality and performance of the portfolio. Specific to this upsize, we did execute last week on a new $65 million 5-year term loan, including a $15 million delayed draw component. The proceeds were utilized to repay all revolver borrowings outstanding.

While entering the fourth quarter with sufficient liquidity, we've been active in issuing equity. During the fourth quarter in net of issuance costs, we opportunistically raised $20.4 million through common stock sales, $1.5 million through preferred Series E stock sales, and we also raised $1.6 million through our preferred Series F program. We continue to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements, including our most recent acquisitions. As of today, we have approximately $4 million in cash and $20 million of availability under our line of credit. With our current availability, the strong performance of the portfolio and access to our ATM programs, we believe that we have significant incremental flexibility to fund our current operations, near and long term. We encourage you to also review our quarterly financial supplement posted on our website, which provides more detailed financial and portfolio information for the quarter.

Institutional ownership of our stock has increased over time to 58% as of December 31, nearly a 20% increase over the past 4 years. Bob and I continue to be very active in meeting with current and potential investors, portfolio managers, coverage analysts, investment banks and the like. We look forward to establishing new relationships as the company moves forward to its next chapter.

Regarding the common stock dividend, we did increase it in the first quarter of 2020. And while the increase was small, we have also announced that we are leaving the dividend unchanged as we begin 2021. We have not cut or suspended the dividend since our IPO in 2003.

Our stock closed on Wednesday -- Tuesday at $19.17. The distribution yield on our stock is about 7.8%. Many REITs are trading at much lower yields.

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

All right. Mike, that was a good report, and it's a good one from Bob Cutlip and Michael LiCalsi, too. The team continues to perform. And this company has not been hurt much by the various government reactions to COVID-19. It was a very nice quarter and a nice year altogether, considering we came through some difficult times. You've heard a lot today about the numbers for new transactions and new leases, and the quarter really is impressive.

We collected all the rents that were due from tenants in the first quarter, 98% in the second quarter. Third quarter rents collections were strong, 99%. And we're 98% collected in the fourth quarter. So very strong performance.

We bought 3 industrial assets during the quarter. And we executed 2 lease extensions, and 1 new lease during the quarter. And finally, we sold 3 noncore assets in Champaign, Illinois. And at the same time, we sold 1 property in Austin, Texas. That's a smaller building in Texas. The commercial team is growing the real estate we own at a really good pace now, and the team is doing a great job managing the properties we own, especially during the pandemic.

Our team is strong professionals continue to pursue potential quality properties on the list of acquisitions they are reviewing. Our acquisition team is seeking strong credit tenants. That's the first thing we look at. They know that the quality of the tenant is the reason we buy the real estate and make it -- it makes excellent investments when we spend time there. Our asset managers are actively managing the properties that the company owns today in order to maximize their value. It's a different environment that we're living in today. The middle market business, which is where we are, that's most of our tenants, like many of our tenants is being challenged with the government's restrictions related to COVID-19. But our tenants are paying their rents and committing to pay any past deferred rents that we've stacked up on the balance sheet. This is the times that we've become very good at negotiating with our first-class tenants. And so we'll see if that works out over time, and I think it will.

I'm going to stop here and have Rob come on, and let's get some questions from those of you that are listening in today.

(Operator Instructions) And our first question today is coming from the line of Barry Oxford with D.A. Davidson.

Getting back to the capital recycling and selling 1 story office buildings and moving into industrial. Bob, how should we think about the cap rate differential?

Well, as it relates to -- we're selling those at levered returns of 13% to 15%. The cap rate themselves are somewhere around 7.50% to 8.50%. And then we're acquiring product in the 6.25% to 6.5%. But with our GAAP rent at about 7.4% to 7.6%. And one thing -- if I could add to that, Barry. One of the key reasons that we plan to do this is that re-leasing and re-tenanting single-story office properties is extremely expensive. You have a 60,000 square foot single-tenant property that has, let's say, the restrooms all over the place. And then they move out, and you have to break it up into multiple tenants. The cost of demise, separate the electrical service, add new restrooms, far exceeds what I think is the margin drop when we go from selling them to investing into an asset that has very, very low re-leasing costs.

Right. No, that absolutely makes sense. Switching gears a little bit when we are looking at rent deferrals. Are we through the bulk of that and you shouldn't be seeing too many "phone calls" coming through? And then also a question for Mike. How should we think about bad debt expense in '21?

Okay. On the rent deferrals, we -- as I indicated in my comments, I do expect to probably receive a few more over the next 3 to 4 months until the vaccine rollout really gets around across the populus. We are seeing from our office tenants that they are planning to come back to the office, the second quarter -- second and third quarter of 2021. And that's COVID permitting. But we are somewhat encouraged. And I think very -- what I think really helps us is that we have always connected with our tenants every quarter. So we have a personal relationship with them.

And if we do have upcoming rent deferrals, I know that we'll either be able to extend the lease or get the return within a very limited period of time.

And Barry specific to the second piece of your question, bad debt expense, I believe you are really referring to rental collection and the implications of accruals there. The guidance itself dictates a fairly high bar in terms of probability of ultimate collection that you must solve for to continue to accrue for rents. Our childcare tenants that we've given interim deferrals to, 2019 was their best year on record. We believe this is an interim event, and they are a long-term profitable going concern that has resulted us in continuing to accrue rents for that property. So really, the only thing that we would be aware of today would be that 0.01% that Bob made mention to with that 6,000 square foot medical office tenant.

The next question is from the line of Gaurav Mehta with National Securities.

So first question on the Austin market. I was hoping if you could talk about some of the supply that's coming in office market in Austin, and how that's impacting your efforts to re-lease your vacant space there?

Actually, the new product has slowed down. And since we're up in the North, Northeast section, and we're directly across from where BAE is going to be putting their upcoming campus. We're actually very encouraged about the demand for the space. I don't have the specifics, but I will get the specifics to you, Gaurav, so that you know how much it is, and I'll also send it to everyone else on the line.

Okay. Great. What kind of feedback are you getting from prospects in regards to that property in terms of why they're not signing up the lease?

Part of it is that they can't get through the property. With what's transpired in Texas, it was opened and then it closed. And so getting demand, and we have demand from places on the West Coast and in Chicago. And so getting those people to tour the property has been difficult. But as I indicated, the 5 prospects that we have right now, 2 of which were started -- were really collected by the chamber. And then the other is through our brokerage group, through their national kind of investment sales side of the business and leasing side of the business.

We're somewhat -- I'm somewhat encouraged. I mean I think what's going to happen if I had to really place a probability is that it will turn out to be a multi-tenant building, and it will probably have 2 to 3 tenants in it. But it's set up so well with 40,000 square foot floor plates on 2 wings. And most of the prospects that we are seeing are multiples of 40,000 square feet. They can each take a single floor and expand and yet have security since both wings have their own separate elevator banks. So Dell did a great job on the design and construction of the building. And so once we actually can get a lot more people through the building, I think we're going to have a very, very positive outcome.

The Next question comes from the line of Rob Stevenson with Janney.

Just a follow up on that -- on the last question. I mean when you look at the Austin asset, is a sale here to a tenant that would occupy the whole building? Is that on the table at this point? You guys explored the relevant return of an outright sale versus re-leasing it?

You're exactly right, Rob. That is one of the options, it definitely could happen. And with our current basis, I believe that's in the mid-$30 million right now. We would realize a very strong capital gain that we could redeploy in industrial assets very quickly. And as I've indicated to Gaurav, I mean, we have -- I'm not too excited about having a large multi-tenant office property long term. It's in a great corridor quarter. The Parmer technology corridor has all the high-tech companies there. So it's going to be a successful asset, but it also tells me then that we would have a very successful exit from that property that we can go and redeploy the assets into our preferred asset class of industrial.

Okay. And beyond the former GM space, where is the -- where are the larger pockets of vacancy left in the portfolio today?

Okay. We have a property that is in Tulsa, Oklahoma. It's an industrial property at the port. And we have a letter of intent out to a prospect right now for 2/3 of the building. We have a single-story office property that's been converted to industrial in Minneapolis. And we are right now negotiating a lease for 2/3 of the property, which I think is very positive. We also have another 3-story office property in Minneapolis, that is 2/3 leased. We have a property, let's see, let me take care -- let me make sure I get it right. We have a property in Houston. That's the lab that we're talking about. That's 12,000 square feet. And a tenant is going to -- is actually vacating that space. And what's very good about that is that the adjacent medical provider is interested in expanding into a good portion of that to-be vacant space.

Okay. And then when you take a look, including the GM space as to whatever incremental cost you need to get that into shape for multiple tenants, et cetera. How much tenant improvements, leasing commissions are you expecting, the need to lease-up your current vacancy? What's the sort of ballpark there when you think about it in aggregate as to how meaningful that will be?

You're talking about the Parmer building?

Just all the -- just whatever vacancy that you're working on today? I mean, obviously, there's a cost, right, to get a new tenant into not only the GM space, but these other spaces. How meaningful is that sort of cost to you to take the space from what it is today to what somebody is going to want to sign a lease on it.

Well, if you look at the GM -- let's talk about each one of them. I'll give it to you on a dollar per square foot basis. The GM tenant improvements is going to be somewhere between $20 to $25 a square foot. If we have leasing in the $19 to $28 (sic) [20] or $21 per square foot, which is $5 more than the last cash rent. And then you're going to have commissions of probably $3 to $5, depending upon the length of the lease. If you go to the Port of Catoosa, you're looking at probably a $3 to $4 per square foot price for the tenant improvements. And then the commissions are going to be probably $1 to $2 a square foot. Then if we go to the property in Houston, it's only 6,000 square feet. But it's probably going to be somewhere between $20 and $25 a square foot and then probably $3 to $5 for the commissions.

And then I did talk about another one. We have a property in Mason that has 18,000 square feet vacant out of 60,000. We're negotiating a lease right now for approximately 50% of that vacancy. And that single-story office -- and I expect that to come in somewhere between $18 and $20 a square foot plus $3 to $4 for commissions. So...

Okay. That's helpful. In terms of -- it's been a while since you guys have acquired an office asset. What's the characteristic of the office asset that you talked about that you were pursuing in the acquisition pipeline? What makes that one special versus continuing your almost exclusive industrial acquisition?

Well, it is a facility that is -- so let me make sure I get this correct. It's in Kansas City, Missouri. It's a headquarters facility for them. It's about 150,000 square feet, which falls into the size we typically like. And they've got data center information -- data center space in there as well, which makes it a pretty sticky asset and leases, the lease is for 15 years. So if we can underwrite the credit, which we spend a tremendous amount of time on and we see the enduring nature of the company in their space we'll buy it. But with only 1 property out of 16 being office, our emphasis is definitely going to remain on the industrial side because Mike and I really think we're going to get to 60%, as I indicated, in the next 18, 24 months, and I actually want to get to 70% within 24 to 30 months. So we're going to still acquire office assets. We're going to keep the multistory office assets. We will, in fact, exit the balance of the single-story office properties. I am not in favor of that asset class.

Okay. And then just on the assets that are being held for sale, are those being marketed currently? Is that a later in 2021? Is that -- as the market conditions allow, how should we be thinking about those assets being sold?

Yes. A very modest amount of assets, Rob. Those are being marketed for sale or they could be further along in that process. I would say for those assets, you should be thinking about them being sold during the first 6 months of the year.

Next question is from the line of Craig Kucera with B. Riley.

I appreciate the color on your thoughts of future dispositions, but what is the total size of the single-story office pool that you might look to monetize over the next several years? Is it half of your office exposure? Or just some color there would be helpful.

No. No. I'll tell you. Well, let me get to the specifics, but it is a small percentage because we have exited a number of single-story office over the last 3 to 4 years. It was 1 objective that Mike and I put in our strategy, and we're living by it. But it's a rather small percentage. I just don't have the specifics in front of me right now.

But thematically, Craig, our dispositions per year -- again, we deal that is in the $15 million to $25 million range. So certainly, single-story office probably makes up half or more of that, but it is a very modest number as compared to what we intend to acquire annually.

Got it. No, that makes sense. I appreciate the color. And I just wanted to circle back to the new term loan and your debt capacity. The 8-K REITs that increases the overall credit facility size by the $65 million, but you're not getting that initial availability, it sounds like. Can you talk about sort of how mechanically you -- is that just adding more properties to the line for additional debt capacity or just sort of how you access that incremental capacity over time?

Sure. Without doing too much brain damage. So again, that $65 million, $15 million of it is delayed draw. So we'll pull that down in the coming months and marry that with new acquisitions and the requisite debt that we need to fund them. That $50 million fully paid off the revolver, to your point. Our properties are pledged against the line. They are not secured. So we get "value and availability" based upon -- it depends whether we just newly bought the asset or they've been in the portfolio forever a year, Craig. But just generically think about it with respect to every asset we buy, we get roughly a 60% leverage within that -- through availability within the aggregate credit facility.

We have one more question from the line of John Massocca with Ladenburg Thalmann.

You mentioned the $280 million worth of potential investments in the pipeline. I guess you think about the hit rate on that, what would you kind of maybe expect there? And in the context of that, what do you think is kind of the 2021 acquisition target, if you will?

Well, I'll talk about the target first. I think our target is going to be somewhere between $130 million and $140 million this year. We've got 1 asset in the bar right now. If I had to look at probabilities, our history has been -- once we get into the letter of intent stage, in the letter of intent stage, we'll be somewhere around 1/3 of those -- actually 1/3 to 50% of them coming to fruition. Because what we're seeing also is a number of off-market opportunities, John, that -- because of some of the relationships we have with the other funds, we've been able to identify PE companies that want to sell those assets and redeploy the money into the business. So I would say that you could expect -- once we get into letter of intent stage, close to 50% of those will, in fact, go to actual deals.

No additional questions, Mr. Gladstone.

All right. Well, we thank you all for tuning in and asking some good questions, and we'll see you next quarter. That's the end of this conference call.

Thank you, everyone, for joining us today. This concludes today's conference. You may disconnect your lines at this time. Have a great day.