Gladstone Commercial Corp (GOOD) 2007 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Gladstone Commercial December 31 Quarterly Report. At this time, all participants are in a listen-only mode and a brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder this conference is being record. It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman for Gladstone Commercial. Thank you, Mr. Gladstone you may now begin.

And thank you, Jackie, for that nice introduction and thank you all for calling in. We really do enjoy these times that we share with our shareholders and I wish there were a lot more of them. We have to do our business. If you're in this area, the D.C. area or in McLean, Virginia area, please come by and visit us and say "Hello". You have an open invitation to stop by and see us.

Let me read the statement about forward-looking statements. This report that I'm about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Security and 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 and we believe that plan to the 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" of our Company's 10K and our 10Q filings that are filed with the Securities and Exchange Commission. Those 10Ks and Qs can be found on our website at gladstonecommercial.com and on the SEC website as well. The Company undertakes no obligation to publicly update or revise any of these forward-looking statements whether as a result of new information or future events or otherwise.

In my talk today I plan to talk about the term called Funds From Operation or FFO. 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 plus depreciation and amortization of the real estate assets. The National Association of Real Estate Investment Trust or NAREIT has endorsed FFO as one of those non-accounting standards that we can use in discussion of our REIT and I plan to use that term. Please see our 10K filed yesterday with the SEC -- our 10K was filed yesterday? That's right. And our financial statements for detailed descriptions of FFO.

Our December 2007 quarter and year end results reflects another positive step forward. We invested at a really good pace and the outlook is optimistic for Gladstone Commercial. During the quarter we completed one acquisition that really was six fully leased properties for approximately $19.5 million. We also closed one financing secured by three of our properties for $16 million and we also closed on $20 million of a one year loan with our banking group and that will help finance us going forward.

We currently have a strong pipeline and are still anticipating strong growth in 2008. For the year ending December 2007, we invested in 15 properties. One of those was a lease -- a ground lease for a total of $104.2 million. We're building our portfolio by using our line of credit funded by a group of banks. Once we buy our property, we get long-term fixed rate mortgage on the property as soon as we can and get that mortgage in place and by doing this, we lock in the profits or the spread as it's called on the property and we expect that profit to continue for five, ten years or longer.

Our portfolio and rental contracts have automatically in them rent increases. They're built in so that every year or two the rents go up by 2% to 3%. This falls directly to the bottom line for profit. These rents are wonderful in the sense that we don't really have to anything. They're already built in. We just notify the tenant that the bump in the rent's going up. The portfolio is very good shape today. All our tenants seem to be doing fine and all are paying as agreed. All the properties are rented. So we're in good shape today.

The current credit market is showing some difficulty. The conduit lenders that we deal have become much more difficult to please. We have other mortgages in the works and I hope those will close during the quarter. As long as liquidity holds up, we have the spread we need then the Company will continue to do just fine. I think all of the turmoil in the credit markets in 2008 will be a banner year for this Company. If we're one of the few that can close and finance commercial real estate properties, then it will be one of those grand opportunities that comes along every five and ten years.

At the end, we had approximately $202 million of long-term mortgages. That's at the end of December. And a weighted average interest rate of 5.8%. And we borrowed against the properties that we own and that's how we put these mortgages in place. I'm sure the rates will be higher in 2008, perhaps as high as 3.5% over the ten year treasury notes or about 7.3%. We are expecting to get our smaller transactions financed with local banks and some with insurance companies at 2.5% to 3.5% over the ten year treasuries. That would come out somewhere around 6.5% today. So you're going to see the interest rates go up on the mortgages that we have to put in place but at the same time the cap rates on the properties that we're buying are going up as well. As long as that spread is there, we'll be in good shape.

All total, we have approximately $226 million in mortgages and short-term borrowings at year end. So we're about 1.6 to one in debt to equity at the end of the year. This is still a very conservative position to have on our balance sheet. We have very low leverage today and we will be increasing it over time. We're looking to increase it to about 2.5 to one in terms of debt to equity. We think that would be a reasonable goal to achieve that. Maybe in this year but as time goes on. But assuming we had 2.5 leverage -- 2.5 to one leverage, we should be able to invest another $129 million or so in properties based on this method of operation. And let me explain what that means, if we do that.

Each time we close another investment and let's say we borrowed about 6.6% today and purchased a building yielding 8.9% and every $10 million in new properties that we put in the portfolio will generate an estimated $230,000 to pay increases in expense but also being able to increase the dividend. Based on this type of financing, by placing another $129 million in properties on the books, that would yield approximately an additional $3 million in FFO on the books or about $0.35 a share in FFO. That's based on the current share count.

This strategy of investing with leverage is our vision for the Company. It's the way we intend to work going forward this year. So as long as we can borrow at a reasonable rate and of course buy properties with reasonable cap rates, we should be just fine.

As I talk about per share numbers, now as we move over to the quarterly results, please know that I'm talking about fully diluted, weighted average common shares. This is the most conservative way of talking about that. And net income available to common share holders for the quarter ending December 31, 2007 was approximately $439,000 or about $0.05 a share. This result had some impact by the six properties we purchased during the quarter but we didn't own them for the whole quarter so they'll have their full impact during the quarter ending March 31. That was about $19.5 million.

For this December quarter, funds from operation available to common shareholders, this FFO, was approximately $3.2 million or $0.38. On a per share basis this is 36% increase in FFO for the same period as we had a year ago. And for the year ending December 31, 2007, our FFO was approximately $12.5 million or $1.46 a share. This was a 24% increase in FFO on a per share basis for the same period as compared to a year ago. I'm extremely proud of the team that has increased our FFO and FFO per share by these numbers. I think they're working hard and they've done a great job in 2007. I think in 2008 it will be a very strong year for us again.

We increased the dividend on our common stock from $0.12 to $0.12.5. That's a 4.2% increase. Very hard to do in unusual times that we're in. That $0.125 per share per month is for January, February, and March. So our run rate now is $1.50 per share. We did also after the end of the quarter purchase two fully leased properties for approximately $17.8 million. Again, they will be on the books for part of the quarter and have some impact on the quarter. But their full impact won't come until the June 30 quarter.

The backlog, we remain optimistic about closing the properties we have in our backlog. We do have a very, very substantial backlog today. We see hundreds of properties for sale but often the price is either too high or after tying up the property with a commitment letter, we discover a problem during our investigations of the property. I believe there's now twice a many commercial and industrial properties on the market as there was last year this time; however, many have unrealistic prices based six months or 12 months ago sale prices. But I believe as the year goes on, many will drop the price that they're asking and we'll see more opportunities. We also see some of the properties just being taken off the marketplace and people are going to wait. But I think still this is going to be a good year for us.

That's the way it was back in -- when we worked on properties in 1992. Same kind of thing went on and those were boom years for us in '92, '93, and '94. I think we're in a similar mode today. The real estate marketplace has changed because the mortgage marketplace has changed so much. This of course will cause more sellers to be realistic in their sale prices and if we have mortgages available to us, we'll be able to capture a lot of that marketplace. The market's still divided into three basic segments; tenants that have triple-A or certainly a rated -- like a triple-B ratings and the property's well located and let's assume it's high quality real estate. These are the things sought after by the very large REITs and the cap rates have changed and they've gone up but they still are in the seven something and that's just too low for us. So we're not in that marketplace.

The small real estate properties like fast food locations or pharmacy chains -- those were being purchased by individual investors such as the 1031 swap buyers and those cap rates used to be about 6.5. They've come up substantially. They're in the sevens now. They do this for income and also to roll over the profits they have in another property. The cap rates in that segment are still just too low for us and so until they change and come up we probably won't be in that marketplace either.

So that leaves our investment space in the middle market. We see non-rated tenants, small and medium sized businesses and our expertise here is the ability to underwrite both the small business tenant and the real estate. We're in a good ability to do that because in our other businesses we have lending and buying capability of small businesses and we literally see hundreds and hundreds of them and our folks are well established in that marketplace to understand small businesses. So we underwrite them just as if we were going to lend them money or buy their business and in this case of course they're just our tenants. But we give them the same underwriting characteristics.

At any rate, we're doing our best to load up on good properties and long-term financing that matches our long-term leases, locking in all that with good financing in place. Should be good for us in the future. Our leases, as I mentioned, do have escalation clauses in them, so that they go up automatically every year or so by 2% to 3%. So we've got a great portfolio and hope to add to it a lot this year. The industrial base of small to midsized businesses -- it just continues to remain steady. We don't think it will grow much in 2008 but we don't think it's going to shrink much either.

At this point I'm very optimistic about the future for this Company and believe it will perform well over the next six to twelve months. The housing market collapsed just as we suggested it would some years ago. There's now more homes in foreclosure than any period in the past as a result of all these subprime mortgages written during the past few years. And new construction, of course, is at a 14 year low and the largest number of houses that are for sale in a long while. It will take at least ten months to work off what we have in backlog now, assuming there was nothing else to come to marketplace.

All of this low cost financing and low document financing, those mortgages are gone and it's going to take a change in the heart of a lot of the mortgage lenders in order to remove a lot of that real estate from the market place. And prices will have to come down significantly to make the numbers work. They are down, as you know. But if you remember, only a few years back housing prices soared and so they've got a ways to go before they come down. They collapsed -- and the reason I mention this is the collapse in the housing market has caused the global markets to crash and default rates on securities backed by these subprime mortgages have skyrocketed. And as a result, the credit market is strained and have resulted in a tremendous pull back not only in the mortgage area for homes but for all lending. And you can imagine a bank that's been lending to the subprime marketplace that's now injured because of those problems. It pulls back from everything. So we see the commercial mortgage area has pulled back as well.

So not only is it harder to get a loan on a mortgage loan but the prices are more expensive and many of the conduit lenders, these are the people who package loans, have really shut down because the buyers of the strips of these pools have shut down as well. And it will be a slow period for mortgages in the next year as conduit lenders and these conduit lenders are usually bank sponsored groups that package the loans into pools and then sell them off. Some of those will come back into the marketplace. But right now the most active people in the marketplace are banks and folks like insurance companies and some investors out there. So it's a much smaller marketplace and much harder to get the mortgages. But we seem to be doing okay there.

In January of 2008, the board increased the monthly distributions to 12.5 per month. That's $1.50 a year. It's a very nice rate. And of course, as most of you know, the distributions are about 74% of return of capital. This is because the depreciation on the real estate assets and other items cause us not to have a lot of earnings after depreciation. That's why we talk about funds from operation of FFO because that adds back the real estate depreciation.

As you know, depreciation of a building is a bit of a fiction anyways since at the end of 20 years the building is usually still standing and can continue to be used. So it's just a method of depreciating an asset that really doesn't depreciate that much. The great thing about that, of course, is that if you own the stock personally, you don't pay any taxes on the part that is sheltered by the depreciation. That is the 74% of the dividend, the distribution, is considered a return of capital and you owe no taxes on it; however, the return of capital does reduce the cost basis of the stock which may result in a larger capital gains tax when the stock is sold.

With a stock price averaging -- yesterday's close I think was $17.61, the FFO yield on the stock or the dividend yield on the stock is about 8.5% today. Many REITs are trading at 4% and 5% yields. We should be trading there but we're still kind of small and I guess we haven't attracted enough attention. But over time you should see us become more like all the other REITs that are out there. We will declare the next monthly dividend in early April 2008 for the months of April, May, and June. I'm hopeful that during this calendar year and fiscal year we'll be able to increase the dividend.

Now I'll turn it back to Becky and she'll set us up for some questions from our loyal fans out there. Will the Operator please come on now?

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. (OPERATOR INSTRUCTIONS) Thank you. Our first question is coming from Tony Howard of Hilliard Lions.

Good morning, David.

Good morning, Tony.

How are you doing?

I'm good today.

I haven't had a chance to look at the 10K. I've looked at the 8K. What was the cap rate of the acquisition subsequent to the end of the fourth quarter, the one you just bought recently?

I'll have to look it up. You're talking about the one for the December quarter or the quarter we're in?

The quarter we're in.

Oh. The two we just did in the quarter. Cap rates. I think it's about 8 -- no. 8.4 is not it. I'll have to look it up, Tony. I'm sorry.

Okay. This question comes up every quarter. As far as waiving the incentive fee, in the fourth quarter basically you waived 86% of that. My understand was that part of you goal is that you could start earning that incentive fee. I guess where there's some concern is where the managers, they will continuing raising that fee?

The point is that we in this quarter, we shared it. For example, we gave some of the increase in the earnings to shareholders in the form of an increase in the dividend and we paid out some of it to the employees. We're estimating that by the end of this fiscal year, we'll probably be through all of that. I'm hopeful that we'll continue to grow at a pace that will get us through that. But I just can't forecast when we'll be finished with that other than a good guess of by the end of this year. This will be our transition year in which we'll transition out of that, I think, Tony.

Okay. So you're saying that the total incentive fee would be paid out in that way at the end of this year?

I think by the fourth quarter, yes. Did you know that when we waited for a quarter, there's no going back. It's lost by the management company forever. So I think by the fourth quarter, the December quarter, we will be through that and we will be paying the full amount out and hopefully have increased the dividend more. Just going back, you asked about the two yields. One was at a 10% cap rate and the other was at an 8.9%. But the 8.9% has a fairly steep increase in itself, it might look a little low.

Thanks. You mentioned on one hand that as far as it being more difficult to get mortgages, but on the other hand you seem pretty positive that as far as the ability to make acquisitions and to increase your level this year. Can you kind of talk about the difference between those two situations?

Yes. On the one hand, as you know, this is the way the world works. When everybody's got plenty of money, prices go up and it's hard to find a good deal because prices are so high and when mortgage money and equity money is dear, then you have plenty of opportunities at high rates but no way to finance them. We're sort of in a twilight zone here in between that. Some of the normal people, the conduits have gone away in terms of financing and that has removed a lot of the easy money for mortgages and has driven up the cap rates.

So as the cap rates have gone up, that means more and more opportunities to hit what we need in terms of our cap rate. And so we get -- we have a huge backlog because of that. On the other hand, we have to find the right mortgage when we're doing those transactions to make sure there's a very adequate spread between what we're paying for our mortgage on the one hand and paying for our dividend on the other hand and then that's the right hand side of the balance sheet. And then the cap rate on the left hand side of the balance sheet. So far, Tony, we're doing just fine. We've got nice spreads. Everything's working in our direction but --

Do you set a target? You did about $104 million in 2007. Would that be a good target for 2008?

I think it's a good target but quite frankly I hope to exceed it.

Okay. Final question. This is another question that seems like we ask every quarter -- keep on comparing your dividend yield to the industry, part of the reason though is that you're paying out more than maybe what you're earning or getting close to earning on a FFO basis. So my supposition is that maybe if you didn't raise the dividend so much, the yield would come down some so the risk would in fact be reduced.

There's two kinds of REITs out there in terms of the equity world. One kind of REIT has to not pay it out because they need the money in order to pick up the land and buildings that they're in. For example, if you own a large office building, you've got to take care of all of that stuff. Yes, you can pass some of it through to your tenants. But you're always having to make investments in the building. In our situation, when we have triple net tenants, we really don't have any of that. We pass it all through. As a result, we can pay out all of our earnings or nearly. I think we're paying out about 95%. Is that where we are on that? About 95%. We can pay it out because at the end of the day we don't have those expenses coming back. You talk to some of these real estate folks that have shopping centers or office buildings with multiple tenants -- they need that cash in order to reinvest it in the properties to keep them going. We don't need that. As a result we take the position that for us the best thing to do is not to keep the cash on the balance sheet or even to use it to buy another property. The best thing to do is to pay it out to our shareholders.

(inaudible) David, because I do follow other companies. Anyway, thank you, David.

Alright. Next question?

(OPERATOR INSTRUCTIONS) Our next question is coming from Charlie Place of Ferris Baker Watts.

Good morning, David.

Good morning, Charlie.

One of the things that you had -- when GOOD was originally established, there was a component of providing mortgages to some of the properties I think -- or maybe it wasn't properties owned but were being out in the marketplace as a lender as well. You had said about a year ago or maybe more so that because of the way that the financing was available out there, it just was un -- there was just -- it made no sense to be active in that market. Now that we're seeing lenders leave the market, is that something that you're seeing an opportunity to get some capital out at attractive rates to some of these small non-rated tenants?

Yes. We are seeing some of that. And the way it happens in the two that we did -- one was a situation where they had a very low basis on the real estate. And so we set up a LLC and they put they put the real estate in the LLC and we made a loan to it. So it was almost the same as a triple net lease with the exception that at the end of the lease, at the end of the period, we didn't own the building which is not something I like to do. Right now, Tony, the opportunities are in buying buildings at very attractive rates and financing them. If we can do that, it would be better than going into the market and using our equity and debt capital for loans. So at this point in time we're sticking with the plan of buy to own rather than lending.

Okay. And I might've missed -- Tony might've asked this question earlier. You did $104 million of acquisitions in '07. Do you have an expectation for '08 in general terms?

We think $104 million is a goal that we should be able to get to. There's no guarantees in this world. I'm hoping to beat that number. If we can beat it, that would be great. If we don't beat it, we'll still be up substantially. As you know, earnings were up pretty dramatically this year on $104 million and I think if we did another $104 million they'd by up dramatically again. I'd be happy with another 36% increase in earnings.

Right. Okay. That's it for me, David. Thanks.

Alright. Next question?

(OPERATOR INSTRUCTIONS) Thank you. Mr. Gladstone, there are no further questions at this time. I'd like to hand the floor back over to you for any closing comments.

We appreciate everybody calling in. We are glad that everybody's understanding it and no more questions. With that, we will adjourn the meeting. Thank you all for attending.

Ladies and gentlemen, this does concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.