Gladstone Commercial Corp (GOOD) 2011 Q1 法說會逐字稿

Good morning and welcome to the Gladstone Commercial Corporation First Quarter Ended March 31, 2011 Shareholders Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to David Gladstone. Please, go ahead.

Alright. Thank you, Valerie, for that introduction and thank you, all, for calling in. We always enjoy the time that we have with shareholders and wish we had many more of these calls, but only do it once a quarter. Again, the invitation is open that if you're in the Washington, DC area. We are located in a suburb called McLean, Virginia. You have an open invitation to stop by and say hello. You'll see a great team working for you.

We're also holding our annual shareholders meeting this Thursday, May 5, beginning at 11 a.m. We're at the McLean Hilton located at 7920 Jones Branch Drive, McLean, Virginia. You're all welcome to join us here. We always have a good time at those meetings.

Now let me read the statement about forward-looking statements. This report that we are about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and 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 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 the forward-looking statements, including those risk factors listed under the caption Risk Factors in the Company's 10K and 10Q filings that are filed with the Securities and Exchange Commission. Those 10Ks and 10Qs can be found on our website at www.GladstoneCommercial.com and 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 our talk today we plan to talk about funds from operation or as it's abbreviated, 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 plus the depreciation and amortization of 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 discussing REITs. Please see our 10Q filed yesterday with the SEC and our other financial statements for a detailed description of FFO.

Alright. We always begin our calls with hearing from our President, Chip Stelljes. Chip is also the Chief Investment Officer of all of the Gladstone Companies. Chip, will you give your report, please?

Yes. Thanks, David. Our March 2011 quarter was active. We were able to extend one of our leases, raise some common stock, and acquire a property just after the quarter ended. As of today, all but three of our buildings are occupied and all the buildings that remain occupied are paying as agreed. The three empty buildings constituted about 3.2% of our gross portfolio income and about 3.6% of the total square feet of space that we own. We're taking the appropriate action to re-tenant these properties as quickly as possible.

As previously announced we closed an acquisition in early April. This acquisition was a 60,000 square foot office building located in Hickory, North Carolina. We purchased the property for approximately $10.7 million, including related acquisition expenses and funded it through borrowings on our line of credit. The cap rate on this acquisition over the term of the lease is 9.8%. The property is leased to Fiserv Solutions Inc. Fiserv provides information management and electronic commerce systems and services and is a rated tenant.

Equity in debt markets continue to improve. However, the overall disruption of these markets is still making it somewhat difficult to obtain new mortgage debt on terms that we think are attractive. On the equity side, our common stock price continues to rebound. As a result we were able to issue and sell $14.3 million of common stock in an underwritten public offering during the quarter. On the debt side, the current credit market is still difficult in the long-term mortgage markets including the CMBS market where we traditionally sourced our long-term mortgage financing remains limited. We are seeing some banks willing to issue mortgages up to, say, ten years, albeit on less favorable terms than we could get in the past. But it is improving. So, we're focusing on these mortgages until the CMBS market returns.

We continue to use our line of credit only to make acquisitions that we believe can be refinanced with longer-term mortgage debt. As you recall, our customary business model called for us initially to borrow from the line of credit to buy properties. We then obtained longer-term fixed rate mortgages as soon as we could. We're able to secure the spread between the rent coming in and the mortgage payments going out and by doing this we're able to lock in the profit for five to ten years and in some cases longer. The proceeds from the mortgages would then pay down our line of credit, thus making the line available for the purchase of our next property. With the turmoil in the credit and equity markets over the past few years, our model has adjusted so that we're matching as closely as possible long-term leases with longer-term credit and if we don't believe we'll be able to source attractive debt on new acquisitions we'll plan on buying properties that already have assumable long-term mortgages on them.

In addition to making acquisitions selectively, we'll continue to improve the value of the properties by reviewing and renegotiating existing leases and performing improvements at the properties and selling certain assets. To this end we did extend one lease during the quarter, the master lease on five of our properties located in Georgia were extended for an additional period of five years. The lease was originally set to expire in 2026 and will now expire in 2031. We also received a payment of $750,000 from this tenant for changes in certain covenants under their lease.

We have mortgage debt in the aggregate principal amount of $5.4 million payable during the remainder of 2011 and $3.8 million payable during 2012. This does not include the $45.2 million of balloon principle payments maturing on one of our long-term mortgages in 2011. However, that mortgage has two remaining annual extension options through 2013 and we intend to exercise one of these options in 2011. The mortgage payments due in 2011 are comprised of $2.8 million of balloon principle payment due on debt collateralized by one of our vacant properties. The remaining $2.6 million are debt amortization payments.

Mortgage payments due in 2012 reflect debt amortization payments only. We have no other balloon principle payments due under any other mortgage loans until 2013. And we plan to fund these payments through operating cash flow and borrowings under our line of credit. The quality of our assets remains very good. All but three of the properties are leased and all of our existing tenants are current in their rent payments today. We're working to locate new tenants for the three vacant properties. For one of the vacant properties we are considering a plan to reposition that property to a higher value operation. These transitions will all require some level of capital outlay.

And now let's turn it back to David.

Alright. Thank you, Chip. That was a great presentation. Now let's hear from our Chief Financial Officer, Danielle Jones, for a report on the financial results. Danielle?

Thank you, David. The quarterly results were positive. At the end of the quarter, our total assets increased to $416 million, $381 million of which is our net investment in real estate. We had $123 million of both common and preferred equity and approximately $260 million in long-term mortgages borrowed against the properties we own. We had $21 million outstanding under our line of credit at the end of the quarter at a weighted average interest rate of approximately 3.3% for a total $281 million in mortgages and short-term borrowings resulting in a debt to equity ratio of approximately 2.3 to 1.

Our sources of liquidity include cash flows from operations, cash, borrowings under our line of credit, obtaining mortgages on our unencumbered properties, and issuing addition equity securities. Our available liquidity at March 31 was approximately $26.3 million including $14.3 million in cash and cash equivalents and an available borrowing capacity of $12 million under our line of credit. We used $10.7 million of this available liquidity to fund to the acquisition in April. The borrowing capacity on our line is limited to a percentage of the value of properties pledged as collateral on the line plus both the amount outstanding under the line in our outstanding letters of credit. We are in the process of pledging the asset we purchased in early April to our line of credit. So, we expect our borrowing capacity to increase accordingly. With the remaining capacity under our line of credit and our current cash flows from operations, we have ample liquidity to fund operations, service our debt, perform capital improvements, and maintain our distribution for shareholders.

In addition, we have the ability to raise approximately $282 million of equity capital to the sale of securities that are registered under our universal shelf registration statement in one or more future public offerings. Of the approximately $282 million of available capacity under our universal shelf, approximately $21.6 million of common stock is reserved for additional sales under our open market sale agreement.

Now I will discuss the operating results for the quarter. As I talk about per share numbers, please know that I am talking about fully diluted weighted average common shares. Funds from operations available to common stockholders or FFO for the quarter were approximately $3.8 million or $0.41 per share, a 12.6% increase over the prior year's quarter. The increase in FFO for the quarter was primarily a result of an out of period adjustment recorded during the quarter. Subsequent to reporting our yearend results, we discovered that approximately $250,000 of due diligence costs that were expensed related to the acquisition during the fourth quarter of last year that has been capitalized since the cost of the property. These expenses were costs borne by the seller of the property that were inadvertently expensed by us. We deemed the adjustment immaterial to restate prior year's numbers thus we recorded the adjustment during the current quarter.

Despite the vacancies in our portfolio, our rental income remains flat compared to the first quarter of 2010 because of income generated during the current quarter from the acquisition during the fourth quarter of 2010. However, our property operating expenses increased because of expenses we are now required to pay at these vacant properties. Our general and administrative expenses also increased because of timing of expenses incurred relating to our proxy and annual report.

We paid out 42% of the incentive fee for the quarter. We adjusted the amount of the incentive fee for the quarter. We adjusted the amount of the incentive fee credited in accordance with our agreement under our line of credit lender for the $250,000 adjustment to due diligence costs. Thus the credit fee and incentive fee was larger than in previous quarters. We continue to believe that 2011 will be an active year for us as we build our portfolio and our income grows. We believe we will be able to pay out 100% of the incentive fee earned so that we will be able to grow our FFO.

Now I'll turn the program back over to David.

Alright. Thank you, Danielle. Good report. We're encouraged by all the numbers that are coming in. We do encourage all the listeners to read the press release and the quarterly report that was filed yesterday with the SEC on form 10Q. There's a lot of good material in that document. You can find them at our website at GladstoneCommercial.com and on the SEC website.

To stay up to date, we also have a new way of doing things. The news involving Gladstone Commercial and our other public companies, you can follow us on Twitter under GladstoneComps. That's GladstoneComps. And you can follow us on Facebook, key word The Gladstone Companies. You can also go our general website and see more information about all of our companies that we manage. That's at www.Gladstone.com.

I think the main news this quarter can be -- for the March 2011 quarter -- can be expressed in a couple of bullet points. First, we were able to raise the $14 million in new common equity at a reasonable price. That's always the consideration, to make sure it's a good price. Our friends at Janney Montgomery Scott were the lead on it and our friends at Hilliard Lyons did part of the selling as well. And the reason behind the sale of those shares is we sold the stock in order to fund the Hickory, North Carolina purchases that we had in our pipeline. We have one other that we hope to announce soon.

The second bullet point is that we built up a nice pipeline of new deals and should be able to grow the assets during this year. We have used a small stock selling program called the ATM program. I'm just not sure that we're going to use much of the ATM program until we put the equity that we have raised now into the new properties. Then we might go back to that program.

We are moving forward on our senior common stock sale. It's the lowest cost form of raising money for us now with our stock price so low and the yield so high. This time we're going forward on a very low budget approach with the registered offering. The management Company and not this real estate investment trust, not your Company, will take most of the risk and expenses of raising the money. We're hopeful that we can be successful with this offering unlike the last time we tried which wasn't a very good outcome.

I think this Company is in a great position now to increase the assets and increase the income of those assets. These are very strong positives for the Company that we're seeing now. And we're working hard to have the remainder of 2011 to be a good one. I am very bullish that we can find some attractive long-term mortgages. The market is getting much better. I think 2011 will be a really great year for this REIT.

I just hope we can announce some financing on our un-mortgaged properties in the near future. We have a few mortgages in the process but I just don't know if they'll close or not. Now we have more equity, we're in a position to buy more properties. We have room on our line of credit. So, we are actively looking to buy more properties. And we are also looking at some properties where the properties already have a mortgage on them and we can assume that mortgage. I think we can do some of those during this year as well. And the mortgage market is coming back. I know we've all been waiting for it to come back. It's come back for the really good properties but I'm looking for it to come back in our area as well.

As you all know, the market for real estate properties, we group it into three big categories? First, the tenants that have rated either triple-A or triple-B but somewhere in there. They're strong tenants and they're usually in well located, high quality real estate. This is being sought by all of the large real estate investment trusts and primarily by insurance companies and pension funds. The cap rates or the rate of return that you can get on those and the initial years continues to move around. And I don't know where it's going to stop, but it's very low right now. Too low for us to consider because the returns are very low on this form of real estate. There are others in the category with lower ratings and we purchased a few of those properties over the years. But I don't expect that to be one of our primary areas.

There's a second big category called -- I call it small real estate investment properties like fast food locations and pharmacy chains. These are usually being purchased by individual investors at cap rates that yield about 7.5% today. They do this for income purposes. These are flat leases meaning they don't change over ten, 15 years. And right now this area is still pretty much in flux and we'll see if some of that market comes our way. I'd like to add some of these retail properties to our portfolio just to get diversification but we haven't found anything that really fits for us right now and so don't look for that to be a big part of the portfolio.

The third big area is the one we do most of our transactions in. This area is a middle market or in some cases some of the smaller businesses are the tenants. And these are non-rated tenants. They're small, medium-sized businesses in commercial and office and industrial properties as well as some of the medical properties. Our competitive advantage here is always what we tout out at each one of these discussions is the expertise in underwriting non-rated business tenants in conjunction with underwriting the real estate. We have a great team that does the underwriting of these tenants and I think we come up with as good a rating as you would find from any of the rating agencies.

We are in a great position now to see a lot of opportunities here. Cap rates for this group are in the 8% and 9% range. If we can get a little leverage on them, that pushes the equity returns in the 11% to 13% and that's our sweet spot. We like to be in that area. We are focusing our efforts on finding good properties and long-term financing to match the long-term leases. We like to match the book, as it's called, and the business. That means locking in the long-term financing along with the long-term leases. That should be good for us over a long-term. We're much more optimistic today than we were even last quarter that things are going to be very good for us in 2011 because the mortgage market seems to be coming back.

In terms of economics, I go through this each time and give you an idea of what we're seeing there. The industrial base that many people thought were going to come apart at the seams, industrial and commercial properties remain steady. Most of them are paying their rents and doing reasonably well. There are a lot of auctions. You'll see those in the newspapers, for commercial properties that have been foreclosed on or taken back by the bank. But those are some pretty difficult properties. They're really not a good fit for the things we're looking for. There still are some businesses that are having problems of course but to my way of thinking, things are so much better now than they were last year that we expect good growth during 2011 for this real estate investment trust. And while we do not have any retail properties, we like to see those. Some drug stores, some fast food restaurants. We're still working in that area. My hope is that we can come up with that. We have a lot of expertise in that area, it's just that a lot of other people have the same amount of expertise.

At this point I'm very optimistic about this Company and its fine future. But we'll continue to be cautious in our acquisitions, just to make sure we don't put a lot of risk in the portfolio. We're looking at a number of ways to continue the growth of the business and growth is still limited due to the lack of low cost commercial mortgages for tenants like ours. We continue to talk with the local banks to provide mortgages for our properties and the local banks, that means local near the properties that we own, may be able to offer us some mortgage money. We have over $90 million now worth of properties that do not have mortgages on them and we're working on getting mortgages in place. We have a few term sheets.

One term sheet has moved along very nicely and if we can find good mortgages for those new properties, we can convert the short-term loans that we have through the line of credit into long-term mortgages and that's what we would like to do. And then that frees up our opportunity to go out and do more transactions. We were successful in raising common equity and we like to raise more equity in 2011 once we buy some more properties and build up the income stream. We're hopeful that we can raise and use the new equity for more acquisitions. It just continues to be the same thing. We raise money, buy properties, and raise more money.

We continue to look for various forms of preferred stock that we may be able to issue at reasonable rates. I will note that most of our preferred stock is trading a little below par or at par. I'm hopeful that we can raise some additional funds in preferred stock and variations thereof. The current rate that others are selling preferred stock for to yield to those investors buying the preferred stock is still very high. It doesn't work especially well for us after we pay underwriters' commission and expenses. The yield on that money would get preferred stock penciled out to be around 9% to day and that is after you factor in all the costs of raising the money through lawyers and underwriters, et cetera. So, it's still very extensive money. We're looking at other ways, not anything that's worth discussing at this point in time.

In April, the board declared monthly distributions of $0.125 per common share for April, May, and June. That's $1.50 a year. It's a very nice run rate for such a good solid REIT. Because the real estate can be depreciated, we're able to shelter the income for the Company, the distributions in 2010 were about 84% of return of capital and that of course is tax free. This stock can be a good one to hold in your regular accounts because it's so tax friendly. The return of capital is due to the depreciation of the real estate assets. I've had a number of people call and want to know how this works. It's caused the earnings to remain low after you factor in the depreciation. That's why we talk about FFO because that's adding back all the real estate depreciation.

As you all know, depreciation of a building is a bit of a fiction since at the end of the depreciation period the building is still standing. The great thing is if you own the stock personally as opposed to having it into an IRA or retirement plan, you don't pay any tax on that part of the sheltered appreciation. Shelter by depreciation. That's considered a return of capital. However, there is a trick to that, of course. The IRS does want to get paid and the return of capital does reduce the cost basis on the stocks which may result in a larger capital gains tax when the stock is sold.

With the stock price at $18.16 the dividend yield on our stock is about 8.25%. Many REITs are trading at much lower yields. I just read a report that the entire REIT universe is trading at an average of 3.9% yield. If we were trading at that, it would be a $38 stock. I really don't expect that. But all of the triple-net REITs like us that are investing in properties on a triple-net basis, the average there is trading at 5.6% and if we were trading at that, it would be a $26 per share. I do expect the stock to move into the 20s because it's such a solid yield. We did have one large institutional buyer of about 200,000 shares of our stock in the offering that we did and that should lead the way for some more stock buyers from institutions. We will declare the next monthly distribution in early July for the months of July, August, and September.

And that's really the end of my report. So, if you'll come on, Valerie, and give us the question and answer methodology, we'll start the questions now.

Thank you. (Operator Instructions) Our first question comes from John Roberts of Hilliard Lyons.

Good morning, David.

Good morning, John.

Chip mentioned that there was a payment of $750,000 from a tenant. Was that recognized in the Q1 numbers?

Yes. Danielle can comment after me. It was recognized but it's being amortized over the time of the lease so, it's not coming in all at one time. How much is that a month? Or a year?

$38,000 a year.

$38,000 a year, John. So, it's not a lot.

Chip, you mentioned three buildings were empty. I think last quarter it was two. You lost a tenant during the quarter?

We had a tenant in St. Louis file bankruptcy. I think we mentioned it last quarter. And that tenant did not confirm the lease in bankruptcy and moved out as of the end of April. But they are now out of the building. That lease was due within the next -- in January of 2012 anyway. We knew they were not going to stay in the building. So, we're a little early on having to market that building but we're close to signing an agreement with a broker to lease it or put it up for sale and then the signage just going out. It's one that we knew about. We had announced that we thought it was going to go dark and it did.

Okay. So, you're anticipating you'll either release it pretty quickly or sell it?

That's right. That market's not a bad market. We have some comments. We may be able to get some traction there.

Alright. Great. And David, I might've missed this. Did you mention what the return of capital percent was for 2010?

It's 84% as return in 2010. We think it'll be more or less the same in this year or --

It might be a little bit higher this year. We have that big bump of income from the branch payoff last year.

That's right.

It might be more typical of 2009 which was closer to 93%.

So, it might be closer to 90% or 93% for this year.

Very good. Thanks.

Okay. Next question?

Our next question comes from Chris Lucas of Robert W. Baird.

Hi. Good morning, David.

Good morning.

I just had one quick question. You talked about $90 million of unencumbered assets. Is that -- how much of those assets are essentially not pledged because they are supporting the line of credit facility?

They all support the line of credit facility. They're not all on the line. How many do we have?

At least about $70 million's on the line.

About $70 million's on the line.

One's about to go on, so it'll be more like $80 million.

So -- go ahead.

What happened is we would use the money that we get in to pay down the line and then as we buy a new property, you put it on the line and get leverage that way.

So, how does that work? In terms of if you think about the -- I'm just trying to understand what the leverage capacity you really have given the credit facility and the -- ?

If you borrow property for -- let's just assume we've mortgaged an existing property and laid the line down to zero. And at that point in time you could buy a property, say, for $10 million and assuming for the sake of argument that you got half or three-quarters of the money from the bank on your line of credit. The rest would have to go up as capital, equity capital. Did you follow the math?

No. Let me do it this way. The current balance on the -- the end of quarter balance on the credit facility was what?

$21 million.

Okay. So, that $21 million of borrowing is supported by how much in the way of assets that are essentially supporting that line?

It's about $70 million.

It's about $70 million. It's way over -- we don't need $70 million to support the $21 million loan balance.

What level of assets do you need to support that $21 million of loan balance? I guess that's really the right question.

65% loan to value --

65% is what we get from the line.

Okay. That's helpful. So, that's essentially in line with what sort of roughly the mortgage market is giving in proceeds today?

Exactly right.

Okay. So, that's a fungible -- ?

It is. We're just converting. When you do these deals -- unless you do more -- if we did the entire $70 million and got 65% you'd have cash on the balance sheet.

Right. Okay. That's helpful. Thanks, David. And then I guess just on the acquisitions, what sort of range of cap rates are you seeing in the marketplace today? Is there pipeline? Is it all one-off? Single deals? Are there any portfolio opportunities in that mix?

There are portfolios but every time we see a portfolio they will have two good ones and two really doggy ones. We're not interested in taking on workouts. And so we go in and we ask them if they'll sell the two good ones alone and most of the time they're trying to bundle them so they can get rid of some of their problems. So, we're not doing those transactions. We're seeing mostly one-offs from individual owners or some small fund, some funds that were built up during the crazy time and they're now having to sell some of them to pay down their debt.

And the dollar range on these single transactions?

They're running anywhere from a low side of $7 million up to just around $15 million.

And, I'm sorry, the cap rate range then is -- ?

Cap rate is for us 8% to 9.5%.

Okay. Very good. Thanks, David.

Next question, please?

(Operator Instructions)

Anybody have any questions? Please log in.

At this time I am showing no further questions. This concludes our question and answer session. I would like to turn the conference back over to David Gladstone for any closing remarks.

Alright. Thank you, all, for attending. If you have questions, email them in to us. We try to answer those if they're already covered in some of our reports. It's something new. We put it on the website for everybody to see. That's the end of the conference. Thank you, all.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect and have a great day.