Gladstone Commercial Corp (GOOD) 2011 Q3 法說會逐字稿

Good morning and welcome to the Gladstone Commercial Corporation third-quarter ended 9/30/11 shareholders conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to David Gladstone. Please go ahead, sir.

Okay. Thank you so much for that nice introduction, and thanks to all of you for calling in. As I have mentioned every time, we enjoy these times we have with you on the phone and wish we had a lot more of these. We only do them once a quarter. If you are ever in the Washington DC area, please come by and visit us. We are located in a suburb of Washington DC called McLean, Virginia, and you have an open invitation to stop by and see us here at the office. You will see a great team in action.

And now let me read this statement that we read each time. 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 Securities Exchange Act of 1934, including the 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 correct. 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 10-K and 10-Q filings that we file with the Securities and Exchange Commission, and those 10-Ks and 10-Qs 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 of these 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 FFO as we call it, and since FFO is a non-generally accepted accounting principle and in terms of accounting, I need to define FFO. And that is the net income, excluding the gains and losses from the sale of real estate, but including and plus the depreciation and amortization of real estate assets. The National Association of Real Estate Investment Trust has endorsed FFO as one of those non-accounting standards that we can use in discussions of our real estate investment trust. Please see our 10-Q filed yesterday with the SEC in our financial statements for a detailed description of FFO.

We begin this call today from hearing our President, Chip Stelljes. Chip is also our Chief Investment Officer for all of the Gladstone Companies, and Chip, take it away.

Good morning, everyone. We had minimal investing activity during the third quarter; however, we were able to put some of the equity to work that we raised in June of this year as we acquired two properties subsequent to quarter-end. As of today, all but two of our buildings are occupied. All the buildings that are occupied are paying as agreed. The two empty buildings constitute about 2.3% of our gross portfolio income and about 1.3% of the total square feet of space that we own.

In addition, while we released one of our previously vacant properties, the lease only has four months remaining, so we continue to take the appropriate action to re-tenant all three properties as quickly as possible.

As to our acquisition, subsequent to the quarter-end, the first property acquired was a 25,000 square-foot office building located in Boston Heights, Ohio. We purchased the property for approximately $4.4 million and funded it through borrowings from our line of credit. The average cap rate on this acquisition over the term of the 10-year lease is 8.6%. The property is leased to Paychex Inc. Paychex is the second largest provider of payroll human resources and benefits outsourcing solutions for small to medium-sized businesses in the US with a 20% market share.

The second acquisition was a 60,000 square-foot office building located in Parsippany, New Jersey. We purchased the property for approximately $11.1 million and funded it through a combination of borrowings from a line of credit and issuance of a new 10-year, $7.2 million mortgage on the property at 6%. The average cap rate on this acquisition over the term of the 15-year lease is 10%.

Both the equity and debt capital markets remain very choppy and challenging. The market for long-term mortgages has been limited for some time now. However, we have recently seen mid-term five- to 10-year type mortgages become more available. The market for long-term mortgages, the CMBS market, has been trying to make a comeback, but it's much more conservative than it was prior to the recession.

Consequently we are looking to regional banks, non-bank lenders and a limited CMBS market to issue mortgages to finance our real estate activities.

On the equities side, our common stock price is around $17, down from a recent high of $19 during the second quarter. Stock price has been impacted by the volatility in the equity markets during the third quarter. However, we have sufficient equity on hand to fund the remaining deals in our pipeline through the end of the year. So we will not need to tap the equity markets until next year.

We continue to only use our line of credit to make acquisitions that we believe can be financed 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, and we then obtain longer-term fixed rate mortgages as quickly as we could. This permitted us to secure the difference between the rent coming in and the mortgage payments going out. And by doing this, we were able to lock in the profit for five to 10 years and in some cases longer. The proceeds from the mortgages would then pay down our line of credit, thus making the line of available for the purchase of the next property. And with the turmoil in the credit and equity markets over the past two years, our model has adjusted so that we are matching as closely as possible long-term leases with longer-term credit. If we don't believe we will be able to source attractive debt on a new acquisition, then we will not buy it. So we are only buying properties that already have long-term mortgages on them or where we are able to simultaneously or soon thereafter close long-term debt on them.

One of the properties acquired in October had a simultaneous loan in place at closing, and the other is going into a pool where we already have a term sheet from a lender.

We also continue to improve the value of our existing portfolio of properties by renewing and renegotiating existing leases, performing improvements at the properties and selling certain of our assets. To this end, we are actually working with our existing tenants who have leases expiring in 2012 and 2013 to renegotiate the terms of their leases and extend those terms.

We have mortgage debt on our properties in the aggregate principal amount of $715,000 payable during the remainder of 2011 and $4 million payable during 2012. This does not include the $45 million of balloon principal payments maturing on one of our long-term mortgages due in 2012. However, this $45 million mortgage has one remaining annual extension option through 2013, and we intend to exercise this option in 2012. Mortgage payments due in 2011 and 2012 are comprised solely of debt to amortization payments. We have no balloon principal payments due under any of our mortgage loans until 2013, and we plan to fund these payments through operating cash flow and borrowings under our line of credit.

We are working to locate new tenants for the two vacant properties and for the two leases that expire in 2012. Signing leases with new tenants will require some level of capital outlay, and our pipeline of possible acquisitions is very strong today.

And with that, I will turn it back to David.

All right. Good presentation. Now let's turn it to our Chief Financial Officer, Danielle Jones, and she will sum up some of the financial results. Danielle?

Good morning, everybody. Our quarterly results were stable and reflect our growth during 2011. At the end of the quarter, our total assets were $427 million, $401 million of which is our net investment in real estate. With this acquisition of the two properties in October, our total assets grew by approximately $15.5 million to $443 million. We had $139 million of both common and preferred equity and approximately $266 million in long-term mortgages borrowed against the properties we owned. The weighted average interest rate on these mortgages is 5.7%.

We had one mortgage loan for $45 million, which would have matured in October of this year; however, we exercised the extension option during the quarter to extend the term until October 2012 and expect to exercise the remaining extension option to extend the term through 2013.

Along with the extension, the interest rate increased slightly for the next year to 4.76% from 4.58%, which is still a very low rate on this debt.

We had $9.1 million outstanding under our line of credit at the end of the quarter and a weighted average interest rate of approximately 3.2% for a total of $275 million in mortgages and short-term borrowings, resulting in a debt to equity ratio of approximately 2 to 1. Our sources of liquidity include our cash flows generated from operations, cash, borrowings under our line of credit, obtaining mortgages on our unencumbered properties, and issuing additional equity securities. Our available liquidity at September 30 was approximately $33.7 million, including $2.4 million in cash and an available borrowing capacity of $31.3 million under our line of credit.

Our available liquidity decreased by about $9 million to $24.7 million subsequent to quarter-end from the funding of our two new acquisitions. The borrowing capacity on our line of credit is limited to a percentage of the value of properties pledged as collateral to the line, plus the amount outstanding under the line and our outstanding letters of credit. With the remaining capacity under our line and our current cash flows from operations, we have sufficient liquidity to acquire the properties remaining in our pipeline through the end of the year, fund our operations, service our debt, perform any capital improvements at our properties and maintain our distribution to our shareholders.

In addition, we continue to have the ability to raise $257 million of additional equity through the sale of securities that are registered under our shelf registration statement in one or more future public offerings. Of the approximately $257 million of available capacity under our shelf, approximately $22 million of common stock is reserved for additional sales under our ATM program.

And now I will discuss the operating results for the quarter. Per share numbers referenced are fully diluted and weighted average common shares. FFO available to common stockholders for the quarter was approximately $4.3 million or $0.39 per share, which was a 1% increase in FFO from the same period of last year. Increase in FFO was primarily a result of the 9% increase in our rental income compared to the third quarter of last year because of income generated from the three properties acquired subsequent to September 30, 2010.

Our incentive fee also decreased significantly this quarter due to an increase in common stockholders equity from the issuance of 2.2 million common shares during 2011, which resulted in a higher hurdle rate to overcome, which is the main component of the calculation. Our administration fee also decreased because of a decrease in the amount of the total expenses allocated from our administrator, and our general and administrative expenses decreased significantly during the quarter because of the write-off of $1.6 million of expenses incurred in 2010 related to the termination of the private offering of our unregistered senior common stock in September 2010. These were all partially offset by $3.3 million of additional income and prepayment fees we received in July 2010 in connection with the early repayment of our mortgage loan and higher due diligence expense this quarter because of expenses incurred during the quarter because for the two acquisitions that subsequently closed in October, coupled with due diligence expense incurred during the quarter for other deals in our pipeline.

Our base management fee also increased because of the increase in our total common stockholders equity.

FFO for the nine months was approximately $12 million or $1.18 per share, an 8.3% increase over prior year's FFO. The increase in FFO for the nine months was the result of what I just discussed, coupled with an out of period adjustment recorded during this three months ended March 31, 2011, for $250,000, which if you remember related to due diligence costs of the Company's acquisition during the quarter ended December 31, 2010, which were inadvertently expensed rather than capitalized in the cost of the property. These expenses were costs which were borne by the seller of the property and should not have been expensed items.

FFO per share was down from 2010 because of issuance of the common shares during 2011, and we we were not able to pay out a large percentage of the incentive fee this quarter because of the $22.7 million of additional equity we raised in June, which was not put to work until October. We are hopeful that we will be able to pay out a larger percentage of the incentive fee next quarter, and as we continue to build our portfolio and our FFO grows, we will be able to consistently pay out 100% of the incentive fee earned so that we will be able to grow our FFO.

And now I will turn the program back over to David.

All right. Thank you, Danielle. That was a good report.

We encourage all of our listeners to read the press release and the quarterly reports that were filed yesterday with the SEC. That is Form 10-Q. There is a lot of good material in there, a lot of information for all of you, and you can find all of that on our website at www.gladstonecommercial.com, as well as the SEC website.

To stay up-to-date on the latest news involving Gladstone Commercial and our other public companies, you can follow us on Twitter using GladstoneComps and on Facebook, and the keyword there is the Gladstone Companies. And you can go through our general website to see more information about all of our companies at www.gladstone.com.

I think the main news for this reporting season was what we spoke about. We acquired two properties, simultaneously closing on a ten-year financing on one of them, and we have more purchases in the works. I think that is really good news for all of you shareholders. We built up a nice pipeline of new properties that we want to buy, and because of that pipeline, we hope to be able to grow the assets even more during the remainder of this year and also into 2012. We may need to use the ATM stock selling program that we used a year or so ago, and that will help us put a little more equity on the property -- on the Company so that we can buy more properties.

The ATM program permits us to raise small amounts of stock in the open market, and it is very good for that. We are moving forward today on our senior common stock offering. It is the lowest cost form of raising money today since our common stock price is so high and so low today and the yield is so high, this time we are going forward with a registered offering and with that very low cost effective approach. The Company has capped the amount of expenses that the Company will incur in this offering, and the cost over the cap less the management company will have to take care of that remainder amount. So it takes the risk of the expense rising -- the expenses of raising money going up very much. We are hopeful that we can successfully use this offering because it is so great a securities for buyers and it also works for us.

I think this Company is in great position to increase the assets during this coming year. 2011 is shaping up to be a very good year for us, and I think it will be a great year for shareholders when we finally close the books in December.

On another note, I am hopeful we can find some attractive long-term mortgages to finance our unencumbered properties. As you know, we still have about $90 million. The mortgage marketplace at some banks is getting much better, but certainly not robust, and I'm hopeful that we can announce additional financing at some of our non-mortgage properties in the near future. We have a few mortgages working, and the process is slow and tedious of making sure that everything is in place. But I'm hopeful that they will close by the end of the year. This will move those properties off our line of credit and finance them long-term, and it will give us a larger line of credit that we can use to go out and buy other properties.

As you know, we like to put on long-term mortgages to match up with our long-term leases. It is called matching the book, and that is one thing we have been very proud of.

We continue to look for properties with mortgages already on them that we can assume. That is a great way to do deals, and we seek to acquire properties and to secure the financing and close simultaneously with the acquisition as we did on one of the properties acquired in October. I think we can do a lot more of that during this coming year.

As I like to mention each time where we fit into the marketplace, it has really divided the marketplace into three different categories. One is where the tenant is either AAA or even down as low as BBB in a well-located, high quality real estate marketplace. Now this would be something like an office building in Washington DC. The larger REITs and insurance companies are buying those, and the cap rates continue to move around. I don't know where they are going to end up with, but they are way too low for us to consider as a category of real estate since we cannot find cheap mortgages. There are other categories with lower ratings, and one of those is small real estate properties like fast food locations or pharmacy chains. These are being purchased by individual investors at cap rates that yield today about 7%. They do this -- that is the buyers do this for income purposes. This area, too, is in flux, and we're starting to see some of these, and I'm hopeful that we can buy one or two of them in the next year or so.

The area most like -- that we most like to invest in is the middle market where we see non-rated tenants and small and medium-size businesses and commercial or office or industrial or in some cases medical properties that fit what we are looking for. Our competitive advantage in this area is that we have the expertise to underwrite the non-rated business tenant in conjunction with the real estate. I think most people can underwrite the real estate, but we have a particular ability because of all of our lending programs to underwrite the tenants as well.

So we are in a good position to see a lot of opportunity here. Most people have exited that marketplace. Cap rates, or interest rates if you will, on -- that we get as a return are in the 8% to 9% range, which is a nice range for us. We are focusing all of our efforts, of course, on finding good properties and long-term financing to match up with the long-term leases. If we are able to lock in that long-term financing with the long-term leases, that provides good income for this Company over the future years.

We are much more optimistic about things going good for this Company in 2011 and also most of 2012. So while we proceed cautiously, we are expecting some good transactions in the near term.

Much of the industrial base that we see out there rents in the industrial area. Commercial properties remain pretty steady. It is not as disastrous as it looks. I know there is a lot of auctions, and people see all those auctions in the newspaper. These are commercial properties that have been taken back by banks or by other lenders, and those are some pretty difficult properties. They probably should have never made them. Obviously if that is true, they should have never made those loans in the first place. But they foreclosed on the properties, they own them, and they are trying to sell them off. These really don't fit with what we are trying to do. They are sort of the far, far end of the spectrum. There are still many businesses out there that are having problems, of course, but to my way of thinking, we are much better off this year than last year, and we think 2012 is going to be a good year for this REIT.

Needless to say, I'm optimistic about our Company, and we will be fine for the future. Nevertheless, we always continue to be cautious in all of the acquisitions that we have done in the past years, as well as going forward. Because of our cautiousness, we made it through the last recession without cutting the dividend or having a lot of problems from tenants.

So we are looking for a number of ways to continue our growth, and we are still limited, of course, by the lack of low-cost commercial mortgages for tenants like the ones that we like. So we are still working on that problem, and we were successful in raising common stock twice in this year, and we will use the new equity. That is we are using it now -- we just closed on two of the deals. We will continue to use that equity to fund even more acquisitions.

As we continue to look for various forms of raising money, preferred stock comes to mind. We may be able to issue preferred stock at a reasonable rate, so we are looking at that. I want to note that our preferred stock is now trading at close to par. So that gives us some insight into what we may be able to do in the future.

We are looking for other ways to raise money, but it is really hard to tell you how we are going to do that at this point in time, and we will just have to take a look at it as time goes on.

In October 2011, the Board maintained a monthly distribution of $0.125 for October, November and December. So our annual run rate is $1.50 per share. This is a very nice rate for such a good solid REIT that we have today with such high occupancy.

Because the real estate can be depreciated, we are able to shelter the income from the Company. The distributions in 2010 were about 84% return of capital, and that is -- that means that 84% of that dividend is tax-free. And this is really a tax-friendly stock in my opinion and a good one for personal accounts that are seeking income.

This return of capital is due to the depreciation of the real estate asset and other items on the balance sheet, and that causes the earnings to remain low after depreciation. That is why we talk about FFO because that is with depreciation added back, and depreciation on a building has always been pretty much of a fiction anyway. So, at the end of the depreciation period, the building is still standing, still usable, still rentable. The great thing is that owning the stock personally as opposed to having it in an IRR or other retirement plan is you don't pay any taxes on that part that is sheltered by depreciation as that is considered a return of capital. However, as you all know, the return of capital does reduce the cost basis on the stock, which may result in a larger capital gains tax when the stock is sold.

Just to take note with the stock price at around $16.35, the distribution yield on the stock is about 9.2%. Many of the REITs today are trading at much lower yields, and I just read the REIT universe report and most of them are trading at 4.6% yield. If we could trade at that, obviously it would be a $32 stock, and the net-net-net REITs, if you added them all together, they are trading at about 6.6%. If we were trading at that, we would be trading at $22, almost $23 a share. We were trading at that price some years ago.

Should the trading -- we should be trading there obviously. There is no reason for us not to be traded there. We did have one large institution at about 200,000 shares of stock in a recent offering that we had, and that should lead some of the other institutions to buy the stock as well.

We will vote at the next monthly -- on the vote -- on the next monthly distribution in early January during our quarterly board meeting for the months of January, February and March. And now I will have some questions from the loyal shareholders and analysts who follow us in this great REIT.

Will the operator please come on and help us go through those questions?

(Operator Instructions). Andrew DiZio, Janney Capital Markets.

Just a question, first, on the new mortgage. I am sorry, Chip, did you say that was at a rate of 6%? The one on the Parsippany asset?

Correct.

And can you -- the tenant in that asset, is that a credit tenant, or just what kind of tenant is there?

It is a middle-market company like David described, and unfortunately the deal we have with that tenant is we won't divulge the name of the tenant. But it is a middle-market credit, not a pure credit tenant.

Okay. That is fair. And then second, also on the mortgage front, I think you talked about the other acquisition, the Paychex asset being in a pool, and there is an existing term sheet. Can you just talk about that pool? Is that a potential with a CMBS lender, or is that just a single lender?

Well, we have actually had two term sheets on this pool, one of which was a CMBS type structure, but the one we are working on now, it is more of a balance sheet lender.

Okay. And is that with a bank, an insurance company? Can you talk about what kind of lender that is?

It is a bank.

Great. Thanks a lot.

(Operator Instructions). Steve Percoco, Lark Research.

You have made a decision to extend the $45 million mortgage. Could you give us a little bit of color around that? Why extend it? Why not try to refinance it for longer-term? Give us some sense of how the lender is thinking about it. What rates might be available. Obviously it is under-collateralized. You have collateral that you could use. So any color that you could give us as to your thinking there would be appreciated.

Do you want to take that one, Chip?

Sure. I mean I think the thinking behind it is we have a good extension. We have got an attractive rate on that debt now. We are in front of that mortgage and starting to think about how we would refinance it and talk to the existing lender and additional lenders. But I think we have got enough time on it. We are not under-collateralized. We are perfectly fine collateralized in that mortgage. So the question will be, what is our next step? But we have got a good bit of time.

Yes, we really have two years. We just extended it for one year, and then we have another year on top of that. Probably next year at this time we will be looking very hard at some way of refinancing that, and I think the marketplace may be better then than it is now. That is obviously the gamble that we have taken to try to make sure that we do the best thing for the Company.

(Operator Instructions). And I am showing no additional questions in the queue. I would like to turn the question -- or close the question and answer session and turn the conference back over to Mr. David Gladstone for closing remarks.

All right. Thank you all for calling in. We appreciate the time we have with you. I think you are going to be real pleased with the future of this Company, and we will see you next quarter. That is the end of this session.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.