Gladstone Commercial Q3 2024 Earnings Report

Gladstone Commercial EPS Results

• Actual EPS: $0.20
• Consensus EPS: $0.34
• Beat/Miss: Missed by -$0.14
• One Year Ago EPS: $0.34

Gladstone Commercial Revenue Results

• Actual Revenue: $39.24 million
• Expected Revenue: $36.66 million
• Beat/Miss: Beat by +$2.58 million
• YoY Revenue Growth: N/A

Gladstone Commercial Announcement Details

• Quarter: Q3 2024
• Date: 11/4/2024
• Time: After Market Closes
• Conference Call Date: Tuesday, November 5, 2024
• Conference Call Time: 8:30AM ET

Gladstone Commercial (NASDAQ:GOOD) is a real estate investment trust (REIT) that owns, acquires, and manages primarily single-tenant and select multi-tenant commercial properties. Its portfolio has historically included industrial, office, medical office, and other commercial real estate leased to businesses under long-term agreements.

The company focuses on properties that can generate recurring rental income and typically seeks tenants and assets with durable operating characteristics. In recent years, Gladstone Commercial has emphasized growing its industrial real estate holdings while continuing to manage a diversified portfolio of commercial properties.

Founded in 2003, Gladstone Commercial is headquartered in McLean, Virginia, and invests in properties located throughout the United States. The company is externally managed by Gladstone Management Corporation, an affiliate of the Gladstone family of investment companies.

Gladstone Commercial Q3 2024 Earnings Call Transcript

Key Takeaways

• Positive Sentiment: Our portfolio sustained minimal impact from the recent Southeast hurricanes, with 100% rent collection and proactive tenant support measures in place.
• Neutral Sentiment: The Fed cut rates by 50 basis points to 4.75%–5.0%, with future moves contingent on labor market strength, inflation data, and election-driven volatility.
• Positive Sentiment: U.S. industrial net absorption slowed 36% year-to-date but new construction fell 54%, keeping vacancy at 6.6% and setting the stage for vacancy declines in 2025.
• Positive Sentiment: Industrial concentration rose to 63% of annualized straight-line rent, portfolio occupancy held at 98.5%, and 242,000 sq ft of new leases/extensions were signed at a 7.2-year average lease term.
• Positive Sentiment: Management acquired a $10 M Midland, Texas industrial asset, sold two Georgia medical offices for $10.3 M in gains, and maintains $80.7 M of liquidity with leverage below 50% as it targets >70% industrial exposure.

Presentation

[Operator]

Greetings and welcome to Gladstone Commercial Corporation's third quarter 2024 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce David Gladstone, Chief Executive Officer. Thank you, Mr. Gladstone. You may begin.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Well, thank you for that nice introduction, and we thank all of you for calling in today. We certainly enjoy the time we have with you on the phone and wish there were more time to talk with you. Now we're here from Michael LiCalsi. He's our General Counsel and Secretary to give us legal and regulatory matters concerning this call this morning. Michael.

[Michael LiCalsi, General Counsel at Gladstone Commercial Corporation]

Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. 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 result expressed or implied by these forward-looking statements, including all the risk factors in our Forms 10-Q, 10-K, and other documents that we file with the SEC, and you can find these on our website, and that's gladstonecommercial.com. Specifically, go to the investors' page or on the SEC's website, which is www.sec.gov. 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.

[Michael LiCalsi, General Counsel at Gladstone Commercial Corporation]

Today, we will discuss FFO, which is funds from operations. FFO is a non-GAAP accounting term defined as net income, excluding the gains or losses from the sale of real estate and any impairment losses on property, plus depreciation and amortization of real estate assets. We'll also discuss Core FFO, which is generally FFO adjusted for certain other non-recurring 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. We ask that you visit our website, which is gladstonecommercial.com, and sign up for our email notification service. You'll also find us on Facebook. The keyword there is The Gladstone Companies, and Twitter, which is @gladstonecomps. Now, today's call is an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday, for more detailed information.

[Michael LiCalsi, General Counsel at Gladstone Commercial Corporation]

Now, with that, I'll turn it over to Gladstone Commercial's President, Buzz Cooper.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Thank you, Michael, and thank you all for joining today's call. We have several key updates regarding our operations and the broader economic environment. First, I'd like to share our concern for all those impacted by the recent hurricanes that swept through communities in the Southeast. Our thoughts are with all those affected. As it relates to our portfolio, we fortunately sustained minimal impact. Our team has been proactive in reaching out, supporting tenants, and responding promptly to any needs. Turning to the broader economic environment, the Fed in September implemented its first rate cut, marking a change in policy since rate hikes began in 2022. They lowered the benchmark federal funds rate by 50 basis points to a range of 4.75%-5%, down from its prior range of 5.25%-5.5%, which had been the highest level in 23 years.

[Buzz Cooper, President at Gladstone Commercial Corporation]

This marks a significant reversal after a prolonged period of high rates that negatively impacted capital markets. We expect additional cuts to follow, though the timing and magnitude of those cuts depends on economic indicators. September U.S. job growth surged, with employers adding 254,000 jobs, significantly surpassing expectations, while the unemployment rate also dipped to 4.1% from 4.2%. While this is positive for the overall economy, the strength of the labor market and the higher-than-expected inflation in September may push out any further rate cuts. Continued momentum could create challenges in balancing inflation concerns with market expectations for lower interest rates. Today's election is likely to bring further volatility to the markets as fiscal and regulatory policies are debated. We believe our portfolio is well-positioned regardless of which party is in office.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Despite broader economic uncertainties, our portfolio continues to perform well, with industrial real estate being a key growth driver. According to Colliers Industrial Market Statistics, for the third quarter, net absorption in the United States totaled 39 million sq ft, bringing the year-to-date total to 115 million sq ft. This compares to 180 million sq ft of absorption recorded during the same period of time last year. This reflects a 36% decline due primarily to a particularly slow first quarter. Of the 77 markets tracked by Colliers, 19 saw net absorption over 1 million sq ft in Q3, while 26 markets turned negative. We expect leasing to pick up in the fourth quarter, driven by increased economic activity. On the supply side, new construction slowed to 76 million sq ft in Q3, which was 54% lower than last year.

[Buzz Cooper, President at Gladstone Commercial Corporation]

This has tempered the rise in vacancy rates, which increased by only 19 basis points to 6.6%. However, a higher rate environment has discouraged new starts from last year and led to declining new completions. So we expect vacancies to begin to decline in 2025. Although the broader economic outlook has its challenges, we have not observed any significant decline in tenant credit quality across our portfolio. In the longer term, industrial real estate, specifically manufacturing-related real estate, is poised for continued growth, driven by reshoring and nearshoring. We are well-positioned to capitalize on new opportunities, utilizing our expertise in underwriting middle-market credits to grow our portfolio of well-located, mission-critical industrial assets. Now, moving on to a few company portfolio specifics for the third quarter.

[Buzz Cooper, President at Gladstone Commercial Corporation]

During the quarter, we increased our industrial concentration as a % of annualized straight-line rent from 62% - 63%, and we decreased our office from 34% - 33%. We successfully leased or extended more than 242,000 sq ft across five assets for a weighted average of 7.2 years. These new leases and extensions resulted in a more than $100,000 straight-line rent plus-up. Through the third quarter, our portfolio management team has released or renewed more than 2.6 million square feet across 10 assets for an aggregate of $3.7 million straight-line rent plus-up. We have no remaining expiring leases in 2024. We acquired an industrial asset in Midland, Texas, for $10 million with a weighted GAAP cap rate of 9.94% in a 15-year term. We successfully sold two medical office assets in Georgia, resulting in more than $10.3 million in gain on sale.

[Buzz Cooper, President at Gladstone Commercial Corporation]

We've collected 100% of cash-based rents, and portfolio occupancy remains at 98.5%. Before turning the call over to Gary Gerson, our CFO, I will highlight our plans and goals for the next 12 months. We are proud of our progress since COVID, particularly our shift toward a higher concentration of industrial assets. Since 2018, all but two acquisitions have been industrial, with almost $565 million invested in this property type. As capital markets open up, we will continue growing our industrial concentration, aiming to exceed 70% of annualized straight-line rent in the next 12 months. We are actively disposing of non-core office assets and currently have one new industrial opportunity under contract for $12.1 million set to close in the fourth quarter. We will continue disposing of non-core office assets. We will use office sale proceeds and our existing cash flow to redeploy into industrial assets.

[Buzz Cooper, President at Gladstone Commercial Corporation]

We will leverage our proprietary in-house credit underwriting expertise to capitalize on sale leaseback opportunities, a hallmark of our value proposition. Unlike many of our peers, we have the ability to closely monitor our tenants' financial health, allowing us to proactively manage risk. Additionally, we'll have the flexibility to structure our leases and covenants in ways that provide added protection, ensuring long-term stability for both us and our tenants. We will focus on keeping a healthy and flexible balance sheet. As of September 30, we have liquidity of $80.7 million, including $70.2 million of availability under our credit facility and $10.5 million in cash. We remain below a 50% levered level as of September 30, 2025. Successfully completing these goals will better position us for our next stage of growth, including obtaining a credit rating and a private placement and expanding our industrial portfolio in new and existing markets.

[Buzz Cooper, President at Gladstone Commercial Corporation]

I will now turn the call over to Gary to review our financial results for the quarter and liquidity position.

[Gary Gerson, CFO at Gladstone Commercial Corporation]

Thank you, Buzz. I'll start my remarks regarding our financial results this morning by reviewing our operating results for the third quarter of 2024. All per-share numbers referenced are based on fully diluted weighted average common shares. FFO and core FFO per share available to common stockholders were both $0.38 per share for the quarter. FFO and core FFO available to common stockholders during the third quarter of 2023 were $0.33 and $0.34 per share, respectively. FFO and core FFO for the nine months ended September 30 were $1.07 and $1.08 per share, respectively. FFO and core FFO for the same period in 2023 were $1.10 and $1.11 per share, respectively. Same-store rents increased by 10.2% in the three months ended September 30 over the same period in 2023 due to a settlement received by one of our properties related to deferred maintenance.

[Gary Gerson, CFO at Gladstone Commercial Corporation]

Our same-store rent in the first three quarters of 2024 increased by 1.4% over the same period in 2023 due to the previously mentioned 2024 settlement partially offset by accelerator rent during the same period in 2023. Our third-quarter results reflected total operating revenues of $39.2 million, with operating expenses of $28.5 million as compared to operating revenues of $36.5 million and operating expenses of $29.6 million for the same period in 2023. Expenses were higher in 2023, mainly due to larger impairment charges offset by the waiver of the incentive fee in 2023. Looking at our debt profile, 38% is fixed rate, 53% is hedged floating rate, and 9% is floating rate, which is the amount drawn on our revolving credit facility and one mortgage note. As of September 30, our effective average SOFR was 4.96%.

[Gary Gerson, CFO at Gladstone Commercial Corporation]

Our outstanding bank term loans are hedged with $310 million of interest rate swaps and the remainder with interest caps. We continue to monitor interest rates closely and update our hedging strategy as needed. As of today, we have no 2024 loan maturities, and our 2025 maturities are manageable at $10.5 million. As of the end of the quarter, we had $53.3 million of revolver borrowings outstanding. During the nine months ended September 30, 2024, we sold 3.45 million shares of common stock under our ATM program, raising net proceeds of $49.5 million. We also received net proceeds of $700,000 from sales of our Series F preferred stock through September 30. We continue to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements and new acquisitions. At present, we have three properties held for sale.

[Gary Gerson, CFO at Gladstone Commercial Corporation]

As of today, we have approximately $5.4 million in cash and $73.3 million of availability under our line of credit. 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. Our common stock dividend is $0.30 per share per quarter or $1.20 per year. Our stock closed yesterday at $16.01, and our distribution yield on our stock is 7.5%. Now I'll turn the program back to David.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Thank you. That was a good report, Gary, and a good one from Buzz and Michael. They were both good reports. The team has performed extremely well overall. It was a very nice quarter. You have heard a lot today. During the third quarter, we acquired one industrial facility in Midland, Texas, for about $10 million. We sold two non-core properties. These were medical offices in Georgia. We also renewed or leased five of our properties, so this company has just continued to move along at a great pace. The commercial team is growing the real estate we own at a really good pace, and the team is doing a great job managing the properties we own, especially during these times that I am not sure what is going on sometimes, but they are challenging, and we are managing through it.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Our team is a strong professional group, and they continue to pursue potential quality properties on the list of acquisitions they are reviewing, and our acquisition team is seeking strong credit tenants. That's what we're looking for. Okay, we'll stop here and take some questions from people on the phone.

[Operator]

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your headset before pressing the star key. Our first question is from Gaurav Mehta with Alliance Global Partners. Please proceed.

[Gaurav Mehta, Managing Director of Senior Equity Research Analyst at Alliance Global Partners]

Thank you. Good morning. I wanted to ask you on your three-year results. You talked about a settlement at one of your properties. Can you provide some color on how much that settlement revenue was?

[Gary Gerson, CFO at Gladstone Commercial Corporation]

The total amount was $2 million.

[Gaurav Mehta, Managing Director of Senior Equity Research Analyst at Alliance Global Partners]

Okay. Second question, I think in your remarks, you said that three properties held for sale. Any color on the timing, expected timing of the sale of those three properties?

[Gary Gerson, CFO at Gladstone Commercial Corporation]

One of them we're looking to sell by the end of the year, and the other one probably mid-next year.

[Gaurav Mehta, Managing Director of Senior Equity Research Analyst at Alliance Global Partners]

Okay, and lastly, maybe big picture, can you provide some color on what you were seeing in the acquisition market?

[Buzz Cooper, President at Gladstone Commercial Corporation]

Acquisitions are right now, toward the end of the year, we've seen quite a few, and we're proceeding underwriting currently two. We expect a pickup into the first quarter of 2025. As you know, Gaurav, there's lots of competition for such, but we are seeing our fair share of actionable deals.

[Gaurav Mehta, Managing Director of Senior Equity Research Analyst at Alliance Global Partners]

Okay. Thank you. That's all I had.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Thank you.

[Gary Gerson, CFO at Gladstone Commercial Corporation]

Thank you.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Next question.

[Operator]

Our next question is from Dave Storms with Stonegate. Please proceed.

[Dave Storms, Director of Equity Research at Stonegate]

Morning.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Morning.

[Dave Storms, Director of Equity Research at Stonegate]

Just wanted to start by touching on the one new property you mentioned you have under contract. Is there any more you can give us maybe around the sense of timing or the anticipated cap rate for this?

[Buzz Cooper, President at Gladstone Commercial Corporation]

On the closing, it should occur here in the fourth quarter, early fourth quarter. On a straight-line basis, the cap rate over term is going to be over 9%.

[Dave Storms, Director of Equity Research at Stonegate]

Okay. So also high single digits. Just curious, maybe your overall thoughts around the cap rates in the markets right now and maybe where you see them going.

[Buzz Cooper, President at Gladstone Commercial Corporation]

We're hopeful, of course, with interest rates coming down, will affect cap rates for us. Again, a very competitive market. The sellers, I think, have gotten a little bit of understanding as to where the market is today. We're seeing competition, but cap rates seem to be coming down a bit.

[Dave Storms, Director of Equity Research at Stonegate]

Understood. And then just one more for me. It looks like a couple of tenants dropped off quarter over quarter. Is that just the regular runnings of the business, the selling of the couple of offices in Georgia, or is there more to the story there?

[Buzz Cooper, President at Gladstone Commercial Corporation]

No, that would be sales.

[Dave Storms, Director of Equity Research at Stonegate]

Understood. Thank you for taking my questions, and good luck in the fourth quarter.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Thanks, David.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Thank you. Next question.

[Operator]

Our next question is from Barry Oxford with Colliers. Please proceed.

[Barry Oxford, SVP at Colliers]

Great. Thanks, guys. To build on the cap rate question, you guys have been selling industrial, buying industrial, and selling office. What do you see kind of going forward as you implement that plan as far as the cap rate spread between the two? Because it seems like you would probably be losing a little bit on the cap rate spread.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Barry, I would agree with you because of the competition within the market. However, that being said, we also, with obviously the way our stock has performed, are looking to bring down our cost of capital. So we've had some success there as we recycle out of the office into industrial. So we are making ourselves more competitive as we are proceeding.

[Barry Oxford, SVP at Colliers]

Great. You touched on your stock price. That leads me to my second question. Are you guys going to continue over the next few quarters to have sort of an elevated tapping the ATM at an elevated level or not necessarily?

[Gary Gerson, CFO at Gladstone Commercial Corporation]

Barry, we'll probably continue to tap the ATM for just to fund acquisitions and to maintain leverage level and maybe to reduce leverage. We did a specifically large amount over the last quarter. Our leverage level had kind of tipped up during all the dispositions over the last year. So I think it was an unusual amount for us, but we will continue to sell under the ATM again to finance acquisitions and to keep our leverage level and potentially lower.

[Barry Oxford, SVP at Colliers]

Great. All that makes sense. Thanks, guys.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Thank you.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Next question.

[Operator]

As a reminder, to star one on your telephone keypad, if you would like to ask a question. Our next question is from John Massocca with B. Riley Securities. Please proceed.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Good morning, everyone.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Morning.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Morning.

[John Massocca, Senior Research Analyst at B. Riley Securities]

So it looked like kind of CapEx and leasing commissions jumped up a little bit quarter over quarter. Was there something specific driving that? And maybe what's kind of a rule of thumb on expectations for those two kind of cash flow line items for the remainder of the year and into 2025?

[Buzz Cooper, President at Gladstone Commercial Corporation]

John, specifically, as you know, we had a large asset in Lehigh Valley that was fully tenanted. We re-tenanted with a new tenant at almost double income on the rent side, but that carried with it, obviously, a large lease commission as well as modest TI dollars going into that property, and so that was part of that tick up, but we do not have any foreseen large CapEx items coming forward, but we do know, obviously, that that is good accretive money being put out the door as it relates to the tenancy, so some of that CapEx is very "profitable" for us.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Okay, and then just to clarify, I think you may have mentioned it in the prepared remarks, but did you address the one remaining 2024 lease expiration? And maybe what's kind of the outlook for some of the leases expiring in 2025?

[Buzz Cooper, President at Gladstone Commercial Corporation]

So relative to that transaction, we have agreement with a new tenant, which will take that property that does mature here in November with an option to buy. We've written a 10-year, sorry, 7-year lease on that, but they have an option to exercise to purchase in the beginning of 2025. Our expectation is that they will purchase. And relative to 2025, we have four properties that do have maturities in 2025, of which one is under sale to close in the first quarter of 2025. The other one has a five-year lease out for signature. One is current tenant. We are discussing re-upping. And then another one is also in discussion, very preliminary. It has a nine-month lead to it as it relates to notice that we'll begin discussions. And we're very close with that tenant in the first quarter of 2025.

[Buzz Cooper, President at Gladstone Commercial Corporation]

So I think, as you know, we do stay in front of our tenants and try to get to discussions with them and renewals as early as possible.

[John Massocca, Senior Research Analyst at B. Riley Securities]

And then, just broad strokes, in terms of the lease expirations over the next, call it, 15 months, are those kind of mostly office? Is that industrial? I mean, what's kind of the broad mix? I don't need an exact number.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Yes. No, I would say it's a mix between the two, more office than industrial, and some of those will be taken care of by dispositions.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Okay. And then lastly, the competitive environment, are you seeing maybe with interest rates having, particularly on the short end of the curve, tick down, more competition from some of the buyers that were out there pre-2022, smaller PE funds, more finance-oriented buyers, or have they still been kind of cautious getting back into the market?

[Buzz Cooper, President at Gladstone Commercial Corporation]

I believe somewhat cautious. We have seen, as you mentioned, the smaller PE shops. We have seen opportunities there for sale leasebacks that we've seen out there. Brokers are giving an opinion of value. So we are seeing more as it relates to opportunities there. But certainly, our marketplace is competitive.

[John Massocca, Senior Research Analyst at B. Riley Securities]

Good. I appreciate the color. That's it for me.

[Buzz Cooper, President at Gladstone Commercial Corporation]

Thank you.

[Operator]

There are no more further questions. I would like to turn the conference back over to management for closing remarks.

[David Gladstone, CEO at Gladstone Commercial Corporation]

Okay. Thank you very much, all of you. Hope you've all gone out and voted, but only voted for people that are pro-industrial real estate. So thank you all for calling in. That's the end of this. We'll catch you next quarter.

[Operator]

Thank you. This will conclude today's conference. You may disconnect at this time, and thank you for your participation.

Participants

Executives

• Buzz Cooper, President
• Gary Gerson, CFO
• David Gladstone, CEO
• Michael LiCalsi, General Counsel

Analysts

• Dave Storms, Director of Equity Research at Stonegate
• Gaurav Mehta, Managing Director of Senior Equity Research Analyst at Alliance Global Partners
• Barry Oxford, SVP at Colliers
• John Massocca, Senior Research Analyst at B. Riley Securities