Gladstone Commercial Corp

NASDAQ:GOOD

Earnings Call Analysis

Strong growth in industrial assets drives third quarter performance.

In the third quarter of 2024, the company reported funds from operations (FFO) of $0.38 per share, up from $0.33 a year ago. Same-store rents surged by 10.2% due to a $2 million settlement related to deferred maintenance, though year-to-date growth remains modest at 1.4%. The focus is on expanding industrial assets, which now represent 63% of annualized rent. With $80.7 million in liquidity, including planned asset sales, the company targets over 70% in industrial assets by next year, while managing minimal debt maturity risks ahead. A new $12.1 million industrial acquisition is expected to close this quarter.

Navigating Economic Winds

In the recent earnings call for Gladstone Commercial Corporation, the team expressed optimism amidst a changing economic landscape. The Federal Reserve's decision to lower interest rates by 50 basis points marked a pivotal shift from the high-rate environment that has prevailed since 2022. As of September, the federal funds rate now stands between 4.75% and 5%, a refreshing change that could influence the broader capital markets positively. However, potential inflationary pressures stemming from job growth and higher-than-expected inflation rates may affect future rate cuts.

Acquisitions and Enhancements

Gladstone is actively reshaping its portfolio by divesting non-core office properties and reinvesting in industrial real estate, as evidenced by their recent acquisition of an industrial facility in Midland, Texas for approximately $10 million, boasting a 9.94% cap rate. The company’s strategy aims to raise industrial assets to over 70% of annualized straight-line rent by next year, increasing from 62% to 63% in the most recent quarter.

Strong Revenue Performance

The company's third-quarter results showcase a healthy growth trajectory, with total operating revenues rising to $39.3 million, an improvement from $36.5 million year-on-year. Funds from Operations (FFO) and Core FFO per share stand at $0.38 for the quarter, compared to $0.33 and $0.34 respectively in Q3 2023. This suggests a steady underlying operational performance, even as the overall FFO for the first nine months decreased slightly from $1.10 and $1.11 in 2023 to $1.07 and $1.08 this year.

Operating Metrics

The company reported a notable increase in same-store rents, up by 10.2% in the latest quarter, due in part to a $2 million settlement received related to deferred maintenance at one property. This highlights solid demand and operational management within their portfolio, where portfolio occupancy remains high at 98.5%.

Liquidity and Financial Flexibility

Gladstone's financial position remains healthy, boasting $80.7 million in liquidity as of September 30, including $70.2 million from available credit facilities and $10.5 million in cash. With no impending 2024 loan maturities and only $10.5 million due in 2025, the company maintains a leverage ratio comfortably below 50%, positioning them well for future growth and investment opportunities.

Navigating Future Lease Expirations

The management has detailed plans for upcoming lease expirations, with no remaining expirations in 2024 and four properties maturing in 2025. The company has actively engaged tenants ahead of potential renewals, emphasizing a proactive approach to portfolio management. This forethought is crucial in maintaining stable revenue flows as they transition their portfolio.

Strategic Focus on Industrial Assets

Looking ahead, Gladstone is gearing up to capitalize on the continued demand for industrial real estate, expecting the sector to thrive due to trends such as reshoring and nearshoring. Their focus on underwriting middle-market credits positions them well to strategically acquire mission-critical industrial assets, which is critical for long-term growth.

A Competitive Landscape

As they navigate a competitive acquisition market, Gladstone is measuring cap rates closely. They expect improved conditions due to decreasing interest rates, making it an opportune time for investments. Historically, competition from smaller private equity firms remains, but Gladstone's strategy to shift focus from office to industrial properties is expected to yield competitive advantages.

Conclusion: A Balanced View

In summary, Gladstone Commercial Corporation is adeptly adjusting to market conditions by focusing on industrial asset growth while maintaining strong financial metrics. Their ability to monitor tenant health, coupled with an agile strategy for acquisitions and dispositions, presents a compelling narrative for potential investors, particularly as they seek stability and growth in a fluctuating economic environment.

Earnings Call Transcript 2024-Q3

[Operator]

Greetings, and welcome to Gladstone Commercial Corporation Third Quarter 2024 Earnings Call. [Operator Instructions] 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, executive]

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'll hear from Michael LiCalsi. He's our General Counsel and Secretary, to give us legal regulatory matters concerning this call this morning. Michael?

[Michael LiCalsi, executive]

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.

The many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all 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. That's gladstonecommercial.com, specifically go to the Investors page or on the website, which is www.sec.gov.

And 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. 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 nonrecurring revenues and expenses. And we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance.

We ask that you visit our website, which is gladstonecommercial.com, and sign up for our e-mail notification service. You can also find us on Facebook. The keyword there is The Gladstone Companies and Twitter, which is @GladstoneComps. 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.

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

[Arthur Cooper, executive]

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 have 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 policies since rate hikes began in 2022. They lowered the benchmark federal funds rate by 50 basis points to a range of 4.75% to 5%, down from its prior range of 5.25% to 5.5%, which had been the highest level in 23 years. 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 surge with employers adding 254,000 jobs significantly surpassing expectations, while 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.

This election is likely to bring further volatility to the markets as fiscal regulatory policies are debated. We believe our portfolio is well positioned regardless of which party is in office. Despite broader economic uncertainties, our portfolio continues to perform well with industrial real estate being growth driver.

According to Colliers' industrial market statistics for the third quarter, net absorption in the United States totaled 39 million square feet, bringing the year-to-date total to 115 million square feet. This compares to 180 million square feet 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 a net absorption over 1 million square feet 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 square feet in Q3, which was 54% lower than last year. This has tempered the rise in vacancy rates, which increased by only 19 bids which points to 6.6%. However, for longer 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. During the quarter, we increased our industrial concentration as a percentage of annualized straight-line rent from 62% to 63%, and we decreased our office from 34% of 33%. We successfully leased or extended more than 242,000 square feet across 5 assets for weighted average 7.2 years. These new leases and extensions resulted in a more than 100,000 straight up rent plus up. Through the third quarter, our portfolio management team has released a review of more than 2.6 million square feet across 10 assets for an aggregate 3.7 million straight-line rent plus up. We have no remaining expiring leases in 2024.

We acquired industrial asset in Midland, Texas for $10 million with a weighted GAAP cap rate of 9.94% and a 15-year term. We successfully sold 2 medical office assets in Georgia, resulting in more than $10.3 million in gain on sale. We have 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 2 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 noncore 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 noncore office assets. We will use office sale proceeds in our existing cash flow to redeploy into industrial assets. 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.

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

[Gary Gerson, executive]

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 9 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 3 months ended September 30, the same period in 2023 due to a settlement received by one of our properties related to deferred maintenance. Our same-store rent in the first 3 quarters of 2024 increased by 1.4% over the same period in 2023 due to the previously mentioned 2024 settlement, partially offset by accelerated rent during the same period in 2023.

Our third quarter results reflected total operating revenues of $39.3 million with operating expenses of $28.5 million as compared to revenues of $36.5 million in operating expenses of $29.6 million for the same period in 2023. Expenses were higher in 2023 mainly due to a larger impairment charge 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 on mortgage note.

As of September 30, our effective average SOFR was 4.96%. Our outstanding bank term loans are hedged with $310 million of interest rate swaps and the remainder with interest cap. 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 our revolver borrowings outstanding. During the 9 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 capital requirements and new acquisitions.

At present, we have 3 properties held for sale. 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%.

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

[David Gladstone, executive]

Thank you. That was a good report, Gary, and one from Buzz and Michael were both good report. The team has performed extremely well. Overall, it's a very nice quarter.

You've heard a lot today. During the third quarter, we acquired 1 industrial facility in Midland, Texas for about $10 million. We sold 2 noncore properties. These were medical offices in Georgia. We also renewed or leased 5 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'm not sure what's going on sometimes, but they're challenging and they're managing through it. Our team is a strong professional group and they continue to pursue potential quality properties 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]

[Operator Instructions] Our first question is from Gaurav Mehta with Alliance Global Partners.

[Gaurav Mehta, analyst]

I wanted to ask on your 3Q 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, executive]

The total amount was $2 million.

[Gaurav Mehta, analyst]

Okay. The second question, I think in your remarks, you said that 3 properties held for sale. Any color on the timing -- expected timing of the sale of those 3 properties?

[Gary Gerson, executive]

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

[Gaurav Mehta, analyst]

Okay. And lastly, maybe big picture. Can you provide some color on what you were seeing in the acquisition market?

[Arthur Cooper, executive]

Acquisitions are, right now toward the end of the year, we've seen quite a few, and we're proceeding underwriting currently, too. We expect to pick up into the first quarter of '25. As you know, Gaurav, there's lots of competition for such, but we are seeing our fair share of actionable deals.

[Operator]

Our next question is from Dave Storms with Stonegate.

[David Storms, analyst]

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 anticipating cap rate for this?

[Arthur Cooper, executive]

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%.

[David Storms, analyst]

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 that going?

[Arthur Cooper, executive]

We are 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.

[David Storms, analyst]

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 a couple of offices in Georgia? Or is there more to the story there?

[Arthur Cooper, executive]

No, that would be sales.

[Operator]

Our next question is from Barry Oxford with Colliers.

[Barry Oxford, analyst]

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 cap rate spread between the two? Because it seems like you would probably be losing a little bit on the cap rate spread?

[Arthur Cooper, executive]

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, 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, analyst]

Right. 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, executive]

Barry, we'll probably continue to tap the ATM for -- to fund acquisitions and to maintain leverage levels and maybe to reduce leverage. We did specifically a large amount of 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.

[Operator]

[Operator Instructions] Our next question is from John Massocca with B. Riley Securities.

[John Massocca, analyst]

So it looks like kind of CapEx and leasing commissions jumped up a little bit quarter-over-quarter. Was there something specific driving that? And maybe what kind of a rule of thumb on expectations for those 2 kind of cash flow line items for the remainder of the year and into '25?

[Arthur Cooper, executive]

John, specific, as you know, we had a large asset in Lehigh Valley that we fully -- was fully tenanted. We retenanted it 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 pick up. But we do not have any foreseen large CapEx items coming forward. But we do know, obviously, 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, analyst]

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 '25?

[Arthur Cooper, executive]

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, a 7-year lease on that, but they have an option to exercise to purchase in the beginning of '25. Our expectation is that they will purchase.

And relative to 2025, we have 4 properties that do have maturities in '25, of which one is under sale to close in the first quarter of '25. The other one has a 5-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 9-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 '25. We do stay in front of our tenants and try to get to discussions with them in renewals as early as possible.

[John Massocca, analyst]

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.

[Arthur Cooper, executive]

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, analyst]

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

[Arthur Cooper, executive]

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 opinion of value. So we are seeing more as it relates to opportunities there. But certainly, our marketplace is competitive.

[Operator]

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

[David Gladstone, executive]

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.