Gladstone Commercial Corp Q1 FY2021 Earnings Call

Greetings. Welcome to Gladstone Commercial's First Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I'll now turn the conference over to Mr. David Gladstone, Chief Executive Officer. Mr. Gladstone, you may begin.

Okay. Thank you, Rob. Nice introduction and thanks to all of you for calling in this morning. We always enjoy this time with you on the phone and wish there was more time to talk with you. Bob Cutlip, President, will be along in a few minutes. But first, we're going to hear from Michael LiCalsi. He's our General Counsel and Secretary to give us legal and regulatory matters concerning this report. Michael?

Yes, thanks David, and good morning everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and 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. 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 Risk Factors listed in our Forms 10-Q, 10-K, and other documents that we file with the SEC. You can find all of these on our website at www.gladstonecommercial.com, specifically on the Investors page. You could always go to the SEC's website as well and that's www.sec.gov. Now 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, or 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 FFO as adjusted for comparability and core FFO, which are generally FFO adjusted for certain other non-recurring revenues and expenses. We believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. Please take the opportunity to visit our website again at gladstonecommercial.com and sign up for our e-mail notification service. You can also find us on Facebook, keyword The Gladstone Companies, and our Twitter handle is @GladstoneComps. Today's call will always provide an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday for more information. Now with that, I'll hand the baton to Gladstone Commercial's President, Bob Cutlip. Bob?

Thanks Mike. Good morning everyone. Among our activities through the first quarter and subsequent period ended April 30, we acquired a 180 square foot distribution property in Findlay, Ohio for $11 million, collected 98% of cash-based rents during the first quarter. No amounts have been abated throughout the pandemic, extended the lease at our 69,000 square foot office facility in Wichita, Kansas through 2027, expanded our tenant into the entire 123,000 square foot industrial facility in Raleigh, North Carolina, and extended their lease through 2032. We replaced the tenant in our 189,000 square foot Denver industrial facility with a full building tenant and extended the lease through 2026, experiencing no downtime. Lastly, we expanded the term loan in our credit facility by $65 million to $225 million.

Thank you Bob, and good morning everyone. I'll start by reviewing our operating results for the first quarter of 2021. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common shareholders were $0.40 and $0.42 per share for the quarter respectively. FFO and core FFO available to common shareholders during the first quarter of 2020 were $0.39 and $0.40 per share, respectively. The increase demonstrates the accretive yet prudent growth of the company as well as the performance of the in-place portfolio. In addition, our same-store cash rent grew by 1.4% over the first quarter of 2021. Our first quarter results reflect stable total operating revenues of $34.7 million with operating expenses of $26.9 million, as compared to operating revenues of $33.6 million and operating expenses of $24.1 million for the same period in 2020. Okay. Thank you, Gary. That was a good one for Bob and Michael. The team has performed very well. We have not been impacted significantly by the various government reactions to the coronavirus, and this was just an excellent quarter. We heard a lot today about the number of new transactions and new leases and quarterly events that are going on. Bob reported that he and his team collected 98% of the cash base rents due during the first quarter. They acquired one industrial asset, executed six lease transactions during the period, which represented about $3.3 million of annualized straight-line rent. So they're moving right along, and they also added a $65 million term loan with a $15 million delayed draw component. That's a solid piece of financing for us. Finally, they sold two non-core assets in Champaign, Illinois and Rancho Cordova in California. The commercial team is growing the real estate we own at a very good pace. The team is doing a great job managing properties we own, especially during this time of the pandemic, where many unknowns are present. Our strong professionals will continue to pursue potential quality properties on the list of acquisitions they are reviewing. Our acquisition team is seeking strong credit tenants. The quality of the tenants and the real estate provide excellent investment opportunities, and our asset managers are actively managing the properties the company owns. The middle market businesses, like many of our tenants, are being challenged with government restrictions related to the virus, but our team is successfully collecting their rents or committing to pay us and pass deferred rents in the coming months. These times are unprecedented, but we have a first-class team that is doing a fantastic job. Since most of our properties are financed with long-term fixed rates, we are not concerned about the inflation that people keep discussing in the media. I'm going to stop now and see if there are any questions.

Thank you, Mr. Gladstone. At this time we’ll be conducting a question-and-answer session. Our first question is coming from the line of Gaurav Mehta with National Securities. Please proceed with your questions.

Thanks. Good morning.

Good morning, Gaurav.

First question on your acquisition. Bob, I was wondering if you could talk about your target acquisition for the year. I believe in the last call you mentioned expecting to acquire $130 million to $140 million this year. Are you still expecting to acquire that?

As I indicated, we're seeing a pickup in activity. The inflation that everyone is concerned about may slow things down, but I still believe that right now, given our current position, we have about $34 million in either due diligence or letter of intent, and those letters of intent have been executed. So if we look at that and what we have in the pipeline, I still believe that we should be in the $110 million to $130 million range this year. I really do. The activity has been increasing for us, and I believe that, in these secondary growth markets, we're seeing more opportunities. Cap rates are compressing, as we all know, even in these secondary markets, but we're able to compete effectively, and I think we'll be successful.

Second question on your lease expirations for 2021, can you talk about where the expiring rents are compared to the market?

The current rents are at market with the exception of an asset in Salt Lake City, which is a little above market, but not by much. I can get you the specifics on that, Gaurav, so you have the actuals for your analysis.

Great. And lastly on Austin, I think in the last call you mentioned considering selling that property. Is there any thought on putting that asset for sale, given that it hasn't been in operation for over a year now?

Are you referring to the Austin asset?

Yes.

What we're doing is interesting. With Austin reopening, we're now starting to see a lot more foot traffic at the building. We have three tours scheduled for this week. If we can find an opportunity to sell the asset and it makes sense to redeploy that capital into an industrial portfolio quickly, we will do that. There's no doubt about it.

Okay. Thank you. That’s all I have.

Okay. Next question please?

The next question comes from the line of Rob Stevenson with Janney.

Good morning, guys. Just a follow-up on the Austin asset. At this point, if you were to secure a lease for that property in the near future, is the expectation that cash rents wouldn't start until 2022, given the free rent component and the time needed for any tenant improvements required in the lease?

Yes. They're probably looking at anywhere from a half to a single month per year. The transactions that are taking place there are expected to be somewhere between seven to 10 years. It also depends on the rental rate. The one advantage we have, Rob, is that we are significantly under market, which allows us to attract tenants at a lower rental rate. This, in turn, would likely reduce tenant improvement costs and lower concession requirements because we understand the current market dynamics.

Okay. And then given your capital raising and cash position, what is the current acquisition capacity you have, the so-called dry powder available for closing acquisitions?

Right now, we have $11 million in cash and about $18.3 million of availability on our credit facility.

Perfect. If you start to hit on more of that $280 million pipeline, are you looking to accelerate dispositions to raise more capital? How are you thinking about that?

David and I will discuss it, but I would not be opposed to us doing a follow-on capital raise. I'll let David elaborate on that. It's heavily influenced by inflation trends and how that impacts our stock price moving forward. David, would you like to add to that?

Well, I think Rob knows most of the investors out there would be delighted to underwrite for us. So we don't have any reason to believe they would withdraw support if we wanted to pursue that. We are looking at and have already started selling non-traded preferred stock in commercial real estate. This should generate significant funds. We're moving commercial into that position as well. I know the ATM program hasn't been generating as much as we would like, so we need to improve that effort with some current investors. However, there are plenty of parties interested in stepping up to do another preferred offering or potentially selling common stock at this range.

How are you addressing the incremental level of preferred stock you can incorporate into your capital structure without becoming overly weighted? Given that common shares yield seven and preferred shares yield lower than that, it’s attractive from a pricing perspective, but you could face constraints like some entities that are at 80% preferred, right?

Rob, we will not go to 80% preferred, so no need to worry about that. We work closely with our bankers; they do not favor excessive preferred offerings. We don't have a strict number, and we’ll evaluate based on market conditions and available alternatives. I want to see our ATM program performing much better in selling common stock right now, but it hasn't happened, and I don’t know why the market seems sluggish.

Anecdotally, how much of your acquisitions and dispositions over the past few years have involved parties you would classify as 1031 buyers or sellers? Would that alter behavior if the 1031 rules change? Is that a significant portion of your pipeline?

I think it's a minor aspect. Some larger transactions may not have reached the 1031 stage. However, we have allowed several parties seeking 1031 exchanges to participate in our transactions by offering them UPREIT shares in exchange for what they are selling. We anticipate more such transactions this year, partly due to tax implications from changes in the national government's tax policies.

To reinforce what David is saying, two of the assets we’re pursuing currently, moving towards letters of intent, will be UPREIT transactions, and we aim to pursue more of these opportunities as we move forward.

Okay. Thanks, guys. Appreciate the time.

Okay. Next question, please.

Next question is coming from the line of Brian Hollenden with Aegis Capital.

Good morning, and thanks for taking my call.

Good morning.

You alluded to it, but could you talk a little bit more about what you are experiencing regarding inflation and how incremental inflation might affect your company, customers, and potential acquisitions?

Yes. Inflation is present and there's no way to downplay my belief that we are in an inflationary period today. The prices of copper, lumber, steel, and all other commodities have risen significantly. The Fed is trying to manage rates, but they cannot ignore market movements. I believe that due to our business model, which involves long-term rentals tied to mortgages, we’re well-positioned to weather this inflationary period that usually lasts for two to three years. If you look back to the inflationary movements during the Jimmy Carter administration, you can see the implications clearly. For us, being well-capitalized with long-term financing means we can endure any downturns caused by inflation.

Brian, to add to what David just said based on our conversations with peers and tenants, especially in the development arena, we are seeing dramatic increases in construction pricing and significant delays in product availability. I believe this situation will begin to impact the market by the second half of this year. Additionally, manufacturers are reporting increases in raw material costs. This could either decrease their margins or force them to raise prices for their end products, ultimately contributing to overall inflation.

Next question, please?

Thank you.

Next question. Operator, can we get question number four?

Yes, that's coming from the line of John Massocca with Ladenburg Thalmann.

Good morning.

Good morning, John.

Hi, John.

There is a decent amount of lease termination income in the quarter. Just trying to determine if that is typical of what we should expect for the rest of the year, or was this quarter elevated? And if elevated, what might be the reasons?

I think it was elevated slightly, John, due to a couple of factors. We had a single-story office property that became vacant in March of 2020, and thanks to our asset management team's strength, we decided to convert it to an industrial property, and leased out 60,000 square feet. This started in April and counts towards your figures. Additionally, we were able in our Denver property to replace an existing tenant, which included some accelerated rent. If I had to guess, moving forward, with us having $4.4 million and nearly $3 million of that at the end of December, there will be a slight decline in leasing activity. We still have some vacant spaces to fill, especially the notable one in Austin. However, our team has done an excellent job of leasing vacant spaces and renewing existing tenants, so we won't have much more that is significant in size until later in the year.

Do you mean in terms of termination income, or overall leasing activity?

Overall leasing activity because we don't have that many transactions coming up. We did successfully lease the 189,000 square foot building in Denver and a 60,000 square foot property in Blaine, Minnesota. We just don't have anything significant lined up until near year's end.

Understood. And can you remind us of the size of the single-story office potential disposition target?

I cannot provide an exact figure right now, John, but I will get that to you. From the fourth quarter through the first quarter of this year, we sold $28 million worth of single-story office product, resulting in a net gain of $6 million. I would estimate that moving forward, I’m not too keen on selling more than approximately $15 million a year, with at least two-thirds of that coming from single-story offices.

Is the remainder in non-core markets, or reverse inquiries? Are you observing cap rate compression on certain industrial assets?

It will likely involve exiting non-core markets, as well as some retail properties. Additionally, we have a small medical facility in Houston that we may consider selling. But the focus will remain primarily on single-story office properties.

That’s all I have. Thank you very much.

John and others on the phone, rest assured that when Bob says he will provide that information, he will put it on the website under questions and answers, so that everyone listening or anyone else who wishes to view that data can find it. I don't believe the answers to the two questions are significant enough to impact share prices. However, I understand it is important information for your models. We will get that to you this week, and you can proceed from there.

Mr. Gladstone, at this time there are no additional questions.

Well that said, we appreciate questions, but it would be much more enjoyable if we could respond to more questions. Since there is no further interest, we look forward to seeing you next quarter. Thank you for calling in and that concludes our call.

Thank you everyone. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.