Earnings Call Transcript - GOOD Q2 2021

Operator, Operator

Greetings. Welcome to Gladstone Commercial's Second Quarter Earnings Call. Please note this conference is being recorded. At this time, I'll now turn the conference over to Mr. David Gladstone. Mr. Gladstone, please go ahead.

David Gladstone, CEO

Well, thank you, Rob. That was a nice introduction and instructions. And thank all of you on the line for calling in and listening to us this morning. We enjoy this time together and having you on the phone. I wish there were more times like this to talk to you. Going to start out, as we always do, with Michael LiCalsi, our General Counsel and Secretary, to give us some legal and regulatory matters concerning the call today. Michael?

Michael LiCalsi, General Counsel

Thanks, David, and good morning. 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. Now 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 in our Forms 10-Q, 10-K, and other documents we file with the SEC. You can find them on our website at gladstonecommercial.com. Specifically, go to the Investors page, or on the SEC's website, which is 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. Now today, we will discuss FFO, that's 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, 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 nonrecurring revenues and expenses. Now we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. And please take the opportunity to visit our website, once again, gladstonecommercial.com, sign up for our email notification service. You could also find us on Facebook. Keyword there is the Gladstone Companies. We even have our own Twitter handle, and that's @GladstoneComps. Today's call is simply 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. Again, you can find them on the Investors page of our website. Now with that, I'll pass it over to Gladstone Commercial's President, Bob Cutlip. Bob?

Robert Cutlip, President

Thank you, Michael. Good morning, everyone. During the second quarter, we acquired a 25,200 square foot industrial service facility in Baytown, Texas for $8.1 million. We collected 100% of cash-based rents during the second quarter. No amounts have been abated throughout the pandemic. We leased 61,000 square feet in our Blaine, Minnesota industrial facility through 2028. We leased our 238,000 square foot industrial facility at the Port of Catoosa in Tulsa, Oklahoma, for 12.5 years. We renewed a lease of a 315,000 square foot industrial facility in Monroe, Michigan, which is a Detroit suburb, through August of 2029. We issued $100 million of Series G preferred stock, where proceeds were used primarily to redeem all our outstanding Series D preferred stock. Subsequent to the end of the quarter, we acquired an 80,600 square foot industrial facility in the St. Louis, Missouri MSA for $22 million; renewed a lease of 12,600 square feet in our office property in Burnsville, Minnesota through December 2029; and renewed a lease of a 60,245 square foot flex office building in San Antonio, Texas through November of 2031. On the personnel front, we appointed Gary Gerson as our Chief Financial Officer in June. As you know, Gary is with us today. He had been our interim CFO since March and was previously the company's Treasurer several years ago. We're very pleased to have him on board as our permanent CFO as he has seamlessly stepped right into the Capital Markets leadership role. In addition, we have appointed Buzz Cooper as our Chief Investment Officer. Buzz is an Executive Vice President in the firm and our South Central region leader. He leads our acquisitions team and has the knowledge and experience of acquiring a significant percentage of our current portfolio of properties across several regions. Buzz has been with us since the IPO in 2003. As noted on earlier calls, we are continuing our investment strategy to increase our portfolio's industrial allocation, which we believe will improve our property operating efficiencies. Since January 2019, our total investment volume has been $299 million, all of which is industrial, providing further evidence of that commitment. Our industrial allocation has increased from 33% in January of 2019 to 49% today, with an objective of achieving a 60% allocation within the next 18-plus months. We will continue to overweight industrial acquisitions, and our primary focus has been and will be acquisition candidates ranging in size from 50,000 to 300,000 square feet. We continued our industrial acquisition strategy during the second quarter and subsequent thereto. We acquired a 25,200 square foot industrial service facility in Baytown, Texas, with a total investment of $8.1 million, with 12.6 years remaining lease term and a GAAP cap rate of 7.1%. We also acquired an 80,600 square foot industrial facility in St. Louis, Missouri MSA. The total investment was $22 million, with 17.4 years of remaining lease term and a GAAP cap rate of 7.5%. Our asset management team continued to deliver on improving our same-store operations. Year-to-date ending July 31, the team extended, expanded, and/or leased 1.27 million square feet, covering 12 tenants, with an average weighted lease term of 8.6 years and a tenant improvement allowance of just $2.56 per square foot. The annualized straight-line rent of these transactions totals $8.4 million. As an example of the successful performance, we leased a previously vacant facility at the Port of Catoosa in Oklahoma. This 238,000 square foot industrial facility had been vacant during the pandemic. This lease not only increased our straight-line lease payments by over $1 million per year, but the increased occupancy also reduced our vacancy rate by 1.5%. Our rent collection experience continues to be strong. 100% of second quarter cash rent collections were paid, and July collections were 99%. We're very pleased with our portfolio and tenants' performance during these challenging times for all industries. Anticipating that many on the call are interested in lease expirations through 2021, I wanted to summarize the team's thoughts and activities going forward. We are encouraged about our same-store performance over the next two years, as we currently have 2.9% of our leases expiring through year-end 2021 and 4.5% in 2022. For the balance of 2021, we have $3.3 million of annualized straight-line rent expiring, and $2.9 million of this total expires at the end of December. So future expirations should be quite manageable. Our Austin office vacancy remains our largest. Activity in the Austin market has increased significantly during the second quarter. Our previous GAAP rent at the property of $14.50 per square foot compares quite favorably, as I've indicated in the past, in our submarket, with current space offerings in the low to mid-$20 per square foot on the triple-net basis. Tesla's decision to build a Gigafactory in Austin and BAE's decision to create a campus in the same submarket as our property is generating interest. We are currently exploring dual strategies of either re-leasing and/or selling the property, and have active tenant and buyer prospects, with an expectation to have a significant transaction announced by the end of the third quarter. Market conditions are worthy of comment, particularly with the adverse effects from the onset of the COVID virus. A review of research reports relating to industrial and office statistics for the second quarter reflects both improvements and some continued challenges. Investment sales volume for both product types were higher compared to the second quarter of 2020. Overall, industrial activity continues to be strong, with second quarter vacancy at a 4% to 4.5% level. Net absorption exceeding 100 million square feet and over 400 million square feet under construction, with approximately 40% of this total pre-leased according to CBRE. E-commerce and logistics demand continue to drive the industrial sector. Office vacancy increased to 16.5% with negative absorption of 8 million square feet. But that's an interesting number because the last few quarters, the negative absorption has been over 30 million square feet, so maybe we've got some improvement taking place in the office sector. That vacancy level does not include, however, over 150 million square feet of sublease space available on a national basis. Office rents increased approximately 1% quarter-over-quarter. However, net effective rents declined by over 4% due to increased concessions. New supply activity continues as over 100 million square feet of office product is currently under construction. And as it relates to growth opportunities, we are seeing an increase in investment sales listings. Our current pipeline of acquisition candidates is approximately $360 million in volume, representing 21 properties, 2 of which are office and the balance are industrial. Of the 21 properties, 1 property is in due diligence, 3 are in the letter of intent stage and the balance are under initial review. Our team is staying actively engaged in the markets as we believe acquisition opportunities will arise that we can and will pursue. So in summary, our second quarter activities reflected strong leasing and rental collection success, continued active engagement to identify industrial acquisition opportunities and collectively positions us well to pursue growth opportunities. Now let's turn it over to Gary for a report on the financial results, including our capital markets activities.

Gary Gerson, CFO

Thank you, Bob, and good morning, everyone. I'll start my remarks by reviewing our operating results for the second quarter of 2021. All per share numbers referenced are based on fully diluted weighted average common shares. FFO adjusted for comparability and core FFO available to common stockholders were $0.36 and $0.37 per share for the quarter, respectively. FFO - core FFO available to common stockholders during the second quarter of 2020 were $0.40 and $0.41 per share, respectively. FFO adjusted comparability and core FFO available to common stockholders for the first 6 months of 2021 were $0.76 and $0.78. FFO and core FFO available to common stockholders during the first 6 months of 2020 were both $0.80 per share, respectively. Our same-store cash rent in Q2 grew at 2.8% over the second quarter of 2020. For the first 6 months of 2021, it grew at 4% over the first 6 months of 2020. Second quarter results reflected stable total operating revenues of $33.4 million, with operating expenses of $25 million, as compared to operating revenues of $33.5 million and operating expenses of $25.9 million for the same period in 2020. We continue to enhance our strong balance sheet as we grow our assets and continue to focus on reducing our leverage. We have reduced our debt to gross assets over the past 6 years by over 20% to 44.8% through refinancing maturing debt and financing new acquisitions at lower leverage levels. We believe that we are within 1% to 2% of our target leverage level. During the quarter, we issued $100 million of 6% Series G perpetual preferred stock, which were primarily used to redeem our 7% Series D preferred stock. In addition to reducing our dividend expense, the offering provided us with over $8 million of additional investable capital. Our bank group, led by Stifel, Nicolaus, Goldman Sachs, and B. Riley did a wonderful job. We continue to primarily use long-term mortgage debt to make acquisitions. As we grow through disciplined investments, we also continue to expand our unsecured property pool with additional high-quality assets. Over time, we expect this will increase our debt financing options. Looking at our debt profile: 65% is fixed rate; 33% is hedged floating rate; and 2% is floating. As of today, our 2021 and 2022 loan maturities are manageable, with $11 million due in 2021 and $97 million coming due in 2022. We will refinance these amounts at the appropriate time. We upsized our credit facility last quarter, which consisted of a $65 million term loan, with a $15 million delayed draw component. Subsequent to the end of the quarter, we drew down on the remaining $15 million. The proceeds were utilized to acquire properties. As of the end of the quarter, there were no revolver borrowings outstanding. While entering the second quarter with sufficient liquidity, we've been active in issuing equity through our ATM program. During the 6 months ending June 30, 2021 and net of issuance cost, we raised $19.4 million through common stock sales. We continued to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements. As of today, we have approximately $11 million in cash and $18.3 million of availability under our line of credit. With our credit availability, the strong performance of our portfolio and access to our ATM program, we believe that we have sufficient significant incremental flexibility to fund our current operations near and long term. 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. Institutional ownership of our stock has increased over time to 54.3% as of June 30, which is a 7% increase over the last 5 years. We continue to be very active in meeting with current and potential investors, portfolio managers, coverage analysts, and investment banks. We look forward to establishing new relationships as the company grows. We continue to pay our common stock dividend of $0.37545 per share per quarter or $1.502 per year. We have not cut or suspended dividends since our IPO in 2003. Our common stock closed yesterday at $22.98. The distribution yield on our stock is approximately 6.5%. And now I'll turn the program back to David.

David Gladstone, CEO

Thank you, Gary. Bob and Michael provided great updates on our current situation. I encourage everyone to check the website for the updates Gary has shared, as there are many important items included. The team has performed exceptionally well and has largely avoided any negative impact from government actions and the virus. We had a strong quarter ending on June 30. We've seen a lot of activity today, including numerous transactions and new leases. Operations are impressive, with the team having collected 100% of the cash-based rents for the second quarter. They have also acquired industrial properties in Baytown, Texas, and St. Louis, Missouri, and executed 12 leases representing about $8.4 million in annualized straight-line rent as of July 31. Furthermore, they issued $100 million of 6% Series G perpetual stock, primarily used to pay off the 7% Series D preferred stock we had outstanding. This move helped reduce our total dividend by providing over $8 million in additional investable capital. Our commercial team is expanding our real estate holdings at a good pace. They are doing an excellent job managing our properties, especially during the pandemic, and achieving strong results. Our team is robust and is actively pursuing quality property acquisitions. Unlike many others, our acquisition team evaluates tenant credit, ensuring we attract strong tenants. We believe these real estate investments are excellent, and our asset managers are committed to maximizing their value. Although we are navigating a different environment today, our team is well-prepared for the challenges in the middle market. The businesses occupying our properties have faced challenges from previous government restrictions due to the virus, but they are continuing to pay their rents, for which we are very grateful, as it allows us to distribute dividends to our shareholders. These unprecedented times may not be repeated in the future, but our dedicated team is performing admirably. Rob, I'll stop here and let you facilitate questions from our listeners.

Operator, Operator

Our first question comes from the line of Rob Stevenson with Janney.

Robert Stevenson, Analyst

Gary, can you talk a little bit more about what's the sequential revenue drop? And what caused that? And to what extent has the leasing that you guys done here in the second and third quarters kind of caused that to bump back up?

Gary Gerson, CFO

I believe two key factors contributed to the situation. First, we had some accelerated rents from the first quarter that did not carry into the second quarter. Additionally, there was a decrease in general and administrative costs in the first quarter due to lower due diligence expenses, while the second quarter saw an increase in G&A costs because of various professional, legal, and shareholder-related expenses. To directly answer your question, the disappointing aspect of the second quarter figures is that they do not reflect much of what I have mentioned today due to timing issues. For instance, we completed a $30 million acquisition and an $8 million acquisition in mid-June and mid-July, respectively, which are not adequately represented in the second quarter numbers. Also, while the vacancy issue at the Port of Catoosa was resolved, the lease wasn't finalized until the end of June, so it is also absent from the numbers. Moving forward, you can expect to see a lot of the activities we accomplished this quarter reflected in our future financial results, as they were not captured this time due to timing.

Robert Stevenson, Analyst

Okay. And on the 310 million square feet of vacant space that you guys have leased, I mean, how much free rent, etc., is in there? When does that actually start paying effective cash rents for you guys? Has that already started? Is that sometime later this year? How should we be thinking about that?

Robert Cutlip, President

The rent doesn't start until, I think it's November, Rob, everything else is starting, as I can recall.

Robert Stevenson, Analyst

Okay. And then the last one for me: What was the spread on the rents on the roughly 600,000 of square feet of renewals that you guys have done since the end of the first quarter?

Robert Cutlip, President

I've got the information from January. We completed transactions on 12 properties, and 10 of those properties, which accounted for about $6.3 million in straight-line rent, saw an increase of around 8.5%, amounting to roughly $560,000. This is a positive development that we will benefit from in the future. Additionally, there were 2 properties that experienced rent reductions, yet they still represent a positive adjustment. One of them is the Blaine Minnesota property, which we transformed from a single-story office into an industrial space. This property had been vacant for over a year, costing us approximately $550,000 in operating expenses. After the conversion, Karen Priesman, our Head of Asset Management for the Midwest region, successfully leased two-thirds of the property, resulting in an improvement of nearly $800,000 when accounting for the operating expenses and leasing. This will be advantageous for us in the next 12 months. The other property Gary mentioned is the Port of Catoosa. This location was incurring around $500,000 in operating expenses, but now that it is leased with a lease amount exceeding $1 million, we can expect a $1.5 million improvement starting in July when you combine the $500,000 operating expenses with the $1 million lease. Although it's important to note that this is not cash yet, as there is still a period of free rent, this will end, and the funds from operations will begin immediately.

Robert Stevenson, Analyst

Okay. I actually have one more question for Gary. When discussing G&A, the first quarter was unusually low and the second quarter unusually high. How much of the second quarter amount is nonrecurring? I believe the year-to-date figure is around 1.7 million, and about 865,000 seems to be the average for that. Is that a reasonable run rate moving forward, based on the average of the first two quarters? Should we be excluding anything from that to determine the run rate for the future? How should we approach G&A in the second half of the year?

Gary Gerson, CFO

I believe that if you consider our general and administrative expenses from a long-term view, we've typically averaged in the mid-800s, which seems reasonable. Much of what has been discussed reflects that our G&A was artificially low in the first quarter and artificially high in the second quarter.

Operator, Operator

The next question is coming from John Massocca with Ladenburg Thalmann.

John Massocca, Analyst

So last quarter, I think you were saying that you kind of saw the potential investments in 2021 as being kind of $110 million to $130 million. Has that changed at all based on what's happened in 2Q, based maybe on the interest rate environment out there? And what that's going to cap rates? Just any kind of changes or maybe no changes to those investment expectations?

Robert Cutlip, President

Well, right now, John, we've got about $60 million in the letter of intent stage and just under $5 million in due diligence that we're going to close in the next week or so. So I'm thinking that we're still going to be north of $110 million. I don't know that we'll get to $130 million. But I believe that now, with the increased activity that we have in the markets we want to be in, that we should be able to reach that level for sure.

John Massocca, Analyst

And I guess maybe since we kind of last talked, has there been any kind of market change in the cap rate environment, particularly for your kind of subsector of smaller assets in non-gateway markets?

Robert Cutlip, President

You're still observing that in the gateway markets, the rates are ranging from the low 5s to high 4s. In our secondary markets, however, we're able to find products that are in the mid- to high 5s with 7- to 10-year leases, giving us a GAAP cap rate of about 7%. If I'm not mistaken, Gary, with our current stock price and our cost of debt, we're looking at about a 5 weighted average cost of capital. This still provides us with a 50 to 75 basis point spread that I would like to maintain with our acquisition teams.

John Massocca, Analyst

Okay. Regarding the Austin office asset, you mentioned there might be some actionable developments by the end of the third quarter. I understand there may be limitations on what you can disclose right now. Can you share any additional insights that might explain your confidence in having more to discuss at the end of the third quarter?

Robert Cutlip, President

I think at the end of 3Q, for sure. We're just seeing a lot more interest in property tours as well as buyers. Buyers have come into the Austin market, and that's why we're looking at a kind of a dual strategy there of potentially re-leasing it and/or selling it. We may end up trying to lease part of it and then sell the building and redeploying that capital in industrial. But at least I'm encouraged that we're getting a lot more foot traffic and a lot more interest on both the tenant prospect side and the buyer prospect side.

John Massocca, Analyst

And I guess maybe on a price per square foot basis roughly, what is the difference out there in the market today, selling it, leased or partially leased versus completely vacant?

Gary Gerson, CFO

Are you talking about the sale price differences?

Robert Cutlip, President

Okay. Right now, I'd rather not talk about that publicly because we are in conversation with parties. And therefore, they have access to it.

John Massocca, Analyst

And then one last quick detail one back on Tulsa. I know the cash rent doesn't start until November. But if we think about that cash rent versus maybe the pre-vacancy cash rent, should that be kind of relatively level with what that asset was doing before?

Robert Cutlip, President

No, John. No, John, it isn't. You know I'm a transparent kind of guy. We leased it. The leaders there, Buzz Cooper and Perry Finney, found an excellent tenant. They only wanted to be in the majority of the building. When we looked at where they were going to be in the building and the difficulty of potentially leasing the balance, Buzz was able to convince them to take the entire building. It cut us down a little bit in the rent, but it picked them up paying the balance of the OpEx in the building. So we're down a little bit. Let me put something on the website so at least you'll know what it is. I don't have the specific amount, but it is below where we were before.

David Gladstone, CEO

I know the second quarter.

Robert Cutlip, President

We are fumbling trying to look at that.

David Gladstone, CEO

We'll have to get back to you on that one.

Robert Cutlip, President

Craig, we will put something on that website that tells you where those are, and I don't know why we don't know those, but they are not at top of mind, so we'll have to get back to you.

Craig Kucera, Analyst

That's fine. I guess the kind of other follow-up question, in regard to that, I think there is maybe a portion of that yet to be recognized. We expect to see that accelerated in the third quarter, or is that would that be randomly spread to the rest of the year or in '22?

Robert Cutlip, President

Again we'll have to get back to you on that. Craig, I know that we will have something at the end of the third quarter, but we also have negotiated buy it, really goes into the next year, and that's an addition to the current rent that they are paying. So it's going to be a combination on those two.

David Gladstone, CEO

All right. Do we have a fourth question?

Operator, Operator

We do not Sir.

David Gladstone, CEO

All right. Well let me summarize. We had a good quarter. It looks like the road is wide open for us to have this second half, and so with that since there is no other questions, we will terminate this. And so that's the end of this presentation. Thank you all.

Operator, Operator

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