Q2 2022 Gladstone Commercial Corp Earnings Call

August 2, 2022

Greetings and welcome to the Gladstone Commercial Corporation, Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Gladstone, CEO . Thank you, David. You may begin. And thank you, Paul, and thanks to all these nice people.

or including those regarding our future performance. These are the statements involved certain risks and uncertainties that are based upon our current plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different. For many future results, express their implied by these forward-looking statements, including all risk factors listed on our forms 10Q, 10K. For the documents we follow at the SEC and you can find them on our website at gladstonecommercial.com.

Specifically, the Investors page, you can always go to the SEC's website as well, and that's 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. And today, we will discuss FFO, which is funds from operations. Now, FFO is a non-gapet counting 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 generally adjusts FFO 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 everyone to visit our website, once again, gladsnolecommercial.com and sign up for our email notification service.

You can also find us on Facebook. Key word there is the Gladstone Companies, and our Twitter handle is at GladstoneCops. Today's call is an overview of our results, so we ask that you review our press release and Form 10Q, both issued yesterday, for more detailed information. Again, go to the investors page of our website and you can find them there. Now I'll hand the presentation over to Gladstone Commercial's president, Buzz Cooper. Buzz. Thank you, Michael. Good morning, everyone, and thank you for dialing in.

I will cover the highlights for last quarter and provide some comment on the state of the portfolio and market outlook before turning the call over to Gary Gerson, Gladstone Commercial's CFO to review our financial results for the period and our capital and liquidity positions.

During the second quarter of 2022, we continued our focus on industrial acquisitions and improving operations.

We acquired a 260,719 square foot industrial portfolio with locations in Fort Payne, Alabama and Cleveland, Ohio for $19.3 million.

acquired a 345,584 square foot industrial manufacturing distribution facility in Wilmington, North Carolina for 18.8 million.

Least and renewed 34,732 square feet, weighted average lease term of 5.3 years.

Subsequent to the end of the quarter, we sold our Jupiter, Florida office property for $19 million, resulting in a gain on sale of $8 million and a levered IRR of approximately 18 percent. Three years later, it is assumed the space in that space has aIns Saturnwhat we would

We also leased 41,225 square feet at our Palmer Austin, Texas, office building to Cognizant Technology Solutions.

for a 5.7 year term at market rates.

These investments, dispositions, and releasing activities further reinforce our strategy to increase our portfolio's industrial location and improve property operations.

Acquisition activity since July of 2021 has been steady and consistent in spite of the uncertain market conditions driven by rising inflation, but war in Europe and pandemic challenges.

Team average 11 million of investments per month, the strong average gap cap rate of 6.99%.

The acquisition volume since 2019 has exceeded 400 million and all assets have been industrial on nature.

Our industrial allocation has increased from 32% to 52% during this period, while pure office allocation has been reduced to 44%.

Teams' near-term objective is to reach an industrial allocation of 60% within the next 12 to 18 months. Our success has been with acquisition candidates in the 50,000 to 300,000 square foot range with the predominance of sale-leaseback transactions and we expect to continue this focus.

Now I'd like to comment upon the portfolio.

Our asset management team continued to deliver on improving our same store operations. Year to date, July 30, the team leased renewed and extended 292,710 square feet every 610.

with a weighted average lease term of 10.1 years. The annualized straight line rent totaled 3.2 million. We're also continuing our capital recycling efforts in order to redeploy sale proceeds into industrial assets.

These transactions will benefit our 2022 operating performance and in the out years as well.

We have leases representing 3% of our annualized straight-line rent expiring in 2022, which will be quite manageable for the team.

and will enable us to continue our emphasis on top line rental growth through expansion of our portfolio.

Our rent collection experiences continues to be strong. 100% first half of 2022 cash rent collections were paid, plus the month of July as well. We are very pleased with our portfolio and with our tenants' performance during these challenging times for all industries.

On the personnel side, we continue to grow our talent in size and experience. Recently, we promoted E.J. Whistler, who is head of the Southeast and Northeast regions, to be the chief investment officer, where he will head up our acquisition efforts.

To recap, in the second quarter we close two transactions for a total of 38.1 million.

Again, the first was a two-propry portfolio in Fort Paine, Alabama, and Cleveland, Ohio. The purchase price was 19.3 with a gap cap rate of 6.7.

Second closing was in Wilmington, North Carolina. Purchase price $18.8 million and the gap cap rate at $6.45.

And again, subsequent to the end of recorder, we executed a 41,225 square foot lease at our Austin, Texas asset increasing occupancy to approximately 70%. And again, we executed a 41,225 square foot lease at our Austin, Texas asset increasing occupancy to approximately 80%. And again, we executed a 41,225 square foot lease at our Austin, Texas asset increasing occupancy and again, we executed a 41,225 square foot lease

This lease improves overall FFO as compared to the prior lease for the 100% occupancy of the building.

We also have signed two sales agreements for two of our office properties, which will close the next 45 days. We also have signed two sales agreements, which will close the next 45 days.

It is appropriate to mention that since January 2022, the average gap cap rate on our 51.4 million of acquisitions is 6.57%.

Our transactions in due diligence schedule to close within the next 45 days are above 7%, which is very creative to our shareholders.

Market conditions are worthy of comment, particularly with the continued effects of COVID-19 virus, rising inflation, supply chains, challenges, rapid interest rate increases, and world appeal. A review of research reports relating to industrial and office statistics for the fourth quarter reflects both improvements and continued challenges.

for indus. Most property types continue to outperform expectations and the fundamentals remain strong despite the economic volatility.

creating a disconnect between the property markets and capital.

While investors are beginning to take a risk off approach, learned long-term quality real estate investment opportunities remain.

Despite headwinds indicating an economic slowdown, the national industrial market remains resilient. For Newmark, for the fifth consecutive quarter, net absorption exceeded 100 million square feet, bringing vacancy to a new record low of 3.7%.

Demand continues to outpace deliveries and rising construction costs are driving the average industrial casking rates to new heights of 12.7% year of year.

National rents are poised to continue growing ahead of inflation over the next several months given the record low vacancy rate.

The construction pipeline increased dramatically to 613 million square feet in the second quarter, roughly 12.5% from Q1. The construction pipeline increased significantly to 613 million square feet in the second quarter. The construction pipeline increased significantly to 613 million square feet in the second quarter. from Q1.

Supply chain labor and inflationary pressures have delayed development schedules contributing to the record high construction pipeline.

The industrial market is expected to remain robust. The office market has continued to evolve and gradually recover from the pandemic. However, Cushman and Wakefield references that office absorption has continued to be negative.

In Q2 2022, there was a net negative absorption of 7.8 million square feet across the US. The net negative absorption of 7.8 million square feet across the US.

For Burj LL, leasing activity remained relatively flat during Q2 with approximately 47 million square feet leased, just a 10 basis point increase from Q1.

Nearly 50% of all due volume was for terms of 10 years or longer, bringing the average lease to seven years above the pandemic lower 6.7 years.

The office sector recorded 11.8 million square feet of new deliveries, bringing near-to-day completions to 26.5 million and on track to repeat, 2021's 50 million square feet of new space deliveries. 2021's 50 million square feet of new space deliveries.

As relates to growth opportunities, we are recently seeing a reduction in sale listing activity and investment sales brokers are indicating that the number of acquisition candidates on a per-propery basis has been reduced. We continue to monitor market conditions to see if the increase in interest rates on debt will translate into a further expansion of cap rates over time. We will translate into a further expansion of cap rates over time.

Our current pipeline of acquisition candidates is approximately $275 million in volume, representing 15 properties, all of which are industrial.

Of the 15 properties, three properties are in due diligence totaling 58 million, three properties are in letter of intent stage totaling 68 million, and the balance are under initial review.

Our team is staying actively engaged in our markets, as we believe acquisition opportunities will continue to arise that we can and will pursue.legen

So in summary, our second quarter activities reflected continued strong leasing and rental collection success, continued active engagement to identify industrial acquisition opportunities, and collectively position us well to pursue growth opportunities.

Now, let me turn it over to Gary, our CFO for report on the financial results, including our capital market activities. November 2020.

Thank you Buzz. Good morning everyone.

Start my remarks.

Regarding our financial results this morning by reviewing our operating results for the second quarter of 2022, all per share numbers and reference are based on fully diluted weighted average common shares. FFO and core FFO available to common shareholders were both 39 cents per share for the board respectively. FFO adjusted for comparability and core FFO available to common stockholders during the second quarter of 2021 toward 36 cents and 37 cents per share respectively.

FFO and Core FFO available to common stock shareholders for the two quarters ended June 30, 2022, were 78 cents.

respectively.

FFO adjusted for comparability and core FFO for the two quarters ended June 30, 2021, where 76 cents and 78 cents respectively. Our same store cash rent in the two quarters of 2022 increased by 2.5% over the first two quarters of 2021 exclusive accelerated rent recognized during the six months of 2021, the first six months of 2021 from early lease trans terminations. FFO adjusted for comparability and core FFO

Our second quarter results reflected total operating revenues of 36.4 million operating distances of 27.8 million as compared to operating revenues of 33.3 million and operating expenses of 25 million for the same period in 2021. Moving on to the balance sheet, we continue to grow our assets and focus on reducing our leverage. In the second quarter, we increased total assets by approximately 39 million dollars, primarily due to the two acquisitions buzz described earlier.

We continue to reduce our debt to gross assets that are now down to 44.9% as of the end of the quarter. We believe that we are 1-2% away from our target leverage level.

We continue to 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, 59% is fixed, 31.6% is hedged floating rate, and 9.4% is floating rate, which is the amount drawn on a revolving credit facility. We have seen increased expenses this quarter due to the rise in short-term interest rates. As of June 30, our effective average LIBOR was 1.79%. Given our current hedging, the impact of a 1 to 2% increase over the 1.79% would be between a $1.9 million and $2.6 million increase.

We have a number of options and will refinance these amounts at the appropriate time. As of the end of the quarter we had $47 million dollars of Revolver borrowings outstanding.

While entering the first quarter with sufficient liquidity, we've been active in issuing

Equity through our ATM market program. During the second quarter of 2022 and net of issuance costs, we raised $11.4 million through common stock sales. We also raised net proceeds of $1.4 million from sales with our Series F preferred stock. We continue to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements. As of today, we have approximately $3.8 million in cash.

and $34.6 million of availability under our line of credit. With our current availability, the strong performance of our portfolio and access to our ATM program, we believe that we have sufficient 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 for our stock has increased over time to 49.7% as of June .

cut or suspended the dividends since our IPO in 2003. Our common stock closed on Monday at $20.78. The distribution on our stock is 7.24%. Many REITs are trading at much lower yields. And now I'll return the program back to David. Okay, thank you Gary. That was a good report and it's also a good one from Buzz and Michael. The team has performed very well.

and reacted and added really to the various challenges presented doing this slower economy that we're in today overall very nice quarter

You heard a lot today in terms of the numbers of transactions Gary said and I think we've said the same thing at 100% of the cash base rents during the second quarter.

We acquired two industrial assets during the quarter for total investments of 38.1 million, and we also leased.

and renewed a total of 34,732 square feet, which is part of 293,000 of total loses renewals today. Subsequent to the end of the quarter, we sold our... total loses renewals today. Subsequent to the end of the quarter, we sold our...

Oh, a wonderful Florida location that had been vacated by one of the large technology companies and we sold it to a group that was willing to take the

risk of leasing it up again and we got about eight million dollars in capital gains out of that.

We released on over 41,000 square feet in Austin, Texas. That one was a drag on us for so many years. And now of course, it's almost released up. We're a very good shape there.

The commercial team is...

The real estate we own is in good place. The team is doing a great job of managing the properties we own, especially during the pandemic and now of course doing this very slow economy.

Our team of strong professionals continues to pursue quality properties on the list of acquisitions they're reviewing our acquisition team is seeking strong credit tenants, quality tenants in real estate make excellent investments. Our asset managers are axiomably managing the properties that we own in order to maximize their value to us. It's a different environment out there today, but the team is up to the challenge.

The middle market business like many of our tenants are in, have been challenged with previous government restrictions related to the pandemic, the inflation, the rise in interest rates, and supply chains disruptions. But our tenants continue to pay their rent. This is wonderful for us. These are times that have never been seen before and there will be future challenges, but our first-class team, I know they're going to do a fantastic job.

Advisors who follow the economy say that you should buy hard assets.

and believe me, these buildings in real estate, they are hard assets. So if you buy our stock, you're getting a piece of what we own. I'm going to stop here and ask anyone, or have the operator tell people how they can ask questions that we can answer for you. So Paul, if you'll come on, that'd be great.

Thank you. We will now be conducting a question and answer session.

If you would like to ask your question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question key. You may press star 2 if you would like to remove your question from the keypad. For participants using speaker equipment, it may be necessary to pick up your hands that are for pressing the star key.

One moment please while we pull for questions.

Thank you. Our first question is from Gaurav Mehta with EF HUD. Please proceed with your question. Your question is for Gaurav Mehta.

Thank you. Good morning. First question on the transaction market. The India prepared remarks you talked about declining investments that's listing in the market. I was wondering if you could catch up on the cap rates, what kind of impact have you seen on the cap rates yet?

Thank you Gaurav. We have seen cap rates push out. We don't have enough information at this point that they are out to what the rise in interest rate is at this point in time. But what we have seen is that they indeed have pushed out, which works to our benefit, as well as a few opportunities that we looked at in the past have come back to life, so to speak.

So it is having an effect on the numbers that we look at, but what I was referring to is the competition on those is also still very intense albeit fewer shops are some are pencils down till Labor Day.

Okay, second question on your lease expirations. Can you provide some color on the three leases that you're expiring in 2022?

with leases expiring.

does anyone have'dranlaa from michael leprater cheese?

I have three. Yeah, we've only got three of which we are working hard upon. South Carolina, Ohio, which actually the building is under. South Carolina, Ohio, which actually the building is under.

consideration for sale as well as another one in Ohio that is up for sale. So quite manageable here in 22 and then of course the team is also focused on 23.

Okay, and then lastly, can you provide some color on the $1.3 million in payment charge that you had in this quarter?

Yes, that has to do with a building that we have that is held for sale and that we will be, as one of the three buildings that Buzz referred to earlier, we'll probably be consummating that sale here shortly. And that has to do with a, basically just the structuring of the accounting on that. But generally, the building will be sold for a overall slight gain. We just had to impair the property because of the accounting treatment.

improvements, any color there to be helpful.

On the ti dollars meaningful yes because anything out of pocket to us is meaningful however well below market Market down there on ti dollars are 50 to 70 even higher for some of the properties At a 5.7 year deal we could be aggressive on the ti side we kept those under 30 bucks a square foot and as it relates to a rental rate It's north of where it was when GM exited

that approached me it was at 14-5 when they exited were north of 20, but I don't want to get too specific relative to that for cognizance and say. You

Fair enough. And as far as the asset sales, you sold the building earlier this month in Jupiter, Florida. You've got another couple in New Jersey and Ohio. Can you give us a sense of kind of what initial cap rates you're selling those buildings at?

Again, the gain on the opportunity down in Florida was an 18 IRR. I'd have to go back and look up the cap rate for those sales, but they're north of where we were.

their benefit as to where we purchased them.

Okay.

All right, and I think you had last quarter you mentioned you had one tenant that was vacating in Utah, I think at the end of the second quarter. Has that building been leased up or did I miss that maybe?

You did not lease it. We are working at heart or missing. We are working at heart. It has not been leased up.

We also were entertaining a interesting transaction on that. I can't get too specific upon but could be a very positive outcome. We are looking to release it and or sell it.

And the remaining leaf terminations are those, or not in terminations, the aspirations, are those fourth quarter events or those sort of randomly through the rest of the year. Or those sort of randomly through the rest of the year.

They are going to be either at the end of the third quarter or into the fourth yes.

Okay, thanks, appreciate it.

Yes, sir.

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