Q2 2023 Gladstone Commercial Corporation Earnings Call
Greetings and welcome.
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Greetings and welcome to the Gladstone Commercial Corporation second quarter earnings call.
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Brief question and answer session will follow the formal presentation.
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It is now my pleasure to.
Introduce your host Mr. David Gladstone, Chief Executive Officer.
Thank you you may begin sir.
Alright, Thank you very much and very nice introduction and thanks to all of you for calling in.
We really do enjoy this time, we have with you on the phone and wish we had more time to talk with you.
But first before we get started Michael the calcium general counsel and Secretary has to give oh.
Legal and regulatory matters overview, Michael Thanks, David 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.
Forward looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable and many factors may cause our actual results to be materially different from any future results expressed or implied by these forward looking statements, including all risk factors in our forms 10-Q10-K and other documents we filed with the SEC you go to the investors page of our <unk>.
Website, you can find them there could also find them on the SEC's website at Www Dot FCC Dot G O P 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 F F L which is.
Funds from operations F. F. O 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 <unk>, which are generally F F. All adjusted for.
Certain other nonrecurring revenues and expenses and will.
And 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 or visit our website. Once again that Gladstone commercial dotcom sign up for our email notification service on Facebook you can find us at the Gladstone companies.
And on Twitter the handle is at Gladstone comps now 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, that's on the investors page of our website with that I'll turn it over to Gladstone Commercial's President for school bus.
Thank you Michael and thank you all for calling in today, we will discuss economic and portfolio topics that are top of mind.
The country is going through a transitional period economically which has affected the commercial property markets, although remote work and lingering effects of the pandemic have weakened the office property market the industrial property markets remained strong.
We continue to pivot to a higher percentage of industrial assets by divesting noncore office assets, we are lowering our exposure to office market and Derisking our portfolio.
Like to high light several positive developments are overall, all portfolio remains stable and strong and we continue to see attractive acquisition candidates.
Whether we continue to have success with re tenant in and capital recycling into industrial assets with them.
These facts in mind, let me move onto a discussion covering the results over the last quarter. Despite some comments on the state of the portfolio and market outlook before turning the call over to Gary Dickerson, Our CFO to review the financial results for the period and our capital liquidity positions.
During the second quarter of 2023, we continued our focus on industrial acquisitions and improving operations, we acquired a 76000 square foot industrial manufacturing facility in Riverdale, Illinois, and a GAAP capitalization rate of nine seven fully leased our 119224 square foot office.
In Fort Lauderdale, Florida for 11.1 years.
We executed a lease with a subtenant of 125682 square foot industrial property in Milwaukee, Wisconsin for 10 years through 'twenty 38.
Ended the lease.
Of our 220.
Excuse me 220500 square foot Monroe, Michigan industrial facility for an additional five years extended the lease at our 13919 square foot Cumming, Georgia Medical office building for an additional five years.
Extended the 22031 square foot lease at our Burns Vale, Minnesota industrial property by additional five four years, and we sold 12070 foot square foot.
Office property in Baytown, Texas outside of Houston.
We also sold 30850 square foot office property in Birmingham, Alabama.
Subsequent to the end of the quarter, we acquired a 7714 square foot medical property and buildings.
In Texas with a 10 year lease in place.
Acquired 800000 square foot industrial manufacturing and distribution facility and Cedar Hill, Texas for $9 1 million and 20 year sale leaseback transaction and a GAAP cap rate of 10.1, we.
We sold 26000 square foot office building in Pittsburgh P. A.
For $6 75 million, resulting in a gain on sale of $3 6 million.
We extended the lease on our Wilmington, North Carolina Industrial property until June 30, 2037.
And we extended the lease of 51940 square feet at our New Albany, Ohio Office property by additional five years. These.
These investments dispositions and re leasing activity further reinforce our strategy to increase our portfolio's industrial allocation and improved property operations.
Our acquisitions volume since 2019 has exceeded $487 million and 99% of the acquisitions had been industrial in nature our.
Our industrial allocation based on straight line rent has increased from 32% to 59% during this period.
Your office allocation has been reduced to 37%.
The team's near term objective is to reach an industrial allocation of at least 60% within the next six to 12 months and we continue to have success with acquisitions in the 50000 to 300 square foot range with a predominance of sale leasebacks and we expect to continue this focus.
Now I'd like to comment on the portfolio.
Our asset management team continues to deliver on improving our same store operations Q2, 'twenty twenty-three over Q2, 2022 the same store and lease revenues increased by 9.5%.
We are also continuing our capital recycling efforts in order to redeploy sales proceeds into industrial assets.
Our rent collections continue to be strong 100 per cent of cash rents were collected through July and we are very pleased with our portfolio and with our tenants performance. During these challenging times for all industries.
It is appropriate to mention that the average GAAP cap rate on our three acquisitions year to date was 9.56%, which is very accretive to our shareholders. The potential acquisitions currently our pipeline our pipeline are above eight 5%.
Uncertainty and volunteer volatility continued in the second quarter of 2023 within the economy and financial markets. As a result of higher interest rates and tightened credit standards transaction volumes are down by over 60% year over year and the disconnect between buyers and sellers as it relates to pricing expectations.
Throughout the second quarter the.
The industrial sector normalized in the second quarter of 2023 relative to last two record setting years in 'twenty one 'twenty two.
However, overall fundamentals remain sound and the sector continues to outperform other asset classes.
The increase in cost of high yield debt and leveraged loans has made the sale leasebacks and attractive source of capital for private equity backed businesses and an increasing number of firms are exploring it as a financing alternative.
The fed rate continued on its path of raising interest rates by 25% in July meeting signaling that the fed will look for lower levels of inflation before determining peak rate levels with inflation moderating to it. So it was year over year increase since March of 'twenty one.
Economy is showing the effects of a rapid rate hikes and tightening credit standards over the past 18 months.
Companies continue to push return to work policies in the second quarter.
Formulary, Facebook and Lyft announced office mandates in the second quarter, which now.
It means that the top 10 U S technology tenants all have some form of high pressure high bred attendance policies. Additionally, federal agencies continue to implement policies for their employees to return to the office.
Approximately 1.5 million office based employees have had new attendance policies take effect in 2023 and another one man will face returned to office mandates that will take effect through the end of the year.
New office development activity has decreased significantly due to high material cost decreased demand and increased cost of capital just 5 million square feet of office has broken ground year to date.
But potentially providing much needed supply constraints in high quality office for years to come.
U S is seeking seen a high record of office property is removed from the market for demolition redevelopment where conversion to other property types are firm continues to successfully execute on the disposition of noncore office buildings.
As it relates to acquisition opportunities, we continue to see a reduction in sales listing activity, primarily from third party leases and investment sales brokers are indicating that the number of acquisition candidates on a per property basis has been reduced we.
We have seen cap rate expansion in the market due to the continued rise in interest rates and cost of debt.
And new sponsors exploring sale leaseback transactions. Our current pipeline of acquisition candidates is approximately 8 million and buy them representing 25 properties.
Yeah.
Five properties to have that all eyes out for consideration and the balance are under review are.
Our team is staying actively engaged in our markets and we believe acquisition opportunities will continue to arise as we can that we can and will pursue.
So in summary, our second quarter activities reflected continued strong leasing and rental collection success continued active engagements to identify industrial acquisition opportunities and have collectively position us well to pursue growth opportunities now.
Now, let me turn it over to Gary our CFO for a report on the financial results, including our capital market activities. Gary. Thank you Buzz I'll start my remarks regarding our financial results. This morning by reviewing our operating results for the second quarter of 2023 all per share numbers referenced are based on fully diluted weighted average common shares.
<unk> that's S O in core <unk> per share available to common stockholders were both 41 cents per share for the quarter S. S O and core S. F O available to common stockholders. During the second quarter was 2022 were both 39 cents per share respectively, SSO and core F. S. O for the six months ended June 32023 were 77 cents.
78 cents, respectively S. S O and core S. S O for the same period in 2022 were both 78 cents per share our same store cash rent in the first two quarters of 'twenty twenty-three increased by nine four at 595% over the same period in 2022. This was primarily due to one time accelerated rental.
From a lease termination or.
Our second quarter results reflected total operating revenues of $38 7 million with operating expenses of $33 7 million as compared to operating revenues of $36 4 million in operating expenses of $27 8 million for the same period in 2022 operating expenses were higher in this period in 12.
Twenty-three, mainly due to an impairment charges of $6 8 million take it against three office properties all of which are currently held for sale in connection with the preparation of our financial statements for the second quarter of 2023 we identified errors in the calculation of depreciation of tenant funded improvements assets at a number of our.
Properties, we had depreciated these assets through a term that was different than their useful lives. Their correction resulted in changes to depreciation expense noncash amount and net income.
The correction of these errors had an immaterial impact on the incentive fee and no impact on any other advisory fee. The identified errors were included in our previous previously issued 2021 quarterly and annual financial statements. The 2022 quarterly and annual financial statements and our quarterly financial statements for this.
Three three months ended March 31, 2023, we evaluated the errors and determined that the related impact was not material to the consolidated statements of operations and comprehensive income consolidated balance sheets consolidated statements of cash flows or consolidated statements of equity for any period impacted.
We have revised the previously issued financial statements as of and for the three and six months ended June 30, 2022 to correct for these errors. These revisions are reflected in our 10-Q filed yesterday, a summary of the corrections.
To the impacted financial statement line items to our previously issued financial statements.
For each after mentioned affected period is presented in note nine to the 10-Q. Please note.
These corrections had no effect on F. S. Though looking at our debt profile 46, 2% is fixed rate 48, 7% is hedged floating rate and five 1% is floating rate, which is the amount drawn on our revolving credit facility as of June 30, our effective average sofer rate was five point.
One 9% our outstanding Bank term loans are hedged with $200 million of interest rate swaps and the remainder with interest rate caps. In addition, we have $100 million of forward starting swaps to replace the maturing caps. In Q3 2023, we have continued to monitor interest rates closely and update our hedging strategy as needed.
As of today, our 2023 and 'twenty 'twenty four loan maturities are manageable with $9 million due in 2023 and $19 $7 million coming due in 2024 as of the end of the quarter, we had $38 5 million or a vault of revolver borrowings outstanding.
We had no activity this quarter and issuing equity through our aftermarket or ATM program during the quarter, we repurchased $1 million of our common stock. We also received net proceeds of $3 $8 million from sales of our series F preferred stock we continue to manage our equity activity to ensure that we have sufficient liquidity.
For upcoming capital requirements and new acquisitions.
We have six office properties held for sale what is scheduled to close in August as of today, we have approximately $6 $9 million in cash and $44 $1 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.
The information for the quarter, our common stock dividend.
Is 30 cents per quarter or $1 20 per year, our common stock closed yesterday at $13.36. The distribution yield on our stock is at nine 2% and now I'll turn the program back to David well. Thank you very much Gary It was a good report good one from baas as well and Michael.
Our team is producing very well this quarter and reacted admirably to the various challenges presented by the lasting impact of a pandemic and our economy, that's seems to be in a bit of turmoil.
Overall, we have a nice quarter.
You've heard a lot today summary, doing the quarter, we had 76000 square foot building and industrial building and we collected 100% of cash rent.
Also reviewed and leased.
502000 square feet of remaining lease terms.
From 5.4 to 14 years and six of our properties so were going right along in our renewals.
Subsequent to the end of the quarter, we acquired two additional properties, including 100000 square foot industrial facility. We also renewed 397000 square feet of remaining lease ranging from 13.9 to 18.7 years.
At two of our properties. So again everything is filling out as we'd like to see it. The commercial team is growing the real estate, we own at a good pace and the team is doing great job of managing the properties, we own, especially doing these times that are a little bit challenged by all of the interest rates.
The company outlook again, the team is strong professionals continuing to pursue potential quality properties on the list of acquisitions. They are reviewing.
Our acquisition team is seeking strong credit tenants.
So that's the quality of the tenants that are real estate and make an excellent investment.
Our asset managers are actively managing the properties that the company owns in order to maximize that value.
It is a different environment that we're in and the team is doing a good job of doing that so I'm going to stop here and let the operator come on and help us listened to some questions that should be asked from some of the listeners.
Thank you.
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One moment, please while we poll for questions.
Thank you.
Our first question is from Rob Stevenson with Janney Montgomery Scott.
Please proceed sir.
Hi, good morning, guys.
So you had you know call it little over $63 million of assets held for sale at June 30.
Hold on one already for just under 7 million so call. It 57, more or less still held for sale whats the expected timing on those remaining five dispositions are they likely to close in third quarter by year end some of that spillover into 'twenty, four and worse pricing coming in versus your acquisition cap rates.
Thanks, Rob I will give a shot at this also I have my Chief investment Officer E. J Whistler here.
The number you mentioned I think one may bleed into 'twenty four other than that I'm, not expecting such and the reason would be it is a re.
Positioning within the marketplace of the property.
So it could fall into 'twenty, three but most likely I think it'll be first quarter 'twenty four.
And as it relates to valuations.
I don't have the exact figure of what we are as we laid out with impairment, but other than that I can't be certain because a few of them honestly have some.
Necessary adjustments coming to it currently as we go through due diligence.
Okay. That's helpful. And then how should we be thinking about the investment grade tenant base in the portfolio. If I go back pre Covid yearend 2019, your portfolio was 63% investment grade tenants now its 51 I assume that the vast majority of that is the migration farm investment grade office tenant.
It's to industrial but you know when Youre looking at new acquisitions. You know how are you guys thinking about the credit quality of industrial tenants in the sort of smaller and mid range assets.
Versus the sort of underwriting that you did when you were focused on you know investment grade office tenants.
Again, I'll, let D. J have a statement here as well, but we have not gotten away from our historical and prioritized underwriting as it relates to all of our tenants.
Lost some credit tenants as relates to they're either going remote and we're selling buildings, but as it relates to our internal underwriting as well we have maintained those standards T. J yeah, Yeah. It's obviously really important to us on the underwriting side to your point to make sure we're putting good credit tenants into the portfolio.
As we've moved more into industrial to your point, you do see more middle market type businesses, especially in the manufacturing space. What we do find though is you're able to acquire assets. There are a lot more mission critical to the tenant. So you have a lot higher renewal probabilities on your legacy office assets. So it's a bit of a balancing act as we look to construct the portfolio.
But for US it's the key is making sure that the asset you're acquiring is a major revenue and EBITDA driver to the underlying business in order to ensure a high renewal probability mixed in with the overall corporate strength of that tenant.
Okay. That's helpful. And then Gary you guys bought back a million dollars of stock what was the average price. There are how many shares did you wind up buying I didn't see that in the release.
I think we can get back to you on the average price I believe it was somewhere around 12 $12.
But in and around 90000 shares something around that that neighborhood.
Okay. That's helpful. And then lastly, you guys paid out in the release you guys paid down $36 million of debt here in the third quarter any disposition proceeds off of that stuff likely to be used to pay down additional debt is it are you still in the market to buy back stock is it just going to be to fund acquisitions how are you.
Thinking about sort of uses of proceeds.
From the dispositions and any type of free cash flow at this point.
Excuse me.
Obviously, we look to redeploy capital into industrial acquisitions as we've stressed.
We'll be talking internally as to whether or not we continue to look to buyback at this point. It is on the table, but at this point in time, what we want to do is redeploy that capital into for lack of a better word Harry accretive deals.
Okay. That's helpful.
Move away from us.
Alright, guys. Thanks.
Just so you know Rob it was 880000 or so shares at an average price of $12 47.
Okay do we have a new question.
Yeah.
Okay.
Thank you. Our next question is from Craig Cassandra with B Riley Securities. Please proceed sir.
Yeah, Hey, good morning, guys could you give us a little bit more color on the lease termination this quarter, where the tenant was located anything in that regard.
Certainly I'll, let D. J have that he did a great job with as asset manager on getting that completed for us yeah.
That was specific to the Fort Lauderdale office property, where Citrix was the legacy tenant there as part of their take private a few years ago. They had gone remote and so we've been working with them, putting a sub tenant in and we worked on with the subtenant to make that a prime lease.
Great opportunity for us to effectuate, a termination fee and go direct with the tenant that took the entire facility.
On the cash value of that was approximately 2 million offset a bit by some deferred rent assets there.
So it was it was a great outcome there.
Being able to execute it over an 11 year lease to go direct and make that their corporate headquarters with a new tenant.
Got it that's helpful and did you mention a with the two dispositions this quarter, what what the cap rate was.
No I don't think we mentioned it but on average Ah I may have to get back to you on that I'm not sure I have that handy.
It's for the.
One of them had some vacancies so a true cap rate on in place wouldn't be the best way to look at it. The office building that was sold subsequent to the quarter was fully leased and that was exited just inside of a six and a half initial cap. So we'll be looking to redeploy that at least a 200 basis point spread so that'll be a good outcome there.
Got it and.
Big pick up in assets you are expecting to sell of course or it's one of those buildings are the former Verizon call Center that went dark at the end of last year, but can you just give us some color on what the sort of average occupancy of those buildings.
Hi, Verizon is a big one are we are looking forward to that sale in this quarter.
We are waiting for.
Blessing in order for it to close from.
From the municipality and that a little get that off our books.
That's the primary if you will size one that I think you're referring to.
Correct.
Got it and then I guess, what I'm just looking for is just some color on or are these are these office assets that have no meaningful they can see or are they you know.
Are there any industrial assets in that pool, or just any color would be helpful.
There's not any industrial assets in that class a.
And relative.
They are.
You know Verizon was a single storey office or two storey building in Richardson, Texas.
And again I'll point out these are held for sale, obviously with the TSA is on them or currently being negotiated.
Uh huh.
And.
Total square foot there is for 558000 square feet and again, we should get them all done save one by the end of this.
This year.
And to that point the majority of those have some vacancy or are completely vacant and so the thought process. There as we kind of look at the office market today, There's some office markets, where there is still good activity like Fort Lauderdale, but in certain markets, where absorption is negative or leasing is very slow we view it as a more crude.
And our capital allocation strategy to exit those deals redeploy them versus thinking money into those buildings. So that's kind of a thought process there and it should hopefully see an uptick in occupancy as we move through those vacant assets.
Okay. That's that's helpful.
And I apologize, but there was some background noise. When you were reading through your comments on your.
Sort of acquisition pipeline and what was under due diligence et cetera can you can you go through those again, just so we have a little clearer listening on that.
What I'll do just said that it is more clear as I'll, let EJ provide an update on that for you, but the team is actively engaged looking at many opportunities. Yeah. So the pipeline is about 408 million plus or minus two deals. We have LOI is out we had closed a few deals recently subsequent to quarter end. So nothing is currently in diligence.
We've got a few deals we think are very actionable at the moment, we're reviewing a lot and as Bob mentioned in the prepared remarks, I'm seeing a lot of interesting sale leaseback opportunities.
Got it and are you at this point comfortable handicapping sort of what your expectations are on the acquisition front for the rest of the year or third quarter or is it still sort of TBD.
I'd say, it's more TBD, obviously with it being as it relates to what cap rates are doing and the availability of capital.
And that.
Got it and just one more for me we've seen Reits I think.
And a lot of sector sort of pick up there their activity of stepping in as sort of a temporary lender for merchant builders I don't know if new product necessarily fits kind of what you've been doing on the industrial front, but is that something you guys are looking at as far as sourcing some additional transaction volume.
I don't know if we're gonna be merchant builders per se, we certainly would look at that.
And have been exploring internally, how we can generate more business, whether it's the JV or otherwise.
I'll, let D. J have a have a throw at that yeah to your point, obviously with a lot of regional banks and bank sort of on the sideline with construction lending world. We have seen some groups private and public that are traditionally equity players stepping in to provide construction financing we see those opportunities we have some of those discussions and our view is we've kind of look.
Our capital allocation strategy, you can still see better better returns on the equity side, especially in the sale leaseback space as we look construct of our long term weighted average lease term for our portfolio. So we.
We look at those I don't see us doing any in the near term.
Alright. Thanks.
Thank you we have another question.
Thank you.
As there are no further questions at this time I am turning the call back to Mr. David Gladstone for closing comments. Please proceed sir.
Well, we thank you very much for a good meeting and wish you all well and we'll see you next quarter. That's the end of this call.
Yeah.
Okay.
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