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Edited Transcript of GOOD earnings conference call or presentation 31-Oct-19 12:30pm GMT

Q3 2019 Gladstone Commercial Corp Earnings Call

McLean Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Gladstone Commercial Corp earnings conference call or presentation Thursday, October 31, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David John Gladstone

Gladstone Commercial Corporation - Founder, Chairman & CEO

* Michael B. LiCalsi

Gladstone Commercial Corporation - General Counsel & Secretary

* Michael J. Sodo

Gladstone Commercial Corporation - CFO

* Robert G. Cutlip

Gladstone Commercial Corporation - President

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Conference Call Participants

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* Craig Gerald Kucera

B. Riley FBR, Inc., Research Division - Analyst

* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Equities Research

* John James Massocca

Ladenburg Thalmann & Co. Inc., Research Division - Associate

* Robert Chapman Stevenson

Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Gladstone Commercial Corporation's Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Gladwell. Gladstone, I'm sorry. Go ahead, Sir.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [2]

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Okay, thank you, Stephanie. It was a nice introduction and we are coming to you from the town that has the world-famous Washington National Baseball Team that just won the World Series in case you're wondering why we're still celebrating here. We do enjoy this time we have with you on the phone and wish we had more time like this. We'll start off with Michael LiCalsi, who is actually in his Washington Nationals' baseball team uniform. So Michael, go ahead.

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Michael B. LiCalsi, Gladstone Commercial Corporation - General Counsel & Secretary [3]

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Maybe not the full uniform, that would be kind of silly, but that's okay. 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 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, www.gladstonecommercial.com, specifically the Investor Relations page. Or on the SEC's Website which is www.sec.gov. Now the company undertakes 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 of course, as required by law. And today we will discuss FFO, which is funds from operations. FFO is a non-GAAP accounting term defined as net income excluding the gains or losses from the sale of real estate and any impairment losses on property, plus depreciation and amortization of any real estate assets. We'll also discuss core FFO, which is generally FFO adjusted for certain other nonrecurring revenues and expenses. We believe this is a better indication of our operating results and allows better comparability of our period-over-period performance. Please take the opportunity to visit our website, once again, gladstonecommercial.com. You can sign up for our email notification service online there. You can 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, again, both issued yesterday for more detailed information. Again, those can be found on the Investor Relations page of our website. Up in the bullpen we have Bob Cutlip, Gladstone Commercial's President, and he'll take over from here.

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Robert G. Cutlip, Gladstone Commercial Corporation - President [4]

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Thank you, super Nat's fan. Good morning, everyone. During the third quarter we acquired a 78,500 square foot industrial property in Denton, Texas. We acquired a 211,000 square foot 2-building industrial property in Temple, Texas. Recast the company's line of credit and term loan. And implemented energy savings improvements at 3 office properties to reduce operating costs.

Subsequent to the end of the quarter, we entered due diligence for the acquisition of a 65,000 square foot industrial property in Indianapolis, entered due diligence for the acquisition of a 231,000 square foot industrial property in Indianapolis, entered due diligence for the acquisition of a 241,000 square foot industrial property in Jackson, Tennessee, have 2 lease amendments negotiated and out for signature, a 100,000 square foot office tenant in Denver, Colorado, and a 40,000 square foot office tenant in Mason, Ohio. And completed a public offering of 6-5/8% Series E perpetual preferred stock.

As I noted in the second quarter, we are beginning to enjoy the benefits of our teams' focused efforts across all functions to improve operating results. This has been accomplished through 3 major activities. Acquired accretive assets. During the period from 2012 through 2018, the average GAAP cap rate on acquisitions was 8.7%, with mortgage debt placed at a 4.6% interest rate. Renewed expiring leases and released vacant space. We maintained occupancy greater than 96% during the highest lease expiration period in company history and refinanced maturing mortgages at lower leverage levels. We've lowered our leverage from a high of 63% in 2013 to 45.9% as of the end of the third quarter.

The results of these efforts equate to increasing cash flow year-after-year and an improved capital structure as we approach $1 billion in total assets after depreciation. And the outcome of the recent recast of our line of credit and term loan and the successful offering of 6-5/8% perpetual preferred stock further demonstrates the improvement in our operating position which we believe will create opportunities for growth. Mike is going to expand upon the characteristics of these capital events shortly.

Our investment in asset management activities continued to generate positive momentum for our operations during the quarter. We acquired a 78,500 square foot industrial building in Denton, Texas. The acquisition price was $6.5 million and the going-in and GAAP cap rates are 6.4% and 7.1% respectively. The unexpired lease term is 12 years. We also acquired a 211,000 square foot 2-building industrial property in Temple, Texas. The acquisition price was $14 million, the going-in and GAAP cap rates are 6.9% and 8.2% respectively, and the transaction was structured as a 20-year sale/leaseback.

Subsequent to quarter end, we entered due diligence on 3 industrial properties, a $9 million building in Jackson, Tennessee, and 2 buildings totaling $13.7 million in Indianapolis. The average GAAP cap rate on the properties is 7.5% and the weighted average remaining lease term is approximately 10.2 years. We expect each of these properties to close during the fourth quarter subject to the successful completion of our due diligence.

Our asset management team continued to deliver on improving our same store operations. From a leasing perspective, our Midwest team has a lease amendment out for signature for a 40,000 square foot office tenant in Mason, Ohio which will extend the lease through April of 2030 as compared to the current lease expiration date of June of 2020 and will require no tenant improvements without amortization of all costs.

Our Mountain West team has a lease amendment out for signature which extends a 100,000 square foot tenant in a Denver multi-story office property from September of 2021 through September of 2026. These combined efforts serve to increase the weighted average lease term on our entire portfolio.

From an operations standpoint, our team is implementing energy savings improvements at 3 office locations in Ohio and Indiana. These programs require no capital expenditures by Gladstone, lower energy consumption in the states, upgrade building equipment, and lower going forward operating costs for the tenants. We plan to implement these energy savings projects at other locations as appropriate.

Anticipating that many on the call are interested in lease expirations through 2020, I wanted to summarize the team's thoughts. During the remainder of 2019, we have 3 leases expiring representing $2.4 million of annual GAAP rent. We have active prospects for each of these buildings at this time. During 2020, we have 8 leases expiring, representing $8.8 million of annual rent. $6.6 million of this total expires during the second half of the year. Now 2 tenants have formally notified us that they are vacating the premises and we are actively marketing those spaces now. In fact, we are in lease negotiations for 50% of one of the buildings representing a 10-year lease term with occupancy commencing upon the existing lease expiration date. And we are in conversation with the balance of the tenants and are hopeful of positive outcomes with renewals.

For GM, with a lease expiration of August 31, 2020, we are pursuing 2 scenarios. They renew their lease or they vacate all or a portion of the space. They are not required to provide notice until December of this year. Therefore, we have begun to actively plan a release scenario by preparing space design concepts for a multitenant or full building user and are engaging the market to identify potential tenant prospects and to validate current market rents and tenant improvement requirements. This information is helpful for either renewal negotiations or a new lease scenario.

I think it's interesting to note that our GAAP rent at the property of $14.50 per square foot triple net compares favorably in the submarket with current space offerings in the low to mid-$20 per square foot on a triple net basis.

Market conditions are worthy of some comment. National research firms have noted that single property listings and closings are down as much as 10% for the first 2 quarters of 2019 versus the prior year volumes and are estimating a similar, maybe somewhat lower result for the third quarter. Entering the 11th year of this cycle, they estimate that both pricing and investment sales volume may be peaking. In addition, we have noticed there is an apparent buyer/seller disconnect in the office sector as evidenced by several notable properties returning to market after being under contract. Now, with that information in mind, significant capital is still available on the sidelines for the considerable interest in US real estate and the expectation is for the 2019 investment sales volume to be similar to that of 2018, which is really still quite healthy for the industry. Our team is going to continue to monitor market conditions and actively investigate opportunities that promote our measured growth strategy.

As it relates to growth opportunities, we have noted an increase in activity in sales listings as of late. Our current pipeline of acquisition candidates is approximately $300 million in volume representing 25 properties, 22 of which are industrial. Of this total, approximately $140 million is either in the letter of intent or due diligence stage and the balance is under initial review. As I've noted previously, we have made a conscious effort to increase our industrial allocation. Our focus is in fully developed industrial parks with properties that are 50,000 to 300,000 square feet in size and occupied predominantly by middle market nonrated tenants, a tenant profile which we believe we can underwrite with our proven credit underwriting capabilities. This property type is also considered last mile in nature with the recent explosion in ecommerce activity.

To show evidence of this strategy, from the last week of September, 2018 through the end of October, 2019, just over 12 months, we have acquired $114 million of properties. Over 80% of this volume, or $96 million, were industrial properties. These properties are located in our target locations and the average GAAP cap rate is 8.1%. We believe this shift to increasing industrial allocation of our portfolio will result in the long-term benefits of lowering tenant improvement costs, reducing the intensity of our property management activities, and improving operating efficiencies.

So in summary, our third quarter activities continued our acquisition and leasing success, refinanced maturing mortgages, amended and extended our credit facility, issued equity through our ATM program, and is positioning us well to pursue growth opportunities. Now let's turn it over to Mike for a report on the financial results.

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Michael J. Sodo, Gladstone Commercial Corporation - CFO [5]

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Good morning, I'll start by reviewing our operating results for the third quarter of 2019. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common stockholders were both $0.39 per share for the third quarter and $1.16 and $1.18 per share respectively for the first 9 months of 2019. This performance demonstrates the accretive yet prudent growth that the company has completed in recent years as well as the performance of the in-place portfolio inclusive of maintaining 99% occupancy.

In addition to these accretive deals, our same store cash rent growth continues to be 2% on an annual basis. Prior to 2018, core FFO hovered in the $1.50 to $1.54 per share range for the past number of years as we de-levered the balanced sheet and addressed lease rollover. 2018 results demonstrated our highest core FFO per share and we intend to continue to grow profitability for our shareholders as well as increasing the industrial allocation of the portfolio. Our third quarter results reflected an increase in total operating revenues to $28.7 million including $100,000 in lease termination and contraction revenue as compared to total operating expenses of $19.4 million for the period.

Now let's take a look at our debt activity and capital structure. We continue to enhance our strong balance sheet as we grow our assets and focus on decreasing our leverage. We reduced our debt to gross assets by nearly 15% to 45.9% over the past 5 years through refinancing maturing debt and financing new acquisitions at lower leverage levels. We believe that we are 1% to 2% away from our target leverage level which means that nearly all raised equity will be allocated to accretive acquisitions. We believe that this will put us at the proper leverage level going forward.

We continue to primarily use long-term mortgage debt to make acquisitions. As we grow through disciplined investments, we'll also look to expand our unsecured property pool with additional high-quality assets. Over time, we expect this will increase our financing alternatives. As we continue to manage our balance sheet, we have repaid $55 million of debt over the past 24 months often with new long-term variable rate mortgages at interest rates equal to the one-month LIBOR plus a spread ranging from 2.5% to 2.75%.

We have placed interest rate caps on all-new variable rate loans. We also added some of these properties to our unencumbered pool under our line of credit, whether an advanced or permanent debt placement, disposition, or in an effort to provide more flexibility in the future by increasing the size of our total unencumbered assets. As Bob mentioned and was discussed last call, we amended, extended and upsized our existing credit facility and term loan on July 2. This highly efficient execution was well supported by not only our existing lending group but also with the additions of Goldman Sachs and Wells Fargo. The combined facility was increased by $100 million to $260 million with the term loan being the majority of the facility at $160 million including a delayed draw component. The entire facility was extended for nearly 2 years with a 10-basis point rate improvement. All term loan borrowings continue to be hedged with LIBOR rate caps in the 2.5% to 2.75% range. In addition, and after quarter end, we did successfully issue our new Series E 6-5/8% perpetual preferred on October 4, totaling $69 million. With significant institutional and retail support, this execution allowed us to redeem our previously existing Series E and Series B Preferreds which on a weighted basis were nearly 100 basis points above the new Series E from a coupon perspective. We believe these capital market transactions continue to speak to the growth of the company and balance sheet enhancements that have been achieved as well as the long-term prospects for further prosperity with incremental bank backing going forward and access to efficient capital.

Looking at our debt profile, and with the credit facility recast complete, 2019 and 2020 loan maturities are very manageable with no maturities remaining in 2019 and only $20 million coming due in 2020. A number of these loans have extension options. We have continued to proactively manage and improve our liquidity and maturity profile over time. Depending on several factors, including the tenant's credit, property type, location, terms of the lease, leverage and the amount and term of the loan, we're generally seeing all-in rates on refinances and new acquisition debt ranging from the mid-3% to low-4% range. We continue to minimize our exposure to rising interest rates with over 90% of our existing debt being fixed rate or hedged to fixed through interest rate swaps and caps.

We've remained active in issuing our common stock using our ATM program. During the third quarter net of issuance costs, we opportunistically raised $7.4 million through common stock sales. While we continue to view the ATM as an extremely efficient way to raise equity, we continually keep our assessment of the relative value of our common stock as compared to trading prices in mind as we determine when to raise capital.

As of today, we have $4 million in cash and $31 million of availability under our line of credit. With our current availability and access to our ATM programs, we believe that we have significant incremental flexibility to fund our current operations, properties we are underwriting, and any known upcoming improvements at our properties. 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.

We feel good about continuing to execute our business plan during the remainder of 2019 and beyond as we continue to increase our high-quality asset base and continue to improve our metrics. We are focused on maintaining our high occupancy with strong credit in real estate. With minimal near-term lease expirations along with manageable loan maturities, our deployment of capital will be heavily focused on high-quality real estate acquisitions with strong credit tenants.

Institutional ownership of our stock increased by more than 17% since the beginning of 2016 to 58% as of September 30. Bob and I continue to be active in meeting with current and potential institutional investors, portfolio managers, investment banks and the like. We look forward to further engaging with not only our existing investor base, lenders and coverage analysts, but also establishing new relationships as the company moves forward to its next chapter.

Now I'll give it back it to David.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [6]

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All right. Thank you very much, Mike. That was a good report and good report from Bob Cutlip and Michael LiCalsi as well. It was a very nice quarter, acquiring industrial properties in Denton, Texas and a 2-building property in Temple as well. That's near Austin, Texas. We recast the company's credit line and term loan so we're in good shape there. And we did issue the Series E Preferred on September 30. The team is growing the portfolio at a really good pace and doing a great job managing the balance sheet. We continue to believe that they have a promising list of potential quality properties with good tenants and expect a number of acquisitions over the next 2 to 3 quarters.

The middle market business area is still very strong. We are seeing our tenants being able to pay their rent, and so as a result we are cranking along. It's a good time to be in this business.

In October the Board voted to maintain a monthly distribution of $0.125 per common share for October, November and December. That's an annual run rate of $1.50 per year. This is a very attractive rate for a well-managed REIT like ours which we believe is an excellent investment for individuals that want monthly income.

I know you are asking us again when we're going to increase the distribution and our policy is not to discuss the strategy or board matters prior to adoption, but we are going to be focused heavily on it in January. However, we do hope to make some small increases. We don't like staying at $1.50. We want to increase it per year just to keep up with inflation. We've now paid 177 consecutive common stock cash distributions and we went through the recession as you know without cutting the distributions. We don't want to hurt that record. The stock now is at $23.19, the distribution yield is about 6.5%. That's a really good rate considering that the whole net universe is trading at about 4.4% yield, and if our stock was there, we'd be over $30 a share. So we still have plenty of room to run. A lot of chance that the price could expand even further. Okay, I'm going to stop here, and Stephanie, if you'll come onboard and let some of our good listeners ask some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Rob Stevenson with Janney.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [2]

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Good morning, guys. Bob, can you talk about where you're seeing the most opportunity acquisition wise and what's the sort of pipeline for maybe latter half of fourth quarter and into 2020 look like today? Is it still largely industrial and you're still able to hit the yields that you've been achieving on recent transactions?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [3]

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Yeah, Rob, very good question. I mean the team has made I think an excellent transition to focusing on industrial. And I think because of the engagement of our regional teams from junior investment salespeople to senior investment salespeople, we're able to stay in what we call that sweet spot of somewhere between $5 million and $25 million per copy. Where we're seeing the opportunities are in the Midwest. As I've indicated, Indy has been a very good player for us. Columbus is a very good player for us. Philadelphia is a very good player for us. Chicago now, we're seeing a couple because of our stock price where it is and where debt is, we're able to see some there. Even in the suburbs of Atlanta. And I must say the suburbs of Atlanta. We did that Orgill acquisition, that's in Tipton, Georgia, and David had commented, Bob, where in the heck are you going to buy this building? And I go, listen, look at this building. It's midway between the Port of Brunswick and the Port of Jacksonville on I-75 going south out of Atlanta. And there just happens to be a huge concentration of industrial players there. And why not? Because they're utilizing the port. So our team is really focused on those types of locations where we have access to ports, we have access to being let's say an asset that is the last mile, and as I've indicated and what really makes me feel very good about our opportunities here, is our ability to underwrite credit. I mean we can underwrite these middle market tenants which are predominantly those in the last mile, and we do a very good job of keeping those highly occupied. So if we stay in those markets I'm talking about right there, plus we can work also in and outside of let's say Dallas and in Austin as well, those will be good. Gateway markets though, we're not going to be able to play because the cap rates are still too low for us. But we will be able to still stay in that going-in cap rate low to high 6s, mid 7s to high 7s on the GAAP cap rates so long as our stock price holds and the debt stays as it is.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [4]

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Okay. And then Bob or David, given the comments on exploring some sort of inflationary dividend increase out there, does that impact your thoughts on selling assets? Obviously, there's not a tremendous cushion between earnings and the dividend. How much dilution would you be willing to take on a sale of office assets and redeploying into industrial if it meant hitting earnings by a penny or so, but improving NAV? How do you guys think about that with the board in terms of the sort of triangulation of earnings growth, earnings cover, or dividend coverage, and dispositions?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [5]

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I think from a disposition standpoint, we are not making a focused effort to exit office assets. As Mike and I and David have said, we want to exit these noncore single property markets, but selectively. And the reason that it's selectively is that the tenants are good rent payers and we've been through a renewal with most of them. So you're probably only going to see us exit $10 million to $15 million a year which I think is not going to create an issue for us as we look forward to increasing the dividend. And we've worked extremely hard now to get our AFFO payout ratio down to at par which Mike can address a little bit more if he wishes, and so I feel confident that we are going to be able to increase that dividend. And as David said earlier, when we start, we want to make sure that we can do it consistently on a year-over-year basis. And I believe with now our leverage coming in line, with the payout ratio coming in line, and with our pipeline really improving dramatically and with the shift to industrial where our re-tenanting costs or tenant improvement costs are much less, I feel confident we're going to be able to do it.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [6]

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Yeah, Rob, we've been debating this at every board meeting probably for the last year, year and a half, of beginning to move up the dividend by little tiny smidgeons of increases. But all total during the year would be enough to keep ahead of inflation. With inflation being as low as it is, you don't have to do a lot. We just don't want to be a sort of static bond fund with the same dividend forever and a day. I can't give you more information than that because it's on the agenda to talk about again in January.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [7]

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Okay, and then Mike, given the various capital raises, how much dry powder do you have for acquisitions without raising additional capital or taking leverage levels out of whack?

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Michael J. Sodo, Gladstone Commercial Corporation - CFO [8]

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Sure. So as of today, I made mention on the call, Rob, I mean we about $4 million to $5 million of cash on hand, $30 million plus available on the credit facility. So you're looking at $35 million without raising a dime and doing those deals. If you did not have access to the ATM program and you did those deals at 50% leverage, that would imply real time that you could fund $70 million of acquisitions. I would say that the ATM program has been active in every month of 2019, the expectations should be based upon a clearly robust pipeline that we will be active in the near term to incrementally increase that liquidity.

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Operator [9]

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Your next question is from the line of Henry Coffey with Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [10]

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Yes, good morning, everyone. I don't know whether it's winning the World Series or putting out a phenomenal quarter, but you guys, the tone is more upbeat than it's been in a long time, so congratulations. Is this good news or bad news? Everyone we talk to in the commercial real estate space tells us multifamily is really active, industrial is really active. Are portfolios changing hands at levels that you think are attractive or is all of this volume because there is sort of inflationary -- the values are inflated? I never know whether a good market is good news or bad news for someone whose primary goal is investing in new properties. So what are your thoughts on the overall tone of the market given call it active industrialists?

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [11]

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Henry, the market is very good. Ad you know, our background here has been lending and investing in small businesses for years and years and years. So when we see a tenant that's a midsized business and has a good balance sheet and P&L, we feel pretty comfortable with that, being able to underwrite them. And so the tone today in terms of what we're seeing in the industrial marketplace is good. The tenants are good. Doesn't say it's going to be that way for even a year, but at this point in time, we're not feeling the pain that some of the people are in other parts of the real estate marketplace.

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Robert G. Cutlip, Gladstone Commercial Corporation - President [12]

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The only thing I would add to that is our asset management team stays so very close to tenants. And it reinforces what David said, our tenants are feeling very good about their future. And most of them are in a growth mode, so that is encouraging to us, particularly with the type of asset, the smaller asset that we are focusing on.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [13]

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So, Henry, I'd say things are positive.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [14]

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I think we get that part. The thought process in terms of outlook for 2020 is obviously going to be very solid. As you start thinking about a recession, how would the business adjust? Is industrial a stronger asset class versus office versus other assets? I know -- I mean we know what you did last time which was really good.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [15]

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Henry, all of these assets are only as good as the tenants. If you look at our business, we're really buying, when we buy a building, we are buying a tenant and we're buying a leasing agreement. So we are investigating whether they can pay enough probably more than most people in the business simply because many people rely on some kind of evaluation by S&P or somebody like that. We don't rely on that. We rely on our own analysis of that business, that time and place that they're in at that point in time and what the outlook is going to be like. And I think we've chosen tenants that will survive nicely through any kind of normal recession. If we have some kind of off the wall kind of recession, we'll have pain like everybody else. But at this point in time, we feel really good. The retail climate is very strong today and so many of our tenants are in that part of the world and I think we have clear vision about the next 6 months and maybe even a year. But nobody knows much further than that.

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Operator [16]

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Your next question is from the line of Craig Kucera with B. Riley FBR.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [17]

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Good morning. Appreciate the color on the 3 leases expiring later this year. I know the Tulsa asset is industrial, but what are the other 2?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [18]

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One is an industrial asset that is in kind of Northern Ohio. And the other one is an office property in Columbus, Ohio. But it is not, neither one of those are 100%. The one in Ohio that is in the industrial is 50% of the building. And then the asset that is in Columbus, Ohio, it's less than 20% of the building. So we have active prospects for those 2 assets. And for the Tulsa asset, we also have a long-term opportunity there that is probably maybe 2 to 3 months off from a final decision. And then we have a short-term opportunity that we're pursuing for that Tulsa asset as well. So encouraging because the office asset in Columbus is in an excellent mixed-use environment and we're somewhat partially encouraged about the industrial asset in Maple Heights, Ohio.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [19]

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Got it. Do you have a sense of where the current rents are at those properties relative to market and kind of whether the rents are rolling up or down?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [20]

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The rents in the Maple Heights office are right at market. And then if I talk about the asset that's in Columbus, Ohio, I think we are at or a little below market there. And in the Tulsa market, we are probably, to be brutally honest, we're probably 5% to 10% above market based on our current rent. It's just a -- when you get into a long-term lease with net leases and it's 2% to 3% escalations and you go through a correction, it's difficult to be at market. But I feel very good about the Maple Heights and the Columbus asset for sure.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [21]

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Got it. And switching to acquisitions, I think last quarter you guys had thought maybe you'd hit $115 million, maybe upwards of $125 million of acquisitions for this year. I think after this quarter and what you disclosed here that's sort of under due diligence, you're probably a little closer to maybe $90 million, $91 million. Are you far enough along in the remainder of your pipeline to maybe still hit an acquisition total in that range? Or is that maybe a bit of a stretch at this point?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [22]

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I think that we are going to be somewhere between $110 million and $125 million. With us having $140 million in the letter of intent stage and only $20 million to $22 million in due diligence, we have just recently been selected for 2 other items, 2 other acquisitions. But I am not identifying those in due diligence because we have just begun the purchase and sale agreement negotiations. But because of the desire for a lot of these sellers to close by the end of the year, I feel very confident that we're going to be in that $110 million to $125 million range.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [23]

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Got it. And just when we think about that, that $300 million pipeline that you guys discussed, conceptually is this going to be more or less what you're been doing? I understand it's tilted to industrial, but sort of midwestern shall we say industrial, sort of middle market type of properties? Or is there anything shifting in pipeline?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [24]

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I think Midwest has been a very good player for us. But we are starting to see opportunities, continuing to see opportunities in Florida and in Georgia. And I think that you will hear us doing a bit more in Georgia and South Carolina going forward. And surprisingly, our Southcentral leader is finding assets in Dallas and Houston. So are we going to go out far west? Only if it's a portfolio. If it's a portfolio of 5 to 6 properties where it makes sense to put them together, we will do that. But otherwise, we're really going to be focused more on the Midwest, Southeast and Southcentral.

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Operator [25]

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Your next question is from the line of John Massocca with Ladenburg Thalmann.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [26]

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Good morning. With the understanding that your GM asset in Austin is R&D focused and not manufacturing, even with that, was there anything that maybe came out of the recently agreed to kind of labor contract with GM that gives you any kind of insight as to what you think you're going to end up doing with that property? Was there anything in there that given what happens in that Austin facility you think may continue to be a focus or not a focus going forward for them?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [27]

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You know, we have not been given any direct information from them. But with this being an innovation facility and with the movement in the entire auto industry to continue to improve innovation, there's 4 of these assets in the country for GM. So they may elect to leave, John. If they do, as I indicated in the last quarter's call, I'm not overly concerned, because our doggone, our current GAAP rate is probably $5 to $6 below current asking lease rates. Having walked the property myself and it really setting up well as two 160,000 square foot buildings with creative office and being in the Palmer Technology corridor, we have already received interest from a couple of prospects even though the notice period hasn't even, the notice period notification hasn't actually come to us. So I'm not overly concerned. Do I wish they would renew? Oh, yes, there's no doubt about that. But if they don't, being in Austin and that market being extremely hot, we feel very encouraged long term.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [28]

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Very helpful color. And then can you maybe walk us through the impact of the clean energy improvement program that you accomplished at some of your office properties? How big is maybe the opportunity set to utilize that within the existing portfolio, and maybe how impactful is that to operating expenses?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [29]

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I have a little knowledge, so I'm dangerous. But I can give you a summary of how the program is set. It's really a combination of the state and of the local jurisdiction and of lenders and companies who can provide these let's say improvements in HVAC systems, LED lighting. And the analysis that is done indicates that the cost to replace this equipment enables the tenant at the end of the day to realize anywhere from 10% to maybe 20% reduction in utility costs. Not overall operating costs, but in utility costs. And it also is a function of part of the payment is done by them increasing their taxes, but then you have lower operating costs. And at the end of the day, everybody wins. And sometimes it's a state program, sometimes it is not a state program.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [30]

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But is it being done at any kind of offices where you have a gross lease in place and therefore it flows through your -- the lower operating expenses for you?

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Robert G. Cutlip, Gladstone Commercial Corporation - President [31]

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It's going to benefit the tenant. It's going to benefit the tenant. Because most of our leases, when we actually acquire the property, if it's a gross lease, for the most part everything above that is paid for by the tenant. And what happens, John, is that their taxes go up, but their utilities go down. And so at the end, our benefit is that we don't have to put any capital in the building, we get building improvements, and the tenant at the end of the day pays less which encourages them to renew.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [32]

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Okay, understood. Then moving to the balance sheet, in light of the kind of term loan expansion, do you think the time is kind of right maybe to migrate the balance sheet to a more significant usage of unsecured debt going forward? I mean is that the strategy here in the near term?

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Michael J. Sodo, Gladstone Commercial Corporation - CFO [33]

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Good question, John. I think it's a dual track strategy, appreciating a rate environment where the one-month LIBOR is right on top of the 10-year. As I've made mention in the past, we're selectively financing our acquisitions twofold. There's very attractive, long duration money when coupled with long leases. So I would say roughly half of the acquisitions we're continuing to put mortgages on, generally in the mid to high 3% range. But to your point, as we have aspirations to continue to grow and we are approaching net of depreciation $1 billion of assets, we look at the balance sheet within the lens of where we will want to finance properties over the next 12 to 24 months even. And yes, we would like to continue to cultivate our unencumbered asset pool via the expanded credit facility. So when we get to the time and place where we have a use of proceeds for larger corporate issuances such as private placement debt or ultimately getting to corporate unsecured, we've cultivated that unencumbered asset pool to a place at which it's palatable for us to borrow. Right now, our unencumbered asset pool sits in the call it 25% to 27% range. We know to get to private placement you need to be in the mid to high 30s, and corporate unsecured/investment grade calls for roughly 50% with pro forma to 60%. So we're going to continue to put on the books fixed rate or swapped or hedged to fixed long duration debt while also improving that unencumbered percentage.

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Operator [34]

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I am showing no further questions at this time. I would now like to turn the call back to David Gladstone.

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David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [35]

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All right. Thank you, all. We had a good quarter. Everything is perking along as expected and we'll talk to you next quarter. That's the end of this call.

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Operator [36]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may now disconnect.