U.S. Markets closed

Edited Transcript of GOOD earnings conference call or presentation 31-Oct-18 12:30pm GMT

Q3 2018 Gladstone Commercial Corp Earnings Call

McLean Nov 2, 2018 (Thomson StreetEvents) -- Edited Transcript of Gladstone Commercial Corp earnings conference call or presentation Wednesday, October 31, 2018 at 12:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* 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

================================================================================

Conference Call Participants

================================================================================

* Barry Paul Oxford

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Craig Gerald Kucera

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

* 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

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to Gladstone Commercial Corporation Third Quarter Earnings Ended September 30, 2018, Earnings Conference Call and webcast. (Operator Instructions).

I would now like to give this conference call to Mr. David Gladstone, you may begin, sir.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Kevin. Nice introduction. Thank you all for calling in. We really enjoy these times we have with you on the phone and wish there were more of them. And please come visit us if you are ever in the Washington D.C. area. We're located in a suburb called Mclean, Virginia, just outside of Washington D.C. You will see a great team at work. At least some of them are here, many of them on the road and it's about 66 of us now.

We will now hear from Michael LiCalsi. He is our General Counsel and Secretary, and Michael is also President of Gladstone Administration which serves as the administrator to all the public funds that we manage here. Michael, go ahead.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. Thanks David, and good morning. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. 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 the risk factors listed on our Forms 10-Q, 10-K, and other documents that we file with the SEC. Those can be found on our Investor Relations page of our website, www.gladstonecommercial.com or on the SEC's website, which is www.sec.gov.

Now we undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. And today, we will discuss FFO, which is funds from operations. Now, FFO is a non-GAAP accounting term, defined as net income, excluding the gains or losses from the sale of real estate and any impairment losses on property, plus depreciation and amortization of real estate assets.

We'll also discuss core FFO, which is generally FFO adjusted for certain other nonrecurring revenue and expenses, and we believe this is a better indication of our operating results, and allows better comparability of our period-over-period performance. Now please take the opportunity to visit our website, again, gladstonecommercial.com, sign up for our e-mail notification service. You can also find us on Facebook. Keyword there is The Gladstone Companies. And we even have our own Twitter handle and that is @GladstoneComps. Today's call's 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, those can be found on the Investor Relations page of our website.

And now I'll turn the presentation back over to Gladstone Commercial's President, Bob Cutlip.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Michael. Good morning, everyone. During the third quarter through October, we acquired a 157,000 square foot industrial property for $8.5 million in Columbus, Ohio, acquired 2 industrial properties totaling 218,000 square feet for $21.3 million in Detroit under a single UPREIT transaction. We're currently in due diligence to acquire a 26,000 square foot industrial facility in the Philadelphia submarket. We're expanding our tenants parking facility in Springfield, Missouri, are currently under contract to sell our noncore 150,000 square foot asset in South Hadley, Massachusetts. Renewed a tenant whose lease was scheduled to expire in 2020 and participated in a nondeal roadshow in St. Louis and Mike and I will be in San Francisco next week at the REITworld and have over 15 meetings, I think, at this point.

Since July of 2017, we've witnessed significant activity across our investment, asset management and capital raising functions. These events are noteworthy and they include the following. We've invested a $161 million in 10 property acquisitions during this timeframe at an average cap rate over the term of over 8%. These acquisitions were in our target growth markets and 65% of this acquisition volume is with rated investment grade tenants or tenants with investment grade parent companies. We exited 3 noncore properties as part of our capital recycling program, completed the lease-up of an industrial property in Raleigh, and an office property in Houston. Renewed, extended or expanded the leases of 4 tenants at a GAAP rental rate per square foot increase of 8.1%. Recast, expanded and extended our revolver in term loan at lower costs, and refinanced over $30 million of maturing mortgages at lower leverage and lower interest rates.

We expect each of these items to have positive impact on our FFO per share, cash available for distribution, capital availability and leverage. One can also conclude that every team member across all of our functions were contributors to these achievements.

As noted on our second quarter call, we've been focused on improving our financial metrics since 2013, during a period of 23 lease expirations and over $210 million of mortgage maturities. This activity has required considerable personnel resources as well as significant amounts of equity capital to fund tenant improvements, leasing commissions, pay operating expenses on vacant space and to lower our leverage.

The good news is that our occupancy remained high throughout this period. We lowered our leverage from 63% to below 47% and we improved our cash payout ratio year-over-year. We were able to improve upon that payout ratio and maintain a $1.50 to a $1.54 FFO per share, because we acquired accretive assets each and every year, while improving the credit profile of the balance sheet through significant deleveraging. The characteristics of those investments and the capital structure enhancements, validate the strength of our growth trajectory, balance sheet security and really are worthy of some note.

Since 2012, the average annual acquisition volume has been approximately $110 million with lease terms ranging from 7 to 10 plus years with annual lease rate escalations, and the average GAAP cap rate on these assets is currently 8.7%.

These characteristics equate to a increasing cash flow year-after-year. We're also approaching the time period at which these leases' cash rents will be exceeding the straight line GAAP rents, as the 7 to 10 year leases are at or are approaching the inflection point from a straight line rent perspective. This should continue to improve the payout ratio to the benefit of shareholders and our working capital position. Looking at the third quarter of 2018, as compared to the same quarter of 2017, same store GAAP rents increased by 0.3% whereas cash basis same store rent increased by approximately 2%.

Our investment in asset management activities continued to generate positive momentum for our operations. We acquired a 157,000 square foot industrial property in the Columbus, Ohio market for $8.5 million. The going in and GAAP cap rates are estimated at 7.6% and 9.2% respectively and the remaining lease term is 15 years. We also acquired 2 industrial properties in Detroit for $21.3 million. The 2 properties total 218,000 square feet with unexpired lease terms of 10 years and the going in and GAAP cap rates are estimated at 7.5% and 8% respectively.

We acquired these buildings under an UPREIT format and issued operating partnership units or OP units for the equity component of the transaction. This is our first OP unit deal and provides us with further optimism that we may do more of these efficiently in the future, thereby also providing some incremental value and attractiveness to prospective sellers of real estate.

We're also expanding our Springfield, Missouri's parking facility by about 160 spaces, increasing the parking ratio to 10 spaces per 1,000. Our tenant is relocating over 100 people to our facility in a consolidation move and we believe this is solidifying their commitment to our property, and of course, we're increasing the rental income with the expanded spaces.

From an asset management perspective, we have begun renewal discussions with tenant's whose leases are expiring in 2020. To that end, we renewed our 60,000 square foot office tenant in Hickory, North Carolina through March of 2025. Their lease had been scheduled to expire in March of 2020. The tenant improvement allowance is $6 per square foot, which is significantly below, what I believe, is typical for single-storey office properties. The GAAP rents increased by 5.6% and we provided no free rent in this transaction.

Market conditions are worthy of some comment. The first 6 months of the year witnessed reduced listing opportunities compared to 2017 as reported and communicated to our team by our national broker relationships. And national research firms reported investment sales volume was lower for the first half of 2018 versus 2017 for individual property sales and net lease asset sales. And we believe there is an apparent buyer/seller disconnect in several markets. Green Street Advisors, the noted real estate advisory and research firm, suggested that nominal cap rates in most property types, except for maybe industrial, appear to be moving up slowly. And our experience with mortgage debt reflects that long term interest rates risen approximately 50 to 75 basis points over the past 12 months.

Now with that information in mind, significant capital, as we all know, is available on the sidelines with considerable interest in U.S. real estate. And the expectations are for 2018 investment sales volume to be similar to that of 2017, which is really still quite healthy for the industry. Our team will continue to monitor market conditions and actively investigate accretive opportunities that will promote our measured growth strategy.

Before I address our current pipeline and the opportunities we are pursuing, a few comments about our operating characteristics through year-end 2019, which help set the stage for our execution strategy. We have no lease expirations for the balance of this year and we are currently 99% occupied. For 2019, we have only 3.3% of forecasted rents expiring and approximately 55% of those expirations are at December 31, 2019. In addition, our loan maturities for both 2018 and 2019 averaged just $24 million per year, which is a very manageable level. Therefore, we should have stable and growing cash flow on our same store properties and our capital should be available for pursuing growth of our portfolio.

As it relates to growth opportunities and our strategy, we have noted an increase in activity in sales listings as of late. Our current pipeline of acquisition candidates exceeds $300 million in volume, representing 18 properties, 11 of which are industrial. Of this, total $49 million is either in the letter-of-intent or due diligence stage and the balance is under initial review.

We're making a conscious effort to increase our industrial allocation. With the heated competition for larger properties, our focus is in fully developed industrial parks. And these are locations which have been really designated as the last mile by the e-commerce industry. The properties we seek are 50,000 to 300,000 square feet in size, 24 to 28 foot clear heights in the warehouse, ample trailer parking and occupied by middle market non-rated tenants, a tenant profile which we believe we can underwrite with our proven credit underwriting capabilities.

The larger properties with higher clear heights, larger trailer parking capabilities, we think are really trading well above replacement costs in many markets. And we don't believe that this is an appropriate strategy for us. Our year-to-date acquisitions confirmed our focus on this strategy as the sizes range from 74,000 square feet to 157,000 square feet and all were in developed submarkets of our targeted locations. GAAP cap rates range from 7.6% to 9.2%, so very accretive for our shareholders.

So in summary, our third quarter and last 12 months continued our acquisition and leasing success, extended our credit facility, refinanced maturing loans and positioned us well to pursue growth opportunities.

Now let's turn it over to Mike for a report on the financial results.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Bob. Good morning. I'll start by reviewing our operating results for the third quarter and first 9 months of 2018. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and FFO core available to common stockholders were $0.40 per share for the third quarter. On a core FFO basis, this equate to $0.02 additional per share as compared to the third quarter of 2017, which is over 5% increase. For the 9 months ended September 30, FFO and core FFO available to common stockholders was $1.21 per share.

On a core FFO basis this equates to $0.07 additional per share as compared to the first 9 months of 2017, which is a 6.5% increase. This performance demonstrates the accretive, yet prudent growth, that the company has completed in 2017 and '18 as well as the performance of the in-place portfolio. As Bob mentioned, core FFO hovered in the $1.50 to $1.54 range for the past few years as we delevered the balance sheet and addressed lease rollover. The first 9 months of the year have demonstrated the highest core FFO per share number in the history of the company. With no near term meaningful lease expirations and only fractional deleveraging to do, we're excited about the prospects of continuing to increase earnings going forward. Our third quarter results reflect an increase in total operating revenues to $26.6 million as compared to total operating expense of $17.4 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've reduced our debt to gross assets by over 10% to 46.6% since the beginning of 2016 through refinancing maturing debt and financing new acquisitions at lower leverage levels. We expect to continue to gradually decrease our leverage over the next 18 to 24. As we've discussed this with analysts, investors and lenders, we believe this will put at the proper leverage level going forward in long term. 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, and over time we expect this to increase our financing alternatives. As we continue to manage our balance sheet, we've repaid $85 million of debt over the past 24 months, often with new long term variable rate mortgages at interest rates equal to the 1 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 advance 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.

In order to improve our balance sheet, we've often put addition equity into refinanced properties. As previously discussed, it has helped to significantly reduce leverage and generally enabled us to obtain improved interest rates on our mortgages, thereby, reducing the related interest expense by in excess of $1.2 million annually.

Looking at the debt profile, 2018 loan maturities are very manageable with only $7.9 million coming due after extending the maturity date on one loan from 2018 to 2021 and a second loan from 2018 to 2019 during the quarter. Further, we have less than $45 million of mortgages maturing in any single until 2022. 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 to high 4% to the low 5% range. We continue to minimize our exposure to rising interest rates with 94% of our existing debt being fixed rate or hedged to fixed through interest rate swaps and caps.

We've remained somewhat active in issuing our common stock during -- using our ATM program. During the third quarter and net of issuance costs, we raised $6.6 million through common stock sales. While we continue to view the ATM as an extremely efficient way to raise equity, we entered the year with significant liquidity and 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 Bob mentioned, we did complete our first UPREIT transaction yesterday. We issued 743,000 OP units at a price of $18.59 per unit, which was determined by using the average closing share price over the prior 10 trading days. This deal continues our strategic pursuit of high quality real estate with credit tenants and deleveraging through the unit issuance at minimal expense to the company.

As of today, we have $2 million in cash and $55 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're underwriting in any known upcoming improvements at our properties. We encourage you to also review our quarterly financial supplement, which is posted on our website. This provides more detailed financial and portfolio information for the quarter.

We feel good about executing our business plan during the remainder of 2018 and into '19 as we continue to increase our high quality asset base and improve our metrics, including core FFO and leverage. We're focused on maintaining our high occupancy with strong credit in real estate. With minimal and 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 has increased by 15% since the beginning of 2016 to over 55% as of September 30. Bob and I have been active in meeting with current and potential institutional investors, portfolio managers investment, 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 turn it back to David.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Okay. Very good report, Mike, and good one from Bob Cutlip and Michael LiCalsi. A very nice quarter, everything is clicking right along. Have meaningful increase in earnings and the main news report here through October is that we acquired industrial properties and 1 property in Columbus, Ohio, we acquired 2 industrial properties in Detroit, Michigan under a single UPREIT transaction. That was after quarter end, but in this quarter that new quarter we're in. This should be a non-tax transaction to the seller which is very, very strong opportunity for sellers to sell their property and end up owning shares of our stock and not having to pay taxes until they sell the stock.

We're currently under contract to acquire another industrial property in Philadelphia submarket, hoping that one will close soon. Are expanding our tenant parking facility in Springfield. We do that a lot for our tenants and renewed the tenant who was leasing -- who schedule was to expire in 2020, we got that one way ahead of time, because they want to make sure they're in the building.

There are some pundits that are saying that many of the banks and financial institutions are financing real estate with very, very cheap credit and they think some banks are going to be in trouble. I don't think any of our banks have any worries. Since inception in 2003, this REIT has only given back one property to the lender and none of our other lenders have lost any money to my knowledge. In the last recession, we made every payment to our banks and this REIT did not start or cut its monthly cash distributions to stockholders during that recession. We have not lowered our dividends since inception in 2003, and that's quite a success story, I think. So, if there is another recession, I don't expect, we would be in trouble at all.

We are in a good position today. We don't have any leases coming due for the rest of 2018 and less than 4% in 2019. So we expect low risk, low spending on new tenant improvements. We continue to refinance loans that are coming due and we do so at rates that are generally lower or similar to the rates that we had on the property. So those have come along very nicely as well.

From time-to-time we do raise more preferred stock in our Series D which has a 7% yield. We have a new webpage on our site at www.gladstonecommercial.com and that explains that all our series are preferred stocks. So you can go there and take a look at the preferred stocks and get some good information. We had some large institutions buying the preferred stock in the past, so if you have an interest in our company, I think, that will continue to make institutions come in. I think we are about 50% owned by institutions now.

We continue to have a promising list of potential quality properties that we are interested on acquiring, some of that will happen during the fourth quarter of 2018 and going into 2019. We've increased the portfolio of properties and with that comes greater diversification and much better earnings as well. Much of the industrial base that's out there and the office base that's out there that rent industrial and office properties like the ones that we have remain steady. Most of them are paying their rents and all of ours are. As you know we have a terrific credit underwriting group that underwrites our tenants. And considering the track record of our tenants paying their rent, I think the future is bright for us.

In this strong underwriting discipline that we have inside the company, it kept the company more than 96% occupied since 2003 and with a low to let 99% as of today. And while I'm optimistic that our company will be fine in the future, I know Bob and his team will continue to be cautious in their acquisitions as they've done in years past.

In October, the board voted to maintain the monthly distribution of $12.5 per common share for October, November and December of this year, that's an annual run rate of $1.50. This is very attractive rate for well-managed REIT like ours, which we believe is an excellent investment for individuals that want monthly income. And, yes, I know, you want see to increase in the distributions and Bob is promising that he is going to do it, just don't have a date certain today. But we argue about it a lot inside this company.

All I can say at this point is that, as FFO increases, and you've heard Michael -- Mike talk about FFO, some small increase in dividends has to occur. We can't keep the money and reinvest it. We need to start increasing the dividend now that we have inflation. I think we're very close to that point. That's been demonstrated during the first 9 months of this year and as we go forward.

We've now paid 165 consecutive common stock cash distributions and we went through the recession without cutting our distribution. And I think it's -- even though people said we were highly leveraged, with this wonderful track record, I don't think we're highly leveraged and certainly not today. But back in the day when we were putting a lot of new ones on there, there were people who felt we were over leveraged and as it turns out we didn't have any problems with leverage during the recession.

Because real estate can be depreciated, we're able to shelter the income that's coming into the company. Return to capital was 60% of common stock paid out in 2017. So this is a very tax friendly stock and in my opinion a good one to hold in your personal accounts, that's seeking income, because so much of it is covered by the depreciation shield and you don't have to pay tax on that. This is a return to capital when we shelter it like that and it's caused earnings to remain very low after depreciation and that's why we talk about funds from operation or FFO or core FFO, because this is adding back the real estate depreciation to get the cash flow.

Depreciation of a building, as you all know, is a fiction, since at the end of the depreciation period and building still standing, and if you own stock in a non-retirement account and supposed to having an IRA or retirement plan, you don't pay any taxes on that part that's sheltered by the depreciation as it's considered a return to capital. However, the return to capital does reduce your cost basis in the stock which may result in a larger capital gains tax when you do sell it.

Stock closed yesterday at $18.81. It was up $0.20 a share yesterday. The distribution yield on the stock is about 8%. Many of the REITs that are like us are trading at much lower yields. This recent downdraft in the equity market has created great time to buy some stock, especially our stock. The net, net, net REITs that are generally traded at about 5% or 6% yields, so if our stock was in that range, it be $27 a share. So as we get larger, there is lot of room for the price to expand and our yield to go down.

My guess is that investors continue to discover and familiarize themselves with our company. Let's see the price of the stock increase and bring the yield in line with the other REITs. There's simply no reason this REIT to trade at such a high yield, 8% -- think about that, 8% and most of it covered by depreciation. So with low lease turnover forecast and good opportunities out there, again it's just an excellent stock to own.

The analyst always beat me up. They always say that you are externally managed. However, being externally managed allows us to access the team of credit underwriters like -- I mean that's really unlike any internally managed REIT. Our high occupancy level is a testament to the access we have to the credit underwriting. We are a REIT that looks first at the tenant to make sure they can pay in their rent, but most REITs look first to the real estate. So we're looking at both, but we pay a lot of attention to our tenants.

There is study out from KeyBanc that shows that G&A of REITs -- and it's about 181 REITs that they look at. We're certainly not the highest of the internally managed REITs and not the lowest, somewhere in the middle. Being externally managed should not make a difference to anyone. So I can tell you to challenge anybody who says that externally managed REITs are bad. Most of the REITs that are out there are internally managed, but there's more and more that are externally managed and the entire mutual fund industry has been externally managed for decades and decades and there's only a few of these mutual funds with employees like our REIT. Our REIT runs like a mutual fund and it works just fine.

We've been -- every time we go out to refinance our properties, we're deleveraging. We've been putting up more equity when we refinance our mortgages, but we're near the end of doing that. We need to take that equity and put it into new transactions and increase our dividend. Our current leverage level is, I think, conservative. Some people would say it's a little high, but it's strong, we're in good position. So recording our debt, I want to make sure that everyone knows that the mortgages we have are what they call exculpatory and this just means the lender only looks at the property they're financing and not our company. So just another safety fixture to mention here.

Well, we have some questions, I'm sure, from our shareholders and some analysts are out there, so if our operator would please come on and let's take some questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Rob Stevenson with Janney.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Can talk a little bit about how you're thinking about financing the $49 million of our acquisitions under contract plus the pipeline beyond that? Are any of these deals likely to be OP unit deals? And given the debt capacity that Mike highlighted, can you meet the equity requirements that you're going to want to do under the ATM or you're going to need to get more into more preferred or a wider marketed equity offering?

--------------------------------------------------------------------------------

Michael J. Sodo, Gladstone Commercial Corporation - CFO [3]

--------------------------------------------------------------------------------

I will speak to the equity piece of it. Rob, I think we're pretty comfortable based upon the progression of these deals and seeing them coming on the calendar to the extent we're successful and actually closing them. We will be able to source the equity piece of it via the ATM program. Obviously, we would hope that there -- our performance over the first 9 months of the year will put some pressure on the dividend yields, so we can further efficiently issue the equity. But I have no real cause based upon the dates that I have to arise the requisite of capital.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

And from an operating unit standpoint, partnership units, we are in conversation with people. But it's in the really the initial review stage, Rob. So I wouldn't count on those in the near term anyhow.

--------------------------------------------------------------------------------

Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [5]

--------------------------------------------------------------------------------

And then what was the cap rate on the third quarter and then the stuff that you've done in the fourth quarter acquisition wise?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [6]

--------------------------------------------------------------------------------

The third quarter was -- the GAAP cap rate was 9.2% going in with 7.6% and the fourth quarter going in with 7.5% and the GAAP cap rate is 8%.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

And then how are you guys thinking about disposition to the portfolios today. I mean is there much left in the portfolio that doesn't fit longer term that you'll want to monetize and use and flip around for industrial or even some office acquisitions?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [8]

--------------------------------------------------------------------------------

Mike and I have -- we've gone through this in talking with our regional leaders. I think that we will still probably be exiting anywhere from $12 million to maybe $15 million or $20 million a year and it will be in those that we can immediately redeploy into those target markets with primarily an emphasis on the industrial. If I had to say what type of properties they would be, they would probably be single storey office properties, because as I think we all know, single-storey office properties from releasing standpoint, tenant improvements are much higher and they're much more difficult to release then let's say the multi-storey floor plate type property. So if we have an emphasis, Rob, it would be in that type of property.

--------------------------------------------------------------------------------

Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [9]

--------------------------------------------------------------------------------

And then David, I appreciate your comments on the dividend. But what is the board really looking at to evaluate an increase here? I mean -- and given that you guys are paying already an 8% yield, I wouldn't expect it to be anything major. But even sort of a token increase even, if it's just a penny on an annual basis sort of bumping from $1.50 to $1.51, gets you back to being a dividend grower, probably positively impacts the stock price, probably also makes the stock more attractive from a OP unit standpoint with people who are selling assets. And so what metrics are you guys looking at the board level to determine whether or not there will be a -- even a small dividend increase in the near term?

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [10]

--------------------------------------------------------------------------------

Yes. The way I think about it and I think the board is on the same wavelength, is that we want to stay ahead of inflation. There haven't been an inflation to speak of over the last 5 years. So as a result, there wasn't this desire to move the dividend as strong as it is today. With inflation coming along, we want to be better than a bond fund that doesn't raise its dividend and so as a result, we'll have to start tracking and looking at inflation and saying to ourselves, next year we're going to have to pay X in order to be ahead of inflation. And that's the way we look at it. And I think you should expect us to do nominal to begin with, just to keep it going ahead of inflation and then hopefully we have some good news to announce as we go forward and we can bump it up little faster. But that's the goal. Okay, next question.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Our next question comes from Barry Oxford with D.A. Davidson.

--------------------------------------------------------------------------------

Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [12]

--------------------------------------------------------------------------------

You guys indicated that your interest rate has moved up for debt kind of going forward into the high 4s or the low 5s. If we're looking at acquisitions in 2019 and cap rates stay relatively steady, I mean, is that going to chip in to your profitability or your accretion on acquisitions or not necessarily?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [13]

--------------------------------------------------------------------------------

I think not necessarily, and the reason I'm saying that is, Barry, we are now seeing deals coming back. In fact, one of the deals that's in the letter-of-intent stage that we're pursuing right now fell out of escrow, because the intent of the seller was not achieved, because I think that the buyer prospect recognized that's gone up a little bit. So our emphasis is, as I indicated on the industrial side, are going to be in the smaller properties that we're going to still be able to maintain our margin over our cost of capital. I mean, when you look at what -- were -- what we bought in the third -- in the beginning of the fourth quarter, those are still very creative at the 4.5% to 5% mortgage debt size. So I still feel comfortable that we're going to be able to find these deals. They're not going to be the 500,000 to 700,000 square foot industrial deals. They're going to be the, what I call, the bread and butter 50,000 to maybe 200,000 square foot properties where we're seeing them in Columbus. We're seeing them in parts of North Denver, Indianapolis, Philadelphia. So I think that's where we place our emphasis and that's where we will be buying.

--------------------------------------------------------------------------------

Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [14]

--------------------------------------------------------------------------------

If you take that type of approach, would it be fair to say that, look, our 2019 acquisition volume maybe less than $100 million because we're just not going to be able to run this fast or again not necessarily?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [15]

--------------------------------------------------------------------------------

No, I don't think so. I really don't. I mean, when you see what's going on with the last mile and we've been pursuing a number of, let's say, properties that are in that that smaller size. A lot of those tenants are middle market, non-rated tenants, so those cap rates are going to be higher than let's say the investment grade and we play in that envelop extremely well. And so I don't think it will be below 100, I really don't, unless the market just completely tanks next year. I think we're really moving into a very opportunistic position for the company. Our leverage is down, our payout ratio is now becoming really, as David indicated, close to us raising the dividend. So our free cash flow is going to start taking place and I feel very confident that we're going to be able to find and secure industrial and office properties that will give us our margin above our cost of capital.

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [16]

--------------------------------------------------------------------------------

And Barry as interest rates go up, it has to depress the price that anyone can pay for properties. There aren't that many people around that buy properties with no debt and all equity. I mean, some of the big transactions go down that way when foreign money comes in from China or Europe. But in the smaller -- and what I like to emphasize here is that we're in middle market companies. And this middle market -- the middle market in the United States is the third largest economy in the world. There are literally 1,000s of small businesses. They all need places to work. So as a result, there's opportunity there. And I don't think anybody plays that marketplace any better than we do. We're in all of our funds our BDCs, our REIT, is all oriented toward the middle market. We just have to put more deals on the books than most other people because they are smaller transactions. But this place now runs like an oiled piece of machinery. It's really quite easy for us to put deals together and close them.

--------------------------------------------------------------------------------

Barry Paul Oxford, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [17]

--------------------------------------------------------------------------------

I just worry about the lag between the increase in the interest rate and then sellers adjusting their prices. That's -- I agree with you that eventually the 2 are going to be correlated. And for lack of a better word, the margins that you get on your acquisitions are going to be there. But I just worry about kind of an air pocket if you will?

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [18]

--------------------------------------------------------------------------------

There is an air pocket. By the air pocket -- everybody has already gotten the first shock. Things have moved up by at least 1%, so everybody had to decrease their prices pretty quick they wanted it to sell. And as Bob mentioned we're watching deals fall out of bit, because the people get to the closing table and they realize their mortgage is going to be much higher priced than they had originally thought and they just walk away from the deal. So I think the opportunity is for us. People know we close, we lock up things before we get ready to close. So we're in good shape today.

--------------------------------------------------------------------------------

Michael J. Sodo, Gladstone Commercial Corporation - CFO [19]

--------------------------------------------------------------------------------

I think a lot of added just flushed out during the first 9 months of the year. I mean, the rise in a tenure from 2.4 to North of 3 happened in a very accelerated fashion. So that pocket, Barry, you're speaking to. I think a lot of that we would have ascribe to, call it the last 6 to 8 months. And I think that would be indicative to what you've seen from a pipeline and closing perspective with our net lease peers.

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [20]

--------------------------------------------------------------------------------

Okay, next question.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

The next question comes from Craig Kucera with B. Riley FBR.

--------------------------------------------------------------------------------

Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [22]

--------------------------------------------------------------------------------

I believe this summer you guys were working on a large UPREIT transaction out west, maybe close to $100 million. Is that still part of the $300 million pipeline?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [23]

--------------------------------------------------------------------------------

No, it is not, it is not. That has gone silent. We are looking at another opportunity in the West, but I think the one that was identified, that is not part of the $300 million. The $300 million really is -- if you take that -- the number of projects we have, they range anywhere from, let's say, $5 million to maybe $22 million, is the range of the size of the individual transactions we're pursuing.

--------------------------------------------------------------------------------

Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [24]

--------------------------------------------------------------------------------

And when you mentioned the Springfield expansion, do you have a sense of your expected ROI on that incremental investment?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [25]

--------------------------------------------------------------------------------

I'll tell you what, okay. I know it is north of 8, but I do not have the specific number on that. But I -- we can -- Mike and I can get that to you.

--------------------------------------------------------------------------------

Michael J. Sodo, Gladstone Commercial Corporation - CFO [26]

--------------------------------------------------------------------------------

It's roughly $800,000 project, that's 8, 8.5.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

8.5, yes.

--------------------------------------------------------------------------------

Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [28]

--------------------------------------------------------------------------------

And you mentioned that you have another property in Philadelphia. Can you give us some metrics as far as kind of going in yield and cap rate? I may have missed this, but what the dollar value of that property was?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

It's very small. It's only 26,000 square feet. It is a sale leaseback. It is going to probably trade -- I'm not going to give you the exact, because I don't want my competition to know that as well. But it's going to trade in the mid to high 7s

--------------------------------------------------------------------------------

Michael J. Sodo, Gladstone Commercial Corporation - CFO [30]

--------------------------------------------------------------------------------

And it is the middle market company too.

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [31]

--------------------------------------------------------------------------------

Next question.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from John Massocca with Ladenburg Thalmann.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [33]

--------------------------------------------------------------------------------

So on the acquisition front, you kind of mentioned that you're looking for kind of these smaller boxes on the industrial side. I mean, who are you competing for -- for these assets, mostly private players, are you running into other REITs when you kind of underwrite and look to buy these assets?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [34]

--------------------------------------------------------------------------------

Mostly private players. Although, we could run into you know the likes of Stag, because they're very well run operation, because we could running into them. We can run into Monmouth occasionally. But they really are a little bit higher in volume for most of their transactions. So it's mostly private players. We are seeing -- what's interesting is we are seeing even some of the foreign monies, and who are run by general partners, operating partners here in the United States, move into some of this area as well. But it's mostly private.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [35]

--------------------------------------------------------------------------------

And it's because they're chasing the higher -- percentage of higher yield because the higher, bigger quality assets have kind of seen their cap rates compressed so much, you just think it's so much money flowing in industrial that has to go?

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [36]

--------------------------------------------------------------------------------

No, I think it's what you just said. The yields are a bit higher, there's no doubt about it.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [37]

--------------------------------------------------------------------------------

And then looking kind of the existing portfolio, I know you have no leases expiring in 2018, but as look at in 2019 and 2020, what portion of these leases roughly are office versus industrial?

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [38]

--------------------------------------------------------------------------------

They're looking -- trying to figure that out really quick. Sorry, I don't have it off the top.

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [39]

--------------------------------------------------------------------------------

Yes, don't have it...

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [40]

--------------------------------------------------------------------------------

No worries. You can give it offline with that.

--------------------------------------------------------------------------------

Robert G. Cutlip, Gladstone Commercial Corporation - President [41]

--------------------------------------------------------------------------------

I'll get that information to you though, John. I'm not going to represent some that -- I'm not have the accurate on that line. It was an office property as you know.

--------------------------------------------------------------------------------

John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [42]

--------------------------------------------------------------------------------

And then -- sorry, if you mentioned this. Just one more detail question, the 2 loans you extended, what was the interest rate on those?

--------------------------------------------------------------------------------

Michael J. Sodo, Gladstone Commercial Corporation - CFO [43]

--------------------------------------------------------------------------------

The loans remain constant in terms of their rate, John, they both had extension options where we paid I think less than 10 basis points on each in terms of fee. I believe they're in the mid to high 4s.

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [44]

--------------------------------------------------------------------------------

Okay...

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

I'm not showing -- I'm sorry, I wasn't showing any further questions. I'd like to turn it back to David for closing remarks.

--------------------------------------------------------------------------------

David John Gladstone, Gladstone Commercial Corporation - Founder, Chairman & CEO [46]

--------------------------------------------------------------------------------

All right. Thank you all for listening and we appreciate all those good questions and we'll see you next quarter. That's the end of this meeting.

--------------------------------------------------------------------------------

Operator [47]

--------------------------------------------------------------------------------

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.