Gladstone Commercial Corporation

Q3 2021 Earnings Conference Call

11/2/2021

spk04: Greetings and welcome to Gladstone Commercial Third Quarter Earnings Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Gladstone, Chairman and Chief Executive Officer. Thank you, sir. Please proceed.
spk00: Thank you, LaTanya. That was a nice introduction. And thanks to all of you for calling in. As I mentioned, every time we enjoy these times with you and have a chance for you to ask questions. And I wish we had more time to talk with you, but we only do it once a quarter. Now we will start out by hearing from Michael Lacalce. He's our general counsel and secretary. He'll give you the legal and regulatory matters concerning the call report. Michael?
spk02: Thanks, David. Good morning, everybody. Today's call may include forward-looking statements on 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. Now, many factors may cause our actual results to be materially different For any future results expressed or implied by these forward-looking statements, including all risk factors in our Forms 10Q, 10K, and other documents that we file with the SEC, you can find them on our website, www.gladstonecommercial.com. Specifically, you would go to the Investors page or on the SEC's website, and that's 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, but otherwise accepted as required by law. Today we'll focus, we'll 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 real estate assets. We'll also discuss FFO as adjusted for comparability and core FFO, which are generally FFO adjusted for certain other non-recurring revenue and expenses. And we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. And we ask that you visit our website, GladstoneCommercial.com, sign up for our email notification service. You can also find us on Facebook. The keyword there is the Gladstone Companies. And the Twitter handle is at GladstoneComps. Today's call is 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, they're on the investors' page of our website. With that, I'll hand it over to Gladstone Commercial's president, Bob Gottlieb. Bob?
spk03: Thank you, Mike. Good morning, everyone. During the third quarter, we continued our focus on industrial acquisitions and increasing occupancy. We acquired an 80,600-square-foot industrial facility and product storage yard in St. Louis, Missouri, for $22 million. In 17.4 years of remaining lease terms, and a gap cap rate of 7.5%. Acquired an 81,700 square foot industrial facility in Peru, Illinois, which is just west of Chicago, for $4.7 million, with 15 years of remaining lease term and a gap cap rate of 7.6%. We leased 176,000 square feet at our Austin, Texas property through 2026 to a rated investment grade tenant. commenced the 12-and-a-half-year lease of our 238,000-square-foot industrial facility at the Tulsa port of Catoosa, renewed a lease of a 60,000-square-foot flex office building in San Antonio, Texas through November of 2031, and collected 100% of cash-based rents during the third quarter and 100% of October scheduled rents. Our recent investments further reinforce our strategy to increase our portfolio's industrial allocations. The acquisition volume since 2019 is approaching $350 million, and all assets have been industrial in nature. Our industrial allocation has increased from 33 percent to within striking distance of 50 percent today. Our near-term objective is to reach 60 percent within the next 12-plus months, and our long-term objective is to reach 70 to 75 percent within the next two-plus years. Our success has been with acquisition candidates in the 50,000 to 300,000 square foot range, and we expect to continue this size focus. On the personnel front, we hired Ryan Carter as an executive vice president to lead our Midwest and West regions. Ryan possesses over 20 years of experience as a principal acquiring and developing commercial properties and as a senior investment sales professional. He has a long prior history with our company, having sold several properties to us through the years, and has a strong familiarity with our investment strategy. We're extremely excited that Ryan has agreed to join the team. Our asset management team continued to deliver, improving our same-store operations. Year-to-date, ending September 30th, the team extended, expanded, and or leased 1.4 million square feet, covering 13 tenants, with an average weighted lease term of 7.5 years, and intended improvement allowance of just $2.99 per square foot. The annualized straight-line rent of these transactions totals $12.8 million. As noted in the introduction, the releasing of our 238,000-square-foot industrial facility in Tulsa and the 176,000-square-foot lease in Austin are two very positive outcomes for the quarter. These leases not only increased our straight-line lease payments by over $5 million per year, but the increased occupancy also reduced our vacancy rate by 2.6 percent and will result in a very positive impact on same-store performance going forward. Anticipating that many on the call are interested in lease expirations through 2022, I wanted to summarize the team's thoughts and activities. We have but 4.5% of our leases expiring in 2022, and the expiration dates are at the end of June, end of July, and end of October. So future expiration should be quite manageable, and we'll be able to continue our emphasis on top-line rent growth through the expansion of our portfolio. As everyone knows, the Austin office vacancy has been our largest, and our team has achieved excellent recent lease-up success. As noted in the introduction, we leased approximately 176,000 square feet, or nearly 55% of the building. The end result of that transaction alone is that we have replaced approximately 95% of the former straight-line rent when the property was 100% occupied by GM. Since the property was completely vacant from September 2020 until September 15th of this year, this transaction will have a sizable positive impact on same-store performance going forward. And with Austin leasing activity increasing since the second quarter, we have additional prospects for the balance of the space and we therefore expect final straight-line rents at this property to be considerably higher than with the prior occupant. Market conditions are worthy of comment, particularly with the adverse effects from the onset of the COVID-19 virus. A review of research reports relating to industrial and office statistics for the third quarter reflects both improvements and some continued challenges. Investment sales volume for all product types exceeded $450 billion during the first three quarters and is the highest for the first nine months of any year since 2007. Prices for all property types increased by about 16% according to Real Capital Analytics. Industrial overall activity continues to be strong, with vacancy at about the 4% level, net absorption exceeding 100 million square feet for the fourth straight quarter, and over 500 million square feet under construction. Although supply chain disruption is creating challenges for all product sectors, e-commerce and logistics demand continue to drive the industrial sector. Office vacancy, on the other hand, increased as negative absorption was estimated to be about 10 million square feet according to JLL research. This figure, however, is an improvement over the prior three quarters, which witnessed negative absorption of approximately 20 million square feet per quarter. And the vacancy level does not include over 150 million square feet of sublease space available on a national basis. And new supply activity continues for office product, as over 100 million square feet is currently under construction. And as it relates to growth opportunities, we are seeing increased investment sales listings. Our current pipeline of acquisition candidates is approximately $350 million in volume, representing 18 properties, one of which is office, and the balance are industrial. Of the 18 properties, three properties are in due diligence, totaling about $54 million. Three properties are in the letter of intent stage, exceeding $60 million, and the balance are under initial review. Our team is staying actively engaged in our target markets as we believe acquisition opportunities will continue to arise that we can and we will pursue. In summary, our third quarter activities reflected strong leasing and rental collection success, continued active engagement to identify and close industrial acquisitions, and collectively positions us well to pursue growth opportunities. Now I'd like to turn it over to Gary for a report on the financial results, including our capital market activities.
spk01: Thank you, Bob, and good morning, everyone. I'll start my remarks by reviewing our operating results for the third quarter. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common shareholders were 44 cents and 39 cents per share for the quarter, respectively. FFO and core FFO available to common shareholders during the third quarter of 2020 were 39 cents and 40 cents per share respectively. FFO adjusted for comparability and core FFO available to common shareholders for the first nine months of 2021 were $1.20 and $1.17 respectively. FFO and core FFO adjusted for comparability available to common shareholders during the first nine months of 2020 were $1.19 and $1.20 per share respectively. Our same store cash rent in the third quarter grew at 2.2% over the third quarter of 2020. And for the first nine months of 2021, it grew at 3.4% over the first nine months of 2020. Our third quarter results reflected total operating revenues of $34.3 million with operating expenses of $25.5 million. As compared to operating revenues of $33.1 million and operating expenses of $25.3 million for the same period in 2020. We continue to enhance our strong balance sheet as we grow our assets and continue to focus on reducing our leverage. We have reduced our debt to gross assets over the past six years to 44.8% through refinancing maturing debt and financing new acquisitions at lower leverage levels. We believe we are between 1% and 2% away from our target leverage level. to primarily use long-term mortgage debt to make acquisitions. As we grow through disciplined investments, we also continue to expand our unsecured property pool with additional high-quality assets. Over time, we expect this will increase our debt financing options. Looking at our debt profile, 63 percent is fixed rate, 34.5 percent is hedged floating rate, and 2.5 percent is floating rate. As of today, Our 2021 and 2022 loan maturities are manageable with $7.5 million due in 2021 and $96 million coming due in 2022. We will finance these amounts at the appropriate time. We upsized our credit facility in the first quarter of 2021, which consisted of a $65 million term loan with a $15 million delayed draw component. This quarter, we drew down on the remaining $15 million. The proceeds were utilized to acquire accretive properties. As of the end of the quarter, we had $2.1 million of revolver borrowings outstanding. While entering the third quarter with sufficient liquidity, we've been active in issuing equity through our ATM program. During the nine months ended September 30, 2021, and net of issuance costs, we raised $24.1 million through common stock sales. We continue to manage our equity actively to ensure that we have sufficient liquidity for upcoming capital investments. As of today, we have approximately $84 million in cash and $36.5 million of availability under our line of credit. With our current availability, the strong performance of our portfolio, and access to our ATM program, we believe that we have significant incremental flexibility to fund our current operations near and long term. We encourage you to also review our quarterly financial supplement posted on our website, which provides more detailed financial and portfolio information for the quarter. Institutional ownership of our stock has increased over time to 51.5%. We continue to be very active in meeting with current and potential investors, portfolio managers, coverage analysts, and investment banks. We look forward to establishing new relationships as the company grows. We have raised our common stock dividend to $37.5825 per share per quarter, or $1.50.33 per year. We have not cut or suspended the dividend since our IPO in 2003. Our common stock closed yesterday at $22. The distribution yield on our stock is at 6.83%. And now I'll turn the program back to David.
spk00: Thank you very much. That was a good report, Gary, and a good one from Bob Cutlip and Michael Lacalse, too. Our team has performed very well this quarter, and we have not been hurt much by the various government reactions to the virus. So we ended up with a very nice quarter. You've heard a lot today on the numbers of new transactions, new leases, and the quarter was impressive. The team has collected 100% of the cash-based rents during the quarter, and the team also acquired two industrial assets during the quarter, and at least over half of our Austin property. That was one that had drug us down for quite a while, and now it's back paying, and we're in good shape. That led to us thinking about increasing the dividend, which we did. Including the Austin property, the team executed 13 lease transactions year-to-date, ending September 30, and represents about $12.8 million in annualized straight-line rents. The commercial team is growing the real estate we own at a really good pace, and the team is doing a great job managing the properties we already own, especially during the pandemic times. This team has a strong professional group and continues to pursue quality properties on the list of acquisitions they are reviewing. The acquisition team is seeking strong credit tenants. We look at the credit first and the real estate second. They know that quality tenants and real estate make excellent investments. And the asset managers that we have are very active managing the properties that the company owns in order to maximize their value. It's a different environment we're in today, but the team has been up to the challenges and has done a great job. The outlook, well, we're in the middle market business. Like many of our tenants, we've been challenged with previous government restrictions related to the virus, but our teams continue to pay their Our tenants continue to pay their rents, and these times we have never been seen before, and there will be future challenges, I'm sure, but our first class team is doing a fantastic job. Okay, let's stop here and have our operator come on and help our listeners ask a few questions. Thank you.
spk04: At this time, we will conduct a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star 1 at this time. One moment while we pull for our first question. Our first question comes from Craig Suri with B Riley and Securities. Please proceed.
spk05: Yeah, hey, good morning, guys. I just want to make sure I'm connecting the dots here and thinking about Austin, which I think is a big part of the story here this quarter. So GM shows back up as your top tenant. Looks like you leased about half of the building, but it's pretty close to the same total rent, should we, you know, infer from that that whereas before you, you know, they were paying $1,450 and you thought you could get close to $20, that that was actually closer to maybe the high 20s and how to think about, you know, what the rent might be at that building or I guess just additional color on that building would be great.
spk03: Sure, Craig. As I've indicated, Ian, we've got a nondisclosure and a confidentiality agreement with the tenant, so I can't disclose specific numbers, but if you look at The last couple of quarters where I indicated that rents, new asking rents, which of course are less than straight line, but new asking rents were in the low to mid-20s, we ended up at that location. And we feel very, very good about it. And as it relates to the balance of the building, we think that we're going to still be in that price range. So since we've got, you know... 45% of the buildings still to lease, we're very excited about what the ultimate outcome will be with that building. And activity has picked up. We have one RFP out right now for a tenant, and so we're just going to see how things unfold. But we are definitely encouraged because the activity in Austin has, in fact, picked up. And when you see some of the research reports that have just recently been released, CBRE indicates that tech leasing comprised, you know, I think over a fourth of all leases that were done in the third quarter, and Austin was signaled out as one of the strongest markets. So we're encouraged. Of course, we participated in that third quarter with us leasing that property, but we think going forward it's still going to be very, very strong for us.
spk05: Got it. And is there, you know, of course, recognizing that there is a nondisclosure agreement here, but can you give us an additional color as far as maybe a period of free rent or at what point that tenant might take occupancy and start paying rent and it starts to hit your income statement?
spk03: All I can say is it was minimal and our tenant improvements were very low. So we're very excited about the outcome. Team did an absolutely phenomenal job. in the negotiations, and we're encouraged about this new tenant who we believe will be in there for a long time.
spk05: And one more for me on the same topic. Over the past years, those assets have been taken. You've contemplated leasing it up or selling it, and you've leased up about half of it. are you thinking once those assets are leased up that they were going to be long-term holds or is that still potentially something you might sell down the line once you get it all leased up?
spk03: All the options are on the table. I think right now our objective is to lease the balance of the building and then at that point I think David and I and Gary will make a decision as to whether or not we want to exit that property, and redeploy it into industrial assets. I'm more of an industrial player, as you know, and so long-term, I think, as I indicated, our goal is to get to 75% on the industrial side, and this could be a very, very huge sale for us that could be redeployed into another industrial portfolio, which, from an operating efficiency standpoint, as we all know, industrial assets Releasing is much less expensive compared to office releasing. Got it. And one more for me, sorry.
spk05: Just thinking about acquisitions for 2021, kind of where are you thinking you're going to settle in as far as, you know, cumulative closings for the year versus, you know, where we were? Kind of your thoughts last quarter or so.
spk03: You know, we've been saying and we've been kind of sticking to the thought that we wanted to be somewhere between 100 and 120 million acquisitions. this year with some of the disruption we had at the beginning of the year. The team has now come back extremely strong. When I think that we've got $54 million in the barn, so to speak, and another $63 million under letter of intent, and those would all be probably by the end of January, first part of February. We may not finish this year much more over $100 million, but we start off – really with the wind at our back, particularly with a number of properties that will close within the first two months of 2022. And we're seeing a lot more listings. I mean, the team is staying extremely focused on our target markets. We're staying within our, let's say, $5 to, let's say, $20 million range and are successful. And we do participate a lot on sale leasebacks, as you saw earlier. Those two leases that we did were in excess of, well, one was 17 and one was 15 years. We like that middle market kind of non-traded company that we can underwrite the credit and work with private equity companies to offload those assets so they can put the money into the operating business. Okay. Appreciate the call. Thanks.
spk04: Other questions? Our next question comes from John Masako with Lattenberg. Please proceed.
spk07: Good morning. Good morning, John. How are you doing? Not bad. So on the lease expiration front, I know you touched a bit on 2022, but there's still a little left for 2021. Can you maybe just give any color on how that is progressing and maybe what that's composed of?
spk03: Yeah, we have an 86,000-square-foot office property in Salt Lake City that occupied by a strong tenant. They are going to move. Right now we have a prospect for a third of the building. And then the other property is, it's like a 16,000 square foot tenant in Tampa, Florida. And we're talking to the lead tenant in that building to take the balance of the space, which we're somewhat encouraged about. But until we get it across the goal line, as you know, it's not done. But, you know, I still feel very good about what we have done so far. But those two leases, John and expire at the very end of December. So we've got a little bit of headway yet, but, you know, we don't have it across the goal line. And then next year we have just three leases that are expiring, as I indicated, in June, July, and October, one of which we are already in conversation. The tenant is moving out. But we have another tenant that we're in final negotiations that they would move in actually before that tenant moves out in July. So somewhat encouraged about what's going on there.
spk07: Okay. And then, you know, obviously we kind of talked about it a little bit with Austin specifically, but what's kind of the bigger appetite for maybe recycling out of office properties and redeploying that capital into – industrial? And I guess, how do you balance maybe what could potentially be a headwind from the cap rate environment for office versus industrial, versus that desire to get to 75% or more industrial exposure in a couple of years?
spk03: Sure. As you probably know, as you do know, the last six properties we've sold have been single-story office properties, which everybody on our team knows that I despise and that's why we have exited some of those properties and we're going to continue to do that. Gary and I have done an assessment and I think probably over the next two to three years, I mean, I'm still interested in suburban office that are in mixed-use environments. I think that's a great long-term play regardless, particularly the type of assets that we buy which are mission critical. but we will continue to exit those single-story office properties. The releasing costs are just too high for square-foot basis, and I think we'll probably move out of anywhere from $15 million to $20 million a year. Most of those, John, are well under $10 million or smaller facilities, but we will move out of them and then redeploy the capital. And, yes, I agree, there's going to be some cap rate, let's say, arbitrage, but if we can keep it to just the $15 million to $20 million, it's not going to be a major impact to us. And, you know, I'm more of a long-term looker at our strategy and bringing on properties that have much better operating efficiencies, less cost to renew and or release, stickier product. We're going to go industrial.
spk07: Okay. And I guess today in kind of the specific areas you look at, what's maybe the cap rate mix between industrial, some of the office that looks attractive to you, and then some of the office that you might potentially be looking to kind of capital recycle out of?
spk03: Well, I would say that on the industrial side, where we're seeing deals that make sense for us are in the mid fives to low sixes going in. You saw the two that we bought this last quarter were higher than that. We were fortunate. But that's really what we're seeing in our target markets. As you know, there's a lot of cap rate compression there. completely across the country on the industrial side, but we can still find deals that are between five and a half and let's say six and a quarter that suit our needs. And you can look at the office product that we're looking at is probably 50 to 75 basis points higher. We're really not finding much that makes any sense. I mean, the people who are selling office product are smart. There's CapEx requirements. We're not into... a bunch of HVAC replacement, roof replacement, parking replacement, redoing lobbies, and quite frankly, the smart office sellers are selling assets that are like that. So as you can tell, we have one out of 18, our office product, and that's kind of the way I think we're going to see it going forward. It's going to be less than 20% of our total pipeline, let's say. And the arbitrage, You know, I do think that the arbitrage is going to be probably 50 basis points anyhow, maybe 75, but I still look at it long-term, and since we're talking about $15 to $20 million per year, I don't think it's a significant impact on our same-store performance and going forward FFO per share.
spk07: Understood. Thanks for taking the questions. That's it for me. Thanks. Next question, please.
spk04: Once again, ladies and gentlemen, to ask a question, please press star 1 on your telephone keypad. Our next question comes from Brian Hollandon with Aegis. Please proceed.
spk06: Morning, and thanks for taking my call.
spk03: Thank you, Brian.
spk06: How much does the Austin asset, 55% filled, impact the same store revenue? I know that your same store revenue was 2.2% in the quarter. What would that have been if the Austin asset was – you know, leased for that full quarter?
spk03: It would have, oh boy, I might have to tell you, but I would say for the full quarter, we're talking about a million and a half, about a million and a half of rent, and a million and a half of rent, and we've got 38 million shares. So you can probably do the calculation on that. But it was only really participating about 15 days because They moved in September 15th.
spk06: Okay. And then year-to-date, about 13 lease transactions. How much of an increase are you getting for industrial versus office when you exclude that Austin asset?
spk03: I don't have the specifics. All I can tell you is that through September, of the 13 assets that were done, five of them were office assets. and the balance were industrial, and our overall straight-line rent on that was in excess of 11% through September. We did another lease at the end of October, which we had a roll-down in the rent down there, and so that reduced our straight-line rent increase to the high single digits. And that was an industrial property, but it was cold storage, and that There was a big roll down. We bought that property back in 2007. So the rents were well over market. The key for us is that we've got the tenant in there for another 10 years. And I'm going to get 2% to 3% increases in the rents every year.
spk06: Thank you. And then maybe the last one for me. Can you just talk a little bit about what you're seeing on the acquisition front this quarter, maybe in the last couple of quarters? It does look like you know, with the three assets and due diligence and three LOI that you have, you know, quite a pipeline coming over the next, you know, few months?
spk03: Yeah, you know, what we're seeing is a combination of quasi-manufacturing and quasi-distribution. And in our secondary growth markets, that is playing well for us. You know, with 18 properties and due diligence and what our history has been that if we get something into the letter of intent stage, we typically close on about a third of those for sure at the bottom side. So I expect that we're going to continue to see that amount of velocity. You know, as I indicated, we average anywhere, you know, we average really between 16 and 18 million per copy on our acquisitions over the last couple of years. I think that's going to continue. If we stay at that level, then we're not competing against, I would say, the larger peers, and we're much more competitive there. And I still think that we'll have the opportunity to have a pipeline in excess of $300 million, and our expectations, Gary's and my expectation, is for us to grow the portfolio by $120 to $150 million a year going forward. Thank you.
spk04: Next question. We have a follow-up question from Craig Kucera with B. Riley. Please proceed.
spk05: Hey, guys, just one more for me. Just going through a queue, you know, you did have a $2.4 million legal settlements that kind of booked in other income, and I'm just curious, do you have any other lawsuits out there? Are there any other potential legal settlements that might close over the next quarter or two, or was that really sort of a unique situation for you?
spk01: That was a very unique situation, non-recurring, one time. So, no, we don't have anything else like that coming up.
spk05: Okay. Thanks. I appreciate it.
spk00: Next question.
spk04: Mr. Glassstone, we have no further questions in queue at this time. I would like to turn it back over to you for closing comments, please.
spk00: Well, thank you all for calling in and asking good questions. Ask a lot more next time we meet because we only meet once a quarter and we'd love to hear from all of you and your concerns and you bring up some good questions. So that's the end of this. Thank you for calling in. Thank you. This does conclude today's teleconference.
spk04: You may disconnect your lines at this time and thank you for your participation and have a great day.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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