Gladstone Commercial Corp
NASDAQ:GOOD
Earnings Call Analysis
Q4-2023 Analysis
Gladstone Commercial Corp
In a year marked by notable interest rate fluctuations, with the benchmark 10-year treasury yield peaking above 5% and concluding the year below 4%, the company managed to navigate the volatile capital markets effectively. Industrial real estate, which represents a significant portion of the company's annualized straight-line rent, displayed resilience in a challenging environment, with industrial rent growth outpacing fixed annual escalations of the assets. The company has strategically divested noncore office assets and focused on acquiring mission-critical industrial properties in growing markets, enhancing its industrial concentration from 56% to 60% of annualized straight-line rent. Demonstrating operational success, the company has secured high occupancy rates and implemented a cost-efficient $154 million net mortgage debt reduction since January 2022.
Financially, the company has reported stable funds from operations (FFO) and core FFO at $0.36 per share for the fourth quarter of 2023, showing slight improvement from the previous year's quarter. Annual FFO and core FFO saw a marginal decrease in comparison to 2022. A standout achievement is a 6.5% increase in same-store cash rent for 2023 over the previous year. The company's balance sheet remains healthy with $56.5 million in available liquidity and moderate leverage, maintaining a strategic and flexible stance to capitalize on opportunities with accretive cap rates, especially in the realm of sale leasebacks.
The company maintains a manageable debt profile with $15.6 million in loan maturities for 2024, associated with two properties held for sale. With a focus on equity activity to ensure liquidity for capital needs and acquisitions, they successfully raised funds through common stock and Series F preferred stock sales. The company's proactive management of equity has resulted in $3.4 million in cash and an additional $51.5 million under a line of credit. The common stock offers an attractive dividend of $1.20 per year with a distribution yield of approximately 9.59%.
The management team received praise for their adaptability and performance amidst the prolonged effects of the pandemic and evolving economic conditions. The company's proactive property management led to the acquisition of two new industrial facilities and the disposal of several noncore office properties. Entering 2024, there is optimism around continuing this trajectory, with a strong acquisition pipeline focused on properties with robust credit tenants, aligning with the company's goal of high-quality and secure investments.
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Greetings. Welcome to the Gladstone Commercial Year-end and Fourth Quarter Earnings Call. [Operator Instructions] Please note this conference is being recorded. I'll now turn the conference over to Mr. David Gladstone, Chief Executive Officer. Mr. Gladstone, you may now begin your presentation.
Okay. Thank you, Rob. That's a nice introduction, and thank all of you for calling in this morning. It's nice of you. We enjoy the time that you take away from your day to come listen to our phone presentation. I wish we had more time to you. We only get this sort of once a quarter. Now we hear from Michael LiCalsi, our General Counsel and Secretary, give us a legal and regulatory matters concerning the call today. Michael?
Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. And many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all the risk factors in our Forms 10-Q, 10-K, and other documents we file with the SEC.
You can find them on our website, gladstonecommercial.com, specifically the Investors page. Or on the SEC's website, which is www.sec.gov. And we undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Today, we'll 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, 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 revenues and expenses. And we believe these metrics are a better indication of our operating results and will have better comparability of our period-over-period performance.
Now please visit our website, once again, gladstonecommercial.com, sign up for our e-mail notification service. You could also find us on Facebook. Keyword there is the Gladstone Companies, and on Twitter @GladstoneComps.
Today's call is an overview of our results, so we ask that you review our press release and Form 10-K, again, both issued yesterday, for more detailed information. And with that, I'll hand the baton over to Gladstone Commercial's President, Buzz Cooper. Buzz?
Thank you, Michael, and thank you all for calling in. Today, we will discuss our operations and topics that are top of mind. Interest rates continue to have outsized impacts on capital markets and real estate. In October 2023, the benchmark 10-year treasury yield peaked above 5% for the first time since 2007. Rates remained volatile through the end of the year with the 10-year yield finishing below 4% and increasing to 4.32% as of yesterday. This volatility translated directly to capital markets and investment volumes as sellers' pricing expectations lagged real time changes in rates. According to CBRE, the net lease investment volume fell 55% year-over-year through Q3 of 2023. Despite volatile capital markets, industrial real estate, which now accounts for more than 60% of our annualized straight-line rent, continues to perform. According to CBRE, average industrial asking rents Q4 of 2023 rose 6% year-over-year, and the industrial vacancy rates at the end of the year were just 4.8%, despite record annual completions of 612 million square feet.
Moving on to office. The broader market continued to struggle in 2023. According to Cushman & Wakefield, office net absorption in Q4 of 2023 was negative for the 8th consecutive quarter. We made tremendous progress throughout the year of delivering on our current core strategies, divesting noncore office assets, acquiring mission-critical industrial assets in the path of growth markets, and diligently underwriting our tenants credits. We exited 7 noncore markets and properties, completed nearly $30 million in new acquisitions, and increased portfolio industrial concentration from 56% of annualized straight-line rent as of December 2022 to 60% as of December 2023.
All of our acquisitions throughout the year were completed in established growing markets, including Chicago, Dallas-Fort Worth, Indianapolis, and the Lehigh Valley in Pennsylvania. Furthermore, the acquisitions improved portfolio WAULT with a weighted average lease term at closing of 19.3 years.
In addition to new acquisitions during the year, our asset management team led more than 1.4 million square feet of leases resulting in a more than 1.2 million or 13% net increase in same-store GAAP rent. The annualized straight-line rent of these transactions totaled $10.7 million. While we cannot control the Fed or predict exactly where interest rates will go, we remain confident that all of these developments have better positioned our portfolio for 2024.
Portfolio occupancy was at 96.8% as of December 31, 2023, and we collected 100% of cash base rents during the year. This is a testament to the mission-critical nature of our assets and quality credits of our tenant, both of which position us well to weather any economic storms we may face. In addition, we believe there are levers which we have yet to fully realize. Most of our industrial assets have fixed annual escalations of 1.5% to 3.5%. Industrial rent growth over the last few years has exceeded these escalation rates, resulting in rents that are below market and valuable upon lease renewal.
Our balance sheet is healthy and flexible, positioning us to continue deploying capital into industrial deals at accretive cap rates as seller expectations normalize. Since January 1, 2022, we have repaid more than $194 million of mortgage debt and grown our unencumbered asset base by 61% from $510 million to $822 million. Following the completion of the 4 office building sales currently under contract, we'll have only 5 office mortgages remaining and the first maturity of those 5 is in 2026. We have $56.5 million in available liquidity via our revolving credit facility and cash on hand and remain below 50% levered as of December 2023.
In short, 2023 was a successful year for selling legacy noncore office assets and redeploying proceeds into mission-critical industrial assets. Seller expectations have yet to fully normalize to the new standards set by the Federal Reserve. But as we do, we will be well positioned to capitalize on accretive new opportunities. We expect sale leasebacks in particular to be the primary source of new deals for us. And sale leasebacks provide additional credit diligence and term, which are both hallmarks of our value proposition.
Our balance sheet is flexible, driven by more than $154 million of net mortgage debt reduction since January of 2022, and again, we have more than $56 million of liquidity on hand to continue growing our industrial base. Since 2019, our industrial concentration as a percentage of annualized straight-line rents has increased from 32% to 60%. And we expect to further increase this concentration in the next 6 to 12 months.
I will now turn the call over to Gary Gerson, our CFO, to review our financial results for the quarter and our liquidity position. Gary?
Thank you, Buzz. I'll start my remarks regarding our financial results this morning by reviewing our operating results for the fourth quarter of 2023. All per share numbers referenced are based on fully diluted weighted average common shares. FFO and core FFO per share available to common stockholders were both $0.36 per share for the quarter. FFO and core FFO available to common stockholders during the fourth quarter of 2022 were both $0.34 per share. FFO and core FFO for the 12 months ended December 31 were $1.46 and $1.47, respectively. FFO and core FFO for the same period in 2022 were $1.54 and $1.56 per share, respectively.
Our same-store cash rent in the 4 quarters of 2023 increased by 6.5% over the same period in 2022. This was due to a onetime accelerated rental and increased recovery. Fourth quarter results reflected total operating revenues of $35.9 million, with operating expenses of $28.1 million as compared to operating revenues of $37.2 million and operating expenses of $25.7 million for the same period in 2022. Expenses were higher in this period, mainly due to impairment charges offset by the waiver of the incentive fee in 2023.
Looking at our debt profile, 40.1% is fixed rate, 49.7% is hedged floating rate, and 10.2% is floating rate, which is the amount drawn on our revolving credit facility. As of December 31, our effective average SOFR was 5.38%. Our outstanding bank term loans are hedged with $310 million of interest rate swaps and the remainder with interest rate caps. We continue to monitor interest rates closely and update our hedging strategy as needed. As of today, our 2024 loan maturities are manageable with $15.6 million due, which encumbered 2 properties held for sale. As of the end of the quarter, we had $75.8 million of revolver borrowings outstanding.
We sold 1,776 shares of common stock this quarter, resulting in net proceeds of $24,000 through our at-the-market program for ATM. We received net proceeds of $400,000 from sales of our Series F preferred stock. We continue to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements and new acquisitions. Presently, we have 4 properties held for sale. As of today, we have approximately $3.4 million in cash and $51.5 million of availability under our line of credit. We encourage you to also review our quarterly financial supplement posted on our website, which provides more detailed financial and portfolio information for the quarter. Our common stock dividend is $0.30 per share per quarter or $1.20 per year. Our common stock closed yesterday at $12.51. The distribution yield is about 9.59%.
And now I'll turn the program back to David.
Well, thank you, Gary. That was a good report, and Buzz and Michael did good reports as well. This team has performed very well and reacted admirably to the various changes presented by the lasting impact of the pandemic and changes in the economy. Overall, I just have to tell you, it's a very nice quarter. So you heard today of some of the things that they've been doing in summary. During the fourth quarter, they acquired 2 new industrial facilities, again, manufacturing oriented. They sold 2 noncore properties. These were both office properties. And we're talking about the end, December 31, 2023. We, of course, are off to a good start. We also, during the last quarter, sold at least 6 of our properties. Subsequent to the end of the quarter, we sold an additional noncore/office prem.
The commercial team is growing the real estate that we own at a good pace, and the team is doing a great job of managing the existing properties. We have quite a good team of people that are working those deals that come up and very proud of them. Our team of strong professionals continue to pursue the potential quality projects on the list of acquisitions that they are reviewing. They've got quite a list to go through now. Our acquisition team is seeking only strong credit tenants and not going after the marginal ones.
Well, that's really enough from me. Let's stop here, and Rob, if you'll come on and show them how to ask questions, we'll take some questions from those listening.
[Operator Instructions] Our first question today will be coming from the line of John Massocca with B. Riley Securities.
So maybe a quick question. Sorry, if you touched on it somewhere in the call and I missed it. But have you made any decision yet on the incentive fee going forward into 2024? Is that something you are still considering spending? Or is that going to be potentially back in kind of operating expense this year?
John, it's Buzz. We are having internal discussions. We have not met with the Board and had any formal recommendations at this point. So I cannot give you a definitive answer, but we are obviously looking at all our alternatives as we did waive it last year. As we look going into '24, we obviously want to be cognizant of doing the right thing.
That's understood. And then in terms of kind of the existing vacancy, can you provide some updates on either your disposition potential or lease-up just given the number kind of stayed flat quarter-over-quarter in terms of both partially vacant assets and fully vacant assets?
Sure. And I'll hit first, obviously, an asset we have discussed previously, our asset in Austin on Parmer. We have had some interest there. We continue to work with the tenancy, trying to attract new tenancy or expansion. There are some requirements in the market that are of good size. I can't disclose who they are that we are certainly running down and trying to work with. Our hope there is to get tenancy. And then within that building, look to see what is best for us, for the stockholders, as it relates to hold or sell. But at this point in time, I don't have anything from the standpoint of being able that I can report from leasing activity there other than that.
And I have my CIO here, E.J. Wislar. I can have him comment on some positive activity that we have on our leasing front within the portfolio. Do want to state that it's all very positive. And I think as you know, we stay in front of our tenants on a quarterly and certainly annual basis. So we're ahead of the curve as it relates to our vacancy. E.J.?
Thanks, Buzz. John, as we kind of look at where things stand today in our current held for sale as of 12/31, and obviously, it was mentioned that there's additional asset held for sale currently. A few of those are vacant office assets. So as we kind of look at our capital allocation strategy, making sure we're being the most efficient, whether we want to break those buildings or sell them and redeploy those proceeds, I would expect we'd see that vacancy rate improve over the next few quarters as we dispose a few vacant office assets.
Okay. Understood. And then maybe just on a line item basis, your property operating expense was kind of down in the quarter, and you called out some successful real estate tax appeals. Can you maybe just provide some more color on that? And is that something that's sustainable on a go-forward basis? Or is that kind of a onetime true-up in 4Q?
I'll let Gary handle that, if I may. I will tell you that we are aggressive where we can be as it relates to appeals, and we've had successes there. Gary?
John, as I mentioned, as a onetime, I think these were appeals, so they lowered the taxes on some of these buildings. I believe 1 of them was in Texas, which was significant -- or 2 in Texas that were significant. And I think that's a going forward. So these are basically reappraisals from a tax perspective.
Okay. So it's not just a true-up what was budgeted in '23, it's a lower base tax rate essentially?
Yes.
The next question is from the line of Dave Storms with Stonegate.
I just want to start, occupancy had a really nice jump subsequent to the end of the quarter. Is that a product of a couple of real good wins or 1 giant win? Kind of what's the story there?
As mentioned, we do stay in front of the tenants and, obviously, work with them. We're well ahead of our lease expirations and discussions. So we have had some successes there as I referenced in my notes of several -- exactly on 1.4 million square feet and 1.2 million in net operating increase on the same-store GAAP rent. So we are, again, actively engaged there and had good success. We will continue that as we go into 2024. I'll also ask E.J. to give a comment here on a couple that he's been working as well specific, because our concentration, for lack of a better word, is light relative to 1 asset that we are in good stead with.
Yes, thanks. The occupancy increase was also related to the sale of 1 vacant office asset in South Carolina. So that was an improvement there. And as I mentioned before, we've got a few more vacant office assets that will be sold here in the next quarter or so.
Very helpful. And then you mentioned in the comments that you're focusing more on higher quality credit tenants. Is that a comment on just demand being strong enough that you can focus on those higher quality tenants? Or is that more of a comment on spread shrinking between high-grade and low-grade tenants? Kind of what's driving that increased focus?
Obviously, with the market and with our company history, we've always been focused on credit of our tenancy. I'll let E.J. take that specific to market from the standpoint of what the market is also providing to us in the way of tenancies. E.J.?
Yes. And Dave, when we say high-quality tenants, it doesn't necessarily mean rated investment-grade tenants. What we mean is, when we look to acquire mission-critical industrial assets where the underlying tenancy has strong fixed-charge coverage ratios, moderate-to-low leverage, strong EBITDA margins, and operates in a countercyclical or defensible industry with a strong moat, and so what we like to do is acquire those mission-critical assets that are generating an outsized portion of corporate revenue and EBITDA and free cash flow at the asset level.
And so we certainly do like to acquire assets leased to rated investment-grade tenants, but there's also something to be said for acquiring an asset that is very important to the underlying tenants. So when we say credit tenants, it's not just investment grade, but also those kind of upper middle market tenants that we get additional granular information into their operations that helps us underwrite them.
Understood. That's very helpful. And then just 1 more for me. Do you have a sense of what your geographic focus is going to be in 2024 one way or another?
We have obviously seen, as it relates to the health of the country, from the standpoint of growth, has been Southeast, South Central in nature. So we have had good success there. And certainly, it's a concentration, the more we do, the more that also comes our way. I'll let E.J. get more specific on those markets. But that's where we are as well as the Midwest seeing a focus. It's not on the West, and it's not certainly in the Northeast at this point in time, and we've had good success.
Yes. Obviously, Dave. When we look at our markets, what we like to see is business-friendly environments with strong demographic inflows as well as business formation. And so that leads us to be focusing on places like the Sunbelt as well as some select Midwest markets. We like those markets as well. They've got a strong manufacturing base, and we like the light manufacturing space and that the tenants are very sticky, meaning they've got significant capital invested into the assets, which increases the renewal probability. So I would expect you'll see us continue to focus on those markets over the next few years.
Okay. Rob, any more questions?
There are no additional questions at this time, Mr. Gladstone.
Oh, that's terrible. We need more questions. We like it when you ask questions. So now you're going to have to hold your questions until next quarter. So we'll see you next quarter. That's the end of this conference call.
Thank you. This will conclude today's call. You may disconnect your lines at this time. We thank you for your participation.