Gladstone Commercial Corp. Q4 FY2023 earnings call

• Interest rates had outsized impacts on capital markets and real estate in 2023, with the 10-year treasury yield being volatile. Net lease investment volume fell 55% year-over-year through Q3 2023.
• In 2023, the company successfully divested non-core office assets and redeployed proceeds into mission-critical industrial assets. Completed nearly $30 million in new acquisitions, increasing portfolio industrial concentration from 56% to 60% of annualized straight-line rent as of December 2023, with a weighted average lease term at closing of 19.3 years.
• The 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, with annualized straight line rent of these transactions totaling $10.7 million.
• The balance sheet is healthy and flexible. Since Jan 1, 2022, more than $194 million of mortgage debt has been repaid, and the unencumbered asset base has grown by 61%. Following the sale of four office buildings, only five office mortgages remain, with the first maturity in 2026. There is $56.5 million in available liquidity and the company remains below 50% levered.

Industrial real estate now accounts for more than 60% of the company's annualized straight line rent. In Q4 2023, average industrial asking rents rose 6% year-over-year, and industrial vacancy rates at the end of the year were just 4.8%. The broader office market struggled in 2023, with office net absorption in Q4 2023 being negative for the eighth consecutive quarter.

• Expect sale lease backs to be the primary source of new deals.
• Expect to further increase industrial concentration in the next 6 to 12 months.
• 2024 loan maturities are manageable with $15.6 million due, encumbering two properties held for sale.

• Interest rate volatility may cause changes in capital markets and sellers' expectations have not fully adjusted to new interest rate standards.
• The broader office market continues to struggle, which may impact the company's performance.

Q: Have you made any decision yet on the incentive fee going forward into 2024?

A: 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 2024, we obviously want to be cognizant of doing the right thing.

Q: Can you provide some updates on either potential disposition potential or lease up given the flat vacancy quarter-over-quarter?

A: Sure. Our asset in Austin on Parmer has had some interest, and we continue to work with the tenancy. There are some requirements in the market that are of good size. We have sold a vacant office asset in South Carolina. And we would expect the vacancy rate to improve over the next few quarters as we dispose of a few vacant office assets.

Q: Can you provide more color on property operating expense related to real estate tax appeals and if it's sustainable?

A: These were appeals, so they lowered the taxes on some of these buildings. I believe one of them was in Texas, which was significant, or two in Texas were significant. And this is basically reappraisals from a tax perspective, so it's not just a one-time true-up in 4Q.

Q: Is the occupancy jump subsequent to the end of the quarter due to specific good wins?

A: As mentioned, we do stay in front of the tenants and work with them. We have had some successes there as we referenced in our notes of several exactly on 1.4 million square feet and $1.2 million in net operating increase on the same-store GAAP rent. The occupancy increase was also related to the sale of one vacant office asset in South Carolina.

Q: What's driving the increased focus on higher quality credit tenants?

A: When we say high-quality tenants, it doesn't necessarily mean a rated investment grade tenants. What we mean is when we look to acquire mission-critical industrial assets where the underlying tenancy has strong fixed coverage ratios, moderate to low leverage, strong EBITDA margins, and operates in a counter-cyclical or defensible industry with a strong moat. So we like to acquire those mission-critical assets that are generating an outsized portion of corporate revenue and EBITDA and free cash flow at the asset level.

Q: What is the geographic focus in 2024?

A: We have seen growth in the Southeast, South Central in nature. We are also focusing on some select Midwest markets. We like those markets as they've got a strong manufacturing base, and the tenants are very sticky, meaning they've got significant capital invested into the assets, which increases the renewal probability.