Gladstone Commercial Corp. Q2 FY2024 earnings call

Management Statement and Operational Highlights:

• Industrial outperformance: Continues to show near-term and long-term strength. Near-term, industrial vacancy rates are peaking as new developments have slowed. Long-term, tailwinds from reshoring and near-shoring manufacturing operations benefit the portfolio.
• Portfolio highlights: Increased industrial concentration to 62% from 60%; decreased office concentration to 34% from 36%. Successfully leased and mark-to-market nearly 1 million sq ft in Taylor, PA; inquired an industrial asset in Southern PA for $11.7 million; sold a 29,000 sq ft office asset in Egg Harbor, NJ. Renewed nearly 2.4 million sq ft across five assets; portfolio occupancy at 98.5%; renewed a 72,000 sq ft office lease in Columbus, OH to 2030; raised $21.6 million net proceeds from common stock sales and $100,000 from Series F preferred stock sales.
• Debt profile: 37% fixed rate, 51% hedged floating rate, 12% floating rate; effective average SOFR at 5.33% as of June 30; no 2024 loan maturities, 2025 maturities manageable at $25.5 million.

Segment Performance: Industrial concentration increased from 60% to 62% of annualized straight line rent, while office concentration decreased from 36% to 34% of annualized straight line rent. Operating revenues for the second quarter were $37.1 million, compared to $38.7 million in the same period in 2023. Operating expenses were $26 million in 2024 versus $33.7 million in 2023. The decrease in expenses in 2024 was due in part to lower impairment charges, offset by a waiver of the incentive fee in 2023.

Guidance:

• Plan to increase industrial concentration above 70% of annualized straight line rent in the next 6 to 12 months.
• Continue disposing of non-core office assets, with proceeds redeployed into industrial assets.
• Leverage in-house credit underwriting expertise for sale-leaseback opportunities.
• Aim to maintain a healthy and flexible balance sheet with $52.5 million liquidity as of June 30, 2024.

Risks:

• Economic weakness and potential recession could impact real estate capital markets.
• Interest rate risks, with a significant portion of debt hedged floating rate.
• One tenant credit quality concern, though not material to the overall portfolio at present.

Q: Gaurav Mehta asked about the acquisition pipeline and cap rates, and if the incentive fee waiver would continue.

A: Buzz Cooper stated there is one transaction closing with a north of 10 cap, LOIs above 10, and the pipeline is expected to pick up later in the year; Gary Gerson said the incentive fee was waived in 2023, with a partial payment in Q1 2024, and intent to pay at a reduced rate.

Q: Rob Stevenson inquired about core FFO, held-for-sale properties, dispositions, and tenant credit.

A: Gary Gerson explained core FFO was due to a termination fee from the Egg Harbor property sale (~$570k); Buzz Cooper confirmed the medical office sales in Georgia; Buzz Cooper said they would be aggressive in disposing of non-core offices when rates drop and mentioned one industrial tenant credit issue.

Q: Dave Storms asked about renewing office assets and underwriting with expected rate cuts.

A: Buzz Cooper said they would renew office assets where feasible, and underwriting remains tenant-by-tenant disciplined; rate cuts are expected to allow more acquisition opportunities.

Q: John Massocca asked about leasing activity and tenant improvement (TI) costs.

A: Buzz Cooper discussed TIs in leasing, noting TI costs are lower in industrial compared to office, and TI asks are down in Austin office market.