Business Context and Reporting Period
Company: Gladstone Commercial Corporation (Gladstone Commercial Corp)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: Gladstone Commercial is a Maryland-domiciled Real Estate Investment Trust (REIT) that invests in and owns net-leased industrial and commercial real property and selectively makes long-term mortgage loans. As of December 31, 2008, the Company owned 65 properties totaling approximately 6.3 million square feet and held one mortgage loan. The portfolio is leased to a diverse cross-section of tenants, primarily under triple-net leases where tenants pay operating costs, maintenance, insurance, and taxes.
Key Financial Metrics
| Metric | 2008 | 2007 |
|---|---|---|
| Total Operating Revenue | $40.91 million | $32.79 million |
| Net Income | $4.91 million | $6.14 million |
| Net Income Available to Common Stockholders | $0.82 million | $2.05 million |
| Funds From Operations (FFO) Available to Common | $13.52 million | $12.50 million |
| FFO Per Share (Basic) | $1.58 | $1.46 |
| Net Cash Provided by Operating Activities | $17.58 million | $16.10 million |
| Total Assets | $429.10 million | $378.90 million |
| Total Debt (Mortgage Notes, Line of Credit, Short-Term Loan) | $286.61 million | $226.52 million |
| Stockholders' Equity | $130.50 million | $142.37 million |
| Cash and Cash Equivalents | $4.50 million | $1.36 million |
Material Changes vs. Prior Period
- Revenue Growth: Total operating revenue increased 25% to $40.91 million, driven primarily by the acquisition of six new properties during 2008 and full-year contributions from 2007 acquisitions. Rental income rose 26% to $39.68 million.
- Net Income Decline: Net income decreased 20% to $4.91 million. Net income available to common stockholders dropped 60% to $0.82 million, primarily due to a 46% increase in interest expense ($16.86 million) resulting from increased leverage and long-term financings.
- Acquisition Activity: The Company acquired six properties totaling approximately 756,000 square feet for a gross investment of $53.6 million. Capital improvements of $2.2 million were also made, bringing total investment to $55.8 million.
- Financing Activity: The Company borrowed $48.0 million in September 2008 via a long-term note from GE Commercial Mortgage Financial Corporation to pay down its line of credit. Net borrowings under the line of credit were $7.1 million, with $11.5 million outstanding at year-end.
- Due Diligence Expenses: Due diligence expenses surged to $1.18 million (from $21,000 in 2007), largely due to fees for a large potential acquisition that did not close.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management notes that the U.S. recession and global credit market dislocation have increased the cost of capital and reduced the ability to obtain new debt and equity. The market for long-term mortgages has "frozen," forcing the Company to focus on medium-term mortgages (2-5 years) at less favorable terms. Equity financing is currently not viable due to a 56% discount in stock price compared to the 2008 average. The near-term strategy involves retaining capital, building value in the existing portfolio, and making conservative investments funded by the line of credit.
Risks and Contingencies
- Liquidity and Refinancing: The Company has a $95.0 million line of credit maturing in December 2009 (with an extension option) and a $20.0 million short-term loan maturing in June 2009. Renewal or refinancing is subject to updated property appraisals and market conditions.
- Tenant Credit Risk: While all tenants were current as of December 31, 2008, the recession increases the risk of tenant bankruptcy and default. The portfolio includes many small and medium-sized businesses without publicly rated debt.
- Interest Rate Risk: The Company has variable-rate debt (line of credit, short-term loan) and one variable-rate mortgage loan. A 1% increase in LIBOR would decrease net income available to common stockholders by approximately 26%.
- Accounting Changes: The adoption of SFAS 141(R) in 2009 will require the expensing of acquisition costs rather than capitalization, which is expected to lower earnings in future years.
Unusual Items
- Adviser Fee Waiver: To comply with a line of credit covenant limiting distributions to 95% of FFO, the Adviser voluntarily waived approximately $2.2 million of incentive fees for 2008.
- Discontinued Operations: A loss of $35,376 was recorded related to legal fees for the dissolution of entities associated with Canadian properties sold in 2006.
Investor Verification Checklist
- Debt Maturities: Verify the Company's ability to refinance the $20.0 million short-term loan (June 2009) and the $95.0 million line of credit (December 2009) given the frozen CMBS market.
- Tenant Concentration: Review the creditworthiness of the top 5 tenants, who accounted for approximately 24.7% of total rental income.
- FFO Coverage: Confirm that FFO continues to cover distributions, noting the reliance on the Adviser's voluntary fee waiver to maintain the 95% FFO distribution covenant.
- Property Valuations: Assess the impact of potential updated appraisals on the borrowing base of the line of credit, which could reduce available liquidity.
- Stock Price Volatility: Monitor the common stock price, which was trading at a significant discount to its 2008 average, impacting equity financing options.