GOODN - Gladstone Commercial Crosses The Rubicon With Rare Dividend Cut

Summary

• Gladstone Commercial has cut its monthly dividend payout for the first time since it went public close to the turn of the new millennium.
• The preferreds now offer a yield on par with the commons and trade at a 10% discount to par.
• The comparatively highly leveraged balance sheet is protected from further interest rate hikes.

Gladstone Commercial ( GOOD ) welcomed its shareholders into the new year with a dividend cut. The REIT recently declared a monthly per share cash dividend payout of $0.10 , a 20.3% decrease from the prior payout, which forms an annualized yield of 7.2% against the current share price. The $670 million McLean, Virginia-based REIT which started trading close to the turn of the millennium has quite literally kept its dividend on an upward trajectory since 2003. The monthly payout was maintained during the 2020 flash pandemic crash, was increased during the 2008 financial crisis, and had been maintained at its prior payout of $0.13 per share since January 18, 2008. The no cut since inception mantra was a defining part of management's pitch of Gladstone Commercial, hence, the sudden cut to kick start the new year undoubtedly came as a surprise to some shareholders.

What happened? Management billed the move as a precautionary pivot ahead of expected economic headwinds and broader volatility this year. The economic forecasts for 2023 are indeed grim, with the US widely expected to fall into a recession against interest rates that are still being hiked to new highs and inflation still far ahead of the Fed's 2% target.

However, the dividend cut represents a watershed moment in Gladstone's twenty-year history as a publicly traded REIT. That management had performed such a hard pivot against a defining feature of their investability, a recurring theme in their earnings call, and a likely driver of the relatively strong returns of the externally managed REIT represents a point of no return, symbolically akin to Caeser's crossing of the Rubicon river in my view.

A New Way Forward

With the REIT's investment advisor waiving incentive fees for the first half of 2023, management stated that they expect this to aggregate with the dividend cut to improve the overall liquidity position of their balance sheet. The REIT held total debt of $747.2 million as of the end of its last reported fiscal 2022 third quarter and placed the REIT's debt-to-capital ratio at 65.84%, nearly 35% higher than its peer group's median debt-to-capital ratio of 48.85%. This was also likely a consideration in the dividend cut as with the Fed set to hike rates to between 5% and 5.25% this year, the highest rate in 17 years, its debt position would have come under some pressure.

Whilst quarterly interest expenses have been rising and reached $9.1 million during the third quarter, its highest level in over ten earning quarters, the bulk of the REIT's debt profile should be less sensitive to future interest rate hikes. Around 49.5% of their debt is at a fixed rate, another 49.5% is floating rate debt hedged through a mix of interest rate swaps and interest rate caps, and the remaining 1% is at a floating rate. Further, as of the end of the quarter, their effective average SOFR was 2.98% with only $66.1 million in loan maturities coming due in 2023. The REIT has also been leaning on secondary offerings and raised $8.9 million in the third quarter net of costs through its at-the-market offering program. This is still running with the company holding the view to using proceeds to opportunistically buy back their preferreds.

The single-tenant REIT which owns approximately 17.2 million square feet of industrial and office real estate across 137 properties in the US last reported occupancy of 96.9% and $1.61 in adjusted FFO per share. Tenants which include Citrix Systems came with an average remaining lease term of 7.1 years.

The Series E Preferreds Against Commons Volatility

Gladstone Commercial 6.625% Series E Cumulative Redeemable Preferred Stock ( GOODN ) offer another way to gain exposure to the REIT's portfolio. The value proposition of Series E preferreds centers on the $1.66 annual coupon paid in monthly instalments. This currently works out to be a 7.3% yield with the preferreds currently trading at $22.75 per share.

Not only is this on par with the dividend on the commons, but the preferreds are also trading around $2.25 lower than their redemption value. This near 10% discount to its par value opens up the further scope of capital appreciation as the commons get rerated on the back of the dividend cut.

Gladstone Commercial recently announced its intention to buy back at least $20 million worth of the Series E preferreds, around one-third of the total amount issued. This is a bittersweet event. On one hand, it helps close the discount to par and benefits the current owners of the preferreds with the scope of further repurchases on the open market at a discount to par reducing the possibility of material downside.

To be clear, the preferreds as less likely to significantly deviate from their redemption price against economic disruption if the REIT has signaled an intention to buy them back on the open market ahead of its October 4, 2024 maturity date. Bears would however point to this move being created by a possible lack of investment opportunities above their cost of capital. I'm neutral on Gladstone Commercial after the cut. The preferreds should be considered by more risk-averse income investors.

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