GOODN - Gladstone Commercial: How Safe Is The 10% Yield Paid Monthly?

2023-11-09 17:37:03 ET

Summary

• Gladstone Commercial reported fiscal 2023 third quarter FFO per share that dipped from its prior quarter.
• The REIT is covering its dividend by 123% and faces no material debt maturities in 2024.
• New industrial property acquisitions have come with high GAAP cap rates that have helped the REIT phase down its office exposure.

Gladstone Commercial ( GOOD ) is a tepid battleground stock whose common shares have tracked the REIT market lower as they're down 36% year-to-date. The broadly industrial property REIT last declared a monthly cash dividend of $0.10 per share , unchanged from its prior payment and for a 10% annualized forward dividend yield. The trend of the monthlies has not been ideal, down roughly $0.03 per share from what had been terrific stability from a $0.13 per share monthly payout for over a decade. Critically, the current payout is under pressure from higher interest rates, and this pressure is likely to be sustained if the Fed follows through on its higher for longer rhetoric. The common shares are now trading hands at a price to trailing 12-month funds from operations of 8.27x , a low for the REIT and around 30% lower than its peer group median.

GOOD owned roughly 17.2 million square feet of industrial and office real estate across the US at the end of the third quarter, leased to 110 tenants with an average remaining term of 6.8 years. However, the issue for the bears isn't the increasingly diversified and industrial footing of a 135 property portfolio that was 96.6% occupied , it is with FFO that's been trending lower in recent quarters on the back of a $750 million total debt balance. The third quarter FFO was $0.34 per share, around $0.04 below analyst consensus for FFO per share of $0.37. It was also a material drop from FFO of $0.41 per share in the second quarter.

I have a material position in the series E cumulative preferreds ( GOODN ) and intend to continue adding to my overall positioning in the REIT's preferreds. Why? An 8.44% yield on cost, 22% discount to their $25 per share par value, and monthly distributions. They're coming up for redemption next year (October 4, 2024) but GOOD is unlikely to follow through with redeeming the series next year on the back of upcoming debt maturities and higher interest rate expenses. The series G preferreds ( GOODO ) offer a deeper discount to par of 29.5% and an 8.43% yield on cost so I might swap to them as a play on capital uplift once the Fed possibly starts to cut rates in 2024 or 2025.

Revenue, Dispositions, And Acquisitions

GOOD reported third-quarter revenue of $36.46 million , down 8.5% over its year-ago period and a miss by $2.37 million on analyst consensus. Same-store revenues were up by 5.4% with the revenue miss during the third quarter driven by a property portfolio in flux. GOOD has sold six office assets year-to-date as part of its sustained strategy to reposition its portfolio from a broad divestiture of office assets its management described as legacy during the third-quarter earnings call. The disposition cap rate on stabilized office sales during the third quarter was 8.23% , around 130 basis points lower than the combined GAAP cap rate of 9.54% on new industrial acquisitions during the same period.

GOOD has followed up with a $7.8 million purchase of an industrial manufacturing facility in Allentown, Pennsylvania at a 9.2% GAAP cap rate. The triple net lease 20-year sale-leaseback transaction highlights why the shift to industrial represents an inherent deepening of the intrinsic value of the preferreds. To be clear, office properties are seeing a consolidation across the US and the two preferred series will become fundamentally safer as GOOD phases down its exposure to the sector. Industrial concentration as a percentage of annualized straight-line rent has increased from 32% in 2019 to 59% at the end of the third quarter.

FFO, Dividend Coverage, And Debt

FFO per share at $0.37 meant the 3-month aggregate of the dividend was 123% covered, around an 81% payout ratio, and down from healthier coverage in the second quarter. This came with the REIT's external advisor waiving the incentive fee that was at $1.5 million during the second quarter. Interest expenses were higher by around $830,000 with around 49% of debt at a hedged floating rate and around 41.6% at a fixed rate. The REIT's overall debt balance comes with an effective SOFR rate of 5.31% but leverage on a net debt to gross assets basis has flatlined at 45.5% in the third quarter since 2020. There are also no material debt maturities into 2025, likely a period when the Fed would have cut back rates from their 22-year highs allowing GOOD to refinance its debts lower. The common shares are a cautious hold but I intend to keep accumulating the preferreds.

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