GOODN - Gladstone Commercial: Why I Went Heavy On Buying The 8.8% Yielding Preferreds

2023-08-11 01:01:15 ET

Summary

• Gladstone Commercial reported fiscal 2023 second-quarter funds from operations that beat consensus by 5 cents.
• The REIT is currently paying out 73% of its FFO as a 3-monthly dividend to its common shareholders.
• I've been buying the preferreds on the back of their continued discount to par and a near 9% yield on cost.

The bearish base for Gladstone Commercial ( GOOD ) has been built around its office exposure, a rising Fed funds rate, and a potentially cloudy outlook for future dividends after a rare cut at the start of 2023. The common shares have dipped 26% since the beginning of the year, a move that reflects market angst over an office exposure that stood at 37% as of the end of its last reported fiscal 2023 second quarter. The REIT just declared a monthly cash dividend of $0.10 per common share , in line with its prior payout and for an 8.6% annualized forward yield. The yield has actually moved down from record highs on the back of the common shares staging a tepid recovery from their 52-week lows. The dividend is the prize here and the REIT recorded a second-quarter funds from operations of $0.41 per share , a 5 cents beat and growth from $0.39 in its year-ago comp.

GOOD's FFO growth comes on the back of the continued move towards a more industrial property base. The REIT held 136 properties with occupancy at a high 96% as of the end of its second quarter. This was up 10 basis points sequentially from the first quarter with 100% of cash base rents paid and collected during the second quarter. GOOD has been actively disposing of non-core office properties and reinvesting the proceeds to buy more industrial property. The externally managed REIT recently sold a 26,080 square foot Pittsburgh, Pennsylvania office building. This was disposed of at a leveraged internal rate of return of 18% and was quickly followed up with the $9.08 million acquisition of a 100,000 square foot industrial manufacturing facility in Cedar Hill, Texas through a 20-year absolute net sale leaseback transaction and at a GAAP cap rate of 10.1%.

Debt Maturities And Capital Structure

Bearish concerns on the ticker have honed in on the 37% office exposure . The current REIT stock market zeitgeist has been highly defined by fear around the long-term impact of remote working on overall US office demand. This comes as a Fed funds rate that's been hiked to a 22-year high of 5.25% to 5.5% has rendered the refinancing of upcoming debt maturities a significantly more Sisyphean task. GOOD held a net debt of $737 million as of the end of the second quarter.

Only around 46.2% of GOOD's debt is at a fixed rate with the rest a mix of floating and hedged floating rates. GOOD has generally been deleveraging its balance sheet with its net debt to gross assets at 45.4% as of the end of the second quarter. Critically, the company's near-term debt maturities will see only around 3.8% of its total debt, around $19.8 million, come due next year with another 4.8% coming due in 2025. Around $44.7 million of debt is still set to come due through 2023 as of the end of the second quarter.

Is this all manageable? Yes. The REIT is actively selling parts of its office portfolio at attractive IRRs plus held cash and equivalents of $16.5 million as of the end of its second quarter. GOOD is targeting 75% of its rents to come from industrial tenants, a target that saw the REIT renew 502,362 square feet with remaining lease terms ranging from 5.4 years to 14 years during the second quarter. GOOD has now extended and executed 858,768 square feet across eight tenants since the beginning of 2023. These have been at a weighted average remaining lease term of 8.9 years with an annualized straight-line rent of $6.4 million.

I Went Heavy On The Preferreds As Dual Beats Dull Bearish Concerns

I've been buying the Series E preferreds ( GOODN ) over the last few weeks. Firstly, they're monthly payers and currently come with what's an intrinsically safer 8.8% yield on cost whilst still trading for 75 cents on the dollar. I went heavy due to this outsized yield which also comes with the possibility of a future move of the preferred ticker back to its $25 par value. This is a possibility once the market sees a conclusive end of the current monetary tightening cycle.

GOOD reported second-quarter revenue of $38.66 million, up 5.8% over the prior first quarter and a beat of $1.69 million on consensus estimates. FFO of $0.41 for the quarter means the REIT is set to pay 73% of its FFO as a 3-monthly dividend. Hence, the common share dividends look safe for now as GOOD approaches a still favorable wall of debt maturities. The commons are a buy on the back of a healthy payout ratio and the overall long-term shift towards industrial.

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