2024-01-04 02:05:15 ET
Summary
- Gladstone Commercial slashed its dividend by 20% in 2022 to align with lower earnings, but the dividend has remained stable since.
- The struggling U.S. office market has impacted the Company's performance in 2023, but the central bank's potential interest rate cuts in 2024 could provide hope for the market.
- GOOD stock may see a re-rating higher with changing fundamentals and potential recovery in the commercial property market in 2024.
In December of 2022, Gladstone Commercial Corporation (GOOD) slashed its dividend by a whopping 20% to realign its payout with lower underlying earnings for its real estate portfolio.
The real estate investment trust has paid a stable $0.10 per month dividend since, however, and the dividend remained well-covered by the trust's funds from operations in the last three quarters.
The central bank could give the struggling U.S. office market, which I think can be blamed for Gladstone Commercial's underwhelming performance in 2023, hope and potentially a shot in the arm in 2024.
With fundamentals possibly changing next year in terms of lower short-term interest rates, Gladstone Commercial's stock may finally re-rate higher.
My Rating History
I issued a Buy recommendation for Gladstone Commercial in March 2023, suggesting that passive income investors might want to consider buying the 52-week lows back then.
Unfortunately, the stock price of the commercial real estate investment trust has consistently slipped throughout the year, which in my view is related to Gladstone Commercial suffering from its association with the office sector.
With the central bank now primed to take pressure off of short-term interest rates in 2024, Gladstone Commercial might finally see a recovery.
Central Bank Is Set to Shift Gears In 2024
The main purpose of Gladstone Commercial is to invest in single-tenant and anchored multi-tenant net leased properties, mainly in the industrial category.
The real estate investment trust also owns office properties that are facing unique headwinds from changing market dynamics as well as high interest rates.
At the of the third quarter, Gladstone Commercial had 135 properties in its real estate portfolio that reflected 17.2 million square feet of both industrial and office real estate. The property portfolio produces $148.9 million in lease revenue annually, based on a LTM basis, and had solid occupancy of 96.6%.
About 59% of the trust's income is produced from its industrial investments whereas 37% of revenues come from the office category. Offices have suffered mightily in 2023, due to the central bank pushing rates up, making refinancing not only more expensive but also harder to come by as lenders, aware of the risks, have pulled back from commercial property lending.
Furthermore, the office market has been under pressure as more workers than ever before are working from home and vacancies in the U.S. office property market have been rising since the pandemic.
This poses a challenge for office commercial property investors, banks and other lenders as vacancies are set to rise further when lease extensions are to be negotiated. Office-focused real estate investment trusts might force to write down the value of their office holdings if their rental income streams decline. These factors have quite considerable weight on valuations of commercial property REITs in 2023.
The announced shift in the Fed's strategy with respect to interest rates is set to help commercial property investors and financial institutions and by extension Gladstone Commercial.
With pressure coming off short-term interest rates in 2024, I think Gladstone Commercial may see also improving fundamentals in the commercial property market.
Dividend Cut Has Been Effective In Establishing A Healthier Payout Ratio
With everything that played out in 2023, mainly the deterioration of the fundamentals in the U.S. office market, the dividend cut in December 2022 was a necessary and ultimately effective way for the real estate investment trust to correct its unsustainable payout ratio.
Gladstone Commercial has paid a $0.10 per share per month dividend, starting in 2023, and the trust's dividend has consistently been covered by its funds from operations. As of 3Q-23, the real estate investment trust paid out 91% of its funds from operations and succeeded in lowering its LTM payout ratio to 88%, down from 97% in 1Q-23.
FFO Multiple And Upside
There is no guidance available for Gladstone Commercial, but merely going with 3Q-23 run-rate fund from operations implies FFO potential of somewhere around $1.30-1.32.
Gladstone Commercial is selling for $13.38 at the present time, thus reflecting a 10.2x leading FFO multiple. STAG Industrial, Inc. ( STAG ) , a pure-play industrial trust I recommend to passive income investors due to its eCommerce potential sells at a 2023 core FFO multiple of 17.3x while Prologis, Inc. ( PLD ) , a leader in the industrial property market, sells for 24.0X estimated 2023 FFO. The discount to Gladstone Commercial is probably due to the fact that the trust's portfolio includes office properties that are subjected to unique market headwinds.
2024 And An Evolving Risk Situation
Just because the central bank has said that it will seek interest rate cuts in 2024 doesn't mean that the market will immediately feel the impact of lower financing costs and therefore the recovery potential of GOOD may be suppressed.
Gladstone Commercial obviously would profit from an accelerating speed of interest rate cuts, but a strongly performing U.S. economy could give the central a good reason to take it easy with its timeline.
The longer it takes for interest rate cuts to actually trickle through to the bottom of the economy, the longer valuation headwinds might persist for Gladstone Commercial.
My Conclusion
Gladstone Commercial's valuation got clobbered in 2023 as a number of storms gathered on the horizon:
First, the real estate investment trust lowered its dividend by a not-insignificant 20%. Second, concerns over the state of the U.S. office market have weighed on the trust's FFO multiple.
With the central bank now poised to take pressure off of short-term interest rates, I think Gladstone Commercial might see an FFO multiple recovery in 2024. The dividend has now been covered consistently for three quarters with funds from operations and with conditions in the U.S. office market potentially improving in 2024, with help from the central bank, I continue to bet my chips on Gladstone Commercial's 9% yield.
For further details see:
Gladstone Commercial: 2024 Could Finally See A Re-Rating