Gladstone Commercial Corporation (GOOD) Q1 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Gladstone Commercial’s First Quarter Earnings Call. At this time all participant lines are in a listen-only mode to reduce background noise but later we will be holding a question-and-answer session after the prepared remarks and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now like to introduce your first speaker for today, David Gladstone. You have the floor, sir.

All right. Thank you very much for that nice introduction. And we thank all of you for calling in. We have a great deal of fun with these calls and enjoyed doing them. You’re ever in this area we’re in a suburb called McLean Virginia, stop mine say hello, you’ll see some of the people that here they’re over 60 members of the team now. And we’re over $2 billion in assets under management. Now we’ll hear from Michael LiCalsi, he’s General Counsel & Secretary and Michael is also President of Administration, Gladstone’s Administration. And it’s the administrator for all the public funds that we manage. He’ll make a brief announcement regarding some of the legal regulatory matters. Michael?

Good morning everyone. The report that you were about to hear may include forward-looking statements within the meaning of the Securities Act of 1993 and the Securities Exchange Act of 1934 including statements with regard to the Company’s future performance. And Forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. There are many factors that may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements including all the risk factors included in our Forms 10-K and 10-Q that we filed with the SEC. And those can be found at our website, gladstonecommercial.com, and on the SEC’s website, which is www.sec.gov. And the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. And in our report today, we also plan to talk about funds from operations, or FFO. FFO is a non-GAAP accounting term, defined as net income excluding the gains or losses from the sale of real estate and any impairment losses from the property plus depreciation and amortization of real estate assets. The National Association of REITs has endorsed FFO as one of the non-GAAP accounting standards that we can use in discussion of REIT. Now, please see our Form 10-Q, filed yesterday with the SEC, for a detailed description of FFO. And we also plan to discuss core FFO today, which is generally FFO adjusted for certain non-recurring revenues and expenses. And we believe this is a better indication of the operating results of our portfolio and allows better comparability of period-over-period performance. And to stay up-to-date on our fund, and the other Gladstone publicly traded funds, you can sign up on our website to receive email updates and the latest news plus you can follow us on Twitter, the username there is GladstoneComps and on Facebook, the keyword is The Gladstone Companies. And finally, you can visit our general website to see more information at www.gladstone.com. In today’s presentation is an overview, so we ask that you read our press release issued yesterday, and also our Form 10-Q for the quarter ended March 31, 2017, as well as the financial supplement that we prepared. And all these provide further detail on our portfolio and results of operations; these can all be accessed on our website, gladstonecommercial.com. And now we will begin the presentation today by hearing from Gladstone Commercial’s President, Bob Cutlip.

Thanks Mike. Good morning everyone. During the first quarter, we completed the lease up of both our Chicago industrial property and our Minneapolis office property sold a non-core property in Franklin, New Jersey for a nice capital gain of $5.9 million, issued $4.6 million of common and preferred equity through our aftermarket programs, we paid $35.4 million of maturing mortgages, continued our investor and investment bank outreach program by visiting with four registered investment advisors in three investment banks and conducting conference calls with fund managers to discuss operating results and strategy. Subsequent to the end of the quarter, we sold a non-core property in Hazelwood, Missouri completed the construction of the 75,000 square foot expansion of our industrial property adjacent to the Mercedes-Benz assembly plant in Vance, Alabama. We’re selected to acquire a 60,000 square foot multi-story office property in Philadelphia commenced activities to expand an existing tenant by 200,000 square feet on adjacent property in Big Flats, New York under a long-term lease and issued an additional $5.9 million of common and preferred stock under our ATM programs. As you can see from this overview we had another excellent quarter as we continue to re-lease a vacant property and maintain our exceptionally high occupancy. We are 97.9% occupied at March 31. We continue to be pleased with our activity and have a healthy pipeline of acquisition candidates. As noted during our last quarterly call, overall investment sales volume during 2016 was about 10% below 2015 as reported by national research firms. This slower pace continued through the first quarter. Entering the 9th year of the current cycle noted researchers have forecasted that the market cycle maybe peaking. And discussions with brokers at conferences reflect that listings are up but closings are down. Whether this leads to some cap rate expansion remains to be seen as research firms are forecasting that overall investment volume for 2017 will be similar to or maybe a little bit lower as compared to 2016, regardless our team will continue to monitor market conditions and actively investigate opportunities and will acquire properties when the tenant credit location and asset returns are accretive and promote our measured growth strategy. Now for some company specific details, we completed the physical construction on the 75,000 square foot expansion to our Lear industrial facility in Vance, Alabama. The tenant is now completing the furnishing of the building. The lease term will reset to 10-years on or about June 1. The average cap rate over the new term for the entire 245,000 square foot, $20 million investment is 10.4% so very accretive for us. We also began design activities for the development of a 200,000 square foot industrial facility for a tenant in New York. The new facility scheduled for completion the second quarter of 2018 will be adjacent to the 120,000 square foot industrial building that they currently occupy. The estimated total development cost is $12.6 million. Upon completion of the new facility the leases will reset to 15 years for both buildings. The average cap rate for the expansion will be about 8.9% so also very accretive. New properties were acquired during the first quarter, we investigated numerous opportunities in our target markets but we passed on multiple candidates because either the re-leasing risk was too great due to the tenant credit or building configuration or the estimated deferred maintenance and the near-term capital requirements were excessive. We are long into this expansion cycle and some sellers are motivated to take cash off the table and let the buyer assume these potentially near-term risks. That doesn’t fit our model. Now our team continues to have a strong pipeline of acquisition candidates exceeding about $350 million today, 18 properties and 11 of which are industrial where we’re placing increased emphasis. We’ve been selected for one transaction at this time a 60,000 square foot, $15 million multi-story office property in Philadelphia. Now closing on this transaction is not guaranteed but we’re optimistic that it will be added to our portfolio during the June or July timeframe. We also have three industrial properties in the letter of intent stage valued an excess of $50 million and the balance of the pipeline is under initial review. As we’ve noted on our previous calls the hallmark of our continuing high occupancy remains and will continue to remain thorough tenant credit underwriting in the mission critical nature of the property. Location and configuration are also important and over the past years – three years, excuse me, to promote this aspect of our strategy, we’ve invested in growth markets including Phoenix, Salt Lake City twice, Denver three times, Dallas four times, Austin, Atlanta twice, South Florida, Philadelphia, Indianapolis and Columbus, Ohio twice. This emphasis on select markets will also improve our overall operating efficiency. So our strategy is credit emphasis with an added focus on growth market locations. Our asset management team continued our strong leasing performance. As noted we leased the remaining space in our office property in Burnsville, Minnesota as well as the balance of the vacant space in our industrial property in Chicago. Both of these leases were for approximately 20,000 square feet and commenced in February. During 2015 and 2016 as I noted in our prior call, we successfully concluded 16 of 18 lease expirations resulting in over 1 million square feet of leasing activity. Year-to-date we have renewed three of the five expiring leases in 2017 representing 75% of expiring rents and have begun discussions with tenants whose leases expire in 2018. We have the three leases expiring in 2018 and only two in 2019. At this time only 0.5% of our GAAP rents were expiring in 2017 and 1.3% of our GAAP rent expire in 2018. Our team is focused on staying ahead of lease expirations and actively managing our properties. We only have one fully vacant property remaining today and that is the property in North Eastern Massachusetts, Newburyport an 86,000 square foot freezer cooler industrial property. We have one full building prospect and one prospect for 50% of the building at this time. We have also received and signed a letter of intent to sell the property as is. We will see how this unfolds over the next few months and in which direction we will proceed. As part of our portfolio rightsizing efforts to operate in cities we deem to have strong growth prospects, we sold one property during the quarter and one property subsequent to the end of the quarter. The overall capital gain from both transactions was approximately $5.8 million on book value. The initial capital investment was approximately $11.5 million. Both of these assets are considered non-core in our efforts to move out of smaller single asset market and redeploy the proceeds in our target locations. Since January 2015, we have exited eight single property markets as part of this capital recycling program. As we reflect on our recent portfolio efforts the better long-term news for our overall growth strategy is that only 4% of our forecast of rental income is expiring before 2020. So our cash rent should be stable and growing and our occupancy should remain high even if economic conditions deteriorate. This is an important fact for our shareholders, as the majority of our peers have a minimum of 20% and as high as nearly 50% of their leases expiring during the same period. The majority of our capital availability will be used to pursue growth opportunities because we do not anticipate needing significant capital for tenant improvements and leasing commissions to retain tenants and re-lease space or to fund operating deficits. Mike Sodo, our CFO is going to expand upon our refinancing activities, but I think it’s important to note that our refinancings continue to lower our loan to value, lower our annual interest costs and the amount of debt maturing is already reduce significantly through 2017. This combination of our improving capital structure, our lower annual debt costs on our same-store properties, the rightsizing of our portfolio and the opportunity to emphasize growth, positions us well in the current environment. So in summary, our first quarter and year-to-date activities continued our leasing and investment success, and we refinanced maturing mortgages at lower interest rates. Our team continues to have a strong pipeline of acquisition candidates and will adhere to our strategy of only acquiring properties with credit worthy tenants in growth markets that are accretive to our operations. Now, let’s turn it over to Mike to report on the financial results.

Good morning. I’ll start by reviewing our first quarter operating results. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common stockholders was $9.7 million or $0.38 per share for the quarter, while this is a 4% increase totaling approximately $350,000 over the prior quarter the per share number remains the same. This is a function of increase in common shares outstanding related to our opportunistic $14 million direct placement in December and our continued usage of our ATM program. This dry powder will assist us in funding the acquisition pipeline that was laid out by Bob. Our first quarter results reflects an increase in total operating revenues to $22.3 million, as compared to total operating expenses excluding impairment charges of $14 million for the period. Net operating expenses at the property level declined by approximately $150,000 from the fourth quarter. In addition, we continue to reduce our interest expense by $100,000 from Q4, due to our gradual deleveraging and efficient loan refinancings. As Bob mentioned, we did sell one non-core property during the quarter, the sale resulted in a gain of $5.9 million. Now, let’s look further into our debt activity and capital structure. We continue to have a strong balance sheet as we grow our assets and focus on decreasing our leverage. We’ve reduced our debt to gross assets to 51% from 57% at the beginning of 2016 through refinancing maturing mortgage debt at lower leverage levels and redeeming our Series C preferred stock, which was considered debt due to its mandatory redemption date. We expect to continue to gradually decrease our leverage over the next 18 to 24 months. We continue to use primarily long-term mortgage debt as well as our line of credit to make acquisitions. As we grow through disciplined investments, we’ll look forward – look to expand our unsecured property pool with additional good assets. Overtime this will only increase our funding alternatives. As we manage our balance sheet, we repaid $35.4 million of maturing mortgage debt during the quarter with a combination of borrowings under our line of credit, cash on hand, equity and proceeds from our Franklin, New Jersey asset sale. Over the past 15 months, we’ve repaid $115 million of debt, primarily with new variable rate mortgages and interest rates equal to the one month LIBOR plus a spread, generally ranging from 2.35% to 2.75%. We have placed interest rate caps on all these new mortgages. We also added some of these properties to our unencumbered pool under our line of credit in an effort to provide more flexibility in the future. Prior to the refinancings, these mortgages had a weighted average interest rate of 6%. Our deleveraging and refinancing efforts have been tremendous success with first quarter interest expense decreasing by approximately 8.5% versus first quarter 2016, on an annual basis this equates to a $2 million reduction in interest. Looking at our upcoming maturities, we have only two balloon principal payments of $22.1 million payable during the remainder of 2017. These loans have a weighted average interest rate of 5.4%, we anticipate refinancing these maturities into new long-term debt or adding some of these properties to our asset pool under our line of credit, either outcome should result in reduction interest expense. Long-term mortgage debt continues to be available, but it’s slightly higher rates than we’ve experienced in recent years. Interest rates have been volatile in the past six months, this has been a function of global uncertainty, changes in the government including anticipation of further potential Federal Reserve rate hikes and the unknown future of the U.S. economy. With all that said, interest rates do still remain retroactively low from historical perspective and we’ll continue to actively try to match our acquisitions with cost effective debt. Depending on several factors including the tenant’s credit, property type, location, terms of lease, leverage and the amount and term of the loan, we are generally seeing interest rates in the 4% to 5% range. Finally, I’ll turn to our equity activity during the first quarter, which I referred to previously. We raised both, common and Series D preferred equity under our ATM programs during the quarter for combined net proceeds of $4.6 million. We use these funds primarily for deleveraging the balance sheet and tenant improvements at certain of our properties. We continue to view the ATM is the most efficient way to deploy equity. Subsequent to quarter end, we issued another $5.9 million of equity through the collective ATM programs to support the acquisition pipeline. As of today, our available liquidity is approximately $32.1 million comprised of $7.1 million in cash, and available borrowing capacity of $25 million under our line of credit. With our current availability and access to our ATM programs, we believe that we have enough liquidity to fund our current operations, deals in our pipeline, and any known upcoming improvements at our properties. We encourage you to also review our quarterly financial supplement posted on the website, which does provide more detailed financial and portfolio information for the quarter. We feel good about executing our business plan for the rest of the year, as we continue to increase our high quality asset base and continue to improve our metrics inclusive of leverage. We’re focused on maintaining our high occupancy with strong credit and real estate. Institutional ownership of the stock increased by 13% over the past 15 months to over 53% as of – the end of the first quarter. Certainly some of this is a function of being included in the RMC index last year. In addition, David, Bob and I have been extremely active and meeting with current potential institutional and retail investors, portfolio managers, investment banks in the like, through these initiatives David, Bob and I look forward to further engaging with not only our existing investor based lenders and coverage analysts, but also establishing new relationships as the company moves forward to its next chapter. And now I’ll turn the program back to David.

That was good report Mike. Thanks so much. And Bob Cutlip and Mike LiCalsi good reports as well. Main news again is very similar raise common and preferred stock for future acquisitions, we have a nice list of potential acquisitions, leased more vacant space that we have and repaid maturing loans or refinance them at lower interest rates and positioned ourselves for growth. The one item that Bob mentioned, which was the Alabama thing explains our success in the marketplace and that we’re willing to step up and help existing tenants, do most anything including expanding plans. Obviously, we have to increase the rent and we build on to it. As many of you know, the Company didn’t cut its monthly cash distributions during the recession that was quite a success story. We watched many very good REITs cut their distributions, most of them are never recovered, bringing the dividend back to the original level and we’re in a great position not to have a problem if the economy hits the skids again. Here is some of the things that we’re doing today. We need to continue to increase the common stock marketplace capitalization in order to increase the trading volumes. This will give the institutions who want to buy the stock, the ability to do this. Institutions always say the same thing; they want to be able to buy $10 million, $20 million, $30 million worth of our stocks. So we need to be big enough to accommodate that, they also want to obviously sell some day and so they want liquidity. We continue to grow the company, but consistently, we’ve built our assets and equity base doubling the size in the past five years with this growth, we hope we will see more buyers come into the stock and that should hopefully help to increase the price and lower our cost of capital. And as they lower their cost of capital, obviously, we can buy different properties that we are precluded from buying today, because of their low cap rates. We’re raising more preferred stock in the Series D, which has a 7% yield. We have a new webpage in our website at www.gladstonecommerical.com that explains this preferred stock. We can’t redeem it for five years. So its very investor friendly and I think that’s the reason most of the institutions have piled into it. We have some very large institutions that have been buying that preferred stock all of those names have been known to you, as we started to reveal them. So we have interest in our company and I don’t think it’ll be very long before many of those same institutions are being a buying a lot of the common stock as well. We continue to have our promising list of potential quality properties, doesn’t mean we’re going to jump on every one that comes in and we are interested in acquiring even though, we didn’t acquire any during the quarter. We expect to continue to grow the asset portfolio even more during this year that we’re in and with an increase in the portfolio of properties comes greater diversification. We believe that’s better for our earnings – better protection for the earnings. However, please know that the prices are good – prices to date to buy good buildings are very, very difficult and it takes us a long time to fund what we exactly want every time we buy something. We’re focusing our efforts on funding good properties obviously, and with long-term financing to match the long-term leases and this is been a hallmark of the company from day one as matching the long-term leases with long-term debt and that keeps us out of trouble, when banks get in trouble. Being able to lock in those long-term financings, wonderful for us in the future between 2017 and 2019, we only have about 4% of the forecasted rents expiring with manageable debt maturities along the way. We’re much more optimistic that things are going to be positive for us over the next four or five years. So stay with us, we like having all of our good shareholders right with us during these times. Much of the industrial base today is businesses that rent industrial and office properties like our properties. They remain steady and most of them are paying their rent. So we don’t see many defaults out there these days. As you know, we have a terrific credit underwriting group that underwrites each of our tenants, that’s the reason we’re able to go into some of the transactions that others don’t. And considering the track record of our tenants paying their rent, I think it’s hard to beat the fact that we do have a very bright future underwriting these tenants that we see. It’s the strong underwriting that kept the company more than 96% occupied from 2003 to today. Well, I’m optimistic that our company will be fine in the future and I want you to know that all of us, Bob and I in particular continue to be very cautious in the acquisitions that we’re doing, just to make sure we don’t have any problems just because we want to be bigger than we are today. We’re not going out buying everything that hits the deck here. And made it through the last recession without cutting the dividend, having a lot of problems from the tenants and I think if there’s another recession lurking on the horizon, portfolio continue to be steady and strong as it has in the past. In April the Board voted to maintain the monthly discretion of $0.125 per common share for April, May and June, it’s an annual run rate of $1.50 per year, this is still a very attractive and well managed REIT like ours and it don’t come along every day. So this is one of the few gems that are out there in the marketplace. And yes, I know, you’re always asked the same question when we’re going to increase the distributions and all I can say is, at this point the FFO as it increases will have to look at some small increases over time. We’ve now paid 147 consecutive common stock cash distributions and we went through the recessions without missing any of those. It’s just a wonderful track record and because the real estate can be depreciated all of you know we’re able to shelter the income, last year 71% of the payback was from return of capital. So this is a very tax friendly stock in my opinion, it’s a good place to put in your personal account, you don’t need to put it in your IRA or Keogh or any of those. This return of capital is mainly due to the depreciation of the real estate and other items and it’s caused earnings to remain low after depreciation that’s why we talk about FFO and core FFO, because it adds back the real estate depreciation. As most of you know depreciation of a building is a bit of a fiction anyway since at the end of the depreciation period the buildings use – they are still standing and still strong and usually rented. So it’s a kind of fictitious that goes on in the tax world. If you own the stock in a non-retirement account as opposed to having into the IRA or retirement plan, you don’t pay any taxes on that part that is sheltered. So the money is coming in, you’re able to use it. However, of course, when you sell your stock you supposed to reduce your cost basis based on that amount that you got back and pay a capital gains on hopefully a larger amount. On Monday, the stock was about $22.08, distribution yields about 6.8%, many of the other REITs are trading at much lower yields, the average Triple Net REITs that are some like us are at 5.6%. So we’re way above that in yield. So the stocks trading at a yield that – if the stock was trading at a yield of 5.6%, we’d be at $26.78 that’s what we’re aiming for us to get to the average and we are going push hard to try to get there. In these calls, I’ve suggested to buy the stock because there was a projection that the company get as it gets larger will trade like its peers, some of the peers and most of the peers are trading at about 5.6% for those of you who purchased the stock you’ve seen the stock price increase if we paid that $150 million per year in dividends. Now I’m going to tell you, you have to go out and buy the stock again, because as we progress and the income increases based on our projections that we’re looking at any increase will put pressure on us to increase the dividend. No guarantee, we’re going to increase the dividend but that’s the goal. And it’s simply no reason a company like this REIT trade such a high yield given the track record, since 2003 and the low lease turnover during the next four years. We have a great company and when we were doing our preferred stock, we asked one of the rating agencies to rate us and they rated us as a triple V [ph] and the guy who was doing that said, he’d never seen a company that had only one bad deal since 2003. I know the analysts who will say, you will manage but you’re externally managed then the mains that you should be, I don’t know. They get so upset about external management that they make me angry. Our high occupancy level is a testament to the access, we have to these great credit underwriters we are a REIT that looks first to the tenant to make sure they can pay the rent whereas most REITs looks first to the real estate and more and more REITs are externally managed. So we ought to get off of that. We also performed an analysis of cost of operating this REIT versus the REITs that are internally managed and there’s really no difference, whereas the internally managed or externally managed and as you know as we get bigger, we’ve said that as we’ve approached $1 billion would adjust the management contract, we did that. The management contract is now lower in terms of fee being paid. And I just want to push one more item of this externally management. When the recession came the internal REITs cut their dividend we did not. And now because it’s externally managed, we can cut the management fee, if we need to, during that period of time we fade back or we didn’t collect $18 million worth of dividends, worth of fees that we should have collected. That is we gave it back and it was very easy to do that and I just ask how many internally managed REITs had their managers cut their salary in order to give money to stockholders like we did. My guess is none. So that’s just another reason to be externally managed because at that point, you can be able to cut your fee pretty easily. So keep in mind that using our ATM program, we’re going to continue to grow the company in the past years, because we’re extremely managed. We have high flexibility, we gave back $18 million worth about $0.72. So I know a couple of you have called me and said, what are these articles that are out there, well the two articles that are out there from people who are shorting the stock. They’re trying to knock down the stock so that they can make money. And I would say to all of you don’t listen to the articles they’re making statements that are mostly false and it just seems to me that anybody who’s trying to make money or knocking a price of a share down is not a good person to be listening to. They’re just in it for themselves. So now we’ll have some questions from our shareholders and analyst who follow this wonderful company. Operator, please come on and we’ll try to answer some questions.

[Operator Instructions] We will be taking our first question from the line of Dan Donlan from Ladenburg Thalmann. Your line is open.

Thank you and good morning. David all the talk on the external management agreement makes you think you must know I was in the queue.

We still love you, Dan. I know you don’t like external managers but still love you.

Well, to be honest with David at this point time given where you’re trading not – doesn’t seem to be an issue for investor itself. Our issue has always been that externally advice, we intended to trade at discount to NAV and clearly that’s not the case now. Just want to move to kind of growth versus the deleveraging. You’ve got a good cost to capital now with your equity. So I’m just curious, how you’re looking to manage that, it’s oftentimes kind of hard to grow when you’re delivering. But given your comments about how far we are out in the recovery. I’m just kind of curious your – how you weighted too?

Dan, as you know I’m highly in favor of leverage. I have been in this business and I think because we don’t have the kind of defaults and problems that others have had. That we’ve had this over 96% rented REIT for so long, that it’s proved that what we’re doing is not the high risk proposition that many REITs get into. And I don’t disagree with what they’re doing. They’re going out trying to make a lot of money by building things and changing things. We’re just sluggers, we’re in there every day, buying companies, buying buildings that have companies that are just solid payers of rent. So we’re building ours one brick at a time and growth for us is dependent on what we see in the marketplace. If we find the right one, we’re going to buy it. We’re under – Mike under a 50% leverage now.

We’re at 51% on a book basis.

51% on a book basis, that’s a nice number for me, Dan. I would like to knock it down any more than that. As you know during the last three or four years, we’ve been every time we were refinance something we borrowed less against the building even though it had probably gone up in value than we had before. So we had to put equity in. I’d like to stop doing that but I’m going to follow Bob on this. And Bob has to live with his leverage and so do I but, I want to grow and we’re going to grow, it just won’t grow as fast as someone would in this position. And I don’t really want to delever beyond this. But Bob will probably delever it down in the 40%s. So that he looks well, when he’s talking with people, he’s out in the marketplace today and one of the things people always say is you’re highly leveraged. Well, we’re not highly leveraged if you look at the track record of the company. We’ve been able to pay our dividends, we’ve been able to do things that others haven’t been able to do and given the strength of the portfolio, I just think deleveraging as a mistake. But Bob, you want to answer how you’re going to deleverage.

Sure. And Mike can add to this. I think Mike and I have spoken with a lot of analysts, investment banks, investors. And we think that if we lower the leverage another 5% to 7% maybe Mike – we think we are where we are. I mean, I think as David said, and what has always and I’ve had this conversation with you, before Dan. What always impressed me when I before I joined this company was our ability to acquire properties with people who are long-term rent payers. And I think our renewal percentage kind of supports that. And so yes, I think we can be a little bit higher leverage but for us to get I think more institutional coverage and to get even better multiples on our income. We’re going to need to lower and lower a bit. So you know 5% to 7% is where I think we’re going to be going Dan.

Okay. I appreciate the comments. And then as we look at this kind of shifting to set future financings, how do you feel about unsecured versus secured debt. A lot of the bigger public REITs IT is unsecured. But it kind of does limit their ability to hand back buildings and in the event something goes wrong. So just kind of curious, how you’re viewing that and if you’re going to continue to use more secured debt in order to protect yourself in the event of default or something like that.

Yes. Thanks, Dan. And I’ll address that. I think by and large you will see predominately continue to use secured debt, candidly we’ve been watching the peers, appreciating how other people do use corporate debt, corporate unsecured debt, I would think it would be reasonable over time as we grow the portfolio and some of those buckets of capital become more viable to a larger company that you would see some gradual shift in terms of contemplation and execution on the unsecured side. But all this is just going to be done on an organic level, we’re not going to wake up one day and have a dramatically different balance sheet. So by and large sticking to the Gladstone strategy, but probably with some trending toward being closer to our peer set from a desirable corporate execution.

Okay, appreciate that. And then maybe Bob for you. As you look at your – at the portfolio you definitely seem to shift to more higher growth markets with your acquisitions since you come on board. Just kind of curious, what percentage of the portfolio you may view as non-core, I mean you’ve been an active seller over the last couple of years. When – does that continue and how do you see that trending.

Well, I think a lot of its market driven there’s a couple of factors that we look at. As David indicates, we want to grow the portfolio or we can’t go into a wholesale capital recycling program and we don’t need to because these tenants are good rent payers. But when we look at long-term operating efficiencies, we know that we need to reduce the number of markets that we’re going to be operating in. Our goal and we stated in our business plan is for us to get down to 30 to 35 markets over time. We’re now just under 50 markets but it’s going to be gradual because we’ve already gone through renewals with a number of these smaller tenants. But as the opportunities present themselves and we can match acquisitions with the dispositions will continue to slowly leave those markets. But it’s going to be gradual, this is a marathon, it’s not a sprint and the team has done a great job of selling assets, when it made sense and we’ll continue to do so. But it’s not going to be aggressive Dan, just because the quality of the cash flow is very good. But long-term to be a better operating company, we do need to be in fewer markets and we will be.

Okay, it makes sense. And then just in terms of asset type. Something that you continue to add to both office and industrial. Is there any type of bent towards one or the other it really just simply depends on the tenant credit and I hate to use the word mission critical, but maybe the importance of the asset to the tenants underlying business?

Well as David said, first and foremost we look at the tenant and we spend a lot of time there. We look at the mission critical nature of the property, I mean as he indicated we’ve only had one BK in the entire history of the company approximately 100 tenants. So that is critical to us. I think from the standpoint of just looking purely real estate, we would like to move more towards industrial and as I indicated in my comments, we are being able to see – we are able to see more industrial now just because our cost to capital is dropped. And I like to move that to more of a higher percentage on the industrial long-term, but we’re not going to be in a big rush to do it. The majority of our pipeline right now is industrial because we can’t operate in that space. But we will continue to be looking at mission critical first and if it’s in office property, we will buy it.

Okay. Thank you, appreciate it.

Okay, next question.

Our next question comes from the line of Larry Raiman from LTR Capital Management. Your line is open.

Thank you. Good morning, everyone. Nice job on the quarter to the team. Two quick questions, first, with regard to any maintenance capital expenditures in the portfolio, I know so many of your properties are net lease than there’s not much lease roll. But in terms of maintenance requirements at the company level regarding parking lots or routes, could you guide folks with regard to how much money you spend in that activity?

Yes. This is Bob. And I can give you a macro right now and Larry, I can give you some more specifics when I have access to it. But this year for both tenant improvements and the capital for the buildings themselves. We’re looking at about $7 million and of that it’s about 50-50 with tenant improvements – and tenant improvements and building improvements. We have probably another $4.5 million of capital we’re going to expand during the first half of the year relating to that expansion of the Lear facility. But you could probably anticipate that with the size of this company our recurring cap improvement for us is probably $3 million to $4 million a year.

So $3 million to $4 million a year for just building, maintaining it not reimbursed by the tenants, is that correct.

That is correct.

$3 million to $4 million.

Yes, it’s about – and it’s probably closer to $3 million because some of our capital requirements on these buildings, we do get amortization of HVAC systems and roofs depending upon how the lease is structured and of course, we inherit the lease that is given to us when we buy the property.

Right, okay. Thank you for that disclosure. And then one final question there was a – I saw on the income statement that there was about a $3.7 million reserve taken for an asset. Could you describe what happened there?

Sure. And Larry, it’s more further expanded within the footnotes of the financial. The impairment charges of $3.7 million were pertaining to the accounting assessment on two non-core properties within the portfolio. Obviously, appreciating as an accounting exercise that goes along with that where you probability weigh. Your sales scenario as well as – cash flows for the remaining lease clearly within the accounting guidance you don’t get upside on any of your properties within your GAAP income statement. You take the down side so these would be two properties that as of today we consider that non-core and it’s just part of really the quarterly assessment of the entire portfolio.

And are those assets that are earmarked for sale at some point in the future.

I wouldn’t say. Bob can expand after I speak to it. I don’t think of that’s a probable scenario, it’s a possible scenario. But they would be ones that potentially at the right price we would certainly consider it.

Okay, thank you.

Next question.

[Operator Instructions] Looks like we have no other questioners in the queue at this time. So I’d like to turn the call back over to Mr. Gladstone for closing comments.

All right. Thank you all for all the support you’ve given us. Just watch, we’re going to keep going, keep growing. Thanks again, that’s the end of this call.

Ladies and gentlemen, thank you again for your participation in today’s conference call. This now concludes the program and you may now disconnect your phones at this time. Everyone have a great day.