Greetings. Welcome to Gladstone Commercial Corporation's Fiscal Year Ended December 31, 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . Please note this conference is being recorded. At this time, I'll turn the conference over to Mr. David Gladstone. Mr. Gladstone, you may begin. Mr. Gladstone, please go ahead.

Thank you, all for tuning in, and thank you, Rob. I appreciate everybody coming in this morning. This is Gladstone Commercial's quarterly shareholders call for the year ending December 31, 2020. And we have a good time on these. We'll hopefully get some good questions at the end.

Thanks, David and good morning. Today's report may include forward-looking statements under the Securities Act of 1933 and Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that are based on our current plans which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all Risk Factors in our Forms 10-Q, 10-K, and other documents that we file with the SEC and you could find this on our website at www.gladstonecommercial.com, specifically on the Investors page or on the SEC's website which is www.sec.gov. Now we undertake no obligation to publicly update or revise any of these forward-looking statements whether as a result of new information, future events, or otherwise except as required by law. And today, we will discuss FFO, which is Funds From Operations. Now 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 on property, plus depreciation and amortization of real estate assets. We'll also discuss FFO as adjusted for comparability and core FFO, which are generally FFO adjusted for certain other non-recurring revenues and expenses. Now we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. And please take the opportunity to visit our website once again gladstonecommercial.com; sign up for our e-mail notification service. You can also find us on Facebook, keyword there is The Gladstone Companies and our Twitter handle is @GladstoneComps. Today's call is an overview of our results. So we ask that you review our press release and Form 10-K, both issued yesterday for more detailed information. Again, you can find them on the Investors page of our website. Now I'll turn the baton over to Gladstone Commercial's President, Bob Cutlip. Bob?

Thank you, Michael. Good morning, everyone. During the fourth quarter, we acquired three industrial properties totaling 674,000 square feet, and $46.9 million in investment volume in Pittsburgh, Pennsylvania; Montgomery, Alabama; and Huntsville, Alabama. Sold a three properties single-storey office portfolio in Champaign, Illinois, for $13.4 million, resulting in a gain of $4.1 million; sold a 52,000 square foot single-storey office property in Austin, Texas, for $8.6 million, resulting in a gain of $2.8 million; extended the lease for our 21,000 square foot industrial tenant in Bolingbrook, Illinois, for an additional seven years; executed a lease for 21,000 square feet at our Akron, Ohio single-storey office property for seven years; extended and expanded the lease for five years for an office tenant in our Indianapolis anchored multi-tenant property and collected 99% of the scheduled rental income during 2020, with the remaining 1%, representing deferred rent to be paid over time.

Thanks Bob. Good morning. I'll start by reviewing our operating results for the fourth quarter of 2020. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common stockholders were $0.37 and $0.38 per share for the quarter respectively. FFO and core FFO available to common stockholders were $1.56 and $1.57 per share for the year respectively. This performance demonstrates the accretive yet prudent growth of the company as well the performance of the employee's portfolio. In addition to these accretive deals, our same-store cash rent continues to grow at 2% on an annualized basis. Our fourth quarter results reflected stable total operating revenues of $32.9 million as compared to total operating expenses of $24 million for the period, excluding one property impairment charge. As Bob laid out, our team is actively engaged with every tenant of ours, as we intend to maximize shareholder value through and beyond the COVID-19 pandemic. We're pleased with the teams and portfolios continued exceptional performance, but these are uncharted times. We continue to enhance our strong balance sheet, as we grow our assets and focus on decreasing our leverage. We've reduced our debt to gross assets by nearly 15% to 49.9% over the past five years through refinancing, maturing debt and financing new acquisitions at lower leverage levels. We believe that we're 1% to 2% away from our target leverage level long-term.

All right. Mike, that was a good report and a good one from Bob Cutlip and Michael LiCalsi too. The team continues to perform and this company has not been hurt much by the various government reactions to COVID-19. It was a very nice quarter and a nice year altogether considering we came through some difficult times. You've heard a lot today about the numbers for new transactions and new leases and the quarter really is impressive. We collected all the rents that were due from tenants in the first quarter, 98% in the second quarter, third quarter rents collections are strong 99% and were 98% collected in the fourth quarter, so very strong performance. We bought three industrial assets during the quarter. We executed two lease extensions and one new lease during the quarter. And finally, we sold three non-core assets in Champaign, Illinois, and at the same time, we sold one property in Austin, Texas, that's a smaller building in Texas. The commercial team is growing the real estate we own at a really good pace now. And the team is doing a great job managing the properties, we own especially during the pandemic. Our team is strong; professionals continue to pursue potential quality properties on the list of acquisitions they're reviewing. Our acquisition team is seeking strong credit tenants that's the first thing we look at. They know that the quality of the tenant is the reason we buy the real estate and makes excellent investments when we spend time there. Our asset managers are actively managing the properties that the company owns today in order to maximize their value. It's a different environment that we're living in today. The middle market business which is where we’re, that's most of our tenants, like many of our tenants is being challenged with the Government's restrictions related to COVID-19. But our tenants are paying their rents and committing to pay any past deferred rents that we've stacked up on the balance sheet. This is the times that we've become very good at negotiating with our first-class tenants. And so we'll see if that works out over time, and I think it will. I'm going to stop here and have Rob come on and let's get some questions from those of you that are listening in today.

Thank you, Mr. Gladstone. At this time, we'll be conducting a question-and-answer session. . Thank you. And our first question today is coming from the line of Barry Oxford with D.A. Davidson. Please proceed with your questions.

Great, thanks guys. Getting back to the capital recycling and selling one-storey office buildings and moving into industrial. Bob, how should we think about the cap rate differential?

Well, as it relates to, we're selling those at levered returns of 13 to 15. The cap rate themselves are somewhere around 7.5% to 8.5% and then we're acquiring product in the 6.25% to 6.5% but with our GAAP rent at about 7.4% to 7.6%.

Okay. Okay, thanks. And then --

And one thing, if I could add to that, Barry.

Go ahead, yes.

One of the key reasons that we plan to do this is that re-leasing and re-tenanting single-storey office properties is extremely expensive. You have a 60,000 square foot single tenant property that has, let's say, the restrooms all over the place. And then they move out and you have to break it up into multiple tenants. The cost of demise separate electrical service, add new restrooms far exceeds what I think is the margin drop when we go from selling them to investing into an asset that has very, very low re-leasing costs.

Right. Now that that absolutely makes sense. Switching gears a little bit, when we're looking at rent deferrals, are we through the bulk of that and you shouldn't be seeing too many "phone calls" coming through. And then also a question for Mike, how should we think about bad debt expense in 2021?

Okay. On the rent deferrals -- we -- as I indicated in my comments, I do expect to probably receive a view more over the next three to four months until the vaccine rollout really gets around across the populace. We're seeing from our office tenants that they're planning to come back to the office in the second quarter, second, and third quarter of 2021. And that's COVID permitting. But we're somewhat encouraged, and I think, Barry what I think really helps us is that we have always connected with our tenants every quarter. So we have a personal relationship with them. And if we do have upcoming rent deferrals, I know that we'll either be able to extend the lease or get the return within a very limited period of time.

And Barry, specific to the second piece of your question bad debt expense, I believe you're really referring to rental collection and the implications of accruals there.

Correct.

The guidance itself dictates a fairly high bar in terms of probability of Ultimate Collection that you must solve for to continue to accrue for rents. Our childcare tenants that we've given interim deferrals to 2019 was their best year on record. We believe this is an interim event, and they're a long-term profitable growing concern that has resulted us in continuing to accrue rents for that property. So really the only thing that we would be aware of today would be that 0.01% that Bob made mention to with that 6,000 square foot Medical Office tenant.

Okay, great. Thanks, guys.

Thank you.

Thank you, Barry.

Next question?

The next question is from the line of Gaurav Mehta with National Securities.

First question on the Austin market, I was hoping if you could talk about some of the supply that's coming in office market at Austin, and how that's impacting your efforts to re-lease your vacant space there?

Actually, the new product has slowed down. And since we're up in the North, North East section, and we're directly across from where BAE is going to be putting their upcoming campus, we're actually very encouraged about the demand for the space. I don't have the specifics, but I will get the specifics to you, Gaurav, so that you know how much it is. And I'll also send it to everyone else on the line.

Okay, great. What kind of feedback are you getting from prospects in regards to that property in terms of why they're not signing up the lease?

Part of it is that they can't get through the property. With what's transpired in Texas, it first opened, and then it closed. And so getting demand and we have demand from places on the West Coast and in Chicago. And so getting those people to tour the property has been difficult. But as I indicated, the five prospects that we have right now, two of which were started were really collected by the Chamber, and then the other is through our brokerage group, through their national kind of investment sales side of the business and leasing side of the business. We're somewhat -- I'm somewhat encouraged, I mean I think what's going to happen if I had to really place a probability is that it will turn out to be a multi-tenant building, and it'll probably have two to three tenants in it. But it's set up so well with 40,000 square foot floor plates on two wings. And most of the prospects that we're seeing are multiples of 40,000 square feet, they can each take a single floor and expand and yet have security since both wings have their own separate elevator bank. So, Dell did a great job on the design and construction of the building. And so once we actually can get a lot more people through the building, I think we're going to have very, very positive outcome.

Okay, thank you.

Thanks, Gaurav. Any more questions?

Yes. The next question comes from the line of Rob Stevenson with Janney.

Good morning, guys.

Good morning, Rob.

Just a follow-up on that -- on the last question, I mean when you look at the Austin asset, is a sale here to a tenant that would occupy the whole building is that on the table at this point, you guys explored the relevant return of an outright sale versus re-leasing it?

You're exactly right, Rob, that is one of the options. It definitely could happen. And with our current basis, I believe that's in the mid-$30 million right now. We would realize a very strong capital gain that we could redeploy in industrial assets very quickly. And as I've indicated to Gaurav, I mean we have, I'm not too excited about having a large multi-tenant office property long-term, it's in a great corridor, the Palmer Technology Corridor has all the high-tech companies there. So it's going to be a successful asset. But it also tells me then, that we would have a very successful exit from that property that we can go and redeploy the assets into our preferred asset class of industrial.

Okay. And beyond the former GM space, where is the -- where are the larger pockets of vacancy left in the portfolio today?

Okay. We have a property that is in Tulsa, Oklahoma, it's an industrial property at the port. And we have a Letter of Intent out to a prospect right now, for two-thirds of the building. We have a single-storey office property that's been converted to industrial in Minneapolis. And we're right now negotiating a lease for two-thirds of the property, which I think is very positive. We also have another three-storey office property in Minneapolis that is two-thirds -- two-thirds leased. We have a property let's see, let me make sure I get it right. We have a property in Houston, that's the lab that we're talking about that's 12,000 square feet, and a tenant is going to -- is actually vacating that space. And what's very good about that is that the adjacent medical provider is interested in expanding into a good portion of that to be vacant space.

Okay. And then when you take a look including the GM space as to whatever incremental cost, you need to get that into shape for multiple tenants, et cetera. How much tenant improvements and leasing commissions, are you expecting to need to lease up your current vacancy? What's the sort of ballpark there when you think about it in aggregate as to how meaningful that'll be?

You're talking about the Palmer -- Palmer building?

Just all those -- just whatever vacancy that you're working on today, I mean, obviously, there's a cost right to get a new tenant into not only the GM space, but these other spaces. How meaningful is that sort of cost to you to take the space from what it is today to what somebody is going to want to sign-in a lease on it?

Well, if you look at the GM, let's talk about each one of them. I'll give it to you in a dollar per square foot basis. The GM tenant improvements is going to be somewhere between $20 to $25 a square foot, if we have leasing in the $19 to $20 or $21 per square foot, which is $5, more than the last cash rent, and then you're going to have commissions of probably $3 to $5 depending upon the length of the lease. If you go to the Port of Catoosa, you're looking at probably a $3 to $4 per square foot price for the tenant improvements and then the commissions are going to be probably $1 to $2 a square foot. Then if we go to the property in Houston, it's only 6,000 square feet. But it's probably going to be somewhere between $20 and $25 a square foot, and then probably $3 to $5 for the commissions. And then I did talk about another one we have a property in Mason that has 18,000 square feet vacant out of 60,000. We're negotiating a lease right now for approximately 50% of that vacancy in that single-storey office. And I expect that to come in somewhere between $18 and $20 a square foot plus $3 to $4 for commissions.

Okay, that's helpful. Thank you. In terms of -- it's been a while since you guys have acquired an office asset, what's the characteristic of the office asset that you talked about that you were pursuing in the acquisition pipeline? What makes that one special versus continuing your almost exclusive industrial acquisition?

Well, it's -- it is a facility that is, and let me make sure I get this correct. It's in Kansas City, Missouri; it's a headquarters facility for them. It's about 150,000 square feet, which falls into the size we typically like. And they've got data center information, data center space in there as well, which makes it a pretty sticky asset and leases, the lease is for 15 years. So if we can underwrite the credit, which we spend a tremendous amount of time on, and we see the enduring nature of the company in their space, we'll buy it. But with only one property out of 16 being office, our emphasis is definitely going to remain on the industrial side; because Mike and I really think we're going to get to 60% as I indicated next 18 to 24 months. And I actually want to get to 70%, within 24 to 30 months. So we're going to still acquire office assets. We're going to keep the multi-storey office assets. We will in fact, exit the balance of the single-storey office properties. I'm not in favor of that asset class.

Okay. And then just on the assets that are being held-for-sale, are those being marketed currently, is that a later in 2021? Is that as the market conditions allow, how should we be thinking about those assets being sold?

Yes, very modest amount of assets, Rob, those are being marketed for sale, or they could be further along in that process. I would say for those assets, could be thinking about them being sold during the first six months of the year.

Okay. Thanks guys. Appreciate it.

Thank you.

Okay. Any more questions?

Yes. Next question is from the line of Craig Kucera with B. Riley.

Hey, good morning, guys.

Good morning.

I appreciate the color on your thoughts, future dispositions. But what is the total size of the single-storey office pool that you might look to monetize over the next several years? Is it half of your office exposure? Or just some color there would be helpful?

No, no, I'll tell you what, let me get to the specifics. But it is a small percentage, because we have exited a number of single-storey office over the last three to four years. It was one objective that Mike and I put in our strategy. And we're living by it. But it's a rather small percentage. I just don't have the specifics in front of me right now.

But thematically, Craig, our net -- our dispositions per year again, we feel that it in the $15 million to $25 million range. So, certainly single-storey office probably makes up a half or more of that, but it is a very modest number as compared to what we intend to acquire annually.

Got it. That makes sense, I appreciate the color. And I just wanted to circle back to the new term loan and your debt capacity. The 8-K REIT that increases the overall credit facility size by $65 million, but you're not getting that initial availability. It sounds like can you talk about sort of how mechanically you -- is that just adding more properties to the line for additional debt capacity, or just sort of how you access that incremental capacity over time?

Sure. Without doing too much brain damage, so again, that's $65 million, $15 million of it is delayed draw so we'll pull that down in the coming months and marry that with new acquisitions and the requisite debt that we need to fund them. That $50 million fully paid-off the revolver. To your point, our properties are pledged against the line, they are not secured. So we get "value and availability" based upon -- it depends whether we just newly bought the asset or they've been in the portfolio for over a year, Craig. But just generically think about it with respect to every asset we buy, we get roughly 60% leverage within that through availability within the aggregate credit facility.

Okay. Now, I appreciate the color. Thanks. That's it for me.

Okay. Thanks, Craig.

Any other questions?

Yes. We have one more question from the line of John Massocca with Ladenburg Thalmann.

You mentioned the $280 million worth of potential investments in the pipeline; I guess you think about the hit rate on that. What would you kind of maybe expect there and in the context of that, what do you think is kind of the 2021 acquisition target, if you will?

Well, I'll talk about the target first. I think our target is going to be somewhere between $130 million and $140 million this year. We've got one asset in the barn right now. If I had to look at probabilities our history has been once we get into Letter of Intent stage, a Letter of Intent stage we'll be somewhere around a third of those, actually a third to 50% of them coming to fruition, because what we're seeing also is a number of off-market opportunities, John, that because of some of the relationships we have with the other funds, we've been able to identify PE companies that want to sell those assets and redeploy the money into the business. So I would say that you could expect once we get into Letter of Intent stage, close to 50% of those will in fact go to actual deals.

Okay. And that's actually it for me. Thanks very much.

Any other questions?

There are no additional questions, Mr. Gladstone.

All right. Well, we thank you all for tuning in and asking some good questions. And we'll see you next quarter. That's the end of this conference call.

Thank you everyone for joining us today. This concludes today's conference. You may disconnect your lines at this time. Have a great day.