A Good Entry Point For Gladstone Commercial – Gladstone Commercial Corporation (NASDAQ:GOOD) No ratings yet.

Gladstone Commercial Corporation (GOOD) is a REIT that invests in single-tenant and anchored multi-tenant net leased industrial and office properties nationwide. GOOD has never cut its distributions to shareholders – even during the Great Financial Crisis – and has a track record of consistent occupancy greater than 96% since its IPO in 2003.

Gladstone Commercial is the living proof that externally managed REITs can perform and outperform. GOOD is one of the three externally managed REITs (together with NexPoint Residential Trust (NXRT) and Gladstone Land (LAND)) that trade at a premium to NAV. The current weakness in the share price presents a good entry point.

Gladstone Commercial

Gladstone Commercial invests in high-quality properties located in primary and secondary growth markets occupied by tenants that meet their rigorous credit underwriting standards. GOOD’s portfolio includes 109 properties in 24 states leased to 101 different tenants. Occupancy stands currently at 98.8% and has never dipped below 96.0%. The portfolio is for 60% invested in office and 35% in industrial properties.

Exhibit 1: Portfolio

Source: Company presentation

GOOD’s management wants to increase the industrial allocation. It wants to focus on fully developed industrial parks with properties that are 50,000 to 300,000 square feet in size and occupied predominantly by middle market non-rated tenants. GOOD has the credit underwriting capabilities for such a tenant profile. The aim of this shift to increasing the industrial allocation of the portfolio are long-term benefits of lowering tenant improvement costs, reducing the intensity of the property management activities, and improving operating efficiencies. The industrial sector trades at a higher valuation and the shift will have a positive impact on GOOD’s valuation.

GOOD is very focused on the credit strength of its tenants. As part of the Gladstone Companies family of investment funds, it uses insights from its corporate cash flow lending and private equity practices to properly qualify the commercial real estate investments – quickly and thoroughly underwriting the credit strength of any tenant’s business. In its history, GOOD had only one tenant who defaulted: an average annual default rate of 0.02%.

Exhibit 2: Credit ratings

Source: Company presentation

The average remaining lease term of the portfolio is seven years and the percentage of rents expiring is well spread over the coming years.

Exhibit 3: Lease expiring schedule

Source: Company presentation

External management

The average annual total returns of externally managed REITs are claimed to lag those of the industry. While this is true in general, there are exceptions. In our article on externally managed REITs, we identified two outperforming externally managed REITs: Preferred Apartment Communities (APTS), Universal Health Realty Income Trust (UHT), CorEnergy Infrastructure Trust (CORR) and Gladstone Commercial.

Exhibit 4: Total return

Source: Seeking Alpha

This good performance has also led to an increased institutional ownership.

Exhibit 5: Institutional ownership

Source: Company presentation

Externally managed REITs are also claimed to trade at a steeper discount to NAV compared to internally managed REITs. This claim is also true in general.

Three externally managed REITs trade at a premium to NAV: NexPoint Residential Trust, Gladstone Land and Gladstone Commercial.

Dividend safety

GOOD has never cut its distributions to shareholders – even during the Great Financial Crisis. But will it be able to keep a stable monthly dividend?

Exhibit 6: Dividend history

Source: Seeking Alpha

Gladstone Commercial has been reducing its heavy debt burden the past years, thereby increasing the dividend safety.

Exhibit 7: Leverage

Source: Company presentation

GOOD’s management has no real intention to lower the leverage much further: “We believe that we are 1% to 2% away from our targeted leverage level, which means that nearly all raised equity will be allocated through accretive acquisitions.”

The debt maturity schedule looks well spread.

Exhibit 8: debt maturity schedule

Source: Company presentation

Gladstone Commercial is part of the diversified REIT sector. In the below exhibit, we also compare GOOD with the office and industrial REIT sectors because it’s for 60% invested in office and for the remainder in industrial properties.

The first thing we notice is GOOD’s high payout ratio. GOOD’s debt ratios are better than those of the diversified REIT sector, but a bit worse than those of the office and industrial REIT sectors.

Exhibit 9: Dividend safety ratios

So while GOOD’s dividend safety has improved the past years, it’s still not first class. That’s probably the reason why it has stayed stable for so many years. On the latest earnings call, the management was discussing openly the idea of increasing the dividend, albeit very slightly. CEO David Gladstone said: “We just don’t want to be a sort of static bond fund with the same dividend forever. We do hope to make some small increases. We don’t like staying at $1.50. We want to increase it per year just to keep up with inflation.”

Based on debt and payout ratios, GOOD should trade at a discount to office and industrial REITs and with a valuation in line with that of diversified REITs.

Growth

The premium or discount at which REITs trade can give us an indication of expected growth. The equity markets have a strong preference for higher levels of NAV growth, and at times when this exists, they price REITs at premiums to NAV. When real estate value growth is more muted, short-term focused equity investors look elsewhere leading to REITs trading at a discount.

Exhibit 10: Expected growth

The expected growth of GOOD is higher than the average diversified REIT and in between that of office and industrial REITs. This calls for GOOD to trade at a slight premium to diversified REITs and in line with the average of office and industrial REITs.

Currently GOOD is trading at a valuation discount to diversified, office and industrial REITs.

Exhibit 11: Valuation

At the same time, GOOD is trading close to the lowest yields of the last 10 years. We have of course to take into account that GOOD is steadily moving more and more into the industrial space and this warrants a higher valuation.

Exhibit 12: Dividend yield

Source: Koyfin

We put our fair yield for GOOD at 6%. This gives a fair value per share of $25 and a P/FFO multiple of 15.5.

Momentum

Gladstone Commercial is both in a clear uptrend (when we look at the 200 day moving average) and oversold.

Exhibit 13: Price chart

Conclusion

Gladstone Commercial is both a value and a momentum REIT. The current weakness in the share price presents a nice buying opportunity. GOOD has reduced its leverage and thinks about an increase in its (monthly) dividend. The industrial sector trades at a higher valuation and GOOD invests more and more in industrial properties. This move will further support the share price in the future. Buy the dip.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor.

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