Gladstone Business: The Ache Is Simply Starting (NASDAQ:GOOD)

Since Gladstone Business (NASDAQ:GOOD) at all times bought itself because the REIT that by no means lower its dividend, the primary earnings name after it introduced a dividend lower promised to be fascinating. Buyers or analysis analysts hoping for a mea culpa from administration and some acknowledgement that that they had been overly optimistic in assuming they might keep their dividend within the face of a worsening workplace market and growing rates of interest had been disenchanted. This may occasionally clarify the extra aggressive line of questioning through the name by the analysis analysts who little question had been embarrassed in entrance of their accounts by not predicting the dividend lower or the FFO miss. As a substitute of starting the decision by specializing in points with their very own capital construction or lease expirations, administration mentioned the warfare in Ukraine. I’m positive buyers listening to that GOOD collected 100% of their contractual rents, however nonetheless wanted to chop the dividend had been left scratching their heads questioning how Ukraine is a part of the story.

GOOD might very properly gather 100% of its contractual rents in 2023, nevertheless, I believe the ache is simply starting. As I identified in (Gladstone Commercial Beats Estimates on $4.3 Million In Non-Recurring Accelerated Rents) 1Q23 would be the first quarter the place GOOD feels the complete quarter influence of the expiration of its lease with Verizon at its property in Columbia, SC which expired in October. On the earnings name administration talked about that the property is now being dealt with by a receiver which signifies it’s more likely to be bought for lower than the worth of its mortgage. This implies the income (and curiosity funds) from the property will transfer off of GOOD’s books, however they are going to obtain nothing for the property. Their fairness has been decreased to zero. The property is valued on their steadiness sheet at $3 million (GOOD 10-Okay 2022, p. 76) in opposition to a mortgage of $9 million. (GOOD 10-Okay 2022, p. 88.) They’re fortunate this can be a non-recourse mortgage.

Workplace Lease Expirations

The challenges of lease expirations won’t finish for GOOD with the brand new yr. In 2023 GOOD has 7.1% of its annual straight-line hire expiring or $8.8 million. (GOOD 4Q22 Monetary Complement, p.19) When queried for particulars about its 2023 lease expirations on its earnings name, administration talked about that two of the workplace lease expirations are beneath buy settlement and out for execution. Just a few issues buyers ought to take into accout:

1. The one property that’s listed as Held for Sale in its 10-Okay is the vacant Columbia, SC property. This implies the auditors (and GOOD) seemingly have some doubts as as to if or not these gross sales will shut. The PSA’s have not been executed.
2. If GOOD does promote these properties I believe it is going to virtually definitely be at a really excessive cap fee based mostly on 2022 NOI as the marketplace for workplace properties with no tenants is horrible. As I discussed in my final article (Gladstone Commercial’s Dividend Cut Announcement: A Signal on Office Lease Expirations in 2023) a few their workplace properties with expiring leases are at the moment listed on the market. Two of them are Class B workplace properties per the brokers’ advertising materials. (250 E Arapaho, 7450 Huntington Park Drive) Vacant suburban Class B workplace shouldn’t be drawing a lot curiosity from patrons proper now because of the imbalance of demand and provide within the workplace market in addition to the shortage of financing for workplace properties usually. This was mentioned by the Wall Road Journal of their February twenty first article Office Landlord Defaults Are Escalating as Lenders Brace for More Distress. As buyers noticed on GOOD’s asset in Columbia, SC when a tenant leaves an workplace constructing vacant it not trades off a cap fee. The present truthful worth of the Columbia, SC asset is $3 million. (GOOD 10-Okay 2022, p.76) Final yr its budgeted NOI was $3.6 million (GOOD August 18, 2022 8-Okay. Schedule 6.25) which means a cap fee of over 100%. I believe related markdowns might emerge on the vacant workplace properties GOOD is making an attempt to promote this yr.
3. Assuming GOOD follows by means of on its plan to reinvest the proceeds in Industrial Properties with long-term leases, I believe these transactions might be very dilutive as they won’t come near changing the misplaced revenue from the expiring workplace leases.

Maturing Mortgages and Debt Amortization

Maturing mortgages and debt amortization funds may even must be addressed in 2023. In 2023 GOOD has $58.3 million in balloon maturities as proven within the chart under from their 4Q22 Investor Presentation.

Nearly all of GOOD’s 2023 mortgages maturities are secured by workplace properties with tenants on short-term leases of three years or much less as proven under.

I believe it will make issues notably tough for GOOD. Because the Wall Road Journal highlighted of their article on misery within the workplace sector on February twenty first mortgage officers are avoiding simply the sorts of buildings GOOD is trying to refinance.

Whereas all of those properties might be tough to refinance, I believe the $29.3 million mortgage on the Austin property presents the largest problem for GOOD. Though GM remains to be on the lease for over half of the constructing by means of 2026, it has already vacated the property. JLL is at the moment advertising the sublease house. I believe it’s uncertain that any lender would think about this property acceptable collateral for a mortgage.

When pressed on plans for refinancing administration’s solutions don’t encourage confidence. Beneath is administration’s response.

Administration didn’t reply the analyst’s query on the speed they anticipated on the refinancings, and every of the choices administration suggests for accessing capital has some adverse implications for GOOD. Refinancing properties with long-term leases which might be at the moment collateral for the road that may be enticing to banks after which utilizing the properties with maturing mortgages as collateral for the road wouldn’t solely infuriate their line lenders, it will additionally convey down the typical lease time period for properties securing the road. GOOD’s total weighted common lease time period is 7 years. (Web page 4 Buyers Presentation.) The road requires a mean weighted lease time period of 5 years for the unencumbered pool of belongings supporting the Credit score Facility. (§9.3 of 4^th Amended and Restated Credit score Settlement filed as an 8-Okay on August 18^th, 2023.) I believe GOOD will solely have the ability to transfer a restricted variety of properties to line with out tripping this covenant and the Austin property is massive sufficient that it will transfer the needle.

I believe simply drawing off the road shouldn’t be actually an possibility for GOOD. They’ve $86 million obtainable, however they might want to purchase belongings to proceed citing their weighted common lease time period and proceed their shift to industrial properties. As soon as once more, I believe their lenders would make life powerful for GOOD in the event that they merely tried to push borrowing on the road to the utmost degree with out buying new properties.

Moreover, they might want to use $9 million of line capability merely to maintain up with the amortization on their present debt. As detailed of their 10-Okay on p. 79 their principal debt funds due in 2023 are $67.3 million. The $58.3 million talked about on their earnings name and proven of their Investor Presentation merely displays the balloon funds which might be due. The $9 million distinction represents amortization funds. The funds for these funds might want to come from someplace.

I believe the thought of issuing inventory by means of the ATM to repay the maturing mortgages would make GOOD’s lenders completely happy, nevertheless, it will be extremely dilutive to FFO. The rate of interest on the maturing debt is within the 4.8% vary. At GOOD’s present inventory worth of $14.37, assuming a run fee FFO of $0.34/quarter GOOD’s FFO a number of is 10.6x or a FFO yield of 9.5%. Briefly GOOD’s 2023 mortgage maturities have put them between a rock and a tough place.

Capex Funding

Lastly, funding growing capex could also be one other drain on the road’s capability within the coming yr. In This autumn capex jumped to $4.4 million. If GOOD used an AFFO calculation this is able to have dinged their AFFO/share by $0.11. Administration’s response to an analyst’s query on the long run pattern of capex leaves a lot unanswered and plenty of buyers questioning what different surprises could also be in retailer for them. Nobody answered the query as to why capex went up in 4Q22. You’ve got one government saying workplace properties are dearer from a capex perspective and one other saying industrial are the difficulty. Primarily based on the advertising supplies from 717 Parmer in Austin, I believe among the work they’re doing on the property brought about capex to spike. I do not know if that work is full or on-going. The trade with the analyst is under.

In abstract it was an unsightly quarter for GOOD and its analysts as everybody needed to face the music of workplace lease expirations in a traditionally dangerous workplace market together with rising charges. In my opinion, administration did not rise to the event nor encourage any confidence that they are going to have the ability to navigate the challenges of the yr forward. Blaming the year-old warfare in Ukraine and rising charges, when a number of months in the past administration advised buyers all the things was high quality has to rub folks the incorrect approach. It’s potential that administration actually did assume they might have the ability to keep the dividend, however this merely suggests to me that they’re fairly disconnected from the fact of their enterprise. Nothing illustrates the Advisor’s lack of consideration to this externally managed REIT higher than David Gladstone’s feedback on the dividend.

The chairman doesn’t bear in mind which firm he’s discuss. Buyers ought to do not forget that as some attempt to take solace in claims that all the things might be OK in a yr and we might be growing the dividend.

Dangers to Shorting GOOD

It’s important for readers to know that regardless of the issues I imagine GOOD faces in 2023, the inventory may be very risky as its investor base turns over. This implies any variety of issues may trigger the inventory spike worth to spike briefly. A brief vendor with out enough capital could possibly be pressured to liquidate their place at a loss on this state of affairs. It’s straightforward to ascertain circumstances the place GOOD’s inventory worth rises quickly on perceived excellent news, For instance, GOOD may report the sale of an asset at a considerable achieve or they might use accelerated rents or termination charges to exceed analysts’ estimates like they did in Q322 as was mentioned in my earlier piece on GOOD. Alternatively, they might announce an association with their line lenders that the market views as a profit. Moreover, GOOD will seemingly proceed to pay its decreased dividend till its lenders inform them they should cease. Not solely does the dividend signify a price to a brief vendor, I imagine the dividend will put a ground on the inventory worth for a while as there’ll at all times be buyers who’re in search of yield. My assumption is that lenders will wait till the final potential second to ask GOOD for a further discount to its dividend. Within the interim, they are going to merely strain GOOD to boost extra fairness to assist their place within the capital stack. In different phrases, I imagine somebody shorting GOOD must have the endurance and capital to attend till the market has a transparent and knowledgeable view of GOOD’s projected 2023 and presumably 2024 FFO/share.

Moreover, short-sellers must be ready for the likelihood that if GOOD efficiently leases a few of their vacant workplace house at enticing charges the inventory may transfer upward.