By Allison Landa
David Gladstone knows his sweet spot. The chairman and chief executive officer of Gladstone Management, Gladstone has been working with small businesses for the last 30 years and in 2003 launched Gladstone Commercial Corporation (Nasdaq: GOOD) as the company's real estate arm.
Gladstone Commercial is handled externally by Gladstone Management and provides three main services: buying real estate and leasing it to small businesses on a long-term basis; buying property already owned by small businesses and then leasing it back in order to free up equity for the businesses; and issuing long-term mortgages.
"We find our best opportunities helping small businesses find real estate and grow their businesses," Gladstone, who previously served as chairman and chief executive officer with Allied Capital Corporation and as a director of The Riggs National Corporation, says. "We can provide a one-two punch: loans for working capital as well as buying and financing buildings. ... Almost all of the things we do are office and industrial, so we're very heavy in those segments. We're not investors in shopping centers or hotels. These are facilities used by small businesses to carry on their daily business activities."
Gladstone Commercial's 22-building, $200 million portfolio is spread throughout the continental U.S., with holdings in Michigan, New Jersey, North Carolina, Pennsylvania, Ohio and Texas. All properties are single tenant, whether they are a small office building or a larger manufacturing facility. The company deals mostly with clients' real estate needs at the sales, warehousing and distribution level.
MTC Technologies in Dayton, Ohio |
Part of an Investment Family
A registered investment advisor founded in 2001, Gladstone Management manages two other firms in addition to Gladstone Commercial: Gladstone Capital, which invests in senior and subordinated debt of small and medium-sized businesses, and Gladstone Investment, which invests in junior subordinated and mezzanine loans along with preferred-stock investments in small and mid-sized businesses.
Gladstone Commercial's inception has allowed Gladstone Management to more fully focus on its clients' real estate goals, according to Gladstone. "We understand customers' needs," he says. "If we like the business and want to help them in a certain way, we can use any of our tools. We can provide loans, equity and, of course, our REIT will provide real estate help."
As part of a family of firms, Gladstone Commercial prides itself on offering a complete slate of services to its clients. "We can finance the entire right-hand side of the balance sheet," Gladstone says. "Whether it's senior credit or a mezzanine loan, if you need anything on that side of the balance sheet, we can provide it."
Though Gladstone Commercial provides sale-and-leaseback services as well as mortgages, Gladstone estimates that the former is 90 percent of its business. He doesn't imagine that this figure will change any time soon, since most small businesses would rather put their equity into their work than their workspace.
"When a small business thinks through the problem, they don't want to have a significant amount of their equity tied up in real estate. It gives low returns," he says, estimating that real estate only provides 10 percent to 15 percent returns to small companies, compared to a potential 40 percent to 50 percent return from investing in its core business.
"They'd much rather put all of that equity into their business, where it can grow faster and provide tremendous returns. So when we sit down and discuss whether they want to get a mortgage, or if they would like us to buy the building (on their behalf), they almost always choose the latter," Gladstone says.
Gladstone Properties, T-Mobile building in Wichita, Kansas. |
Filling a Need
Gladstone Commercial's clientele constitutes a specific part of the business community that Gladstone himself has spent the length of his career addressing: the needs of small businesses. This impacts the scale of the deals that the company handles.
"Most of the needs are for smaller buildings," Gladstone says, estimating that the company's average transaction value is a relatively small $5 million; most transactions range from $3 million to $15 million. "Our customers don't need large campuses. They're not big users of real estate, and in terms of financial needs, it would be modest by most standards. I suspect most REITs don't target (this clientele) because of that."
Gladstone says his company is set apart by its willingness to take on unrated tenants. The company's clients often do not meet Standard & Poor's credit requirements and therefore face difficulty in buying or leasing real estate—smaller businesses that might otherwise be overlooked along the capital stack.
Gladstone Properties, interior of T-Mobile building. |
"Our forte is the ability to underwrite the tenant," Gladstone says. "The difference is quite measurable in that we do look for non-rated tenants. ... What sets us apart is the ability to not go into the prime tenant area, but rather work with secondary and tertiary tenants, be able to underwrite them and understand their business and be able to help them, whereas other companies might not be able to help them."
In order to minimize its own risk, Gladstone Commercial has developed a proprietary suite of tools to analyze a business' financial profile and its default risk. This consists of a risk-rating model as well as projections made on a given business.
"We get all their financial statements, we spread them out on a financial model, we put it through our risk-rating analysis much the same way Standard & Poor's would, except we have small businesses," Gladstone says, adding that in the company's two-year history, no client has defaulted or even been late on a payment.
Current tenants include Elster Electricity, a provider of advanced electricity metering products, communication solutions, and metering automation systems with which Gladstone completed a sale-leaseback deal on a 59,000 square foot office building in Raleigh, N.C..; Corinthian Colleges, Inc., a post-secondary education company with which Gladstone Commercial has a 10-year lease agreement on a 51,933 square foot office building in Austin, Texas; and Graphic Enterprises, Inc., a graphics-systems retailer with which Gladstone Commercial completed a sale-leaseback on a 54,500 square foot office warehouse in Canton, Ohio.
Gladstone Properties, York Technologies in Eatontown, New Jersey. |
A "GOOD" Offering
Gladstone Commercial launched with $10 million in seed money in February 2003. Shortly thereafter in August 2003, the company filed for a $66.3 million initial public offering, listing 4.4 million shares at $15 each.
Today, the company gets its funds from equity from shareholders in the public marketplace, Wall Street funds including pensions, insurance companies and conduits, and a $50 million revolving line of credit from a consortium of banks. The latter became available in March, and under certain conditions it can be upped to $75 million.
The line of credit is a warehouse line and the company expects to use borrowings under the line of credit to purchase real estate that is leased to small and mid-sized businesses. The short-term line of credit will be used to finance the real estate until a permanent long-term mortgage is placed on the property and for working capital.
In the first half of 2005, Gladstone Commercial announced that net income available to common stockholders was 1.68 million, or $0.22 per diluted common share compared to a net loss of $61,029 in the first half of 2004. Funds from operations rose from $145,072 to $2.92 million, or $0.38 per diluted common share. During the quarter, the company added four properties to its portfolio, with purchase prices totaling just shy of $29 million and in April extended a $10 million mortgage loan on an office building. As of the end of the quarter, Gladstone Commercial's aggregate outstanding borrowings totaled $49.4 million, and its available borrowing capacity was just less than $59 million.
As for the future, Gladstone says his company will maintain its current strategy doing what it does best: investing in the real estate interests of smaller businesses that perhaps could not get funding elsewhere.
"We do not finance Wal-Marts," he says. "They are a rated tenant and can get
financing relatively easily. But we would finance a tenant that was perhaps a new company looking to buy a location or have us buy a location and lease it to them."
Allison Landa is a regular
contributor to Portfolio.
