Gladstone Commercial: The Goldilocks of High-Yield REITs

Not too hot, not too cold, but just right: That’s one way to spin Gladstone Commercial’s (NASDAQ: GOOD) investment thesis. A dependable, high-yield investment for every income portfolio is another.reits
Gladstone paid its first dividend in late 2003 soon after its August 2003 stock-market debut. It has never missed a beat since. In fact, it has not only kept the beat, it has upped the tempo four times with dividend increases. The time count has also increased: In the first year the dividend was delivered in quarterly increments; subsequent deliveries have all been monthly.
At the current beat, Gladstone delivers $0.125 per share in monthly dividends (or $1.50 annually). The payout delivers an 8.2% yield. That’s a healthy yield in a world plagued with negative-yield sovereign debt and sub-2% yields on most U.S. Treasury offerings.
Of course, a high yield matters only if the dividend that supports the high yield is sustainable. Gladstone has proven its dividend is sustainable through thick and thin. Gladstone has never reduced its dividend, even when everything hit the fan during the 2008-2009 financial crisis. Many REITs slashed their dividends 50% or more. Gladstone was the rare exception. It held firm.
I expect Gladstone to hold firm into the distant future.

Well-Managed Properties

For one, its portfolio of 99 properties are diversified across use – industrial, commercial, retail, and medical – and geography. The properties cover 24 states.
What’s more, these properties are occupied by tenants who have signed triple-net leases. With a triple-net lease, the tenant agrees to pay all real estate taxes, building insurance, and maintenance. Triple-net leases reduce the risk of unexpected expenditures associated with tax increases and building maintenance. Triple-net leases also motivate tenants to mind the property.
Gladstone’s properties are chalked full of triple-net-lease paying tenants. Its 98.5% occupancy rate is among the best in the business. Less than 2% of Gladstone’s leasable space is vacant. The National Association of Realtors forecast a 10.4% vacancy rate for office space, an 8.7% vacancy rate for industrial space, and a 10.5% vacancy rate for retail space nationally over the coming year.
Gladstone manages its financial structure as well as it manages its properties. During the second quarter, Gladstone refinanced its 6.25%-rate debt with new debt priced at 3.2%. Gladstone also retired a 7.125% preferred-stock issue and replaced it with a 7% preferred issue.
Lower capital costs will, in turn, enhance funds from operations (FFO) – an important measure of dividend sustainability. Gladstone continually generates the FFO to cover the dividend. Last quarter, FFO posted at $0.39 per share. Gladstone paid out $0.375 per share in dividends. With the gap between revenue and costs widening, FFO should trend higher over the coming quarters.
Gladstone shares have trended 25% higher year to date. At the beginning of the year, investors were worried that stocks would be hit by a series of interest-rate increases from the Federal Reserve. When that worry abated in the first quarter, stocks rallied, particularly high-yield stocks like Gladstone. (Worries of higher interest rates hurting REIT financial performance were unfounded anyway. REITs outperformed the S&P 500 with a cumulative total return of nearly 80% while the Fed continually raised its interest rate target from 2004 through 2006.)

Gladstone Dividend Towers Over Others

Even with the strong year-to-date advance, Gladstone shares still appear undervalued compared to the competition. The current 8.2% dividend yield dwarfs the national average. The National Association of Real Estate Investment Trusts reports that triple-net-lease REITs, which includes Gladstone, average a 4.7% dividend yield. If Gladstone shares were to trade with the national average, they’d trade 75% higher.
Gladstone’s shares won’t trade 75% higher in the near future. Gladstone’s small size – a $420 million market cap – limits institutional investor interest. But that could change in the distant future. Gladstone has doubled its asset base, reaching $833 million, over the past five years. It has the potential to add up $300 million of new property assets in the coming year. A bulkier Gladstone could pique institutional investor interest and raise the requisite trading liquidity needed to perpetuate that interest.
For now, though, Gladstone offers a just-right dividend yield, delivered in just-right increments, at a just-right price.

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