Gladstone Commercial Corporation
GLADSTONE COMMERCIAL CORP (Form: 10-Q, Received: 05/02/2017 16:15:06)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549  
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2017
OR  
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                      TO                     
COMMISSION FILE NUMBER: 001-33097  
GLADSTONE COMMERCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
MARYLAND
 
02-0681276
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
1521 WESTBRANCH DRIVE, SUITE 100
MCLEAN, VIRGINIA
 
22102
(Address of principal executive offices)
 
(Zip Code)
(703) 287-5800
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and formal fiscal year, if changed since last report)  
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 

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Table of Contents

Large accelerated filer
 
¨
  
Accelerated filer
 
ý
 
 
 
 
Non-accelerated filer
 
¨   (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   ý
The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding as of May 2, 2017 was 25,195,443 .

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Table of Contents

GLADSTONE COMMERCIAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED
March 31, 2017
TABLE OF CONTENTS
 
 
 
 
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Gladstone Commercial Corporation
Condensed Consolidated Balance Sheets
(Dollars in Thousands, Except Share and Per Share Data)
(Unaudited)  
 
 
March 31, 2017
 
December 31, 2016
ASSETS
 
 
 
 
Real estate, at cost
 
$
821,921

 
$
821,749

Less: accumulated depreciation
 
138,070

 
131,661

Total real estate, net
 
683,851

 
690,088

Lease intangibles, net
 
102,075

 
105,553

Real estate and related assets held for sale, net
 
2,359

 
9,562

Cash and cash equivalents
 
4,105

 
4,658

Restricted cash
 
3,116

 
3,030

Funds held in escrow
 
4,281

 
6,806

Deferred rent receivable, net
 
30,151

 
29,725

Other assets
 
3,039

 
2,320

TOTAL ASSETS
 
$
832,977

 
$
851,742

LIABILITIES, MEZZANINE EQUITY AND STOCKHOLDERS’ EQUITY
 
 
 
 
LIABILITIES
 
 
 
 
Mortgage notes payable, net
 
$
407,574

 
$
445,278

Borrowings under Revolver, net
 
63,797

 
39,225

Borrowings under Term Loan, net
 
24,897

 
24,892

Deferred rent liability, net
 
12,316

 
12,647

Asset retirement obligation
 
3,440

 
3,406

Accounts payable and accrued expenses
 
3,461

 
5,891

Liabilities related to assets held for sale, net
 
332

 
1,041

Due to Adviser and Administrator (1)
 
2,103

 
2,075

Other liabilities
 
7,488

 
6,667

TOTAL LIABILITIES
 
$
525,408

 
$
541,122

Commitments and contingencies (2)
 

 

MEZZANINE EQUITY
 
 
 
 
Series D redeemable preferred stock, net, par value $0.001 per share; $25 per share liquidation preference; 6,000,000 shares authorized; and 3,007,293 and 2,917,458 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively (3)
 
$
72,965

 
$
70,743

TOTAL MEZZANINE EQUITY
 
$
72,965

 
$
70,743

STOCKHOLDERS’ EQUITY
 
 
 
 
Series A and B redeemable preferred stock, par value $0.001 per share; $25 per share liquidation preference; 5,350,000 shares authorized and 2,264,000 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
 
$
2

 
$
2

Senior common stock, par value $0.001 per share; 4,450,000 shares authorized; and 957,481 and 959,552 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
 
1

 
1

Common stock, par value $0.001 per share, 34,200,000 and 34,040,000 shares authorized and 25,003,842 and 24,882,758 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
 
25

 
25

Additional paid in capital
 
465,790

 
463,436

Distributions in excess of accumulated earnings
 
(231,214
)
 
(223,587
)
TOTAL STOCKHOLDERS' EQUITY
 
234,604

 
239,877

TOTAL LIABILITIES, MEZZANINE EQUITY AND STOCKHOLDERS’ EQUITY
 
$
832,977

 
$
851,742

(1)
Refer to Note 2 "Related-Party Transactions"
(2)
Refer to Note 9 “Commitments and Contingencies
(3)
Refer to Note 10 “Stockholders' Equity and Mezzanine Equity

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents

Gladstone Commercial Corporation
Condensed Consolidated Statements of Operations
(Dollars in Thousands, Except Share and Per Share Data)
(Unaudited)  
 
 
For the three months ended March 31,
 
 
2017
 
2016
Operating revenues
 
 
 
 
Rental revenue
 
$
21,954

 
$
20,657

Tenant recovery revenue
 
360

 
485

Interest income from mortgage note receivable
 

 
385

Total operating revenues
 
22,314

 
21,527

Operating expenses
 
 
 
 
Depreciation and amortization
 
9,921

 
9,133

Property operating expenses
 
1,380

 
1,610

Base management fee (1)
 
1,181

 
861

Incentive fee (1)
 
569

 
618

Administration fee (1)
 
360

 
404

General and administrative
 
551

 
588

Impairment charge
 
3,746

 
43

Total operating expenses
 
17,708

 
13,257

Other (expense) income
 
 
 
 
Interest expense
 
(6,158
)
 
(6,731
)
Distributions attributable to Series C mandatorily redeemable preferred stock
 

 
(686
)
Gain on sale of real estate, net
 
5,906

 

Other income
 
2

 

Total other expense, net
 
(250
)
 
(7,417
)
Net income
 
4,356

 
853

Distributions attributable to Series A, B and D preferred stock
 
(2,373
)
 
(1,027
)
Distributions attributable to senior common stock
 
(248
)
 
(252
)
Net income (loss) available (attributable) to common stockholders
 
$
1,735

 
$
(426
)
Earnings (loss) per weighted average share of common stock - basic & diluted
 
 
 
 
Earnings (loss) attributable to common shareholders
 
$
0.07

 
$
(0.02
)
Weighted average shares of common stock outstanding
 
 
 
 
Basic and Diluted
 
24,963,926

 
22,545,285

Earnings per weighted average share of senior common stock
 
$
0.26

 
$
0.26

Weighted average shares of senior common stock outstanding - basic
 
958,194

 
964,036

 
(1)
Refer to Note 2 “Related-Party Transactions”


The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

Gladstone Commercial Corporation
Condensed Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
 
 
For the three months ended March 31,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
4,356

 
$
853

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
9,921

 
9,133

Impairment charge
 
3,746

 
43

Gain on sale of real estate
 
(5,906
)
 

Amortization of deferred financing costs
 
483

 
471

Amortization of deferred rent asset and liability, net
 
(207
)
 
(102
)
Amortization of discount and premium on assumed debt
 
(30
)
 
(60
)
Asset retirement obligation expense
 
34

 
37

(Increase) decrease in other assets
 
(719
)
 
290

Increase in deferred rent receivable
 
(795
)
 
(1,087
)
Decrease in accounts payable, accrued expenses, and amount due Adviser and Administrator
 
(976
)
 
(121
)
Increase (decrease) in other liabilities
 
735

 
(303
)
Leasing commissions paid
 
(167
)
 
(372
)
Net cash provided by operating activities
 
10,475

 
8,782

Cash flows from investing activities:
 
 
 
 
Improvements of existing real estate
 
(4,964
)
 
(1,685
)
Proceeds from sale of real estate
 
12,398

 

Collection of mortgage note receivable
 

 
5,900

Receipts from lenders for funds held in escrow
 
3,108

 
2,143

Payments to lenders for funds held in escrow
 
(583
)
 
(476
)
Receipts from tenants for reserves
 
597

 
763

Payments to tenants from reserves
 
(433
)
 
(738
)
Increase in restricted cash
 
(86
)
 
(85
)
Net cash provided by investing activities
 
10,037

 
5,822

Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of equity
 
4,657

 
2,800

Offering costs paid
 
(81
)
 
(52
)
Retirement of senior common stock
 

 
(178
)
Borrowings under mortgage notes payable
 

 
18,475

Payments for deferred financing costs
 
(17
)
 
(380
)
Principal repayments on mortgage notes payable
 
(38,063
)
 
(23,534
)
Borrowings from revolving credit facility
 
38,500

 
15,800

Repayments on revolving credit facility
 
(14,000
)
 
(18,000
)
Increase in security deposits
 
(78
)
 
59

Distributions paid for common, senior common and preferred stock
 
(11,983
)
 
(9,736
)
Net cash used by financing activities
 
(21,065
)
 
(14,746
)
Net decrease in cash and cash equivalents
 
$
(553
)
 
$
(142
)
Cash and cash equivalents, beginning of period
 
$
4,658

 
$
5,152

Cash and cash equivalents, end of period
 
$
4,105

 
$
5,010

NON-CASH INVESTING AND FINANCING INFORMATION
 
 
 
 
Capital improvements included in accounts payable and accrued expenses
 
$
1,849

 
$
2,829


The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents

Gladstone Commercial Corporation
Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Organization, Basis of Presentation and Significant Accounting Policies

Gladstone Commercial Corporation is a real estate investment trust ("REIT") that was incorporated under the General Corporation Law of the State of Maryland on February 14, 2003. We focus on acquiring, owning and managing primarily office and industrial properties. On a selective basis, we may make long term industrial and commercial mortgage loans; however, we do not have any mortgage loans currently outstanding. Subject to certain restrictions and limitations, our business is managed by Gladstone Management Corporation, a Delaware corporation, or the Adviser, and administrative services are provided by Gladstone Administration, LLC, a Delaware limited liability company, or the Administrator, each pursuant to a contractual arrangement with us. Our Adviser and Administrator collectively employ all of our personnel and pay their salaries, benefits, and general expenses directly. Gladstone Commercial Corporation conducts substantially all of its operations through a subsidiary, Gladstone Commercial Limited Partnership, a Delaware limited partnership, or the Operating Partnership.

All further references herein to “we,” “our,” and “us” mean Gladstone Commercial Corporation and its consolidated subsidiaries, except where it is made clear that the term means only Gladstone Commercial Corporation.

Interim Financial Information

Our interim financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and pursuant to the requirements for reporting on Form 10-Q and in accordance with Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. The year-end balance sheet data presented herein was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of our management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of financial statements for the interim period, have been included. The interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016 , as filed with the U.S. Securities and Exchange Commission on February 15, 2017. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from those estimates.

Critical Accounting Policies

The preparation of our financial statements in accordance with GAAP requires management to make judgments that are subjective in nature to make certain estimates and assumptions. Application of these accounting policies involves the exercise of judgment regarding the use of assumptions as to future uncertainties, and as a result, actual results could materially differ from these estimates. A summary of all of our significant accounting policies is provided in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 . There were no material changes to our critical accounting policies during the three months ended March 31, 2017 .

Reclassifications

Certain items on condensed consolidated statement of operations for the three months ended March 31, 2016 have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously-reported equity, net loss, or net change in cash and cash equivalents.


6


Recently Issued Accounting Pronouncements

In February 2017, the FASB issued Accounting Standards Update 2017-05 ("ASU 2017-05") to provide guidance for recognizing gains and losses from the transfer of nonfinancial assets and in-substance non-financial assets in contracts with non-customers, unless other specific guidance applies. The standard requires a company to derecognize nonfinancial assets once it transfers control of a distinct nonfinancial asset or distinct in substance nonfinancial asset. Additionally, when a company transfers its controlling interest in a nonfinancial asset, but retains a noncontrolling ownership interest, the company is required to measure any non-controlling interest it receives or retains at fair value. The guidance requires companies to recognize a full gain or loss on the transaction. As a result of the new guidance, the guidance specific to real estate sales in ASC 360-20 will be eliminated, and partial sales of real estate assets will now be subject to the same derecognition model as all other nonfinancial assets. The amendments to the nonfinancial asset guidance are effective at the same time an entity adopts the new revenue guidance. We are in the process of evaluating the impact of this new guidance on our consolidated financial statements. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period. The effective date of this guidance coincides with revenue recognition guidance. We expect to utilize the modified retrospective approach.

2. Related-Party Transactions

Gladstone Management and Gladstone Administration

We are externally managed pursuant to contractual arrangements with our Adviser and our Administrator, which collectively employ all of our personnel and pay their salaries, benefits, and general expenses directly. Both our Adviser and Administrator are affiliates of ours, as their parent company is owned and controlled by Mr. David Gladstone, our chairman and chief executive officer. Two of our executive officers, Mr. Gladstone and Mr. Terry Brubaker (our vice chairman and chief operating officer) serve as directors and executive officers of our Adviser and our Administrator. Our president, Mr. Robert Cutlip, is an executive managing director of our Adviser. Mr. Michael LiCalsi, our general counsel and secretary, serves as our Administrator’s president, general counsel and secretary. We have an Advisory Agreement (as defined below) with our Adviser and an administration agreement with our Administrator, or the Administration Agreement. The services and fees under the Advisory Agreement and Administration Agreement are described below. At March 31, 2017 and December 31, 2016 , $ 2.1 million and $2.1 million , respectively, was collectively due to our Adviser and Administrator.

Base Management Fee

On July 24, 2015, we entered into a Second Amended and Restated Advisory Agreement with the Adviser, effective July 1, 2015. We subsequently entered into a Third Amended and Restated Advisory Agreement with the Adviser on July 12, 2016, effective July 1, 2016, and, as described below, a Fourth Amended and Restated Investment Advisory Agreement with the Adviser on January 10, 2017, effective October 1, 2016, which we collectively refer to herein as the Advisory Agreement. Our entrance into each of the amended agreements was approved unanimously by our Board of Directors. Our Board of Directors reviews and considers renewing the agreement with our Adviser each July.

As a result of the July 2015 amendment, the calculation of the annual base management fee equals 1.5% of our adjusted total stockholders’ equity, which is our total stockholders’ equity (before giving effect to the base management fee and incentive fee), adjusted to exclude the effect of any unrealized gains or losses that do not affect realized net income (including impairment charges) and adjusted for any one-time events and certain non-cash items (the later to occur for a given quarter only upon the approval of our Compensation Committee). The fee is calculated and accrued quarterly as 0.375%  per quarter of such adjusted total stockholders’ equity figure. As a result of the July 2016 amendment, the definition of adjusted total stockholders' equity in the calculation of the base management fee and the incentive fee (described below) includes total mezzanine equity. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties, as is common in other externally managed REITs; however, our Adviser may earn fee income from our borrowers, tenants or other sources. Prior to the 2015 amendment, the Advisory Agreement provided for an annual base management fee equal to 2.0% of our common stockholders’ equity, which was our total stockholders’ equity, less the recorded value of any preferred stock and adjusted to exclude the effect of any unrealized gains, losses, or other items that did not affect realized net income (including impairment charges).

For the three months ended March 31, 2017 and 2016 , we recorded a base management fee of $1.2 million , and $ 0.9 million , respectively.


7


Incentive Fee

As a result of the July 2015 amendment, the calculation of the incentive fee was revised to reward the Adviser in circumstances where our quarterly Core FFO (defined at the end of this paragraph), before giving effect to any incentive fee, or pre-incentive fee Core FFO, exceeds 2.0% quarterly, or 8.0% annualized, of adjusted total stockholders’ equity (after giving effect to the base management fee but before giving effect to the incentive fee, and which, as a result of the July 2016 amendment to the Advisory Agreement, now includes total mezzanine equity). We refer to this as the new hurdle rate. The Adviser will receive 15.0% of the amount of our pre-incentive fee Core FFO that exceeds the new hurdle rate. However, in no event shall the incentive fee for a particular quarter exceed by 15.0% (the cap) the average quarterly incentive fee paid by us for the previous four quarters (excluding quarters for which no incentive fee was paid). Core FFO (as defined in the Advisory Agreement) is GAAP net income (loss) available to common stockholders, excluding the incentive fee, depreciation and amortization, any realized and unrealized gains, losses or other non-cash items recorded in net income (loss) available to common stockholders for the period, and one-time events pursuant to changes in GAAP.

The incentive fee prior to the July 2015 amendment rewarded the Adviser in circumstances where our quarterly funds from operations, or FFO, before giving effect to any incentive fee, or pre-incentive fee FFO, exceeded 1.75% , or 7.0% annualized, or the hurdle rate, of common stockholders’ equity. FFO, included any realized capital gains and capital losses, less any distributions paid on preferred stock and Senior Common Stock, but FFO did not include any unrealized capital gains or losses (including impairment charges). The Adviser received 100.0% of the amount of the pre-incentive fee FFO that exceeded the hurdle rate, but was less than 2.1875% of our common stockholders’ equity. The Adviser also received an incentive fee of 20.0% of the amount of our pre-incentive fee FFO that exceeded 2.1875% of common stockholders’ equity.

For the three months ended March 31, 2017 and 2016 , we recorded an incentive fee of $0.6 million and $ 0.6 million , respectively. The Adviser did not waive any portion of the incentive fee for the three months ended March 31, 2017 or 2016 , respectively. Waivers cannot be recouped by the Adviser in the future.

Capital Gain Fee

Under the Advisory Agreement, as amended in July 2015, we will pay to the Adviser a capital gains-based incentive fee that will be calculated and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement). In determining the capital gain fee, we will calculate aggregate realized capital gains and aggregate realized capital losses for the applicable time period. For this purpose, aggregate realized capital gains and losses, if any, equals the realized gain or loss calculated by the difference between the sales price of the property, less any costs to sell the property and the current gross value of the property (which is calculated as the original acquisition price plus any subsequent non-reimbursed capital improvements). At the end of the fiscal year, if this number is positive, then the capital gain fee payable for such time period shall equal 15.0% of such amount. No capital gain fee was recognized during the three months ended March 31, 2017 or 2016 .

On January 10, 2017, we amended and restated the Advisory Agreement by entering into the Fourth Amended and Restated Investment Advisory Agreement between us and the Adviser to revise the calculation of the capital gains fee. Based upon the amendment, the calculation of the capital gains fee is based on the all-in acquisition cost of disposed of properties. The impact of this amendment would not have resulted in a capital gains fee for previously reported periods.

Termination Fee

As a result of the July 2015 amendment, the Advisory Agreement includes a termination fee whereby, in the event of our termination thereof without cause (with 120 days’ prior written notice and the vote of at least two-thirds of our independent directors), a termination fee would be payable to the Adviser equal to two times the sum of the average annual base management fee and incentive fee earned by the Adviser during the 24-month period prior to such termination. A termination fee is also payable if the Adviser terminates the Advisory Agreement after we have defaulted and applicable cure periods have expired. The Advisory Agreement may also be terminated for cause by us (with 30 days’ prior written notice and the vote of at least two-thirds of our independent directors), with no termination fee payable. Cause is defined in the agreement to include if the Adviser breaches any material provisions thereof, the bankruptcy or insolvency of the Adviser, dissolution of the Adviser and fraud or misappropriation of funds.


8


Administration Agreement

Under the terms of the Administration Agreement, we pay separately for our allocable portion of the Administrator’s overhead expenses in performing its obligations to us including, but not limited to, rent and our allocable portion of the salaries and benefits expenses of our Administrator's employees, including, but not limited to, our chief financial officer, treasurer, chief compliance officer, general counsel and secretary (who also serves as our Administrator’s president, general counsel and secretary), and their respective staffs. Our allocable portion of the Administrator’s expenses are generally derived by multiplying our Administrator's total expenses by the approximate percentage of time the Administrator's employees perform services for us in relation to their time spent performing services for all companies serviced by our Administrator under contractual agreements. For the three months ended March 31, 2017 and 2016 , we recorded an administration fee of $0.4 million and $0.4 million , respectively.

Gladstone Securities

Gladstone Securities, LLC, or Gladstone Securities, is a privately held broker dealer registered with the Financial Industry Regulatory Authority and insured by the Securities Investor Protection Corporation. Gladstone Securities is an affiliate of ours, as its parent company is owned and controlled by Mr. David Gladstone, our chairman and chief executive officer. Mr. Gladstone also serves on the board of managers of Gladstone Securities.

Mortgage Financing Arrangement Agreement

We entered into an agreement with Gladstone Securities, effective June 18, 2013, for it to act as our non-exclusive agent to assist us with arranging mortgage financing for properties we own. In connection with this engagement, Gladstone Securities will, from time to time, continue to solicit the interest of various commercial real estate lenders or recommend to us third party lenders offering credit products or packages that are responsive to our needs. We pay Gladstone Securities a financing fee in connection with the services it provides to us for securing mortgage financing on any of our properties. The amount of these financing fees, which are payable upon closing of the financing, are based on a percentage of the amount of the mortgage, generally ranging from 0.15% to a maximum of 1.0% of the mortgage obtained. The amount of the financing fees may be reduced or eliminated, as determined by us and Gladstone Securities, after taking into consideration various factors, including, but not limited to, the involvement of any third party brokers and market conditions. We did not pay financing fees to Gladstone Securities during the three months ended March 31, 2017 but paid Gladstone Securities $0.08 million during the three months ended March 31, 2016 , which are included in mortgage notes payable, net, in the condensed consolidated balance sheets, or 0.43% of mortgage principal secured. Our Board of Directors renewed the agreement for an additional year, through August 31, 2017, at its July 2016 meeting.

3. Earnings per Share of Common Stock

The following tables set forth the computation of basic and diluted earnings (loss) per share of common stock for the three months ended March 31, 2017 and 2016 , respectively. We computed basic earnings (loss) per share for the three months ended March 31, 2017 and 2016 , respectively, using the weighted average number of shares outstanding during the periods. Diluted earnings (loss) per share for the three months ended March 31, 2017 and 2016 , reflects additional shares of common stock related to our convertible Senior Common Stock (if the effect would be dilutive), that would have been outstanding if dilutive potential shares of common stock had been issued, as well as an adjustment to net income available to common stockholders as applicable to common stockholders that would result from their assumed issuance (dollars in thousands, except per share amounts).

9


 
 
For the three months ended March 31,
 
 
2017
 
2016
Calculation of basic earnings (loss) per share of common stock:
 
 
 
 
Net income (loss) available (attributable) to common stockholders
 
$
1,735

 
$
(426
)
Denominator for basic weighted average shares of common stock
 
24,963,926

 
22,545,285

Basic earnings (loss) per share of common stock
 
$
0.07

 
$
(0.02
)
Calculation of diluted earnings (loss) per share of common stock:
 
 
 
 
Net income (loss) available (attributable) to common stockholders
 
$
1,735

 
$
(426
)
Add: income impact of assumed conversion of senior common stock (1)
 

 

Net income (loss) available (attributable) to common stockholders plus assumed conversions (1)
 
$
1,735

 
$
(426
)
Denominator for basic weighted average shares of common stock
 
24,963,926

 
22,545,285

Effect of convertible Senior Common Stock (1)
 

 

Denominator for diluted weighted average shares of common stock (1)
 
24,963,926

 
22,545,285

Diluted earnings (loss) per share of common stock
 
$
0.07

 
$
(0.02
)
 
(1)
We excluded convertible shares of Senior Common Stock of 798,388 and 800,116 from the calculation of diluted earnings per share for the three months ended March 31, 2017 and 2016 , respectively, because it was anti-dilutive.

4. Real Estate and Intangible Assets

Real Estate

The following table sets forth the components of our investments in real estate as of March 31, 2017 and December 31, 2016 , respectively, excluding real estate held for sale as of March 31, 2017 and December 31, 2016 , respectively (dollars in thousands):
 
 
 
March 31, 2017

December 31, 2016
Real estate:
 
 
 
 
Land
 
$
104,337

 
$
104,719

Building and improvements
 
663,262

 
662,661

Tenant improvements
 
54,322

 
54,369

Accumulated depreciation
 
(138,070
)
 
(131,661
)
Real estate, net
 
$
683,851

 
$
690,088


Real estate depreciation expense on building and tenant improvements was $ 6.4 million and $ 5.9 million for the three months ended March 31, 2017 and 2016 , respectively.

Significant Real Estate Activity on Existing Assets

During the three months ended March 31, 2017 and 2016 , we executed zero and one lease, respectively, which is aggregated below (dollars in thousands):
 
Three Months Ended
 
Aggregate Square Footage
 
Weighted Average Lease Term
 
Aggregate Annualized GAAP Rent
 
Aggregate Tenant Improvement
 
Aggregate Leasing Commissions
March 31, 2016
 
13,816

 
7.2 years
 
70

 
69

 
28


10


 
Intangible Assets

The following table summarizes the carrying value of intangible assets, liabilities and the accumulated amortization for each intangible asset and liability class as of March 31, 2017 and December 31, 2016 , excluding real estate held for sale as of March 31, 2017 and December 31, 2016 , respectively (in thousands):

 
 
March 31, 2017

December 31, 2016
 
 
Lease Intangibles
 
Accumulated Amortization
 
Lease Intangibles
 
Accumulated Amortization
In-place leases
 
$
71,391

 
$
(29,782
)
 
$
71,482

 
$
(28,182
)
Leasing costs
 
48,162

 
(19,669
)
 
48,000

 
(18,599
)
Customer relationships
 
50,201

 
(18,228
)
 
50,252

 
(17,400
)
 
 
$
169,754

 
$
(67,679
)
 
$
169,734

 
$
(64,181
)
 
 
Deferred Rent Receivable/(Liability)
 
Accumulated (Amortization)/Accretion
 
Deferred Rent Receivable/(Liability)
 
Accumulated (Amortization)/Accretion
Above market leases
 
$
10,479

 
$
(7,420
)
 
$
10,479

 
$
(7,296
)
Below market leases and deferred revenue
 
(21,606
)
 
9,290

 
(21,606
)
 
8,959

 
 
$
(11,127
)
 
$
1,870

 
$
(11,127
)
 
$
1,663


Total amortization expense related to in-place leases, leasing costs and customer relationship lease intangible assets was $ 3.5 million and $ 3.3 million for the three months ended March 31, 2017 and 2016 , respectively, and is included in depreciation and amortization expense in the condensed consolidated statement of operations.

Total amortization related to above-market lease values was $ 0.1 million for both the three months ended March 31, 2017 and 2016 , respectively, and is included in rental revenue in the condensed consolidated statement of operations. Total amortization related to below-market lease values was $ 0.3 million and $ 0.2 million for the three months ended March 31, 2017 and 2016 , respectively, and is included in rental revenue in the condensed consolidated statement of operations.

5. Real Estate Dispositions, Held for Sale and Impairment Charges

Real Estate Dispositions

During the three months ended March 31, 2017 , we continued to execute our capital recycling program, whereby we opportunistically sold properties outside of our core markets and redeployed proceeds to fund property acquisitions in our target secondary growth markets, as well as repay outstanding debt. During the three months ended March 31, 2017 , we sold one non-core property, which is summarized below (dollars in thousands):

Square Footage Sold
 
Sales Price
 
Sales Costs
 
Gain on Sale of Real Estate
183,000

 
$
12,800

 
$
402

 
$
5,906


Our disposition during the three months ended March 31, 2017 was not classified as a discontinued operation because it did not represent a strategic shift in operations, nor will it have a major effect on our operations and financial results. Accordingly, the operating results of this property are included within continuing operations for all periods reported.


11


The table below summarizes the components of operating income from the real estate and related assets disposed of during the three months ended March 31, 2017 , and 2016 , respectively (dollars in thousands):

 
 
For the three months ended March 31,
 
 
2017
 
2016
Operating revenue
 
$
87

 
$
247

Operating expense
 

 
54

Other income (expense)
 
5,781

(1)
(93
)
Income from real estate and related assets sold
 
$
5,868

 
$
100


(1) Includes a $5.9 million gain on sale of our Franklin, New Jersey property.

Real Estate Held for Sale

During the three months ended March 31, 2017 , we had one property classified as held for sale. We considered the property classified as held for sale during the three months ended March 31, 2017 to be non-core to our long term strategy. The one property classified as held for sale during the three months ended March 31, 2017 was sold subsequent to the end of the quarter, and we recognized a loss of $0.1 million . The assets and liabilities of the one property classified as held for sale are presented separately in our condensed consolidated balance sheet as of March 31, 2017 .

Our assets classified as held for sale during the three months ended March 31, 2017 were not classified as discontinued operations because they do not represent a strategic shift in our operations, nor will they have a major effect on our operations and financial results.

The table below summarizes the components of income from real estate and related assets held for sale (dollars in thousands):
 
 
 
For the three months ended March 31,
 
 
2017
 
2016
Operating revenue
 
$
51

 
$
59

Operating expense
 
1

 
47

Other expense
 
(28
)
 
(36
)
Income (loss) from real estate and related assets held for sale
 
$
22

 
$
(24
)

The table below summarizes the components of the assets and liabilities held for sale reflected on the accompanying condensed consolidated balance sheet (dollars in thousands):
 
 
March 31, 2017
 
December 31, 2016
Assets Held for Sale
 
 
 
Real estate, at cost
$
3,106

 
$
11,454

Less: accumulated depreciation
859

 
2,668

Total real estate held for sale, net
2,247

 
8,786

Lease intangibles, net
34

 
200

Deferred rent receivable, net
78

 
575

Other assets

 
1

Total Assets Held for Sale
$
2,359

 
$
9,562

Liabilities Held for Sale
 
 
 
Deferred rent liability, net
$
239

 
$
755

Asset retirement obligation
93

 
286

Total Liabilities Held for Sale
$
332

 
$
1,041


12



Impairment Charges

We performed an evaluation and analysis of our entire portfolio to determine if any of our held and used assets were impaired during the three months ended March 31, 2017 and identified two held and used assets which potentially were impaired during March 2017. For these properties, during March 2017, we received unsolicited interest from potential buyers, and as a result, we included a sale scenario and shortened our hold period when comparing the undiscounted cash flows against the respective carrying values. Based upon our analysis, we concluded that the undiscounted cash flows for these properties were below their respective carrying values indicating that these assets were impaired as of March 31, 2017 . Therefore we recorded $3.7 million in impairment charges to adjust the carrying value for both assets to fair market value. We evaluated both properties for held for sale classification, and concluded that these assets did not qualify, and both properties were classified as held and used assets as of March 31, 2017 .

Fair market value for these assets was calculated using Level 3 inputs, which were determined using comparable asset sale data from the respective asset locations. We continue to evaluate our properties on a quarterly basis for changes that could create the need to record impairment. Future impairment losses may result, and could be significant, should market conditions deteriorate in the markets in which we hold our assets or we are unable to secure leases at terms that are favorable to us, which could impact the estimated cash flow of our properties over the period in which we plan to hold our properties. Additionally, changes in management's decisions to either long-term own and lease or sell a particular asset will have an impact on this analysis.

As part of our held for sale process, we perform an analysis of all properties classified as held for sale during the three months ended March 31, 2017 , and compare the fair market value of the asset less selling costs against the carrying value of assets available for sale. We did not record any impairment related to our held for sale assets during the three months ended March 31, 2017 .

We recognized $0.4 million of impairment charges on one property during the three months ended March 31, 2016 . This property was classified as held for sale during the three months ended March 31, 2016 , and through our held for sale analysis, we concluded that the fair market value less selling costs was below the carrying value of this property. This property was sold in May 2016.

The fair values for the above held for sale property was calculated using Level 3 inputs which were calculated using an estimated sales price, less estimated costs to sell. The estimated sales price was determined using an executed purchase and sale agreement.

6. Mortgage Note Receivable

On July 25, 2014, we closed a $5.6 million second mortgage development loan for the construction of an 81,371 square foot, build-to-suit transitional care facility located on a major hospital campus in Phoenix, Arizona. Subsequently, on April 14, 2015, we closed an additional $0.3 million interim financing loan for the development of the Phoenix, Arizona property. Construction was completed in July 2015 and we earned 9.0% interest, paid currently in cash, on the loan during construction and through maturity. Prior to completion of the facility, we were granted a right of first offer to purchase the property at fair value. We elected not to purchase the property, and received an exit fee upon maturity of the loan in an amount sufficient for us to earn an internal rate of return of 22.0% on the second mortgage development loan, inclusive of interest earned. The principal balance of the loans and all associated interest income and exit fee revenue was received in January 2016. We recognized no interest income or exit fee revenue during the three months ended March 31, 2017 . We recognized $ 0.4 million in both cash interest income and exit fee revenue during the three months ended March 31, 2016 . We currently have no mortgage notes receivable outstanding.


13


7. Mortgage Notes Payable and Credit Facility

Our mortgage notes payable and Credit Facility as of March 31, 2017 and December 31, 2016 are summarized below (dollars in thousands):
 
 
 
Encumbered properties at
 
 
 
Carrying Value at
 
Stated Interest Rates at
 
Scheduled Maturity Dates at
 
 
March 31, 2017
 
 
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017

March 31, 2017
Mortgage and other secured loans:
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate mortgage loans
 
46

 
 
 
$
348,983

 
$
378,477

 
(1)
 
(2)
Variable rate mortgage loans
 
17

 
 
 
63,138

 
71,707

 
(3)
 
(2)
Premiums and discounts, net
 
-

 
 
 
187

 
217

 
N/A
 
N/A
Deferred financing costs, mortgage loans, net
 
-

 
 
 
(4,734
)
 
(5,123
)
 
N/A
 
N/A
Total mortgage notes payable, net
 
63

 
 
 
$
407,574

 
$
445,278

 
(4)
 
 
Variable rate revolving credit facility
 
28

 
(6)
 
$
64,200

 
$
39,700

 
LIBOR + 2.25%
 
8/7/2018
Deferred financing costs, revolving credit facility
 
-

 
 
 
(403
)
 
(475
)
 
N/A
 
N/A
Total revolver, net
 
28

 
 
 
$
63,797

 
$
39,225

 
 
 
 
Variable rate term loan facility
 
-

 
 
 
$
25,000

 
$
25,000

 
LIBOR + 2.20%
 
10/5/2020
Deferred financing costs, term loan facility
 
-

 
 
 
(103
)
 
(108
)
 
N/A
 
N/A
Total term loan, net
 
N/A

 
 
 
$
24,897

 
$
24,892

 
 
 
 
Total mortgage notes payable and credit facility
 
91

 
 
 
$
496,268

 
$
509,395

 
(5)
 
 
 
(1)
Interest rates on our fixed rate mortgage notes payable vary from 3.75% to 6.63% .
(2)
We have 42 mortgage notes payable with maturity dates ranging from 11/8/2017 through 7/1/2045 .
(3)
Interest rates on our variable rate mortgage notes payable vary from one month LIBOR + 2.15% to one month LIBOR + 2.75% . At March 31, 2017 , one month LIBOR was approximately 0.98% .
(4)
The weighted average interest rate on the mortgage notes outstanding at March 31, 2017 was approximately 4.66% .
(5)
The weighted average interest rate on all debt outstanding at March 31, 2017 was approximately 4.40% .
(6)
The amount we may draw under our Revolver and Term Loan is based on a percentage of the fair value of a combined pool of 28 unencumbered properties as of March 31, 2017 .
N/A - Not Applicable

Mortgage Notes Payable

As of March 31, 2017 , we had 42 mortgage notes payable, collateralized by a total of 63 properties with a net book value of $610.0 million . Gladstone Commercial Corporation has limited recourse liabilities that could result from any one or more of the following circumstances: a borrower voluntarily filing for bankruptcy, improper conveyance of a property, fraud or material misrepresentation, misapplication or misappropriation of rents, security deposits, insurance proceeds or condemnation proceeds, or physical waste or damage to the property resulting from a borrower’s gross negligence or willful misconduct. Gladstone Commercial Corporation has full recourse for $8.9 million of the mortgages notes payable outstanding, or 2.2% of the outstanding balance. We will also indemnify lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property. 

14



During the three months ended March 31, 2017 , we repaid 3 mortgages, collateralized by 7 properties, which is aggregated below (dollars in thousands):
 
Aggregate Fixed Rate Debt Repaid
 
Weighted Average Interest Rate on Fixed Rate Debt Repaid
$
27,188

 
6.05%

Aggregate Variable Rate Debt Repaid
 
Weighted Average Interest Rate on Variable Rate Debt Repaid
$
8,163

 
LIBOR +
2.50%


We made payments of $0.0 million and $0.4 million for deferred financing costs during the three months ended March 31, 2017 and 2016 , respectively.

Scheduled principal payments of mortgage notes payable for the remainder of 2017 , and each of the five succeeding fiscal years and thereafter are as follows (dollars in thousands):
 
Year
 
Scheduled Principal Payments
 
Nine Months Ending December 31, 2017
 
$
27,259

 
2018
 
46,462

 
2019
 
46,094

 
2020
 
12,573

 
2021
 
31,583

 
2022
 
95,963

 
Thereafter
 
152,187

 
Total
 
$
412,121

(1)

(1) This figure does not include $0.2 million of premiums and (discounts), net and $4.7 million of deferred financing costs, which are reflected in mortgage notes payable on the condensed consolidated balance sheet.

Interest Rate Cap Agreements

We have entered into interest rate cap agreements that cap the interest rate on certain of our variable-rate debt. We have adopted the fair value measurement provisions for our financial instruments recorded at fair value. The fair value guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Generally, we will estimate the fair value of our interest rate caps, in the absence of observable market data, using estimates of value including estimated remaining life, counterparty credit risk, current market yield and interest rate spreads of similar securities as of the measurement date. At March 31, 2017 and December 31, 2016 , our interest rate cap agreements were valued using Level 2 inputs.

The fair value of the interest rate cap agreements is recorded in other assets on our accompanying condensed consolidated balance sheets. We record changes in the fair value of the interest rate cap agreements quarterly based on the current market valuations at quarter end as interest expense on our accompanying condensed consolidated statements of operations. The following table summarizes the interest rate caps at March 31, 2017 and December 31, 2016 (dollars in thousands):
 

15


 
 
March 31, 2017
 
December 31, 2016
Aggregate Cost
 
Aggregate Notional Amount
 
Aggregate Fair Value
 
Aggregate Notional Amount
 
Aggregate Fair Value
$
455

(1)
$
88,144

 
$
131

 
$
71,721

 
$
101


(1) We have entered into various interest rate cap agreements on variable rate debt with LIBOR caps ranging from 2.50% to 3.00% .

The fair value of all mortgage notes payable outstanding as of March 31, 2017 was $412.2 million , as compared to the carrying value stated above of $412.1 million . The fair value is calculated based on a discounted cash flow analysis, using management’s estimate of market interest rates on long-term debt with comparable terms and loan to value ratios. The fair value was calculated using Level 3 inputs of the hierarchy established by ASC 820, “Fair Value Measurements and Disclosures.”

Credit Facility

In August 2013, we procured a senior unsecured revolving credit facility, or the Revolver, with KeyBank National Association ("KeyBank") (serving as a revolving lender, a letter of credit issuer and an administrative agent). On October 5, 2015, we expanded our Revolver to $85.0 million , extended the maturity date one year through August 2018, with a one -year extension option through August 2019. We also added a $25.0 million term loan facility, or the Term Loan, which matures in October 2020. The Revolver and the Term Loan are referred to collectively herein as the Credit Facility. The interest rate on the Revolver was also reduced by 25 basis points at each of the leverage tiers and the total maximum commitment under the Credit Facility was increased from $100.0 million to $150.0 million . We also added 3 new lenders to the bank syndicate, which is now comprised of KeyBank, Comerica Bank, Fifth Third Bank, US Bank and Huntington Bank.

The Term Loan is subject to the same leverage tiers as the Revolver; however the interest rate at each leverage tier is five basis points lower. We have the option to repay the Term Loan in full, or in part, at any time without penalty or premium prior to the maturity date.

As of March 31, 2017 , there was $89.2 million outstanding under our Credit Facility at a weighted average interest rate of approximately 3.22% and $1.0 million outstanding under letters of credit at a weighted average interest rate of 2.25% . As of March 31, 2017 , the maximum additional amount we could draw under the Revolver was $19.8 million . We were in compliance with all covenants under the Revolver and Term Loan as of March 31, 2017 .

The amount outstanding under the Line of Credit and Term Loan Facility approximates fair value as of March 31, 2017 , as the debt is variable rate.

8. Mandatorily Redeemable Term Preferred Stock

In February 2012, we completed a public offering of 1,540,000 shares of 7.125% Series C Cumulative Term Preferred Stock ("Term Preferred Stock"), par value $0.001 per share, at a public offering price of $25.00 per share. Gross proceeds of the offering totaled $38.5 million and net proceeds, after deducting offering expenses borne by us, were $36.7 million . The shares of the Term Preferred Stock had a mandatory redemption date of January 31, 2017.

During the year ended December 31, 2016, we redeemed all outstanding shares of the Term Preferred Stock. Accordingly, we wrote-off unamortized offering costs of $0.2 million during the year ended December 31, 2016, which were recorded to interest expense in our condensed consolidated statements of operations.

The Term Preferred Stock was recorded as a liability in accordance with ASC 480, “Distinguishing Liabilities from Equity,” which states that mandatorily redeemable financial instruments should be classified as liabilities and therefore the related dividend payments are treated as a component of interest expense in the condensed consolidated statements of operations.

9. Commitments and Contingencies

Ground Leases

We are obligated as lessee under four ground leases. Future minimum rental payments due under the terms of these leases as of March 31, 2017 , are as follows (dollars in thousands):

16


 
Year
 
Minimal Rental Payments Due
Nine Months Ending December 31, 2017
 
$
348

2018
 
464

2019
 
465

2020
 
466

2021
 
392

2022
 
319

Thereafter
 
4,236

Total
 
$
6,690


Expenses recorded in connection to rental expense incurred for the properties listed above during the three months ended March 31, 2017 and 2016 were $0.1 million for both periods, respectively. Rental expenses are reflected in property operating expenses on the condensed consolidated statements of operations.

Letters of Credit

As of March 31, 2017 , there was $1.0 million outstanding under letters of credit. These letters of credit are not reflected on our condensed consolidated balance sheet.

10. Stockholders’ and Mezzanine Equity

Stockholders' Equity

The following table summarizes the changes in our stockholders’ equity for the three months ended March 31, 2017 (dollars in thousands):
 
 
 
Shares Issued and Retired
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series A and B Preferred Stock
 
Common Stock
 
Senior Common Stock
 
Series A and B Preferred Stock
 
Senior Common Stock
 
Common Stock
 
Additional Paid in Capital
 
Distributions in Excess of Accumulated Earnings
 
Total Stockholders' Equity
Balance at December 31, 2016
 
2,264,000

 
24,882,758

 
959,552

 
$
2

 
$
1

 
$
25

 
$
463,436

 
$
(223,587
)
 
$
239,877

Issuance of Series A and B preferred stock and common stock, net
 

 
119,356

 

 

 

 

 
2,354

 

 
2,354

Conversion of senior common stock to common stock
 

 
1,728

 
(2,071
)
 

 

 

 

 

 

Distributions declared to common, senior common and preferred stockholders
 

 

 

 

 

 

 

 
(11,983
)
 
(11,983
)
Net income
 

 

 

 

 

 

 

 
4,356

 
4,356

Balance at March 31, 2017
 
2,264,000

 
25,003,842

 
957,481

 
$
2

 
$
1

 
$
25

 
$
465,790

 
$
(231,214
)
 
$
234,604



17


Distributions

We paid the following distributions per share for the three months ended March 31, 2017 and 2016 :
 
 
 
For the three months ended March 31,
 
 
2017
 
2016
Common Stock
 
$
0.375

 
$
0.375

Senior Common Stock
 
0.2625

 
0.2625

Series A Preferred Stock
 
0.4843749

 
0.4843749

Series B Preferred Stock
 
0.4688

 
0.4688

Series C Preferred Stock
 

(1)
0.4453

Series D Preferred Stock
 
0.4375

 


(1)
We fully redeemed our Series C Preferred Stock on August 19, 2016.

Recent Activity

Common Stock ATM Program

In February 2016, we amended our common ATM program with Cantor Fitzgerald (the "Common Stock ATM Program"). The amendment increased the amount of shares of common stock that we may offer and sell through Cantor Fitzgerald, to $160.0 million . All other terms of the Common Stock ATM program remained unchanged. During the three months ended March 31, 2017 , we sold 0.1 million shares of common stock, raising $2.4 million in net proceeds under the Common Stock ATM Program. As of March 31, 2017 , we had a remaining capacity to sell up to $130.1 million of common stock under the Common Stock ATM Program.

Series A and B Preferred Stock ATM Programs

In February 2016, we entered into an open market sales agreement with Cantor Fitzgerald (the "Series A and B Preferred ATM Program"), pursuant to which we may, from time to time, offer to sell (i) shares of our 7.75% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred"), and (ii) shares of our 7.50% Series B Cumulative Redeemable Preferred Stock ("Series B Preferred"), having an aggregate offering price of up to $40.0 million , through Cantor Fitzgerald, acting as sales agent and/or principal. We did not sell any shares of our Series A Preferred or Series B Preferred during the three months ended March 31, 2017 . As of March 31, 2017 , we had a remaining capacity to sell up to $37.2 million of preferred stock under the Series A and B Preferred ATM Program.

Mezzanine Equity

The 7.00% Series D Cumulative Redeemable Preferred Stock ("Series D Preferred"), is classified as mezzanine equity in our condensed consolidated balance sheet because it is redeemable at the option of the shareholder upon a change of control of greater than 50% in accordance with ASC 480-10-S99 "Distinguishing Liabilities from Equity," which requires mezzanine equity classification for preferred stock issuances with redemption features which are outside of the control of the issuer. A change in control of our company outside of our control is only possible if a tender offer is accepted by over 90% of our shareholders. All other change in control situations would require input from our Board of Directors. We will periodically evaluate the likelihood that a change of control greater than 50% will take place, and if we deem this probable, we would adjust the Series D Preferred presented in mezzanine equity to their redemption value, with the offset to gain (loss) on extinguishment. We currently believe the likelihood of a change of control greater than 50% is remote.

In June 2016, we entered into an open market sales agreement with Cantor Fitzgerald (the "Series D Preferred ATM Program"), pursuant to which we may, from time to time, offer to sell shares of our Series D Preferred, having an aggregate offering price of up to $50.0 million , through Cantor Fitzgerald, acting as sales agent and/or principal. During the three months ended March 31, 2017 , we sold approximately 0.1 million shares of our Series D Preferred for net proceeds of $ 2.2 million . As of March 31, 2017 , we had a remaining capacity to sell up to $ 31.4 million of Series D Preferred under the Series D Preferred ATM Program.


18


Amendment to Articles of Incorporation

On January 11, 2017, we filed with the Maryland State Department of Assessments and Taxation an Articles Supplementary reclassifying the remaining 160,000 authorized but unissued shares of our Series C Preferred Stock, as authorized but unissued shares of our common stock, and made a corresponding amendment to the Operating Partnership's Partnership Agreement with regard to corresponding units of partnership interest. As a result of the reclassification, there are zero authorized shares of Series C Preferred Stock and zero authorized corresponding units of partnership interest remaining. On the same date, we filed with the Maryland State Department of Assessments and Taxation an Articles of Restatement, restating and integrating into a single instrument all prior Articles Supplementary and amendments thereto.

11. Subsequent Events

Distributions

On April 11, 2017, our Board of Directors declared the following monthly distributions for the months of April , May and June of 2017 :

 
Record Date
 
Payment Date
 
Common Stock Distributions per Share
 
Series A Preferred Distributions per Share
 
Series B Preferred Distributions per Share
 
Series D Preferred Distributions per Share
April 21, 2017
 
April 28, 2017
 
$
0.125

 
$
0.1614583

 
$
0.15625

 
$
0.1458333

May 19, 2017
 
May 31, 2017
 
0.125

 
0.1614583

 
0.15625

 
0.1458333

June 21, 2017
 
June 30, 2017
 
0.125

 
0.1614583

 
0.15625

 
0.1458333


 
 
 
$
0.375

 
$
0.4843749

 
$
0.46875

 
$
0.4375


Senior Common Stock Distributions
Payable to the Holders of Record During the Month of:
 
Payment Date
 
Distribution per Share
April
 
May 5, 2017
 
$
0.0875

May
 
June 7, 2017
 
0.0875

June
 
July 10, 2017
 
0.0875


 
 
 
$
0.2625


Sale Activity

On April 7, 2017, we completed the sale of our Hazelwood, Missouri property for $2.1 million , recognizing a loss of $0.1 million . This property was classified as held for sale on our condensed consolidated balance sheet as of March 31, 2017 .


19


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

All statements contained herein, other than historical facts, may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements may relate to, among other things, future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our business, financial condition, liquidity, results of operations, funds from operations or prospects to be materially different from any future business, financial condition, liquidity, results of operations, funds from operations or prospects expressed or implied by such forward-looking statements. For further information about these and other factors that could affect our future results, please see the captions titled “Forward-Looking Statements” and “Risk Factors” in this report and in our Annual Report on Form 10-K for the year ended December 31, 2016 . We caution readers not to place undue reliance on any such forward-looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Quarterly Report on Form 10-Q.

All references to “we,” “our,” and “us” in this Report mean Gladstone Commercial Corporation and its consolidated subsidiaries, except where the context indicates that the term means only Gladstone Commercial Corporation.

General

We are an externally-advised real estate investment trust ("REIT") that was incorporated under the General Corporation Law of the State of Maryland on February 14, 2003. We focus on acquiring, owning, and managing primarily office and industrial properties. On a selective basis, we may make long term industrial and commercial mortgage loans; however, we do not have any mortgage loans currently outstanding. Our properties are geographically diversified and our tenants cover a broad cross section of business sectors and range in size from small to very large private and public companies. We actively communicate with buyout funds, real estate brokers and other third parties to locate properties for potential acquisition or to provide mortgage financing in an effort to build our portfolio. We target secondary growth markets that possess favorable economic growth trends, diversified industries, and growing population and employment.

We have historically entered into, and intend in the future to enter into, purchase agreements for real estate having net leases with remaining terms of approximately 7 to 15 years and built in rental rate increases. Under a net lease, the tenant is required to pay most or all operating, maintenance, repair and insurance costs and real estate taxes with respect to the leased property.

All references to annualized generally accepted accounting principles ("GAAP") rent are rents that each tenant pays in accordance with the terms of its respective lease reported evenly over the non-cancelable term of the lease.

As of May 2, 2017 :
 
we owned 94 properties totaling 10.9 million square feet in 24 states;
our occupancy rate was 97.9% ;
the weighted average remaining term of our mortgage debt was 6.7 years and the weighted average interest rate was 4.66% ; and
the average remaining lease term of the portfolio was 7.6 years.


20

Table of Contents

Business Environment

In the United States, vacancy rates have decreased for both office and industrial properties in most markets, as increased user demand has led to improved conditions. Vacancy rates in many markets have been reduced to levels seen at the peak before the most recent recession and rental rates have increased in many primary and secondary markets. This condition has led to a rise in construction activity for both office and industrial properties in many markets; however, vacancy rates in certain secondary and tertiary markets are still higher than pre-recession levels as job growth has yet to return to all areas of the country even though the published unemployment rate has decreased over the past 12 months. Interest rates have been volatile since the beginning of 2016 and although interest rates are still relatively low, lenders have varied on their required spreads over the last several quarters and overall financing costs for fixed rate mortgages appear to be on the rise. At the beginning of the year, several research firm surveys reflected that the current real estate cycle may be peaking and that publicly traded real estate investment trusts were net sellers during 2016. Year-end statistics from national research firms indicate that total investment sales volume was approximately 10% less than the volume recorded in 2015.

From a more macro-economic perspective, the strength of the global economy and U.S. economy in particular continue to be uncertain with increased volatility due to the vote last year in the United Kingdom to exit the European Union, the upcoming elections in several countries in Continental Europe, and an apparent global economic slowdown. In addition, the uncertainty surrounding the ability of the federal government to address its fiscal condition in both the near and long term as well as other geo-political issues has increased domestic and global instability. These developments could cause interest rates and borrowing costs to rise, which may adversely affect our ability to access both the equity and debt markets and could have an adverse effect on our tenants as well.

We continue to focus on re-leasing vacant space, renewing upcoming lease expirations, re-financing upcoming loan maturities, and acquiring additional properties with associated long-term leases. Currently, we only have one fully vacant building, which is located in Newburyport, Massachusetts, and a total of three partially vacant buildings.

We have two expiring leases in 2017, which account for 0.5% of rental revenue recognized during the three months ended March 31, 2017 and three expiring leases in 2018, which account for 1.3% of rental revenue recognized during the three months ended March 31, 2017 .

Our available vacant space at March 31, 2017 represents 2.1% of our total square footage and the annual carrying costs on the vacant space, including real estate taxes and property operating expenses, are approximately $0.7 million . We continue to actively seek new tenants for these properties.

Our ability to make new investments is highly dependent upon our ability to procure financing. Our principal sources of financing generally include the issuance of equity securities, long-term mortgage loans secured by properties and borrowings under our $85.0 million senior unsecured revolving credit facility ("Revolver"), with KeyBank National Association (serving as a revolving lender, a letter of credit issuer and an administrative agent), which matures in August 2018, and our $25.0 million term loan facility ("Term Loan"), which matures in October 2020, which we refer to collectively herein as the Credit Facility. While lenders’ credit standards have tightened, we continue to look to national and regional banks, insurance companies and non-bank lenders, in addition to the collateralized mortgage backed securities market, or the CMBS market, to issue mortgages to finance our real estate activities.

In addition to obtaining funds through borrowing, we have been active in the equity markets during the three months ended March 31, 2017 . We have issued shares of both common and preferred stock through our at-the-market programs, or ATM Programs, pursuant to our open market sale agreements with Cantor Fitzgerald, discussed in more detail below.

Recent Developments

2017 Sale Activity

During the three months ended March 31, 2017 , we continued to execute our capital recycling program, whereby we opportunistically sell properties outside of our core markets, and redeploy proceeds to fund property acquisitions located in our target secondary growth markets, or repay outstanding debt. During the three months ended March 31, 2017 , we sold one non-core property, and applied the proceeds towards outstanding debt. We will continue to sell non-core properties under advantageous circumstances.


21

Table of Contents

Square Footage Sold
 
Sales Price
 
Sales Costs
 
Gain on Sale of Real Estate
183,000

 
12,800

 
402

 
5,906


On April 7, 2017, we completed the sale of our Hazelwood, Missouri property for $2.1 million , recognizing a loss of $0.1 million . This property was classified as held for sale on our condensed consolidated balance sheet as of March 31, 2017 . We used the proceeds from this sale to repay outstanding debt.

2017 Financing Activity

During the three months ended March 31, 2017 , we repaid 3 mortgages, collateralized by 7 properties, which are aggregated below (dollars in thousands):

Aggregate Fixed Rate Debt Repaid
 
Weighted Average Interest Rate on Fixed Rate Debt Repaid
$
27,188

 
6.05%

Aggregate Variable Rate Debt Repaid
 
Weighted Average Interest Rate on Variable Rate Debt Repaid
$
8,163

 
LIBOR +
2.50%

2017 Equity Activities

Common Stock ATM Program

In February 2016, we amended our common ATM program with Cantor Fitzgerald (the "Common Stock ATM Program"). The amendment increased the amount of shares of common stock that we may offer and sell through Cantor Fitzgerald, to $160.0 million . All other terms of the Common Stock ATM program remained unchanged. During the three months ended March 31, 2017 , we sold 0.1 million shares of common stock, raising $2.4 million in net proceeds under the Common Stock ATM Program. As of March 31, 2017 , we had a remaining capacity to sell up to $130.1 million of common stock under the Common Stock ATM Program.

Preferred ATM Programs

Series A and B Preferred Stock : In February 2016, we entered into an open market sales agreement (the "Series A and B Preferred ATM Program"), with Cantor Fitzgerald, pursuant to which we may, from time to time, offer to sell (i) shares of our 7.75% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred"), and (ii) shares of our 7.50% Series B Cumulative Redeemable Preferred Stock ("Series B Preferred"), having an aggregate offering price of up to $40.0 million , through Cantor Fitzgerald, acting as sales agent and/or principal. We did not sell any shares of our Series A Preferred or Series B Preferred during three months ended March 31, 2017 . As of March 31, 2017 , we had a remaining capacity to sell up to $37.2 million of preferred stock under the Series A and B Preferred ATM Program.

Series D Preferred Stock : In June 2016, we entered into an open market sales agreement (the "Series D Preferred ATM Program") , with Cantor Fitzgerald, pursuant to which we may, from time to time, offer to sell shares of our 7.00% Series D Cumulative Redeemable Preferred ("Series D Preferred"), having an aggregate offering price of up to $50.0 million , through Cantor Fitzgerald, acting as sales agent and/or principal. During the three months ended March 31, 2017 , we sold approximately 0.1 million shares of our Series D Preferred for net proceeds of $ 2.2 million . As of March 31, 2017 , we had a remaining capacity to sell up to $ 31.4 million of Series D Preferred under the Series D Preferred ATM Program.

22



Amendment to Articles of Incorporation

On January 11, 2017, we filed with the Maryland State Department of Assessments and Taxation an Articles Supplementary reclassifying the remaining 160,000 authorized but unissued shares of our Series C Preferred Stock, as authorized but unissued shares of our common stock, and made a corresponding amendment to the partnership agreement of our operating partnership, Gladstone Commercial Limited Partnership, which is a wholly owned subsidiary of ours, with regard to corresponding units of partnership interest. As a result of the reclassification, there are zero authorized shares of Series C Preferred Stock and zero authorized corresponding units of partnership interest remaining. On the same date, we filed with the Maryland State Department of Assessments and Taxation an Articles of Restatement, restating and integrating into a single instrument all prior Articles Supplementary and amendments thereto.

Diversity of Our Portfolio

Our Adviser seeks to diversify our portfolio to avoid dependence on any one particular tenant, industry or geographic market. By diversifying our portfolio, our Adviser intends to reduce the adverse effect on our portfolio of a single under-performing investment or a downturn in any particular industry or geographic market. For the three months ended March 31, 2017 , our largest tenant comprised only 5.5% of total rental income. The table below reflects the breakdown of our total rental income by tenant industry classification for the three months ended March 31, 2017 and 2016 , respectively (dollars in thousands):
 
 
 
For the three months ended March 31,
 
 
2017
 
2016
Industry Classification
 
Rental Revenue
 
Percentage of Rental Revenue
 
Rental Revenue
 
Percentage of Rental Revenue
Telecommunications
 
$
3,851

 
17.6
%
 
$
3,280

 
15.9
%
Healthcare
 
3,332

 
15.2

 
3,347

 
16.2

Automobile
 
2,641

 
12.0

 
2,639

 
12.8

Diversified/Conglomerate Services
 
2,000

 
9.1

 
1,970

 
9.5

Information Technology
 
1,498

 
6.8

 
588

 
2.8

Diversified/Conglomerate Manufacturing
 
1,205

 
5.5

 
1,149

 
5.6

Electronics
 
1,082

 
4.9

 
1,082

 
5.2

Personal, Food & Miscellaneous Services
 
892

 
4.1

 
892

 
4.3

Chemicals, Plastics & Rubber
 
770

 
3.5

 
779

 
3.8

Personal & Non-Durable Consumer Products
 
664

 
3.0

 
656

 
3.2

Banking
 
612

 
2.8

 
612

 
3.0

Machinery
 
560

 
2.6

 
682

 
3.3

Buildings and Real Estate
 
558

 
2.5

 
548

 
2.7

Childcare
 
556

 
2.5

 
556

 
2.7

Beverage, Food & Tobacco
 
525

 
2.4

 
525

 
2.5

Containers, Packaging & Glass
 
519

 
2.4

 
666

 
3.2

Printing & Publishing
 
393

 
1.8

 
390

 
1.9

Education
 
164

 
0.7

 
164

 
0.8

Home & Office Furnishings
 
132

 
0.6

 
132

 
0.6

Total
 
$
21,954

 
100.0
%
 
$
20,657

 
100.0
%


23


The table below reflects the breakdown of total rental income by state for the three months ended March 31, 2017 and 2016 , respectively (dollars in thousands):

State
 
Rental Revenue for the three months ended March 31, 2017
 
% of Base Rent
 
Number of Leases for the three months ended March 31, 2017
 
Rental Revenue for the three months ended March 31, 2016
 
% of Base Rent
 
Number of Leases for the three months ended March 31, 2016
Texas
 
$
3,781

 
17.2
%
 
12

 
$
3,722

 
18.0
%
 
12

Ohio
 
2,296

 
10.5

 
14

 
2,337

 
11.3

 
16

Pennsylvania
 
2,230

 
10.2

 
7

 
1,678

 
8.1

 
6

North Carolina
 
1,499

 
6.8

 
8

 
1,441

 
7.0

 
8

Georgia
 
1,192

 
5.4

 
6

 
1,192

 
5.8

 
6

South Carolina
 
1,153

 
5.3

 
2

 
1,153

 
5.6

 
2

Florida
 
1,117

 
5.1

 
3

 
617

 
3.0

 
2

Michigan
 
1,082

 
4.9

 
4

 
1,074

 
5.2

 
4

Utah
 
946

 
4.3

 
2

 
588

 
2.8

 
1

Minnesota
 
916

 
4.2

 
6

 
845

 
4.1

 
4

All Other States
 
5,742

 
26.1

 
35

 
6,010

 
29.1

 
37

Total
 
$
21,954

 
100.0
%
 
99

 
$
20,657

 
100.0
%
 
98


Our Adviser and Administrator

Our Adviser is led by a management team with extensive experience purchasing real estate and originating mortgage loans. Our Adviser and Administrator are controlled by Mr. David Gladstone, who is also our chairman and chief executive officer. Mr. Gladstone also serves as the chairman and chief executive officer of both our Adviser and Administrator. Mr. Terry Lee Brubaker, our vice chairman and chief operating officer, is also the vice chairman and chief operating officer of our Adviser and Administrator. Mr. Robert Cutlip, our president, is also an executive managing director of our Adviser. Gladstone Administration, LLC, or our Administrator, employs our chief financial officer, treasurer, chief compliance officer, general counsel and secretary (who also serves as our Administrator’s president, general counsel, and secretary) and their respective staffs.

Our Adviser and Administrator also provide investment advisory and administrative services, respectively, to certain of our affiliates, including, but not limited to, Gladstone Capital Corporation and Gladstone Investment Corporation, both publicly-traded business development companies, as well as Gladstone Land Corporation, a publicly-traded REIT that primarily invests in farmland. With the exception of Mr. Michael Sodo, our chief financial officer, Mr. Jay Beckhorn, our treasurer, and Mr. Robert Cutlip, our president, all of our executive officers and all of our directors serve as either directors or executive officers, or both, of Gladstone Capital Corporation and Gladstone Investment Corporation. In addition, with the exception of Mr. Cutlip, and Mr. Sodo, all of our executive officers and all of our directors, serve as either directors or executive officers, or both, of Gladstone Land Corporation. Mr. Cutlip and Mr. Sodo spend 100% of their time focused on Gladstone Commercial Corporation, and do not put forth any material efforts in assisting affiliated companies. In the future, our Adviser may provide investment advisory services to other companies, both public and private.

Advisory and Administration Agreements

We are externally managed pursuant to contractual arrangements with our Adviser and our Administrator, which collectively employ all of our personnel and pay their salaries, benefits and general expenses directly. Both our Adviser and Administrator are affiliates of ours, as their parent company is owned and controlled by Mr. David Gladstone, our chairman and chief executive officer. Two of our executive officers, Mr. Gladstone and Mr. Terry Brubaker (our vice chairman and chief operating officer) serve as directors and executive officers of our Adviser and our Administrator. Mr. Michael LiCalsi, our general counsel and secretary, serves as our Administrator's president, general counsel and secretary. We have an advisory agreement with our Adviser, or the Advisory Agreement, and an administration agreement with our Administrator, or the Administration Agreement. The services and fees under the Advisory Agreement and Administration Agreement are described below.


24


Under the terms of the Advisory Agreement between us and our Adviser, as amended, we are responsible for all expenses incurred for our direct benefit. Examples of these expenses include legal, accounting, interest, directors' and officers' insurance, stock transfer services, stockholder-related fees, consulting and related fees. In addition, we are also responsible for all fees charged by third parties that are directly related to our business, which include real estate brokerage fees, mortgage placement fees, lease-up fees and transaction structuring fees (although we may be able to pass all or some of such fees on to our tenants and borrowers).

Base Management Fee

On July 24, 2015, we renewed the Advisory Agreement by entering into a Second Amended and Restated Advisory Agreement, with the Adviser effective July 1, 2015. We subsequently renewed the Advisory Agreement by entering into a Third Amended and Restated Advisory Agreement with the Adviser on July 12, 2016 effective July 1, 2016. Our entrance into each of the amended agreements was approved unanimously by our Board of Directors. Our Board of Directors reviews and considers approving or renewing the Advisory Agreement with our Adviser each July.

As a result of the July 2015 amendment, the calculation of the annual base management fee equals 1.5% of our adjusted total stockholders’ equity, which is our total stockholders’ equity (before giving effect to the base management fee and incentive fee), adjusted to exclude the effect of any unrealized gains or losses that do not affect realized net income (including impairment charges) and adjusted for any one-time events and certain non-cash items (the later to occur for a given quarter only upon the approval of our Compensation Committee). The fee is calculated and accrued quarterly as 0.375% per quarter of such adjusted total stockholders’ equity figure. As a result of the July 2016 amendment, the definition of adjusted total stockholders' equity in the calculation of the base management fee and the incentive fee (described below) includes total mezzanine equity. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties as is common in other externally managed REITs; however, our Adviser may earn fee income from our borrowers, tenants or other sources. Prior to the 2015 amendment, our Advisory Agreement provided for an annual base management fee equal to 2.0% of our common stockholders’ equity, which was our total stockholders’ equity, less the recorded value of any preferred stock and adjusted to exclude the effect of any unrealized gains, losses, or other items that did not affect realized net income (including impairment charges).

Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties as is common in other externally managed REITs; however, our Adviser may earn fee income from our borrowers, tenants or other sources. Prior to the 2015 amendment, our Advisory Agreement provided for an annual base management fee equal to 2.0% of our common stockholders’ equity, which was our total stockholders’ equity, less the recorded value of any preferred stock and adjusted to exclude the effect of any unrealized gains, losses, or other items that did not affect realized net income (including impairment charges).

Incentive Fee

As a result of the 2015 amendment, the calculation of the incentive fee was revised to reward the Adviser in circumstances where our quarterly Core FFO (defined at the end of this paragraph), before giving effect to any incentive fee, or pre-incentive fee Core FFO, exceeds 2.0% quarterly, or 8.0% annualized, of adjusted total stockholders’ equity (after giving effect to the base management fee but before giving effect to the incentive fee). We refer to this as the new hurdle rate. The Adviser will receive 15.0% of the amount of our pre-incentive fee Core FFO that exceeds the new hurdle rate. However, in no event shall the incentive fee for a particular quarter exceed by 15.0% (the cap) the average quarterly incentive fee paid by us for the previous four quarters (excluding quarters for which no incentive fee was paid). Core FFO (as defined in the Advisory Agreement) is GAAP net income (loss) available to common stockholders, excluding the incentive fee, depreciation and amortization, any realized and unrealized gains, losses or other non-cash items recorded in net income (loss) available to common stockholders for the period, and one-time events pursuant to changes in GAAP. The incentive fee prior to the July 2015 amendment rewarded the Adviser in circumstances where our quarterly funds from operations, or FFO, before giving effect to any incentive fee, or pre-incentive fee FFO, exceeded 1.75%, or 7.0% annualized, or the hurdle rate, of common stockholders’ equity. FFO included any realized capital gains and capital losses, less any distributions paid on preferred stock and Senior Common Stock (defined herein), but FFO did not include any unrealized capital gains or losses (including impairment charges). The Adviser received 100.0% of the amount of the pre-incentive fee FFO that exceeded the hurdle rate, but was less than 2.1875% of our common stockholders’ equity. The Adviser also received an incentive fee of 20.0% of the amount of our pre-incentive fee FFO that exceeded 2.1875% of common stockholders’ equity.


25


Capital Gain Fee

Under the Advisory Agreement, as amended in July 2015, we will pay to the Adviser a capital gains-based incentive fee that will be calculated and payable in arrears as of the end of each fiscal year (or upon termination of the Advisory Agreement). In determining the capital gain fee, we will calculate aggregate realized capital gains and aggregate realized capital losses for the applicable time period. For this purpose, aggregate realized capital gains and losses, if any, equals the realized gain or loss calculated by the difference between the sales price of the property, less any costs to sell the property and the current gross value of the property (which is calculated as the original acquisition price plus any subsequent non-reimbursed capital improvements). At the end of the fiscal year, if this number is positive, then the capital gain fee payable for such time period shall equal 15.0% of such amount. No capital gain fee was recognized during the three months ended March 31, 2017 or 2016 .

On January 10, 2017, we amended and restated the Advisory Agreement by entering into the Fourth Amended and Restated Investment Advisory Agreement between us and the Adviser to revise the calculation of the capital gains fee. Based upon the amendment, the calculation of the capital gains fee is based on the all-in acquisition cost of disposed of properties. The impact of this amendment would not have resulted in a capital gains fee for previously reported periods. Our entrance into the Fourth Amended and Restated Investment Advisory Agreement was approved unanimously by our Board of Directors.

Termination Fee

As a result of the July 2015 amendment, the Advisory Agreement includes a termination fee whereby, in the event of our termination of the agreement without cause (with 120 days’ prior written notice and the vote of at least two-thirds of our independent directors), a termination fee would be payable to the Adviser equal to two times the sum of the average annual base management fee and incentive fee earned by the Adviser during the 24-month period prior to such termination. A termination fee is also payable if the Adviser terminates the agreement after the Company has defaulted and applicable cure periods have expired. The agreement may also be terminated for cause by us (with 30 days’ prior written notice and the vote of at least two-thirds of our independent directors), with no termination fee payable. Cause is defined in the agreement to include if the Adviser breaches any material provisions of the agreement, the bankruptcy or insolvency of the Adviser, dissolution of the Adviser and fraud or misappropriation of funds.

Administration Agreement

Under the terms of the Administration Agreement, we pay separately for our allocable portion of our Administrator’s overhead expenses in performing its obligations to us including, but not limited to, rent and our allocable portion of the salaries and benefits expenses of our Administrator’s employees, including, but not limited to, our chief financial officer, treasurer, chief compliance officer, general counsel and secretary (who also serves as our Administrator’s president, general counsel and secretary), and their respective staffs. As approved by our Board of Directors, effective July 1, 2014, our allocable portion of the Administrator’s expenses are generally derived by multiplying our Administrator’s total expenses by the approximate percentage of time the Administrator’s employees perform services for us in relation to their time spent performing services for all companies serviced by our Administrator under contractual agreements. We believe that the new methodology of allocating the Administrator’s total expenses by approximate percentage of time services were performed among all companies serviced by our Administrator more closely approximates fees paid to actual services performed.

Critical Accounting Policies and Estimates

The preparation of our financial statements in accordance with GAAP, requires management to make judgments that are subjective in nature in order to make certain estimates and assumptions. Application of these accounting policies involves the exercise of judgment regarding the use of assumptions as to future uncertainties, and as a result, actual results could materially differ from these estimates. A summary of all of our significant accounting policies is provided in Note 1 to our consolidated financial statements in our 2016 Form 10-K. There were no material changes to our critical accounting policies or estimates during the three months ended March 31, 2017 .

Results of Operations

The weighted average yield on our total portfolio, which was 8.6% as of both March 31, 2017 and 2016 , is calculated by taking the annualized straight-line rents, reflected as rental income on our condensed consolidated statements of operations, of each acquisition since inception as a percentage of the acquisition cost plus subsequent capital improvements. The weighted average yield does not account for the interest expense incurred on the mortgages placed on our properties.


26


A comparison of our operating results for the three months ended March 31, 2017 and 2016 is below (dollars in thousands, except per share amounts) :
 
 
 
For the three months ended March 31,
 
 
2017
 
2016
 
$ Change
 
% Change
Operating revenues
 
 
 
 
 
 
 
 
Rental revenue
 
$
21,954

 
$
20,657

 
$
1,297

 
6.3
 %
Tenant recovery revenue
 
360

 
485

 
(125
)
 
(25.8
)%
Interest income from mortgage note receivable
 

 
385

 
(385
)
 
(100.0
)%
Total operating revenues
 
22,314

 
21,527

 
787

 
3.7
 %
Operating expenses
 
 
 
 
 
 
 
 
Depreciation and amortization
 
9,921

 
9,133

 
788

 
8.6
 %
Property operating expenses
 
1,380

 
1,610

 
(230
)
 
(14.3
)%
Base management fee
 
1,181

 
861

 
320

 
37.2
 %
Incentive fee
 
569

 
618

 
(49
)
 
(7.9
)%
Administration fee
 
360

 
404

 
(44
)
 
(10.9
)%
General and administrative
 
551

 
588

 
(37
)
 
(6.3
)%
Impairment charge
 
3,746

 
43

 
3,703

 
8,611.6
 %
Total operating expenses
 
17,708

 
13,257

 
4,451

 
33.6
 %
Other expense
 
 
 
 
 
 
 
 
Interest expense
 
(6,158
)
 
(6,731
)
 
573

 
(8.5
)%
Distributions attributable to Series C mandatorily redeemable preferred stock
 

 
(686
)
 
686

 
(100.0
)%
Gain on sale of real estate
 
5,906

 

 
5,906

 
100.0
 %
Other income
 
2

 

 
2

 
100.0
 %
Total other expense, net
 
(250
)
 
(7,417
)
 
7,167

 
(96.6
)%
Net income
 
4,356

 
853

 
3,503

 
410.7
 %
Distributions attributable to Series A, B and D preferred stock
 
(2,373
)
 
(1,027
)
 
(1,346
)
 
131.1
 %
Distributions attributable to senior common stock
 
(248
)
 
(252
)
 
4

 
(1.6
)%
Net income (loss) available (attributable) to common stockholders
 
$
1,735

 
$
(426
)
 
$
2,161

 
507.3
 %
Net income (loss) available (attributable) to common stockholders per weighted average share of common stock - basic and diluted
 
$
0.07

 
$
(0.02
)
 
$
0.09

 
450.0
 %
FFO available to common stockholders - basic
 
$
9,496

 
$
8,750

 
$
746

 
8.5
 %
FFO per weighted average share of common stock - basic
 
$
0.38

 
$
0.39

 
$
(0.01
)
 
(2.6
)%
FFO per weighted average share of common stock - diluted
 
$
0.38

 
$
0.39


$
(0.01
)
 
(2.6
)%

Same Store Analysis

For the purposes of the following discussion, same store properties are properties we owned as of January 1, 2016 , which have not been subsequently vacated, or disposed of. Acquired and disposed of properties are properties which were either acquired, disposed of or classified as held for sale at any point subsequent to December 31, 2015 . Properties with vacancy are properties that were fully vacant or had greater than 5% vacancy, based on square footage, at any point subsequent to January 1, 2016 .


27


Operating Revenues

 
 
For the three months ended March 31,
 
 
(Dollars in Thousands)
Rental Revenues
 
2017
 
2016
 
$ Change
 
% Change
Same Store Properties
 
$
19,483

 
$
19,466

 
$
17

 
0.1
%
Acquired & Disposed Properties
 
1,549

 
497

 
1,052

 
211.7
%
Properties with Vacancy
 
922

 
694

 
228

 
32.9
%
 
 
$
21,954

 
$
20,657

 
$
1,297

 
6.3
%

Rental revenue from same store properties increased slightly for the three months ended March 31, 2017 , primarily because of additional rental income received from leases subject to consumer price index increases, coupled with increased rent earned from lease extensions executed subsequent to March 31, 2016 . Rental revenue increased significantly for acquired and disposed of properties for the three months ended March 31, 2017 , as compared to the three months ended March 31, 2016 , because we acquired three properties subsequent to March 31, 2016 , offset by a loss of revenue from the seven properties we sold subsequent to the three months ended March 31, 2016 . Rental revenue increased for our properties with vacancy for the three months ended March 31, 2017 because we leased approximately 110,000 square feet of vacant space in properties with partial vacancies during the three months ended March 31, 2016 .
 
 
 
For the three months ended March 31,
 
 
(Dollars in Thousands)
Tenant Recovery Revenue
 
2017
 
2016
 
$ Change
 
% Change
Same Store Properties
 
$
348

 
$
432

 
$
(84
)
 
(19.4
)%
Acquired & Disposed Properties
 
3

 
47

 
(44
)
 
(93.6
)%
Properties with Vacancy
 
9