David Gladstone - Chairman & CEO Mike Sodo - CFO Bob Cutlip - President

Rob Stevenson - Janney Montgomery Scott David Corak - B. Riley FBR Laura Engel - Stonegate Capital John Massocca - Ladenburg Thalmann Jeff Rudner - UBS Rick Murray - Sorin Capital

Good day, ladies and gentlemen and welcome to the Gladstone Commercial Fourth Quarter and Year Ended December 31, 2017 Earnings Call and Webcast. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll host a question-and-answer session and our instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. It is now my pleasure to hand the conference over to Mr. David Gladstone. Sir, you may begin.

All right. Thank you, Brian. Nice introduction and thanks to all of you for calling in. We always as we mentioned every time enjoy these calls and hope we can have more of them. Please come and visit us if you are in the Washington DC area. We're located in the suburb called McLean, Virginia and you have an open invitation to stop by and see us if you are in this area. You'll see a great team at work. As mentioned before we still have over 60 members in the team here. Now you're going to hear from -- well, before we begin just wanted to say how sad we all are about the shootings in South Florida. We have properties in Florida and wish all those people just breaks our heart to see such events. So now we'll hear from Eric Helm. He is our number two lawyer. He works with Michael LiCalsi and he is General Counsel for us and he is going to give us brief announcement regarding some of the legal and regulatory matters concerning the call as we move forward today.

Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that are based upon our current plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors, in our forms 10-Q, 10-K, and other documents we file with the SEC. Those can be found on our website, www.gladstonecommercial.com specifically the Investor Relations page or on the SEC's website, www.sec.gov. We undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Today we will discuss FFO, which is funds from operations. FFO is a non-GAAP accounting term defined as net income excluding the gains or losses from the sale of real estate and any impairment losses from property, plus depreciation and amortization of real estate assets. We will also discuss core FFO, which is generally FFO adjusted for certain other nonrecurring revenues and expenses. We believe this is a better indication of our operating results and allows better comparability of our period-over-period performance. Please take the opportunity to visit our website www.gladstonecommercial.com and sign up for email notification service. You can also find us on Facebook, keyword, The Gladstone Companies and we even have our own Twitter handle @gladstonecomps. Today's call is an overview of our results. So, we ask that you please review our press release and Form 10K issued yesterday for more detailed information. Again, those can be found on the Investor Relations page of our website Now over to Gladstone Commercial's President, Bob Cutlip.

Thanks Eric. Good morning, everyone. During the fourth quarter, we acquired a $17.2 million office property in Columbus, Ohio, acquired a $20.4 million office property in Salt Lake City, Utah, executed an agreement to sell our property in Tewksbury, Massachusetts for $5.5 million, executed an agreement to sell our property in Arlington, Texas for $5.6 million, issued $16.2 million of common stock and preferred stock under our ATM programs and extended and expanded the line of credit and term loan, resulting in increased capacity, significantly extended maturities and our lower borrowing cost. Subsequent to the end of the quarter, we executed an agreement to acquire a $14 million industrial property adjacent to the Mercedes-Benz assembly plant in Vance, Alabama. We leased 35,000 square feet in our Maple Heights, Ohio industrial property effective January 1. Repaid a maturing $6.7 million mortgage note and conducted multiple non-deal roadshows including two held in Boston and Los Angeles that were hosted by research analysts that recently initiated coverage. For the full year ended December 31 some noted investment, capital and asset management highlights worthy of note include that we invested $138 million in seven property acquisitions and one expansion project at an average yield to us or average cap rate over the term of 8.2%. The impact of these accretive acquisitions is expected to be fully felt in 2018 as the timing of these transactions resulted in only three to four months of income contribution during 2017. We exited four non-core single property markets. We completed the lease up of an industrial property in Raleigh, North Carolina and an office property in Houston, Texas. We renewed and extended the leases of five tenants at a GAAP rental rate per square foot increase of 6.9%, recast and extended our revolver and term loan at lower costs and refinanced $49.2 million of maturing mortgages at lower leverage and interest rates. As you can see from this overview, every team member across all functions contributed to a successful 2017. As of year-end, our properties were 98% occupied. We continue to be pleased with our activity and have a healthy pipeline of acquisition properties. As noted during our last quarterly call, overall investment sales volume for the year was trending lower than for 2016. The most recent published reports reflect overall sales volume reducing by somewhere between 8% and 10%, as compared to 2016. Completing the ninth year of the current cycle, noted researchers in the industry have forecast that the market cycle maybe peaking from a volume standpoint. Prices continue to rise for most product types, but at a much slower rate with maybe the exception of industrial properties. Investment sales listing started the year at a much slower pace than normal. However, research firms are forecasting that overall investment volume for 2018 could be similar to 2017. Our team will monitor -- continue to monitor market conditions and actively investigate opportunities and we will acquire properties when the tenant credit, location and asset returns are accretive and promote our measured growth strategy. Now for some company-specific details. We completed two acquisitions during the quarter. These acquisitions said a lot about our team approach to transactions and our broker relationships, as the acquisitions were with the same investment grade tenant, the same seller located in two of our target markets and closed on the same day December 1. To briefly summarize these transactions, the multistory office properties are in Columbus, Ohio and Salt Lake City, Utah. The tenant is Morgan Stanley Wealth Management who has been in both properties since 2007 and has personally invested $20 million in building improvements at each location. There's also a regional bank occupying approximately 15% of the Columbus property. The investment in the Columbus, Ohio property is $17.2 million and the Salt Lake City investment is $20.4 million. The average unexpired lease term is 8.6 years and the average yield to us or the average cap rate is 9.9%. A design requirement of the seller was to complete the sale prior to year-end with our knowledge of the markets, the properties, the tenant credit and possessing significant availability of capital, we executed the purchase and sale agreement in November and closed the transaction on December 1. Matt Tucker who leads our Midwest region and Andrew White, who leads our West region, their teams worked diligently with their counterparts at both the listing agent and the seller and created a win-win transaction for all. We executed an agreement to acquire our second industrial property adjacent to the Mercedes-Benz Assembly Plant in Vance, Alabama. We are currently in the due diligence phase with an expected closing in March. The property was recently constructed and the lease term is 10 years. The acquisition price $14.2 million and the average cap rate of the lease term is 7.6%. The tenant has invested $25 million in an automated assembly system for this just-in-time manufacturing facility. Closing this transaction, will promote our strategy of increasing our allocation to industrial buildings over the next few years, of course market conditions permitting. Our team continues to have a strong pipeline of acquisition candidates exceeding $305 million in volume in 18 properties, seven of which are industrial. Of this total, $14.2 million is in the due diligence stage, $61 million is in the Letter of Intent stage and the balance is under initial review. Our asset management team has continued managing our portfolio to ensure strong performance. As noted earlier, two of our partially vacant properties in Raleigh and Houston, Texas, are now fully occupied as of January 1 and we leased 35,000 square feet in our Maple Heights, Ohio property. Our only fully vacant property in Tewksbury, Massachusetts, is currently under contract with an expected sale date before the end of March. We recognize a $2.8 million impairment on this property in the fourth quarter. That's due to what we believe are inferior market characteristics and determine the better strategy to sell this asset and redeploy the proceeds in our target markets. The better news for 2018 is that we have no further lease expirations for the balance of the year. Of the three expirations that were scheduled for 2018, one tenant renewed, one tenant elected to acquire the property with an expected closing date before the end of the first quarter and one 8,000 square foot tenant vacated at the end of January. Our team is already engaging tenants with expiring leases in 2019 and those leases represent just 4% of our contractual rent as of the end of 2017. This is an important fact for our shareholders as the majority of our peers have approximately 15% or more of their leases expiring during the same period. The majority of our capital availability will be used to pursue growth opportunities because we do not anticipate needing significant capital for either tenant improvements or leasing commissions to retain tenants and re-lease vacant space or to fund operating deficits. I think it's important to note that from a capital structure standpoint, our refinancings continue to lower our loan-to-value and lower our annual costs and the amount of debt maturing in the years ahead is at a very manageable level. This combination of limited lease expirations and improving capital structure, lower annual debt cost on our properties and the selective sale of non-core properties and redeployment of those proceeds gives us more opportunities to emphasize growth. So, in summary, our fourth quarter and year-to-date activities continued our acquisition and leasing success, extended our credit facility and refinanced maturing loans. Our team continues to have a strong pipeline of acquisition candidates and we'll adhere to our strategy of only acquiring properties with creditworthy tenants in growth markets that are accretive to our operations. Now let's turn it over to Mike for a report on the financial results.

Thanks Bob. Good morning. I'll start by reviewing our fourth quarter and full year operating results. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common stockholders were $10.9 million and $11 million respectively or $0.381 and $0.384 respectively per share for the quarter. On a core FFO basis this is over 3% increase, totaling approximately $336,000 from the prior quarter. FFO and core FFO available to common stockholders were $41.7 million and $41.2 million or $1.54 and $1.52 per share respectively for the year. On a core FFO basis, this is an 11% increase, totaling approximately $4.1 million from the prior year. We acquired two office properties in December as Bob mentioned. The rents from these properties as well as the five other property acquisitions completed between the latter half of the second quarter and at the end of the third quarter contributed to the growth of core FFO and are anticipated to help us increase profitability going forward given their full year participation in earnings for 2018. Our fourth quarter results reflected an increase in total operating revenues to $25.3 million as compared to total operating expenses excluding impairment losses of $17.6 million for the period. Now let's take a look at our debt activity and capital structure. We continue to enhance our strong balance sheet as we grow our assets and focus on decreasing our leverage. We've reduced our debt to gross assets by 10% to 47% since the beginning of 2016, generally through refinancing maturing debt and financing new acquisitions at lower leverage levels. We expect to continue to gradually decrease our leverage over the next 18 to 24 months. As we discussed this with various analysts, investors and lenders, we believe this will put us at the proper leverage level going forward long-term. We continue to primarily use long term mortgage debt to make acquisitions. As we grow through disciplined investments, we'll look to expand our unsecured property pool with additional high-quality assets as well. Over time, this will increase our funding alternatives. As we manage our balance sheet, we have repaid $129 million of debt over the past 24 months primarily with new long-term variable rate mortgages at interest rates equal to the one-month LIBOR plus a spread ranging from 2.35% to 2.75%. We placed interest rate caps on all of these loans. We also added some of these properties to our unencumbered line of credit whether an advanced permanent debt placement, disposition or an effort to provide more flexibility in the future. The prospects for doing this were further enhanced through our refinance of our credit facility in October which I'll discuss further. Prior to the refinancings, these mortgages had a weighted average interest rate of 6% and our deleveraging and refinancing efforts have been a tremendous success with 2017 interest expense decreasing by approximately 5% versus 2016. We did amend, extend and upsized our combined credit facility in October. The new facility has $85 million of revolving credit capacity as well as an upsize term loan totaling $75 million, which is $50 million larger than the prior term loan. At close, we termed out all previous combined borrowings, leaving us with a fully undrawn revolving credit facility. The revolving credit facility was extended for a new four-year term through October of 2021 with the term loan extended through October of 2022. We have interest rate caps in place on all of the outstanding term debt. In addition to successfully upsizing the facility as well as significantly extending the maturity profile, we also improved pricing on both the revolving credit facility and the term loan by 25 basis points. We believe this execution was important as we continue to prudently address our maturing debt, pursue opportunities to improve pricing, increase our unencumbered asset pool over time and provide the necessary liquidity to operate the business. Looking at our debt profile, after this important refinance, 2018 loan maturities are very manageable with only $38 million of debt coming due. Further we have less than $50 million of mortgages maturing in each of the next four years. From a long-term mortgage debt perspective, issuances continue to be available but at higher rates than we've experienced in recent years. Interest rates have been very volatile this year, particularly with the recent rise in interest rates on U.S. treasuries. With that said, interest rates still remain attractively low from a historical perspective and we'll continue to actively try to match our acquisitions with cost-effective debt. Depending on several factors, including the tenant's credit, property-type, location, terms of the lease, leverage and the amount and term of the loan, we're generally seeing all in rates in the 4% to high 4% range. In 2017, the rate on the 10-year fixed-rate loans related to our acquisitions range from 3.5% to 3.9%. We continue to minimize our exposure to rising interest rates with 70% of our existing debt being fixed rate and an additional 26% being hedged through interest rate swaps and caps. We remain active in issuing both our common stock and our Series D preferred stock using our ATM programs. During the fourth quarter and net of issuance cost we raised $14.7 million of common stock and $1.5 million of Series D preferred stock. We continue to view the ATM as an efficient -- extremely efficient way to raise equity and fund attractive acquisitions. As of today, we have $4 million in cash and $43.2 million of availability under our line of credit. With our current availability and access to our ATM programs, we believe that we have enough liquidity to fund our current operations properties we are reviewing and any known upcoming improvements at our properties. We continue to also encourage you to review our quarterly financial supplement posted on our website, which provides more detailed financial and portfolio information for the quarter. We feel good about executing our business plan during 2018 as we continue to increase our high-quality asset base and continue to improve our metrics including leverage. We're focused on maintaining our high occupancy with strong credit and real estate. Institutional ownership of our stock has increased by 15% in the past 24 months to over 55% as of year-end. Certainly, some of this is a function of being included in the RMZ Index in December 2016, but Bob and I have been very active in meeting with current and potential institutional investors, portfolio managers, investment banks and the like. We look forward to further engaging with not only our existing investor base, lenders and coverage analysts, but also establishing new relationships as the company moves forward to its next chapter. Now I'll turn it back to David.

That was a good report, Mike and good ones from Bob and Eric as well. All you can say about the last three months as well as the year as well, everything is clicking right along, making good progress in building the assets and keeping ourselves occupied. We marked two high-quality office buildings during the last three months and that's in place and should add good amount of money to the bottom line as we go forward. We sold over $16.2 million of combined new preferred and common. So, there is your equity that's going to help us build up. We executed lease extensions on up to two of our buildings are now 100% leased that weren't before, executed sales agreements on two non-core assets during the first quarter of 2018, that's total of four for the year. So, everything is falling into place. We got a great team working there and this should position the company for continued growth. As many of you know, the company didn't cut its monthly cash distributions during the recession and I bring that up each time because people keep talking about things are going to get worse and all I can say is I think our balance sheet and P&L is going to be able to go through any kind of recession. That was quite a success story when we went through the last one and watched some of our very good companies that we compete with cut their distributions and most of them have never recovered to bring their dividend back to their original level. And we're in a great position not to have to have substantial problems if they come and hits the skids again. We are in a good position today because we do not have many leases coming due until 2020. We expect low spending on tenant improvements. We continue to refinance loans that are coming due and most of these are going into really long-term debt with fixed rates that match up with our buildings that have long-term leases at fixed rates. We're now building up the asset base with new purchases and have more to come. I think our balance sheet is strong. It's really battle ready if there is a recession or problem in the marketplace. We built our assets and our equity base, doubling the size over the last five years, which I think is a very strong indication of what a great team is here. With the growth that we see and hope to see, the buyers come into the stock and should hopefully help increase the price of the stock. It's extremely low right now. We're raising more preferred stock in the Series D, which is a 7% yield. People who want to yield in very safe stock and think that's one of the best. We do have a new webpage on our website at www.gladstonecommercial.com that explains the preferred stock. We cannot redeem this for another I think about three years. So, its very investor friendly. Not that we normally even consider. We're moving some of our preferred stock from our balance sheet. We continue to have a promising list of potential quality properties that we're interested in acquiring. We expect to continue to grow the portfolio even more in 2018. With the increase in the portfolio of properties comes greater diversification and we believe more predictable earnings. However, please note that prices for good buildings with good tenants is very high and yields are relatively low. So, we have to shop around and we can't just go out and buy half a dozen buildings this afternoon and we have to make sure that the tenants in the buildings fit our mode of operation. Much of the industrial base of businesses that rent industrial and office properties, like the ones we have remain very steady. As you know, we have a terrific credit underwriting group that underwrites our tenants and considering the track record of tenants paying their rents, I think the future is bright. It's a strong underwriting and it has kept this company more than 96% occupied since 2003. While I'm optimistic of our company and its fine future, Bob and his team will continue to be cautious of the acquisitions as they've done in past years. Now the fun part in December, the Board voted to maintain the monthly distribution of $0.125 per common share for January, February and March. This is an annual run rate of a $1.50 per year. This is a very attractive rate for well-managed REIT like ours, which we believe is well perfect for individuals that want monthly income and yes, I know you want to know when we're going to increase the distribution amount and all I can say is take a look at the FFO as it increases, we'll have to look at some small increases in dividends. We need to keep the dividend ahead of inflation, so our stockholders do not have a reduction in their buying power of their dividends they're receiving and we're working on that now. We now have paid 156 consecutive common stock cash distributions, that's more than 13 years. I think it's just a wonderful track record and speaks volumes about how strong this company is. Because the real estate can be depreciated, here's another one. We are able to shelter the income of the company. The return of capital was about 60% for the common stock in 2017. This is a tax-friendly stock that in my good opinion is one that's wonderful for personal accounts and I like it in my personal account because I don't pay taxes on the 60.4% that is sheltered. The return of capital as you all know is mainly due to the depreciation of real estate assets and other items since it caused earnings to remain low after depreciation and that's why we talk about FFO and core FFO because this adds back the real estate depreciation. Depreciation of a building is always in my mind been a fiction since at the end of the depreciation period, the building is still standing and usually has a tenant in it. So, it's a nonevent. The stock is nonretirement accounts as opposed to having an IRA or retirement plan. That means you don't pay taxes on the part that's sheltered by depreciation as it's considered a return of capital. However, when you sell the stock, you do have a lower cost basis so you may have some taxes but looks like the new tax laws will give us some benefit there as well. Stock closed on Monday at not Monday, closed yesterday at $17.28. The distribution yield on our stock is now about 8.68%. Many REITs are trading at much lower yields. This recent downdraft in the equity market has created a great time to buy some of our stock. I hope you'll all call your brokers after this and get some stock purchases. The NNN REIT Index is generally trading about 6.61% yield. So, if our stock was trading at that today, price would be about $24.60. So, there is a lot of room for expansion of the stock price to be closer to the industry's quite hours and that's about a 70% -- 30% discount on about 70% of the average that's out there today. My guess is that as investors continue to discover and familiarize themselves with our company, we'll see the price of the stock increase and bring the yield in line with the other REITs that are like us. There are simply no reason for this REIT to trade at such a high yield, given the track record in the low lease turnover for the next two years. I always complain about being criticized for being externally managed, but folks, being externally managed allows us to access a team of credit underwriters unlike any other internally managed REIT. Our high occupancy level is a testament to this access that we have. We also are a REIT that looks first at the tenant, make sure they can pay the rent, whereas of many of the REITs always look at the real estate and talk about location, location, location. We're always talking about tenant, tenant, tenant, just to make sure that we're going to get our paid rent. In addition, while the salaries were paid by the external advisor, many of the resources such as Bob and Mike are solely dedicated to Gladstone Commercial and we have a whole team of people that do nothing but work on this REIT every day. We've also performed an analysis on cost of operating our REITs not higher than ours. We look at the internally managed REITs and we put the numbers together and we publish some of this over time and I know when Bob and Mike get on the road and they're asked that question, they pull out the slides and show people that we're right in line with many of the people that are out there doing exactly what we are. And we have been methodically decreasing our leverage every quarter. We get criticized for being a little heavily leveraged, we're not anymore. We've been putting up more equity when we refinance our mortgages. This allows us obviously to get lower cost capital, but we're near the end of using our equity lower on debt amounts and current level of leverage is quite conservative. Equity will be used by more new properties. So, we'll always have to raise money to buy these new properties, but raising money to pay down the debt, so that our debt equity ratio that's not something I want to see us spend a lot of money doing that. So, at this point, let's get some questions from our shareholders and some of the analysts out there who follow this wonderful company with Brian, come on please and help us get through some of these questions.

My pleasure, Sir. [Operator instructions] And our first question will come from the line of Rob Stevenson with Janney. Your line is now open.

All right. Good morning, guys. When you think about financing acquisitions in a $17 stock world, obviously there's some balance sheet capacity left that you guys have, but is it preferred that you guys look at once that's exhausted? How do you guys think about that? Is it asset sales and trying to basically call the bottom end of the portfolio and redeploy into higher growth assets? I was just curious how you guys are thinking about that if the current REIT environment persists?

Yeah, it's always a problem of trying to figure out how you're going to finance the company in a falling stock price because quite frankly all the REITs are down as you know Rob in terms of price. So, what we look at first of course is how many of our existing portfolio were going to sell and as we sell those off, we want to redeploy the money into something that we think is going to be a better fit for us long-term. So that's the first-order of business. Second order of business of course is to look at the ATM program for our preferred stock and see if we can sell some more preferred stock. We didn't sell much last quarter. It was down $2 million worth of preferred sold. So that's not going to help us that much, but that's the first two orders of business. And then we have to look at okay, are we going to sell some stock at $17? If we are, that means when we go out to buy a piece of property, we've got to get a much lower price for the property and higher yield in order to make up for that loss in stock price. So, Rob, we just need you to keep writing buy recommendations and we'll be all right I think.

Sorry, just to expand on that a little bit, and just to David's point on the modest amount of ATM activity, we do obviously look at the dividend yields on the common and the preferreds. To the end that we’re [seeding][ph] deals with common, it does put a stress on the weighted average cost of capital. Today with the [8.7][ph] dividend yield on the common, so potentially could issue more preferred, I would say more so really the downdraft in the stock price has not been why we have not issued meaningful amounts of equity within the ATM programs year-to-date. Bob mentioned an individual property for $14 million being in due diligent phase with $43 million availability in the line and $4 million of cash, there just hasn't been liquidity requirement. So, we will watch the trading and pivot if necessary to whether it's common or pref, but the deal team really just needs to stick to their knitting in terms of the spreads we need to obtain over that weighted average cost of capital to do accretive deals.

Okay. And then at your deal size level, what are you guys seeing out there in terms of volume of properties for sale? Has the 50 basis points move in the 10-year and the likelihood that you're going to get another fed rate increase here in March started to weave its way in less product being up for sales, people try to figure out where our cap rates set aloud in that type of environment? Has there been sort of any noticeable change for you guys over the last, call it 60, 90 days in terms of product out there over in the market even stopped it beyond the stoppage you guys are looking at?

Rob, as I kind of indicated the year started off slow, and I think it's started off slow for a number of reasons. You know a lot of people are talking about buyer seller disconnects, which I think is happening because smarter buyers are saying, well we know rates are rising, and so why would we be in that same very low cap rate environment that we've been over the last two to three years. So, I think that's one item, and you know it's amazing that the brokers have been telling us that they started off the year slower but now they are starting to see a lot more BOVs, brokers opinion of values being requested. So, I think that the market is going to come back to where there are more - is more activity. Although I would say if I compare this year to the last three, our activity is probably off somewhere between 25 and maybe a third but still with the activity that we have, we're seeing a little bit of movement in the cap rates primarily in the Midwest not in the West yet, and a little bit in the mid-Atlantic but I think it’s just going to be a challenge because as what happened in 2015 and 2016 as you recall, our stock price will hit dramatically as was the majority of the REITs. And so, we were prudent, we still bought in the mid-8s from an average cap standpoint. Last year our average cap rate was 8.2% and I think unfortunately we’re going to have to probably be in that general range until I think the market wakes up and recognizes. This hasn't changed, you know we still have the same margins we've had before, and we got stability in our portfolio and our cash flow. So, we just have to be patient persistent and as you know I think, so of my colleagues says, just have to be opportunistic Cutlip and that's what we will be.

So, Rob just to add on to that. Remember what marketplace we're in, we're not up there competing with the guys who will have big tenants like IBM and those kind of properties where there is almost 100% certainty that if you buy anything with those names on it, you're going to get paid. So those traded relatively low yields. We're in the marketplace where we're doing the underwriting that would've been done by S&P or somebody else. We pride ourselves on being able to take on a middle-market company that doesn't have the kind of ratings that you'd see in some of the other REITs. And I know people get little bit nervous about that but gosh, 30 years doing this now, you ought to wake up and say, I think these guys know what they’re underwriting in terms of the tenant. And obviously we underwrite the real estate the way everybody does. So, we're in a different marketplace. We should be able to fund transactions that will give us the same kind of yields that we've gotten before. Our real challenge now is, where we're going to get the equity at what price in order to make these transactions happen. Right now, we got plenty of money, we can do what we want to do. I think when we talk to you guys at the end of the next quarter, will have to answer this question again.

Yes. And one last comment Rob talking about size. In our letter-of-intent stage right now nearly every deal is between 5 million and let's say $18 million or $19 million. So, it's not in the $25 million to $40 million range and I think as David alluded, those are a lot of the middle-market non-rated companies in our secondary growth markets but the ones that have been in the property a long time and we think we can underwrite them well, and can get a little bit better cap rate.

And then last one from me. Mike given where lease roles look to be in 2018 versus 2017, you talked just briefly about where you see the sort of overall level of tenant improvements, CapEx and leasing commissions being in order to maintain the occupancy in 2018 versus 2017?

Sure. To your point we have very little role in 2018. As we guide towards ballpark numbers, I would say from a CapEx perspective, we are looking at a number roughly in the $2.5 million to $3 million range for 2018, and then combines TI's and LC's on top of that in the $1.5 million to $2.5 million range. So, for 2017 Rob CapEx, when you stripped out the Lear improvements, which were income producing improvements and extension of that lease '17 was like a $3.5 million to $3.7 million number. We probably will roughly be on top of that on the low end of the range.

Okay. Perfect. I appreciate it guys.

Thank you. Next question.

Yes Sir. Our next question will come from the line of David Corak with B. Riley FBR. Your line is now open.

Hey. Good morning, guys. I just wanted to With operating expense little bit higher than we had anticipated this quarter. I was wondering how much was going to one-time items, what those items were or is it just mainly related to less triple net exposure? And then Mike what's a good run rate leakage number to model going forward?

Sure. So, Dave I appreciate the question. I think generically as you guys look at tenant recovery revenue as compared to the property operating expense line items it needs to be a little double or further in that. What's happening is as we're doing less triple net deals and we're doing more base year leases, particularly as an example of the Mainland acquisition we did in July of last year, being anchored multitenant with ADP, taking up 72% of the space, there is recovery revenue pertaining to that property, but it actually is coming in, in the form of what's being recorded as rental income. So, as I look at run rate, if you just truly took the property operating expenses per the income statement, less tenant recovery revenue, Q1 through Q3, the run rate there was about $1.3 million per quarter number, just doing the mathematical exercise and it went up to about $1.9 million for Q4. That $600,000 of increase, the vast majority of that actually was recovered, but it was recovered in the form of what was defined as rental income, getting pretty particular in the next two years in terms of how your income statement is actually going to be presented in 2019 as a revenue recognition concept that's coming out that actually is going to split out that component of what is now being recorded to rental income to your actual tenant recovery line item. So, it's not an exact science just taking the delta between the two and saying that's leakage, that absolutely is not our leakage number. We've be crucified is that was. I need to get back to you in terms of what the specific run rate number is perhaps for leakage in '18. So, I apologize I don't have that in front of me, but I'll get back to you in short order on that?

Why don't we put that on our website under question-and-answer? So, everybody can get to that number.

Great idea. Will do.

How much of the portfolio at this point, sorry…?

Go ahead.

How much of the portfolio is triple net at this point?

At least two thirds of it.

Okay. All right and then just following up on Rob's question about leasing spreads, specifically with the office portfolio, some of the stuff you transacted this year, and actually there are maybe two assets, pair of assets this quarter, can you just talk about the kind of releasing activity and the spreads you're getting there and where that is compared to market.

Dave I'm trying to understand during this quarter, the one lease that we did was an industrial lease in Maple Heights, Ohio. It's a 350,000 square foot industrial lease. So, we did not -- we did not do -- the most recent one is a believe it or not, a small lease, a 2900 square foot lease in our Indianapolis property and that one went up a little bit just because, by less than 5%, but that's directly related to the tenant who moved into that space is our anchor tenant in that building. And so, they just assume the same -- continuation of the same rental rate. So, I would globally we're looking at no more than 2% to 3% increases cash wise on office just because the office market I think for the most part is starting to get a little bit not dicey, but it's getting to where a little bit more is under construction as compared to what absorption is based on the research reports on reading. So, going forward, I think there's going to be a much lower increase in rental rates. We don't have anything this year that is rolling now. The one lease that just expired that the tenant left the 8,000 square foot that I mentioned, we expect that one to come probably in line with the current rental rate. So, it will probably be flat.

Okay. Fair enough. And then last one for me, you talked a little bit about the dividend and how it relates to FFO, core FFO, obviously an attractive yield today with an eight handle, but do you have kind of a target payout or coverage ratio that you would like to get to down the road, just some color on how you think about that big picture?

Bob and I and David obviously have been lead various REITs throughout our tenures here. I think peers set probably ranges from generically 65% to 85% on an AFFO basis payout ratio. We're encouraged that as we look out into '18 that on a run rate basis toward the end of '18 we'll be at a point where on a cash bill for distribution, the way I think you would look at it Dave will be covering the dividend. An FFO payout ratio will probably be in the low 90s at that point. We don't think we need to really get the midpoint of peer set, but I would say we need to work for our cash bill for distribution to at least be in the low 90s or better before we're in a good state to pragmatically do those ratable increase in the dividend that David alluded to.

Okay. Fair enough. Thanks guys.

Thank you.

Thank you. Our next question will come from Laura Engel with Stonegate Capital. Your line is now open.

Good morning. Congratulations on a strong finish to the year.

Thank you.

A line of my questions have been answered, just curious could you summarize with the two, it looks like two properties held for sale at year end under contract to close first quarter. You mentioned I think an impairment online. Can you just summarize how that will play out as far as the contract value versus cured out versus I think the impairment charge you took?

I can't get you the exact number right now, but as David indicated, we'll get that and put it on the Q&A, but it's going to be pretty flat with what the impairment was. The impairment was $2.8 million and we're going to be right on that revised number with the sale of the property. On the other property, we are expecting a capital gain on that asset in Arlington Texas.

The impaired property is the only fully vacant store in the portfolio.

Okay. Got it. Well, thank you for that and again congratulations on a strong finish to the year.

Thank you. Next question.

[Operator instructions] And our next question will come from the line of John Massocca with Ladenburg Thalmann. Your line is now open.

Good morning, everyone.

Good morning, John.

So, you guys, mentioned that after you have used the available liquidity maybe to invest at the next primary levered pool in terms of raising proceeds to invest with the capital recycling, how deep do you think your disposition pipeline is in terms of an non-core assets you will be looking to sell?

John at this point, with our tenants paying extremely well, even though they're in the smaller markets and we've been through renewals with each one of them, I am in no big rush to be truthful with you. I think though as we've indicated in our prior presentations and when Mike and I are on the road we want to selectively move out of those markets and then we're going to match it with opportunistic buys at that particular point, which we've done in the past. So, if I had to -- I can't tell you what the magic -- what the magic one would be on it, but if I look globally in macro from a macro standpoint, we're probably looking at just a few assets a year over the next two to three years. It's going to depend on what type of let's say opportunities we have to redeploy the capital. There's no reason for us to sell just for the sake of selling.

Understood. So, it's more kind of in some ways if you find a good use of the proceeds, given what you could sell for than what you could buy, so you're opportunistic in that kind of means rather than let's go out and sell a bunch of assets so we can have some dry powder on hand to do deals?

That's exactly right, that exactly right.

And I think more on the acquisition side. You guys mentioned that the pipelines would be smaller deals $15 million to $18 million, do you think that's just because that's what's transacting in the marketplace right now or is that you have yields on those assets, moved up quicker in line with the changes in interest rates and therefore they're more attractive?

I would say that which -- the letter that is at the lower end of the size, the yields are a bit more attractive for us right now and as I alluded to before in '15 and '16 it was the same way. Prior to that, we were buying $20 million to $30 million assets and then when our stock price dropped, we were able to be a lot more competitive in the $10 million to $20 million range and that's what the team is doing right now. I think doing a very good job. With the $60 million that we have in Letter of Intent, that's actually six properties. So, it's really where the opportunity for us to get the margins we require. So, the team has adjusted very well.

Make sense. And then on the more financial side, you guys mentioned the 26% of debt was swapped in cap. What's the split between that? How much of swaps and how much of that is capped?

Yeah in round numbers John I would say about 20% of it is capped and the remaining 6% is swapped.

And if there is a 50-basis point move in LIBOR, probably wouldn't have that much of an effect ballpark number.

That's right.

That's it for me. Thank you very much.

Thank you. Next question.

Yes Sir. Our next question will come from line of Jeff Rudner with UBS. Your line is now open.

Good morning, David. It's been a long, long time. How are you?

Good Jeff.

Good. I missed part of the reference you made earlier in your presentation at the end regarding Blackstone Commercial. Could you comment on that a little bit further?

You mean Gladstone Commercial.

Gladstone Commercial, yes.

Good. I didn't want to.

I understand right.

I don't know, Gladstone Commercial, it seems to me has a wonderful opportunity because people are not going out and jumping on these middle market tenants. We love them and we built this business around that whole area. We're not I don't even know what the number is today, but it's relatively small compared to the rest of the world. And in terms of how many of our tenants are rated by big firms like S&P or Moody's and so when you look at what we do, we do the same underwriting and I think actually we do it better than some of the people inside of Moody's for example. And so, I think we've done a good job Jeff of picking out good, small businesses. We have two other companies that are business development companies and we're always underwriting small companies and so whether we're underwriting them to do a probability of default on their loan or the investment we've made or underwriting to do the probability of default on their lease, it's a very similar process and having been in this business for the last 40 years it seem to me maybe even longer. I don't even know now. I've been here so long.

Back to the days of Allied Capital.

Our underwriting skills are really strong and I think that differentiates us substantially from all the other people out there and I know a lot of the institutions will come in and say you're paying out too much of your income and you got to get it way down. And I just don't follow that logic. If you've got something that pays and pays and pays and never drops below 96% payout a larger percentage of that than say somebody's whose going out and doing development deals where they're buying empty buildings, refurbishing them and leasing them up. It's just a different business and it's more predictable. It's every year we seem to get better at growing our asset base and our dividends. So, from my standpoint, I think Gladstone Commercial is just very strong in that area.

Well I certainly appreciate that and I think two comments you made also, which are very important is one even during the financial crisis, the dividend was never cut. You were able to maintain the $1.50 annual dividend. And secondly, in making your loans you look more at the ability of the tenant to pay their rent as opposed to location, location, location what the property might be worth.

That is the way we run the business. We look at the tenant first and say, we don't believe in the tenant. Why bother even looking at the real estate.

Okay. Thanks very much, David. Good quarter.

Okay. Good. Thank you for calling in. Call in more often Jeff. Any more questions?

Yes Sir. [Operator instructions] And our next question will come from the line of Rick Murray with Sorin Capital. Your line is now open.

Good morning. You guys have made good progress over the last couple of years in bringing down the leverage, but I wanted to follow-up on David Corak's question because I was a little bit surprised to see the gap between your cash flow from operations and the dividend widen out again this year after some improvement the year before. So what is causing that to happen? Why is the dividend growing more than the cash flow from operations and what are the steps that you have in your plan to narrow that gap?

Thanks for the question, Rick. We don't look at the exact same way. So, the dividend hasn’t grown obviously from a per-share level obviously as we've issued incremental shares, there's been incremental need for the notional to pay the dividend, but our core FFO per share and while it's not a disclose number, but AFFO is a form of cash available for distribution has improved every single year. So, as we see it, we're actually getting in a better spot in terms of either if it's on a core FFO basis, improving net payout ratio for something that has been in the 99% range to something that I believe is around 95% range right now. And on a cash available for distribution, that had been something historically that had run at a payout ratio of 125% and north and as I made mention, I think in my comments to David, we think by the end of '18 we'll be a place where more or less AFFO/CAD will actually be covering the dividend. So, we may be looking out little bit different things, but we think the per-share earnings has improved quarter-over-quarter and year-over-year while the dividends remain constant.

Right, but if I look at your cash flow statement, the cash flow from operations in '17 was $47 million, your dividend is a little over $50 million. So, there's that gap before any CapEx. So I guess I'm trying to understand why that gap has widened? Is it because you're doing deals at cap rates than you needed to or is it timing differences, and what are the steps that are going to get us to bridge that gap?

I understand 2017 basis was you're doing from an analysis perspective, 47 versus a 50 number and that correlates directly to what I made mention to in terms of AFFO or cash available for distribution really now being at a point, which is about 110% payout ratio. I haven't done it with those metrics. Historically the way we look at that which has improved over time. We said we would expect it to improve over time, doing $140 million of acquisitions backend loaded in '17 and weighted 82 cap based upon ou balance sheet structure, should only improve that comparison as we look into '18. So, I don't know if that move that from a cash flow statement, but '17 numbers is the way we look at it as we compare the AFFO.

[indiscernible]

…enjoy this time together. So, see you next quarter. That's the end of this call.

Thank you, Sir. Ladies and gentlemen, this concludes our conference. We appreciate your participation. You can now disconnect.