GLADSTONE COMMERCIAL CORP - Quarter Report: 2009 September (Form 10-Q)

Interim Financial Information

Interim financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of financial statements for the interim period have been included.

Investments in Real Estate

The Company records investments in real estate at cost and capitalizes improvements and replacements when they extend the useful life or improve the efficiency of the asset. The Company expenses costs of repairs and maintenance as incurred. The Company computes depreciation using the straight-line method over the estimated useful life of 39 years for buildings and improvements, five to seven years for equipment and fixtures and the shorter of the useful life or the remaining lease term for tenant improvements and leasehold interests.

The Company accounts for its acquisitions of real estate in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations,” which requires the purchase price of real estate to be allocated to the acquired tangible assets and liabilities, consisting of land, building, tenant improvements, long-term debt and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases, the value of unamortized lease origination costs, the value of tenant relationships and the value of capital lease obligations, based in each case on their fair values.

Management’s estimates of value are made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets and liabilities acquired. In estimating carrying costs, management also includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, which primarily range from nine to eighteen months, depending on specific local market conditions. Management also estimates costs to execute similar leases, including leasing commissions, legal and other related expenses to the extent that such costs are not already incurred in connection with a new lease origination as part of the transaction.

The Company allocates purchase price to the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant. The “as-if-vacant” value is allocated to land, building, and tenant improvements based on management’s determination of the relative fair values of these assets. Real estate depreciation expense on these tangible assets, including discontinued operations, was approximately $2.4 million and $7.1 million for the three and nine months ended September 30, 2009, respectively, and approximately $2.3 million and $6.7 million for the three and nine months ended September 30, 2008, respectively.

Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values, included in the accompanying balance sheet as part of deferred rent receivable, are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. Total amortization related to above-market lease values was approximately $63,000 and $190,000 for both the three and nine months ended September 30, 2009 and 2008, respectively. The capitalized below-market lease values,

included in the accompanying balance sheet as deferred rent liability, are amortized as an increase to rental income over the remaining non-cancelable terms of the respective leases. Total amortization related to below-market lease values was approximately $196,000 and $589,000 for both the three and nine months ended September 30, 2009 and 2008, respectively.

The total amount of the remaining intangible assets acquired, which consist of in-place lease values, unamortized lease origination costs, and customer relationship intangible values, are allocated based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics to be considered by management in allocating these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors.

The value of in-place leases and unamortized lease origination costs are amortized to expense over the remaining term of the respective leases, which generally range from 10 to 15 years. The value of customer relationship intangibles, which is the benefit to the Company resulting from the likelihood of an existing tenant renewing its lease, are amortized to expense over the remaining term and any anticipated renewal periods in the respective leases, but in no event does the amortization period for intangible assets exceed the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the above-market and below-market lease values, in-place lease values, unamortized lease origination costs and customer relationship intangibles will be immediately charged to the related income or expense. Total amortization expense related to these intangible assets, including discontinued operations, was approximately $0.9 million and $2.8 million for both the three and nine months ended September 30, 2009 and 2008, respectively.

Impairment

Investments in Real Estate

The Company accounts for the impairment of real estate in accordance with ASC 360-10-35, “Property, Plant, and Equipment,” which requires that the Company periodically review the carrying value of each property to determine if circumstances indicate impairment in the carrying value of the investment exist or that depreciation periods should be modified. If circumstances support the possibility of impairment, the Company prepares a projection of the undiscounted future cash flows, without interest charges, of the specific property and determines if the investment in such property is recoverable. If impairment is indicated, the carrying value of the property would be written down to its estimated fair value based on the Company’s best estimate of the property’s discounted future cash flows. There have been no impairments recognized on real estate assets in the Company’s history.

In light of current economic conditions, the Company performed an impairment analysis of its entire portfolio at September 30, 2009. In performing the analysis, the Company considered such factors as the tenants’ payment history and financial condition, the likelihood of lease renewal, business conditions in the industry in which the tenants operate and whether the carrying value of the real estate has decreased. The Company concluded that none of its properties were impaired, and will continue to monitor its portfolio for any indicators that may change this conclusion.

Provision for Loan Losses

The Company’s accounting policies require that it reflect in its financial statements an allowance for estimated credit losses with respect to mortgage loans it has made based upon its evaluation of known and inherent risks associated with its private lending assets. Management reflects provisions for loan losses based upon its assessment of general market conditions, its internal risk management policies and credit risk rating system, industry loss experience, its assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying its investments. Actual losses, if any, could ultimately differ from these estimates. There have been no provisions for loan losses in the Company’s history.

Cash and Cash Equivalents

The Company considers all short-term, highly liquid investments that are both readily convertible to cash and have a maturity of three months or less at the time of purchase to be cash equivalents; except that any such investments purchased with funds held in escrow or similar accounts are classified as restricted cash. Items classified as cash equivalents include money-market deposit accounts. All of the Company’s cash and cash equivalents at September 30, 2009 were held in the custody of one financial institution, and the Company’s balance at times may exceed federally insurable limits.

Restricted Cash

Restricted cash consists of security deposits and funds held in escrow for certain tenants. These funds will be released to the tenants upon completion of agreed upon tasks as specified in the lease agreements, mainly consisting of maintenance and repairs on the buildings, and when evidence of insurance and tax payments has been received by the Company.

Funds Held in Escrow

Funds held in escrow consist of funds held by certain of the Company’s lenders for properties held as collateral by these lenders. These funds will be released to the Company upon completion of agreed upon tasks as specified in the mortgage agreements, mainly consisting of maintenance and repairs on the buildings, and when evidence of insurance and tax payments has been submitted to the lenders.

Deferred Financing Costs

Deferred financing costs consist of costs incurred to obtain financing, including legal fees, origination fees and administrative fees. The costs are deferred and amortized using the straight-line method, which approximates the effective interest method over the term of the financing secured. The Company made payments of approximately $2,000 and $106,000 for deferred financing costs during the three and nine months ended September 30, 2009, respectively, and $1,097,000 and $1,153,000 for the three and nine months ended September 30, 2008, respectively. Total amortization expense related to deferred financing costs was approximately $421,000 and $1,145,000 for the three and nine months ended September 30, 2009, respectively, and $300,000 and $806,000 for the three and nine months ended September 30, 2008, respectively.

Prepaid Expenses and Other Assets

Prepaid expenses and other assets consist of accounts receivable, interest receivable, prepaid assets and deposits on real estate.

Obligation Under Capital Lease

In conjunction with the Company’s acquisition of a building in Fridley, Minnesota in February 2008, the Company acquired a ground lease on the parking lot of the building, which had a purchase obligation to acquire the land under the ground lease at the end of the term in April 2014 for $300,000. In accordance with ASC 840-10-25, “Leases,” the Company accounted for the ground lease as a capital lease and recorded the corresponding present value of the obligation under the capital lease. The Company recorded total interest expense related to the accretion of the capital lease obligation of approximately $3,100 and $9,200 for the three and nine months ended September 30, 2009, respectively, and approximately $3,100 and $7,200 for the three and nine months ended September 30, 2008, respectively.

Revenue Recognition

Rental revenue includes rents that each tenant pays in accordance with the terms of its respective lease reported evenly over the non-cancelable term of the lease. Most of the Company’s leases contain rental increases at specified intervals. The Company recognizes such revenues on a straight-line basis by averaging the non-cancelable rental revenues over the lease terms. Deferred rent receivable in the accompanying balance sheet includes the cumulative difference between rental revenue as recorded on a straight line basis and rents received from the tenants in accordance with the lease terms, along with the capitalized above-market lease values of certain acquired properties. Accordingly, the Company determines, in its judgment, to what extent the deferred rent receivable applicable to each specific tenant is collectible. The Company reviews deferred rent receivable, as it relates to straight line rents, on a quarterly basis and takes into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of deferred rent with respect to any given tenant is in doubt, the Company records an allowance for uncollectible accounts or records a direct write-off of the specific rent receivable. No such reserves have been recorded as of September 30, 2009.

Management considers its loans and other lending investments to be held-for-investment. The Company reflects loans classified as long-term investments at amortized cost, less allowance for loan losses, acquisition premiums or discounts, and deferred loan fees. On occasion, the Company may acquire loans at small premiums or discounts based on the credit characteristics of such loans. These premiums or discounts are recognized as yield adjustments over the lives of the related loans. Loan origination fees, as well as direct loan origination costs, are also deferred and recognized over the lives of the related loans as yield adjustments. If loans with premiums, discounts, or loan origination fees are prepaid, the Company immediately recognizes the unamortized portion as a decrease or increase in the prepayment gain or loss. Interest income is recognized using the effective interest method applied on a loan-by-loan basis. Prepayment penalties or yield maintenance payments from borrowers are recognized as additional income when received.

Income Taxes

The Company has operated and intends to continue to operate in a manner that will allow it to qualify as a REIT under the Internal Revenue Code of 1986, as amended, and accordingly will not be subject to federal income taxes on amounts distributed to stockholders (except income from foreclosure property), provided it distributes at least 90% of its REIT taxable income to its stockholders and meets certain other conditions. To the extent that the Company satisfies the distribution requirement but distributes less than 100% of its taxable income, the Company will be subject to federal corporate income tax on its undistributed income.

Commercial Advisers is a wholly-owned TRS that is subject to federal and state income taxes. Though Commercial Advisers has had no activity to date, the Company would account for any future income taxes in accordance with the provisions of ASC 740, “Income Taxes.” Under ASC 740-10-25, the Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

Segment Information

ASC 280, “Segment Reporting,” provides standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker or decision making group in determining how to allocate resources and in assessing performance. Company management is the chief decision making group. As discussed in Note 9, the Company’s operations are derived from two operating segments, one segment purchases real estate (land, buildings and other improvements), which is simultaneously leased to existing users, and the other segment originates mortgage loans and collects principal and interest payments.

Asset Retirement Obligations

ASC 410, “Asset Retirement and Environmental Obligation,” requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. ASC 410-20-20 clarifies that the term “Conditional Asset Retirement Obligation” refers to a legal obligation (pursuant to existing laws or by contract) to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. ASC 410-20-25-6 clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company has accrued a liability and corresponding increase to the cost of the related properties for disposal related to all properties constructed prior to 1985 that have, or may have, asbestos present in the building. The Company accrued a liability during the nine months ended September 30, 2008 of $245,195 related to properties acquired during the period, which reflected the present value of the future obligation. There was no liability accrued during the nine months ended September 30, 2009. The Company also recorded expense, including discontinued operations, of approximately $36,000 and $107,000 during the three and nine months ended September 30, 2009, respectively, and approximately $35,000 and $98,000 for the three and nine months ended September 30, 2008, respectively related to the cumulative accretion of the obligation.

Real Estate Held for Sale and Discontinued Operations

ASC 360-10, “Property, Plant, and Equipment,” requires that the results of operations of any properties which have been sold, or are held for sale, be presented as discontinued operations in the Company’s consolidated financial statements in both current and prior periods presented. Income items related to held for sale properties are listed separately on the Company’s consolidated income statement. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value, less the cost to sell, and are listed separately on the Company’s consolidated balance sheet. Once properties are listed as held for sale, no further depreciation is recorded.

Recently Issued Accounting Pronouncements

On July 1, 2009, the FASB issued FASB Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles also known as ASC 105, “Generally Accepted Accounting Principles.” ASC 105 establishes the FASB Accounting Standards Codification and identifies it as the single source of accounting principles and the framework for selecting the principles used in the preparation of financial statements of non-governmental entities that are presented in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates, which will update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification. GAAP was not intended to be changed as a result of the FASB’s Codification project, but it will change the way the guidance is organized and presented. ASC 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company adopted this pronouncement during the quarter ended September 30, 2009, and the adoption had no material impact on the Company’s results of operations.

ASC 805, “Business Combinations,” requires that the assets and liabilities of all business combinations be recorded at fair value, with limited exceptions. ASC 805-10-25-23 requires that all expenses related to the acquisition be expensed as incurred, rather than capitalized into the cost of the acquisition as had been the previous accounting. ASC 805 is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008. The Company adopted this pronouncement effective for the fiscal year beginning January 1, 2009, and the

adoption could have a significant impact on its results of operations because of the requirement to expense costs associated with acquisitions rather than capitalize the costs as has been done in the past. There was no significant impact from the adoption of this pronouncement during the nine months ended September 30, 2009, because there was limited activity during the period related to potential acquisitions.

ASC 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. ASC 820-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption had no impact on the Company’s results of operations.

ASC 820-10-35-15A, “Fair Value Measurements and Disclosures,” further clarifies the application of the standard in a market that is not active. More specifically, ASC 820-10-35-51E states that significant judgment should be applied to determine if observable data in a dislocated market represents forced liquidations or distressed sales and are not representative of fair value in an orderly transaction. ASC 820-10-35-55A provides further guidance that the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available. In addition, ASC 820-10-35-55B provides guidance on the level of reliance of broker quotes or pricing services when measuring fair value in a non active market stating that less reliance should be placed on a quote that does not reflect actual market transactions and a quote that is not a binding offer. The guidance is effective upon issuance for all financial statements that have not been issued and any changes in valuation techniques as a result of applying the guidance are accounted for as a change in accounting estimate. The Company adopted these pronouncements during the quarter ended December 31, 2008, and the adoption had no material impact on the Company’s results of operations.

ASC 820-10-35-51A, “Fair Value Measurements and Disclosures,” provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased when compared with normal market activity for the asset or liability. ASC 820-10-35-51E provides guidance on identifying circumstances that indicate when a transaction is not orderly. ASC 820-10-35-51D emphasizes that the fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. The guidance is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. The Company adopted this pronouncement during the quarter ended March 31, 2009, and the adoption had no material impact on the Company’s results of operations.

ASC 825-10-50, “Financial Instruments,” requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements, whether recognized or not recognized in the statement of financial position. The guidance in ASC 825-10-50 is effective for interim periods ending after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009. The Company adopted this pronouncement during the quarter ended March 31, 2009, and the adoption had no material impact on the Company’s results of operations.

ASC 855-10-50, “Subsequent Events,” requires disclosure of the date through which an entity has evaluated subsequent events and defines the types of subsequent events that should be recognized or nonrecognized. ASC 855-10-50 is effective for interim or annual periods ending after June 15, 2009. The Company adopted this pronouncement during the quarter ended June 30, 2009, and the adoption had no material impact on the reporting of its subsequent events.

ASC 860, “Transfers and Servicing,” removes the concept of a qualifying special-purpose entity (“QSPE”) and removes the exception from applying to variable interest entities that are QSPEs. This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This statement is effective for fiscal years beginning after November 15, 2009, and is effective for the Company’s fiscal year beginning January 1, 2010. The Company does not expect there to be an impact from adopting this standard on the Company’s results of operations.

ASC 810-10-25-38, “Consolidation,” amends the consolidation guidance for variable-interest entities (“VIE”) and requires an enterprise to qualitatively assess the determination of the primary beneficiary (or “consolidator”) of a VIE based on whether the entity has the power to direct matters that most significantly impact the activities of the VIE, and had the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. ASC 810 is effective for the Company’s fiscal year beginning January 1, 2010. The Company does not expect there to be an impact from adopting this standard on the Company’s results of operations.

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 period. Actual results could materially differ from those estimates.

Reclassifications

Certain amounts from prior years’ financial statements have been reclassified to conform to the current year presentation. The Company’s property located in Norfolk, Virginia was classified as held for sale during the quarter ended June 30, 2009 and, as a result, the results of operations related to this property for 2008 were reclassified from continuing operations to discontinued operations. These reclassifications had no effect on previously reported net income or stockholders’ equity.

2. Related Party Transactions

The Company is externally managed pursuant to contractual arrangements with its Adviser and a wholly-owned subsidiary of the Adviser, Gladstone Administration, LLC (the “Administrator”), under which its Adviser and Administrator employ all of the Company’s personnel and pays their payroll, benefits, and general expenses directly. The Company has an advisory agreement with its Adviser (the “Advisory Agreement”) and an administration agreement (the “Administration Agreement”) with its Administrator. The management services and fees under the Advisory and Administration Agreements are described below.

Advisory Agreement

The Advisory Agreement provides for an annual base management fee equal to 2% of the Company’s total stockholders’ equity, less the recorded value of any preferred stock, and an incentive fee based on funds from operations (“FFO”). For the three and nine months ended September 30, 2009, the Company recorded a base management fee of approximately $343,000 and $1,073,000, respectively, and for the three and nine months ended September 30, 2008, the Company recorded a base management fee of approximately $404,000 and $1,256,000, respectively. For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any distributions paid on preferred stock, but FFO does not include any unrealized capital gains or losses. The incentive fee rewards the Adviser if the Company’s quarterly FFO, before giving effect to any incentive fee (“pre-incentive fee FFO”), exceeds 1.75%, or 7% annualized, (the “hurdle rate”) of total stockholders’ equity, less the recorded value of any preferred stock. The Adviser receives 100% of the amount of the pre-incentive fee FFO that exceeds the hurdle rate, but is less than 2.1875% of the Company’s pre-incentive fee FFO. The Adviser also receives an incentive fee of 20% of the amount of the Company’s pre-incentive fee FFO that exceeds 2.1875%.

For the three and nine months ended September 30, 2009, the Company recorded an incentive fee of approximately $835,000 and $2,434,000, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $200,000 and $565,000, respectively, for a net incentive fee for the three and nine months ended September 30, 2009 of approximately $635,000 and $1,869,000, respectively. For the three and nine months ended September 30, 2008, the Company recorded an incentive fee of approximately $794,000 and $2,300,000, respectively, offset by a credit related

to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $206,000 and $942,000, respectively, for a net incentive fee for the three and nine months ended September 30, 2008 of approximately $588,000 and $1,358,000, respectively. The board of directors of the Company accepted the Adviser’s offer to waive on a quarterly basis a portion of the incentive fee for both the three and nine months ended September 30, 2009 and 2008in order to support the current level of distributions to the Company’s stockholders. These waivers were applied through September 30, 2009 and any waived fees may not be recouped by the Adviser in the future.

Administration Agreement

Under the Administration Agreement, the Company pays separately for its allocable portion of the Administrator’s overhead expenses in performing its obligations including, but not limited to, rent for employees of the Administrator, and its allocable portion of the salaries and benefits expenses of its chief financial officer, chief compliance officer, treasurer and their respective staffs. The Company’s allocable portion of expenses is derived by multiplying the Administrator’s total allocable expenses by the percentage of the Company’s total assets at the beginning of each quarter in comparison to the total assets of all companies managed by the Adviser under similar agreements. For the three and nine months ended September 30, 2009, the Company recorded an administration fee of approximately $293,000 and $775,000, respectively, and for the three and nine months ended September 30, 2008, the Company recorded an administration fee of approximately $238,000 and $725,000, respectively.

3. Earnings per Common Share

The following tables set forth the computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2009 and 2008:

		For the three months ended September 30,								For the nine months ended September 30,
		2009				2008				2009				2008
Net income available to common stockholders		$	255,553			$	118,122			$	415,194			$	707,395
Denominator for basic & diluted weighted average shares			8,563,264				8,565,264				8,563,264				8,565,264
Basic & diluted earnings per common share		$	0.03			$	0.01			$	0.05			$	0.08

4. Real Estate and Intangible Assets

Real Estate

The following table sets forth the components of the Company’s investments in real estate, including capitalized leases, as of September 30, 2009 and December 31, 2008:

		September 30, 2009				December 31, 2008
Real estate:
Land		$	55,035,962	(1)		$	55,226,042	(1)
Building			324,843,293				325,515,390
Tenant improvements			9,820,706				9,820,706
Accumulated depreciation			(31,754,201	)			(24,757,576	)
Real estate, net		$	357,945,760			$	365,804,562

On May 5, 2009, the Company extended the lease with one of its tenants on its property located in Akron, Ohio for a period of six months. The lease was originally set to expire in August 2009, and will now expire

in February 2010. Except for the extension of the lease term, all other existing provisions of the lease, including the current rental rate, will remain the same during the extension period.

On May 19, 2009, the Company extended the lease on its property located in Eatontown, New Jersey for a period of 15 years, and the tenant has two options to extend the lease for additional periods of 5 years each. The lease was originally set to expire in August 2011, and will now expire in April 2024. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $540,000.

Future operating lease payments from tenants under non-cancelable leases, excluding tenant reimbursement of expenses and future operating lease payments for discontinued operations, in effect at September 30, 2009, were as follows:

		Tenant
Year		Lease Payments
Three months ending December 31, 2009		$	9,831,618
2010			38,819,446
2011			38,525,805
2012			38,614,845
2013			33,261,384
2014			29,025,909
Thereafter		$	160,507,642

In accordance with the lease terms, substantially all tenant expenses are required to be paid by the tenant; however, the Company would be required to pay property taxes on the respective properties, and ground lease payments on the property located in Tulsa, Oklahoma, in the event the tenant fails to pay them. The total annualized property taxes for all properties held by the Company at September 30, 2009 was approximately $6.0 million, and the total annual ground lease payments on the Tulsa, Oklahoma property was approximately $153,000.

Intangible Assets

The following table summarizes the net value of other intangible assets and the accumulated amortization for each intangible asset class:

		September 30, 2009								December 31, 2008
						Accumulated								Accumulated
		Lease Intangibles				Amortization				Lease Intangibles				Amortization
In-place leases		$	15,935,445			$	(6,323,990	)		$	15,981,245			$	(5,079,343	)
Leasing costs			9,909,528				(3,618,782	)			9,662,731				(2,987,360	)
Customer relationships			17,136,501				(4,076,341	)			17,136,501				(3,179,931	)
		$	42,981,474			$	(14,019,113	)		$	42,780,477			$	(11,246,634	)

The estimated aggregate amortization expense for the remainder of the current and each of the five succeeding fiscal years is as follows:

		Estimated
Year		Amortization Expense
Three months ending December 31, 2009		$	1,363,565
2010			5,339,721
2011			4,875,279
2012			4,229,792
2013			2,292,544
2014			2,036,328
Thereafter		$	8,825,133

5. Real Estate Held for Sale and Discontinued Operations

As of June 30, 2009, the Company classified its property located in Norfolk, Virginia as held for sale under the provisions of ASC 360-10, which requires that the results of operations of any properties which have been sold, or are held for sale, be presented as discontinued operations in the Company’s consolidated financial statements in both current and prior periods presented. The Company received an unsolicited offer from a buyer for this property. On July 17, 2009, the Company sold this property located in Norfolk, Virginia for $1.15 million, for a gain on the sale of approximately $160,000.

In addition, on July 21, 2006, the Company sold its two Canadian properties and the Company continues to incur legal fees related to the dissolution of the remaining Canadian entities. The table below summarizes the components of income from discontinued operations:

		For the three months ended September 30,								For the nine months ended September 30,
		2009				2008				2009				2008
Operating revenue		$	4,452			$	25,875			$	56,202			$	77,626
Operating expense			(382	)			(8,284	)			(13,379	)			(56,234	)
Income from discontinued operations		$	4,070			$	17,591			$	42,823			$	21,392

6. Mortgage Note Receivable

On April 15, 2005, the Company originated a mortgage loan in the amount of $10.0 million, collateralized by an office building in McLean, Virginia, where the Company’s Adviser and Administrator are subtenants in the building. This 12 year mortgage loan accrues interest at the greater of 7.5% per year or the one month London Interbank Offered Rate (“LIBOR”) rate plus 6.0% per year, with a ceiling of 10.0%. The mortgage loan is interest only for the first nine years of the term, with payments of principal commencing after the initial period. The balance of the principal and all interest remaining is due at the end of the 12 year term. At September 30, 2009, the interest rate was 7.5%.

The fair market value of the mortgage note receivable as of September 30, 2009 was approximately $9.5 million, as compared to the carrying value stated above of approximately $10.0 million. The fair market value is calculated based on a discounted cash flow analysis, using an interest rate based on management’s estimate of the interest rate on a mortgage note receivable with comparable terms.

On July 20, 2009, the borrower on the Company’s mortgage loan signed a purchase agreement with a third party to sell the building. Currently, the sale is expected to close during the fourth quarter of 2009. The Company signed a letter with its borrower agreeing that if the sale is completed, the Company will accept

full repayment of the mortgage loan at the time of sale along with any prepayment penalties associated with the early exit, which management estimates to be approximately $3.0 million.

7. Mortgage Notes Payable, Line of Credit and Short-Term Loan

The Company’s mortgage notes payable, line of credit and short-term loan as of September 30, 2009 and December 31, 2008 are summarized below:

								Principal Balance Outstanding
		Date of
		Issuance/		Principal		Stated Interest Rate at
		Assumption		Maturity Date		September 30, 2009(1)		September 30, 2009				December 31, 2008
Fixed-Rate Mortgage Notes Payable:
		03/16/05		04/01/30		6.33%		$	2,901,378			$	2,948,753
		08/25/05		09/01/15		5.33%			21,172,666				21,399,644
		09/12/05		09/01/15		5.21%			12,433,691				12,560,673
		12/21/05		12/08/15		5.71%			19,056,322				19,241,117
		02/21/06		12/01/13		5.91%			9,228,511				9,344,908
		02/21/06		06/30/14		5.20%			19,207,834				19,472,740
		03/29/06		04/01/16		5.92%			17,000,000				17,000,000
		04/27/06		05/05/16		6.58%			14,080,170				14,281,616
		11/22/06		12/01/16		5.76%			14,181,437				14,309,000
		12/22/06		01/01/17		5.79%			21,672,370				21,846,000
		02/08/07		03/01/17		6.00%			13,775,000				13,775,000
		06/05/07		06/08/17		6.11%			14,240,000				14,240,000
		09/06/07		12/11/15		5.81%			4,377,989				4,426,393
		10/15/07		11/08/17		6.63%			15,701,935				15,828,612
		08/29/08		06/01/16		6.80%			6,328,608				6,421,717
		09/15/08		10/01/10(2)		6.85%			48,015,000				48,015,000
Total Fixed-Rate Mortgage Notes Payable:									253,372,911				255,111,173
Variable-Rate Line of Credit:		12/29/06		12/29/09(3)		LIBOR + 1.9%			31,800,000				11,500,000
Variable-Rate Short-Term Loan:		12/21/07		06/20/09(4)		LIBOR + 2.75%			—				20,000,000
Total Mortgage Notes Payable, Line of Credit and Short-Term Loan								$	285,172,911			$	286,611,173

Mortgage Notes Payable

As of September 30, 2009, the Company had 16 fixed-rate mortgage notes payable, collateralized by a total of 55 properties. The obligors under each of these notes are wholly-owned separate borrowing entities, which own the real estate collateral. The Company is not a co-borrower but has limited recourse liabilities that could result from: 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, and physical waste or damage to the property, resulting from a borrower’s gross negligence or willful misconduct. The Company also indemnifies lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property. The weighted-average interest rate on the mortgage notes payable as of September 30, 2009 was approximately 6.0%

The fair market value of all fixed-rate mortgage notes payable outstanding as of September 30, 2009 was approximately $240.0 million, as compared to the carrying value stated above of approximately $253.4

million. The fair market value is calculated based on a discounted cash flow analysis, using interest rates based on management’s estimate of interest rates on long-term debt with comparable terms.

Scheduled principal payments of mortgage notes payable are as follows:

		Scheduled principal
Year		payments
Three months ending December 31, 2009		$	715,713
2010			50,533,486	(1)
2011			2,799,601
2012			3,087,824
2013			11,828,375
2014			20,367,143
Thereafter			164,040,769
		$	253,372,911

Line of Credit

The Company has a $50.0 million senior revolving credit agreement (the “Credit Agreement”) with a syndicate of banks led by KeyBank National Association (“KeyBank”), which matures on December 29, 2009. On June 30, 2009, the Company amended its Credit Agreement to reduce its commitment from $95.0 million to $50.0 million, in exchange for modifications to certain terms under the Credit Agreement. The definition of FFO was modified to exclude from the calculation of FFO acquisition related costs that are required to be expensed under ASC 805. In addition, the aggregate amount the Company can issue under the Credit Agreement as letters of credit was reduced from $20.0 million to $10.5 million.

As long as the Company is in compliance with its covenants under the line of credit, the Company has the option to extend the line of credit for an additional year. The Company must notify KeyBank of its intention to exercise the renewal option 45 days prior to the maturity date and pay an extension fee of 0.20% of the total commitment outstanding at the date of notification. The interest rate charged on the advances under the facility is based on the LIBOR, the prime rate or the federal funds rate, depending on market conditions, and adjusts periodically. The unused portion of the line of credit is subject to a fee of 0.15% per year. The Company’s ability to access this funding source is subject to the Company continuing to meet customary lending requirements such as compliance with financial and operating covenants and meeting certain lending limits. One such covenant requires the Company to limit its distributions to stockholders to 95% of its FFO less those acquisition related costs that are required to be expensed under ASC 805. In addition, the maximum amount the Company may draw under this agreement is based on a percentage of the value of properties pledged as collateral to the banks, which must meet agreed upon eligibility standards. KeyBank has requested that the Company obtain updated appraisals for the properties pledged to the line of credit as borrowing base collateral in connection with the upcoming extension of the line of credit. If the aggregate value of the updated appraisals obtained is lower than the current aggregate value of appraisals, it would lower the amount of the Company’s borrowing base and reduce the amount the Company could borrow under its line of credit with that borrowing base. The Company is currently obtaining updated appraisals on its pledged properties, and does not believe that any change in the value of the properties will be significant enough to trigger a scenario whereby the Company would have to repay amounts currently outstanding under its line of credit; however, the receipt of updated appraisals may serve to reduce the current and future borrowing availability under the line of credit. In addition, under the Credit Agreement those properties that are pledged as collateral to the banks are pledged through a perfected first priority lien in the equity interest of the special purpose entity (“SPE”) that owns the property. In addition the Operating Partnership, which is the entity that owns the SPEs, is precluded from transferring the SPEs or unconsolidated affiliates to the Company.

If and when long-term mortgages are arranged for these pledged properties, the banks will release the properties from the line of credit and reduce the availability under the line of credit by the advanced amount of the removed property. Conversely, as the Company purchases new properties meeting the

eligibility standards, the Company may pledge these new properties to obtain additional advances under this agreement. The availability under the line of credit may also be reduced by letters of credit used in the ordinary course of business. The Company may use the advances under the line of credit for both general corporate purposes and the acquisition of new investments. As of September 30, 2009, there was $31.8 million outstanding under the line of credit at an interest rate of approximately 2.2%, and approximately $3.6 million outstanding pursuant to letters of credit at a weighted average interest rate of approximately 2.0%. At September 30, 2009, the remaining borrowing capacity available under the line of credit was approximately $14.6 million. The Company was in compliance with all covenants under the line of credit as of September 30, 2009. The amount outstanding on the line of credit as of September 30, 2009 approximates fair market value, because the debt is short-term and variable rate.

Short-Term Loan

On December 21, 2007, the Company entered into a $20.0 million unsecured short-term loan with KeyBank, which matured on December 21, 2008. The Company exercised its option to extend the term for an additional six months and, on March 31, 2009, the Company repaid in full the unsecured short-term loan, using proceeds from borrowings under its line of credit. The interest rate charged on the loan was based on the LIBOR, the prime rate or the federal funds rate, depending on market conditions, and adjusted periodically.

8. Stockholders’ Equity

The following table summarizes the changes in stockholders’ equity for the nine months ended September 30, 2009:

														Notes				Distributions in
										Capital in				Receivable				Excess of				Total
		Preferred				Common				Excess of				From Sale of				Accumulated				Stockholders’
		Stock				Stock				Par Value				Common Stock				Earnings				Equity
Balance at December 31, 2008		$	2,150			$	8,563			$	170,622,581			$	(2,595,886	)		$	(37,542,148	)		$	130,495,260
Repayment of principal on notes receivable - employees			—				—				—				44,285				—				44,285
Distributions declared to common and preferred stockholders			—				—				—				—				(12,703,991	)			(12,703,991	)
Net income			—				—				—				—				3,485,506				3,485,506
Balance at September 30, 2009		$	2,150			$	8,563			$	170,622,581			$	(2,551,601	)		$	(46,760,633	)		$	121,321,060

Distributions paid per common share for both the three and nine months ended September 30, 2009 and 2008 were $0.375 and $1.125 per share, respectively. Distributions paid per share of Series A Preferred Stock for both the three and nine months ended September 30, 2009 and 2008 were approximately $0.48 and $1.45 per share, respectively. Distributions paid per share of Series B Preferred Stock for both the three and nine months ended September 30, 2009 and 2008 were approximately $0.47 and $1.41 per share, respectively.

The following table is a summary of all outstanding notes issued to employees of the Adviser for the exercise of stock options:

										Amount of				Outstanding Balance
		Number of Options				Strike Price of				Promissory Note				of Employee Loans				Maturity Date of				Interest Rate on
Date Issued		Exercised				Options Exercised				Issued to Employees				at 9/30/09				Note				Note
Sep 2004			25,000			$	15.00			$	375,000			$	360,007			Sep 2013					5.00	%
Apr 2006			12,422				16.10				199,994				199,994			Apr 2015					7.77	%
May 2006			50,000				16.85				842,500				842,500			May 2016					7.87	%
May 2006			15,000				16.10				241,500				241,500			May 2016					7.87	%
May 2006			2,000				16.10				32,200				32,200			May 2016					7.87	%
May 2006			2,000				16.10				32,200				32,200			May 2016					7.87	%
May 2006			2,000				15.00				30,000				30,000			May 2016					7.87	%
Oct 2006			12,000				16.10				193,200				193,200			Oct 2015					8.17	%
Nov 2006			25,000				15.00				375,000				375,000			Nov 2015					8.15	%
Dec 2006			25,000				15.00				375,000				245,000			Feb 2010					8.12	%
			170,422							$	2,696,594			$	2,551,601

In accordance with ASC 505-10-45-2, “Equity,” receivables from employees for the issuance of capital stock to employees prior to the receipt of cash payment should be reflected in the balance sheet as a reduction to stockholders’ equity. Therefore, these notes were recorded as loans to employees and are included in the equity section of the accompanying consolidated balance sheets.

9. Segment Information

As of September 30, 2009, the Company’s operations were derived from two operating segments. One segment purchases real estate (land, buildings and other improvements), which is simultaneously leased to existing users and the other segment extends mortgage loans and collects principal and interest payments. The amounts included under the “other” column in the tables below include other income, which consists of interest income from temporary investments and employee loans and any other miscellaneous income earned, and operating and other expenses that were not specifically derived from either operating segment.

The following table summarizes the Company’s consolidated operating results and total assets by segment as of and for the three and nine months ended September 30, 2009 and 2008:

		As of and for the three months ended September 30, 2009																As of and for the nine months ended September 30, 2009
		Real Estate				Real Estate												Real Estate				Real Estate
		Leasing				Lending				Other				Total				Leasing				Lending				Other				Total
Operating revenues		$	10,465,427			$	191,667			$	—			$	10,657,094			$	31,398,016			$	568,750			$	—			$	31,966,766
Operating expenses			(3,540,320	)			—				(1,528,698	)(1)			(5,069,018	)			(10,685,159	)			—				(4,730,744	)(1)			(15,415,903	)
Other expense			(4,146,341	)			—				(326,853	)(2)			(4,473,194	)			(12,343,000	)			—				(925,218	)(2)			(13,268,218	)
Discontinued operations			164,108				—				—				164,108				202,861				—				—				202,861
Net income		$	2,942,874			$	191,667			$	(1,855,551	)		$	1,278,990			$	8,572,718			$	568,750			$	(5,655,962	)		$	3,485,506
Total Assets		$	398,456,908			$	10,062,500			$	9,762,275			$	418,281,683			$	398,456,908			$	10,062,500			$	9,762,275			$	418,281,683

		As of and for the three months ended September 30, 2008																As of and for the nine months ended September 30, 2008
		Real Estate				Real Estate												Real Estate				Real Estate
		Leasing				Lending				Other				Total				Leasing				Lending				Other				Total
Operating revenues		$	10,214,822			$	216,446			$	—			$	10,431,268			$	29,444,905			$	673,548			$	—			$	30,118,453
Operating expenses			(3,516,118	)			—				(1,498,484	)(1)			(5,014,602	)			(10,183,248	)			—				(4,301,914	)(1)			(14,485,162	)
Other expense			(3,426,160	)			—				(866,538	)(2)			(4,292,698	)			(9,593,917	)			—				(2,283,059	)(2)			(11,876,976	)
Discontinued operations			17,591				—				—				17,591				21,392				—				—				21,392
Net income		$	3,290,135			$	216,446			$	(2,365,022	)		$	1,141,559			$	9,689,132			$	673,548			$	(6,584,973	)		$	3,777,707
Total Assets		$	409,461,178			$	10,070,714			$	10,751,163			$	430,283,055			$	409,461,178			$	10,070,714			$	10,751,163			$	430,283,055

10. Subsequent Events

The Company evaluated all events that have occurred subsequent to September 30, 2009 through November 4, 2009, the date of the filing of this Form 10-Q.

On October 6, 2009, the Company’s Board of Directors declared a cash distribution of $0.125 per common share, $0.1614583 per share of the Series A Preferred Stock, and $0.15625 per share of the Series B Preferred Stock for each of the months of October, November and December of 2009. Monthly distributions will be payable on October 30, 2009, November 30, 2009 and December 31, 2009, to those stockholders of record as of the close of business on October 22, 2009, November 19, 2009 and December 22, 2009, respectively.

On November 4, 2009, the Company entered into an Open Market Sale Agreement (the “Open Market Sale Agreement”) with Jefferies & Company, Inc. (“Jefferies”) under which the Company may, from time to time, offer and sell shares of its common stock with an aggregate sales price of up to $25.0 million through Jefferies, or to Jefferies for resale, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). Sales of its common stock through Jefferies, if any, will be executed by means of ordinary brokers’ transactions on the NASDAQ Global Market or otherwise at market prices, in privately negotiated transactions, crosses or block transactions or such other transactions as may be agreed between the Company and Jefferies, including a combination of any of these transactions. The Company will pay Jefferies a commission, or allow a discount, as the case may be, in each case equal to 2.0% of the gross sales proceeds of any common stock sold through Jefferies as agent, or to Jefferies as principal, under the Open Market Sale Agreement.

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. 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 actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. 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 Form 10-Q.

OVERVIEW

General

We were incorporated under the General Corporation Laws of the State of Maryland on February 14, 2003, primarily for the purpose of investing in and owning net leased industrial and commercial real property and selectively making long-term industrial and commercial mortgage loans. Most of the portfolio of real estate we currently own is leased to a wide cross section of tenants ranging from small businesses to large public companies, many of which are corporations that do not have publicly rated debt. We have in the past entered into, and intend in the future to enter into, purchase agreements for real estate having triple net leases with terms of approximately 10 to 15 years and built in rental increases. Under a triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property. We are actively communicating 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. At September 30, 2009, we owned 64 properties totaling approximately 6.3 million square feet, and had one mortgage loan outstanding. The total gross investment in these acquisitions, including the $10.0 million mortgage loan investment, was approximately $442.7 million at September 30, 2009.

Business Environment

The United States remains in a recession, and, as a result, conditions within the global credit markets and the U.S. real estate credit markets in particular continue to experience dislocation and stress. While we are beginning to see signs of economic improvementand stabilization in the equity markets, the debt markets are still difficult at best, and we do not know if adverse conditions will again intensify or the full extent to which the disruptions will affect us. In addition, conditions continue to make it difficult to price and finance new investment opportunities on attractive terms. We believe it will be some time before the United States has recovered from the recession, and as a result the continued weak economic conditions could still adversely impact the financial condition of one or more of our tenants and therefore, could make a tenant bankruptcy and payment default on the related lease or loan more likely. Currently, all of our properties are fully leased and all of our tenants and our borrower are current and paying in accordance with their leases and loan, respectively. In addition, no balloon payments are due under our mortgage notes payable until 2010, and the only mortgage note that matures in 2010 has three annual extension options through 2013.

Our ability to make new investments is highly dependent upon external financing. Our principal external financing sources generally include the issuance of equity securities, the issuance of long-term mortgages secured by properties and borrowings under our line of credit. The market for long-term mortgages continues to be frozen as the collateralized mortgage-backed securities, or CMBS, market has virtually

disappeared. With the closure of the CMBS market, many banks are not lending on commercial real estate as they are no longer able to sell these loans to the CMBS market and are not willing or able to keep these loans on their balance sheets. We are now seeing banks only willing to issue medium-term mortgages, between two to five years, at substantially less favorable terms. As a result, we intend to focus on using medium-term mortgages to finance our real estate until the market for long-term mortgages returns. Our ability to increase the availability under our line of credit is dependent upon us pledging additional properties as collateral. Traditionally, we have pledged new properties to the line of credit as we arrange for long-term mortgages for these pledged properties. Currently, only nine of our properties do not have long-term mortgages, and eight of those are pledged as collateral under our line of credit. Our line of credit matures in December 2009, however, we intend to exercise our option to extend the term for an additional year, through December 2010.

On November 4, 2009, we entered into an Open Market Sale Agreement (the “Open Market Sale Agreement”) with Jefferies & Company, Inc. (“Jefferies”) under which we may, from time to time, offer and sell shares of our common stock with an aggregate sales price of up to $25.0 million through Jefferies, or to Jefferies, for resale. To date, we have not sold any common stock under the Open Market Sale Agreemennt.If we are able to raise equity capital in the near term, in addition to continuing to invest in industrial and commercial real property, we will also seek to expand our investments to other categories such as retail and medical properties. In addition, we also intend to expand our mortgage lending activity to include purchasing mortgage loans from banks and CMBS pools.

However, until we are able to raise debt or equity capital, our near-term strategy has become somewhat dependent upon building the value of our existing portfolio of properties by renegotiating existing leases and making capital improvements to our properties. Capital improvements will be limited to the extent we have available capital. We will continue to review potential acquisitions and we intend to continue our strategy of making conservative investments in properties that have existing financing that we believe will weather the current recession and that are likely to produce attractive long-term returns for our stockholders.

Recent Events

Financing Activities:

During the nine months ended September 30, 2009, we had net borrowings under our line of credit of approximately $20.3 million, with $31.8 million outstanding at September 30, 2009. The proceeds from borrowings under the line of credit were used to pay off the $20.0 million unsecured short-term loan with KeyBank and fund other capital improvements at our properties.

On November 4, 2009, we entered into the Open Market Sale Agreement with Jefferies under which we may, from time to time, offer and sell shares of our common stock with an aggregate sales price of up to $25.0 million through Jefferies, or to Jefferies, for resale.

Leasing Activities:

On May 5, 2009, we extended the lease with one of our tenants in our property located in Akron, Ohio for a period of six months. The lease was originally set to expire in August 2009, and will now expire in February 2010. Except for the extension of the lease term, all other existing provisions of the lease, including the current rental rate, will remain the same during the extension period.

On May 19, 2009, we extended the lease on our property located in Eatontown, New Jersey for a period of 15 years, and the tenant has two options to extend the lease for additional periods of 5 years each. The lease was originally set to expire in August 2011, and will now expire in April 2024. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $540,000.

Dispositions:

On July 17, 2009, we sold our property located in Norfolk, Virginia for $1.15 million, for a gain on the sale of approximately $160,000. The proceeds from the sale were used to pay down our line of credit.

Industry Classifications

Gladstone Management Corporation, or our Adviser, seeks to diversify our portfolio to avoid dependence on any one particular tenant, geographic location or tenant industry. 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 region. Our largest tenant at September 30, 2009 comprised approximately 7.3% of our total rental income, and our largest concentration of properties was located in Ohio, which accounted for approximately 17.7% of our total rental income. The table below reflects the breakdown of our total rental income by tenant industry classification for the nine months ended September 30, 2009 and 2008, respectively:

		September 30, 2009								September 30, 2008
						Percentage of								Percentage of
Industry Classification		Rental Income				Rental Income				Rental Income				Rental Income
Automobile		$	874,990				2.8	%		$	874,990				3.0	%
Beverage, Food & Tobacco			1,641,563				5.3	%			1,534,622				5.3	%
Buildings and Real Estate			1,519,251				4.9	%			1,507,099				5.2	%
Chemicals, Plastics & Rubber			2,395,845				7.7	%			1,655,620				5.7	%
Containers, Packaging & Glass			1,747,626				5.6	%			1,706,406				5.8	%
Diversified/Conglomerate Manufacturing			2,748,515				8.8	%			2,249,576				7.7	%
Diversified/Conglomerate Services			231,079				0.7	%			231,079				0.8	%
Electronics			4,624,341				14.8	%			4,624,341				15.8	%
Healthcare, Education & Childcare			4,609,061				14.8	%			4,182,663				14.3	%
Home & Office Furnishings			397,307				1.3	%			397,307				1.4	%
Insurance			542,150				1.7	%			542,150				1.9	%
Machinery			1,791,453				5.8	%			1,644,601				5.6	%
Oil & Gas			855,391				2.7	%			864,332				3.0	%
Personal & Non-Durable Consumer Products			1,016,041				3.3	%			1,016,380				3.5	%
Personal, Food & Miscellaneous Services			431,255				1.4	%			431,255				1.5	%
Printing & Publishing			1,639,363				5.3	%			1,644,212				5.6	%
Telecommunications			4,085,192				13.1	%			4,084,777				13.8	%
		$	31,150,423				100.0	%		$	29,191,410				100.0	%

Our Adviser and Administrator

Our Adviser is led by a management team which has extensive experience in our lines of business. Our Adviser is controlled by David Gladstone, our chairman and chief executive officer. Mr. Gladstone is also the chairman and chief executive officer of our Adviser. Terry Lee Brubaker, our vice chairman, chief operating officer, secretary and director, is a member of the board of directors of our Adviser and its vice chairman and chief operating officer. George Stelljes III, our president, chief investment officer and director, is a member of the board of directors of our Adviser and its president and chief investment officer. Our Adviser also has a wholly-owned subsidiary, Gladstone Administration, LLC, or our Administrator, which employs our chief financial officer, chief compliance officer, treasurer and their respective staffs.

Our Adviser and Administrator also provide investment advisory and administrative services to our affiliates, Gladstone Capital Corporation and Gladstone Investment Corporation, both publicly traded business development companies, as well as Gladstone Land Corporation, a private agricultural real estate company. With the exception of our chief financial officer, all of our executive officers serve as either directors or executive officers, or both, of Gladstone Capital Corporation and Gladstone Investment Corporation. In the future, our Adviser may provide investment advisory and administrative services to other funds, both public and private, of which it is the sponsor.

Advisory and Administration Agreements

We are externally managed pursuant to contractual arrangements with our Adviser and our Administrator, under which our Adviser and Administrator have directly employed all of our personnel and paid their payroll, benefits, and general expenses directly. On January 1, 2007, we entered into an advisory agreement with our Adviser, which we refer to as the Advisory Agreement, and an administration agreement with our Administrator, which we refer to as the Administration Agreement.

Under the terms of the Advisory Agreement, we are responsible for all expenses incurred for our direct benefit. Examples of these expenses include legal, accounting, interest on short-term debt and mortgages, tax preparation, 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 may include real estate brokerage fees, mortgage placement fees, lease-up fees and transaction structuring fees (although we may be able to pass some or all of such fees on to our tenants and borrowers). During the three and nine months ended September 30, 2009 and 2008, none of these expenses were incurred by us directly. The actual amount of such fees that we incur in the future will depend largely upon the aggregate costs of the properties we acquire, the aggregate amount of mortgage loans we make and the extent to which we are able to shift the burden of such fees to our tenants and borrowers. Accordingly, the amount of these fees that we will pay in the future is not determinable at this time.

Management Services and Fees under the Advisory Agreement

The Advisory Agreement provides for an annual base management fee equal to 2.0% of our total stockholders’ equity, less the recorded value of any preferred stock, and an incentive fee based on funds from operations, or FFO.

For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any distributions paid on preferred stock, but FFO does not include any unrealized capital gains or losses. The incentive fee would reward our Adviser if our quarterly FFO, before giving effect to any incentive fee, or pre-incentive fee FFO, exceeds 1.75%, or the hurdle rate, of total stockholders’ equity, less the recorded value of any preferred stock. We pay our Adviser an incentive fee with respect to our pre-incentive fee FFO in each calendar quarter as follows:

	•		no incentive fee in any calendar quarter in which our pre-incentive fee FFO does not exceed the hurdle rate of 1.75% (7% annualized);
	•		100% of the amount of the pre-incentive fee FFO that exceeds the hurdle rate, but is less than 2.1875% in any calendar quarter (8.75% annualized); and
	•		20% of the amount of our pre-incentive fee FFO that exceeds 2.1875% in any calendar quarter (8.75% annualized).

Quarterly Incentive Fee Based on FFO

Pre-incentive fee FFO
(expressed as a percentage of total common stockholders’ equity)

Percentage of pre-incentive fee FFO allocated to incentive fee

The incentive fee may be reduced because of our line of credit covenant which limits distributions to our stockholders to 95% of FFO. In order to comply with this covenant, our board of directors accepted our Adviser’s offer to unconditionally, irrevocably and voluntarily waive on a quarterly basis a portion of the incentive fee for the three and nine months ended September 30, 2009 and 2008, which allowed us to maintain the current level of distributions to our stockholders. These waivers were applied through September 30, 2009 and any waived fees may not be recouped by our Adviser in the future. Our Adviser has indicated that it intends to continue to waive all or a portion of the incentive fee in order to support the current level of distributions to our stockholders, however, our Adviser is not required to issue any waiver, in whole or in part.

Administration Agreement

Under the Administration Agreement, we pay separately for our allocable portion of our Administrator’s overhead expenses in performing its obligations including, but not limited to, rent for employees of our Administrator, and our allocable portion of the salaries and benefits expenses of our chief financial officer, chief compliance officer, treasurer and their respective staffs. Our allocable portion of expenses is derived by multiplying our Administrator’s total expenses by the percentage of our total assets at the beginning of each quarter in comparison to the total assets of all companies managed by our Adviser under similar agreements.

Critical Accounting Policies

The preparation of our financial statements in accordance with generally accepted accounting principles in the United States of America, or GAAP, requires management to make judgments that are subjective in nature in order to make certain estimates and assumptions. Management relies on its experience, collects historical data and current market data, and analyzes this information in order to arrive at what it believes to be reasonable estimates. Under different conditions or assumptions, materially different amounts could be reported related to the accounting policies described below. In addition, application of these accounting policies involves the exercise of judgment on 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 elsewhere in this report. Below is a summary of accounting polices involving estimates and assumptions that require complex, subjective or significant judgments in their application and that materially affect our results of operations.

Allocation of Purchase Price

When we acquire real estate, we allocate the purchase price to the acquired tangible assets and liabilities, consisting of land, building, tenant improvements, long-term debt and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases,

the value of unamortized lease origination costs, the value of tenant relationships and the value of capital lease obligations, based in each case on their fair values.

Management’s estimates of value are made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. We also consider information obtained about each property as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets and liabilities acquired. In estimating carrying costs, management also includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, which primarily range from 9 to 18 months, depending on specific local market conditions. Management also estimates costs to execute similar leases, including leasing commissions, legal and other related expenses to the extent that such costs are not already incurred in connection with a new lease origination as part of the transaction. Management also considers the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors. A change in any of the assumptions above, which are very subjective, could have a material impact on our results of operations.

The allocation of the purchase price directly affects the following in our consolidated financial statements:

	•		The amount of purchase price allocated to the various tangible and intangible assets on our balance sheet;
	•		The amounts allocated to the value of above-market and below-market lease values are amortized to rental income over the remaining non-cancelable terms of the respective leases. The amounts allocated to all other tangible and intangible assets are amortized to depreciation or amortization expense. Thus, changes in the purchase price allocation among our assets could have a material impact on our FFO, which is used by many REIT investors to evaluate our operating performance; and
	•		The period of time that tangible and intangible assets are depreciated over varies greatly and thus, changes in the amounts allocated to these assets will have a direct impact on our results of operations. Intangible assets are generally amortized over the respective life of the leases, which normally range from 10 to 15 years, we depreciate our buildings over 39 years, and land is not depreciated. These differences in timing could have a material impact on our results of operations.

Asset Impairment Evaluation

We periodically review the carrying value of each property to determine if circumstances that indicate impairment in the carrying value of the investment exist or that depreciation periods should be modified. In determining if impairment exists, management considers such factors as our tenants’ payment history, the financial condition of our tenants, including calculating the current leverage ratios of tenants, the likelihood of lease renewal, business conditions in the industry in which our tenants operate and whether the carrying value of our real estate has decreased. If any of the factors above support the possibility of impairment, we prepare a projection of the undiscounted future cash flows, without interest charges, of the specific property and determine if the carrying amount in such property is recoverable. In preparing the projection of undiscounted future cash flows, we estimate the hold periods of the properties and cap rates using information we obtain from market comparability studies and other comparable sources. If impairment is indicated, the carrying value of the property would be written down to its estimated fair value based on our best estimate of the property’s discounted future cash flows using assumptions or market participants. Any material changes to the estimates and assumptions used in this analysis could have a significant impact on our results of operations, as the changes would impact our determination of whether impairment is deemed to have occurred and the amount of impairment loss we would recognize.

Using the methodology discussed above and in light of the current economic conditions discussed above in “Overview-Business Environment,” we performed an impairment analysis of our entire portfolio at September 30, 2009. We concluded that none of our properties are currently impaired, and we will continue to monitor our portfolio for any indicators that may change our conclusion.

Provision for Loan Losses

Our accounting policies require that we reflect in our financial statements an allowance for estimated credit losses with respect to mortgage loans we have made based upon our evaluation of known and inherent risks associated with our private lending assets. Management reflects provisions for loan losses based upon our assessment of general market conditions, our internal risk management policies and credit risk rating system, industry loss experience, our assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying our investments. Any material changes to the estimates and assumptions used in this analysis could have a significant impact on our results of operations. We did not make a loss allowance for our existing mortgage loan receivable as of September 30, 2009, as we believe the carrying value of the loan is fully collectible.

Recently Issued Accounting Pronouncements

Refer to Note 1 in the accompanying consolidated financial statements for a summary of all recently issued accounting pronouncements.

Results of Operations

Our weighted-average yield on the portfolio as of September 30, 2009 was approximately 9.57%. The weighted-average yield on our portfolio is calculated by taking the annualized straight-line rents, reflected as rental income on our consolidated statements of operations, or mortgage interest payments, reflected as interest income from mortgage notes receivable on our consolidated statements of operations, of each acquisition or mortgage loan as a percentage of the acquisition or loan price, as applicable. The weighted-average yield does not take into account the interest expense incurred on the financings placed on our properties.

A comparison of our operating results for the three and nine months ended September 30, 2009 and 2008 is below:

		For the three months ended September 30,																For the nine months ended September 30,
														%
		2009				2008				$ Change				Change				2009				2008				$ Change				% Change
Operating revenues
Rental income		$	10,383,002			$	10,131,678			$	251,324				2	%		$	31,150,423			$	29,191,410			$	1,959,013				7	%
Interest income from mortgage notes receivable			191,667				216,446				(24,779	)			-11	%			568,750				673,548				(104,798	)			-16	%
Tenant recovery revenue			82,425				83,144				(719	)			-1	%			247,593				253,495				(5,902	)			-2	%
Total operating revenues			10,657,094				10,431,268				225,826				2	%			31,966,766				30,118,453				1,848,313				6	%
Operating expenses
Depreciation and amortization			3,284,723				3,256,602				28,121				1	%			9,875,156				9,416,786				458,370				5	%
Property operating expenses			219,537				222,647				(3,110	)			-1	%			687,129				665,103				22,026				3	%
Due diligence expense			—				2,158				(2,158	)			-100	%			16,433				4,282				12,151				284	%
Base management fee			342,743				404,108				(61,365	)			-15	%			1,073,041				1,255,833				(182,792	)			-15	%
Incentive fee			835,003				793,787				41,216				5	%			2,433,945				2,300,286				133,659				6	%
Administration fee			293,075				238,241				54,834				23	%			774,636				724,978				49,658				7	%
Professional fees			105,368				117,857				(12,489	)			-11	%			466,529				362,584				103,945				29	%
Insurance			50,757				43,354				7,403				17	%			147,561				126,947				20,614				16	%
Directors fees			49,459				54,702				(5,243	)			-10	%			149,547				161,202				(11,655	)			-7	%
Stockholder related expense			32,914				42,232				(9,318	)			-22	%			204,806				271,430				(66,624	)			-25	%
Asset retirement obligation expense			36,060				34,711				1,349				4	%			106,441				97,077				9,364				10	%
General and administrative			19,643				10,079				9,564				95	%			45,647				40,582				5,065				12	%
Total operating expenses before credit from Adviser			5,269,282				5,220,478				48,804				1	%			15,980,871				15,427,090				553,781				4	%
Credit to incentive fee			(200,264	)			(205,876	)			5,612				-3	%			(564,968	)			(941,928	)			376,960				-40	%
Total operating expenses			5,069,018				5,014,602				54,416				1	%			15,415,903				14,485,162				930,741				6	%
Other income (expense)
Interest income from temporary investments			524				4,559				(4,035	)			-89	%			17,989				20,796				(2,807	)			-13	%
Interest income — employee loans			48,130				49,624				(1,494	)			-3	%			145,878				152,620				(6,742	)			-4	%
Other income			—				7,500				(7,500	)			-100	%			11,320				56,493				(45,173	)			-80	%
Interest expense			(4,521,848	)			(4,354,381	)			(167,467	)			4	%			(13,443,405	)			(12,106,885	)			(1,336,520	)			11	%
Total other expense			(4,473,194	)			(4,292,698	)			(180,496	)			4	%			(13,268,218	)			(11,876,976	)			(1,391,242	)			12	%
Income from continuing operations			1,114,882				1,123,968				(9,086	)			-1	%			3,282,645				3,756,315				(473,670	)			-13	%
Discontinued operations
Income from discontinued operations			4,070				17,591				(13,521	)			-77	%			42,823				21,392				21,431				100	%
Gain on sale of real estate			160,038				—				160,038				100	%			160,038				—				160,038				100	%
Total discontinued operations			164,108				17,591				146,517				833	%			202,861				21,392				181,469				848	%
Net income			1,278,990				1,141,559				137,431				12	%			3,485,506				3,777,707				(292,201	)			-8	%
Distributions attributable to preferred stock			(1,023,437	)			(1,023,437	)			—				0	%			(3,070,312	)			(3,070,312	)			—				0	%
Net income available to common stockholders		$	255,553			$	118,122			$	137,431				116	%		$	415,194			$	707,395			$	(292,201	)			-41	%