GLADSTONE COMMERCIAL CORP - Quarter Report: 2010 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 001-33097

GLADSTONE COMMERCIAL CORPORATION

(Exact name of registrant as specified in its charter)

MARYLAND		02-0681276
(State or other jurisdiction of incorporation or		(I.R.S. Employer Identification No.)
organization)

1521 WESTBRANCH DRIVE, SUITE 200
MCLEAN, VIRGINIA 22102
(Address of principal executive office)

(703) 287-5800
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No þ

The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding as of July 30, 2010 was 8,545,264.

 

 

GLADSTONE COMMERCIAL CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED
JUNE 30, 2010

TABLE OF CONTENTS

		PAGE
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009			3
Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009			4
Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			22
Item 3. Quantitative and Qualitative Disclosures about Market Risk			39
Item 4. Controls and Procedures			40
PART II OTHER INFORMATION
Item 1. Legal Proceedings			41
Item 1A. Risk Factors			41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			41
Item 3. Defaults Upon Senior Securities			41
Item 4. Removed and Reserved			41
Item 5. Other Information			41
Item 6. Exhibits			42
SIGNATURES			44
EX-12
EX-31.1
EX-31.2
EX-32.1
EX-32.2

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

		June 30, 2010				December 31, 2009
ASSETS
Real estate, at cost		$	391,329,596			$	390,753,892
Less: accumulated depreciation			38,886,713				34,111,952
Total real estate, net			352,442,883				356,641,940
Lease intangibles, net			26,246,904				28,177,461
Mortgage note receivable			10,000,000				10,000,000
Cash and cash equivalents			3,312,409				3,096,598
Restricted cash			2,295,525				2,633,538
Funds held in escrow			2,344,342				2,487,680
Deferred rent receivable			9,697,709				8,975,196
Deferred financing costs, net			2,653,246				3,136,055
Prepaid expenses and other assets			2,186,373				1,716,905
TOTAL ASSETS		$	411,179,391			$	416,865,373
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Mortgage notes payable		$	251,453,252			$	252,761,651
Borrowings under line of credit			36,300,000				33,200,000
Deferred rent liability			2,738,784				3,213,195
Asset retirement obligation liability			2,380,748				2,305,644
Accounts payable and accrued expenses			1,530,275				2,086,741
Due to Adviser (Refer to Note 2)			1,292,211				1,213,640
Obligation under capital lease			253,841				247,686
Rent received in advance, security deposits and funds held in escrow			3,321,442				3,386,274
Total Liabilities			299,270,553				298,414,831
STOCKHOLDERS’ EQUITY
Redeemable preferred stock, $0.001 par value; $25 liquidation preference; 2,300,000 shares authorized and 2,150,000 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively			2,150				2,150
Senior common stock, $0.001 par value; 4,000,0000 shares authorized and 2,073 and 0 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively			2				—
Common stock, $0.001 par value, 43,700,000 shares authorized and 8,545,264 and 8,563,264 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively			8,545				8,563
Additional paid in capital			170,404,393				170,622,581
Notes receivable — employees			(2,260,586	)			(2,304,999	)
Distributions in excess of accumulated earnings			(56,245,666	)			(49,877,753	)
Total Stockholders’ Equity			111,908,838				118,450,542
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	411,179,391			$	416,865,373

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		For the three months ended June 30,								For the six months ended June 30,
		2010				2009				2010				2009
Operating revenues
Rental income		$	10,409,519			$	10,379,172			$	20,824,586			$	20,767,420
Interest income from mortgage note receivable			189,583				189,583				377,083				377,083
Tenant recovery revenue			82,285				82,734				164,695				165,167
Total operating revenues			10,681,387				10,651,489				21,366,364				21,309,670
Operating expenses
Depreciation and amortization			3,390,492				3,282,629				6,712,362				6,590,438
Property operating expenses			229,733				230,785				474,088				467,595
Due diligence expense			—				6,886				21,876				16,433
Base management fee (Refer to Note 2)			296,141				357,650				608,705				730,298
Incentive fee (Refer to Note 2)			829,264				812,653				1,675,456				1,598,942
Administration fee (Refer to Note 2)			219,119				257,207				451,003				481,561
Professional fees			201,801				125,965				377,411				361,161
Insurance expense			56,513				48,125				112,838				96,804
Directors’ fees			49,025				50,386				98,443				100,088
Stockholder-related expenses			78,596				88,245				123,812				171,892
Asset retirement obligation expense			37,857				35,476				75,104				70,384
General and administrative			17,733				15,453				35,563				26,005
Total operating expenses before credit from Adviser			5,406,274				5,311,460				10,766,661				10,711,601
Credit to incentive fee			(56,073	)			(129,623	)			(56,073	)			(364,704	)
Total operating expenses			5,350,201				5,181,837				10,710,588				10,346,897
Other income (expense)
Interest income from temporary investments			113				184				378				17,465
Interest income — employee loans			42,574				48,862				85,674				97,748
Other income			5,013				11,320				8,329				11,320
Interest expense			(4,372,435	)			(4,433,998	)			(8,657,373	)			(8,921,555	)
Total other expense			(4,324,735	)			(4,373,632	)			(8,562,992	)			(8,795,022	)
Income from continuing operations			1,006,451				1,096,020				2,092,784				2,167,751
Discontinued operations
Income from discontinued operations			—				20,916				—				38,754
Total discontinued operations			—				20,916				—				38,754
Net income			1,006,451				1,116,936				2,092,784				2,206,505
Distributions attributable to preferred stock			(1,023,437	)			(1,023,437	)			(2,046,876	)			(2,046,875	)
Distributions attributable to senior common stock			(375	)			—				(375	)			—
Net (loss) income available to common stockholders		$	(17,361	)		$	93,499			$	45,533			$	159,630
Earnings per weighted average share of common stock — basic
Income from continuing operations (net of distributions attributable to preferred stock)		$	0.00			$	0.01			$	0.01			$	0.02
Discontinued operations			0.00				0.00				0.00				0.00
Net income available to common stockholders		$	0.00			$	0.01			$	0.01			$	0.02
Earnings per weighted average share of common stock — diluted
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.00			$	0.01			$	0.01			$	0.02
Discontinued operations			0.00				0.00				0.00				0.00
Net income available to common stockholders		$	0.00			$	0.01			$	0.01			$	0.02
Weighted average shares of common stock outstanding — basic			8,545,264				8,563,264				8,551,927				8,563,264
Weighted average shares of common stock outstanding — diluted			8,546,529				8,563,264				8,552,563				8,563,264
Earnings per weighted average share of senior common stock		$	0.26			$	0.00			$	0.52			$	0.00
Weighted average shares of senior common stock outstanding — basic			1,435				0				722				0

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		For the six months ended June 30,
		2010				2009
Cash flows from operating activities:
Net income		$	2,092,784			$	2,206,505
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, including discontinued operations			6,712,362				6,600,853
Amortization of deferred financing costs			544,080				723,828
Amortization of deferred rent asset and liability, net			(347,663	)			(266,035	)
Accretion of obligation under capital lease			6,155				6,154
Asset retirement obligation expense, including discontinued operations			75,104				70,845
Increase in prepaid expenses and other assets			(963,368	)			(137,854	)
Increase in deferred rent receivable			(849,261	)			(1,082,278	)
(Decrease) increase in accounts payable, accrued expenses, and amount due Adviser			(478,074	)			230,245
Increase (decrease) in rent received in advance			273,181				(210,575	)
Net cash provided by operating activities			7,065,300				8,141,688
Cash flows from investing activities:
Real estate investments			(575,704	)			(54,319	)
Leasing commissions paid			(7,044	)			(298,270	)
Receipts from lenders for reserves held in escrow			1,016,102				773,187
Payments to lenders for reserves held in escrow			(872,764	)			(919,041	)
Decrease (increase) in restricted cash			338,013				(668,151	)
Deposits refunded			250,000				200,000
Net cash provided by (used in) investing activities			148,603				(966,594	)
Cash flows from financing activities:
Proceeds from issuance of senior common stock			30,000				—
Offering costs			(4,500	)			—
Principal repayments on mortgage notes payable			(1,308,399	)			(1,160,248	)
Principal repayments on employee notes receivable			44,413				6,921
Borrowings from line of credit			13,400,000				39,300,000
Repayments on line of credit			(10,300,000	)			(19,000,000	)
Repayment of short-term loan			—				(20,000,000	)
Receipts from tenants for reserves			1,036,621				1,996,723
Payments to tenants from reserves			(947,606	)			(1,339,968	)
(Decrease) increase in security deposits			(427,028	)			11,396
Payments for deferred financing costs			(61,271	)			(103,563	)
Distributions paid for common and preferred			(8,460,322	)			(8,469,322	)
Net cash used in financing activities			(6,998,092	)			(8,758,061	)
Net increase (decrease) in cash and cash equivalents			215,811				(1,582,967	)
Cash and cash equivalents, beginning of period			3,096,598				4,503,578
Cash and cash equivalents, end of period		$	3,312,409			$	2,920,611
NON-CASH OPERATING, INVESTING AND FINANCING INFORMATION
Forfeiture of common stock in satisfaction of employee note receivable		$	243,900			$	—
Senior common dividend issued in the dividend reinvestment program		$	375			$	—

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

GLADSTONE COMMERCIAL CORPORATION

1. Organization and Significant Accounting Policies

Gladstone Commercial Corporation (the “Company”) was incorporated on February 14, 2003 under the General Corporation Law of Maryland. The Company operates in a manner so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes and exists primarily for the purposes of engaging in the business of investing in real estate properties net leased to creditworthy entities and making mortgage loans to creditworthy entities. Subject to certain restrictions and limitations, the business of the Company is managed by Gladstone Management Corporation, a Delaware corporation (the “Adviser”).

Subsidiaries

The Company conducts substantially all of its operations through a subsidiary, Gladstone Commercial Limited Partnership, a Delaware limited partnership (the “Operating Partnership”). As the Company currently owns all of the general and limited partnership interests of the Operating Partnership through GCLP Business Trust I and II, as discussed in more detail below, the financial position and results of operations of the Operating Partnership are consolidated with those of the Company.

Gladstone Commercial Lending, LLC, a Delaware limited liability company (“Gladstone Commercial Lending”) and a subsidiary of the Company, was created to conduct all operations related to real estate mortgage loans of the Company. As the Operating Partnership currently owns all of the membership interests of Gladstone Commercial Lending, the financial position and results of operations of Gladstone Commercial Lending are consolidated with those of the Company.

Gladstone Commercial Advisers, Inc., a Delaware corporation (“Commercial Advisers”) and a subsidiary of the Company, is a taxable REIT subsidiary (“TRS”), which was created to collect all non-qualifying income related to the Company’s real estate portfolio. It is currently anticipated that this income will predominately consist of fees received by the Company related to the leasing of real estate. There have been no such fees earned to date. Since the Company owns 100% of the voting securities of Commercial Advisers, the financial position and results of operations of Commercial Advisers are consolidated with those of the Company.

GCLP Business Trust I and GCLP Business Trust II, each a subsidiary and business trust of the Company, were formed under the laws of the Commonwealth of Massachusetts on December 28, 2005. The Company transferred its 99% limited partnership interest in the Operating Partnership to GCLP Business Trust I in exchange for 100 trust shares. Commercial Partners transferred its 1% general partnership interest in the Operating Partnership to GCLP Business Trust II in exchange for 100 trust shares.

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 in accordance with Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of the Company’s Management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of the financial statements for the interim period have been included. The interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission on February 24, 2010.

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 such costs are incurred. The Company computes depreciation using the straight-line method over the estimated useful life or 39 years for buildings and improvements, 5 to 7 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 that the purchase price of real estate be recorded at fair value and 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. ASC 805 also 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.

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 hypothetical 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 $4.8 million for the three and six months ended June 30, 2010, respectively, and approximately $2.4 million and $4.7 million for the three and six months ended June 30, 2009, 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 $127,000 for both the three and six months ended June 30, 2010 and 2009, respectively. The capitalized below-market lease values, included in the accompanying consolidated 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 $231,000 and $474,000 for the three and six months ended June 30, 2010, respectively, and approximately $196,000 and $393,000 for the three and six months ended June 30, 2009, 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 the Company’s 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 $1.0 million and $1.9 million for the three and six months ended June 30, 2010, respectively, and approximately $0.9 million and $1.9 million for the three and six months ended June 30, 2009, 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 the Company to 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 June 30, 2010. 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 it to reflect in its financial statements an allowance for estimated credit losses with respect to mortgage loans that 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 cash equivalents to be 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, 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 June 30, 2010 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 upon receipt by the Company of evidence of insurance and tax payments.

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 secured financing. The Company made payments of approximately $11,000 and $61,000 for deferred financing costs during the three and six months ended June 30, 2010, respectively, and approximately $50,000 and $104,000 for deferred financing costs during the three and six months ended June 30, 2009, respectively. Total amortization expense related to deferred financing costs was approximately $272,000 and $544,000 for the three and six months ended June 30, 2010, respectively, and $349,000 and $724,000 for the three and six months ended June 30, 2009, respectively.

Prepaid Expenses and Other Assets

Prepaid expenses and other assets consist of accounts receivable, interest receivable, prepaid assets, prepaid offering costs 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 $3,000 and $6,000 for both the three and six months ended June 30, 2010 and 2009, 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 consolidated 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 collectable. 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 geographic 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 uncollectable accounts or records a direct write-off of the specific rent receivable. No such reserves have been recorded as of June 30, 2010.

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.

Tenant recovery revenue includes payments from tenants as reimbursements for franchises taxes, management fees, insurance, and ground lease payments. The Company recognizes tenant recovery revenue in the same periods that it incurs the related expenses.

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 that 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. There were no liabilities accrued during the six months ended June 30, 2010 or 2009. The Company also recorded expenses, including discontinued operations, of approximately $38,000 and $75,000 during the three and six months ended June 30, 2010, respectively, and approximately $35,000 and $71,000 during the three and six months ended June 30, 2009, 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

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 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 adopted this pronouncement during the quarter ended March 31, 2010, and the adoption had no impact on the Company’s financial position or 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.

2. Related-Party Transactions

The Company is externally managed pursuant to contractual arrangements with its Adviser and Gladstone Administration, LLC (the “Administrator”), which collectively 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 with its Administrator (the “Administration Agreement”). The management services and administrative fees under the Advisory and Administration Agreements are described below. As of June 30, 2010 and December 31, 2009, respectively, approximately $1.3 million and $1.2 million were due to the Adviser.

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 (“common stockholders’ equity”), and an incentive fee based on funds from operations (“FFO”). For the three and six months ended June 30, 2010, the Company recorded a base management fee of approximately $296,000 and $609,000, respectively, and for the three and six months ended June 30, 2009, the Company recorded a base management fee of approximately $358,000 and $730,000, 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 common stockholders’ equity. 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 common stockholders’ equity. The Adviser also receives an incentive fee of 20% of the amount of the Company’s pre-incentive fee FFO that exceeds 2.1875% of common stockholders’ equity.

For the three and six months ended June 30, 2010, the Company recorded an incentive fee of approximately $829,000 and $1,675,000, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $56,000 and $56,000, respectively, resulting in a net incentive fee for the three and six months ended June 30, 2010, of approximately $773,000 and $1,619,000, respectively. For the three and six months ended June 30, 2009, the Company recorded an incentive fee of approximately $813,000 and $1,599,000, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $130,000 and $365,000, respectively, resulting in a net incentive fee for the three and six months ended June 30, 2009, of approximately $683,000 and $1,234,000, 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 the three and six months ended June 30, 2010 and 2009, respectively, in order to support the current level of distributions to the Company’s stockholders. This waiver may not be recouped by the Adviser in the future.

Administration Agreement

Pursuant to the Administration Agreement, the Company pays for its allocable portion of the Administrator’s overhead expenses in performing its obligations to the Company, including, but not limited to, rent, and the salaries and benefits expenses of its chief financial officer, chief compliance officer, internal counsel, treasurer, investor relations 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 six months ended June 30, 2010, the Company recorded an administration fee of approximately $219,000 and $451,000, respectively, and for the three and six months ended June 30, 2009, the Company recorded an administration fee of approximately $257,000 and $482,000, respectively.

3. Earnings per Share of Common Stock

The following tables set forth the computation of basic and diluted earnings per share of common stock for the three and six months ended June 30, 2010 and 2009. The Company computed basic earnings per share for the three and six months ended June 30, 2010 and 2009 using the weighted average number of shares outstanding during the periods. Diluted earnings per share for the three and six months ended June 30, 2010, reflects additional shares of common stock, related to our convertible senior common stock, that would have been outstanding if dilutive potential shares of common stock had been issued, as well as an adjustment to net income available to common stockholders as applicable to common stockholders that would result from their assumed issuance.

		For the three months ended June 30,								For the six months ended June 30,
		2010				2009				2010				2009
Calculation of basic earnings per share of common stock:
Net (loss) income available to common stockholders		$	(17,361	)		$	93,499			$	45,533			$	159,630
Denominator for basic weighted average shares of common stock			8,545,264				8,563,264				8,551,927				8,563,264
Basic earnings per share of common stock		$	0.00			$	0.01			$	0.01			$	0.02
Calculation of diluted earnings per share of comon stock:
Net (loss) income available to common stockholders		$	(17,361	)		$	93,499			$	45,533			$	159,630
Add: Income impact of assumed conversion of senior common stock			375				—				375				—
Net (loss) income available to common stockholders plus assumed conversions		$	(16,986	)		$	93,499			$	45,908			$	159,630
Denominator for basic weighted average shares of common stock			8,545,264				8,563,264				8,551,927				8,563,264
Effect of convertible senior common stock			1,265				—				636				—
Denominator for diluted weighted average shares of common stock			8,546,529				8,563,264				8,552,563				8,563,264
Diluted earnings per share of common stock		$	0.00			$	0.01			$	0.01			$	0.02

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 June 30, 2010 and December 31, 2009:

		June 30, 2010				December 31, 2009
Real estate:
Land		$	55,025,707	(1)		$	55,025,707	(1)
Building and improvements			326,483,183				325,907,479
Tenant improvements			9,820,706				9,820,706
Accumulated depreciation			(38,886,713	)			(34,111,952	)
Real estate, net		$	352,442,883			$	356,641,940

On May 4, 2010, the Company extended the lease with the tenant which occupies its property located in Grand Rapids, Michigan for a period of 15 years, and the tenant has two options to extend the lease for additional periods of 10 years each. The lease was originally set to expire in July 2016, and will now expire in April 2025. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.1 million.

Future operating lease payments from tenants under non-cancelable leases, excluding tenant reimbursement of expenses, for the remainder of 2010, each of the five succeeding fiscal years and thereafter is as follows:

		Tenant
Year		Lease Payments
Six months ending December 31, 2010		$	19,392,848
2011			38,589,674
2012			38,698,289
2013			33,356,072
2014			29,132,246
2015			25,044,969
Thereafter			145,637,227

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 June 30, 2010 was approximately $6.2 million, and the total annual ground lease payments on the property located in Tulsa, Oklahoma 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:

		June 30, 2010								December 31, 2009
						Accumulated								Accumulated
		Lease Intangibles				Amortization				Lease Intangibles				Amortization
In-place leases		$	15,935,445			$	(7,577,354	)		$	15,935,445			$	(6,741,817	)
Leasing costs			10,060,049				(4,263,737	)			10,053,004				(3,832,623	)
Customer relationships			17,136,501				(5,044,000	)			17,136,501				(4,373,049	)
		$	43,131,995			$	(16,885,091	)		$	43,124,950			$	(14,947,489	)

The estimated aggregate amortization expense for the remainder of 2010, each of the five succeeding fiscal years and thereafter is as follows:

		Estimated
Year		Amortization Expense
Six months ending December 31, 2010		$	3,029,920
2011			5,403,532
2012			4,502,386
2013			2,342,887
2014			2,075,125
2015			1,708,575
Thereafter			7,184,479

5. Real Estate Held for Sale and Discontinued Operations

As of June 30, 2009, the Company classified its property 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. On July 17, 2009, the Company sold this property for $1.15 million, and recognized a gain on the sale of approximately $160,000.

The table below summarizes the components of income from discontinued operations:

		For the three months ended June 30,								For the six months ended June 30,
		2010				2009				2010				2009
Operating revenue		$	—			$	25,875			$	—			$	51,751
Operating expense			—				(4,959	)			—				(12,997	)
Income from discontinued operations		$	—			$	20,916			$	—			$	38,754

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 located in McLean, Virginia, in which 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 June 30, 2010, the interest rate was 7.5%. This loan was repaid in full on July 22, 2010.

7. Mortgage Notes Payable and Line of Credit

The Company’s mortgage notes payable and line of credit as of June 30, 2010 and December 31, 2009 are summarized below:

		Date of
		Issuance/				Principal				Stated Interest Rate at				Principal Balance Outstanding
		Assumption				Maturity Date				June 30, 2010 (1)				June 30, 2010				December 31, 2009
Fixed-Rate Mortgage Notes Payable:
			03/16/05				04/01/30				6.33	%		$	2,792,532			$	2,884,908
			08/25/05				09/01/15				5.33	%			20,933,204				21,093,917
			09/12/05				09/01/15				5.21	%			12,299,802				12,389,647
			12/21/05				12/08/15				5.71	%			18,860,364				18,991,934
			02/21/06				12/01/13				5.91	%			9,105,276				9,188,044
			02/21/06				06/30/14				5.20	%			18,929,519				19,116,277
			03/29/06				04/01/16				5.92	%			17,000,000				17,000,000
			04/27/06				05/05/16				6.58	%			13,865,869				14,009,918
			11/22/06				12/01/16				5.76	%			14,045,923				14,136,921
			12/22/06				01/01/17				5.79	%			21,467,597				21,605,106
			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	%			4,326,704				4,361,144
			10/15/07				11/08/17				6.63	%			15,565,851				15,657,330
			08/29/08				06/01/16				6.80	%			6,230,611				6,296,505
			09/15/08				10/01/10	(2)			6.85	%			48,015,000				48,015,000
Total Fixed-Rate Mortgage Notes Payable:															251,453,252				252,761,651
Variable-Rate Line of Credit:			12/29/06				12/29/10			LIBOR + 2.15%					36,300,000				33,200,000
Total Mortgage Notes Payable and Line of Credit														$	287,753,252			$	285,961,651

Mortgage Notes Payable

As of June 30, 2010, 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 will also indemnify lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property. The weighted-average interest rate on the mortgage notes payable as of both June 30, 2010 and December 31, 2009 was approximately 6.0%.

The Company has $48.0 million of balloon principal payments maturing under one of its long-term mortgages in 2010; however, the mortgage has three annual extension options through 2013, which the Company currently intends to exercise. At the time of notification of extension of the $48.0 million loan, the Company is required to remit a fee of 0.25% of the outstanding principal balance and a certification to the lender that its aggregate debt service coverage ratio is not less than 1.2. As of June 30, 2010, the Company was in compliance with this covenant. The interest rate for the extension periods will adjust based upon the 1-year swap rate at the time of extension and a fixed spread of 4.16% in the first year, 4.29% in the second year and 4.41% in the third year.

The fair market value of all fixed-rate mortgage notes payable outstanding as of June 30, 2010 was approximately $241.2 million, as compared to the carrying value stated above of approximately $251.5

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
Six months ending December 31, 2010		$	49,458,334	(1)
2011			3,055,867
2012			3,379,984
2013			12,176,273
2014			20,781,319
2015			54,529,438
Thereafter			108,072,037
		$	251,453,252

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, 2010. Currently, eight properties are pledged as collateral under the Company’s line of credit. 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’s continued ability to meet customary lending requirements, such as compliance with financial and operating covenants and satisfaction of 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 that 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. The maximum amount that the Company may currently draw under the Credit Agreement is approximately $45.1 million. Furthermore, 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 Credit Agreement by the advanced amount of the released property. Conversely, as the Company purchases new properties meeting the eligibility standards, the Company may pledge such 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 June 30, 2010, there was $36.3 million outstanding under the line of credit at an interest rate of approximately 2.5%, and approximately $3.9 million outstanding pursuant to letters of credit at a weighted average interest rate of approximately 2.2%. At June 30, 2010, the remaining borrowing capacity available under the line of credit was approximately $4.9 million. The Company’s ability to increase the availability under its line of credit is dependent upon its pledging additional properties as collateral. Traditionally, the Company has pledged new properties to its line of credit as it arranges for long-term mortgages for these pledged properties. Currently, only nine of the Company’s properties do not have long-term mortgages, and eight of those are pledged as collateral under its line of credit. Accordingly, the Company only has one property which is unencumbered and which may

be pledged as collateral to increase the borrowing capacity available under the line of credit. The Company was in compliance with all covenants under the Credit Agreement as of June 30, 2010. The amount outstanding on the line of credit as of June 30, 2010 approximates fair market value, because the debt is short-term and variable rate.

The Company’s line of credit matures in December 2010, and it is actively negotiating a renewal of the line of credit with Key Bank and simultaneously in negotiations with other banks to find replacement financing, though its ability to obtain replacement financing at the time of maturity could be constrained by current economic conditions affecting the credit markets generally. Consequently, no assurance can be given that we will be successful in renewing or replacing the line of credit with terms similar to the Company’s existing line of credit or at all; however, the Company is optimistic that it will be able to secure a new line of credit before December. The Company’s inability to obtain replacement financing for its line of credit on favorable terms, or at all, could have a material adverse effect on the Company’s liquidity, its ability to make distributions to its stockholders and its ability to fund new investments. In the interim, to maintain sufficient liquidity and capital resources, the Company has, and will, continue to evaluate all available financing options.

8. Stockholders’ Equity

The following table summarizes the changes in stockholders’ equity for the six months ended June 30, 2010:

																		Notes				Distributions in
														Capital in				Receivable				Excess of				Total
		Preferred				Senior Common				Common				Excess of				From Sale of				Accumulated				Stockholders’
		Stock				Stock				Stock				Par Value				Common Stock				Earnings				Equity
Balance at December 31, 2009		$	2,150			$	—			$	8,563			$	170,622,581			$	(2,304,999	)		$	(49,877,753	)		$	118,450,542
Issuance of senior common stock			—				2				—				25,694				—				—				25,696
Repayment of principal on notes receivable			—				—				—				—				44,413				—				44,413
Distributions declared to common, senior common and preferred stockholders			—				—				—				—				—				(8,460,697	)			(8,460,697	)
Forfeiture of common stock in satisfaction of employee note receivable (1)			—				—				(18	)			(243,882	)			—				—				(243,900	)
Net income			—				—				—				—				—				2,092,784				2,092,784
Balance at June 30, 2010		$	2,150			$	2			$	8,545			$	170,404,393			$	(2,260,586	)		$	(56,245,666	)		$	111,908,838

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

																		Outstanding Balance
										Amount of				Outstanding Balance				of Employee Loans
		Number of Options				Strike Price of				Promissory Note				of Employee Loans				at December 31,				Maturity Date of				Interest Rate on
Date Issued		Exercised				Options Exercised				Issued to Employees				at June 30, 2010				2009				Note				Note
Sep 2004			25,000			$	15.00			$	375,000			$	314,961			$	358,405			Sep 2013					5.00	%
Apr 2006			12,422				16.10				199,994				199,994				199,994			Apr 2015					7.77	%
May 2006			50,000				16.85				842,500				842,500				842,500			May 2016					7.87	%
May 2006			15,000				16.10				241,500				241,500				241,500			May 2016					7.87	%
May 2006			2,000				16.10				32,200				32,200				32,200			May 2016					7.87	%
May 2006			2,000				16.10				32,200				32,200				32,200			May 2016					7.87	%
May 2006			2,000				15.00				30,000				30,000				30,000			May 2016					7.87	%
Oct 2006			12,000				16.10				193,200				192,231				193,200			Oct 2015					8.17	%
Nov 2006			25,000				15.00				375,000				375,000				375,000			Nov 2015					8.15	%
			145,422							$	2,321,594			$	2,260,586			$	2,304,999

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 full recourse loans to employees and are included in the equity section of the accompanying consolidated balance sheets. As of June 30, 2010, each loan maintained its full recourse status.

Distributions paid per share of common stock for both the three and six months ended June 30, 2010 and 2009 were $0.375 and $0.75 per share, respectively. Distributions paid per share of Series A Preferred Stock for both the three and six months ended June 30, 2010 and 2009 were $0.4843749 and $0.9687498 per share, respectively. Distributions paid per share of Series B Preferred Stock for both the three and six months ended June 30, 2010 and 2009 were $0.46875 and $0.9375 per share, respectively. Distributions paid per share of senior common stock for both the three and six months ended June 30, 2010 were $0.0849 per share. There were no distributions paid to senior common stockholders for either the three or six months ended June 30, 2009, as senior common stock was not issued until the three month period ended June 30, 2010.

On November 4, 2009, the Company entered into an open market sale agreement, or the Open Market Sale Agreement, with Jefferies & Company, Inc., or Jefferies, under which it may, from time to time, offer to sell shares of its common stock with an aggregate sales price of up to $25.0 million on the open market through Jefferies, as agent, or to Jefferies, as principal. To date, the Company has not sold any shares of common stock under the Open Market Sale Agreement.

On November 19, 2009, the Company entered into a dealer manager agreement, or the Dealer Manager Agreement, with Halcyon Capital Markets, LLC, or Halcyon, pursuant to which Halcyon will act as the Company’s dealer manager in connection with the Company’s continuous private offering of up to 3,333,333 shares of its newly designated senior common stock at $15.00 per share. Holders of the senior common stock will have the right, but not the obligation, following the fifth anniversary of the issuance of such shares proposed to be exchanged, to exchange any or all of such shares of senior common stock for shares of the Company’s common stock. On April 29, 2010, the Company issued 2,060 shares of senior common stock in a private offering. Net proceeds from the sale, after commissions and the dealer manager fee, were $27,675 The proceeds from the sale of the senior common stock will be used for investment in additional properties and mortgage loans, to repay indebtedness, to potentially purchase shares of the Company’s preferred stock on the open market, or other general corporate purposes.

9. Segment Information

As of June 30, 2010, the Company’s operations were comprised of 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 six months ended June 30, 2010 and 2009:

		As of and for the three months ended June 30, 2010																As of and for the six months ended June 30, 2010
		Real Estate Leasing				Real Estate Lending				Other				Total				Real Estate Leasing				Real Estate Lending				Other				Total
Operating revenues		$	10,491,804			$	189,583			$	—			$	10,681,387			$	20,989,281			$	377,083			$	—			$	21,366,364
Operating expenses			(3,658,082	)			—				(1,692,119	) (1)			(5,350,201	)			(7,283,430	)			—				(3,427,158	) (1)			(10,710,588	)
Other expense			(4,090,012	)			—				(234,723	) (2)			(4,324,735	)			(8,135,657	)			—				(427,335	) (2)			(8,562,992	)
Discontinued operations			—				—				—				—				—				—				—				—
Net income		$	2,743,710			$	189,583			$	(1,926,842	)		$	1,006,451			$	5,570,194			$	377,083			$	(3,854,493	)		$	2,092,784
Total Assets		$	393,575,318			$	10,062,500			$	7,541,573			$	411,179,391			$	393,575,318			$	10,062,500			$	7,541,573			$	411,179,391

		As of and for the three months ended June 30, 2009																As of and for the six months ended June 30, 2009
		Real Estate Leasing				Real Estate Lending				Other				Total				Real Estate Leasing				Real Estate Lending				Other				Total
Operating revenues		$	10,461,906			$	189,583			$	—			$	10,651,489			$	20,932,587			$	377,083			$	—			$	21,309,670
Operating expenses			(3,555,776	)			—				(1,626,061	) (1)			(5,181,837	)			(7,144,850	)			—				(3,202,047	) (1)			(10,346,897	)
Other expense			(4,114,021	)			—				(259,611	) (2)			(4,373,632	)			(8,196,656	)			—				(598,366	) (2)			(8,795,022	)
Discontinued operations			20,916				—				—				20,916				38,754				—				—				38,754
Net income		$	2,813,025			$	189,583			$	(1,885,672	)		$	1,116,936			$	5,629,835			$	377,083			$	(3,800,413	)		$	2,206,505
Total Assets		$	401,711,306			$	10,062,500			$	10,471,976			$	422,245,782			$	401,711,306			$	10,062,500			$	10,471,976			$	422,245,782

10. Subsequent Events

On July 7, 2010, the Company’s Board of Directors declared a cash distribution of $0.125 per share of common stock, $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 July, August and September of 2010. Monthly distributions will be payable on July 30, 2010, August 31, 2010 and September 30, 2010, respectively, to stockholders of record as of the close of business on July 22, 2010, August 23, 2010 and September 22, 2010, respectively. Additionally, the Company’s Board of Directors declared a cash distribution of $0.0875 per share of senior common stock for each of the months of July, August, and September of 2010. Senior common stock monthly distributions will be payable on August 6, 2010, September 8, 2010, and October 7, 2010.

In July 2010, the Company issued 8,227 additional shares of senior common stock. Net proceeds from the sales, after selling commissions and the dealer manager fees, were approximately $110,000. The proceeds from the sale of the senior common stock will be used for investment in additional properties and mortgage loans, to repay indebtedness, to potentially purchase shares of the Company’s preferred stock on the open market, or other general corporate purposes.

On July 22, 2010, the borrower on the Company’s $10.0 million mortgage loan, which was collateralized by an office building located in McLean, Virginia, repaid in full the outstanding principal balance and all accrued and unpaid interest. The mortgage loan was originally set to mature in May 2017. The Company received $3.3 million of additional interest and prepayment penalties in connection with the early payment. The proceeds were used to repay a portion of the Company’s line of credit.

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

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

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

OVERVIEW

General

We were incorporated under the General Corporation Law 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 that 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 historically 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 rate 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 June 30, 2010, 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 $444.5 million at June 30, 2010.

Business Environment

The United States is beginning to recover from the recession that it entered into during late 2007, though it continues to experience pervasive and fundamental disruptions in its financial and capital markets. As a result, conditions within the U.S. capital markets generally and the U.S. real estate capital markets, in particular, continue to experience significant dislocation and stress. While we are beginning to see signs of economic improvement and stabilization in both the equity and debt capital markets, these markets remain challenging, and we do not know if adverse conditions will again intensify, nor are we able to gauge the full extent to which the disruptions will affect us. Additionally, economic conditions continue to disrupt our ability to price and finance new investment opportunities on attractive terms. We believe that it will take some time for the United States to fully recover from the recession. As a result, the continued weak economic conditions could still materially and adversely impact the financial condition of one or more of our tenants, and, therefore, could increase the likelihood that a tenant may declare bankruptcy or default

upon its payment obligations arising under a related lease or loan, as applicable. Currently, two of our buildings, which comprise approximately 2.6% of our total annualized rental income, are vacant. We also have one lease, which comprises less than 1% of our total annualized rental income that expires in December of this year. We are currently renegotiating this lease and are optimistic that we will be able to extend this lease prior to its expiration. All of our remaining tenants are current and paying in accordance with their leases. In addition, we have $48.0 million of balloon principal payments maturing under one of our long-term mortgages in October 2010; however, the mortgage has three annual extension options through 2013, each of which we currently intend to exercise. We have no other balloon principal payments due under any of our mortgages until 2013.

Our ability to make new investments is highly dependent upon our ability to procure external financing. Our principal sources of external financing generally include the issuance of equity securities, long-term mortgages secured by properties, and borrowings under our line of credit. The market for long-term mortgages is extremely limited, 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 industrial and 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. In addition, many banks have significantly curtailed their general lending practices, as they are having difficulty valuing the underlying real estate in this market. We are, however, beginning to see banks that are willing to issue medium-term mortgages, between two and five years, on substantially less favorable terms than were previously available. Consequently, we continue to focus on using medium-term mortgages to finance our real estate activities until the market for long-term mortgages returns. In addition, the maximum amount that the Company may draw under its line of credit is based upon a percentage of the value of properties pledged as collateral against the line which must meet agreed upon eligibility standards. The maximum amount that the Company may currently draw under the line of credit is approximately $45.1 million.

Our ability to increase the availability under our line of credit is dependent upon our 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. Accordingly, we only have one property which is unencumbered and which may be pledged as collateral to increase the borrowing capacity available under our line of credit. Our line of credit matures in December 2010, and we are actively seeking to negotiate a renewal of the line of credit or procure replacement financing this year. We anticipate that the terms under a renewal or replacement line of credit will be less favorable then the terms under our current line of credit.

Further, we currently have two ongoing equity offerings pursuant to which we have raised an aggregate of $138,000 of net proceeds. If we are able to raise additional equity capital in the near term, we will continue to invest in industrial and commercial real property as well as expand our investment portfolio into other real property sectors, such as retail and medical properties. Furthermore, we intend to expand our mortgage lending activity to include purchasing mortgage loans from banks and CMBS pools; however, until we are able to raise significant debt or additional equity capital, our near-term strategy is contingent upon building the value of our existing portfolio of properties by renegotiating existing leases and making capital improvements to our properties. Capital improvements, however, will be limited to the extent that we have available capital. We will continue to actively seek potential acquisitions, and we will continue our strategy of making conservative investments in properties that have existing financing sufficient to withstand the current economic conditions, and that are likely to produce attractive long-term returns for our stockholders.

Recent Events

Financing Activities:

During the six months ended June 30, 2010, we had net borrowings under our line of credit of approximately $3.1 million, with a $36.3 million outstanding principal balance at June 30, 2010. The

proceeds from borrowings under the line of credit were used for working capital and to fund capital improvements at certain of our properties.

Equity Activities:

On November 4, 2009, we entered into an open market sale agreement, or the Open Market Sale Agreement, with Jefferies & Company, Inc., or Jefferies, under which we may, from time to time, offer to sell shares of our common stock with an aggregate sales price of up to $25.0 million on the open market through Jefferies, as agent, or to Jefferies, as principal. To date, we have not sold any common stock under the Open Market Sale Agreement.

On November 19, 2009, we entered into a dealer manager agreement, or the Dealer Manager Agreement, with Halcyon Capital Markets, LLC, or Halcyon, pursuant to which Halcyon will act as our dealer manager in connection with our continuous private offering of up to 3,333,333 shares of our newly designated senior common stock at $15.00 per share. To date, we have issued 10,287 shares of senior common stock. Net proceeds from these sales, after selling commissions and dealer manager fees, were approximately $138,000. The net proceeds from future sales of senior common stock will be used for investment in additional properties and mortgage loans, to repay indebtedness, to potentially purchase shares of our preferred stock on the open market, or other general corporate purposes.

Leasing Activities:

On May 4, 2010, we extended the lease on our property located in Grand Rapids, Michigan for a period of 15 years, and the tenant has two options to extend the lease for additional periods of 10 years each. The lease was originally set to expire in July 2016, and will now expire in April 2025. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.1 million.

Industry Classifications

Gladstone Management Corporation, or our Adviser, seeks to diversify our portfolio to avoid dependence on any one particular tenant, geographic market 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 market. Our largest tenant at June 30, 2010 comprised approximately 7.3% of our total rental income, and our largest concentration of properties was located in Ohio, which accounted for approximately 17.9% of our total rental income. The table below reflects the breakdown of our total rental income by tenant industry classification for both the six months ended June 30, 2010 and 2009, respectively:

		June 30, 2010								June 30, 2009
						Percentage of								Percentage of
Industry Classification		Rental Income				Rental Income				Rental Income				Rental Income
Automobile		$	583,326				2.8	%		$	583,327				2.8	%
Beverage, Food & Tobacco			1,094,383				5.2	%			1,094,371				5.3	%
Buildings and Real Estate			1,022,674				4.9	%			1,012,834				4.9	%
Chemicals, Plastics & Rubber			1,565,065				7.5	%			1,598,724				7.7	%
Containers, Packaging & Glass			1,165,237				5.6	%			1,165,007				5.6	%
Diversified/Conglomerate Manufacturing			1,832,341				8.8	%			1,832,344				8.8	%
Diversified/Conglomerate Services			154,052				0.7	%			154,052				0.8	%
Electronics			3,083,187				14.8	%			3,082,895				14.8	%
Healthcare, Education & Childcare			3,072,703				14.8	%			3,072,707				14.8	%
Home & Office Furnishings			264,871				1.3	%			264,872				1.3	%
Insurance			361,433				1.7	%			361,433				1.7	%
Machinery			1,194,308				5.7	%			1,194,301				5.8	%
Oil & Gas			647,121				3.1	%			572,645				2.8	%
Personal & Non-Durable Consumer Products			677,090				3.2	%			677,361				3.3	%
Personal, Food & Miscellaneous Services			287,503				1.4	%			287,503				1.4	%
Printing & Publishing			1,095,611				5.3	%			1,089,693				5.3	%
Telecommunications			2,723,681				13.2	%			2,723,351				12.9	%
		$	20,824,586				100.0	%		$	20,767,420				100.0	%

Lease Expirations

The following table summarizes the lease expirations by year for the Company’s properties for leases in place as of June 30, 2010:

										Rental Revenue
										for the Six Month
Year of Lease						Number of				Period Ended				Annualized Base				% of Annualized
Expiration		Square Feet				Leases				June 30, 2010				Rental Revenue				Base Rent
2010			215,581				3			$	704,844			$	1,409,688				3.4	%
2011			—				0				—				—				0.0	%
2012			479,982				3				2,214,824				4,429,648				10.6	%
2013			438,422				6				2,336,675				4,673,350				11.2	%
2014			614,132				5				1,541,098				3,082,196				7.4	%
2015			896,876				8				3,423,921				6,847,842				16.4	%
2016			898,257				5				2,107,425				4,214,850				10.1	%
2017			102,200				1				461,462				922,924				2.2	%
2018			59,894				1				134,020				268,040				0.6	%
2019+			2,598,815				18				7,900,317				15,800,634				38.1	%
Total			6,304,159				50			$	20,824,586			$	41,649,172				100	%