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EX-21 - EX-21 - GLADSTONE COMMERCIAL CORPw77452exv21.htm
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EX-31.2 - EX-31.2 - GLADSTONE COMMERCIAL CORPw77452exv31w2.htm
EX-31.1 - EX-31.1 - GLADSTONE COMMERCIAL CORPw77452exv31w1.htm
EX-32.1 - EX-32.1 - GLADSTONE COMMERCIAL CORPw77452exv32w1.htm
EX-10.40 - EX-10.40 - GLADSTONE COMMERCIAL CORPw77452exv10w40.htm
EX-10.39 - EX-10.39 - GLADSTONE COMMERCIAL CORPw77452exv10w39.htm
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
OR
     
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 organization)   (I.R.S. Employer Identification No.)
1521 WESTBRANCH DRIVE, SUITE 200
MCLEAN, VIRGINIA 22102
(Address of principal executive office)
(703) 287-5800
(Registrant’s telephone number, including area code)
     
Securities registered pursuant to Section 12(b) of the Act:
   
Common Stock, par value $0.001 per share
  NASDAQ Global Select Market
7.75% Series A Cumulative Redeemable Preferred Stock, par value $0.001 per share
  NASDAQ Global Select Market
7.50% Series B Cumulative Redeemable Preferred Stock, par value $0.001 per share
  NASDAQ Global Select Market
(Title of Each Class)
  (Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ.
Indicate by check if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ.
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to this Form 10-K. 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
(Do not check if a smaller reporting company)
Smaller reporting company o
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 aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2009, based on the closing price on that date of $12.96 on the Nasdaq Global Market, was $103,972,270. For the purposes of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates.
The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding as of February 19, 2010 was 8,563,264.
Documents Incorporated by Reference: Portions of the registrant’s Proxy Statement relating to the Registrant’s 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.
 
 

 


 

GLADSTONE COMMERCIAL CORPORATION
FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 2009
TABLE OF CONTENTS
             
        PAGE  
 
           
PART I
           
 
           
  Business     3  
 
           
  Risk Factors     18  
 
           
  Unresolved Staff Comments     30  
 
           
  Properties     31  
 
           
  Legal Proceedings     34  
 
           
  Submission of Matters to a Vote of Security Holders     34  
 
           
           
 
           
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     35  
 
           
  Selected Financial Data     36  
 
           
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     38  
 
           
  Quantitative and Qualitative Disclosures about Market Risk     55  
 
           
  Financial Statements and Supplementary Data     57  
 
           
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     88  
 
           
  Controls and Procedures     88  
 
           
  Other Information     88  
 
           
           
 
           
  Directors, Executive Officers and Corporate Governance     89  
 
           
  Executive Compensation     89  
 
           
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     89  
 
           
  Certain Relationships and Related Transactions, and Director Independence     89  
 
           
  Principal Accountant Fees and Services     89  
 
           
           
 
           
  Exhibits and Financial Statement Schedules     90  

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Forward-Looking Statements
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( the “Securities Act”), as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (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 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. Such factors include, among others: (1) further adverse changes in the economy and the capital markets; (2) risks associated with negotiation and consummation of pending and future transactions; (3) the loss of one or more of our executive officers, in particular David Gladstone, Terry Lee Brubaker, or George Stelljes III; (4) changes in our business strategy; (5) availability, terms and deployment of capital, including the ability to maintain and borrow under our existing line of credit, arrange for long-term mortgages on our properties, secure one or more additional long-term credit facilities, and to raise equity capital; (6) changes in our industry, interest rates, exchange rates or the general economy; (7) the degree and nature of our competition; and (8) those factors described in the “Risk Factors” section of this Form 10-K. We caution readers not to place undue reliance on any such forward-looking statements, which 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-K.
Item 1. Business
Overview
Gladstone Commercial Corporation (which we refer to as “we,” “us,” or the “Company,”) is a real estate investment trust, or REIT, that was 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 our 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 currently own a total of 64 properties and hold one mortgage loan.
We conduct substantially all of our activities, including the ownership of all of our properties, through Gladstone Commercial Limited Partnership, a Delaware limited partnership that we refer to as our Operating Partnership. We control our Operating Partnership through our ownership of GCLP Business Trust II, a Massachusetts business trust, which is the general partner of our Operating Partnership, and of GCLP Business Trust I, a Massachusetts business trust, which currently holds all of the limited partnership units of our Operating Partnership. We expect that our Operating Partnership may issue limited partnership units from time to time in exchange for industrial and commercial real property. Limited partners who hold limited partnership units in our Operating Partnership will be entitled to redeem these units for cash or, at our election, shares of our common stock on a one-for-one basis at any time.
Our Operating Partnership is also the sole member of Gladstone Lending, LLC, which we refer to as Gladstone Lending. Gladstone Lending is a Delaware limited liability company that was formed to hold all of our real estate mortgage loans.

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Recent Developments
Financing 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 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 shares of our 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 a proposed continuous private offering of up to 3,333,333 shares of our newly designated senior common stock at $15.00 per share. This offering is only being made to accredited investors. To date, we have not sold any shares of senior common stock under the Dealer Manager Agreement.
On November 24, 2009, we, through our wholly-owned subsidiary Gladstone Commercial Limited Partnership, exercised our option under our existing credit agreement with KeyBank National Association and certain other parties to extend the term of our $50 million line of credit by one year, resulting in a new maturity date of December 29, 2010. The loan was originally set to expire on December 29, 2009. During the year ended December 31, 2009, we had net borrowings under our line of credit of approximately $21.7 million, with $33.2 million outstanding at December 31, 2009. The proceeds from borrowings under the line of credit were used to pay off a $20.0 million unsecured short-term loan with KeyBank and fund other capital improvements at certain of our properties.
Leasing Activities:
On May 19, 2009, we extended the lease with one of our tenants 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.
On November 18, 2009, we extended the lease with one of our tenants in our property located in Akron, Ohio for a period of five years. The lease was originally set to expire in February 2010, and will now expire in March 2015. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $160,000.
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.
Our Investment Objectives and Our Strategy
Our principal investment objectives are to generate income from rental properties and, to a much lesser extent, mortgage loans, which we use to fund our continuing operations and to pay out monthly cash distributions to our stockholders. We intend to grow the distribution to stockholders over time, and to increase the value of our common stock. Our primary strategy to achieve our investment objectives is to invest in and own a diversified portfolio of leased industrial and commercial real estate that we believe will produce stable cash flow and increase in value. We expect to sell some of our real estate assets from time to time when our external adviser, Gladstone Management Corporation, which we refer to as our Adviser, determines that doing so would be advantageous to us and our stockholders. We also expect to occasionally make mortgage loans secured by income-producing commercial or industrial real estate, which loans may have some form of equity participation.

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Our strategy includes the use of leverage so that we may make more investments than would otherwise be possible in order to maximize potential returns to stockholders. We are not limited with respect to the amount of leverage that we may use for the acquisition of any specific property. We intend to use non-recourse mortgage financing that will allow us to limit our loss exposure on any property to the amount of equity invested in such property. However, the market for long-term mortgages, as we have traditionally accessed, 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, on 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.
Investment Policies and Policies with Respect to Certain Activities
Types of Investments
Overview
We intend that substantially all of our investments will be generated from the ownership of income-producing real property or, to a much lesser extent, mortgage loans secured by real property. We expect that the vast majority of our investments will be structured as net leases, but if a net lease would have an adverse impact on a potential tenant, or would otherwise be inappropriate for us, we may structure our investment as a mortgage loan. Investments are not restricted as to geographical areas, but we expect that most of our investments in real estate will be made within the continental United States. Some of our investments may also be made through joint ventures that would permit us to own interests in large properties without restricting the diversity of our portfolio. Our stockholders are not afforded the opportunity to evaluate the economic merits of our investments or the terms of any dispositions of properties. See “Risk Factors—Our success depends on the performance of our Adviser and if our Adviser makes inadvisable investment or management decisions, our operations could be materially adversely impacted.”
We anticipate that we will make substantially all of our investments through our Operating Partnership and Gladstone Lending. Our Operating Partnership and Gladstone Lending may acquire interests in real property or mortgage loans in exchange for the issuance of limited partnership units, for cash or through a combination of both. Units issued by our Operating Partnership will be redeemable for cash or, at our election, shares of our common stock on a one-for-one basis at any time. However, we may in the future also conduct some of our business and hold some of our interests in real properties or mortgage loans through one or more wholly-owned subsidiaries, each classified as a qualified REIT subsidiary, or QRS.
Property Acquisitions and Net Leasing
To date a majority of our properties have been purchased from owners that have leased their properties to non-affiliated tenants, and while we have engaged in some transactions with tenants who have consummated sale-leaseback transactions, this is not the dominant portion of our portfolio. We expect that some of our sale-leaseback transactions will be in conjunction with acquisitions, recapitalizations or other corporate transactions affecting our tenants. In these transactions, we may act as one of several sources of financing for these transactions by purchasing one or more properties from the tenant and by net leasing it to the tenant or its successor in interest. For a discussion of the risks associated with leasing property to leveraged tenants, see “Risk FactorsHighly leveraged tenants or borrowers may be unable to pay rent or make mortgage payments, which could adversely affect our cash available to make distributions to our stockholders.”

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In limited circumstances, we have granted tenants an option to purchase the leased property, and we anticipate granting these options to select tenants in the future. In these cases, we generally seek to fix the option purchase price at the greater of our purchase price for the property and the fair market value of the property at the time the option is exercised.
Our portfolio consists primarily of single-tenant commercial and industrial real property, however, we also consider multi-tenant commercial and industrial properties. We have not in the past and do not anticipate that in the future we will invest in residential properties. Generally, we lease properties to tenants that our Adviser deems creditworthy under leases that will be full recourse obligations of our tenants or their affiliates. In most cases, our leases will be “triple net leases” that require the tenant to pay all the operating costs, costs of maintenance, insurance and real estate taxes on the property. We seek to obtain lease terms of approximately 10 to 15 years with built-in rental increases.
Investments in Mortgage Loans
Although we expect such investments to be made sparingly, we may elect to structure our investment in a particular property as a mortgage loan secured by the property in situations where a standard net lease transaction would have an adverse tax impact on the seller of a property or would otherwise be inappropriate for us. We anticipate that most of our lending transactions will be loans secured by industrial or commercial property. We have not in the past and do not anticipate in the future we will invest in residential mortgages. Our Adviser will attempt to structure mortgage loans in a manner that would provide us with current income substantially similar to that which we could expect to receive had the investment been structured as a net lease transaction.
To the extent that we invest in mortgage loans, we will generally originate those loans. However, we may also purchase mortgage loans from other lenders if such transactions are consistent with our investment objectives. Our Adviser will service the mortgage loans in our portfolio by monitoring the collection of monthly principal and interest payments on our behalf.
Underwriting Criteria, Due Diligence Process and Negotiating Lease Provisions
We consider underwriting the real estate and the tenant for the property (or the borrower in the case of a mortgage loan) to be the most important aspects of making an investment. Evaluating the creditworthiness of the tenant or borrower and its ability to generate sufficient cash flow to make payments to us pursuant to the lease or the mortgage loan is the most important aspect of our underwriting procedures. In analyzing potential acquisitions of properties and leases, our Adviser reviews all aspects of the potential transaction, including tenant and real estate fundamentals, to determine whether potential acquisitions and leases can be structured to satisfy our acquisition criteria. The criteria listed below provide general guideposts that our Adviser may consider when underwriting leases and mortgage loans:
  Credit Evaluation. Our Adviser evaluates each potential tenant for its creditworthiness, considering factors such as management experience, industry position and fundamentals, operating history and capital structure. A prospective tenant that is deemed creditworthy does not necessarily mean that we will consider the tenant’s property to be “investment grade.” Our Adviser seeks tenants that range from small businesses, many of which do not have publicly rated debt, to large public companies. Our Adviser’s investment professionals have substantial experience in locating and financing these types of companies. By leasing properties to these tenants, we believe that we will generally be able to charge rent that is higher than the rent charged to tenants with unleveraged balance sheets and recognized credit, thereby enhancing current return from these properties as compared with properties leased to companies whose credit potential has already been recognized by the market. Furthermore, if a tenant’s credit does improve, the value of our lease or investment will likely increase (if all other factors affecting value remain unchanged). In

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    evaluating a possible investment, we believe that the creditworthiness of a prospective tenant is normally a more significant factor than the unleased value of the property itself. While our Adviser selects tenants it believes to be creditworthy, tenants are not required to meet any minimum rating established by an independent credit rating agency. Our Adviser’s standards for determining whether a particular tenant is creditworthy vary in accordance with a variety of factors relating to specific prospective tenants. The creditworthiness of a tenant is determined on a tenant by tenant and case by case basis. Therefore, general standards for creditworthiness cannot be applied.
  Leases with Increasing Rent. Our Adviser seeks to include a clause in each lease that provides for annual rent escalations over the term of the lease. These increases will generally be fixed, however certain leases are tied to increases in indices such as the consumer price index.
 
  Diversification. Our Adviser attempts to diversify our portfolio to avoid dependence on any one particular tenant, facility type, 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. Total rental income consisted of the following tenant industry classifications as of December 31, 2009 and December 31, 2008:
                                 
    December 31, 2009     December 31, 2008  
            Percentage of             Percentage of  
Industry Classification   Rental Income     Rental Income     Rental Income     Rental Income  
Automobile
  $ 1,166,654       2.8 %   $ 1,166,654       2.9 %
Beverage, Food & Tobacco
    2,188,755       5.3 %     2,079,113       5.3 %
Buildings and Real Estate
    2,025,668       4.9 %     2,013,515       5.1 %
Chemicals, Plastics & Rubber
    3,173,514       7.6 %     2,452,628       6.2 %
Containers, Packaging & Glass
    2,330,246       5.6 %     2,288,909       5.8 %
Diversified/Conglomerate Manufacturing
    3,664,686       8.8 %     3,165,747       8.0 %
Diversified/Conglomerate Services
    308,105       0.7 %     308,105       0.8 %
Electronics
    6,164,789       14.9 %     6,165,789       15.7 %
Healthcare, Education & Childcare
    6,145,415       14.8 %     5,719,016       14.5 %
Home & Office Furnishings
    529,743       1.3 %     529,743       1.3 %
Insurance
    722,866       1.7 %     722,866       1.8 %
Machinery
    2,389,607       5.8 %     2,241,752       5.7 %
Oil & Gas
    1,138,136       2.7 %     1,152,443       2.9 %
Personal & Non-Durable Consumer Products
    1,354,721       3.3 %     1,355,061       3.4 %
Personal, Food & Miscellaneous Services
    575,006       1.4 %     575,006       1.5 %
Printing & Publishing
    2,189,033       5.3 %     2,189,602       5.5 %
Telecommunications
    5,447,033       13.1 %     5,446,338       13.6 %
 
                       
 
  $ 41,513,977       100.0 %   $ 39,572,287       100.0 %
 
                       
  Property Valuation. The business prospects and the financial strength of the tenant are important aspects of the evaluation of any sale and leaseback of property, or acquisition of property subject to a net lease, particularly a property that is specifically suited to the needs of the tenant. We generally require quarterly unaudited and annual audited financial statements of the tenant in order to continuously monitor the financial performance of the property. We evaluate the financial capability of the tenant and its ability to perform per the terms of the lease. We may also examine the available operating results of prospective investment properties to determine whether or not projected rental levels are likely to be met. We then compute the value of the property based on historical and projected operating results. In addition, each property that we propose to purchase will be appraised by an independent appraiser. These appraisals may take into consideration, among other things, the terms and conditions of the particular lease transaction, the quality of the tenant’s credit and the conditions of the credit markets at the time the lease transaction is negotiated. The appraised value may be greater than the construction cost or the replacement cost of a property, and the actual sale price of a property, if we resell the property in the future, may be greater or less than its appraised value. We generally limit our property acquisition cost or value to between $3 million and $30 million
 
  Properties Important to Tenant Operations. Our Adviser generally seeks to acquire investment properties that are essential or important to the ongoing operations of the prospective tenant. We believe that these investment properties provide better protection in the event a tenant becomes bankrupt, since leases on properties essential or important to the operations of a bankrupt tenant are typically less likely to be rejected in the bankruptcy or otherwise terminated.

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  Lease Provisions that Enhance and Protect Value. When appropriate, our Adviser attempts to include provisions in our leases that require our consent to specified tenant activity or require the tenant to satisfy specific operating tests. These provisions may include, for example, operational or financial covenants of the tenant, as well as indemnification of us by the tenant against environmental and other contingent liabilities. We believe that these provisions serve to protect our investments from changes in the operating and financial characteristics of a tenant that may impact its ability to satisfy its obligations to us or that could reduce the value of our properties. We generally also seek covenants requiring tenants to receive our consent prior to any change in control of the tenant.
 
  Credit Enhancement. Our Adviser may also seek to enhance the likelihood of a tenant’s lease obligations being satisfied through a cross-default with other tenant obligations, a letter of credit or a guaranty of lease obligations from each tenant’s corporate parent. We believe that this type of credit enhancement, if obtained, provides us with additional financial security.
Underwriting of the Real Estate and Due Diligence Process
In addition to underwriting the tenant or borrower, we also underwrite the real estate to be acquired or secured by one of our mortgages. On our behalf, our Adviser performs a due diligence review with respect to each property, such as evaluating the physical condition of a property, zoning and site requirements to ensure the property is in conformance with all zoning regulations as well as an environmental site assessment, in an attempt to determine potential environmental liabilities associated with a property prior to its acquisition, although there can be no assurance that hazardous substances or wastes (as defined by present or future federal or state laws or regulations) will not be discovered on the property after we acquire it. See “Risk FactorsPotential liability for environmental matters could adversely affect our financial condition.”
Our Adviser also reviews the structural soundness of the improvements on the property and may engage a structural engineer to review all aspects of the structures in order to determine the longevity of each building on the property. This review normally also includes the components of each building, such as the roof, the electrical wiring, the heating and air-conditioning system, the plumbing, parking lot and various other aspects such as compliance with state and federal building codes.
Our Adviser also physically inspects the real estate and surrounding real estate as part of determining the value of the real estate. All of our Adviser’s due diligence is aimed at arriving at a valuation of the real estate under the assumption that it was not rented to the tenant we are considering. As part of this process, our Adviser may consider one or more of the following items:
    The comparable value of similar real estate in the same general area of the prospective property. In this regard, comparable property is hard to define since each piece of real estate has its own distinct characteristics. But to the extent possible, comparable property in the area that has sold or is for sale will be used to determine if the price being paid for the property is reasonable. The question of comparable properties’ sale prices is particularly relevant if a property might be sold by us at a later date.
 
    The comparable real estate rental rates for similar properties in the same area of the prospective property.
 
    Alternative property uses that may offer higher value.
 
    The cost of replacing the property if it were to be sold.
 
    The assessed value as determined by the local real estate taxing authority.

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In addition, our Adviser supplements its valuation with a real estate appraisal in connection with each investment that we consider. When appropriate, our Adviser may engage experts to undertake some or all of the due diligence efforts described above.
Additional Investment Considerations
Terms of Mortgage Loans
Some of the mortgage loans that we may make, purchase or otherwise acquire in the future, in addition to providing for base interest at a fixed or variable rate, may allow us to participate in the economic benefits of any increase in the value of the property securing repayment of the loan as though we were an equity owner of a portion of the property. In addition, it is possible that participation may take other forms where our Adviser deems participation available or otherwise appropriate, provided that such participation does not jeopardize our REIT tax status. The form and extent of our participation, if any, will vary with each transaction depending on factors such as credit support provided by the borrower, the interest rate on our mortgage loans and the anticipated and actual cash flow from the underlying real property. Our mortgage loans may include first mortgage loans, leasehold mortgage loans or conventional mortgage loans without equity enhancements. We have not in the past, nor do we intend in the future to make or invest in sub-prime mortgage loans.
Except as described below, any mortgage loan in our portfolio will generally be secured by real property with a demonstrable income-producing potential as well as a security interest in personal or mixed property connected with the real property.
In the event that we make or invest in a mortgage loan, we will generally require a mortgagee’s title insurance policy or commitment as to the lien priority of a mortgage or the condition of title in connection with each mortgage loan. We also may obtain an independent appraisal for underlying real property, that our Adviser may consider when determining whether or not to make or invest in a particular mortgage loan. In making mortgage loans that, when combined with existing loans that are on a parity with or senior to our mortgage loan, exceed 85% of the appraised value of any underlying real property, our Adviser considers additional underwriting criteria such as the net worth of the borrower, the borrower’s credit rating, if any, the anticipated cash flow of the borrower, any additional collateral or other credit enhancements provided by the borrower or its affiliates and other factors our Adviser deems appropriate. Where we think it is appropriate we may make mortgage loans that are subordinated to a first mortgage on a property. For example, if the property is subject to an economic development loan as a first mortgage at a particularly low interest rate, we may make a second mortgage loan on the property. However, we will not make a second mortgage loan on any property that we would not consider owning, subject to the existing senior financing, and leasing to the tenant.
From time to time, we may purchase mortgage loans, including loans being sold at a discount, from banks and other financial institutions if the subject property otherwise satisfies our underwriting criteria.
Other Investments
We may invest up to an aggregate of 10% of our net equity in unimproved or non-income-producing real property and in “equity interests.” “Equity interests” are defined generally to mean stock, warrants or other rights to purchase the stock of, or other equity interests in, a tenant of a property, an entity to which we lend money or a parent or controlling person of a borrower or tenant, and we will not acquire equity interests in any entity other than in connection with a lease or mortgage loan transaction. We anticipate that equity interests will not exceed 5% of our net equity in the aggregate, and we will not make any such investment in equity interests if such investment would adversely affect our qualification as a REIT for tax purposes. To the extent that we hold equity interests in tenants or borrowers, we anticipate that they will generally be “restricted securities” as defined in Rule 144 under the Securities Act. Under this rule, we may be prohibited from reselling the equity securities without limitation until we have fully paid for and held any

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such securities for one year. The issuer of equity interests in which we invest may never register these interests under the federal securities laws, since any decision of an issuer to register its securities may depend on any number of factors, including the success of its operations.
We will generally invest in unimproved or non-income-producing property only when our Adviser believes that such property will appreciate in value or will increase the value of an adjoining or neighboring property that we own.
We might use taxable REIT subsidiaries to acquire or hold property, including equity interests, that may not be deemed to be REIT-qualified assets. Taxable REIT subsidiaries are taxed as ordinary corporations and any taxes paid by such entity will reduce cash available to us for payment of distributions to our stockholders.
Temporary Investments
Our working capital and other reserves are invested in permitted temporary investments. Our Adviser evaluates the relative risks and rates of return, our cash needs and other appropriate considerations when making short-term investments on our behalf. The rates of return of permitted temporary investments may be less than or greater than what would be obtainable from real estate investments.
If at any time the character of our investments would cause us to be deemed to be an “investment company” for purposes of the Investment Company Act of 1940, which we refer to as the 1940 Act, we will take the necessary action to ensure that we are not deemed to be an “investment company.” Our Adviser will continually review our investment activity and the composition of our portfolio to ensure that we do not come within the application of the 1940 Act. If we were to be deemed an investment company under the 1940 Act, it would result in penalties and substantial additional operating costs.
Qualified REIT Subsidiaries
While we intend to conduct substantially all of our activities through our Operating Partnership and Gladstone Lending, we may also form one or more wholly-owned qualified REIT subsidiaries, or QRSs, to purchase properties. These QRSs would be formed for the sole purpose of acquiring a specific property or properties located in one or more states and would have organizational documents that are substantially similar in all relevant ways to our organizational documents and comply with all applicable state securities laws and regulations.
Joint Ventures
In the future, we may also enter into joint ventures, partnerships and other mutual arrangements with real estate developers, property owners and others for the purpose of obtaining an equity interest in a property in accordance with our investment policies. Joint venture investments could permit us to own interests in large properties without unduly restricting the diversity of our portfolio. We will not enter into a joint venture to make an investment that we would not otherwise be permitted to make on our own. We expect that in any joint venture the cost of structuring joint investments would be shared ratably by us and the other participating investors.
Use of Leverage
Non-recourse Financing
Our strategy is to use long-term mortgage borrowings as a financing mechanism in amounts that we believe will maximize the return to our stockholders. As discussed above in Our Investment Objectives and Our Strategy, long-term mortgages are currently unavailable to us, and we will focus on medium-term

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mortgages until the market returns. Currently, all of our long-term mortgage borrowings are structured as non-recourse to us, and we intend to structure any medium-term mortgages in the same manner, with limited exceptions that would trigger recourse to us only upon the occurrence of certain fraud, misconduct, environmental or bankruptcy events. The use of non-recourse financing allows us to limit our exposure to the amount of equity invested in the properties pledged as collateral for our borrowings. Non-recourse financing generally restricts a lender’s claim on the assets of the borrower and, as a result, the lender generally may look only to the property securing the debt for satisfaction of the debt. We believe that this financing strategy, to the extent available, protects our other assets. However, we can provide no assurance that non-recourse financing will be available on terms acceptable to us, or at all, and there may be circumstances where lenders have recourse to our other assets. There is no limitation on the amount we may borrow against any single investment property.
We believe that, by operating on a leveraged basis, we will have more funds available and, therefore, will make more investments than would otherwise be possible if we operated on a non-leveraged basis. We believe that this creates a more diversified portfolio and maximizes potential returns to our stockholders. We may refinance properties during the term of a loan when we believe it is advantageous.
Recourse Financing
Borrowings under our $50.0 million short-term line of credit, which is secured by those properties pledged to the borrowing base under the line of credit are considered recourse financing, which means that our lenders have a claim against our assets. We intend to use our existing line of credit as a warehouse line of credit whereby we borrow on a short-term basis until long-term financing can be arranged, however until we obtain replacement financing for our existing line of credit, which matures in December 2010, we will use the line primarily for working capital.
Other Investment Policies
Working Capital Reserves
We may establish a working capital reserve, which we would anticipate to be sufficient to satisfy our liquidity requirements. Our liquidity could be adversely affected by unanticipated costs, greater-than-anticipated operating expenses or cash shortfalls in funding our distributions to stockholders. To the extent that the working capital reserve is insufficient to satisfy our cash requirements, additional funds may be produced from cash generated from operations or through short-term borrowings. In addition, subject to limitations described in this report, we may incur indebtedness in connection with:
    the acquisition of any property;
 
    the refinancing of the debt upon any property; or
 
    the leveraging of any previously unleveraged property.
For additional information regarding our borrowing strategy, see “Investment Policies and Policies with Respect to Certain Activities—Use of Leverage.”
Holding Period for and Sale of Investments; Reinvestment of Sale Proceeds
We intend to hold each property we acquire for an extended period. However, circumstances might arise which could result in the early sale of some properties if, in the judgment of our Adviser, the sale of the property is in the best interest of us and our stockholders.

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The determination of whether a particular property should be sold or otherwise disposed of will be made after consideration of all relevant factors, including prevailing economic conditions, with a view to achieving maximum capital appreciation. The selling price of a property which is subject to a net lease will be determined in large part by the amount of rent payable under the lease, the remaining term of the lease, and the creditworthiness of the tenant. In connection with our sales of properties, we may lend the purchaser all or a portion of the purchase price. In these instances, our taxable income may exceed the cash received by us in connection with any such sale, which could cause us to delay required distributions to our stockholders.
The terms of any sale will be dictated by custom in the area in which the property being sold is located and the then-prevailing economic conditions. A decision to provide financing to any purchaser would be made only after an investigation into and consideration of the same factors regarding the purchaser, such as creditworthiness and likelihood of future financial stability, as are undertaken when we consider a net lease or mortgage loan transaction.
We may continually reinvest the proceeds of property sales in investments that either we or our Adviser believe will satisfy our investment policies.
Investment Limitations
There are numerous limitations on the manner in which we may invest our funds, which unless otherwise noted below, may be amended or waived by the Board of Directors at anytime. The Board of Directors has adopted a policy that we will not:
    invest in real property owned by our Adviser, any of its affiliates or any business in which our Adviser or any of its subsidiaries have invested except that we may lease property to existing and prospective portfolio companies of current or future affiliates, such as Gladstone Capital Corporation, Gladstone Investment Corporation and entities advised by our Adviser, so long as that entity does not control the portfolio company and the transaction is approved by both companies’ board of directors (this policy may not be changed without the approval of our stockholders);
 
    invest in commodities or commodity futures contracts, with this limitation not being applicable to futures contracts when used solely for the purpose of hedging in connection with our ordinary business of investing in properties and making mortgage loans;
 
    invest in contracts for the sale of real estate unless the contract is appropriately recorded in the chain of title;
 
    invest in any individual property with a cost in excess of 20% of our total assets at the time of investment;
 
    make investments in unimproved property or indebtedness secured by a deed of trust or mortgage loans on unimproved property in excess of 10% of our total assets. “Unimproved real property” is property which has the following three characteristics:
    the property was not acquired for the purpose of producing rental or other operating income;
 
    no development or construction is in process on the property; and
 
    no development or construction on the property is planned in good faith to commence on the property within one year of acquisition;
    issue equity securities on a deferred payment basis or other similar arrangement;
 
    issue debt securities in the absence of adequate cash flow to cover debt service;

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    issue “redeemable securities” as defined in Section 2(a)(32) of the 1940 Act;
 
    grant warrants or options to purchase shares of our stock to our Adviser or its affiliates;
 
    engage in trading, as compared with investment activities, or engage in the business of underwriting, or the agency distribution of, securities issued by other persons;
 
    acquire securities in any company holding investments or engaging in activities prohibited in the foregoing clauses; or
 
    make or invest in mortgage loans that are subordinate to any mortgage or equity interest of any of our affiliates.
Conflict of Interest Policy
We have adopted policies to reduce potential conflicts of interest. In addition, our directors are subject to certain provisions of Maryland law that are designed to minimize conflicts. However, we cannot assure you that these policies or provisions of law will reduce or eliminate the influence of these conflicts.
Under our current conflict of interest policy, without the approval of a majority of our disinterested directors, we will not:
    acquire from or sell to any of our officers, directors or employees, or any entity in which any of our officers, directors or employees has an interest of more than 5%, any assets or other property;
 
    borrow from any of our directors, officers or employees, or any entity, other than Gladstone Land Corporation or Gladstone Management Corporation, our Adviser, in which any of our officers, directors or employees has an interest of more than 5%. or
 
    engage in any other transaction with any of our directors, officers or employees, or any entity in which any of our directors, officers or employees has an interest of more than 5% (except that our Adviser may lease office space in a building that we own, provided that the rental rate under the lease is determined by our independent directors to be at a fair market rate).
Our policy also prohibits us from purchasing any real property owned by or co-investing with our Adviser, any of its affiliates or any business in which our Adviser or any of its subsidiaries have invested, except that we may lease property to existing and prospective portfolio companies of current or future affiliates, such as Gladstone Capital Corporation or Gladstone Investment Corporation and other entities advised by our Adviser, so long as that entity does not control the portfolio company and the transaction is approved by both companies’ board of directors. If we decide to change this policy on co-investments with our Adviser or its affiliates, we will seek our stockholders’ approval.
Future Revisions in Policies and Strategies
Our independent directors periodically review our investment policies to evaluate whether they are in the best interest of us and our stockholders. Our investment procedures, objectives and policies may vary as new investment techniques are developed or as regulatory requirements change, and except as otherwise provided in our bylaws or articles of incorporation, may be altered by a majority of our directors (including a majority of our independent directors) without the approval of our stockholders, to the extent that our board of directors determines that such modification is in the best interest of our stockholders. Among other factors, developments in the market which affect the policies and strategies described in this report or which change our assessment of the market may cause our board of directors to revise our investment policies and strategies.

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Our Adviser and Administrator
Our business is managed by our Adviser. The officers, directors and employees of our Adviser have significant experience in making investments in and lending to businesses of all sizes, including investing in real estate and making mortgage loans. We have entered into an advisory agreement with our Adviser under which our Adviser is responsible for managing our assets and liabilities, for operating our business on a day-to-day basis and for identifying, evaluating, negotiating and consummating investment transactions consistent with our investment policies as determined by our Board of Directors from time to time. Gladstone Administration LLC, or our Administrator, employs our chief financial officer, chief compliance officer, internal counsel, treasurer and their respective staffs.
David Gladstone, our chairman and chief executive officer, is also the chairman, chief executive officer and the controlling stockholder of our Adviser. Terry Lee Brubaker, our vice chairman, secretary and chief operating officer and a member of our board of directors, also serves in the same capacities for our Adviser. George Stelljes III, our president and chief investment officer and a member of our board of directors, also serves in the same capacities for our Adviser.
Our Adviser maintains an investment committee that approves each of our investments. This investment committee is comprised of Messrs. Gladstone, Brubaker and Stelljes. We believe that our Adviser’s investment committee review process gives us a unique competitive advantage over other REITs because of the substantial experience and perspective that the members possess in evaluating the blend of corporate credit, real estate and lease terms that combine to provide an acceptable risk for our investments.
Our Adviser’s board of directors has empowered its investment committee to authorize and approve our investments, subject to the terms of the advisory agreement. Before we acquire any property, the transaction is reviewed by our Adviser’s investment committee to ensure that, in its view, the proposed transaction satisfies our investment criteria and is within our investment policies. Approval by our Adviser’s investment committee is generally the final step in the property acquisition approval process, although the separate approval of our board of directors is required in certain circumstances described below. For further detail on this process, please see “Underwriting Criteria, Due Diligence Process and Negotiating Lease Provisions.”
Our Adviser is headquartered in McLean, Virginia, a suburb of Washington D.C., and also has offices in New York, New Jersey, Illinois, Texas and Georgia.
Investment Advisory and Administration Agreements
Many of the services performed by our Adviser and Administrator in managing our day-to-day activities are summarized below. This summary is provided to illustrate the material functions which our Adviser and Administrator perform for us pursuant to the terms of the advisory and administration agreements, respectively, but it is not intended to include all of the services which may be provided to us by third parties.
Investment Advisory Agreement
On January 1, 2007, we entered into an amended and restated investment 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. All of these charges are incurred directly by us rather than by our Adviser for our benefit. Accordingly, we did not make any reimbursements to our Adviser for these amounts.

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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). In the event that any of these expenses are incurred on our behalf by our Adviser, we are required to reimburse our Adviser on a dollar-for-dollar basis for all such amounts. During the years ended December 31, 2009, 2008 and 2007, none of these expenses were incurred by our Adviser or 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. We do not presently expect that our Adviser will incur any of these fees on our behalf.
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. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties as is common in other REITs. Furthermore, there are no fees charged when our Adviser secures long or short term credit or arranges mortgage loans on our properties.
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)
(GRAPHIC)
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.

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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, internal counsel, 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.
Adviser Duties and Authority under the Advisory Agreement
Under the terms of the advisory agreement, our Adviser is required to use its best efforts to present to us investment opportunities consistent with our investment policies and objectives as adopted by our board of directors. In performing its duties, our Adviser, either directly or indirectly by engaging an affiliate:
    finds, evaluates, and enters into contracts to purchase real estate and make mortgage loans on our behalf in compliance with our investment procedures, objectives and policies, subject to approval of our board of directors, where required;
 
    provides advice to us and acts on our behalf with respect to the negotiation, acquisition, financing, refinancing, holding, leasing and disposition of real estate investments;
 
    takes the actions and obtains the services necessary to effect the negotiation, acquisition, financing, refinancing, holding, leasing and disposition of real estate investments; and
 
    provides day-to-day management of our business activities and other administrative services for us as requested by our board of directors.
Our board of directors has authorized our Adviser to make investments in any property on our behalf without the prior approval of our board if the following conditions are satisfied:
    our Adviser has obtained an independent appraisal for the property indicating that the total cost of the property does not exceed its appraised value; and
 
    our Adviser has concluded that the property, in conjunction with our other investments and proposed investments, is reasonably expected to fulfill our investment objectives and policies as established by our board of directors then in effect.
The actual terms and conditions of transactions involving investments in properties and mortgage loans are determined in the sole discretion of our Adviser, subject at all times to compliance with the foregoing requirements. Some types of transactions, however, require the prior approval of our board of directors, including a majority of our independent directors, including the following:
    loans not secured or otherwise supported by real property;
 
    any acquisition or mortgage loan which at the time of investment would have a cost exceeding 20% of our total assets;
 
    transactions that involve conflicts of interest with our Adviser (other than reimbursement of expenses in accordance with the Advisory Agreement); and
 
    the lease of assets to our Adviser, its affiliates or any of our officers or directors.

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Our Adviser and Administrator also engage in other business ventures and, as a result, their resources are not dedicated exclusively to our business. For example, our Adviser and Administrator also serve as the external adviser to Gladstone Capital Corporation and Gladstone Investment Corporation, both publicly traded business development companies affiliated with us, and Gladstone Land Corporation, a private agricultural real estate company. However, under the Advisory Agreement, our Adviser is required to devote sufficient resources to the administration of our affairs to discharge its obligations under the agreement. The Advisory Agreement is not assignable or transferable by either us or our Adviser without the consent of the other party, except that our Adviser may assign the Advisory Agreement to an affiliate for whom our Adviser agrees to guarantee its obligations to us. Either we or our Adviser may assign or transfer the Advisory Agreement to a successor entity.
Employees
We do not currently have any employees and do not expect to have any employees in the foreseeable future. Currently, services necessary for our business are provided by individuals who are employees of our Adviser and our Administrator pursuant to the terms of the Advisory Agreement and the Administration Agreement, respectively. Each of our executive officers is an employee or officer, or both, of our Adviser or our Administrator. No employee of our Adviser or our Administrator will dedicate all of his or her time to us. However, we expect that 15-20 full time employees of our Adviser or our Administrator will spend substantial time on our matters during calendar year 2010. To the extent that we acquire more investments, we anticipate that the number of employees of our Adviser and our Administrator who devote time to our matters will increase.
As of December 31, 2009, our Adviser and our Administrator collectively had 51 full-time employees. A breakdown of these employees is summarized by functional area in the table below:
     
Number of    
Individuals   Functional Area
11
  Executive Management
 
   
32
  Investment Management, Portfolio Management and Due Diligence
 
   
8
  Administration, Accounting, Compliance, Human Resources, Legal and Treasury
Competition
We compete with a number of other real estate companies and traditional mortgage lenders, many of whom have greater marketing and financial resources than we do. Principal factors of competition in our primary business of investing in and owning leased industrial and commercial real property are the quality of properties, leasing terms, attractiveness and convenience of location. Additionally, our ability to compete depends upon, among other factors, trends of the national and local economies, investment alternatives, financial condition and operating results of current and prospective tenants and borrowers, availability and cost of capital, taxes and governmental regulations.
Available Information
Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments, if any, to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website at www.GladstoneCommercial.com and on the Security and Exchange Commission’s website at www.sec.gov. A request for any of these reports may also be submitted to us by writing: Investor Relations, Gladstone Commercial Corporation, 1521 Westbranch Drive, Suite 200, McLean, VA 22102, or by calling our toll-free investor relations line at 1-866-366-5745.

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Item 1A. Risk Factors
An investment in our securities involves a number of significant risks and other factors relating to our structure and investment objectives. As a result, we cannot assure you that we will achieve our investment objectives. You should consider carefully the following information before making an investment in our securities.
Risk related to the economy
The current state of the economy and the capital markets increases the possibility of adverse effects on our financial position, results of operations and common stock price. Continued adversity in the capital markets could impact our ability to raise capital and limit our ability to make new investments.
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 seeing signs of economic improvement and stabilization in the equity markets, the debt markets are still 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. The stress to the global credit markets has resulted in an extreme tightening of liquidity and while the United States government has implemented plans designed to ease the credit markets, the credit markets remain very constricted for commercial real estate. Continued weak economic and credit conditions could adversely impact the financial condition of one or more of our tenants or our borrower and, therefore, could make a tenant or borrower bankruptcy, and payment default on the related lease or loan, more likely. As of December 31, 2009, all of our tenants and borrower were paying as agreed, however, there is no guarantee this will continue. The recession generally, and the disruptions in the capital markets in particular, have decreased liquidity and increased our cost of equity capital which has impacted our ability to raise capital and in turn greatly reduced our ability to make new investments as we did not acquire any properties during 2009. The longer these conditions persist, the greater the probability that these factors will have an adverse effect on our liquidity, financial condition, results of operations, ability to pay distributions to stockholders and the price of our common stock.
Risks related to our financing
Our line of credit contains various covenants which, if not complied with, could accelerate our repayment obligations, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions to stockholders.
The agreement governing our line of credit requires us to comply with certain financial and operational covenants. These covenants require us to, among other things, maintain certain financial ratios, including fixed charge coverage, debt service coverage and a minimum net worth. We are also required to limit our distributions to stockholders to 95% of our FFO, and continued compliance with this covenant may require us to limit our distributions to stockholders. As of December 31, 2009, we were in compliance with these covenants. However, our continued compliance with these covenants depends on many factors, and could be impacted by current economic conditions, and thus there are no assurances that we will continue to comply with these covenants. In addition, our lender has the option to obtain updated appraisals for the properties pledged to the line of credit as borrowing base collateral if the lender believes there has been a material adverse change to the value of any of the pledged properties. If the aggregate value of the updated appraisals is lower than the current aggregate value of appraisals, it would lower the amount of our borrowing base and reduce the amount we could borrow under the line of credit with that borrowing base. If the line is fully drawn, and the value of the borrowing base is reduced because of a lower aggregate updated appraisal value, we would be required to repay a portion of the outstanding line. Failure to comply with these covenants would result in a default which, if we were unable to obtain a waiver from the lenders, could accelerate our repayment obligations under the line of credit and thereby have a material adverse impact on our liquidity, financial condition, results of operations and ability to pay distributions to stockholders.

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Our ability to obtain replacement financing on our line of credit on terms favorable to us, or at all, could adversely impact our liquidity and ability to fund new investments.
Our revolving line of credit matures in December 2010. Our ability to obtain replacement financing at the time of maturity could be constrained by current economic conditions affecting the credit markets generally. In the event that we are not able to obtain replacement financing for our credit facility on favorable terms, or at all, could have a material adverse effect on our liquidity, our ability to make distributions to our stockholders and our ability to fund new investments.
Our business strategy relies heavily on external financing, which may expose us to risks associated with leverage such as restrictions on additional borrowing and payment of distributions to stockholders, risks associated with balloon payments, and risk of loss of our equity upon foreclosure.
Our current business strategy involves the use of leverage so that we may make more investments than would otherwise be possible in order to maximize potential returns to stockholders. If the income generated by our properties and other assets fails to cover our debt service, we could be forced to reduce or eliminate distributions to our stockholders and may experience losses.
Our ability to achieve our investment objectives will be affected by our ability to borrow money in sufficient amounts and on favorable terms. We expect that we will borrow money that will be secured by our properties and that these financing arrangements will contain customary covenants such as those that limit our ability, without the prior consent of the lender, to further mortgage the applicable property or to discontinue insurance coverage. Accordingly, we may be unable to obtain the degree of leverage we believe to be optimal, which may cause us to have less cash for distribution to stockholders than we would have with an optimal amount of leverage. Our use of leverage could also make us more vulnerable to a downturn in our business or the economy, as it may become difficult to meet our debt service obligations if our cash flows are reduced due to tenant defaults. There is also a risk that a significant increase in the ratio of our indebtedness to the measures of asset value used by financial analysts may have an adverse effect on the market price of our common stock.
Some of our debt financing arrangements may require us to make lump-sum or “balloon” payments at maturity. Our ability to make a balloon payment at maturity is uncertain and may depend upon our ability to obtain additional financing or to sell the financed property. At the time the balloon payment is due, we may not be able to refinance the balloon payment on terms as favorable as the original loan or sell the property at a price sufficient to make the balloon payment, which could adversely affect the amount of distributions to our stockholders.
We intend to acquire additional properties by using our line of credit and by continuing to seek long-term financing, where we will borrow all or a portion of the purchase price of a potential acquisition and securing the loan with a mortgage on some or all of our existing real property. However, the market for long-term mortgages remains frozen in the current economic environment as the collateralized mortgage-backed securities, or CMBS, market has virtually disappeared. We are now only seeing banks willing to issue medium-term mortgages, between two and five years, on substantially less favorable terms than were previously available. Consequently, we intend to focus on using medium-term mortgages to finance our real estate until the market for long-term mortgages returns. To date we have obtained approximately $253 million in long-term financing, which we have used to acquire additional properties. If we are unable to make our debt payments as required, a lender could foreclose on the property securing its loan. This could cause us to lose part or all of our investment in such property which in turn could cause the value of our securities or the amount of distributions to our stockholders to be reduced.
Interest rate changes may adversely affect our results of operations.
We may experience interest rate volatility in connection with mortgage loans on our properties or other variable-rate debt that we may obtain from time to time. We currently have one variable rate mortgage loan, certain of our leases contain escalations based on market interest rates, and the interest rate on our existing line of credit is variable. Although we seek to mitigate this risk by structuring such provisions to

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contain a minimum interest rate or escalation rate, as applicable, these features do not eliminate this risk. We are also exposed to the effects of interest rate changes as a result of the holding of our cash and cash equivalents in short-term, interest-bearing investments. We have not entered into any derivative contracts to attempt to further manage our exposure to interest rate fluctuations. A significant change in interest rates could have an adverse impact on our results of operations.
Risks related to the real estate industry
We are subject to certain risks associated with real estate ownership and lending which could reduce the value of our investments.
Our investments include net leased industrial and commercial property and mortgage loans secured by industrial and commercial real estate. Our performance, and the value of our investments, is subject to risks incident to the ownership and operation of these types of properties, including:
    changes in the general economic climate;
 
    changes in local conditions such as an oversupply of space or reduction in demand for real estate;
 
    changes in interest rates and the availability of financing;
 
    competition from other available space; and
 
    changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes.
The debt obligations of our tenants and borrowers are dependent upon certain factors which neither we nor our tenants or borrowers control, such as national, local and regional business and economic conditions, government economic policies, and the level of interest rates. As discussed in “Risk related to the economy” above, the credit markets have tightened resulting in a significant contraction in available liquidity. Accordingly, the credit market constraints and recession may increase the operating expenses of our tenants and borrowers and decrease their ability to make lease or mortgage payments, and thereby adversely affect our liquidity, financial condition, results of operations and ability to pay distributions to our stockholders.
Competition for the acquisition of real estate may impede our ability to make acquisitions or increase the cost of these acquisitions.
We compete for the acquisition of properties with many other entities engaged in real estate investment activities, including financial institutions, institutional pension funds, other REITs, other public and private real estate companies and private real estate investors. These competitors may prevent us from acquiring desirable properties or may cause an increase in the price we must pay for real estate. Our competitors may have greater resources than we do, and may be willing to pay more for certain assets or may have a more compatible operating philosophy with our acquisition targets. In particular, larger REITs may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors may also adopt transaction structures similar to ours, which would decrease our competitive advantage in offering flexible transaction terms. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase, resulting in increased demand and increased prices paid for these properties.
Our ownership of properties through ground leases exposes us to risks which are different than those resulting from our ownership of fee title to other properties.
We have acquired an interest in certain of our properties by acquiring a leasehold interest in the land underlying the property, and we may acquire additional properties in the future that are subject to similar ground leases. In this situation, we have no economic interest in the land underlying the property and do not control this land. Because we do not control the underlying land, this type of ownership interest poses potential risks for our business because (i) if the ground lease terminates for any reason, we will lose our interest in the property, including any investment that we made in the property, (ii) if our tenant defaults

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under the previously existing lease, we will continue to be obligated to meet the terms and conditions of the ground lease without the annual amount of ground lease payments reimbursable to us by the tenant, and (iii) if the third party owning the land under the ground lease disrupts our use either permanently or for a significant period of time, then the value of our assets could be impaired and our results of operations could be adversely affected.
Risks related to our tenants, borrowers and properties
Highly leveraged tenants and borrowers may be unable to pay rent or make mortgage payments, which could adversely affect our cash available to make distributions to our stockholders.
Some of our tenants and borrowers may have recently been either restructured using leverage, or acquired in a leveraged transaction. Tenants and borrowers that are subject to significant debt obligations may be unable to make their rent or mortgage payments if there are adverse changes to their businesses or because of the impact of the recession discussed in “Risk related to the economy.” Tenants that have experienced leveraged restructurings or acquisitions will generally have substantially greater debt and substantially lower net worth than they had prior to the leveraged transaction. In addition, the payment of rent and debt service may reduce the working capital available to leveraged entities and prevent them from devoting the resources necessary to remain competitive in their industries.
In situations where management of the tenant or borrower will change after a transaction, it may be difficult for our Adviser to determine with certainty the likelihood of the tenant’s or borrower’s business success and of its ability to pay rent or make mortgage payments throughout the lease or loan term. These companies generally are more vulnerable to adverse economic and business conditions, and increases in interest rates.
Leveraged tenants and borrowers are more susceptible to bankruptcy than unleveraged tenants. Bankruptcy of a tenant or borrower could cause:
    the loss of lease or mortgage payments to us;
 
    an increase in the costs we incur to carry the property occupied by such tenant;
 
    a reduction in the value of our securities; or
 
    a decrease in distributions to our stockholders.
Under bankruptcy law, a tenant who is the subject of bankruptcy proceedings has the option of continuing or terminating any unexpired lease. If a bankrupt tenant terminates a lease with us, any claim we might have for breach of the lease (excluding a claim against collateral securing the claim) will be treated as a general unsecured claim. Our claim would likely be capped at the amount the tenant owed us for unpaid rent prior to the bankruptcy unrelated to the termination, plus the greater of one year’s lease payments or 15% of the remaining lease payments payable under the lease (but no more than three years’ lease payments). In addition, due to the long-term nature of our leases and terms providing for the repurchase of a property by the tenant, a bankruptcy court could re-characterize a net lease transaction as a secured lending transaction. If that were to occur, we would not be treated as the owner of the property, but might have additional rights as a secured creditor.
Net leases may not result in fair market lease rates over time.
We expect a large portion of our rental income to come from net leases and net leases frequently provide the tenant greater discretion in using the leased property than ordinary property leases, such as the right to sublease the property, subject to our approval, to make alterations in the leased premises and to terminate the lease prior to its expiration under specified circumstances. Further, net leases are typically for longer lease terms and, thus, there is an increased risk that contractual rental increases in future years will fail to result in fair market rental rates during those years. As a result, our income and distributions to our stockholders could be lower than they would otherwise be if we did not engage in net leases.

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Many of our tenants are small and medium size businesses, which exposes us to additional risks unique to these entities.
Leasing real property or making mortgage loans to small and medium-sized businesses exposes us to a number of unique risks related to these entities, including the following:
    Small and medium-sized businesses may have limited financial resources and may not be able to make their lease or mortgage payments on a timely basis, or at all. A small or medium-sized tenant or borrower is more likely to have difficulty making its lease or mortgage payments when it experiences adverse events, such as the failure to meet its business plan, a downturn in its industry or negative economic conditions. In addition, because of the lack of available credit in the current marketplace, as discussed further in “Risk related to the economy” above, our tenants might not be able to obtain the financing necessary to fund their working capital, which could hinder their ability to make their lease or mortgage payment on a timely basis, or at all.
 
    Small and medium-sized businesses typically have narrower product lines and smaller market shares than large businesses. Because our target tenants and borrowers are smaller businesses, they will tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, our target tenants and borrowers may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing and other capabilities and a larger number of qualified managerial and technical personnel.
 
    There is generally little or no publicly available information about our target tenants and borrowers. Many of our tenants and borrowers are likely to be privately owned businesses, about which there is generally little or no publicly available operating and financial information. As a result, we will rely on our Adviser to perform due diligence investigations of these tenants and borrowers, their operations and their prospects. We may not learn all of the material information we need to know regarding these businesses through our investigations.
 
    Small and medium-sized businesses generally have less predictable operating results. We expect that many of our tenants and borrowers may experience significant fluctuations in their operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive positions, may otherwise have a weak financial position or may be adversely affected by changes in the business cycle. Our tenants and borrowers may not meet net income, cash flow and other coverage tests typically imposed by their senior lenders. The failure of a tenant or borrower to satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially, foreclosure on credit facilities, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the ability of the tenant or borrower to make required payments to us would be jeopardized.
 
    Small and medium-sized businesses are more likely to be dependent on one or two persons. Typically, the success of a small or medium-sized business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on our tenant or borrower and, in turn, on us.
 
    Small and medium-sized businesses may have limited operating histories. While we intend to target as tenants and borrowers stable companies with proven track records, we may lease properties or lend money to new companies that meet our other investment criteria. Tenants or borrowers with limited operating histories will be exposed to all of the operating risks that new businesses face and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers.

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We may not have funding for future tenant improvements.
When a tenant at one of our properties does not renew its lease or otherwise vacates its space in one of our buildings, it is likely that, in order to attract one or more new tenants, we will be required to expend substantial funds for tenant improvements and tenant refurbishments to the vacated space. We cannot assure you that we will have sufficient sources of funding available to us for such purposes in the future.
Our real estate investments may include special use and single or multi-tenant properties that may be difficult to sell or re-lease upon tenant defaults or early lease terminations.
We focus our investments on commercial and industrial properties, a number of which include manufacturing facilities, special use storage or warehouse facilities and special use single or multi-tenant properties. These types of properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity will limit our ability to quickly change our portfolio in response to changes in economic or other conditions. With these properties, if the current lease is terminated or not renewed or, in the case of a mortgage loan, if we take such property in foreclosure, we may be required to renovate the property or to make rent concessions in order to lease the property to another tenant or sell the property. In addition, in the event we are forced to sell the property, we may have difficulty selling it to a party other than the tenant or borrower due to the special purpose for which the property may have been designed.
These and other limitations may affect our ability to sell or re-lease properties without adversely affecting returns to our stockholders.
Our real estate investments have a limited number of tenants and are concentrated in a limited number of industries, which subjects us to an increased risk of significant loss if any one of these tenants is unable to pay or if particular industries experience downturns.
As of December 31, 2009, we owned 64 properties and had 50 tenants in these properties, and our 5 largest tenants accounted for approximately 24.0% of our total rental income. A consequence of a limited number of tenants is that the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of tenants. We do not have fixed guidelines for industry concentration and our investments could potentially be concentrated in relatively few industries. As of December 31, 2009, 14.9% of our total rental income was earned from tenants in the electronic industry, 14.8% of our total rental income was earned from tenants in the healthcare, education and childcare industry and 13.1% of our total rental income was earned from tenants in the telecommunications industry. As a result, a downturn in an industry in which we have invested a significant portion of our total assets could have a material adverse effect on us.
The inability of a tenant in a single tenant property to pay rent will reduce our revenues and increase our carrying costs of the building.
Since most of our properties are occupied by a single tenant, the success of our investments will be materially dependent on the financial stability of these tenants. If a tenant defaults, our rental revenues would be reduced and our expenses associated with carrying the property would increase, as we will be responsible for payments such as taxes and insurance. Lease payment defaults by these tenants could adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders. In the event of a default by a tenant, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing our property. If a lease is terminated, there is no assurance that we will be able to lease the property for the rent previously received or sell the property without incurring a loss.
Liability for uninsured losses could adversely affect our financial condition.
Losses from disaster-type occurrences (such as wars or earthquakes) may be either uninsurable or not insurable on economically viable terms. Should an uninsured loss occur, we could lose our capital investment or anticipated profits and cash flow from one or more properties.

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Potential liability for environmental matters could adversely affect our financial condition.
Our purchase of industrial and commercial properties subjects us to the risk of liabilities under federal, state and local environmental laws. Some of these laws could subject us to:
    responsibility and liability for the cost of removal or remediation of hazardous substances released on our properties, generally without regard to our knowledge of or responsibility for the presence of the contaminants;
 
    liability for the costs of removal or remediation of hazardous substances at disposal facilities for persons who arrange for the disposal or treatment of these substances; and
 
    potential liability for common law claims by third parties for damages resulting from environmental contaminants.
We generally include provisions in our leases making tenants responsible for all environmental liabilities and for compliance with environmental regulations, and requiring tenants to reimburse us for damages or costs for which we have been found liable. However, these provisions will not eliminate our statutory liability or preclude third party claims against us. Even if we were to have a legal claim against a tenant to enable us to recover any amounts we are required to pay, there are no assurances that we would be able to collect any money from the tenant. Our costs of investigation, remediation or removal of hazardous substances may be substantial. In addition, the presence of hazardous substances on one of our properties, or the failure to properly remediate a contaminated property, could adversely affect our ability to sell or lease the property or to borrow using the property as collateral.
We obtain environmental site assessments, or ESAs, on all of our properties at the time of acquisition. The ESAs are intended to identify potential environmental contamination. The ESAs include a historical review of the property, a review of certain public records, a preliminary investigation of the site and surrounding properties, screening for the presence of hazardous substances and underground storage tanks, and the preparation and issuance of a written report.
The ESAs that we have obtained have not revealed any environmental liability or compliance concerns that we believe would have a material adverse effect on our business, assets, results of operations or liquidity, nor are we aware of any such liability. Nevertheless, it is possible that these ESAs do not reveal all environmental liabilities or that there are material environmental liabilities or compliance concerns that we are not aware of. Moreover, we cannot assure you that (i) future laws, ordinances or regulations will not impose material environmental liability, or (ii) the current environmental condition of a property will not be affected by the condition of properties in the vicinity of the property (such as the presence of leaking underground storage tanks) or by third parties unrelated to us.
If a sale-leaseback transaction is re-characterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.
We may enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be re-characterized as either a financing or a joint venture, either of which outcomes could adversely affect our business. If the sale-leaseback were re-characterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms, and prevented from foreclosing our lien on the property. If the sale-leaseback were re-characterized as a joint venture, we could be treated as a co-venturer with our lessee with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property. Either of these outcomes could adversely affect our cash flow and our ability to pay distributions to stockholders.

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Risks related to our Adviser
We are dependent upon our key management personnel, who are employed by our Adviser, for our future success, particularly David Gladstone, Terry Lee Brubaker and George Stelljes III.
We are dependent on our senior management and other key management members to carry out our business and investment strategies. Our future success depends to a significant extent on the continued service and coordination of our senior management team, particularly David Gladstone, our chairman and chief executive officer, Terry Lee Brubaker, our vice chairman and chief operating officer, and George Stelljes III, our president and chief investment officer, all of whom are subject to an employment agreement with our Adviser. The departure of any of our executive officers or key employees could have a material adverse effect on our ability to implement our business strategy and to achieve our investment objectives.
Our success depends on the performance of our Adviser and if our Adviser makes inadvisable investment or management decisions, our operations could be materially adversely impacted.
Our ability to achieve our investment objectives and to pay distributions to our stockholders is dependent upon the performance of our Adviser in evaluating potential investments, selecting and negotiating property purchases and dispositions and mortgage loans, selecting tenants and borrowers, setting lease or mortgage loan terms and determining financing arrangements. Accomplishing these objectives on a cost-effective basis is largely a function of our Adviser’s marketing capabilities, management of the investment process, ability to provide competent, attentive and efficient services and our access to financing sources on acceptable terms. Our stockholders have no opportunity to evaluate the terms of transactions or other economic or financial data concerning our investments and must rely entirely on the analytical and management abilities of our Adviser and the oversight of our board of directors. If our Adviser or our board of directors makes inadvisable investment or management decisions, our operations could be materially adversely impacted. As we grow, our Adviser may be required to hire, train, supervise and manage new employees. Our Adviser’s failure to effectively manage our future growth could have a material adverse effect on our business, financial condition and results of operations.
We may have conflicts of interest with our Adviser and other affiliates.
Our Adviser manages our business and locates, evaluates, recommends and negotiates the acquisition of our real estate investments. At the same time, our advisory agreement permits our Adviser to conduct other commercial activities and provide management and advisory services to other entities, including Gladstone Capital Corporation, Gladstone Investment Corporation and Gladstone Land Corporation, an entity affiliated with our chairman David Gladstone. Moreover, with the exception of our chief financial officer, all of our officers and directors are also officers and directors of Gladstone Capital Corporation and Gladstone Investment Corporation, which actively make loans to and invest in small and medium-sized companies. As a result, we may from time to time have conflicts of interest with our Adviser in its management of our business and with Gladstone Capital and Gladstone Investment, which may arise primarily from the involvement of our Adviser, Gladstone Capital, Gladstone Investment, Gladstone Land and their affiliates in other activities that may conflict with our business.
Examples of these potential conflicts include:
    our Adviser may realize substantial compensation on account of its activities on our behalf, and may, therefore, be motivated to approve acquisitions solely on the basis of increasing compensation to itself;
 
    we may experience competition with our affiliates for financing transactions;
 
    our Adviser may earn fee income from our borrowers or tenants; and
 
    our Adviser and other affiliates such as Gladstone Capital, Gladstone Investment and Gladstone Land could compete for the time and services of our officers and directors.

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These and other conflicts of interest between us and our Adviser and other affiliates could have a material adverse effect on the operation of our business and the selection or management of our real estate investments.
Our Adviser is not obligated to provide a waiver of the incentive fee, which could negatively impact our earnings and our ability to maintain our current level of, or increase, distributions to our stockholders.
The Advisory Agreement contemplates a quarterly incentive fee based on our funds from operations. Our Adviser has the ability to issue a full or partial waiver of the incentive fee for current and future periods, however, our Adviser is not required to issue any waiver. Any waiver issued by our Adviser is an unconditional and irrevocable waiver. For the years ended December 31, 2009, 2008 and 2007, an unconditional and irrevocable voluntary waiver was issued by our Adviser for approximately $0.7 million, $2.2 million and $2.3 million, respectively. If our Adviser does not issue this waiver in future quarters, it could negatively impact our earnings and may compromise our ability to maintain our current level of, or increase, distributions to our stockholders, which could have a material adverse impact on our stock price.
We may be obligated to pay our Adviser incentive compensation even if we incur a loss.
The Advisory Agreement entitles our Adviser to incentive compensation based on our FFO, which rewards the Adviser if our quarterly FFO (before giving effect to any incentive fee) exceeds 1.75% (7% annualized) of our total stockholders’ equity (less the recorded value of any preferred stock). Our pre-incentive fee FFO for incentive compensation purposes excludes the effect of any unrealized gains, losses or other items that do not affect realized net income that we may incur in the fiscal quarter, even if such losses result in a net loss on our statement of operations for that quarter. Thus, we may be required to pay our Adviser incentive compensation for a fiscal quarter even if we incur a net loss for that quarter.
Risks of being a REIT
We may not qualify as a REIT for federal income tax purposes, which would subject us to federal income tax on our taxable income at regular corporate rates, thereby reducing the amount of funds available for paying distributions to our stockholders.
We have historically operated and intend to continue to operate in a manner that will allow us to qualify as a REIT for federal income tax purposes. Our qualification as a REIT depends on our ability to meet various requirements set forth in the Internal Revenue Code concerning, among other things, the ownership of our outstanding common stock, the nature of our assets, the sources of our income and the amount of our distributions to our stockholders. The REIT qualification requirements are extremely complex, and interpretations of the federal income tax laws governing qualification as a REIT are limited. Accordingly, we cannot be certain that we will be successful in operating so as to qualify as a REIT. At any time new laws, interpretations or court decisions may change the federal tax laws relating to, or the federal income tax consequences of, qualification as a REIT. It is also possible that future economic, market, legal, tax or other considerations may cause our board of directors to revoke our REIT election, which it may do without stockholder approval.
If we lose or revoke our REIT status, we will face serious tax consequences that will substantially reduce the funds available for distribution to you because:
    we would not be allowed a deduction for distributions to stockholders in computing our taxable income, we would be subject to federal income tax at regular corporate rates and we might need to borrow money or sell assets in order to pay any such tax;
 
    we could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and
 
    unless we are entitled to relief under statutory provisions, we would be prevented from re-qualifying to be taxed as a REIT for the four taxable years following the year during which we ceased to qualify.

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In addition, if we fail to qualify as a REIT, all distributions to stockholders would be subject to tax to the extent of our current and accumulated earnings and profits. If we were taxed as a regular corporation, corporate distributees might be eligible for the dividends received deduction, but we would not be required to make distributions to stockholders.
We have not sought a ruling from the Internal Revenue Service that we qualify as a REIT, nor do we intend to do so in the future.
An IRS determination that we do not qualify as a REIT would deprive our stockholders of the tax benefits of our REIT status only if the IRS determination is upheld in court or otherwise becomes final. To the extent that we challenge an IRS determination that we do not qualify as a REIT, we may incur legal expenses that would reduce our funds available for distribution to our stockholders. As a result of all these factors, our failure to qualify as a REIT could impair our ability to expand our business and raise capital, and would adversely affect the value of our common stock.
Failure to make required distributions or to satisfy certain income requirements would subject us to tax.
In order to qualify as a REIT, each year we must distribute to our stockholders at least 90% of our taxable income, other than any net capital gains. To the extent that we satisfy the distribution requirement but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any year are less than the sum of:
    85% of our ordinary income for that year;
 
    95% of our capital gain net income for that year; and
 
    100% of our undistributed taxable income from prior years.
In addition, each year at least 95% of our gross income must be derived from passive sources in real estate and securities, and at least 75% of our gross income must be derived from real estate sources. If we fail to satisfy either of these gross income tests, but nonetheless continue to qualify as a REIT because we meet certain other requirements, we will incur a tax of up to 100% on the greater of the excess of 95% of our gross income over the amount of our qualifying income, or the excess of 75% of our gross income over the amount of our qualifying income.
We intend to pay out our income to our stockholders in a manner intended to satisfy the distribution requirement applicable to REITs and the foregoing gross income tests and, thus, avoid corporate income taxes and the 4% excise tax. Differences in timing between the recognition of income and the related cash receipts or the effect of required debt amortization payments could require us to borrow money or sell assets to pay out enough of our taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. In the future, we may borrow funds to pay distributions to our stockholders and the limited partners of our Operating Partnership. Any funds that we borrow would subject us to interest rate and other market risks.
Because we must distribute a substantial portion of our net income to qualify as a REIT, we largely depend on third-party sources of capital to fund our future capital needs.
To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our taxable income each year, excluding capital gains. Because of this distribution requirement, it is not likely that we will be

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able to fund a significant portion of our future capital needs, including property acquisitions, from retained earnings. Therefore, we mostly rely on public and private debt and equity capital to fund our business. This capital may not be available on favorable terms or at all. Our access to additional capital is also dependent on the market’s perception of our growth potential and our current and potential future earnings. Moreover, additional debt financings may substantially increase our leverage. As discussed in “Risk related to the economy” above, the current recession has severely decreased liquidity and increased our cost of debt and equity capital, thus limiting our ability to raise additional capital and to fund new property acquisitions.
Other risks
Recent accounting pronouncements may impact our results of operations.
Beginning January 1, 2009, Accounting Standards Codification, or ASC, 805, “Business Combinations,” significantly changed the accounting for acquisitions involving business combinations, including our acquisition of properties with existing leases in place, as it requires that the assets and liabilities of all business combinations be recorded at fair value, with limited exceptions. ASC 805 requires that all expenses related to an acquisition be expensed as incurred, rather than capitalized into the cost of the acquisition as had been the previous accounting. ASC 805 was 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. We anticipate that approximately 1% of the total acquisition price will be expensed as part of the acquisition, however this amount could differ significantly. Because we did not acquire any properties during 2009, this pronouncement did not have a significant impact on our operations during 2009. We expect, however, that the expensing of acquisition costs will lower our earnings during 2010 and any future years in which we acquire new properties.
We are subject to restrictions that may discourage a change of control. Certain provisions contained in our articles of incorporation and Maryland law may prohibit or restrict a change of control.
    Our articles of incorporation prohibit ownership of more than 9.8% of the outstanding shares of our capital stock by one person. This restriction may discourage a change of control and may deter individuals or entities from making tender offers for our capital stock, which offers might otherwise be financially attractive to our stockholders or which might cause a change in our management.
 
    Our board of directors is divided into three classes, with the term of the directors in each class expiring every third year. At each annual meeting of stockholders, the successors to the class of directors whose term expires at such meeting will be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election. After election, a director may only be removed by our stockholders for cause. Election of directors for staggered terms with limited rights to remove directors makes it more difficult for a hostile bidder to acquire control of us. The existence of this provision may negatively impact the price of our securities and may discourage third-party bids to acquire our securities. This provision may reduce any premiums paid to stockholders in a change in control transaction.
 
    Certain provisions of Maryland law applicable to us prohibit business combinations with:
    any person who beneficially owns 10% or more of the voting power of our common stock, referred to as an “interested stockholder;”
 
    an affiliate of ours who, at any time within the two-year period prior to the date in question, was an interested stockholder; or
 
    an affiliate of an interested stockholder.

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These prohibitions last for five years after the most recent date on which the interested stockholder became an interested stockholder. Thereafter, any business combination with the interested stockholder must be recommended by our board of directors and approved by the affirmative vote of at least 80% of the votes entitled to be cast by holders of our outstanding shares of common stock and two-thirds of the votes entitled to be cast by holders of our common stock other than shares held by the interested stockholder. These requirements could have the effect of inhibiting a change in control even if a change in control were in our stockholders’ interest. These provisions of Maryland law do not apply, however, to business combinations that are approved or exempted by our board of directors prior to the time that someone becomes an interested stockholder.
Market conditions could adversely affect the market price and trading volume of our securities.
The market price of our common and preferred stock may be highly volatile and subject to wide fluctuations, and the trading volume in our common and preferred stock may fluctuate and cause significant price variations to occur. Due to market volatility, our common stock significantly fluctuated during 2009. We cannot assure investors that the market price of our common stock will not fluctuate or decline further in the future. Some market conditions that could negatively affect our share price or result in fluctuations in the price or trading volume of our securities include:
    price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies;
 
    significant volatility in the market price and trading volume of shares of REITs, real estate companies or other companies in our sector, which is not necessarily related to the performance of those companies;
 
    price and volume fluctuations in the stock market as a result of terrorist attacks, or speculation regarding future terrorist attacks, in the United States or abroad;
 
    actual or anticipated variations in our quarterly operating results or distributions to stockholders;
 
    changes in our funds from operations or earnings estimates or the publication of research reports about us or the real estate industry generally;
 
    actions by institutional stockholders;
 
    speculation in the press or investment community;
 
    changes in regulatory policies or tax guidelines, particularly with respect to REITs; and
 
    investor confidence in the stock market.
Shares of common stock eligible for future sale may have adverse effects on our share price.
We cannot predict the effect, if any, of future sales of common stock, or the availability of shares for future sales, on the market price of our common stock. Sales of substantial amounts of common stock (including shares of common stock issuable upon the conversion of units of our operating partnership that we may issue from time to time or issuable upon conversion of our senior common stock), or the perception that these sales could occur, may adversely affect prevailing market prices for our common stock.
Legislative or regulatory action could adversely affect investors.
In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of the federal and state income tax laws applicable to investments in REIT shares. Additional changes to tax laws are likely to continue to occur in the future, and we cannot assure you that any such changes will not adversely affect the taxation of our stockholders. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our properties.

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Our Board of Directors may change our investment policy without stockholders’ approval.
Subject to our co-investment policy, our Board of Directors will determine its investment and financing policies, growth strategy and its debt, capitalization, distribution, acquisition, disposition and operating policies. Our Board of Directors may revise or amend these strategies and policies at any time without a vote by stockholders. Accordingly, stockholders’ control over changes in our strategies and policies is limited to the election of directors, and changes made by our Board of Directors may not serve the interests of stockholders and could adversely affect our financial condition or results of operations, including our ability to distribute cash to stockholders or qualify as a REIT.
If our Operating Partnership fails to maintain its status as a partnership or other form of pass-through entity for federal income tax purposes, its income may be subject to taxation.
As we hold all of the ownership interests in our Operating Partnership, it is currently disregarded for income tax purposes. We intend that it will qualify as a partnership for income tax purposes upon the admission of additional partners; however, if the IRS were to successfully challenge the status of our Operating Partnership as a partnership, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that our Operating Partnership could make to us. This could also result in our losing REIT status and becoming subject to a corporate level tax on our own income. This would substantially reduce our cash available to pay distributions and the return on your investment. In addition, if any of the entities through which our Operating Partnership owns its properties, in whole or in part, loses its characterization as a partnership for federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to our Operating Partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain REIT status.
Our potential participation in joint ventures creates additional risk.
We may participate in joint ventures or purchase properties jointly with other unaffiliated entities. There are additional risks involved in these types of transactions. These risks include the potential of our joint venture partner becoming bankrupt or our economic or business interests diverging. These diverging interests could, among other things, expose us to liabilities of the joint venture in excess of our proportionate share of these liabilities. The partition rights of each owner in a jointly owned property could reduce the value of each portion of the divided property.
Item 1B. Unresolved Staff Comments
None.

30


 

Item 2. Properties
As of December 31, 2009, we owned 64 properties of which the details are outlined in the table below:
                                                         
                                            Total Rental    
                                    Total Rental Income for   Income per   Year of
    Year Built/           Rentable           the Year Ended   Occupied Square   Lease
Property   Improvements   Date of Purchase   Square Feet   Occupancy   December 31, 2009   Foot   Expiration
 
                                                       
208 South Rogers Lane
(Raleigh NC)
    1997       12/23/2003       58,926       100 %   $ 624,118     $ 10.59       2015  
3874 Highland Park NW
(Canton, OH)
    1994       1/30/2004       54,018       100 %   $ 337,625     $ 6.25       2014  
260 Springside Drive
(Akron, OH)
    1968/1999       4/29/2004       83,891       100 %   $ 1,063,216     $ 12.67       2015 (1)
5815 Westpark Drive
(Charlotte, NC)
    1984/1995       6/30/2004       64,500       100 %   $ 996,484     $ 15.45       2019  
171 Great Oak Drive
(Canton, NC)
    1998       7/6/2004       228,000       100 %   $ 600,145     $ 2.63       2024  
Rt. 219, Tax Parcel No. 33-251-0246,
(Snyder Township, PA)
    1991       8/5/2004       290,000       100 %   $ 930,522     $ 3.21       2014  
9698 Old US Hwy. 52
(Lexington, NC)
    1986       8/5/2004       154,000       100 %   $ 424,964     $ 2.76       2014  
9100 Highway 290 East
(Austin, TX)
    2001       9/16/2004       51,933       100 %   $ 751,333     $ 14.47       2015  
13 Industrial Park Drive
(Mt. Pocono, PA)
    1995-1999       10/15/2004       223,275       100 %   $ 638,554     $ 2.86       2021  
6550 First Park Ten Boulevard
(San Antonio, TX)
    1999       2/10/2005       60,245       100 %   $ 769,793     $ 12.78       2014  
4630 Journal Street
(Columbus, OH)
    1995       2/10/2005       39,000       100 %   $ 308,105     $ 7.90       2015  
199 Sing Sing Road
(Big Flats, NY)
    2001       4/15/2005       120,000       100 %   $ 644,252     $ 5.37       2013  
2525 North Woodlawn Avenue
(Wichita, KS)
    2000       5/18/2005       69,287       100 %   $ 1,109,217     $ 16.01       2012  
725 & 737 Great Southwest Pkwy
(Arlington, TX)
    1966       5/26/2005       64,000       100 %   $ 580,596     $ 9.07       2013  
4032 Linden Avenue
(Dayton, OH)
    1956       6/30/2005       59,894       100 %   $ 268,042     $ 4.48       2018  
81 Corbett Way
(Eatontown, NJ)
    1991       7/7/2005       30,268       100 %   $ 536,989     $ 17.74       2024  
17 & 20 Veronica Avenue
(Franklin Township, NJ)
    1978       7/11/2005       183,000       100 %   $ 974,760     $ 5.33       2020  
150 Ridgeview Center Drive
(Duncan, SC)
    1984/2001/2007       7/14/2005       222,670       100 %   $ 1,539,286     $ 6.91       2020  
170 Ridgeview Center Drive
(Duncan, SC)
    1984/2001/2007       7/14/2005       55,350       100 %   $ 382,627     $ 6.91       2020  
5656 Campus Parkway (Hazelwood, MO)
    1977       8/5/2005       51,155       100 %   $ 289,928     $ 5.67       2012  
914 Wohlert Street
(Angola, IN)
    1982       9/2/2005       52,080       100 %   $ 125,202     $ 2.40       2020  
800 Growth Parkway
(Angola, IN)
    1998       9/2/2005       50,000       100 %   $ 125,202     $ 2.50       2020  
802 East 11th Street
(Rock Falls, IL)
    1988       9/2/2005       52,000       100 %   $ 125,202     $ 2.41       2020  

31


 

Item 2. Properties (Continued)
                                                         
                                            Total Rental    
                                    Total Rental Income for   Income per   Year of
    Year Built/           Rentable           the Year Ended   Occupied Square   Lease
Property   Improvements   Date of Purchase   Square Feet   Occupancy   December 31, 2009   Foot   Expiration
 
                                                       
2 Opportunity Way
(Newburyport, MA)
    1994       10/17/2005       86,308       100 %   $ 891,492     $ 10.33       2015  
255 Spring Street
(Clintonville, WI)
    1992       10/31/2005       291,142       100 %   $ 575,006     $ 1.98       2020  
5700 Lee Road
(Maple Heights, OH)
    1974       12/21/2005       347,218       100 %   $ 1,138,136     $ 3.28       2015  
7545 Midlothian Turnpike
(Richmond, VA)
    1972       12/30/2005       42,213       100 %   $ 722,866     $ 17.12       2010  
3930 Sunforest Court
(Toledo, OH)
    1979       12/30/2005       23,368       100 %   $ 327,152     $ 14.00       2010  
75 Canal Street
(South Hadley, MA)
    1978       2/15/2006       150,000       100 %   $ 359,673     $ 2.40       2010  
2101 Fox Drive
(Champaign, IL)
    1996       2/21/2006       20,400       100 %   $ 295,220     $ 14.47       2013  
2109 Fox Drive
(Champaign, IL)
    1996       2/21/2006       40,000       100 %   $ 578,863     $ 14.47       2013  
2215 Fox Drive
(Champaign, IL)
    1996       2/21/2006       25,000       100 %   $ 361,790     $ 14.47       2013  
2301 Fox Drive
(Champaign, IL)
    1996       2/21/2006       22,862       100 %   $ 330,849     $ 14.47       2013  
2470 Highcrest Road
(Roseville, MN)
    1964       2/21/2006       359,540       100 %   $ 3,030,460     $ 8.43       2012  
12000 Portland Avenue South
(Burnsville, MN)
    1984       5/10/2006       114,100       100 %   $ 1,234,662     $ 10.82       2015  
14701 Anthony Avenue
(Menomonee Falls, WI)
    1986/2000       6/30/2006       125,692       100 %   $ 775,274     $ 6.17       2016  
1025 Birdsong Drive
(Baytown, TX)
    1997       7/11/2006       12,000       100 %   $ 254,121     $ 21.18       2013  
42400 Merrill Road
(Sterling Heights, MI)
    1979/1989       9/22/2006       532,869       100 %   $ 1,166,654     $ 2.19       2016  
2150, 2200 Pinson Valley Parkway
(Birmingham, AL)
    1961/1980       9/29/2006       63,514       100 %   $ 271,164     $ 4.27       2016  
2325 West Fairview Avenue
(Montgomery, AL)
    1962/1989       9/29/2006       29,472       100 %   $ 125,827     $ 4.27       2016  
5221 N Highway 763
(Columbia, MO)
    1978       9/29/2006       16,275       100 %   $ 69,484     $ 4.27       2016  
4690 Parkway Drive
(Mason, OH)
    2002       1/5/2007       60,000       100 %   $ 681,270     $ 11.35       2013  
201 South Rogers Lane
(Raleigh, NC)
    1994       2/16/2007       115,500       100 %   $ 717,203     $ 6.21       2015  
1110 West Tenkiller
(Tulsa, OK)
    2004       3/1/2007       238,310       100 %   $ 1,565,794     $ 6.57       2019  
3725 East 10th Court
(Hialeah, FL)
    1956/1992       3/9/2007       132,337       100 %   $ 995,048     $ 7.52       2022  
554 Clark Road
(Tewksbury, MA)
    1985/1989       5/17/2007       102,200       100 %   $ 922,926     $ 9.03       2017  
5324 Natorp Boulevard
(Mason, OH)
    2007       7/1/2007       21,264       100 %   $ 583,131     $ 27.42       2027  

32


 

Item 2. Properties (Continued)
                                                         
                                            Total Rental        
                                    Total Rental Income for     Income per     Year of  
    Year Built/             Rentable             the Year Ended     Occupied Square     Lease  
Property   Improvements     Date of Purchase     Square Feet     Occupancy     December 31, 2009     Foot     Expiration  
7282 Willam Barry Boulevard (Cicero, NY)
    2005       9/6/2007       71,880       100 %   $ 529,743     $ 7.37       2020  
1515 Arboretum Drive SE (Grand Rapids, MI)
    2001       9/28/2007       63,235       100 %   $ 1,029,184     $ 16.28       2016  
4 Territorial Court (Bollingbrook, IL)
    2002       9/28/2007       55,869       100 %   $ 619,296     $ 11.08       2014  
2349 Lawrenceville Highway (Decatur, GA)
    1989       12/13/2007       16,740       100 %   $ 404,159     $ 24.14       2026  
2341 Lawrenceville Highway (Decatur, GA)
    1989       12/13/2007       4,372       100 %   $ 105,555     $ 24.14       2026  
2339 Lawrenceville Highway (Decatur, GA)
    1989       12/13/2007       5,488       100 %   $ 132,498     $ 24.14       2026  
311 Phillip Boulevard (Lawrenceville, GA)
    2005       12/13/2007       12,412       100 %   $ 349,871     $ 28.19       2026  
2096 McGee Road (Snellville, GA)
    1986       12/13/2007       3,800       100 %   $ 90,815     $ 23.90       2026  
7174 Wheat Street (Covington, GA)
    2000       12/13/2007       5,000       100 %   $ 119,493     $ 23.90       2026  
1055 Haw Creek Parkway (Cumming, GA)
    2004       12/13/2007       13,919       100 %   $ 380,410     $ 27.33       2026  
1293 Wellbrook Circle (Conyers, GA)
    1994       12/13/2007       6,400       100 %   $ 152,951     $ 23.90       2026  
425 Gateway Drive (Reading, PA)
    2007       1/29/2008       42,900       100 %   $ 716,667     $ 16.71       2028  
6499 University Avenue NE (Fridley, MN)
    1985/2006       2/26/2008       74,160       100 %   $ 946,380     $ 12.76       2013  
7528 Auburn Road (Concord Township, OH)
    1957/2008       3/31/2008       273,300       100 %   $ 1,724,133     $ 6.31       2028  
10021 Rodney Street (Pineville, NC)
    1985       4/30/2008       74,950       100 %   $ 438,282     $ 5.85       2028  
28305 State Route 7 (Marietta, OH)
    1992/2007       8/29/2008       223,458       100 %   $ 896,743     $ 4.01       2028  
400 Highpoint Drive (Chalfont, PA)
    1987       8/29/2008       67,200       100 %   $ 757,570     $ 11.27       2016  
 
                                                   
Totals
                    6,304,159             $ 41,513,977                  
 
                                                   
 
(1)     Two tenants occupy this building, each with separate leases ending in the same year.

33


 

The following table summarizes the lease expirations by year for our properties for leases in place as of December 31, 2009:
                                 
Year of Lease                   Annualized Base     % of Annualized  
Expiration   Square Feet     Number of Leases     Rental Revenue     Base Rent  
2010
    215,581       3     $ 1,409,691       3.4 %
2011
          0             0.0 %
2012
    479,982       3       4,429,605       10.7 %
2013
    438,422       6       4,673,341       11.3 %
2014
    614,132       5       3,082,200       7.4 %
2015
    896,876       8       6,728,265       16.2 %
2016
    898,257       5       4,195,157       10.1 %
2017
    102,200       1       922,926       2.2 %
2018
    59,894       1       268,042       0.7 %
2019+
    2,598,815       18       15,804,750       38.0 %
 
                       
 
Total
    6,304,159       50     $ 41,513,977       100 %
 
                       
The following table summarizes the geographic locations of our properties for leases in place as of December 31, 2009:
                                 
            Number of     Annualized Base     % of Annualized  
State   Square Feet     Leases     Rental Revenue     Base Rent  
Ohio
    1,185,411       11     $ 7,327,553       17.7 %
Minnesota
    547,800       3       5,211,502       12.6 %
North Carolina
    695,876       6       3,801,196       9.2 %
Pennsylvania
    623,375       4       3,043,313       7.3 %
Texas
    188,178       4       2,355,843       5.7 %
Michigan
    596,104       2       2,195,838       5.3 %
Illinois
    164,131       2       2,186,018       5.3 %
Massachusetts
    338,508       3       2,174,091       5.2 %
All Other States
    1,964,776       15       13,218,623       31.7 %
 
                       
 
Total
    6,304,159       50     $ 41,513,977       100 %
 
                       
Item 3. Legal Proceedings
We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2009.

34


 

PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq Global Market under the symbol “GOOD.” The following table reflects the range of the high and low sale prices of our common stock on the Nasdaq Global Market and the distributions per share for the years ended December 31, 2009 and 2008. Distributions to stockholders are declared quarterly and paid monthly. Amounts presented represent the cumulative amount of the distributions declared for the months composing such quarter.
                         
    Market price per share   Distributions
Quarter Ended   High   Low   Declared Per Share
3/31/2008
  $ 18.50     $ 14.81     $ 0.375  
6/30/2008
  $ 18.50     $ 15.36     $ 0.375  
9/30/2008
  $ 17.38     $ 13.96     $ 0.375  
12/31/2008
  $ 15.89     $ 6.37     $ 0.375  
3/31/2009
  $ 10.20     $ 5.36     $ 0.375  
6/30/2009
  $ 16.21     $ 8.20     $ 0.375  
9/30/2009
  $ 14.50     $ 11.26     $ 0.375  
12/31/2009
  $ 14.19     $ 11.85     $ 0.375  
In order to qualify as a REIT, we are required to make ordinary dividend distributions to our stockholders. The amount of these distributions must equal at least:
    the sum of (A) 90% of our “REIT taxable income” (computed without regard to the dividends paid deduction and capital gain) and (B) 90% of the net income (after tax), if any, from foreclosure property, less
 
    the sum of certain non-cash items.
For federal income tax purposes, distributions may consist of ordinary income, capital gains, nontaxable return of capital or a combination of those items. Distributions that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend, which reduces a stockholder’s basis in the shares of common stock and will not be taxable to the extent that the distribution equals or is less than the stockholder’s basis in the stock. To the extent a distribution exceeds both current and accumulated earnings and profits and the stockholder’s basis in the stock, that distribution will be treated as a gain from the sale or exchange of that stockholder’s shares. Every year, we notify stockholders of the taxability of distributions paid to stockholders during the preceding year.
As of February 4, 2010, there were approximately 9,788 beneficial owners of our common stock.
There were no unregistered sales of securities during the fiscal year ended December 31, 2009.

35


 

Item 6. Selected Financial Data
The following selected financial data for the fiscal years ended December 31, 2009, 2008, 2007, 2006 and 2005 is derived from our audited consolidated financial statements. Certain amounts from prior years’ financial statements have been reclassified to discontinued operations and these reclassifications had no effect on previously reported net income or stockholders’ equity. The data should be read in conjunction with our consolidated financial statements and notes thereto, included elsewhere in this report, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this report.
                                         
    Year ended     Year ended     Year ended     Year ended     Year ended  
    December 31, 2009     December 31, 2008     December 31, 2007     December 31, 2006     December 31, 2005  
Operating Data:
                                       
Total operating revenue
  $ 42,608,937     $ 40,807,497     $ 32,690,038     $ 25,842,045     $ 12,778,005  
Total operating expenses
    (20,540,529 )     (19,363,723 )     (15,791,430 )     (14,035,669 )     (7,156,347 )
Other expense
    (17,668,460 )     (16,570,753 )     (10,940,394 )     (8,521,419 )     (2,185,509 )
 
                             
Income from continuing operations
    4,399,948       4,873,021       5,958,214       3,284,957       3,436,149  
Discontinued operations
    203,100       39,926       182,015       1,087,871       165,796  
 
                             
Net income
  $ 4,603,048     $ 4,912,947     $ 6,140,229     $ 4,372,828     $ 3,601,945  
Dividends attributable to preferred stock
    (4,093,750 )     (4,093,750 )     (4,093,750 )     (2,186,890 )      
 
                             
Net income available to common stockholders
  $ 509,298     $ 819,197     $ 2,046,479     $ 2,185,938     $ 3,601,945  
 
                             
 
Share and Per Share Data:
                                       
Earnings per weighted average common share — basic
                                       
Income from continuing operations (net of dividends attributable to preferred stock)
  $ 0.04     $ 0.09     $ 0.22     $ 0.14     $ 0.45  
Discontinued operations
    0.02       0.01       0.02       0.14       0.02  
 
                             
Net income available to common stockholders
  $ 0.06     $ 0.10     $ 0.24     $ 0.28     $ 0.47  
 
                             
 
                                       
Earnings per weighted average common share — diluted
                                       
Income from continuing operations (net of dividends attributable to preferred stock)
  $ 0.04     $ 0.09     $ 0.22     $ 0.14     $ 0.45  
Discontinued operations
    0.02       0.01       0.02       0.13       0.02  
 
                             
Net income available to common stockholders
  $ 0.06     $ 0.10     $ 0.24     $ 0.27     $ 0.47  
 
                             
 
                                       
Weighted average shares outstanding-basic
    8,563,264       8,565,149       8,565,264       7,827,781       7,670,219  
Weighted average shares outstanding-diluted
    8,563,264       8,565,149       8,565,264       7,986,690       7,723,220  
Cash dividends declared per common share
  $ 1.50     $ 1.50     $ 1.44     $ 1.44     $ 0.96  
 
                                       
Supplemental Data:
                                       
Net income available to common stockholders
  $ 509,298     $ 819,197     $ 2,046,479     $ 2,185,938     $ 3,601,945  
Real estate depreciation and amortization, including discontinued operations
    13,171,703       12,704,641       10,528,458       8,349,474       3,651,119  
Less: Gain on sale of real estate, net of taxes paid
    (160,038 )           (78,667 )     (1,106,590 )      
 
                             
Funds from operations available to common stockholders (1)
    13,520,963       13,523,838       12,496,270       9,428,822       7,253,064  
 
                             
Ratio of earnings to combined fixed charges and preferred dividends (2)
    1.0x       1.0x       1.1x       1.1x       2.4x  
 
Balance Sheet Data:
                                       
Real estate, before accumulated depreciation
  $ 390,753,892     $ 390,562,138     $ 340,500,406     $ 243,713,542     $ 165,043,639  
Total assets
  $ 416,865,373     $ 429,098,785     $ 378,902,689     $ 315,766,022     $ 207,046,954  
Mortgage notes payable, term loan and borrowings under the line of credit
  $ 285,961,651     $ 286,611,173     $ 226,520,471     $ 154,494,438     $ 105,118,961  
Total stockholders’ equity
  $ 118,450,542     $ 130,495,260     $ 142,368,068     $ 152,224,176     $ 98,948,536  
Total common shares outstanding
    8,563,264       8,565,149       8,565,264       8,565,264       7,672,000  
 
(1)   Funds from Operations (“FFO”) was developed by The National Association of Real Estate Investment Trusts (“NAREIT”), as a relative non-GAAP (“Generally Accepted Accounting Principles in the United States”) supplemental measure of operating performance of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO, as defined by NAREIT, is net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. FFO does not represent cash flows from operating activities in accordance with GAAP and should not be considered an alternative to either net income (loss) as an indication of our performance or to cash flow from operations as a measure of liquidity or ability to make distributions to stockholders. Comparison of FFO to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
FFO available to common stockholders is FFO adjusted to subtract preferred share distributions. We believe that net income available to common stockholders is the most directly comparable GAAP measure to FFO available to common stockholders.

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Basic funds from operations per share, or Basic FFO per share, and diluted funds from operations per share, or Diluted FFO per share, is FFO available to common stockholders divided by weighted average common shares outstanding and FFO available to common stockholders divided by weighted average common shares outstanding on a diluted basis, respectively, during a period. We believe that FFO available to common stockholders, Basic FFO per share and Diluted FFO per share are useful to investors because they provide investors with a further context for evaluating our FFO results in the same manner that investors use net income and earnings per share, or EPS, in evaluating net income available to common stockholders. In addition, since most REITs provide FFO available to common stockholders, Basic FFO and Diluted FFO per share information to the investment community, we believe these are useful supplemental measures for comparing us to other REITs. We believe that net income is the most directly comparable
GAAP measure to FFO, Basic EPS is the most directly comparable GAAP measure to Basic FFO per share, and that diluted EPS is the most directly comparable GAAP measure to Diluted FFO per share.
The following table provides a reconciliation of our FFO for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 to the most directly comparable GAAP measure, net income, and a computation of basic and diluted FFO per weighted average common share and basic and diluted net income per weighted average common share:
                                         
    Year Ended     Year Ended     Year Ended     Year Ended     Year Ended  
    December 31, 2009     December 31, 2008     December 31, 2007     December 31, 2006     December 31, 2005  
 
Net income
  $ 4,603,048     $ 4,912,947     $ 6,140,229     $ 4,372,828     $ 3,601,945  
Less: Distributions attributable to preferred stock
    (4,093,750 )     (4,093,750 )     (4,093,750 )     (2,186,890 )      
 
                             
Net income available to common stockholders
    509,298       819,197       2,046,479       2,185,938       3,601,945  
 
                                       
Add: Real estate depreciation and amortization, including discontinued operations
    13,171,703       12,704,641       10,528,458       8,349,474       3,651,119  
Less: Gain on sale of real estate
    (160,038 )           (78,667 )     (1,106,590 )      
 
                             
FFO available to common stockholders
  $ 13,520,963     $ 13,523,838     $ 12,496,270     $ 9,428,822     $ 7,253,064  
 
                                       
Weighted average shares outstanding — basic
    8,563,264       8,565,149       8,565,264       7,827,781       7,670,219  
Weighted average shares outstanding — diluted
    8,563,264       8,565,149       8,565,264       7,986,690       7,723,220  
 
                                       
Basic net income per weighted average common share
  $ 0.06     $ 0.10     $ 0.24     $ 0.28     $ 0.47  
 
                             
Diluted net income per weighted average common share
  $ 0.06     $ 0.10     $ 0.24     $ 0.27     $ 0.47  
 
                             
Basic FFO per weighted average common share
  $ 1.58     $ 1.58     $ 1.46     $ 1.20     $ 0.95  
 
                             
Diluted FFO per weighted average common share
  $ 1.58     $ 1.58     $ 1.46     $ 1.18     $ 0.94  
 
                             
Distributions declared per common share
  $ 1.50     $ 1.50     $ 1.44     $ 1.44     $ 0.96  
 
                             
 
                                       
Percentage of FFO paid per common share
    95 %     95 %     99 %     120 %     102 %
 
                             
 
(2)   The calculation of the ratio of earnings to combined fixed charges and preferred distributions is below. “Earnings” consist of net income from continuing operations before fixed charges. “Fixed charges” consist of interest expense, amortization of deferred financing fees and the portion of operating lease expense that represents interest. The portion of operating lease expense that represents interest is calculated by dividing the amount of rent expense, allocated to us by our Adviser as part of the administration fee payable under the Advisory Agreement, by three.
                                         
    For the year ended     For the year ended     For the year ended     For the year ended     For the year ended  
    December 31, 2009     December 31, 2008     December 31, 2007     December 31, 2006     December 31, 2005  
 
                                       
Net income from continuing operations
  $ 4,399,948     $ 4,873,021     $ 5,958,214     $ 3,284,957     $ 3,436,149  
 
                                       
Add: fixed charges
    22,000,728       20,963,484       15,670,067       11,490,476       2,494,245  
 
                                       
Less: preferred distributions
    (4,093,750 )     (4,093,750 )     (4,093,750 )     (2,186,890 )      
 
                             
 
                                       
Earnings
  $ 22,306,926     $ 21,742,755     $ 17,534,531     $ 12,588,543     $ 5,930,394  
 
                                       
Fixed Charges:
                                       
Interest expense
    16,398,938       15,574,735       10,847,346       8,041,412       2,187,586  
Amortization of deferred financing fees
    1,495,598       1,283,952       717,195       1,207,198       260,098  
Estimated interest component of rent
    12,442       11,047       11,776       54,976       46,561  
Preferred distributions
    4,093,750       4,093,750       4,093,750       2,186,890        
 
                             
 
                                       
Total fixed charges and preferred distributions
    22,000,728       20,963,484       15,670,067       11,490,476       2,494,245  
 
                                       
Ratio of earnings to combined fixed charges and preferred distributions
    1.0       1.0       1.1       1.1       2.4  

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the notes thereto contained elsewhere in this Form 10-K.
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 December 31, 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 $443.9 million at December 31, 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 improvement and stabilization in the equity markets, the debt markets are still difficult at best, 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, 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 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, however, we have three leases that expire in 2010, which comprise approximately 3.4% of our total annualized rental income. Two of these tenants have notified us that they will not renew their leases, and we are currently seeking new tenants for these properties In addition, we have $48.0 million of balloon principal payments due under one of our long-term mortgages in 2010, however the mortgage has three annual extension options through 2013, 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 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 remains 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 only seeing banks willing to issue medium-term mortgages, between two and five years, on substantially less favorable terms than were previously available. Consequently, 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

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collateral under our line of credit. Our line of credit matures in December 2010, and we are currently in the process of searching for replacement financing for the line of credit.
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 and sell shares of our common stock with an aggregate sales price of up to $25.0 million through or to Jefferies, for resale. 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 a proposed 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 not sold any senior common stock under the Dealer Manager Agreement.
If we are able to raise equity capital in the near term, we will continue to invest in industrial and commercial real property as well as expand our investment portfolio to other categories, 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 debt or 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 will be limited to the extent 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 weather the current economic conditions, and that are likely to produce attractive long-term returns for our stockholders.
Recent Events
Financing Activities:
On November 24, 2009, we through our wholly-owned subsidiary, Gladstone Commercial Limited Partnership, exercised our option under our existing credit agreement with KeyBank National Association, or KeyBank, and certain other parties to extend the term of our $50 million line of credit by one year, resulting in a new maturity date of December 29, 2010. The loan was originally set to expire on December 29, 2009. During the year ended December 31, 2009, we had net borrowings under our line of credit of approximately $21.7 million, with $33.2 million outstanding at December 31, 2009. The proceeds from borrowings under the line of credit were used to pay off a $20.0 million unsecured short-term loan with KeyBank and fund other capital improvements at certain of our properties.
Leasing Activities:
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.
On November 18, 2009, we extended the lease with one of our tenants in our property located in Akron, Ohio for a period of five years. The lease was originally set to expire in February 2010, and will now expire in March 2015. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $160,000.

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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 December 31, 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 year ended December 31, 2009 and 2008, respectively:
                                 
    December 31, 2009     December 31, 2008  
            Percentage of             Percentage of  
Industry Classification   Rental Income     Rental Income     Rental Income     Rental Income  
Automobile
  $ 1,166,654       2.8 %   $ 1,166,654       2.9 %
Beverage, Food & Tobacco
    2,188,755       5.3 %     2,079,113       5.3 %
Buildings and Real Estate
    2,025,668       4.9 %     2,013,515       5.1 %
Chemicals, Plastics & Rubber
    3,173,514       7.6 %     2,452,628       6.2 %
Containers, Packaging & Glass
    2,330,246       5.6 %     2,288,909       5.8 %
Diversified/Conglomerate Manufacturing
    3,664,686       8.8 %     3,165,747       8.0 %
Diversified/Conglomerate Services
    308,105       0.7 %     308,105       0.8 %
Electronics
    6,164,789       14.9 %     6,165,789       15.7 %
Healthcare, Education & Childcare
    6,145,415       14.8 %     5,719,016       14.5 %
Home & Office Furnishings
    529,743       1.3 %     529,743       1.3 %
Insurance
    722,866       1.7 %     722,866       1.8 %
Machinery
    2,389,607       5.8 %     2,241,752       5.7 %
Oil & Gas
    1,138,136       2.7 %     1,152,443       2.9 %
Personal & Non-Durable Consumer Products
    1,354,721       3.3 %     1,355,061       3.4 %
Personal, Food & Miscellaneous Services
    575,006       1.4 %     575,006       1.5 %
Printing & Publishing
    2,189,033       5.3 %     2,189,602       5.5 %
Telecommunications
    5,447,033       13.1 %     5,446,338       13.6 %
 
                               
 
                       
 
  $ 41,513,977       100.0 %   $ 39,572,287       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. Gladstone Administration, LLC, or our Administrator, employs our chief financial officer, chief compliance officer, internal counsel, 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.

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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 years ended December 31, 2009, 2008 and 2007, 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. Our Adviser does not charge acquisition or disposition fees when we acquire or dispose of properties as is common in other REITs. Furthermore, there are no fees charged when our Adviser secures long or short term credit or arranges mortgage loans on our properties.
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).

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Quarterly Incentive Fee Based on FFO
Pre-incentive fee FFO
(expressed as a percentage of total common stockholders’ equity)
(GRAPHIC)
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 years ended December 31, 2009, 2008 and 2007, which allowed us to maintain the current level of distributions to our stockholders. These waivers were applied through December 31, 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, internal counsel, 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,

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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, depending on the amounts allocated between land and other depreciable assets, 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.

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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 December 31, 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 December 31, 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.

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Results of Operations
Our weighted-average yield on the portfolio as of December 31, 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 years ended December 31, 2009 and 2008 is below:
                                 
    For the year ended December 31,  
    2009     2008     $ Change     % Change  
Operating revenues
                               
Rental income
  $ 41,513,977     $ 39,572,287     $ 1,941,690       5 %
Interest income from mortgage notes receivable
    760,417       898,573       (138,156 )     -15 %
Tenant recovery revenue
    334,543       336,637       (2,094 )     -1 %
 
                         
Total operating revenues
    42,608,937       40,807,497       1,801,440       4 %
 
                         
 
                               
Operating expenses
                               
Depreciation and amortization
    13,161,287       12,679,437       481,850       4 %
Property operating expenses
    915,120       875,850       39,270       4 %
Due diligence expense
    40,574       1,176,379       (1,135,805 )     -97 %
Base management fee
    1,401,402       1,637,851       (236,449 )     -14 %
Incentive fee
    3,238,634       2,831,722       406,912       14 %
Administration fee
    1,015,695       954,635       61,060       6 %
Professional fees
    649,566       521,410       128,156       25 %
Insurance
    203,682       173,414       30,268       17 %
Directors fees
    198,882       216,851       (17,969 )     -8 %
Stockholder related expense
    236,160       298,384       (62,224 )     -21 %
Asset retirement obligation expense
    143,089       131,472       11,617       9 %
General and administrative
    62,886       63,263       (377 )     -1 %
 
                         
Total operating expenses before credit from Adviser
    21,266,977       21,560,668       (293,691 )     -1 %
 
                         
 
                               
Credit to incentive fee
    (726,448 )     (2,196,945 )     1,470,497       -67 %
 
                         
Total operating expenses
    20,540,529       19,363,723       1,176,806       6 %
 
                         
 
                               
Other income (expense)
                               
Interest income from temporary investments
    20,748       21,844       (1,096 )     -5 %
Interest income — employee loans
    192,350       202,097       (9,747 )     -5 %
Other income
    12,978       63,993       (51,015 )     -80 %
Interest expense
    (17,894,536 )     (16,858,687 )     (1,035,849 )     6 %
 
                         
Total other expense
    (17,668,460 )     (16,570,753 )     (1,097,707 )     7 %
 
                         
 
                               
Income from continuing operations
    4,399,948       4,873,021       (473,073 )     -10 %
 
                         
 
                               
Discontinued operations
                               
Income from discontinued operations
    43,062       39,926       3,136       8 %
Gain on sale of real estate
    160,038             160,038       100 %
 
                         
Total discontinued operations
    203,100       39,926       163,174       409 %
 
                         
 
                               
Net income
    4,603,048       4,912,947       (309,899 )     -6 %
 
                         
 
                               
Distributions attributable to preferred stock
    (4,093,750 )     (4,093,750 )           0 %
 
                         
 
                               
Net income available to common stockholders
  $ 509,298     $ 819,197     $ (309,899 )     -38 %
 
                         

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Operating Revenues
Rental income increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of the properties acquired during the year ended December 31, 2008 that were held for the full year in 2009.
Interest income from mortgage notes receivable decreased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily because interest income on our mortgage loan is based on the London Interbank Offered Rate, or LIBOR, which has significantly decreased over the past year.
Tenant recovery revenue decreased slightly for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of a decrease in the insurance premiums on some of our properties in which the tenants reimburse us for insurance expense, partially offset by an increase in the reimbursement of ground lease payments from a tenant.
Operating Expenses
Depreciation and amortization expenses increased during the year ended December 31, 2009, as compared to the year ended December 31, 2008, as a result of the properties acquired during the year ended December 31, 2008 that were held for the full year in 2009.
Property operating expenses consist of franchise taxes, management fees, insurance, ground lease payments and overhead expenses paid on behalf of certain of our properties. Property operating expenses increased slightly during the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily because of an increase in ground lease payments coupled with repairs and maintenance performed at certain of our properties.
Due diligence expense primarily consists of legal fees and fees incurred for third-party reports prepared during our due diligence work. Due diligence expenses decreased significantly for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily because of over $1.0 million of fees incurred related to a large potential acquisition that did not close during 2008. However, with the adoption of Accounting Standards Codification, or ASC, 805 “Business Combinations,” on January 1, 2009, discussed in detail in Note 1 of the accompanying consolidated financial statements, which requires us to no longer capitalize due diligence costs into the price of the acquisition, we expect our due diligence expense to increase significantly once we begin to acquire properties again.
The base management fee decreased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, as a result of a decrease in total common stockholders’ equity, the main component of the calculation. Total common stockholders’ equity decreased because distributions to common stockholders for the year ended December 31, 2009 exceeded net income during the period by approximately $8.2 million. The calculation of the base management fee is described in detail above under “—Advisory and Administration Agreements.”
The incentive fee increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, due to the increase in pre-incentive fee FFO as a result of our increased rental income discussed above, coupled with the decrease in total common stockholders’ equity. In addition, the amount that was credited to the incentive fee during the year ended December 31, 2009 decreased, because of an increase in operating income and a decrease in operating expenses. The calculation of the incentive fee is described in detail above under “—Advisory and Administration Agreements.”
The administration fee increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of an increase in our total assets in comparison to the total assets of all companies managed by our Adviser under similar agreements, coupled with approximately $80,000 incurred by our Administrator, which was directly allocable to us, for the implementation of real estate

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software. The calculation of the administration fee is described in detail above under “—Advisory and Administration Agreements.”
Professional fees, consisting primarily of legal and accounting fees, increased during the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of an increase in legal and other professional fees relating to ongoing lease renegotiations and reviews of our legal work with our existing tenants.
Insurance expense consists of the premiums paid for directors’ and officers’ insurance, which is renewed annually each September. Insurance expense increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, because of an increase in the premiums for the periods from September 2008 through September 2009 and from September 2009 through September 2010.
Directors’ fees decreased during the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of one of the independent directors becoming an interested director in January 2008, and thus not being paid an annual stipend during 2009.
Stockholder related expense decreased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of decreased costs associated with printing and filing our proxy materials.
Asset retirement obligation expense increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008, because of the increase in the accretion of the expense over the term of the lease including renewal periods.
General and administrative expenses remained flat for the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily as a result of a decrease in the amount of travel for site visits to our properties, offset by an increase in dues and subscriptions.
Other Income and Expense
Interest income from temporary investments decreased during the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily because of lower interest rates earned on our money market accounts, partially offset by interest received in 2009 from funds held on deposit for a prospective real estate acquisition, coupled with interest earned on amounts held in reserve accounts with our lenders.
Interest income on employee loans decreased during the year ended December 31, 2009, as compared to the year ended December 31, 2008. This decrease was a result of loan payoffs by employees during 2008 and 2009, coupled with other partial principal repayments over the periods.
Other income decreased during the year ended December 31, 2009, as compared to the year ended December 31, 2008, primarily because we no longer receive management fees from our tenant in our Burnsville, Minnesota property.
Interest expense increased for the year ended December 31, 2009, as compared to the year ended December 31, 2008. This was primarily a result of long-term financings, which closed during 2008, that were held for the full period during 2009.
Discontinued Operations
Income from discontinued operations primarily relates to the property we sold, which was located in Norfolk, Virginia, including a gain on the sale of the property of approximately $160,000. This is partially offset by continuing expenses related to the two Canadian properties, which we sold in July 2006. The expenses for the two Canadian properties relate to legal fees associated with the dissolution of the entities, which sold the properties.

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Net Income Available to Common Stockholders
Net income available to common stockholders decreased for the year ended December 31, 2009, as compared to the year ended December 31, 2008. This decrease was primarily a result of increased interest expense from the increased number of properties which have long-term financing partially offset by the gain on sale of our property in Norfolk, Virginia coupled with the growth of our portfolio of investments in the past year and the corresponding increase in our revenues and the other events described above.
A comparison of our operating results for the years ended December 31, 2008 and 2007 is below:
                                 
    For the year ended December 31,  
    2008     2007     $ Change     % Change  
Operating revenues
                               
Rental income
  $ 39,572,287     $ 31,365,796     $ 8,206,491       26 %
Interest income from mortgage notes receivable
    898,573       1,013,889       (115,316 )     -11 %
Tenant recovery revenue
    336,637       310,353       26,284       8 %
 
                         
Total operating revenues
    40,807,497       32,690,038       8,117,459       25 %
 
                         
 
                               
Operating expenses
                               
Depreciation and amortization
    12,679,437       10,503,258       2,176,179       21 %
Property operating expenses
    875,850       798,939       76,911       10 %
Due diligence expense
    1,176,379       20,968       1,155,411       5510 %
Base management fee
    1,637,851       1,858,120       (220,269 )     -12 %
Incentive fee
    2,831,722       2,564,365       267,357       10 %
Administration fee
    954,635       837,898       116,737       14 %
Professional fees
    521,410       625,349       (103,939 )     -17 %
Insurance
    173,414       214,141       (40,727 )     -19 %
Directors fees
    216,851       229,000       (12,149 )     -5 %
Stockholder related expense
    298,384       244,629       53,755       22 %
Asset retirement obligation expense
    131,472       114,821       16,651       15 %
General and administrative
    63,263       101,539       (38,276 )     -38 %
 
                       
Total operating expenses before credit from Adviser
    21,560,668       18,113,027       3,447,641       19 %
 
                         
 
                               
Credit to incentive fee
    (2,196,945 )     (2,321,597 )     124,652       -5 %
 
                       
Total operating expenses
    19,363,723       15,791,430       3,572,293       23 %
 
                         
 
                               
Other income (expense)
                               
Interest income from temporary investments
    21,844       354,249       (332,405 )     -94 %
Interest income — employee loans
    202,097       222,051       (19,954 )     -9 %
Other income
    63,993       47,847       16,146       34 %
Interest expense
    (16,858,687 )     (11,564,541 )     (5,294,146 )     46 %
 
                       
Total other expense
    (16,570,753 )     (10,940,394 )     (5,630,359 )     51 %
 
                         
 
                               
Income from continuing operations
    4,873,021       5,958,214       (1,085,193 )     -18 %
 
                         
 
                               
Discontinued operations
                               
Income from discontinued operations
    39,926       69,989       (30,063 )     -43 %
Net realized income from foreign currency transactions
          33,359       (33,359 )     -100 %
Taxes refunded on sale of real estate
          78,667       (78,667 )     100 %
 
                       
Total discontinued operations
    39,926       182,015       (142,089 )     -78 %
 
                         
 
                               
Net income
    4,912,947       6,140,229       (1,227,282 )     -20 %
 
                         
 
                               
Distributions attributable to preferred stock
    (4,093,750 )     (4,093,750 )           0 %
 
                         
 
                               
Net income available to common stockholders
  $ 819,197     $ 2,046,479     $ (1,227,282 )     -60 %
 
                         

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Operating Revenues
Rental income increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of the six properties acquired during 2008, coupled with properties acquired during 2007 that were held for the full year in 2008.
Interest income from mortgage notes receivable decreased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily because interest income on our mortgage loan is based on the London Interbank Offered Rate, or LIBOR, which significantly decreased during the year ended December 31, 2008.
Tenant recovery revenue increased for the year ended December 31, 2008 as compared to the year ended December 31, 2007, primarily as a result of the reimbursement of the ground lease payments on our Tulsa, Oklahoma property acquired in March 2007, which was held for the entire year in 2008, coupled with properties acquired during 2008 in which tenants reimbursed us for insurance expense.
Operating Expenses
Depreciation and amortization expenses increased during the year ended December 31, 2008, as compared to the year ended December 31, 2007, as a result of the six properties acquired during 2008, and properties acquired during 2007 that were held for the full year in 2008.
Property operating expenses consist of franchise taxes, management fees, insurance, ground lease payments and overhead expenses paid on behalf of certain of our properties. Property operating expenses increased during the year ended December 31, 2008, as compared to the year ended December 31, 2007, due to an increase in the amount of franchise taxes paid as a result of the properties acquired during 2008. In addition, property operating expenses included ground lease payments on our Tulsa, Oklahoma property acquired in March 2007, which was held for the entire year in 2008.
Due diligence expense consists of fees incurred for acquisitions that did not close. The fees primarily consist of legal fees and fees incurred for third-party reports prepared during our due diligence work. Over $1.0 million of the fees incurred were related to a large potential acquisition that did not close during 2008. The base management fee decreased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, as a result of a decrease in total common stockholders’ equity, the main component of the calculation. The calculation of the base management fee is described in detail above under “Investment Advisory and Administration Agreements.”
The incentive fee increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, due to the decrease in total common stockholders’ equity, coupled with the increase in FFO. The calculation of the incentive fee is described in detail above under “Investment Advisory and Administration Agreements.”
The administration fee increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of the increased number of employees of our Administrator, coupled with an increase in overhead expenses allocated by our Administrator. The calculation of the administration fee is described in detail above under “Investment Advisory and Administration Agreements.”
Professional fees, consisting primarily of legal and accounting fees, decreased during the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of a reduction in legal fees combined with fees incurred during the year ended December 31, 2007 for state tax research and costs related to the implementation of ASC 740-10-25, “Income Taxes,” which were not incurred during the year ended December 31, 2008.

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Insurance expense consists of the premiums paid for directors and officers insurance, which is renewed annually each September. Insurance expense decreased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, because of a decrease in the premiums for the period from September 2007 through September 2008. Premiums for directors and officers insurance increased approximately 11% for the period from September 2008 through September 2009.
Directors’ fees decreased during the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of fewer committee meetings occurring in the year ended December 31, 2008 coupled with one of the independent directors becoming an interested director in January 2008, and thus the director no longer receiving fees for attending board meetings.
Stockholder related expense increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of the increase in our costs associated with printing and filing the annual report, coupled with costs associated with the solicitation of the stockholder vote for the 2008 annual meeting.
Asset retirement obligation expense increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of a property acquired during 2008, which was required to recognize an asset retirement liability, coupled with a property acquired where a liability was recorded during 2007 that was held for the full year in 2008.
General and administrative expenses decreased for the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily as a result of a decrease in the amount of dues and subscriptions, office expense and bank service charges incurred in 2008.
Other Income and Expense
Interest income from temporary investments decreased during the year ended December 31, 2008, as compared to the year ended December 31, 2007. The decrease was primarily a result of the decrease in our average cash balances during the year ended December 31, 2008.
Interest income on employee loans decreased during the year ended December 31, 2008, as compared to the year ended December 31, 2007. This decrease was a result of employees who paid off their loans during 2008, coupled with other partial principal repayments over the periods.
Other income increased during the year ended December 31, 2008, as compared to the year ended December 31, 2007, primarily because of a real estate tax reimbursement we received from our property located in Sterling Heights, Michigan in 2008.
Interest expense increased for the year ended December 31, 2008, as compared to the year ended December 31, 2007. This was primarily a result of the long-term financings we closed on 16 of our properties during 2008, coupled with an increased amount outstanding on our line of credit during 2008.
Discontinued Operations
The loss from discontinued operations for the year ended December 31, 2008 is the expense related to our two Canadian properties, which were sold in July 2006. The expense relates to legal fees associated with the dissolution of the entities which sold the properties. The 2006 tax returns were filed in March 2007, and we were due a refund of approximately $79,000, which is reflected on the accompanying consolidated statements of operations under taxes refunded on sale of real estate for the year ended December 31, 2007.
Net Income Available to Common Stockholders
Net income available to common stockholders decreased for the year ended December 31, 2008, as compared to the year ended December 31, 2007. This decrease was primarily a result of increased interest expense from the increased number of properties which have long-term financing, partially offset by the increase in the size of our portfolio of investments in the year ended December 31, 2008 and the corresponding increase in our revenues and the other events described above.

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Liquidity and Capital Resources
Future Capital Needs
At December 31, 2009, we had approximately $3.1 million in cash and cash equivalents. We have access to our existing line of credit with an available borrowing capacity of $8.3 million, and have obtained mortgages on 55 of our properties. As of December 31, 2009 we had investments in 64 real properties for a net carrying value, including intangible assets, of approximately $384.8 million and one mortgage loan receivable for $10.0 million.
As discussed in “OverviewBusiness Environment” above, while there have been improvements in the economy, we continue to be impacted by weak economic conditions, which have affected our ability to obtain additional mortgages, as well as our ability to borrow funds and issue equity securities, our principal sources of external financing. Until economic conditions recover, we intend to fund our existing contractual obligations with our cash flows from operations and borrowing against our existing line of credit. If economic conditions continue to improve, we are hopeful that we will be able to issue additional equity securities under our effective shelf registration statement, including pursuant to out Open Market Sale Agreement, and through a private offering of senior common stock. If we are able to raise significant equity, we would intend to use the proceeds to acquire additional properties, make mortgage loans, purchase shares of our preferred stock on the open market or pay down borrowings under our line of credit.
Our existing shelf registration statement permits us to issue, through one or more transactions, up to an aggregate of $300.0 million in securities consisting of common or preferred stock, all of which was available as of December 31, 2009. On November 4, 2009, we entered into an 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 or to Jefferies for resale, based upon our instructions (including any price, time or size limits or other customary parameters or conditions we may impose). Sales of our common stock through Jefferies, if any, will be executed by means of ordinary brokers’ transactions on the NASDAQ Global Select Market or otherwise at market prices, in privately negotiated transactions, crosses or block transactions as may be agreed between us and Jefferies, including a combination of any of these transactions. We 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 under the Open Market Sale Agreement. To date, we have not sold any shares of our common stock under the Open Market Sale Agreement and there is no guarantee that we will sell any common stock under the agreement in the future. In addition, on November 19, 2009, we entered into a dealer manager agreement with Halcyon who will act as our dealer manager in connection with a proposed continuous private offering of up to 3,333,333 shares of our newly designated senior common stock at $15.00 per share. This offering is only being made to accredited investors. To date, we have not sold any shares of senior common stock under the Dealer Manager Agreement and there can be no assurances that we will sell any senior common stock under the agreement in the future.
As banks begin lending again we intend to obtain mortgages on any additional acquired properties by collateralizing the mortgages with some or all of our real property, or by borrowing against our existing line of credit. We may also use these funds for general corporate needs. If we are unable to make any required debt payments on any borrowings, our lenders could foreclose on the properties collateralizing their loans, which could cause us to lose part or all of our investments in such properties. We have $48.0 million of balloon principal payments due under one of our long-term mortgages in 2010, however the mortgage has three annual extension options through 2013, which we currently intend to exercise. We have no other balloon principal payments due under any of our mortgages until 2013.
We also need sufficient capital to fund our distributions to stockholders, pay the debt service costs on our existing long-term mortgages, and fund our current operating costs. We may require credits to our management fees, issued from our Adviser, in order to meet these obligations, although our Adviser is

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under no obligation to provide such credits, in whole or in part. We routinely review our liquidity requirements, and we believe that our current cash flows from operations, coupled with our current availability on our line of credit, are sufficient to continue operations and pay distributions to our stockholders.
Operating Activities
Net cash provided by operating activities during the year ended December 31, 2009 was approximately $17.0 million, compared to net cash provided by operating activities of approximately $17.6 million for the year ended December 31, 2008. The decrease in net cash provided by operating activities was primarily a result of an increase in the amount of the net incentive fee paid to our Adviser. A majority of cash from operating activities is generated from the rental payments we receive from our tenants and the interest payments we receive from our borrower. We utilize this cash to fund our property-level operating expenses and use the excess cash primarily for debt and interest payments on our mortgage notes payable, interest payments on our line of credit, distributions to our stockholders, management fees to our Adviser, and other entity level expenses.
Investing Activities
Net cash used in investing activities during the year ended December 31, 2009 was approximately $830,000, which primarily consisted of tenant improvements performed at our property located in Maple Heights, Ohio and net payments to lenders for reserves and leasing commissions paid related to the extension of the lease for our property located in Eatontown, New Jersey, partially offset by proceeds from the sale of our property located in Norfolk, Virginia, as compared to net cash used in investing activities during the year ended December 31, 2008 of approximately $50.8 million, which primarily consisted of the purchase of six properties. We have not purchased any properties since August 2008 because of the lack of access to capital as discussed in “Overview-Business Environment” above, which resulted in the significant decrease in the cash used in investing activities from 2008 to 2009.
Financing Activities
Net cash used in financing activities for the year ended December 31, 2009 was approximately $17.6 million, which primarily consisted of repayment of our short-term loan, repayments on our line of credit, principal repayments on mortgage notes payable and distributions paid to our stockholders, partially offset by borrowings on our line of credit. Net cash provided by financing activities for the year ended December 31, 2008 was approximately $36.3 million, which primarily consisted of the proceeds from borrowings from mortgage notes payable and borrowings on our line of credit, partially offset by principal repayments on mortgage notes payable, repayments on our line of credit, distributions paid to our stockholders and payments for deferred financing costs.
Mortgage Notes Payable
As of December 31, 2009 we had 16 fixed-rate mortgage notes payable in the aggregate principal amount of approximately $252.8 million, collateralized by a total of 55 properties with terms at issuance ranging from 2 years to 25 years. The weighted-average interest rate on the mortgage notes payable as of December 31, 2009 was approximately 6.0%.
Line of Credit
We have a $50.0 million senior revolving credit agreement, or Credit Agreement, with a syndicate of banks led by KeyBank National Association, or KeyBank, which matures on December 29, 2010. On June 30, 2009, we amended our Credit Agreement to reduce our 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 we can issue under the Credit Agreement as letters of credit was reduced from $20.0 million to $10.5 million.

52


 

The interest rate charged on the advances under the facility is based on 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. Our ability to access this funding source is subject to us continuing to meet customary lending requirements such as compliance with financial and operating covenants and meeting certain lending limits. One such covenant requires us to limit distributions to our stockholders to 95% of our FFO less those acquisition related costs that are required to be expensed under ASC 805. In addition, the maximum amount we 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 requested that we obtain updated appraisals for the properties pledged \under the line of credit as borrowing base collateral in connection with the extension of the Credit Agreement. As a result, the maximum amount we may draw under the Credit Agreement was reduced to 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, or SPE, that owns the property. In addition, Gladstone Commercial Limited Partnership, a Delaware limited partnership that owns the SPEs, or the Operating Partnership, is precluded from transferring the SPEs or unconsolidated affiliates to us.
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 we purchase new properties meeting the eligibility standards, we may pledge these new properties to obtain additional advances under this agreement. The availability under the line of credit will also be reduced by letters of credit used in the ordinary course of business. We may use the advances under the line of credit for both general corporate purposes and the acquisition of new investments. As of December 31, 2009, there was $33.2 million outstanding under the line of credit at an interest rate of approximately 2.2%, and approximately $3.6 million outstanding under letters of credit at a weighted average interest rate of approximately 2.0%. At December 31, 2009, the remaining borrowing capacity available under the line of credit was approximately $8.3 million. We were in compliance with all covenants under the Credit Agreement as of December 31, 2009.
Short-Term Loan
On December 21, 2007, we entered into a $20.0 million unsecured short-term loan with KeyBank, which matured on December 20, 2008. We exercised our option to extend the term for an additional six months and, on March 31, 2009, we repaid in full the unsecured short-term loan, using proceeds from borrowings under our line of credit. The interest rate charged on the loan was based on LIBOR, the prime rate or the federal funds rate, depending on market conditions, and adjusted periodically.

53


 

Contractual Obligations
The following table reflects our significant contractual obligations as of December 31, 2009:
                                         
    Payments Due by Period  
            Less than 1                     More than 5  
Contractual Obligations   Total     Year     1-3 Years     3-5 Years     Years  
Debt Obligations (1)
  $ 285,961,651     $ 83,770,508     $ 5,878,841     $ 32,233,838     $ 164,078,464  
Interest on Debt Obligations (2)
    78,727,727       15,724,516       23,698,172       21,930,064       17,374,975  
Capital Lease Obligations (3)
    300,000                   300,000        
Operating Lease Obligations (4)
    1,753,868       152,510       305,020       305,020       991,318  
 
                             
Total
  $ 366,743,246     $ 99,647,534     $ 29,882,033     $ 54,768,922     $ 182,444,757  
 
                             
 
(1)   Debt obligations represent borrowings under our line of credit, which represents $33.2 million of the debt obligation due in less than 1 year, and mortgage notes payable that were outstanding as of December 31, 2009. The line of credit matures in December 2010. The $48.0 million mortgage note issued in September 2008 matures in October 2010, and we expect to exercise our options to extend the term through October 2013.
 
(2)   Interest on debt obligations includes estimated interest on our borrowings under our line of credit. The balance and interest rate on our line of credit is variable, thus the amount of interest calculated for purposes of this table was based upon rates and balances as of December 31, 2009.
 
(3)   Capital lease obligations represent the obligation to purchase the land held under the ground lease on our property located in Fridley, Minnesota.
 
(4)   Operating lease obligations represent the ground lease payments due on our Tulsa, Oklahoma property. The lease expires in June 2021.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K as of December 31, 2009.

54


 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The primary risk that we believe we will be exposed to is interest rate risk. We currently own one variable rate loan receivable, certain of our leases contain escalations based on market interest rates, and the interest rate on our existing line of credit is variable. Although we seek to mitigate this risk by structuring such provisions of our loans and leases to contain a minimum interest rate or escalation rate, as applicable, these features do not eliminate this risk. We are also exposed to the effects of interest rate changes as a result of the holding of our cash and cash equivalents in short-term, interest-bearing investments. We have not entered into any derivative contracts to attempt to further manage our exposure to interest rate fluctuations.
To illustrate the potential impact of changes in interest rates on our net income for the years ended December 31, 2009 and 2008, we have performed the following analysis, which assumes that our balance sheet remains constant and no further actions beyond a minimum interest rate or escalation rate are taken to alter our existing interest rate sensitivity.
The following table summarizes the impact of a 1% increase and 1% decrease in the one month LIBOR for the years ended December 31, 2009 and 2008.
                 
    For the year ended December 31,  
  2009     2008  
1% increase in the one month LIBOR
       
Rental & interest income
  $ 5     $ 106,031  
Interest expense
    336,611       320,250  
 
           
Net decrease
  $ (336,606 )   $ (214,219 )
 
           
Net income available to common stockholders (as reported)
  $ 509,298     $ 819,197  
Net decrease as percentage of Net income available to common stockholders (as reported)
    -66.1 %     -26.1 %
 
               
1% decrease in the one month LIBOR
               
 
               
Rental & interest income
  $     $ (96,882 )
Interest expense
  $ (336,611 )   $ (320,250 )
 
           
Net increase
  $ 336,611     $ 223,368  
 
           
Net income available to common stockholders
  $ 509,298     $ 819,197  
Net increase as percentage of Net income available to common stockholders
    66.1 %     27.3 %
As of December 31, 2009, the fair value of our fixed rate debt outstanding was approximately $239.1 million. Interest rate fluctuations may affect the fair value of our fixed rate debt instruments. If interest rates on our fixed rate debt instruments, using rates at December 31, 2009, had been one percentage point higher or lower, the fair value of those debt instruments on that date would have decreased or increased by approximately $9.6 million and $10.2 million, respectively.

55


 

In the future, we may be exposed to additional effects of interest rate changes primarily as a result of our line of credit or long-term mortgage debt used to maintain liquidity and fund expansion of our real estate investment portfolio and operations. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, we will borrow primarily at fixed rates or variable rates with the lowest margins available and, in some cases, with the ability to convert variable rates to fixed rates. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate the interest rate risk on a related financial instrument. We will not enter into derivative or interest rate transactions for speculative purposes.
In addition to changes in interest rates, the value of our real estate is subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of lessees and borrowers, all of which may affect our ability to refinance debt if necessary.

56


 

Item 8. Financial Statements and Supplementary Data
         
Index to Consolidated Financial Statements
       
 
       
    58  
 
       
    59  
 
       
    61  
 
       
    62  
 
       
    63  
 
       
    64  
 
       
    65  
 
       
    82  
 
       
    87  

57


 

Report of Management on Internal Controls over Financial Reporting
To the Stockholders and Board of Directors of Gladstone Commercial Corporation:
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and include those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets, provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations (COSO). Based on our assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2009.
The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
February 24, 2010

58


 

Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Gladstone Commercial Corporation:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Gladstone Commercial Corporation and its subsidiaries at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

59


 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
McLean, VA
February 24, 2010

60


 

GLADSTONE COMMERCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
                 
    December 31, 2009     December 31, 2008  
 
               
ASSETS
               
Real estate, at cost
  $ 390,753,892     $ 390,562,138  
Less: accumulated depreciation
    34,111,952       24,757,576  
 
           
Total real estate, net
    356,641,940       365,804,562  
 
               
Lease intangibles, net
    28,177,461       31,533,843  
Mortgage note receivable
    10,000,000       10,000,000  
Cash and cash equivalents
    3,096,598       4,503,578  
Restricted cash
    2,633,538       2,677,561  
Funds held in escrow
    2,487,680       2,150,919  
Deferred rent receivable
    8,975,196       7,228,811  
Deferred financing costs, net
    3,136,055       4,383,446  
Due from adviser (Refer to Note 2)
          108,898  
Prepaid expenses and other assets
    1,716,905       707,167  
 
           
 
               
TOTAL ASSETS
  $ 416,865,373     $ 429,098,785  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
LIABILITIES
               
Mortgage notes payable
  $ 252,761,651     $ 255,111,173  
Short-term loan and borrowings under line of credit
    33,200,000       31,500,000  
Deferred rent liability
    3,213,195       3,147,472  
Asset retirement obligation liability
    2,305,644       2,190,192  
Accounts payable and accrued expenses
    2,086,741       2,673,787  
Due to adviser (Refer to Note 2)
    1,213,640        
Obligation under capital lease
    247,686       235,378  
Rent received in advance, security deposits and funds held in escrow
    3,386,274       3,745,523  
 
           
 
               
Total Liabilities
    298,414,831       298,603,525  
 
           
 
               
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
    2,150       2,150  
Common stock, $0.001 par value, 47,700,000 shares authorized and 8,563,264 shares issued and outstanding
    8,563       8,563  
Additional paid in capital
    170,622,581       170,622,581  
Notes receivable — employees
    (2,304,999 )     (2,595,886 )
Distributions in excess of accumulated earnings
    (49,877,753 )     (37,542,148 )
 
           
 
               
Total Stockholders’ Equity
    118,450,542       130,495,260  
 
           
 
               
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 416,865,373     $ 429,098,785  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

61


 

GLADSTONE COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
                         
    For the year ended December 31,  
    2009     2008     2007  
Operating revenues
                       
Rental income
  $ 41,513,977     $ 39,572,287     $ 31,365,796  
Interest income from mortgage note receivable
    760,417       898,573       1,013,889  
Tenant recovery revenue
    334,543       336,637       310,353  
 
                 
Total operating revenues
    42,608,937       40,807,497       32,690,038  
 
                 
 
                       
Operating expenses
                       
Depreciation and amortization
    13,161,287       12,679,437       10,503,258  
Property operating expenses
    915,120       875,850       798,939  
Due diligence expense
    40,574       1,176,379       20,968  
Base management fee (Refer to Note 2)
    1,401,402       1,637,851       1,858,120  
Incentive fee (Refer to Note 2)
    3,238,634       2,831,722       2,564,365  
Administration fee (Refer to Note 2)
    1,015,695       954,635       837,898  
Professional fees
    649,566       521,410       625,349  
Insurance
    203,682       173,414       214,141  
Directors fees
    198,882       216,851       229,000  
Stockholder related expenses
    236,160       298,384       244,629  
Asset retirement obligation expense
    143,089       131,472       114,821  
General and administrative
    62,886       63,263       101,539  
 
                 
Total operating expenses before credit from Adviser
    21,266,977       21,560,668       18,113,027  
 
                 
 
                       
Credit to incentive fee
    (726,448 )     (2,196,945 )     (2,321,597 )
 
                 
 
                       
Total operating expenses
    20,540,529       19,363,723       15,791,430  
 
                 
 
                       
Other income (expense)
                       
Interest income from temporary investments
    20,748       21,844       354,249  
Interest income — employee loans
    192,350       202,097       222,051  
Other income
    12,978       63,993       47,847  
Interest expense
    (17,894,536 )     (16,858,687 )     (11,564,541 )
 
                 
Total other expense
    (17,668,460 )     (16,570,753 )     (10,940,394 )
 
                 
 
                       
Income from continuing operations
    4,399,948       4,873,021       5,958,214  
 
                 
 
                       
Discontinued operations
                       
Income from discontinued operations
    43,062       39,926       69,989  
Net realized income from foreign currency transactions
                33,359  
Gain on sale of real estate
    160,038              
Taxes refunded on sale of real estate
                78,667  
 
                 
 
                       
Total discontinued operations
    203,100       39,926       182,015  
 
                 
 
                       
Net income
    4,603,048       4,912,947       6,140,229  
 
                 
 
                       
Distributions attributable to preferred stock
    (4,093,750 )     (4,093,750 )     (4,093,750 )
 
                 
 
                       
Net income available to common stockholders
  $ 509,298     $ 819,197     $ 2,046,479  
 
                 
 
                       
Earnings per weighted average common share — basic & diluted
                       
Income from continuing operations (net of distributions attributable to preferred stock)
  $ 0.04     $ 0.09     $ 0.22  
Discontinued operations
    0.02       0.01       0.02  
 
                 
 
                       
Net income available to common stockholders
  $ 0.06     $ 0.10     $ 0.24  
 
                 
 
                       
Weighted average shares outstanding — basic & diluted
    8,563,264       8,565,149       8,565,264  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

62


 

GLADSTONE COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                 
                            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, 2006
  $ 2,150     $ 8,565     $ 170,640,979     $ (3,201,322 )   $ (15,226,196 )   $ 152,224,176  
 
                                   
 
                                               
Repayment of Principal on Notes Receivable
                      431,399             431,399  
 
                                               
Distributions Declared to Common and Preferred Stockholders
                            (16,427,736 )     (16,427,736 )
 
                                               
Net income
                            6,140,229       6,140,229  
 
                                   
Balance at December 31, 2007
  $ 2,150     $ 8,565     $ 170,640,979     $ (2,769,923 )   $ (25,513,703 )   $ 142,368,068  
 
                                   
 
                                               
Forfeiture of Common Stock
          (2 )     (18,398 )                 (18,400 )
 
                                               
Repayment of Principal on Notes Receivable
                      174,037             174,037  
 
                                               
Distributions Declared to Common and Preferred Stockholders
                            (16,941,392 )     (16,941,392 )
 
                                               
Net income
                            4,912,947       4,912,947  
 
                                   
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
                      45,887             45,887  
 
                                               
Reclassification of Loan Balance to Other Assets
                      245,000             245,000  
 
                                               
Distributions Declared to Common and Preferred Stockholders
                            (16,938,653 )     (16,938,653 )
 
                                               
Net income
                            4,603,048       4,603,048  
 
                                   
Balance at December 31, 2009
  $ 2,150     $ 8,563     $ 170,622,581     $ (2,304,999 )   $ (49,877,753 )   $ 118,450,542  
 
                                   
The accompanying notes are an integral part of these consolidated financial statements.

63


 

GLADSTONE COMMERCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
                         
    For the year ended December 31,  
    2009     2008     2007  
Cash flows from operating activities:
                       
Net income
  $ 4,603,048     $ 4,912,947     $ 6,140,229  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization, including discontinued operations
    13,171,703       12,704,641       10,528,458  
Amortization of deferred financing costs
    1,491,389       1,283,956       717,195  
Amortization of deferred rent asset and liability, net
    (532,068 )     (532,066 )     (532,068 )
Accretion of obligation under capital lease
    12,309       10,311        
Asset retirement obligation expense, including discontinued operations
    143,550       133,244       116,478  
Gain on sale of real estate
    (160,038 )            
(Increase) decrease in prepaid expenses and other assets
    (959,738 )     172,096       64,990  
Increase in deferred rent receivable and deferred rent liability, net
    (1,177,167 )     (2,387,509 )     (1,741,016 )
Increase in accounts payable, accrued expenses, and amount due adviser
    735,492       1,001,639       625,398  
(Decrease) increase in rent received in advance
    (315,223 )     275,916       176,145  
 
                 
Net cash provided by operating activities
    17,013,257       17,575,175       16,095,809  
 
                 
 
                       
Cash flows from investing activities:
                       
Real estate investments
    (1,139,711 )     (49,359,852 )     (105,599,587 )
Leasing commissions paid
    (441,745 )            
Proceeds from sale of real estate
    1,089,269              
Receipts from lenders for reserves held in escrow
    1,465,133       874,227       1,603,309  
Payments to lenders for reserves held in escrow
    (1,801,894 )     (1,623,452 )     (1,369,186 )
Decrease (increase) in restricted cash
    44,023       (763,494 )     (688,905 )
Deposits on future acquisitions
    (250,000 )     (1,650,000 )     (2,110,000 )
Deposits refunded or applied against real estate investments
    200,000       1,750,000       2,110,000  
 
                 
Net cash used in investing activities
    (834,925 )     (50,772,571 )     (106,054,369 )
 
                 
 
                       
Cash flows from financing activities:
                       
Borrowings under mortgage notes payable
          48,015,000       48,521,690  
Principal repayments on mortgage notes payable
    (2,349,522 )     (1,485,901 )     (895,657 )
Principal repayments on employee notes receivable
    290,887       155,637       431,399  
Borrowings from line of credit
    57,600,000       76,900,000       65,500,000  
Repayments on line of credit
    (35,900,000 )     (69,800,000 )     (41,100,000 )
Repayment of short-term loan
    (20,000,000 )            
Receipts from tenants for reserves
    4,454,102       2,391,360       2,023,019  
Payments to tenants from reserves
    (4,526,409 )     (2,159,671 )     (1,710,685 )
Increase in security deposits
    28,282       531,806       376,572  
Payments for deferred financing costs
    (243,999 )     (1,262,273 )     (1,409,320 )
Distributions paid for common and preferred
    (16,938,653 )     (16,941,392 )     (16,427,736 )
 
                 
Net cash (used in) provided by financing activities
    (17,585,312 )     36,344,566       55,309,282  
 
                 
 
                       
Net (decrease) increase in cash and cash equivalents
    (1,406,980 )     3,147,170       (34,649,278 )
Cash and cash equivalents, beginning of year
    4,503,578       1,356,408       36,005,686  
 
                 
Cash and cash equivalents, end of year
  $ 3,096,598     $ 4,503,578     $ 1,356,408  
 
                 
 
                       
Cash paid during year for interest
  $ 16,558,955     $ 14,337,944     $ 10,693,440  
 
                 
 
                       
NON-CASH OPERATING, INVESTING AND FINANCING INFORMATION
                       
 
                       
Additions to real estate included in accounts payable, accrued expenses, and amount due adviser
  $     $     $ 81,400  
 
                 
Increase in asset retirement obligation
  $     $ 245,196     $ 180,458  
 
                 
Fixed rate debt assumed in connection with acquisitions
  $     $ 6,461,603     $ 4,506,689  
 
                 
Obligation under capital lease
  $     $ 225,068     $  
 
                 
Forfeiture of common stock in satisfaction of employee note receivable
  $     $ 18,400     $  
 
                 
Reclassificaton of principal on employee note (Refer to Note 8)
  $ 245,000     $     $  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

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GLADSTONE COMMERCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Significant Accounting Policies
Gladstone Commercial Corporation (the “Company”) is a Maryland corporation that operates in a manner so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes and was incorporated on February 14, 2003 under the General Corporation Law of Maryland, primarily for the purpose 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 disclosed below, the financial position and results of operations of the Operating Partnership are consolidated with those of the Company.
Gladstone Commercial Partners, LLC, a Delaware limited liability company (“Commercial Partners”) and a subsidiary of the Company, was organized to engage in any lawful act or activity for which a limited liability company may be organized in Delaware. Commercial Partners has the power to make and perform all contracts and to engage in all activities to carry out the purposes of the Company, and all other powers available to it as a limited liability company. As the Company currently owns all of the membership interests of Commercial Partners, the financial position and results of operations of Commercial Partners 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, subsidiaries of the Company, each are business trusts 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.

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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 or 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 $9.4 million, $9.0 million and $7.1 million for the years ended December 31, 2009, 2008 and 2007, 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 $253,000 for each of the years ended December 31, 2009, 2008 and 2007, 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 $786,000 for each of the years ended December 31, 2009, 2008 and 2007, 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.

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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 $3.7 million, $3.7 million and $3.4 million for the years ended December 31, 2009, 2008 and 2007, 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 December 31, 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 December 31, 2009 were held in the custody of one financial institution, and the Company’s balance at times may exceed federally insurable limits.

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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 $244,000, $1.3 million and $1.4 million for deferred financing costs during the years ended December 31, 2009, 2008 and 2007, respectively. Total amortization expense related to deferred financing costs was approximately $1.5 million, $1.3 million and $0.7 million for the years ended December 31, 2009, 2008 and 2007, respectively.
Prepaid Expenses and Other Assets
Prepaid expenses and other assets consist of accounts receivable, interest receivable, prepaid assets, a note receivable from a former employee 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 $12,000 and $10,000 for the years ended December 31, 2009 and 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 December 31, 2009.

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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 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 year ended December 31, 2008 of approximately $245,000 related to properties acquired during the period,

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which reflected the present value of the future obligation. There was no liability accrued during the year ended December 31, 2009. The Company also recorded expense, including discontinued operations, of approximately $144,000, $133,000 and $116,000 during the years ended December 31, 2009, 2008 and 2007, 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 Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (the “Codification”) 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 an 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 the Company has done in the past. There was no significant impact from the adoption of this pronouncement during the year ended December 31, 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 Company’s adoption of ASC 820-10 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 ASC 820-1- 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

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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 the 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 the Company’s 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 (the “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 is currently evaluating the 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

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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 all years presented 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 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. As of December 31, 2009, approximately $1.2 million was due to the Adviser, and as of December 31, 2008, approximately $0.1 was due from 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, and an incentive fee based on funds from operations (“FFO”). For the years ended December 31, 2009, 2008 and 2007, the Company recorded a base management fee of approximately $1.4 million, $1.6 million and $1.9 million, 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 years ended December 31, 2009, 2008 and 2007, the Company recorded an incentive fee of approximately $3.2 million, $2.8 million and $2.6 million, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $0.7 million, $2.2 million and $2.3 million, respectively, for a net incentive fee for the years ended December 31, 2009, 2008 and 2007, of approximately $2.5 million, $0.6 million and $0.3 million, 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 years ended December 31, 2009, 2008 and 2007 in order to support the current level of distributions to the Company’s stockholders. These waivers were applied through December 31, 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, internal counsel, 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 years ended

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December 31, 2009, 2008 and 2007 the Company recorded an administration fee of approximately $1.0 million, $1.0 million and $0.8 million, respectively.
3. Earnings per Common Share
The following tables set forth the computation of basic and diluted earnings per common share for the years ended December 31, 2009, 2008 and 2007:
                         
    For the year ended December 31,  
    2009     2008     2007  
Net income available to common stockholders
  $ 509,298     $ 819,197     $ 2,046,479  
Denominator for basic & diluted weighted average shares
    8,563,264       8,565,149       8,565,264  
 
                 
Basic & diluted earnings per common share
  $ 0.06     $ 0.10     $ 0.24  
 
                 
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 December 31, 2009 and 2008:
                 
    December 31, 2009     December 31, 2008  
Real estate:
               
Land
  $ 55,025,707 (1)   $ 55,226,042 (1)
Building and improvements
    325,907,479       325,515,390  
Tenant improvements
    9,820,706       9,820,706  
Accumulated depreciation
    (34,111,952 )     (24,757,576 )
 
           
Real estate, net
  $ 356,641,940     $ 365,804,562  
 
           
 
(1)   Includes land held under a capital lease carried at approximately $1.1 million.
On May 19, 2009, the Company extended the lease with one of its tenants in 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.
On November 18, 2009, the Company extended the lease with one of its tenants in its property located in Akron, Ohio for a period of five years. The lease was originally set to expire in February 2010, and will now expire in March 2015. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $160,000.

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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 December 31, 2009, were as follows:
         
    Tenant
Year   Lease Payments
2010   $ 38,922,256  
2011
    38,657,936  
2012
    38,751,645  
2013
    33,402,994  
2014
    29,172,473  
Thereafter
    160,527,477  
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 December 31, 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:
                                 
    December 31, 2009     December 31, 2008  
            Accumulated             Accumulated  
    Lease Intangibles     Amortization     Lease Intangibles     Amortization  
 
                               
In-place leases
  $ 15,935,445     $ (6,741,817 )   $ 15,981,245     $ (5,079,343 )
Leasing costs
    10,053,004       (3,832,623 )     9,662,731       (2,987,360 )
Customer relationships
    17,136,501       (4,373,049 )     17,136,501       (3,179,931 )
 
                       
 
  $ 43,124,950     $ (14,947,489 )   $ 42,780,477     $ (11,246,634 )
 
                       
The estimated aggregate amortization expense for each of the five succeeding fiscal years is as follows:
         
    Estimated
Year   Amortization Expense
2010   5,610,770
2011
    5,047,473  
2012
    4,309,990  
2013
    2,310,995  
2014
    2,051,524  
Thereafter
  $ 8,846,709  

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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 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 year ended December 31,  
    2009     2008     2007  
 
Operating revenue
  $ 56,202     $ 103,501     $ 103,501  
Operating expense
    (13,140 )     (63,575 )     (33,512 )
Net realized income from foreign currency transactions
                33,359  
Taxes refunded on sale of real estate
                78,667  
Gain on sale of real estate
    160,038              
 
                 
Income from discontinued operations
  $ 203,100     $ 39,926     $ 182,015  
 
                 
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 December 31, 2009, the interest rate was 7.5%.
The fair market value of the mortgage note receivable as of December 31, 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.

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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 December 31, 2009 and December 31, 2008 are summarized below:
                             
                 
    Date of   Principal   Stated Interest Rate   Principal Balance Outstanding  
    Issuance/   Maturity   at December 31,   December 31,     December 31,  
    Assumption   Date   2009 (1)   2009     2008  
 
                           
Fixed-Rate Mortgage Notes Payable:
                           
 
                           
 
  03/16/05   04/01/30   6.33%   $ 2,884,908     $ 2,948,753  
 
  08/25/05   09/01/15   5.33%     21,093,917       21,399,644  
 
  09/12/05   09/01/15   5.21%     12,389,647       12,560,673  
 
  12/21/05   12/08/15   5.71%     18,991,934       19,241,117  
 
  02/21/06   12/01/13   5.91%     9,188,044       9,344,908  
 
  02/21/06   06/30/14   5.20%     19,116,277       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%     14,009,918       14,281,616  
 
  11/22/06   12/01/16   5.76%     14,136,921       14,309,000  
 
  12/22/06   01/01/17   5.79%     21,605,106       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%     4,361,144       4,426,393  
 
  10/15/07   11/08/17   6.63%     15,657,330       15,828,612  
 
  08/29/08   06/01/16   6.80%     6,296,505       6,421,717  
 
  09/15/08   10/01/10 (2)  6.85%     48,015,000       48,015,000  
 
                       
Total Fixed-Rate Mortgage Notes Payable:
                252,761,651       255,111,173  
 
                       
 
                           
Variable-Rate Line of Credit:
  12/29/06   12/29/10 (3)  LIBOR + 1.9%     33,200,000       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       $ 285,961,651     $ 286,611,173  
 
                       
 
(1)   The weighted average interest rate on all debt outstanding at December 31, 2009 was approximately 5.59%.
 
(2)   This note has three annual extension options, which extends the term of the note until October 1, 2013.
 
(3)   The line of credit was extended for a one-year period through December 29, 2010.
 
(4)   The short-term loan was repaid in full on March 31, 2009.
Mortgage Notes Payable
As of December 31, 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 December 31, 2009 was approximately 6.0%.
The fair market value of all fixed-rate mortgage notes payable outstanding as of December 31, 2009 was approximately $239.1 million, as compared to the carrying value stated above of approximately $252.8 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.

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Scheduled principal payments of mortgage notes payable are as follows:
         
    Scheduled principal  
Year   payments  
2010
  $ 50,570,506 (1)
2011
    2,795,411  
2012
    3,083,429  
2013
    11,840,020  
2014
    20,401,572  
Thereafter
    164,070,713  
 
     
 
  $ 252,761,651  
 
     
 
(1)   The $48.0 million mortgage note issued in September 2008 matures in October 2010, and we expect to exercise our options to extend through October 2013.
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. 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.
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 requested that the Company obtain updated appraisals for the properties pledged under the line of credit as borrowing base collateral in connection with the extension of the Credit Agreement. As a result, the maximum amount that the Company may draw under the Credit Agreement was reduced to 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 removed 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 December 31, 2009, there was $33.2 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 December 31, 2009, the remaining borrowing capacity available under the line of credit was approximately $8.3 million. The Company was in compliance with all covenants under the Credit

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Agreement as of December 31, 2009. The amount outstanding on the line of credit as of December 31, 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
Distributions paid per common share for the years ended December 31, 2009, 2008 and 2007 were $1.50, $1.50 and $1.44 per share, respectively. Distributions paid per share of Series A Preferred Stock for each of the years ended December 31, 2009, 2008 and 2007 were approximately $1.94 per share. Distributions paid per share of Series B Preferred Stock for each of the years ended December 31, 2009, 2008 and 2007 were approximately $1.88 per share. For Federal income tax purposes, distributions paid to stockholders may be characterized as ordinary income, capital gains or return of capital. The characterization of distributions during each of the last three years is reflected in the table below:
                         
    Ordinary   Return of   Long-Term
    Income   Capital   Capital Gains
 
                       
Common Stock
                       
For the year ended December 31, 2007
    25.86040 %     74.13960 %     0.00000 %
For the year ended December 31, 2008
    9.26770 %     90.73230 %     0.00000 %
For the year ended December 31, 2009
    6.04080 %     93.95920 %     0.00000 %
 
                       
Series A Preferred Stock
                       
For the year ended December 31, 2007
    100.00000 %     0.00000 %     0.00000 %
For the year ended December 31, 2008
    100.00000 %     0.00000 %     0.00000 %
For the year ended December 31, 2009
    100.00000 %     0.00000 %     0.00000 %
 
                       
Series B Preferred Stock
                       
For the year ended December 31, 2007
    100.00000 %     0.00000 %     0.00000 %
For the year ended December 31, 2008
    100.00000 %     0.00000 %     0.00000 %
For the year ended December 31, 2009
    100.00000 %     0.00000 %     0.00000 %

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The following table is a summary of all outstanding notes issued to employees of the Adviser for the exercise of stock options:
                                                         
                            Outstanding                    
                    Amount of     Balance of     Outstanding              
    Number of     Strike Price     Promissory Note     Employee     Balance of     Maturity     Interest  
    Options     of Options     Issued to     Loans at     Employee Loans     Date of     Rate on  
Date Issued   Exercised     Exercised     Employees     12/31/09     at 12/31/08     Note     Note  
 
Sep 2004
    25,000     $ 15.00     $ 375,000     $ 358,405     $ 365,927     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
    2,500       16.01       40,000       (1)     38,365     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       193,200       193,200     Oct 2015     8.17 %
Nov 2006
    25,000       15.00       375,000       (2)     245,000     Dec 2016     8.15 %
Nov 2006
    25,000       15.00       375,000       375,000       375,000     Nov 2015     8.15 %
 
                                               
 
                                                       
 
    172,922             $ 2,736,594     $ 2,304,999     $ 2,595,886                  
 
                                               
 
(1)   This loan was paid in full on July 1, 2009.
 
(2)   This loan was to a former employee of the Adviser and accordingly was transferred from notes receivable — employees to other assets in connection with the that employee’s termination of employment with the Adviser and the later amendment of the loan. The interest on the loan from the date the employee stopped working for the Adviser is included in other income on the consolidated statement of operations.
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.
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 and sell shares of its common stock with an aggregate sales price of up to $25.0 million through or to Jefferies, for resale. To date, the Company has not sold any 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 its dealer manager in connection with a proposed continuous private offering of up to 3,333,333 shares of its newly designated senior common stock at $15.00 per share. To date, the Company has not sold any senior common stock under the Dealer Manager Agreement.
9. Segment Information
As of December 31, 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 years ended December 31, 2009, 2008 and 2007:

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    As of and for the year ended December 31, 2009  
    Real Estate     Real Estate              
    Leasing     Lending     Other     Total  
 
                               
Operating revenues
  $ 41,848,520     $ 760,417     $     $ 42,608,937  
Operating expenses
    (14,260,070 )           (6,280,459 )(1)     (20,540,529 )
Other expense
    (16,480,535 )           (1,187,925 )(2)     (17,668,460 )
Discontinued operations
    203,100                   203,100  
 
                       
Net income
  $ 11,311,015     $ 760,417     $ (7,468,384 )   $ 4,603,048  
 
                       
 
                               
Total Assets
  $ 399,867,563     $ 10,000,000     $ 6,997,810     $ 416,865,373  
 
                       
 
                               
                                 
    As of and for the year ended December 31, 2008  
    Real Estate     Real Estate              
    Leasing     Lending     Other     Total  
 
                               
Operating revenues
  $ 39,908,924     $ 898,573     $     $ 40,807,497  
Operating expenses
    (14,863,138 )           (4,500,585 )(1)     (19,363,723 )
Other expense
    (13,769,417 )           (2,801,336 )(2)     (16,570,753 )
Discontinued operations
    39,926                   39,926  
 
                       
Net income
  $ 11,316,295     $ 898,573     $ (7,301,921 )   $ 4,912,947  
 
                       
 
                               
Total Assets
  $ 413,760,683     $ 10,000,000     $ 5,338,102     $ 429,098,785  
 
                       
                                 
    As of and for the year ended December 31, 2007  
    Real Estate     Real Estate              
    Leasing     Lending     Other     Total  
 
                               
Operating revenues
  $ 31,676,149     $ 1,013,889     $     $ 32,690,038  
Operating expenses
    (11,437,986 )           (4,353,444 )(1)     (15,791,430 )
Other expense
    (10,860,826 )           (79,568 )(2)     (10,940,394 )
Discontinued operations
    182,015                   182,015  
 
                       
Net income
  $ 9,559,352     $ 1,013,889     $ (4,433,012 )   $ 6,140,229  
 
                       
 
                               
Total Assets
  $ 366,231,132     $ 10,086,111     $ 2,585,446     $ 378,902,689  
 
                       
 
                               
 
(1)   Operating expenses includes base management fees, incentive fees, adminstration fees, professional fees, insurance expense, directors fees, stockholder related expenses and general and administrative expenses that are not practicable to allocate to either operating segment, thus it is included in the “other” column.
 
(2)   Other expense includes interest expense on the Company’s line of credit and short-term loan of $1,414,001, $3,089,270 and $703,715 for the years ended December 31, 2009, 2008 and 2007, respectively. It is not practicable to allocate the interest from the line of credit or short-term loan to either operating segment, thus it is included in the “other” column.

80


 

10. Quarterly Financial Information (unaudited)
The following table reflects the quarterly results of operations for the years ended December 31, 2009 and 2008, certain amounts from prior quarters’ financial statements have been reclassified to conform to the current quarter’s presentation. These reclassifications had no effect on previously reported net income or stockholders’ equity.
                                 
    Year ended December 31, 2009
    Quarter ended     Quarter ended     Quarter ended     Quarter ended  
    March 31, 2009     June 30, 2009     September 30, 2009     December 31, 2009  
 
                               
Operating revenues
  $ 10,658,176     $ 10,651,489     $ 10,657,094     $ 10,642,178  
Operating expenses
    5,165,052       5,181,837       5,069,018       5,124,622  
Other expense
    (4,421,393 )     (4,373,632 )     (4,473,194 )     (4,400,241 )
 
                       
Income from continuing operations
    1,071,731       1,096,020       1,114,882       1,117,315  
Discontinued operations
    17,838       20,916       164,108       238  
 
                       
Net income
    1,089,569       1,116,936       1,278,990       1,117,553  
Dividends attributable to preferred stock
    (1,023,437 )     (1,023,437 )     (1,023,437 )     (1,023,439 )
 
                       
Net income available to common stockholders
    66,132       93,499       255,553       94,114  
 
                               
Net income available to common stockholders — basic & diluted
  $ 0.01     $ 0.01     $ 0.03     $ 0.01  
 
                               
Weighted average shares outstanding — basic & diluted
    8,563,264       8,563,264       8,563,264       8,563,264  
                                 
    Year ended December 31, 2008
    Quarter ended     Quarter ended     Quarter ended     Quarter ended  
    March 31, 2008     June 30, 2008     September 30, 2008     December 31, 2008  
 
                               
Operating revenues
  $ 9,487,601     $ 10,199,583     $ 10,431,268     $ 10,689,045  
Operating expenses
    4,371,325       5,099,235       5,014,602       4,878,561  
Other expense
    (3,685,063 )     (3,899,215 )     (4,292,698 )     (4,693,777 )
 
                       
Income from continuing operations
    1,431,213       1,201,133       1,123,968       1,116,707  
Discontinued operations
    (14,511 )     18,312       17,591       18,534  
 
                       
Net income
    1,416,702       1,219,445       1,141,559       1,135,241  
Distributions attributable to preferred stock
    (1,023,437 )     (1,023,437 )     (1,023,437 )     (1,023,439 )
 
                       
Net income available to common stockholders
    393,265       196,008       118,122       111,802  
 
                               
Net income available to common stockholders — basic & diluted
  $ 0.05     $ 0.02     $ 0.02     $ 0.01  
 
                               
Weighted average shares outstanding — basic & diluted
    8,565,264       8,565,264       8,565,264       8,564,807  
11. Subsequent Events
The Company evaluated all events that have occurred subsequent to December 31, 2009 through February 24, 2010, the date of the filing of this Form 10-K.
On January 12, 2010, 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 January, February and March of 2010. Monthly distributions will be payable on January 29, 2010, February 26, 2010 and March 31, 2010, to those stockholders of record as of the close of business on January 21, 2010, February 18, 2010 and March 23, 2010, respectively.
On February 1, 2010, the maturity date for a $245,000 employee stock option loan to a former employee of the Adviser was extended from February 2010 to August 2010. The former employee was also granted the option to either repay the principal and interest in full or return the pledged shares to the Company in full satisfaction of the loan. If the employee returns the pledged shares in satisfaction of the loan, the Company would be required to record compensation expense if the market value of the pledged shares on the date of repayment is less than the outstanding principal balance of the loan. As of February 18, 2010, the market value of the pledged shares was in excess of the outstanding principal balance of the loan.

81


 

GLADSTONE COMMERCIAL CORPORATION
SCHEDULE III — REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2009
                                                                                 
            Initial Cost     Costs Capitalized     Total Cost                      
                    Buildings &     Subsequent to             Buildings &             Accumulated             Date  
Location of Property   Encumbrances     Land     Improvements     Acquisition     Land     Improvements     Total(1)     Depreciation(2)     Net Real Estate     Acquired  
Raleigh, North Carolina Office Building
  $ 4,939,999     $ 960,000     $ 4,480,772     $     $ 960,000     $ 4,480,772     $ 5,440,772     $ 1,086,838     $ 4,353,934       12/23/2003  
Canton, Ohio Office & Warehouse Building
    2,903,516       186,739       3,082,007             186,739       3,082,007       3,268,746       520,837       2,747,909       1/30/2004  
Akron, Ohio Office & Laboratory Building
    7,440,875       1,974,000       6,769,565       34,926       1,974,000       6,804,491       8,778,491       1,009,627       7,768,864       4/29/2004  
Charlotte, North Carolina Office Building
    6,907,853       741,296       8,423,389       59,190       741,296       8,482,579       9,223,875       1,213,977       8,009,898       6/30/2004  
Canton, North Carolina Commercial & Manufacturing Building
    2,884,908       150,000       5,050,000             150,000       5,050,000       5,200,000       709,395       4,490,605       7/6/2004  
Snyder Township, Pennsylvania Commercial & Warehouse Building
    5,622,612       100,000       6,573,902       135,175       100,000       6,709,077       6,809,077       917,082       5,891,995       8/5/2004  
Lexington, North Carolina Commercial & Warehouse Building
    2,846,353       819,760       2,106,845       6,637       819,760       2,113,482       2,933,242       293,485       2,639,757       8/5/2004  
Austin, Texas Office Building
    6,500,000       1,000,000       6,295,794       46,095       1,000,000       6,341,889       7,341,889       877,479       6,464,410       9/16/2004  
Mt. Pocono, Pennsylvania Commercial & Manufacturing Building
    5,240,313       350,000       5,818,703       18,430       350,000       5,837,133       6,187,133       791,067       5,396,066       10/15/2004  
San Antonio, Texas Flexible Office Building
    7,172,691       843,000       7,513,750       22,673       843,000       7,536,423       8,379,423       1,249,219       7,130,204       2/10/2005  
Columbus, Ohio Industrial Building
    2,733,214       410,000       2,385,108             410,000       2,385,108       2,795,108       302,401       2,492,707       2/10/2005  
Big Flats, New York Industrial Building
    5,630,000       275,000       6,459,318       33,666       275,000       6,492,984       6,767,984       790,812       5,977,172       4/15/2005  
Wichita, Kansas Office Building
    8,492,719       1,525,000       9,702,731       67,611       1,525,000       9,770,342       11,295,342       1,228,451       10,066,891       5/18/2005  
Arlington, Texas Warehouse & Bakery Building
    4,117,875       635,964       3,694,876       45,003       635,964       3,739,879       4,375,843       451,104       3,924,739       5/26/2005  
Dayton, Ohio Office Building
    2,045,256       525,000       1,876,992       119,736       525,000       1,996,728       2,521,728       329,244       2,192,484       6/30/2005  
Eatontown, New Jersey Office Building
    4,580,000       1,350,630       3,520,062       6,681       1,350,630       3,526,743       4,877,373       473,882       4,403,491       7/7/2005  
Frankling Township, New Jersey Office & Warehouse Building
    6,790,000       1,631,534       6,199,849             1,631,534       6,199,849       7,831,383       712,307       7,119,076       7/11/2005  
Duncan, South Carolina Office & Warehouse Building
    11,361,811       783,212       10,790,451       2,033,148       783,212       12,823,599       13,606,811       1,386,290       12,220,521       7/14/2005  
Duncan, South Carolina Manufacturing Building
    2,824,252       194,686       2,682,227             194,686       2,682,227       2,876,913       344,596       2,532,317       7/14/2005  
Hazelwood, Missouri Office & Warehouse Building
    2,360,000       763,178       2,309,058       29,962       763,178       2,339,020       3,102,198       276,829       2,825,369       8/5/2005  

82


 

GLADSTONE COMMERCIAL CORPORATION
SCHEDULE III — REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
DECEMBER 31, 2009
                                                                                 
            Initial Cost     Costs Capitalized     Total Cost                      
                    Buildings &     Subsequent to             Buildings &             Accumulated             Date  
Location of Property   Encumbrances     Land     Improvements     Acquisition     Land     Improvements     Total(1)     Depreciation(2)     Net Real Estate     Acquired  
Angola, Indiana Industrial Building
  $ 596,577     $ 65,780     $ 1,074,758     $     $ 65,780     $ 1,074,758     $ 1,140,538     $ 105,517     $ 1,035,021       9/2/2005  
Angola, Indiana Industrial Building
    1,193,145       131,559       1,129,874             131,559       1,129,874       1,261,433       211,032       1,050,401       9/2/2005  
Rock Falls, Illinois Industrial Building
    318,168       35,082       1,113,340             35,082       1,113,340       1,148,422       56,275       1,092,147       9/2/2005  
Newburyport, Massachusetts Industrial Building
    6,770,510       628,690       6,504,056       1,846,895       628,690       8,350,951       8,979,641       783,828       8,195,813       10/17/2005  
Clintonville, Wisconsin Industrial Manufacturing Building
    3,409,309       54,674       4,717,090             54,674       4,717,090       4,771,764       518,701       4,253,063       10/31/2005  
Maple Heights, Ohio Industrial Building
    10,636,109       1,608,976       10,065,475       987,265       1,608,976       11,052,740       12,661,716       1,202,647       11,459,069       12/21/2005  
Richmond, Virginia Industrial Building
    5,275,000       735,820       5,335,863       36,437       735,820       5,372,300       6,108,120       598,251       5,509,869       12/30/2005  
Toledo, Oho Industrial Building
    2,966,919       263,068       2,811,801       39,916       263,068       2,851,717       3,114,785       351,654       2,763,131       12/30/2005  
South Hadley, Massachusetts Industrial Building
    2,418,750       470,636       2,765,376       10,000       470,636       2,775,376       3,246,012       275,004       2,971,008       2/15/2006  
Champaign, Illinois Office Building
    1,731,319       686,979       2,035,784       10,546       686,979       2,046,330       2,733,309       227,832       2,505,477       2/21/2006  
Champaign, Illinois Office Building
    3,394,744       1,347,017       3,991,733             1,347,017       3,991,733       5,338,750       446,730       4,892,020       2/21/2006  
Champaign, Illinois Office Building
    2,121,715       841,886       2,494,833             841,886       2,494,833       3,336,719       279,206       3,057,513       2/21/2006  
Champaign, Illinois Office Building
    1,940,266       769,888       2,281,475             769,888       2,281,475       3,051,363       255,329       2,796,034       2/21/2006  
Roseville, Minnesota Office Building
    19,116,278       2,587,757       25,290,127             2,587,757       25,290,127       27,877,884       3,051,186       24,826,698       2/21/2006  
Burnsville, Minnesota Office Building
    11,867,677       3,510,711       8,746,407             3,510,711       8,746,407       12,257,118       1,083,501       11,173,617       5/10/2006  
Menomonee Falls, Wisconsin Industrial Building
    6,940,000       624,700       6,910,616             624,700       6,910,616       7,535,316       630,547       6,904,769       6/30/2006  
Baytown, Texas Office Building
    2,000,000       221,314       2,443,469             221,314       2,443,469       2,664,783       251,080       2,413,703       7/11/2006  
Sterling Heights, Michigan Industrial Building
          2,734,887       8,606,190       12,676       2,734,887       8,618,866       11,353,753       723,554       10,630,199       9/22/2006  
Birmingham, Alabama Industrial Building
          611,597       2,325,761             611,597       2,325,761       2,937,358       198,766       2,738,592       9/29/2006  
Montgomery, Alabama Industrial Building
          221,965       844,081             221,965       844,081       1,066,046       72,137       993,909       9/29/2006  
Columbia, Missouri Industrial Building
          145,988       555,157             145,988       555,157       701,145       47,445       653,700       9/29/2006  

83


 

GLADSTONE COMMERCIAL CORPORATION
SCHEDULE III — REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
DECEMBER 31, 2009
                                                                                 
            Initial Cost     Costs Capitalized     Total Cost                      
                    Buildings &     Subsequent to             Buildings &             Accumulated             Date  
Location of Property   Encumbrances     Land     Improvements     Acquisition     Land     Improvements     Total(1)     Depreciation(2)     Net Real Estate     Acquired  
Mason, Ohio
Office Building
  $ 5,400,000     $ 797,274     $ 6,258,344     $ 47,471     $ 797,274     $ 6,305,815     $ 7,103,089     $ 607,885     $ 6,495,204       1/5/2007  
Raleigh, North Carolina
Industrial Building
    5,534,866       1,605,551       5,513,353             1,605,551       5,513,353       7,118,904       415,958       6,702,946       2/16/2007  
Tulsa, Oklahoma
Manufacturing Building
                14,057,227                   14,057,227       14,057,227       1,196,825       12,860,402       3/1/2007  
Hialeah, Florida
Industrial Building
          3,562,452       6,671,600             3,562,452       6,671,600       10,234,052       484,367       9,749,685       3/9/2007  
Tewksbury, Massachusetts
Industrial Building
          1,394,902       8,893,243             1,394,822       8,893,243       10,288,065       647,665       9,640,400       5/17/2007  
Mason, Ohio Retail Building
    4,882,152       1,201,338       4,960,987             1,201,338       4,960,987       6,162,325       320,260       5,842,065       7/1/2007  
Cicero, New York
Industrial Building
    4,361,144       299,066       5,018,628             299,066       5,018,628       5,317,694       298,472       5,019,222       9/6/2007  
Grand Rapids, Michigan
Office Building
    9,225,000       1,629,270       10,500,066             1,629,270       10,500,066       12,129,336       668,003       11,461,333       9/28/2007  
Bollingbrook, Illinois
Industrial Building
    4,968,750       1,271,543       5,003,124             1,271,543       5,003,124       6,274,667       308,974       5,965,693       9/28/2007  
Decatur, Georgia
Office Building
          784,188       3,245,281             784,188       3,245,281       4,029,469       179,411       3,850,058       12/13/2007  
Decatur, Georgia
Office Building
    1,117,698       204,807       847,573             204,807       847,573       1,052,380       46,857       1,005,523       12/13/2007  
Decatur, Georgia
Office Building
    1,403,002       257,086       1,063,925             257,086       1,063,925       1,321,011       58,818       1,262,193       12/13/2007  
Lawrenceville, Georgia
Office Building
    3,704,723       678,854       2,809,365             678,854       2,809,365       3,488,219       155,312       3,332,907       12/13/2007  
Snellville, Georgia
Office Building
    961,622       176,208       729,217             176,208       729,217       905,425       40,314       865,111       12/13/2007  
Covington, Georgia
Office Building
    1,265,292       231,852       959,496             231,852       959,496       1,191,348       53,045       1,138,303       12/13/2007  
Cumming, Georgia
Office Building
    4,028,089       738,107       3,054,580             738,107       3,054,580       3,792,687       168,869       3,623,818       12/13/2007  
Conyers, Georgia
Office Building
    1,619,574       296,771       1,228,155             296,771       1,228,155       1,524,926       67,897       1,457,029       12/13/2007  

84


 

GLADSTONE COMMERCIAL CORPORATION
SCHEDULE III — REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2009
                                                                                 
            Initial Cost     Costs Capitalized     Total Cost                      
                    Buildings &     Subsequent to             Buildings &             Accumulated             Date  
Location of Property   Encumbrances     Land     Improvements     Acquisition     Land     Improvements     Total(1)     Depreciation(2)     Net Real Estate     Acquired  
Reading, Pennsylvania
Industrial Building
  $ 5,257,500     $ 490,646     $ 6,202,376     $     $ 490,646     $ 6,202,376     $ 6,693,022     $ 306,759     $ 6,386,263       1/29/2008  
Fridley, Minnesota
Office Building
          1,354,233       8,073,526             1,354,233       8,073,526       9,427,759       584,131       8,843,628       2/26/2008  
Concord Township, Ohio
Industrial Building
          1,796,467       11,154,123             1,786,212       11,154,123       12,940,335       538,336       12,401,999       3/31/2008  
Pineville, North Carolina
Industrial Building
    2,145,000       669,025       3,028,320             669,025       3,028,320       3,697,345       133,612       3,563,733       4/30/2008  
Marietta, Ohio
Industrial Building
    4,500,000       829,014       6,607,265             829,014       6,607,265       7,436,279       229,063       7,207,216       8/29/2008  
Chalfont, Pennsylvania
Industrial Building
    6,296,506       1,249,415       6,419,607             1,249,415       6,419,607       7,669,022       265,975       7,403,047       8/29/2008  
 
                                                                               
 
                                                           
 
  $ 252,761,651     $ 55,036,042     $ 330,078,046     $ 5,650,139     $ 55,025,707     $ 335,728,185     $ 390,753,892     $ 34,111,952     $ 356,641,940          
 
                                                             
 
(1)   The aggregate cost for land and building improvements for federal income tax purposes is the same as the total gross cost of land and building improvements.
 
(2)   Depreciable life of all buildings is 39 years. Depreciable life of all improvements is the shorter of the useful life of the assets or the life of the respective leases on each building, which range from 5-20 years.

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The following table reconciles the change in the balance of real estate during the years ended December 31, 2009, 2008 and 2007, respectively:
                         
    2009     2008     2007  
 
                       
Balance at beginning of period
  $ 390,562,138     $ 340,500,406     $ 243,713,542  
 
                       
Acquisitions during period
          47,874,020       95,396,039  
 
                       
Improvements or other additions
    1,139,711       2,187,712       1,390,825  
 
                       
Dispositions during period
    (947,957 )            
 
                 
 
                       
Balance at end of period
  $ 390,753,892     $ 390,562,138     $ 340,500,406  
 
                 
The following table reconciles the change in the balance of accumulated depreciation during the years ended December 31, 2009, 2008 and 2007, respectively:
                         
    2009     2008     2007  
 
                       
Balance at beginning of period
  $ 24,757,576     $ 15,738,634     $ 8,595,419  
 
                       
Additions during period
    9,445,768       9,018,942       7,143,215  
 
                       
Dispositions during period
    (91,392 )            
 
                 
 
                       
Balance at end of period
  $ 34,111,952     $ 24,757,576     $ 15,738,634  
 
                 

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GLADSTONE COMMERCIAL CORPORATION
SCHEDULE IV — MORTGAGE LOANS ON REAL ESTATE
DECEMBER 31, 2009
                                             
Location and Type of Real           Final
Maturity
          Face Amount of     Carrying
Amount of
    Principal Amount of Loans
Subject to Delinquent
 
Estate   Type of Loan   Interest Rate   Date   Periodic Payment Term   Prior Lien   Mortgage     Mortgage (1)     Principal or Interest  
 
                                           
McLean, Virginia; Office Property
  First Mortgage   1 month LIBOR +6%; Floor of 7.5%, Ceiling of 10%   5/30/2017   Monthly payment based upon a 24 year amortization term, which changes based on LIBOR, with a floor of 7.5% and a ceiling of 10%. Payments are interest only until June 2011. Balloon payment at maturity is $8,221,344.     $ 10,000,000     $ 10,000,000     $  
 
                                           
 
                      $ 10,000,000     $ 10,000,000          
 
                                           
 
(1)   The aggregate cost for federal income tax purposes is the same as the total gross cost.
The following table reconciles the change in the balance of mortgage loans on real estate during the years ended December 31, 2009, 2008 and 2007, respectively:
                         
    2009     2008     2007  
 
                       
Balance at beginning of period
  $ 10,000,000     $ 10,000,000     $ 10,000,000  
 
                       
Collections of principal
                 
 
                 
 
Balance at end of period
  $ 10,000,000     $ 10,000,000     $ 10,000,000  
 
                 

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures
a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2009, our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were effective as of December 31, 2009 in providing a reasonable level of assurance that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in applicable SEC rules and forms, including providing a reasonable level of assurance that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate to allow timely decisions regarding required disclosure. However, in evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of necessarily achieving the desired control objectives, and management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
b) Management’s Annual Report on Internal Control Over Financial Reporting
Refer to Management’s Report on Internal Controls over Financial Reporting located in Item 8 of this Form 10-K.
c) Attestation Report of the Registered Public Accounting Firm
Refer to the Report of Independent Registered Public Accounting Firm located in Item 8 of this Form 10-K.
d) Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
Not applicable.

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PART III
We will file a definitive Proxy Statement for our 2010 Annual Meeting of Stockholders (the “2010 Proxy Statement”) with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year. Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form 10-K. Only those sections of the 2010 Proxy Statement that specifically address the items set forth herein are incorporated by reference.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Ethics.”
Item 11. Executive Compensation
The information required by Item 11 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Executive Compensation” and “Director Compensation.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is hereby incorporated by reference from our 2010 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management.”
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Transactions with Related Persons” and “Information Regarding the Board of Directors and Corporate Governance.”
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is hereby incorporated by reference from our 2010 Proxy Statement under the captions “Independent Registered Public Accounting Firm Fees” and “Pre-Approval Policy and Procedures.”

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PART IV
Item 15. Exhibits and Financial Statement Schedules
a.   DOCUMENTS FILED AS PART OF THIS REPORT
  1.   The following financial statements are filed herewith:
    Report of Management on Internal Controls over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2009 and December 31, 2008
Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2009, 2008 and 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007
Notes to Financial Statements
  2.   Financial statement schedules
    Schedule III — Real Estate and Accumulated Depreciation is filed herewith.
Schedule IV — Mortgage Loans on Real Estate is filed herewith.
All other schedules are omitted because they are not applicable, or because the required information is included in the financial statements or notes thereto.
  3.   Exhibits
    The following exhibits are filed as part of this report or hereby incorporated by reference to exhibits previously filed with the Securities and Exchange Commission:

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Exhibit Index
     
Exhibit   Description of Document
3.1
  Amended and Restated Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-11 (File No. 333-106024), filed September 11, 2003.
 
   
3.1.1
  Articles of Amendment to Articles of Amended and Restated Articles of Incorporation, incorporated by reference to Exhibit 3.1.1 to the Form 10-Q (File No. 001-33097), filed July 30, 2009.
 
   
3.2
  Bylaws, incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-11 (File No. 333-106024), filed September 11, 2003.
 
   
3.2.1
  First Amendment to Bylaws, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K (File No. 000-50363), filed July 10, 2007.
 
   
4.1
  Articles Supplementary Establishing and Fixing the Rights and Preferences of the 7.75% Series A Cumulative Redeemable Preferred Stock, incorporated by reference to Exhibit 3.3 of Form 8-A (File No. 000-50363), filed January 19, 2006.
 
   
4.2
  Articles Supplementary Establishing and Fixing the Rights and Preferences of the 7.5% Series B Cumulative Redeemable Preferred Stock, incorporated by reference to Exhibit 3.4 of Form 8-A (File No. 000-50363), filed October 19, 2006.
 
   
4.3
  Form of Certificate for 7.75% Series A Cumulative Redeemable Preferred Stock of Gladstone Commercial Corporation, incorporated by reference to Exhibit 4.1 of Form 8-A (File No. 000-50363), filed January 19, 2006.
 
   
4.4
  Form of Certificate for 7.5% Series B Cumulative Redeemable Preferred Stock of Gladstone Commercial Corporation, incorporated by reference to Exhibit 4.2 of Form 8-A (File No. 000-50363), filed October 19, 2006.
 
   
10.1
  Real Property Purchase and Sale Agreement between 3058348 Nova Scotia Company, 3058349 Nova Scotia Company and Gladstone Commercial Limited Partnership, dated August 11, 2004, incorporated by reference to Exhibit 10.4 to the Form 10-K (File No. 000-50363), filed March 8, 2005.
 
   
10.2
  Real Property Purchase and Sale Agreement between PBC— Pocono, L.L.C., PBC— Norfolk, L.L.C. and Gladstone Commercial Limited Partnership, dated August 11, 2004, incorporated by reference to Exhibit 10.5 to the Form 10-K (File No. 000-50363), filed March 8, 2005.
 
   
10.3
  Promissory Note between Key Bank National Association and CMI04 Canton NC LLC, dated March 14, 2005, incorporated by reference to Exhibit 10.1 of the Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 (File No. 000-50363), filed May 4, 2005.
 
   
10.4
  Loan Agreement between AFL05 Duncan SC LLC and Little Arch Charlotte NC LLC and Bank of America, N.A., dated as of August 25, 2005, incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K (File No. 000-50363), filed August 29, 2005.
 
   
10.5
  Promissory Note between AFL05 Duncan SC LLC and Little Arch Charlotte NC LLC and Bank of America, N.A., dated as of August 25, 2005, incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K (File No. 000-50363), filed August 29, 2005.
 
   
10.6
  Mortgage and Security Agreement between 260 Springside Drive, Akron OH LLC and JP Morgan Chase Bank, N.A., dated as of September 12, 2005, incorporated by reference to

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Exhibit   Description of Document
 
  Exhibit 10.6 of the Current Report on Form 8-K (File No. 000-50363), filed September 13, 2005.
 
   
10.7
  Fixed Rate Note between 260 Springside Drive, Akron OH LLC and JP Morgan Chase Bank, N.A., dated as of September 12, 2005, incorporated by reference to Exhibit 10.7 of the Current Report on Form 8-K (File No. 000-50363), filed September 13, 2005.
 
   
10.8
  Loan Agreement between PZ05 Maple Heights OH LLC, WMI05 Columbus OH LLC, and OB Crenshaw GCC, LP, and Countrywide Commercial Real Estate Finance, Inc., dated as of December 21, 2005, incorporated by reference to Exhibit 10.8 of the Current Report on Form 8-K (File No. 000-50363), filed December 22, 2005.
 
   
10.9
  Promissory Note between PZ05 Maple Heights OH LLC, WMI05 Columbus OH LLC, and OB Crenshaw GCC, LP, and Countrywide Commercial Real Estate Finance, Inc., dated as of December 21, 2005, incorporated by reference to Exhibit 10.9 of the Current Report on Form 8-K (File No. 000-50363), filed December 22, 2005.
 
   
10.10
  First Amended and Restated Agreement of Limited Partnership of Gladstone Commercial Limited Partnership, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K (File No. 000-50363), filed February 1, 2006.
 
   
10.11
  Loan agreement between Stonewater Dox Funding LLC and Wells Fargo Bank, National Association, dated as of November 21, 2003, incorporated by reference to Exhibit 10.20 of the Current Report on Form 8-K (File No. 000-50363), filed February 24, 2006.
 
   
10.12
  Assumption agreement between Stonewater Dox Funding LLC, ACI06 Champaign IL LLC, Gladstone Commercial Corporation and LaSalle Bank National Association, dated as of February 21, 2006, incorporated b