UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

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

COMMISSION FILE NUMBER: 001-33097

GLADSTONE COMMERCIAL CORPORATION

(Exact name of registrant as specified in its charter)

MARYLAND		02-0681276
(State or other jurisdiction of incorporation or 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)

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 Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

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

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

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

The number of shares of the registrant’s Common Stock, $0.001 par value, outstanding as of October 29, 2010 was 8,605,264.

 

 

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

TABLE OF CONTENTS

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

		September 30, 2010				December 31, 2009
ASSETS
Real estate, at cost		$	391,502,046			$	390,753,892
Less: accumulated depreciation			41,268,421				34,111,952
Total real estate, net			350,233,625				356,641,940
Lease intangibles, net			25,348,564				28,177,461
Mortgage note receivable			—				10,000,000
Cash and cash equivalents			3,230,471				3,096,598
Restricted cash			2,606,065				2,633,538
Funds held in escrow			2,714,936				2,487,680
Deferred rent receivable			10,020,329				8,975,196
Deferred financing costs, net			2,553,660				3,136,055
Other assets			864,726				1,716,905
TOTAL ASSETS		$	397,572,376			$	416,865,373
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Mortgage notes payable		$	250,781,740			$	252,761,651
Borrowings under line of credit			22,700,000				33,200,000
Deferred rent liability			2,507,408				3,213,195
Asset retirement obligation liability			2,414,048				2,305,644
Accounts payable and accrued expenses			1,662,045				2,086,741
Due to Adviser			1,720,203				1,213,640
Other liabilities			3,726,929				3,633,960
Total Liabilities			285,512,373				298,414,831
STOCKHOLDERS’ EQUITY
Redeemable preferred stock, $0.001 par value; $25 liquidation preference; 2,300,000 shares authorized and 2,150,000 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			2,150				2,150
Senior common stock, $0.001 par value; 7,500,0000 shares authorized and 51,737 and 0 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			52				—
Common stock, $0.001 par value, 40,200,000 shares authorized and 8,605,264 and 8,563,264 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			8,605				8,563
Additional paid in capital			172,023,461				170,622,581
Notes receivable — employees			(1,516,016	)			(2,304,999	)
Distributions in excess of accumulated earnings			(58,458,249	)			(49,877,753	)
Total Stockholders’ Equity			112,060,003				118,450,542
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	397,572,376			$	416,865,373

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		For the three months ended September 30,								For the nine months ended September 30,
		2010				2009				2010				2009
Operating revenues
Rental income		$	10,209,211			$	10,383,002			$	31,033,797			$	31,150,423
Interest income from mortgage note receivable			43,750				191,667				420,833				568,750
Tenant recovery revenue			81,452				82,425				246,147				247,593
Total operating revenues			10,334,413				10,657,094				31,700,777				31,966,766
Operating expenses
Depreciation and amortization			3,280,048				3,284,723				9,992,411				9,875,156
Property operating expenses			262,686				219,537				738,327				687,129
Due diligence expense			—				—				20,788				16,433
Base management fee			298,393				342,743				907,098				1,073,041
Incentive fee			1,070,145				835,003				2,745,601				2,433,945
Administration fee			356,856				293,075				807,859				774,636
Professional fees			1,822,683				105,368				2,200,094				466,529
Insurance expense			53,219				50,757				166,056				147,561
Directors’ fees			54,533				49,459				152,976				149,547
General and administrative			83,656				88,617				317,669				356,894
Total operating expenses before credit from Adviser			7,282,219				5,269,282				18,048,879				15,980,871
Credit to incentive fee			—				(200,264	)			(56,073	)			(564,968	)
Total operating expenses			7,282,219				5,069,018				17,992,806				15,415,903
Other income (expense)
Interest income from temporary investments			114				524				492				17,989
Interest income — employee loans			36,557				48,130				122,231				145,878
Other income			3,309,887				—				3,318,216				11,320
Interest expense			(4,370,500	)			(4,521,848	)			(13,027,872	)			(13,443,405	)
Total other expense			(1,023,942	)			(4,473,194	)			(9,586,933	)			(13,268,218	)
Income from continuing operations			2,028,252				1,114,882				4,121,038				3,282,645
Discontinued operations
Income from discontinued operations			—				4,070				—				42,823
Gain on sale of real estate			—				160,038				—				160,038
Total discontinued operations			—				164,108				—				202,861
Net income			2,028,252				1,278,990				4,121,038				3,485,506
Distributions attributable to preferred stock			(1,023,437	)			(1,023,437	)			(3,070,313	)			(3,070,312	)
Distributions attributable to senior common stock			(4,282	)			—				(4,657	)			—
Net income available to common stockholders		$	1,000,533			$	255,553			$	1,046,068			$	415,194
Earnings per weighted average share of common stock — basic
Income from continuing operations (net of distributions attributable to preferred stock)		$	0.12			$	0.01			$	0.12			$	0.03
Discontinued operations			0.00				0.02				0.00				0.02
Net income available to common stockholders		$	0.12			$	0.03			$	0.12			$	0.05
Earnings per weighted average share of common stock — diluted
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.12			$	0.01			$	0.12			$	0.03
Discontinued operations			0.00				0.02				0.00				0.02
Net income available to common stockholders		$	0.12			$	0.03			$	0.12			$	0.05
Weighted average shares of common stock outstanding — basic			8,562,777				8,563,264				8,555,517				8,563,264
Weighted average shares of common stock outstanding — diluted			8,577,173				8,563,264				8,560,734				8,563,264
Earnings per weighted average share of senior common stock		$	0.26			$	0.00			$	0.79			$	0.00
Weighted average shares of senior common stock outstanding — basic			16,286				0				5,903				0

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		For the nine months ended September 30,
		2010				2009
Cash flows from operating activities:
Net income		$	4,121,038			$	3,485,506
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, including discontinued operations			9,992,411				9,885,571
Amortization of deferred financing costs			836,884				1,144,991
Amortization of deferred rent asset and liability, net			(515,665	)			(399,052	)
Asset retirement obligation expense, including discontinued operations			108,404				106,902
Gain on sale of real estate			—				(160,038	)
Decrease (increase) in other assets			358,279				(413,620	)
Increase in deferred rent receivable			(1,235,255	)			(1,564,298	)
Increase in accounts payable, accrued expenses, and amount due Adviser			80,899				124,761
Increase (decrease) in other liabilities			120,442				(81,672	)
Net cash provided by operating activities			13,867,437				12,129,051
Cash flows from investing activities:
Real estate investments			(748,155	)			(85,534	)
Leasing commissions paid			(7,044	)			(298,270	)
Proceeds from sale of real estate			—				1,089,031
Principal repayments on mortgage notes receivable			10,000,000				—
Receipts from lenders for reserves held in escrow			1,081,987				853,264
Payments to lenders for reserves held in escrow			(1,309,245	)			(1,399,699	)
Decrease (increase) in restricted cash			27,473				(371,538	)
Deposits refunded			250,000				200,000
Net cash provided by (used in) investing activities			9,295,016				(12,746	)
Cash flows from financing activities:
Proceeds from issuance of common and senior common stock			1,792,923				—
Offering costs			(149,801	)			—
Principal repayments on mortgage notes payable			(1,979,911	)			(1,738,262	)
Principal repayments on employee notes receivable			788,983				44,285
Borrowings from line of credit			22,400,000				49,700,000
Repayments on line of credit			(32,900,000	)			(29,400,000	)
Repayment of short-term loan			—				(20,000,000	)
Receipts from tenants for reserves			1,615,313				2,541,657
Payments to tenants from reserves			(1,216,487	)			(2,197,535	)
(Decrease) increase in security deposits			(426,299	)			27,415
Payments for deferred financing costs			(254,489	)			(106,054	)
Distributions paid for common and preferred			(12,698,812	)			(12,703,991	)
Net cash used in financing activities			(23,028,580	)			(13,832,485	)
Net increase (decrease) in cash and cash equivalents			133,873				(1,716,180	)
Cash and cash equivalents, beginning of period			3,096,598				4,503,578
Cash and cash equivalents, end of period		$	3,230,471			$	2,787,398
NON-CASH OPERATING, INVESTING AND FINANCING INFORMATION
Forfeiture of common stock in satisfaction of employee note receivable		$	243,900			$	—
Senior common dividend issued in the dividend reinvestment program		$	1,753			$	—

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

GLADSTONE COMMERCIAL CORPORATION

1. Organization and Significant Accounting Policies

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

Subsidiaries

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

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

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

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

Interim Financial Information

Interim financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and in accordance with Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of the Company’s Management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of the financial statements for the interim period have been included. The interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the Securities and Exchange Commission (“SEC”) on February 24, 2010.

Investments in Real Estate

The Company records investments in real estate at cost and capitalizes improvements and replacements when they extend the useful life or improve the efficiency of the asset. The Company expenses costs of repairs and maintenance as such costs are incurred. The Company computes depreciation using the straight-line method over the estimated useful life or 39 years for buildings and improvements, 5 to 7 years for equipment and fixtures and the shorter of the useful life or the remaining lease term for tenant improvements and leasehold interests.

The Company accounts for its acquisitions of real estate in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations,” which requires that the purchase price of real estate be recorded at fair value and allocated to the acquired tangible assets and liabilities, consisting of land, building, tenant improvements, long-term debt and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases, the value of unamortized lease origination costs, the value of tenant relationships and the value of capital lease obligations, based in each case on their fair values. ASC 805 also requires that all expenses related to the acquisition be expensed as incurred, rather than capitalized into the cost of the acquisition as had been the previous accounting.

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

The Company allocates purchase price to the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant. The “as-if-vacant” value is allocated to land, building, and tenant improvements based on Management’s determination of the relative fair values of these assets. Real estate depreciation expense on these tangible assets, including discontinued operations, was approximately $2.4 million and $7.2 million for the three and nine months ended September 30, 2010, respectively, and approximately $2.4 million and $7.1 million for the three and nine months ended September 30, 2009, respectively.

Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) Management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values, included in the accompanying balance sheet as part of deferred rent receivable, are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. Total amortization related to above-market lease values was approximately $63,000 and $190,000 for both the three and nine months ended September 30, 2010 and 2009, respectively. The capitalized below-market lease values, included in the accompanying consolidated balance sheet as deferred rent liability, are amortized as an increase to rental income over the remaining non-cancelable terms of the respective leases. Total amortization related to below-market lease values was approximately $231,000 and $706,000 for the three and nine months ended September 30, 2010, respectively, and approximately $196,000 and $598,000 for the three and nine months ended September 30, 2009, respectively.

The total amount of the remaining intangible assets acquired, which consist of in-place lease values, unamortized lease origination costs, and customer relationship intangible values, are allocated based on

Management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics to be considered by Management in allocating these values include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and the Company’s expectations of lease renewals (including those existing under the terms of the lease agreement), among other factors.

The value of in-place leases and unamortized lease origination costs are amortized to expense over the remaining term of the respective leases, which generally range from 10 to 15 years. The value of customer relationship intangibles, which is the benefit to the Company resulting from the likelihood of an existing tenant renewing its lease, are amortized to expense over the remaining term and any anticipated renewal periods in the respective leases, but in no event does the amortization period for intangible assets exceed the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the above-market and below-market lease values, in-place lease values, unamortized lease origination costs and customer relationship intangibles will be immediately charged to the related income or expense. Total amortization expense related to these intangible assets, including discontinued operations, was approximately $0.9 million and $2.8 million for both the three and nine months ended September 30, 2010 and 2009, respectively.

Impairment

Investments in Real Estate

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

In light of current economic conditions, the Company performed an impairment analysis of its entire portfolio at September 30, 2010. In performing the analysis, the Company considered such factors as the tenants’ payment history and financial condition, the likelihood of lease renewal, business conditions in the industry in which the tenants operate and whether the carrying value of the real estate has decreased. The Company concluded that none of its properties were impaired, and will continue to monitor its portfolio for any indicators that may change this conclusion.

Provision for Loan Losses

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

Cash and Cash Equivalents

The Company considers cash equivalents to be all short-term, highly-liquid investments that are both readily convertible to cash and have a maturity of three months or less at the time of purchase, except that any such investments purchased with funds held in escrow or similar accounts are classified as restricted cash. Items classified as cash equivalents include money-market deposit accounts. All of the Company’s cash and cash equivalents at September 30, 2010 were held in the custody of one financial institution, and the Company’s balance at times may exceed federally insurable limits.

Restricted Cash

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

Funds Held in Escrow

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

Deferred Financing Costs

Deferred financing costs consist of costs incurred to obtain financing, including legal fees, origination fees and administrative fees. The costs are deferred and amortized using the straight-line method, which approximates the effective interest method over the term of the secured financing. The Company made payments of approximately $193,000 and $254,000 for deferred financing costs during the three and nine months ended September 30, 2010, respectively, and approximately $2,000 and $106,000 for deferred financing costs during the three and nine months ended September 30, 2009, respectively. Total amortization expense related to deferred financing costs was approximately $293,000 and $837,000 for the three and nine months ended September 30, 2010, respectively, and approximately $421,000 and $1,145,000 for the three and nine months ended September 30, 2009, respectively.

Obligation Under Capital Lease

In conjunction with the Company’s acquisition of a building in Fridley, Minnesota in February 2008, the Company acquired a ground lease on the parking lot of the building, which had a purchase obligation to acquire the land under the ground lease at the end of the term in April 2014 for $300,000. In accordance with ASC 840-10-25, “Leases,” the Company accounted for the ground lease as a capital lease and recorded the corresponding present value of the obligation under the capital lease. The Company recorded total interest expense related to the accretion of the capital lease obligation of approximately $3,100 and $9,200 for both the three and nine months ended September 30, 2010 and 2009, respectively.

Revenue Recognition

Rental revenue includes rents that each tenant pays in accordance with the terms of its respective lease reported evenly over the non-cancelable term of the lease. Most of the Company’s leases contain rental increases at specified intervals. The Company recognizes such revenues on a straight-line basis by averaging the non-cancelable rental revenues over the lease terms. Deferred rent receivable in the accompanying consolidated balance sheet includes the cumulative difference between rental revenue as recorded on a straight line basis and rents received from the tenants in accordance with the lease terms, along with the capitalized above-market lease values of certain acquired properties. Accordingly, the Company determines, in its judgment, to what extent the deferred rent receivable applicable to each specific tenant is collectable. The Company reviews deferred rent receivable, as it relates to straight line

rents, on a quarterly basis and takes into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the geographic area in which the property is located. In the event that the collectability of deferred rent with respect to any given tenant is in doubt, the Company records an allowance for uncollectable accounts or records a direct write-off of the specific rent receivable. No such reserves have been recorded as of September 30, 2010.

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

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

Income Taxes

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

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

Segment Information

ASC 280, “Segment Reporting,” provides standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements. Operating segments are defined as components of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker or decision making group in determining how to allocate resources and in assessing performance. Company Management is the chief decision making group. As discussed in Note 9, the Company’s operations are derived from two operating segments, one segment purchases real estate (land, buildings and other improvements), which is simultaneously leased to existing users, and the other segment originates mortgage loans and collects principal and interest payments. The Company had no mortgage loans receivable outstanding as of September 30, 2010.

Asset Retirement Obligations

ASC 410, “Asset Retirement and Environmental Obligation,” requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. ASC 410-20-20 clarifies that the term “Conditional Asset Retirement Obligation” refers to a legal obligation (pursuant to existing laws or by contract) to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. ASC 410-20-25-6 clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company has accrued a liability and corresponding increase to the cost of the related properties for disposal related to all properties constructed prior to 1985 that have, or may have, asbestos present in the building. There were no liabilities accrued during the nine months ended September 30, 2010 or 2009, respectively. The Company also recorded expenses of approximately $33,000 and $108,000 during the three and nine months ended September 30, 2010, respectively, and approximately $36,000 and $107,000 during the three and nine months ended September 30, 2009, respectively related to the cumulative accretion of the obligation.

Stock Issuance Costs

The Company accounts for stock issuance costs in accordance with SEC Staff Accounting Bulletin (“SAB”) Topic 5.A, which states that incremental costs directly attributable to a proposed or actual offering of securities should be deferred and charged against the gross proceeds of the offering. Accordingly, the Company records costs incurred related to its ongoing equity offerings to other assets on its consolidated balance sheet and ratably applies these amounts to the cost of equity as stock is issued. If an equity offering is subsequently terminated and there are amounts remaining in other assets that have not been allocated to the cost of the offering, the remaining amounts are recorded as an expense on the consolidated income statement. Accordingly, in connection with the termination of the Company’s private offering of unregistered senior common stock, it wrote-off approximately $1.6 million of fees and expenses incurred related to the offering and for which it does not expect to be reimbursed. The expenses consisted primarily of legal, accounting and fees paid to Halcyon, and are recorded as professional fees in the Company’s consolidated statement of operations.

Other Income

The Company records non-operating and unusual or infrequently earned income as other income on its consolidated statement of operations. Accordingly, the Company recorded the $3.3 million of prepayment fees it received in connection with the early payment of its mortgage loan as other income.

Real Estate Held for Sale and Discontinued Operations

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

Recently Issued Accounting Pronouncements

ASC 810-10-25-38, “Consolidation,” amends the consolidation guidance for variable-interest entities (“VIE”) and requires an enterprise to qualitatively assess the determination of the primary beneficiary of a VIE based on whether the entity has the power to direct matters that most significantly impact the activities of the VIE, and had the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. ASC 810 is effective for the Company’s fiscal year beginning

January 1, 2010. The Company adopted this pronouncement during the quarter ended March 31, 2010, and the adoption has had no impact on the Company’s financial position or results of operations.

Use of Estimates

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

2. Related-Party Transactions

The Company is externally managed pursuant to contractual arrangements with its Adviser and Gladstone Administration, LLC (the “Administrator”), which collectively employ all of the Company’s personnel and pays their payroll, benefits, and general expenses directly. The Company has an advisory agreement with its Adviser (the “Advisory Agreement”) and an administration agreement with its Administrator (the “Administration Agreement”). The management services and administrative fees under the Advisory and Administration Agreements are described below. As of September 30, 2010 and December 31, 2009, respectively, approximately $1.7 million and $1.2 million were due to the Adviser.

Advisory Agreement

The Advisory Agreement provides for an annual base management fee equal to 2% of the Company’s total stockholders’ equity, less the recorded value of any preferred stock (“common stockholders’ equity”), and an incentive fee based on funds from operations (“FFO”). For the three and nine months ended September 30, 2010, the Company recorded a base management fee of approximately $298,000 and $907,000, respectively, and for the three and nine months ended September 30, 2009, the Company recorded a base management fee of approximately $343,000 and $1,073,000, respectively. For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any distributions paid on preferred stock, but FFO does not include any unrealized capital gains or losses. The incentive fee rewards the Adviser if the Company’s quarterly FFO, before giving effect to any incentive fee (“pre-incentive fee FFO”), exceeds 1.75%, or 7% annualized (the “hurdle rate”), of total common stockholders’ equity. The Adviser receives 100% of the amount of the pre-incentive fee FFO that exceeds the hurdle rate, but is less than 2.1875% of the Company’s common stockholders’ equity. The Adviser also receives an incentive fee of 20% of the amount of the Company’s pre-incentive fee FFO that exceeds 2.1875% of common stockholders’ equity.

For the three and nine months ended September 30, 2010, the Company recorded an incentive fee of approximately $1,070,000 and $2,746,000, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $0 and $56,000, respectively, resulting in a net incentive fee for the three and nine months ended September 30, 2010, of approximately $1,070,000 and $2,690,000, respectively. For the three and nine months ended September 30, 2009, the Company recorded an incentive fee of approximately $835,000 and $2,434,000, respectively, offset by a credit related to an unconditional and irrevocable voluntary waiver issued by the Adviser of approximately $200,000 and $565,000, respectively, resulting in a net incentive fee for the three and nine months ended September 30, 2009, of approximately $635,000 and $1,869,000, respectively. The board of directors of the Company accepted the Adviser’s offer to waive on a quarterly basis a portion of the incentive fee for the nine months ended September 30, 2010, and for the three and nine months ended September 30, 2009, respectively, in order to support the current level of distributions to the Company’s stockholders. This waiver may not be recouped by the Adviser in the future. There was no waiver to the incentive fee for the three months ended September 30, 2010.

Administration Agreement

Pursuant to the Administration Agreement, the Company pays for its allocable portion of the Administrator’s overhead expenses in performing its obligations to the Company, including, but not limited to, rent, and the salaries and benefits expenses of its chief financial officer, chief compliance officer, internal counsel, treasurer, investor relations and their respective staffs. The Company’s allocable portion of expenses is derived by multiplying the Administrator’s total allocable expenses by the percentage of the Company’s total assets at the beginning of each quarter in comparison to the total assets of all companies managed by the Adviser under similar agreements. For the three and nine months ended September 30, 2010, the Company recorded an administration fee of approximately $357,000 and $808,000, respectively, and for the three and nine months ended September 30, 2009, the Company recorded an administration fee of approximately $293,000 and $ 775,000, respectively.

3. Earnings per Share of Common Stock

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

		For the three months ended September 30,								For the nine months ended September 30,
		2010				2009				2010				2009
Calculation of basic earnings per share of common stock:
Net income available to common stockholders		$	1,000,533			$	255,553			$	1,046,068			$	415,194
Denominator for basic weighted average shares of common stock			8,562,777				8,563,264				8,555,517				8,563,264
Basic earnings per share of common stock		$	0.12			$	0.03			$	0.12			$	0.05
Calculation of diluted earnings per share of comon stock:
Net income available to common stockholders		$	1,000,533			$	255,553			$	1,046,068			$	415,194
Add: Income impact of assumed conversion of senior common stock			4,282				—				4,657				—
Net income available to common stockholders plus assumed conversions		$	1,004,815			$	255,553			$	1,050,725			$	415,194
Denominator for basic weighted average shares of common stock			8,562,777				8,563,264				8,555,517				8,563,264
Effect of convertible senior common stock			14,396				—				5,217				—
Denominator for diluted weighted average shares of common stock			8,577,173				8,563,264				8,560,734				8,563,264
Diluted earnings per share of common stock		$	0.12			$	0.03			$	0.12			$	0.05

4. Real Estate and Intangible Assets

Real Estate

The following table sets forth the components of the Company’s investments in real estate, including capitalized leases, as of September 30, 2010 and December 31, 2009:

		September 30, 2010				December 31, 2009
Real estate:
Land		$	55,025,707	(1)		$	55,025,707	(1)
Building and improvements			326,655,633				325,907,479
Tenant improvements			9,820,706				9,820,706
Accumulated depreciation			(41,268,421	)			(34,111,952	)
Real estate, net		$	350,233,625			$	356,641,940

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

			Tenant
Year			Lease Payments
Three months ending December 31, 2010			$	9,696,424
2011				38,589,674
2012				38,698,289
2013				33,356,072
2014				29,132,246
2015				25,044,969
Thereafter				145,637,227

In accordance with the lease terms, substantially all tenant expenses are required to be paid by the tenant; however, the Company would be required to pay property taxes on the respective properties, and ground lease payments on the property located in Tulsa, Oklahoma, in the event the tenant fails to pay them. The total annualized property taxes for all properties held by the Company at September 30, 2010 was approximately $6.3 million, and the total annual ground lease payments on the property located in Tulsa, Oklahoma was approximately $153,000.

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

On September 29, 2010, the sole tenant in the Company’s building located in Hazelwood, Missouri declared bankruptcy. The lease for this property is scheduled to expire in January 2012, and rental income from this tenant comprises less than 1% of the Company’s total annualized rental income. Although the Company received the October rental payment from this tenant, it continues to monitor this situation closely.

Intangible Assets

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

		September 30, 2010								December 31, 2009
						Accumulated								Accumulated
		Lease Intangibles				Amortization				Lease Intangibles				Amortization
In-place leases		$	15,935,445			$	(7,975,361	)		$	15,935,445			$	(6,741,817	)
Leasing costs			10,060,049				(4,473,392	)			10,053,004				(3,832,623	)
Customer relationships			17,136,501				(5,334,678	)			17,136,501				(4,373,049	)
		$	43,131,995			$	(17,783,431	)		$	43,124,950			$	(14,947,489	)

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

			Estimated
Year			Amortization Expense
Three months ending December 31, 2010			$	1,680,653
2011				5,672,016
2012				4,628,033
2013				2,361,473
2014				2,088,320
2015				1,718,027
Thereafter				7,200,042

5. Real Estate Held for Sale and Discontinued Operations

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

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

		For the three months ended September 30,								For the nine months ended September 30,
		2010				2009				2010				2009
Operating revenue		$	—			$	4,452			$	—			$	56,202
Operating expense			—				(382	)			—				(13,379	)
Income from discontinued operations		$	—			$	4,070			$	—			$	42,823

6. Mortgage Note Receivable

On April 15, 2005, the Company originated a mortgage loan in the amount of $10.0 million that was collateralized by an office building located in McLean, Virginia in which the Company’s Adviser and Administrator are subtenants. The mortgage loan was originally scheduled to mature in May 2017 but, on July 22, 2010 this mortgage was fully repaid. The Company received $3.3 million of additional income and prepayment fees in connection with the early payment, which was recorded as other income in the consolidated statement of operations. The proceeds were used to repay a portion of the Company’s line of credit.

7. Mortgage Notes Payable and Line of Credit

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

														Principal Balance Outstanding
		Date of Issuance/				Principal Maturity				Stated Interest Rate at
		Assumption				Date				September 30, 2010 (1)				September 30, 2010				December 31, 2009
Fixed-Rate Mortgage Notes Payable:
			03/16/05				04/01/30				6.33	%		$	2,718,623			$	2,884,908
			08/25/05				09/01/15				5.33	%			20,854,306				21,093,917
			09/12/05				09/01/15				5.21	%			12,255,763				12,389,647
			12/21/05				12/08/15				5.71	%			18,796,119				18,991,934
			02/21/06				12/01/13				5.91	%			9,064,449				9,188,044
			02/21/06				06/30/14				5.20	%			18,837,012				19,116,277
			03/29/06				04/01/16				5.92	%			17,000,000				17,000,000
			04/27/06				05/05/16				6.58	%			13,794,558				14,009,918
			11/22/06				12/01/16				5.76	%			14,001,666				14,136,921
			12/22/06				01/01/17				5.79	%			21,400,768				21,605,106
			02/08/07				03/01/17				6.00	%			13,775,000				13,775,000
			06/05/07				06/08/17				6.11	%			14,240,000				14,240,000
			09/06/07				12/11/15				5.81	%			4,309,798				4,361,144
			10/15/07				11/08/17				6.63	%			15,521,814				15,657,330
			08/29/08				06/01/16				6.80	%			6,196,864				6,296,505
			09/15/08				10/01/11	(2)			4.58	%			48,015,000				48,015,000
Total Fixed-Rate Mortgage Notes Payable:															250,781,740				252,761,651
Variable-Rate Line of Credit:			12/29/06				12/29/10			LIBOR + 2.15%					22,700,000				33,200,000
Total Mortgage Notes Payable and Line of Credit														$	273,481,740			$	285,961,651

Mortgage Notes Payable

As of September 30, 2010, the Company had 16 fixed-rate mortgage notes payable, collateralized by a total of 55 properties. The obligors under each of these notes are wholly-owned separate borrowing entities, which own the real estate collateral. The Company is not a co-borrower, but has limited recourse liabilities that could result from: a borrower voluntarily filing for bankruptcy, improper conveyance of a property, fraud or material misrepresentation, misapplication or misappropriation of rents, security deposits, insurance proceeds or condemnation proceeds, and physical waste or damage to the property, resulting from a borrower’s gross negligence or willful misconduct. The Company will also indemnify lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property. The weighted-average interest rate on the mortgage notes payable as of September 30, 2010 was approximately 5.61% and as of December 31, 2009 was approximately 6.00%.

The Company had $48.0 million of balloon principal payments maturing under one of its long-term mortgages in 2010; however, the mortgage has three annual extension options through 2013, and the Company exercised one of these options on September 30, 2010. In connection with the exercise of the option, the interest rate reset from 6.85% to 4.58% through September 30, 2011. At the time of notification of extension, the Company remitted a fee of 0.25% of the outstanding principal balance, or approximately $120,000, which is recorded as a deferred financing cost in the Company’s consolidated balance sheet. The

Company also remitted a certification to the lender that its aggregate debt service coverage ratio is not less than 1.2, thus the Company was in compliance with all covenants under the mortgage loan. The interest rate for the two additional extension periods will adjust based upon the 1-year swap rate at the time of extension and a fixed spread of 4.29% and 4.41%, respectively. In addition, one of the buildings pledged as collateral to the $48.0 million mortgage is the building located in South Hadley, Massachusetts, in which the tenant did not renew its lease. The Company has six months from the vacancy date of June 30, 2010 to find a replacement tenant or substitute properties in the loan collateral pool. After the six-month period, the Company will have 120 days, or until April 30, 2011, to pay off the portion of the loan allocated to the South Hadley property. The payoff amount is 115% of the allocated loan amount or approximately $2.8 million.

The fair market value of all fixed-rate mortgage notes payable outstanding as of September 30, 2010 was approximately $242.9 million, as compared to the carrying value stated above of approximately $250.8 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.

Scheduled principal payments of mortgage notes payable for the remainder of 2010, each of the five succeeding fiscal years and thereafter are as follows:

			Scheduled principal
Year			payments
Three months ending December 31, 2010			$	770,999
2011				51,069,825	(1)
2012				3,378,830
2013				12,174,998
2014				20,779,913
2015				54,527,909
Thereafter				108,079,266
			$	250,781,740

Line of Credit

The Company has a $50.0 million senior revolving credit agreement (the “Credit Agreement”) with a syndicate of banks led by KeyBank National Association (“KeyBank”), which matures on December 29, 2010. Currently, eight properties are pledged as collateral under the Company’s line of credit. The interest rate charged on the advances under the line is based on the LIBOR, the prime rate or the federal funds rate, depending on market conditions, plus a pricing spread ranging from 1.4% to 2.15%, and adjusts periodically. The unused portion of the line of credit is subject to a fee of 0.15% per year. The Company’s ability to access this funding source is subject to the Company’s continued ability to meet customary lending requirements, such as compliance with financial and operating covenants and satisfaction of certain lending limits. One such covenant requires the Company to limit its distributions to stockholders to 95% of its FFO, less those acquisition-related costs that are required to be expensed under ASC 805. In addition, the maximum amount that the Company may draw under this agreement is based on a percentage of the value of properties pledged as collateral to the banks, which must meet agreed upon eligibility standards. The maximum amount that the Company may currently draw under the Credit Agreement is approximately $38.0 million. Furthermore, those properties that are pledged as collateral to the banks are pledged through a perfected first priority lien in the equity interest of the special purpose entity (“SPE”) that owns the

property. In addition the Operating Partnership, which is the entity that owns the SPEs, is precluded from transferring the SPEs or unconsolidated affiliates to the Company.

If and when long-term mortgages are arranged for these pledged properties, the banks will release the properties from the line of credit and reduce the availability under the Credit Agreement by the advanced amount of the released property. Conversely, as the Company purchases new properties meeting the eligibility standards, the Company may pledge such properties to obtain additional advances under this agreement. The availability under the line of credit may also be reduced by letters of credit used in the ordinary course of business. The Company may use the advances under the line of credit for both general corporate purposes and the acquisition of new investments. As of September 30, 2010, there was $22.7 million outstanding under the line of credit at an interest rate of approximately 2.5%, and approximately $3.9 million outstanding pursuant to letters of credit at a weighted average interest rate of approximately 2.2%. At September 30, 2010, the remaining borrowing capacity available under the line of credit was approximately $11.4 million. The Company’s ability to increase the availability under its line of credit is dependent upon its pledging additional properties as collateral. Traditionally, the Company has pledged new properties to its line of credit as it arranges for long-term mortgages for these pledged properties. Currently, only nine of the Company’s properties do not have long-term mortgages, and eight of those are pledged as collateral under its line of credit. Accordingly, the Company only has one property which is unencumbered and which may be pledged as collateral to increase the borrowing capacity available under the line of credit. The Company was in compliance with all covenants under the Credit Agreement as of September 30, 2010. The amount outstanding on the line of credit as of September 30, 2010 approximates fair market value, because the debt is short-term and variable rate.

8. Stockholders’ Equity

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

																		Notes				Distributions in
														Capital in				Receivable				Excess of				Total
		Preferred				Senior Common				Common				Excess of				From Sale of				Accumulated				Stockholders’
		Stock				Stock				Stock				Par Value				Common Stock				Earnings				Equity
Balance at December 31, 2009		$	2,150			$	—			$	8,563			$	170,622,581			$	(2,304,999	)		$	(49,877,753	)		$	118,450,542
Issuance of senior common stock and common stock			—				52				60				1,644,762				—				—				1,644,874
Repayment of principal on notes receivable			—				—				—				—				788,983				—				788,983
Distributions declared to common, senior common and preferred stockholders			—				—				—				—				—				(12,701,534	)			(12,701,534	)
Forfeiture of common stock in satisfaction of employee note receivable (1)			—				—				(18	)			(243,882	)			—				—				(243,900	)
Net income			—				—				—				—				—				4,121,038				4,121,038
Balance at September 30, 2010		$	2,150			$	52			$	8,605			$	172,023,461			$	(1,516,016	)		$	(58,458,249	)		$	112,060,003

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

														Outstanding Balance				Outstanding Balance
										Amount of				of Employee Loans				of Employee Loans
		Number of Options				Strike Price of				Promissory Note				at September 30,				at December 31,				Maturity Date of				Interest Rate on
Date Issued		Exercised				Options Exercised				Issued to Employees				2010				2009				Note				Note
Sep 2004			25,000			$	15.00			$	375,000			$	20,253			$	358,405			Sep 2013					5.00	%
Apr 2006			12,422				16.10				199,994				4,563				199,994			Apr 2015					7.77	%
May 2006			50,000				16.85				842,500				842,500				842,500			May 2016					7.87	%
May 2006			15,000				16.10				241,500				241,500				241,500			May 2016					7.87	%
May 2006			2,000				16.10				32,200				32,200				32,200			May 2016					7.87	%
May 2006			2,000				16.10				32,200				—				32,200			May 2016					7.87	%
May 2006			2,000				15.00				30,000				—				30,000			May 2016					7.87	%
Oct 2006			12,000				16.10				193,200				—				193,200			Oct 2015					8.17	%
Nov 2006			25,000				15.00				375,000				375,000				375,000			Nov 2015					8.15	%
			145,422							$	2,321,594			$	1,516,016			$	2,304,999

In accordance with ASC 505-10-45-2, “Equity,” receivables from employees for the issuance of capital stock to employees prior to the receipt of cash payment should be reflected in the balance sheet as a reduction to stockholders’ equity. Therefore, these notes were recorded as full recourse loans to employees and are included in the equity section of the accompanying consolidated balance sheets. As of September 30, 2010, each loan maintained its full recourse status.

Distributions paid per share of common stock for both the three and nine months ended September 30, 2010 and 2009 were $0.375 and $1.125 per share, respectively. Distributions paid per share of Series A Preferred Stock for both the three and nine months ended September 30, 2010 and 2009 were $0.4843749 and $1.4531247 per share, respectively. Distributions paid per share of Series B Preferred Stock for both the three and nine months ended September 30, 2010 and 2009 were $0.46875 and $1.40625 per share, respectively. Distributions paid per share of senior common stock for the three and nine months ended September 30, 2010 were $0.2625 and $0.3474 per share, respectively. There were no distributions paid to senior common stockholders for either the three or nine months ended September 30, 2009, as no senior common stock was outstanding during this period.

On November 4, 2009, the Company entered into an open market sale agreement, or the Open Market Sale Agreement, with Jefferies & Company, Inc., or Jefferies, under which it may, from time to time, offer to sell shares of its common stock with an aggregate sales price of up to $25.0 million on the open market through Jefferies, as agent, or to Jefferies, as principal. To date, the Company has sold 60,000 shares of common stock under the Open Market Sale Agreement. Net proceeds from the sales were approximately $1.0 million, which were used to repay a portion of the Company’s line of credit.

On November 19, 2009, the Company entered into a dealer manager agreement, as amended and restated on December 22, 2009, or the Dealer Manager Agreement, with Halcyon Capital Markets, LLC, or Halcyon, pursuant to which Halcyon agreed to act as the Company’s dealer manager in connection with the Company’s continuous private offering of up to 3,333,333 shares of its then newly designated unregistered senior common stock at $15.00 per share. Holders of the unregistered senior common stock have the right, but not the obligation, following the fifth anniversary of the issuance of such shares, to exchange any or all of such shares of senior common stock for shares of the Company’s common stock. On October 19, 2010, the Company terminated the private offering of unregistered senior common stock, including the dividend reinvestment plan for the senior common stock. In connection with the termination, the Company wrote-off approximately $1.6 million of fees and expenses incurred related to the offering and for which the Company does not expect to be reimbursed. The expenses consisted primarily of legal, accounting and fees paid to Halcyon, and are recorded as professional fees in the Company’s consolidated statement of operations. To date, the Company has issued 58,893 shares of unregistered senior common stock pursuant

to the private offering and related dividend reinvestment plan. Net proceeds from these sales, after selling commissions and dealer manager fees, were approximately $787,000.

9. Segment Information

The Company’s operations are comprised of two operating segments. One segment purchases real estate (land, buildings and other improvements), which is simultaneously leased to existing users, and the other segment extends mortgage loans and collects principal and interest payments. As of September 30, 2010, the Company had no mortgage loans receivable outstanding. The amounts included under the “Other” column in the tables below include other income, which consists of interest income from temporary investments and employee loans and any other miscellaneous income earned, and operating and other expenses that were not specifically derived from either operating segment.

The following table summarizes the Company’s consolidated operating results and total assets by segment as of and for the three and nine months ended September 30, 2010 and 2009:

		As of and for the three months ended September 30, 2010																As of and for the nine months ended September 30, 2010
		Real Estate Leasing				Real Estate Lending				Other				Total				Real Estate Leasing				Real Estate Lending				Other				Total
Operating revenues		$	10,290,663			$	43,750			$	—			$	10,334,413			$	31,279,944			$	420,833			$	—			$	31,700,777
Operating expenses			(3,576,499	)			—				(3,705,720	) (1)			(7,282,219	)			(10,859,930	)			—				(7,132,876	) (1)			(17,992,806	)
Other expense			(4,141,538	)			—				3,117,596	(2)			(1,023,942	)			(12,277,195	)			—				2,690,262	(2)			(9,586,933	)
Net income		$	2,572,626			$	43,750			$	(588,124	)		$	2,028,252			$	8,142,819			$	420,833			$	(4,442,614	)		$	4,121,038
Total Assets		$	391,142,468			$	—			$	6,429,908			$	397,572,376			$	391,142,468			$	—			$	6,429,908			$	397,572,376

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

10. Subsequent Events

On October 5, 2010, the Company’s Board of Directors declared a cash distribution of $0.125 per share of common stock, $0.1614583 per share of the Series A Preferred Stock, and $0.15625 per share of the Series B Preferred Stock for each of the months of October, November and December of 2010. Monthly distributions will be payable on October 29, 2010, November 30, 2010 and December 31, 2010, respectively, to stockholders of record as of the close of business on October 21, 2010, November 19, 2010 and December 23, 2010, respectively. Additionally, the Company’s Board of Directors declared a cash distribution of $0.0875 per share of senior common stock for each of the months of October, November, and December of 2010. Senior common stock monthly distributions will be payable on November 5, 2010, December 7, 2010, and January 7, 2011, respectively.

On October 8, 2010, the Company extended the lease with the tenant that occupies its property located in Toledo, Ohio for a period of 10 years, and the tenant has two options to extend the lease for additional periods of 10 years each. The lease was originally set to expire in December 2010, and will now expire in

December 2020. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $276,000.

On October 19, 2010, the Company terminated its private offering of unregistered senior common stock, including the dividend reinvestment plan for the senior common stock. In connection with the termination, the Company wrote-off approximately $1.6 million of fees and expenses incurred in relation to the offering and for which the Company does not expect to be reimbursed. The expenses consisted primarily of legal, accounting and fees paid to Halcyon, and are recorded as professional fees in the Company’s consolidated statement of operations. The Company issued 58,893 shares of unregistered senior common stock pursuant to the private offering and related dividend reinvestment plan. Net proceeds from these sales, after selling commissions and dealer manager fees, were approximately $787,000.

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

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

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

OVERVIEW

General

We were incorporated under the General Corporation Law of the State of Maryland on February 14, 2003, primarily for the purpose of investing in and owning net leased industrial and commercial real property and selectively making long-term industrial and commercial mortgage loans. Most of the portfolio of real estate that we currently own is leased to a wide cross section of tenants ranging from small businesses to large public companies, many of which are corporations that do not have publicly-rated debt. We have historically entered into, and intend in the future to enter into, purchase agreements for real estate having triple net leases with terms of approximately 10 to 15 years and built in rental rate increases. Under a triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property. We are actively communicating with buyout funds, real estate brokers and other third parties to locate properties for potential acquisition or to provide mortgage financing in an effort to build our portfolio. At September 30, 2010, we owned 64 properties totaling approximately 6.3 million square feet. The total gross investment in these properties was approximately $434.6 million at September 30, 2010.

Business Environment

The United States is beginning to recover from the recession that it entered into during late 2007, though it continues to experience pervasive and fundamental disruptions in its financial and capital markets. As a result, conditions within the U.S. capital markets generally, and the U.S. real estate capital markets particularly, continue to experience significant dislocation and stress. While we are seeing signs of economic improvement and stabilization in both the equity and debt capital markets, these markets remain challenging, and we do not know if adverse conditions will again intensify, nor are we able to gauge the full extent to which the disruptions will affect us. Additionally, economic conditions continue to disrupt our ability to price and finance new investment opportunities on attractive terms. We believe that it will take some time for the United States to fully recover from the recession.

As a result, the continued challenging economic conditions could still materially and adversely impact the financial condition of one or more of our tenants and, therefore, could increase the likelihood that a tenant may declare bankruptcy or default upon its payment obligations arising under a related lease.

Moreover, our ability to make new investments is highly dependent upon our ability to procure external financing. Our principal sources of external financing generally include the issuance of equity securities, long-term mortgages secured by properties, and borrowings under our line of credit. The market for long-term mortgages has been limited, as the collateralized mortgage-backed securities, or CMBS, market has experienced significant disruption. With the stresses upon the CMBS market, many banks are not lending on industrial and commercial real estate as they are no longer able to sell these loans to the CMBS market and are not willing or able to keep these loans on their balance sheets. In addition, many banks have significantly curtailed their general lending practices, as they are having difficulty valuing the underlying real estate in this market. We are, however, beginning to see banks that are willing to issue medium-term mortgages, between two and five years, on substantially less favorable terms than were previously available. Consequently, we continue to focus on using medium-term mortgages to finance our real estate activities until the market for long-term mortgages returns.

Recent Events

Financing Activities:

During the nine months ended September 30, 2010, we had net repayments under our line of credit of $10.5 million, with $22.7 million outstanding under the line at September 30, 2010. The proceeds from borrowings under the line of credit were used for working capital and to fund capital improvements at certain of our properties.

On April 15, 2005, we originated a mortgage loan in the amount of $10.0 million that was collateralized by an office building located in McLean, Virginia in which our Adviser and Administrator are subtenants. The mortgage loan was originally set to mature in May 2017, though, on July 22, 2010, it was fully repaid. We received $3.3 million of additional income and prepayment fees in connection with the early payment and the proceeds were used to repay a portion of our line of credit.

Debt Activities:

We had $48.0 million of balloon principal payments maturing under one of our long-term mortgages in 2010; however, the mortgage has three annual extension options through 2013, and we exercised one of these options on September 30, 2010. In connection with the exercise of the option, the interest rate reset from 6.85% to 4.58%. At the time of notification of extension, we remitted a fee of 0.25% of the outstanding principal balance, or approximately $120,000, and a certification to the lender that its aggregate debt service coverage ratio is not less than 1.2. The interest rate for the two additional extension periods will adjust based upon the 1-year swap rate at the time of extension and a fixed spread of 4.29% and 4.41%, respectively. We expect to exercise our remaining two annual extension options as they come due in 2012 and 2013. We have no other balloon principal payments due under any of our mortgages until 2013.

Equity Activities:

We have raised approximately $1.8 million in net proceeds from equity offerings during 2010. On November 4, 2009, we entered into an open market sale agreement, or the Open Market Sale Agreement, with Jefferies & Company, Inc., or Jefferies, under which we may, from time to time, offer to sell shares of our common stock with an aggregate sales price of up to $25.0 million on the open market through Jefferies, as agent, or to Jefferies, as principal based upon our instructions (including any price, time or size limits or other customary parameters or conditions that we may impose). Sales of shares of our common stock through Jefferies 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 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 sold 60,000 shares of common stock under the Open Market Sale Agreement, for net proceeds of approximately $1.0 million. The proceeds were used to repay a portion of our line of credit.

On November 19, 2009, we entered into a dealer manager agreement, or the Dealer Manager Agreement, as amended and restated on December 22, 2009, with Halcyon Capital Markets, LLC, or Halcyon, pursuant to which Halcyon agreed to act as our dealer manager in connection with our continuous private offering of up to 3,333,333 shares of our then newly designated unregistered senior common stock at $15.00 per share. Holders of the unregistered senior common stock have the right, but not the obligation, following the fifth anniversary of the issuance of such shares, to exchange any or all of such shares of senior common stock for shares of our common stock. On October 19, 2010, we terminated the private offering of unregistered senior common stock, including the dividend reinvestment plan for the senior common stock. In connection with the termination, we wrote-off approximately $1.6 million of fees incurred in relation to the offering and for which we do not expect to be reimbursed. The expenses consisted primarily of legal, accounting and fees paid to Halcyon, and are recorded as professional fees in our consolidated statement of operations. We issued 58,893 shares of unregistered senior common stock pursuant to the private offering and related dividend reinvestment plan.. Net proceeds from these sales, after selling commissions and dealer manager fees, were approximately $787,000.

In September 2010, we filed a universal shelf registration statement on Form S-3, or Universal Shelf, with the Securities and Exchange Commission, or SEC, which, among other securities, registered shares of common stock, senior common stock and preferred stock. The Universal Shelf, which was declared effective by the SEC on September 27, 2010, will allow us to raise debt or equity capital from time to time in future public offerings through the sale of securities registered on the shelf, in one or more series of transactions.

Leasing Activities:

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

On June 30, 2010 and July 31, 2010, respectively, the leases with the tenants that occupied our properties located in South Hadley, Massachusetts and Richmond, Virginia, respectively, expired and currently remain vacant. These two leases comprised approximately 2.6% of our total annualized rental income. We are actively seeking new tenants for these two properties while concurrently researching alternative uses for these two properties and expect that it will re-lease these properties in the near future.

On September 29, 2010, the tenant in our building located in Hazelwood, Missouri declared bankruptcy. The lease for this property is scheduled to expire in January 2012, and rental income from this tenant comprises less than 1% of our total annualized rental income. Although we received the October rental payment from this tenant, we continue to monitor this situation closely.

On October 8, 2010, we extended the lease with the tenant that occupies our property located in Toledo, Ohio for a period of 10 years, and the tenant has two options to extend the lease for additional periods of 10 years each. The lease was originally set to expire in December 2010, and will now expire in December 2020. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $276,000.

All of our remaining tenants are current and paying in accordance with their leases.

Diversity of Our Portfolio

Gladstone Management Corporation, or our Adviser, seeks to diversify our portfolio to avoid dependence on any one particular tenant, geographic market or tenant industry. By diversifying our portfolio, our Adviser intends to reduce the adverse effect on our portfolio of a single under-performing investment or a downturn in any particular industry or geographic market. Our largest tenant at September 30, 2010 comprised approximately 7.3% of our total rental income, and our largest concentration of properties was located in Ohio, which accounted for approximately 18.0% of our total rental income. The table below reflects the breakdown of our total rental income by tenant industry classification for both the nine months ended September 30, 2010 and 2009, respectively:

		September 30, 2010								September 30, 2009
						Percentage of								Percentage of
Industry Classification		Rental Income				Rental Income				Rental Income				Rental Income
Electronics		$	4,624,341				14.9	%		$	4,624,341				14.8	%
Healthcare, Education & Childcare			4,609,061				14.9	%			4,609,061				14.8	%
Telecommunications			4,085,525				13.3	%			4,085,192				12.9	%
Diversified/Conglomerate Manufacturing			2,748,512				8.9	%			2,748,515				8.8	%
Chemicals, Plastics & Rubber			2,347,601				7.6	%			2,395,845				7.7	%
Machinery			1,791,467				5.8	%			1,791,453				5.8	%
Containers, Packaging & Glass			1,747,976				5.6	%			1,747,626				5.6	%
Beverage, Food & Tobacco			1,641,588				5.2	%			1,641,563				5.3	%
Printing & Publishing			1,641,559				5.3	%			1,639,363				5.3	%
Buildings and Real Estate			1,548,889				5.0	%			1,519,251				4.9	%
Oil & Gas			964,852				3.1	%			855,391				2.7	%
Personal & Non-Durable Consumer Products			926,123				2.9	%			1,016,041				3.3	%
Automobile			874,990				2.8	%			874,990				2.8	%
Personal, Food & Miscellaneous Services			431,255				1.4	%			431,255				1.4	%
Insurance			421,672				1.4	%			542,150				1.7	%
Home & Office Furnishings			397,307				1.3	%			397,307				1.3	%
Diversified/Conglomerate Services			231,079				0.6	%			231,079				0.9	%
		$	31,033,797				100.0	%		$	31,150,423				100.0	%

Lease Expirations

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

										Rental Revenue for
										the Nine Month
Year of Lease						Number of				Period Ended				Annualized Base				% of Annualized
Expiration		Square Feet				Leases (1)				September 30, 2010				Rental Revenue				Base Rent
2010			192,213				2			$	601,509			$	802,012				1.9	%
2011			—				0				—				—				0.0	%
2012			479,982				3				3,322,203				4,429,604				10.7	%
2013			438,422				6				3,505,028				4,673,371				11.3	%
2014			614,132				5				2,311,650				3,082,200				7.5	%
2015			896,876				8				5,130,057				6,840,076				16.5	%
2016			898,257				5				3,170,982				4,227,976				10.2	%
2017			102,200				1				692,194				922,925				2.2	%
2018			59,894				1				201,031				268,041				0.7	%
2019+			2,622,183				19				12,099,143				16,132,192				39.0	%
Total			6,304,159				50			$	31,033,797			$	41,378,397				100	%