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 MARCH 31, 2007

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

GLADSTONE COMMERCIAL CORPORATION

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 No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer o Accelerated Filer þ Non-Accelerated Filer 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 number of shares of the registrant’s Common Stock, $0.001 par value, outstanding as of April 27, 2007 was 8,565,264.

 

 

 

GLADSTONE COMMERCIAL CORPORATION
TABLE OF CONTENTS

				PAGE
PART I		FINANCIAL INFORMATION
Item 1.		Consolidated Financial Statements (Unaudited)
		Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006			3
		Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006			4
		Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006			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 Disclosure About Market Risk			33
Item 4.		Controls and Procedures			34
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings			35
Item 1A.		Risk Factors			35
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			35
Item 3.		Defaults Upon Senior Securities			35
Item 4.		Submission of Matters to a Vote of Security Holders			35
Item 5.		Other Information			35
Item 6.		Exhibits			36
SIGNATURES					37

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

		March 31, 2007				December 31, 2006
ASSETS
Real estate, net of accumulated depreciation of $10,189,209 and $8,595,419, respectively		$	272,001,341			$	235,118,123
Lease intangibles, net of accumulated amortization of $4,999,702 and $4,175,685, respectively			25,958,470				23,416,696
Mortgage notes receivable			10,000,000				10,000,000
Cash and cash equivalents			7,086,594				36,005,686
Restricted cash			1,354,961				1,225,162
Funds held in escrow			1,633,184				1,635,819
Interest receivable – mortgage note			86,111				—
Interest receivable – employees			60,422				43,716
Deferred rent receivable			3,914,132				3,607,279
Deferred financing costs, net of accumulated amortization of $1,631,759 and $1,467,297, respectively			3,927,288				3,713,004
Prepaid expenses			337,777				521,290
Deposits on real estate			450,000				300,000
Accounts receivable			379,055				179,247
TOTAL ASSETS		$	327,189,335			$	315,766,022
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Mortgage notes payable		$	168,074,478			$	154,494,438
Deferred rent liability			4,522,208				4,718,599
Asset retirement obligation liability			1,723,437				1,631,294
Accounts payable and accrued expenses			457,332				673,410
Due to adviser			689,062				183,042
Rent received in advance, security deposits and funds held in escrow			2,050,220				1,841,063
Total Liabilities			177,516,737				163,541,846
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, respectively			2,150				2,150
Common stock, $0.001 par value, 17,700,000 shares authorized and 8,565,264 shares issued and outstanding, respectively			8,565				8,565
Additional paid in capital			170,640,979				170,640,979
Notes receivable — employees			(3,176,310	)			(3,201,322	)
Distributions in excess of accumulated earnings			(17,802,786	)			(15,226,196	)
Total Stockholders’ Equity			149,672,598				152,224,176
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	327,189,335			$	315,766,022

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 March 31,
		2007				2006
Operating revenues
Rental income		$	7,078,036			$	4,867,075
Interest income from mortgage notes receivable			250,000				552,913
Tenant recovery revenue			55,735				5,623
Total operating revenues			7,383,771				5,425,611
Operating expenses
Depreciation and amortization			2,417,812				1,799,201
Base management fee (refer to Note 2)			482,044				652,742
Administration fee (refer to Note 2)			207,018				—
Incentive fee (refer to Note 2)			585,768				—
Professional fees			149,431				198,459
Taxes and licenses			15,007				50,894
Insurance			146,252				82,998
General and administrative			111,902				47,817
Directors fees			54,250				33,500
Stockholder related expenses			99,617				64,469
Asset retirement obligation expense			28,160				46,702
Stock option compensation expense			—				46,216
Total operating expenses before credit from Adviser			4,297,261				3,022,998
Credit to incentive fee (Refer to Note 2)			(585,768	)			—
Total expenses net of credit to incentive fee			3,711,493				3,022,998
Other income (expense)
Interest income from temporary investments			229,016				7,373
Interest income — employee loans			60,422				5,548
Other income			8,414				—
Interest expense			(2,514,461	)			(1,618,571	)
Total other expense			(2,216,609	)			(1,605,650	)
Income from continuing operations			1,455,669				796,963
Discontinued operations
(Loss) income from discontinued operations			(4,001	)			38,038
Net realized income (loss) from foreign currency transactions			7				(816	)
Net unrealized gain from foreign currency transactions			—				12,615
Taxes on sale of real estate			78,667				—
Total discontinued operations			74,673				49,837
Net income			1,530,342				846,800
Dividends attributable to preferred stock			(1,023,437	)			(344,444	)
Net income available to common stockholders		$	506,905			$	502,356
Earnings per weighted average common share — basic
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.05			$	0.06
Discontinued operations			0.01				0.01
Net income available to common stockholders		$	0.06			$	0.07
Earnings per weighted average common share — diluted
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.05			$	0.06
Discontinued operations			0.01				0.00
Net income available to common stockholders		$	0.06			$	0.06
Weighted average shares outstanding
Basic			8,565,264				7,672,000
Diluted			8,565,264				7,821,658

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

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		For the three months ended March 31,
		2007				2006
Cash flows from operating activities:
Net income		$	1,530,342			$	846,800
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization, including discontinued operations			2,417,812				1,834,740
Amortization of deferred financing costs, including discontinued operations			164,462				121,871
Amortization of deferred rent asset			63,374				63,374
Amortization of deferred rent liability			(196,391	)			(80,290	)
Asset retirement obligation expense, including discontinued operations			28,160				55,143
Increase in deferred rent receivable			(370,227	)			(224,386	)
Stock compensation			—				46,216
Increase in mortgage notes payable due to change in value of foreign currency			—				(12,615	)
(Increase) decrease in mortgage interest receivable			(86,111	)			163
Increase in employee interest receivable			(16,706	)			(5,548	)
Increase in prepaid expenses and other assets			(16,295	)			(126,847	)
Increase in accounts payable, accrued expenses, and amount due adviser			289,942				282,551
Increase in rent received in advance			79,357				204,757
Net cash provided by operating activities			3,887,719				3,005,929
Cash flows from investing activities:
Real estate investments			(41,778,821	)			(18,302,939	)
Principal repayments on mortgage notes receivable			—				25,360
Net payments to lenders for reserves held in escrow			(214,107	)			(1,251,385	)
(Increase) decrease in restricted cash			(129,799	)			38,695
Deposits on future acquisitions			(610,000	)			(350,000	)
Deposits applied against real estate investments			460,000				750,000
Net cash used in investing activities			(42,272,727	)			(19,090,269	)
Cash flows from financing activities:
Proceeds from share issuance			—				25,000,000
Offering costs			—				(1,302,006	)
Borrowings under mortgage notes payable			13,775,000				17,000,000
Principal repayments on mortgage notes payable			(194,961	)			(117,486	)
Borrowings from line of credit			—				35,200,000
Repayments on line of credit			—				(56,500,000	)
Increase in reserves from tenants			346,542				523,636
Principal repayments on employee loans			25,012				—
Payments for deferred financing costs			(378,745	)			(1,073,561	)
Dividends paid for common and preferred			(4,106,932	)			(3,106,364	)
Net cash provided by financing activities			9,465,916				15,624,219
Net decrease in cash and cash equivalents			(28,919,092	)			(460,121	)
Cash and cash equivalents, beginning of period			36,005,686				1,740,159
Cash and cash equivalents, end of period		$	7,086,594			$	1,280,038
NON-CASH INVESTING ACTIVITIES
Increase in asset retirement obligation		$	92,143			$	1,373,820
NON-CASH FINANCING ACTIVITIES
Fixed rate debt assumed in connection with acquisitions		$	—			$	30,129,654

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

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 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 Lending, LLC, a Delaware limited liability company (“Gladstone 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 Lending, the financial position and results of operations of Gladstone 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 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. Gladstone Commercial Partners, LLC 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 Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair statement of financial statements for the interim period have been included.

Investments in real estate

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

The Company accounts for its acquisitions of real estate in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “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 and the value of tenant relationships, 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 $1,593,790 and $1,154,114 for the three months ended March 31, 2007 and 2006, 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 $63,374 for both the three months ended March 31, 2007 and 2006, 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 initial term and any fixed-rate renewal periods in the respective leases. Total amortization related to below-market lease values was $196,391 and $80,290 for the three months ended March 31, 2007 and 2006, respectively.

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

The value of in-place leases and unamortized lease origination costs are amortized to expense over the remaining term of the respective leases, which generally range from five to twenty 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 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 in-place lease value and customer relationship intangibles will be charged to expense. Total amortization expense related to these intangible assets, including discontinued operations, was $824,017 and $680,626 for the three months ended March 31, 2007 and 2006, respectively.

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

		March 31, 2007								December 31, 2006
						Accumulated								Accumulated
		Lease Intangibles				Amortization				Lease Intangibles				Amortization
In-place leases		$	11,317,645			$	(2,269,738	)		$	10,738,319			$	(1,907,668	)
Leasing costs			6,688,334				(1,481,987	)			5,891,099				(1,267,829	)
Customer relationships			12,952,193				(1,247,977	)			10,962,963				(1,000,188	)
		$	30,958,172			$	(4,999,702	)		$	27,592,381			$	(4,175,685	)

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

		Estimated Amortization
Year		Expense
2007		$	3,422,106
2008			3,422,106
2009			3,294,466
2010			3,126,169
2011			2,655,799

Impairment

Investments in Real Estate

The Company accounts for the impairment of real estate in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires that the Company 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. 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 the Company’s real estate assets at March 31, 2007.

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 at March 31, 2007.

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 commercial paper and money-market funds. All of the Company’s cash and cash equivalents at March 31, 2007 were held in the custody of two financial institutions, and the Company’s balance at times may exceed federally insurable limits. The Company mitigates this risk by depositing funds with major financial institutions.

Restricted cash

Restricted cash consists of security deposits and funds held in escrow for certain tenants. The funds held in escrow are for capital improvements, taxes, insurance and other replacement reserves for certain of our 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 submitted to 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 consist of replacement reserves for capital improvements, repairs and maintenance, insurance and taxes. 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 long-term 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. Total amortization expense related to deferred financing costs, including discontinued operations, was $164,462 and $121,871 for the three months ended March 31, 2007 and 2006, respectively. Amortization of financing costs are included in the interest expense line item in the consolidated financial statements.

Revenue recognition

Rental revenue includes rents that each tenant pays in accordance with the terms of its respective lease reported on a straight-line basis over the non-cancelable term of the lease. Certain of the Company’s leases currently contain rental increases at specified intervals, and straight-line basis accounting requires the Company to record an asset, and include in revenues, deferred rent receivable that will be received if the tenant makes all rent payments required through the expiration of the initial term of the lease. 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 collectibility of deferred rent with respect to any given tenant is in doubt, the Company records an increase in the allowance for uncollectible accounts or records a direct write-off of the specific rent receivable, which would have an adverse effect on the net income for the year in which the reserve is increased or the direct write-off is recorded and would decrease total assets and stockholders’ equity. No such reserves have been recorded as of March 31, 2007.

Management considers its loans and other lending investments to be held-for-investment. The Company reflects held-for-investment investments at amortized cost less allowance for loan losses, acquisition premiums or discounts, deferred loan fees and undisbursed loan funds. 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 or exit 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, loan origination or exit fees are prepaid, the Company immediately recognizes the unamortized portion as a decrease or increase in the prepayment gain or loss. Interest income is recognized using the effective interest method applied on a loan-by-loan basis. Prepayment penalties or yield maintenance payments from borrowers are recognized as additional income when received.

Income taxes

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

Commercial Advisers is a wholly-owned TRS that is subject to federal and state income taxes. The Company accounts for such income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, 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.

In July of 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109.” This Interpretation provides guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return, and provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN No. 48 effective for the fiscal year beginning January 1, 2007, and the adoption had no impact on the Company’s results of operations.

Segment information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” 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 10, 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.

Foreign Currency Transactions

The Company purchased two properties in Canada in October of 2004. These properties were classified as held for sale as of June 30, 2006, and were sold in July 2006. All gains and losses from foreign currency transactions are reflected in discontinued operations in the Company’s Consolidated Financial Statements. Rental payments from these properties were received in Canadian dollars. In accordance with SFAS No. 52 “Foreign Currency Translation,” the rental revenue received was recorded using the exchange rate as of the transaction date, which is the first day of each month. In addition to rental payments that were denominated in Canadian dollars, the Company also has a bank account in Canada and the long-term financings on the two Canadian properties were also issued in Canadian dollars. All cash, deferred rent assets and mortgage notes payable related to the Canadian properties were re-valued at each balance sheet date to reflect the current exchange rate. The gains or losses from the valuation of the cash were recorded on the income statement as a realized gain or loss, and the valuation of the deferred rent assets and mortgage notes payable was recorded on the income statement as unrealized gains or losses on the translation of assets and liabilities. A realized foreign currency gain of $7 and a realized foreign currency loss of $816 were recorded for the three months ended March 31, 2007 and 2006, respectively, from the valuation of cash, tax payments made to the Canadian government, and the previously unrealized foreign currency losses associated with the valuation of the deferred rent assets and mortgage notes payable that became a realized foreign currency loss as of the date of sale. An unrealized foreign currency gain of $12,615 was recorded for the three months ended March 31, 2006.

Asset retirement obligations

In March of 2005, the FASB issued Interpretation No. 47 “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. FIN 47 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. FIN 47 also 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 three months ended March 31, 2007 of $63,983 related to properties acquired during the period. The Company also recorded $28,160 and $55,143 of expense, including discontinued operations, related to the cumulative accretion of the obligation during the three months ended March 31, 2007 and 2006, respectively.

Real estate held for sale and discontinued operations

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” 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 for the current period. Once properties are listed as held for sale, no further depreciation is recorded.

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 differ from those estimates.

Reclassifications

Certain amounts from prior years’ financial statements have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported net income or stockholders’ equity.

2. Management Advisory Fee

The Company has been externally managed pursuant to a contractual investment advisory arrangement with its Adviser, under which its Adviser has directly employed all of the Company’s personnel and paid its payroll, benefits, and general expenses directly. The Company’s initial investment advisory agreement with its Adviser was in place from August 12, 2003 through December 31, 2006 (the “Initial Advisory Agreement”). On January 1, 2007, the Company entered into an amended and restated investment advisory agreement with its Adviser (the “Amended Advisory Agreement”) and an administration agreement (the “Administration Agreement”) with Gladstone Administration, LLC (the “Administrator”). The management services and fees in effect under the Initial, Amended Advisory and Administration Agreements are described below.

Amended Advisory Agreement

The Amended Advisory Agreement provides for an annual base management fee equal to 2% of the Company’s total stockholders equity, less the recorded value of any preferred stock, and an incentive fee based on funds from operations (“FFO”). For the three months ended March 31, 2007, the Company recorded a base management fee of $482,044. For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any dividends paid on preferred stock, but FFO does not include any unrealized capital gains or losses. The incentive fee will reward the Adviser if the Company’s quarterly FFO, before giving effect to any incentive fee, exceeds 1.75%, or 7% annualized, (the “hurdle rate”) of total stockholders’ equity, less the recorded value of any preferred stock. The Adviser will receive 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 will also receive an incentive fee of 20% of the amount of the Company’s pre-incentive fee FFO that exceeds 2.1875%. For the three months ended March 31, 2007, the Company recorded an incentive fee of $585,768 offset by a credit from a voluntary waiver issued by the Adviser’s board of directors of $585,768, for a net incentive fee of $0. The board of directors for the Company accepted the Advisers’ offer to waive the entire incentive fee for the quarter ended March 31, 2007 in order to maintain the current level of distributions to the Company’s stockholders.

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, controller, treasurer and their respective staffs. The Company recorded an administration fee of $207,018 for the three months ended March 31, 2007.

Initial Advisory Agreement

Under the Initial Advisory Agreement, the Company was required to reimburse its Adviser for its pro rata share of its Adviser’s payroll and benefits expenses on an employee-by-employee basis, based on the percentage of each employee’s time devoted to the Company’s matters. During the three months ended March 31, 2006 these expenses were approximately $468,000.

The Company was also required to reimburse its Adviser for its pro rata portion of all other expenses of its Adviser not reimbursed under the arrangements described above (“overhead expenses”), equal to the total overhead expenses of its Adviser, multiplied by the ratio of hours worked by its Adviser’s employees on the Company’s projects to the total hours worked by its Adviser’s employees. However, the Company was only required to reimburse its Adviser for its portion of its overhead expenses if the amount of payroll and benefits the Company reimbursed to its Adviser was less than 2.0% of the Company’s average invested assets for the year. Additionally, the Company was only required to reimburse its Adviser for overhead expenses up to the point that reimbursed overhead expenses and payroll and benefits expenses, on a combined basis, equaled 2.0% of the Company’s average invested assets for the year. The Adviser billed the Company on a monthly basis for these amounts. The Adviser was required to reimburse the Company annually for the amount by which overhead expenses billed to and paid by the Company exceeded this combined 2.0% limit during a given year. The overhead expenses never exceeded the combined 2.0% limit, and consequently the Company never received reimbursement. During the three months ended March 31, 2006, the Company reimbursed its Adviser approximately $185,000 of overhead expenses.

3. Stock Options

In December of 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment.” The new standard was effective for awards that are granted, modified, or settled in cash for annual periods beginning after June 15, 2005. The Company previously accounted for these plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and disclosure requirements established by SFAS No. 123, “Accounting for Stock-Based Compensation.” In this regard, these options had been granted to individuals who are the Company’s officers, and who would qualify as leased employees under FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25.” Under APB Opinion No. 25, no expense was recorded in the income statement for the Company’s stock options. The pro forma effects on income for stock options were instead disclosed in a footnote to the financial statements. Under SFAS No. 123(R), all share-based compensation cost was measured at the grant date, based on the fair value of the award, and was recognized as an expense in the income statement over an employee’s requisite service period.

The Company adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective approach. Under the modified prospective approach, stock-based compensation expense was recorded for the unvested portion of previously issued awards that remained outstanding at January 1, 2006 using the same estimate of the grant date fair value and the same attribution method used to determine the pro forma disclosure under SFAS No. 123. SFAS No. 123(R) also requires that all share-based payments to employees after January 1, 2006, including employee stock options, be recognized in the financial statements as stock-based compensation expense based on the fair value on the date of grant. The Company recorded total stock option compensation expense of $46,216 for the three months ended March 31, 2006. There were no stock options outstanding as the Company terminated its stock option plan on December 31, 2006, therefore no stock option compensation expense was recorded for the three months ended March 31, 2007.

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

																		Outstanding
						Number of				Strike Price of				Amount of				Balance of
						Options				Options				Promissory Note				Employee Loans								Interest Rate
		Date Issued				Exercised				Exercised				Issued to Employees				at 3/31/07				Term of Note				on Note
		Sep-04					25,000			$	15.00			$	375,000			$	374,155			9 years					5.00	%
		May-05					5,000			$	15.00			$	75,000			$	57,796			9 years					6.00	%
		Apr-06					25,000			$	15.00			$	375,000			$	375,000			5 years					7.77	%
		Apr-06					12,422			$	16.10			$	199,994			$	199,994			9 years					7.77	%
		May-06					50,000			$	16.85			$	842,500			$	842,500			10 years					7.87	%
		May-06					15,000			$	16.10			$	241,500			$	241,500			10 years					7.87	%
		May-06					2,500			$	16.01			$	40,000			$	39,405			10 years					7.87	%
		May-06					2,000			$	16.10			$	32,200			$	32,200			10 years					7.87	%
		May-06					2,000			$	16.10			$	32,200			$	32,200			10 years					7.87	%
		May-06					2,000			$	16.68			$	33,360			$	33,360			10 years					7.87	%
		May-06					2,000			$	15.00			$	30,000			$	30,000			10 years					7.87	%
		Oct-06					12,000			$	16.10			$	193,200			$	193,200			9 years					8.17	%
		Nov-06					25,000			$	15.00			$	375,000			$	350,000			9 years					8.15	%
		Dec-06					25,000			$	15.00			$	375,000			$	375,000			10 years					8.12	%
							204,922							$	3,219,954			$	3,176,310

These notes were recorded as loans to employees and are included in the equity section of the accompanying consolidated balance sheets.

4. Earnings per Common Share

The following tables set forth the computation of basic and diluted earnings per share for the three months ended March 31, 2007 and 2006:

		For the three months ended March 31,
		2007				2006
Net income available to common stockholders		$	506,905			$	502,356
Denominator for basic weighted average shares			8,565,264				7,672,000
Dilutive effect of stock options			—				149,658
Denominator for diluted weighted average shares			8,565,264				7,821,658
Basic earnings per common share		$	0.06			$	0.07
Diluted earnings per common share		$	0.06			$	0.06

5. Real Estate

A summary of the 42 properties held by the Company as of March 31, 2007 is as follows:

Date Acquired		Location		Square Footage				Property Description		Net Real Estate
Dec-03		Raleigh, North Carolina			58,926			Office		$	4,760,671
Jan-04		Canton, Ohio			54,018			Office and Warehouse			2,989,983
Apr-04		Akron, Ohio			83,891			Office and Laboratory			8,238,111
Jun-04		Charlotte, North Carolina			64,500			Office			8,616,887
Jul-04		Canton, North Carolina			228,000			Commercial and Manufacturing			4,846,695
Aug-04		Snyder Township, Pennsylvania			290,000			Commercial and Warehouse			6,229,466
Aug-04		Lexington, North Carolina			154,000			Commercial and Warehouse			2,819,024
Sep-04		Austin, Texas			51,933			Flexible Office			6,931,126
Oct-04		Norfolk, Virginia			25,797			Commercial and Manufacturing			900,003
Oct-04		Mt. Pocono, Pennsylvania			223,275			Commercial and Manufacturing			5,813,769
Feb-05		San Antonio, Texas			60,245			Flexible Office			7,829,028
Feb-05		Columbus, Ohio			39,000			Industrial			2,661,847
Apr-05		Big Flats, New York			120,000			Industrial			6,435,011
May-05		Wichita, Kansas			69,287			Office			10,774,768
May-05		Arlington, Texas			64,000			Warehouse and Bakery			3,929,026
Jun-05		Dayton, Ohio			59,894			Office			2,372,679
Jul-05		Eatontown, New Jersey			30,268			Office			4,687,996
Jul-05		Franklin Township, New Jersey			183,000			Office and Warehouse			7,560,265
Jul-05		Duncan, South Carolina			278,020			Office and Manufacturing			14,881,734
Aug-05		Hazelwood, Missouri			51,155			Office and Warehouse			2,997,774
Sep-05		Angola, Indiana			52,080			Industrial			1,138,635
Sep-05		Angola, Indiana			50,000			Industrial			1,138,635
Sep-05		Rock Falls, Illinois			52,000			Industrial			1,138,636
Oct-05		Newburyport, Massachusetts			70,598			Industrial			6,924,169
Oct-05		Clintonville, Wisconsin			291,142			Industrial			4,595,406
Dec-05		Maple Heights, Ohio			347,218			Industrial			11,320,461
Dec-05		Richmond, Virginia			42,213			Office			5,921,309
Dec-05		Toledo, Ohio			23,368			Office			3,004,987
Feb-06		South Hadley, Massachusetts			150,000			Industrial			3,156,184
Feb-06		Champaign, Illinois			108,262			Office			14,113,153
Feb-06		Roseville, Minnesota			359,540			Office			27,001,551
May-06		Burnsville, Minnesota			114,100			Office			11,991,416
Jun-06		Menomonee Falls, Wisconsin			125,692			Industrial			7,400,232
Jul-06		Baytown, Texas			12,000			Office			2,612,859
Sep-06		Sterling Heights, Michigan			532,869			Industrial			11,237,940
Sep-06		Birmingham, Alabama			63,514			Industrial			1,560,285
Sep-06		Montgomery, Alabama			29,472			Industrial			1,560,285
Sep-06		Columbia, Missouri			16,275			Industrial			1,560,286
Jan-07		Mason, Ohio			60,000			Office			7,003,126
Feb-07		Raleigh, North Carolina			115,500			Industrial			7,104,290
Mar-07		Tulsa, Oklahoma			238,310			Manufacturing			14,023,672
Mar-07		Hialeah, Florida			132,337			Industrial			10,217,961
		Total real estate, net			5,175,699					$	272,001,341

The following table sets forth the components of the Company’s investments in real estate:

		March 31, 2007				December 31, 2006
Real estate:
Land		$	39,729,393			$	33,764,113
Building			236,083,427				204,115,481
Tenant improvements			6,377,730				5,833,948
Accumulated depreciation			(10,189,209	)			(8,595,419	)
Real estate, net		$	272,001,341			$	235,118,123

On January 5, 2007, the Company acquired a 60,000 square foot office building in Mason, Ohio for approximately $7.88 million, including transaction costs. At closing, the Company was assigned the previously existing triple net lease with the sole tenant, which had a remaining term of approximately six years. The tenant has two options to extend the lease for additional periods of five years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $0.68 million.

On February 16, 2007, the Company acquired an 115,500 square foot industrial building in Raleigh, North Carolina for approximately $7.80 million, including transaction costs. At closing, the Company was assigned the previously existing triple net lease with the sole tenant, which had a remaining term of approximately three years. The tenant has one option to extend the lease for an additional period of five years. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $0.66 million.

On March 1, 2007, the Company acquired the leasehold interest in a 238,310 square foot office building in Tulsa, Oklahoma for $15.80 million, including transaction costs. Under the terms of the leasehold interest, the Company has a ground lease on which the property is located that has a remaining term, including renewal options, of approximately 34.5 years. Upon acquisition of the leasehold interest in the building, the Company was assigned the previously existing triple net lease with the sole tenant, which had a remaining term of approximately 12.5 years at the time of assignment. The tenant also has two options to extend the lease for additional periods of five years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.57 million.

On March 9, 2007, the Company acquired an 132,337 square foot industrial building in Hialeah, Florida for approximately $10.28 million, including transaction costs. At closing, we extended a 15 year triple net lease with the sole tenant, and the tenant has five options to extend the lease for additional periods of five years each. The lease provides for prescribed rent escalations over the life of the lease, with annualized straight line rents of approximately $1.0 million.

In accordance with SFAS No. 141, “Business Combinations,” the Company allocated the purchase price of the properties acquired during the three months ended March 31, 2007 as follows:

										Tenant												Customer				Total Purchase
		Land				Building				Improvements				In-place leases				Leasing Costs				relationships				Price
Mason, Ohio		$	797,274			$	5,957,217			$	296,277			$	—			$	144,703			$	683,471			$	7,878,942
Raleigh, North Carolina			1,605,551				5,462,017				48,767				142,209				64,110				478,083				7,800,737
Tulsa, Oklahoma			—				13,858,300				198,738				437,117				587,605				723,168				15,804,928
Hialeah, Florida			3,562,455				6,613,758				—				—				817				104,508				10,281,538
		$	5,965,280			$	31,891,292			$	543,782			$	579,326			$	797,235			$	1,989,230			$	41,766,145

The weighted average amortization period, for properties acquired during the three months ended March 31, 2007, for in-place leases is approximately 10.9 years, for leasing costs is approximately 10.8 years, for customer relationships is approximately 24.5 years, and for all intangible assets is approximately 16.7 years.

Future operating lease payments under non-cancelable leases, excluding customer reimbursement of expenses in effect at March 31, 2007, are as follows:

Year		Lease Payments
2007			22,153,134
2008			28,849,624
2009			28,235,119
2010			27,125,213
2011			25,014,549
Thereafter			106,135,747

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 outstanding as of March 31, 2007, is approximately $4.6 million, and the total annual ground lease payments on the Tulsa, Oklahoma property are approximately $134,000.

6. Discontinued Operations

On July 21, 2006, the Company sold its two Canadian properties for approximately $6.9 million, for a gain on the sale of approximately $1.4 million. The Company paid and fully accrued approximately $315,000 in taxes related to the gain on the sale in 2006. The 2006 tax returns were subsequently filed in March of 2007, and the amount owed was approximately $236,000. The Company is due a refund in the amount of approximately $79,000, which is reflected on the income statement in discontinued operations under taxes on sale of real estate. The operating expenses incurred during the three months ended March 31, 2007 are legal fees related to the Canadian entities which can not be dissolved until the final tax returns have been accepted by the Canadian tax authorities. The mortgages associated with the Canadian properties were assumed by the buyer at closing.

The Company classified its two Canadian properties as discontinued operations, in accordance with the provisions of SFAS No. 144, 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 table below summarizes the components of income from discontinued operations:

		For the three months ended March 31,
		2007				2006
Operating revenue		$	—			$	154,410
Operating expense			(4,001	)			(13,090	)
Taxes & licenses			78,667				(3,365	)
Interest expense			—				(64,376	)
Depreciation expense			—				(35,541	)
Realized and unrealized losses on foregin currency transactions			7				11,799
Income from discontinued operations		$	74,673			$	49,837

7. 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 is one of the subtenants in the building. The loan was funded using a portion of the net proceeds from the Company’s initial public offering. 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.

8. Mortgage Notes Payable

As of March 31, 2007 the Company had 11 fixed-rate mortgage notes payable collateralized by a total of 26 properties. The weighted-average interest rate on the mortgage notes payable as of March 31, 2007 was approximately 5.7%. A summary of the mortgage notes payable is below:

Date of Issuance		Principal								Principal Balance Outstanding
of Note		Maturity Date				Interest Rate				March 31, 2007				December 31, 2006
3/16/2005			4/1/2030				6.3300 %			$	3,045,636			$	3,060,093
8/25/2005			9/1/2015				5.3310 %				21,757,000				21,757,000
9/12/2005			9/1/2015				5.2100 %				12,588,000				12,588,000
12/21/2005			12/8/2015				5.7107 %				19,456,000				19,456,000
2/21/2006			12/1/2013				5.9100 %				9,583,875				9,620,050
2/21/2006			6/30/2014				5.2000 %				20,022,086				20,104,716
3/29/2006			4/1/2016				5.9200 %				17,000,000				17,000,000
4/27/2006			5/5/2016				6.5800 %				14,691,881				14,753,579
11/22/2006			12/1/2016				5.7600 %				14,309,000				14,309,000
12/22/2006			1/1/2017				5.7900 %				21,846,000				21,846,000
2/8/2007			3/1/2017				6.0000 %				13,775,000				—
										$	168,074,478			$	154,494,438

The fair market value of all fixed-rate debt outstanding as of March 31, 2007 is approximately $168.0 million, which is equivalent to the carrying value stated above.

Scheduled principal payments of mortgage notes payable are as follows:

		Scheduled principal
Year		payments
2007		$	673,252
2008			1,371,558
2009			2,017,730
2010			2,137,220
2011			2,407,409
Thereafter			159,467,309
		$	168,074,478

On February 8, 2007, through wholly-owned subsidiaries, the Company borrowed approximately $13.8 million pursuant to a long-term note payable from KeyBank National Association, which is collateralized by security interests in its Austin, Texas property, its Richmond, Virginia property and its Baytown, Texas property in the amounts of approximately $6.5 million, $5.3 million and $2.0 million, respectively. The note accrues interest at a rate of 6.0% per year. The note has a maturity date of March 1, 2017, although the Company may repay this note with 60 days notice to KeyBank, but would be subject to a substantial prepayment penalty. The Company used the proceeds from the note for acquisitions of properties.

9. Stockholders’ Equity

The following table summarizes the changes in stockholders’ equity for the three months ended March 31, 2007:

														Notes				Distributions in
										Capital in				Receivable				Excess of				Total
		Common				Preferred				Excess of				From Sale of				Accumulated				Stockholders’
		Stock				Stock				Par Value				Common Stock				Earnings				Equity
Balance at December 31, 2006		$	8,565			$	2,150			$	170,640,979			$	(3,201,322	)		$	(15,226,196	)		$	152,224,176
Repayment of Principal on Notes Receivable															25,012								25,012
Distributions Declared to Common and Preferred Stockholders																			(4,106,932	)			(4,106,932	)
Net income																			1,530,342				1,530,342
Balance at March 31, 2007		$	8,565			$	2,150			$	170,640,979			$	(3,176,310	)		$	(17,802,786	)		$	149,672,598

Dividends paid per common share for the three months ended March 31, 2007 and 2006 were both $0.36 per share. Dividends paid per share of Series A Preferred Stock for the three months ended March 31, 2007 and 2006 was approximately $0.48 and $0.34 per share, respectively. Dividends paid per share of Series B Preferred Stock for the three months ended March 31, 2007 was approximately $0.47. There were no dividends paid on the Series B Preferred Stock for the three months ended March 31, 2006, because the class of stock had not yet been issued.

10. Segment Information

As of March 31, 2007, 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 following table summarizes the Company’s consolidated operating results and total assets by segment as of and for the three months ended March 31, 2007 and 2006:

		As of and for the three months ended March 31, 2007
		Real Estate				Real Estate
		Leasing				Lending				Other				Total
Operating revenues		$	7,133,771			$	250,000			$	—			$	7,383,771
Operating expenses			(2,460,979	)			—				(1,250,514	)			(3,711,493	)
Other loss			—				—				(2,216,609	)			(2,216,609	)
Discontinued operations			74,673				—				—				74,673
Net income (loss)		$	4,747,465			$	250,000			$	(3,467,123	)		$	1,530,342
Total Assets		$	304,124,119			$	10,000,000			$	13,065,216			$	327,189,335

		As of and for the three months ended March 31, 2006
		Real Estate				Real Estate
		Leasing				Lending				Other				Total
Operating revenues		$	4,872,698			$	552,913			$	—			$	5,425,611
Operating expenses			(1,896,797	)			—				(1,126,201	)			(3,022,998	)
Other loss			—				—				(1,605,650	)			(1,605,650	)
Discontinued operations			49,837				—				—				49,837
Net income (loss)		$	3,025,738			$	552,913			$	(2,731,851	)		$	846,800
Total Assets		$	232,323,606			$	21,071,041			$	6,412,452			$	259,807,099

The amounts included under other income or loss in the tables above includes interest income, interest expense and any other miscellaneous income earned that was not specifically derived from either operating segment.

11. Line of Credit

On December 29, 2006, the Company entered into a $75 million senior revolving credit agreement with a syndicate of banks led by KeyBank National Association, which matures on December 29, 2009 with an option to extend for an additional year. The new revolving credit facility replaces a previous facility led by BB&T, which was terminated upon the closing of the new line. 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. 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. As the Company arranges for long-term mortgages for these pledged properties, the banks will release the properties from the line of credit and reduce the availability under the line of credit by the advanced amount of the removed property. Conversely, as the Company purchases new properties meeting the eligibility standards, the Company may pledge these new properties to obtain additional advances under this agreement. The Company may use the advances under the line of credit for both general corporate purposes and the acquisition of new investments. As of March 31, 2007, there were no borrowings outstanding under the line of credit.

12. Pro Forma Financial Information (unaudited)

The Company acquired three properties and one leasehold interest during the three months ended March 31, 2007. The following table reflects pro-forma consolidated income statements as if the three properties and leasehold interest were acquired as of the beginning of the periods presented:

		For the three				For the three
		months ended				months ended
		March 31, 2007				March 31, 2006
Operating Data:
Total operating revenue		$	7,927,719			$	6,402,312
Total operating expenses			(3,899,167	)			(3,323,383	)
Other expense			(2,178,856	)			(1,605,649	)
Net income		$	1,849,696			$	1,473,280
Dividends attributable to preferred stock			(1,023,437	)			(344,444	)
Net income available to common stockholders		$	826,259			$	1,128,836
Share and Per Share Data:
Basic net income		$	0.10			$	0.15
Diluted net income		$	0.10			$	0.14
Weighted average shares outstanding-basic			8,565,264				7,672,000
Weighted average shares outstanding-diluted			8,565,264				7,821,658

These pro-forma consolidated income statements are not necessarily indicative of what actual results would have been had the Company acquired the specified properties as of the beginning of the periods presented.

13. Subsequent Events

On April 11, 2007, the Company’s Board of Directors declared cash dividends of $0.12 per common share, $0.1614583 per share of the Series A preferred stock, and $0.15625 per share on the Series B preferred stock for each of the months of April, May and June of 2007. Monthly dividends will be payable on April 30, 2007, May 31, 2007 and June 29, 2007, to those stockholders of record for those dates on April 20, 2007, May 22, 2007 and June 21, 2007, respectively.

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

All statements contained herein, other than historical facts, may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements may relate to, among other things, future events or our future performance or financial condition. In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others: (1) general volatility of the capital markets and the market price of our securities; (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 credit facility, 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 (7) those factors listed under the caption “Risk Factors” of the Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 27, 2007. We caution readers not to place undue reliance on any such forward-looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this Form 10-Q.

OVERVIEW

Our Investment Strategy

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 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 March 31, 2007, we owned 42 properties totaling approximately 5.2 million square feet, and had one mortgage loan outstanding. The total gross investment in these acquisitions and the mortgage loan investment was approximately $325.1 million.

Recent Events

Investment Activities: During the three months ended March 31, 2007, we acquired three properties and one leasehold interest totaling approximately 546,000 square feet, for a total gross investment of approximately $41.8 million.

Financing Activities: During the three months ended March 31, 2007, we borrowed approximately $13.8 million pursuant to a long-term note payable collateralized by security interests in three of our properties.

Our Investment Adviser and Administrator

Gladstone Management Corporation, or 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 president and chief operating officer, is a member of the board of directors of our Adviser and its vice chairman and chief operating officer. George Stelljes III, our executive vice president and chief investment officer, is a member of the board of directors of our Adviser and its president and chief investment officer. Harry Brill, our chief financial officer, is also the chief financial officer of our Adviser. Our Adviser also has a wholly-owned subsidiary, Gladstone Administration, LLC, or the Administrator, which employs our chief financial officer, chief compliance officer, controller, 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 wells as Gladstone Land Corporation, an agricultural real estate company owned by Mr. Gladstone. All of our directors and 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.

Our Adviser was organized as a corporation under the laws of the State of Delaware on July 2, 2002, and is a registered investment adviser under the Investment Advisers Act of 1940, as amended. Our Adviser is headquartered in McLean, Virginia, a suburb of Washington D.C., and also has offices in New York, New Jersey, Pennsylvania, Illinois, Texas and Kentucky.

Investment Advisory and Administration Agreements

We have been externally managed pursuant to a contractual investment advisory arrangement with our Adviser, under which our Adviser has directly employed all of our personnel and paid its payroll, benefits, and general expenses directly. Our initial investment advisory agreement with our Adviser was in place from August 12, 2003 through December 31, 2006, which we refer to as the Initial 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 Amended Advisory Agreement, and an administration agreement, which we refer to as the Administration Agreement, with Gladstone Administration.

Under the terms of the Initial Advisory Agreement and the Amended Advisory Agreement, we were and remain 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, shareholder related fees, consulting and related fees. During the three months ended March 31, 2007 and 2006, the total amount of these expenses that we incurred was approximately $3.1 million and $2.1 million, respectively. 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.

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). 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 three months ended March 31, 2007 and 2006, we passed all such fees along to our tenants, and accordingly we did not incur any such fees during these periods. Accordingly, we did not make any reimbursements to our Adviser for these amounts. 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 Initial Advisory Agreement

Pursuant to the Initial Advisory Agreement, we were required to reimburse our Adviser for our pro rata share of our Adviser’s payroll and benefits expenses on an employee-by-employee basis, based on the percentage of each employee’s time devoted to our matters. During the three months ended March 31, 2006, these expenses were approximately $468,000.

We were also required to reimburse our Adviser for our pro rata portion of all other expenses of our Adviser not reimbursed under the arrangements described above, which we refer to as overhead expenses, equal to the total overhead expenses of our Adviser, multiplied by the ratio of hours worked by our Adviser’s employees on our projects to the total hours worked by our Adviser’s employees. However, we were only required to reimburse our Adviser for our portion of its overhead expenses if the amount of payroll and benefits we reimbursed to our Adviser was less than 2.0% of our average invested assets for the year. Additionally, we were only required to reimburse our Adviser for overhead expenses up to the point that reimbursed overhead expenses and payroll and benefits expenses, on a combined basis, equaled 2.0% of our average invested assets for the year. Our Adviser billed us on a monthly basis for these amounts. Our Adviser was required to reimburse us annually for the amount by which amounts billed to and paid by us exceeded this 2.0% limit during a given year. The amounts never exceeded the 2.0% limit, and we never received reimbursement. During the three months ended March 31, 2006, we reimbursed our Adviser approximately $185,000 of overhead expenses.

Management services and fees under the Amended Advisory Agreement

The Amended Advisory Agreement provides for an annual base management fee equal to 2.0% of our total stockholders equity, less the recorded value of any preferred stock, and an incentive fee based on funds from operations, or FFO. For purposes of calculating the incentive fee, FFO includes any realized capital gains and capital losses, less any dividends 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, exceeds 1.75%, or 7% annualized, (the “hurdle rate”) of total stockholders’ equity, less the recorded value of any preferred stock. Our Adviser will receive 100% of the amount of the pre-incentive fee FFO that exceeds the hurdle rate, but is less than 2.1875% of our pre-incentive fee FFO. Our Adviser will also receive an incentive fee of 20% of the amount of our pre-incentive fee FFO that exceeds 2.1875%.

For the three months ended March 31, 2007, the base management fee, based on the Amended Advisory Agreement fees was $482,044. For the three months ended March 31, 2007, we recorded a gross incentive fee of $585,768 which was offset by a waiver voluntarily issued by the Adviser’s Board of Directors of $585,768, which resulted in a net incentive fee payable to the Adviser of $0. Our board of directors accepted our Advisers’ offer to waive the entire incentive fee for the quarter ended March 31, 2007 in order to maintain the current level of distributions to our stockholders.

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, controller, treasurer and their respective staffs. For the three months ended March 31, 2007, we incurred $207,018 for the administration fee.

Critical Accounting Policies

Management believes our most critical accounting policies are revenue recognition (including straight-line rent), investment accounting, purchase price allocation, accounting for our investments in real estate, provision for loan losses, the accounting for our derivative and hedging activities, if any, income taxes and stock based compensation. Each of these items involves estimates that require management to make judgments that are subjective in nature. Management relies on its experience, collects historical data and current market data, and analyzes these assumptions 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 judgments on the use of assumptions as to future uncertainties and, as a result, actual results could materially differ from these estimates. For a summary of all of our critical accounting policies, see Note 1 to our consolidated financial statements included elsewhere in this report.

Recently Issued Accounting Pronouncements

In July of 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109.” This Interpretation provides guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return, and provides guidance on recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition of tax positions. This Interpretation is effective for fiscal years beginning after December 15, 2006. We adopted FIN No. 48 effective for the fiscal year beginning January 1, 2007, and the adoption had no impact on our results of operations.

Results of Operations

Our weighted-average yield on the portfolio as of March 31, 2007 was approximately 9.3%. The weighted-average yield was calculated by taking the annualized straight line rent, 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. The weighted-average yield is a non-GAAP (Generally Accepted Accounting Principles in the United States of America) measure that we believe is useful to our readers in estimating our future earnings.

A comparison of our operating results for the three months ended March 31, 2007 and 2006 is below:

		For the three months ended March 31,
		2007				2006				$ Change				% Change
Operating revenues
Rental income		$	7,078,036			$	4,867,075			$	2,210,961				45	%
Interest income from mortgage notes receivable			250,000				552,913				(302,913	)			-55	%
Tenant recovery revenue			55,735				5,623				50,112				891	%
Total operating revenues			7,383,771				5,425,611				1,958,160				36	%
Operating expenses
Depreciation and amortization			2,417,812				1,799,201				618,611				34	%
Base management fee			482,044				652,742				(170,698	)			-26	%
Administration fee			207,018				—				207,018				100	%
Incentive fee			585,768				—				585,768				100	%
Professional fees			149,431				198,459				(49,028	)			-25	%
Taxes and licenses			15,007				50,894				(35,887	)			-71	%
Insurance			146,252				82,998				63,254				76	%
General and administrative			111,902				47,817				64,085				134	%
Directors fees			54,250				33,500				20,750				62	%
Stockholder related expense			99,617				64,469				35,148				55	%
Asset retirement obligation expense			28,160				46,702				(18,542	)			-40	%
Stock option compensation expense			—				46,216				(46,216	)			-100	%
Total operating expenses before credit from Adviser			4,297,261				3,022,998				1,274,263				42	%
Credit to incentive fee			(585,768	)			—				(585,768	)			100	%
Total expenses net of credit to incentive fee			3,711,493				3,022,998				688,495				23	%
Other income (expense)
Interest income from temporary investments			229,016				7,373				221,643				3006	%
Interest income — employee loans			60,422				5,548				54,874				989	%
Other income			8,414				—				8,414				100	%
Interest expense			(2,514,461	)			(1,618,571	)			(895,890	)			55	%
Total other expense			(2,216,609	)			(1,605,650	)			(610,959	)			38	%
Income from continuing operations			1,455,669				796,963				658,706				83	%
Discontinued operations
Income from discontinued operations			(4,001	)			38,038				(42,039	)			-111	%
Net realized loss from foreign currency transactions			7				(816	)			823				-101	%
Net unrealized loss from foreign currency transactions			—				12,615				(12,615	)			-100	%
Taxes on sale of real estate			78,667				—				78,667				100	%
Total discontinued operations			74,673				49,837				24,836				50	%
Net income			1,530,342				846,800				683,542				81	%
Dividends attributable to preferred stock			(1,023,437	)			(344,444	)			(678,993	)			197	%
Net income available to common stockholders		$	506,905			$	502,356			$	4,549				1	%

Operating Revenues

Rental income increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, primarily due to the acquisition of 11 properties subsequent to March 31, 2006, and properties acquired during the first quarter of 2006 that were held for the full first quarter of 2007.

Interest income from mortgage loans decreased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, due to the defaulted mortgage loan on the Sterling Heights, Michigan in August 2006. We acquired the building in satisfaction of the mortgage loan in September of 2006.

Tenant recovery revenue increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, as a result of an increase in the number of tenants which reimbursed us for insurance expense, partially offset by an over-accrual of franchise taxes in 2005, which resulted in a credit to tenant recovery revenue in the three months ended March 31, 2006.

Operating Expenses

Depreciation and amortization expenses increased in the three months ended March 31, 2007 as compared to the three months ended March 31, 2006, as a result of the 11 property acquisitions completed between March 31, 2006 and March 31, 2007, coupled with properties acquired during the three months ended March 31, 2006 that were held for the full three months ended March 31, 2007.

For the three months ended March 31, 2007, we incurred a base management fee of $482,044 as compared to the three months ended March 31, 2006, in which we incurred a base management fee of $652,742. The base management fee for the three months ended March 31, 2007 was computed under the terms of the Amended Advisory Agreement and the base management fee for the three months ended March 31, 2006 was computed under the terms of the Initial Advisory Agreement. Both agreements are described above under “Investment Advisory and Administration Agreements.”

On January 1, 2007, the Administration Agreement became effective and we began paying our Administrator amounts equal to our allocable portion of our Administrator’s overhead expenses in performing its obligations under the Administration Agreement. The Administration Agreement is described above under “Investment Advisory and Administration Agreements.” We incurred an administration fee of $207,018 for the three months ended March 31, 2007. There was no administration fee recorded during the three months ended March 31, 2006, as the Administration Agreement was not in effect.

On January 1, 2007, the Amended Advisory Agreement, which includes an incentive fee component, became effective and as such we recorded a gross incentive fee of $585,768, which was reduced by a voluntary waiver issued by our Adviser’s board of directors of $585,768, which resulted in a net incentive fee of $0. The calculation of the incentive fee is described in detail above under “Investment Advisory and Administration Agreements.” There was no incentive fee recorded for the three months ended March 31, 2006, as the Amended Advisory Agreement was not in effect.

Professional fees, consisting primarily of legal and accounting fees, decreased during the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, primarily as a result of $50,000 of audit fees recorded in the three months ended March 31, 2006, which related to the 2005 year end audit.

Taxes and licenses decreased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, primarily because of the reversal of accrued taxes on our Sterling Heights, Michigan property, in which the taxes were subsequently paid by the tenant Taxes and licenses primarily consists of franchise taxes we pay for doing business in certain states, coupled with fees paid for state and annual licenses for our entities operating in each of these states.

Insurance expense increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006. The increase was primarily a result of an increase in premiums for directors and officers insurance from the prior year, coupled with the 11 properties acquisitions completed between March 31, 2006 and March 31, 2007, which required insurance.

General and administrative expenses increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, as a result of approximately $36,000 in operating expenses that we were required to pay on behalf of a tenant under the terms of its lease for the three months ended March 31, 2007, coupled with an increase in management fees we paid on behalf of certain of our properties, and an increase in the amount of due diligence expense written off related to deals that did not close during the three months ended March 31, 2007.

Directors’ fees increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, because of the increase in the annual fees each board member collects, coupled with an increased number of committee meetings. The annual fees for each board member were increased in 2007 as a result of the termination of our stock option plan.

Stockholder related expense increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, as a result of the increase in our annual fees due to NASDAQ, increased costs associated with the annual report, the proxy statement, and an increased number of Form 8-Ks filed.

Asset retirement obligation expense decreased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006, as a result of the expense recorded during the three months ended March 31, 2006, which included expense related to prior periods, partially offset by the increased number of properties acquired subsequent to March 31, 2006 that were required to recognize a liability related to asset retirement. Asset retirement obligation expense is the result of the adoption of FASB Interpretation No. 47 “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 requires an entity to recognize a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. FIN 47 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. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. We have accrued a liability for disposal related to all properties constructed prior to 1985 that have, or may have, asbestos present in the building. The asset retirement obligation expense is the result of the accretion of the asset retirement obligation liability accrued on our books.

There was no stock option compensation expense recorded for the three months ended March 31, 2007 as the Company terminated its stock option plan on December 31, 2006. Stock option compensation expense for the three months ended March 31, 2006 was the result of the adoption of the SFAS No. 123 (revised 2004) “Share-based Payment.”

Other Income and Expenses

Interest income on cash and cash equivalents increased during the three months ended March 31, 2007, as compared to the three months ended March 31, 2006. The increase was primarily a result of the increase in our average cash balances during the three months ended March 31, 2007 as a result of long-term financings on our properties that closed during the past two quarters.

During the three months ended March 31, 2007, interest income on employee loans increased, as compared to the three months ended March 31, 2006. This increase was a result of 12 employee loans that were originated subsequent to March 31, 2006.

Other income for the three months ended March 31, 2007 consisted of,management fees we received from certain of our tenants.

Interest expense increased for the three months ended March 31, 2007, as compared to the three months ended March 31, 2006. This was primarily a result of the long-term financings we closed on 12 properties subsequent to March 31, 2006, partially offset by an increased amount outstanding on our line of credit during the three months ended March 31, 2006 for which no amounts were outstanding for the three months ended March 31, 2007.

Discontinued Operations

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that the results of operations of any properties which have been sold, or are held for sale, be presented as discontinued operations in our Consolidated Financial Statements in both current and prior periods presented. As a result, income from discontinued operations is the income from our two Canadian properties, which were sold in July 2006. Income for the three months ended March 31, 2006 was a result of operations from the Canadian properties held during that time, whereas the expense for the three months ended March 31, 2007 was a result of expenses related to the entities that we incurred subsequent to the sale. We also paid and fully accrued approximately $315,000 in taxes related to the gain on the sale in 2006. The 2006 tax returns were subsequently filed in March of 2007, and the amount owed was approximately $236,000. We are due a refund in the amount of $79,000, which is reflected on the income statement in discontinued operations under taxes paid on sale of real estate.

Liquidity and Capital Resources

Cash and Cash Equivalents

At March 31, 2007, we had approximately $7.1 million in cash and cash equivalents. We have access to our existing line of credit and have obtained mortgages on 26 of our properties. We expect to obtain additional mortgages secured by some or all of our real property in the future. We anticipate continuing to borrow funds and issuing additional equity securities in order to obtain additional capital. We expect that the funds from our line of credit, additional mortgages and securities offerings will provide us with sufficient capital to make additional investments and to fund our continuing operations for the foreseeable future.

Operating Activities

Net cash provided by operating activities during the three months ended March 31, 2007, consisting primarily of the items described in “Results of Operations,” was approximately $3.9 million, compared to net cash provided by operating activities of $3.0 million for the three months ended March 31, 2006.

Investing Activities

Net cash used in investing activities during the three months ended March 31, 2007 was $42.3 million, which primarily consisted of the purchase of three properties and one leasehold interest, as described in the “Investments” section above, as compared to net cash used in investing activities during the three months ended March 31, 2006 of $18.6 million, which primarily consisted of the purchase of three properties.

Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2007 was approximately $9.5 million, which primarily consisted of the proceeds received from the long-term financing of three of our properties, partially offset by payments for deferred financing costs, principal repayments on mortgage notes payable and dividend payments. Net cash provided by financing activities for the three months ended March 31, 2006 was approximately $15.1 million, which consisted of the proceeds received from the long-term financing of five of our properties, the proceeds from borrowing under our line of credit, and the proceeds from the offering of our preferred stock, partially offset by principal repayments on the mortgage notes payable, repayments on the line of credit, payments for deferred financing costs and dividend payments to our stockholders.

Future Capital Needs

We had purchase commitments for two properties at March 31, 2007 in the aggregate amount of approximately $12.9 million.

As of March 31, 2007, we had investments in 42 real properties for a net value, including intangible assets, of approximately $298 million and one mortgage loan for $10 million. During 2007 and beyond, we expect to complete additional acquisitions of real estate and to extend additional mortgage notes. We intend to acquire additional properties by borrowing all or a portion of the purchase price and collateralizing the loan with mortgages secured by some or all of our real property, by borrowing against our existing line of credit, or by issuing additional equity securities. We may also use these funds for general corporate needs. If we are unable to make any required debt payments on any borrowings we make in the future, 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.

Line of Credit

On December 29, 2006, we entered into a $75 million senior revolving credit agreement with a syndicate of banks led by KeyBank National Association, which matures on December 29, 2009 with an option to extend for an additional year. The new revolving credit facility replaces a previous facility led by Branch Banking and Trust, or BB&T, which was terminated upon the closing of the new line. Upon termination of the credit facility with BB&T, we wrote off approximately $590,000 in unamortized deferred financing fees. The interest rate charged on the advances under the facility is based on the London Interbank Offered Rate, or 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. 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. As we arrange for long-term mortgages 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. We may use the advances under the line of credit for both general corporate purposes and the acquisition of new investments. As of March 31, 2007, there were no borrowings outstanding under the line of credit.

Mortgage Note Payable

On February 8, 2007, through wholly-owned subsidiaries, we borrowed approximately $13.8 million pursuant to a long-term note payable from KeyBank National Association which is collateralized by security interests in our Austin, Texas property, our Richmond, Virginia property and our Baytown, Texas property in the amounts of approximately $6.5 million, $5.3 million, and $2.0 million, respectively. The note accrues interest at a rate of 6.0% per year, and we may repay this note with 60 days notice to KeyBank, but would be subject to a substantial prepayment penalty. The note has a maturity date of March 1, 2017, and we invested the proceeds from the note in our money market account and plan to use the proceeds for future acquisitions.

Contractual Obligations

The following table reflects our significant contractual obligations as of March 31, 2007:

						Payments Due by Period												More than 5
Contractual Obligations		Total				Less than 1 Year				1-3 Years				3-5 Years				Years
Long-Term Debt Obligations (1)		$	168,074,478			$	1,002,691			$	3,608,690			$	4,638,366			$	158,824,731
Interest on Long-Term Debt Obligations (2)			82,744,552				9,752,821				19,202,042				18,744,999				35,044,690
Capital Lease Obligations			—				—				—				—				—
Operating Lease Obligations (3)			—				—				—				—				—
Purchase Obligations (4)			12,900,000				12,900,000				—				—				—
Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP			—				—				—				—				—
Total		$	263,719,030			$	23,655,512			$	22,810,732			$	23,383,365			$	193,869,421