UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

COMMISSION FILE NUMBER: 0-50363

GLADSTONE COMMERCIAL CORPORATION

1616 ANDERSON ROAD, SUITE 208
MCLEAN, VIRGINIA 22102
(Address of principal executive office)

(703) 286-7000
(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.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. The number of shares of the issuer’s Common Stock, $0.001 par value, outstanding as of November 4, 2003May 7, 2004 was 7,642,000.

PART I –— FINANCIAL INFORMATION

Gladstone Commercial Corporation

Item 1 — Consolidated Financial Statements

(Unaudited)

September 30, 2003March 31, 2004

CONTENTS

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statement of Cash Flows

Notes to Financial Statements

GLADSTONE COMMERCIAL CORPORATION

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

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GLADSTONE COMMERCIAL CORPORATION

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

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GLADSTONE COMMERCIAL CORPORATION

GLADSTONE COMMERCIAL CORPORATION

CONSOLIDATED STATEMENTSTATEMENTS OF CASH FLOWS
For the Period February 14, 2003 (Inception) to September 30, 2003

(Unaudited)

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

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     The Company will allocateallocates purchase price to the fair value of the tangible assets of an acquired property

(which (which includes the land, building, and tenant improvements) to be determined by valuing the property as if it were vacant. The “as-if-vacant” value will beis allocated to land, building, and tenant improvements based on management’s determination of the relative fair values of these assets.

     Above-market and below-market in-place lease values for owned properties will beare 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 will be amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values (presented in the accompanying balance sheet as value of assumed lease obligations) will beare amortized as an increase to rental income over the initial term and any fixed-rate renewal periods in the respective leases. Since the Company’s strategy will to a large degree involveinvolves sale-leaseback transactions with newly originated leases at market rates, the above-market and below-market in-place lease values are not expected to be significant for many of the transactions the Company will ultimately enter into.

     The aggregate value of other intangible assets acquired are measured based on the difference between (i) the property valued with existing in-place leases adjusted to market rental rates and (ii) the property valued as if vacant. Management’s estimates of value 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 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 six to 18 months, depending on specific local market conditions. Management also estimates costs to execute similar leases including leasing commissions, legal and other related expenses to the extent that such costs are not already incurred in connection with a new lease origination as part of the transaction.

     The total amount of other intangible assets acquired will beis further allocated to in-place lease values and customer relationship intangible values 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 the Company’s 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.

     Management’s estimates of value are expected to be made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors to be 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 will also consider 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 acquired. In estimating carrying costs, management will also include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, which are expected to primarily range from six to 18 months, depending on specific local market conditions. Management will also estimate 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 value of in-place leases will beis amortized to expense over the initial term of the respective leases, which are primarily expected to range from tensix to 20 years. The value of customer relationship intangibles will beare amortized to expense over the initial term and any renewal periods in the respective leases, but in no event willdoes 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 (including above and below market lease values, lease origination costs, and lease-up carrying costs) and customer relationship intangibles will be charged to earnings.expense. Total amortization expense was $13,587 for the three months ended March 31, 2004.

Impairment

     The Company periodically reviews 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 will prepare a projection of the undiscounted future cash flows, without interest charges, of the specific property and determine if the investment in such property is recoverable. If impairment is indicated, the carrying value of the property is 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, 2004.

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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 generally three months or less at the time of purchase to be cash equivalents.equivalents; except that any such investments purchased with funds on deposit in escrow or similar accounts are classified as restricted deposits. Items classified as cash equivalents include commercial paper and money-market funds, and U.S. Treasury bills, and are carried at amortized cost.funds. All of the Company’s cash and cash equivalents at September 30, 2003March 31, 2004 were held in the custody of one financial institution, and which balance at times may exceed federally insurable limits. The Company mitigates this risk by depositing funds with major financial institutions.

Deferred offering costs

     Costs incurred prior to the Offering were deferred at June 30, 2003 and were charged to stockholder’s equity upon completion of the Offering.

Organizational costs

     The Company expenses organizational costs (primarily filing fees and legal expenses) as incurred.

Stock based compensation

     In December 2002, the Financial Accounting Standards Board (“FASB”) approved the issuance of Statement of Financial Accounting Standards (“SFAS”) No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure.” The statement amended SFAS No. 123 “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation. Furthermore, SFAS No. 148 amended the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method and related effect on results of accounting for stock-based employee compensation, effective for fiscal year and interim periods beginning after December 15, 2002.

     The Company accounts for the issuance of stock options under its 2003 Equity Incentive plan in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees.” In this regard, these options have been granted to individuals who are the Company’s officers, and who would qualify as leased employees under FIN 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25.”

Income taxes

     At the earliest date possible, theThe Company intendshas and will operate in a manner that will allow it to qualify as a real estate investment trust under the Internal Revenue Code of 1986, and accordingly will not be subject to Federal Incomeincome taxes on amounts distributed to stockholders (except income from foreclosure property), provided it distributes at least 90% of its real estate investment trust taxable income to its stockholders and meets certain other conditions.

Stock OptionsRevenue recognition

     The Company accounts for the issuance of stock options under our 2003 Equity Incentive Plan     Rental revenues include rents that each tenant pays in accordance with APB Opinion No. 25, “Accountingthe terms of its respective lease reported on a straight-line basis over the non-cancelable term of the lease. Since one of the Company’s leases currently contains rental increases at specified intervals, 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 represents 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. 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 on a quarterly basis and takes into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of deferred rent with respect to any given tenant is in doubt, the Company records an increase in the allowance for Stock Issueduncollectible accounts or

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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.

     Management considers its loans and other lending investments to Employee.” In this regard, these options have been granted to individuals whobe 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 our officersrecognized 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 who would qualifyrecognized over the lives of the related loans as leased employees under FIN 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25.”yield adjustment. 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.

Use of estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

New Accounting PronouncementsSegment information

     SFAS 149No. 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.

     In April 2003, the Financial Accounting Standards Board (“FASB”) issued StatementAs of Financial Accounting Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and hedging relationships designated after June 30, 2003, except for those provisions of SFAS No. 149 which relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003. The Company does not expect the adoption of SFAS 149 to have a material impact onMarch 31, 2004, the Company’s consolidated financial statements.operations are derived from two operating segments. One segment purchases real estate (land, buildings and other improvements) which are simultaneously leased to existing users and the other segment extends mortgage loans and collects principal and interest payments.

  SFAS 150

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or as an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. The Company does not expect the adoption of SFAS No. 150 to have a material impact on the Company’s consolidated financial statements.

  FIN 45

     In November 2002, the FASB published Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a guarantor recognize a liability for the fair value of an obligation assumed under a guarantee and also discusses additional disclosures to be made in the interim and annual financial statements of the guarantor regarding obligations under certain guarantees. The initial measurement and recognition requirements of

FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The adoption did not have an impact on the Company’s consolidated financial statements at September 30, 2003.

  FIN 46

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” This standard clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and addresses consolidation by business enterprises of variable interest entities (more commonly known as Special Purpose Entities or SPE’s). FIN 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among the parties involved. FIN 46 also enhances the disclosure requirements related to variable interest entities. This statement is effective for variable interest entities created or in which an enterprise obtains an interest after January 31, 2003. In October 2003, the FASB issued FIN 46-6, which deferred the implementation until after the fourth quarter of 2003 for entities created prior to January 31, 2003. At September 30, 2003, the Company has not invested in any SPEs. The Company does not expect the adoption of FIN 46 to have a material impact on the Company’s consolidated financial statements.

3. Management Advisory Fee

     The Company has entered into an agreement with the Company’s Adviser in which the Adviser will be responsible for managing the Company on a day-to-day basis and for identifying, evaluating, negotiating and consummating investment transactions consistent with the Company’s criteria. In exchange for such services, the Company will reimburse the Adviser for certain expenses. The Company will reimburse the Adviser for its pro-rata share of the payroll and related benefit expenses on an employee-by-employee basis, based on the percentage of each employee’s time devoted to Company matters. The Company will also reimburse the Adviser for general overhead expenses multiplied by the ratio of hours worked by

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Adviser employees on Company matters to the total hours worked by Adviser employees. Through September 30, 2003,For the three months ended March 31, 2004, the Company has incurred $124,096approximately $229,000 in management advisory fees, of which $41,203fees. Approximately $464,000 (which includes prior fiscal year accruals) was unpaid at September 30, 2003.March 31, 2004.

4. Stock Options

     In December 2002, the FASB approved the issuance of SFAS No. 148 “Accounting for Stock-Based Compensation –— Transition and Disclosure.” The statement amended SFAS No. 123 “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock based employee compensation. Furthermore, SFAS No. 148 amended the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method and related effect on results of accounting for stock-based employee compensation, effective for fiscal year and interim periods beginning after December 15, 2002.

The following tables summarizes the Company’s operating results as if the Company elected to account for its stock-based compensation under the fair value provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” for the three months ended September 30, 2003 and the period from February 14, 2003 (inception) to September 30, 2003:

Due to the Company’s net loss, the incremental shares have an anti-dilutive effect for the periods ended September 30, 2003. As a result, diluted loss per average common share is equal to the basic loss per average common share for the periods ended September 30, 2003.March 31, 2004:

The stock-based compensation expense under the fair value method, as reported in the above table, was computed using an estimated weighted average fair value of $4.89 using the Black-Scholes option-pricing model and the following assumptions: dividend yield of five percent, risk-free interest rate of 2.24%1.94%, expected volatility factor of 0.1839,18.39%, and expected lives of three years.

There were no stock options outstanding during the period February 14, 2003 (inception) through March 31, 2003.

At March 31, 2004, 679,000 options were outstanding with exercise prices ranging from $15 to $16.85 with terms of ten years.

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5. Earnings Per Common Share

The following table sets forforth the computation of basic and diluted decrease in stockholders’ equity from operationsearnings (loss) per share for the three months ended September 30, 2003 and from the period February 14, 2003 (inception) through September 30, 2003:

Due to the Company’s net loss, the incremental shares, related to stock options, have an anti-dilutive effect for the periodsthree months ended September 30, 2003March 31, 2004 and as a result diluted loss per average common share is equal to the basic loss per average common shareshare.

6. Real Estate

     The following table sets forth the Company’s real estate holdings at March 31, 2004:

     On December 23, 2003 the Company acquired a 58,926 square foot commercial office building in Raleigh, North Carolina. The property was acquired for $5.8 million including transaction costs and was funded using a portion of the periods ended September 30, 2003.net proceeds from the Company’s initial public offering. The property is leased to a single tenant. The lease has a remaining term of six years. In connection with this acquisition, the Company recorded lease intangibles in the amount of $359,228 related to the avoided costs to lease the property and obtain the current lease. These intangibles will be amortized over the remaining lease term.

     On January 30, 2004, the Company acquired a 54,018 square foot commercial office and warehouse space building in Canton, Ohio for $3.65 million including transaction costs and was funded using a portion of the net proceeds from the Company’s initial public offering. The Company, upon acquisition of the property, extended a ten year triple net lease with the sole tenant. The monthly lease payments are the greater of LIBOR based plus 600 basis points or 9.25% multiplied by the purchase price.

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     Future operating lease payments under non-cancelable leases, excluding customer reimbursement of expenses, in effect at March 31, 2004 are as follows:

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 property in the event the tenant fails to pay them.

7. Mortgage Note Receivable

     On February 18, 2004, the Company extended a promissory mortgage note in the amount of $11,170,000 collateralized by property in Sterling Heights, Michigan. The note was issued from a portion of the net proceeds of the Company’s initial public offering. The note accrues interest at the greater of 10% per annum or the one month LIBOR rate plus 400 basis points per annum, and is for a period of 10 years maturing on February 18, 2014.

8. Dividends Declared per Share

     During the three months ended March 31, 2004, the Company declared a $0.12 per common share dividend to stockholders of record on March 31, 2004 which is payable on April 15, 2004.

9. Subsequent Event

     On April 29, 2004, the Company purchased an 83,891 square foot commercial office and laboratory space in Akron, Ohio for $9.3 million. The purchase was funded using a portion of the proceeds of the Company’s initial public offering. The property is currently leased to two tenants under separate triple net leases, one of which occupies 79% of the property and has a remaining term of twelve years and the other of which occupies 21% of the property and has a remaining term of five years. The leases will provide approximately $649,000 of base rents during fiscal year 2004 with prescribed escalations thereafter.

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

Forward-Looking Statements

     Some of the statements in this QuarterlyAnnual Report onForm 10-Q10-K constitute forward-looking statements under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements made with respect to possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate” or similar expressions, we intend to identify forward-looking statements. You should not place undue reliance on these forward-looking statements. Statements regarding the following subjects are forward-looking by their nature:

	•		our business strategy;
•		pending transactions;
•		our projected operating results;
•		our ability to obtain future financing arrangements;
•		estimates relating to our future distributions;
•		our understanding of our competition;
•		market trends;
•		projected capital expenditures; and
•		use of the proceeds of our initial public offering.

     These statements involve known and unknown risks, uncertainties and other factors that may cause results, levels of activity, growth, performance, tax consequences or achievements to be materially different from any future results, levels of activity, growth, performance, tax consequences or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those listed below, as well as those further set forth under the heading “Risk Factors” included elsewhere in our prospectus dated August 12, 2003 as filed with the SEC on August 13, 2003.this report.

     The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Although we believe that these beliefs, assumptions and expectations are reasonable, we cannot guarantee future results, levels of activity, performance, growth or achievements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our common stock, along with the following factors that could cause actual results to vary from our forward-looking statements:

	•		the loss of any of our key employees, such as Mr. Gladstone, Mr. Brubaker or Mr. Stelljes;
•		general volatility of the capital markets and the market price of our common stock;
•		risks associated with negotiation of consummation of pending and future transactions;
•		changes in our business strategy;
•		availability, terms and deployment of capital;
•		availability of qualified personnel;
•		changes in our industry, interest rates or the general economy; and
•		the degree and nature of our competition.

We are under no duty to update any of the forward-looking statements after the date of this Form 10-Qreport to conform such statements to actual results.

Overview

     We were incorporated under the General Corporation Law of the State of Maryland on February 14, 2003 primarily for the purpose of investing in and owning net leased industrial and commercial real property and selectively making long-term industrial and commercial mortgage loans. We

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expect that a large portion of our tenants and borrowers will be small and medium-sized businesses that have significant buyout fund ownership and will be well capitalized, with equity constituting between 20% and 40% of their permanent capital. We expect that other tenants and borrowers will be family-owned businesses that have built significant equity from paying down the mortgage loans securing their real estate or through the appreciation in the value of their real estate. We will seek to enter into triple net leases having terms of approximately 15 years, with rent increases built into the leases. 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. AlthoughAt March 31, 2004, we have not yet purchased anyowned two properties or made anyand had one mortgage loans, weloan. We are actively communicating with buyout funds, real estate brokers and other third parties to locate properties for potential acquisition or mortgage financing.financing in an effort to build our portfolio.

     We will conduct substantially all of our activities through, and substantially all of our properties will beare held directly or indirectly by, Gladstone Commercial Limited Partnership, a Delaware limited partnership formed on May 28, 2003, which we refer to as our “Operating Partnership.” We control our Operating Partnership as its sole general partner, and, through our wholly owned subsidiary Gladstone Commercial Partners, LLC, we also own all limited partnership units of our Operating Partnership. We expect our Operating Partnership to issue limited partnership units from time to time in exchange for industrial and commercial real property. By structuring our acquisitions in this manner, the sellers of the real estate will generally be able to defer the realization of gains until they redeem the limited partnership units. Limited partners who hold limited partnership units in our Operating Partnership will be entitled to redeem these units for cash or, at our election, shares of our common stock on a one-for-one basis at any time after the first anniversary of the completion of our initial public offering. Whenever we issue common stock for cash, we will be obligated to contribute any net proceeds we receive from the sale of the stock to our Operating Partnership and our Operating Partnership will, in turn, be obligated to issue an equivalent number of limited partnership units to us. Our Operating Partnership will distribute the income it generates from its operations to us and its limited partners on a pro rata basis. We will, in turn, distribute the amounts we receive from our Operating Partnership to our stockholders in the form of quarterly cash distributions. We intend to qualify as a REIT for federal tax purposes, thereby generally avoiding federal and state income taxes on the distributions we make to our stockholders.

     Gladstone Management Corporation, a registered investment adviser and an affiliate of ours, serves as our external adviser (our “Adviser”). Our Adviser is responsible for managing our business on a day-to-day basis and for identifying and making acquisitions and dispositions that it believes meet our investment criteria.

Recent Events

     In August 2003, we completed our initial public offering of 7,590,000 shares of common stock (including 990,000 shares sold in September 2003 upon the exercise by the underwriters of an over-allotment option granted in connection with our initial public offering), at a public offering price of $15 per share, resulting in aggregate net proceeds to us after underwriters’ discounts and offering expenses of approximately $105 million.

     On December 23, 2003 we acquired a 58,926 square foot commercial office building in Raleigh, North Carolina. The $5.8 million acquisition cost for the building (including transaction costs) was funded using proceeds of our initial public offering. The building is currently leased to a single tenant under a triple net lease with a remaining term of six years, and the tenant has an option to renew the lease for an additional five year term.

     On January 30, 2004, we acquired a 54,018 square foot commercial office and warehouse building in Canton, Ohio. The $3.65 million acquisition cost for the building (including transaction costs) was funded using proceeds of our initial public offering. This building has been leased to one tenant under a 10 year triple net lease. The monthly lease payments are the greater of LIBOR based plus 600 basis points or 9.25% multiplied by the purchase price.

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     On February 18, 2004, we extended a mortgage loan in the amount of $11.17 million for the purchase of a commercial property in Sterling Heights, Michigan. The loan was funded using proceeds from our initial public offering. This 10 year mortgage loan, collateralized by the Sterling Heights property, accrues interest at the greater of 10% per annum or the one month LIBOR rate plus four percent per annum.

     On April 29, 2004, we purchased an 83,891 square foot commercial office and laboratory space in Akron, Ohio for $9.3 million. The purchase was funded using a portion of the proceeds of our initial public offering. The property is currently leased to two tenants under separate triple net leases, one of which occupies 79% of the property and has a remaining term of twelve years, and the second of which occupies 21% of the property and has a remaining term of five years.

Expenses

     Our Adviser currently has an expense sharing arrangement with Gladstone Capital Advisers, a wholly-owned subsidiary of our affiliate Gladstone Capital Corporation, through which our entire workforce is employed. Under that relationship, our Adviser reimburses Gladstone Capital Advisers for a portion of Gladstone Capital Advisers’ total payroll and benefits expenses (based on the percentage of total hours worked by Gladstone Capital Advisers’ employees on our matters on an employee-by-employee basis) and a portion of Gladstone Capital Advisers’ total overhead expense (based on the percentage of total hours worked by all Gladstone Capital Advisers’ employees on our matters). In turn, subject to the terms and conditions of our advisory agreement, Gladstone Management passes these charges on to us.

     During the three months ended March 31, 2004, payroll and benefits expenses were approximately $165,000. The actual amount of payroll and benefits expenses which we will be required to reimburse our Adviser in the future is not determinable, but we currently estimate that during the year ending December 31, 2004 this amount will be approximately $425,000. This estimate is based on our current expectations regarding our Adviser’s payroll and benefits expenses and the proportion of our Adviser’s time we believe will be spent on matters relating to our business. To the extent that our Adviser’s payroll and benefits expenses are greater than we expect or our Adviser allocates a greater percentage of its time to our business, our actual reimbursement of our Adviser for our share of its payroll and benefits expenses could be materially greater that we currently project.

     During the three months ended March 31, 2004, the amount of overhead expenses that we reimbursed our Adviser was approximately $64,000. The actual amount of overhead expenses for which we will be required to reimburse our Adviser in the future is not determinable, but we currently estimate that during the year ending December 31, 2004 this amount will be approximately $275,000.

     Under the terms of the advisory agreement, we are responsible for all expenses incurred for our direct benefit. Examples of these expenses include expenses incurred in connection with our organization and initial public offering, legal, accounting, tax preparation, consulting and related fees. During the three months ended March 31, 2004, the total amount of these expenses that we incurred was approximately $388,000.

     In addition, we are also responsible for all fees charged by third parties that are directly related to our business, which may include real estate brokerage fees, mortgage placement fees, lease-up fees and transaction structuring fees (although we may be able to pass some or all of such fees on to our tenants and borrowers). During the three months ended March 31, 2004, we passed all such fees along to our tenants, and accordingly we did not incur any such fees during this time. 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.

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Critical Accounting Policies

     Management believes our most critical accounting policies are the accounting for lease revenuesrevenue recognition (including straight-line rent), purchase price allocation, accounting for our investments in real estate, provision for loans losses, the regular evaluation of whether the value of a real estate asset has been impaired and the accounting for our derivativesderivative and hedging activities, if any.any , income taxes, stock based compensation and our Advisory agreement. 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.

Revenue Recognition

     OurRental revenues which will be comprised largely of rental income, will include rents that each tenant pays in accordance with the terms of its respective lease reported on a straight-line basis over the initial term of the lease. Since ourone of the Company’s leases may provide forcurrently contains rental increases at specified intervals, straight-line basis accounting will require us to record as an asset, and include in revenues, unbilleddeferred rent receivable that we will only receive 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 represents 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. Accordingly, our management must determine, in its judgment, to what extent the unbilleddeferred rent receivable

applicable to each specific tenant is collectible. We will review unbilleddeferred rent receivable on a quarterly basis and take into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collectability of unbilleddeferred rent with respect to any given tenant is in doubt, we would be required to record an increase in our allowance for uncollectible accounts or record a direct write-off of the specific rent receivable, which would have an adverse effect on our net income for the year in which the reserve is increased or the direct write-off is recorded and would decrease our total assets and stockholders’ equity.

Investments in Real Estate

     Management considers its loans and other lending investments to be held-for-investment. We will recordreflect held-for-investment investments in real estate at amortized cost less allowance for loan losses, acquisition premiums or discounts, deferred loan fees and undisbursed loan funds. On occasion, we will capitalize improvements and replacements when they extendmay acquire loans at small premiums or discounts based on the useful lifecredit characteristics of such loans. These premiums or improvediscounts are recognized as yield adjustments over the efficiencylives of the asset. We will expense costs of repairs and maintenance as incurred. We will compute depreciation using the straight-line method over the estimated useful life of 40 years for buildings and improvements, five to seven years for equipment and fixtures and the shorter of the useful liferelated loans. Loan origination or the remaining lease term for tenant improvements and leasehold interests.

     We will be required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments will have a direct impact on our net income because, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

     We have adopted SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which establishes a single accounting model for the impairment or disposal of long-lived assets including discontinued operations. SFAS 144 requires that the operations related to properties that have been sold or that we intend to sell be presented as discontinued operations in the statement of operations for all periods presented, and properties we intend to sell be designated as “held for sale” on our balance sheet.

     When circumstances such as adverse market conditions indicate a possible impairment of the value of a property, we will review the recoverability of the property’s carrying value. The review of recoverability will be based on our estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. Our forecast of these cash flows will consider factors such as expected future operating income, market and other applicable trends and residual value,exit fees, as well as direct loan origination costs, are also deferred and recognized over the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair valuelives of the property. We will be required to make subjective assessmentsrelated loans as to whether thereyield adjustment. If loans with premiums, discounts, loan origination or exit fees are impairmentsprepaid, we immediately recognize the unamortized portion as a decrease or increase in the values of our investments in real estate.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.

Purchase Price Allocation

     We will record above-market and below-market in-place lease values for owned properties 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. We will amortize the capitalized above-market lease values as a reduction of rental income over the remaining non-cancelable terms of the respective leases. We will amortize the capitalized below-market lease values (presented in the accompanying balance sheet as value of assumed lease obligations) as an increase to rental income over the initial term and any fixed-rate renewal periods in the respective leases. Since our strategy will to a large degree involveinvolves sale-leaseback transactions with newly originated leases at market rates, we do not expect the above-market and below-market in-place lease values to be significant for many of the transactions we will ultimately enter into.are not significant.

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     The total amount of other intangible assets acquired will beare further allocated to in-place lease values and customer relationship intangible values based on management’s evaluation of the specific characteristics of each tenant’s lease and our 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.

     Management’s estimates of value are expected to be made using methods similar to those used by independent appraisers (e.g., discounted cash flow analysis). Factors to be considered by management in its analysis include an estimate of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. We will also consider information obtained about each property as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets acquired. In estimating carrying costs, management will also includeincludes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, which we expect to primarily range from six to eighteen months, depending on specific local market conditions. Management will also estimateestimates 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.

     We will amortize the value of in-place leases to expense over the initial term of the respective leases, which we primarily expect to range from ten to twenty years. The value of customer relationship intangibles will beare amortized to expense over the initial term and any renewal periods in the respective leases, but in no event will 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 (including above and below market lease values, lease origination costs, and lease-up carrying costs) and customer relationship intangibles willwould be charged to earnings.expense.

Investments in Real Estate

     We record investments in real estate at cost and we capitalize improvements and replacements when they extend the useful life or improve the efficiency of the asset. We expense costs of repairs and maintenance as incurred. We compute 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.

     We are required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

     We have adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which establishes a single accounting model for the impairment or disposal of long-lived assets including discontinued operations. SFAS 144 requires that the operations related to properties that have been sold or that we intend to sell be presented as discontinued operations in the statement of operations for all periods presented, and properties we intend to sell be designated as “held for sale” on our balance sheet.

     When circumstances such as adverse market conditions indicate a possible impairment of the value of a property, we review the recoverability of the property’s carrying value. The review of recoverability is based on our estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. Our forecast of these cash flows considers factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, an impairment loss is recorded to the extent that the

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carrying value exceeds the estimated fair value of the property. We are required to make subjective assessments as to whether there are impairments in the values of our investments in real estate.

Provision for Loan Losses

     Our accounting policies require that we reflect in our financial statements an allowance for estimated credit losses with respect to mortgage loans we have made based upon our evaluation of known and inherent risks associated with our private lending assets. We have only recently extended one mortgage loan and have not experienced any actual losses in connection with our lending investments. Management will reflect provisions for loan losses on a portfolio basis based upon our assessment of general market conditions, our internal risk management policies and credit risk rating system, industry loss experience, our assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying our investments. Actual losses, if any, could ultimately differ from these estimates.

Accounting for Derivative Financial Investments and Hedging Activities

     We will account for our derivative and hedging activities, if any, using SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 137 and SFAS 149, which requires all derivative instruments to be carried at fair value on the balance sheet.

     Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, will be considered cash flow hedges. We will formally document all relationships between hedging instruments and hedged items, as well as our risk-management objective and strategy for undertaking each hedge transaction. We will periodically review the effectiveness of each hedging transaction, which involves estimating future cash flows. Cash flow hedges will be accounted for by recording the fair value of the derivative instrument on the balance sheet as either an asset or liability, with a corresponding amount recorded in other comprehensive income within stockholders’ equity. Amounts will be reclassified from other comprehensive income to the income statement in the period or periods the hedged forecasted transaction affects earnings. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, will be considered fair value hedges under SFAS 133. We areAs of March 31, 2004, we were not currently a party to any separate derivatives contract. Certain of our leases and loans contain embedded derivatives which do not require separate accounting.

Provision for Loan Losses

     Our accounting policies require that we reflect in our financial statements an allowance for estimated credit losses with respect to mortgage loans we have made based upon our evaluation of known and inherent risks associated with our private lending assets. While we have not yet made any mortgage loans and therefore have not experienced any actual losses in connection with our lending investments, management considers it prudent, once we have made mortgage loans, to reflect provisions for loan losses on a portfolio basis based upon our assessment of general market conditions, our internal risk management policies and credit risk rating system, industry loss experience, our assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying our investments. Actual losses, if any, could ultimately differ from these estimates.

Income Taxes

     Our financial results generally do not reflect provisions for current or deferred income taxes. Management believes that we have and will operate in a manner that will allow us to be taxed as a REIT and, as a result, we do not expect to pay substantial corporate-level income taxes. Many of the requirements for REIT qualification, however, are highly technical and complex. If we were to fail to meet these requirements, we would be subject to federal income tax which could have a material adverse impact on our results of operations and amounts available for distributions to our stockholders.

Stock Based Compensation

     We intend to apply the intrinsic value method to account for the issuance of stock options under our 2003 Equity Incentive Plan in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees,” where appropriate. In this regard, it is currently anticipated that athe substantial portion of these options will bewere granted to individuals who are our officers and who would qualify as leased employees under FIN 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25.” Accordingly, because the grants are expected to bewere at exercise prices that representequal to the fair value of the stock at date of grant, we dodid not currently anticipate that we will record any expense related to the issuance of these options under the intrinsic value method. If the actual terms vary from the expected, the impact to our compensation expense could differ.

Relationships and Related Transactions16

Advisory Agreement

We have entered into an advisory agreement with our Adviser, Gladstone Management Corporation, pursuant to which our Adviser will be responsible for managing our business on a day-to-day basis and for identifying, evaluating, negotiating and consummating investment transactions consistent with our investment criteria. In return for providing such services, we have agreed to reimburse our Adviser for certain expenses it incurs related to its management of our activities on the following bases:

	•		reimbursement on a dollar-for-dollar basis for all expenses incurred by our Adviser for our direct benefit (for example, organizational and offering expenses, legal, accounting, tax and consulting fees), which we currently estimate will be approximately $1.3 million during the first twelve months following the completion of our initial public offering (including approximately $1 million of expenses incurred in connection with the offering) and $300,000 annually thereafter;
	•		reimbursement on a dollar-for-dollar basis for all additional fees charged by third parties that are directly related to our business (for example, real estate brokerage fees, mortgage placement fees, lease-up fees and transaction structuring fees), which we currently are unable to estimate;
	•		reimbursement for our pro rata share of our Adviser’s employee payroll and benefits expenses, on an employee-by-employee basis, based on the percentage of each employee’s time devoted to our matters. We currently estimate that reimbursement of payroll and benefits will be approximately

Results of Operations

For the three months ended September 30, 2003March 31, 2004

Revenues

     For the three months ended March 31, 2004, we earned $197,773 of rental revenue, representing three months of rent from our Raleigh, North Carolina property and the periodtwo months of rent from February 14, 2003 (inception) through September 30, 2003

Revenuesour Canton, Ohio property, which was acquired January 2004.

     Because we have not yet entered into any real estate transactions, we did not earn revenues from operationsWe recorded interest income of $133,149 for the three months ended September 30, 2003 orMarch 31, 2004, which represents approximately two months of interest income on the mortgage loan that we extended in February 2004 for the period from inception through September 30, 2003.purchase of a Sterling Heights, Michigan commercial property.

Expenses

     Operating expenseexpenses for the three months ended September 30, 2003 and for the period from inception through September 30, 2003March 31, 2004 were $195,740 and $206,394, respectively.$696,959. Operating expenses mainly consist of the management advisory fee, insurance expense, directors’ fees, organizational costsdepreciation and professional fees.amortization, and general and administrative expenses. The management advisory fee consists of the reimbursement of expenses, including direct allocation of employee salaries and benefits as well as general overhead costscost to our Adviser in accordance with the terms of the advisory agreement. For both the quarter and periodthree months ended September 30, 2003,March 31, 2004, the aggregate management advisory fees were $124,096.$229,416.

     We also incurred insurance expenseDepreciation and amortization expenses of $50,506$79,330 were recorded for both the three months ended September 30, 2003March 31, 2004. General and administrative expenses were $388,213 for the period from inception through September 30, 2003three months ended March 31, 2004 and consisted mainly of incurred insurance expense for directors and officers insurance, as well as general insurance. Directorsinsurance, directors fees, of $12,333 were expensed for the quarter ended September 30, 2003 and for the period from inception through September 30, 2003, and professional fees (consisting of $5,000legal and $10,000 were expensed foraccounting fees), and also stockholder-related expenses such as the quarter ended September 30,printing of our 2003 and for the period from inception through September 30, 2003, respectively. For the period from inception through September 30, 2003, we also incurred organization costs of $5,549 in connection with the organization of the Company. General and administrative expenses were $3,805 and $3,910 for the three months ended September 30, 2003 and the period from inception through September 30, 2003, respectively.

annual report.

     Because we have only recently begun our operations, we do not believe that our current level of operating expenses is indicative of our operationoperating expenses in the future. As we begin entering intoto expand our real estate investments, we expect our revenues and operating expenses to increase and that ultimately our management advisory fee will be approximately 2% of our invested assets.

Interest Income

     During both the three months ended September 30, 2003 and for the period from inception through September 30, 2003, the CompanyMarch 31, 2004, we earned interest income on cash and cash equivalents of $91,532.$172,462. This interest represents the interest earned on the investment of the net proceeds from our initial public offering in short-term investment grade securities, primarily U.S. Treasury Bills, from August 15, 2003 through September 30, 2003.Bills. As we begin to acquireincrease our real estate investment portfolio, we anticipate that the interest earned on cash and cash equivalents will decrease.

Net Loss

     For the three months ended September 30, 2003 and for the period from inception through September 30, 2003,March 31, 2004, we incurred a net loss of $104,208 and $114,862, respectively.$193,305. Based on the basic and diluted weighted average common shares outstanding of 3,551,451 and 1,448,4827,642,000 for the three months ended September 30, 2003 and for the period from inception though September 30, 2003, respectively,March 31, 2004, the basic and diluted loss per common share was $0.03 for the three months ended September 30, 2003 and $0.08 for the period from inception through September 30, 2003.March 31, 2004.

Liquidity and Capital Resources

     At September 30, 2003,March 31, 2004, we had notwo real estate investments in real estate.and one mortgage note outstanding. At September 30, 2003,March 31, 2004, we had approximately $104.9$84.7 million in cash and cash equivalents which are available to make investments and fund our continuing operations. Those funds were predominantly raised though our initial public offering.offering in 2003.

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     During the three months ended March 31, 2004, we acquired a 54,018 square foot commercial office and warehouse building in Canton, Ohio for $3.65 million in cash (including transaction costs) and also extended one mortgage loan in the amount of approximately $11.2 million.

     On April 29, 2004, we purchased an 83,891 square foot commercial office and laboratory space in Akron, Ohio for $9.3 million.

     As of May 5, 2004, we have invested approximately $30 million, or 28.5 percent, of the net proceeds from our initial public offering in real properties and mortgage loans. Investments in three real properties account for approximately $18.8 million of the currently invested net proceeds, and an investment in one mortgage loan accounts for approximately $11.2 million of the currently invested net proceeds. We anticipate that the remaining net proceeds will be sufficient to fund our real estate investments for the foreseeable future. However, once the net proceeds of our initial public offering have been substantially fully invested, we intend to acquire additional properties by borrowing all or a portion of the purchase price and collateralizing the loan with a mortgage on some or all of our real property. If we were 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. We also may issue additional equity securities in the future to finance future investment although there can be no assurance that we would be able to do so on favorable terms if at all.

     Net cash provided by operating activities during the three months ended March 31, 2004 was $495,502, consisting primarily of an increase in the amount due to Adviser, increases in rent received in advance and security deposits and an increase in accrued expenses and other liabilities. Net cashed used by operating activities was $340,717, consisting$42,000 for the period from inception through March 31, 2003 and consisted primarily of costs associated with our formation.

     Cash used by investing activities during the three months ended March 31, 2004 was $14.8 million, and consisted primarily of our purchase of the Canton, Ohio commercial office and warehouse property in January 2004 and our extension of a mortgage loan of approximately $11.2 million in February 2004.

     Net cash used in financing activities for the three months ended March 31, 2004 was $84,150 for the three months ended March 31, 2004. These amounts consisted primarily of the paymentdividend payments to our stockholders of the management advisory fee$76,420 and the purchase of insurance policies.

$7,730 in costs associated with our initial public offering. Net cash provided by financing activities was $105,233,148$52,000 for the period from inception through September 30, 2003. These amountsMarch 31, 2003 and consisted mainly of the proceeds from the initial public offering that closed on August 13, 2003 ( including $13,810,510 that was received on September 17, 2003issuance of common stock to our founder in connection with our formation.

     There were no contractual obligations or commitments at March 31, 2004.

Funds from Operations

     The National Association of Real Estate Investment Trusts (NAREIT) developed Funds from Operations, (“FFO”), as a relative non-GAAP (Generally Accepted Accounting Principles in the closingUnited States) financial measure of performance and liquidity of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO, as defined by NAREIT, is net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures.

     FFO does not represent cash flows from operating activities in accordance with GAAP (which, unlike FFO, generally reflects all cash effects of transactions and other events in the determination of net income (loss)) and should not be considered an alternative to net income (loss) as an indication of our performance or to cash flow from operations as a measure of liquidity or ability to make distributions. Comparison of FFO, using the NAREIT definition, to similarly titled measures for other REITs may not

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necessarily be meaningful due to possible differences in the application of the underwriters’ over-allotment option) partially offsetNAREIT definition used by our subsequent payment of the direct offering costs.such REITs.

     SubsequentDiluted funds from operations per share (“Diluted FFO per share”) is FFO divided by weighted average common shares outstanding on a diluted basis during a period. We believe that Diluted FFO per share is useful to September 30, 2003,investors because it provides investors with a further context for evaluating our FFO results in the same manner that investors use earnings per share (“EPS”) in evaluating net income available to common shareholders. In addition, since most REITs provide Diluted FFO per share information to the investment community, we entered into signed commitment lettersbelieve Diluted FFO per share is a useful supplemental measure for comparing us to other REITs. We believe that diluted EPS is the most directly comparable GAAP measure to Diluted FFO per share.

     The following table provides a reconciliation of our FFO for the potential acquisitionthree months ended March 31, 2004 to the most directly comparable GAAP measure, net income (loss) and a computation of real properties with an aggregate purchase price of $11.8 million. We currently anticipate that these investments will close on or around December 31, 2003. However, each of these potential investments is subjectdiluted FFO per weighted average common share to certain terms and conditions, including the successful completion of our due diligence investigations, prior to closing. Accordingly there can be no assurance that we will not discover facts during the course of our due diligence that would render one or more of these investments imprudent. As a result, there can be no assurance that we will consummate any of these transactions.diluted net income (loss) per weighted average common share.

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Item 3. Quantitative and Qualitative Disclosure About Market Risk

     Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The primary risk that we believe we will be exposed to is interest rate risk.

     In the future, we may be exposed to the effects of interest rate changes primarily as a result of long-term debt used to maintain liquidity and fund expansion of our real estate investment portfolio and operations. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, we will borrow primarily at fixed rates or variable rates with the lowest margins available and, in some cases, with the ability to convert variable rates to fixed rates. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate the interest rate risk on a related financial instrument. We will not enter into derivative or interest rate transactions for speculative purposes.

     In addition to changes in interest rates, the value of our real estate is subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of lessees, all of which may affect our ability to refinance debt if necessary.

Item 4. Controls and Procedures

     As of September 30, 2003,March 31, 2004, our management, including the chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the chief executive officer and chief financial officer, concluded that the disclosure controls and procedures were effective in timely alerting management of material information about the Company required to be included in our periodic Securities and Exchange Commission filings. However, while evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures.

     There were no significant changes in internal controls for the period ended September 30, 2003.March 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Neither we nor any of our subsidiaries are currently subject to any material legal proceedings nor, to our knowledge, is any material legal proceeding threatened against us or our subsidiaries.

Item 2. Changes in Securities and Use of Proceeds

On February 15, 2003,As of March 31, 2004, we issued and sold 52,000 shareshad invested approximately $20.7 million of common stock for an aggregate purchase price of $52,000 to David Gladstone,the net proceeds from our chairman and chief executive officer. We issued these shares to Mr. Gladstone in reliance upon exemption from registration provided by Section 4(2) under the Securities Act and Rule 506 promulgated thereunder.

On August 12, 2003, our registration statements on Form S-11 (SEC File Nos. 333-106024 and 333-107897) for the initial public offering in two real properties and one mortgage loan. As of 6,600,000 sharesMarch 31, 2004, we have used approximately $688,000 in our operating activities, of common stock, par value $0.001 per share, became effective. All 6,600,000 shares were sold upon completion of the initial public offering at an aggregate public offering price of $99,000,000, reflecting an offering price of $15 per share. Ferris, Baker Watts, Incorporated, Jefferies & Company, Inc., J.J.B. Hillard, W.L. Lyons, Inc. and Stifel, Nicolaus & Company, Incorporated acted as underwriters for the initial public offering.

In connection with the initial public offering, we registered and offered the underwriters an option to purchase an additional 990,000 shares of common stock solely to cover over-allotments. The underwriters exercised this option in full on September 17, 2003. The gross proceeds from the exercise of this option were $14,850,000.

Underwriting discounts and commissions for the shares sold in the initial public offering (including the shares sold upon the exercise of the over-allotment option) totaled $7,969,500. In connection with the initial public offering, we incurred expenses ofwhich approximately $700,000. None of these expenses were$83,000 has been paid directly or indirectly to our directors, officers or associates, or to persons owning 10% or moreAdviser (which is an affiliate of ours) in partial payment of amounts owed under our common stock or other affiliates. After deducting underwriting discounts and commissions and other expenses, we receive net proceedsadvisory agreement. As of approximately $105.2 million from the initial public offering.

The primary purpose of the initial public offering was to obtain capital with which to invest in and own net leased industrial and commercial real property and selectively make long-term industrial and commercial mortgage loans. To date, we have not made any such investments. Accordingly,March 31, 2004, substantially all of the remaining net proceeds we received from theour initial public offering have beenwere invested in short-term, , investment grade, interest-bearing instruments.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information.

Not applicable.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits
See Exhibit Index.

(b) Reports on Form 8-K
Not applicable.8-K:

On January 16, 2004, we filed with the Securities and Exchange Commission (“SEC”) a report on Form 8-K under Item 2 reporting our acquisition of a commercial office building located in Raleigh, North Carolina. We filed the required financial statements and pro forma financial information regarding this acquisition to the SEC under Item 7 of Form 8-K/A on March 8, 2004.

On March 4, 2004, we filed with the SEC a report on Form 8-K under Item 2 reporting our acquisition of a commercial office building located in Canton, Ohio.

On March 8, 2004, we filed with the SEC a report on Form 8-K under Item 2 reporting our extension of a mortgage note on February 18, 2004 to Mayco Property Holdings LLC.

On March 11, 2004, we furnished to the SEC under Item 12 of Form 8-K our press release, dated March 10, 2004, announcing our results of operations for the period from February 14,2 003 (inception) through December 31, 2003. In accordance with the regulations of the SEC, this report was deemed to be furnished to, rather than filed with, the SEC.

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SIGNATURE

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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Exhibit Index