PILLARSTONE CAPITAL REIT Unless the context otherwise requires, all references in this report to the
"Company," "we," "us" or "our" are to
Forward-Looking StatementsThe following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto in this Quarterly Report on Form 10-Q.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters. These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry. Forward-looking statements are typically identified by the use of terms such as "may," "will," "should," "potential," "predicts," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" or the negative of such terms and variations of these words and similar expressions, although not all forward-looking statements include these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. You are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.
Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:
•uncertainties related to the COVID-19 pandemic, including the unknown duration and economic, operational and financial impacts of the COVID-19 pandemic and the actions taken or contemplated byU.S. and local governmental authorities or others in response to the pandemic on our business, employees and tenants, including, among others, (a) changes in tenant demand for our properties; (b) financial challenges confronting tenants, including as a result of decreased customers' willingness to visit our tenants' businesses, and potential renewed mandated shelter in place orders that may prevent customers from visiting some of our tenants' businesses and the impact of these issues on our ability to collect rent from our tenants; (c) operational changes implemented by us, including remote working arrangements, which may put increased strain on our technology systems and create increased vulnerability to cybersecurity incidents; (d) reduction in our liquidity due to the limited ability to access the capital markets and other sources of financing on attractive terms or at all, and (e) prolonged measures to contain the spread of COVID-19, the rate and acceptance of vaccines, or the premature easing of government-imposed restrictions implemented to contain the spread of COVID-19; •uncertainties related to the national economy, the real estate industry in general and in our specific markets, including but not limited to, the significant volatility and disruption in the global financial markets caused by the COVID-19 pandemic; •legislative or regulatory changes, including the impact of the legislation commonly known as the Tax Cuts and Jobs Act •adverse economic or real estate developments or conditions inTexas , including as a result of a surge in COVID-19 cases in such areas and the impact on our tenants' ability to pay their rent, which could result in bad debt allowances or straight-line rent reserve adjustments; •adverse changes in governmental rules and fiscal policies; •increases in interest rates and operating costs; •availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures, in each case, on terms favorable to the Company; 18 -------------------------------------------------------------------------------- •decreases in rental rates or increases in vacancy rates; •litigation risks; •lease-up risks, including leasing risks arising from exclusivity and consent provisions in leases with significant tenants; •the impact of public health crises and pandemics, such as the COVID-19 outbreak; •cybersecurity attacks, loss of confidential information and other business disruptions; •our inability to renew tenants or obtain new tenants upon the expiration of existing leases; and •our inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws. In addition, an investment in the Company involves numerous risks that potential investors should consider carefully, including, without limitation: •our cash resources are limited; •we have a history of losses; •we have not raised funds through a public equity offering; •our trustees control a significant percentage of our voting shares; •shareholders could experience possible future dilution through the issuance of additional shares; •we are dependent on a small number of key senior professionals who are part-time employees; and •we currently do not plan to distribute dividends to the holders of our shares.
Overview
The Company is aMaryland real estate investment trust ("REIT") engaged in investing in, owning and operating commercial properties. Future real estate investments may include (i) acquisition and development of retail, office, office warehouse, industrial, multifamily, hotel and other commercial properties, (ii) acquisition of or merger with a REIT or real estate operating company, and (iii) joint venture investments. Substantially all of our business is conducted through our operating partnership Pillarstone OP. We are the sole general partner of Pillarstone OP. As ofSeptember 30, 2021 , we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our condensed consolidated financial statements. As ofSeptember 30, 2021 , the Company is a smaller reporting company current in its quarterly and annual financial statement filings with theSEC , that may make future real estate investments. There can be no assurance that we will be able to close additional transactions. Even if our management is successful in closing additional transactions, investors may not value the transactions or the Company in the same manner as we do, and investors may not value the transactions as they would value other transactions or alternatives. Failure to obtain additional sources of capital will materially and adversely affect the Company's ability to continue operations, as well as its liquidity and financial results. Brief History Pillarstone was formed onMarch 15, 1994 as a Maryland REIT. The Company operated as a traditional REIT by buying, selling, owning and operating commercial and residential properties throughDecember 31, 1999 . In 2000, the Company purchased a software technology company, resulting in the Company not meeting the qualifications to be a REIT under the Code. In 2002, the Company discontinued the operations of the technology segment, and from 2003 through 2006, pursued a value-added business plan primarily focused on acquiring well located, under-performing multifamily residential properties, including affordable housing communities, and repositioning them through renovation, leasing, improved management and branding. From 2006 untilDecember 2016 , the Company continued its existence as a corporate shell current in itsSEC filings. OnDecember 8, 2016 , Pillarstone and Pillarstone OP entered into the Contribution Agreement with Whitestone OP, a subsidiary and the operating partnership of Whitestone, both of which are related parties to Pillarstone and Pillarstone OP, pursuant to which Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries: Whitestone CP Woodland Ph. 2, LLC, aDelaware limited liability company ("CP Woodland"); Whitestone 19 --------------------------------------------------------------------------------Industrial-Office, LLC , aTexas limited liability company ("Industrial-Office");Whitestone Offices, LLC , aTexas limited liability company ("Whitestone Offices"); andWhitestone Uptown Tower, LLC , aDelaware limited liability company ("Uptown Tower") that owned 14 real estate assets (the "Real Estate Assets") for aggregate consideration of approximately$84 million , consisting of (1) approximately$18.1 million of Class A units representing limited partnership interests in Pillarstone OP issued at a price of$1.331 per OP Unit; and (2) the assumption of approximately$65.9 million of liabilities by Pillarstone OP (collectively, the "Acquisition"). Impact of COVID-19 The following discussion is intended to provide our shareholders with certain information regarding the impacts of the COVID-19 pandemic on our business and management's efforts to respond to those impacts. Unless otherwise specified, the statistical and other information regarding our portfolio and tenants are estimates based on information available to us as ofNovember 12, 2021 . As a result of the rapid development, fluidity and uncertainty surrounding this situation, we expect that such statistical and other information will change, potentially significantly, going forward and may not be indicative of the actual impact of the COVID-19 pandemic on our business, operations, cash flows and financial condition, and that of our tenants, for future periods. We anticipate that the ongoing global health crisis caused by COVID-19 and the related responses intended to control its spread, including as a result of the delta variant or other strains, will continue to adversely affect business activity, particularly relating to our retail tenants, across the markets in which we operate. Any such impacts may be material in nature. As part of the initial response to the virus, many governmental authorities implemented measures such as enhanced screenings, quarantine or shelter in place requirements and travel restrictions, including local governments inTexas , where all our properties are located. InMay 2020 , parts of theU.S. began to ease certain restrictions and allow for the reopening of businesses but with required or recommended safety protocols. Due to the increase in the number of COVID-19 cases in the fall of 2020, parts of theU.S. implemented additional stay in place orders and other restrictions. While as of the date of this Quarterly Report on Form 10-Q, service businesses are permitted to be fully open inTexas , there can be no assurance that service businesses will remain open in the near term, or that state and local governments will not take additional measures to control a resurgence of COVID-19 as a result of new strains or variants, inTexas and worldwide, any of which may materially and adversely impact our or our tenants' businesses and their ability to pay their rental payments or otherwise continue to occupy their space. In light of the changing nature of the COVID-19 pandemic, we are unable to predict the extent that its impact will have on our financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration of the pandemic and spread of the disease, its severity in our markets and elsewhere, governmental actions to contain the spread of the disease and respond to the reduction in global economic activity, the unknown timing or effectiveness of treatments, adoption of vaccines, resurgences of COVID-19 cases in future periods and how quickly and to what extent normal economic and operating conditions can resume. The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business and markets, including how it will impact the businesses of its tenants. Our portfolio and tenants have been impacted by these and other issues as follows: •As of the date of this Quarterly Report on Form 10-Q, all of our properties are open and operating in compliance with federal, state and local COVID-19 guidelines and mandates.
•Approximately 96% of our tenants (based on annualized base rent ("ABR")) are open and operating.
•Included in our adjustments to rental revenue for the three and nine months endedSeptember 30, 2021 was a bad debt adjustment of$6,341 and$57,515 , respectively, related to credit loss for the conversion of four tenants to cash basis revenue as a result of our COVID-19 collectability analysis.
We have taken a number of proactive measures to maintain the strength of our business and manage the impact of COVID-19 on our operations and liquidity, including the following:
•We have cash and cash equivalents of approximately
•We are carefully evaluating acquisition, development and redevelopment opportunities on an individual basis.
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•The health and safety of our employees, the staff that manages our properties,
and their respective families is a top priority. We have adapted our operations
to protect employees, including social distancing where possible within our
offices and a work from home policy when necessary.
While we believe these steps have been effective to date, we expect there will
be additional challenges ahead that may impact either our operations or those of
our tenants, which could have an adverse effect on our and our tenants'
businesses and financial performance. We expect to continue to implement
proactive measures until we determine that the COVID-19 pandemic is adequately
contained for purposes of our business, and we may take further actions as
government authorities require or recommend or as we determine to be in the best
interests of our employees and tenants. As a result, we may incur additional
expenses in future periods in response to the pandemic, which could adversely
affect our results of operations. In addition, we may revise our approach to
these initiatives or take additional actions to meet the needs of our employees
and tenants.
Results of Operations
The following is a discussion of our results of operations for the three and
nine month periods ended
•Explanation of changes in the results of operations in the Condensed
Consolidated Statements of Operations for the three and nine month periods ended
•Our critical accounting policies and estimates that require our subjective judgment and are important to the presentation of our financial condition and results of operations.
•Our primary sources and uses of cash for the nine month periods ended
•Our current income tax status.
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report.
Comparison of the Nine Month Periods Ended
Leasing Activity
For the nine month period endedSeptember 30, 2021 , we executed 61 leases for a total lease value of$4.6 million compared to 41 leases for a total lease value of$2.3 million for the nine month period endedSeptember 30, 2020 .
Results of Operations
The following provides a general comparison of our results of operations for the
nine month periods ended
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Nine Months Ended
2021 2020
Number of properties 8 8
Aggregate GLA (sq. ft.) 926,798 926,798
Ending occupancy rate 59 % 61 %
Total revenues $ 6,843 $ 7,396
Total operating expenses 5,962 6,198
Total other expenses 584 711
Provision for income tax expense (benefit) (12) (34)
Net income 309 521
Less: Non-controlling interest in subsidiary 510 828
Net loss available to Common Shareholders $ (201) $ (307)
Revenues from Operations
We had total revenues for the nine month periods ended September 30, 2021 and
2020 of approximately $6,843,000 and $7,396,000 , respectively, for a decrease of
approximately $553,000 , or 7%. The difference was comprised of a decrease of
approximately $447,000 in rental revenues, a decrease of $239,000 in expense
reimbursements, a decrease of $5,000 in other revenue, and a decrease of
$138,000 in bad debt, which is classified as a part of revenue. The majority of
the overall decrease was due to lower occupancy during the nine months ended
September 30, 2021 , compared to the nine months ended September 30, 2020 .
Expenses from Operations
Our operating expenses were approximately$5,962,000 for the nine months endedSeptember 30, 2021 compared to approximately$6,198,000 for the nine months endedSeptember 30, 2020 , a decrease of approximately$236,000 , or 4%. The overall decrease was primarily due to decreases in trustee fee expense and real estate taxes, offset by increases in miscellaneous repairs, contract services, and electricity usage at our properties for the nine months endedSeptember 30, 2021 , compared to the nine months endedSeptember 30, 2020 . The primary components of operating expenses are detailed in the table below (in thousands): Nine Months Ended September 30, 2021 2020 Change % Change Depreciation and amortization$ 1,540 $ 1,551 $ (11) (1) % Operating and maintenance 2,213 1,986 227 11 % Real estate taxes 1,232 1,384 (152) (11) % General and administrative 550 828 (278) (34) % Management fees 427 449 (22) (5) % Total operating expenses$ 5,962 $ 6,198 $ (236) (4) %
The comparability of our results of operations for the nine months ended
Comparison of the Three Month Periods Ended
Leasing Activity
For the three month period endedSeptember 30, 2021 , we executed 15 leases for a total lease value of$1.4 million compared to 18 leases for a total lease value of$0.7 million for the three month period endedSeptember 30, 2020 . 22 --------------------------------------------------------------------------------
Results of Operations
The following provides a general comparison of our results of operations for the
three month periods ended
Three Months Ended
2021 2020
Number of properties 8 8
Aggregate GLA (sq. ft.) 926,798 926,798
Ending occupancy rate 59 % 61 %
Total revenues $ 2,381 $ 2,370
Total operating expenses 2,040 1,946
Total other expenses 201 239
Provision for income tax expense - 2
Net income 140 183
Less: Non-controlling interest in subsidiary 196 217
Net loss available to Common Shareholders $ (56) $ (34)
Revenues from Operations
We had total revenues for the three month periods ended September 30, 2021 and
2020 of approximately $2,381,000 and $2,370,000 , respectively, for a small
increase of approximately $11,000 . The difference was comprised of a decrease of
approximately $4,000 in rental revenues, a decrease of $14,000 in expense
reimbursements, a decrease of $7,000 in other revenue, and a decrease of $36,000
in bad debt, which is classified as a part of revenue.
Expenses from Operations
Our operating expenses were approximately$2,040,000 for the three months endedSeptember 30, 2021 compared to approximately$1,946,000 for the three months endedSeptember 30, 2020 , an increase of approximately$94,000 , or 5%. The overall increase was due to higher miscellaneous repairs, contract services, and electricity usage at our properties, offset by lower real estate taxes for the three months endedSeptember 30, 2021 , compared to the three months endedSeptember 30, 2020 . The primary components of operating expenses are detailed in the table below (in thousands): Three Months Ended September 30, 2021 2020 Change % Change Depreciation and amortization$ 541 $ 476 $ 65 14 % Operating and maintenance 759 638 121 19 % Real estate taxes 430 534 (104) (19) % General and administrative 167 153 14 9 % Management fees 143 145 (2) (1) % Total operating expenses$ 2,040 $ 1,946 $ 94 5 %
The comparability of our results of operations for the three months ended
Liquidity and Capital Resources
Cash Flows
As ofSeptember 30, 2021 , our unrestricted cash resources were approximately$5,146,000 . We are dependent on cash generated by our ownership of the eight Real Estate Assets to meet our liquidity needs. 23 -------------------------------------------------------------------------------- During the nine months endedSeptember 30, 2021 , the Company's cash balance increased by$37,000 from$5,109,000 atDecember 31, 2020 to$5,146,000 atSeptember 30, 2021 . This increase in cash was due to cash provided by operating activities of approximately$1,092,000 , cash used in investing activities of approximately$839,000 and cash used in financing activities of approximately$218,000 .
Our ability to access the capital markets will be dependent on a number of factors, including general market conditions and market perceptions about our Company.
Future Obligations None.
Long Term Liquidity and Operating Strategies
Historically, we have financed our long term capital needs, including acquisitions, as follows:
•borrowings from new loans; •additional equity issuances of our common and preferred shares and operating partnership units; and •proceeds from the sales of our Real Estate Assets. From 2006 untilDecember 2016 , the Company continued its existence as a corporate shell filing its periodic reports with theSEC so that it could be used for future real estate transactions or sold to another company. During this time, the Company was funded by its trustees who contributed$500,000 in exchange for 125,000 Preferred C Shares and$197,780 in exchange for convertible notes payable. Subsequent to the Acquisition, Pillarstone has been developing strategies for the Real Estate Assets in order to create value for the enterprise and our shareholders and selling assets to pay off some of its debt. To implement the strategy to create value with the Real Estate Assets, additional capital will need to be raised. Current Tax Status As ofSeptember 30, 2021 andDecember 31, 2020 , we had net deferred tax liabilities of$34,000 and$82,000 , respectively. As ofSeptember 30, 2021 , we have an operating loss carryforward of approximately$251,000 available to be carried to future periods.
The income tax expense (benefit) included in the condensed consolidated
statements of operations for the three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Federal $ (13) $ (10) $ (48) $ (73)
Texas franchise tax 13 12 36 39
Provision for income tax expense
(benefit) $ - $ 2 $ (12) $ (34)
Interest Rates
The Company was not significantly affected by interest rates during the periods
presented in this report due primarily to the Company having approximately 100%
of its debt with fixed rates as of September 30, 2021 .
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have, or are likely to have, a
current or future material effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.
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--------------------------------------------------------------------------------Application of Critical Accounting Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP, which require us to make certain estimates and assumptions. The following section is a summary of certain estimates that both require our most subjective judgment and are most important to the presentation of our financial condition and results of operations. It is possible that the use of different estimates or assumptions in making these judgments could result in materially different amounts being reported in our condensed consolidated financial statements. Revenue recognition. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases. For the three and nine months endedSeptember 30, 2021 , we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately$21,942 and$22,878 , respectively, for the conversion of one tenant to cash basis as a result of our COVID-19 collectibility analysis. For the nine months endedSeptember 30, 2020 , we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately$50,000 for the conversion of four tenants to cash basis as a result of our COVID-19 collectibility analysis. For the three months endedSeptember 30, 2020 , we did not recognize a straight-line rent reserve adjustment. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred. We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the condensed consolidated statements of operations. We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured.Acquired Properties and Acquired Lease Intangibles. We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt. Due to the effects of the COVID-19 pandemic, we are carefully evaluating acquisitions, development and redevelopment opportunities on an individual basis. Depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings. Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter. Impairment. We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value. Management has determined that there has been no impairment in the carrying value of our real estate assets as ofSeptember 30, 2021 .
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