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 mandated shelter in place orders that have prevented 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 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; •legislative or regulatory changes; •adverse economic conditions inTexas ; •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; •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; 21 -------------------------------------------------------------------------------- •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 professionalswho 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, 2020 , 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, 2020 , 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 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 22 -------------------------------------------------------------------------------- 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"). OnDecember 27, 2018 , Pillarstone OP sold a portfolio of three Real Estate Assets, resulting in 11 Real Estate Assets in the Pillarstone OP's real estate portfolio atDecember 31, 2018 . OnOctober 8, 2019 , Pillarstone OP, through an indirect wholly owned subsidiary,Industrial-Office, LLC , sold a portfolio of three Real Estate Assets inHouston, Texas to an unaffiliated third party for$39.7 million in cash. Pillarstone OP used the net proceeds, after customary closing deductions, to pay off mortgage debt on several of the remaining Real Estate Assets, and repaid the remaining$5.7 million loan from Whitestone. In addition to the$5.7 million loan repayment, Whitestone received a$5.4 million cash distribution based on its approximate 81.6% ownership in Pillarstone OP as a result of the sale. TheOctober 8, 2019 sale of three Real Estate Assets resulted in eight Real Estate Assets remaining in the Company's real estate portfolio atSeptember 30, 2020 .
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.
The comparability of our results of operations for the nine months ended
Comparison of the Nine Month Periods Ended
Leasing Activity
For the nine month period endedSeptember 30, 2020 , we executed 41 leases for a total lease value of$2.3 million compared to 78 leases for a total lease value of$9.1 million for the nine month period endedSeptember 30, 2019 .
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
2020 2019
Number of properties 8 11
Aggregate GLA (sq. ft.) 926,798 1,307,930
Ending occupancy rate 61 % 77 %
Total revenues $ 7,396 $ 11,536
Total operating expenses 6,198 8,080
Total other expenses 711 1,590
Provision for income tax expense (benefit) (34) (35)
Net income 521 1,901
Less: Non-controlling interest in subsidiary 828 1,610
Net income (loss) available to Common Shareholders Revenues from Operations
We had total revenues for the nine month periods endedSeptember 30, 2020 and 2019 of approximately$7,396,000 and$11,536,000 , respectively, for a decrease of approximately$4,140,000 , or 36%. The difference was comprised of a decrease of approximately$3,107,000 in rental revenues,$977,000 in expense reimbursements and an increase of$62,000 in bad debt, which is classified as a reduction of revenue, offset by an increase of$6,000 in other revenue. The overall decrease was primarily due to the sale of three Real Estate Assets as ofOctober 8, 2019 ; however a portion of the bad debt increase was due to the impact of the COVID-19 pandemic.
Expenses from Operations
Our operating expenses were approximately$6,198,000 for the nine months endedSeptember 30, 2020 compared to approximately$8,080,000 for the nine months endedSeptember 30, 2019 , a decrease of approximately$1,882,000 , or 23%. The overall decrease was mostly due to the sale of three Real Estate Assets as ofOctober 8, 2019 , offset by an increase in general and administrative expenses of approximately$289,500 for Trustee fees. The overall decrease was primarily due to the sale of three Real Estate Assets as ofOctober 8, 2019 , and a significant amount of the bad debt increase was due to the impact of the COVID-19 pandemic.The primary components of operating expenses are detailed in the table below (in thousands): Nine Months Ended September 30, 2020 2019 Change % Change Operating and maintenance$ 1,986 $ 2,595 $ (609) (23) % Real estate taxes 1,384 1,954 (570) (29) % General and administrative 828 511 317 62 % Depreciation and amortization 1,551 2,360 (809) (34) % Management fees 449 660 (211) (32) % Total operating expenses$ 6,198 $ 8,080 (1,882) (23) %
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, 2020 , we executed 18 leases for a total lease value of$0.7 million compared to 23 leases for a total lease value of$3.0 million for the three month period endedSeptember 30, 2019 . 24 --------------------------------------------------------------------------------
Results of Operations
The following provides a general comparison of our results of operations for the
three month periods ended
Three Months Ended
2020 2019
Number of properties 8 11
Aggregate GLA (sq. ft.) 926,798 1,307,930
Ending occupancy rate 61 % 77 %
Total revenues $ 2,370 $ 3,863
Total operating expenses 1,946 2,694
Total other expenses 239 537
Provision for income tax expense (benefit) 2 (133)
Net income 183 765
Less: Non-controlling interest in subsidiary 217 551
Net income (loss) available to Common Shareholders
$ (34)
Revenues from Operations
We had total revenues for the three month periods endedSeptember 30, 2020 and 2019 of approximately$2,370,000 and$3,863,000 , respectively, for a decrease of approximately$1,493,000 , or 39%. The difference was comprised of a decrease of approximately$1,110,000 in rental revenues,$341,000 in expense reimbursements and an increase of$50,000 in bad debt, which is classified as a reduction of revenue, offset by an increase of$8,000 in other revenue. The overall decrease was primarily due to the sale of three Real Estate Assets as ofOctober 8, 2019 ; however a portion of the bad debt increase was due to the impact of the COVID-19 pandemic. Expenses from Operations Our operating expenses were approximately$1,946,000 for the three months endedSeptember 30, 2020 compared to approximately$2,694,000 for the three months endedSeptember 30, 2019 , a decrease of approximately$748,000 , or 28%. The overall decrease was mostly due to the sale of three Real Estate Assets as ofOctober 8, 2019 . The primary components of operating expenses are detailed in the table below (in thousands): Three Months
Ended
2020 2019 Change % Change
Operating and maintenance $ 638 $ 873 $ (235) (27) %
Real estate taxes 534 659 (125) (19) %
General and administrative 153 137 16 12 %
Depreciation and amortization 476 801 (325) (41) %
Management fees 145 224 (79) (35) %
Total operating expenses $ 1,946 $ 2,694 $ (748) (28) %
The comparability of our results of operations for the three months ended
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--------------------------------------------------------------------------------Liquidity and Capital Resources
Cash Flows
As ofSeptember 30, 2020 , our unrestricted cash resources were approximately$5,548,000 . We are dependent on cash generated by our ownership of the eight Real Estate Assets to meet our liquidity needs. During the nine months endedSeptember 30, 2020 , the Company's cash balance increased by$924,000 from$4,624,000 atDecember 31, 2019 to$5,548,000 atSeptember 30, 2020 . This increase in cash was due to cash provided by operating activities of approximately$1,737,000 , offset by cash used in investing activities of approximately$607,000 and cash used in financing activities of approximately$206,000 . Our ability to access the capital markets will be dependent on a number of factors as well, including general market conditions and market perceptions about our Company. In light of the impact of the COVID-19 pandemic and other dynamics in the capital markets impacted by COVID-19 and the economic slowdown, our access to capital may be diminished.
Future Obligations
As part of the Acquisition onDecember 8, 2016 , Pillarstone OP assumed approximately$65.9 million of liabilities related to the Real Estate Assets contributed by Whitestone OP. As the general partner of Pillarstone OP, we are ultimately liable for the repayment of the loans. Included in the$65.9 million of liabilities was$15.5 million due to Whitestone OP byDecember 8, 2018 . As ofDecember 31, 2018 , Pillarstone repaid$17.3 million in outstanding loans, which included$9.8 million to Whitestone OP and$7.5 million to other noteholders using cash from operations and proceeds from the sale of certain Real Estate Assets. OnDecember 27, 2018 , the Company sold three Real Estate Assets inHouston, Texas to an unaffiliated third party for$15.9 million , resulting in 11 Real Estate Assets in the Company's real estate portfolio atDecember 31, 2018 . OnOctober 8, 2019 , Pillarstone OP, sold three Real Estate Assets inHouston, Texas to an unaffiliated third party for$39.7 million in cash, resulting in eight Real Estate Assets in the Company's real estate portfolio atDecember 31, 2019 . Pillarstone OP used the net proceeds, after customary closing deductions, to repay mortgage debt secured by the Real Estate Assets sold onOctober 8, 2019 and other Real Estate Assets, and to repay the remaining$5.7 million of its$15.5 million loan from Whitestone OP. In addition to the$5.7 million loan repayment, Whitestone received a$5.4 million cash distribution from its 81.4% ownership of Pillarstone OP as a result of the sale. We expect our remaining debt balance to be repaid from raising capital, selling assets, and/or debt refinancing. As ofSeptember 30, 2020 , the Company's debt obligations are approximately$15.5 million , including convertible notes payable. See Note 8 for more details on the Company's convertible notes payable.
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 •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 trusteeswho 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. 26 --------------------------------------------------------------------------------
COVID-19
The following discussion is intended to provide 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 13, 2020 . As a result of the rapid development, fluidity and uncertainty surrounding the COVID-19 pandemic, 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 for future periods. TheWorld Health Organization has declared COVID-19 to constitute a "Public Health Emergency of International Concern" and characterized COVID-19 as a pandemic. As a result,U.S. and many local governments have implemented enhanced screenings, quarantine or shelter in place requirements and travel restrictions. For example, local governments inTexas , where all our properties are located, mandated a stay in place order, closed non-essential businesses and closed other types of service businesses, such as bars and restaurants, though they can continue to provide take out and drive through services temporarily and under certain circumstances be open at a limited capacity. However, the timing and ultimate impact of any such steps on the economy as a whole and on our tenants' businesses and financial condition remains uncertain. We are unable to predict the impact that the COVID-19 pandemic will have on our financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration and spread of the pandemic, its severity in our markets and elsewhere, governmental actions to contain the spread of the pandemic and respond to the reduction in global economic activity, and how quickly and to what extent normal economic and operating conditions can resume.
Our portfolio and tenants have been impacted by these and other factors as follows:
•As of the date of this Quarterly Report, all of our properties are open and
have been operating in compliance with federal, state and local COVID-19
guidelines and mandates.
•Approximately 95% of our tenants (based on annualized base rent ("ABR")) are
open and operating.
•As of the date of this Quarterly Report, we have received payment of
approximately 93% of contractual base rent and common area maintenance
reimbursable expenses billed for the third quarter. As is believed to be the
case with other landlords across the U.S. , we have received a number of rent
relief requests from tenants, most often in the form of rent deferral requests,
which we are evaluating on a case-by-case basis. Collections and rent relief
requests to-date may not be indicative of collections or requests in any future
period.
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$5,548,000 as ofSeptember 30, 2020 . •We are carefully evaluating acquisition, development and redevelopment opportunities on an individual basis. •We have put in place a temporary response team to address tenant concerns. The response team is in ongoing communication with our tenants and is assisting tenants in identifying local, state and federal resources that may be available to support their businesses and employees during the pandemic, including stimulus funds that may be available under the Coronavirus Aid, Relief, and Economic Security Act of 2020. •We are proactively implementing expense reductions at the property level to minimize cost pass-throughs to our tenants and at the corporate level to preserve profitability. •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 by implementing a work from home policy. 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. 27 --------------------------------------------------------------------------------
Current Tax Status As ofSeptember 30, 2020 andDecember 31, 2019 , we had net deferred tax liabilities of$95,000 and$96,000 , respectively. As ofSeptember 30, 2020 , we have an operating loss carryforward of approximately$345,000 available to be carried to future periods.
The income tax benefit (expense) 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,
2020 2019 2020 2019
Federal $ 10 $ 154 $ 73 $ 141
Texas franchise tax (12) (21) (39) (106)
Provision for income tax benefit
(expense) $ (2) $ 133 $ 34 $ 35
Interest Rates and Inflation
The Company was not significantly affected by inflation during the periods
presented in this report due primarily to the relative low nationwide inflation
rates and the Company having approximately 100% of its debt with fixed rates as
of September 30, 2020 .
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.
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 operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases. For the nine months endingSeptember 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 revenue as a result of our COVID-19 collectibility analysis. For the three months endingSeptember 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. Additionally, we may have tenantswho pay real estate taxes directly to the taxing authority. We exclude these costs paid directly by the tenant to third parties on our behalf from revenue recognized and the associated property operating expense.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 28 -------------------------------------------------------------------------------- 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. 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, 2020 . 29
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