PILLARSTONE CAPITAL REIT Overview
The Company is a Maryland 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 ofDecember 31, 2020 , we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our consolidated financial statements. As ofDecember 31, 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: CP Woodland; Industrial-Office; Whitestone Offices; andUptown Tower that own 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"). OnDecember 27, 2018 , Pillarstone OP sold the 2018 Real Estate Assets Sold inHouston, Texas , resulting in 11 Real Estate Assets in the Company's real estate portfolio atDecember 31, 2018 . OnOctober 8, 2019 , Pillarstone OP, through an indirect wholly owned subsidiary,Whitestone Industrial-Office, LLC , sold the 2019 Real Estate Assets Sold 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 from its stake in Pillarstone OP as a result of the sale. The sale of the 2019 Real Estate Assets Sold resulted in eight Real Estate Assets remaining in the Company's real estate portfolio atDecember 31, 2020 .
Results of Operations
The following is a discussion of our results of operations and net income for
the years ended
•Explanation of changes in the results of operations in the Consolidated Statements of Operations for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . •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. 7 --------------------------------------------------------------------------------
•Our primary sources and uses of cash for the year ended
The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein.
The comparability of our results of operations for the year ended
Comparison of the Year Ended
Leasing Activity
For the year endedDecember 31, 2020 , we executed 61 leases for a total lease value of$3.3 million compared to 89 leases for a total lease value of$10.0 million for the year endedDecember 31, 2019 .
Results of Operations
The following table provides a general comparison of our results of operations
for the years ended
Year Ended December 31,
2020 2019
Number of properties 8 8
Aggregate GLA (sq. ft.) 926,798 926,798
Ending occupancy rate 61 % 75 %
Total revenues $ 9,671 $ 14,253
Total operating expenses 8,120 10,208
Total other (income) expense 928 (14,534)
Income tax provision (benefit) (35) 280
Net income 658 18,299
Less: Noncontrolling interest in subsidiary 1,029
15,232
Net income (loss) available to Common Shareholders
$ 3,067 Revenues from Operations We had total revenues for the years endedDecember 31, 2020 and 2019 of approximately$9,671,000 and$14,253,000 , respectively, for a decrease of approximately$4,582,000 , or 32%. The difference was comprised of a decrease of approximately$3,492,000 in rental revenues,$1,008,000 in expense reimbursements and an increase of$82,000 in bad debt, which is classified as a reduction of revenue. The overall decrease was primarily due to the sale of the 2019 Real Estate Assets Sold 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$8,120,000 for the year endedDecember 31, 2020 compared to approximately$10,208,000 for the year endedDecember 31, 2019 , a decrease of approximately$2,088,000 , or 20%, which was primarily due to the sale of the 2019 Real Estate Assets Sold as ofOctober 8, 2019 . The primary components of property expenses are detailed in the table below (in thousands): 8 --------------------------------------------------------------------------------
Year Ended December 31,
Increase
2020 2019 (Decrease) % Increase (Decrease)
Depreciation and amortization $ 2,055 $ 2,901 $ (846) (29) %
Operating and maintenance 2,644 3,480 (836) (24) %
Real estate taxes 1,824 2,257 (433) (19) %
General and administrative 1,006 753 253 34 %
Management fees 591 817 (226) (28) %
Total property expenses $ 8,120 $ 10,208 $ (2,088) (20) %
Federal and State Income Tax Provision (Benefit)
Our income tax provision (benefit) was approximately$(35,000) for the year endedDecember 31, 2020 as compared to approximately$280,000 for the year endedDecember 31, 2019 , a decrease in expense of approximately$315,000 . The decrease in tax expense primarily resulted from approximately$17.0 million in gains on sales of properties by Pillarstone OP during the year endedDecember 31, 2019 that did not repeat during the year endedDecember 31, 2020 .
Non-Controlling Interest
Our non-controlling interest represents 81.4% of the total outstanding units of Pillarstone OP which is owned by Whitestone OP. Net income from our non-controlling interest was$1.0 million for the year endedDecember 31, 2020 compared to$15.2 million for the year endedDecember 31, 2019 . The majority of the decrease in net income for the non-controlling interest was primarily due to the sale of the 2019 Real Estate Assets Sold as ofOctober 8, 2019 at a gain of$17.0 million .
Liquidity and Capital Resources
Cash Flows
As of
During the year endedDecember 31, 2020 , the Company's cash balance increased by$485,000 from$4,624,000 atDecember 31, 2019 to$5,109,000 atDecember 31, 2020 . This increase in cash was due to cash provided by operating activities of approximately$2,460,000 , offset by cash used in investing activities of$659,000 , and cash used in financing activities of approximately$1,316,000 . 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 the 2018 Real Estate Assets Sold 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 . 9 -------------------------------------------------------------------------------- As ofDecember 31, 2019 , Pillarstone OP, sold the 2019 Real Estate Assets Sold 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 the 2019 Real Estate Assets Sold 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 ofDecember 31, 2020 , the Company's debt obligation is approximately$15.5 million , including convertible notes payable. See Note 10 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, a technology segment, and marketable securities.
From 2006 untilDecember 2016 , the Company continued its existence as a corporate shell filing its periodic reports with theSEC so that the Company could be used for future real estate transactions or sold to another company. During this time, the Company was funded by the trustees who contributed$500,000 in exchange for 125,000 ClassC Convertible Preferred Shares and$197,780 in exchange for convertible notes payable. Currently, Pillarstone intends to develop strategies for the properties in order to create value for the enterprise and our shareholders. To implement the strategy to create value with the remaining eight Real Estate Assets additional capital will need to be raised.
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 ofMarch 26, 2021 . 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. InMarch 2020 , theWorld Health Organization declared COVID-19 a "Public Health Emergency of International Concern" and characterized COVID-19 as a pandemic. As a result, theU.S. and many local governments 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 continued to provide take out and drive through services and were able to be open at a limited capacity. As of the date of this Annual Report on Form 10-K, businesses are permitted to be open inTexas at 100% occupancy through Executive Order (GA-34). 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 Annual Report, all of our properties are open and have
been operating in compliance with federal, state and local COVID-19 guidelines
and mandates.
•Approximately 94% of our tenants (based on annualized base rent ("ABR")) are
open and operating.
•As of the date of this Annual Report, we have received payment of approximately
95% of contractual base rent and common area maintenance reimbursable expenses
billed for the fourth 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
10
--------------------------------------------------------------------------------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$5,109,000 as ofDecember 31, 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. Current Tax Status
As of
The income tax provision (benefit) included in the consolidated statements of operations for the years endedDecember 31, 2020 and 2019 was comprised of the following components (in thousands): Year Ended December 31, 2020 2019 Federal $ (86)$ 39 Texas franchise tax 51 241 $ (35)$ 280
Interest Rates and Inflation
The Company was not significantly affected by inflation during the periods
presented in this report due primarily to the relatively low nationwide
inflation rates and the Company having 100% of its debt with a fixed rate as of
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.
11
--------------------------------------------------------------------------------Application of Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance withU.S. GAAP, which requires 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 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 year endedDecember 31, 2020 , we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately$51,000 for the conversion of four tenants to cash basis revenue as a result of our COVID-19 collectability analysis. For the year endedDecember 31, 2019 , 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 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 tenants who pay real estate taxes directly to the taxing authority.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. 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 ofDecember 31, 2020 . Valuation Allowance of Deferred Tax Asset. We account for income taxes using the asset and liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. The Company had net deferred tax liabilities of$82,000 as ofDecember 31, 2020 , and$96,000 as ofDecember 31, 2019 .
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