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MarketScreener Homepage  >  Equities  >  OTC Bulletin Board - Other OTC  >  Pillarstone Capital REIT    PRLE

PILLARSTONE CAPITAL REIT

(PRLE)
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PILLARSTONE CAPITAL REIT : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (form 10-Q)

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11/13/2019 | 05:53pm EDT

Unless the context otherwise requires, all references in this report to the "Company," "we," "us" or "our" are to Pillarstone Capital REIT and its consolidated subsidiaries.

                           Forward-Looking Statements

The following discussion should be read in conjunction with our unaudited 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 Quarterly Report on Form 10-Q include:

• uncertainties related to the national economy, the real estate industry in

general and in our specific markets;

• legislative or regulatory changes;

• adverse economic conditions in Texas;

• 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;

• decreases in rental rates or increases in vacancy rates;


• litigation risks;


• lease-up risks;

• 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



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• we currently do not plan to distribute dividends to the holders of our shares.




Overview

The Company is a Maryland real estate investment trust 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 of September 30, 2019, we owned approximately 18.6% of the
outstanding equity in Pillarstone OP, and we fully consolidate it on our
financial statements.

As of September 30, 2019, the Company is a smaller reporting company current in
its quarterly and annual financial statement filings with the Securities and
Exchange Commission ("SEC"), 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 on March 15, 1994 as a Maryland REIT. The Company
operated as a traditional real estate investment trust by buying, selling,
owning and operating commercial and residential properties through December 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 Internal
Revenue Code of 1986 as amended. 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 until December 2016, the Company
continued its existence as a corporate shell current in its SEC filings.

On December 8, 2016, Pillarstone and Pillarstone OP entered into the
Contribution Agreement with Whitestone OP, a subsidiary and the operating
partnership of Whitestone REIT, 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; and Uptown Tower that own the
real estate assets (the "Real Estate Assets" and, together with the
Subsidiaries, the "Property") 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").
During 2018, the Company sold three of the Real Estate Assets, resulting in 11
Real Estate Assets in the Company's real estate portfolio at December 31, 2018.
No additional Real Estate Assets were purchased or sold during the nine months
ended September 30, 2019.

On October 8, 2019, Pillarstone OP, through an indirect wholly owned subsidiary,
Whitestone Industrial-Office, LLC, sold a portfolio of three Real Estate Assets
in Houston, 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 Real Estate Assets, and repay the remaining $5.7
million of its $15.5 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.


Results of Operations

The following is a discussion of our results of operations for the three and nine month periods ended September 30, 2019 and 2018 and our financial condition, including:

• Explanation of changes in the results of operations in the Consolidated

       Statements of Operations for the three and nine month periods ended
       September 30, 2019 compared to the three and nine month periods ended
       September 30, 2018.




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• 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
       September 30, 2019 and 2018, and how we intend to generate cash for
       long-term capital needs.


• Our current income tax status.

The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein.

Comparison of the Nine Month Periods Ended September 30, 2019 and 2018

Leasing Activity


For the nine month period ended September 30, 2019, we executed 78 leases for a
total lease value of $9.1 million compared to 107 leases for a total lease value
of $14.1 million for the period ended September 30, 2018.

Results of Operations


The following provides a general comparison of our results of operations for the
nine month periods ended September 30, 2019 and 2018 (in thousands, except for
property and square footage information):

                                                  Nine Months Ended September 30,
                                                     2019                 2018
Number of properties                                       11                   14
Aggregate GLA (sq. ft.)                             1,307,930            1,529,861
Ending occupancy rate                                      77 %                 80 %

Total revenues                                 $       11,536$       12,991
Total operating expenses                                8,080                8,955
Total other expenses                                    1,590                2,063
Provision for income taxes                                (35 )                 67
Net income                                              1,901                1,906
Less: Non-controlling interest in subsidiary            1,610               

1,842

Net income available to Common Shareholders $ 291 $

    64



Revenues from Operations

We had total revenues for the nine month periods ended September 30,
2019 and 2018 of approximately $11,536,000 and $12,991,000, respectively, for a
decrease of approximately $1,455,000, or 11%. The difference was comprised of
decreases of approximately $999,000 in rental revenues, $44,000 in other
revenues, $288,000 in expense reimbursements and an increase of approximately
$124,000 in bad debt which is classified as a decrease in revenue for the nine
months ended September 30, 2019. The overall decrease was primarily due to the
sale of three of the Real Estate Assets as of December 31, 2018.

Expenses from Operations


Our operating expenses were approximately $8,080,000 for the nine months ended
September 30, 2019 compared to approximately $8,955,000 for the nine months
ended September 30, 2018, a decrease of approximately $875,000, or 10% mostly
due to the sale of three Real Estate Assets as of December 31, 2018. The primary
components of property expenses are detailed in the table below (in thousands):

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                                  Nine Months Ended September 30,
                                       2019               2018            Change        % Change
Operating and maintenance,
excluding bad debt              $          2,595     $       2,722$     (127 )           (5 )%
Real estate taxes                          1,954             2,135           (181 )           (8 )%
General and administrative                   511               578            (67 )          (12 )%
Depreciation and amortization              2,360             2,612           (252 )          (10 )%
Management fees                              660               755            (95 )          (13 )%
Bad debt                                       -               153           (153 )         (100 )%
 Total property expenses        $          8,080     $       8,955$     (875 )          (10 )%



Comparison of the Three Month Periods Ended September 30, 2019 and 2018

Leasing Activity


For the three month period ended September 30, 2019, we executed 23 leases for a
total lease value of $3.0 million compared to 41 leases for a total lease value
of $5.1 million for the three month period ended September 30, 2018.

Results of Operations


The following provides a general comparison of our results of operations for the
three month periods ended September 30, 2019 and 2018 (in thousands, except for
property and square footage information):

                                                            Three Months Ended September 30,
                                                              2019                      2018
Number of properties                                                 11                         14
Aggregate GLA (sq. ft.)                                       1,307,930                  1,529,861
Ending occupancy rate                                                77 %                       80 %

Total revenues                                       $            3,863         $            4,450
Total operating expenses                                          2,694                      3,291
Total other expenses                                                537                        698
Provision for income taxes                                         (133 )                       23
Net income                                                          765                        438
Less: Non-controlling interest in subsidiary                        551                        529
Net income (loss) available to Common Shareholders   $              214         $              (91 )



Revenues from Operations


We had total revenues for the three month periods ended September 30,
2019 and 2018 of approximately $3,863,000  and $4,450,000, respectively, for a
decrease of approximately $587,000, or 13%. The difference was comprised of
decreases of approximately $352,000 in rental revenues, $3,000 in other revenue,
$227,000 in expense reimbursements and an increase of $5,000 in bad debt which
is classified as a decrease in revenue for the three months ended September 30,
2019. The overall decrease was primarily due to the sale of three Real Estate
Assets as of December 31, 2018.


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Expenses from Operations


Our operating expenses were approximately $2,694,000 for the three months ended
September 30, 2019 compared to approximately $3,291,000 for the three months
ended September 30, 2018, a decrease of approximately $597,000, or 18%. The
overall decrease was mostly due to the sale of three Real Estate Assets as of
December 31, 2018. The primary components of property expenses are detailed in
the table below (in thousands):

                                  Three Months Ended September 30,
                                       2019                2018            Change        % Change
Operating and maintenance,
excluding bad debt              $             873     $         970     $      (97 )          (10 )%
Real estate taxes                             659               874           (215 )          (25 )%
General and administrative                    137               285           (148 )          (52 )%
Depreciation and amortization                 801               860            (59 )           (7 )%
Management fees                               224               249            (25 )          (10 )%
Bad debt                                        -                53            (53 )         (100 )%
 Total property expenses        $           2,694     $       3,291$     (597 )          (18 )%



Liquidity and Capital Resources

Cash Flows

As of September 30, 2019, our unrestricted cash resources were approximately $2,292,000. We are dependent on cash generated by our ownership of the Real Estate Assets to meet our liquidity needs.


During the nine months ended September 30, 2019, the Company's cash balance
increased by $282,000 from $2,010,000 at December 31, 2018 to $2,292,000 at
September 30, 2019. This increase in cash was due to cash provided by operating
activities of approximately $3,535,000, offset by cash used in financing
activities of approximately $1,864,000 and investing activities of approximately
$1,389,000.

Future Obligations

As part of the Acquisition on December 8, 2016, the Operating Partnership
assumed approximately $65.9 million of liabilities related to the Real Estate
Assets contributed by Whitestone OP. As the general partner of the Operating
Partnership, 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 by
December 8, 2018. As of December 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. During the year ended December 31, 2018, the Company
sold three Real Estate Assets, leaving 11 properties remaining. As of
September 30, 2019, the Company's debt obligation is $46,471,000. Subsequent to
September 30, 2019, Pillarstone OP, through an indirect wholly owned subsidiary,
Whitestone Industrial-Office, LLC, sold a portfolio of three Real Estate Assets
in Houston, 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 the three Real Estate Assets, and 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 stake in Pillarstone OP as a result of the sale. We expect our
remaining debt balance to be repaid from raising capital, selling assets, and
debt refinancing.

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.





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From 2006 until December 2016, the Company continued its existence as a
corporate shell filing its periodic reports with the SEC 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 of September 30, 2019 and December 31, 2018, we had net deferred tax assets
of $538,000 and $199,000, respectively. Management has determined that
sufficient uncertainty exists regarding the realizability of the net deferred
tax assets and has provided a full valuation allowance of $538,000 and $199,000
against the net deferred tax assets of the Company as of September 30, 2019 and
December 31, 2018, respectively. A valuation allowance is considered to be a
significant estimate that may change in the near term.

As of September 30, 2019, we have an operating loss carryforward of approximately $634,000 available to be carried to future periods.

The income tax expense (income) included in the consolidated statements of operations for the three and nine months ended September 30, 2019 and 2018 was comprised of the following components (in thousands):

                                   Three Months Ended September 30,                   Nine Months Ended September 30,
                                     2019                       2018                   2019                       2018
Federal                     $             (154 )         $              -     $             (141 )         $              -
Texas franchise tax                         21                         23                    106                         67
                            $             (133 )         $             23     $              (35 )         $             67



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 88% of its debt with fixed rates.

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 consolidated financial statements are prepared in accordance with U.S. 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 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. 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.

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Additionally, we may have tenants who 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 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 September 30, 2019.


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