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

PILLARSTONE CAPITAL REIT

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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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05/15/2020 | 04:42pm 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 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 by U.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 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, 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 coronavirus
       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



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•      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 a Maryland 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 of March 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 of March 31, 2020, the Company is a smaller reporting company current in its quarterly and annual financial statement filings with the 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 REIT 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 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 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, 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, a Delaware limited liability company ("CP Woodland"); Whitestone Industrial-Office, LLC, a Texas limited liability company ("Industrial-Office"); Whitestone Offices, LLC, a Texas limited liability company ("Whitestone Offices"); and Whitestone Uptown Tower, LLC, a Delaware 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"). On December 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 at December 31, 2018.


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On October 8, 2019, Pillarstone OP, through an indirect wholly owned subsidiary, 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 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 October 8, 2019 sale of three Real Estate Assets resulted in eight Real Estate Assets remaining in the Company's real estate portfolio at March 31, 2020. Results of Operations

The following is a discussion of our results of operations for the three month periods ended March 31, 2020 and 2019 and our financial condition, including:

•      Explanation of changes in the results of operations in the Condensed
       Consolidated Statements of Operations for the three month periods ended
       March 31, 2020 and 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.



•      Our primary sources and uses of cash for the three month periods ended
       March 31, 2020 and 2019, 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 Three Month Periods Ended March 31, 2020 and 2019

Leasing Activity

For the three month period ended March 31, 2020, we executed 15 leases for a total lease value of $1.2 million compared to 34 leases for a total lease value of $3.8 million for the three month period ended March 31, 2019.

Results of Operations

The following provides a general comparison of our results of operations for the three month periods ended March 31, 2020 and 2019 (dollars in thousands):

                                                            Three Months Ended March 31,
                                                             2020                   2019
Number of properties                                                 8                      11
Aggregate GLA (sq. ft.)                                        926,798               1,307,930
Ending occupancy rate                                               69 %                    79 %

Total revenues                                       $           2,586       $           3,856
Total operating expenses                                         2,164                   2,646
Total other expenses                                               261                     529
Provision for income taxes                                           2                      67
Net income                                                         159                     614
Less: Non-controlling interest in subsidiary                       218                     568
Net income (loss) available to Common Shareholders   $             (59 )     $              46






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Revenues from Operations

We had total revenues for the three month periods ended March 31, 2020 and 2019 of approximately $2,586,000 and $3,856,000, respectively, for a decrease of approximately $1,270,000, or 33%. The difference was comprised of decreases of approximately $935,000 in rental revenues, $357,000 in expense reimbursements, $19,000 in bad debt, offset by an increase of $3,000 in other revenue. The overall decrease was primarily due to the sale of three Real Estate Assets as of October 8, 2019.

Expenses from Operations


Our operating expenses were approximately $2,164,000 for the three months ended
March 31, 2020 compared to approximately $2,646,000 for the three months ended
March 31, 2019, a decrease of approximately $482,000, or 18%. The overall
decrease was mostly due to the sale of three Real Estate Assets as of October 8,
2019. The primary components of property expenses are detailed in the table
below (in thousands):

                                   Three Months Ended March 31,
                                      2020               2019            Change         % Change
Operating and maintenance       $           825     $         834     $       (9 )           (1 )%
Real estate taxes                           417               650           (233 )          (36 )%
General and administrative                  223               187             36             19  %
Depreciation and amortization               551               763           (212 )          (28 )%
Management fees                             148               212            (64 )          (30 )%
 Total property expenses        $         2,164     $       2,646$     (482 )          (18 )%


Liquidity and Capital Resources

Cash Flows

As of March 31, 2020, our unrestricted cash resources were approximately $4,163,000. We are dependent on cash generated by our ownership of the eight Real Estate Assets to meet our liquidity needs.

During the three months ended March 31, 2020, the Company's cash balance decreased by $461,000 from $4,624,000 at December 31, 2019 to $4,163,000 at March 31, 2020. This decrease in cash was due to cash used in operating activities of approximately $72,000, cash used in investing activities of approximately $320,000 and cash used in financing activities of approximately $69,000.

Future Obligations

As part of the Acquisition on December 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 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. On December 27, 2018, the Company sold three Real Estate Assets in Houston, Texas to an unaffiliated third party for $15.9 million, resulting in 11 Real Estate Assets in the Company's real estate portfolio at December 31, 2018.

On October 8, 2019, Pillarstone OP, sold three Real Estate Assets in Houston, 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 at December 31, 2019. Pillarstone OP used the net proceeds, after customary closing deductions, to repay mortgage debt secured by the Real Estate Assets sold on October 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 of March 31, 2020, the Company's debt obligation is approximately $15.6 million, including convertible notes payable. See Note 8 for more details on the Company's convertible notes payable.



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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 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.

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 of April 30, 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.

The World 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 in Texas, where all our properties are located, have mandated shelter in place orders, closed non-essential businesses until April 30, 2020, and closed other types of service businesses, such as bars and restaurants, though such businesses can continue to provide take out and drive through services. On April 17, 2020, the Texas governor announced initial steps to begin the process of reopening the Texas economy. However, the timing and ultimate impact of any such steps on the economy as a whole and on our and our tenants' businesses and financial condition remains uncertain. While we did not incur significant disruptions during the three months ended March 31, 2020 from the COVID-19 pandemic, 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:

•         All of our properties remained open and have been operating in
          compliance with federal, state and local COVID-19 guidelines and
          mandates.


•         Approximately 67% of our tenants (based on GLA) have been designated
          "essential businesses" in accordance with state guidelines. Of these
          tenants, approximately 97% are open and operating.


•         Approximately 87% of our tenants (based on GLA) are open and operating
          and approximately 13% of our tenants are closed as of April 30, 2020.


•         As of April 30, 2020, we have received payment of approximately 83% of
          contractual base rent and common area maintenance reimbursables billed
          for the month of April. 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.


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 $4,163,000 as of
          March 31, 2020.


•         We have taken a prudent pause in looking for acquisitions and are
          carefully evaluating development and redevelopment activities on a
          case-by-case basis.



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•         We have put in place a temporary response team to address tenant
          concerns. The response team is in constant 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 implementing a
          work from home policy, and our technology systems have enabled our team
          to work seamlessly. As of May 15, 2020, none of our employees has
          contracted nor tested positive for COVID-19.


Current Tax Status

As of March 31, 2020 and December 31, 2019, we had net deferred tax liabilities of $102,000 and $96,000, respectively. As of March 31, 2020, we have an operating loss carryforward of approximately $89,000 available to be carried to future periods.

The income tax expense (income) included in the consolidated statements of operations for the three months ended March 31, 2020 and 2019 was comprised of the following components (in thousands):

                         Three Months Ended March 31,
                              2020                2019
Federal               $           (12 )         $     -
Texas franchise tax                14                67
                      $             2           $    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 100% of its debt with fixed rates as of March 31, 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 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. 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.



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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 March 31, 2020.




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