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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 Condition and Results of Operations. (form 10-K)

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03/30/2020 | 07:13am EDT

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 of December 31, 2019, we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our consolidated financial statements.

As of December 31, 2019, 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: CP
Woodland; Industrial-Office; Whitestone Offices; and Uptown 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").
On December 27, 2018, the Company sold a portfolio of three Real Estate Assets,
resulting in 11 Real Estate Assets in the Company's real estate portfolio at
December 31, 2018.
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 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 at December 31, 2019.
Results of Operations

The following is a discussion of our results of operations and net income for the years ended December 31, 2019 and 2018 and financial condition, including:

•            Explanation of changes in the results of operations in the
             Consolidated Statements of Operations for the year ended
             December 31, 2019 compared to the year ended December 31, 2018.


•            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 year ended December 31,
             2019 and 2018, and how we intend to generate cash for long-term
             capital needs.



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• 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 Year Ended December 31, 2019 and 2018

Leasing Activity

For the year ended December 31, 2019, we executed 89 leases for a total lease value of $10.0 million compared to 143 leases for a total lease value of $17.5 million for the year ended December 31, 2018.

Results of Operations

The following table provides a general comparison of our results of operations for the years ended December 31, 2019 and 2018 (dollars in thousands):

                                                   Year Ended December 31,
                                                    2019              2018
Number of properties                                      8                11
Aggregate GLA (sq. ft.)                             926,798         1,307,930
Ending occupancy rate                                    75 %              80 %

Total revenues                                 $     14,253$    17,180
Total operating expenses                             10,208            12,036
Total other income                                  (14,534 )          (4,891 )
Provision for income taxes                              280               229
Net income                                           18,299             9,806
Less: Non-controlling interest in subsidiary         15,232             8,490

Net income available to Common Shareholders $ 3,067$ 1,316

Revenues from Operations

We had total revenues for the years ended December 31, 2019 and 2018 of approximately $14,253,000 and $17,180,000, respectively, for a decrease of approximately $2,927,000, or 17%. The difference was comprised of decreases of approximately $2,082,000 in rental revenues, $55,000 in other revenues, $630,000 in expense reimbursements and approximately $160,000 in bad debt which is classified as a decrease in revenue for the twelve months ended December 31, 2019. The overall decrease was primarily due to the sale of the 2018 Real Estate Assets Sold as of December 27, 2018 and also impacted by the sale of the 2019 Real Estate Assets Sold as of October 8, 2019.

Expenses from Operations

Our operating expenses were approximately $10,208,000 for the twelve months ended December 31, 2019 compared to approximately $12,036,000 for the twelve months ended December 31, 2019, a decrease of approximately $1,828,000, or 15%, which was primarily due to the sale of the 2018 Real Estate Assets Sold as of December 27, 2018 and also impacted by the sale of the 2019 Real Estate Assets Sold as of October 8, 2019. The primary components of property expenses are detailed in the table below (in thousands):



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                                     Year Ended December 31,
                                      2019              2018           Decrease       % Decrease
Operating and maintenance,
excluding bad debt              $        3,480$       3,674$     (194 )           (5 )%
Real estate taxes                        2,257             2,720           (463 )          (17 )%
General and administrative                 753               776            (23 )           (3 )%
Depreciation and amortization            2,901             3,566           (665 )          (19 )%
Management fees                            817             1,008           (191 )          (19 )%
Bad debt                                     -               292           (292 )         (100 )%
 Total property expenses        $       10,208$      12,036$   (1,828 )          (15 )%



Gain on Sale of Properties

On December 27, 2018, we completed the sale of Dairy Ashford Business Park, Westbelt Plaza and Main Park, each located in Houston, Texas. Dairy Ashford Business Park sold for $2.1 million, and we recorded a gain on sale of $0.8 million. Westbelt Plaza sold for $5.4 million, and we recorded a gain on sale of $2.7 million. Main Park sold for $8.4 million, and we recorded a gain on sale of $4.3 million. We have not included the 2018 Real Estate Assets Sold in discontinued operations as they did not meet the definition of discontinued operations.

On October 8, 2019, we completed the sale of Corporate Park West, Corporate Park Woodland and Plaza Park, each located in Houston, Texas. Corporate Park West sold for $20.3 million, and we recorded a gain on sale of $6.9 million. Plaza Park sold for $7.3 million, and we recorded a gain on sale of $4.0 million. Corporate Park Woodland sold for $12.2 million, and we recorded a gain on sale of $6.1 million. We have not included the 2019 Real Estate Assets Sold in discontinued operations as they did not meet the definition of discontinued operations.

Provision for Federal and State Income Taxes

Our provision for income taxes was approximately $280,000 for the year ended December 31, 2019 as compared to approximately $229,000 for the year ended December 31, 2018, an increase of approximately $51,000, or 22%. The increase was primarily comprised of increased state margin tax resulting from the gains on sale of properties during the year ended December 31, 2019.

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 $15.2 million for the year ended December 31, 2019 compared to $8.5 million for the year ended December 31, 2018. The majority of the increase in net income for the non-controlling interest was primarily due to the sale of the 2019 Real Estate Assets Sold as of October 8, 2019 at a gain of $17.0 million compared to the sale of the 2018 Real Estate Assets Sold as of December 27, 2018 at a gain of $7.8 million.

Liquidity and Capital Resources

Cash Flows

As of December 31, 2019, our unrestricted cash resources were approximately $4,624,000. We are dependent on cash generated by Pillarstone OP through Pillarstone OP's ownership of the remaining eight Real Estate Assets acquired in the Acquisition to meet our liquidity needs.

During the year ended December 31, 2019, the Company's cash balance increased by $2,614,000 from $2,010,000 at December 31, 2018 to $4,624,000 at December 31, 2019. This increase in cash was due to cash provided by operating activities of approximately $4,458,000 and investing activities of approximately $37,396,000 offset by cash used in financing activities of approximately $39,240,000.




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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.

As of December 31, 2019, Pillarstone OP, sold the 2019 Real Estate Assets Sold 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 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 of December 31, 2019, the Company's debt obligation is approximately $15.7 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 until December 2016, the Company continued its existence as a corporate shell filing its periodic reports with the SEC 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 Class C 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.

Current Tax Status

As of December 31, 2019 and December 31, 2018, we had net deferred tax liabilities and assets of $96,000 and $199,000, respectively. As of December 31, 2018, management determined that sufficient uncertainty existed regarding the realizability of the net deferred tax asset and provided a full valuation allowance of $199,000 against the net deferred tax assets of $199,000. A valuation allowance is considered to be a significant estimate that may change in the near term.

As of December 31, 2019, the Company had no net operating loss carry-forwards available to be carried to future periods.


The income tax expense included in the consolidated statements of operations for
the years ended December 31, 2019 and 2018 was comprised of the following
components (in thousands):

                              Twelve Months Ended December 31,
                                        2019                      2018
Federal               $             39                           $ 141
Texas franchise tax                241                              88
                      $            280                           $ 229




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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 fixed rates as of December 31, 2019.

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 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. 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.

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 of December 31, 2019.

Valuation Allowance of Deferred Tax Asset. We account for income taxes using the asset and liability method under


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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 $96,000 as of December 31, 2019, and, as of December 31, 2018, management determined that sufficient uncertainty existed regarding the realizability of the net deferred tax assets and provided a full valuation allowance of $199,000 against the net deferred tax assets of $199,000.

© Edgar Online, source Glimpses


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