12/312021Q2false0000928953Operating lease right of use assets (net)Operating lease liabilitiesRental Rental revenues $2,042 $2,337; Recoveries 178 280; Bad debt (40) (48); Total rental $2,180 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  UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2021
 
OR 
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from ____________ to ____________
 
Commission File Number 001-15409
PILLARSTONE CAPITAL REIT
(Exact name of registrant as specified in its charter) 
Maryland  
 39-6594066
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)
 
2600 South Gessner, Suite 555
Houston, Texas 77063
(Address of principal executive offices)
 
(832) 810-0100
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒    No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ☒    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☒ Smaller reporting company ☒
Emerging growth company ☐
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new ore revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐      No ☒

 
The Registrant had 606,000 Common Shares, par value $0.01 per share, outstanding as of August 13, 2021.


FORM 10-Q
INDEX
 
PART I. Financial Information  
2
2
4
6
7
8
18
26
   
Part II. Other Information  
26
26
26
26
26
27
28





PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
June 30, 2021 December 31, 2020
(unaudited)
ASSETS (a)
Real estate assets, at cost
Property $ 56,631  $ 56,294 
Accumulated depreciation (7,912) (7,180)
Total real estate assets 48,719  49,114 
Cash and cash equivalents 4,758  5,109 
Escrows and utility deposits 1,319  1,449 
Accrued rents and accounts receivable, net of allowance for doubtful accounts 1,159  1,273 
Receivable due from related party 487  132 
Unamortized lease commissions and deferred legal cost, net 478  490 
Prepaid expenses and other assets (1)
194  89 
Total assets $ 57,114  $ 57,656 
LIABILITIES AND EQUITY (b)
Liabilities:
Notes payable $ 15,053  $ 15,185 
Accounts payable and accrued expenses (2)
1,581  2,506 
Payable due to related party 646  335 
Convertible notes payable - related parties 198  198 
Accrued interest payable 176  165 
Tenants' security deposits 832  825 
Total liabilities 18,486  19,214 
Commitments and contingencies: —  — 
Shareholders' Equity:
Preferred A Shares - $0.01 par value, 1,518,000 authorized: 256,636 Class A cumulative convertible shares issued and outstanding at June 30, 2021 and December 31, 2020, $10.00 per share liquidation preference
3  3 
Preferred C Shares - $0.01 par value, 300,000 authorized: 231,944 Class C cumulative convertible shares issued and outstanding at June 30, 2021 and December 31, 2020, $10.00 per share liquidation preference
2  2 
Common Shares - $0.01 par value, 400,000,000 authorized: 633,130 shares issued and 595,000 outstanding at June 30, 2021 and December 31, 2020
6  6 
Additional paid-in capital 28,511  28,494 
Accumulated deficit (23,768) (23,623)
Treasury stock, at cost, 38,130 shares
(801) (801)
Total Pillarstone Capital REIT shareholders' equity 3,953  4,081 
Noncontrolling interest in subsidiary 34,675  34,361 
Total equity 38,628  38,442 
Total liabilities and equity $ 57,114  $ 57,656 
The accompanying notes are an integral part of the condensed consolidated financial statements.
2

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS - Continued
(in thousands)
June 30, 2021 December 31, 2020
(unaudited)
(1) Operating lease right of use assets (net)
$ —  $ 7 
(2) Operating lease liabilities
$ —  $ 7 

June 30, 2021 December 31, 2020
(unaudited)
(a) Assets of condensed consolidated Variable Interest Entity included in the total assets above:
Real estate assets, at cost
Property $ 56,628  $ 56,290 
Accumulated depreciation (7,908) (7,177)
Total real estate assets 48,720  49,113 
Cash and cash equivalents 4,196  4,321 
Escrows and utility deposits 1,319  1,449 
Accrued rents and accounts receivable, net of allowance for doubtful accounts 1,086  1,201 
Receivable due from related party 487  132 
Unamortized lease commissions and deferred legal cost, net 478  490 
Prepaid expenses and other assets 156  37 
Total assets $ 56,442  $ 56,743 
(b) Liabilities of condensed consolidated Variable Interest Entity included in the total liabilities above:
Notes payable $ 15,053  $ 15,185 
Accounts payable and accrued expenses 1,463  2,333 
Payable due to related party 629  319 
Accrued interest payable 65  63 
Tenants' security deposits 829  825 
Total liabilities $ 18,039  $ 18,725 



The accompanying notes are an integral part of the condensed consolidated financial statements.


3

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
Three Months Ended June 30, Six Months Ended June 30,
   2021 2020 2021 2020
Revenues
Rental (1)
$ 2,259  $ 2,436  $ 4,439  $ 5,005 
Transaction and other fees 13  4  23  21 
Total revenues 2,272  2,440  4,462  5,026 
Operating expenses
Depreciation and amortization 502  524  999  1,075 
Operating and maintenance 736  523  1,454  1,348 
Real estate taxes 393  433  802  850 
General and administrative 176  452  383  675 
Management fees 145  156  284  304 
Total operating expenses 1,952  2,088  3,922  4,252 
Other expenses (income)
Interest expense, net 204  210  407  406 
Loss on disposal of assets —  1  —  66 
Other income (24) —  (24) — 
Total other expenses 180  211  383  472 
Income before income taxes 140  141  157  302 
Provision for income tax benefit (expense) 5  38  12  36 
Net income 145  179  169  338 
Less: Noncontrolling interest in subsidiary 205  393  314  611 
Net loss attributable to Common Shareholders $ (60) $ (214) $ (145) $ (273)
Loss Per Share:
Basic loss per Common Share:
Net loss available to Common Shareholders $ (0.10) $ (0.53) $ (0.24) $ (0.67)
Diluted loss per Common Share:
Net loss available to Common Shareholders $ (0.10) $ (0.53) $ (0.24) $ (0.67)
Weighted average number of Common Shares outstanding:
Basic:
595,000  405,169  595,000  405,169 
Diluted:
595,000  405,169  595,000  405,169 

The accompanying notes are an integral part of the condensed consolidated financial statements.
4

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
(unaudited)
(in thousands)
Three Months Ended June 30, Six Months Ended June 30,
2021 2020 2021 2020
(1) Rental
        Rental revenues $ 2,037  $ 2,185  $ 4,079  $ 4,522 
        Recoveries 211  334  389  614 
        Bad debt 11  (83) (29) (131)
        Total rental $ 2,259  $ 2,436  $ 4,439  $ 5,005 

The accompanying notes are an integral part of the condensed consolidated financial statements.
5

     Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
(unaudited)
(in thousands)
Class A Preferred Shares Class C Preferred Shares Common Shares Additional Paid-in Capital Accumulated Deficit Cost of Shares Held in Treasury Total Shareholders' Equity (Deficit) Noncontrolling Interest Total Equity
Balance, December 31, 2020 $ 3  $ 2  $ 6  $ 28,494  $ (23,623) $ (801) $ 4,081  $ 34,361  $ 38,442 
Share-based compensation
—  —  —  15  —  —  15  —  15 
Net income (loss) —  —  —  —  (85) —  (85) 109  24 
Balance, March 31, 2021 3 2 6 28,509 (23,708) (801) 4,011 34,470 38,481
Share-based compensation
—  —  —  2  —  —  2  —  2 
Net income (loss) —  —  —  —  (60) —  (60) 205  145 
Balance, June 30, 2021 $ 3  $ 2  $ 6  $ 28,511  $ (23,768) $ (801) $ 3,953  $ 34,675  $ 38,628 
Class A Preferred Shares Class C Preferred Shares Common Shares Additional Paid-in Capital Accumulated Deficit Cost of Shares Held in Treasury Total Shareholders' Equity (Deficit) Noncontrolling Interest Total Equity
Balance, December 31, 2019
$ 3  $ 2  $ 4  $ 28,203  $ (23,252) $ (801) $ 4,159  $ 34,371  $ 38,530 
Share-based compensation
—  —  —  13  —  —  13  —  13 
Net income (loss) —  —  —  —  (59) —  (59) 218  159 
Balance, March 31, 2020
3 2 4 28,216 (23,311) (801) 4,113 34,589 38,702
Share-based compensation
—  —  —  23  —  —  23  —  23 
Net income (loss) —  —  —  —  (214) —  (214) 393 179 
Balance, June 30, 2020 $ 3  $ 2  $ 4  $ 28,239  $ (23,525) $ (801) $ 3,922  $ 34,982  $ 38,904 


The accompanying notes are an integral part of the condensed consolidated financial statements.

6

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended June 30,
2021 2020
Cash flows from operating activities:  
Net income $ 169  $ 338 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 999  1,075 
Amortization of deferred loan costs 14  14 
Loss on disposal of assets —  66 
Bad debt 29  131 
Share-based compensation 17  36 
Changes in operating assets and liabilities:
Accrued rents and accounts receivable 85  (136)
Receivable due from related party (355) (492)
Escrows and utility deposits 130  (391)
Unamortized lease commissions and deferred legal cost (88) (47)
Prepaid expenses and other assets (105) (97)
Accounts payable and accrued expenses (914) (269)
Payable due to related party 311  693 
Tenants' security deposits 7  (4)
Net cash provided by operating activities 299  917 
Cash flows from investing activities:
Additions to real estate (504) (529)
Net cash used in investing activities (504) (529)
Cash flows from financing activities:
Repayments of notes payable (146) (137)
Net cash used in financing activities (146) (137)
Net change in cash and cash equivalents (351) 251 
Cash and cash equivalents at beginning of period 5,109  4,624 
Cash and cash equivalents at end of period $ 4,758  $ 4,875 
Supplemental disclosure of cash flow information:
Cash paid for interest $ 396  $ 399 
Cash paid for taxes $ 51  $ — 
Non cash investing activities:
Disposal of fully depreciated real estate $ 137  $ 52 

The accompanying notes are an integral part of the condensed consolidated financial statements.
7
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Accounting.  Pillarstone Capital REIT's (the “Company,” “Pillarstone,” “we,” “our,” or “us”) financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.

Use of estimates.  In order to conform with generally accepted accounting principles in the United States ("U.S. GAAP"), management, in preparation of our condensed consolidated financial statements, is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of June 30, 2021 and December 31, 2020, and the reported amounts of revenues and expenses for the three and six months ended June 30, 2021 and 2020. Actual results could differ from those estimates. In particular, the COVID-19 pandemic has adversely impacted and is likely to further adversely impact the Company's business and markets, including the Company's operations and the operations of its tenants. The full extent to which the pandemic will directly or indirectly impact the Company's business, results of operations and financial condition, including revenues, expenses, reserves and allowances, fair value measurements, and asset impairment charges, will depend on future developments that are highly uncertain and difficult to predict. These developments include, but are 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.

Cash and cash equivalents. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.  Cash and cash equivalents as of June 30, 2021 and December 31, 2020 consisted of demand deposits at a commercial bank and a brokerage account. We maintain our cash in bank accounts that are federally insured.

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. Due to the effects of the COVID-19 pandemic, we are carefully evaluating acquisitions, development and redevelopment opportunities on an individual basis.

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 June 30, 2021.





8
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


Accrued Rents and Accounts Receivable.  Included in accrued rent and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. We review the collectability of charges under our tenant operating leases on a regular basis, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located, including the impact of the COVID-19 pandemic on tenants' businesses and financial condition. We recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Our review of collectability under our operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue. As of June 30, 2021 and December 31, 2020, we had an allowance for uncollectible accounts of approximately $429,000 and $398,000, respectively. For the three and six months ended June 30, 2021, we recorded an adjustment to rental revenue in the amount of approximately $(11,000) and $29,000, respectively. Included in our adjustments to rental revenue for the three and six months ended June 30, 2021 was a bad debt adjustment of $10,913 and $51,174, respectively, related to a potential credit loss for the conversion of three tenants to cash basis revenue as a result of our COVID-19 collectability analysis. For the three and six months ended June 30, 2020, we recorded an adjustment to rental revenue in the amount of approximately $83,000 and $131,000, respectively. Included in the adjustment to rental revenue for the three and six months ended June 30, 2020 was an adjustment of approximately $20,000 and $33,000, respectively, related to credit loss for the conversion of approximately six and seven tenants, respectively, to cash basis revenue as a result of our COVID-19 collectability analysis.

We anticipate that the ongoing global health crisis caused by COVID-19 and the related responses intended to control its spread, including as a result of the Delta variant or other strains, will continue to adversely affect business activity, particularly relating to our retail tenants, across the markets in which we operate. Any such impacts may be material in nature. As part of the initial response to the virus, many governmental authorities implemented measures such as enhanced screenings, quarantine or shelter in place requirements and travel restrictions, including local governments in Texas, where all our properties are located. In May 2020, parts of the U.S. began to ease certain restrictions and allow for the reopening of businesses but with required or recommended safety protocols. Due to the increase in the number of COVID-19 cases in the fall of 2020, parts of the U.S. implemented additional stay in place orders and other restrictions. While as of the date of this Quarterly Report on Form 10-Q, services businesses are permitted to be fully open in Texas, there can be no assurance that service businesses will remain open in the near term, or that state and local governments will not take additional measures to control a resurgence of COVID-19 as a result of new strains or variants, in Texas and worldwide, any of which may materially and adversely impact our or our tenants’ businesses and their ability to pay their rental payments or otherwise continue to occupy their space. In light of the changing nature of the COVID-19 pandemic, we are unable to predict the extent that its impact will have on our financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration of the pandemic and spread of the disease, its severity in our markets and elsewhere, governmental actions to contain the spread of the disease and respond to the reduction in global economic activity, the unknown timing or effectiveness of treatments, adoption of vaccines, resurgences of COVID-19 cases in future periods and how quickly and to what extent normal economic and operating conditions can resume. The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business and markets, including how it will impact the businesses of its tenants.

The Company has put in place a temporary response team to address tenant concerns in light of the COVID-19 pandemic. Collections and rent relief requests to-date may not be indicative of collections or requests in any future period. Not all tenant requests will ultimately result in lease concessions, nor is the Company forgoing its contractual rights under its lease agreements at this time. As of the date of this Quarterly Report on Form 10-Q, we have received payments of approximately 98% of contractual base rent and common area maintenance reimbursables billed for the second quarter.

Unamortized Lease Commissions and Deferred Legal Cost.  Leasing commissions and deferred legal cost are amortized using the straight-line method over the terms of the related lease agreements.  Costs allocated to in-place leases whose terms differ from market terms related to acquired properties are amortized over the remaining life of the respective leases.

Prepaid expenses and Other assets. Prepaid expenses and other assets include escrows established pursuant to certain mortgage financing arrangements for real estate taxes and insurance.

Noncontrolling Interests. Noncontrolling interests are the portion of equity in a subsidiary not attributable to a parent. Accordingly, we have reported noncontrolling interest in equity on the condensed consolidated balance sheets but separate from Pillarstone’s equity.  On the condensed consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to Pillarstone and noncontrolling interest.

9
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)

Revenue recognition. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases.  For the three and six months ended June 30, 2021, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $1,000 for the conversion of one tenant to cash basis as a result of our COVID-19 collectibility analysis. For the three and six months ended June 30, 2020, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $50,000 for the conversion of four tenants to cash basis as a result of our COVID-19 collectibility analysis. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the condensed consolidated statements of operations. We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured.

Stock-based compensation. The Company accounts for stock-based compensation in accordance with ASC No. 718, "Compensation - Stock Compensation," which addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. ASC No.718 generally requires that these transactions be accounted for using a fair-value-based method. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards.

Income taxes. Because we have not elected to be taxed as a REIT for federal income tax purposes, 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. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in provision for income taxes in the condensed consolidated statements of operations and has not been separately stated due to its insignificance.

The Company evaluates potential uncertain tax positions on an annual basis in conjunction with the board of trustees and its tax accountants. Authoritative literature provides a two-step approach to recognize and measure tax benefits when realization of the benefits is uncertain. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%.

As of June 30, 2021, we had a net operating loss carry-forward of $199,000, and as of June 30, 2021 and December 31, 2020, we had net deferred tax liabilities of $47,000 and $82,000, respectively.

Concentration of Risk.  Substantially all of our revenues are obtained from office and warehouse locations in the Dallas and Houston metropolitan areas. We maintain cash accounts in major U.S. financial institutions. The terms of these deposits are on demand to minimize risk. The balances of these accounts sometimes exceed the federally insured limits, although no losses have been incurred in connection with these deposits.

Recent accounting pronouncements. In April 2020, the Financial Accounting Standards Board ("FASB") issued guidance on the application of Topic 842, relating to concessions being made by lessors in response to the COVID-19 pandemic. The guidance notes that it would be acceptable for entities to make an election to account for lease concessions relating to the effects of the COVID-19 pandemic consistent with how those concessions would be accounted for under Topic 842 as though enforceable rights and obligations for those concessions existed, even if such enforceable rights and obligations
are not explicitly contained in the lease contract. Thus, for concessions relating to COVID-19, an entity would not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract, and would
have the option to apply, or not to apply, the general lease modification guidance in Topic 842 as it stands. We have elected this option to account for lease concessions relating to the effects of the COVID-19 pandemic consistent with how those
concessions would be accounted for under Topic 842 as though enforceable rights and obligations for those concessions existed. Therefore, such concessions are not accounted for as a lease modification under Topic 842.

    
10
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


2. ACCRUED RENTS AND ACCOUNTS RECEIVABLE, NET

Accrued rents and accounts receivable, net consists of amounts accrued, billed and due from tenants, allowance for doubtful accounts and other receivables as follows (in thousands):
June 30, 2021 December 31, 2020
Tenant receivables $ 563  $ 558 
Accrued rents and other recoveries 1,025  1,113 
Allowance for doubtful accounts (429) (398)
Total $ 1,159  $ 1,273 

3. LEASES

As a Lessor. All leases on our properties are classified as noncancelable 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. Percentage rents, if applicable, are recognized as rental income when the thresholds upon which they are based have been met.  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, recoveries, and percentage rents into a single line item, Rental, within the condensed consolidated statements of operations.

A summary of minimum future rents to be received (exclusive of renewals, tenant reimbursements, contingent rents, and collectability adjustments under Topic 842) under noncancelable operating leases in existence as of June 30, 2021 is as follows (in thousands): 

Years Ended December 31,
Minimum Future Rents(1)
2021 (remaining) $ 3,660 
2022 5,479 
2023 3,942 
2024 2,306 
2025 1,135 
Thereafter 807 
Total $ 17,329 

(1) These amounts do not reflect future rental revenues from the renewal or replacement of existing leases and exclude reimbursements of operating expenses and rental increases that are not fixed.

As a Lessee. On June 8, 2021, Pillarstone's lease became month to month with Whitestone for the premises located at 2600 S. Gessner Road, Suite 555 Houston, Texas 77063. The rentable area of the premises is approximately 678 square feet. Total rent expense for the three and six months ended June 30, 2021 was $10,051 and $17,611, respectively, compared to $3,633 and $9,808, for the three and six months ended June 30, 2020, respectively.

11
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


4. UNAMORTIZED LEASE COMMISSIONS AND DEFERRED LEGAL COST, NET

Costs which have been deferred consist of the following (in thousands):
June 30, 2021 December 31, 2020
Leasing commissions $ 1,332  $ 1,290 
Deferred legal cost 12  12 
  Total cost 1,344  1,302 
Less: leasing commissions accumulated amortization (855) (802)
Less: deferred legal cost accumulated amortization (11) (10)
Total cost, net of accumulated amortization $ 478  $ 490 

5. VARIABLE INTEREST ENTITY

On December 8, 2016, Pillarstone and Pillarstone OP, entered into a Contribution Agreement (the “Contribution Agreement”) with Whitestone REIT Operating Partnership, L.P. (“Whitestone OP”), a subsidiary and the operating partnership of Whitestone REIT (“Whitestone”), both of which are related parties to Pillarstone and Pillarstone OP. Pursuant to the terms of the Contribution Agreement, Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries (the “Subsidiaries”): Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company; Whitestone Industrial-Office, LLC, a Texas limited liability company; Whitestone Offices, LLC, a Texas limited liability company; and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower”) that owned 14 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 (“OP Units”), issued at a price of $1.331 per OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by Pillarstone OP. Pursuant to the Contribution Agreement, Pillarstone became the general partner of Pillarstone OP with an equity ownership interest in Pillarstone OP totaling approximately an 18.6% interest valued at $4.1 million as of the date of the Contribution Agreement.

In connection with the Contribution Agreement, on December 8, 2016, the Company, as the general partner of Pillarstone OP, entered into an Amended and Restated Agreement of Limited Partnership of Pillarstone OP (as amended and restated, the “Amended and Restated Agreement of Limited Partnership”). Pursuant to the Amended and Restated Agreement of Limited Partnership, subject to certain protective rights of the limited partners described below, the general partner has full, exclusive and complete responsibility and discretion in the management and control of Pillarstone OP, including the ability to cause Pillarstone OP to enter into certain major transactions including a merger of Pillarstone OP or a sale of substantially all of the assets of Pillarstone OP. The limited partners have no power to remove the general partner without the general partner's consent. In addition, pursuant to the Amended and Restated Agreement of Limited Partnership, the general partner may not conduct any business without the consent of a majority of the limited partners other than in connection with certain actions described therein. The Company is deemed to exercise significant influence over Pillarstone OP as it has the power to direct the activities that most significantly impact Pillarstone OP's economic performance and the Company's right to receive benefits
based on its ownership percentage in Pillarstone OP. Accordingly, the Company accounts for Pillarstone OP as a Variable Interest Entity.

The Amended and Restated Agreement of Limited Partnership designates two classes of units of limited partnership interest in Pillarstone OP: the OP Units and LTIP units. In general, LTIP units are similar to the OP Units and will receive the same quarterly per-unit profit distributions as the OP Units. The rights, privileges, and obligations related to each series of LTIP units will be established at the time the LTIP units are issued. As profits interests, LTIP units initially will not have full parity, on a per-unit basis, with OP Units with respect to liquidating distributions. Upon the occurrence of specified events, LTIP units can over time achieve full parity with the OP Units and therefore accrete to an economic value for the holder equivalent to OP Units. If such parity is achieved, vested LTIP units may be converted on a one-for-one basis into OP Units, which in turn are redeemable by the holder for cash or, at the Company’s election, exchangeable for Common Shares on a one-for-one basis.

12
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)



The carrying amounts and classification of certain assets and liabilities for Pillarstone OP in our condensed consolidated balance sheets as of June 30, 2021 and December 31, 2020 consists of the following (in thousands):
June 30, 2021 December 31, 2020
(unaudited)
Real estate assets, at cost
  Property $ 56,628  $ 56,290 
  Accumulated depreciation (7,908) (7,177)
    Total real estate assets 48,720  49,113 
Cash and cash equivalents 4,196  4,321 
Escrows and utility deposits 1,319  1,449 
Accrued rents and accounts receivable, net of allowance for doubtful accounts 1,086  1,201 
Receivable due from related party (1)
487  132 
Unamortized lease commissions and deferred legal cost, net 478  490 
Prepaid expenses and other assets 156  37 
     Total assets $ 56,442  $ 56,743 
Liabilities
  Notes payable $ 15,053  $ 15,185 
  Accounts payable and accrued expenses 1,463  2,333 
Payable due to related party 629  319 
Accrued interest payable 65  63 
  Tenants' security deposits 829  825 
     Total liabilities $ 18,039  $ 18,725 

(1)    Excludes approximately $0.03 million in accounts receivable due from Pillarstone that was eliminated in consolidation as of June 30, 2021 and December 31, 2020.

6. REAL ESTATE

As of June 30, 2021, Pillarstone OP owned eight Real Estate Assets in the Dallas and Houston areas comprised of approximately 0.9 million square feet of gross leasable area.
13
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


7. DEBT

Mortgages and other notes payable consist of the following (in thousands):
Description June 30, 2021 December 31, 2020
Fixed rate notes
$16.5 million 4.97% Note, due September 26, 2023
$ 15,116  $ 15,262 
Total notes payable principal 15,116  15,262 
Less deferred financing costs, net of accumulated amortization (63) (77)
Total notes payable $ 15,053  $ 15,185 

Our mortgage debt was collateralized by one operating property as of June 30, 2021 and December 31, 2020 with a net book value of $21.6 million and $21.8 million, respectively. Our loan contains restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and is secured by a deed of trust on our property and the assignment of certain rents and leases associated with the property. Our loan is subject to customary covenants. As of June 30, 2021, we were in compliance with all loan covenants.

Scheduled maturities of notes payable as of June 30, 2021 were as follows (in thousands):
Year Amount Due
2021 (remaining) $ 146 
2022 311 
2023 14,659 
Total $ 15,116 


8. CONVERTIBLE NOTES PAYABLE - RELATED PARTIES

On November 20, 2015, five trustees on our board of trustees loaned $197,780 to the Company in exchange for convertible notes payable. The convertible notes payable accrue interest at 10% per annum and originally matured on November 20, 2018. In 2019, our board of trustees approved an extension of the maturity date to November 20, 2021. The convertible notes payable can be converted by the noteholders into Common Shares at the rate of $1.331 per Common Share at any time. At maturity or when the Company chooses to call the convertible notes payable, the noteholders have the option to receive cash plus accrued interest or convert the convertible notes payable into Common Shares at $1.331 per Common Share. Accrued interest on these related convertible notes was approximately $111,000 as of June 30, 2021 compared with approximately $101,000 as of December 31, 2020.


9. EARNINGS (LOSS) PER SHARE

The Company applies the guidance of ASC 260, "Earnings Per Share," for all periods presented herein. Net earnings (loss) per weighted average Common Share outstanding, basic and diluted, is computed based on the weighted average number of Common Shares outstanding for the period. The following table shows the weighted average number of Common Shares outstanding and reconciles the numerator and denominator of earnings per Common Share calculations for the three and six month periods ended June 30, 2021 and 2020.

For the three and six month periods ended June 30, 2021 and 2020, Class A Preferred Shares and Class C Preferred Shares were not included in net loss per weighted average number of Common Share outstanding-diluted, because the effect of the conversion would be anti-dilutive. For the three and six month periods ended June 30, 2021 and 2020, Restricted Common Shares awarded pursuant to the 2016 plan (defined in Note 11 below) were not included in net loss per weighted average number of Common Share outstanding-dilutive, because the effect of the conversion would be anti-dilutive.


14
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)



During the three and six month periods ended June 30, 2021 and 2020, the Company had $197,780 of convertible notes payable as discussed in Note 8. The convertible notes payable were not included in the computation of diluted loss per share for the three and six months ended June 30, 2021 and 2020 because the effect of the conversion would be anti-dilutive.
Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except share and per share data) 2021 2020 2021 2020
Numerator:
Net loss attributable to common shareholders $ (60) $ (214) $ (145) $ (273)
Denominator:
   Weighted average number of common shares - basic 595,000  405,169  595,000  405,169 
   Weighted average number of common shares - dilutive 595,000  405,169  595,000  405,169 
Loss Per Share:
Basic loss per common share:
Net loss available to common shareholders $ (0.10) $ (0.53) $ (0.24) $ (0.67)
Diluted loss per common share:
Net loss available to common shareholders $ (0.10) $ (0.53) $ (0.24) $ (0.67)


10. RELATED PARTY TRANSACTIONS
    
On December 8, 2016, the Company entered into the Contribution Agreement with Whitestone OP, a related party, resulting in the contribution of an equity ownership interest in Pillarstone OP by the Company valued at $4,121,312 and representing approximately 18.6% of the outstanding equity in Pillarstone OP. The terms of the Contribution Agreement were determined through arm's-length negotiations and were recommended to the board of trustees by a special committee of the board of trustees consisting solely of disinterested trustees of the Company and approved by the full board.

Pursuant to the Contribution Agreement, the Company agreed to file with the Securities and Exchange Commission (the "SEC") on or prior to June 8, 2018, a shelf registration statement to register for sale under the Securities Act of 1933, as amended, the issuance of the common shares in the Company that may be issued upon redemption of the OP Units issued pursuant to the Contribution Agreement and the offer and resale of such common shares by the holders thereof. In addition, pursuant to the Contribution Agreement, in the event of a Change of Control (as defined therein) of Whitestone, Pillarstone OP shall have the right, but not the obligation, to repurchase the OP Units issued thereunder from Whitestone OP at their initial issue price of $1.331 per OP Unit. Pillarstone and Whitestone agreed to extend the filing of the shelf registration statement to the date that the Company closes a public equity offering.

In connection with the Contribution Agreement, on December 8, 2016, the Company and Pillarstone OP entered into a Tax Protection Agreement (the “Tax Protection Agreement”) with Whitestone OP pursuant to which Pillarstone OP agreed to indemnify Whitestone OP for certain tax liabilities resulting from its recognition of income or gain prior to December 8, 2021 if such liabilities result from a transaction involving a direct or indirect taxable disposition of all or a portion of the Property or if Pillarstone OP fails to maintain and allocate to Whitestone OP for taxation purposes minimum levels of liabilities as specified in the Tax Protection Agreement, the result of which causes such recognition of income or gain and Whitestone incurs taxes that must be paid to maintain its REIT status for federal tax purposes. In December 2018, Pillarstone OP sold three of the Real Estate Assets, which did not create additional tax liabilities for Whitestone OP. In addition, the sale of three more Real Estate Assets in 2019 also did not create additional tax liabilities for Whitestone OP.






15
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


During the ordinary course of business, we have transactions with Whitestone that include, but are not limited to, rental income, interest expense, general and administrative costs, commissions, management and asset management fees, and property expenses.     

In connection with the Contribution Agreement, on December 8, 2016, the Company entered into a Management Agreement (collectively, the “Management Agreements”) with Whitestone TRS, Inc., a subsidiary of Whitestone (“Whitestone TRS"). Pursuant to the Management Agreements with respect to each property, other than Uptown Tower, Whitestone TRS
agreed to provide certain property management, leasing and day-to-day advisory and administrative services to such properties in exchange for (1) a monthly property management fee equal to 5.0% of the monthly revenues of each property and (2) a monthly asset management fee equal to 0.125% of GAV (as defined in each Management Agreement as, generally, the purchase price of the respective property based upon the purchase price allocations determined pursuant to the Contribution Agreement, excluding all indebtedness, liabilities or claims of any nature) of such property. Pursuant to the Management Agreement with respect to Uptown Tower, Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services in exchange for (1) a monthly property management fee equal to 3.0% of the monthly revenues of Uptown Tower and (2) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.

The following table presents the revenue and expenses with Whitestone included in our condensed consolidated statement of operations for the three and six months ended June 30, 2021 and 2020 (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
Location of Revenue (Expense) 2021 2020 2021 2020
Rent Rental $ 226  $ 220  $ 451  $ 481 
Property management fees Management fees (100) (110) (194) (221)
Asset management fees Management fees (45) (46) (90) (83)
Rent expense Office expenses (10) (4) (18) (10)

Receivables due from and payables due to related parties consisted of the following as of June 30, 2021 and December 31, 2020 (in thousands):
Location of Receivable (Payable) June 30, 2021 December 31, 2020
Tenant receivables and other receivables Receivable due from related party $ 487  $ 132 
Accrued interest due to related party
Accrued interest payable (111) (101)
Other payables due to related party Payable due to related party (646) (335)


11. INCENTIVE EQUITY PLAN

At the 2016 Annual Meeting of Shareholders, our shareholders approved the 2016 Equity Plan ("2016 Plan").
 
The 2016 Plan provides that awards may be made in Common Shares of the Company or units in the Company’s operating partnership, which may be converted into Common Shares. Subject to adjustment as provided by the terms of the 2016 Plan, the maximum aggregate number of Common Shares with respect to which awards may be granted under the 2016 Plan will be increased based on future issuances of Common Shares and units of the operating partnership, including issuances pursuant to the 2016 Plan, so that at any time the maximum number of shares that may be issued under the 2016 Plan shall equal 12.5% of the aggregate number of Common Shares and units of the operating partnership issued and outstanding (other than treasury shares and/or units issued to or held by the Company).
 
The Management, Organization and Compensation Committee (the “Committee”) administers the 2016 Plan, except with respect to awards to non-employee trustees, for which the 2016 plan is administered by the board of trustees. Subject to the terms of the 2016 Plan, the Committee is authorized to select participants, determine the type and number of awards to be granted, determine and later amend (subject to certain limitations) the terms and conditions of any award, interpret and specify the rules and regulations relating to the 2016 Plan, and make all other determinations which may be necessary or desirable for

16
Pillarstone Capital REIT
Notes to Condensed Consolidated Financial Statements
(unaudited)


the administration of the 2016 Plan. The 2016 Plan includes the types of awards for grants and types of financial performance measures.

On July 1, 2019, the Committee approved the grant of 45,031 Restricted Common Share Units (the "Units") subject to the restrictions, terms and conditions set forth in the Restricted Unit Award Agreement (the "Award"). These Units are time-based shares that vest each year over the next three years and will be fully vested on July 1, 2022.

On July 1, 2019, the Committee approved the grant of 45,031 Units subject to the restrictions and terms and conditions set forth in the Award. These Units are performance-based shares linked to five specific goals set forth in the Award. If the Company does not attain the performance goals before July 1, 2022, the Units still subject to restriction will be forfeited to the Company.

On August 7, 2020, three independent members of the Company's Board of Trustees were issued 122,665 Common Share Units which vested immediately. The fair value of the shares was based on the closing market price on the day preceding issuance.

On December 17, 2020, three independent members of the Company's Board of Trustees were issued 56,607 Common Share Units which vested immediately. The fair value of the shares was based on the closing market price on the day preceding issuance.
 
As of June 30, 2021, the maximum number of Common Shares or OP Units available to be granted is 2,073,686. During the three months ended June 30, 2021, the following shares were granted and the following shares vested:

Description Shares
Weighted-Average Grant Date Fair Value (1)
Non-vested at January 1, 2021 75,052  $ 2.18 
Non-vested at June 30, 2021 75,052  $ 2.18 
Available for grant at June 30, 2021 2,073,686 

(1) The fair value of the shares granted on July 1, 2019 were determined based on the share activity from the date of the three property sales on December 27, 2018 until the grant date July 1, 2019.

As of June 30, 2021, per the Award granted July 1, 2019, the Company has determined that the time-based shares and the performance-based shares will fully vest by July 1, 2022. Time-based shares granted on July 1, 2019 are amortized over their respective amortization periods. The performance-based shares granted on July 1, 2019 will be amortized for three years. Performance-based shares that have not been achieved as of July 1, 2022 will be forfeited to the Company.

The total value of the time-based and performance-based shares granted on July 1, 2019 is approximately $196,000. The Company recognized approximately $2,000 and $17,000 in stock-based compensation expense for the three and six months ended June 30, 2021, respectively, and recognized approximately $23,000 and $36,000 for the three and six months ended June 30, 2020, respectively.

The total value of the Company's Board of Trustee's shares issued on August 7, 2020 and December 17, 2020 was approximately $166,000 and $65,000, respectively. The Company did not recognize any stock-based compensation expense for trustee compensation for the three and six months ended June 30, 2021 and 2020.


12. SUBSEQUENT EVENTS

Management has evaluated subsequent events through August 13, 2021, the date the condensed consolidated financial statements were available to be issued and has determined that there are no subsequent events to be reported.

17

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    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 condensed consolidated financial statements and the notes thereto in this Quarterly Report on Form 10-Q. 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters. These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry. Forward-looking statements are typically identified by the use of terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative of such terms and variations of these words and similar expressions, although not all forward-looking statements include these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.
 
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. You are cautioned not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.

Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:

•uncertainties related to the COVID-19 pandemic, including the unknown duration and economic, operational and financial impacts of the COVID-19 pandemic and the actions taken or contemplated 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 potential renewed mandated shelter in place orders that may prevent 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, the rate and acceptance of vaccines, 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, including but not limited to, the significant volatility and disruption in the global financial markets caused by the COVID-19 pandemic;

•legislative or regulatory changes, including the impact of the legislation commonly known as the Tax Cuts and Jobs Act;

•adverse economic or real estate developments or conditions in Texas, including as a result of a surge in COVID-19 cases in such areas and the impact on our tenants' ability to pay their rent, which could result in bad debt allowances or straight-line rent reserve adjustments;

•adverse changes in governmental rules and fiscal policies;
•increases in interest rates and operating costs;
•availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures, in each case, on terms favorable to the Company;
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•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 COVID-19 outbreak;
•cybersecurity attacks, loss of confidential information and other business disruptions;
•our inability to renew tenants or obtain new tenants upon the expiration of existing leases; and 
•our inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws.

In addition, an investment in the Company involves numerous risks that potential investors should consider carefully, including, without limitation:
•our cash resources are limited;
•we have a history of losses;
•we have not raised funds through a public equity offering;
•our trustees control a significant percentage of our voting shares;
•shareholders could experience possible future dilution through the issuance of additional shares;
•we are dependent on a small number of key senior 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 June 30, 2021, we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our condensed consolidated financial statements.

As of June 30, 2021, 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
19


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”).
Impact of COVID-19
The following discussion is intended to provide our 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 August 13, 2021. As a result of the rapid development, fluidity and uncertainty surrounding this situation, 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, and that of our tenants, for future periods.
We anticipate that the ongoing global health crisis caused by COVID-19 and the related responses intended to control its spread, including as a result of the Delta variant or other strains, will continue to adversely affect business activity, particularly relating to our retail tenants, across the markets in which we operate. Any such impacts may be material in nature. As part of the initial response to the virus, many governmental authorities implemented measures such as enhanced screenings, quarantine or shelter in place requirements and travel restrictions, including local governments in Texas, where all our properties are located. In May 2020, parts of the U.S. began to ease certain restrictions and allow for the reopening of businesses but with required or recommended safety protocols. Due to the increase in the number of COVID-19 cases in the fall of 2020, parts of the U.S. implemented additional stay in place orders and other restrictions. While as of the date of this Quarterly Report on Form 10-Q, services businesses are permitted to be fully open in Texas, there can be no assurance that service businesses will remain open in the near term, or that state and local governments will not take additional measures to control a resurgence of COVID-19 as a result of new strains or variants, in Texas and worldwide, any of which may materially and adversely impact our or our tenants’ businesses and their ability to pay their rental payments or otherwise continue to occupy their space. In light of the changing nature of the COVID-19 pandemic, we are unable to predict the extent that its impact will have on our financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration of the pandemic and spread of the disease, its severity in our markets and elsewhere, governmental actions to contain the spread of the disease and respond to the reduction in global economic activity, the unknown timing or effectiveness of treatments, adoption of vaccines, resurgences of COVID-19 cases in future periods and how quickly and to what extent normal economic and operating conditions can resume. The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business and markets, including how it will impact the businesses of its tenants.
Our portfolio and tenants have been impacted by these and other issues as follows:
•As of the date of this Quarterly Report on Form 10-Q, all of our properties are open and operating in compliance with federal, state and local COVID-19 guidelines and mandates.

•Approximately 97% of our tenants (based on annualized base rent ("ABR")) are open and operating.

•Included in our adjustments to rental revenue for the three and six months ended June 30, 2021 was a bad debt adjustment of $10,913 and $51,174, respectively, related to credit loss for the conversion of three tenants to cash basis revenue as a result of our COVID-19 collectability analysis.

•As of the date of this Quarterly Report on Form 10-Q, we have received payments of approximately 98% of contractual base rent and common area maintenance reimbursables billed for the second quarter. As is believed to be the case with retail landlords across the U.S., we have received a few rent relief requests from tenants, most often in the form of rent deferral requests, which we evaluate on an individual basis. Collections and rent relief requests to-date may not be indicative of collections or requests in any future period.


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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 $4,758,000 as of June 30, 2021.

•We are carefully evaluating acquisition, development and redevelopment opportunities on an individual basis.

•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 social distancing where possible within our offices and a work from home policy when necessary.

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.


Results of Operations

The following is a discussion of our results of operations for the three and six month periods ended June 30, 2021 and 2020 and our financial condition, including:

•Explanation of changes in the results of operations in the Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2021 and 2020.

•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 six month periods ended June 30, 2021 and 2020, 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 condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report.

Comparison of the Six Month Periods Ended June 30, 2021 and 2020

Leasing Activity

For the six month period ended June 30, 2021, we executed 46 leases for a total lease value of $3.2 million compared to 27 leases for a total lease value of $2.0 million for the six month period ended June 30, 2020.

Results of Operations

The following provides a general comparison of our results of operations for the six month periods ended June 30, 2021 and 2020 (dollars in thousands):
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  Six Months Ended June 30,
  2021 2020
Number of properties 8  8 
Aggregate GLA (sq. ft.) 926,798  926,798 
Ending occupancy rate 61  % 67  %
Total revenues $ 4,462  $ 5,026 
Total operating expenses 3,922  4,252 
Total other expenses 383  472 
Provision for income tax expense (benefit) (12) (36)
Net income 169  338 
Less:  Non-controlling interest in subsidiary 314  611 
Net loss available to Common Shareholders $ (145) $ (273)

Revenues from Operations

We had total revenues for the six month periods ended June 30, 2021 and 2020 of approximately $4,462,000 and $5,026,000, respectively, for a decrease of approximately $564,000, or 11%. The difference was comprised of a decrease of approximately $443,000 in rental revenues, a decrease of $225,000 in expense reimbursements, an increase of $2,000 in other revenue, and a decrease of $102,000 in bad debt, which is classified as a reduction of revenue. The overall decrease was due to occupancy, which was 6% lower for the six months ended June 30, 2021 compared to the six months ended June 30, 2020 .


Expenses from Operations

Our operating expenses were approximately $3,922,000 for the six months ended June 30, 2021 compared to approximately $4,252,000 for the six months ended June 30, 2020, a decrease of approximately $330,000, or 8%. The overall decrease was primarily due to a decrease in trustee fee expense for the six months ended  June 30, 2021 compared to the six months ended June 30, 2020, and partially offset by an increase in operating and maintenance due to miscellaneous repairs at our properties and higher electricity usage compared to the prior year period. The primary components of operating expenses are detailed in the table below (in thousands):
Six Months Ended June 30,
2021 2020 Change % Change
Depreciation and amortization $ 999  $ 1,075  $ (76) (7) %
Operating and maintenance 1,454  1,348  106  8  %
Real estate taxes 802  850  (48) (6) %
General and administrative 383  675  (292) (43) %
Management fees 284  304  (20) (7) %
  Total operating expenses $ 3,922  $ 4,252  $ (330) (8) %

The comparability of our results of operations for the six months ended June 30, 2021 to future periods may be impacted by the effects of the COVID-19 pandemic.

Comparison of the Three Month Periods Ended June 30, 2021 and 2020

Leasing Activity

For the three month period ended June 30, 2021, we executed 23 leases for a total lease value of $1.9 million compared to 12 leases for a total lease value of $0.8 million for the three month period ended June 30, 2020.


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Results of Operations

The following provides a general comparison of our results of operations for the three month periods ended June 30, 2021 and 2020 (dollars in thousands):
  Three Months Ended June 30,
  2021 2020
Number of properties 8  8 
Aggregate GLA (sq. ft.) 926,798  926,798 
Ending occupancy rate 61  % 67  %
Total revenues $ 2,272  $ 2,440 
Total operating expenses 1,952  2,088 
Total other expenses 180  211 
Provision for income tax expense (benefit) (5) (38)
Net income 145  179 
Less:  Non-controlling interest in subsidiary 205  393 
Net loss available to Common Shareholders $ (60) $ (214)

Revenues from Operations

We had total revenues for the three month periods ended June 30, 2021 and 2020 of approximately $2,272,000 and $2,440,000, respectively, for a decrease of approximately $168,000, or 7%. The difference was comprised of a decrease of approximately $148,000 in rental revenues, a decrease of $123,000 in expense reimbursements, an increase of $9,000 in other revenue, and a decrease of $94,000 in bad debt, which was previously recorded as a reduction of revenue. The overall decrease was primarily due to occupancy, which was 6% lower for the three months ended June 30, 2021 compared to the three months ended June 30, 2020.

Expenses from Operations

Our operating expenses were approximately $1,952,000 for the three months ended June 30, 2021 compared to approximately $2,088,000 for the three months ended June 30, 2020, a decrease of approximately $136,000, or 7%. The overall decrease was due to a decrease in trustee fee expense for the three months ended June 30, 2021 compared to the three months ended June 30, 2020, and partially offset by an increase in operating and maintenance due to miscellaneous repairs at our properties and higher electricity usage compared to the prior year period. The primary components of operating expenses are detailed in the table below (in thousands):
Three Months Ended June 30,
2021 2020 Change % Change
Depreciation and amortization $ 502  $ 524  $ (22) (4) %
Operating and maintenance 736  523  213  41  %
Real estate taxes 393  433  (40) (9) %
General and administrative 176  452  (276) (61) %
Management fees 145  156  (11) (7) %
  Total operating expenses $ 1,952  $ 2,088  $ (136) (7) %


The comparability of our results of operations for the three months ended June 30, 2021 to future periods may be impacted by the effects of the COVID-19 pandemic.


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Liquidity and Capital Resources

Cash Flows

As of June 30, 2021, our unrestricted cash resources were approximately $4,758,000. We are dependent on cash generated by our ownership of the eight Real Estate Assets to meet our liquidity needs.
    
During the six months ended June 30, 2021, the Company's cash balance decreased by $351,000 from $5,109,000 at December 31, 2020 to $4,758,000 at June 30, 2021. This decrease in cash was due to cash provided by operating activities of approximately $299,000, cash used in investing activities of approximately $504,000 and cash used in financing activities of approximately $146,000.

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 dynamics in the capital markets impacted by COVID-19 and the economic slowdown, our access to capital may be diminished.
    
Future Obligations

None.

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.

Current Tax Status

As of June 30, 2021 and December 31, 2020, we had net deferred tax liabilities of $47,000 and $82,000, respectively. As of June 30, 2021, we have an operating loss carryforward of approximately $199,000 available to be carried to future periods.

The income tax expense (benefit) included in the condensed consolidated statements of operations for the three and six months ended June 30, 2021 and 2020 was comprised of the following components (in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2021 2020 2021 2020
Federal $ (17) $ (51) $ (35) $ (63)
Texas franchise tax 12  13  23  27 
Provision for income tax expense (benefit) $ (5) $ (38) $ (12) $ (36)





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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 relative low nationwide inflation rates and the Company having approximately 100% of its debt with fixed rates as of June 30, 2021.

Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have, or are likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Application of Critical Accounting Estimates

Our condensed consolidated financial statements are prepared in accordance with GAAP, which require us to make certain estimates and assumptions. The following section is a summary of certain estimates that both require our most subjective judgment and are most important to the presentation of our financial condition and results of operations. It is possible that the use of different estimates or assumptions in making these judgments could result in materially different amounts being reported in our condensed consolidated financial statements.

Revenue recognition. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases.  For the three and six months ended June 30, 2021, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $1,000 for the conversion of one tenant to cash basis as a result of our COVID-19 collectibility analysis. For the three and six months ended June 30, 2020, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $50,000 for the conversion of four tenants to cash basis as a result of our COVID-19 collectibility analysis. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the condensed consolidated statements of operations. We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured.

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. Due to the effects of the COVID-19 pandemic, we are carefully evaluating acquisitions, development and redevelopment opportunities on an individual basis.

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
25

(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 June 30, 2021.


ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures in ensuring that the information required to be disclosed in our filings under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, including ensuring that such information is accumulated and communicated to its management, as appropriate, to allow timely decisions regarding required disclosure.

Based on such evaluation, our principal executive and financial officers have concluded that such disclosure controls and procedures were effective as of June 30, 2021 (the end of the period covered by this Quarterly Report).

Changes in Internal Control Over Financial Reporting

There have been no significant changes in our internal control over financial reporting during the three months ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting


PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We may from time to time become a party to legal proceedings and claims that arise in the ordinary course of our business. These matters are generally covered by insurance. While the frequency and resolutions of any such matters cannot be predicted with certainty, we believe that occurrence and outcomes of these matters will not have a material effect on our financial position, results of operations or cash flows.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.
 
ITEM 5. OTHER INFORMATION
 
None.







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ITEM 6. EXHIBITS
Exhibit Number   Exhibit Description
     
3.1
 
3.2
 
 
 
101  
The following financial information of the Registrant for the quarter ended June 30, 2021, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of June 30, 2021 (unaudited) and December 31, 2020, (ii) Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2021 and 2020 (unaudited), (iii) Condensed Consolidated Statements of Shareholders' Equity (Deficit) for the three months ended March 31 and June 30, 2021 and 2020 (unaudited), (iv) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2021 and 2020 (unaudited) and (iv) Notes to Condensed Consolidated Financial Statements (unaudited).
104   Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document.
 



27

SIGNATURES
 
In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  PILLARSTONE CAPITAL REIT
   
  By: /s/ James C. Mastandrea
Date: August 13, 2021  
James C. Mastandrea
Chief Executive Officer
(Principal executive officer)
 
  PILLARSTONE CAPITAL REIT
   
  By: /s/ John J. Dee
Date: August 13, 2021  
John J. Dee
Chief Financial Officer
(Principal financial and accounting officer)

28
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