UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K


(Mark One)
x☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20182020
OR
o ☐ 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)
Maryland39-6594066
(State or Other Jurisdiction of Incorporation or(I.R.S. Employer
Organization)Identification No.)
2600 South Gessner, Suite 555, Houston, Texas77063
(Address of Principal Executive Offices)(Zip Code)
Registrant's telephone number, including area code: (832) 810-0100
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares of Beneficial Interest, par value $0.01 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o ☐No x☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o ☐No x☒
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 x ☒No o☐
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 (§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 o ☐No x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o ☐Accelerated filer o☐Non-accelerated filer x☒Smaller reporting company x☒
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 or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o☐ No x☒
The aggregate market value of the voting common shares held by non-affiliates of the registrant as of June 30, 20182020 (the last business day of the registrant's most recently completed second fiscal quarter) was approximately $502,709$363,086 based on the closing price of $2.80$2.00 per common share on the Over-The-Counter Bulletin Board on that date.


As of March 26, 2019,2021, the Registrant had issued 443,299633,130 common shares of beneficial interest and had 405,169595,000 shares outstanding after deducting 38,130 shares held in treasury.

DOCUMENTS INCORPORATED BY REFERENCE: We incorporate by reference in Part III of this Annual Report on Form 10-K portions of our definitive proxy statement for our 20192021 Annual Meeting of Shareholders, which proxy statement will be filed no later than 120 days after the end of our fiscal year ended December 31, 2018.

2020.



PILLARSTONE CAPITAL REIT
FORM 10-K
Year Ended December 31, 20182020




 
Page
PART I
Item 1.
Business.
2
Item 1B.
Unresolved Staff Comments.
4
Item 2.   
Properties.
4
Item 3.    
Legal Proceedings.
4
Item 4.       
Mine Safety Disclosures.
4
Item 1.
3
Item 2.   
5
Item 3.    
5
Item 4.       
5
Item 5.  
56
Item 7. 
67
Item 8.    
1012
Item 9.
1113
Item 9A.  
1113
Item 9B. 
1213
 
Item 10.  
1214
Item 11.
1214
Item 12. 
1214
Item 13.   
1214
Item 14.    
1314
 
Item 15.  
1415
Item 16.
17
1718







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 audited consolidated financial statements and the notes thereto in this Annual Report on Form 10-K. 


This Annual Report on Form 10-K 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 Annual Report on Form 10-K. 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 Annual Report on Form 10-K include:

•uncertainties related to the COVID-19 pandemic, including the unknown duration and economic, operational and financial impacts of the COVID-19 pandemic and the actions taken or contemplated by U.S. and local governmental authorities or others in response to the pandemic on our business, employees and tenants, including, among others, (a) changes in tenant demand for our properties; (b) financial challenges confronting tenants, including as a result of decreased customers’ willingness to visit our tenants' businesses, and mandated shelter in place orders that have prevented customers from visiting some of our tenants’ businesses and the impact of these issues on our ability to collect rent from our tenants; (c) operational changes implemented by us, including remote working arrangements, which may put increased strain on our technology systems and create increased vulnerability to cybersecurity incidents; (d) reduction in our liquidity due to the limited ability to access the capital markets and other sources of financing on attractive terms or at all, and (e) prolonged measures to contain the spread of COVID-19 or the premature easing of government-imposed restrictions implemented to contain the spread of COVID-19;
•uncertainties related to the national economy, the real estate industry in general and in our specific markets;
•legislative or regulatory changes;
•adverse economic conditions in Texas;
•adverse changes in governmental rules and fiscal policies;
•increases in interest rates and operating costs;
•availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures;matures, in each case, on terms favorable to the Company;
•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 
1

•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.
     

2

PART I

Item 1. Business.


Company Overview
Pillarstone Capital REIT (the “Company,” “Pillarstone,” “we,” “our,” or “us”) 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 real estate investment trust (“REIT”)REIT or a real estate operating company and (iii) joint venture investments. Excess funds can be invested in cash equivalents depending on market conditions.
The Company was formed on March 15, 1994 as a Maryland REIT. The Company operated as a traditional real estate investment trustREIT 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 no longer meeting qualifications to be a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). In 2002, the Company discontinued the operations of the technology segment.
From 2003 through 2006, we pursued a value-added business plan primarily focused on acquiring well located, under-performing multi-familymultifamily residential properties, including affordable housing communities, and repositioning them through renovation, leasing, improved management and branding. In 2006, the Company did not complete a public offering for a portfolio acquisition due to market conditions, and consequently, was not able to meet the listing requirements of the former American Stock Exchange (“Amex”). Accordingly, Pillarstone’s common shares were delisted from the Amex and commenced being quoted on the Over-The-Counter Bulletin Board (“OTC Bulletin Board”) and on the pink sheets under the symbol “PRLE”.
From 2006 until December 2016, the Company continued its existence as a corporate shell filing its quarterly and annual reports with the Securities and Exchange Commission ("SEC") so that it could be used for future real estate transactions. 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. In 2016, the shareholders of Pillarstone approved changing the Company's name from Paragon Real Estate Equity and Investment Trust to Pillarstone Capital REIT.
Substantially all of our business is conducted through Pillarstone Capital REIT Operating Partnership LP, a Delaware limited partnership organized in 2016 (“Pillarstone OP”). We are the sole general partner of Pillarstone OP. As of December 31, 2018,2020, we owned 18.6% of the outstanding equity in Pillarstone OP and fully consolidate it on our financial statements.
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: Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company (“CP Woodland”); Whitestone Industrial-Office, LLC, a Texas limited liability company (“Industrial-Office”); Whitestone Offices, LLC, a Texas limited liability company (“Whitestone Offices”); and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower”, and together with CP Woodland, Industrial-Office and Whitestone Offices, the “Entities”) that owned 14 real estate assets (the “Real Estate Assets” and, together with the Entities, 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, consisting of (a) approximately $15.5 million of Whitestone OP’s liability under that certain Amended and Restated Credit Agreement, dated as of November 7, 2014, as amended, among the Bank of Montreal, as Administrative Agent (the “Agent”), the lenders party thereto, BMO Capital Markets, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, and U.S. Bank, National Association, Whitestone OP, as borrower, and Whitestone and certain subsidiaries of Whitestone OP, as guarantors (as amended, the “Whitestone Credit Facility”); (b) an approximately $16.3 million promissory note (the “Whitestone Uptown Tower Promissory Note”) of Uptown Tower issued under that certain Loan Agreement, dated as of September 26, 2013, (as amended, the “Whitestone Uptown Tower Loan Agreement” and, together with the Whitestone Uptown Tower Promissory Note, the “Whitestone Uptown Tower Loan Documents”) between Uptown Tower, as borrower, and U.S. Bank National Association, as successor to Morgan Stanley Mortgage Capital Holdings LLC, as lender, and (c) an approximately $34.1 million promissory note (the “Whitestone Industrial-Office Promissory Note”) of Industrial-Office issued under that certain Loan Agreement, dated as of November 26,

2013 (the “Whitestone Industrial-Office Loan Agreement” and, together with the Whitestone Industrial-Office Promissory
3

Note, the “Whitestone Industrial-Office Loan Documents”), between Industrial-Office, as borrower, and Jackson National Life Insurance Company, as lender (collectively, the “Acquisition”). During 2018, Pillarstone OP sold three of the Real Estate Assets.
Pursuant to the Contribution Agreement, Pillarstone agreed to file with 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 “Securities Act”), the issuance of the common shares of beneficial interest in Pillarstone (the “Common Shares”)the Company that may be issued upon redemption of the OP Units issued pursuant to each of the Contribution Agreement and that certain OP Unit Purchase Agreement dated December 8, 2016 between Pillarstone, Pillarstone OP and Whitestone OP (the "OP Unit Purchase Agreement") and the offer and resale of such Common Sharescommon 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. No Pillarstone OP units were purchased under the OP Unit Purchase Agreement. Pillarstone and Whitestone agreed to extend the filing of the shelf registration statement to a date not later than June 8, 2019, or the date that the Company closes a public equity offering. On December 8, 2018, the OP Unit Purchase Agreement and the offer and resale of common shares terminated pursuant to its terms. There was no issuance of our Common Shares during 2018.
In connection with the Acquisition, (1) with respect to each Real Estate Asset (other than the Real Property Asset owned by Uptown Tower), Whitestone TRS, Inc. (“Whitestone TRS”), a subsidiary of Whitestone, entered into a Management Agreement with the Entity thatPillarstone OP who owns such Real Estate Asset and (2) with respect to Uptown Tower, Whitestone TRS entered into a Management Agreement with Pillarstone OP (collectively, the “Management Agreements”). Pursuant to the Management Agreements with respect to each Real Estate Asset (other than Uptown Tower), Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services to such Real Estate Asset in exchange for (x) a monthly property management fee equal to 5.0% of the monthly revenues of such Real Estate Asset and (y) a monthly asset management fee equal to 0.125% of GAVgross asset value ("GAV") (as defined in each Management Agreement as, generally, the purchase price of the respective Real Estate Asset based upon the purchase price allocations determined pursuant to the Contribution Agreement, excluding all indebtedness, liabilities or claims of any nature) of such Real Estate Asset. 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 to Pillarstone OP in exchange for (x) a monthly property management fee equal to 3.0% of the monthly revenues of Uptown Tower and (y) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.
    
As a result of the Acquisition, Whitestone OP owns approximately 81.4% and Pillarstone owns approximately 18.6% of the outstanding equity in Pillarstone OP, which is fully consolidated on Pillarstone's financial statements.


CompetitionOn October 8, 2019, we completed the sale of Corporate Park West, Corporate Park Woodland and Plaza Park (the "2019 Real Estate Assets Sold"), 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.


Competition

We compete for the acquisition of properties with many entities, including, among others, publicly traded REITs, life insurance companies, pension funds, partnerships and individual investors. Many competitors have substantially greater financial resources than us. In addition, certain competitors may be willing to accept lower returns on their investments. If competitors prevent us from buying properties that may be targeted for acquisition, our capital appreciation and valuation may be impacted.


Employees
    
As of April 1, 2019,December 31, 2020, the Company has one full time employee and two part time employees and one full time independent contractor.employees.


Reports to Security Holders
We file or furnish with the SEC pursuant to Section 13(a), 15(d) or 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, proxy statements with respect to meetings of our shareholders, as well as Reports on Forms 3, 4 and 5 regarding our officers, trustees or 10% beneficial owners. The SEC also maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC as we do. The website address is http://www.sec.gov. Copies of our Audit Committee Charter, Management, Organization and Compensation Committee Charter, Nominating Committee Charter, and Code of Conduct and Ethics are available free of

charge through our website (www.pillarstone-capital.com). In the event of any changes to these documents, revised copies will
4

also be made available on our website. Materials on our website are not part of our Annual Report on Form 10-K. The contents of these websites are not incorporated into this filing.


Item 1B.  Unresolved Staff Comments.
None.

Item 2.  Properties.


General Physical and Economic Attributes
 
Pursuant to the Contribution Agreement, Pillarstone, through Pillarstone OP, acquired an investment portfolio consisting of 14 real estate assets (the "Real Estate Assets"). On December 27, 2018, Pillarstone sold a portfolio of three Real Estate Assets. During 2018,Assets (the "2018 Real Estate Assets Sold") and on October 8, 2019, Pillarstone OP sold three of the 2019 Real Estate Assets Sold. The forementioned sales decreased Pillarstone's investment portfolio from 14 Real Estate Assets to eight Real Estate Assets. The following table sets forth certain information relating to each of our properties owned as of December 31, 2018.2020.
 
 
Community Name		 
 
Location		 
Year Built/
Renovated		GLAPercent
Occupied at
12/31/2020
Annualized Base
Rental Revenue 
(in thousands) (1)
Average
Base Rental
Revenue Per
Sq. Ft. (2)
Average Net Effective Annual Base Rent Per Leased Sq. Ft.(3)
9101 LBJ FreewayDallas1985 125,874 47 %$1,038 $17.55 $18.56 
Corporate Park NorthwestHouston1981 174,359 76 %1,834 13.84 13.59 
Corporate Park Woodland IIHouston2000 14,344 100 %244 17.01 16.94 
Holly Hall Industrial ParkHouston1980 90,000 49 %308 6.98 6.89 
Holly KnightHouston1984 20,015 100 %432 21.58 21.23 
Interstate 10 WarehouseHouston1980 151,000 31 %287 6.13 6.09 
Uptown TowerDallas1982 253,981 66 %3,952 23.58 23.25 
Westgate Service CenterHouston1984 97,225 81 %656 8.33 8.00 
Total / Weighted Average926,798 61 %$8,751 $15.48 $15.36 
 
 
Community Name
 
 
 
Location
 
 
Year Built/
Renovated
 GLA 
Percent
Occupied at
12/31/2018
 
Annualized Base
Rental Revenue 
(in thousands) (1)
 
Average
Base Rental
Revenue Per
Sq. Ft. (2)
 
Average Net Effective Annual Base Rent Per Leased Sq. Ft.(3)
9101 LBJ Freeway Dallas 1985 125,874
 62% $1,209
 $15.49
 $15.15
Corporate Park Northwest Houston 1981 174,359
 78% 1,659
 12.20
 12.54
Corporate Park West Houston 1999 175,665
 83% 1,625
 11.15
 11.45
Corporate Park Woodland Houston 2000 99,937
 93% 880
 9.47
 11.13
Corporate Park Woodland II Houston 2000 14,344
 100% 232
 16.17
 16.38
Holly Hall Industrial Park Houston 1980 90,000
 67% 544
 9.02
 8.39
Holly Knight Houston 1984 20,015
 95% 340
 17.88
 17.83
Interstate 10 Warehouse Houston 1980 151,000
 85% 713
 5.56
 5.44
Plaza Park Houston 1982 105,530
 75% 569
 7.19
 7.81
Uptown Tower Dallas 1982 253,981
 80% 3,825
 18.83
 19.58
Westgate Service Center Houston 1984 97,225
 87% 610
 7.21
 7.01
               
Total / Weighted Average     1,307,930
 80% $12,206
 $11.67
 $12.00


(1)    Calculated as the tenant's actual December 31, 2020 base rent (defined as cash base rents including abatements) multiplied by 12. Excludes vacant space as of December 31, 2020. Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), historical results differ from the annualized amounts. Total abatements for leases in effect as of December 31, 2020 equaled approximately $8,000 for the month ended December 31, 2020.
(1)
Calculated as the tenant's actual December 31, 2018 base rent (defined as cash base rents including abatements) multiplied by 12. Excludes vacant space as of December 31, 2018. Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), historical results differ from the annualized amounts. Total abatements for leases in effect as of December 31, 2018 equaled approximately $46,000 for the month ended December 31, 2018.
 
(2)  
Calculated as annualized base rent divided by gross leasable area ("GLA") leased as of December 31, 2018.  Excludes vacant space as of December 31, 2018.

(3)
Represents (i) the contractual base rent for leases in place as of December 31, 2018, adjusted to a straight-line basis to reflect changes in rental rates throughout the lease term and amortized free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) square footage under commenced leases of December 31, 2018.

(2)      Calculated as annualized base rent divided by gross leasable area ("GLA") leased as of December 31, 2020.  Excludes vacant space as of December 31, 2020.

(3)    Represents (i) the contractual base rent for leases in place as of December 31, 2020, adjusted to a straight-line basis to reflect changes in rental rates throughout the lease term and amortized free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) square footage under commenced leases as of December 31, 2020.

Item 3.  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 4.  Mine Safety Disclosures.


Not applicable.

5

PART II


Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
 
Market Information
 
Common Shares


Our Common Shares are not on an exchange but are quoted on the OTC Bulletin Board and on the pink sheets with the symbol "PRLE". The number of holders of record of our Common Shares was 102100 as of March 26, 2019,23, 2021, and we estimate we have approximately 304275 beneficial holders of Common Shares as of that date. As of March 26, 2019,23, 2021, we had 405,169595,000 Common Shares of beneficial interest outstanding.


There is no established public trading market for the Common Shares. The following table sets forth the quarterly high and low sale prices per share of our Common Shares for the years ended December 31, 21082020 and 20172019 as reported on the OTC Bulletin Board. The quotations shown represent inter-dealer prices without adjustment for retail markups, markdowns or commissions, and may not reflect actual transactions.

For the Year Ended December 31, 2020HighLow
First Quarter$1.20 $1.20 
Second Quarter$2.26 $1.20 
Third Quarter$2.30 $1.29 
Fourth Quarter$2.25 $1.15 
For the Year Ended December 31, 2019HighLow
First Quarter$2.80 $1.65 
Second Quarter$1.80 $1.60 
Third Quarter$1.80 $1.80 
Fourth Quarter$1.80 $1.20 

For the Year Ended December 31, 2018 High Low
     
First Quarter $2.80
 $2.78
Second Quarter $2.80
 $2.80
Third Quarter $3.00
 $2.80
Fourth Quarter $3.00
 $2.40
     
For the Year Ended December 31, 2017 High Low
     
First Quarter $5.25
 $3.00
Second Quarter $3.60
 $3.50
Third Quarter $3.50
 $3.24
Fourth Quarter $4.05
 $2.78



On March 26, 2019,23, 2021, the closing price of our Common Shares reported on the OTC Bulletin Board was $1.65$1.90 per share.


Our Class A Cumulative Convertible Preferred Shares ("Class A Preferred Shares") are quoted on the OTC Bulletin Board with the symbol "PRLEP". The number of holders of record of our Class A Preferred Shares is two. Class A Preferred shareholders have the right to convert their shares into Common Shares as follows: 95,226 Class A Preferred Shares are each convertible into 0.046 Common Shares and 161,410 Class A Preferred Shares are each convertible into 0.305 Common Shares.


Our Class C Convertible Preferred Shares ("Class C Preferred Shares") were issued effective September 29, 2006 to the trustees of the Company who contributed cash and/or services for these shares. The Class C Convertible Preferred Shares are not quoted on an exchange or the OTC Bulletin Board.


Dividend Policy


We have not declared or paid dividends on our Common Shares since 1999, and we do not anticipate paying dividends on our Common Shares in the foreseeable future. Declaration or payment of dividends, if any, in the future, will be at the discretion of the board of trustees and will depend on our then current financial condition, results of operations, capital requirements and other factors deemed relevant by the board of trustees.
 
Issuer Purchases of Equity Securities


The Company did not purchase any of its equity securities in 2018.2020.

6

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.


Overview


The Company is a Maryland real estate investment trustREIT 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 Capital REIT Operating Partnership LP ("Pillarstone OP").OP. As of December 31, 2018,2020, we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our consolidated financial statements.


As of December 31, 2018,2020, the Company is a smaller reporting company current in its quarterly and annual financial statement filings with the SEC, that may make future real estate investments. There can be no assurance that we will be able to close additional transactions.  Even if our management is successful in closing additional transactions, investors may not value the transactions or the Company in the same manner as we do, and investors may not value the transactions as they would value other transactions or alternatives. Failure to obtain additional sources of capital will materially and adversely affect the Company’s ability to continue operations, as well as its liquidity and financial results.


Brief History


Pillarstone was formed on March 15, 1994 as a Maryland REIT. The Company operated as a traditional real estate investment trustREIT 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.

Executive Overview

During most of From 2006 until December 2016, the Company existedcontinued 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”).
DuringOn December 27, 2018, Pillarstone OP sold the Company sold three of the2018 Real Estate Assets Sold in Houston, Texas, 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 the 2019 Real Estate Assets Sold 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, 2020.

Results of Operations


The following is a discussion of our results of operations and net income for the years ended December 31, 20182020 and 20172019 and financial condition, including:


•Explanation of changes in the results of operations in the Consolidated Statements of Operations for the year ended December 31, 20182020 compared to the year ended December 31, 2017.2019.
•Our critical accounting policies and estimates that require our subjective judgment and are important to the presentation of our financial condition and results of operations.
7

•Our primary sources and uses of cash for the year ended December 31, 2018,2020 and 2019, and how we intend to generate cash for long-term capital needs.
•Our current income tax status.


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

The comparability of our results of operations for the year ended December 31, 2020 to future periods may be impacted by the effects of the COVID-19 pandemic.

Comparison of the Year Ended December 31, 2018 Compared to Year Ended December 31, 2017 2020 and 2019


Leasing Activity


For the year ended December 31, 2018,2020, we executed 14361 leases for a total lease value of $17.5$3.3 million compared to 11689 leases for a total lease value of $12.3$10.0 million for the year ended December 31, 2017.2019.


Results of Operations


The following table provides a general comparison of our results of operations for the years ended December 31, 20182020 and 20172019 (dollars in thousands, except for property and sq. ft. information)thousands):

 Year Ended December 31,
 20202019
Number of properties8 8 
Aggregate GLA (sq. ft.)926,798 926,798 
Ending occupancy rate61 %75 %
Total revenues$9,671 $14,253 
Total operating expenses8,120 10,208 
Total other (income) expense928 (14,534)
Income tax provision (benefit)(35)280 
Net income658 18,299 
Less:  Noncontrolling interest in subsidiary1,029 15,232 
Net income (loss) available to Common Shareholders$(371)$3,067 
  Year Ended December 31,
  2018 2017
Number of properties 11
 14
Aggregate GLA (sq. ft.) 1,307,930
 1,531,737
Ending occupancy rate 80% 81%
     
Total property revenues $17,180
 $16,768
Total property expenses 7,694
 7,701
Total other expenses 7,174
 6,501
Provision for income taxes 229
 88
Gain on sale of properties (7,778) —
Loss on disposal of assets 55
 31
Net income 9,806
 2,447
Less:  Net income attributable to noncontrolling interests 8,490
 2,232
Net income attributable common shareholders $1,316
 $215


Revenues from Operations
    
We had total revenues for the years ended December 31, 20182020 and 20172019 of $17,180,000approximately $9,671,000 and $16,768,000,$14,253,000, respectively, for a decrease of approximately $4,582,000, or 32%. The difference was comprised of a decrease of approximately $3,492,000 in rental revenues, $1,008,000 in expense reimbursements and an increase of $412,000, or 2%.$82,000 in bad debt, which is classified as a reduction of revenue. The overall decrease was primarily due to the sale of the 2019 Real Estate Assets Sold as of October 8, 2019; however, a portion of the bad debt increase was compriseddue to the impact of increases of $287,000 in expense recovery revenues, $74,000 in rent revenues and $51,000 in other revenues.the COVID-19 pandemic.

Expenses from Operations


Our propertyoperating expenses were approximately $7,694,000$8,120,000 for the year ended December 31, 2018 as2020 compared to $7,701,000approximately $10,208,000 for the year ended December 31, 2017,2019, a decrease of $7,000.approximately $2,088,000, or 20%, which was primarily due to 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 (dollars in(in thousands):

8

  Year Ended December 31,    

 2018 2017 Change % Change
Real estate taxes $2,720
 $2,672
 $48
 2 %
Utilities 1,307
 1,122
 185
 16 %
Contract services 1,079
 1,128
 (49) (4)%
Repairs and maintenance 912
 980
 (68) (7)%
Bad debt 292
 412
 (120) (29)%
Management fees 1,008
 996
 12
 1 %
Labor and other 376
 391
 (15) (4)%
Total property expenses $7,694
 $7,701
 $(7) — %
Year Ended December 31,
20202019Increase (Decrease)% Increase (Decrease)
Depreciation and amortization$2,055 $2,901 $(846)(29)%
Operating and maintenance2,644 3,480 (836)(24)%
Real estate taxes1,824 2,257 (433)(19)%
General and administrative1,006 753 253 34 %
Management fees591 817 (226)(28)%
  Total property expenses$8,120 $10,208 $(2,088)(20)%




Other ExpensesFederal and State Income Tax Provision (Benefit)


Our other expenses wereincome tax provision (benefit) was approximately $7,174,000$(35,000) for the year ended December 31, 20182020 as compared to $6,501,000approximately $280,000 for the year ended December 31, 2017, an increase2019, a decrease in expense of $673,000, or 10%.approximately $315,000. The primary components of property expenses are detaileddecrease in the table below (dollarstax expense primarily resulted from approximately $17.0 million in thousands):

  Year Ended December 31,    
  2018 2017 Change % Change
General and administrative $776
 $508
 $268
 53%
Depreciation and amortization 3,566
 3,268
 298
 9%
Interest expense 2,832
 2,725
 107
 4%
Total other expenses $7,174
 $6,501
 $673
 10%

General and administrative expenses increased approximately $268,000 for the year ended December 31, 2018 due to an increase in legal and other professional fees related to the ongoing SEC discussions regarding the accounting of the Acquisition. Interest expense increased approximately $107,000 as a result of early extinguishment of debt costs following the sale of three of the Real Estate Assets as of December 31, 2018. Depreciation and amortization was approximately $3,566,000 for the year ended December 31, 2018 compared to $3,268,000 for the year ended December 31, 2017. The increase of $298,000 was mostly due to several large capital projects on certain properties being placed in service during 2018.

Gain on Sale of Properties

On December 27, 2018, we completed the sale of Dairy Ashford Business Park, Westbelt Plaza and Main Park (the "Real Estate Assets Sold"), 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 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 $229,000 for the year ended December 31, 2018 as compared to $88,000 for the year ended December 31, 2017, an increase of $141,000, or 160%. The increase was primarily comprised of increased federal income taxes resulting from the gains on salesales of properties by Pillarstone OP during the year ended December 31, 2018.2019 that did not repeat during the year ended December 31, 2020.


Non-Controlling Interest


Our non-controlling interest represents 81.4% of the total outstanding units of Pillarstone OP which is owned by Whitestone OP. Net income from our non-controlling interest was $8.5$1.0 million for the year ended December 31, 20182020 compared to $2.2$15.2 million for the year ended December 31, 2017.2019. The majority of the increasedecrease in net income for the non-controlling interest was primarily due to the sale of the three2019 Real Estate Assets sold forSold as of October 8, 2019 at a total net income to non-controlling interest contributiongain of $6.3$17.0 million.


Liquidity and Capital Resources


Cash Flows


As of December 31, 2018,2020, our unrestricted cash resources were $2,010,000.approximately $5,109,000. 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, 2018,2020, the Company's cash balance decreasedincreased by $981,000$485,000 from $2,991,000$4,624,000 at December 31, 20172019 to $2,010,000$5,109,000 at December 31, 2018.2020. This decreaseincrease in cash was due to cash used in financing activities of $18,782,000 offset by cash provided by operating activities of approximately $5,278,000 and$2,460,000, offset by cash used in investing activities of $659,000, and cash used in financing activities of approximately $12,523,000.$1,316,000.



Our ability to access the capital markets will be dependent on a number of factors as well, including general market conditions and market perceptions about our Company. In light of the impact of the COVID-19 pandemic and other dynamics in the capital markets impacted by COVID-19 and the economic slowdown, our access to capital may be diminished.

Future Obligations


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

9

As of December 31, 2018,2019, 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 obligation is $47,329,000.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, andand/or debt refinancing. In addition, asAs of December 31, 2018, Whitestone OP has agreed to extend2020, the maturity date of its loan with Pillarstone OP to December 8, 2021.Company's debt obligation is approximately $15.5 million, including convertible notes payable. See Note 10 for more details on the Company's convertible notes payable.


Long Term Liquidity and Operating Strategies


Historically, we have financed our long term capital needs, including acquisitions, as follows:


•borrowings from new loans;
•additional equity issuances of our common and preferred shares; and
•proceeds from the sales of our real estate, a technology segment, and marketable securities.


From 2006 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.
    
Subsequent to the Acquisition,Currently, Pillarstone intends to develop strategies for the properties in order to create value for the enterprise and our shareholders. To implement the strategy to create value with the remaining eight Real Estate Assets additional capital will need to be raised.


COVID-19

The following discussion is intended to provide shareholders with certain information regarding the impacts of the COVID-19 pandemic on our business and management’s efforts to respond to those impacts. Unless otherwise specified,the statistical and other information regarding our portfolio and tenants are estimates based on information available to us as of March 26, 2021. As a result of the rapid development, fluidity and uncertainty surrounding the COVID-19 pandemic, we expect that such statistical and other information will change, potentially significantly, going forward and may not be indicative of the actual impact of the COVID-19 pandemic on our business, operations, cash flows and financial condition for future periods.

In March 2020, the World Health Organization declared COVID-19 a "Public Health Emergency of International Concern" and characterized COVID-19 as a pandemic. As a result, the U.S. and many local governments implemented enhanced screenings, quarantine or shelter in place requirements and travel restrictions. For example, local governments in Texas, where all our properties are located, mandated a stay in place order, closed non-essential businesses and closed other types of service businesses, such as bars and restaurants, though they continued to provide take out and drive through services and were able to be open at a limited capacity. As of the date of this Annual Report on Form 10-K, businesses are permitted to be open in Texas at 100% occupancy through Executive Order (GA-34).

We are unable to predict the impact that the COVID-19 pandemic will have on our financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration and spread of the pandemic, its severity in our markets and elsewhere, governmental actions to contain the spread of the pandemic and respond to the reduction in global economic activity, and how quickly and to what extent normal economic and operating conditions can resume.

Our portfolio and tenants have been impacted by these and other factors as follows:

•As of the date of this Annual Report, all of our properties are open and have been operating in compliance with federal, state and local COVID-19 guidelines and mandates.
•Approximately 94% of our tenants (based on annualized base rent ("ABR")) are open and operating.
•As of the date of this Annual Report, we have received payment of approximately 95% of contractual base rent and common area maintenance reimbursable expenses billed for the fourth quarter. As is believed to be the case with other landlords across the U.S., we have received a number of rent relief requests from tenants, most often in the form of
10

rent deferral requests, which we are evaluating on a case-by-case basis. Collections and rent relief requests to-date may not be indicative of collections or requests in any future period.

We have taken a number of proactive measures to maintain the strength of our business and manage the impact of COVID-19 on our operations and liquidity, including the following:

•We have cash and cash equivalents of approximately $5,109,000 as of December 31, 2020.
•We are carefully evaluating acquisition, development and redevelopment opportunities on an individual basis.
•We have put in place a temporary response team to address tenant concerns. The response team is in ongoing communication with our tenants and is assisting tenants in identifying local, state and federal resources that may be available to support their businesses and employees during the pandemic, including stimulus funds that may be available under the Coronavirus Aid, Relief, and Economic Security Act of 2020.
•We are proactively implementing expense reductions at the property level to minimize cost pass-throughs to our tenants and at the corporate level to preserve profitability.
•The health and safety of our employees, the staff that manages our properties, and their respective families is a top priority. We have adapted our operations to protect employees, including by implementing a work from home policy.

While we believe these steps have been effective to date, we expect there will be additional challenges ahead that may impact either our operations or those of our tenants, which could have an adverse effect on our and our tenants' businesses and financial performance. We expect to continue to implement proactive measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees and tenants. As a result, we may incur additional expenses in future periods in response to the pandemic, which could adversely affect our results of operations. In addition, we may revise our approach to these initiatives or take additional actions to meet the needs of our employees and tenants.

Current Tax Status


As of December 31, 20182020 and 2017,December 31, 2019, we had net deferred tax assetsliabilities of $199,000$82,000 and $490,000,$96,000, respectively. The major temporary differences that gave rise to the deferred tax assets are depreciation and amortization and acquisition and organizational costs. Realization of deferred tax assets is dependent upon generation of sufficient future taxable income and the effects of other loss utilization provisions. Management has determined that sufficient uncertainty exists regarding the realizability of the net deferred tax assets and has provided a full valuation allowance of $199,000 and $490,000 against the net deferred tax assets of the Company as of December 31, 2018 and 2017, respectively. A valuation allowance is considered to be a significant estimate that may change in the near term.
As of December 31, 2018, the Company had no net2020, we do not have an operating loss carry-forwardscarryforward available to be carried to future periods.


The Company’s effective income tax rate is lower than what would be expected if the federal statutory rate were applied to income before income taxes primarily because of Whitestone OP’s 81.4% noncontrolling interestprovision (benefit) included in the earningsconsolidated statements of Pillarstone OP.operations for the years ended December 31, 2020 and 2019 was comprised of the following components (in thousands):

Year Ended December 31,
20202019
Federal$(86)$39 
Texas franchise tax51 241 
$(35)$280 



Interest Rates and Inflation


The Company was not significantly affected by inflation during the periods presented in this report due primarily to the relativerelatively low nationwide inflation rates and the Company having approximately 76%100% of its debt with a fixed rates.rate as of December 31, 2020.


Off-Balance Sheet Arrangements


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



11

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. For the year ended December 31, 2020, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $51,000 for the conversion of four tenants to cash basis revenue as a result of our COVID-19 collectability analysis. For the year ended December 31, 2019, we did not recognize a straight-line rent reserve adjustment.  Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Percentage rents 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 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 established an allowance for doubtful accounts againsttenants who pay real estate taxes directly to the portion of tenant accounts receivable which is estimated to be uncollectible.taxing authority.


Acquired Properties and Acquired Lease Intangibles.  We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt.


Depreciation.  Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings. Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter.
 
Impairment.  We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations.  We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property.  If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value.  Management has determined that there has been no impairment in the carrying value of our real estate assets as of December 31, 2018.2020.


Valuation Allowance of Deferred Tax Asset.     We account for income taxes using the asset and liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. Management has determined that sufficient uncertainty exists regarding the realizability of theThe Company had net deferred tax assets and has provided a full valuation allowanceliabilities of $199,000 and $490,000 against the net deferred tax assets of the Company$82,000 as of December 31, 20182020, and 2017, respectively.$96,000 as of December 31, 2019.



Item 8.  Financial Statements and Supplementary Data.


The required audited consolidated financial statements of the Company are included herein commencing on page F-1.




12

Item 9. Changes in and Disagreements with Accountants


None.


Item 9A.  Controls and Procedures.


Evaluation of Disclosure Controls and Procedures


Our management, under the supervision and with the participation of our principal executive officer and principal financial officer,officers, has evaluated the effectiveness of our disclosure controls and procedures, as of December 31, 2018. Thesuch term “disclosure controls and procedures,” asis defined in Rules 13a-15(e)13a 15(e) and 15d-15(e)15d 15(e) under the Securities Exchange Act means controls and other procedures of a company1934, as amended (the "Exchange Act") in ensuring that are designed to ensure thatthe information required to be disclosed by a company in the reports that it files or submitsour filings under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’sSEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensureforms, including ensuring that such information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to its management including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Based on thesuch evaluation, of our disclosure controls and procedures as of December 31, 2018, our principal executive officer and principal financial officerofficers have concluded at a reasonable assurance level that as of such date, our disclosure controls and procedures were effective.

Inherent Limitations of Internal Controls
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Previously Identified Material Weakness
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. As previously disclosed in the Form 10-K/A for the year ended December 31, 2016, the Chief Executive Officer and the Chief Financial Officer identified a material weakness in the Company's internal control over financial reporting. This material weakness continued to be in place as of September 30, 2018.
A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.
The specific material weakness related to the misapplication of ASC 810 upon the formation of the Company. The Company adjusted its accounting of Pillarstone OP, changing the account from the equity method (ASC 323, "Investments - Equity Method and Joint Venture") to consolidation under ASC 810. This change in accounting is a one-time adjustment that affected several reporting periods through the first quarter 2018 Form 10-Q, after the December 8, 2016 Contribution Agreement (the "Contribution Agreement") with Whitestone REIT Operating Partnership, L.P.
This material weakness was remediated as of December 31, 2018.2020.

Remediation of Material Weakness

We completed the remediation of the material weakness during the fourth quarter of 2018, with revisions to our internal controls over financial reporting, including reviewing the processes that identify unique accounting transactions, implementing new control procedures that clearly document how unique transactions will be assessed under U.S. GAAP and the use of external advisors and adjustments to our communications with the Audit Committee that describe the results of such documentation.

As a result of the implementation of the remediation plan and based on the evaluation of our disclosure controls and procedures as of December 31, 2018, our principal executive officer and principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective.


Management’s Report on Internal Control Over Financial Reporting


OurThe Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f), as a process designed by, or under the supervision of, the principal executive and principal financial officers, or persons performing similar functions, and effected by the board of directors,trustees, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP defined in the Exchange Act and includes those policies and procedures that:


•pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of our assets;
•provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of management and/or members of the board of trustees; and
•provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.


Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 20182020 was based on the criteria for effective internal control over financial reporting described in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).


Based on our evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2018.2020.


Changes in Internal Control overOver Financial Reporting


Other than those described above, thereThere have been no significant changes in our internal control over financial reporting during the Company's quarter ended December 31, 20182020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


Item 9B.  Other Information.
 
None.









13


PART III


Item 10.  Trustees, Executive Officers and Corporate Governance.
 
The information required by Item 10 of Form 10-K is incorporated herein by reference to such information as set forth in the Company’s definitive proxy statement for our 20192021 Annual Meeting of Shareholders.


Item 11.  Executive Compensation.


The information required by Item 11 of Form 10-K is incorporated herein by reference to such information as set forth in the Company’s definitive proxy statement for our 20192021 Annual Meeting of Shareholders.


Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.


The information required by Item 12 of Form 10-K is incorporated herein by reference to such information as set forth in the Company’s definitive proxy statement for our 20192021 Annual Meeting of Shareholders.


Item 13.  Certain Relationships and Related Transactions, and Director Independence.
 
The information required by Item 13 of Form 10-K is incorporated herein by reference to such information as set forth in the Company’s definitive proxy statement for our 20192021 Annual Meeting of Shareholders.


Item 14.  Principal Accountant Fees and Services.


The information required by Item 14 of Form 10-K is incorporated herein by reference to such information as set forth in the Company’s definitive proxy statement for our 20192021 Annual Meeting of Shareholders.



14

PART IV


Item 15. Exhibits and Financial Statement Schedules.
Exhibit NumberExhibit Description
2.1
2.2
3.1
3.2
4.1
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16

15

Exhibit NumberExhibit Description
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.33
10.34
10.35
10.36

16

Exhibit NumberExhibit Description
10.37
10.38
24.1
31.1
31.2
32.1
101.INS*101The following financial information of the Registrant for the years ended December 31, 2020 and 2019, formatted in Inline XBRL Instance Document(eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements.
101.SCH*104Cover Page Interactive Data File - the cover page XBRL Taxonomy Extension Schema Document
101.CAL*tags are embedded within the Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*XBRL Taxonomy Extension Label Linkbase Document
101.PRE*XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*XBRL Taxonomy Extension Definition Linkbase Documentdocument.


* The following financial information of the Registrant for the years ended December 31, 2018 and 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Cash Flows, and (iv) Notes to Consolidated Financial Statements.(1)Indicates a management contract or compensatory plan or arrangement

(2)Filed or furnished herewith
(1)Indicates a management contract or compensatory plan or arrangement
(2)Filed or furnished herewith




Item 16. Form 10-K Summary.

None.
17

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
 
 
 
Date:April 1, 2019March 26, 2021 By:
/s/ James C. Mastandrea
James C. Mastandrea, Chairman and CEO
PILLARSTONE CAPITAL REIT
 
 
 
Date:April 1, 2019March 26, 2021 By:
/s/ John J. Dee
John J. Dee, CFO
 
POWER OF ATTORNEY


KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John J. Dee, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to by done by virtue hereof.


In accordance with Section 13 or 15(d) of the Securities Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


PILLARSTONE CAPITAL REIT

SignatureTitleDate
/s/ James C. Mastandrea
James C. Mastandrea
Trustee, Chief Executive Officer and
   President
April 1, 2019March 26, 2021
(Principal Executive Officer)
/s/ John J. Dee
John J. Dee
Trustee, Senior Vice President and
   Chief Financial Officer
April 1, 2019March 26, 2021
(Principal Finance and Principal Accounting Officer)
/s/ Dennis H. Chookaszian
Dennis H. Chookaszian
TrusteeApril 1, 2019March 26, 2021
/s/ Daniel G. DeVos
Daniel G. DeVos
TrusteeApril 1, 2019
/s/ Kathy M. Jassem
Kathy M. Jassem
TrusteeApril 1, 2019March 26, 2021
/s/ Paul T. Lambert
Paul T. Lambert
TrusteeApril 1, 2019March 26, 2021



18

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTSPage
Page
F-2F-2
F-3F-4
F-5F-6
F-6F-8
F-7F-9
F-8F-10





F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Trustees and Shareholders of
Pillarstone Capital REIT:

Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Pillarstone Capital REIT and subsidiary (the “Company”) as of December 31, 20182020 and 2017,2019, and the related consolidated statements of operations, changes in equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 2018,2020, and the related notes and financial statement schedules listed in the Index to Consolidated Financial Statements at Item 15 (collectively referred to as the “Consolidated Financial Statements”). In our opinion, the Consolidated Financial Statements present fairly, in all material respects, the financial position of the Company as of December 31, 20182020 and 2017,2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2018,2020, in conformity with U.S. generally accepted accounting principles.

Basis for Opinion

These Consolidated Financial Statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s Consolidated Financial Statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the Consolidated Financial Statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the Consolidated Financial Statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the Consolidated Financial Statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the Consolidated Financial Statements. We believe that our audits provide a reasonable basis for our opinion.


Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the Consolidated Financial Statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the Consolidated Financial Statements, taken as a whole, and we are not, by communicating critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Impairment Assessment of Real Estate Assets

As described in Note 3 to the Consolidated Financial Statements, management reviews 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. Management determines if 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. Actual results could differ from estimates supporting the Company's impairment analysis. If management's analysis indicates an impairment, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value. As of December 31, 2020, the Company had $49 million in real estate assets, net of accumulated depreciation, with no impairment recognized for the year ended December 31, 2020.

F-2


We identified management's impairment assessment as a critical audit matter primarily because of the significant estimates involved in management's impairment analysis, as these estimates resulted in audit procedures involving a high degree of auditor judgment and subjectivity and challenges in obtaining and evaluating audit evidence.

Our testing procedures to address this critical audit matter included the following:

•obtaining an understanding of the Company’s internal control over financial reporting applicable to management’s impairment assessment, including controls pertaining to management’s estimates supporting the impairment analysis;

•evaluating the methodology used by management in its impairment analysis;

•comparing the operating income before depreciation for each property to historical results;

•evaluating the reasonableness of capitalization rates used in management’s impairment analysis, taking into consideration comparable market data, including the location and quality rating of the properties; and

•evaluating the completeness and accuracy of the underlying data used by management in its impairment analysis.

Collectability Assessment of Accrued Rents and Accounts Receivable

As described in Note 3 to the Consolidated Financial Statements, management reviews the collectability of charges under its tenant operating leases and accrued rental revenues related to the straight-line method of reporting rental revenue, taking into consideration changes in factors such as the tenant's payment history, the financial condition of the tenant, business conditions 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. Actual results could differ from estimates supporting the Company's collectability analysis. If management deems it probable that a receivable will not be collected, an adjustment will be made to reduce rental revenue. As of December 31, 2020, the Company had $1,273,000 in accrued rents and accounts receivable, net of a $398,000 allowance for doubtful accounts. For the year ended December 31, 2020, the Company had a bad debt reduction to its rental revenue of $242,000, which included a bad debt adjustment of $57,000 and a straight-line rent reserve adjustment of $51,000 related to the conversion of 4 tenants to cash basis revenue.

We identified management's collectability assessment as a critical audit matter primarily because of the significant and unusual nature of the economic impact of the COVID-19 pandemic on collectability of charges under tenant operating leases, which materially contributed to a high degree of auditor judgment and challenges in obtaining and evaluating audit evidence when performing audit procedures.

Our testing procedures to address this critical audit matter included the following:

•obtaining an understanding of the Company’s internal control over financial reporting applicable to management’s collectability assessment, including controls pertaining to management’s estimates supporting the collectability analysis;

•evaluating the methodology used by management in its collectability analysis;

•evaluating the reasonableness of the aggregate allowance percentage for accrued rent and accounts receivable, taking into consideration rent payments receivable per leasing agreements and rent payments received from tenants during the year ended December 31, 2020; and

•evaluating the completeness and accuracy of the underlying data used by management in its collectability analysis.

/s/ Pannell Kerr Forster of Texas, P.C.

We have served as the Company’s auditor since 2016.

Houston, Texas
April 1, 2019.



March 26, 2021
F-3
Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
   
  December 31,
  2018 2017
     
ASSETS (1)
Real estate assets, at cost    
Property $77,944
 $83,144
Accumulated depreciation (5,281) (2,934)
Total real estate assets 72,663
 80,210
Cash and cash equivalents 2,010
 2,991
Escrows and acquisition deposits 1,835
 2,188
Accrued rents and accounts receivable, net of allowance for doubtful accounts 1,360
 798
Receivable due from related party 58
 1,304
Unamortized lease commissions. loan costs and deferred legal costs, net 1,164
 1,265
Prepaid expenses and other assets 60
 160
Total assets $79,150
 $88,916
LIABILITIES AND EQUITY (DEFICIT) (2)
Liabilities:    
Notes payable $47,064
 $64,313
Accounts payable and accrued expenses 2,817
 3,414
Payable due to related party 372
 959
Convertible notes payable - related parties
 198
 198
Accrued interest payable 258
 260
Stock redemption payable - related party 143
 —
Tenants' security deposits 1,236
 1,191
Total liabilities 52,088
 70,335
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 December 31, 2018 and 2017, $10.00 per share liquidation preference 3
 3
Preferred C Shares - $0.01 par value, 300,000 authorized: 231,944 and 244,444 Class C cumulative convertible shares issued and outstanding at December 2018 and 2017, respectively, $10.00 per share liquidation preference 2
 2
Common Shares - $0.01 par value, 400,000,000 authorized: 443,299 shares issued and 405,169 outstanding at December 31, 2018 and 2017 4
 4
Additional paid-in capital 28,147
 28,147
Accumulated deficit (26,319) (27,635)
Treasury stock, at cost, 38,130 shares (801) (801)
Total Pillarstone Capital REIT shareholders' equity (deficit) 1,036
 (280)
Noncontrolling interest in subsidiary 26,026
 18,861
Total equity 27,062
 18,581
Total liabilities and equity $79,150
 $88,916



Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
December 31,
20202019
ASSETS (a)
Real estate assets, at cost
Property$56,294 $55,861 
Accumulated depreciation(7,180)(5,522)
Total real estate assets49,114 50,339 
Cash and cash equivalents5,109 4,624 
Escrows and utility deposits1,449 566 
Accrued rents and accounts receivable, net of allowance for doubtful accounts1,273 1,421 
Receivable due from related party132 184 
Unamortized lease commissions and deferred legal cost, net490 685 
Prepaid expenses and other assets (1)
89 62 
Total assets$57,656 $57,881 
LIABILITIES AND EQUITY (b)
Liabilities:
Notes payable$15,185 $15,434 
Accounts payable and accrued expenses (2)
2,506 2,344 
Payable due to related party335 346 
Convertible notes payable - related parties198 198 
Accrued interest payable165 148 
Tenants' security deposits825 881 
Total liabilities19,214 19,351 
Commitments and contingencies:0 0 
Shareholders' Equity:
Preferred A Shares - $0.01 par value, 1,518,000 authorized: 256,636 Class A cumulative convertible shares issued and outstanding at December 31, 2020 and December 31, 2019, $10.00 per share liquidation preference3 3 
Preferred C Shares - $0.01 par value, 300,000 authorized: 231,944 Class C cumulative convertible shares issued and outstanding at December 31, 2020 and December 31, 2019, $10.00 per share liquidation preference2 2 
Common Shares - $0.01 par value, 400,000,000 authorized: 633,130 shares issued and 595,000 outstanding at December 31, 2020 and 443,299 shares issued and 405,169 outstanding at December 31, 20196 4 
Additional paid-in capital28,494 28,203 
Accumulated deficit(23,623)(23,252)
Treasury stock, at cost, 38,130 shares(801)(801)
Total Pillarstone Capital REIT shareholders' equity4,081 4,159 
Noncontrolling interest in subsidiary34,361 34,371 
Total equity38,442 38,530 
Total liabilities and equity$57,656 $57,881 

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


F-4

Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS - Continued
(in thousands)
  December 31,
  2018 2017
     
(1) Assets of consolidated Variable Interest Entity included in the total assets above:
Real estate assets, at cost    
Property $77,941
 $83,141
Accumulated depreciation (5,281) (2,934)
Total real estate assets 72,660
 80,207
Cash and cash equivalents 1,872
 2,812
Escrows and acquisition deposits 1,835
 2,188
Accrued rents and accounts receivable, net of allowance for doubtful accounts 1,360
 798
Receivable due from related party 58
 1,304
Unamortized lease commissions and deferred legal costs, net 1,164
 1,265
Prepaid expenses and other assets 51
 150
Total assets $79,000
 $88,724
     
(2) Liabilities of consolidated Variable Interest Entity included in the total liabilities above:
Notes payable $47,064
 $64,313
Accounts payable and accrued expenses 2,617
 3,322
Payable due to related party 373
 959
  Accrued interest payable 197
 218
Tenants' security deposits 1,236
 1,191
Total liabilities $51,487
 $70,003


Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS - Continued
(in thousands)
December 31,
20202019
(1) Operating lease right of use assets (net) (related to adoption of Topic 842)
$7 $7 
(2) Operating lease liabilities (related to adoption of Topic 842)
$7 $7 



December 31,
20202019
(a) Assets of consolidated Variable Interest Entity included in the total assets above:
Real estate assets, at cost
Property$56,290 $55,857 
Accumulated depreciation(7,177)(5,519)
Total real estate assets49,113 50,338 
Cash and cash equivalents4,321 3,331 
Escrows and utility deposits1,449 566 
Accrued rents and accounts receivable, net of allowance for doubtful accounts1,201 1,360 
Receivable due from related party132 184 
Unamortized lease commissions and deferred legal cost, net490 685 
Prepaid expenses and other assets37 35 
Total assets$56,743 $56,499 
(b) Liabilities of consolidated Variable Interest Entity included in the total liabilities above:
Notes payable$15,185 $15,434 
Accounts payable and accrued expenses2,333 2,164 
Payable due to related party319 344 
  Accrued interest payable63 67 
Tenants' security deposits825 881 
Total liabilities$18,725 $18,890 

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



F-5
Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
     
  Year Ended December 31,
  2018 2017
     
Property revenues    
Rental revenues $14,326
 $14,218
Other revenues 2,854
 2,550
Total property revenues 17,180
 16,768
     
Property expenses    
Property operation and maintenance 3,966
 4,033
Real estate taxes 2,720
 2,672
Management fees 1,008
 996
Total property expenses 7,694
 7,701
     
Other expenses    
General and administrative 776
 508
Depreciation and amortization 3,566
 3,268
Interest expense 2,832
 2,725
Total other expense 7,174
 6,501
     
Income before gain (loss) on disposal of assets and sale of properties and income taxes 2,312
 2,566
     
Loss on disposal of assets (55) (31)
Gain on sale of properties 7,778
 —
Provision for income taxes (229) (88)
     
Net income 9,806
 2,447
     
Less: noncontrolling interest in subsidiary 8,490
 2,232
     
Net income attributable to Common Shareholders $1,316
 215
     
Earnings Per Share:    
Basic income per Common Share:    
Net income available to Common Shareholders $3.25
 $0.53
Diluted income per Common Share:    
Net income available to Common Shareholders $0.44
 $0.07
     
Weighted average number of Common Shares outstanding:    
Basic: 405,169
 405,169
Diluted: 3,066,027
 2,903,219

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


Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
(in thousands)
              Total    
  Class A Class C   Additional   Cost of Shareholders'    
  Preferred Preferred Common Paid-in Accumulated Shares held Equity Noncontrolling Total
  Shares Shares Shares Capital Deficit in Treasury (Deficit) Interest Equity
Balance, December 31, 2016 $3
 $2
 $4
 $28,147
 $(27,850) $(801) $(495) $18,292
 $17,797
                   
Distributions to operating partnership limited partner —
 —
 —
 —
 —
 —
 —
 (1,663) (1,663)
                   
Net income —
 —
 —
 —
 215
 —
 215
 2,232
 2,447
                   
Balance, December 31, 2017 3
 2
 4
 28,147
 (27,635) (801) (280) 18,861
 18,581
                   
Distributions to operating partnership limited partner —
 —
 —
 —
 —
 —
 —
 (1,325) (1,325)
                   
Net income —
 —
 —
 —
 1,316
 —
 1,316
 8,490
 9,806
                   
Balance, December 31, 2018 $3
 $2
 $4
 $28,147
 $(26,319) $(801) $1,036
 $26,026
 $27,062
Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
 Year Ended December 31,
 20202019
Revenues
Rental (1)
$9,618 $14,200 
Transaction and other fees53 53 
Total revenues9,671 14,253 
Operating expenses
Depreciation and amortization2,055 2,901 
Operating and maintenance2,644 3,480 
Real estate taxes1,824 2,257 
General and administrative1,006 753 
Management fees591 817 
Total operating expenses8,120 10,208 
Other expense (income)
Interest expense816 2,409 
Loss on disposal of assets112 24 
Gain on sale of properties0 (16,967)
Total other expense (income)928 (14,534)
Income before income taxes623 18,579 
Income tax benefit (provision)35 (280)
Net income658 18,299 
Less: Noncontrolling interest in subsidiary1,029 15,232 
Net income (loss) attributable to Common Shareholders$(371)$3,067 
Earnings (Loss) Per Share:
Basic income (loss) per Common Share:
Net income (loss) available to Common Shareholders$(0.81)$7.57 
Diluted income (loss) per Common Share:
Net income (loss) available to Common Shareholders$(0.81)$1.02 
Weighted average number of Common Shares outstanding:
Basic:460,389 405,169 
Diluted:460,389 3,025,556 





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


F-6

Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
     
  Year Ended December 31,
  2018 2017
     
Cash flows from operating activities:    
Net income $9,806
 $2,447
Adjustments to reconcile net income to net cash provided by operating activities:    
Depreciation and amortization 3,566
 3,268
Deferred loan costs 100
 97
Loss (gain) on disposal of assets and sale of properties (7,723) 31
Bad debt expense 292
 412
Changes in operating assets and liabilities:    
Escrows and acquisition deposits 353
 86
Accrued rent and accounts receivable (854) (997)
Receivable from related party 1,201
 120
Unamortized lease commissions and deferred legal costs (346) (567)
Prepaid expenses and other assets (119) (11)
Accounts payable and accrued expenses (599) 143
Accounts payable due to related party (587) 694
Stock redemption payable - related party 143
 —
Tenants' security deposits 45
 195
Net cash provided by operating activities 5,278
 5,918
     
Cash flows from investing activities:    
Proceeds from sale of real estate 14,881
 —
Additions to real estate (2,358) (1,249)
Net cash provided by (used in) investing activities 12,523
 (1,249)
     
Cash flows from financing activities:    
Distributions paid to noncontrolling interest in subsidiary (1,325) (1,663)
Extinguishment of debt costs (108) —
Repayments of notes payable (17,349) (1,258)
Net cash used in financing activities (18,782) (2,921)
     
Net increase (decrease) in cash and cash equivalents (981) 1,748
Cash and cash equivalents at beginning of period 2,991
 1,243
Cash and cash equivalents at end of period $2,010
 $2,991
     
Supplemental disclosure of cash flow information:    
Cash paid for interest $2,599
 $2,611
Cash paid for taxes 88
 —
Non cash investing and financing activities:    
Disposal of fully depreciated real estate $56
 $20
Additions to real estate contributed by related party $45
 $1,394
Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
(in thousands)
Year Ended December 31,
20202019
(1) Rental
        Rental revenues$8,752 $12,244 
        Recoveries1,108 2,116 
        Bad debt(242)(160)
        Total rental$9,618 $14,200 




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


F-7



     Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
(in thousands)
Class A Preferred SharesClass C Preferred SharesCommon SharesAdditional Paid-in CapitalAccumulated DeficitCost of Shares Held in TreasuryTotal Shareholders' Equity (Deficit)Noncontrolling InterestTotal Equity
Balance, December 31, 2018$3 $2 $4 $28,147 $(26,319)$(801)$1,036 $26,026 $27,062 
Share-based compensation— — — 56 — — 56 — 56 
Contributions to operating partnership— — — — — — — 40 40 
Distributions to operating partnership limited partner— — — — — — — (6,927)(6,927)
Net income— — — — 3,067 — 3,067 15,232 18,299 
Balance, December 31, 2019$3 $2 $4 $28,203 (23,252)$(801)$4,159 $34,371 $38,530 
Repurchase of common shares (1)
— — — (6)— — (6)— (6)
Share-based compensation— — 2 297 — — 299 — 299 
Distributions to operating partnership limited partner— — — — — — — (1,039)(1,039)
Net income (loss)— — — — (371)— (371)1,029 658 
Balance, December 31, 2020$3 $2 $6 $28,494 $(23,623)$(801)$4,081 $34,361 $38,442 

(1) During the year ended 2020, the Company acquired common shares held by an employee who tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted shares.

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

F-8

Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Year Ended December 31,
 20202019
Cash flows from operating activities: 
Net income$658 $18,299 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization2,055 2,901 
Amortization of deferred loan costs28 160 
Loss (gain) on sale or disposal of assets and properties112 (16,943)
Bad debt242 160 
Share-based compensation293 56 
Changes in operating assets and liabilities:
Escrows and utility deposits(883)1,269 
Accrued rents and accounts receivable(94)(221)
Receivable due from related party52 (126)
Unamortized lease commissions and deferred legal cost, net(68)118 
Prepaid expenses and other assets(47)(108)
Accounts payable and accrued expenses179 (583)
Payable due to related party(11)(26)
Stock redemption payable - related party0 (143)
Tenants' security deposits(56)(355)
Net cash provided by operating activities2,460 4,458 
Cash flows from investing activities:
Proceeds from sale of real estate0 39,123 
Additions to real estate(659)(1,727)
Net cash provided by (used in) investing activities(659)37,396 
 
Cash flows from financing activities:
Distributions paid to noncontrolling interest in subsidiary(1,039)(6,927)
Extinguishment of debt costs0 (523)
Repayments of notes payable(277)(31,790)
Net cash used in financing activities(1,316)(39,240)
Net increase in cash and cash equivalents485 2,614 
Cash and cash equivalents at beginning of period4,624 2,010 
Cash and cash equivalents at end of period$5,109 $4,624 
Supplemental disclosure of cash flow information:
Cash paid for interest$795 $1,833 
Cash paid for taxes$195 $279 
Non-cash investing activities:
Disposal of fully depreciated real estate$50 $49 
Additions to real estate contributed by related party$0 $40 

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

F-9



Notes to Consolidated Financial Statements
December 31, 20182020






1.ORGANIZATION

1.ORGANIZATION

Pillarstone Capital REIT (the “Company,” “Pillarstone,” “we,” “our,” or “us”) 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 real estate investment trust (“REIT”)REIT or real estate operating company and (iii) joint venture investments. We serve as the general partner of Pillarstone Capital REIT Operating Partnership LP (the “Operating Partnership” or “Pillarstone OP”), which was formed on September 23, 2016 as a Delaware limited partnership. We currently conduct substantially all operations and activities through Pillarstone OP. As the general partner of PillatstonePillarstone OP, we have the exclusive power to manage and conduct the business of Pillarstone OP, subject to certain customary exceptions.    


2. BASIS OF PRESENTATION


Basis of consolidation. We have prepared the consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and generally accepted accounting principles in the United States ("U.S. GAAP"). In our opinion, all adjustments (consisting solely of normal recurring items) necessary for a fair presentation of our financial position as of December 31, 20182020 and 2017,2019, the results of our operations for the years ended December 31, 20182020 and 2017,2019, and of our cash flows for the years ended December 31, 20182020 and 20172019 have been included. We also consolidate a variable interest entity ("VIE") when we are determined to be the primary beneficiary. Determination of the primary beneficiary is based on whether an entity has (1) the power to direct activities that most significantly impact the economic performance of the VIE and (2) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our determination of the primary beneficiary considers all relationships between us and the VIE, including management and other contractual agreements. Consequently, the accompanying consolidated financial statements include the accounts of Pillarstone OP and a wholly-owned subsidiary that discontinued operations in 2002. See Note 4 for additional disclosure on our VIE.


Noncontrolling interest in the accompanying consolidated financial statements represents the share of equity and earnings of Pillarstone OP allocable to holders of partnership interests other than us. Net income or loss is allocated to noncontrolling interest based on the weighted-average percentage ownership of Pillarstone OP during the year. Issuance of additional units of limited partnership interest in Pillarstone OP changes the percentage of ownership interests of both the noncontrolling interest and Pillarstone.


Going concern. The financial statements have been prepared assuming the Company will continue as a going concern, which contemplates continued operations as a public company and paying liabilities in the normal course of business. The Company, through Pillarstone OP, acquired 14 real estate assets in December 2016 and its distributions of cash from Pillarstone OP are expected to be sufficient for the Company to continue as a going concern.


Reclassification of Prior Year Presentation. Prior year amounts for the year ended December 31, 2017 have been reclassified for consistency with the current year presentation. The reclassifications had no effect on the reported results of operations. Adjustments have been made to the Consolidated Balance Sheet and the Statement of Cash Flows to reclassify related party and non-related party interest. The adjustments reclassify related party interest from related party payable to accrued interest payable and non-related party interest from accounts payable to accrued interest payable.




3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Basis of Accounting.  OurPillarstone's 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 U.S. GAAP, management, in preparation of our 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 December 31, 20182020 and 2017,2019, and the reported amounts of revenues and expenses for the years ended December 31, 20182020 and 2017.2019. Actual results could differ from those estimates. Significant estimates that we use include the estimated fair value of properties acquired, allowance for doubtful accounts, impairment, the estimated useful lives for depreciable and amortizable assets and costs, and deferred taxes and the related valuation allowance for deferred taxes,taxes. Actual results could differ from those estimates. In particular, the COVID-19 pandemic has adversely impacted and these significant estimates, as well as other estimatesis likely to further adversely impact the Company's business and assumptions, may changemarkets, 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 near term.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.


F-10


Notes to Consolidated Financial Statements
December 31, 2018

2020

Change in accounting estimate. The calculation of the Company's tax provision is performed using management's best judgment with the assistance of tax advisers and is re-evaluated as changes in facts and circumstances occur that may impact the application of tax laws. The Company seeks to reduce its overall tax burden and to minimize or delay cash outflows for taxes by implementing tax efficient business structures, entering into tax advantaged transactions, and seeking tax optimal transactions. During the year ended December 31, 2019, a change in facts and circumstances occurred involving the timing and amount of gains on sales of properties in relation to the timing of the Company's potential election of REIT status. This new information resulted in the change in tax strategy that is described in more detail below under Income taxes. Based on the change in tax strategy, we reversed an estimated $141,000 federal income tax liability recorded as of December 31, 2018. The impact of the change in tax strategy and the reversal of the tax liability resulted in a decrease in tax expense for the year ended December 31, 2019 of $426,000, which increased our reported net income by $426,000 or $0.14 per diluted share for the year ended December 31, 2019.


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 December 31, 20182020 and 20172019 consisted of demand deposits at commercial banks and brokerage accounts. 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 COVID-19, 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 no0 impairment in the carrying value of our real estate assets as of December 31, 2018.2020.


Accrued Rents and Accounts Receivable.  Included in accrued rentrents and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. AnWe 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. With the adoption of Accounting Standards Codification ("ASC") No. 842, "Leases" ("Topic 842") effective January 1, 2019, we recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Prior to the adoption of Topic 842, we recognized an allowance for the uncollectible portion of accrued rentsdoubtful accounts and accounts receivable is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends.Asexpense of the specific rents receivable. Our review of collectability under our operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue. For the years ended December 31, 20182020 and 2017,2019, we had an allowance for uncollectible accounts of $53,000approximately $398,000 and $539,000, respectively,$161,000, respectively. For the years ended December 31, 2020 and bad debt expense2019, we recorded an adjustment to rental revenue in the amount of $292,000approximately $242,000 and $412,000,$160,000, respectively. Included in the adjustment to rental revenue for the year ended December 31, 2020 was an adjustment of approximately

F-11
Notes to Consolidated Financial Statements
December 31, 2020
$57,000, related to credit losses for the conversion of approximately 4 tenants to cash basis revenue as a result of our COVID-19 collectability analysis.

In December 2019, a novel strain of coronavirus ("COVID-19") was reported to have surfaced in China. In March 2020, the World Health Organization declared COVID-19 a "Public Health Emergency of International Concern" and characterized COVID-19 as a pandemic. The U.S. government implemented enhanced screenings, quarantine requirements and travel restrictions in connection with the COVID-19 outbreak. The spread of this virus caused business disruption to the Company beginning in 2020, because businesses in the United States were concerned about the impact of COVID-19 on their operations. Local governments in Texas, where all our properties are located, mandated a stay in place order, closed non-essential businesses, and closed other types of service businesses, such as bars and restaurants, (though they continued to provide take out and drive through services). As of the date of this Annual Report on Form 10-K, businesses are permitted to be open in Texas at 100% occupancy through Executive Order (GA-34).

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. The response team is in ongoing communication with the Company's tenants and is assisting tenants in identifying local, state and federal resources that may be available to support their businesses and employees during the pandemic, including stimulus funds that may be available under the Coronavirus Aid, Relief, and Economic Security Act of 2020. The Company has received a number of rent relief requests from tenants, most often in the form of rent deferral requests, as a result of the COVID-19 pandemic. The Company is evaluating each tenant rent relief request on an individual basis, considering a number of factors. 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. The Company is unable to predict the ongoing impact that the COVID-19 pandemic will have on its future financial condition, results of operations and cash flows due to numerous uncertainties including, but not limited to, the duration and spread of the pandemic, its severity in the Company's 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. As of the date of this Annual Report on Form 10-K, as a result of the impact of the COVID-19 pandemic, we have received payments of approximately 95% of contractual base rent and common area maintenance reimbursable expenses billed for the fourth quarter of 2020. As of December 31, 2020 we had 2 tenants on a deferred payment plan.

Unamortized Lease Commissions and Loan Costs and Deferred Legal Costs.  Leasing commissions and deferred legal costs are amortized using the straight-line method over the terms of the related lease agreements.  Loan costs are amortized on the straight-line method over the terms of the loans, which approximates the interest method. 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.


Prepaids and Other assets. Prepaids 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.  The ownership interests not held by the parent are considered noncontrolling interests. Accordingly, we have reported noncontrolling interest in equity on the consolidated balance sheets but separate from Pillarstone’s equity.  On the consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to Pillarstone and noncontrolling interest.  Consolidated statements of changes in equity are included for both quarterly and annual financial statements, including beginning balances, activity for the period and ending balances for shareholders’ equity, noncontrolling interest and total equity.




Notes to Consolidated Financial Statements
December 31, 2018



Revenue recognition. All leases on our properties are classified as operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases. For the year ending December 31, 2020, we recognized a straight-line rent reserve adjustment decreasing rental revenue by approximately $51,000 for the conversion of 4 tenants to cash basis revenue as a result of our COVID-19 collectability analysis. For the year ending December 31, 2019, we did not recognize a straight-line rent reserve adjustment.  Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Percentage rents 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 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 established an allowance for doubtful accounts againsttenants who pay real estate taxes directly to the portion of tenant accounts receivable which is estimatedtaxing authority.

F-12
Notes to be uncollectible.Consolidated Financial Statements

December 31, 2020
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 718No.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 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%. The Company has no uncertain

Embedded in the effective tax positions that required adjustmentsrate for the years ended December 31, 2020 and December 31, 2019 are the tax effects of the Company's operating activities. For the year ended December 31, 2020, the Company's effective tax rate applied to ourits income before income taxes decreased in relation to the statutory rate as a result of income allocated to noncontrolling interest and increased in relation to the statutory rate primarily as a result of state income tax. For the year ended December 31, 2019, the Company's effective tax rate applied to its income before income taxes decreased in relation to the statutory tax rate primarily as a result of a change in the treatment of the gain on certain Real Estate Asset sales described below and income allocated to noncontrolling interest. Please refer to Note 15 (Income Taxes) to the accompanying consolidated financial statements in 2018 or 2017.for more information regarding the effective tax rate.


As of December 31, 2018,2020, we did not have noa net operating loss carry-forwards. We have a net deferred tax asset,carry-forward and a valuation allowance was applied against the asset. Management has determined that sufficient uncertainty exists regarding the realizability of the net deferred tax assets and has provided a full valuation allowance of $199,000 and $490,000 against the net deferred tax assets of the Company as of December 31, 20182020 and 2017,December 31, 2019, we had net deferred tax liabilities of $82,000 and $96,000, respectively.


On December 9, 2016, Whitestone OP contributed 14 real estate assets ("Real Estate Assets") to Pillarstone OP in exchange for operating partnership units of Pillarstone OP. The contribution of these assets in exchange for Pillarstone OP units resulted in a "built in tax gain" in the Pillarstone OP units owned by Whitestone OP. The amount of the "built in tax gain" represented the difference between the contribution amount and Whitestone OP's tax basis in the properties. On December 27, 2018, Pillarstone OP sold 3 of the 14 contributed Real Estate Assets, and on October 8, 2019, Pillarstone OP sold an additional 3 Real Estate Assets.

As a result of new information and facts obtained, and changes in circumstances that occurred in the year ended December 31, 2019, including but not limited to, new contracts entered into for property sales and the expected timing of the Company's potential REIT status election, the Company changed its tax strategy regarding the recognition of the "built in tax gain" by the Company. Under Internal Revenue Code Section 704(c), the Company adopted a method in which it allocates all tax gains from the sale of the contributed properties to Whitestone OP until the full amount of the "built in tax gain" has been depleted. The original tax position which determined the Company's accounting estimates recorded in prior periods was taken before the Company had knowledge of additional information and facts, and changes in circumstances that occurred in the year ended December 31, 2019.

The impact of these changes resulted in a decrease in tax expense for the year ended December 31, 2019 of $426,000, which increased our reported net income by $426,000 or $0.14 per diluted share for the year ended December 31, 2019.

Fair Value of Financial Instruments.  Our financial instruments consist primarily of cash, cash equivalents, accounts receivable, accounts and notes payable and investments in marketable securities.payable.  The carrying value of cash, cash equivalents, accounts receivable and accounts payable are representative of their respective fair values due to their short-term nature.  The fair value of our long-term debt, consisting of a fixed rate secured notes aggregatenote aggregates to approximately $47.2$15.8 million and $65.1$16.3 million as compared to the book value of approximately $47.3$15.3 million and $64.7$15.5 million as of December 31, 20182020 and 2017,2019, respectively. The fair value of our long-term debt is estimated on a Level 2 basis (as provided by ASC No. 820, “Fair Value Measurements and Disclosures”), using a discounted cash flow analysis based on the borrowing rates currently available to us for loans with similar terms and maturities,
F-13
Notes to Consolidated Financial Statements
December 31, 2020
discounting the future contractual interest and principal payments.


Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 20182020 and December 31, 2017 .2019. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since December 31, 20182020 and current estimates of fair value may differ significantly from the amounts presented herein.


Concentration of Risk.  Substantially all of our revenues are obtained from office and warehouse locations in the Dallas-Fort WorthDallas 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.

In February 2016, the FASB issued an accounting standard update ("ASU") that provided the principles for the recognition, measurement, presentation, and disclosure of leases. Additional guidance and targeted improvements to the February 2016 ASU were made through the issue of supplementary ASUs in July 2018, December 2018 and March 2019.

Effective January 1, 2019, we adopted the new lease accounting guidance in Topic 842. As the lessee and lessor, we have elected the package of practical expedients permitted in Topic 842. Accordingly, we have accounted for our existing leases as operating leases under the new guidance, without reassessing (a) whether the contract contains a lease under Topic 842, (b) whether classification of the operating lease would be different in accordance with Topic 842, or (c) whether the unamortized initial direct costs before transition adjustments (as of December 31, 2018) would have met the definition of initial direct costs in Topic 842 at lease commencement. Additionally, as the lessee and lessor, we will use hindsight in determining the lease term and in assessing impairment of our right-of-use assets. As a result of the adoption of the new lease accounting guidance, as the lessee, we recognized on January 1, 2019 (a) a lease liability of approximately $21,000, which represents the present value of the remaining lease payments of approximately $22,000 discounted using our incremental borrowing rate of 4.5%, and (b) a right-of-use asset of approximately $21,000.

Upon adoption of Topic 842, lessees and lessors are required to apply a modified retrospective transition approach. Reporting entities are permitted to choose one of two methods to recognize and measure leases within the scope of Topic 842:

•Apply Topic 842 to each lease that existed at the beginning of the earliest comparative period presented in the financial statements as well as leases that commenced after that date. Under this method, prior comparative periods presented are adjusted. For leases that commenced prior to the beginning of the earliest comparative period presented, a cumulative-effect adjustment is recognized at that date.
•Apply the guidance to each lease that had commenced as of the beginning of the reporting period in which the entity first applies the lease standard with a cumulative-effect adjustment as of that date. Prior comparative periods would not be adjusted under this method.

We have elected an optional transition method that allows entities to initially apply Topic 842 at January 1, 2019, the date of adoption, and to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As the lessor, we have not assessed unamortized legal costs as part of the package of practical expedients, and we will not make any adjustment to retained earnings at the date of adoption to write off unamortized legal costs. We will continue to amortize unamortized legal costs as of December 31, 2019 over the life of the respective leases. We did not have a cumulative-effect adjustment as of the adoption date. Additionally, the optional transition method does not allow us to apply the new standard (including disclosure requirements) to comparative periods presented. Those periods can continue to be presented in accordance with prior generally accepted accounting principles.

F-14


Notes to Consolidated Financial Statements
December 31, 2018

2020


Recent accounting pronouncements. In May 2014, the FASB issuedTopic 842 requires lessors to account for leases using an approach that is substantially equivalent to existing guidance as amended in subsequent updates, establishing a single comprehensive model for entities to use in accounting for revenue arising from contracts with customerssales-type leases and supersedes mostoperating leases. Based on our election of the package of practical expedients, our existing revenue recognition guidance. The standard also requires an entity to recognize revenue to depictcommercial leases, where we are the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expectslessor, continue to be entitledaccounted for as operating leases under the new standard. However, Topic 842 changed certain requirements regarding the classification of leases that could result in exchange for those goodsus recognizing certain long-term leases entered into or services and also requires certain additional disclosures. This guidance became effective for the reporting periods beginning on ormodified after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance as of January 1, 2018 and applied it on a modified retrospective approach upon adoption.

In February 2016, the FASB issued guidance requiring lessees to recognize a lease liability and a right-of-use asset for all leases. Lessor accounting will remain largely unchanged with the exception of changes related to costs which qualify as initial direct costs. The guidance will also require new qualitative and quantitative disclosures to help financial statement users better understand the timing, amount and uncertainty of cash flows arising from leases. This guidance became effective for reporting periods beginning on or after December 15, 2018, with early adoption permitted. We adopted this guidance on a modified retrospective basis beginning January 1, 2019 as sales-type leases or finance leases, as opposed to operating leases. We will continue to monitor our leases following the adoption date to ensure that they are classified in accordance with the new lease standards.

We elected a practical expedient which allows lessors to not separate non-lease components from the lease component when the timing and such adoption willpattern of transfer for the lease components and non-lease components are the same and if the lease component is classified as an operating lease. As a result, in certain costs (primarily legal costs relatedwe now present all rentals and reimbursements from tenants as a single line item, Rental, within the consolidated financial statements of operations. For the year ended December 31, 2020, we had rental revenues of approximately $8,752,000, and rental reimbursements of approximately $1,108,000 compared to lease negotiations) being expensed rather than capitalized. We capitalized $34,000 in legal related costsrental
revenues of approximately $12,244,000 and rental reimbursements of approximately $2,116,000 for the year ended December 31, 2018. 2019.

We had $47,000review the collectability of capitalized legal related costscharges under our tenant operating leases on a regular basis, taking into consideration changes in factors such as the tenants' 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 tenant's business and financial condition. Each tenant is included in one of several portfolios and an allowance is calculated using the calculation methodology for the year ended December 31, 2017.

In November 2016, the FASB issued guidance requiring that the statement of cash flows explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance will become effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance effective January 1, 2018, and we have reconciled cash and cash equivalents and restricted cash and restricted cash equivalents on a retrospective basis, whereas under the previous guidance, we reported restricted cash and restricted cash equivalents under cash flows from financing activities.

In January 2017, the FASB issued guidance clarifying the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a prospective basis beginning January 1, 2018 and continue to believe the majority of our future acquisitions will qualify as asset acquisitions and the associated transaction costs will be capitalized instead of being expensed under previous guidance.

In February 2017, the FASB issued guidance clarifying the scope of asset derecognition guidance, added guidance for partial sales of nonfinancial assets and clarified recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a modified retrospective basis beginning January 1, 2018, andrespective portfolio. With the adoption of this guidance didTopic     842, we will recognize an adjustment to rental revenue if we deem it probable that the receivable will not have a material impact onbe collected. Our review of collectability under our consolidated financial statements.operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue.






4. VARIABLE INTEREST ENTITIES


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, both of which are related parties to Pillarstone and Pillarstone OP, pursuantOP. Pursuant to whichthe terms of the Contribution Agreement, Whitestone OP contributed to Pillarstone OP all of the equity interests in four4 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”). The Subsidiaries that owned 14 real estate assets (the “Real Estate Assets” and, together with the Subsidiaries the(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 a 18.6% valued at $4.1 million as of the date of the agreement.Contribution Agreement.
    



Notes to Consolidated Financial Statements
December 31, 2018


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(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 VIE.Variable Interest Entity.

F-15
Notes to Consolidated Financial Statements
December 31, 2020

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-one1-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-one1-for-one basis.


The carrying amounts and classification of certain assets and liabilities for Pillarstone OP in our consolidated balance sheetsheets as of December 31, 20182020 and 20172019 consists of the following (in thousands):
December 31,
20202019
Real estate assets, at cost
Property$56,290 $55,857 
Accumulated depreciation(7,177)(5,519)
Total real estate assets49,113 50,338 
Cash and cash equivalents4,321 3,331 
Escrows and utility deposits1,449 566 
Accrued rents and accounts receivable, net of allowance for doubtful accounts1,201 1,360 
Receivable due from related party (1)
132 184 
Unamortized lease commissions and deferred legal cost, net490 685 
Prepaid expenses and other assets37 35 
Total assets$56,743 $56,499 
Notes payable$15,185 $15,434 
Accounts payable and accrued expenses2,333 2,164 
Payable due to related party319 344 
  Accrued interest payable63 67 
Tenants' security deposits825 881 
Total liabilities$18,725 $18,890 
  December 31,
  2018 2017
Real estate assets, at cost    
  Property $77,941
 $83,141
  Accumulated depreciation (5,281) (2,934)
    Total real estate assets 72,660
 80,207
Cash and cash equivalents 1,872
 2,812
Escrows and acquisition deposits 1,835
 2,188
Accrued rents and accounts receivable, net of allowance for doubtful accounts (1)
 1,360
 798
Receivable due from related party 58
 1,304
Unamortized lease commissions and deferred legal costs, net 1,164
 1,265
Prepaid expenses and other assets 51
 150
     Total assets $79,000
 $88,724
     
Liabilities    
  Notes payable 47,064
 64,313
  Accounts payable and accrued expenses 2,617
 3,322
  Payable due to related party 373
 959
  Accrued interest payable 197
 218
  Tenants' security deposits 1,236
 1,191
     Total liabilities $51,487
 $70,003


(1)    Excludes approximately $0.3$0.03 million in accounts receivable due from Pillarstone that was eliminated in consolidation as
of December 31, 20182020 and 2017.




Notes to Consolidated Financial Statements
approximately $0.5 million as of December 31, 20182019.






5. REAL ESTATE


As of December 31, 2018,2020, Pillarstone OP owned 118 commercial properties in the Dallas and Houston metropolitan areas comprised of approximately 1.30.9 million square feet of gross leasable area.

On December 27, 2018,October 8, 2019, we completed the sale of Dairy Ashford BusinessCorporate Park WestbeltWest, Corporate Park Woodland and Plaza and Main Park (the "Real"2019 Real Estate Assets Sold"), each located in Houston, Texas. Dairy Ashford BusinessCorporate Park West sold for $2.1$20.3 million, and we recorded a gain on sale of $0.8$6.9 million. Westbelt Plaza Park sold for $5.4$7.3 million, and we recorded a gain on sale of $2.7$4.0 million. MainCorporate Park Woodland sold for $8.4$12.2 million, and we recorded a gain on sale of $4.3$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.


F-16
Notes to Consolidated Financial Statements
December 31, 2020
6. 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):
December 31,
20202019
Tenant receivables$558 $271 
Accrued rents and other recoveries1,113 1,311 
Allowance for doubtful accounts(398)(161)
Total$1,273 $1,421 
  December 31,
  2018 2017
Tenant receivables $252
 $680
Accrued rents and other recoveries 1,161
 657
Allowance for doubtful accounts (53) (539)
Total $1,360
 $798


7. UNAMORTIZED LEASE COMMISSIONS AND DEFERRED LEGAL COSTS, NET


Costs which have been deferred consist of the following (in thousands):
December 31,
20202019
Leasing commissions$1,290 $1,377 
Deferred legal costs12 18 
  Total cost1,302 1,395 
Less: leasing commissions accumulated amortization(802)(698)
Less: deferred legal costs accumulated amortization(10)(12)
Total cost, net of accumulated amortization$490 $685 
  December 31,
  2018 2017
Leasing commissions $1,780
 $1,577
Deferred legal costs 34
 47
  Total cost 1,814
 1,624
Less: leasing commissions accumulated amortization (636) (350)
Less: deferred legal costs accumulated amortization (14) (9)
Total cost, net of accumulated amortization $1,164
 $1,265


A summary of expected future amortization of deferred costs is as follows (in thousands):
Years Ended December 31,Leasing CommissionsDeferred Legal CostsTotal
2021$175 $1 $176 
2022121 1 122 
202381 0 81 
202449 0 49 
202531 0 31 
Thereafter31 0 31 
Total$488 $2 $490 

F-17
Years Ended December 31, Leasing Commissions 
Deferred Legal Costs (1)
 Total
2019 $345
 $20
 $365
2020 277
 —
 277
2021 205
 —
 205
2022 139
 —
 139
2023 97
 —
 97
Thereafter 81
 —
 81
Total $1,144
 $20
 $1,164



Notes to Consolidated Financial Statements
December 31, 20182020



(1) The Company will recognize a cumulative-effect adjustment to the opening balance of retained earnings of $20,000 in deferred legal costs in 2019 from the modified retrospective adoption of ASC 842.


8. FUTURE MINIMUM LEASE INCOMELEASES


WeEffective January 1, 2019, we adopted the new lease accounting guidance in Topic 842. As the majoritylessee and lessor, we have elected the package of practical expedients in Topic 842. See Note 3 for additional disclosure on Topic 842.

As a Lessor. All leases on our properties underare classified as noncancelable operating leases, which provide for minimum base rents plus, in some instances, contingent rents based uponand the related rental income is recognized on a percentagestraight-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 tenants' gross receipts. sales exceed specified amounts in our leases.  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 consolidated statements of operations.

A summary of minimum future rents to be received (exclusive of renewals, tenant reimbursements, contingent rents, and contingent rents)collectability adjustments under Topic 842) under noncancelable operating leases in existence as of December 31, 20182020 is as follows (in thousands):
Years Ended December 31,
Minimum Future Rents (1)
2021$6,780 
20224,516 
20233,249 
20241,925 
2025962 
Thereafter735 
Total$18,167 

(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 February 1, 2017, Pillarstone signed a lease with Whitestone for the premises located at 2600 S. Gessner Road, Suite 555 Houston, Texas 77063. The lease term is three years and five months. The rentable area of the premises is approximately 678 square feet. Total rent expense for the year ended December 31, 2020 was approximately $12,328 compared to $11,785 for the year ended December 31, 2019. The weighted average incremental borrowing rate was 4.5% at December 31, 2020. The previous lease term expired on June 30, 2020 and a renewal lease was signed extending the term through June 30, 2021. The remaining lease term as of December 31, 2020 was six months.

The following table summarizes the fixed, future minimum rental payment, excluding variable costs, which are discounted by our weighted average incremental borrowing rates to calculate the lease liability for our operating lease in which we are the lessee as of December 31, 2020 (in thousands):
Year Ended December 31,Minimum Future Rents
2021$7 
Total undiscounted rental payments7 
Total lease liabilities (1)
$7 

(1) Imputed interest is immaterial and therefore not disclosed in the above table.


F-18
Years Ended December 31, Minimum Future Rents
2019 $11,140
2020 8,924
2021 6,350
2022 4,111
2023 2,802
Thereafter 12,190
Total $45,517
Notes to Consolidated Financial Statements

December 31, 2020
9. DEBT


Mortgages and other notes payable consist of the following (in thousands):
December 31,
Description20202019
Fixed rate notes
$16.5 million 4.97% Note, due September 26, 2023$15,262 $15,539 
Total notes payable principal15,262 15,539 
Less deferred financing costs, net of accumulated amortization(77)(105)
Total notes payable$15,185 $15,434 
  December 31,
Description 2018 2017
Fixed rate notes    
$37.0 million 3.76% Note, due December 1, 2020 $25,863
 $33,148
$16.5 million 4.97% Note, due September 26, 2023 15,805
 16,058
Floating rate notes    
Related party Note, LIBOR plus 1.40% to 1.95%, due December 31, 2019 5,661
 15,473
Total notes payable principal 47,329
 64,679
Less deferred financing costs, net of accumulated amortization (265) (366)
Total notes payable $47,064
 $64,313


Our mortgage debt was collateralized by seven1 operating properties as of December 31, 2018 and 10 propertiesproperty as of December 31, 20172020 and December 31, 2019 with a combined net book value of $55.8$21.8 million and $63.0$22.3 million, respectively. Our loans containloan contains restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and areis secured by deedsa deed of trust on certain of our propertiesproperty and the assignment of certain rents and leases associated with those properties. Certain other of our loans are subject to customary covenants.property. As of December 31, 2018,2020, we were in compliance with allour loan covenants.


Scheduled maturities of notes payable as of December 31, 2020 were as follows, (in thousands):
YearAmount Due
2021$292 
2022311 
202314,659 
Total$15,262 


F-19


Notes to Consolidated Financial Statements
December 31, 20182020


Annual maturities of notes payable as of December 31, 2018 are due during the following years:
Year Amount Due (in thousands)
2019 $6,856
2020 25,272
2021 308
2022 323
2023 14,570
Total $47,329




Notes to Consolidated Financial Statements
December 31, 2018


10. CONVERTIBLE NOTES PAYABLE - RELATED PARTIES


On November 20, 2015, five5 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, the Pillarstone 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. After six months, the Company can convert the notes payable into Common Shares. At maturity or when the Company chooses to convertcall the convertible notes payable, into Common Shares, the noteholders have the option to receive cash plus accrued interest or convert the convertible notes payable into Common Shares.Shares at $1.331 per Common Share. Accrued interest on these related party convertible notes was approximately $101,000 as of December 31, 2020 compared with approximately $81,000 as of December 31, 2019.


11. SHAREHOLDERS' EQUITY


Operating partnership units. Substantially all of our business is conducted through Pillarstone OP and we are the sole general partner. As of December 31, 2018,2020, we owned an 18.6% interest in Pillarstone OP. At any time on or after six months following the date of the initial issuance thereof, limited partners in Pillarstone OP holding OP Units have the right to convert their OP Units for cash, or at our option, Common Shares of Pillarstone. As of December 31, 2018,2020, there were 16,688,167 OP Units outstanding.


The holders of our common shares, Class A Cumulative Preferred Shares ("Class A Preferred Shares") and Preferred Class C Convertible Preferred shares ("Preferred Class C Preferred Shares") approved changes to our declaration of trust, as amended and restated, in March 2016.restated. We presently have authority to issue up to 450,000,000 shares of beneficial interest, $0.01 par value per share, of which 400,000,000 are classified as Common Shares of beneficial interest, $0.01 par value per share and 50,000,000 are classified as preferred shares of beneficial interest, $0.01 par value per share. Of the 50,000,000 preferred shares of beneficial interest, 1,518,000 shares are designated as Preferred Class A Preferred Shares and 300,000 shares are designated as Preferred Class C Shares. Previously, we had authority to issue up to 110,000,000 shares of beneficial interest, $0.01 par value per share, of which 100,000,000 were classified as Common Shares of beneficial interest, $0.01 par value per share, and 10,000,000 were classified as preferred shares of beneficial interest, $0.01 par value per share, with 1,518,000 shares designated as Preferred Class A Shares and 300,000 shares designated as Preferred Class C Shares.


Preferred shares. The Company has outstanding 256,636 Class A Preferred Shares of which 95,226 Class A Cumulative Convertible Preferred Shares (“Class A Preferred Shares”) that were issued to the public. The Class A Preferred Shares bear a liquidation value of $10.00 per share. The Class A Preferred Shares are each convertible into 0.046 Common Shares subject to certain formulas. We have the right to redeem the Class A Preferred Shares.


Effective June 30, 2003, we issued 696,078 Class A Preferred Shares valued at approximately $2.4 million to James C. Mastandrea, our Chairman, Chief Executive Officer and President, and John J. Dee, our Chief Financial Officer and Senior Vice President, pursuant to separate restricted share agreements. Under each restricted share agreement, the restricted shares vest upon the later of the following dates:
•the date our gross assets exceed $50 million, or


•50% of the restricted shares on March 4, 2004; 25% of the shares on March 4, 2005 and the remaining 25% of the shares on March 4, 2006.


The Company has not vested any of the above shares. While the Company's gross assets exceed $50 million, when considering its 18.6% ownership of Pillarstone OP, its effective ownership of gross assets is less than $50 million.
In conjunction with a one-time incentive exchange offer for Class A Preferred shareholders, Messrs. Mastandrea and Dee exchanged 534,668 of these restricted Class A Preferred Shares into 163,116 restricted Common Shares. The restrictions described above are also applicable to their Common Shares. The remaining 161,410 restricted Class A Preferred Shares held by Messrs. Mastandrea and Dee can each be converted into 0.305 restricted Common Shares. The market value of 161,410 restricted Class A Preferred Shares and 163,116 restricted Common Shares is approximately $595,000$478,000 at December 31, 20182020 and there is limited trading volume of the Common Shares on OTC Bulletin Board.
The number of Common Shares and the conversion factor have been revised to reflect the 1-for-75 reverse split of the



Notes to Consolidated Financial Statements
December 31, 2018


Common Shares that occurred in July 2006.


During 20182020 and 2017, no2019, 0 Class A Preferred Shares were converted into Common Shares.


F-20
Notes to Consolidated Financial Statements
December 31, 2020
Effective September 29, 2006, Pillarstone filed articles supplementary to its Declaration of Trust, as amended, restated and supplemented with the State Department of Assessment and Taxation of Maryland designating 300,000 Class C Convertible Preferred Shares (“Class C Preferred Shares”).Shares. The Class C Preferred Shares have voting rights equal to the number of Common Shares into which they are convertible. Each Class C Preferred Share is convertible into Common Shares by dividing by the sum of $10.00 and any accrued but unpaid dividends on the Class C Preferred Shares by the conversion price of $1.00. The Class C Preferred Shares have a liquidation preference of $10.00 per share, plus any accrued but unpaid dividends, and can be redeemed by the board of trustees at any time, with notice, at the same price per share.
    
Effective September 29, 2006, three3 independent trustees of Pillarstone signed subscription agreements to purchase 125,000 Class C Preferred Shares for an aggregate contribution of $500,000 to maintain Pillarstone as a corporate shell current in its SEC filings.


In addition, on September 29, 2006, Mr. Mastandrea signed a subscription agreement to purchase 44,444 restricted shares of Class C Preferred Shares. The consideration for the purchase was Mr. Mastandrea’s services as an officer of Pillarstone for the period beginning September 29, 2006 and ending September 29, 2008. The Class C Preferred Shares are subject to forfeiture and are restricted from being sold by Mr. Mastandrea until the latest to occur of a public offering by Pillarstone sufficient to liquidate the Class C Preferred Shares, an exchange of Pillarstone’s existing shares for new shares, or September 29, 2008. These shares were fully amortized by the original date in 2008.
Each of the trustees of Pillarstone, who were members of the board of trustees in September 2006, signed a restricted share agreement with Pillarstone, dated September 29, 2006, to receive a total of 12,500 restricted Class C Preferred Shares in lieu of receiving fees in cash for service as a trustee for the two years ending September 29, 2008. The restrictions on the Class C Preferred Shares were to be removed upon the latest to occur of a public offering by Pillarstone sufficient to liquidate the Class C Preferred Shares, an exchange of Pillarstone's existing shares for new shares, or September 29, 2008. These shares were fully amortized by the original date in 2008. On October 22, 2018, Daryl Carter, one of the trustees, forfeited his Class C Preferred Shares as a result of his resignation from our board of trustees.
Shares held in treasury. On October 1, 2003, we completed the sale of our 92.9% general partnership interest in our four4 commercial properties. A portion of the proceeds from the sale was paid in 38,130 of our Common Shares at an average closing price for the 30 calendar days prior to June 27, 2003 of $21.00 or approximately $801,000. These shares are recorded at cost in the accompanying consolidated balance sheets under treasury shares.
    
Restricted Common Shares. The following table summarizes the activity of our unvested restricted Common Shares for the years ended December 31, 20182020 and 2017:2019:
Unvested Restricted Common Shares
Weighted-Average
Number ofGrant-Date
SharesFair Value
Unvested at December 31, 2018168,449$11.44
Vested00
Unvested at December 31, 2019168,449$11.44
Vested00
Unvested at December 31, 2020168,449$11.44
 Unvested Restricted Common Shares
   Weighted-Average
 Number of Grant-Date
 Shares Fair Value
    
Unvested at December 31, 2016168,449 $11.44
Vested— —
Unvested at December 31, 2017168,449 $11.44
Vested— —
Unvested at December 31, 2018168,449 $11.44


In the above table, 163,116 restricted shares vest upon meeting performance goals as discussed under “Preferred Shares.” Since the grant date, we have determined that meeting these performance goals is not probable, and no0 compensation expense has been recognized related to this grant. The grant date fair value of $1,847,000 would be recognized at the point we



Notes to Consolidated Financial Statements
December 31, 2018


deem it probable that we would meet the performance goals. The balance of 5,333 restricted shares had grant date fair values totaling $79,000, which was recognized in prior periods though the restrictions remain on the shares.

On June 30, 2003, our shareholders approved the issuance of an agreement to issue additional Common Shares to Paragon Real Estate Development, LLC of which Mr. Mastandrea is the managing member, and Mr. Dee is a member. In September 2006, Pillarstone amended this agreement to include each of the trustees to the agreement so that if a trustee brings a new transaction to Pillarstone, he would receive additional Common Shares of Pillarstone in accordance with a formula in the agreement. In January 2016, the non-employee trustees and Mr. Mastandrea agreed to make this agreement for only non-employeenon-
F-21
Notes to Consolidated Financial Statements
December 31, 2020
employee trustees. The agreement is intended to serve as an incentive for our trustees to increase the asset base, net operating income, funds from operations, and share value of Pillarstone. The exact number of Common Shares that would be issued will be calculated in accordance with a formula in the agreement based on future acquisition, development or redevelopment transactions. Any of these transactions would be subject to approval by the members of our board of trustees who are not receiving the additional Common Shares. We would issue our Common Shares only upon the closing of a transaction. The maximum number of Common Shares a trustee may receive under the additional contribution agreement is limited to a total value of $26 million based on the average closing price of our Common Shares for 30 calendar days preceding the closing of any acquisition transaction. The Common Shares will be restricted until we achieve the five years-year pro forma income target for the acquisition, as approved by the board of trustees, and an increase of 5% in Pillarstone's net operating income and funds from operations. The restricted shares would vest immediately upon any “shift in ownership,” as defined in the agreement. In 2020, the non-employee trustees decided not to participate in the agreement.
Options. On November 16, 1998, we adopted the 1998 Share Option Plan. In 2004 the board of trustees unanimously recommended and the shareholders approved amendments to our 1998 Share Option Plan to increase the number of shares available for grant from 42,222 to 46,666 and to conform with then current tax regulations (“2004 Plan”). The 2004 Plan expired in 2014; the one outstanding grant of 667 options remains effective until 90 days after the term ends of the individual trustee. As of December 31, 2020 and 2019, there was no remaining unrecognized cost related to stock options.


The following table summarizes the activity for outstanding stock options:
Options Outstanding
Options OutstandingWeighted-Average
    Weighted-Average  Weighted-AverageRemaining
  Weighted-Average Remaining  Number ofExerciseContractual TermAggregate
Number of Exercise Contractual Term AggregateSharesPrice(in years)
Intrinsic Value (1)
Shares Price (in years) 
Intrinsic Value (1)
       
Balance at December 31, 2016667
 $33.75
 1.25
 $—
Balance at December 31, 2018Balance at December 31, 2018667 $33.75 1.25$0 
Granted—
 —
    Granted0 0 
Exercised—
 —
    Exercised0 0 
Canceled / forfeited / expired—
 $—
    Canceled / forfeited / expired0 $0 
Balance at December 31, 2017667
 $33.75
 1.25
 $—
Balance at December 31, 2019Balance at December 31, 2019667 $33.75 1.25$0 
Granted—
 —
    Granted0 0 
Exercised—
 —
    Exercised0 0 
Canceled / forfeited / expired—
 —
    Canceled / forfeited / expired0 0 
Balance at December 31, 2018667
 $33.75
 1.25
 $—
Vested and exercisable as of December 31, 2017—
 $—
 —
 $—
Balance at December 31, 2020Balance at December 31, 2020667 $33.75 1.25$0 
Vested and exercisable as of December 31, 2020Vested and exercisable as of December 31, 20200 $0 — $0 


(1)
(1)    The aggregate intrinsic value is calculated as approximately the difference between the weighted average exercise price of the underlying awards and the Company’s estimated current fair market value at December 31, 2018. Because the weighted average exercise price exceeds fair market value at December 31, 2018, there is no aggregate intrinsic value for the options.

The Company did not recognize any stock-based compensation expense during the years ending December 31, 2018 and 2017. As of2020. Because the weighted average exercise price exceeds fair market value at December 31, 2018 and 2017,2020, there was no remaining unrecognized cost related to stockis 0 aggregate intrinsic value for the options.






Notes to Consolidated Financial Statements
December 31, 2018


12. 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).
 
F-22
Notes to Consolidated Financial Statements
December 31, 2020
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 the administration of the 2016 Plan. The 2016 Plan includes the types of awards for grants and the 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, the Committee approved the grant of 122,665 Common Share Units to 3 independent members of the Company's board of trustees. These Common Share Units were issued on August 12, 2020 and vested immediately.

On December 17, 2020, the Committee approved the grant of 56,607 Common Share Units to 3 independent members of the Company's board of trustees. These Common Share Units were issued on December 17, 2020 and vested immediately.
 
As of December 31, 2018,2020, the maximum number of Common Shares or OP Units available to be granted is 2,338,5692,073,686. During the year ended December 31, 2020, the following shares were granted:
DescriptionShares
Weighted-Average Grant Date Fair Value (1)
Non-vested at January 1, 202090,062 $2.18 
Granted179,272 $1.29 
Vested(194,282)$1.36 
Non-vested at December 31, 202075,052 $2.18 
Available for grant at December 31, 20202,073,686

(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. The fair value of the shares issued on August 12, 2020 and no grantsDecember 17, 2020 were determined by the market price on the dates of issuance.

As of December 31, 2020, per the Award, the Company has determined that the time-based shares and the performance-based shares will vest by July 1, 2022. The 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 issued underachieved as of July 1, 2022 will be forfeited to the 2016 Plan.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 $68,000 and $56,000 in share-based compensation expense for the years ended December 31, 2020 and 2019, respectively. For the year ended December 31, 2020, the Company had approximately $73,000 in unrecognized share-based compensation expense.

The total value of the Company's board of trustee's shares granted on August 7, 2020 and December 17, 2020 is approximately $166,000 and $65,000, respectively. The Company recognized approximately $231,000 in share-based compensation expense for the year ended December 31, 2020. NaN share-based compensation expense for trustee compensation was recognized for the year ended December 31, 2019.



F-23
Notes to Consolidated Financial Statements
December 31, 2020
13. EARNINGS (LOSS) PER SHARE


The Company applies the guidance of ASC No. 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 both earnings (loss) per Common Share calculations for the years ended December 31, 20182020 and 2017.2019.


For the year ended December 31, 2018,2020, Class A Preferred Shares, and Class C Preferred Shares and Restricted Common Shares awarded pursuant to the 2016 Plan (defined in Note 11 above) were not included in net loss per weighted average Common Share outstanding-diluted, because the effect of the conversion would be anti-dilutive. For the year ended December 31, 2019, Class A Preferred Shares, Class C Preferred Shares and Restricted Common Shares awarded pursuant to the 2016 Plan were included in net income (loss) per weighted average Common Share outstanding-diluted. During the years ended December 31, 20182020 and 2017,2019, the Company had $197,780 of convertible notes payable as discussed in Note 10. The convertible notes payable were not included in the computation of diluted loss per share in 2020 but were included in the computation of diluted earnings per share in 2018 but were not included in 2017 because the effect of the conversion would be anti-dilutive in 2017.2019.

For the Year Ended December 31,
(in thousands, except share and per share data)20202019
Numerator:
Net income (loss) available to common shareholders$(371)$3,067 
Dilutive effect of interest from convertible notes payable0 20 
Net income (loss) available to common shareholders with assumed conversion$(371)$3,087 
Denominator:
Weighted average number of common shares - basic460,389 405,169 
Effect of dilutive securities:
Dilutive effect of restricted common shares0 45,031 
Assumed conversion of Class A Preferred Shares0 53,610 
Assumed conversion of Class C Preferred Shares0 2,319,440 
Assumed conversion of convertible notes payable0 202,306 
Weighted average number of common shares - dilutive460,389 3,025,556 
Earnings (Loss) Per Share:
Basic income (loss) per Common Share:
Net income (loss) available to Common Shareholders$(0.81)$7.57 
Diluted income (loss) per Common Share:
Net income (loss) available to Common Shareholders$(0.81)$1.02 



Notes to Consolidated Financial Statements
December 31, 2018


 For the year ended December 31,
(in thousands, except share and per share data)2018 2017
    
Numerator:   
Net income available to Common Shareholders$1,316
 $215
Dilutive effect of interest from convertible notes payable20
 —
Net income available to Common Shareholders with assumed conversion$1,336
 $215
    
Denominator:   
Weighted average number of Common Shares - basic405,169
 405,169
Effect of dilutive securities:   
Assumed conversion of Preferred A Shares53,610
 53,610
Assumed conversion of Preferred C Shares2,419,782
 2,444,440
Assumed conversion of convertible notes payable187,466
 —
Weighted average number of Common Shares - dilutive3,066,027
 2,903,219
    
Earnings Per Share:   
Basic income per Common Share:   
Net income available to Common Shareholders$3.25
 $0.53
Diluted income per Common Share:   
Net income available to Common Shareholders$0.44
 $0.07


14. DIVIDENDS AND DISTRIBUTIONS


NoNaN cash distributions were declared during 20182020 and 20172019 with respect to common or preferred shares.




15. INCOME TAXES

For financial reporting purposes, income before federal income taxes attributable to Common Shareholders includes the following components (in thousands):

 For the year ended December 31,
 2018 2017
Net income$9,806
 $2,447
Less: noncontrolling interest in subsidiary8,490
 2,232
Net income attributable to Common Shareholders$1,316
 $215


The Company follows the provisions of ASC Topic 740 which provides for recognition of deferred tax assets and liabilities for deductible temporary timing differences, net of a valuation allowance for any asset for which it is more-likely-than-not will not be realized in the Company’s tax return.

Income tax provisions were $229,000 and $88,000 for the years ended December 31, 2018 and 2017, respectively.



F-24


Notes to Consolidated Financial Statements
December 31, 2018

2020

Income tax benefit (provision) was $35,000 and $(280,000) for the years ended December 31, 2020 and 2019, respectively.

The income tax expense (benefit)benefit (provision) included in the consolidated statements of operations for the years ended December 31, 20182020 and 20172019 was comprised of the following components (in thousands):

For the Year Ended December 31,
20202019
Federal:
Current$72 $57 
Deferred14 (295)
Change in valuation allowance0 199 
$86 $(39)
State:
Current$(51)$(241)
$(51)$(241)
Total tax benefit (provision)$35 $(280)
 For the year ended December 31,
 2018 2017
Federal:   
Current$141
 $—
Deferred291
 46
Change in deferred rate from 34% to 21% for 2017—
 331
Change in valuation allowance(291) (377)
 $141
 $—
    
State:   
Current$88
 $88
 $88
 $88
    
Total tax expense$229
 $88


The items accounting for the difference between income taxes computed at the Federal statutory rate and our effective rate were as follows:
For the year ended December 31,For the Year Ended December 31,
2018 201720202019
Federal statutory rate21 % 34 %Federal statutory rate21 %21 %
Effect of:   Effect of:
Noncontrolling interest(18)% (31)%Noncontrolling interest(35)%(17)%
State income tax benefit, net of Federal tax effect1 % 4 %
State income tax, net of Federal tax effectState income tax, net of Federal tax effect6 %1 %
Permanent differencePermanent difference2 %0 %
Change in deferred valuations1 % — %Change in deferred valuations0 %(2)%
Change in deferred rate from 34% to 21% for 2017— % 12 %
Change in valuation allowance(3)% (15)%Change in valuation allowance0 %(1)%
Effective rate2 % 4 %Effective rate(6)%2 %
    
Deferred tax assets and liabilities consist of the following (in thousands):
 December 31,
 2018 2017
Deferred tax assets and liabilities:   
Net operating loss carry-forwards$—
 $164
Depreciation and amortization180
 209
Acquisition and organizational costs67
 72
Accruals and others(48) 45
Total deferred tax assets and liabilities199
 490
Valuation allowance(199) (490)
Deferred tax assets and liabilities net of valuation allowance$—
 $—
December 31,
20202019
Deferred tax assets and (liabilities):
Depreciation and amortization$(137)$(121)
Acquisition and organizational costs56 61 
Accruals and others(1)(36)
Total deferred tax assets and (liabilities)$(82)$(96)
    



Notes to Consolidated Financial Statements
December 31, 2018


Realization ofThe Company had deferred tax assets is dependent upon generationliabilities of sufficient future taxable income$82,000 and the effects of other loss utilization provisions. Management has determined that sufficient uncertainty exists regarding the realizability of the net deferred tax assets and has provided a full valuation allowance of $199,000 and $490,000, against the net deferred tax assets of the Company$96,000 as of December 31, 20182020 and 2017,December 31, 2019, respectively. A valuation allowance is considered to be a significant estimate that may change inDeferred tax liabilities are accounted for on the near term.
accounts payable and accrued expenses line item on the Company's balance sheet. As of December 31, 2018,2020, the Company had no0 net operating loss carry-forwards available to be carried to future periods.


F-25
Notes to Consolidated Financial Statements
December 31, 2020
16. RELATED PARTY TRANSACTIONS


On December 8, 2016, the Company entered into the Contribution Agreement with Pillarstone OP and Whitestone OP, both of which are related parties, resulting in the contribution of an equity ownership interest in Pillarstone OP to 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.


Mr. James C. Mastandrea, the Chairman and Chief Executive Officer of Whitestone REIT, also serves as the Chairman and Chief Executive Officer of Pillarstone Capital REIT and beneficially owns approximately 78.2% of the outstanding equity in Pillarstone Capital REIT (when calculated in accordance with Rule 13d-3(d)(1) under the Exchange Act of 1934, as amended (the “Exchange Act”)). Mr. John J. Dee, the Chief Operating Officer and Corporate Secretary of Whitestone REIT, also serves as the Senior Vice President and Chief Financial Officer of Pillarstone Capital REIT and beneficially owns approximately 27.0% of the outstanding equity in Pillarstone Capital REIT (when calculated in accordance with Rule 13d-3(d)(1) under the Exchange Act). In addition, Mr. Paul T. Lambert, a Trustee of Whitestone REIT, also serves as a Trustee of Pillarstone Capital REIT.

Pursuant to the Contribution Agreement, the Company has agreed to file with 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 of beneficial interestcommon shares in the Company (the “Common Shares”) that may be issued upon redemption of the OP Units issued pursuant to each of the Contribution Agreement and the OP Unit Purchase Agreement (as defined below) and the offer and resale of such Common Sharescommon 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. No Pillarstone OP units were purchased under the OP Unit Purchase Agreement. Pillarstone and Whitestone agreed to extend the filing of the shelf registration statement to a date not later than June 8, 2019, or the date that the Company closes a public equity offering. No additional OP units have been issued as of December 31, 2018 and the requirement has expired.

In connection with the Contribution Agreement, on December 8, 2016, the Company and Pillarstone OP entered into an OP Unit Purchase Agreement (the “OP Unit Purchase Agreement”) with Whitestone OP pursuant to which Pillarstone OP may require Whitestone OP to purchase up to an aggregate of $3.0 million of OP Units at a price of $1.331 per OP Unit over the two-year term of the OP Unit Purchase Agreement on the terms set forth therein. In addition, pursuant to the OP Unit Purchase 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. On December 8, 2018, the OP Unit Agreement and the offer and resale of common shares terminated pursuant to its terms. There was no issuance of our Common Shares during 2018.


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 properties,3 of the Real Estate Assets, which did not create additional tax liabilities for Whitestone OP. In addition, the sale of the 2019 Real Estate Assets Sold did not create additional tax liabilities for Whitestone OP.


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.     




Notes to Consolidated Financial Statements
December 31, 2018



In connection with the Contribution Agreement, on December 8, 2016, the Company and Pillarstone OP 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 (y)(2) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.


F-26
Notes to Consolidated Financial Statements
December 31, 2020
The following table presents the revenue and expenses with Whitestone OP included in our consolidated statements of operations for the years ended December 31, 20182020 and 20172019 (in thousands):
For the Year Ended December 31,
Location of Revenue (Expense)20202019
RentRental$921 $703 
Property management feesManagement fees(418)(626)
Asset management feesManagement fees(173)(191)
Rent expenseOffice expenses(17)(12)
Interest expenseInterest expense0(171)
    Year Ended December 31,
  Location of Revenue (Expense) 2018 2017
Rent Rental revenues $779
 $782
Property management fees and admin salaries Management fees $(743) $(732)
Asset management fees Management fees $(265) $(264)
Interest expense Interest expense $(582) $(528)


Receivables due from related parties consisted of the following as of December 31, 2018 and 2017 (in thousands):
  December 31,
  2018 2017
Construction in process (1)
 $—
 $45
Tenant receivables and other receivables 58
 1,259
  Total $58
 $1,304

(1)
Amount relates to future tenant and building improvement expenditures implicit within the Contribution Agreement to be paid by Whitestone OP and capitalized by the Company in subsequent periods when placed in service.

Payablespayables due to related parties consisted of the following as of December 31, 20182020 and 20172019 (in thousands):
December 31,
Location of Receivable (Payable)20202019
Tenant receivables and other receivablesReceivable due from related party$132 $184 
Accrued interest due to related partyAccrued interest payable(101)(81)
Other payables due to related partyPayable due to related party(335)(346)
  December 31,
  2018 2017
Accrued interest due to related party (2)
 $112
 $88
Other payables due to related party  (3)
 372
 959
  Total $484
 $1,047


(2)
Included in accrued interest payable on the balance sheet.
(3)
Included in payable due to related party on the balance sheet.


17. COMMITMENTS AND CONTINGENCIES


Employment Agreements


On April 3, 2006, the board of trustees authorized modifications to Mr. Mastandrea’s employment agreement. The modification agreement allows Mr. Mastandrea to devote time to other business and personal investments while performing his



Notes to Consolidated Financial Statements
December 31, 2018


duties for Pillarstone. The original employment agreement with Mr. Mastandrea provides for an annual salary of $60,000 effective as of March 4, 2003. The initial term of Mr. Mastandrea’s employment is for two years and may be extended for terms of one year. Mr. Mastandrea’s base annual salary may be adjusted from time to time, except that the adjustment may not be lower than the preceding year’s base salary. The employment agreement provides that Mr. Mastandrea will be entitled to base salary and bonus at the rate in effect before any termination for a period of three years in the event that his employment is terminated without cause by us or for good reason by Mr. Mastandrea. Effective September 29, 2006, in lieu of an annual salary of $100,000 and to conserve cash, Mr. Mastandrea agreed to receive 44,444 Class C Preferred Shares for his services as an officer of Pillarstone through September 29, 2008. The shares were fully amortized by the original date in 2008.


Mr. Dee’s employment agreement was also modified on April 3, 2006 in a similar way to Mr. Mastandrea’s employment agreement as explained above, except Mr. Dee does not receive any Class C Preferred Shares for his services as an officer of Pillarstone. Mr. Dee’s base annual salary may be adjusted from time to time, except that the adjustment may not be lower than the preceding year’s base salary. The employment agreement provides that Mr. Dee will be entitled to base salary and bonus at the rate in effect before any termination for a period of three years in the event that his employment is terminated without cause by us or for good reason by Mr. Dee. On September 29, 2006, the board of trustees approved compensation to Mr. Dee of $125 per hour, up to a maximum of $5,000 per month. However, Mr. Dee has forgone receiving any cash compensation under this arrangement in order to preserve the Company’s cash.


Lease Agreement

On February 1, 2017 Pillarstone Capital REIT signed a lease with Whitestone Woodlake Plaza, LLC for the premises located at 2600 S. Gessner Road, Suite 555 Houston, Texas 77063. The lease term is three years and five months. The rentable area of the premises is approximately 678 square feet. Total rent expense for the year ended December 31, 2018 was approximately $14,200 compared to $12,600 for the year ended December 31, 2017.

Years Ended December 31, Minimum Future Rents
2019 $14,604
2020 7,410
Total $22,014

18. SEGMENT INFORMATION


Our management historically has not differentiated by property types and therefore does not present segment information.

19. SUBSEQUENT EVENTS



F-27
Notes to Consolidated Financial Statements
December 31, 2020
Management has evaluated subsequent events through March 26, 2021, the date the consolidated financial statements were available to be issued and has determined that there are no subsequent events to be reported.


F-28

PILLARSTONE CAPITAL REIT
Schedule II - Valuation and Qualifying Accounts
December 31, 20182020




 (in thousands)
 Balance atCharged toDeductionsBalance at
 Beginning Revenue/fromEnd of
Descriptionof YearExpenseReservesYear
Deferred tax asset allowance:    
Year ended December 31, 2020$0 $0 $0 $0 
Year ended December 31, 2019199 (199)0 0 
Year ended December 31, 2018490 (291)0 199 
Allowance for doubtful accounts:
Year ended December 31, 2020$161 $242 $(5)$398 
Year ended December 31, 201953 160 (52)161 
Year ended December 31, 2018539 292 (778)53 







F-29
  (in thousands)
  Balance at Charged to Deductions Balance at
  Beginning Costs and from End of
Description of Year Expense Reserves Year
Deferred tax asset allowance:        
Year ended December 31, 2018 $490
 $(291) $—
 $199
Year ended December 31, 2017 867
 (377) —
 490
Year ended December 31, 2016 1,031
 (164) —
 867
         
Allowance for doubtful accounts:        
Year ended December 31, 2018 $539
 292
 (778) $53
Year ended December 31, 2017 125
 412
 2
 539
Year ended December 31, 2016 —
 127
 (2) 125

PILLARSTONE CAPITAL REIT
Schedule III - Real Estate and Accumulated Depreciation
December 31, 20182020






   Costs Capitalized SubsequentGross Amount at which Carried at
 Initial Cost (in thousands)to Acquisition (in thousands)
End of Period (in thousands)(1) (2)
  Building andImprovementsCarrying Building and 
Property NameLandImprovements(net)CostsLandImprovementsTotal
Pillarstone OP Properties:      
9101 LBJ Freeway$3,590 $2,811 $274 $0 $3,590 $3,085 $6,675 
Corporate Park Northwest1,326 5,009 688 0 1,326 5,697 7,023 
Corporate Park Woodland II2,730 24 41 0 2,730 65 2,795 
Holly Hall Industrial Park2,730 1,768 85 0 2,730 1,853 4,583 
Holly Knight807 1,231 193 0 807 1,424 2,231 
Interstate 10 Warehouse2,915 765 163 0 2,915 928 3,843 
Uptown Tower r (3)
7,304 15,493 2,462 0 7,304 17,955 25,259 
Westgate Service Center937 2,502 446 0 937 2,948 3,885 
Total - Pillarstone OP Properties$22,339 $29,603 $4,352 $0 $22,339 $33,955 $56,294 


F-30
      Costs Capitalized Subsequent Gross Amount at which Carried at
  Initial Cost (in thousands) to Acquisition (in thousands) 
End of Period (in thousands)(1) (2)
    Building and Improvements Carrying   Building and  
Property Name Land Improvements (net) Costs Land Improvements Total
               
Pillarstone OP Properties:  
    
  
  
  
  
9101 LBJ Freeway $3,590
 $2,811
 $151
 $—
 $3,590
 $2,962
 $6,552
Corporate Park Northwest 1,326
 5,009
 359
 —
 1,326
 5,368
 6,694
Corporate Park West 2,772
 10,144
 1,129
 —
 2,772
 11,273
 14,045
Corporate Park Woodland 1,144
 4,764
 215
 —
 1,144
 4,979
 6,123
Corporate Park Woodland II 2,730
 24
 38
 —
 2,730
 62
 2,792
Holly Hall Industrial Park 2,730
 1,768
 16
 —
 2,730
 1,784
 4,514
Holly Knight 807
 1,231
 110
 —
 807
 1,341
 2,148
Interstate 10 Warehouse 2,915
 765
 122
 —
 2,915
 887
 3,802
Plaza Park 1,527
 1,660
 161
 —
 1,527
 1,821
 3,348
Uptown Tower 7,304
 15,493
 1,371
 —
 7,304
 16,864
 24,168
Westgate Service Center 937
 2,502
 316
 —
 937
 2,818
 3,755
Total - Pillarstone OP Properties $27,782
 $46,171
 $3,988
 $—
 $27,782
 $50,159
 $77,941


PILLARSTONE CAPITAL REIT
Schedule III - Real Estate and Accumulated Depreciation
December 31, 20182020







    Accumulated Depreciation Date Depreciation
Property Name Encumbrances (in thousands) Acquired Life
Pillarstone OP Properties:        
9101 LBJ Freeway   $374
 12/8/2016 5-39 years
Corporate Park Northwest   818
 12/8/2016 5-39 years
Corporate Park West (3) 881
 12/8/2016 5-39 years
Corporate Park Woodland (3) 390
 12/8/2016 5-39 years
Corporate Park Woodland II   9
 12/8/2016 5-39 years
Holly Hall Industrial Park (3) 180
 12/8/2016 5-39 years
Holly Knight   111
 12/8/2016 5-39 years
Interstate 10 Warehouse (3) 110
 12/8/2016 5-39 years
Plaza Park (3) 281
 12/8/2016 5-39 years
Uptown Tower (4) 1,821
 12/8/2016 5-39 years
Westgate Service Center (3) 306
 12/8/2016 5-39 years
Total - Pillarstone OP Properties   $5,281
    

(1)
Reconciliations of total real estate carrying value for the years ended December 31, 2018 and 2017 follows:
  (in thousands)
  2018 2017
Balance at beginning of period $83,144
 $80,564
Additions - improvements 2,399
 2,641
Deductions - cost of real estate sold or retired (7,602) (61)
Balance at close of period $77,941
 $83,144

Accumulated DepreciationDateDepreciation
Property NameEncumbrances(in thousands)AcquiredLife
Pillarstone OP Properties:
9101 LBJ Freeway$645 12/8/20165-39 years
Corporate Park Northwest1,496 12/8/20165-39 years
Corporate Park Woodland II37 12/8/20165-39 years
Holly Hall Industrial Park302 12/8/20165-39 years
Holly Knight244 12/8/20165-39 years
Interstate 10 Warehouse227 12/8/20165-39 years
(2)Uptown Tower (3)
The aggregate cost of real estate (in thousands) for federal income tax purposes is $77,358.
(3)
These properties secure a $25.9 million mortgage note.3,494 
12/8/20165-39 years
(4)
Westgate Service Center
This property secures a $15.8 million mortgage note.
735 12/8/20165-39 years
Total - Pillarstone OP Properties$7,180




(1)     Reconciliations of total real estate carrying value for the years ended December 31, 2020 and 2019 follows, (in thousands):
For the Year Ended December 31,
 20202019
Balance at beginning of period$55,861 $77,941 
Additions - improvements659 1,767 
Deductions - cost of real estate sold or retired(226)(23,847)
Balance at close of period$56,294 $55,861 

(2)    The aggregate cost of real estate (in thousands) for federal income tax purposes is $55,282.
(3)    This property secures a $15.3 million mortgage note.

F-27
F-31