UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________

FORM 10-K

(Mark One)

☒     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2020

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File Number: 001-15409

______________________________

PILLARSTONE CAPITAL REIT

(Exact Name of Registrant as Specified in Its Charter)

Maryland						39-6594066
(State or Other Jurisdiction of Incorporation or						(I.R.S. Employer
Organization)						Identification No.)
2600 South Gessner, Suite 555, Houston, Texas						77063
(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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

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 ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☐ No ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 ☐ Accelerated filer ☐     Non-accelerated filer ☒     Smaller reporting company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new 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 ☐ No ☒

The aggregate market value of the voting common shares held by non-affiliates of the registrant as of June 30, 2020 (the last business day of the registrant's most recently completed second fiscal quarter) was approximately $363,086 based on the closing price of $2.00 per common share on the Over-The-Counter Bulletin Board on that date.

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As of March 26, 2021, the Registrant had issued 633,130 common shares of beneficial interest and had 595,000 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 2021 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, 2020.

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PILLARSTONE CAPITAL REIT

FORM 10-K

Year Ended December 31, 2020

 

Page
PART I
			Item 1.			Business.			3
			Item 2.			Properties.			5
			Item 3.			Legal Proceedings.			5
			Item 4.			Mine Safety Disclosures.			5

 

PART II
			Item 5.			Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.			6
			Item 7.			Management’s Discussion and Analysis of Financial Condition and Results of Operations.			7
			Item 8.			Financial Statements and Supplementary Data.			12
			Item 9.			Changes in and Disagreements with Accountants.			13
			Item 9A.			Controls and Procedures.			13
			Item 9B.			Other Information.			13

 

PART III
			Item 10.			Trustees, Executive Officers and Corporate Governance.			14
			Item 11.			Executive Compensation.			14
			Item 12.			Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.			14
			Item 13.			Certain Relationships and Related Transactions, and Director Independence.			14
			Item 14.			Principal Accountant Fees and Services.			14

 

PART IV
			Item 15.			Exhibits and Financial Statement Schedules.			15
			Item 16.			Form 10-K Summary.			17
						SIGNATURES.			18

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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, 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 

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•our inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws.

In addition, an investment in the Company involves numerous risks that potential investors should consider carefully, including, without limitation:

•our cash resources are limited;

•we have a history of losses;

•we have not raised funds through a public equity offering;

•our trustees control a significant percentage of our voting shares;

•shareholders could experience possible future dilution through the issuance of additional shares;

•we are dependent on a small number of key senior professionals who are part-time employees; and

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

     

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PART I

Item 1. Business.

Company Overview

Pillarstone Capital REIT is a Maryland real estate investment trust (“REIT”) engaged in investing in, owning and operating commercial properties. Future real estate investments may include (i) acquisition and development of retail, office, office warehouse, industrial, multifamily, hotel, and other commercial properties, (ii) acquisition of or merger with a REIT or 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 REIT by buying, selling, owning and operating commercial and residential properties through December 31, 1999. In 2000, the Company purchased a software technology company, resulting in the Company 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 multifamily 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, 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

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Note, the “Whitestone Industrial-Office Loan Documents”), between Industrial-Office, as borrower, and Jackson National Life Insurance Company, as lender (collectively, the “Acquisition”).

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 issuance of the common shares in the Company that may be issued upon redemption of the OP Units issued pursuant to the Contribution Agreement and the offer and resale of such common shares by the holders thereof. In addition, pursuant to the Contribution Agreement, in the event of a Change of Control (as defined therein) of Whitestone, Pillarstone OP shall have the right, but not the obligation, to repurchase the OP Units issued thereunder from Whitestone OP at their initial issue price of $1.331 per OP Unit. 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 the date that the Company closes a public equity offering.

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 Pillarstone 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 gross 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.

On 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 December 31, 2020, the Company has one full time employee and two part time 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

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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 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 (the "2018 Real Estate Assets Sold") and on October 8, 2019, Pillarstone sold 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, 2020.

Community Name						Location						Year Built/ Renovated						GLA						Percent 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 Freeway						Dallas						1985						125,874						47		%				$	1,038					$	17.55					$	18.56
Corporate Park Northwest						Houston						1981						174,359						76		%				1,834						13.84						13.59
Corporate Park Woodland II						Houston						2000						14,344						100		%				244						17.01						16.94
Holly Hall Industrial Park						Houston						1980						90,000						49		%				308						6.98						6.89
Holly Knight						Houston						1984						20,015						100		%				432						21.58						21.23
Interstate 10 Warehouse						Houston						1980						151,000						31		%				287						6.13						6.09
Uptown Tower						Dallas						1982						253,981						66		%				3,952						23.58						23.25
Westgate Service Center						Houston						1984						97,225						81		%				656						8.33						8.00
Total / Weighted Average																		926,798						61		%				$	8,751					$	15.48					$	15.36

(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.

 

(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.

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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 100 as of March 23, 2021, and we estimate we have approximately 275 beneficial holders of Common Shares as of that date. As of March 23, 2021, we had 595,000 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, 2020 and 2019 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, 2020						High						Low
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, 2019						High						Low
First Quarter						$	2.80					$	1.65
Second Quarter						$	1.80					$	1.60
Third Quarter						$	1.80					$	1.80
Fourth Quarter						$	1.80					$	1.20

On March 23, 2021, the closing price of our Common Shares reported on the OTC Bulletin Board was $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 Preferred Shares are not quoted on an exchange or the OTC Bulletin Board.

Dividend Policy

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 2020.

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

Overview

The Company is a Maryland REIT engaged in investing in, owning and operating commercial properties. Future real estate investments may include (i) acquisition and development of retail, office, office warehouse, industrial, multifamily, hotel and other commercial properties, (ii) acquisition of or merger with a REIT or real estate operating company, and (iii) joint venture investments. Substantially all of our business is conducted through our operating partnership Pillarstone OP. We are the sole general partner of Pillarstone OP. As of December 31, 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, 2020, the Company is a smaller reporting company current in its quarterly and annual financial statement filings with the SEC, that may make future real estate investments. There can be no assurance that we will be able to close additional transactions.  Even if our management is successful in closing additional transactions, investors may not value the transactions or the Company in the same manner as we do, and investors may not value the transactions as they would value other transactions or alternatives. Failure to obtain additional sources of capital will materially and adversely affect the Company’s ability to continue operations, as well as its liquidity and financial results.

Brief History

Pillarstone was formed on March 15, 1994 as a Maryland REIT. The Company operated as a traditional REIT by buying, selling, owning and operating commercial and residential properties through December 31, 1999. In 2000, the Company purchased a software technology company, resulting in the Company not meeting the qualifications to be a REIT under the Code. In 2002, the Company discontinued the operations of the technology segment, and from 2003 through 2006, pursued a value-added business plan primarily focused on acquiring well located, under-performing multifamily residential properties, including affordable housing communities, and repositioning them through renovation, leasing, improved management and branding. From 2006 until December 2016, the Company continued its existence as a corporate shell current in its SEC filings.

On December 8, 2016, Pillarstone and Pillarstone OP entered into the Contribution Agreement with Whitestone OP, a subsidiary and the operating partnership of Whitestone, both of which are related parties to Pillarstone and Pillarstone OP, pursuant to which Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries: CP Woodland; Industrial-Office; Whitestone Offices; and Uptown Tower that own the Real Estate Assets for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP issued at a price of $1.331 per OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by Pillarstone OP (collectively, the “Acquisition”).

On December 27, 2018, Pillarstone OP sold the 2018 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, 2020 and 2019 and financial condition, including:

•Explanation of changes in the results of operations in the Consolidated Statements of Operations for the year ended December 31, 2020 compared to the year ended December 31, 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.

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

•Our current income tax status.

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

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, 2020 and 2019

Leasing Activity

For the year ended December 31, 2020, we executed 61 leases for a total lease value of $3.3 million compared to 89 leases for a total lease value of $10.0 million for the year ended December 31, 2019.

Results of Operations 

The following table provides a general comparison of our results of operations for the years ended December 31, 2020 and 2019 (dollars in thousands):

						Year Ended December 31,
						2020						2019
Number of properties						8						8
Aggregate GLA (sq. ft.)						926,798						926,798
Ending occupancy rate						61		%				75		%
Total revenues						$	9,671					$	14,253
Total operating expenses						8,120						10,208
Total other (income) expense						928						(14,534)
Income tax provision (benefit)						(35)						280
Net income						658						18,299
Less:  Noncontrolling interest in subsidiary						1,029						15,232
Net income (loss) available to Common Shareholders						$	(371)					$	3,067

Revenues from Operations

    

We had total revenues for the years ended December 31, 2020 and 2019 of approximately $9,671,000 and $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 $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 due to the impact of the COVID-19 pandemic.

Expenses from Operations

Our operating expenses were approximately $8,120,000 for the year ended December 31, 2020 compared to approximately $10,208,000 for the year ended December 31, 2019, a decrease of 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 (in thousands):

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						Year Ended December 31,
						2020						2019						Increase (Decrease)						% Increase (Decrease)
Depreciation and amortization						$	2,055					$	2,901					$	(846)					(29)		%
Operating and maintenance						2,644						3,480						(836)						(24)		%
Real estate taxes						1,824						2,257						(433)						(19)		%
General and administrative						1,006						753						253						34		%
Management fees						591						817						(226)						(28)		%
Total property expenses						$	8,120					$	10,208					$	(2,088)					(20)		%

Federal and State Income Tax Provision (Benefit)

Our income tax provision (benefit) was approximately $(35,000) for the year ended December 31, 2020 as compared to approximately $280,000 for the year ended December 31, 2019, a decrease in expense of approximately $315,000. The decrease in tax expense primarily resulted from approximately $17.0 million in gains on sales of properties by Pillarstone OP during the year ended December 31, 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 $1.0 million for the year ended December 31, 2020 compared to $15.2 million for the year ended December 31, 2019. The majority of the decrease in net income for the non-controlling interest was primarily due to the sale of the 2019 Real Estate Assets Sold as of October 8, 2019 at a gain of $17.0 million.

Liquidity and Capital Resources

Cash Flows

As of December 31, 2020, our unrestricted cash resources were 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, 2020, the Company's cash balance increased by $485,000 from $4,624,000 at December 31, 2019 to $5,109,000 at December 31, 2020. This increase in cash was due to cash provided by operating activities of approximately $2,460,000, offset by cash used in investing activities of $659,000, and cash used in financing activities of approximately $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. On December 27, 2018, the Company sold the 2018 Real Estate Assets Sold in Houston, Texas to an unaffiliated third party for $15.9 million, resulting in 11 Real Estate Assets in the Company's real estate portfolio at December 31, 2018.

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As of December 31, 2019, Pillarstone OP, sold the 2019 Real Estate Assets Sold in Houston, Texas to an unaffiliated third party for $39.7 million in cash, resulting in eight Real Estate Assets in the Company's real estate portfolio at December 31, 2019. Pillarstone OP used the net proceeds, after customary closing deductions, to repay mortgage debt secured by the the 2019 Real Estate Assets Sold and other Real Estate Assets, and to repay the remaining $5.7 million of its $15.5 million loan from Whitestone OP. In addition to the $5.7 million loan repayment, Whitestone received a $5.4 million cash distribution from its 81.4% ownership of Pillarstone OP as a result of the sale. We expect our remaining debt balance to be repaid from raising capital, selling assets, and/or debt refinancing. As of December 31, 2020, the 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.

    

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

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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, 2020 and December 31, 2019, we had net deferred tax liabilities of $82,000 and $96,000, respectively. As of December 31, 2020, we do not have an operating loss carryforward available to be carried to future periods.

The income tax provision (benefit) included in the consolidated statements of operations for the years ended December 31, 2020 and 2019 was comprised of the following components (in thousands):

						Year Ended December 31,
						2020						2019
Federal						$	(86)					$	39
Texas franchise tax						51						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 relatively low nationwide inflation rates and the Company having 100% of its debt with a fixed 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.

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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. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the consolidated statements of operations.

We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured. Additionally, we may have tenants who pay real estate taxes directly to the taxing authority.

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, 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. The Company had net deferred tax liabilities of $82,000 as of December 31, 2020, and $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.

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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 and financial officers, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a 15(e) and 15d 15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") in ensuring that the information required to be disclosed in our filings under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, including ensuring that such information is accumulated and communicated to management to allow timely decisions regarding required disclosure.

Based on such evaluation, our principal executive and financial officers have concluded at a reasonable assurance level that such disclosure controls and procedures were effective as of December 31, 2020.

Management’s Report on Internal Control Over Financial Reporting

The 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 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 2020 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, 2020.

Changes in Internal Control Over Financial Reporting

There have been no significant changes in our internal control over financial reporting during the Company's quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.  Other Information.

 

None.

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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 2021 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 2021 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 2021 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 2021 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 2021 Annual Meeting of Shareholders.

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PART IV

Item 15. Exhibits and Financial Statement Schedules.

Exhibit Number						Exhibit Description
2.1						Additional Contribution Agreement between the Company and Paragon Real Estate Development, LLC (filed as Exhibit 2.7 to the Company’s Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference)
2.2						Amendment to Additional Contribution Agreement between the Company, the Board of Trustees and each Trustee individually dated September 29, 2006. (filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on October 3, 2006 and incorporated herein by reference)
3.1						Articles of Amendment and Restatement of the Declaration of Trust of the Company (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed on March 29, 2016 and incorporated herein by reference)
3.2						Third Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
4.1						Description of the Registrant's securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 (2)
10.1						Employment Agreement of James C. Mastandrea (filed as Exhibit 2.3 to the Company’s Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference) (1)
10.2						Employment Agreement of John J. Dee (filed as Exhibit 2.4 to the Company’s Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference) (1)
10.3						Restricted Share Agreement of James C. Mastandrea (filed as Exhibit 2.5 to the Company’s Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference) (1)
10.4						Restricted Share Agreement of John J. Dee (filed as Exhibit 2.6 to the Company’s Current Report on Form 8-K filed on March 5, 2003 and incorporated herein by reference) (1)
10.5						Form of Restricted Share Agreement for Trustees dated September 26, 2006 (filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on October 3, 2006 and incorporated herein by reference) (1)
10.6						2004 Share Option Plan of the Company (filed as Exhibit 4.1 to the Company’s Registration Statement on Form S-8 filed on July 23, 2004 and incorporated herein by reference)
10.7						Stock Subscription Agreement between James C. Mastandrea and the Company dated as of September 29, 2006 (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 3, 2006 and incorporated herein by reference)
10.8						Form of Stock Subscription Agreement between Investors and the Company dated as of September 29, 2006 (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 3, 2006 and incorporated herein by reference)
10.9						Modification Agreement between the Company and John J. Dee dated April 3, 2006 (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 6, 2006 and incorporated herein by reference)
10.10						Modification Agreement between the Company and James C. Mastandrea dated April 3, 2006 (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 6, 2006 and incorporated herein by reference)
10.11						Form of First Amendment to Restricted Share Agreement for Trustees dated September 25, 2008 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 and incorporated herein by reference)
10.12						First Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 25, 2008 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 and incorporated herein by reference)
10.13						Form of Second Amendment to Restricted Share Agreement for Trustees dated September 21, 2009 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 and incorporated herein by reference)
10.14						Second Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 21, 2009 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 and incorporated herein by reference)
10.15						Form of Third Amendment to Restricted Share Agreement for Trustees dated September 28, 2010 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference)
10.16						Third Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 28, 2010 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 and incorporated herein by reference)

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Exhibit Number						Exhibit Description
10.17						Form of Fourth Amendment to Restricted Share Agreement for Trustees dated September 29, 2011 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 and incorporated herein by reference)
10.18						Fourth Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 29, 2011 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 and incorporated herein by reference)
10.19						Form of Fifth Amendment to Restricted Share Agreement for Trustees dated September 28, 2012 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 and incorporated herein by reference)
10.20						Fifth Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 28, 2012 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 and incorporated herein by reference)
10.21						Form of Sixth Amendment to Restricted Share Agreement for Trustees dated September 30, 2013 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and incorporated herein by reference)
10.22						Sixth Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 30, 2013 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and incorporated herein by reference)
10.23						Form of Seventh Amendment to Restricted Share Agreement for Trustees dated September 30, 2014 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 and incorporated herein by reference)
10.24						Seventh Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 30, 2014 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 and incorporated herein by reference)
10.25						Form of Eighth Amendment to Restricted Share Agreement for Trustees dated September 30, 2015 (filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 and incorporated herein by reference)
10.26						Eighth Amendment to Stock Subscription Agreement between James C. Mastandrea and the Company dated September 30, 2015 (filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 and incorporated herein by reference)
10.27						Contribution Agreement among Whitestone REIT Operating Partnership, L.P., Pillarstone Capital REIT Operating Partnership LP and the Company dated December 8, 2016 (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.28						OP Unit Purchase Agreement among Whitestone REIT Operating Partnership, L.P., Pillarstone Capital REIT Operating Partnership LP and the Company dated December 8, 2016 (filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.29						Tax Protection Agreement among Whitestone REIT Operating Partnership, L.P., Pillarstone Capital REIT Operating Partnership LP and the Company dated December 8, 2016 (filed as Exhibit 10.3 to the Company's Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.30						Amended and Restated Limited Partnership Agreement of Pillarstone Capital REIT Operating Partnership LP, dated December 8, 2016 (filed as Exhibit 10.5 to the Company's Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.31						Form of Management Agreement dated December 8, 2016 (filed as Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.33						Second Amendment to Amended and Restated Credit Agreement, Joinder and Reaffirmation of Guaranties, dated December 8, 2016, among Whitestone REIT Operating Partnership, L.P., Whitestone REIT, Pillarstone Capital REIT Operating Partnership LP, et al., as guarantors, the lenders party thereto, and Bank of Montreal, as Administrative Agent (filed as Exhibit 10.6 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.34						Limited Guaranty, dated December 8, 2016, between Pillarstone Capital REIT Operating Partnership LP and Bank of Montreal, as Administrative Agent (filed as Exhibit 10.7 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.35						Loan Agreement, dated September 26, 2013, by and between Whitestone Uptown Tower, LLC and Morgan Stanley Mortgage Capital Holdings LLC, as amended (filed as Exhibit 10.8 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.36						Promissory Note by Whitestone Uptown Tower, LLC to Morgan Stanley Mortgage Capital Holdings LLC, dated September 23, 2013 (filed as Exhibit 10.9 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)

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Exhibit Number						Exhibit Description
10.37						Loan Agreement, dated November 26, 2013, by and between Whitestone Industrial-Office LLC and Jackson National Life Insurance Company (filed as Exhibit 10.10 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
10.38						Fixed Rate Promissory Note by Whitestone Industrial-Office LLC to Jackson National Life Insurance Company, dated November 26, 2013 (filed as Exhibit 10.11 to the Company’s Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
24.1						Power of Attorney (included on the signature page hereto)
31.1						Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 - Chief Executive Officer (2)
31.2						Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 - Chief Financial Officer (2)
32.1						CEO/CFO Certification under Section 906 of Sarbanes-Oxley Act of 2002 (2)
101						The following financial information of the Registrant for the years ended December 31, 2020 and 2019, formatted in Inline 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.
104						Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document.

(1)Indicates a management contract or compensatory plan or arrangement

(2)Filed or furnished herewith

Item 16. Form 10-K Summary.

None.

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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:

March 26, 2021

By:

/s/ James C. Mastandrea

James C. Mastandrea, Chairman and CEO

PILLARSTONE CAPITAL REIT

Date:

March 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

Signature			Title			Date
/s/ James C. Mastandrea James C. Mastandrea			Trustee, Chief Executive Officer and    President			March 26, 2021
			(Principal Executive Officer)
/s/ John J. Dee John J. Dee			Trustee, Senior Vice President and    Chief Financial Officer			March 26, 2021
			(Principal Finance and Principal Accounting Officer)
/s/ Dennis Chookaszian Dennis Chookaszian			Trustee			March 26, 2021
/s/ Kathy M. Jassem Kathy M. Jassem			Trustee			March 26, 2021
/s/ Paul T. Lambert Paul T. Lambert			Trustee			March 26, 2021

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
						Page
			Report of Independent Registered Public Accounting Firm			F-2
			Consolidated Balance Sheets as of December 31, 2020 and 2019			F-4
			Consolidated Statements of Operations for the Years Ended December 31, 2020 and 2019			F-6
			Consolidated Statements of Changes in Equity (Deficit) for the Years Ended December 31, 2020 and 2019			F-8
			Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019			F-9
			Notes to Consolidated Financial Statements			F-10

F-1

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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, 2020 and 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, 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, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 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.

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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

March 26, 2021

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
						December 31,
						2020						2019
ASSETS (a)
Real estate assets, at cost
Property						$	56,294					$	55,861
Accumulated depreciation						(7,180)						(5,522)
Total real estate assets						49,114						50,339
Cash and cash equivalents						5,109						4,624
Escrows and utility deposits						1,449						566
Accrued rents and accounts receivable, net of allowance for doubtful accounts						1,273						1,421
Receivable due from related party						132						184
Unamortized lease commissions and deferred legal cost, net						490						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 party						335						346
Convertible notes payable - related parties						198						198
Accrued interest payable						165						148
Tenants' security deposits						825						881
Total liabilities						19,214						19,351
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, 2020 and December 31, 2019, $10.00 per share liquidation preference						3						3
Preferred C Shares - $0.01 par value, 300,000 authorized: 231,944 Class C cumulative convertible shares issued and outstanding at December 31, 2020 and December 31, 2019, $10.00 per share liquidation preference						2						2
Common Shares - $0.01 par value, 400,000,000 authorized: 633,130 shares issued and 595,000 outstanding at December 31, 2020 and 443,299 shares issued and 405,169 outstanding at December 31, 2019						6						4
Additional paid-in capital						28,494						28,203
Accumulated deficit						(23,623)						(23,252)
Treasury stock, at cost, 38,130 shares						(801)						(801)
Total Pillarstone Capital REIT shareholders' equity						4,081						4,159
Noncontrolling interest in subsidiary						34,361						34,371
Total equity						38,442						38,530
Total liabilities and equity						$	57,656					$	57,881

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

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED BALANCE SHEETS - Continued
(in thousands)
						December 31,
						2020						2019
(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,
						2020						2019
(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 assets						49,113						50,338
Cash and cash equivalents						4,321						3,331
Escrows and utility deposits						1,449						566
Accrued rents and accounts receivable, net of allowance for doubtful accounts						1,201						1,360
Receivable due from related party						132						184
Unamortized lease commissions and deferred legal cost, net						490						685
Prepaid expenses and other assets						37						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 expenses						2,333						2,164
Payable due to related party						319						344
Accrued interest payable						63						67
Tenants' security deposits						825						881
Total liabilities						$	18,725					$	18,890

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

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
						Year Ended December 31,
						2020						2019
Revenues
Rental (1)						$	9,618					$	14,200
Transaction and other fees						53						53
Total revenues						9,671						14,253
Operating expenses
Depreciation and amortization						2,055						2,901
Operating and maintenance						2,644						3,480
Real estate taxes						1,824						2,257
General and administrative						1,006						753
Management fees						591						817
Total operating expenses						8,120						10,208
Other expense (income)
Interest expense						816						2,409
Loss on disposal of assets						112						24
Gain on sale of properties						—						(16,967)
Total other expense (income)						928						(14,534)
Income before income taxes						623						18,579
Income tax benefit (provision)						35						(280)
Net income						658						18,299
Less: Noncontrolling interest in subsidiary						1,029						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.

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
(in thousands)
						Year Ended December 31,
						2020						2019
(1) Rental
Rental revenues						$	8,752					$	12,244
Recoveries						1,108						2,116
Bad debt						(242)						(160)
Total rental						$	9,618					$	14,200

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

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
(in thousands)
						Class A Preferred Shares						Class C Preferred Shares						Common Shares						Additional Paid-in Capital						Accumulated Deficit						Cost of Shares Held in Treasury						Total Shareholders' Equity (Deficit)						Noncontrolling Interest						Total Equity
Balance, December 31, 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.

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Pillarstone Capital REIT and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
						Year Ended December 31,
						2020						2019
Cash flows from operating activities:
Net income						$	658					$	18,299
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization						2,055						2,901
Amortization of deferred loan costs						28						160
Loss (gain) on sale or disposal of assets and properties						112						(16,943)
Bad debt						242						160
Share-based compensation						293						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 party						52						(126)
Unamortized lease commissions and deferred legal cost, net						(68)						118
Prepaid expenses and other assets						(47)						(108)
Accounts payable and accrued expenses						179						(583)
Payable due to related party						(11)						(26)
Stock redemption payable - related party						—						(143)
Tenants' security deposits						(56)						(355)
Net cash provided by operating activities						2,460						4,458
Cash flows from investing activities:
Proceeds from sale of real estate						—						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 costs						—						(523)
Repayments of notes payable						(277)						(31,790)
Net cash used in financing activities						(1,316)						(39,240)
Net increase in cash and cash equivalents						485						2,614
Cash and cash equivalents at beginning of period						4,624						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						$	—					$	40

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

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Notes to Consolidated Financial Statements

December 31, 2020

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 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 Pillarstone 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, 2020 and 2019, the results of our operations for the years ended December 31, 2020 and 2019, and of our cash flows for the years ended December 31, 2020 and 2019 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.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Accounting.  Pillarstone'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, 2020 and 2019, and the reported amounts of revenues and expenses for the years ended December 31, 2020 and 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. Actual results could differ from those estimates. In particular, the COVID-19 pandemic has adversely impacted and is likely to further adversely impact the Company's business and markets, including the Company's operations and the operations of its tenants. The full extent to which the pandemic will directly or indirectly impact the Company's business, results of operations and financial condition, including revenues, expenses, reserves and allowances, fair value measurements, and asset impairment charges, will depend on future developments that are highly uncertain and difficult to predict. These developments include, but are not limited to, the duration and spread of the pandemic, its severity in our markets and elsewhere, governmental actions to contain the spread of the pandemic and respond to the reduction in global economic activity, and how quickly and to what extent normal economic and operating conditions can resume.

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Notes to Consolidated Financial Statements

December 31, 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, 2020 and 2019 consisted of demand deposits at commercial banks and brokerage accounts.

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 no impairment in the carrying value of our real estate assets as of December 31, 2020.

Accrued Rents and Accounts Receivable.  Included in accrued rents and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. We review the collectability of charges under our tenant operating leases on a regular basis, taking into consideration changes in factors such as the tenant's payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located, including the impact of the COVID-19 pandemic on tenants' businesses and financial condition. 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 doubtful accounts and bad debt expense 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, 2020 and 2019, we had an allowance for uncollectible accounts of approximately $398,000 and $161,000, respectively. For the years ended December 31, 2020 and 2019, we recorded an adjustment to rental revenue in the amount of approximately $242,000 and $160,000, respectively. Included in the adjustment to rental revenue for the year ended December 31, 2020 was an adjustment of approximately

F-11

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Notes to Consolidated Financial Statements

December 31, 2020

$57,000, related to credit losses for the conversion of approximately four 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 two tenants on a deferred payment plan.

Unamortized Lease Commissions and Loan Costs.  Leasing commissions 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. 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.

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 four 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. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the consolidated statements of operations.

We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured. Additionally, we may have tenants who pay real estate taxes directly to the taxing authority.

F-12

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Notes to 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 No.718 generally requires that these transactions be accounted for using a fair-value-based method. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards.

Income taxes. Because we have not elected to be taxed as a REIT for federal income tax purposes, we account for income taxes using the asset and liability method under which deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We are also subject to certain state and local income, excise and franchise taxes. The provision for state and local taxes has been reflected in provision for income taxes in the 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%.

Embedded in the effective tax rate 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 its 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 for more information regarding the effective tax rate.

As of December 31, 2020, we did not have a net operating loss carry-forward and as of December 31, 2020 and 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 three of the 14 contributed Real Estate Assets, and on October 8, 2019, Pillarstone OP sold an additional three 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.  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 note aggregates to approximately $15.8 million and $16.3 million as compared to the book value of approximately $15.3 million and $15.5 million as of December 31, 2020 and 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

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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, 2020 and December 31, 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, 2020 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 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

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Notes to Consolidated Financial Statements

December 31, 2020

Topic 842 requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases and operating leases. Based on our election of the package of practical expedients, our existing commercial leases, where we are the lessor, continue to be accounted for as operating leases under the new standard. However, Topic 842 changed certain requirements regarding the classification of leases that could result in us recognizing certain long-term leases entered into or modified after 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 pattern 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, we 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 rental

revenues of approximately $12,244,000 and rental reimbursements of approximately $2,116,000 for the year ended December 31, 2019.

We review the collectability of charges 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 respective portfolio. With the adoption of Topic     842, we will recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Our review of collectability under our operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue.

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. Pursuant to the terms of the Contribution Agreement, Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries (the “Subsidiaries”): Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company; Whitestone Industrial-Office, LLC, a Texas limited liability company; Whitestone Offices, LLC, a Texas limited liability company; and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower”) that owned 14 real estate assets (the “Real Estate Assets” and, together with the Subsidiaries (the “Property”), for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP (“OP Units”), issued at a price of $1.331 per OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by Pillarstone OP. Pursuant to the Contribution Agreement, Pillarstone became the general partner of Pillarstone OP with an equity ownership interest in Pillarstone OP totaling approximately a 18.6% valued at $4.1 million as of the date of the Contribution Agreement.

    

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

F-15

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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-one basis into OP Units, which in turn are redeemable by the holder for cash or, at the Company’s election, exchangeable for Common Shares on a one-for-one basis.

The carrying amounts and classification of certain assets and liabilities for Pillarstone OP in our consolidated balance sheets as of December 31, 2020 and 2019 consists of the following (in thousands):

						December 31,
						2020						2019
Real estate assets, at cost
Property						$	56,290					$	55,857
Accumulated depreciation						(7,177)						(5,519)
Total real estate assets						49,113						50,338
Cash and cash equivalents						4,321						3,331
Escrows and utility deposits						1,449						566
Accrued rents and accounts receivable, net of allowance for doubtful accounts						1,201						1,360
Receivable due from related party (1)						132						184
Unamortized lease commissions and deferred legal cost, net						490						685
Prepaid expenses and other assets						37						35
Total assets						$	56,743					$	56,499
Notes payable						$	15,185					$	15,434
Accounts payable and accrued expenses						2,333						2,164
Payable due to related party						319						344
Accrued interest payable						63						67
Tenants' security deposits						825						881
Total liabilities						$	18,725					$	18,890

(1)    Excludes approximately $0.03 million in accounts receivable due from Pillarstone that was eliminated in consolidation as of December 31, 2020 and approximately $0.5 million as of December 31, 2019.

5. REAL ESTATE

As of December 31, 2020, Pillarstone OP owned eight commercial properties in the Dallas and Houston metropolitan areas comprised of approximately 0.9 million square feet of gross leasable area.

On 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.

F-16

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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,
						2020						2019
Tenant receivables						$	558					$	271
Accrued rents and other recoveries						1,113						1,311
Allowance for doubtful accounts						(398)						(161)
Total						$	1,273					$	1,421

7. UNAMORTIZED LEASE COMMISSIONS AND DEFERRED LEGAL COSTS, NET

Costs which have been deferred consist of the following (in thousands):

						December 31,
						2020						2019
Leasing commissions						$	1,290					$	1,377
Deferred legal costs						12						18
Total cost						1,302						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

A summary of expected future amortization of deferred costs is as follows (in thousands):

Years Ended December 31,						Leasing Commissions						Deferred Legal Costs						Total
2021						$	175					$	1					$	176
2022						121						1						122
2023						81						—						81
2024						49						—						49
2025						31						—						31
Thereafter						31						—						31
Total						$	488					$	2					$	490

F-17

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Notes to Consolidated Financial Statements

December 31, 2020

8. LEASES

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 in Topic 842. See Note 3 for additional disclosure on Topic 842.

As a Lessor. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Percentage rents, if applicable, are recognized as rental income when the tenants' 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 collectability adjustments under Topic 842) under noncancelable operating leases in existence as of December 31, 2020 is as follows (in thousands): 

Years Ended December 31,						Minimum Future Rents (1)
2021						$	6,780
2022						4,516
2023						3,249
2024						1,925
2025						962
Thereafter						735
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 payments						7
Total lease liabilities (1)						$	7

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

F-18

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Notes to Consolidated Financial Statements

December 31, 2020

9. DEBT

Mortgages and other notes payable consist of the following (in thousands):

						December 31,
Description						2020						2019
Fixed rate notes
$16.5 million 4.97% Note, due September 26, 2023						$	15,262					$	15,539
Total notes payable principal						15,262						15,539
Less deferred financing costs, net of accumulated amortization						(77)						(105)
Total notes payable						$	15,185					$	15,434

Our mortgage debt was collateralized by one operating property as of December 31, 2020 and December 31, 2019 with a net book value of $21.8 million and $22.3 million, respectively. Our loan contains restrictions that would require prepayment penalties for the acceleration of outstanding debt and is secured by a deed of trust on our property and the assignment of certain rents and leases associated with our property. As of December 31, 2020, we were in compliance with our loan covenants.

Scheduled maturities of notes payable as of December 31, 2020 were as follows, (in thousands):

Year						Amount Due
2021						$	292
2022						311
2023						14,659
Total						$	15,262

F-19

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Notes to Consolidated Financial Statements

December 31, 2020

10. CONVERTIBLE NOTES PAYABLE - RELATED PARTIES

On November 20, 2015, five trustees on our board of trustees loaned $197,780 to the Company in exchange for convertible notes payable. The convertible notes payable accrue interest at 10% per annum and originally matured on November 20, 2018. In 2019, 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. At maturity or when the Company chooses to call the convertible notes payable, the noteholders have the option to receive cash plus accrued interest or convert the convertible notes payable into Common Shares at $1.331 per Common Share. Accrued interest on these related 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, 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, 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 ("Class C Preferred Shares") approved changes to our declaration of trust, as amended and 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 Class A Preferred Shares and 300,000 shares are designated as Class C Preferred Shares.

Preferred shares. The Company has outstanding 256,636 Class A Preferred Shares of which 95,226 Class A Preferred Shares 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 $478,000 at December 31, 2020 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 Common Shares that occurred in July 2006.

During 2020 and 2019, no Class A Preferred Shares were converted into Common Shares.

F-20

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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 Preferred 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 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, three 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 four 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, 2020 and 2019:

			Unvested Restricted Common Shares
									Weighted-Average
			Number of						Grant-Date
			Shares						Fair Value
Unvested at December 31, 2018			168,449						$11.44
Vested			—						—
Unvested at December 31, 2019			168,449						$11.44
Vested			—						—
Unvested at December 31, 2020			168,449						$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 no 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 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-

F-21

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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
															Weighted-Average
									Weighted-Average						Remaining
			Number of						Exercise						Contractual Term						Aggregate
			Shares						Price						(in years)						Intrinsic Value (1)
Balance at December 31, 2018			667						$	33.75					1.25						$	—
Granted			—						—
Exercised			—						—
Canceled / forfeited / expired			—						$	—
Balance at December 31, 2019			667						$	33.75					1.25						$	—
Granted			—						—
Exercised			—						—
Canceled / forfeited / expired			—						—
Balance at December 31, 2020			667						$	33.75					1.25						$	—
Vested and exercisable as of December 31, 2020			—						$	—					—						$	—

(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, 2020. Because the weighted average exercise price exceeds fair market value at December 31, 2020, there is no aggregate intrinsic value for the options.

    

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

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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 three 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 three 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, 2020, the maximum number of Common Shares or OP Units available to be granted is 2,073,686. During the year ended December 31, 2020, the following shares were granted:

Description						Shares						Weighted-Average Grant Date Fair Value (1)
Non-vested at January 1, 2020						90,062						$	2.18
Granted						179,272						$	1.29
Vested						(194,282)						$	1.36
Non-vested at December 31, 2020						75,052						$	2.18
Available for grant at December 31, 2020						2,073,686

(1) The fair value of the shares granted on July 1, 2019 were determined based on the share activity from the date of the three property sales on December 27, 2018 until the grant date July 1, 2019. The fair value of the shares issued on August 12, 2020 and December 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 achieved as of July 1, 2022 will be forfeited to the Company.

The total value of the time-based and performance-based shares granted on July 1, 2019 is approximately $196,000. The Company recognized approximately $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. No share-based compensation expense for trustee compensation was recognized for the year ended December 31, 2019.

F-23

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Notes to Consolidated Financial Statements

December 31, 2020

13. EARNINGS PER SHARE

The Company applies the guidance of ASC No. 260, "Earnings Per Share," for all periods presented herein. Net earnings per weighted average Common Share outstanding, basic and diluted, is computed based on the weighted average number of Common Shares outstanding for the period. The following table shows the weighted average number of Common Shares outstanding and reconciles the numerator and denominator of earnings per Common Share calculations for the years ended December 31, 2020 and 2019.

For the year ended December 31, 2020, Class A Preferred Shares, 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 per weighted average Common Share outstanding-diluted. During the years ended December 31, 2020 and 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 2019.

			For the Year Ended December 31,
(in thousands, except share and per share data)			2020						2019
Numerator:
Net income (loss) available to common shareholders			$	(371)					$	3,067
Dilutive effect of interest from convertible notes payable			—						20
Net income (loss) available to common shareholders with assumed conversion			$	(371)					$	3,087
Denominator:
Weighted average number of common shares - basic			460,389						405,169
Effect of dilutive securities:
Dilutive effect of restricted common shares			—						45,031
Assumed conversion of Class A Preferred Shares			—						53,610
Assumed conversion of Class C Preferred Shares			—						2,319,440
Assumed conversion of convertible notes payable			—						202,306
Weighted average number of common shares - dilutive			460,389						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

14. DIVIDENDS AND DISTRIBUTIONS

No cash distributions were declared during 2020 and 2019 with respect to common or preferred shares.

15. INCOME TAXES

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.

F-24

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Notes to Consolidated Financial Statements

December 31, 2020

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

The income tax benefit (provision) included in the consolidated statements of operations for the years ended December 31, 2020 and 2019 was comprised of the following components (in thousands):

			For the Year Ended December 31,
			2020						2019
Federal:
Current			$	72					$	57
Deferred			14						(295)
Change in valuation allowance			—						199
			$	86					$	(39)
State:
Current			$	(51)					$	(241)
			$	(51)					$	(241)
Total tax benefit (provision)			$	35					$	(280)

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,
			2020						2019
Federal statutory rate			21		%				21		%
Effect of:
Noncontrolling interest			(35)		%				(17)		%
State income tax, net of Federal tax effect			6		%				1		%
Permanent difference			2		%				—		%
Change in deferred valuations			—		%				(2)		%
Change in valuation allowance			—		%				(1)		%
Effective rate			(6)		%				2		%

    

Deferred tax assets and liabilities consist of the following (in thousands):

			December 31,
			2020						2019
Deferred tax assets and (liabilities):
Depreciation and amortization			$	(137)					$	(121)
Acquisition and organizational costs			56						61
Accruals and others			(1)						(36)
Total deferred tax assets and (liabilities)			$	(82)					$	(96)

    

The Company had deferred tax liabilities of $82,000 and $96,000 as of December 31, 2020 and December 31, 2019, respectively. Deferred tax liabilities are accounted for on the accounts payable and accrued expenses line item on the Company's balance sheet. As of December 31, 2020, the Company had no net operating loss carry-forwards available to be carried to future periods.

F-25

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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 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 in the Company that may be issued upon redemption of the OP Units issued pursuant to the Contribution Agreement and the offer and resale of such common shares by the holders thereof. In addition, pursuant to the Contribution Agreement, in the event of a Change of Control (as defined therein) of Whitestone, Pillarstone OP shall have the right, but not the obligation, to repurchase the OP Units issued thereunder from Whitestone OP at their initial issue price of $1.331 per OP Unit. 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 the date that the Company closes a public equity offering.

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

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 (2) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.

F-26

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Notes to Consolidated Financial Statements

December 31, 2020

The following table presents the revenue and expenses with Whitestone included in our consolidated statements of operations for the years ended December 31, 2020 and 2019 (in thousands):

												For the Year Ended December 31,
						Location of Revenue (Expense)						2020						2019
Rent						Rental						$	921					$	703
Property management fees						Management fees						(418)						(626)
Asset management fees						Management fees						(173)						(191)
Rent expense						Office expenses						(17)						(12)
Interest expense						Interest expense						—						(171)

Receivables due from and payables due to related parties consisted of the following as of December 31, 2020 and 2019 (in thousands):

									December 31,
			Location of Receivable (Payable)						2020						2019
Tenant receivables and other receivables			Receivable due from related party						$	132					$	184
Accrued interest due to related party			Accrued interest payable						(101)						(81)
Other payables due to related party			Payable due to related party						(335)						(346)

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 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.

18. SEGMENT INFORMATION

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

19. SUBSEQUENT EVENTS

F-27

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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

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PILLARSTONE CAPITAL REIT

Schedule II - Valuation and Qualifying Accounts

December 31, 2020

						(in thousands)
						Balance at						Charged to						Deductions						Balance at
						Beginning						Revenue/						from						End of
Description						of Year						Expense						Reserves						Year
Deferred tax asset allowance:
Year ended December 31, 2020						$	—					$	—					$	—					$	—
Year ended December 31, 2019						199						(199)						—						—
Year ended December 31, 2018						490						(291)						—						199
Allowance for doubtful accounts:
Year ended December 31, 2020						$	161					$	242					$	(5)					$	398
Year ended December 31, 2019						53						160						(52)						161
Year ended December 31, 2018						539						292						(778)						53

F-29

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PILLARSTONE CAPITAL REIT

Schedule III - Real Estate and Accumulated Depreciation

December 31, 2020

																		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					$	274					$	—					$	3,590					$	3,085					$	6,675
Corporate Park Northwest						1,326						5,009						688						—						1,326						5,697						7,023
Corporate Park Woodland II						2,730						24						41						—						2,730						65						2,795
Holly Hall Industrial Park						2,730						1,768						85						—						2,730						1,853						4,583
Holly Knight						807						1,231						193						—						807						1,424						2,231
Interstate 10 Warehouse						2,915						765						163						—						2,915						928						3,843
Uptown Tower r (3)						7,304						15,493						2,462						—						7,304						17,955						25,259
Westgate Service Center						937						2,502						446						—						937						2,948						3,885
Total - Pillarstone OP Properties						$	22,339					$	29,603					$	4,352					$	—					$	22,339					$	33,955					$	56,294

F-30

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PILLARSTONE CAPITAL REIT

Schedule III - Real Estate and Accumulated Depreciation

December 31, 2020

Accumulated Depreciation

Date

Depreciation

Property Name

Encumbrances

(in thousands)

Acquired

Life

Pillarstone OP Properties:

9101 LBJ Freeway

$

645

12/8/2016

5-39 years

Corporate Park Northwest

1,496

12/8/2016

5-39 years

Corporate Park Woodland II

37

12/8/2016

5-39 years

Holly Hall Industrial Park

302

12/8/2016

5-39 years

Holly Knight

244

12/8/2016

5-39 years

Interstate 10 Warehouse

227

12/8/2016

5-39 years

Uptown Tower (3)

3,494

12/8/2016

5-39 years

Westgate Service Center

735

12/8/2016

5-39 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,
						2020						2019
Balance at beginning of period						$	55,861					$	77,941
Additions - improvements						659						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-31