10-K 1 wsr10k2011-12.htm FORM 10-K WSR 10K (2011-12)


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

FORM 10-K

(Mark One)
x     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 001-34855
______________________________

WHITESTONE REIT

(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
76-0594970
(State or Other Jurisdiction of incorporation or
 
(I.R.S. Employer
Organization)
 
Identification No.)
 
 
 
2600 South Gessner, Suite 500, Houston, Texas
 
77063
(Address of Principal Executive Offices)
 
(Zip Code)

Registrant's telephone number, including area code: (713) 827-9595
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Class B Common Shares of Beneficial Interest, par value $0.001 per share
 
NYSE Amex

Securities registered pursuant to Section 12(g) of the Act:
Class A Common Shares of Beneficial Interest, par value $0.001 per share
(Title of Class)
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o        Accelerated filer x        Non-accelerated filer o        Smaller reporting company o
(Do not check if smaller reporting company)
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the Class B common shares held by nonaffiliates of the Registrant as of June 30, 2011 (the last business day of the Registrant's most recently completed second fiscal quarter) was $94,217,676 based on the closing price of Class B common shares of $12.72 per share as reported on the NYSE Amex.
As of February 24, 2012, the Registrant had 1,737,438 Class A and 10,157,114 Class B common shares of beneficial interest outstanding.
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 2012 Annual Meeting of Shareholders to be filed subsequently with the Securities and Exchange Commission.





WHITESTONE REIT
FORM 10-K
Year Ended December 31, 2011


 
Page
 
 
 
 
 
 
 
Item 1.
 
Item 1A.
 
Item 1B. 
 
Item 2.   
 
Item 3.    
 
Item 4.       
 
 
 

 




Unless the context otherwise requires, all references in this report to the “Company,” “we,” “us” or “our” are to Whitestone REIT and its consolidated subsidiaries unless the context clearly indicates otherwise.


Forward-Looking Statements

 
This Annual Report on Form 10-K contains forward-looking statements, 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. 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 to not 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:
 
the imposition of federal taxes if we fail to qualify as a real estate investment trust ("REIT") in any taxable year or forego an opportunity to ensure REIT status;
 
uncertainties related to the national economy, the real estate industry in general and in our specific markets;
 
legislative or regulatory changes, including changes to laws governing REITs;
 
adverse economic or real estate developments in Texas, Arizona or Illinois;
 
increases in interest rates and operating costs;
 
inability to obtain necessary outside financing;
 
litigation risks;
 
lease-up risks;
 
inability to obtain new tenants upon the expiration of existing leases;
 
inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws; and
 
the need to fund tenant improvements or other capital expenditures out of operating cash flow.
 
The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” section of this Annual Report on Form 10-K.




PART I
 
Item 1.  Business.
 
General
 
We are a Maryland REIT engaged in owning and operating commercial properties in culturally diverse markets in major metropolitan areas. Founded in 1998, we changed our state of organization from Texas to Maryland in December 2003.  We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”).
 
We are internally managed and, as of December 31, 2011, we owned a real estate portfolio of 45 properties containing approximately 3.6 million square feet of gross leasable area, located in Texas, Arizona and Illinois.  Our portfolio has a gross book value of approximately $292 million and book equity, including noncontrolling interests, of approximately $131 million as of December 31, 2011.
 
Our Class B common shares of beneficial interest, par value $0.001 per share ("Class B common shares") are currently traded on the NYSE Amex under the ticker symbol "WSR," and our Class A common shares of beneficial interest, par value $0.001 per share ("Class A common shares") are not currently traded on a national securities exchange.  Our offices are located at 2600 South Gessner, Suite 500, Houston, Texas 77063.  Our telephone number is (713) 827-9595 and we maintain a website at www.whitestonereit.com.
 
Our Strategy
 
In October 2006, our current management team joined the company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties. We define Community Centered Properties as visibly located properties in established or developing culturally diverse neighborhoods in our target markets. We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood. Those needs may include specialty retail, grocery, restaurants and medical, educational and financial services. Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property. We employ and develop a diverse group of associates who understand the needs of our multicultural communities and tenants.
Our primary business objective is to increase shareholder value by acquiring, owning and operating Community Centered Properties. The key elements of our strategy include:
 
Strategically Acquiring Properties.

Seeking High Growth Markets. We seek to strategically acquire commercial properties in high-growth markets. Our acquisition targets are located in densely populated, culturally diverse neighborhoods, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston, five of the top 20 markets in the United States in terms of population growth.

Diversifying Geographically. Our current portfolio is concentrated in Houston. We believe that continued geographic diversification in markets where we have substantial knowledge and experience will help offset the economic risk from a single market concentration. We intend to continue to focus our expansion efforts on the Phoenix, Chicago, Dallas and San Antonio markets. We believe our management infrastructure and capacity can accommodate substantial growth in those markets. We may also pursue opportunities in other Southwestern and Western regions that are consistent with our Community Centered Property strategy.

Capitalizing on Availability of Distressed Assets. We believe that during the next several years there will be excellent opportunities in our target markets to acquire quality properties at historically attractive prices. We intend to acquire distressed assets directly from owners or financial institutions holding foreclosed real estate and debt instruments that are either in default or on bank watch lists. Many of these assets may benefit from our corporate strategy and our management team’s experience in turning around distressed properties, portfolios and companies. We have extensive relationships with community banks, attorneys, title companies, and others in the real estate industry with whom we regularly work to identify properties for potential acquisition.
 



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Redeveloping and Re-tenanting Existing Properties. We “turn around” properties and seek to add value through renovating and re-tenanting our properties to create Whitestone-branded Community Centered Properties. We seek to accomplish this by (1) stabilizing occupancy, with per property occupancy goals of 90% or higher; (2) adding leasable square footage to existing structures; (3) developing and building on excess land; (4) upgrading and renovating existing structures; and (5) investing significant effort in recruiting tenants whose goods and services meet the needs of the surrounding neighborhood.
 
Recycling Capital for Greater Returns. We seek to continually upgrade our portfolio by opportunistically selling properties that do not have the potential to meet our Community Centered Property strategy and redeploying the sale proceeds into properties that better fit our strategy. Some of our properties that were acquired prior to the tenure of our current management team may not fit our Community Centered Property strategy, and we may look for opportunities to dispose of these properties as we continue to execute our strategy.
 
Prudent Management of Capital Structure. We currently have 19 properties that are not mortgaged. We may seek to add mortgage indebtedness to existing and newly acquired unencumbered properties to provide additional capital for acquisitions. As a general policy, we intend to maintain a ratio of total indebtedness to undepreciated book value of real estate assets that is less than 60%. As of December 31, 2011, our ratio of total indebtedness to undepreciated book value of real estate assets was 44%.
 
Investing in People. We believe that our people are the heart of our culture, philosophy and strategy. We continually focus on developing associates who are self-disciplined and motivated and display at all times a high degree of character and competence. We provide them with equity incentives to align their interests with those of our shareholders.
 
Our Structure
 
Substantially all of our business is conducted through Whitestone REIT Operating Partnership, L.P., a Delaware limited partnership organized in 1998 (the “Operating Partnership”).  We are the sole general partner of the Operating Partnership.  As of December 31, 2011, we owned an 89.3% interest in the Operating Partnership.

As of December 31, 2011, we owned a real estate portfolio consisting of 45 properties located in three states.  As of December 31, 2011, our Operating Portfolio Occupancy Rate was 87% based on gross leasable area compared to 86% as of December 31, 2010. We define Operating Portfolio Occupancy Rate as physical occupancy on all properties, excluding (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redeveloping or re-tenanting.

We take a very hands-on approach to ownership, and directly manage the operations and leasing of our properties.  Substantially all of our revenues consist of base rents received under long-term leases.  For the year ended December 31, 2011, our total revenues were approximately $34.9 million.  Approximately 60% of our existing leases contain “step up” rental clauses that provide for increases in the base rental payments.
 
As of December 31, 2011, 2010 and 2009, we had one property that accounted for more than 10% of total gross revenue and real estate assets.  Uptown Tower is an office building located in Dallas, Texas that accounted for 10.9%, 12.0% and 11.9% of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively.  Uptown Tower also accounted for  6.8%, 10.2% and 10.9% of our real estate assets, net of accumulated depreciation, for the years ended December 31, 2011, 2010 and 2009, respectively.  Of our 45 properties, 30 are located in the Houston, Texas metropolitan area.
 
Economic Factors

The recent economic recession continues to negatively impact the volume of real estate transactions, occupancy levels, tenants’ ability to pay rent and cap rates. Each of these factors could negatively impact the value of public real estate companies, including ours.  However, the vast majority of our retail properties are located in densely populated metropolitan areas and are occupied by tenants that generally provide basic necessity-type items and tend to be less affected by economic changes.  Furthermore, our portfolio is primarily positioned in metropolitan areas in Texas that have been impacted less by the economic slow down compared to other metropolitan areas.

Competition
 
All of our properties are located in areas that include competing properties.  The amount of competition in a particular

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area could impact our ability to acquire additional real estate, sell current real estate, lease space and the amount of rent we are able to charge.  We may be competing with owners, including, but not limited to, other REITs, insurance companies and pension funds, with access to greater resources than those available to us.
Many of our competitors have greater financial and other resources than us and may have more operating experience than us. Generally, there are other neighborhood and community retail centers within relatively close proximity to each of our properties. There is, however, no dominant competitor in the Houston, Dallas, San Antonio, Phoenix or Chicago metropolitan areas. Our retail tenants also face increasing competition from outlet malls, internet discount shopping clubs, catalog companies, direct mail and telemarketing.
 
Compliance with Governmental Regulations
 
Under various federal and state environmental laws and regulations, as an owner or operator of real estate, we may be required to investigate and clean up certain hazardous or toxic substances, asbestos-containing materials, or petroleum product releases at our properties. We may also be held liable to a governmental entity or to third parties for property damage and for investigation and cleanup costs incurred by those parties in connection with the contamination. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. The presence of contamination or the failure to remediate contaminations at any of our properties may adversely affect our ability to sell or lease the properties or to borrow using the properties as collateral. We could also be liable under common law to third parties for damages and injuries resulting from environmental contamination coming from our properties.

We will not purchase any property unless we are generally satisfied with the environmental status of the property. We may obtain a Phase I environmental site assessment, which includes a visual survey of the building and the property in an attempt to identify areas of potential environmental concerns, visually observing neighboring properties to assess surface conditions or activities that may have an adverse environmental impact on the property, and contacting local governmental agency personnel and performing a regulatory agency file search in an attempt to determine any known environmental concerns in the immediate vicinity of the property. A Phase I environmental site assessment does not generally include any sampling or testing of soil, groundwater or building materials from the property.
 
We believe that our properties are in compliance in all material respects with all federal, state and local ordinances and regulations regarding the handling, discharge and emission of hazardous or toxic substances. During the re-financing of twenty-one of our properties in late 2008 and early 2009, Phase I environmental site assessments were completed at those properties. These assessments revealed that five of the twenty-one properties currently or previously had a dry cleaning facility as a tenant. Since release of chlorinated solvents can occur as a result of dry cleaning operations, a Phase II subsurface investigation was conducted at the five identified properties, and all such investigations revealed the presence of chlorinated solvents. Based on the findings of the Phase II subsurface investigations, we promptly applied for entry into the Texas Commission on Environmental Quality Dry Cleaner Remediation Program, or DCRP, for four of the identified properties and were accepted. Upon entry, and continued good standing with the DCRP, the DCRP administers the Dry Cleaning Remediation fund to assist with remediation of contamination caused by dry cleaning solvents. The response actions associated with the ongoing investigation and subsequent remediation, if necessary, have not been determined at this time. However, we believe that the costs of such response actions will be immaterial, and therefore no liability has been recorded in our financial statements. We have not been notified by any governmental authority, and are not otherwise aware, other than the five identified properties described above, of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of our present or former properties. We have not recorded in our financial statements any material liability in connection with environmental matters. Nevertheless, it is possible that the environmental assessments conducted thus far and currently available to us do not reveal all potential environmental liabilities. It is also possible that subsequent investigations will identify material contamination or other adverse conditions, that adverse environmental conditions have arisen subsequent to the performance of the environmental assessments, or that there are material environmental liabilities of which management is unaware.
 
Under the Americans with Disabilities Act, or ADA, all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons. Our properties must comply with the ADA to the extent that they are considered “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. In addition, we will continue to assess our compliance with the ADA and to make alterations to our properties as required.
 

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Employees
 
As of December 31, 2011, we had 62 employees.


Materials Available on Our Website

Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as well as Reports on Forms 3, 4 and 5 regarding our officers, trustees or 10% beneficial owners, filed or furnished pursuant to Section 13(a), 15(d) or 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) are available free of charge through our website (www.whitestonereit.com) as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission (“SEC”).  We have also made available on our website copies of our Audit Committee Charter, Compensation Committee Charter, Nominating and Governance Committee Charter, Insider Trading Compliance Policy, and Code of Business Conduct and Ethics Policy.  In the event of any changes to these charters, the code or guidelines, revised copies will also be made available on our website.  You may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. 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. Materials on our website are not part of our Annual Report on Form 10-K.

Financial Information
 
Additional financial information related to the Company is included in Item 8 “Consolidated Financial Statements and Supplementary Data.”

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Item 1A.  Risk Factors.
 
In addition to the other information contained in this annual report, the following risk factors should be considered carefully in evaluating our business.  Our business, financial condition, results of operations or the trading price of our Class B common shares could be materially adversely affected by any of these risks.  Please note that additional risks not presently known to us or which we currently consider immaterial may also impair our business and operations.
 
Risks Associated with Real Estate
 
Recent market disruptions may significantly and adversely affect our financial condition and results of operations.
 
The U.S. economy is still experiencing weakness from recent economic conditions, which resulted in increased unemployment, weakening of tenant financial condition, large-scale business failures and tight credit markets. Our results of operations may be sensitive to changes in overall economic conditions that impact tenant leasing practices. Adverse economic conditions affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could reduce overall tenant leasing or cause tenants to shift their leasing practices. In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. Although the U.S. economy has emerged from the recent recession, high levels of unemployment have persisted, and rental rates and valuations for retail space have not fully recovered to pre-recession levels and may not for a number of years. At this time, it is difficult to determine the breadth and duration of the impact of the economic and financial market problems and the many ways in which they could affect our tenants and our business in general. A general reduction in the level of tenant leasing could adversely affect our ability to maintain our current tenants and gain new tenants, affecting our growth and profitability. Accordingly, continuation or further worsening of these difficult financial and macroeconomic conditions could have a significant adverse effect on our cash flows, profitability, results of operations and the trading price of our Class B common shares.

Real estate property investments are illiquid due to a variety of factors and therefore we may not be able to dispose of properties when appropriate or on favorable terms.
 
Our strategy includes opportunistically selling properties that do not have the potential to meet our Community Centered Property strategy. However, real estate property investments generally cannot be disposed of quickly. In addition, the Code imposes restrictions on the ability of a REIT to dispose of properties that are not applicable to other types of real estate companies. Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on favorable terms, which could cause us to incur extended losses, reduce our cash flows and adversely affect distributions to shareholders.
 
We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. To the extent we are unable to sell any properties for our book value, we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income.
 
We may be required to expend funds and time to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements, which may impede our ability to sell a property. Further, we may agree to transfer restrictions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These transfer restrictions would impede our ability to sell a property even if we deem it necessary or appropriate. These facts and any others that would further contribute to the illiquid character of real estate properties and impede our ability to respond to adverse changes in the performance of our properties may have a material adverse effect on our business, financial condition, results of operations, our ability to make distributions to our shareholders and the trading price of our Class B common shares.
 
Our business is dependent upon our tenants successfully operating their businesses and their failure to do so could have a material adverse effect on our ability to successfully and profitably operate our business.
 
We depend on our tenants to operate the properties we own in a manner which generates revenues sufficient to allow them to meet their obligations to us, including their obligations to pay rent, maintain certain insurance coverage, pay real estate taxes and maintain the properties in a manner so as not to jeopardize their operating licenses or regulatory status. The ability of

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our tenants to fulfill their obligations under our leases may depend, in part, upon the overall profitability of their operations. Cash flow generated by certain tenant businesses may not be sufficient for a tenant to meet its obligations to us. Our financial position could be weakened and our ability to fulfill our obligations under our indebtedness could be limited if a number of our tenants were unable to meet their obligations to us or failed to renew or extend their relationship with us as their lease terms expire, or if we were unable to lease or re-lease our properties on economically favorable terms. These adverse developments could arise due to a number of factors, including those described in the risk factors discussed in this annual report.
 
Turmoil in capital markets could adversely impact acquisition activities and pricing of real estate assets.
 
Volatility in capital markets could adversely affect acquisition activities by impacting certain factors, including the tightening of underwriting standards by lenders and credit rating agencies and the significant inventory of unsold collateralized mortgage backed securities in the market. These factors directly affect a lender's ability to provide debt financing as well as increase the cost of available debt financing. As a result, we may not be able to obtain favorable debt financing in the future or at all. This may impair our ability to acquire properties or result in future acquisitions generating lower overall economic returns, which may adversely affect our results of operations and distributions to shareholders. Furthermore, any turmoil in the capital markets could adversely impact the overall amount of capital available to invest in real estate, which may result in price or value decreases of real estate assets.
 
The value of investments in our common shares will be directly affected by general economic and regulatory factors we cannot control or predict.
 
Investments in real estate typically involve a high level of risk as the result of factors we cannot control or predict. One of the risks of investing in real estate is the possibility that our properties will not generate income sufficient to meet operating expenses or will generate income and capital appreciation, if any, at rates lower than those anticipated or available through investments in comparable real estate or other investments. The following factors may affect income from properties and yields from investments in properties and are generally outside of our control:
 
conditions in financial markets;
 
over-building in our markets;
 
a reduction in rental income as the result of the inability to maintain occupancy levels;
 
adverse changes in applicable tax, real estate, environmental or zoning laws;
 
changes in general economic conditions;
 
a taking of any of our properties by eminent domain;
 
adverse local conditions (such as changes in real estate zoning laws that may reduce the desirability of real estate in the area);
 
acts of God, such as hurricanes, earthquakes or floods and other uninsured losses;
 
changes in supply of or demand for similar or competing properties in an area;
 
changes in interest rates and availability of permanent debt capital, which may render the sale of a property difficult or unattractive; and
 
periods of high interest rates, inflation or tight money supply.
 
Some or all of these factors may affect our properties, which could adversely affect our operations and ability to pay dividends to shareholders.

We may face significant competition in our efforts to acquire financially distressed properties and debt.
 
Our acquisition strategy includes acquiring distressed commercial real estate, and we could face significant competition from other investors, REITs, hedge funds, private equity funds and other private real estate investors with greater financial resources and access to capital than us. Therefore, we may not be able to compete successfully for investments. In

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addition, the number of entities and the amount of purchasers competing for suitable investments may increase, all of which could result in competition for accretive acquisition opportunities and adversely affect our business plan and our ability to maintain our current dividend rate.

All of our properties are subject to property taxes that may increase in the future, which could adversely affect our cash flow.
 
Our properties are subject to property taxes that may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities. As the owner of the properties we are ultimately responsible for payment of the taxes to the government. If property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes. In addition, we will generally be responsible for property taxes related to any vacant space in our properties.

Our assets may be subject to impairment charges.
 
We periodically evaluate our real estate investments and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, tenant performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the asset, which could have a material adverse effect on our results of operations and funds from operations in the period in which the write-off occurs.
 
Compliance or failure to comply with laws requiring access to our properties by disabled persons could result in substantial cost.
 
The Americans with Disabilities Act, or ADA, and other federal, state and local laws generally require public accommodations be made accessible to disabled persons. Noncompliance could result in the imposition of fines by the government or the award of damages to private litigants. These laws may require us to modify our existing properties. These laws may also restrict renovations by requiring improved access to such buildings by disabled persons or may require us to add other structural features which increase our construction costs. Legislation or regulations adopted in the future may impose further burdens or restrictions on us with respect to improved access by disabled persons. We may incur unanticipated expenses that may be material to our financial condition or results of operations to comply with ADA and other federal, state and local laws, or in connection with lawsuits brought by private litigants.
 
We face intense competition, which may decrease, or prevent increases of, the occupancy and rental rates of our properties.
 
We compete with a number of developers, owners and operators of commercial real estate, many of whom own properties similar to ours in the same markets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our tenants' leases expire. This competitive environment could have a material adverse effect on our ability to lease our properties or any newly developed or acquired property, as well as on the rents charged.
 
Risks Associated with Our Operations
 
Because of the current geographic concentration of our portfolio, an economic downturn in the Houston metropolitan area could adversely impact our operations and ability to pay dividends to our shareholders.
 
The majority of our assets and revenues are currently derived from properties located in the Houston metropolitan area. As of December 31, 2011, we had 65% of our gross leasable area in Houston. Our results of operations are directly contingent on our ability to attract financially sound commercial tenants. A significant economic downturn may adversely impact our ability to locate and retain financially sound tenants and could have an adverse impact on our tenants' revenues, costs and results of operations and may adversely affect their ability to meet their obligations to us. Likewise, we may be required to lower our rental rates to attract desirable tenants in such an environment. Consequently, because of the geographic concentration among our current assets, if the Houston metropolitan area experiences an economic downturn, our operations and ability to pay dividends to our shareholders could be adversely impacted.
 



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We lease our properties to approximately 900 tenants, with leases for approximately 10% to 20% of our gross leasable area expiring annually. Each year we face the risk of non-renewal of a material percentage of our leases and the cost of re-leasing a significant amount of our available space, and our failure to meet leasing targets and control the cost of re-leasing our properties could adversely affect our rental revenue, operating expenses and results of operations.
 
The nature of our business model warrants shorter term leases to smaller, non-national tenants, and substantially all of our revenues consist of base rents received under these leases. As of December 31, 2011, approximately 33% of the aggregate gross leasable area of our properties is subject to leases that expire prior to December 31, 2013. We are subject to the risk that:
 
tenants may choose not to, or may not have the financial resources to, renew these leases;
 
we may experience significant costs associated with re-leasing a significant amount of our available space;
 
we may not be able to easily re-lease the space subject to these leases, which may cause us to fail to meet our leasing targets or control the costs of re-leasing; and
 
the terms of any renewal or re-lease may be less favorable than the terms of the current leases.
 
We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While our early renewal program and other leasing and marketing efforts target these expiring leases, and while we hope to re-lease most of that space prior to expiration of the leases at rates comparable to or slightly in excess of the current rates, market conditions, including new supply of properties, and macroeconomic conditions in Houston and nationally could adversely impact our renewal rate and/or the rental rates we are able to negotiate. If any of these risks materialize, our rental revenue, operating expenses and results of operations could be adversely affected.
 
Many of our tenants are small businesses, which may have a higher risk of bankruptcy or insolvency.
 
Many of our tenants are small businesses that depend primarily on cash flows from their businesses to pay their rent and without other resources could be at a higher risk of bankruptcy or insolvency than larger, national tenants. If tenants are unable to comply with the terms of our leases, we may be forced to modify the leases in ways that are unfavorable to us. Alternatively, the failure of a tenant to perform under a lease could require us to declare a default, repossess the space and find a suitable replacement tenant. There is no assurance that we would be able to lease the space on substantially equivalent or better terms than the prior lease, or at all, or successfully reposition the space for other uses.
  
If one or more of our tenants files for bankruptcy relief, the Bankruptcy Code provides that a debtor has the option to assume or reject the unexpired lease within a certain period of time. For example, on November 10, 2008, one of our tenants, Circuit City, which leased space at one of our properties and represented approximately 1.1% of our total rent for the year ended December 31, 2008, filed for reorganization under Chapter 11 of the Bankruptcy Code. The tenant elected to reject our lease.

Any bankruptcy filing by or relating to one or more of our tenants could bar all efforts by us to collect pre-bankruptcy debts from that tenant or seize its property. A tenant bankruptcy could also delay our efforts to collect past due balances under the lease and could ultimately preclude collection of all or a portion of these sums. It is possible that we may recover substantially less than the full value of any unsecured claims we hold, if any. Furthermore, dealing with a tenant's bankruptcy or other default may divert management's attention and cause us to incur substantial legal and other costs. The bankruptcy or insolvency of a number of smaller tenants may have an adverse impact on our business, financial condition and results of operations, our ability to make distributions to our shareholders and the trading price of our Class B common shares.
  
Uninsured losses relating to real property or excessively expensive premiums for insurance coverage may adversely affect our returns.
 
We attempt to adequately insure all of our properties to cover casualty losses. However, there are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Our current geographic concentration in the Houston metropolitan area potentially increases the risk of damage to our portfolio due to hurricanes. Insurance risks associated with potential terrorism acts could sharply increase the premiums we pay for coverage against property and casualty claims. In some instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot

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assure you that we will have adequate coverage for these losses. Also, to the extent we must pay unexpectedly large insurance premiums, we could suffer reduced earnings that would result in less cash to be distributed to shareholders.
 
Discovery of previously undetected environmentally hazardous conditions may adversely affect our operating results.
 
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on, under or in its property. The costs of removal or remediation could be substantial. These laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of any hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. Environmental laws provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos containing materials into the air. In addition, third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of compliance with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distributions to our shareholders.
 
We may not be successful in consummating suitable acquisitions or investment opportunities, which may impede our growth and negatively affect our results of operations.
 
Our ability to expand through acquisitions is integral to our business strategy and requires us to consummate suitable acquisition or investment opportunities that meet our criteria and are compatible with our growth strategy. We may not be successful in consummating acquisitions or investments in properties that meet our acquisition criteria on satisfactory terms or at all. Failure to consummate acquisitions or investment opportunities, or to integrate successfully any acquired properties without substantial expense, delay or other operational or financial problems, would slow our growth, which could in turn adversely affect the trading price of our Class B common shares.
 
Our ability to acquire properties on favorable terms may be constrained by the following significant risks:
 
competition from other real estate investors with significant capital, including other REITs and institutional investment funds;
 
competition from other potential acquirers which may significantly increase the purchase price for a property we acquire, which could reduce our growth prospects;
 
unsatisfactory results of our due diligence investigations or failure to meet other customary closing conditions; and
 
failure to finance an acquisition on favorable terms or at all.
 
If any of these risks are realized, our business, financial condition and results of operations, our ability to make distributions to our shareholders and the trading price of our Class B common shares may be materially and adversely affected.
 
Our success depends in part on our ability to execute our Community Centered Property strategy.
 
Our Community Centered Property strategy requires intensive management of a large number of small spaces and small tenant relationships. Our success depends in part upon our management's ability to identify potential Community Centered Properties and find and maintain the appropriate tenants to create such a property. Lack of market acceptance of our Community Centered Property strategy or our inability to successfully attract and manage a large number of tenant relationships could adversely affect our occupancy rates, operating results and dividend rate.
 
Loss of our key personnel, particularly our eight senior managers, could threaten our ability to execute our strategy and operate our business successfully.
 
We are dependent on the experience and knowledge of our key executive personnel, particularly our eight senior managers who have been instrumental in setting our strategic direction, operating our business, identifying, recruiting and training key personnel and arranging necessary financing. Losing the services of any of these individuals could adversely affect our business until qualified replacements could be found. We also believe that they could not quickly be replaced with

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managers of equal experience and capabilities and their successors may not be as effective.
 
Our systems may not be adequate to support our growth, and our failure to successfully oversee our portfolio of properties could adversely affect our results of operations.
 
We cannot assure you that we will be able to adapt our portfolio management, administrative, accounting and operational systems, or hire and retain sufficient operational staff, to support our growth. Our failure to successfully oversee our current portfolio of properties or any future acquisitions or developments could have a material adverse effect on our results of operations and financial condition and our ability to make distributions.
 
There can be no assurance that we will be able to pay or maintain cash distributions or that distributions will increase over time.
 
There are many factors that can affect the availability and timing of cash distributions to shareholders. Distributions are based upon our funds from operations, financial condition, cash flows and liquidity, debt service requirements, capital expenditure requirements for our properties and other matters our board of trustees may deem relevant from time to time. If we do not have sufficient cash available for distributions, we may need to fund the shortage out of working capital or borrow to provide funds for such distributions, which would reduce the amount of proceeds available for real estate investments and increase our future interest costs.

We can give no assurance that we will be able to continue to pay distributions or that distributions will increase over time. In addition, we can give no assurance that rents from our properties will increase, or that future acquisitions of real properties, mortgage loans or out investments in securities will increase our cash available for distributions to shareholders. Our actual results may differ significantly from the assumptions used by our board of trustees in establishing the distribution rate to shareholders. Our inability to make distributions, or to make distributions at expected levels, could result in a decrease in the trading price of our Class B common shares.

Any weaknesses identified in our system of internal controls by us and our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 could have an adverse effect on our business.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that public companies evaluate and report on their systems of internal control over financial reporting. In addition, our independent registered public accounting firm must report on management's evaluation of those controls. In future periods, we may identify deficiencies in our system of internal controls over financial reporting that may require remediation. There can be no assurances that any such future deficiencies identified may not be material weaknesses that would be required to be reported in future periods.

Risks Associated with Our Indebtedness and Financing
 
Current market conditions could adversely affect our ability to refinance existing indebtedness or obtain additional financing for growth on acceptable terms or at all, which could adversely affect our ability to grow, our interest cost and our results of operations.
 
The United States credit markets have recently experienced significant dislocations and liquidity disruptions, including the bankruptcy, insolvency or restructuring of certain financial institutions. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of various types of debt financing. Reductions in our available borrowing capacity, or inability to establish a credit facility when required or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. In addition, we mortgage most of our properties to secure payment of indebtedness. If we are not successful in refinancing our mortgage debt upon maturity, then the property could be foreclosed upon or transferred to the mortgagee, or we might be forced to dispose of some of our properties upon disadvantageous terms, with a consequent loss of income and asset value. A foreclosure or disadvantageous disposal on one or more of our properties could adversely affect our ability to grow, financial condition, interest cost, results of operations, cash flow and ability to pay dividends to our shareholders.
 
Furthermore, if prevailing interest rates or other factors at the time of refinancing result in higher interest rates upon refinancing, then the interest expense relating to that refinanced indebtedness would increase. Higher interest rates on newly incurred debt may negatively impact us as well. If interest rates increase, our interest costs and overall costs of capital will increase, which could adversely affect our transaction and development activity, financial condition, results of operation, cash flow, our ability to pay principal and interest on our debt and our ability to pay dividends to our shareholders.

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If we invest in mortgage loans, these investments may be affected by unfavorable real estate market conditions, including interest rate fluctuations, which could decrease the value of those loans and the return on your investment.
 
If we invest in mortgage loans, we will be at risk of defaults by the borrowers on those mortgage loans as well as interest rate risks. To the extent we incur delays in liquidating such defaulted mortgage loans, we may not be able all amounts due to us under the mortgage loans. Further, we will not know whether the values of the properties securing the mortgage loans will remain at the levels existing on the dates of origination of those mortgage loans or the dates of our investment in the loans. If the values of the underlying properties fall, our risk will increase because of the lower value of the security associated with such loans.
  
Our failure to hedge effectively against interest rate changes may adversely affect results of operations.
 
We currently have mortgages that bear interest at a variable rate and we may incur additional variable rate debt in the future. Accordingly, increases in interest rates on variable rate debt would increase our interest expense, which could reduce net earnings and cash available for payment of our debt obligations and distributions to our shareholders.
 
We may seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements, such as interest cap agreements and interest rate swap agreements. These agreements involve risks, such as the risk that counterparties may fail to honor their obligations under these arrangements, that these arrangements may not be effective in reducing our exposure to interest rate changes and that a court could rule that such an agreement is not legally enforceable. In the past, we have used derivative financial instruments to hedge interest rate risks related to our variable rate borrowings. We will not use derivatives for speculative or trading purposes and intend only to enter into contracts with major financial institutions based on their credit rating and other factors, but we may choose to change this practice in the future. We may enter into interest rate swap agreements for our variable rate debt, which totals $35.6 million as of December 31, 2011. Hedging may reduce the overall returns on our investments. Failure to hedge effectively against interest rate changes may materially adversely affect our results of operations.
 
We currently have and may incur additional mortgage indebtedness and other borrowings, which may increase our business risks and may adversely affect our ability to make distributions to our shareholders.
 
If it is determined to be in our best interests, we may, in some instances, acquire real properties by using either existing financing or borrowing new funds. In addition, we may incur or increase our current mortgage debt to obtain funds to acquire additional properties. We may also borrow funds if necessary to satisfy the REIT distribution requirement described above, or otherwise as may be necessary or advisable to assure that we maintain our qualification as a REIT for federal income tax purposes.
 
On February 27, 2012, we, through our Operating Partnership, entered into a new three-year unsecured $125 million revolving credit facility (the “2012 Facility”). We will use the 2012 Facility for general corporate purposes, including acquisitions and redevelopment of existing properties in our portfolio. The 2012 Facility replaced our existing unsecured revolving credit facility. As of December 31, 2011, $11 million was drawn on our existing credit facility. Like our existing credit facility, the 2012 Facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, maximum secured indebtedness to total asset value, minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges, minimum property net operating income to total indebtedness and maintenance of net worth. The amount available to us and our ability to borrow from time to time under the 2012 Facility is subject to our compliance with these requirements.

We may also incur mortgage debt on a particular property if we believe the property's projected cash flow is sufficient to service the mortgage debt. As of December 31, 2011, we had approximately $116.9 million of mortgage debt secured by 26 of our properties. If there is a shortfall in cash flow, however, the amount available for dividends to shareholders may be affected. In addition, incurring mortgage debt increases the risk of loss because defaults on such indebtedness may result in loss of property in foreclosure actions initiated by lenders. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds. We may give lenders full or partial guarantees for mortgage debt incurred by the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by that entity. If any mortgages contain cross-collateralization or cross-default provisions, there is a risk that more than one property may be affected by a

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default. If any of our properties are foreclosed upon due to a default, our ability to pay cash dividends to our shareholders will be adversely affected. For more discussion, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”


High mortgage rates and/or unavailability of mortgage debt may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our net income and the amount of cash distributions we can make.

If mortgage debt is unavailable at rates acceptable to us, we may not be able to finance the purchase of properties. If we place mortgage debt on properties, we may be unable to refinance the properties when the loans become due, or to refinance on favorable terms. If interest rates are higher when we refinance our properties, our payments on our indebtedness would increase and our income could be reduced. If any of these events occur, our cash flow could be reduced. This, in turn, could reduce cash available for distribution to our shareholders and may hinder our ability to raise more capital by issuing more shares or by borrowing more money.

If we set aside insufficient working capital or are unable to secure funds for future tenant improvements, we may be required to defer necessary property improvements, which could adversely impact our ability to pay cash distributions to our shareholders.

When tenants do not renew their leases or otherwise vacate their space, it is possible that, in order to attract replacement tenants, we may be required to expend substantial funds for tenant improvements and tenant refurbishments to the vacated space. If we have insufficient working capital reserves, we will have to obtain financing from other sources. Because most of our leases will provide for tenant reimbursement of operating expenses, we do not anticipate that we will establish a permanent reserve for maintenance and repairs for our properties. However, to the extent that we have insufficient funds for such purposes, we may establish reserves for maintenance and repairs of our properties out of cash flow generated by operating properties or out of non-liquidating net sale proceeds. If these reserves or any reserves otherwise established are insufficient to meet our cash needs, we may have to obtain financing from either affiliated or unaffiliated sources to fund our cash requirements. We cannot assure you that sufficient financing will be available or, if available, will be available on economically feasible terms or on terms acceptable to us. Additional borrowing for working capital purposes will increase our interest expense, and therefore our financial condition and our ability to pay cash distributions to our shareholders may be adversely affected. In addition, we may be required to defer necessary improvements to our properties that may cause our properties to suffer from a greater risk of obsolescence or a decline in value, or a greater risk of decreased cash flow as a result of fewer potential tenants being attracted to our properties. If this happens, we may not be able to maintain projected rental rates for affected properties, and our results of operations may be negatively impacted.

We may structure acquisitions of property in exchange for limited partnership units in our Operating Partnership on terms that could limit our liquidity or our flexibility.
 
We may acquire properties by issuing limited partnership units in our Operating Partnership in exchange for a property owner contributing property to the Operating Partnership. If we enter into such transactions, in order to induce the contributors of such properties to accept units in our Operating Partnership, rather than cash, in exchange for their properties, it may be necessary for us to provide them with additional incentives. For instance, our Operating Partnership's limited partnership agreement provides that any holder of units may redeem limited partnership units for cash, or, at our option, Class A common shares on a one-for-one exchange basis. We may, however, enter into additional contractual arrangements with contributors of property under which we would agree to redeem a contributor's units for our Class A common shares or cash, at the option of the contributor, at set times. If the contributor required us to redeem units for cash pursuant to such a provision, it would limit our liquidity and thus our ability to use cash to make other investments, satisfy other obligations or pay distributions. Moreover, if we were required to redeem units for cash at a time when we did not have sufficient cash to fund the redemption, we might be required to sell one or more properties to raise funds to satisfy this obligation. Furthermore, we might agree that if distributions the contributor received as a limited partner in our Operating Partnership did not provide the contributor with a defined return, then upon redemption of the contributor's units we would pay the contributor an additional amount necessary to achieve that return. Such a provision could further negatively impact our liquidity and flexibility. Finally, in order to allow a contributor of a property to defer taxable gain on the contribution of property to our Operating Partnership, we might agree not to sell a contributed property for a defined period of time or until the contributor redeemed the contributor's units for cash or our common shares. Such an agreement would prevent us from selling those properties, even if market conditions made such a sale favorable to us.
 



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We may issue preferred shares with a preference in distributions over our common shares, and our ability to issue preferred shares and additional common shares may deter or prevent a sale of our common shares in which you could profit.
 
Our declaration of trust authorizes our board of trustees to issue up to 50,000,000 Class A common shares, 350,000,000 Class B common shares and 50,000,000 preferred shares. Our board of trustees may amend our declaration of trust from time to time to increase or decrease the aggregate number of shares or the number of any class or series that we have authority to issue. In addition, our board of trustees may classify or reclassify any unissued common shares or preferred shares and may set the preferences, rights and other terms of the classified or reclassified shares. The terms of preferred shares could include a preference in distributions over our common shares. If we authorize and issue preferred shares with a distribution preference over our common shares, payment of any distribution preferences of outstanding preferred shares would reduce the amount of funds available for the payment of distributions on our common shares. Further, holders of preferred shares are normally entitled to receive a preference payment in the event we liquidate, dissolve or wind up before any payment is made to our common shareholders, likely reducing the amount our common shareholders would otherwise receive upon such an occurrence. In addition, under certain circumstances, the issuance of preferred shares or a separate class or series of common shares may render more difficult or tend to discourage:
 
a merger, tender offer or proxy contest;
 
assumption of control by a holder of a large block of our shares; or
 
removal of incumbent management.
 
Risks Associated with Income Tax Laws
 
If we fail to qualify as a REIT, our operations and dividends to shareholders would be adversely impacted.
 
We intend to continue to be organized and to operate so as to qualify as a REIT under the Code. A REIT generally is not taxed at the corporate level on income it currently distributes to its shareholders. Qualification as a REIT involves the application of highly technical and complex rules for which there are only limited judicial or administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to continue to qualify as a REIT. In addition, new legislation, new regulations, administrative interpretations or court decisions could significantly change the tax laws, possibly with retroactive effect, with respect to qualification as a REIT or the federal income tax consequences of such qualification.
 
If we were to fail to qualify as a REIT in any taxable year:
 
we would not be allowed to deduct our distributions to shareholders when computing our taxable income;
 
we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates;
 
we would be disqualified from being taxed as a REIT for the four taxable years following the year during which qualification was lost, unless entitled to relief under certain statutory provisions;
 
our cash available for dividends to shareholders would be reduced; and
 
we may be required to borrow additional funds or sell some of our assets in order to pay corporate tax obligations that we may incur as a result of our disqualification.
 
If the Internal Revenue Service, or IRS, were to determine that (i) we failed the 5% asset test for the first quarter of our 2009 taxable year and (ii) our failure of that test was not attributable to reasonable cause, but rather, willful neglect, we would fail to qualify as a REIT for our 2009 taxable year, which would adversely affect our operations and our shareholders.

In 2010, we discovered that we may have inadvertently violated the 5% asset test for the quarter ended March 31, 2009 as a result of utilizing a certain cash management arrangement with a commercial bank. If that investment in a commercial paper investment account is not treated as cash, and is instead treated as a security for purposes of the quarterly 5% asset test applicable to REITs, then we would have failed that test for the first quarter of our 2009 taxable year.

If the IRS were to assert that we failed the 5% asset test for the first quarter of our 2009 taxable year and that such

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failure was not due to reasonable cause, and the courts were to sustain that position, our status as a REIT would terminate as of December 31, 2008. We would not be eligible to again elect REIT status until our 2014 taxable year. Consequently, we would be subject to federal income tax on our taxable income at regular corporate rates and our cash available for distributions to shareholders would be reduced.

Additionally, if we in fact failed the 5% test, but failure is considered due to reasonable cause and not willful neglect, we would be subject to a tax equal to the greater of $50,000 or 35% of the net income from the commercial paper investment account during the period in which we failed to satisfy the 5% asset test. The amount of such tax is $50,000 and we paid such tax on April 27, 2010.
 
We may need to incur additional borrowings to meet the REIT minimum distribution requirement and to avoid excise tax.
 
In order to maintain our qualification as a REIT, we are required to distribute to our shareholders at least 90% of our annual real estate investment trust taxable income (excluding any net capital gain and before application of the dividends paid deduction). In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of (i) 85% of our ordinary income for that year, (ii) 95% of our net capital gain for that year and (iii) 100% of our undistributed taxable income from prior years. Although we intend to pay dividends to our shareholders in a manner that allows us to meet the 90% distribution requirement and avoid this 4% excise tax, we cannot assure you that we will always be able to do so.
 
Our income consists almost solely of our share of our Operating Partnership's income, and the cash available for distribution by us to our shareholders consists of our share of cash distributions made by our Operating Partnership. Because we are the sole general partner of our Operating Partnership, our board of trustees determines the amount of any distributions made by it. Our board of trustees may consider a number of factors in authorizing distributions, including:
 
the amount of the cash available for distribution;
 
our Operating Partnership's financial condition;
 
our Operating Partnership's capital expenditure requirements; and
 
our annual distribution requirements necessary to maintain our qualification as a REIT.
 
Differences in timing between the actual receipt of income and actual payment of deductible expenses and the inclusion of income and deduction of expenses when determining our taxable income, as well as the effect of nondeductible capital expenditures and the creation of reserves or required debt amortization payments could require us to borrow funds on a short-term or long-term basis or make taxable distributions to our shareholders of our shares or debt securities to meet the REIT distribution requirement and to avoid the 4% excise tax described above. In these circumstances, we may need to borrow funds to avoid adverse tax consequences even if our management believes that the then prevailing market conditions generally are not favorable for borrowings or that borrowings would not be advisable in the absence of the tax consideration.
 
If our Operating Partnership were classified as a “publicly traded partnership” taxable as a corporation for federal income tax purposes under the Code, we would cease to qualify as a REIT and would suffer other adverse tax consequences.
 
We structured our Operating Partnership so that it would be classified as a partnership for federal income tax purposes. In this regard, the Code generally classifies “publicly traded partnerships” (as defined in Section 7704 of the Code) as associations taxable as corporations (rather than as partnerships), unless substantially all of their taxable income consists of specified types of passive income. In order to minimize the risk that the Code would classify our Operating Partnership as a “publicly traded partnership” for tax purposes, we placed certain restrictions on the transfer and/or redemption of partnership units in our Operating Partnership. If the IRS were to assert successfully that our Operating Partnership is a “publicly traded partnership,” and substantially all of its gross income did not consist of the specified types of passive income, the Code would treat our Operating Partnership as an association taxable as a corporation.
 
In such event, the character of our assets and items of gross income would change and would prevent us from continuing to qualify as a REIT. In addition, the imposition of a corporate tax on our Operating Partnership would reduce our amount of cash available for payment of distributions by us to our shareholders.
 
Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments.

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To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our shareholders and the ownership of our shares. In order to meet these tests, we may be required to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our performance.
 
In particular, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by the securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our shareholders.
 
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our Class B common shares.
 
At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. We cannot predict when or if any new federal income tax law, regulation, or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation, or interpretation may take effect retroactively. We and our shareholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.
 
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
 
The maximum tax rate applicable to income from “qualified dividends” payable to U.S. shareholders that are individuals, trusts and estates has been reduced by legislation to 15% (currently through 2012). Dividends payable by REITs, however, generally are not eligible for the reduced rates. Although this legislation does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common shares.
 
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
 
The REIT provisions of the Code substantially limit our ability to hedge our liabilities. Any income from a hedging transaction that we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through taxable REIT subsidiaries. This could increase the cost of our hedging activities because any taxable REIT subsidiary that we may form would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in taxable REIT subsidiaries will generally not provide any tax benefit, except for being carried forward against future taxable income in the taxable REIT subsidiaries.
 
Risks Related to Ownership of our Class B Common Shares
 
Following exchange offers that we have in the past conducted and intend to conduct in the future, large numbers of our Class A shareholders receiving Class B common shares may create a significant demand to sell our Class B common shares. Significant sales of our Class B common shares, or the perception that significant sales of such shares could occur, may cause the price of our Class B common shares to decline significantly.

Our Class A common shares are not listed on any national securities exchange and the ability of shareholders to liquidate their investments in Class A common shares is limited. We do not intend to list shares our Class A common shares on

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a national securities exchange. However, we have conducted a series of exchange offers to exchange our Class A common shares and our OP units for Class B common shares. See “Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities-Exchange Offers.” Following each such exchange offer, if our former Class A shareholders and OP unitholders sell, or the market perceives that our shareholders intend to sell, substantial numbers of our Class B common shares in the public market, the market price of our Class B common shares could decline significantly. As of December 31, 2011, we had 2,603,292 Class A common shares and 1,360,927 OP units, not held by us, outstanding.

In addition, because our Class A common shares are not subject to transfer restrictions (other than the restrictions on ownership and transfer of shares set forth in our declaration of trust), such shares are freely tradable. As a result, notwithstanding that such shares will not be listed on a national securities exchange, it is possible that a market may develop for shares of our Class A common shares, and sales of such shares, or the perception that such sales could occur, could have a material adverse effect on the trading price of our Class B common shares.

Increases in market interest rates may result in a decrease in the value of our Class B common shares.

One of the factors that may influence the price of our Class B common shares will be the dividend distribution rate on the Class B common shares (as a percentage of the price of our Class B common shares) relative to market interest rates. If market interest rates rise, prospective purchasers of shares of our Class B common shares may expect a higher distribution rate. Higher interest rates would not, however, result in more funds being available for distribution and, in fact, would likely increase our borrowing costs and might decrease our funds available for distribution. We therefore may not be able, or we may not choose, to provide a higher distribution rate. As a result, prospective purchasers may decide to purchase other securities rather than our Class B common shares, which would reduce the demand for, and result in a decline in the market price of, our Class B common shares.

Broad market fluctuations could negatively impact the market price of our Class B common shares.

The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to ours and that have been unrelated to these companies' operating performances. These broad market fluctuations could reduce the market price of our Class B common shares. Furthermore, our operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations. Either of these factors could lead to a material decline in the market price of our Class B common shares.

Maryland takeover statutes may deter others from seeking to acquire us and prevent you from making a profit in such transactions.

The Maryland General Corporation Law, or the MGCL, contains many provisions, such as the business combination statute and the control share acquisition statute, that are designed to prevent, or have the effect of preventing, someone from acquiring control of us. The business combination statute, subject to limitations, prohibits certain business combinations between us and an “interested shareholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding voting shares or an affiliate or associate of our company who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then outstanding shares) or an affiliate of an interested shareholder for five years after the most recent date on which the person becomes an interested shareholder and thereafter imposes supermajority voting requirements on these combinations. The control share acquisition statute provides that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the shareholder (except solely by virtue of a revocable proxy), entitle the shareholder to exercise one of three increasing ranges of voting power in electing trustees) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding control shares) have no voting rights except to the extent approved by our shareholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

We are currently subject to the control share acquisition statute, although our board of trustees may amend our Amended and Restated Bylaws, or our bylaws, without shareholder approval, to exempt any acquisition of our shares from the statute. Our board of trustees has adopted a resolution exempting any business combination with any person from the business combination statute. The business combination statute (if our board of trustees revokes the foregoing exemption) and the control share acquisition statute could delay or prevent offers to acquire us and increase the difficulty of consummating any such offers, even if such a transaction would be in our shareholders' best interest.
 


16


The MGCL, the Maryland REIT Law and our organizational documents limit your right to bring claims against our officers and trustees.
 
The MGCL and the Maryland REIT Law provide that a trustee will not have any liability as a trustee so long as he performs his duties in good faith, in a manner he reasonably believes to be in our best interests, and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, our declaration of trust provides that no trustee or officer will be liable to us or to any shareholder for money damages except to the extent that (a) the trustee or officer actually received an improper benefit or profit in money, property or services, for the amount of the benefit or profit in money, property, or services actually received; or (b) a judgment or the final adjudication adverse to the trustee or officer is entered in a proceeding based on a finding in the proceeding the trustee's or officer's action or failure to act was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding. Finally, our declaration of trust authorizes our company to obligate itself, and our bylaws obligate us, to indemnify and advance expenses to our trustees and officers to the maximum extent permitted by Maryland law.
 
Our classified board of trustees may prevent others from effecting a change in the control of our board of trustees.

We believe that classification of our board of trustees will help to assure the continuity and stability of our business strategies and policies as determined by the board of trustees. However, the classified board provision could have the effect of making the replacement of incumbent trustees more time-consuming and difficult. At least two annual meetings of shareholders, instead of one, will generally be required to effect a change in a majority of our board of trustees. Thus, the classified board provision could increase the likelihood that incumbent trustees will retain their positions. The staggered terms of trustees may delay, defer or prevent a transaction or a change in control that might involve a premium price for our common shares or otherwise be in the best interest of the shareholders.
 
Future offerings of debt, which would be senior to our common shares upon liquidation, and/or preferred equity securities that may be senior to our common shares for purposes of dividends or other distributions or upon liquidation, may adversely affect the market price of our Class B common shares.

In the future, we may attempt to increase our capital resources by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred shares. Upon liquidation, holders of our debt securities and preferred shares and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common shares. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common shares, or both. Holders of our common shares are not entitled to preemptive rights or other protections against dilution. Our preferred shares, if issued, could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to pay a dividend or make another distribution to the holders of our common shares. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our common shareholders bear the risk of our future offerings reducing the market price of our Class B common shares and diluting their share holdings in us.


17


Item 1B.  Unresolved Staff Comments.
 
Not applicable.
 
Item 2.  Properties.
 
General
 
As of December 31, 2011, we owned 45 commercial properties, including 30 properties in Houston, four properties in Dallas, one property in Windcrest, Texas, a suburb of San Antonio, nine properties in the Scottsdale and Phoenix, Arizona metropolitan areas, and one property in Buffalo Grove, Illinois, a suburb of Chicago.
 
Our tenants consist of national, regional and local businesses. Our properties generally attract a mix of tenants who provide basic staples, convenience items and services tailored to the specific cultures, needs and preferences of the surrounding community. These types of tenants are the core of our strategy of creating Whitestone-branded Community Centered Properties. We also believe daily sales of these basic items are less sensitive to fluctuations in the business cycle than higher priced retail items. Our largest tenant represented only 1.5% of our total revenues for the year ended December 31, 2011.
 
We directly manage the operations and leasing of our properties. Substantially all of our revenues consist of base rents received under leases that generally have terms that range from less than one year to 15 years. Approximately 60% of our existing leases as of December 31, 2011 contain “step up” rental clauses that provide for increases in the base rental payments. The following table summarizes certain information relating to our properties as of December 31, 2011:
 
Commercial Properties
 
Gross Leasable Area
 
Average
Occupancy as of 
12/31/11
 
Annualized Base
Rental Revenue 
(in thousands) (1)
 
Average
Annualized Base
Rental Revenue
Per Sq. Ft. (2)
Retail
 
1,512,199

 
90
%
 
$
15,803

 
$
11.61

Office/Flex
 
1,201,672

 
86
%
 
7,655

 
7.41

Office
 
631,841

 
79
%
 
8,069

 
16.17

Total - Operating Portfolio
 
3,345,712

 
87
%
 
31,527

 
10.83

Redevelopment, New Acquisitions (3)
 
251,625

 
50
%
 
1,314

 
10.44

Total
 
3,597,337

 
84
%
 
$
32,841

 
$
10.87

 
(1)   
Calculated as the tenant's actual December 31, 2011 base rent (defined as cash base rents including abatements) multiplied by 12.  Excludes vacant space as of December 31, 2011.  Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles, historical results differ from the annualized amounts.
 
(2)   
Calculated as annualized base rent divided by net rentable square feet leased at December 31, 2011.  Excludes vacant space as of December 31, 2011.

(3)
Includes (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redevelopment or re-tenanting.

As of December 31, 2011, we had one property that accounted for more than 10% of total gross revenue.  Uptown Tower is an office building located in Dallas, Texas and accounts for 10.9%, 12.0% and 11.9% of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively.  Uptown Tower also accounts for  6.8%, 10.2% and 10.9% of our real estate assets, net of accumulated depreciation, for the years ended December 31, 2011, 2010 and 2009, respectively.

As of December 31, 2011, our total debt of approximately $127.9 million was collateralized by 26 operating properties with a combined net book value of $143.2 million.




18


Location of Properties
 
Of our 45 properties, 34 are located in Texas, with 30 being located in the greater Houston metropolitan statistical area.  These 30 properties represent 70% of our revenue for the year ended December 31, 2011.
 
The Houston workforce is concentrated in energy, chemicals, information technology, aerospace sciences and medical sciences.  According to the United States Census Bureau, Houston ranked 4th in the largest United States cities as of July 1, 2009. In the Census Bureau’s Estimates of Population Change for Metropolitan Statistical Areas and Rankings: July 1, 2008 to July 1, 2009, Houston ranked second in population growth out of 366 metropolitan statistical areas. According to the Bureau of Labor Statistics, the unemployment rate in Houston was less than the national average in each of the last six months of 2011.
 
 
 
July
 
Aug.
 
Sept.
 
Oct.
 
Nov.
 
Dec.
 
National (1)
 
9.1
%
 
9.1
%
 
9.0
%
 
8.9
%
 
8.7
%
 
8.5
%
 
Houston (2)
 
8.4

 
8.5

 
8.5

 
8.4

 
8.1

 
7.8

(3) 

(1) 
Seasonally adjusted.
(2) 
Not seasonally adjusted.
(3) 
Represents estimate.

 
Source: Bureau of Labor Statistics


19


General Physical and Economic Attributes

The following table sets forth certain information relating to each of our properties owned as of December 31, 2011.
Whitestone REIT and Subsidiaries
Property Details
As of December 31, 2011

 
 
Community Name
 
 
 
Location
 
 
Year Built/
Renovated
 
Gross Leasable
Square Feet
 
Percent
Occupied at
12/31/2011
 
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)
Retail Communities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ahwatukee Plaza
 
Phoenix
 
1979
 
72,650

 
100
%
 
$
841

 
$
11.58

 
$
12.79

Bellnott Square
 
Houston
 
1982
 
73,930

 
41
%
 
300

 
9.90

 
10.10

Bissonnet/Beltway
 
Houston
 
1978
 
29,205

 
100
%
 
317

 
10.85

 
10.82

Centre South
 
Houston
 
1974
 
39,134

 
82
%
 
230

 
7.17

 
8.01

Holly Knight
 
Houston
 
1984
 
20,015

 
100
%
 
323

 
16.14

 
17.39

Kempwood Plaza
 
Houston
 
1974
 
101,008

 
96
%
 
849

 
8.76

 
8.33

Lion Square
 
Houston
 
1980
 
119,621

 
92
%
 
795

 
7.22

 
9.27

Pinnacle of Scottsdale
 
Phoenix
 
1991
 
113,108

 
100
%
 
2,315

 
20.47

 
21.03

Providence
 
Houston
 
1980
 
90,327

 
97
%
 
763

 
8.71

 
8.15

Shaver
 
Houston
 
1978
 
21,926

 
98
%
 
252

 
11.73

 
11.45

Shops at Starwood
 
Dallas
 
2006
 
55,385

 
98
%
 
1,396

 
25.72

 
27.30

South Richey
 
Houston
 
1980
 
69,928

 
92
%
 
279

 
4.34

 
8.41

Spoerlein Commons
 
Chicago
 
1987
 
41,455

 
91
%
 
743

 
19.70

 
19.78

SugarPark Plaza
 
Houston
 
1974
 
95,032

 
93
%
 
800

 
9.05

 
9.58

Sunridge
 
Houston
 
1979
 
49,359

 
99
%
 
407

 
8.33

 
9.37

Terravita Marketplace
 
Phoenix
 
1997
 
102,733

 
96
%
 
1,333

 
13.52

 
14.12

Torrey Square
 
Houston
 
1983
 
105,766

 
98
%
 
853

 
8.23

 
8.05

Town Park
 
Houston
 
1978
 
43,526

 
100
%
 
789

 
18.13

 
17.76

Webster Point
 
Houston
 
1984
 
26,060

 
100
%
 
289

 
11.09

 
10.90

Westchase
 
Houston
 
1978
 
49,573

 
84
%
 
495

 
11.89

 
11.50

Windsor Park
 
San Antonio
 
1992
 
192,458

 
76
%
 
1,434

 
9.80

 
9.39

 
 
 
 
 
 
1,512,199

 
90
%
 
15,803

 
11.61

 
12.15

Office/Flex Communities:
 
 
 
 
 
  
 
 
 
  
 
  
 
 
Brookhill
 
Houston
 
1979
 
74,757

 
76
%
 
$
163

 
$
2.87

 
$
4.26

Corporate Park Northwest
 
Houston
 
1981
 
185,627

 
70
%
 
1,352

 
10.40

 
10.44

Corporate Park West
 
Houston
 
1999
 
175,665

 
87
%
 
1,321

 
8.64

 
9.11

Corporate Park Woodland
 
Houston
 
2000
 
99,937

 
96
%
 
820

 
8.55

 
8.73

Dairy Ashford
 
Houston
 
1981
 
42,902

 
92
%
 
210

 
5.32

 
5.35

Holly Hall
 
Houston
 
1980
 
90,000

 
100
%
 
713

 
7.92

 
8.09

Interstate 10
 
Houston
 
1980
 
151,000

 
84
%
 
654

 
5.16

 
5.23

Main Park
 
Houston
 
1982
 
113,410

 
96
%
 
711

 
6.53

 
6.51

Plaza Park
 
Houston
 
1982
 
105,530

 
79
%
 
752

 
9.02

 
8.64

Westbelt Plaza
 
Houston
 
1978
 
65,619

 
76
%
 
400

 
8.02

 
8.16

Westgate
 
Houston
 
1984
 
97,225

 
100
%
 
559

 
5.75

 
5.69

 
 
 
 
 
 
1,201,672

 
86
%
 
7,655

 
7.41

 
7.57


20


 Whitestone REIT and Subsidiaries
Property Details
As of December 31, 2011
(continued)

 
 
Community Name
 
 
 
Location
 
 
Year Built/
Renovated
 
Gross Leasable
Square Feet
 
Percent
Occupied at
12/31/2011
 
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)
Office Communities:
 
 
 
 
 
  
 
 
 
  
 
  
 
 
9101 LBJ Freeway
 
Dallas
 
1985
 
125,874

 
69
%
 
$
1,356

 
$
15.61

 
$
15.06

Featherwood
 
Houston
 
1983
 
49,760

 
84
%
 
772

 
18.47

 
18.02

Pima Norte
 
Phoenix
 
2007
 
33,417

 
18
%
 
110

 
18.29

 
17.95

Royal Crest
 
Houston
 
1984
 
24,900

 
85
%
 
267

 
12.62

 
12.57

Uptown Tower
 
Dallas
 
1982
 
253,981

 
85
%
 
3,655

 
16.93

 
17.00

Woodlake Plaza
 
Houston
 
1974
 
106,169

 
88
%
 
1,343

 
14.37

 
14.06

Zeta Building
 
Houston
 
1982
 
37,740

 
89
%
 
566

 
16.85

 
16.52

 
 
 
 
 
 
631,841

 
79
%
 
8,069

 
16.17

 
15.98

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total - Operating Portfolio
 
 
 
 
 
3,345,712

 
87
%
 
31,527

 
10.83

 
11.11

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Citadel
 
Phoenix
 
1985
 
28,547

 
63
%
 
$
126

 
$
7.01

 
$
14.68

Desert Canyon
 
Phoenix
 
2000
 
62,533

 
74
%
 
546

 
11.80

 
11.80

Gilbert Tuscany Village
 
Phoenix
 
2009
 
49,415

 
22
%
 
202

 
18.58

 
25.76

The MarketPlace At Central
 
Phoenix
 
2000
 
111,130

 
46
%
 
440

 
8.61

 
8.88

Total - Development Portfolio
 
 
 
 
 
251,625

 
50
%
 
1,314

 
10.44

 
12.27

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pinnacle Phase II
 
Phoenix
 
N/A
 

 
%
 

 

 

Shops at Starwood Phase III
 
Dallas
 
N/A
 

 
%
 

 

 

Total - Property Held For Development (4)
 
 
 
 
 

 
%
 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Grand Totals
 
 
 
 
 
3,597,337

 
84
%
 
$
32,841

 
$
10.87

 
$
11.21


 
(1)   
Calculated as the tenant's actual December 31, 2011 base rent (defined as cash base rents including abatements) multiplied by 12. Excludes vacant space as of December 31, 2011. Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles, historical results differ from the annualized amounts. Total abatements for leases in effect as of December 31, 2011 equaled approximately $164,000 for the month ended December 31, 2011.
 
(2)   
Calculated as annualized base rent divided by net rentable square feet leased at December 31, 2011.  Excludes vacant space at December 31, 2011.

(3) 
Represents (i) the contractual base rent for leases in place as of December 31, 2011, calculated on a straight-line basis to reflect changes in rental rates throughout the lease term and amortize free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) square footage under commenced leases of December 31, 2011.

(4) 
As of December 31, 2011, these properties are held for development with no gross leasable area.


21


Significant Tenants
 
The following table sets forth information about our fifteen largest tenants as of December 31, 2011, based upon annualized rental revenues at December 31, 2011.

Tenant Name
 
Location
 
Annualized Rental Revenue (in thousands)
 
Percentage of Total Annualized Base Rental Revenues
 
Initial Lease Date
 
Year Expiring
 
 
 
 
 
 
 
 
 
 
 
Sports Authority
 
San Antonio
 
$
495

 
1.5
%
 
1/1/2004
 
2015
University of Phoenix
 
San Antonio
 
416

 
1.3
%
 
10/18/2010
 
2018
Air Liquide America, L.P.
 
Dallas
 
375

 
1.1
%
 
8/1/2001
 
2013
Safeway Stores, Incorporated
 
Phoenix
 
344

 
1.0
%
 
12/22/2011
 
2021
Walgreen's #3766
 
Phoenix
 
279

 
0.8
%
 
8/9/2011
 
2049
X-Ray X-Press Corporation
 
Houston
 
272

 
0.8
%
 
7/1/1998
 
2019
Rock Solid Images
 
Houston
 
250

 
0.8
%
 
4/1/2004
 
2012
Marshall's
 
Houston
 
248

 
0.8
%
 
5/12/1983
 
2013
Eligibility Services
 
Dallas
 
236

 
0.7
%
 
6/6/2000
 
2012
Albertson's #979
 
Phoenix
 
235

 
0.7
%
 
8/9/2011
 
2022
Merrill Corporation
 
Dallas
 
234

 
0.7
%
 
12/10/2001
 
2014
Fitness Alliance, LLC
 
Phoenix
 
216

 
0.7
%
 
8/17/2011
 
2021
Compass Insurance
 
Dallas
 
213

 
0.6
%
 
1/1/2006
 
2013
River Oaks L-M, Inc.
 
Houston
 
212

 
0.6
%
 
10/15/1993
 
2014
Petsmart, Inc
 
San Antonio
 
199

 
0.6
%
 
1/1/2004
 
2018
 
 
 
 
$
4,224

 
12.7
%
 
 
 
 

 

22


Lease Expirations
 
The following table lists, on an aggregate basis, all of our scheduled lease expirations over the next 10 years.
 
 
 
 
 
 
 
 
 
Annualized Base Rent
 
 
 
 
Gross Leasable Area
 
as of December 31, 2011
Year
 
Number of
Leases
 
Approximate
Square Feet
 
Percent
of Total
 
Amount
(in thousands)
 
Percent of
Total
2012
 
303

 
625,346

 
17.4
%
 
$
7,350

 
22.4
%
2013
 
184

 
571,141

 
15.9
%
 
6,599

 
20.1
%
2014
 
171

 
543,109

 
15.1
%
 
5,880

 
17.9
%
2015
 
89

 
355,534

 
9.9
%
 
3,724

 
11.3
%
2016
 
96

 
332,766

 
9.3
%
 
4,022

 
12.2
%
2017
 
20

 
90,260

 
2.5
%
 
795

 
2.4
%
2018
 
15

 
106,554

 
3
%
 
1,380

 
4.2
%
2019
 
7

 
58,783

 
1.6
%
 
681

 
2.1
%
2020
 
7

 
51,045

 
1.4
%
 
588

 
1.8
%
2021
 
9

 
111,465

 
3.1
%
 
833

 
2.5
%
Total
 
901

 
2,846,003

 
79.2
%
 
$
31,852

 
96.9
%

Insurance
 
We believe that we have property and liability insurance with reputable, commercially rated companies.  We also believe that our insurance policies contain commercially reasonable deductibles and limits, adequate to cover our properties.  We expect to maintain this type of insurance coverage and to obtain similar coverage with respect to any additional properties we acquire in the near future.  Further, we have title insurance relating to our properties in an aggregate amount that we believe to be adequate.
 
Regulations
 
Our properties, as well as any other properties that we may acquire in the future, are subject to various federal, state and local laws, ordinances and regulations.  They include, among other things, zoning regulations, land use controls, environmental controls relating to air and water quality, noise pollution and indirect environmental impacts such as increased motor vehicle activity.  We believe that we have all permits and approvals necessary under current law to operate our properties.
 
Item 3.  Legal Proceedings.
 
We are a participant in various legal proceedings and claims that arise in the ordinary course of our business.  These matters are generally covered by insurance.  While the resolution of these matters cannot be predicted with certainty, we believe that the final outcome 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.


23


PART II
 

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

    There is no established trading market for our Class A common shares of beneficial interest. As of February 24, 2012, we had 1,737,438 Class A common shares of beneficial interest outstanding held by a total of 1,428 shareholders of record.
 
Class B Shares

Our Class B common shares were issued and began trading on the NYSE Amex on August 25, 2010 under the ticker symbol "WSR." As of February 24, 2012, we had 10,157,114 Class B common shares of beneficial interest outstanding held by a total of 7,290 shareholders of record.

The following table sets forth the quarterly high, low, and closing prices per share of our Class B common shares reported on the NYSE Amex for the years ended December 31, 2011 and 2010.

For the Year Ended December 31, 2011
 
High
 
Low
 
Close
 
 
 
 
 
 
 
First Quarter
 
$
14.94

 
$
13.73

 
$
14.31

Second Quarter
 
$
14.94

 
$
11.90

 
$
12.72

Third Quarter
 
$
13.34

 
$
10.77

 
$
11.14

Fourth Quarter
 
$
12.29

 
$
10.05

 
$
11.90

 
 
 
 
 
 
 
For the Year Ended December 31, 2010
 
High
 
Low
 
Close
 
 
 
 
 
 
 
First Quarter
 
N/A

 
N/A

 
N/A

Second Quarter
 
N/A

 
N/A

 
N/A

Third Quarter (1)
 
$
12.03

 
$
11.32

 
$
11.74

Fourth Quarter
 
$
14.94

 
$
11.79

 
$
14.80

(1) 
Trading commenced on August 25, 2010.

On February 24, 2012, the closing price of our Class B common shares reported on the NYSE Amex was $13.01 per share.

Exchange Offers

On September 2, 2011, we commenced an offer to exchange Class B common shares on a one-for-one basis for (i) up to 867,789 outstanding Class A common shares; and (ii) up to 453,642 outstanding OP units (the “First Exchange Offer”). The First Exchange Offer expired on October 3, 2011, and 867,789 Class A common shares and 453,642 OP units were accepted for exchange.

On December 9, 2011, we commenced a second offer to exchange Class B common shares on a one-for-one basis for (i) up to 867,789 outstanding Class A common shares; and (ii) up to 453,642 outstanding OP units (the “Second Exchange Offer”). The Second Exchange Offer expired on January 11, 2012, and 867,789 Class A common shares and 453,580 OP units were accepted for exchange.




24


Distributions
 
U.S. federal income tax law generally requires that a REIT distribute annually to its shareholders at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates on any taxable income that it does not distribute. We currently, and intend to continue to, accrue dividends quarterly and pay dividends in three monthly installments following the end of the quarter. For a discussion of our cash flow as compared to dividends, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

The timing and frequency of our distributions are authorized and declared by our board of trustees based upon a number of factors, including:

our funds from operations;
our debt service requirements;
our capital expenditure requirements for our properties;
our taxable income, combined with the annual distribution requirements necessary to maintain REIT qualification;
requirements of Maryland law;
our overall financial condition; and
other factors deemed relevant by our board of trustees of trustees.

Any distributions we make will be at the discretion of our board of trustees and we cannot provide assurance that our dividends will be made or sustained.

The following table reflects the total distributions we have paid (including the total amount paid and the amount paid per share) in each indicated quarter (in thousands, except per share data):

 
 
Class A Common Shareholders
 
Class B Common Shareholders
 
Noncontrolling OP Unit Holders
 
 
Quarter Paid
 
Distribution Per Common Share
 
Total Amount Paid
 
Distribution Per Common Share
 
Total Amount Paid
 
Distribution Per OP Unit
 
Total Amount Paid
 
Total Amount Paid
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
807

 
$
0.2850

 
$
2,386

 
$
0.2850

 
$
430

 
$
3,623

Third Quarter
 
0.2850

 
974

 
0.2850

 
2,141

 
0.2850

 
514

 
3,629

Second Quarter
 
0.2850

 
989

 
0.2850

 
1,132

 
0.2850

 
515

 
2,636

First Quarter
 
0.2850

 
989

 
0.2850

 
627

 
0.2850

 
515

 
2,131

Total
 
$
1.1400

 
$
3,759

 
$
1.1400

 
$
6,286

 
$
1.1400

 
$
1,974

 
$
12,019

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
989

 
$
0.2850

 
$
627

 
$
0.2850

 
$
514

 
$
2,130

Third Quarter
 
0.2850

 
992

 
0.0960

 
211

 
0.2850

 
515

 
1,718

Second Quarter
 
0.3375

 
1,176

 

 

 
0.3375

 
610

 
1,786

First Quarter
 
0.3375

 
1,163

 

 

 
0.3375

 
610

 
1,773

Total
 
$
1.2450

 
$
4,320

 
$
0.3810

 
$
838

 
$
1.2450

 
$
2,249

 
$
7,407

 
Equity Compensation Plan Information
 
Please refer to Item 12 of this report for information concerning securities authorized under our incentive share plan.

25



Performance Graph

The following graph compares the total shareholder returns of the Company's Class B common shares to the Standard & Poor's 500 Index (“S&P 500”) and to the Morgan Stanley Capital International US REIT Index ("REIT Index") from August 25, 2010 to December 31, 2011. The graph assumes that the value of the investment in our Class B common shares and in the S&P 500 and NAREIT indices was $100 at August 25, 2010 and that all dividends were reinvested. The price of our Class B common shares on August 25, 2010 (on which the graph is based) was $12.00. The past shareholder return shown on the following graph is not necessarily indicative of future performance. The performance graph and related information shall not be deemed "filed" with the SEC, nor shall such information be incorporated by reference into any future filing, except to the extent the Company specifically incorporates it by reference into such filing.


26


Item 6.  Selected Financial Data.
 
The following table sets forth our selected consolidated financial information and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the notes thereto, both of which appear elsewhere in this report.
 
 
 
Year Ended December 31,
 
 
(in thousands, except per share data)
 
 
2011
 
2010
 
2009
 
2008
 
2007
Operating Data:
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
34,915

 
$
31,533

 
$
32,685

 
$
31,201

 
$
29,374

Property expenses
 
13,327

 
12,283

 
12,991

 
12,835

 
12,236

General and administrative
 
6,648

 
4,992

 
6,072

 
6,708

 
6,721

Depreciation and amortization
 
8,365

 
7,225

 
6,958

 
6,859

 
6,048

Involuntary conversion
 

 
(558
)
 
(1,542
)
 
358

 

Interest expense
 
5,728

 
5,620

 
5,749

 
5,857

 
5,402

Interest, dividend and other investment income
 
(460
)
 
(28
)
 
(36
)
 
(182
)
 
(577
)
Other expense (income), net
 

 

 

 

 
30

Income (loss) from continuing operations before loss on disposal of assets and income taxes
 
1,307

 
1,999

 
2,493

 
(1,234
)
 
(486
)
Provision for income taxes
 
(225
)
 
(264
)
 
(222
)
 
(219
)
 
(217
)
Loss on disposal of assets
 
(146
)
 
(160
)
 
(196
)
 
(223
)
 
(9
)
Income (loss) from continuing operations
 
936

 
1,575

 
2,075

 
(1,676
)
 
(712
)
Income (loss) from discontinued operations
 

 

 

 
(188
)
 
589

Gain on sale of property
 
397

 

 

 

 

Gain on sale of properties from discontinued operations
 

 

 

 
3,619

 

Net income (loss)
 
1,333

 
1,575

 
2,075

 
1,755

 
(123
)
Less: net income (loss) attributable to noncontrolling interests
 
210

 
470

 
733

 
621

 
(46
)
Net income (loss) attributable to Whitestone REIT
 
$
1,123

 
$
1,105

 
$
1,342

 
$
1,134

 
$
(77
)
 

27


 
 
Year Ended December 31,
 
 
(in thousands, except per share data)
 
 
2011
 
2010
 
2009
 
2008
 
2007
Earnings per share - basic
 
 
 
 
 
 
 
 
 
 
Income (loss) from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.12

 
$
0.27

 
$
0.41

 
$
(0.33
)
 
$
(0.14
)
Income from discontinued operations attributable to Whitestone REIT
 

 

 

 
0.68

 
0.12

Net income (loss) attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.12

 
$
0.27

 
$
0.41

 
$
0.35

 
$
(0.02
)
Earnings per share - diluted
 
 

 
 

 
 

 
 

 
 

Income (loss) from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares
 
$
0.12

 
$
0.27

 
$
0.40

 
$
(0.33
)
 
$
(0.14
)
Income from discontinued operations attributable to Whitestone REIT
 

 

 

 
0.68

 
0.12

Net income (loss) attributable to common shareholders excluding amounts attributable to unvested restricted shares
 
$
0.12

 
$
0.27

 
$
0.40

 
$
0.35

 
$
(0.02
)
Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Real estate (net)
 
$
246,888

 
$
165,398

 
$
158,398

 
$
150,847

 
$
146,460

Real estate (net), discontinued operations
 

 

 

 

 
7,932

Other assets
 
26,605

 
31,047

 
23,602

 
27,098

 
20,752

Total assets
 
$
273,493

 
$
196,445

 
$
182,000

 
$
177,945

 
$
175,144

Liabilities
 
$
142,786

 
$
112,162

 
$
115,141

 
$
110,773

 
$
94,262

Whitestone REIT shareholders' equity
 
115,958

 
62,708

 
43,590

 
45,891

 
52,843

Noncontrolling interest in subsidiary
 
14,749

 
21,575

 
23,269

 
21,281

 
28,039

 
 
$
273,493

 
$
196,445

 
$
182,000

 
$
177,945

 
$
175,144

Other Data:
 
 
 
 
 
 
 
 
 
 
Proceeds from issuance of common shares
 
$
59,683

 
$
22,970

 
$

 
$

 
$
261

Acquisitions of and additions to real estate
 
88,903

 
12,768

 
12,855

 
5,153

 
10,205

Dividends per share (1)
 
1.09

 
1.17

 
1.35

 
1.59

 
1.80

Funds from operations (2)
 
8,707

 
8,432

 
8,618

 
4,236

 
6,001

Operating Portfolio Occupancy at year end
 
87
%
 
86
%
 
82
%
 
84
%
 
86
%
Average aggregate gross leasable area
 
3,366

 
3,058

 
3,039

 
3,008

 
3,093

Average rent per square foot
 
$
10.37

 
$
10.31

 
$
10.76

 
$
10.37

 
$
9.50

(1)  The dividends per share represent total cash payments divided by weighted average common shares.
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)  We believe that Funds From Operations (“FFO”) is an appropriate supplemental measure of operating performance because it helps our investors compare our operating performance relative to other REITs.  The National Association of Real Estate Investment Trusts (“NAREIT”) defines FFO as net income (loss) available to common shareholders computed in accordance with GAAP, excluding gains or losses from sales of operating properties and extraordinary items, plus depreciation and amortization of real estate assets, including our share of unconsolidated partnerships and joint ventures.  We calculate FFO in a manner consistent with the NAREIT definition.
 
 
Year Ended December 31,
 
 
(in thousands, except per share data)
 
 
2011
 
2010
 
2009
 
2008
 
2007
Net income (loss) attributable to Whitestone REIT
 
$
1,123

 
$
1,105

 
$
1,342

 
$
1,134

 
$
(77
)
Depreciation and amortization of real estate assets (1)
 
7,625

 
6,697

 
6,347

 
5,877

 
6,108

(Gain) loss on sale or disposal of assets (1)
 
(251
)
 
160

 
196

 
(3,396
)
 
16

Net income (loss) attributable to noncontrolling interests
 
210

 
470

 
733

 
621

 
(46
)
FFO
 
$
8,707

 
$
8,432

 
$
8,618

 
$
4,236

 
$
6,001

 
(1) Including amounts for discontinued operations.

28


Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
You should read the following discussion of our financial condition and results of operations in conjunction with our audited consolidated financial statements and the notes thereto included in this annual report.  For more detailed information regarding the basis of presentation for the following information, you should read the notes to our audited consolidated financial statements included in this annual report.
 
Overview of Our Company
 
We are a fully integrated real estate company that owns and operates commercial properties in culturally diverse markets in major metropolitan areas.  Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.
 
In October 2006, our current management team joined the company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties.  We define Community Centered Properties as visibly located properties in established or developing culturally diverse neighborhoods in our target markets.  We market, lease, and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants and medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.  We employ and develop a diverse group of associates who understand the needs of our multicultural communities and tenants.

As of December 31, 2011, we owned and operated 45 commercial properties consisting of:

Operating Portfolio
twenty-one retail properties containing approximately 1.5 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $140.0 million;
seven office properties containing approximately 0.6 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $44.4 million; and
eleven office/flex properties containing approximately 1.2 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $40.8 million.
Redevelopment, New Acquisitions Portfolio
four retail properties containing approximately 0.3 million square feet of leasable space and having a total carrying amount (net of accumulated depreciation) of $18.9 million; and
two parcels of land held for future development having a total carrying amount of $2.8 million.
As of December 31, 2011, we had 915 total tenants.  We have a diversified tenant base with our largest tenant comprising only 1.5% of our total revenues for the year ended December 31, 2011.  Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants.  Our leases generally include minimum monthly lease payments and tenant reimbursements for payment of taxes, insurance and maintenance.  We completed 312 new and renewal leases during 2011, totaling 797,267 square feet and $32.3 million in total lease value.
 
On August 24, 2010, we amended to our declaration of trust to (i) change the name of all of our common shares of beneficial interest, par value $0.001 to Class A common shares, (ii) effect a 1-for-3 reverse share split of our Class A common shares and (iii) change the par value of our Class A common shares to $0.001 per share after the reverse share split. In addition, we created a new class of common shares of beneficial interest, par value $0.001, entitled “Class B common shares.” The Class A and Class B common shares are identical except that Class B common shares are listed on the NYSE Amex, and Class A common shares are not listed on a national securities exchange. Share and unit counts and per share and unit amounts have been retroactively restated to reflect our 1-for-3 reverse share split in August 2010.
On August 25, 2010, in conjunction with the listing of our Class B common shares on the NYSE Amex, we offered and subsequently issued 2.2 million Class B common shares which resulted in $23.0 million in net offering proceeds to us. On May 10, 2011, we completed a second public offering in which we issued 5.3 million Class B common shares for net offering proceeds of approximately $59.7 million. We used the proceeds from these offerings to acquire properties in our target markets and redevelop and re-tenant our existing properties, as well as for general corporate purposes.

29


We employed 62 full-time employees as of December 31, 2011.  As an internally managed REIT, we bear our own expenses of operations, including the salaries, benefits and other compensation of our employees, office expenses, legal, accounting and investor relations expenses and other overhead costs.
 
How We Derive Our Revenue
 
Substantially all of our revenue is derived from rents received from leases at our properties. We had rental income and tenant reimbursements of approximately $34,915,000 for the year ended December 31, 2011 as compared to $31,533,000 for the year ended December 31, 2010, an increase of $3,382,000, or 11%. The twelve months ended December 31, 2011 included $2,504,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired during the period being compared. For the purposes of comparing the twelve months ended December 31, 2011 to the twelve months ended December 31, 2010, this includes properties acquired between January 1, 2010 and December 31, 2011. Same Store revenues increased $878,000. We define "Same Stores" as properties that were owned at the beginning of the period being compared. For the purposes of comparing the twelve months ended December 31, 2011 to the twelve months ended December 31, 2010, this includes properties owned before January 1, 2010. Same Store average occupancy increased from 83.9%  for the twelve months ended December 31, 2010 to 85.7% for the twelve months ended December 31, 2011, increasing Same Store revenue $461,000. The Same Store revenue rate per average leased square foot increased $0.16 for the twelve months ended December 31, 2011 to $12.51 per average leased square foot as compared to the twelve month ended December 31, 2010 revenue rate per average leased square foot of $12.35, increasing Same Store revenue $417,000.

Known Trends in Our Operations; Outlook for Future Results
 
Rental Income
 
We expect our rental income to increase year-over-year due to the addition of properties. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly acquired properties with vacant space, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Negative trends in one or more of these factors could adversely affect our rental income in future periods, although we expect modest continued improvement in the overall economy in our markets to provide slight increases in occupancy at certain of our properties.
 
Scheduled Lease Expirations
 
We tend to lease space to smaller businesses that desire shorter term leases. As of December 31, 2011, approximately 33% of our gross leasable area is subject to leases that expire prior to December 31, 2013.  Over the last three years we have renewed approximately 79% of our square footage expiring as a result of lease maturities. We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While our early renewal program and other leasing and marketing efforts target these expiring leases, we hope to re-lease most of that space prior to expiration of the leases. In the markets in which we operate, we obtain and analyze market rental rates through review of third-party publications which provide market and submarket rental rate data and through inquiry of property owners and property management companies as to rental rates being quoted at properties which are located in close proximity to our properties and we believe display similar physical attributes as our nearby properties. We use this data to negotiate leases with new tenants and renew leases with our existing tenants at rates we believe to be competitive in the markets for our individual properties. Due to the short term nature of our leases, and based upon our analysis of market rental rates, we believe that, in the aggregate, our current leases are at market rates. During the year ended December 31, 2011, our revenue rate per square foot for renewals and new leases for comparable spaces increased 1% when compared to the expiring revenue rate per square foot for previous leases. As such, we expect the 2012 and 2013 expiring square footage to lease at rates which are at, or near, their current rates. Market conditions, including new supply of properties, and macroeconomic conditions in Houston and nationally affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could adversely impact our renewal rate and/or the rental rates we are able to negotiate. We continue to monitor our tenants' operating performances as well as overall economic trends to evaluate any future negative impact on our renewal rates and rental rates, which could adversely affect our cash flow and ability to pay dividends to our shareholders.
 
Acquisitions
 
We expect to actively seek acquisitions in the foreseeable future. We believe that over the next few years we will continue

30


to have excellent opportunities to acquire quality properties at historically attractive prices. We have extensive relationships with community banks, attorneys, title companies and others in the real estate industry which we believe will enable us to take advantage of these market opportunities and maintain an active acquisition pipeline.

Property Acquisitions
 
We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered Properties strategy.  We define Community Centered Properties as visibly located properties in established or developing, culturally diverse neighborhoods in our target markets, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston.  We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery and medical, educational and financial services.  Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.
 
Property Acquisitions. On December 28, 2011, we acquired the Shops at Starwood, a property that meets our Community Centered Property strategy, for approximately $15.7 million in cash and net prorations. The Class A center, which was 98% occupied at the time of purchase, contains 55,385 square feet of gross leasable area, located in Frisco, Texas, a northern suburb of Dallas. The Shops at Starwood has a complementary tenant mix of restaurants, fashion boutiques, salons and second-level office space. Revenue and income of $13,000 and $7,000, respectively, have been included in our results of operations for the year ended December 31, 2011 since the date of acquisition.

On December 28, 2011, we acquired Starwood Phase III, a 2.73 acre parcel of undeveloped land adjacent to the Shops at Starwood for approximately $1.9 million, including a non-recourse loan we assumed for $1.4 million, secured by the land, and cash of $0.5 million. The Phase III development site fronts the Dallas North Tollway within the Tollway Overlay District, which grants the highest allowed density of any zoning district. No revenue or income has been included in our results of operations for the year ended December 31, 2011 since the date of acquisition.

On December 28, 2011, we acquired Pinnacle of Scottsdale Phase II ("Pinnacle Phase II"), a 4.45 acre parcel of developed land adjacent to Pinnacle for approximately $1.0 million in cash and net prorations. Pinnacle Phase II has approximately 400 linear feet of frontage on Scottsdale Road and the potential for additional retail and office development. No revenue or income has been included in our results of operations for the year ended December 31, 2011 since the date of acquisition. As of the date of the acquisition, the estimated fair value of the land was $1.0 million. No other assets or liabilities were recorded at the date of acquisition.

On December 22, 2011, we acquired Phase I of Pinnacle of Scottsdale ("Pinnacle"), a property that meets our Community Centered Property strategy, for approximately $28.8 million, including a non-recourse loan we assumed for $14.1 million, secured by the property and cash of $14.7 million. Pinnacle is a 100% occupied Class A Community Center with 113,108 square feet of gross leasable area in North Scottsdale. The tenant mix at Pinnacle includes Safeway®, Ace® Hardware, Shell® Oil, Hornacek’s House of Golf, Jade Palace, Jalapeno Inferno, SubwayTM, Stag Tobacconist, Starbucks© Coffee, Pinnacle Peak Dentistry, and a variety of other convenience service providers. Revenue and income of $73,000 and $49,000, respectively, have been included in our results of operations for the year ended December 31, 2011 since the date of acquisition.

On August 16, 2011, we acquired Ahwatukee Plaza Shopping Center, a property that meets our Community Centered Property strategy, for approximately $9.3 million in cash and net prorations. The center contains 72,650 square feet of gross leasable area, located in the Ahwatukee Foothills neighborhood in south Phoenix, Arizona. Revenue and income of $446,000 and