10-Q 1 wrop10-q2012x09.htm 10-Q WROP 10-Q (2012-09)

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

FORM 10-Q
 
(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

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

For the transition period from ____________ to ____________

Commission file number 000-53966
WHITESTONE REIT OPERATING PARTNERSHIP, L.P.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
76-0594968
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

2600 South Gessner, Suite 500
Houston, Texas
 
77063
(Address of Principal Executive Offices)
 
(Zip Code)

(713) 827-9595
(Registrant's Telephone Number, Including Area Code)
 
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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.  ýYes     ¨No

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) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ýYes    ¨No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ¨                                                                                      Accelerated filer ¨
Non-accelerated filer (Do not check if a smaller reporting company) ý           Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨Yes   ý No

As of November 6, 2012, the Registrant had outstanding 786,191 units of limited partnership held by non-affiliates. There is no established market for such units.



PART I - FINANCIAL INFORMATION


PART II - OTHER INFORMATION





PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands, except unit data)

 
 
September 30, 2012
 
December 31, 2011
 
 
(unaudited)
 
 
ASSETS
Real estate assets, at cost
 
 
 
 
Property
 
$
389,280

 
$
292,360

Accumulated depreciation
 
(51,362
)
 
(45,472
)
Total real estate assets
 
337,918

 
246,888

Cash and cash equivalents
 
8,339

 
5,695

Marketable securities
 
1,373

 
5,131

Escrows and acquisition deposits
 
5,539

 
4,996

Accrued rents and accounts receivable, net of allowance for doubtful accounts
 
7,177

 
6,053

Unamortized lease commissions and loan costs
 
4,269

 
3,755

Prepaid expenses and other assets
 
1,271

 
975

Total assets
 
$
365,886

 
$
273,493

 
 
 
 
 
LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
 
 
 
 
Notes payable
 
$
167,816

 
$
127,890

Accounts payable and accrued expenses
 
11,099

 
9,017

Tenants' security deposits
 
2,846

 
2,232

Dividends and distributions payable
 
5,027

 
3,647

Total liabilities
 
186,788

 
142,786

Commitments and contingencies:
 

 

Partners' Capital:
 
 
 
 
General Partner, 16,718,796 and 11,317,042 units outstanding as of September 30, 2012 and December 31, 2011, respectively
 
171,336

 
117,077

Limited Partners, 786,191 and 1,360,927 units outstanding as of September 30, 2012 and December 31, 2011, respectively
 
8,209

 
14,959

Accumulated other comprehensive loss
 
(447
)
 
(1,329
)
Total partners' capital
 
179,098

 
130,707

Total liabilities and partners' capital
 
$
365,886

 
$
273,493



See accompanying notes to Consolidated Financial Statements

1


Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands, except per unit data)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Property revenues
 
 
 
 
 
 
 
 
Rental revenues
 
$
8,992

 
$
7,086

 
$
25,643

 
$
20,462

Other revenues
 
2,626

 
1,705

 
7,388

 
4,485

Total property revenues
 
11,618

 
8,791

 
33,031

 
24,947

 
 
 
 
 
 
 
 
 
Property expenses
 
 
 
 
 
 
 
 
Property operation and maintenance
 
2,969

 
2,376

 
8,080

 
6,328

Real estate taxes
 
1,629

 
1,262

 
4,442

 
3,390

Total property expenses
 
4,598

 
3,638

 
12,522

 
9,718

 
 
 
 
 
 
 
 
 
Other expenses (income)
 
 
 
 
 
 
 
 
General and administrative
 
1,888

 
1,495

 
5,392

 
4,737

Depreciation and amortization
 
3,112

 
2,161

 
8,319

 
6,126

Interest expense
 
1,815

 
1,430

 
5,261

 
4,277

Interest, dividend and other investment income
 
(121
)
 
(264
)
 
(274
)
 
(379
)
Total other expense
 
6,694

 
4,822

 
18,698

 
14,761

 
 
 
 
 
 
 
 
 
Income before gain (loss) on sale or disposal of assets and income taxes
 
326

 
331

 
1,811

 
468

 
 
 
 
 
 
 
 
 
Provision for income taxes
 
(77
)
 
(54
)
 
(212
)
 
(165
)
Gain (loss) on sale or disposal of assets
 
(77
)
 
1

 
(105
)
 
(17
)
Income before gain on sale of property
 
172

 
278

 
1,494

 
286

 
 
 
 
 
 
 
 
 
Gain on sale of property
 

 
397

 

 
397

 
 
 
 
 
 
 
 
 
Net income
 
$
172

 
$
675

 
$
1,494

 
$
683










See accompanying notes to Consolidated Financial Statements

2


Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands, except per unit data)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Basic and Diluted Earnings Per Unit:
 
 
 
 
 
 
 
 
Net income attributable to unitholders excluding amounts attributable to unvested restricted shares
 
$
0.01

 
$
0.05

 
$
0.11

 
$
0.07

 
 
 
 
 
 
 
 
 
Weighted average number of units outstanding:
 
 
 
 
 
 
 
 
Basic
 
14,667

 
12,676

 
13,349

 
10,166

Diluted
 
14,786

 
12,688

 
13,466

 
10,181

 
 
 
 
 
 
 
 
 
Distributions declared per OP unit
 
$
0.2850

 
$
0.2850

 
$
0.8550

 
$
0.8550

 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Income (Loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
172

 
$
675

 
$
1,494

 
$
683

 
 
 
 
 
 
 
 
 
Other comprehensive gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on cash flow hedging activities
 
(9
)
 

 
(9
)
 

Unrealized gain (loss) on available-for-sale marketable securities
 
92

 
(1,672
)
 
891

 
(1,881
)
 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
$
255

 
$
(997
)
 
$
2,376

 
$
(1,198
)






See accompanying notes to Consolidated Financial Statements

3


Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' CAPITAL
(Unaudited)
(in thousands)

 
 
 
 
 
 
 
 
 
 
Other
 
Total
 
 
General Partner
 
General Partner
 
Limited Partner
 
Limited Partner
 
Comprehensive
 
Partners'
 
 
Units
 
Unitholders
 
Units
 
Unitholders
 
Loss
 
Capital
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2011
 
11,317

 
$
117,077

 
1,361

 
$
14,959

 
$
(1,329
)
 
$
130,707

 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange of noncontrolling interest OP units for common shares
 
575

 
6,224

 
(575
)
 
(6,224
)
 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
Exchange offer costs
 

 
(334
)
 

 

 

 
(334
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of OP units, net of costs
 
4,830

 
58,679

 

 

 

 
58,679

 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares under distribution reinvestment plan
 
5

 
68

 

 

 

 
68

 
 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation
 
(8
)
 
248

 

 

 

 
248

 
 
 
 
 
 
 
 
 
 
 
 
 
Distributions
 

 
(12,021
)
 

 
(625
)
 

 
(12,646
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized loss on change in value of cash flow hedge
 

 

 

 

 
(9
)
 
(9
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gain on change in fair value of available-for-sale marketable securities
 

 

 

 

 
891

 
891

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 
1,395

 

 
99

 

 
1,494

 
 
 
 
 
 
 
 
 
 
 
 
 
Balance September 30, 2012
 
16,719

 
$
171,336

 
786

 
$
8,209

 
$
(447
)
 
$
179,098










See accompanying notes to Consolidated Financial Statements


4


Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
 
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
 
 
 
 
Cash flows from operating activities:
 
 
 
 
Net income
 
$
1,494

 
$
683

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
7,255

 
5,701

Amortization of deferred loan costs
 
1,064

 
425

Amortization of notes payable discount
 
86

 

Gain on sale of marketable securities
 
(110
)
 
(192
)
Loss (gain) on sale or disposal of assets and properties
 
105

 
(380
)
Bad debt expense
 
720

 
379

Share-based compensation
 
384

 
233

Changes in operating assets and liabilities:
 
 
 
 
Escrows and acquisition deposits
 
29

 
385

Accrued rents and accounts receivable
 
(1,876
)
 
(959
)
Unamortized lease commissions
 
(674
)
 
(705
)
Prepaid expenses and other assets
 
630

 
581

Accounts payable and accrued expenses
 
200

 
13

Tenants' security deposits
 
614

 
160

Net cash provided by operating activities
 
9,921

 
6,324

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Acquisitions of real estate
 
(79,400
)
 
(34,034
)
Additions to real estate
 
(9,297
)
 
(3,970
)
Investments in marketable securities
 
(750
)
 
(13,520
)
Proceeds from sale of property
 

 
1,571

Proceeds from sales of marketable securities
 
5,509

 
7,252

Net cash used in investing activities
 
(83,938
)
 
(42,701
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Distributions paid to OP unitholders
 
(11,326
)
 
(8,396
)
Proceeds from issuance of common shares
 
58,679

 
59,667

Payments of exchange offer costs
 
(249
)
 

Proceeds from notes payable
 

 
2,905

Proceeds from revolving credit facility, net
 
33,956

 

Repayments of notes payable
 
(2,853
)
 
(2,356
)
Payments of loan origination costs
 
(1,546
)
 
(374
)
Net cash provided by financing activities
 
76,661

 
51,446

 
 
 
 
 
Net increase in cash and cash equivalents
 
2,644

 
15,069

Cash and cash equivalents at beginning of period
 
5,695

 
17,591

Cash and cash equivalents at end of period
 
$
8,339

 
$
32,660


See accompanying notes to Consolidated Financial Statements

5


Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

 
 
Nine Months Ended September 30,
 
 
2012
 
2011
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
5,250

 
$
4,271

Cash paid for taxes
 
$
225

 
$
215

Non cash investing and financing activities:
 
 
 
 
Disposal of fully depreciated real estate
 
$
523

 
$
162

Financed insurance premiums
 
$
856

 
$
649

Value of shares issued under distribution reinvestment plan
 
$
68

 
$

Accrued offering costs
 
$
85

 
$

Acquired interest rate swap
 
$
1,901

 
$

Debt discount on acquired note payable
 
$
(1,329
)
 
$

Value of common shares exchanged for OP units
 
$
6,224

 
$

Change in fair value of available-for-sale securities
 
$
891

 
$
(1,881
)
Change in fair value of cash flow hedge
 
$
(9
)
 
$


































See accompanying notes to Consolidated Financial Statements


6

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

The use of the words “we,” “us,” “our,” the "Operating Partnership" or the "Partnership" refers to Whitestone REIT Operating Partnership, L.P. and our consolidated subsidiaries, except where the context otherwise requires. The use of the words "Whitestone," the "General Partner," "Management" or the "Company" refers to Whitestone REIT, except where the context requires otherwise.

1.  INTERIM FINANCIAL STATEMENTS
 
The consolidated financial statements included in this report are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2011 are derived from our audited consolidated financial statements as of that date.  The unaudited financial statements as of September 30, 2012 have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information on a basis consistent with the annual audited consolidated financial statements and with the instructions to Form 10-Q.
 
The consolidated financial statements presented herein reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position of the Partnership and its subsidiaries as of September 30, 2012, and the results of operations for the three and nine month periods ended September 30, 2012 and 2011, the consolidated statements of changes in partners' capital for the nine month period ended September 30, 2012 and cash flows for the nine month periods ended September 30, 2012 and 2011.  All of these adjustments are of a normal recurring nature.  The results of operations for the interim periods are not necessarily indicative of the results expected for a full year.  The statements should be read in conjunction with the audited consolidated financial statements and the notes thereto which are included in our Annual Report on Form 10-K for the year ended December 31, 2011.
 
Business.  Whitestone REIT Operating Partnership, L.P., a Delaware limited partnership, was formed on December 31, 1998 to conduct, together with its subsidiaries, substantially all of the operations of its sole general partner, Whitestone REIT. Whitestone was formed as a real estate investment trust ("REIT"), pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998. In July 2004, Whitestone changed its state of organization from Texas to Maryland. As the general partner of the Partnership, Whitestone has the exclusive power to manage and conduct the business of the Partnership, subject to certain customary exceptions.  As of September 30, 2012 and December 31, 2011, the Partnership owned and operated 50 and 45 commercial properties, respectively, in and around Houston, Dallas, San Antonio, Chicago and Phoenix.


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Consolidation.  The accompanying consolidated financial statements include the accounts of the Partnership and its subsidiaries. All net income or loss is allocated between the General Partner and the limited partners based on the weighted-average percentage ownership of the Partnership during the period.  Issuances of additional common shares of beneficial interest, par value $0.001 per share, in Whitestone (the "common shares") and units of limited partnership interest in the Partnership that are convertible into cash or, at Whitestone's option, common shares on a one-for-one basis (the “OP units”) changes the ownership interests of both the Partnership and Whitestone.
  
Basis of Accounting.  Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.
 
Use of Estimates.   The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates that we use include the estimated fair values of properties acquired, the estimated useful lives for depreciable and amortizable assets and costs, the estimated allowance for doubtful accounts and estimates supporting our impairment analysis for the carrying values of our real estate assets.  Actual results could differ from those estimates.
 
Reclassifications.  We have reclassified certain prior period amounts in the accompanying consolidated financial statements in order to be consistent with the current period presentation.  These reclassifications had no effect on net income, total assets, total liabilities or partners' capital.


7

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

Marketable Securities. We classify our existing marketable equity securities as available-for-sale in accordance with the Financial Accounting Standards Board's ("FASB") Investments-Debt and Equity Securities guidance. These securities are carried at fair value with unrealized gains and losses reported in partners' capital as a component of accumulated other comprehensive income or loss. The fair value of the marketable securities is determined using Level 1 inputs under FASB Accounting Standards Codification ("ASC") 820, "Fair Value Measurements and Disclosures." Level 1 inputs represent quoted prices available in an active market for identical investments as of the reporting date. Gains and losses on securities sold are based on the specific identification method, and are reported as a component of interest, dividend and other investment income. We recognized gains on the sale of marketable securities of approximately $78,000 and $154,000 for the three months ended September 30, 2012 and 2011, respectively, and $110,000 and $192,000 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, our investment in available-for-sale marketable securities was approximately $1,373,000, which includes an aggregate unrealized loss of approximately $438,000.

Derivative Instruments and Hedging Activities. On August 8, 2012, as part of our acquisition of Paradise Plaza (see Note 15), we assumed a $9.2 million variable rate note (see Note 6). The note included an interest rate swap that had a fixed interest rate of 5.72%. Whitestone has designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value recorded in comprehensive income (loss) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, is recognized directly in earnings. As of September 30, 2012, we consider the cash flow hedge to be highly effective. The cash flow hedge is determined using Level 2 inputs under ASC 820. Level 2 inputs represent quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations whose inputs are observable.

As of September 30, 2012, the fair value of the cash flow hedge was $1.8 million. For the three and nine months ended September 30, 2012, we recognized $9,000 as other comprehensive losses. For the three and nine months ended September 30, 2012, we did not recognize any portion of the cash flow hedge into earnings.

Development Properties. Land, buildings and improvements are recorded at cost. Expenditures related to the development of real estate are carried at cost which includes capitalized carrying charges and development costs. Carrying charges, primarily interest, real estate taxes, loan fees, and direct and indirect development costs related to buildings under construction, are capitalized as part of construction in progress. The capitalization of such costs ceases when the property, or any completed portion, becomes available for occupancy. For the three months ended September 30, 2012, approximately $47,000 and $50,000 in interest expense and real estate taxes, respectively, were capitalized, and for the nine months ended September 30, 2012, approximately $135,000 and $113,000 in interest expense and real estate taxes, respectively, were capitalized. No interest expense or real estate taxes were capitalized during the three or nine months ended September 30, 2011.

Share-Based Compensation.   From time to time, Whitestone awards nonvested restricted common share awards or restricted common share unit awards that may be converted into common shares to its trustees, to executive officers and employees under Whitestone's 2008 Long-Term Equity Incentive Ownership Plan (the “2008 Plan”).  The vast majority of the awarded shares and units vest when certain performance conditions are met.  We recognize compensation expense when achievement of the performance conditions is probable based on Whitestone's most recent estimates using the fair value of the shares as of the grant date. We recognized $118,000 and $78,000 in share-based compensation for the three months ended September 30, 2012 and 2011, respectively, and we recognized $384,000 and $233,000 in share-based compensation for the nine months ended September 30, 2012 and 2011, respectively.
    
See our Annual Report on Form 10-K for the year ended December 31, 2011 for further discussion on significant accounting policies.
 
Recent Accounting Pronouncements.  There are no new unimplemented accounting pronouncements that are expected to have a material impact on our results of operations, financial position or cash flows.


8

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

3. MARKETABLE SECURITIES

All of our marketable securities were classified as available-for-sale securities as of September 30, 2012 and December 31, 2011. Available-for-sale securities consisted of the following (in thousands):
 
 
September 30, 2012
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Real estate common stock
 
$
1,811

 
$

 
$
(438
)
 
$
1,373

Total available-for-sale securities
 
$
1,811

 
$

 
$
(438
)
 
$
1,373

 
 
December 31, 2011
 
 
Amortized Cost
 
Gains in Accumulated Other Comprehensive Income
 
Losses in Accumulated Other Comprehensive Income
 
Estimated Fair Value
Exchange-traded fund
 
$
301

 
$

 
$
(37
)
 
$
264

Real estate sector mutual funds
 
351

 

 
(55
)
 
296

Real estate common stock
 
5,808

 

 
(1,237
)
 
4,571

Total available-for-sale securities
 
$
6,460

 
$

 
$
(1,329
)
 
$
5,131


During the three and nine months ended September 30, 2012, available-for-sale securities were sold for total proceeds of $1,583,000 and $5,509,000, respectively. The gross realized gains and losses on these sales during the three months ended September 30, 2012 totaled $78,000 and $0, respectively, and the gross realized gains and losses on the sales during the nine months ended September 30, 2012 totaled $152,000 and $42,000, respectively. During the three and nine months ended September 30, 2011, available-for-sale securities were sold for total proceeds of $6,343,000 and $7,252,000, respectively. Gross realized gains or losses on the sales recognized during the three months ended September 30, 2011 were $263,000 and $109,000, respectively, and the gross realized gains and losses on the sales during the nine months ended September 30, 2011 totaled $302,000 and $110,000, respectively.

4. ACCRUED RENTS AND ACCOUNTS RECEIVABLE, NET

Accrued rents and accounts receivable, net consists of amounts accrued, billed and due from tenants, allowance for doubtful accounts and other receivables as follows (in thousands):

 
 
September 30, 2012
 
December 31, 2011
 
 
 
 
 
Tenant receivables
 
$
3,767

 
$
1,914

Accrued rents and other recoveries
 
5,393

 
5,505

Allowance for doubtful accounts
 
(1,983
)
 
(1,366
)
Total
 
$
7,177

 
$
6,053



9

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

5. UNAMORTIZED LEASING COMMISSIONS AND LOAN COSTS

Costs that have been deferred consist of the following (in thousands):
 
 
September 30, 2012
 
December 31, 2011
 
 
 
 
 
Leasing commissions
 
$
5,378

 
$
5,326

Deferred financing cost
 
4,463

 
2,916

Total cost
 
9,841

 
8,242

Less: leasing commissions accumulated amortization
 
(2,890
)
 
(2,861
)
Less: deferred financing cost accumulated amortization
 
(2,682
)
 
(1,626
)
Total cost, net of accumulated amortization
 
$
4,269

 
$
3,755


6. DEBT

Debt consisted of the following as of the dates indicated (in thousands):
Description
 
September 30, 2012
 
December 31, 2011
Fixed rate notes
 
 
 
 
$1.4 million 5.00% Note, due 2012
 
$
1,363

 
$
1,318

$14.1 million 5.695% Note, due 2013
 
13,923

 
14,110

$3.0 million 6.00% Note, due 2021 (1)
 
2,952

 
2,978

$10.0 million 6.04% Note, due 2014
 
9,189

 
9,326

$1.5 million 6.50% Note, due 2014
 
1,451

 
1,471

$11.2 million 6.52% Note, due 2015
 
10,648

 
10,763

$21.4 million 6.53% Notes, due 2013
 
19,034

 
19,524

$24.5 million 6.56% Note, due 2013
 
23,254

 
23,597

$9.9 million 6.63% Notes, due 2014
 
9,001

 
9,221

$0.7 million 2.97% Note, due 2012
 
193

 
23

Floating rate notes
 
 
 
 

Unsecured line of credit, LIBOR plus 2.75% to 3.75%, due 2015
 
45,000

 
11,000

$9.2 million, Prime Rate less 2.00%, due 2017
 
7,861

 

$26.9 million, LIBOR plus 2.86% Note, due 2013
 
23,947

 
24,559

 
 
$
167,816

 
$
127,890



(1) 
The 6.00% interest rate is fixed through March 30, 2016. On March 31, 2016 the interest rate will reset to the rate of interest for a five-year balloon note with a thirty-year amortization as published by the Federal Home Loan Bank.

As of September 30, 2012, our $122.6 million in secured debt was collateralized by 27 properties with a carrying value of $162.5 million.  Our loans contain restrictions that would require prepayment penalties for the acceleration of outstanding debt and are secured by deeds of trust on certain of our properties and by assignment of the rents and leases associated with those properties.  As of September 30, 2012, we were in compliance with all loan covenants.


10

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

On August 8, 2012, we assumed a $9.2 million variable rate note as part of our acquisition of Paradise Plaza (See Note 15). The variable rate is based on the Prime Rate less 2.00% and matures on December 27, 2017. We consider the variable rate to be below-market and have imputed an interest rate of 4.13%, which we consider to be an appropriate market rate. As a result, we recorded a discount on the note of $1.3 million, which will amortize into interest expense over the life of the loan. See Note 2 to the accompanying consolidated financial statements for a discussion of the interest rate swap included with this note.

Our $125 million unsecured revolving credit facility (the “Credit Facility”), which is available to us for acquisitions of properties and and working capital, is our primary source of additional credit. As of September 30, 2012, $45.0 million was drawn on the Credit Facility, and our borrowing capacity was $80.0 million, assuming use of the proceeds to acquire properties, or repayment of debt on properties, that are eligible to be included in the unsecured borrowing base. The Credit Facility bears interest at LIBOR plus 2.75% to 3.75%, and matures on February 27, 2015. As of September 30, 2012, the interest rate was 3.00%.

Whitestone serves as the guarantor for funds borrowed by the Partnership under the Credit Facility. The Credit 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 and extraordinary items) to fixed charges, minimum property net operating income to total indebtedness and maintenance of net worth. The Credit Facility also contains customary events of default with customary notice and cure, including, without limitation, nonpayment, breach of covenant, material misrepresentation of representations and warranties, cross-default to other major indebtedness, change of control, bankruptcy and loss of REIT tax status for Whitestone. As of September 30, 2012, we were in compliance with all covenants.

Scheduled maturities of our outstanding debt as of September 30, 2012 were as follows (in thousands):
Year
 
Amount Due
 
 
 
2012
 
$
2,291

2013
 
80,292

2014
 
19,171

2015
 
55,317

2016
 
73

Thereafter
 
10,672

Total
 
$
167,816


We will have approximately $14 million of debt maturing in June 2013 and approximately $66 million maturing in October and November 2013. The majority of this debt is with insurance companies and was entered into in late 2008. We have begun renewal discussions with our current lenders and expect to renew this debt with our current lenders or new lenders at rates and terms similar or better than our current rates and terms. We also have availability under our Credit Facility should we be unable to obtain similar or better financing from our current lenders or new lenders.

7.  EARNINGS PER UNIT
 
Basic earnings per OP unit for Partnership's unitholders is calculated by dividing income from continuing operations excluding amounts attributable to unvested restricted shares by the Partnership's weighted-average OP units outstanding during the period.  Diluted earnings per share is computed by dividing the net income from continuing operations excluding amounts attributable to unvested restricted shares by the Partnership's weighted-average OP units outstanding during the period, including any dilutive unvested restricted shares.
 
Certain of Whitestone's performance-based restricted common shares are considered participating securities which require the use of the two-class method for the computation of basic and diluted earnings per OP unit.   
 

11

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

For the three months ended September 30, 2012 and 2011, distributions of $45,000 and $53,000, respectively, were made to holders of certain restricted common shares, $40,000 and $49,000 of which were charged against earnings. For the nine months ended September 30, 2012 and 2011, distributions of $148,000 and $160,000, respectively, were made to holders of certain restricted common shares, $137,000 and $147,000 of which were charged against earnings. See Note 12 for information related to restricted common shares under the 2008 Plan.
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
(in thousands, except per unit data)
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
172

 
$
675

 
$
1,494

 
$
683

Distributions paid on unvested restricted shares
 
(5
)
 
(4
)
 
(11
)
 
(13
)
Undistributed earnings attributable to unvested restricted shares
 

 

 

 

 
 
 
 
 
 
 
 
 
Net income attributable to unitholders excluding amounts attributable to unvested restricted shares
 
$
167

 
$
671

 
$
1,483

 
$
670

 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Weighted average number of units - basic
 
14,667

 
12,676

 
13,349

 
10,166

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted shares
 
119

 
12

 
117

 
15

Weighted average number of units - dilutive
 
14,786

 
12,688

 
13,466

 
10,181

 
 
 
 
 
 
 
 
 
Earnings Per Unit:
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Net income attributable to unitholders excluding amounts attributable to unvested restricted shares
 
$
0.01

 
$
0.05

 
$
0.11

 
$
0.07

Diluted:
 
 
 
 
 
 
 
 
Net income attributable to unitholders excluding amounts attributable to unvested restricted shares
 
$
0.01

 
$
0.05

 
$
0.11

 
$
0.07


8. INCOME TAXES
 
Federal income taxes are not provided because we are taxed as a partnership and the liability incurred is that of our partners. Federal taxes are not provided for Whitestone because it intends to continue to and believes it qualifies as a REIT under the provisions of the Internal Revenue Code (the "Code") and because it has distributed and intends to continue to distribute all of its taxable income to its shareholders.  Whitestone's shareholders include their proportionate taxable income in their individual tax returns.  As a REIT, Whitestone must distribute at least 90% of its real estate investment trust taxable income to its shareholders and meet certain income sources and investment restriction requirements.  In addition, REITs are subject to a number of organizational and operational requirements.  If Whitestone fails to qualify as a REIT in any taxable year, Whitestone will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates.
 

12

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

During 2010, Whitestone discovered that it may have inadvertently violated the “5% asset test,” as set forth in Section 856(c)(4)(B)(iii)(I) of the Code, for the quarter ended March 31, 2009 as a result of utilizing a certain cash management arrangement with a commercial bank. If Whitestone's investment in a commercial paper investment sweep account through such cash management agreement is not treated as cash, and is instead treated as a security of a single issuer for purposes of the “5% asset test,” then Whitestone failed the “5% asset test” for the first quarter of its 2009 taxable year. Whitestone believes, however, that if it failed the “5% asset test,” the failure would be considered due to reasonable cause and not willful neglect and, therefore, Whitestone would not be disqualified as a REIT for its 2009 taxable year. Whitestone would be, however, subject to certain reporting requirements and 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 it failed to satisfy the “5% asset test.” The amount of such tax is $50,000, and Whitestone paid such tax on April 27, 2010.     
    
If the IRS were to assert that Whitestone failed the “5% asset test” for the first quarter of its 2009 taxable year and that such failure was not due to reasonable cause, and the courts were to sustain that position, Whitestone's status as a REIT would terminate as of December 31, 2008. Whitestone would not be eligible to again elect REIT status until its 2014 taxable year. Consequently, Whitestone would be subject to federal income tax on its taxable income at regular corporate rates without the benefit of the dividends-paid deduction, and its cash available for distributions to shareholders would be reduced.

Taxable income differs from net income for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation and rental revenue. 

We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (1% for us) to the profit margin, which generally will be determined for us as total revenue less a 30% standard deduction.  Although House Bill 3 states that the Texas Margin Tax is not an income tax, SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”) which is codified in FASB ASC 740, "Income Taxes" (“ASC 740”) applies to the Texas Margin Tax.  For the three months ended September 30, 2012 and 2011, we recognized $61,000 and $54,000 in margin tax provision, respectively, and for the nine months ended September 30, 2012 and 2011, we recognized $184,000 and $164,000, respectively.

9.  RELATED PARTY TRANSACTIONS
 
Executive Relocation. On July 9, 2010, upon the unanimous recommendation of Whitestone's Compensation Committee of Whitestone's board of trustees, Whitestone entered into an arrangement with James C. Mastandrea, Whitestone's Chairman, President and Chief Executive Officer, with respect to the disposition of his residence in Cleveland, Ohio. Mr. Mastandrea listed the residence in the second half of 2007 and has had no offers. In the meantime, Mr. Mastandrea has continued to pay for security, taxes, insurance and maintenance expenses related to the residence. In May 2010, Whitestone engaged a professional relocation firm to market the home and assist in moving the Mastandrea family to Houston. Since the engagement of the relocation firm, no offers on the home have been received. On August 6, 2012, upon the unanimous recommendation of Whitestone's Compensation Committee to Whitestone's board of trustees, the arrangement with Mr. Mastandrea with respect to the disposition of his residence in Cleveland, Ohio was amended. The following summarizes the amended arrangement:

Reimbursement of Mr. Mastandrea of the amount, if any, by which the sales price for the sale of the residence is less than $2,450,000 (the “Sales Price Shortfall”) upon sale of the residence (the “Shortfall Reimbursement”);

Payment to Mr. Mastandrea of an amount equal to the amount of any Shortfall Reimbursement divided by the net difference of one (1) minus the maximum U.S. federal income tax rate in effect at the time of the sale of the residence, less the Shortfall Reimbursement (the “Tax Payment”);

Payment of the sum of the Shortfall Reimbursement and Tax Payment (the “Lump Sum Payment”) as follows:
(1) Cash within five (5) business days after the sale of the residence (the “Cash Payment”); and (2) Company common shares, with the number of common shares being equal to the Lump Sum Payment, minus the Cash Payment, divided by the last sale price of the common shares on the New York Stock Exchange on the day of the sale of the residence, with the proportion of the Lump Sum Payment to be paid in cash and common shares being determined upon agreement between Mr. Mastandrea and Whitestone's Compensation Committee at the time of the sale of the residence;

Payment of housing expenses in Houston, Texas for a period of one (1) year following the sale of the residence; and

13

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)


Payment of out of pocket moving costs including packing, temporary storage, transportation and moving supplies.

10.  PARTNERS' CAPITAL
 
Reclassification of Common Shares

On June 27, 2012, Whitestone filed with the State Department of Assessments and Taxation of Maryland amendments to its declaration of trust that (i) reclassified each issued and unissued Class A common share of beneficial interest, par value $0.001 per share (the "Class A common shares") into one Class B common share of beneficial interest, par value $0.001 per share (the "Class B common shares") and (ii) changed the designation of all of the Class B common shares to “common shares.” The amendment setting forth the reclassification of the Class A common shares into Class B common shares was approved by Whitestone's shareholders at the 2012 annual meeting of shareholders held on May 22, 2012. The amendment approving the redesignation of the Class B common shares to common shares was approved by Whitestone's board of trustees and did not require shareholder approval.
    
Common Shares    

Following the reclassification of Whitestone's common shares on June 27, 2012, as described above, under its declaration of trust, as amended, Whitestone has authority to issue up to 400,000,000 common shares of beneficial interest, $0.001 par value per share, and up to 50,000,000 preferred shares of beneficial interest, $0.001 par value per share.
  
Equity Offering    

On August 28, 2012, Whitestone completed the sale of 4,830,000 common shares, $0.001 par value per share, including 630,000 common shares pursuant to the exercise of the underwriters' over-allotment option, at a price to the public of $12.80 per share. Total net proceeds from the offering, including over-allotment shares, and after deducting the underwriting discount and offering expenses, were approximately $58.7 million, which were contributed to the Partnership in exchange for 4,830,000 OP units. Whitestone intends to use the net proceeds for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and/or re-tenanting of properties in its portfolio, working capital and other general purposes.

Operating Partnership Units 
Substantially all of Whitestone's business is conducted through the Partnership.  Whitestone is the sole general partner of the Partnership.  As of September 30, 2012, Whitestone owned a 95.5% interest in the Partnership.
 
Limited partners in the Operating Partnership holding OP units have the right to convert their OP units into cash or, at Whitestone's option, common shares at a ratio of one OP unit for one common share.  Distributions to OP unitholders are paid at the same rate per unit as distributions per share to Whitestone common shares.  As of September 30, 2012 and December 31, 2011, there were 17,504,987 and 12,677,969 OP units outstanding, respectively.  Whitestone owned 16,718,796 and 11,317,042 OP units as of September 30, 2012 and December 31, 2011, respectively. The balance of the OP units is owned by third parties, including certain of Whitestone's trustees.  Whitestone's weighted-average share ownership in the Partnership was approximately 94.6% and 85.7% for the three months ended September 30, 2012 and 2011, respectively, and 93.4% and 82.2% for the nine months ended September 30, 2012 and September 30, 2011, respectively.


14

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

 Distributions
 
The following table summarizes the cash distributions paid or payable to holders of OP units during each quarter during 2011 and the nine months ended September 30, 2012 (in thousands, except per share/unit data):

 
 
Whitestone
 
Limited Partners Other than Whitestone
 
Total
Quarter Paid
 
Distributions Per OP Unit
 
Total Amount Paid
 
Distributions Per OP Unit
 
Total Amount Paid
 
Total Amount Paid
2012
 
 
 
 
 
 
 
 
 
 
Third Quarter
 
$
0.2850

 
$
3,859

 
$
0.2850

 
$
224

 
$
4,083

Second Quarter
 
0.2850

 
3,362

 
0.2850

 
258

 
3,620

First Quarter
 
0.2850

 
3,322

 
0.2850

 
301

 
3,623

Total
 
$
0.8550

 
$
10,543

 
$
0.8550

 
$
783

 
$
11,326

 
 
 
 
 
 
 
 
 
 
 
2011
 
 
 
 
 
 
 
 
 
 
Fourth Quarter
 
$
0.2850

 
$
3,193

 
$
0.2850

 
$
430

 
$
3,623

Third Quarter
 
0.2850

 
3,115

 
0.2850

 
514

 
3,629

Second Quarter
 
0.2850

 
2,121

 
0.2850

 
515

 
2,636

First Quarter
 
0.2850

 
1,616

 
0.2850

 
515

 
2,131

Total
 
$
1.1400

 
$
10,045

 
$
1.1400

 
$
1,974

 
$
12,019


New York Stock Exchange Listing

On June 29, 2012, Whitestone transferred the listing of its common shares to the New York Stock Exchange under its existing ticker symbol "WSR." As a result of the transfer, Whitestone voluntarily delisted its common shares from the NYSE MKT LLC (“NYSE MKT”) effective June 28, 2012.

Exchange Offers

On September 2, 2011, Whitestone 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, Whitestone 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.

On May 10, 2012, Whitestone commenced a third 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 “Third Exchange Offer”). The Third Exchange Offer expired on June 8, 2012, and 426,986 Class A common shares and 121,156 OP units were accepted for exchange.

See Note 16 for a description of Whitestone's registration of additional common shares subsequent to the quarter ending September 30, 2012.


15

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

11.  COMMITMENTS AND CONTINGENCIES
 
We are subject to various legal proceedings and claims that arise in the ordinary course of business.  These matters are generally covered by insurance.  While the resolution of these matters cannot be predicted with certainty, management believes the final outcome of such matters will not have a material adverse effect on our consolidated financial statements.
 
Executive Relocation.  On July 9, 2010, upon the unanimous recommendation of Whitestone's Compensation Committee of Whitestone's board of trustees, Whitestone entered into an arrangement with Mr. Mastandrea with respect to the disposition of his residence in Cleveland, Ohio. Mr. Mastandrea listed the residence in the second half of 2007 and has had no offers. In the meantime, Mr. Mastandrea has continued to pay for security, taxes, insurance and maintenance expenses related to the residence. In May 2010, Whitestone engaged a professional relocation firm to market the home and assist in moving the Mastandrea family to Houston. Since the engagement of the relocation firm, no offers on the home have been received. On August 6, 2012, upon the unanimous recommendation of Whitestone's Compensation Committee to Whitestone's board of trustees, the arrangement with Mr. Mastandrea with respect to the disposition of his residence in Cleveland, Ohio was amended. See Note 9 above for a description of the amendment to the arrangement with Mr. Mastandrea.

12.  INCENTIVE SHARE PLAN
 
On July 29, 2008, Whitestone's shareholders approved the 2008 Plan. On December 22, 2010, Whitestone's board of trustees amended the 2008 Plan to allow for awards in or related to Class B common shares pursuant to the 2008 Plan. On June 27, 2012, Whitestone's Class B common shares were redesignated as "common shares." The 2008 Plan, as amended, provides that awards may be made with respect to common shares of Whitestone or OP units, which may be converted into cash or, at Whitestone's option, common shares of Whitestone. The maximum aggregate number of common shares that may be issued under the 2008 Plan is increased upon each issuance of common shares by Whitestone so that at any time the maximum number of shares that may be issued under the 2008 Plan shall equal 12.5% of the aggregate number of common shares of Whitestone and OP units issued and outstanding (other than shares and/or OP units issued to or held by Whitestone).

The Compensation Committee of Whitestone's board of trustees administers the 2008 Plan, except with respect to awards to non-employee trustees, for which the 2008 Plan is administered by Whitestone's board of trustees.  The Compensation Committee is authorized to grant share options, including both incentive share options and non-qualified share options, as well as share appreciation rights, either with or without a related option. The Compensation Committee is also authorized to grant restricted common shares, restricted common share units, performance awards and other share-based awards. 

A summary of the share-based incentive plan activity as of and for the nine months ended September 30, 2012 is as follows:
 
 
Shares
 
Weighted-Average
Grant Date
Fair Value (1)
Non-vested at January 1, 2012
 
504,023

 
$
12.48

Granted
 
99,700

 
13.03

Vested
 
(15,041
)
 
13.84

Forfeited
 
(46,302
)
 
12.62

Non-vested as of September 30, 2012
 
542,380

 
12.53

Available for grant at September 30, 2012
 
1,882,240

 
 

(1) 
The fair value of the common shares granted before trading of the common shares commenced on the NYSE MKT on August 26, 2010 were determined based on observable market transactions occurring near the date of the grants. The fair value of the common shares granted subsequent to August 26, 2010 was determined based on the fair value at the date of grant.


16

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

A summary of Whitestone's non-vested and vested shares activity for the nine months ended September 30, 2012 and years ended December 31, 2011, 2010 and 2009 is presented below:
 
 
Shares Granted
 
Shares Vested
 
 
Non-Vested Shares Issued
 
Weighted-Average Grant-Date Fair Value
 
Vested Shares
 
Total Vest-Date Fair Value
 
 
 
 
 
 
 
 
(in thousands)
Nine months ended September 30, 2012
 
99,700

 
$
13.03

 
(15,041
)
 
$
208

Year ended December 31, 2011
 

 

 
(5,169
)
 
80

Year ended December 31, 2010
 
31,858

 
14.09

 
(55,699
)
 
695

Year ended December 31, 2009
 
600,731

 
12.37

 

 

    
Total compensation recognized in earnings for share-based payments was $118,000 and $78,000 for the three months ended September 30, 2012 and 2011, respectively, and $384,000 and $233,000 for the nine months ended September 30, 2012 and 2011, respectively. With the acquisitions during the three months ended September 30, 2012 (see Note 15), Whitestone expects additional performance-based shares to vest due to the achievement of certain Company-wide performance goals. As a result, at September 30, 2012, there was approximately $1,376,000 in unrecognized compensation cost related to outstanding non-vested performance-based shares, which is expected to vest over a period of fifteen months and approximately $90,000 in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a weighted-average period of approximately one year. The fair value of the shares granted during the nine months ended September 30, 2012 was determined using quoted prices available on the date of grant.

13. GRANTS TO TRUSTEES
On May 22, 2012, each of Whitestone's four independent trustees was granted 1,500 common shares, which vested immediately. The 6,000 common shares granted to Whitestone's four independent trustees had a grant date fair value of $13.03 per share. On June 25, 2012, two of Whitestone's independent trustees elected to receive a total of 915 common shares with a grant date fair value of $13.39 in lieu of cash for board fees. The fair value of the shares granted during the nine months ended September 30, 2012 was determined using quoted prices available on the date of grant.

14. SEGMENT INFORMATION

Historically, management has not differentiated results of operations by property type or location and, therefore, does not present segment information.

15. REAL ESTATE

Property Acquisitions. On September 21, 2012, we acquired Village Square at Dana Park, a property that meets our Community Centered Property strategy, for approximately $46.5 million in cash and net prorations. The 310,979 square foot center was 71% leased at the time of purchase and is located in the Mesa submarket of Phoenix, Arizona. In the same purchase, we also acquired an adjacent development parcel of 4.7 acres for approximately $4.0 million in cash.

On September 21, 2012, we acquired Fountain Square, a property that meets our Community Centered Property strategy, for approximately $15.4 million in cash and net prorations. The 118,209 square foot property was 76% leased at the time of purchase and is located in Scottsdale, Arizona.

On August 8, 2012, we acquired Paradise Plaza, a property that meets our Community Centered Property strategy, for approximately $16.3 million, including the assumption of a $9.2 million non-recourse loan, and cash of $7.1 million. Paradise Plaza was 100% occupied at the time of purchase with 125,898 of square feet of gross leasable area, and is located in Paradise Valley, Arizona, a suburb of Phoenix.


17

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

On May 29, 2012, we acquired the Shops at Pinnacle Peak, a property that meets our Community Centered Property strategy, for approximately $6.4 million in cash and net prorations. The 41,530 square foot center was 76% leased at the time of purchase and is located in North Scottsdale, Arizona.     

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, and is 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.

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 that is 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.

On December 28, 2011, we acquired Pinnacle of Scottsdale Phase II, or Pinnacle Phase II, a 4.45 acre parcel of developed land adjacent to Pinnacle, described below, for approximately $1.0 million in cash and net prorations. Pinnacle Phase II has approximately 400 linear feet of frontage on Scottsdale Road, in North Scottsdale, Arizona and the potential for additional retail and office development.

On December 22, 2011, we acquired Phase I of Pinnacle of Scottsdale, or 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 that is 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, Arizona.

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.

On August 8, 2011, we acquired Terravita Marketplace, a property that meets our Community Centered Property strategy, containing 102,733 square feet of gross leasable area, including of 51,434 square feet leased to two tenants pursuant to ground leases, located in Scottsdale, Arizona for approximately $16.1 million in cash and net prorations. Terravita Marketplace is adjacent to the gated golf course residential community of Terravita, which was developed by DelWebb Corporation/Pulte, with homes ranging in price from $250,000 to $1 million.

On June 28, 2011, we acquired Gilbert Tuscany Village, a property that meets our Community Centered Property strategy, containing 49,415 square feet of gross leasable area, located in Gilbert, Arizona for approximately $5.0 million in cash and net prorations. Gilbert Tuscany Village is surrounded by densely populated, high-end residential developments and is located approximately one mile from Banner Gateway Medical Center, a 60-acre medical complex that is partnering with MD Anderson to add a new 120,000 square foot cancer outpatient center.

On April 13, 2011, we acquired Desert Canyon Shopping Center, a property that meets our Community Centered Property strategy, for approximately $3.65 million in cash and net prorations. The center contains 62,533 square feet of gross leasable area, including 12,960 square feet leased to two tenants pursuant to ground leases, and is located in Mcdowell Mountain Ranch in northern Scottsdale, Arizona. Situated at a prime intersection at East McDowell Mountain Ranch Road and 105th Street, Desert Canyon is the nearest retail and office space to McDowell Mountain Elementary and Junior High Schools. Located adjacent to the Sonora Mountain Desert Preserve, a lighted trail and jogging path wind directly into the Desert Canyon site and provide access from the surrounding upscale residential neighborhoods.

Property Dispositions. On July 22, 2011, we sold Greens Road Plaza, located in Houston, Texas, for $1.8 million in cash and net prorations. We have reinvested the proceeds from the sale of the 20,607 square foot property located in northeast Houston in Community Centered Properties in our target markets. As a result of the transaction, we recorded a gain on sale of property of $0.4 million for the year ended December 31, 2011.



18

WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)

16. SUBSEQUENT EVENTS

On October 9, 2012, Whitestone filed a prospectus supplement, relating to its effective universal shelf registration statement on Form S-3, covering the issuance of up to 786,191 of Whitestone's common shares, par value $0.001 per share, to certain holders of OP units in the Partnership. The OP units may be issued to the extent that OP unit holders tender their OP units for redemption in accordance with the terms of the limited partnership agreement of the Partnership and Whitestone elects, at its sole discretion, to issue common shares to the tendering OP unit holders.


19


Item 2.  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 unaudited consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q (the “Report”), and the consolidated financial statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for the year ended December 31, 2011.  For more detailed information regarding the basis of presentation for the following information, you should read the notes to the unaudited consolidated financial statements included in this Report.

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

the imposition of federal taxes if Whitestone fails to qualify as a 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;
decreases in rental rates or increases in vacancy rates;
litigation risks;
lease-up risks;
inability to renew tenants or 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 potential 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 our Annual Report on Form 10-K for the year ended December 31, 2011, as previously filed with the Securities and Exchange Commission ("SEC") and of this Report below.
 
Overview

We are a Delaware limited partnership formed in 1998 and a majority-owned subsidiary of our sole general partner, Whitestone, a fully integrated real estate company that owns and operates Community Centered Properties in culturally diverse markets in major metropolitan areas.  We define Community Centered Properties as visibly located properties in established or developing culturally diverse neighborhoods in our target markets. We have a portfolio of commercial properties in Texas, Arizona and Illinois.

In October 2006, Whitestone's current management team joined Whitestone and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties.  Management markets, leases and manages 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.  Whitestone employs and develops a diverse group of associates who understand the needs of our multicultural communities and tenants.

20



As of September 30, 2012, we owned and operated 50 commercial properties consisting of:

Operating Portfolio
twenty-four retail centers containing approximately 1.8 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $170.2 million;
seven office centers containing approximately 0.6 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $43.3 million; and
eleven office/flex centers containing approximately 1.2 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $40.1 million.
Redevelopment, New Acquisitions Portfolio
five retail Community Centered Properties containing approximately 0.6 million square feet of gross leasable area and having a total carrying value (net of accumulated depreciation) of $77.2 million; and
three parcels of land held for future development having a total carrying value of $7.1 million.
As of September 30, 2012, we had a total of 1,051 tenants.  We have a diversified tenant base with our largest tenant comprising only 1.2% of our annualized rental revenues for the nine months ended September 30, 2012.  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 245 new and renewal leases during the nine months ended September 30, 2012, totaling approximately 493,000 square feet and approximately $24.0 million in total lease value.  This compares to 224 new and renewal leases totaling approximately 636,000 square feet and approximately $25.1 million in total lease value during the same period in 2011.

As of September 30, 2012, we had no employees and Whitestone employed 59 full-time employees.  As an internally managed REIT, Whitestone bears its own expenses of operations, including the salaries, benefits and other compensation of its employees, office expenses, legal, accounting and investor relations expenses and other overhead costs. As the management and employees of Whitestone work for the benefit of the Partnership, the costs and expenses of Whitestone have been presented in this Report in a manner consistent with Whitestone's presentation in its quarterly report on Form 10-Q for the period ended September 30, 2012.

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 $11.6 million and $8.8 million for the three months ended September 30, 2012 and 2011, respectively, and $33.0 million and $24.9 million for the nine months ended September 30, 2012 and 2011, respectively.

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. We expect modest continued improvement in the economic conditions in our markets to provide slight increases in occupancy at certain of our properties.
 

21


Scheduled Lease Expirations
 
We tend to lease space to smaller businesses that desire shorter term leases. As of September 30, 2012, approximately 29% of our gross leasable area was subject to leases that expire prior to December 31, 2013.  Over the last two years, we have renewed leases covering approximately 75% of our square footage 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.  In the markets in which we operate, we obtain and analyze market rental rates by reviewing third-party publications, which provide market and submarket rental rate data, and by inquiring of property owners and property management companies as to rental rates being quoted at properties located in close proximity to our properties that we believe display similar physical attributes as our properties. We utilize 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 new and renewal comparable spaces increased 1% when compared to the expiring revenue rate per square foot for the previous leases in the same spaces.  As such, we expect to renew our leases expiring in the near term at rates which are at, or near, their current rates. Market conditions, including new supply of properties, and macroeconomic conditions in our markets 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 distributions to our unitholders.
 
Acquisitions
 
We expect to actively seek acquisitions in the foreseeable future. We believe that over the next few years we will continue to have excellent opportunities to acquire quality properties at historically attractive prices. Whitestone, our general partner, has 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.  Management markets, leases and manages our centers to match tenants with the shared needs of the surrounding neighborhood.  Those needs may include specialty retail, grocery, restaurants, 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.

On September 21, 2012, we acquired Village Square at Dana Park, a property that meets our Community Centered Property strategy, for approximately $46.5 million in cash and net prorations. The 310,979 square foot center was 71% leased at the time of purchase and is located in the Mesa submarket of Phoenix, Arizona. In the same purchase, we also acquired an adjacent development parcel of 4.7 acres for approximately $4.0 million in cash.

On September 21, 2012, we acquired Fountain Square, a property that meets our Community Centered Property strategy, for approximately $15.4 million in cash and net prorations. The 118,209 square foot property was 76% leased at the time of purchase and is located in Scottsdale, Arizona.

On August 8, 2012, we acquired Paradise Plaza, a property that meets our Community Centered Property strategy, for approximately $16.3 million, including the assumption of a $9.2 million non-recourse loan, and cash of $7.1 million. Paradise Plaza was 100% occupied at the time of purchase with 125,898 of square feet of gross leasable area, and is located in Paradise Valley, Arizona, a suburb of Phoenix.

On May 29, 2012, we acquired the Shops at Pinnacle Peak, a property that meets our Community Centered Property strategy, for approximately $6.4 million in cash and net prorations. The 41,530 square foot center was 76% leased at the time of purchase and is located in North Scottsdale, Arizona.    


22


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 and is 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.

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 that is 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.

On December 28, 2011, we acquired Pinnacle of Scottsdale Phase II, or Pinnacle Phase II, a 4.45 acre parcel of developed land adjacent to Pinnacle, described below, for approximately $1.0 million in cash and net prorations. Pinnacle Phase II has approximately 400 linear feet of frontage on Scottsdale Road, in North Scottsdale, Arizona and the potential for additional retail and office development.

On December 22, 2011, we acquired Phase I of Pinnacle of Scottsdale, or 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 that is 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, Arizona.

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.

On August 8, 2011, we acquired Terravita Marketplace, a property that meets our Community Centered Property strategy, containing 102,733 square feet of gross leasable area, including 51,434 square feet leased to two tenants pursuant to ground leases, for approximately $16.1 million in cash and net prorations. Terravita Marketplace is located in North Scottsdale, Arizona and adjacent to the gated golf course residential community of Terravita, which was developed by DelWebb Corporation/Pulte, with homes ranging in price from $250,000 to $1 million.

On June 28, 2011, we acquired Gilbert Tuscany Village, a property that meets our Community Centered Property strategy, containing 49,415 square feet of gross leasable area, located in Gilbert, Arizona for approximately $5.0 million in cash and net prorations. Gilbert Tuscany Village is surrounded by densely populated, high-end residential developments and is located approximately one mile from Banner Gateway Medical Center, a 60-acre medical complex that is partnering with MD Anderson to add a new 120,000 square foot cancer outpatient center.

On April 13, 2011, we acquired Desert Canyon Shopping Center, a property that meets our Community Centered Property strategy, for approximately $3.65 million in cash and net prorations. The center contains 62,533 square feet of gross leasable area, including 12,960 square feet leased to two tenants pursuant to ground leases, and is located in Mcdowell Mountain Ranch in northern Scottsdale, Arizona. Situated at a prime intersection at East McDowell Mountain Ranch Road and 105th Street, Desert Canyon is the nearest retail and office space to McDowell Mountain Elementary and Junior High Schools. Located adjacent to the Sonora Mountain Desert Preserve, a lighted trail and jogging path wind directly into the Desert Canyon site and provide access from the surrounding upscale residential neighborhoods.
    
Property Dispositions

On July 22, 2011, we sold Greens Road Plaza, located in Houston, Texas, for $1.8 million in cash and net prorations. We have reinvested the proceeds from the sale of the 20,607 square foot property located in northeast Houston in Community Centered Properties in our target markets. As a result of the transaction, we recorded a gain on sale of property of $0.4 million for the year ended December 31, 2011.


23


Critical Accounting Policies

In preparing the consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. Actual results may differ from these estimates.  A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2011, under "Management's Discussion and Analysis of Financial Condition and Results of Operations."  There have been no significant changes to these policies during the nine months ended September 30, 2012.  For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 in our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

Comparison of the Three Months Ended September 30, 2012 and 2011
 
The following table provides a summary comparison of our results of operations for the three months ended September 30, 2012 and 2011 (dollars in thousands, except per OP unit amounts):
 
 
Three Months Ended September 30,
 
 
2012
 
2011
Number of properties owned and operated
 
50

 
41

Aggregate gross leasable area (sq. ft.)(1)
 
4,195,924

 
3,428,844

Ending occupancy rate - operating portfolio(2)
 
87
%
 
86
%
Ending occupancy rate - all properties
 
85
%
 
84
%
 
 
 
 
 
Total property revenues
 
$
11,618

 
$
8,791

Total property expenses
 
4,598

 
3,638

Total other expenses
 
6,694

 
4,822

Provision for income taxes
 
77

 
54

Gain (loss) on disposal of assets
 
77

 
(1
)
Income before gain on sale of property
 
172

 
278

Gain on sale of property
 

 
397

Net income
 
$
172

 
$
675

 
 
 
 
 
Funds from operations (3)
 
$
2,906

 
$
2,210

Property net operating income (4)
 
7,020

 
5,153

Distributions paid on OP units
 
4,083

 
3,629

Per OP unit
 
$
0.2850

 
$
0.2850

Distributions paid as a % of funds from operations
 
141
%
 
164
%
(1)  
During the first quarter of 2012, we concluded that approximately 2,029 square feet at our Lion Square location was no longer leasable, therefore, such area is no longer included in the gross leasable area as of March 31, 2012.
(2)  
Excludes (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.
(3)  
For a reconciliation of funds from operations to net income, see "Funds From Operations" below.
(4)  
For a reconciliation of property net operating income to net income, see "Property Net Operating Income" below.


24


Property revenues. We had rental income and tenant reimbursements of approximately $11,618,000 for the three months ended September 30, 2012 as compared to $8,791,000 for the three months ended September 30, 2011, an increase of $2,827,000, or 32%. The three months ended September 30, 2012 included $2,458,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired since the beginning of the the period being compared. For purposes of comparing the three months ended September 30, 2012 to the three months ended September 30, 2011, New Stores include properties acquired between July 1, 2011 and September 30, 2012. Same Store revenues increased $369,000 for the three months ended September 30, 2012 as compared to the same period in the prior year. We define "Same Stores" as properties that were owned at the beginning of the period being compared. For purposes of comparing the three months ended September 30, 2012 to the three months ended September 30, 2011, Same Stores include properties owned before July 1, 2011. Same Store average occupancy increased from 81.8% for the three months ended September 30, 2011 to 85.0% for the three months ended September 30, 2012, increasing Same Store revenue $321,000. The Same Store average revenue per leased square foot increased $0.07 for the three months ended September 30, 2012 to $12.72 per leased square foot as compared to the average revenue per leased square foot of $12.65 for the three months ended September 30, 2011, resulting in an increase of Same Store revenues of $48,000.

Property expenses.  Our property expenses were approximately $4,598,000 for the three months ended September 30, 2012 as compared to $3,638,000 for the three months ended September 30, 2011, an increase of $960,000, or 26%.  The primary components of total property expenses are detailed in the table below (in thousands, except percentages):
 
 
Three Months Ended September 30,
 
 
 
 
 
 
2012
 
2011
 
Change
 
% Change
Real estate taxes
 
$
1,629

 
$
1,262

 
$
367

 
29
%
Utilities
 
810

 
678

 
132

 
19
%
Contract services
 
657

 
594

 
63

 
11
%
Repairs and maintenance
 
476

 
396

 
80

 
20
%
Bad debt
 
362

 
165

 
197

 
119
%
Labor and other
 
664

 
543

 
121

 
22
%
Total property expenses
 
$
4,598

 
$
3,638

 
$
960

 
26
%

Real estate taxes.  Real estate taxes increased $367,000, or 29%, during the three months ended September 30, 2012 as compared to the same period in 2011. Real estate taxes for New Store properties were approximately $360,000 for the three months ended September 30, 2012. Same Store real estate taxes increased approximately $7,000 during the three months ended September 30, 2012 as compared to the same period in 2011. Management actively works to keep our valuations and resulting taxes low because a majority of these taxes are charged to our tenants through triple net leases, and we strive to keep these charges to our tenants as low as possible.

Utilities. Utilities expenses increased $132,000, or 19%, during the three months ended September 30, 2012 as compared to the same period in 2011. Utilities expenses for New Store properties were approximately $99,000 for the three months ended September 30, 2012. Same Store utilities expenses increased approximately $33,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The majority of the Same Store increase was attributable to water and drainage fees charged to our Houston properties by the City of Houston.
 
Contract services.  Contract services increased $63,000, or 11%, during the three months ended September 30, 2012 as compared to the same period in 2011. The increase in contract services expenses included $77,000 in contract expenses increases for New Store properties for the three months ended September 30, 2012. Same Store contract service expenses decreased approximately $14,000 during the three months ended September 30, 2012 as compared to the same period in 2011.
  
Repairs and maintenance. Repairs and maintenance expenses increased $80,000, or 20%, during the three months ended September 30, 2012 as compared to the same period in 2011. Repairs and maintenance expenses for the three months ended September 30, 2012 included approximately $150,000 in increases for New Store properties. Same Store repairs and maintenance expenses decreased approximately $70,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The decrease in Same Store repair expenses was primarily attributable to parking lot repairs completed during 2011.
 

25


Bad debt.  Bad debt expenses increased $197,000, or 119%, during the three months ended September 30, 2012 as compared to the same period in 2011. Bad debt expenses for the three months ended September 30, 2012 included approximately $63,000 in increases for New Store properties. Same Store bad debt increased approximately $134,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The Same Store increase in bad debt expenses was primarily attributable to outstanding rent and fees owed by several tenants in our Texas market. We are currently evaluating collection options ranging from downsizing the tenants to possible lockouts. Management vigorously pursues past due accounts, but expects collection of rents to continue to be challenging for the foreseeable future.
 
Labor and other.  Labor and other expenses increased $121,000, or 22%, during the three months ended September 30, 2012 as compared to the same period in 2011. Labor and other expenses for the three months ended September 30, 2012 included approximately $51,000 in increased cost for New Store properties. Same Store labor and other expenses increased approximately $70,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The increase in Same Store labor and other cost was primarily attributable to increased insurance rates and labor allocated for repairs and maintenance and was offset by lower non-recoverable repair costs.

Same Store and New Store net operating income. The components of Same Store, New Store and total property net operating income are detailed in the table below (in thousands):
 
 
Three Months Ended September 30,
 
 
Same Store
 
New Store
 
Total
 
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Property revenues
 
$
8,789

 
$
8,420

 
$
2,829

 
$
371

 
$
11,618

 
$
8,791

Property expenses
 
3,736

 
3,575

 
862

 
63

 
4,598

 
3,638

Property net operating income
 
$
5,053

 
$
4,845

 
$
1,967

 
$
308

 
$
7,020

 
$
5,153


Other expenses.  Our other expenses were $6,694,000 for the three months ended September 30, 2012, as compared to $4,822,000 for the three months ended September 30, 2011, an increase of $1,872,000, or 39%.  The primary components of other expenses are detailed in the table below (in thousands, except percentages):

 
 
Three Months Ended September 30,
 
 
 
 
 
 
2012
 
2011
 
Change
 
% Change
General and administrative
 
$
1,888

 
$
1,495

 
$
393

 
26
 %
Depreciation and amortization
 
3,112

 
2,161

 
951

 
44
 %
Interest expense
 
1,815

 
1,430

 
385

 
27
 %
Interest, dividend and other investment income
 
(121
)
 
(264
)
 
143

 
(54
)%
Total other expenses
 
$
6,694

 
$
4,822

 
$
1,872

 
39
 %

General and administrative.  General and administrative expenses increased approximately $393,000, or 26%, for the three months ended September 30, 2012 as compared to the same period in 2011. The increases in general and administrative expenses included increases in legal fees of $187,000, increases in acquisition expenses of $151,000, increases in share-based compensation of $52,000 and $3,000 in other increases. The majority of the increase in legal expense is attributable to a $190,000 settlement we received from litigation with a former tenant regarding damages to our properties during the three months ended September 30, 2011 that did not repeat during the three months ended September 30, 2012. The increase in acquisition expenses is due to acquisition-related costs for our acquisitions of Paradise Plaza, Fountain Square and Village Square at Dana Park during the three months ended September 30, 2012. The increase in share-based compensation is due to expense related to additional employee grants and expenses related to the expected vesting of performance-based shares. As of September 30, 2012, there was approximately $1,380,000 in unrecognized compensation cost related to outstanding non-vested performance-based shares, which is expected to to vest over a period of fifteen months and approximately $90,000 in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a weighted-average period of approximately one year.
 

26


Depreciation and amortization.  Depreciation and amortization increased $951,000, or 44%, for the three months ended September 30, 2012 as compared to the same period in 2011. Depreciation for improvements to Same Store properties increased $328,000 for the three months ended September 30, 2012 as compared to the same period in 2011, and amortization of capitalized loan fees increased $233,000. The increase in Same Store depreciation is attributable to redevelopment and re-tenanting investments, most notably at our Windsor Park and Lion Square locations, and the increase in amortization of capitalized loan fees is the result of fees associated with our Credit Facility (as defined below). Lease commissions and depreciation of corporate assets increased $14,000 for the three months ended September 30, 2012 as compared to the same period in 2011. Depreciation for New Store properties increased $376,000.

Interest expense. Interest expense increased $385,000, or 27%, for the three months ended September 30, 2012 as compared to the same period in 2011. The increase in interest expense is comprised of approximately $715,000 in interest expense resulting from an approximate $51,292,000 increase in our average notes payable balance during the three months ended September 30, 2012 as compared to the same period 2011, offset by a $330,000 decrease in interest expense resulting from a decrease in the effective interest rate from 5.57% to 4.72% during three months ended September 30, 2012 as compared to the same period in 2011.

Interest, dividend and other investment income. Interest, dividend and other investment income decreased $143,000, or 54%, for the three months ended September 30, 2012 as compared to the same period in 2011. The $143,000 decrease is comprised of a $58,000 decrease in dividend income, a $75,000 decrease in gains on sales of available-for-sale marketable securities and a $10,000 decrease in interest income.

Results of Operations

Comparison of the Nine Month Periods Ended September 30, 2012 and 2011
 
The following table provides a summary comparison of our results of operations for the nine months ended September 30, 2012 and 2011 (dollars in thousands, except per OP unit amounts):

 
 
Nine Months Ended September 30,
 
 
2012
 
2011
Number of properties owned and operated
 
50

 
41

Aggregate gross leasable area (sq. ft.)(1)
 
4,195,924

 
3,428,844

Ending occupancy rate - operating portfolio(2)
 
87
%
 
86
%
Ending occupancy rate - all properties
 
85
%
 
84
%
 
 
 
 
 
Total property revenues
 
$
33,031

 
$
24,947

Total property expenses
 
12,522

 
9,718

Total other expenses
 
18,698

 
14,761

Provision for income taxes
 
212

 
165

Gain (loss) on disposal of assets
 
105

 
17

Income before gain on sale of property
 
1,494

 
286

Gain on sale of property
 

 
397

Net income
 
$
1,494

 
$
683

 
 
 
 
 
Funds from operations (3)
 
$
8,759

 
$
5,913

Property net operating income (4)
 
20,509

 
15,229

Distributions paid on OP units
 
11,326

 
8,396

Per OP unit
 
$
0.8850

 
$
0.8850

Distributions paid as a % of funds from operations
 
129
%
 
142
%


27


(1)  
During the first quarter of 2012, we concluded that approximately 2,029 square feet at our Lion Square location was no longer leasable, therefore such area is no longer included in the gross leasable area as of March 31, 2012.
(2)  
Excludes (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.
(3)  
For a reconciliation of funds from operations to net income, see "Funds From Operations" below.
(4)  
For a reconciliation of property net operating income to net income, see "Property Net Operating Income" below.

Property revenues. We had rental income and tenant reimbursements of approximately $33,031,000 for the nine months ended September 30, 2012 as compared to $24,947,000 for the nine months ended September 30, 2011, an increase of $8,084,000, or 32%. The nine months ended September 30, 2012 included $7,342,000 in increased revenues from New Store operations. For purposes of comparing the nine months ended September 30, 2012 to the nine months ended September 30, 2011, New Stores include properties acquired between January 1, 2011 and September 30, 2012. Same Store revenues increased $742,000 for the nine months ended September 30, 2012 as compared to the same period in the prior year. For purposes of comparing the nine months ended September 30, 2012 to the nine months ended September 30, 2011, Same Stores include properties owned before January 1, 2011. Same Store average occupancy increased from 84.0% for the nine months ended September 30, 2011 to 84.5% for the nine months ended September 30, 2012, increasing Same Store revenue $344,000. The Same Store average revenue per leased square foot increased $0.30 for the nine months ended September 30, 2012 to $12.53 per leased square foot as compared to the nine months ended September 30, 2011 average revenue per leased square foot of $12.23, resulting in an increase of Same Store revenues of $398,000.

Property expenses.  Our property expenses were approximately $12,522,000 for the nine months ended September 30, 2012 as compared to $9,718,000 for the nine months ended September 30, 2011, an increase of $2,804,000, or 29%.  The primary components of total property expenses are detailed in the table below (in thousands, except percentages):
 
 
Nine Months Ended September 30,
 
 
 
 
 
 
2012
 
2011