Note 6 - Investment in Real Estate Partnership

9 Months Ended

Sep. 30, 2024

Notes to Financial Statements

Equity Method Investments and Joint Ventures Disclosure [Text Block]

6. INVESTMENT IN REAL ESTATE PARTNERSHIP

On December 8, 2016, we, through our Operating Partnership, entered into a Contribution Agreement (the “Contribution Agreement”) with Pillarstone OP and Pillarstone Capital REIT (“Pillarstone REIT”) pursuant to which we contributed all of the equity interests in four of our wholly-owned subsidiaries that, at the time, owned 14 non-core properties that did not fit our Community Centered Property® strategy (the “Pillarstone Properties”), to Pillarstone OP for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP (“Pillarstone OP Units”) and (2) the assumption of approximately $65.9 million of liabilities (collectively, the “Contribution”). As of September 30, 2024, our ownership in Pillarstone OP no longer represents a majority interest. On January 25, 2024, the Company exercised its notice of redemption for substantially all of its investment in Pillarstone OP. As of the date of this filing, we have not received consideration for our redemption of our equity investment in Pillarstone OP as required by the partnership agreement. The Company has filed a claim in the Pillarstone Bankruptcies for the value of its redemption claim along with interest and other costs. We intend to pursue collection of amounts due from Pillarstone OP through all means necessary and while we do not know the ultimate amount to be collected, we believe the amount will be in excess of the current carrying value of our equity investment in Pillarstone OP. 

In connection with the Contribution, Whitestone TRS, Inc., a subsidiary of the Company (“Whitestone TRS”), entered into a management agreement with the entities that own the contributed Pillarstone Properties (collectively, the “Management Agreements”). Pursuant to the Management Agreements, Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services. The Management Agreements were terminated on August 18, 2022.  Prior to the termination of the Management Agreement, we reported approximately $144,000 in property management fee income on a quarterly basis. 

The table below presents the real estate partnership investment in which we hold an ownership interest (in thousands):

			Company’s Investment as of
			September 30, 2024		December 31, 2023
Real estate partnership	Ownership Interest
Pillarstone OP		81.4%	$	—	$	31,671
Total real estate partnership(1)(2)(3)			$	—	$	31,671

⁽¹⁾ Representing eight property interests and 926,798 square feet of GLA, as of December 31, 2023. Subsequent to January 25, 2024, we ceased utilizing the equity method following the exercise of our notice of redemption for the majority of our investment in Pillarstone OP. We reclassified our investment in Pillarstone OP to a receivable on our balance sheet after estimating 25 days of our share of the equity investment income.

⁽²⁾ On December 26, 2021, the Board of Trustees of Pillarstone REIT adopted a new shareholder rights agreement (the “Pillarstone Rights Agreement”). Because Pillarstone REIT sought to use the Pillarstone Rights Agreement to prevent us from exercising our contractual Redemption Right, on July 12, 2022, we filed suit against Pillarstone REIT in the Court of Chancery of the State of Delaware challenging the Pillarstone Rights Agreement. On September 8, 2022, our Motion to Preserve the Status Quo was granted by the Court, limiting Pillarstone OP from engaging in any acts outside the ordinary course of business and otherwise imposing restrictions on Pillarstone OP to ensure that our right of redemption is not impaired while the underlying dispute is being considered by the Court. On January 25, 2024, the Delaware Court of Chancery: held that Pillarstone breached the implied covenant of good faith and fair dealing when it adopted the Pillarstone Rights Agreement that thwarted us from exercising the unfettered contractual redemption right we obtained in connection with our investment in the partnership; and the Court held that the Rights Plan was unenforceable as to the limited partner and allowed us to exercise its redemption right; allowed Pillarstone to determine the current value of the Partnership’s assets; and, as necessary, later enter a monetary judgment against Pillarstone for the difference between the amount we would have received in or around December 2021 and the current value. On January 25, 2024, we exercised our notice of redemption for substantially all of its investment in Pillarstone OP. On March 4, 2024, Pillarstone REIT authorized and filed the Pillarstone Bankruptcies. As of the date of this filing, we have not received consideration for its redemption of our equity investment in Pillarstone OP as required by the partnership agreement. We have filed a claim in the Pillarstone Bankruptcies for the value of its redemption claim along with interest and other costs. We intend to pursue collection of amounts due from Pillarstone OP through all means necessary and while we do not know the ultimate amount to be collected, we believe the amount will be in excess of the current carrying value of our equity investment in Pillarstone OP.

⁽³⁾ We rely on reporting provided to us by Pillarstone OP’s general partner for financial information regarding our investment in Pillarstone OP. Because Pillarstone OP financial statements as of December 31, 2023 have not been made available to us, we have estimated the value of the investment based on the information available to us at the time of this report.

The table below presents our share of net loss from our investment in the real estate partnership which is included in deficit in earnings of real estate partnership, net on our consolidated statements of operations and comprehensive income (loss) (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2024		2023			2024			2023
Pillarstone OP	$	—	$	(375	)	$	(28	)	$	(1,627	)

Summarized financial information for our investment in real estate partnership is as follows (in thousands):

	September 30, 2024		December 31, 2023
Assets:
Real estate, net	$	—	$	47,115
Other assets		—		6,680
Total assets(1)		—		53,795
Liabilities and equity:
Notes payable		—		14,292
Other liabilities		—		4,040
Equity		—		35,463
Total liabilities and equity(2)		—		53,795
Company’s share of equity		—		28,885
Cost of investment in excess of the Company’s share of underlying net book value		—		2,786
Carrying value of investment in real estate partnership(3)	$	—	$	31,671

⁽¹⁾ We rely on reporting provided to us by Pillarstone OP’s general partner for financial information regarding our investment in Pillarstone OP. Because Pillarstone OP financial statements as of December 31, 2023 have not been made available to us, we have estimated total assets and its components based on the information available to us at the time of this report.

⁽²⁾ We rely on reporting provided to us by Pillarstone OP’s general partner for financial information regarding our investment in Pillarstone OP. Because Pillarstone OP financial statements as of December 31, 2023 have not been made available to us, we have estimated total liabilities and equity and its components based on the information available to us at the time of this report. 

⁽³⁾ We rely on reporting provided to us by Pillarstone OP’s general partner for financial information regarding our investment in Pillarstone OP. Because Pillarstone OP financial statements as of December 31, 2023 have not been made available to us, we have estimated the value of the investment based on the information available to us at the time of this report. 

	Three Months Ended September 30,					Nine Months Ended September 30,
	2024		2023			01/01/2024-01/25/2024 (2)			2023
Revenues	$	—	$	2,152		$	591		$	6,307
Operating expenses		—		(2,372	)		(559	)		(7,584	)
Other expenses		—		(207	)		(56	)		(621	)
Net loss	$	—	$	(427	)	$	(24	)	$	(1,898	)

⁽¹⁾ We rely on reporting provided to us by Pillarstone OP's general partner for financial information regarding our investment in Pillarstone OP. Because Pillarstone OP financial statements for the three and nine months ended September 30, 2024 and 2023 have not been made available to us, we have estimated net loss and its components based on the information available to us at the time of this report.

⁽²⁾ The estimated net loss and its components are calculated through January 25, 2024, the redemption date. 

The amortization of the basis difference between the cost of investment and our share of underlying net book value for the three months ended  September 30, 2024 and 2023 is $0 and $27,000 respectively, and for the nine months ended September 30, 2024 and 2023 is $7,000 and $81,000. We fully amortized the difference into deficit in earnings of real estate partnership on the consolidated statements of operations and comprehensive income (loss).

The Company has evaluated its guarantee to Pillarstone OP pursuant to ASC 460, “Guarantees,” and has determined the guarantee to be a performance guarantee, for which ASC 460 contains initial recognition and measurement requirements, and related disclosure requirements. The Company is obligated in two respects: (i) a noncontingent liability, which represents the Company’s obligation to stand ready to perform under the terms of the guarantee in the event that the specified triggering event(s) occur; and (ii) the contingent liability, which represents the Company’s obligation to make future payments if those triggering events occur. The fair value of our loan guarantee to Pillarstone OP is estimated on a Level 3 basis (as provided by ASC 820), using a probability-weighted discounted cash flow analysis based on a discount rate, discounting the loan balance. The Company recognized a noncontingent liability of $462,000 at the inception of the guarantee at fair value which is recorded on the Company’s consolidated balance sheets, net of accumulated amortization. The Company amortized the guarantee liability into income over seven years. For both three months ended  September 30, 2024 and 2023, the amortization of the guarantee liability was $ 0. For the nine months ended September 30, 2024 and 2023, the amortization of the guarantee liability was $ 0 and $ 18,000, respectively. 

Estimates regarding Pillarstone OP's guarantee.  The Company, through its subsidiary Whitestone REIT Operating Partnership, L.P., guaranteed Pillarstone OP’s loan for its Uptown Tower property located in Dallas, Texas, with an aggregate principal amount of $14.4 million as of September 30, 2023.  The loan was also secured by the Uptown Tower property.  The debt matured on October 4, 2023, and was in default, as Pillarstone OP failed to refinance the loan.  On October 24, 2023, the Lender provided notice of a planned foreclosure sale on December 5, 2023.  The Lender also claimed that an additional sum of $4.6 million was due which included default interest of approximately $6.3 million and net credits from escrowed funds and other charges of approximately $1.7 million. 

On December 1, 2023, the Company reached an agreement with the Lender that would avoid foreclosure and secure the release of the lien and discharge of the guarantee, and the Company negotiated and satisfied a payoff as of December 4, 2023, in the amount of $13,632,764 (the “DPO Amount”). We paid the DPO amount and will be entitled to assert a subrogation claim against Pillarstone OP. As of September 30, 2024, the DPO amount was recorded as an asset in our financial statement line receivable due from related party.  

The DPO Amount included a compromise settlement of approximately $1,688,000 for the disputed default interest and other fees.

On December 1, 2023, Pillarstone OP authorized and filed the Chapter 11 bankruptcy of its special purpose entity borrower that owns Uptown Tower (Whitestone Uptown Tower LLC) in the United States Bankruptcy Court for the Northern District of Texas.

On January 25, 2024, the Company exercised its notice of redemption for substantially all of its investment in Pillarstone OP.

On February 9, 2024, the Lender filed suit in New York County, New York against the guarantor Whitestone OP and the Company for alleged amounts due under the guarantee. The compromise settlement is our best estimate of the amount due.

On March 4, 2024, Pillarstone REIT authorized and filed the Pillarstone Bankruptcies. As of the date of this filing, Whitestone has not received consideration for our redemption of our equity investment in Pillarstone OP as required by the partnership agreement. The Company has filed a claim in the Pillarstone Bankruptcies for the value of its redemption claim along with interest and other costs. 

On April 24, 2024, the Lender and Pillarstone OP filed a motion with the Bankruptcy Court seeking approval to settle the dispute and dismiss their mutual lawsuits including the lawsuit by the Lender against the Company as Guarantor of the loan. On or before June 10, 2024, Pillarstone OP agreed to pay to the Lender the sum of $1,123,950.24 plus all attorneys’ fees and costs (not to exceed $20,000.00) incurred by the Lender from April 10, 2024 through the date of receipt of such payment. Upon timely receipt of the cash payment from Pillarstone OP, the Lender applied the $13,632,764 tendered to it by Whitestone REIT Operating Partnership, L.P., and the guaranty was subsequently released. On October 2, 2024, the Bankruptcy Court affirmed the Company’s right of subrogation and allowed the Company’s secured claim for the DPO amount.

The Company does not believe a probable loss will be incurred, nor does it anticipate a material adverse effect on its financial position, results of operations, cash flows or liquidity. Therefore, the Company has not recorded a charge as a result of the Pillarstone Bankruptcies.

Accounting treatment of the redemption of our OP units in Pillarstone OP.  On January 25, 2024, we executed an irrevocable redemption of substantially all our investment in Pillarstone OP, converting our equity investment into a receivable. Pillarstone OP conveyed their intention to forego issuing equity, opting instead to liquidate the properties to satisfy creditors, with Whitestone being significantly the largest creditor. Based on insights from our legal team and advisors, we anticipate that the most probable outcome will involve the liquidation of all Pillarstone properties. 

The carrying value of our investment in Pillarstone OP was approximately $31.6 million as of January 25, 2024. We assert a claim of $70 million, inclusive of the $13 million default interest payment and accrued interest. It is anticipated that the claim and proceeds from liquidation will surpass the carrying value of our receivable for the redemption of our former equity investment in Pillarstone OP.

Subsequently, we reclassified our investment in Pillarstone OP to a receivable on our balance sheet after estimating 25 days of our share of the equity investment income. We will assess the credit losses of the receivable on a quarterly basis.

Any gains will be recognized once the proceeds received exceed our receivable.

This is within the scope of ASC 326, “Financial Instruments - Credit Losses.” The value of the unencumbered assets of Pillarstone OP is significantly in excess of Whitestone’s basis in the account receivable, but the precise value cannot be determined at this time. When applying the estimated loss rate method with a zero loss rate, the Current Expected Credit Losses (“CECL”) are zero according to ASC 326.  We will continue to monitor our legal team's assessment of the bankruptcy case and the value of the assets of Pillarstone OP to evaluate the credit risk of the receivable.