UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________

FORM 10-Q

_____________________________

(Mark One)

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

For the quarterly period ended June 30, 2023

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 000-55580

HIGHLANDS REIT, INC.

(Exact Name of Registrant as Specified in Its Charter)

Maryland	81-0862795
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
1 South Dearborn Street, 20th Floor Chicago, Illinois 60603
(Address of Principal Executive Offices)

(312) 583-7990

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Title of each class	Trading Symbol	Name of each exchange on which registered
N/A	N/A	N/A

Securities registered pursuant to Section 12(g) of the Act: Common Stock

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. þ Yes ¨ No

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	Accelerated filer	Non-accelerated filer	Smaller reporting company	Emerging growth company
☐	☐	☑	☑	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of August 10, 2023 there were 888,599,872 shares of the registrant’s common stock outstanding.

TABLE OF CONTENTS

	Part I - Financial Information
Item 1.	Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheets as of June 30, 2023 and December 31, 2022	1
	Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2023 and 2022	2
	Consolidated Statements of Equity for the three and six months ended June 30, 2023 and 2022	3
	Consolidated Statements of Cash Flows for the six months ended June 30, 2023 and 2022	4
	Notes to Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
	Part II - Other Information
Item 1.	Legal Proceedings	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
	Exhibit Index	28
	Signatures	29

i

HIGHLANDS REIT, INC.

Consolidated Balance Sheets (unaudited)

(Amounts in thousands, except per share amounts)

	June 30, 2023		December 31, 2022
Assets	(unaudited)
Investment properties
Land	$	79,726	$	79,726
Building and other improvements	272,981		272,232
Construction in progress	662		484
Total	353,369		352,442
Less accumulated depreciation	(81,927)		(76,888)
Net investment properties	271,442		275,554
Cash and cash equivalents	52,496		26,025
Restricted cash and escrows	3,504		1,893
Accounts receivable (net of allowance of $174 and $104 as of June 30, 2023 and December 31, 2022, respectively)	6,362		6,265
Deferred costs and other assets, net	6,215		5,377
Total assets	$	340,019	$	315,114
Liabilities
Debt, net	$	90,650	$	61,658
Accounts payable and accrued expenses	10,339		11,084
Other liabilities	2,324		2,015
Total liabilities	103,313		74,757
Commitments and contingencies (see Note 11)
Stockholders’ Equity
Common stock, $0.01 par value, 1,000,000 shares authorized, 888,600 and 888,243 shares issued and outstanding as of June 30, 2023 and December 31, 2022, respectively	8,886		8,882
Additional paid-in capital	1,412,733		1,412,637
Accumulated distributions in excess of net income	(1,185,412)		(1,181,567)
Accumulated other comprehensive income	441		326
Total Highlands REIT, Inc. stockholders’ equity	236,648		240,278
Non-controlling interests	58		79
Total equity	236,706		240,357
Total liabilities and equity	$	340,019	$	315,114

See accompanying notes to the consolidated financial statements.

1

HIGHLANDS REIT, INC.

Consolidated Statements of Operations and Comprehensive Loss (unaudited)

(Amounts in thousands, except per share amounts)

	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Revenues
Rental income	$	7,460	$	7,347	$	14,878	$	15,305
Other property income	222		228		434		444
Total revenues	7,682		7,575		15,312		15,749
Expenses
Property operating expenses	2,102		2,084		4,307		4,344
Real estate taxes	1,532		1,330		2,925		2,436
Depreciation and amortization	2,609		2,595		5,179		5,233
General and administrative expenses	2,764		2,569		5,281		4,934
Total expenses	9,007		8,578		17,692		16,947
Loss on sale of investment properties, net	—		—		—		(6)
Loss from operations	(1,325)		(1,003)		(2,380)		(1,204)
Interest income	385		7		515		9
Interest expense	(1,175)		(588)		(1,960)		(1,277)
Net loss	(2,115)		(1,584)		(3,825)		(2,472)
Net income attributable to non-controlling interests	(14)		—		(20)		(2)
Net loss attributable to Highlands REIT, Inc. common stockholders	$	(2,129)	$	(1,584)	$	(3,845)	$	(2,474)
Net loss per common share, basic and diluted	$	(0.00)	$	(0.00)	$	(0.00)	$	(0.00)
Weighted average number of common shares outstanding, basic and diluted	888,333		885,302		888,288		885,262
Comprehensive loss
Net loss	$	(2,115)	$	(1,584)	$	(3,825)	$	(2,472)
Unrealized gain on derivatives	209		182		74		567
Total other comprehensive income	209		182		74		567
Comprehensive loss	(1,906)		(1,402)		(3,751)		(1,905)
Comprehensive (income) loss attributable to non-controlling interests	7		(27)		21		(87)
Comprehensive loss attributable to Highlands REIT, Inc. common stockholders	$	(1,899)	$	(1,429)	$	(3,730)	$	(1,992)

See accompanying notes to the consolidated financial statements.

2

HIGHLANDS REIT, INC.

Consolidated Statements of Equity (unaudited)

(Amounts in thousands)

Three and Six Months Ended June 30, 2023 and 2022

	Common Stock			Additional Paid-in Capital		Accumulated Distributions in Excess of Net Income		Accumulated Other Comprehensive Income (Loss)		Total Company’s Stockholders’ Equity		Non- controlling Interests		Total Equity
	Shares	Amount
Balance at January 1, 2022	885,222	$	8,852	$	1,411,818	$	(1,173,905)	$	(202)	$	246,563	$	(26)	$	246,537
Net income (loss)	—	—		—		(890)		—		(890)		2		(888)
Other comprehensive income	—	—		—		—		327		327		58		385
Balance at March 31, 2022	885,222	$	8,852	$	1,411,818	$	(1,174,795)	$	125	$	246,000	$	34	$	246,034
Net loss	—	—		—		(1,584)		—		(1,584)		—		(1,584)
Other comprehensive income	—	—		—		—		155		155		27		182
Share-based compensation	345	4		96		—		—		100		—		100
Balance at June 30, 2022	885,567	$	8,856	$	1,411,914	$	(1,176,379)	$	280	$	244,671	$	61	$	244,732
Balance at January 1, 2023	888,243	$	8,882	$	1,412,637	$	(1,181,567)	$	326	$	240,278	$	79	$	240,357
Net income (loss)	—	—		—		(1,716)		—		(1,716)		6		(1,710)
Other comprehensive loss	—	—		—		—		(115)		(115)		(20)		(135)
Balance at March 31,2023	888,243	$	8,882	$	1,412,637	$	(1,183,283)	$	211	$	238,447	$	65	$	238,512
Net income (loss)	—	—		—		(2,129)		—		(2,129)		14		(2,115)
Other comprehensive income (loss)	—	—		—		—		230		230		(21)		209
Share-based compensation	357	4		96		—		—		100		—		100
Balance at June 30, 2023	888,600	$	8,886	$	1,412,733	$	(1,185,412)	$	441	$	236,648	$	58	$	236,706

See accompanying notes to the consolidated financial statements.

3

HIGHLANDS REIT, INC.

Consolidated Statements of Cash Flows (unaudited)

(Amounts in thousands)

	Six Months Ended June 30,
	2023		2022
Cash flows from operating activities:
Net loss	$	(3,825)	$	(2,472)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	5,179		5,233
Amortization of below market leases	(5)		(19)
Amortization of debt discounts and financing costs	166		75
Straight-line rental income	(356)		(1,416)
Loss on sale of investment properties, net	—		6
Non-cash stock-based compensation expense	100		100
Changes in assets and liabilities:
Accounts and rents receivable, net	259		83
Deferred costs and other assets, net	(597)		(858)
Accounts payable and accrued expenses	(444)		(416)
Other liabilities	314		345
Net cash flows provided by operating activities	$	791	$	661
Cash flows from investing activities:
Capital expenditures and tenant improvements	(1,228)		(193)
Proceeds from sale of investment properties, net	—		8,938
Payment of leasing fees	(307)		(682)
Net cash flows provided by (used in) investing activities	$	(1,535)	$	8,063
Cash flows from financing activities:
Payment of debt issuance costs	(865)		(222)
Payoff of debt	—		(8,677)
Proceeds from debt	30,250		9,265
Principal payments of debt	(559)		(501)
Net cash flows provided by (used in) financing activities	$	28,826	$	(135)
Net increase in cash and cash equivalents and restricted cash and escrows	28,082		8,589
Cash and cash equivalents and restricted cash and escrows, at beginning of period	27,918		22,010
Cash and cash equivalents and restricted cash and escrows, at end of period	$	56,000	$	30,599

Cash and cash equivalents	$	52,496	$	28,859
Restricted cash and escrows	3,504		1,740
Cash and cash equivalents and restricted cash and escrows, at end of period	$	56,000	$	30,599

See accompanying notes to the consolidated financial statements.

4

HIGHLANDS REIT, INC.

Consolidated Statements of Cash Flows (unaudited) (continued)

(Amounts in thousands)

	Six Months Ended June 30,
	2023		2022
Supplemental disclosure of cash flows information:
Cash paid for interest	$	1,655	$	1,249
Supplemental schedule of non-cash investing and financing activities:
Non-cash accruals for capital expenditures and tenant improvements	$	854	$	414

See accompanying notes to the consolidated financial statements.

5

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

The accompanying Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Readers of this Quarterly Report should refer to the audited consolidated financial statements of Highlands REIT, Inc. for the year ended December 31, 2022, which are included in the Annual Report on Form 10-K, as filed with the U.S. Securities and Exchange Commission by Highlands REIT, Inc. on March 15, 2023, as certain note disclosures contained in such audited consolidated financial statements have been condensed or omitted from this Report. In the opinion of management, all adjustments (consisting of normal recurring accruals, except as otherwise noted) necessary for a fair presentation, and to make these financial statements not misleading, have been included in these financial statements.

1. Organization

Highlands REIT, Inc. (“Highlands”), which was formed in December 2015, is a Maryland corporation with a portfolio of investment properties including multi-family, retail, office and industrial properties, a correctional facility and unimproved land. Prior to April 28, 2016, Highlands was a wholly-owned subsidiary of InvenTrust Properties Corp. (“InvenTrust” and formerly known as Inland American Real Estate Trust, Inc.), its former parent. Unless stated otherwise or the context otherwise requires, the terms “we,” “our” and “us” and references to the “Company” refer to Highlands and its consolidated subsidiaries.

On April 28, 2016, Highlands was spun-off from InvenTrust through a pro rata distribution by InvenTrust of 100% of the outstanding shares of common stock, $0.01 par value per share (the “Common Stock”), of Highlands to holders of record of InvenTrust’s common stock as of the close of business on April 25, 2016 (the “Record Date”). Each holder of record of InvenTrust’s common stock received one share of Common Stock for every one share of InvenTrust's common stock held at the close of business on the Record Date (the “Distribution”). As a result, Highlands became an independent, self-advised, non-listed public company. Highlands has elected to be taxed, and currently qualifies, as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”) for U.S. federal income tax purposes commencing with Highlands' short taxable year ending December 31, 2016.

Each investment property is owned by a separate legal entity which maintains its own books and financial records, and each entity’s assets are not available to satisfy the liabilities of other affiliated entities, except as otherwise disclosed in Note 6. With the exception of one investment property we own through a variable interest entity with a third-party partner (the “Corvue Venture”), we are the sole owner of each of these separate legal entities.  As of June 30, 2023, we have an approximate 85% interest in the Corvue Venture and have funded equity contributions to the Corvue Venture in the approximate amount of $9,000. See Note 2 for additional information regarding the basis of presentation of the Corvue Venture, which is consolidated in the accompanying consolidated financial statements.

As of June 30, 2023 and December 31, 2022, the Company owned 19 investment properties and one parcel of unimproved land.

2. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

The accompanying consolidated financial statements include the accounts of Highlands and its consolidated subsidiaries. Highlands consolidates its wholly-owned subsidiaries and any other entities which it controls (i) through voting rights or similar rights or (ii) by means other than voting rights if Highlands is the primary beneficiary of a variable interest entity (“VIE”). The portions of the equity and net income of consolidated subsidiaries that are not attributable to the Company are presented separately as amounts attributable to non-controlling interests in our consolidated financial statements. Entities which Highlands does not control, and entities which are VIEs in which Highlands is not a primary beneficiary, if any, are accounted for under appropriate GAAP. Highlands’ subsidiaries generally consist of limited liability companies (“LLCs”). The effects of all significant intercompany transactions have been eliminated.

6

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

Refer to the Company’s audited consolidated financial statements for the year ended December 31, 2022, included in the Company’s Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission on March 15, 2023, as certain note disclosures contained in such audited financial statements have been condensed or omitted from these interim consolidated financial statements.

Consolidation

As of June 30, 2023 and December 31, 2022, we have determined we are the primary beneficiary of one VIE, the Corvue Venture, and have consolidated the operations of this entity in the accompanying consolidated financial statements. We reviewed the operating agreement of the Corvue Venture in order to determine our rights and the rights of our third-party partner, including whether those rights are protective or participating. We have determined we are the primary beneficiary of the Corvue Venture because we have (a) the power to direct the activities that most significantly impact the economic performance of the Corvue Venture, (b) the obligation to absorb the losses that could be significant to the Corvue Venture and (c) the right to receive the benefits that could be significant to the Corvue Venture. Included in total assets and liabilities on the Company’s consolidated balance sheets as of June 30, 2023 is $24,598 of assets and $18,158 of liabilities related to the Corvue Venture. Included in total assets and liabilities on the Company’s consolidated balance sheets as of December 31, 2022 is $24,926 of assets and $18,028 of liabilities related to the Corvue Venture. The assets of the Corvue Venture may only be used to settle obligations of the Corvue Venture and the creditors of the Corvue Venture have no recourse to the general credit of the Company.

Recently Issued Accounting Pronouncements

In December 2022, the FASB issued ASU 2022-06, “Deferral of the Sunset Date of Topic 848” (“ASU 2022-06”) which was issued to defer the sunset date of Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform to December 31, 2024. ASU 2022-06 is effective immediately for all companies. ASU 2022-06 did not have an impact on the Company’s consolidated financial statements.

Recently issued accounting standards or pronouncements not discussed herein have been excluded because they are either not relevant to the Company, or are not expected to have, or did not have, a material effect on the consolidated financial statements of the Company.

3. Disposed Investment Properties

There were no investment property dispositions during the six months ended June 30, 2023.

The following table reflects the investment property dispositions during the six months ended June 30, 2022. The Company recognized a net loss on sale of investment properties of $6.

Property	Location	Disposition Date	Gross Disposition Price		Sale Proceeds, Net		Loss on Sale
State Street Market	Rockford, Illinois	March 10, 2022	$	9,000	$	8,938	$	(6)

4. Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following:

	June 30, 2023		December 31, 2022
Accrued real estate taxes	$	6,102	$	6,430
Accrued compensation	1,878		742
Accrued interest payable	348		208
Other accrued expenses	2,011		3,704
Total accounts payable and accrued expenses	$	10,339	$	11,084

7

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

5. Leases

Leasing as a lessor

We lease multifamily investment properties under operating leases with terms of generally one year or less. We lease commercial properties under operating leases with remaining lease terms that range from less than one year to fourteen years as of June 30, 2023.

Lease income related to the Company’s operating leases is comprised of the following:

	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Lease income related to fixed lease payments	$	6,297	$	6,257	$	12,587	$	13,012
Lease income related to variable lease payments (1)	1,163		1,090		2,291		2,293
Other	222		228		434		444
Total revenues	$	7,682	$	7,575	$	15,312	$	15,749

(1)    Variable lease payments are comprised of tenant recovery income.

Future Minimum Rental Income

As of June 30, 2023, commercial operating leases provide for future minimum rental income, assuming no expiring leases are renewed, as follows. Apartment leases are not included as the terms are generally for one year or less.

2023 (remaining)	$	4,834
2024	9,611
2025	8,636
2026	8,258
2027	7,406
Thereafter	45,600
Total	$	84,345

6. Debt

Total debt outstanding as of June 30, 2023 and December 31, 2022 was as follows:

	June 30, 2023		December 31, 2022
Debt, gross	$	92,103	$	62,411
Mortgage discount	(190)		(212)
Deferred financing costs, net	(1,263)		(541)
Total Debt, Net	$	90,650	$	61,658

8

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

As of June 30, 2023, the Company’s outstanding mortgage indebtedness included eight mortgage loans with various maturities through July 2032, as follows:

Debt maturing during the year ended December 31,	As of June 30, 2023		Weighted average interest rate
2023 (remaining)	$	17,286	3.28	%	(1)
2024	—		—	%
2025	20,000		5.86	%	(1)
2026	24,000		4.56	%
2027	11,302		3.99	%
Thereafter	19,515		4.79	%
Total	$	92,103	4.58	%

(1)    See below for discussion of the swap agreements entered into with the mortgage loans obtained on The Locale and Trimble. The weighted average interest rate reflected is the fixed swap rate.

The Company obtained a loan on April 6, 2023 which was secured by a mortgage encumbering one of the buildings comprising the Trimble office investment property. The building is approximately 97,000 square feet and is currently occupied by Veeco Instruments, Inc. The loan secured by a mortgage on this Trimble building has a principal amount of $20,000, $4,000 of which is guaranteed by the Company. The loan matures on April 6, 2025, with a 12-month extension option, provided certain criteria are met at the time of extension. Simultaneously with the loan closing, we entered into a swap arrangement to fix the interest rate at 5.86% for the term of the loan.

The Company obtained a loan on January 24, 2023 which was secured by a mortgage encumbering Tennyson, one of the Company's multi-family investment properties. The loan has a principal balance of $10,250. The loan matures on February 1, 2030, bears interest at a rate of 4.84% and requires interest-only payments for the duration of its 7-year term.

The Company obtained two loans on June 30, 2022 which were each secured by a mortgage encumbering one of the Company's multi-family investment properties. The loan secured by a mortgage on Kenilworth Court has a principal amount of $3,784, and the loan secured by a mortgage on The Lafayette has a principal amount of $5,481. Both loans mature on July 1, 2032, bear interest at a fixed rate of 4.74% and require interest-only payments for the duration of their 10-year term.

The Company’s mortgage and the related swap agreement on The Locale mature on September 1, 2023. The principal balance of this mortgage was $17,286 at June 30, 2023 and the swap agreement entered into at the time of closing fixed the interest rate at 3.28%. Prior to maturity, the Company expects it will either exercise the one-year extension option provided for in the loan documents, which requires, among other criteria, that at the time of extension the mortgage is not in default and a minimum debt service coverage ratio and minimum loan to value ratio are met or will refinance the loan with an alternate lender.

The Company’s ability to pay off the mortgages when they become due is dependent upon the Company's ability either to refinance the related mortgage debt or to sell the related asset. With respect to each mortgage loan, if the applicable wholly-owned property-owning subsidiary is unable to refinance or sell the related asset, or in the event that the estimated asset value is less than the mortgage balance, the applicable wholly-owned property-owning subsidiary may, if appropriate, satisfy a mortgage obligation by transferring title of the asset to the lender or permitting a lender to foreclose. As of June 30, 2023, the Company guaranteed one mortgage loan up to $4,000 and as of December 31, 2022, none of our mortgage debt was recourse to the Company. However, Highlands or its subsidiaries may act as guarantor under customary, non-recourse, carve-out guarantees in connection with obtaining mortgage loans on certain of our investment properties.

The loan documents governing the mortgage that encumbered State Street Market included a “cash trap” provision that was triggered when DICK’S Sporting Goods, which was an anchor tenant at the property, failed to renew its lease agreement. The lender exercised its right to trigger this “cash trap” provision, and, beginning in the fourth quarter of 2020, all of the cash flows from State Street Market which would otherwise have been available for our use were trapped into a blocked account controlled by the lender pending approval of a substitute lease or repayment of the loan. The Company sold State Street Market on March 10, 2022 and the mortgage, with an outstanding principal balance of $8,677 at the time of sale, was simultaneously

9

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

repaid. The funds previously trapped and held by the lender, along with all required lender escrows, totaling $2,000, were returned to the Company in April 2022.

Some of the mortgage loans require compliance with certain covenants, such as debt service coverage ratios and minimum net worth requirements. As of June 30, 2023 and December 31, 2022, the Company was in compliance with such covenants.

LIBOR Reform

Following announcements by the United Kingdom’s Financial Conduct Authority (“FCA”), which regulates LIBOR, and ICE Benchmark Administration Limited, which administers LIBOR’s publication, publication of most LIBOR settings ceased after December 31, 2021. Publication of the remaining U.S. dollar LIBOR settings is expected to cease after June 30, 2023. As a result, the Federal Reserve Board and the Federal Reserve Bank of New York organized the Alternative Reference Rates Committee (“ARRC”), which identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate for USD LIBOR in derivatives and other financial contracts. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities, and the Federal Reserve Bank of New York started to publish SOFR in April 2018.

The discontinuation, reform or replacement of LIBOR or any other benchmark rates may have an unpredictable impact on contractual mechanics in the credit markets or cause disruption to the broader financial markets and could have an adverse effect on LIBOR-based interest rates on our current or future debt obligations.

As of June 30, 2023, the Company had one variable-rate mortgage with an interest rate swap to fix the rate at 3.28% that was indexed to one-month LIBOR. The derivative instrument had an original notional amount of $18,750. In December 2022, the Company completed an amendment to the mortgage loan agreement to replace LIBOR and establish SOFR as the alternate rate for this mortgage and interest rate swap. The amendment did not have a material impact to the Company’s consolidated financial statements.

7. Fair Value Measurements

In accordance with ASC 820, Fair Value Measurement and Disclosures, the Company defines fair value based on the price that would be received upon sale of an asset or the exit price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:

•Level 1 - Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

•Level 2 - Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

•Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The Company has estimated fair value using available market information and valuation methodologies the Company believes to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that would be realized upon disposition.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

Risk Management Objective of Using Derivatives

The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of debt funding and, to a limited extent, the use of derivative financial instruments. Specifically, the Company may enter into derivative financial instruments to manage exposures that arise from business activities that result

10

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments, described below, are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s borrowings.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company may use interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. We do not enter into derivative financial instruments for speculative purposes. As of June 30, 2023, we had two derivative financial instruments designated as cash flow hedges, with original notional amounts of $18,750 (also outstanding as of December 31, 2022) and $20,000 and with maturity dates of September 1, 2023 and April 2025, respectively. These derivatives are interest rate swaps that are measured at fair value on a recurring basis.

For derivatives designated, and that qualify, as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income or loss on the consolidated balance sheets and is subsequently reclassified into interest expense in the same period during which the hedged transaction affects earnings. The amount recorded as other comprehensive income related to our derivative financial instruments was $209 and $74 for the three and six months ended June 30, 2023, respectively and $182 and $567 for the three and six months ended June 30, 2022, respectively.

Amounts reported in accumulated other comprehensive gain related to derivatives will be reclassified to interest expense as interest payments are made on our variable rate debt. The Company estimates that $410 will be reclassified as a decrease to interest expense over the next twelve months.

The table below presents the fair value of the Company’s derivative financial instrument as well as its classification on the consolidated balance sheets as of June 30, 2023 and December 31, 2022, respectively.

	June 30, 2023
	Level 1		Level 2		Level 3		Total
Derivative financial instruments designated as cash flow hedges:
Classified as “Deferred costs and other assets, net”	$	—	$	458	$	—	$	458
	December 31, 2022
Derivative financial instruments designated as cash flow hedges:	Level 1		Level 2		Level 3		Total
Classified as “Deferred costs and other assets, net”	$	—	$	383	$	—	$	383

The fair value of our derivative financial instrument was determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of the derivative financial instrument. This analysis reflected the contractual terms of the derivative, including the period to maturity, and used observable market-based inputs, including interest rate market data and implied volatilities in such interest rates. While it was determined that the majority of the inputs used to value the derivative fall within Level 2 of the fair value hierarchy under authoritative accounting guidance, the credit valuation adjustments associated with the derivative also utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default. However, as of June 30, 2023, the significance of the impact of the credit valuation adjustments on the overall valuation of the derivative financial instrument was assessed, and it was determined that these adjustments were not significant to the overall valuation of the derivative financial instrument. As a result, it was determined that the derivative financial instrument in its entirety should be classified in Level 2 of the fair value hierarchy.

Non-Recurring Measurements     

In accordance with ASC 360-10, the Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that long-lived assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. During the three and six months ended June 30, 2023 and 2022, events and circumstances indicated that certain investment properties might be impaired. However, the Company’s estimate of undiscounted cash flows indicated that such carrying amounts were expected to be recovered. Nonetheless, it is

11

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

reasonably possible that the estimate of undiscounted cash flows may change in the future resulting in the need to write down assets to fair value.

Financial Liabilities Disclosed at Fair Value on a Recurring Basis

The table below represents the fair value of financial instruments presented at carrying values in the consolidated financial statements as of June 30, 2023 and December 31, 2022.

	June 30, 2023				December 31, 2022
	Carrying  Value		Estimated  Fair Value		Carrying  Value		Estimated  Fair Value
Debt	$	92,103	$	86,841	$	62,411	$	57,474

The Company estimates the fair value of its debt instruments using a weighted average market effective interest rate of 7.36% and 7.44% per annum as of June 30, 2023 and December 31, 2022, respectively. The Company estimates the fair value of its mortgage loans by discounting the anticipated future cash flows of each instrument at rates currently offered to the Company by its lenders for similar debt instruments of comparable maturities. The rates used are based on credit spreads observed in the marketplace during the quarter for similar debt instruments, and a floor rate that the Company has derived using its subjective judgment for each asset segment. Based on this, the Company determines the appropriate rate for each of its individual mortgage loans based upon the specific terms of the agreement, including the term to maturity, the quality and nature of the underlying property and its leverage ratio. The weighted average market effective interest rates used range from 5.79% to 9.40% and 5.76% to 8.83% as of June 30, 2023 and December 31, 2022, respectively. The assumptions reflect the terms currently available on similar borrowing terms to borrowers with credit profiles similar to the Company’s. The Company has determined that its debt instrument valuations are classified in Level 2 of the fair value hierarchy.

8. Income Taxes

The Company is taxed and operates in a manner that will allow the Company to continue to qualify as a REIT for U.S. federal income tax purposes. So long as it maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income tax on taxable income that is distributed to stockholders. A REIT is subject to a number of organizational and operational requirements, including a requirement that it distribute at least 90% of its REIT taxable income (subject to certain adjustments) to its stockholders each year. If the Company fails to continue to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, the Company will be subject to U.S. federal and state income tax on its taxable income at regular corporate tax rates and would not be able to re-elect REIT status during the four years following the year of the failure. Although the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and U.S. federal income and excise taxes on its undistributed income.

During the three and six months ended June 30, 2023 and 2022, no income tax benefit or expense was included in the consolidated statements of operations and comprehensive loss.

9. Segment Reporting

GAAP has established guidance for reporting information about a company’s operating segments. The Company monitors and reviews its segment reporting structure in accordance with guidance under ASC Topic 280, Segment Reporting (“ASC 280”) to determine whether any changes have occurred that would impact its reportable segments. The Company currently has two business segments, consisting of multi-family and other.

12

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

The following table summarizes net operating income by segment for the three months ended June 30, 2023 and 2022.

	Three Months Ended June 30, 2023						Three Months Ended June 30, 2022
	Total		Multi-family		Other		Total		Multi-family		Other
Lease income	$	7,460	$	3,979	$	3,481	$	7,347	$	3,905	$	3,442
Other property income	222		222		—		228		228		—
Total revenues	7,682		4,201		3,481		7,575		4,133		3,442
Property operating and real estate tax expenses	3,634		1,923		1,711		3,414		1,882		1,532
Net operating income	$	4,048	$	2,278	$	1,770	$	4,161	$	2,251	$	1,910
Non-allocated expenses (1)	(5,373)						(5,164)
Other income and expenses (2)	(790)						(581)
Net income attributable to non-controlling interests	(14)						—
Net loss attributable to Highlands REIT, Inc. common stockholders	$	(2,129)					$	(1,584)

(1)Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.

(2)Other income and expenses consists of interest income and interest expense.

	Six Months Ended June 30, 2023						Six Months Ended June 30, 2022
	Total		Multi-family		Other		Total		Multi-family		Other
Rental income	$	14,878	$	7,945	$	6,933	$	15,305	$	7,825	$	7,480
Other property income	434		434		—		444		431		13
Total income	15,312		8,379		6,933		15,749		8,256		7,493
Property operating and real estate tax expenses	7,232		3,878		3,354		6,780		3,765		3,015
Net operating income	$	8,080	$	4,501	$	3,579	$	8,969	$	4,491	$	4,478
Non-allocated expenses (1)	(10,460)						(10,167)
Loss on sale of investment properties, net	—						(6)
Other income and expenses (2)	(1,445)						(1,268)
Net income attributable to non-controlling interests	(20)						(2)
Net loss attributable to Highlands REIT, Inc. common stockholders	$	(3,845)					$	(2,474)
Balance Sheet Data
Real estate assets, net	$	271,442	$	168,826	$	102,616	$	278,163	$	173,702	$	104,461
Non-segmented assets (3)	68,577						39,719
Total assets	$	340,019					$	317,882
Capital expenditures	$	927	$	342	$	585	$	193	$	165	$	28

(1)Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.

(2)Other income and expenses consists of interest income and interest expense.

(3)Non-segmented assets include cash and cash equivalents, restricted cash and escrows, accounts receivable and deferred costs and other assets.

13

HIGHLANDS REIT, INC.

Notes to Consolidated Financial Statements (unaudited)

(Amounts in thousands, except square footage and per share amounts)

June 30, 2023

10. Share Based Compensation

Incentive Award Plan

On April 28, 2016, the board of directors adopted, ratified and approved the Highlands REIT, Inc. 2016 Incentive Award Plan (the “Incentive Award Plan”) under which the Company may grant cash and equity-based incentive awards to eligible employees, directors, and consultants. Prior to the Company’s spin-off from InvenTrust, the board of directors of the Company (then a wholly-owned subsidiary of InvenTrust) adopted, and InvenTrust, as the sole stockholder of Highlands, approved, the Incentive Awards Plan.

During the six months ended June 30, 2023, the Company granted 357 shares of common stock with an aggregate value of $100 based on an estimated net asset value per share of $0.28. During the six months ended June 30, 2022, the Company granted 345 shares of common stock with an aggregate value of $100 based on an estimated net asset value per share of $0.29.

Under the Incentive Award Plan, the Company was initially authorized to grant up to 43,000 shares of the Company’s common stock pursuant to awards under the Incentive Award Plan. On August 12, 2021, the board of directors increased the authorized number of shares of its Common Stock under the Incentive Award Plan from 43,000 to 67,000 pursuant to that certain Second Amendment to Highlands REIT, Inc. 2016 Incentive Award Plan, dated as of August 12, 2021. As of June 30, 2023, 16,038 shares were available for future issuance under the Incentive Award Plan.

11. Commitments and Contingencies

The Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of these matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material adverse effect on the financial statements of the Company.

Highlands has also agreed to indemnify InvenTrust against all taxes related to the Company and its assets, including taxes attributable to periods prior to the separation and distribution. InvenTrust has agreed to indemnify the Company for any taxes attributable to the failure of InvenTrust or MB REIT (Florida), Inc., a subsidiary of the Company, to maintain its qualification as a REIT for any taxable year ending on or before December 31, 2016.

In February 2021, the Company executed a lease with Veeco Instruments, Inc. for approximately 97,000 square feet at Trimble. The lease required a significant tenant allowance, which is being accounted for as lessor-owned improvements, and broker commission. The total cost commitment was estimated to be approximately $9,100. As of June 30, 2023, we estimate that remaining costs to be paid under this commitment are approximately $673. The tenant began paying cash rent on January 1, 2023. The remainder of the tenant allowance will be paid by the Company upon final request by tenant.

In November 2022, the Company executed a lease with XP Power, LLC for approximately 80,000 square feet at Trimble. Rental payments under this lease are expected to commence in January 2024. The lease requires significant landlord work, a tenant allowance, which will be accounted for as lessor-owned improvements, and leasing commission. The total cost commitment is estimated to be approximately $12,300. As of June 30, 2023, we estimate remaining costs under this commitment are approximately $10,800.

12. Subsequent Events

We have evaluated subsequent events through the date that the condensed consolidated financial statements were issued, noting none.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

References to “Highlands,” the “Company,” “we” or “us” are to Highlands REIT, Inc., as well as all of Highlands' wholly-owned and consolidated subsidiaries.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and accompanying notes, which appear elsewhere in this Quarterly Report on Form 10-Q, and the historical consolidated financial statements, and related notes included elsewhere in our Annual Report on Form 10-K. The following discussion and analysis contains forward-looking statements based upon our current expectations, estimates and assumptions that involve risks and uncertainties. Our actual results could differ materially from those discussed in these forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to, factors discussed in “Part I - Item 1A. Risk Factors” and “Disclosure Regarding Forward-Looking Statements” in our Annual Report on Form 10-K.

Certain statements in this Quarterly Report on Form 10-Q, other than purely historical information, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements include statements about Highlands’ plans, objectives, strategies, financial performance and outlook, trends, the amount and timing of future cash distributions, prospects or future events and involve known and unknown risks that are difficult to predict. As a result, our actual financial results, performance, achievements or prospects may differ materially from those expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “guidance,” “predict,” “potential,” “continue,” “likely,” “will,” “would,” “illustrative” and variations of these terms and similar expressions, or the negative of these terms or similar expressions. Such forward-looking statements are necessarily based upon estimates and assumptions that, while considered reasonable by Highlands and its management based on their knowledge and understanding of the business and industry, are inherently uncertain. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q. Such risks, uncertainties and other important factors include, among others: the risks, uncertainties and factors set forth in our filings with the U.S. Securities and Exchange Commission, including our Annual Report on Form 10-K; business, financial and operating risks inherent to real estate investments and the industry; our ability to renew leases, lease vacant space, or re-lease space as leases expire; our ability to repay or refinance our debt as it comes due; difficulty selling or re-leasing our investment properties due to their specific characteristics as described elsewhere in this report; contraction in the global economy or low levels of economic growth; our ability to sell our assets at a price and on a timeline consistent with our investment objectives, or at all; our ability to service our debt; changes in interest rates and operating costs; compliance with regulatory regimes and local laws; uninsured or underinsured losses, including those relating to natural disasters or terrorism; domestic or international instability or political or civil unrest, including the ongoing hostilities between Russia and Ukraine and its worldwide economic impact; the amount of debt that we currently have or may incur in the future; provisions in our debt agreements that may restrict the operation of our business; our separation from InvenTrust and our ability to operate as a stand-alone public reporting company; our organizational and governance structure; our status as a REIT; the cost of compliance with and liabilities under environmental, health and safety laws; the uncertainty and economic impact of pandemics, epidemics or other public health emergencies or fear of such events; adverse litigation judgments or settlements; changes in real estate and zoning laws and increase in real property tax rates; changes in federal, state or local tax law, including legislative, administrative, regulatory or other actions affecting REITs; changes in governmental regulations or interpretations thereof; and estimates relating to our ability to make distributions to our stockholders in the future.

These factors are not necessarily all of the important factors that could cause our actual financial results, performance, achievements or prospects to differ materially from those expressed in or implied by any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Forward-looking statements speak only as of the date they are made, and we do not undertake or assume any obligation to update publicly any of these forward-looking statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

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Overview

We are a self-advised and self-administered real estate investment trust (“REIT”) created to own and manage substantially all of the “non-core” investment properties previously owned and managed by our former parent, InvenTrust Properties Corp., a Maryland corporation (“InvenTrust”). On April 28, 2016, we were spun-off from InvenTrust through a pro rata distribution (the “Distribution”) by InvenTrust of 100% of the outstanding shares of our common stock to holders of InvenTrust’s common stock. Prior to or concurrent with the separation, we and InvenTrust engaged in certain reorganization transactions that were designed to consolidate substantially all of InvenTrust’s remaining “non-core” investment properties in Highlands.

This inherited portfolio of “non-core” investment properties, which were acquired by InvenTrust between 2005 and 2008, included investment properties that are special use, single tenant or build to suit; face unresolved legal issues; are in undesirable locations or in weak markets or submarkets; are aging or functionally obsolete; and/or have sub-optimal leasing metrics. Certain of our investment properties are retail properties located in tertiary markets, which are particularly susceptible to the negative trends affecting retail real estate. As a result of these characteristics, such assets are difficult to lease, finance and refinance and are relatively illiquid compared to other types of real estate assets. These factors also significantly limit our asset disposition options, impact the timing of such dispositions and restrict the viable options available to the Company for a future potential liquidity option.

Our strategy is focused on preserving, protecting and maximizing the total value of our portfolio with the long-term objective of providing stockholders with a return of their investment. We engage in rigorous asset management, seek to sustain and enhance our portfolio, and improve the quality and income-producing ability of our portfolio by engaging in selective dispositions, acquisitions, capital expenditures, financing, refinancing and enhanced leasing. We are also focused on cost containment efforts across our portfolio, improving our overall capital structure and making select investments in our existing “non-core” investment properties to maximize their value. To the extent we are able to generate cash flows from operations or dispositions of assets, in addition to the cash uses outlined above, our board of directors has determined that it is in the best interests of the Company to seek to reinvest in assets that are more likely to generate more reliable and stable cash flows, such as multi-family investment properties, as part of the Company’s overall strategy to optimize the value of the portfolio, enhance our options for a future potential liquidity option and maximize shareholder value. Given the nature and quality of the “non-core” investment properties in our portfolio as well as current market conditions, a definitive timeline for execution of our strategy cannot be made. The impact of rising interest rates, high inflation, unstable financial markets, tightening capital markets and general economic conditions on our business has disrupted our efforts to implement a liquidity option and, although we cannot predict when circumstances will improve, we will continue to evaluate options with the goal of implementing a liquidity option during 2023. However, we may be unable to execute on such a transaction on terms we would find attractive for our stockholders and our ability to do so will be influenced by external and macroeconomic factors, including, among others, interest rate movements, inflation, local, regional, national and global economic performance, government policy changes and competitive factors.

As of June 30, 2023, our portfolio of investment properties included  twelve multi-family, three retail, one office and two industrial properties, one correctional facility and one parcel of unimproved land. We currently have two business segments, consisting of multi-family and other assets. We may have additional or fewer segments in the future to the extent we enter into additional real property sectors, dispose of investment properties, or change the character of our assets. For the complete presentation of our reportable segments, see Note 9 to our consolidated financial statements for the three and six months ended June 30, 2023 and 2022.

Basis of Presentation

The accompanying consolidated financial statements reflect the accounts of Highlands and its consolidated subsidiaries (collectively, the “Company”). Highlands consolidates its wholly-owned subsidiaries and any other entities which it controls (i) through voting rights or similar rights or (ii) by means other than voting rights if Highlands is the primary beneficiary of a variable interest entity (“VIE”). The portions of the equity and net income of consolidated subsidiaries that are not attributable to the Company are presented separately as amounts attributable to non-controlling interests in our consolidated financial statements. Entities which Highlands does not control and entities which are VIEs in which Highlands is not a primary beneficiary, if any, are accounted for under appropriate GAAP. Highlands’ subsidiaries generally consist of limited liability companies (“LLCs”). The effects of all significant intercompany transactions have been eliminated.

Critical accounting policies are described in the “Notes to Consolidated Financial Statements” for the year ended December 31, 2022 contained in the Company’s latest Annual Report on Form 10-K. Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in the “Notes to Consolidated Financial Statements” in this Quarterly Report on Form 10-Q. The application of critical accounting policies may require management to

16

make assumptions, judgments and estimates about the amounts reflected in the Consolidated Financial Statements. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.

Revenues and Expenses

Revenues

Our revenues are primarily derived from lease income and expense recoveries we receive from our tenants under leases with us, including monthly rent and other property income pursuant to tenant leases. Tenant recovery income primarily consists of reimbursements for real estate taxes, common area maintenance costs, management fees and insurance costs.

Expenses

Our expenses consist of property operating expenses, real estate taxes, depreciation and amortization expense, general and administrative expenses and provision for asset impairment. Property operating expenses primarily consist of repair and maintenance, management fees, utilities and insurance (some of which are recoverable from the tenant).

Key Indicators of Operating Performance

In evaluating our financial condition and operating performance, management focuses on the following financial and non-financial indicators, discussed in further detail herein:

•Cash flow from operations as determined in accordance with GAAP;

•Economic and physical occupancy and rental rates;

•Leasing activity and lease rollover;

•Management of operating expenses;

•Management of general and administrative expenses;

•Debt maturities and leverage ratios;

•Liquidity levels;

•Funds From Operations (“FFO”), a supplemental non-GAAP measure; and

•Adjusted Funds From Operations (“AFFO”), a supplemental non-GAAP measure.

Acquisition and Disposition Activity

There were no asset acquisitions during the six months ended June 30, 2023 and 2022.

During the six months ended June 30, 2023 there were no asset dispositions. During the six months ended June 30, 2022, consistent with our strategy of disposing of legacy “non-core” investment properties, we sold the following investment property:

			(in thousands)
Property	Location	Disposition Date	Gross Disposition Price		Sale Proceeds, Net		Loss on Sale
State Street Market	Rockford, Illinois	March 10, 2022	$	9,000	$	8,938	$	(6)

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Results of Operations

Comparison of the three and six months ended June 30, 2023 and 2022

Key performance indicators are as follows:

	As of June 30,
	2023			2022
Economic occupancy (1)	74.4		%	74.5		%
Rent per square foot (2)	$	16.61		$	14.68

(1)Economic occupancy is defined as the percentage of total gross leasable area for which a tenant is obligated to pay rent under the terms of its lease agreement, regardless of the actual use or occupation by the tenant of the area being leased. Actual use may be less than economic square footage.

(2)Rent per square foot is computed as annualized rent divided by the total occupied square footage at the end of the period. Annualized rent is computed as revenue for the last month of the period multiplied by twelve months. Annualized rent includes the effect of rent abatements, lease inducements and straight-line rent GAAP adjustments.

Consolidated Results of Operations  

The following section describes and compares our consolidated results of operations for the three and six months ended June 30, 2023 and 2022.

	(dollar amounts in thousands)								(dollar amounts in thousands)
	For the three months ended June 30,								For the six months ended June 30,
	2023		2022		Increase (Decrease)				2023		2022		Increase (Decrease)
Net loss	$	(2,115)	$	(1,584)	$	531	33.5	%	$	(3,825)	$	(2,472)	$	1,353	54.7	%

Net loss increased $0.5 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022, due primarily to an increase in real estate tax and interest expenses, partially offset by an increase in interest income.

Net loss increased $1.4 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022, due primarily to decreased revenues and increased real estate tax and interest expenses, partially offset by an increase in interest income.

Details of these changes are provided below.

The following table presents the changes in our revenues for the three and six months ended June 30, 2023 and 2022.

	(dollar amounts in thousands)								(dollar amounts in thousands)
	For the three months ended June 30,								For the six months ended June 30,
	2023		2022		Increase (Decrease)				2023		2022		Increase (Decrease)
Income:
Rental income	$	7,460	$	7,347	$	113	1.5	%	$	14,878	$	15,305	$	(427)	(2.8)	%
Other property income	222		228		(6)		(2.6)	%	434		444		(10)		(2.3)	%
Total revenues	$	7,682	$	7,575	$	107	1.4	%	$	15,312	$	15,749	$	(437)	(2.8)	%

Total revenues increased $0.1 million during the three months ended June 30, 2023, compared to the three months ended June 30, 2022, due primarily to increased rent per square foot on the portfolio.

Total revenues decreased $0.4 million during the six months ended June 30, 2023, compared to the six months ended June 30, 2022, due primarily to the sale of State Street Market in March 2022 and the expiration of the Fitness International lease at Sherman Plaza in April 2022. This decrease is partially offset by additional tenant recovery income earned from a tenant at Trimble as well as increased rent per square foot on the portfolio.

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The following table presents the changes in our expenses for the three and six months ended June 30, 2023 and 2022.

	(dollar amounts in thousands)								(dollar amounts in thousands)
	For the three months ended June 30,								For the six months ended June 30,
	2023		2022		Increase (Decrease)				2023		2022		Increase (Decrease)
Expenses:
Property operating expenses	$	2,102	$	2,084	$	18	0.9	%	$	4,307	$	4,344	$	(37)	(0.9)	%
Real estate taxes	1,532		1,330		202		15.2	%	2,925		2,436		489		20.1	%
Depreciation and amortization	2,609		2,595		14		0.5	%	5,179		5,233		(54)		(1.0)	%
General and administrative expenses	2,764		2,569		195		7.6	%	5,281		4,934		347		7.0	%
Total expenses	$	9,007	$	8,578	$	429	5.0	%	$	17,692	$	16,947	$	745	4.4	%

Property operating expenses remained relatively consistent during the three and six months ended June 30, 2023, compared to the three and six months ended June 30, 2022.

Real estate taxes increased $0.2 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022, due primarily to higher estimates of expense on our Trimble and Sherman Plaza investment properties.

Real estate taxes increased $0.5 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022, due to higher estimates of expense on our Trimble and Sherman Plaza investment properties and adjustments that decreased the real estate tax estimate as a result of the sale of State Street Market during the three months ended March 31, 2022.

Depreciation and amortization remained relatively consistent during the three and six months ended June 30, 2023, compared to the three and six months ended June 30, 2022.

General and administrative expense increased $0.2 million for the three months ended June 30, 2023, compared to the three months ended June 30, 2022, due primarily to increased salaries as a result of annual increases and increased legal costs related to new employment contracts for our named executives.

General and administrative expense increased $0.3 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022, for the same reasons as described above.

The following table presents the changes in our other income and expenses for the three and six months ended June 30, 2023 and 2022.

	(dollar amounts in thousands)								(dollar amounts in thousands)
	For the three months ended June 30,								For the six months ended June 30,
	2023		2022		Increase (Decrease)				2023		2022		Increase (Decrease)
Other income and (expenses):
Interest income	$	385	$	7	$	378	5,400.0	%	$	515	$	9	$	506	5,622.2	%
Loss on sale of investment properties, net	—		—		—		—	%	—		(6)		6		(100.0)	%
Interest expense	(1,175)		(588)		587		99.8	%	(1,960)		(1,277)		683		53.5	%

Interest income increased $0.4 million for the three months ended June 30, 2023, as compared to the three months ended June 30, 2022, due to higher interest rates and higher cash balances maintained.

Interest income increased $0.5 million for the six months ended June 30, 2023, as compared to the six months ended June 30, 2022 due to the same reasons as described above.

During the six months ended June 30, 2022, the loss on sale of investment properties of $0.01 million was attributed to the sale of State Street Market. There were no sales of investment properties during the three and six months ended June 30, 2023 or the three months ended June 30, 2022.

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Interest expense increased $0.6 million during the three months ended June 30, 2023, as compared to the same period in 2022, due to interest on four new mortgage loans: Kenilworth Court, entered into in June 2022, The Lafayette, entered into in June 2022, Tennyson, entered into in January 2023 and Trimble, entered into in April 2023.

Interest expense increased $0.7 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022, for the same reasons as described above. Partially offsetting this increase is a decrease in expense resulting from the sale of State Street Market in March 2022.

Leasing Activity

Our primary source of funding for our property-level operating activities and debt payments is rent collected pursuant to our tenant leases. The following table represents lease expirations, excluding multi-family leases, as of June 30, 2023, assuming none of the tenants exercise renewal options: 

Lease Expiration Year	Number of Expiring Leases	Gross Leasable Area (GLA) of Expiring Leases (Sq. Ft.)	Annualized Rent of Expiring Leases (in thousands)		Percent of Total GLA		Percent of Total Annualized Rent		Expiring Rent/Square Foot
2023	2	1,800	$	37	0.2	%	0.4	%	$	20.38
2024	5	32,956	648		3.7	%	6.4	%	19.67
2025	17	102,622	1,444		11.7	%	14.3	%	14.07
2026	3	10,441	329		1.2	%	3.3	%	31.52
2027	5	502,032	2,475		57.0	%	24.6	%	4.93
2028	7	30,202	624		3.5	%	6.2	%	20.65
2029	3	53,972	747		6.1	%	7.4	%	13.84
2030	1	2,790	75		0.3	%	0.7	%	27.00
2031	—	—	—		—	%	—	%	—
2032	2	8,800	176		1.0	%	1.7	%	19.98
MTM	2	8,169	42		0.9	%	0.4	%	5.14
Thereafter	3	126,928	3,482		14.4	%	34.6	%	27.44
Grand Total	50	880,712	$	10,079	100.0	%	100.0	%	$	11.44

The following table represents new and renewed leases that commenced during the six months ended June 30, 2023 and 2022:

	Six Months Ended June 30, 2023					Six Months Ended June 30, 2022
	# of  Leases	Gross  Leasable Area	Rent per square  foot		Weighted Average Lease Term	# of  Leases	Gross  Leasable Area	Rent per square foot		Weighted Average Lease Term
New	—	—	$	—	—	1	96,780	$	25.56	16.0
Renewals	4	34,180	14.76		2.93	2	8,608	28.25		3.3
Total	4	34,180	$	14.76	2.93	3	105,388	$	25.78	15.0

Critical Accounting Estimates

General

The accompanying consolidated financial statements have been prepared in accordance with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates, judgments, and assumptions are required in a number of areas, including, but not limited to, evaluating the collectability of accounts receivable, allocating the purchase price of acquired investment properties, and evaluating the impairment of real estate assets. We base these estimates, judgments and assumptions on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.

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Acquisition of Real Estate

We evaluate the inputs, processes and outputs of each asset acquired to determine if the transaction is a business combination or asset acquisition. If an acquisition qualifies as a business combination, the related transaction costs are recorded as an expense in the consolidated statements of operations and comprehensive loss. If an acquisition qualifies as an asset acquisition, the related transaction costs are generally capitalized and amortized over the useful life of the acquired assets. Generally, acquisition of real estate qualifies as an asset acquisition.

We allocate the purchase price of real estate to land, building, other building improvements, tenant improvements, and intangible assets and liabilities (such as the value of above- and below-market leases and in-place leases. The values of above- and below-market leases are recorded as intangible assets, net, and intangible liabilities, net, respectively, in the consolidated balance sheets, and are amortized as either a decrease (in the case of above-market leases) or an increase (in the case of below-market leases) to lease income over the remaining term of the associated tenant lease. The values associated with in-place leases are recorded in intangible assets, net in the consolidated balance sheets and are amortized to depreciation and amortization expense in the consolidated statements of operations and comprehensive income over the remaining lease term.

The difference between the contractual rental rates and our estimate of market rental rates is measured over a period equal to the remaining non-cancelable term of the leases, including below-market renewal options for which exercise of the renewal option appears to be reasonably assured. The remaining term of leases with renewal options at terms below market reflect the assumed exercise of such below-market renewal options and assume the amortization period would coincide with the extended lease term.

Impairment of Real Estate

The Company assesses the carrying values of its long-lived assets whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be fully recoverable, such as a reduction in the expected holding period of the asset. If it is determined that the carrying value is not recoverable because the undiscounted cash flows do not exceed carrying value, the Company records an impairment loss to the extent that the carrying value exceeds fair value. The valuation and possible subsequent impairment of investment properties is a significant estimate that can and does change based on the Company’s continuous process of analyzing each asset and reviewing assumptions about uncertain inherent factors, as well as the economic condition of the asset at a particular point in time.

The use of projected future cash flows and related holding periods is based on assumptions that are consistent with the estimates of future expectations and the strategic plan the Company uses to manage its underlying business. However, assumptions and estimates about future cash flows and capitalization rates are complex and subjective. Changes in economic and operating conditions and the Company’s ultimate investment intent that occur subsequent to the impairment analyses could impact these assumptions and result in future impairment charges of the real estate assets.

Liquidity and Capital Resources

As of June 30, 2023, we had $52.5 million of cash and cash equivalents, and $3.5 million of restricted cash and escrows.

Sources:

•cash flows from our investment properties;

•proceeds from sales of investment properties; and

•proceeds from debt.

Uses:

•to pay the operating expenses of our investment properties;

•to pay our general and administrative expenses;

•to pay for acquisitions;

•to pay for capital commitments;

•to pay for short-term obligations;

•to service or pay-down our debt; and

•to fund capital expenditures and leasing related costs.

21

Certain of our assets have lease maturities within the next two years. If the leases are not renewed or replaced, we expect that our cash flows from operations will be reduced. Significant lease maturities include Old Navy at Market at Hilliard expiring in August 2024, Michael’s at Market at Hilliard expiring in February 2025, Marshalls at Buckhorn Plaza expiring in May 2025 and Office Max at Market at Hilliard expiring in May 2025.

We may, from time to time, repurchase our outstanding equity and/or debt securities, if any, through cash purchases or via other transactions. Such repurchases or transactions, if any, will depend on our liquidity requirements, contractual restrictions, and other factors. The amounts involved may be material.

Material Cash Requirements

In February 2021, the Company executed a lease with Veeco Instruments, Inc. for approximately 97,000 square feet at Trimble. The lease required a significant tenant allowance, which is being accounted for as lessor-owned improvements, and broker commission. The total cost commitment was estimated to be approximately $9.1 million. As of June 30, 2023, we estimate that remaining costs to be paid under this commitment are approximately $0.7 million. The tenant began paying cash rent on January 1, 2023. The remainder of the tenant allowance will be paid by the Company upon final request by the tenant.

In November 2022, the Company executed a lease with XP Power, LLC for approximately 80,000 square feet at Trimble. Rental payments under this lease are expected to commence in January 2024. The lease requires significant landlord work, a tenant allowance, which will be accounted for as lessor-owned improvements, and leasing commission. The total cost commitment is estimated to be approximately $12.3 million. As of June 30, 2023, we estimate remaining costs under this commitment are approximately $10.8 million.

The Company expects to use cash on hand, cash flows from operations and proceeds from financings to fund the above commitments.

Borrowings

Total debt outstanding as of June 30, 2023 and December 31, 2022 was $92.1 million and $62.4 million, respectively, with a weighted average interest rate of 4.58% and 4.12% per annum, respectively.

The table below presents, on a consolidated basis, the principal amount, weighted average interest rates and maturity date (by year) on our mortgage debt, as of June 30, 2023 (dollar amounts are stated in thousands).

Debt maturing during the year ended December 31,	As of June 30, 2023		Weighted average interest rate
2023 (remaining)	$	17,286	3.28	%	(1)
2024	—		—	%
2025	20,000		5.86	%
2026	24,000		4.56	%
2027	11,302		3.99	%
Thereafter	19,515		4.79	%
Total	$	92,103	4.58	%

(1)    See below for discussion of the swap agreement entered into with the mortgage loan obtained in connection with the acquisition of The Locale. The weighted average interest rate reflected is the strike rate.

The Company obtained a loan on April 6, 2023 which was secured by a mortgage encumbering one of the buildings comprising the Trimble office investment property. The building is approximately 97,000 square feet and is currently occupied by Veeco Instruments, Inc. The loan secured by a mortgage on this Trimble building has a principal amount of $20.0 million, $4.0 million of which is guaranteed by the Company. The loan matures on April 6, 2025, with a 12-month extension option, provided certain criteria are met at the time of extension. Simultaneously with the loan closing, we entered into a swap arrangement to fix the interest rate at 5.86% for the term of the loan.

The Company obtained a loan on January 24, 2023 which was secured by a mortgage encumbering Tennyson, one of the Company’s multi-family investment properties. The loan has a principal balance of $10.3 million. The loan matures on February 1, 2030, bears interest at a rate of 4.84% and requires interest-only payments for the duration of its 7-year term.

22

The Company obtained two loans on June 30, 2022 which were each secured by a mortgage encumbering one of the Company's multi-family investment properties. The loan secured by a mortgage on Kenilworth Court has a principal amount of $3.8 million, and the loan secured by a mortgage on The Lafayette has a principal amount of $5.5 million. Both loans mature on July 1, 2032, bear interest at a fixed rate of 4.74% and require interest-only payments for the duration of their entire 10-year term.

The Company’s mortgage and the related swap agreement on The Locale mature on September 1, 2023. The principal balance of this mortgage was $17.3 million at June 30, 2023 and the swap agreement entered into at the time of closing fixed the interest rate at 3.28%. Prior to maturity, the Company expects it will either exercise the one-year extension option provided for in the loan documents, which requires, among other criteria, that at the time of extension the mortgage is not in default and a minimum debt service coverage ratio and minimum loan to value ratio are met or will refinance the loan with an alternate lender.

As of June 30, 2023, one mortgage loan was guaranteed up to $4.0 million and as of December 31, 2022, none of our mortgage debt was recourse to the Company. However, Highlands or its subsidiaries may act as guarantor under customary, non-recourse, carve-out guarantees in connection with obtaining mortgage loans on certain of our investment properties.

Our ability to pay off our mortgages when they become due is, in part, dependent upon our ability either to refinance the related mortgage debt or to sell the related asset. With respect to each loan, if we are unable to refinance or sell the related asset, or in the event that the estimated asset value is less than the mortgage balance, we may, if appropriate, satisfy a mortgage obligation by transferring title of the asset to the lender or permitting a lender to foreclose.

Volatility in the capital markets could expose us to the risk of not being able to borrow on terms and conditions acceptable to us for refinancing.

LIBOR Reform

Following announcements by the United Kingdom’s Financial Conduct Authority (“FCA”), which regulates LIBOR, and ICE Benchmark Administration Limited, which administers LIBOR’s publication, publication of most LIBOR settings ceased after December 31, 2021. Publication of the remaining U.S. dollar LIBOR settings is expected to cease after June 30, 2023. As a result, the Federal Reserve Board and the Federal Reserve Bank of New York organized the Alternative Reference Rates Committee (“ARRC”), which identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate for USD LIBOR in derivatives and other financial contracts. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities, and the Federal Reserve Bank of New York started to publish SOFR in April 2018.

The discontinuation, reform or replacement of LIBOR or any other benchmark rates may have an unpredictable impact on contractual mechanics in the credit markets or cause disruption to the broader financial markets and could have an adverse effect on LIBOR-based interest rates on our current or future debt obligations.

As of June 30, 2023, the Company had one variable-rate mortgage with an interest rate swap to fix the rate at 3.28% that was indexed to one-month USD-LIBOR. The derivative instrument had an original notional amount of $18.8 million . In December 2022, the Company completed an amendment to the mortgage loan agreement to replace LIBOR and establish SOFR as the alternate rate for this mortgage and interest rate swap. The amendment did not have a material impact to the Company’s consolidated financial statements.

Summary of Cash Flows

Comparison of the six months ended June 30, 2023 and 2022

	(in thousands)
	Six Months Ended June 30,
	2023		2022
Net cash flows provided by operating activities	$	791	$	661
Net cash flows provided by (used in) investing activities	(1,535)		8,063
Net cash flows provided by (used in) financing activities	28,826		(135)
Net increase in cash and cash equivalents and restricted cash and escrows	28,082		8,589
Cash and cash equivalents and restricted cash and escrows, at beginning of period	27,918		22,010
Cash and cash equivalents and restricted cash and escrows, at end of period	$	56,000	$	30,599

23

Cash provided by operating activities was $0.8 million for the six months ended June 30, 2023 and was $0.7 million for the six months ended June 30, 2022. The increase in cash provided by operating activities compared to the same period in 2022 is due primarily to cash received from new tenant Veeco Instruments at Trimble and increased base rent per square foot in the overall portfolio. This increase is partially offset by decreased resulting from the sale of State Street Market during the six months ended June 30, 2022 and the expiration of the Fitness International lease at Sherman Plaza in April 2022.

Cash used in investing activities was $1.5 million for the six months ended June 30, 2023, compared to cash provided by investing activities of $8.1 million for the six months ended June 30, 2022. Cash provided by investing activities decreased $9.6 million compared to the same period in 2022 as a result of proceeds in the amount of $8.9 million from the sale of State Street Market during the six months ended June 30, 2022 and higher cash spend for capital expenditures and tenant improvements.

Cash provided by financing activities was $28.8 million for the six months ended June 30, 2023, compared to cash used in financing activities of $0.1 million for the six months ended June 30, 2022. Cash provided by financing activities for the six months ended June 30, 2023 included proceeds from new mortgages on Tennyson and Trimble, totaling $30.3 million, principal payments on mortgage debt in the amount of $0.6 million and payment of debt issuance costs of $0.9 million related to the Tennyson and Trimble mortgages. Cash used in financing activities for the six months ended June 30, 2022 included repayment of the State Street mortgage in conjunction with the property sale in the amount of $8.7 million, principal payments on mortgage debt in the amount of $0.5 million and payment of debt issuance costs of $0.2 million related to mortgage loans on Kenilworth Court and Lafayette. Cash used in financing activities is partially offset by proceeds from the two new mortgage loans closed during the period.

We consider all demand deposits, money market accounts and investments in certificates of deposit and repurchase agreements with a maturity of three months or less at the date of purchase to be cash equivalents. We maintain our cash and cash equivalents at financial institutions. The account balances at one or more institutions exceed the Federal Depository Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage.

Distributions

For the six months ended June 30, 2023 and 2022, no cash distributions were paid by the Company.

Funds from Operations and Adjusted Funds From Operations

The National Association of Real Estate Investment Trusts (“NAREIT”), an industry trade group, has promulgated a non-GAAP financial measure known as Funds From Operations, or FFO. As defined by NAREIT, FFO is net income (loss) in accordance with GAAP excluding gains (or losses) resulting from dispositions of investment properties, plus depreciation and amortization and impairment charges on depreciable property. We have adopted the NAREIT definition in our calculation of FFO as management considers FFO a widely accepted and appropriate measure of performance for REITs. FFO is not equivalent to our net income or loss as determined under GAAP.

Since the definition of FFO was promulgated by NAREIT, management and many investors and analysts have considered the presentation of FFO alone to be insufficient. Accordingly, in addition to FFO, we may also use Adjusted Funds From Operations, or AFFO as a measure of our operating performance. We define AFFO, a non-GAAP financial measure, to exclude from FFO adjustments for gains or losses related to early extinguishment of debt instruments as these items are not related to our continuing operations. By excluding these items, management believes that AFFO provides supplemental information related to sustainable operations that will be more comparable between other reporting periods and to other public, non-listed REITs. AFFO is not equivalent to our net income or loss as determined under GAAP.

In calculating FFO and AFFO, impairment charges of depreciable real estate assets are added back even though the impairment charge may represent a permanent decline in value due to decreased operating performance of the applicable investment property. Further, because gains and losses from sales of investment property are excluded from FFO and AFFO, it is consistent and appropriate that impairments, which are often early recognition of losses on prospective sales of investment property, also be excluded.

We believe that FFO and AFFO are useful measures of our investment properties’ operating performance because they exclude noncash items from GAAP net income. Neither FFO nor AFFO is intended to be an alternative to “net income” nor to “cash flows from operating activities” as determined by GAAP as a measure of our capacity to pay distributions. Other REITs may use alternative methodologies for calculating similarly titled measures, which may not be comparable to our calculation of FFO

24

and AFFO. The Company may not present AFFO if the events and transactions of the reporting period do not include the related reconciling items.

The following section presents our calculation of FFO to net income (in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Net loss attributable to Highlands REIT, Inc. common stockholders	$	(2,129)	$	(1,584)	$	(3,845)	$	(2,474)
Depreciation and amortization (1)	2,570		2,556		5,101		5,155
Loss on sale of investment properties	—		—		—		6
Funds From Operations	$	441	$	972	$	1,256	$	2,687
Funds From Operations per weighted average common shares, basic and diluted	$	—	$	—	$	—	$	—
Weighted average number of common shares outstanding, basic and diluted	$	888,333	$	885,302	$	888,288	$	885,262

(1)    The depreciation and amortization add-back excludes the portion of expense attributable to the non-controlling interest.

Use and Limitations of Non-GAAP Financial Measures

FFO and AFFO do not represent cash generated from operating activities under GAAP and should not be considered as an alternative to net income or loss, operating profit, cash flows from operations or any other operating performance measure prescribed by GAAP. Although we may present and use FFO and AFFO because we believe they are useful to investors in evaluating and facilitating comparisons of our operating performance between periods and between REITs that report similar measures, the use of this non-GAAP measure has certain limitations as an analytical tool. This non-GAAP financial measure is not a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to fund capital expenditures, contractual commitments, working capital, service debt or make cash distributions. This measurement does not reflect cash expenditures for long-term assets and other items that we have incurred and will incur. This non-GAAP financial measure may include funds that may not be available for management’s discretionary use due to functional requirements to conserve funds for capital expenditures, property acquisitions and other commitments and uncertainties. This non-GAAP financial measure, as presented, may not be comparable to non-GAAP financial measures as calculated by other real estate companies.

We compensate for these limitations by separately considering the impact of these excluded items to the extent they are material to operating decisions or assessments of our operating performance. Our reconciliation to the most comparable GAAP financial measures, and our consolidated statements of operations and comprehensive loss and cash flows, include interest expense, capital expenditures and other excluded items, all of which should be considered when evaluating our performance, as well as the usefulness of our non-GAAP financial measure. This non-GAAP financial measure reflects an additional way of viewing our operations that we believe, when viewed with our GAAP results and the reconciliation to the corresponding GAAP financial measure, provides a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.

25

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk associated with changes in interest rates both in terms of variable-rate debt and the price of new fixed-rate debt upon maturity of existing debt and for acquisitions.

Interest Rate Risk

Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. As of June 30, 2023, our debt included two variable-rate mortgage loans, with principal balances of $17.3 million and $20.0 million, which have been swapped to fixed rates.

With regard to our variable-rate financing, we assess interest rate cash flow risk by identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. We maintain risk management control systems to monitor interest rate cash flow risk attributable to both outstanding or forecasted debt obligations.

We may use financial instruments to hedge exposures to changes in interest rates on loans. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the risk of failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates a credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, it does not pose credit risk. We seek to minimize the credit risk in derivative instruments by entering into transactions with what we believe are high-quality counterparties. Market risk is the adverse effect on the value of a financial instrument resulting from a change in interest rates.

In the event that LIBOR is discontinued, the interest rate for certain of our debt instruments, including interest rate swap agreements that are indexed to LIBOR, will be based on a replacement rate or an alternate base rate as specified in the applicable documentation governing such debt or swaps or as otherwise agreed upon. Such an event would not affect our ability to borrow or maintain already outstanding borrowings or swaps, but the replacement rate or alternate base rate could be higher or more volatile than LIBOR prior to its discontinuance.

One of our interest rate swaps is indexed to USD-LIBOR. However, the interest rate swap agreement has provisions that allow for a transition to a new alternative rate, and we believe that the transition from USD-LIBOR to the alternative rate will not have a material impact on our consolidated financial statements.

As of June 30, 2023, we had two derivative financial instruments designated as a cash flow hedges, with original notional amounts of $18.8 million and $20.0 million and maturity dates of September 1, 2023 and April 6, 2025, respectively. The fair value of the derivatives was $0.5 million as of June 30, 2023 and is included in deferred costs and other assets in the accompanying consolidated balance sheets. The gains or losses resulting from marking-to-market our derivative financial instruments during the periods presented are recognized as an increase or decrease in comprehensive income on our consolidated statements of operations and comprehensive loss.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As required by Rule 13a-15(b) and Rule 15d-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our principal executive officer and our principal financial officer evaluated, as of June 30, 2023, the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and Rule 15d-15(e) of the Exchange Act. Based on that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures, as of June 30, 2023, were effective at a reasonable assurance level for the purpose of ensuring that information required to be disclosed by us in this Quarterly Report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the three months ended June 30, 2023 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

26

Part II.

Item 1. Legal Proceedings

We are from time to time involved in legal actions arising in the ordinary course of business. We are not currently involved in any legal or administrative proceedings that we believe are likely to have a material adverse effect on our business, results of operations or financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto and are incorporated herein by reference.

27

EXHIBIT NO.	DESCRIPTION
3.1	Articles of Amendment and Restatement of Highlands REIT, Inc. (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8, filed with the Securities and Exchange Commission on April 27, 2016)
3.2	Amended and Restated Bylaws of Highlands REIT, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2023)
10.1	Amended and Restated Executive Employment Agreement, dated April 12, 2023, by and between Highlands REIT, Inc. and Richard Vance (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 14, 2023)
10.2	Amended and Restated Executive Employment Agreement, dated April 12, 2023, by and between Highlands REIT, Inc. and Robert J. Lange (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 14, 2023)
10.3	Executive Employment Agreement, dated April 12, 2023, by and between Highlands REIT, Inc. and Kimberly Karas (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 14, 2023)
31.1*	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*	Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*	XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*	XBRL Taxonomy Extension Schema Document
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*	XBRL Taxonomy Extension Label Linkbase Document
101.PRE*	XBRL Taxonomy Extension Presentation Link Document
104*	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

*    Filed as part of this Quarterly Report on Form 10-Q.

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SIGNATURES            

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Date
/s/ Richard Vance	August 10, 2023
Name: Richard Vance
Title: President and Chief Executive Officer (Principal Executive Officer)
/s/ Kimberly A. Karas	August 10, 2023
Name: Kimberly A. Karas
Title: Senior Vice President, Chief Accounting Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer)

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