UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2022

OR 

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

 For the transition period from ____________ to ____________

Commission File Number 001-15409

PILLARSTONE CAPITAL REIT

(Exact name of registrant as specified in its charter) 

Maryland	39-6594066
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)

2600 South Gessner, Suite 555

Houston, Texas 77063

(Address of principal executive offices)

(832) 810-0100

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 ore revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐      No ☒

The Registrant had 657,084 Common Shares, par value $0.01 per share, outstanding as of May 16, 2022.

FORM 10-Q

INDEX

PART I. Financial Information
	Item 1. Financial Statements
		Condensed Consolidated Balance Sheets as of March 31, 2022 (Unaudited) and December 31, 2021	2
		Condensed Consolidated Statements of Operations (Unaudited) - For the Three Months Ended March 31, 2022 and 2021	4
		Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited) - For the Three Months Ended March 31, 2022 and 2021	6
		Condensed Consolidated Statements of Cash Flows (Unaudited) - For the Three Months Ended March 31, 2022 and 2021	7
		Notes to Condensed Consolidated Financial Statements (Unaudited)	8
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
	Item 4. Controls and Procedures		23
Part II. Other Information
	Item 1. Legal Proceedings		24
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		24
	Item 3. Defaults upon Senior Securities		24
	Item 4. Mine Safety Disclosures		24
	Item 5. Other Information		24
	Item 6. Exhibits		25
	Signatures		26

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
	March 31, 2022		December 31, 2021
	(unaudited)
ASSETS (a)
Real estate assets, at cost
Property	$	57,087	$	57,027
Accumulated depreciation	(8,861)		(8,754)
Total real estate assets	48,226		48,273
Cash and cash equivalents	4,342		5,206
Escrows and utility deposits	1,511		1,243
Accrued rents and accounts receivable, net of allowance for doubtful accounts	1,412		1,260
Receivable due from related party	1,221		1,011
Unamortized lease commissions and deferred legal cost, net	436		464
Prepaid expenses and other assets	358		126
Total assets	$	57,506	$	57,583
LIABILITIES AND EQUITY (b)
Liabilities:
Notes payable	$	15,129	$	14,920
Accounts payable and accrued expenses	1,048		1,691
Payable due to related party	1,010		846
Convertible notes payable - related parties	198		198
Accrued interest payable	190		185
Tenants' security deposits	803		827
Total liabilities	18,378		18,667
Commitments and contingencies:	—		—
Shareholders' Equity:
Preferred A Shares - $0.01 par value,1,518,000 authorized: 256,636 Class A cumulative convertible shares issued and outstanding at March 31, 2022 and December 31, 2021, $10.00 per share liquidation preference	3		3
Preferred C Shares - $0.01 par value, 300,000 authorized: 231,944 Class C cumulative convertible shares issued and outstanding at March 31, 2022 and December 31, 2021, $10.00 per share liquidation preference	2		2
Common Shares - $0.01 par value, 400,000,000 authorized: 695,214 shares issued and 657,084 outstanding at March 31, 2022 and December 31, 2021	7		7
Additional paid-in capital	28,493		28,493
Accumulated deficit	(23,899)		(23,882)
Treasury stock, at cost, 38,130 shares	(801)		(801)
Total Pillarstone Capital REIT shareholders' equity	3,805		3,822
Noncontrolling interest in subsidiary	35,323		35,094
Total equity	39,128		38,916
Total liabilities and equity	$	57,506	$	57,583

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

2

Pillarstone Capital REIT and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS - Continued

(in thousands)

	March 31, 2022		December 31, 2021
	(unaudited)
(a) Assets of condensed consolidated Variable Interest Entity included in the total assets above:
Real estate assets, at cost
Property	$	57,084	$	57,023
Accumulated depreciation	(8,858)		(8,751)
Total real estate assets	48,226		48,272
Cash and cash equivalents	4,136		4,900
Escrows and utility deposits	1,511		1,243
Accrued rents and accounts receivable, net of allowance for doubtful accounts	1,257		1,104
Receivable due from related party	1,222		1,011
Unamortized lease commissions and deferred legal cost, net	436		464
Prepaid expenses and other assets	347		33
Total assets	$	57,135	$	57,027
(b) Liabilities of condensed consolidated Variable Interest Entity included in the total liabilities above:
Notes payable	$	15,129	$	14,920
Accounts payable and accrued expenses	803		1,483
Payable due to related party	989		827
Accrued interest payable	64		64
Tenants' security deposits	803		827
Total liabilities	$	17,788	$	18,121

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

3

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
	Three Months Ended March 31,
	2022		2021
Revenues
Rental (1)	$	2,310	$	2,180
Transaction and other fees	16		10
Total revenues	2,326		2,190
Operating expenses
Depreciation and amortization	484		497
Operating and maintenance	771		718
Real estate taxes	328		409
General and administrative	187		207
Management fees	140		139
Total operating expenses	1,910		1,970
Other expenses
Interest expense, net	197		203
Total other expenses	197		203
Income before income taxes	219		17
Provision for income tax benefit (expense)	(7)		7
Net income	212		24
Less: Noncontrolling interest in subsidiary	229		109
Net loss attributable to Common Shareholders	$	(17)	$	(85)
Loss Per Share:
Basic loss per Common Share:
Net loss available to Common Shareholders	$	(0.03)	$	(0.14)
Diluted loss per Common Share:
Net loss available to Common Shareholders	$	(0.03)	$	(0.14)
Weighted average number of Common Shares outstanding:
Basic:	657,084		595,000
Diluted:	657,084		595,000

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

4

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - Continued
(unaudited)
(in thousands)
	Three Months Ended March 31,
	2022		2021
(1) Rental
Rental revenues	$	2,018	$	2,042
Recoveries	307		178
Bad debt	(15)		(40)
Total rental	$	2,310	$	2,180

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

5

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
(unaudited)
(in thousands)
	Class A Preferred Shares		Class C Preferred Shares		Common Shares		Additional Paid-in Capital		Accumulated Deficit		Cost of Shares Held in Treasury		Total Shareholders' Equity (Deficit)		Noncontrolling Interest		Total Equity
Balance, December 31, 2021	$	3	$	2	$	7	$	28,493	$	(23,882)	$	(801)	$	3,822	$	35,094	$	38,916
Net income (loss)	—		—		—		—		(17)		—		(17)		229		212
Balance, March 31, 2022	$	3	$	2	$	7	$	28,493	$	(23,899)	$	(801)	$	3,805	$	35,323	$	39,128

	Class A Preferred Shares		Class C Preferred Shares		Common Shares		Additional Paid-in Capital		Accumulated Deficit		Cost of Shares Held in Treasury		Total Shareholders' Equity (Deficit)		Noncontrolling Interest		Total Equity
Balance, December 31, 2020	$	3	$	2	$	6	$	28,494	$	(23,623)	$	(801)	$	4,081	$	34,361	$	38,442
Share-based compensation	—		—		—		15		—		—		15		—		15
Net income (loss)	—		—		—		—		(85)		—		(85)		109		24
Balance, March 31, 2021	$	3	$	2	$	6	$	28,509	$	(23,708)	$	(801)	$	4,011	$	34,470	$	38,481

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

6

Pillarstone Capital REIT and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
	Three Months Ended March 31,
	2022		2021
Cash flows from operating activities:
Net income	$	212	$	24
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization	484		497
Amortization of deferred loan costs	7		7
Bad debt	15		40
Share-based compensation	—		15
Changes in operating assets and liabilities:
Accrued rents and accounts receivable	(167)		(18)
Receivable due from related party	(210)		—
Escrows and utility deposits	(268)		432
Unamortized lease commissions and deferred legal cost	(7)		(35)
Prepaid expenses and other assets	80		(168)
Accounts payable and accrued expenses	(638)		(1,417)
Payable due to related party	164		396
Tenants' security deposits	(24)		(31)
Net cash used in operating activities	(352)		(258)
Cash flows from investing activities:
Additions to real estate	(387)		(215)
Net cash used in investing activities	(387)		(215)
Cash flows from financing activities:
Repayments of notes payable	(125)		(70)
Net cash used in financing activities	(125)		(70)
Net change in cash and cash equivalents	(864)		(543)
Cash and cash equivalents at beginning of period	5,206		5,109
Cash and cash equivalents at end of period	$	4,342	$	4,566
Supplemental disclosure of cash flow information:
Cash paid for interest	$	190	$	197
Non cash investing activities:
Disposal of fully depreciated real estate	$	326	$	137
Financed insurance premium	$	311	$	—

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

7

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Accounting.  Pillarstone Capital REIT's (the “Company,” “Pillarstone,” “we,” “our,” or “us”) financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.

Use of estimates.  In order to conform with generally accepted accounting principles in the United States ("U.S. GAAP"), management, in preparation of our condensed consolidated financial statements, is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of March 31, 2022 and December 31, 2021, and the reported amounts of revenues and expenses for the three months ended March 31, 2022 and 2021. Actual results could differ from those estimates. Significant estimates that we use include the estimated fair value of properties acquired, allowance for doubtful accounts, impairment, the estimated useful lives for depreciable and amortizable assets and costs, and deferred taxes and the related valuation allowance for deferred taxes.

Cash and cash equivalents. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.  Cash and cash equivalents as of March 31, 2022 and December 31, 2021 consisted of demand deposits at a commercial bank and a brokerage account. We maintain our cash in bank accounts that are federally insured.

Acquired Properties and Acquired Lease Intangibles.  We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt.

Depreciation.  Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings.  Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter.

Impairment.  We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations.  We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value.  Management has determined that there has been no impairment in the carrying value of our real estate assets as of March 31, 2022.

8

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

Accrued Rents and Accounts Receivable.  Included in accrued rent and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. We review the collectability of charges under our tenant operating leases on a regular basis, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located, including the impact of the COVID-19 pandemic on tenants' businesses and financial condition. We recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Our review of collectability under our operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue. As of March 31, 2022 and December 31, 2021, we had an allowance for uncollectible accounts of approximately $553,000 and $538,000, respectively. For the three months ended March 31, 2022 and 2021, we recorded an adjustment to rental revenue in the amount of approximately $15,000 and $40,000, respectively. For the three months ended March 31, 2022 and March 31, 2021 our adjustment to rental revenue included three and two cash basis tenants, respectively, resulting in an increase in bad debt of approximately $40,000.

Unamortized Lease Commissions and Deferred Legal Cost.  Leasing commissions and deferred legal cost are amortized using the straight-line method over the terms of the related lease agreements.  Costs allocated to in-place leases whose terms differ from market terms related to acquired properties are amortized over the remaining life of the respective leases.

Prepaid expenses and Other assets. Prepaid expenses and other assets include escrows established pursuant to certain mortgage financing arrangements for real estate taxes and insurance.

Noncontrolling Interests. Noncontrolling interests are the portion of equity in a subsidiary not attributable to a parent. Accordingly, we have reported noncontrolling interest in equity on the condensed consolidated balance sheets but separate from Pillarstone’s equity.  On the condensed consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to Pillarstone and noncontrolling interest.

Revenue recognition. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases.  For the three months ended March 31, 2022 and 2021 we did not have a straight-line rent reserve adjustment. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the condensed consolidated statements of operations. We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured.

Stock-based compensation. The Company accounts for stock-based compensation in accordance with ASC No. 718, "Compensation - Stock Compensation," which addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. ASC No.718 generally requires that these transactions be accounted for using a fair-value-based method. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards.

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

The Company evaluates potential uncertain tax positions on an annual basis in conjunction with the board of trustees and its tax accountants. Authoritative literature provides a two-step approach to recognize and measure tax benefits when realization of the benefits is uncertain. The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step is to determine the amount to be recognized based on the cumulative probability that exceeds 50%.

As of March 31, 2022, we had a net operating loss carry-forward of approximately $94,000, and as of March 31, 2022 and December 31, 2021, we had net deferred tax liabilities of approximately $31,000 and $36,000, respectively.

9

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

Concentration of Risk.  Substantially all of our revenues are obtained from office and warehouse locations in the Dallas and Houston metropolitan areas. We maintain cash accounts in major U.S. financial institutions. The terms of these deposits are on demand to minimize risk. The balances of these accounts sometimes exceed the federally insured limits, although no losses have been incurred in connection with these deposits.

Recent accounting pronouncements. In April 2020, the Financial Accounting Standards Board ("FASB") issued guidance on the application of Topic 842, relating to concessions being made by lessors in response to the COVID-19 pandemic. The guidance notes that it would be acceptable for entities to make an election to account for lease concessions relating to the effects of the COVID-19 pandemic consistent with how those concessions would be accounted for under Topic 842 as though enforceable rights and obligations for those concessions existed, even if such enforceable rights and obligations are not explicitly contained in the lease contract. Thus, for concessions relating to COVID-19, an entity would not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract, and would have the option to apply, or not to apply, the general lease modification guidance in Topic 842 as it stands. We have elected this option to account for lease concessions relating to the effects of the COVID-19 pandemic consistent with how those concessions would be accounted for under Topic 842 as though enforceable rights and obligations for those concessions existed. Therefore, such concessions are not accounted for as a lease modification under Topic 842.

2. ACCRUED RENTS AND ACCOUNTS RECEIVABLE, NET

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

	March 31, 2022		December 31, 2021
Tenant receivables	$	766	$	733
Accrued rents and other recoveries	1,199		1,065
Allowance for doubtful accounts	(553)		(538)
Total	$	1,412	$	1,260

3. LEASES

As a Lessor. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Percentage rents, if applicable, are recognized as rental income when the thresholds upon which they are based have been met.  Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred. We combine lease and nonlease components in lease contracts, which includes combining base rent, recoveries, and percentage rents into a single line item, Rental, within the condensed consolidated statements of operations.

10

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

A summary of minimum future rents to be received (exclusive of renewals, tenant reimbursements, contingent rents, and collectability adjustments under Topic 842) under noncancelable operating leases in existence as of March 31, 2022 is as follows (in thousands): 

Years Ended December 31,	Minimum Future Rents(1)
2022 (remaining)	$	5,036
2023	4,860
2024	3,052
2025	1,528
2026	915
Thereafter	299
Total	$	15,690

(1) These amounts do not reflect future rental revenues from the renewal or replacement of existing leases and exclude reimbursements of operating expenses and rental increases that are not fixed.

As a Lessee. On June 8, 2021, Pillarstone's lease became month to month with Whitestone for the premises located at 2600 S. Gessner Road, Suite 555 Houston, Texas 77063. The rentable area of the premises is approximately 678 square feet. Total rent expense for the three months ended March 31, 2022 and 2021 was $5,670 and $3,780, respectively.

4. UNAMORTIZED LEASE COMMISSIONS AND DEFERRED LEGAL COST, NET

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

	March 31, 2022		December 31, 2021
Leasing commissions	$	1,338	$	1,364
Deferred legal cost	12		12
Total cost	1,350		1,376
Less: leasing commissions accumulated amortization	(902)		(901)
Less: deferred legal cost accumulated amortization	(12)		(11)
Total cost, net of accumulated amortization	$	436	$	464

5. VARIABLE INTEREST ENTITY

On December 8, 2016, Pillarstone and Pillarstone OP, entered into a Contribution Agreement (the “Contribution Agreement”) with Whitestone REIT Operating Partnership, L.P. (“Whitestone OP”), a subsidiary and the operating partnership of Whitestone REIT (“Whitestone”), both of which are related parties to Pillarstone and Pillarstone OP. Pursuant to the terms of the Contribution Agreement, Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries (the “Subsidiaries”): Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company; Whitestone Industrial-Office, LLC, a Texas limited liability company; Whitestone Offices, LLC, a Texas limited liability company; and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower”) that owned 14 real estate assets (the “Real Estate Assets” and, together with the Subsidiaries, the “Property”) for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP (“OP Units”), issued at a price of $1.331 per OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by Pillarstone OP. Pursuant to the Contribution Agreement, Pillarstone became the general partner of Pillarstone OP with an equity ownership interest in Pillarstone OP totaling approximately an 18.6% interest valued at $4.1 million as of the date of the Contribution Agreement.

11

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

In connection with the Contribution Agreement, on December 8, 2016, the Company, as the general partner of Pillarstone OP, entered into an Amended and Restated Agreement of Limited Partnership of Pillarstone OP (as amended and

restated, the “Amended and Restated Agreement of Limited Partnership”). Pursuant to the Amended and Restated Agreement of Limited Partnership, subject to certain protective rights of the limited partners described below, the general partner has full, exclusive and complete responsibility and discretion in the management and control of Pillarstone OP, including the ability to cause Pillarstone OP to enter into certain major transactions including a merger of Pillarstone OP or a sale of substantially all of the assets of Pillarstone OP. The limited partners have no power to remove the general partner without the general partner's

consent. In addition, pursuant to the Amended and Restated Agreement of Limited Partnership, the general partner may not conduct any business without the consent of a majority of the limited partners other than in connection with certain actions described therein. The Company is deemed to exercise significant influence over Pillarstone OP as it has the power to direct the activities that most significantly impact Pillarstone OP's economic performance and the Company's right to receive benefits based on its ownership percentage in Pillarstone OP. Accordingly, the Company accounts for Pillarstone OP as a Variable Interest Entity.

The Amended and Restated Agreement of Limited Partnership designates two classes of units of limited partnership interest in Pillarstone OP: the OP Units and LTIP units. In general, LTIP units are similar to the OP Units and will receive the same quarterly per-unit profit distributions as the OP Units. The rights, privileges, and obligations related to each series of LTIP units will be established at the time the LTIP units are issued. As profits interests, LTIP units initially will not have full parity, on a per-unit basis, with OP Units with respect to liquidating distributions. Upon the occurrence of specified events, LTIP units can over time achieve full parity with the OP Units and therefore accrete to an economic value for the holder equivalent to OP Units. If such parity is achieved, vested LTIP units may be converted on a one-for-one basis into OP Units, which in turn are redeemable by the holder for cash or, at the Company’s election, exchangeable for Common Shares on a one-for-one basis.

The carrying amounts and classification of certain assets and liabilities for Pillarstone OP in our condensed consolidated balance sheets as of March 31, 2022 and December 31, 2021 consists of the following (in thousands):

	March 31, 2022		December 31, 2021
	(unaudited)
Real estate assets, at cost
Property	$	57,084	$	57,023
Accumulated depreciation	(8,858)		(8,751)
Total real estate assets	48,226		48,272
Cash and cash equivalents	4,136		4,900
Escrows and utility deposits	1,511		1,243
Accrued rents and accounts receivable, net of allowance for doubtful accounts	1,257		1,104
Receivable due from related party (1)	1,222		1,011
Unamortized lease commissions and deferred legal cost, net	436		464
Prepaid expenses and other assets	347		33
Total assets	$	57,135	$	57,027
Liabilities
Notes payable	$	15,129	$	14,920
Accounts payable and accrued expenses	803		1,483
Payable due to related party	989		827
Accrued interest payable	64		64
Tenants' security deposits	803		827
Total liabilities	$	17,788	$	18,121

(1)    Excludes approximately $0.03 million in accounts receivable due from Pillarstone that was eliminated in consolidation as of March 31, 2022 and December 31, 2021.

12

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

6. REAL ESTATE

As of March 31, 2022, Pillarstone OP owned eight Real Estate Assets in the Dallas and Houston areas comprised of approximately 0.9 million square feet of gross leasable area.

7. DEBT

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

Description	March 31, 2022		December 31, 2021
Fixed rate notes
$16.5 million 4.97% Note, due September 26, 2023	$	14,890	$	14,968
$0.3 million 3.15% Note, due December 28, 2022	280		—
Total notes payable principal	15,170		14,968
Less deferred financing costs, net of accumulated amortization	(41)		(48)
Total notes payable	$	15,129	$	14,920

Our mortgage debt was collateralized by one operating property as of March 31, 2022 and December 31, 2021 with a net book value of $21.3 million. Our loan contains restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and is secured by a deed of trust on our property and the assignment of certain rents and leases associated with the property. Our loan is subject to customary covenants. During the period ending March 31, 2022, we also entered into an additional loan related to our commercial property insurance policy. As of March 31, 2022, we were in compliance with all loan covenants.

Scheduled maturities of notes payable as of March 31, 2022 were as follows (in thousands):

Year	Amount Due
2022 (remaining)	$	511
2023	14,659
Total	$	15,170

8. CONVERTIBLE NOTES PAYABLE - RELATED PARTIES

On November 20, 2015, five trustees on our board of trustees loaned $197,780 to the Company in exchange for convertible notes payable. The convertible notes payable accrue interest at 10% per annum and originally matured on November 20, 2018. In 2019, our board of trustees approved an extension of the maturity date to November 20, 2021. In 2021, the noteholders agreed to extend the maturity date to November 30, 2022. The convertible notes payable can be converted by the noteholders into Common Shares at the rate of $1.331 per Common Share at any time. At maturity or when the Company chooses to call the convertible notes payable, the noteholders have the option to receive cash plus accrued interest or convert the convertible notes payable into Common Shares at $1.331 per Common Share. Accrued interest on these related convertible notes was approximately $126,000 as of March 31, 2022 compared with approximately $121,000 as of December 31, 2021.

9. EARNINGS (LOSS) PER SHARE

The Company applies the guidance of ASC 260, "Earnings Per Share," for all periods presented herein. Net earnings (loss) per weighted average Common Share outstanding, basic and diluted, is computed based on the weighted average number of Common Shares outstanding for the period. The following table shows the weighted average number of Common Shares outstanding and reconciles the numerator and denominator of earnings per Common Share calculations for the three month periods ended March 31, 2022 and 2021.

13

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

For the three month periods ended March 31, 2022 and 2021, Class A Preferred Shares and Class C Preferred Shares were not included in net loss per weighted average number of Common Share outstanding-diluted, because the effect of the conversion would be anti-dilutive.

During the three month periods ended March 31, 2022 and 2021, the Company had $197,780 of convertible notes payable as discussed in Note 8. The convertible notes payable were not included in the computation of diluted loss per share for the three months ended March 31, 2022 and 2021 because the effect of the conversion would be anti-dilutive.

	Three Months Ended March 31,
(in thousands, except share and per share data)	2022		2021
Numerator:
Net loss attributable to common shareholders	$	(17)	$	(85)
Denominator:
Weighted average number of common shares - basic	657,084		595,000
Weighted average number of common shares - dilutive	657,084		595,000
Loss Per Share:
Basic loss per common share:
Net loss available to common shareholders	$	(0.03)	$	(0.14)
Diluted loss per common share:
Net loss available to common shareholders	$	(0.03)	$	(0.14)

10. RELATED PARTY TRANSACTIONS

On December 8, 2016, the Company entered into the Contribution Agreement with Whitestone OP, a related party, resulting in the contribution of an equity ownership interest in Pillarstone OP by the Company valued at $4,121,312 and representing approximately 18.6% of the outstanding equity in Pillarstone OP. The terms of the Contribution Agreement were determined through arm's-length negotiations and were recommended to the board of trustees by a special committee of the board of trustees consisting solely of disinterested trustees of the Company and approved by the full board.

Pursuant to the Contribution Agreement, the Company agreed to file with the Securities and Exchange Commission (the "SEC") on or prior to June 8, 2018, a shelf registration statement to register for sale under the Securities Act of 1933, as amended, the issuance of the common shares in the Company that may be issued upon redemption of the OP Units issued pursuant to the Contribution Agreement and the offer and resale of such common shares by the holders thereof. In addition, pursuant to the Contribution Agreement, in the event of a Change of Control (as defined therein) of Whitestone, Pillarstone OP shall have the right, but not the obligation, to repurchase the OP Units issued thereunder from Whitestone OP at their initial issue price of $1.331 per OP Unit. Pillarstone and Whitestone agreed to extend the filing of the shelf registration statement to the date that the Company closes a public equity offering.

During the ordinary course of business, we have transactions with Whitestone that include, but are not limited to, rental income, interest expense, general and administrative costs, commissions, management and asset management fees, and property expenses.     

In connection with the Contribution Agreement, on December 8, 2016, the Company entered into a Management Agreement (collectively, the “Management Agreements”) with Whitestone TRS, Inc., a subsidiary of Whitestone (“Whitestone TRS"). Pursuant to the Management Agreements with respect to each property, other than Uptown Tower, Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services to such properties in exchange for (1) a monthly property management fee equal to 5.0% of the monthly revenues of each property and (2) a

14

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

monthly asset management fee equal to 0.125% of GAV (as defined in each Management Agreement as, generally, the purchase price of the respective property based upon the purchase price allocations determined pursuant to the Contribution Agreement, excluding all indebtedness, liabilities or claims of any nature) of such property. Pursuant to the Management Agreement with respect to Uptown Tower, Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services in exchange for (1) a monthly property management fee equal to 3.0% of the monthly revenues of Uptown Tower and (2) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower.

The following table presents the revenue and expenses with Whitestone included in our condensed consolidated statement of operations for the three months ended March 31, 2022 and 2021 (in thousands):

		Three Months Ended March 31,
	Location of Revenue (Expense)	2022		2021
Rent	Rental	$	192	$	225
Property management fees	Management fees	(95)		(94)
Asset management fees	Management fees	(45)		(45)
Rent expense	Office expenses	(6)		(4)

Receivables due from and payables due to related parties consisted of the following as of March 31, 2022 and December 31, 2021 (in thousands):

	Location of Receivable (Payable)	March 31, 2022		December 31, 2021
Tenant receivables and other receivables	Receivable due from related party	$	1,221	$	1,011
Accrued interest due to related party	Accrued interest payable	(126)		(121)
Other payables due to related party	Payable due to related party	(1,010)		(846)

11. INCENTIVE EQUITY PLAN

At the 2016 Annual Meeting of Shareholders, our shareholders approved the 2016 Equity Plan ("2016 Plan").

The 2016 Plan provides that awards may be made in Common Shares of the Company or units in the Company’s operating partnership, which may be converted into Common Shares. Subject to adjustment as provided by the terms of the 2016 Plan, the maximum aggregate number of Common Shares with respect to which awards may be granted under the 2016 Plan will be increased based on future issuances of Common Shares and units of the operating partnership, including issuances pursuant to the 2016 Plan, so that at any time the maximum number of shares that may be issued under the 2016 Plan shall equal 12.5% of the aggregate number of Common Shares and units of the operating partnership issued and outstanding (other than treasury shares and/or units issued to or held by the Company).

The Management, Organization and Compensation Committee (the “Committee”) administers the 2016 Plan, except with respect to awards to non-employee trustees, for which the 2016 plan is administered by the board of trustees. Subject to the terms of the 2016 Plan, the Committee is authorized to select participants, determine the type and number of awards to be granted, determine and later amend (subject to certain limitations) the terms and conditions of any award, interpret and specify the rules and regulations relating to the 2016 Plan, and make all other determinations which may be necessary or desirable for

the administration of the 2016 Plan. The 2016 Plan includes the types of awards for grants and types of financial performance measures.

15

Pillarstone Capital REIT

Notes to Condensed Consolidated Financial Statements

(unaudited)

As of the three months ended March 31, 2022, the following shares are available for grant:

Description	Shares
Available for grant at March 31, 2022	2,086,655

As of March 31, 2022 the Company did not recognize any stock-based compensation expense for trustee compensation. As of March 31, 2021 the Company recognized approximately $15,000 in employee stock-based compensation expense and did not recognize any stock-based compensation expense for trustee compensation.

12. SUBSEQUENT EVENTS

During the first quarter of 2022, based on a legal review of the Pillarstone OP operating partnership agreement dated December 8, 2016, between Pillarstone, as general partner, and Whitestone OP, as limited partner, (the "Operating Partnership Agreement"), Pillarstone determined that its operating and administrative expenses should be reimbursed by Pillarstone OP on a historical and on-going basis. Accordingly, Pillarstone notified Whitestone OP, which manages Pillarstone OP's properties and provides the accounting function for both Pillarstone and Pillarstone OP, to transfer cash of $1,819,729 from Pillarstone OP to Pillarstone as reimbursement for Pillarstone's operating and administrative expenses for the years ended 2017 through 2021. In April 2022, Whitestone and Whitestone OP contested the expense reimbursement. Pillarstone and Pillarstone OP recorded the expense reimbursement of $1,819,729 with a reserve of $1,819,729 on each company’s separate books and records in the first quarter 2022 although these amounts are eliminated in the consolidated financial statements herein. The reserve was recorded due to Whitestone and Whitestone OP's contesting the expense reimbursement. Pillarstone intends to pursue the collection of the expense reimbursement from Pillarstone OP based on the provisions of the Operating Partnership Agreement.

In April 2022, Pillarstone determined the expense reimbursement of $176,593 was due from Pillarstone OP for Pillarstone's operating and administrative expenses for the first quarter of 2022. Pillarstone OP transferred $117,186 to Pillarstone in May 2022. The difference of $59,407 between the expense reimbursement $176,593 and the cash transferred $117,186 are Pillarstone expenses contested by Whitestone and Whitestone OP. Pillarstone and Pillarstone OP recorded the expense reimbursement of $176,593 with an allowance of $59,407 on each company’s separate books and records in the first quarter 2022 although these amounts are eliminated in the consolidated financial statements herein. Pillarstone intends to pursue reimbursement of the contested expenses based on the provisions of the Operating Partnership Agreement.

After Pillarstone notified Whitestone of the $1,819,729 expense reimbursement required from Pillarstone OP, Whitestone and Whitestone OP made a claim to Pillarstone and Pillarstone OP to be reimbursed for construction and lease commission expenditures of $1,425,972 paid by Whitestone OP on behalf of Pillarstone OP during 2017 and 2018. Pillarstone requested additional information for the $1,425,972 expenditures to determine if any of the items claimed should have been prorated between Pillarstone OP and Whitestone OP when the December 8, 2016 transaction occurred for Pillarstone OP’s acquisition of the Real Estate Assets. Whitestone OP is an 81.4% limited partner of Pillarstone OP and Pillarstone is the general partner owning the remaining 18.6% of Pillarstone OP. The $1,425,972 expenditures were recorded on Pillarstone OP in 2017 and 2018 as an increase in the Whitestone OP limited partner investment account and as assets of Pillarstone OP that have been depreciated and amortized to expense over their useful lives. The amount due Whitestone OP for these expenditures, if any, has not been determined. If Pillarstone OP reimburses any amounts to Whitestone OP, the payment would reduce the Whitestone OP limited partner investment account.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Forward-Looking Statements

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto in this Quarterly Report on Form 10-Q. 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, anticipated capital expenditures required to complete projects, amounts of anticipated cash distributions to our shareholders in the future and other matters. These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on its knowledge and understanding of our business and industry. Forward-looking statements are typically identified by the use of terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative of such terms and variations of these words and similar expressions, although not all forward-looking statements include these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. You are cautioned not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.

Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:

•uncertainties related to the COVID-19 pandemic, including the unknown duration and economic, operational and financial impacts of the COVID-19 pandemic and the actions taken or contemplated by U.S. and local governmental authorities or others in response to the pandemic on our business, employees and tenants, including, among others, (a) changes in tenant demand for our properties; (b) financial challenges confronting tenants, including as a result of decreased customers’ willingness to visit our tenants' businesses, and potential renewed mandated shelter in place orders that may prevent customers from visiting some of our tenants’ businesses and the impact of these issues on our ability to collect rent from our tenants; (c) limited ability to access the capital markets and other sources of financing on attractive terms or at all, and (d) prolonged measures to contain the spread of COVID-19;

•legislative or regulatory changes, including the impact of the legislation commonly known as the Tax Cuts and Jobs Act

•adverse economic or real estate developments or conditions in Texas, including as a result of a surge in COVID-19 cases in such areas and the impact on our tenants' ability to pay their rent, which could result in bad debt allowances or straight-line rent reserve adjustments;

•increases in interest rates and operating costs;

•availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures, in each case, on terms favorable to the Company;

•decreases in rental rates or increases in vacancy rates; 

•litigation risks; 

•lease-up risks, including leasing risks arising from exclusivity and consent provisions in leases with significant tenants;

•the impact of public health crises and pandemics, such as the COVID-19 outbreak;

•cybersecurity attacks, loss of confidential information and other business disruptions;

•our inability to renew tenants or obtain new tenants upon the expiration of existing leases; and 

17

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

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

•our cash resources are limited;

•we have a history of losses;

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

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

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

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

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

Overview

The Company is a Maryland real estate investment trust ("REIT") engaged in investing in, owning and operating commercial properties. Future real estate opportunities may include (i) acquisition and development of retail, office, office warehouse, industrial, multifamily, hotel and other commercial properties, (ii) acquisition of or merger with a REIT or real estate operating company, (iii) sales of existing properties, and (iv) joint venture investments. Substantially all of our business is conducted through our operating partnership Pillarstone OP. We are the sole general partner of Pillarstone OP. As of March 31, 2022, we owned approximately 18.6% of the outstanding equity in Pillarstone OP and we fully consolidate it on our condensed consolidated financial statements.

As of March 31, 2022, the Company is a smaller reporting company current in its quarterly and annual financial statement filings with the SEC, that may make future real estate investments. There can be no assurance that we will be able to close additional transactions.  Even if our management is successful in closing additional transactions, investors may not value the transactions or the Company in the same manner as we do, and investors may not value the transactions as they would value other transactions or alternatives. Failure to obtain additional sources of capital will materially and adversely affect the Company’s ability to continue operations, as well as its liquidity and financial results.

Brief History

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

On December 8, 2016, Pillarstone and Pillarstone OP entered into the Contribution Agreement with Whitestone OP, a subsidiary and the operating partnership of Whitestone, both of which are related parties to Pillarstone and Pillarstone OP, pursuant to which Whitestone OP contributed to Pillarstone OP all of the equity interests in four of its wholly-owned subsidiaries: Whitestone CP Woodland Ph. 2, LLC, a Delaware limited liability company (“CP Woodland”); Whitestone Industrial-Office, LLC, a Texas limited liability company (“Industrial-Office”); Whitestone Offices, LLC, a Texas limited liability company (“Whitestone Offices”); and Whitestone Uptown Tower, LLC, a Delaware limited liability company (“Uptown Tower”) that owned 14 real estate assets (the "Real Estate Assets") for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP issued at a price of $1.331 per OP Unit; and (2) the assumption of approximately $65.9 million of liabilities by Pillarstone OP (collectively, the “Acquisition”).

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Impact of COVID-19

The ongoing COVID-19 pandemic has in the past and may continue to materially and adversely impact and disrupt our business, financial condition, results of operations and cash flows. Any future outbreak of any COVID-19 variants or any other highly infectious or contagious disease could have a similar impact.

The impact of COVID-19, including any resurgences, future pandemics or other health crises may adversely affect our business, financial condition, results of operations, cash flows and market value. These type of health crises may impact our business in the following ways:

•closures of, or other operational issues at, our properties resulting from government or tenant action;

•reduced economic activity impacting our tenants' ability to meet their rental and other obligations to us in full or at all;

•the ability of our tenants who have been granted rent deferrals to timely pay deferred rent;

•an inability to renew leases or lease vacant space on favorable terms or at all;

•tenant bankruptcies;

•liquidity issues resulting from reduced cash flows from operations;

•negative impacts to the credit and/or capital markets making it difficult to access capital on favorable terms or at all;

•impairment in value of our properties;

•a general decline in business activity and demand for real estate transactions adversely affecting our portfolio of properties and our ability to service our indebtedness;

•supply chain disruptions adversely affecting our tenants' operations; and

•impacts on the health of our personnel and a disruption in the continuity of our business.

Because substantially all of our income is derived from rentals of commercial real property, our business, income, cash flow, results of operations, financial condition, liquidity, prospects and ability to service our debt obligation would be adversely affected if a significant number of tenants are unable to meet their obligations or their revenues decline. The extent to which the COVID-19 pandemic, or a future pandemic, impacts our operations and those of our tenants will depend on future developments, which are highly uncertain and cannot be predicted with confidence.

Results of Operations

The following is a discussion of our results of operations for the three month periods ended March 31, 2022 and 2021 and our financial condition, including:

•Explanation of changes in the results of operations in the Condensed Consolidated Statements of Operations for the three month periods ended March 31, 2022 and 2021.

•Our critical accounting policies and estimates that require our subjective judgment and are important to the presentation of our financial condition and results of operations.

•Our primary sources and uses of cash for the three month periods ended March 31, 2022 and 2021, and how we intend to generate cash for long-term capital needs.

•Our current income tax status.

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

Comparison of the Three Month Periods Ended March 31, 2022 and 2021

Leasing Activity

For the three month period ended March 31, 2022, we executed 17 leases for a total lease value of $955,000 compared to 23 leases for a total lease value of $1.4 million for the three month period ended March 31, 2021.

19

Results of Operations

The following provides a general comparison of our results of operations for the three month periods ended March 31, 2022 and 2021 (dollars in thousands):

	Three Months Ended March 31,
	2022			2021
Number of properties	8			8
Aggregate GLA (sq. ft.)	926,798			926,798
Ending occupancy rate	56		%	59		%
Total revenues	$	2,326		$	2,190
Total operating expenses	1,910			1,970
Total other expenses	197			203
Provision for income tax expense (benefit)	7			(7)
Net income	212			24
Less:  Non-controlling interest in subsidiary	229			109
Net loss available to Common Shareholders	$	(17)		$	(85)

Revenues from Operations

We had total revenues for the three month periods ended March 31, 2022 and 2021 of approximately $2,326,000 and $2,190,000, respectively, for an increase of approximately $136,000, or 6%. The difference was comprised of a decrease of approximately $24,000 in rental revenues, an increase of $129,000 in expense reimbursements, an increase of $6,000 in other revenue, and a decrease of $25,000 in bad debt, which is classified as a part of revenue. The majority of the overall increase was due to higher reimbursements from common area maintenance and unbilled recoveries from the prior year.

Expenses from Operations

Our operating expenses were approximately $1,910,000 for the three months ended March 31, 2022 compared to approximately $1,970,000 for the three months ended March 31, 2021, a decrease of approximately $60,000, or 3%. The overall decrease was primarily due to a decrease in real estate taxes, offset by increases in miscellaneous repairs, contract services, and electricity usage at our properties for the three months ended March 31, 2022, compared to the three months ended March 31, 2021. The primary components of operating expenses are detailed in the table below (in thousands):

	Three Months Ended March 31,
	2022		2021		Change		% Change
Depreciation and amortization	$	484	$	497	$	(13)	(3)	%
Operating and maintenance	771		718		53		7	%
Real estate taxes	328		409		(81)		(20)	%
General and administrative	187		207		(20)		(10)	%
Management fees	140		139		1		1	%
Total operating expenses	$	1,910	$	1,970	$	(60)	(3)	%

Liquidity and Capital Resources

Cash Flows

As of March 31, 2022, our unrestricted cash resources were approximately $4,342,000. We are dependent on cash generated by our ownership of the eight Real Estate Assets to meet our liquidity needs.

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During the three months ended March 31, 2022, the Company's cash balance decreased by $864,000 from $5,206,000 at December 31, 2021 to $4,342,000 at March 31, 2022. This decrease in cash was due to cash used in operating activities of approximately $352,000, cash used in investing activities of approximately $387,000 and cash used in financing activities of approximately $125,000.

During the first quarter of 2022, Pillarstone Capital REIT (“Pillarstone REIT”) determined that it should be reimbursed for its operating and administrative expenses from Pillarstone OP on a historical and ongoing basis in accordance with the Pillarstone OP operating partnership agreement in which Pillarstone REIT is the general partner and Whitestone OP is the limited partner. Whitestone and Whitestone OP contested the reimbursement of expenses of approximately $1.8 million for the years ended 2017 through 2021 and Pillarstone REIT intends to pursue the reimbursement from Pillarstone OP. The funds are in bank accounts controlled by affiliates of Whitestone and Whitestone OP pursuant to Pillarstone OP management agreements with those Whitestone affiliates. For financial reporting purposes, Pillarstone REIT and Pillarstone OP report on a consolidated basis, therefore, the reimbursement of Pillarstone REIT's expenses would not change net income but only the allocations between controlling and noncontrolling interests. For the three months ended March 31, 2022, Pillarstone OP reimbursed Pillarstone REIT in May 2022 approximately $117,000 for a portion of operating and administrative expenses and Pillarstone REIT will pursue reimbursement from Pillarstone OP for the remaining amount of approximately $59,000 that Whitestone and Whitestone OP have contested.

When Pillarstone REIT made its determination for reimbursement of its operating and administrative expenses from Pillarstone OP for the years ended 2017 through 2021, Whitestone and Whitestone OP determined Whitestone OP should be reimbursed for construction and lease commissions of approximately $1.4 million that it paid on behalf of Pillarstone OP for 2017 and 2018. Pillarstone REIT and Pillarstone OP requested additional information from Whitestone and Whitestone OP for these expenditures. If any reimbursement is made to Whitestone OP, then Pillarstone OP would have less cash available for operations and distributions to its partners and Pillarstone OP’s investment account with Whitestone OP would be reduced.

Our ability to access the capital markets will be dependent on a number of factors, including general market conditions and market perceptions about our Company.

Future Obligations

None.

Long Term Liquidity and Operating Strategies

Historically, we have financed our long term capital needs, including acquisitions, as follows:

•borrowings from new loans;

•additional equity issuances of our common and preferred shares and operating partnership units; and

•proceeds from the sales of our Real Estate Assets.

From 2006 until December 2016, the Company continued its existence as a corporate shell filing its periodic reports with the SEC so that it could be used for future real estate transactions or sold to another company. During this time, the Company was funded by its trustees who contributed $500,000 in exchange for 125,000 Preferred C Shares and $197,780 in exchange for convertible notes payable.

Subsequent to the Acquisition, Pillarstone has been developing strategies for the Real Estate Assets in order to create value for the enterprise and our shareholders and selling assets to pay off some of its debt. To implement the strategy to create value with the Real Estate Assets, additional capital will need to be raised.

Current Tax Status

As of March 31, 2022 and December 31, 2021, we had net deferred tax liabilities of approximately $31,000 and $36,000, respectively. As of March 31, 2022, we have an operating loss carryforward of approximately $94,000 available to be carried to future periods.

The income tax expense (benefit) included in the condensed consolidated statements of operations for the three months ended March 31, 2022 and 2021 was comprised of the following components (in thousands):

21

	Three Months Ended March 31,
	2022		2021
Federal	$	(5)	$	(18)
Texas franchise tax	12		11
Provision for income tax expense (benefit)	$	7	$	(7)

Interest Rates

The Company was not significantly affected by interest rates during the periods presented in this report due primarily to the Company having approximately 100% of its debt with fixed rates as of March 31, 2022.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have, or are likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Application of Critical Accounting Estimates

Our condensed consolidated financial statements are prepared in accordance with GAAP, which require us to make certain estimates and assumptions. The following section is a summary of certain estimates that both require our most subjective judgment and are most important to the presentation of our financial condition and results of operations. It is possible that the use of different estimates or assumptions in making these judgments could result in materially different amounts being reported in our condensed consolidated financial statements.

Revenue recognition. All leases on our properties are classified as noncancelable operating leases, and the related rental income is recognized on a straight-line basis over the terms of the related leases.  For the three months ended March 31, 2022 and 2021 we did not have a straight-line rent reserve adjustment. Differences between rental income earned and amounts due per the respective lease agreements are capitalized or charged, as applicable, to accrued rents and accounts receivable. Recoveries from tenants for taxes, insurance, and other operating expenses are recognized as revenues in the period the corresponding costs are incurred.  We combine lease and nonlease components in lease contracts, which includes combining base rent and recoveries into a single line item, Rental, within the condensed consolidated statements of operations. We recognize lease termination fees in the year that the lease is terminated and collection of the fee is reasonably assured.

Acquired Properties and Acquired Lease Intangibles. We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt.

Depreciation.  Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings.  Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter.

Impairment.  We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. We determine whether an impairment in value has occurred by comparing the estimated future cash flows

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(undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property.  If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value.  Management has determined that there has been no impairment in the carrying value of our real estate assets as of March 31, 2022.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our principal executive and financial officers, has evaluated the effectiveness of our disclosure controls and procedures in ensuring that the information required to be disclosed in our filings under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, including ensuring that such information is accumulated and communicated to its management, as appropriate, to allow timely decisions regarding required disclosure.

Based on such evaluation, our principal executive and financial officers have concluded that such disclosure controls and procedures were effective as of March 31, 2022 (the end of the period covered by this Quarterly Report).

Changes in Internal Control Over Financial Reporting

There have been no significant changes in our internal control over financial reporting during the three months ended March 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We may from time to time become a party to legal proceedings and claims that arise in the ordinary course of our business. These matters are generally covered by insurance. While the frequency and resolutions of any such matters cannot be predicted with certainty, we believe that occurrence and outcomes of these matters will not have a material effect on our financial position, results of operations or cash flows.

ITEM 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.

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ITEM 6. EXHIBITS

Exhibit Number	Exhibit Description
3.1	Articles of Amendment and Restatement of the Declaration of Trust of the Company (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed on March 29, 2016 and incorporated herein by reference)
3.2	Third Amended and Restated Bylaws of the Company (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed on December 13, 2016 and incorporated herein by reference)
31.1	Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 - Chief Executive Officer.
31.2	Section 302 Certification pursuant to the Sarbanes-Oxley Act of 2002 - Chief Financial Officer.
32.1	CEO/CFO Certification under Section 906 of Sarbanes-Oxley Act of 2002.
101	The following financial information of the Registrant for the quarter ended March 31, 2022, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of March 31, 2022 (unaudited) and December 31, 2021, (ii) Condensed Consolidated Statements of Operations for the three months ended March 31, 2022 and 2021 (unaudited), (iii) Condensed Consolidated Statements of Shareholders' Equity (Deficit) for the three months ended March 31, 2022 and 2021 (unaudited), (iv) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021 (unaudited) and (iv) Notes to Condensed Consolidated Financial Statements (unaudited).
104	Cover Page Interactive Data File - the cover page XBRL tags are embedded within the Inline XBRL document.

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		PILLARSTONE CAPITAL REIT
		By:	/s/ Dennis H. Chookaszian
Date:	May 16, 2022		Dennis H. Chookaszian Lead Director (Principal executive officer)

		PILLARSTONE CAPITAL REIT
		By:	/s/ John J. Dee
Date:	May 16, 2022		John J. Dee Chief Financial Officer (Principal financial and accounting officer)

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