Note 6 - Investment in Real Estate Partnership

9 Months Ended

Sep. 30, 2022

Notes to Financial Statements

Equity Method Investments and Joint Ventures Disclosure [Text Block]

6. INVESTMENT IN REAL ESTATE PARTNERSHIP

On December 8, 2016, we, through our Operating Partnership, entered into a Contribution Agreement (the “Contribution Agreement”) with Pillarstone OP and Pillarstone Capital REIT (“Pillarstone REIT”) pursuant to which we contributed all of the equity interests in four of our wholly-owned subsidiaries that, at the time, owned 14 non-core properties that did not fit our Community Centered Property® strategy (the “Pillarstone Properties”), to Pillarstone OP for aggregate consideration of approximately $84 million, consisting of (1) approximately $18.1 million of Class A units representing limited partnership interests in Pillarstone OP (“Pillarstone OP Units”) and (2) the assumption of approximately $65.9 million of liabilities (collectively, the “Contribution”).

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

In connection with the Contribution, on December 8, 2016, the Operating Partnership entered into a Tax Protection Agreement with Pillarstone REIT and Pillarstone OP pursuant to which Pillarstone OP agreed to indemnify the Operating Partnership for certain tax liabilities resulting from its recognition of income or gain prior to December 8, 2021 if such liabilities result from a transaction involving a direct or indirect taxable disposition of all or a portion of the Pillarstone Properties or if Pillarstone OP fails to maintain and allocate to the Operating Partnership for taxation purposes minimum levels of liabilities as specified in the Tax Protection Agreement, the result of which causes such recognition of income or gain and the Company incurs taxes that must be paid to maintain its REIT status for federal income tax purposes.

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

			Company’s Investment as of
			September 30, 2022		December 31, 2021
Real estate partnership	Ownership Interest
Pillarstone OP(1)		81.4%	$	34,891	$	34,588
Total real estate partnership(2)(3)			$	34,891	$	34,588

⁽¹⁾ Representing eight property interests and 926,798 square feet of GLA, as of September 30, 2022 and December 31, 2021.

⁽²⁾ On December 26, 2021, the Board of Trustees of Pillarstone REIT adopted a new rights agreement (the “Pillarstone Rights Agreement”), pursuant to which each holder of Pillarstone REIT common stock received one preferred share purchase right (a “Right”) per common share held as of the applicable record date. Each Right entitles the registered holder to purchase from Pillarstone REIT one one-thousandth (a “Unit”) of a series D preferred share of Pillarstone at a purchase price (“Purchase Price”) of $7.00 per Unit, subject to adjustment. The Rights are exercisable upon the occurrence of certain events as described in the Pillarstone Rights Agreement, including the acquisition by certain holders of 5% or more of the common shares of Pillarstone REIT (an “Acquiring Person”). Upon the acquisition of Pillarstone REIT common shares by an Acquiring Person, each holder of a Right (other than an Acquiring Person), will have the right to receive upon exercise a number of Pillarstone REIT common shares having a market value of two times the Purchase Price.As set forth in the Amended and Restated Limited Partnership Agreement of Pillarstone OP, dated as of December 8, 2016 (the “Pillarstone Partnership Agreement”), we have the contractual right to have our limited partnership interests in Pillarstone redeemed at our discretion. However, upon receipt of a redemption notice, Pillarstone OP has the option of the applicable redemption price in cash, based on the market value of Pillarstone REIT common shares, or in Pillarstone REIT common shares. To the extent we seek to have our partnership units in Pillarstone OP redeemed and Pillarstone OP elects to pay the applicable redemption price in Pillarstone REIT common shares (and such shares represent 5% or more of the outstanding common shares of Pillarstone REIT), the Rights could become exercisable. To the extent the Rights are exercised as a result of our Pillarstone OP units being redeemed for Pillarstone REIT common shares, our ownership interest in Pillarstone REIT would be significantly diluted, which could adversely impact the value of our investment in Pillarstone OP. Because the Pillarstone Rights Agreement seeks to prevent Whitestone OP from exercising its contractual Redemption Right, on July 12, 2022, Whitestone OP filed suit against Pillarstone REIT in the Court of Chancery of the State of Delaware challenging the Pillarstone Rights Agreement due to Pillarstone REIT’s breach of the Pillarstone OP partnership agreement, breach of its fiduciary duty as general partner of Pillarstone OP to Whitestone OP, and breach of the implied covenant of good faith and fair dealing under the Pillarstone OP partnership agreement. The lawsuit seeks rescission and voiding of the Pillarstone Rights Agreement; a declaration that the Pillarstone Rights Agreement is unenforceable, invalid, and of no force and effect; an order permanently enjoining enforcement of the Pillarstone Rights Agreement; an award of monetary damages; and broad restrictions on Pillarstone REIT’s ability to conduct its business, including buying properties, enforcing the Rights Agreement, incurring expenses, or engaging in transactions.On September 8, 2022, the Company’s Motion to Preserve the Status Quo was granted by the Court, limiting Pillarstone from engaging in any acts outside the ordinary course of business and otherwise imposing restrictions on Pillarstone to ensure that Whitestone’s right of redemption right is not impaired while the underlying dispute is being considered by the Court.While we do not believe the overall impact of the Pillarstone Rights Agreement on the carrying value of our investment in Pillarstone OP is material, we cannot reasonably estimate a range of possible loss at this time.

⁽³⁾ We rely on reporting provided to us by our third-party partners for financial information regarding the Company's investment in Pillarstone OP. Because Pillarstone OP financial statements as of September 30, 2022 have not been made available to us, we have estimated the value of the investment based on the information available to us at the time of this report.

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Pillarstone OP	$	65	$	151	$	304	$	429

Summarized financial information for the Company’s investment in real estate partnership is as follows (in thousands):

	September 30, 2022		December 31, 2021
Assets:
Real estate, net	$	47,880	$	48,273
Other assets		9,680		8,790
Total assets(1)		57,560		57,063
Liabilities and equity:
Notes payable		14,757		14,920
Other liabilities		3,653		3,200
Equity		39,150		38,943
Total liabilities and equity(2)		57,560		57,063
Company’s share of equity		31,888		31,718
Cost of investment in excess of the Company’s share of underlying net book value		3,003		2,870
Carrying value of investment in real estate partnership(3)	$	34,891	$	34,588

⁽¹⁾ We rely on reporting provided to us by our third-party partners for financial information regarding the Company's investment in Pillarstone OP. Because Pillarstone OP financial statements as of September 30, 2022 have not been made available to us, we have estimated total assets and its components based on the information available to us at the time of this report.

⁽²⁾ We rely on reporting provided to us by our third-party partners for financial information regarding the Company's investment in Pillarstone OP. Because Pillarstone OP financial statements as of September 30, 2022 have not been made available to us, we have estimated total liabilities and equity and its components based on the information available to us at the time of this report.

⁽³⁾ We rely on reporting provided to us by our third-party partners for financial information regarding the Company's investment in Pillarstone OP. Because Pillarstone OP financial statements as of September 30, 2022 have not been made available to us, we have estimated the value of the investment based on the information available to us at the time of this report.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
Revenues	$	2,288		$	2,379		$	6,892		$	6,843
Operating expenses		(1,895	)		(1,787	)		(5,446	)		(5,184	)
Other expenses		(281	)		(351	)		(974	)		(1,033	)
Net income(1)	$	112		$	241		$	472		$	626

⁽¹⁾ We rely on reporting provided to us by our third-party partners for financial information regarding the Company's investment in Pillarstone OP. Because Pillarstone OP financial statements as of September 30, 2022 have not been made available to us, we have estimated net income and its components based on the information available to us at the time of this report.

The amortization of the basis difference between the cost of investment and the Company's share of underlying net book value for the three months period ended  September 30, 2022 and 2021 is $ 27,000 and $ 45,000, respectively, and for both of the nine months periods ended September 30, 2022 and 2021 is $ 81,000. The Company amortized the difference into equity in earnings of real estate partnership on the consolidated statements of operations and comprehensive income.

The Company has evaluated its guarantee to Pillarstone OP pursuant to ASC 460, “Guarantees,” and has determined the guarantee to be a performance guarantee, for which ASC 460 contains initial recognition and measurement requirements, and related disclosure requirements. The Company is obligated in two respects: (i) a noncontingent liability, which represents the Company’s obligation to stand ready to perform under the terms of the guarantee in the event that the specified triggering event(s) occur; and (ii) the contingent liability, which represents the Company’s obligation to make future payments if those triggering events occur. The fair value of our loan guarantee to Pillarstone OP is estimated on a Level 3 basis (as provided by ASC 820), using a probability-weighted discounted cash flow analysis based on a discount rate, discounting the loan balance. The Company recognized a noncontingent liability of $462,000 at the inception of the guarantee at fair value which is recorded on the Company’s consolidated balance sheets, net of accumulated amortization. The Company will amortize the guarantee liability into income over seven years. For the three months ended September 30, 2022 and 2021, the amortization of the guarantee liability was approximately $ 9,000 and $ 18,000, respectively, and for both of the nine months ended September 30, 2022 and 2021, the amortization of the guarantee liability is $ 28,000.