RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS

In November 2017, the Company and Whitestone each received a comment letter from the Staff (the “Staff”) of the Division of Corporation Finance of the SEC relating to the Company’s and Whitestone’s Annual Reports on Form 10-K for the year ended December 31, 2016. In the respective letters, the Staff requested that the Company and Whitestone provide them with an analysis to support the determination that the Operating Partnership is a VIE of which Whitestone is the primary beneficiary. In response to the Staff’s comment, Whitestone, on its own behalf and on behalf of the Company, provided the Staff with its analysis of Whitestone’s accounting and financial reporting obligations relating to its interest in the Operating Partnership. After communicating its analysis and conclusions to the Staff and responding to additional questions from the Staff relating to this matter, the Staff did not object to or otherwise take exception to the initial determinations at the time of the consummation of the Acquisition in December 2016 but provided a verbal reminder in that the determination of the primary beneficiary of a VIE should be continually reassessed, and recommended that Whitestone consider pre-clearing future accounting treatment of the Operating Partnership with the Staff of the Office of the Chief Accountant (“OCA”).

In connection with the preparation and review of its financial statements for the quarter ended March 31, 2018, Whitestone concluded, in accordance with the Staff’s recommendation, and after consultation with its outside accounting advisors, that it would be prudent to seek pre-clearance from the OCA of Whitestone's proposed treatment of the Operating Partnership in its financial statements for such quarter. Accordingly, in April 2018, Whitestone submitted a letter to the OCA seeking their concurrence with its determinations that Whitestone maintained its status as the primary beneficiary of the Operating Partnership and, accordingly, should continue to consolidate the Operating Partnership in its financial statements for the quarter ended June 30, 2018 in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). After further correspondence, including telephonic meetings between Whitestone, its advisors and the OCA, the OCA informed Whitestone that it objected to Whitestone’s and the Company’s conclusions that Whitestone was the primary beneficiary of the Operating Partnership since the Acquisition in December 2016 and during the subsequent periods. Whitestone and the Company respectfully disagreed with the OCA’s determination and Whitestone, on its own behalf and on behalf of the Company, made a formal appeal to the Chief Accountant of the SEC in June 2018.

In July 2018, Whitestone and its advisory team of accounting and legal professionals met with the Chief Accountant, members of the OCA and Division of Corporate Finance. On July 30, 2018, the Chief Accountant of the SEC informed Whitestone that its formal appeal was denied and that the OCA objected to Whitestone’s and the Company’s presentation of their investments in the Operating Partnership under the VIE accounting guidance since the consummation of the Acquisition in December 2016. As a result, the Company’s management has determined that the Company should not have used the equity method of accounting to present its investment in the Operating Partnership in its audited consolidated financial statements for the years ended December 31, 2016 and December 31, 2017 and unaudited consolidated financial statements for the quarters ended March 31, 2017, June 30, 2017, September 30, 2017 and March 31, 2018 (collectively, the “Prior Period Financial Statements”). After consideration of the OCA’s objection to Whitestone’s original accounting, the Company evaluated its original accounting of the equity method and the materiality of the error quantitatively and qualitatively and concluded that it was material to the Prior Period Financial Statements. The Company revised its original accounting treatment accordingly in the amended filings. The Company determined that it is the primary beneficiary of the Operating Partnership through the Company's power to direct the activities that most significantly impact the Operating Partnership’s economic performance and the Company's right to receive benefits based on its ownership percentage in the Operating Partnership. Accordingly, the Company accounts for the Operating Partnership as a VIE and fully consolidates it in the Company's financial statements. Whitestone OP’s 81.4% interest in the Operating Partnership is accounted for as a non-controlling interest and is deducted from the Company’s share of net income and equity in the Operating Partnership.

The following table presents the effects of the restatement on the consolidated balance sheet as of June 30, 2017 (in thousands):



	June 30, 2017
	As Reported			Adjustment			As Restated
Real estate assets, at cost
Property	$	—		$	81,777		$	81,777
Accumulated depreciation	—			(1,492		)	(1,492		)
Total real estate assets	—			80,285			80,285
Cash and cash equivalents	96			2,088			2,184
Escrows and acquisition deposits	—			1,442			1,442
Accrued rents and accounts receivable, net of allowance for doubtful accounts	—			487			487
Receivable due from related party	—			1,769			1,769
Unamortized lease commissions and deferred legal costs, net	—			1,117			1,117
Prepaid expenses and other assets	4			265			269
Total assets	$	100		$	87,453		$	87,553

Notes payable	$	—		$	64,900		$	64,900
Accounts payable and accrued expenses	18			2,550			2,568
Payable due to related party	316			469			785
Convertible notes payable - related parties	198			—			198
Accrued interest payable	32			—			32
Negative equity investment in Pillarstone Capital REIT Operating Partnership LP	93			(93		)	—
Tenants' security deposits	—			1,074			1,074
Total liabilities	657			68,900			69,557

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 June 30, 2017 and December 31, 2016, $10.00 per share liquidation preference	3			—			3
Preferred C Shares - $0.01 par value, 300,000 authorized: 244,444 Class C cumulative convertible shares issued and outstanding, $10.00 per share liquidation preference at June 30, 2017 and December 31, 2016	2			—			2
Common Shares - $0.01 par value, 400,000,000 authorized: 443,299 shares issued and 405,169 outstanding at June 30, 2017 and December 31, 2016	4			—			4
Additional paid-in capital	28,147			—			28,147
Accumulated deficit	(27,912		)	163			(27,749		)
Treasury stock, at cost, 38,130 shares	(801		)	—			(801		)
Total Pillarstone Capital REIT shareholders' deficit	(557		)	163			(394		)
Noncontrolling interest in subsidiary	—			18,390			18,390
Total equity (deficit)	(557		)	18,553			17,996
Total liabilities and equity (deficit)	$	100		$	87,453		$	87,553

The following table presents the effects of the restatement on the consolidated statement of operations for the three months ended June 30, 2017 (in thousands):



	Three Months Ended June 30, 2017
	As Reported			Adjustment			As Restated
Property revenues
Rental revenues	$	—		$	3,520		$	3,520
Other revenues	—			658			658
Total property revenues	—			4,178			4,178

Property expenses
Property operation and maintenance	—			1,076			1,076
Real estate taxes	—			652			652
Total property expenses	—			1,728			1,728

Other expenses
General and administrative	31			14			45
Depreciation and amortization	—			855			855
Interest expense	5			678			683
Total other expense	36			1,547			1,583

Income (loss) before loss on disposal of assets and income taxes	(36		)	903			867

Loss on sale or disposal of assets	—			(5		)	(5		)
Equity in income of Pillarstone Capital REIT Operating Partnership LP	94			(94		)	—
Provision for income taxes	—			(20		)	(20		)

Net income	58			784			842

Less: non-controlling interest in subsidiary	—			715			715

Net income attributable to Common Shareholders	$	58		$	69		$	127

Net income attributable to Common Shareholders per Common Share:

Basic	$	0.14		$	0.17		$	0.31

Diluted	$	0.02		$	0.02		$	0.04

The following table presents the effects of the restatement on the consolidated statement of operations for the six months ended June 30, 2017 (in thousands):



	Six Months Ended June 30, 2017
	As Reported			Adjustment			As Restated
Property revenues
Rental revenues	$	—		$	7,056		$	7,056
Other revenues	—			1,286			1,286
Total property revenues	—			8,342			8,342

Property expenses
Property operation and maintenance	—			2,363			2,363
Real estate taxes	—			1,300			1,300
Total property expenses	—			3,663			3,663

Other expenses
General and administrative	179			147			326
Depreciation and amortization	—			1,571			1,571
Interest expense	10			1,348			1,358
Total other expense	189			3,066			3,255

Income (loss) before loss on disposal of assets and income taxes	(189		)	1,613			1,424

Loss on sale or disposal of assets	—			(11		)	(11		)
Equity in income of Pillarstone Capital REIT Operating Partnership LP	159			(159		)	—
Provision for income taxes	—			(45		)	(45		)

Net income (loss)	(30		)	1,398			1,368

Less: Non-controlling interests in subsidiary	—			1,268			1,268

Net income (loss) attributable to Common Shareholders	$	(30	)	$	130		$	100

Net income (loss) attributable to Common Shareholders per Common Share:

Basic	$	(0.07	)	$	0.32		$	0.25

Diluted	$	(0.07	)	$	0.10		$	0.03