Whitestone REIT - 10-Q quarterly report FY2019 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



	(Mark One)
[x]	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019



[ ]	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 001-34855

WHITESTONE REIT

(Exact Name of Registrant as Specified in Its Charter)



Maryland		76-0594970
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)



2600 South Gessner, Suite 500 Houston, Texas		77063
(Address of Principal Executive Offices)		(Zip Code)

(713) 827-9595

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Shares of Beneficial Interest, par value $0.001 per share	WSR	New York Stock Exchange

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. ýYes ¨No

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

Non-accelerated filer ¨ Smaller reporting company ¨

Emerging growth company ¨

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

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

As of November 1, 2019, there were 40,633,725 common shares of beneficial interest, $0.001 par value per share, outstanding.

PART I - FINANCIAL INFORMATION



Item 1.	Financial Statements.	1
	Consolidated Balance Sheets as of September 30, 2019 (Unaudited) and December 31, 2018	1
	Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018	3
	Consolidated Statements of Changes in Equity (Unaudited) for the Three Months Ended March 31, June 30, and September 30, 2019 and 2018	6
	Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2019 and 2018	7
	Notes to Consolidated Financial Statements (Unaudited)	9
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.	35
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	60
Item 4.	Controls and Procedures.	60

PART II - OTHER INFORMATION



Item 1.	Legal Proceedings.	62
Item 1A.	Risk Factors.	62
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	62
Item 3.	Defaults Upon Senior Securities.	63
Item 4.	Mine Safety Disclosures.	63
Item 5.	Other Information.	63
Item 6.	Exhibits.	64
	Exhibit Index	65
	Signatures	66

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Whitestone REIT and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)



	September 30, 2019			December 31, 2018
	(unaudited)
ASSETS
Real estate assets, at cost
Property	$	1,062,283		$	1,052,238
Accumulated depreciation	(131,508		)	(113,300		)
Total real estate assets	930,775			938,938
Investment in real estate partnership	26,423			26,236
Cash and cash equivalents	5,539			13,658
Restricted cash	106			128
Escrows and acquisition deposits	8,163			8,211
Accrued rents and accounts receivable, net of allowance for doubtful accounts	22,232			21,642
Receivable due from related party	379			394
Financed receivable due from related party	5,661			5,661
Unamortized lease commissions, legal fees and loan costs	9,011			6,698
Prepaid expenses and other assets⁽¹⁾	3,471			7,306
Total assets	$	1,011,760		$	1,028,872

LIABILITIES AND EQUITY
Liabilities:
Notes payable	$	621,737		$	618,205
Accounts payable and accrued expenses⁽²⁾	38,933			33,729
Payable due to related party	73			58
Tenants' security deposits	6,440			6,130
Dividends and distributions payable	11,820			11,600
Total liabilities	679,003			669,722
Commitments and contingencies:	—			—
Equity:
Preferred shares, $0.001 par value per share; 50,000,000 shares authorized; none issued and outstanding as of September 30, 2019 and December 31, 2018	—			—
Common shares, $0.001 par value per share; 400,000,000 shares authorized; 40,517,569 and 39,778,029 issued and outstanding as of September 30, 2019 and December 31, 2018, respectively	40			39
Additional paid-in capital	540,116			527,662
Accumulated deficit	(207,824		)	(181,361		)
Accumulated other comprehensive gain (loss)	(7,356		)	4,116
Total Whitestone REIT shareholders' equity	324,976			350,456
Noncontrolling interest in subsidiary	7,781			8,694
Total equity	332,757			359,150
Total liabilities and equity	$	1,011,760		$	1,028,872

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(in thousands)



		September 30, 2019		December 31, 2018
		(unaudited)



⁽¹⁾ Operating lease right of use assets (net) (related to adoption of Topic 842)	$	697	N/A



⁽²⁾ Operating lease liabilities (related to adoption of Topic 842)	$	701	N/A

See accompanying notes to Consolidated Financial Statements.

Table of Contents

Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(in thousands)




	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Revenues
Rental⁽¹⁾	$	29,368		$	30,085		$	87,527		$	88,211
Management, transaction, and other fees	511			619			1,624			1,751
Total revenues	29,879			30,704			89,151			89,962

Property expenses
Depreciation and amortization	6,789			6,477			19,865			19,044
Operating and maintenance	5,118			5,452			14,760			15,325
Real estate taxes	4,410			4,379			12,474			12,260
General and administrative⁽²⁾	5,597			4,982			16,514			17,987
Total operating expenses	21,914			21,290			63,613			64,616

Other expenses (income)
Interest expense	6,679			6,419			19,738			18,705
Gain on sale of properties	(37		)	(4,380		)	(37		)	(4,629		)
Loss on sale or disposal of assets	37			3			152			256
Interest, dividend and other investment income	(141		)	(251		)	(550		)	(792		)
Total other expense	6,538			1,791			19,303			13,540

Income before equity investments in real estate partnerships and income tax	1,427			7,623			6,235			11,806

Equity in earnings of real estate partnership	524			502			1,480			1,762
Provision for income tax	(102		)	(92		)	(324		)	(261		)
Income from continuing operations	1,849			8,033			7,391			13,307

Gain on sale of property from discontinued operations	—			—			701			—
Income from discontinued operations	—			—			701			—

Net income	1,849			8,033			8,092			13,307

Less: Net income attributable to noncontrolling interests	42			198			184			342

Net income attributable to Whitestone REIT	$	1,807		$	7,835		$	7,908		$	12,965

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(in thousands, except per share data)





	Three Months Ended September 30,					Nine Months Ended September 30,
	2019			2018		2019			2018
Basic Earnings Per Share:
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares	$	0.04		$	0.20	$	0.18		$	0.33
Income from discontinued operations attributable to Whitestone REIT	0.00			0.00		0.02			0.00
Net income attributable to common shareholders, excluding amounts attributable to unvested restricted shares	$	0.04		$	0.20	$	0.20		$	0.33
Diluted Earnings Per Share:
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares	$	0.04		$	0.19	$	0.17		$	0.31
Income from discontinued operations attributable to Whitestone REIT	0.00			0.00		0.02			0.00
Net income attributable to common shareholders, excluding amounts attributable to unvested restricted shares	$	0.04		$	0.19	$	0.19		$	0.31

Weighted average number of common shares outstanding:
Basic	40,187			39,327		39,942			39,200
Diluted	41,446			40,635		41,084			40,541

Consolidated Statements of Comprehensive Income

Net income	$	1,849		$	8,033	$	8,092		$	13,307

Other comprehensive gain (loss)

Unrealized gain (loss) on cash flow hedging activities	(2,235		)	605		(11,740		)	4,163
Unrealized gain on available-for-sale marketable securities	—			—		—			18

Comprehensive income (loss)	(386		)	8,638		(3,648		)	17,488

Less: Net income attributable to noncontrolling interests	42			198		184			342
Less: Comprehensive gain (loss) attributable to noncontrolling interests	(51		)	15		(266		)	107

Comprehensive income (loss) attributable to Whitestone REIT	$	(377	)	$	8,425	$	(3,566	)	$	17,039

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(in thousands)



Three Months Ended September 30,		Nine Months Ended September 30,
2019	2018	2019	2018



⁽¹⁾Rental
Rental revenues	$	21,623		$	21,964	$	64,752		$	65,018
Recoveries	8,240			8,121		23,701			23,193
Bad debt	(495		)	N/A		(926		)	N/A
Total rental	$	29,368		$	30,085	$	87,527		$	88,211



⁽²⁾ Bad debt included in general and administrative expenses prior to adoption of Topic 842	N/A	$	308	N/A	$	970

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands)




											Accumulated
					Additional						Other			Total			Noncontrolling
	Common Shares				Paid-In			Accumulated			Comprehensive			Shareholders’			Interests					Total
	Shares		Amount		Capital			Deficit			Gain (Loss)			Equity			Units		Dollars			Equity

Balance, December 31, 2018	39,778		$	39	$	527,662		$	(181,361	)	$	4,116		$	350,456		929		$	8,694		$	359,150
Exchange of noncontrolling interest OP units for common shares	1		—		5			—			—			5			(1	)	(5		)	—
Stock issuance costs	—		—		(6		)	—			—			(6		)	—		—			(6		)
Issuance of shares under dividend reinvestment plan	3		—		34			—			—			34			—		—			34
Repurchase of common shares ⁽¹⁾	(64	)	—		(762		)	—			—			(762		)	—		—			(762		)
Share-based compensation	111		1		1,882			—			—			1,883			—		—			1,883
Distributions - $0.285 per common share / OP unit	—		—		—			(11,351		)	—			(11,351		)	—		(264		)	(11,615		)
Unrealized loss on change in value of cash flow hedge	—		—		—			—			(3,390		)	(3,390		)	—		(80		)	(3,470		)
Net income	—		—		—			2,774			—			2,774			—		65			2,839
Balance, March 31, 2019	39,829		$	40	$	528,815		$	(189,938	)	$	726		$	339,643		928		$	8,410		$	348,053
Exchange of noncontrolling interest OP units for common shares	—		—		5			—			—			5			—		(5		)	—
Issuance of common shares under ATM program, net of costs	305		—		3,716			—			—			3,716			—		—			3,716
Stock issuance costs	—		—		1			—			—			1			—		—			1
Issuance of shares under dividend reinvestment plan	2		—		35			—			—			35			—		—			35
Repurchase of common shares ⁽¹⁾	—		—		(14		)	—			—			(14		)	—		—			(14		)
Share-based compensation	—		—		1,025			—			—			1,025			—		—			1,025
Distributions - $0.285 per common share / OP unit	—		—		—			(11,445		)	—			(11,445		)	—		(265		)	(11,710		)
Unrealized loss on change in value of cash flow hedge	—		—		—			—			(5,898		)	(5,898		)	—		(137		)	(6,035		)
Net income	—		—		—			3,327			—			3,327			—		77			3,404
Balance, June 30, 2019	40,136		$	40	$	533,583		$	(198,056	)	$	(5,172	)	$	330,395		928		$	8,080		$	338,475
Exchange of noncontrolling interest OP units for common shares	3		—		27			—			—			27			(3	)	(27		)	—
Issuance of common shares under ATM program, net of costs	374		—		4,830			—			—			4,830			—		—			4,830
Issuance of shares under dividend reinvestment plan	3		—		35			—			—			35			—		—			35
Share-based compensation	1		—		1,641			—			—			1,641			—		—			1,641
Distributions - $0.285 per common share / OP unit	—		—		—			(11,575		)	—			(11,575		)	—		(263		)	(11,838		)
Unrealized loss on change in value of cash flow hedge	—		—		—			—			(2,184		)	(2,184		)	—		(51		)	(2,235		)
Net income	—		—		—			1,807			—			1,807			—		42			1,849
Balance, September 30, 2019	40,517		$	40	$	540,116		$	(207,824	)	$	(7,356	)	$	324,976		925		$	7,781		$	332,757

See accompanying notes to Consolidated Financial Statements.

Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands)



											Accumulated
					Additional						Other		Total			Noncontrolling
	Common Shares				Paid-In			Accumulated			Comprehensive		Shareholders’			Interests					Total
	Shares		Amount		Capital			Deficit			Gain		Equity			Units		Dollars			Equity

Balance, December 31, 2017	39,222		$	38	$	521,314		$	(176,684	)	$	2,936	$	347,604		1,084		$	10,800		$	358,404
Impact of change in accounting principal:
ASU 2014-09⁽²⁾	—		—		—			19,119			—		19,119			—		—			19,119
Balance January 1, 2018	39,222		38		521,314			(157,565		)	2,936		366,723			1,084		10,800			377,523
Exchange of noncontrolling interest OP units for common shares	1		—		4			—			—		4			(1	)	(4		)	—
Issuance of shares under dividend reinvestment plan	2		—		33			—			—		33			—		—			33
Repurchase of common shares ⁽¹⁾	(45	)	—		(466		)	—			—		(466		)	—		—			(466		)
Share-based compensation	—		—		1,845			—			—		1,845			—		—			1,845
Distributions - $0.285 per common share / OP unit	—		—		—			(11,197		)	—		(11,197		)	—		(309		)	(11,506		)
Unrealized gain on change in value of cash flow hedge	—		—		—			—			2,574		2,574			—		71			2,645
Unrealized gain on change in fair value of available-for-sale marketable securities	—		—		—			—			18		18			—		—			18
Net income	—		—		—			3,181			—		3,181			—		88			3,269
Balance, March 31, 2018	39,180		$	38	$	522,730		$	(165,581	)	$	5,528	$	362,715		1,083		$	10,646		$	373,361
Exchange of noncontrolling interest OP units for common shares	74		—		748			—			—		748			(74	)	(748		)	—
Issuance of shares under dividend reinvestment plan	4		—		33			—			—		33			—		—			33
Exchange offer costs	—		—		(128		)	—			—		(128		)	—		—			(128		)
Repurchase of common shares ⁽¹⁾	(47	)	—		(593		)	—			—		(593		)	—		—			(593		)
Share-based compensation	533		—		1,401			—			—		1,401			—		—			1,401
Distributions - $0.285 per common share / OP unit	—		—		—			(11,378		)	—		(11,378		)	—		(287		)	(11,665		)
Unrealized gain on change in value of cash flow hedge	—		—		—			—			890		890			—		23			913
Unrealized gain on change in fair value of available-for-sale marketable securities	—		—		—			—			—		—			—		—			—
Reallocation of ownership between parent and subsidiary	—		—		—			—			12		12			—		(12		)	—
Net income	—		—		—			1,954			—		1,954			—		51			2,005
Balance, June 30, 2018	39,744		$	38	$	524,191		$	(175,005	)	$	6,430	$	355,654		1,009		$	9,673		$	365,327
Exchange of noncontrolling interest OP units for common shares	80		—		793			—			—		793			(80	)	(793		)	—
Issuance of shares under dividend reinvestment plan	2		—		35			—			—		35			—		—			35
Exchange offer costs	—		—		—			(5		)	—		(5		)	—		5			—
Repurchase of common shares ⁽¹⁾	(47	)	—		(640		)	—			—		(640		)	—		—			(640		)
Share-based compensation	(7	)	—		1,401			—			—		1,401			—		—			1,401
Distributions - $0.285 per common share / OP unit	—		—		—			(11,318		)	—		(11,318		)	—		(265		)	(11,583		)
Unrealized gain on change in value of cash flow hedge	—		—		—			—			592		592			—		13			605
Unrealized gain on change in fair value of available-for-sale marketable securities	—		—		—			—			—		—			—		—			—
Reallocation of ownership between parent and subsidiary	—		—		—			—			12		12			—		(12		)	—
Net income	—		—		—			7,835			—		7,835			—		198			8,033
Balance, September 30, 2018	39,772		$	38	$	525,780		$	(178,493	)	$	7,034	$	354,359		929		$	8,819		$	363,178

Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands)


⁽¹⁾	The Company acquired common shares held by employees who tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted common shares.


⁽²⁾	Represents the impact of change in accounting principal for our modified retrospective adoption of ASU 2014-09.

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



	Nine Months Ended
	September 30,
	2019			2018
Cash flows from operating activities:
Net income from continuing operations	$	7,391		$	13,307
Net income from discontinued operations	701			—
Net income	8,092			13,307
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	19,865			19,044
Amortization of deferred loan costs	814			902
Loss on sale of marketable securities	—			20
Loss (gain) on sale or disposal of assets and properties	115			(4,373		)
Bad debt	926			970
Share-based compensation	4,548			4,894
Equity in earnings of real estate partnership	(1,480		)	(1,762		)
Changes in operating assets and liabilities:
Escrows and acquisition deposits	48			214
Accrued rents and accounts receivable	(1,762		)	(1,724		)
Receivable due from related party	15			696
Distributions from real estate partnership	1,005			505
Unamortized lease commissions, legal fees and loan costs	(202		)	(1,396		)
Prepaid expenses and other assets	(6,838		)	619
Accounts payable and accrued expenses	5,206			(2,979		)
Payable due to related party	15			(403		)
Tenants' security deposits	310			226
Net cash provided by operating activities	29,976			28,760
Cash flows from investing activities:
Additions to real estate	(9,953		)	(8,733		)
Proceeds from sales of properties	—			12,574
Proceeds from financed receivable due from related party	—			1,000
Proceeds from sales of marketable securities	—			30
Net cash provided by (used in) investing activities	(9,953		)	4,871
Net cash provided by investing activities of discontinued operations	701			—
Cash flows from financing activities:
Distributions paid to common shareholders	(34,047		)	(33,642		)
Distributions paid to OP unit holders	(793		)	(890		)
Proceeds from issuance of common shares, net of offering costs	8,546			—
Payments of exchange offer costs	(5		)	(128		)
Proceeds from bonds payable	100,000			—
Net proceeds from (payments to) credit facility	(90,200		)	9,000
Repayments of notes payable	(7,502		)	(1,972		)
Payments of loan origination costs	(4,088		)	(30		)
Repurchase of common shares	(776		)	(1,699		)
Net cash used in financing activities	(28,865		)	(29,361		)
Net increase (decrease) in cash, cash equivalents and restricted cash	(8,141		)	4,270
Cash, cash equivalents and restricted cash at beginning of period	13,786			5,210
Cash, cash equivalents and restricted cash at end of period	$	5,645		$	9,480

See accompanying notes to Consolidated Financial Statements.

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Whitestone REIT and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



	Nine Months Ended
	September 30,
	2019			2018
Supplemental disclosure of cash flow information:
Cash paid for interest	$	19,176		$	18,181
Cash paid for taxes	$	396		$	304
Non cash investing and financing activities:
Disposal of fully depreciated real estate	$	203		$	904
Financed insurance premiums	$	1,238		$	1,273
Value of shares issued under dividend reinvestment plan	$	104		$	101
Value of common shares exchanged for OP units	$	37		$	1,545
Change in fair value of available-for-sale securities	$	—		$	18
Change in fair value of cash flow hedge	$	(11,740	)	$	4,163
Reallocation of ownership percentage between parent and subsidiary	$	—		$	24

See accompanying notes to Consolidated Financial Statements.

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WHITESTONE REIT AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

The use of the words “we,” “us,” “our,” “Company” or “Whitestone” refers to Whitestone REIT and our consolidated subsidiaries, except where the context otherwise requires.

1. INTERIM FINANCIAL STATEMENTS

The consolidated financial statements included in this report are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2018 are derived from our audited consolidated financial statements as of that date. The unaudited consolidated financial statements as of and for the period ended September 30, 2019 have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information on a basis consistent with the annual audited consolidated financial statements and with the instructions to Form 10-Q.

The consolidated financial statements presented herein reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position of Whitestone and our subsidiaries as of September 30, 2019 and December 31, 2018, and the results of operations for the three and nine month periods ended September 30, 2019 and 2018, the consolidated statements of changes in equity for the three months periods ended March 31, June 30, and September 30, 2019 and 2018 and cash flows for the nine month periods ended September 30, 2019 and 2018. All of these adjustments are of a normal recurring nature. The results of operations for the interim periods are not necessarily indicative of the results expected for a full year. The statements should be read in conjunction with the audited consolidated financial statements and the notes thereto which are included in our Annual Report on Form 10-K for the year ended December 31, 2018.

Business. Whitestone was formed as a real estate investment trust (“REIT”) pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998. In July 2004, we changed our state of organization from Texas to Maryland pursuant to a merger where we merged directly with and into a Maryland REIT formed for the sole purpose of the reorganization and the conversion of each of the outstanding common shares of beneficial interest of the Texas entity into 1.42857 common shares of beneficial interest of the Maryland entity. We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership. We currently conduct substantially all of our operations and activities through the Operating Partnership. As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions. As of September 30, 2019 and December 31, 2018, Whitestone wholly-owned 57 commercial properties in and around Austin, Chicago, Dallas-Fort Worth, Houston, Phoenix and San Antonio.

These properties consist of:

Consolidated Operating Portfolio


•	52 wholly-owned properties that meet our Community Centered Properties^® strategy; and

Redevelopment, New Acquisitions Portfolio


•	five parcels of land held for future development that meet our Community Centered Properties^® strategy.

As of September 30, 2019, we, through our investment in Pillarstone Capital REIT Operating Partnership LP (“Pillarstone” or “Pillarstone OP”), owned a majority interest in 11 properties that do not meet our Community Centered Property® strategy containing approximately 1.3 million square feet of GLA (the “Pillarstone Properties”). We own 81.4% of the total outstanding units of Pillarstone OP, which we account for using the equity method. We also manage the day-to-day operations of Pillarstone OP.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Consolidation. We are the sole general partner of the Operating Partnership and possess full legal control and authority over the operations of the Operating Partnership. As of September 30, 2019 and December 31, 2018, we owned a majority of the partnership interests in the Operating Partnership. Consequently, the accompanying consolidated financial statements include the accounts of the Operating Partnership.

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Noncontrolling interest in the accompanying consolidated financial statements represents the share of equity and earnings of the Operating Partnership allocable to holders of partnership interests other than us. Net income or loss is allocated to noncontrolling interests based on the weighted-average percentage ownership of the Operating Partnership during the period. Issuance of additional common shares of beneficial interest in Whitestone (the “common shares”) and units of limited partnership interest in the Operating Partnership that are convertible into cash or, at our option, common shares on a one-for-one basis (the “OP units”) changes the percentage of ownership interests of both the noncontrolling interests and Whitestone.

Equity Method. For the years prior to December 31, 2017, Pillarstone OP was accounted for under the profit-sharing method. In accordance with the Financial Accounting Standards Board’s (“FASB”) guidance applicable to sales of real estate or interests therein, specifically FASB Accounting Standards Codification (“ASC”) 360-20, “Real Estate Sales,” Topic 606, “Revenue from Contracts with Customers” and ASC 610, “Other Income–Gains and Losses from the Derecognition of Nonfinancial Assets,” we adopted Topic 606 and ASC 610 as of January 1, 2018, resulting in the derecognition of the underlying assets and liabilities associated with the Contribution (defined below) as of January 1, 2018 and the recognition of the Company’s investment in Pillarstone OP under the equity method. See Note 7 (Investment in Real Estate Partnership) for additional disclosure on Pillarstone OP.

Basis of Accounting. Our 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. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that we use include the estimated fair values of properties acquired, the estimated useful lives for depreciable and amortizable assets and costs, the estimated allowance for doubtful accounts, the estimated fair value of interest rate swaps and the estimates supporting our impairment analysis for the carrying values of our real estate assets. Actual results could differ from those estimates.

Reclassifications. We have reclassified certain prior period amounts in the accompanying consolidated financial statements in order to be consistent with the current period presentation. These reclassifications had no effect on net income, total assets, total liabilities or equity.

Restricted Cash. We classify all cash pledged as collateral to secure certain obligations and all cash whose use is limited as restricted cash. During 2015, pursuant to the terms of our $15.1 million 4.99% Note, due January 6, 2024 (see Note 8 (Debt)), which is collateralized by our Anthem Marketplace property, we were required by the lenders thereunder to establish a cash management account controlled by the lenders to collect all amounts generated by our Anthem Marketplace property in order to collateralize such promissory note.

Derivative Instruments and Hedging Activities. We utilize derivative financial instruments, principally interest rate swaps, to manage our exposure to fluctuations in interest rates. We have established policies and procedures for risk assessment, and the approval, reporting and monitoring of derivative financial instruments. We recognize our interest rate swaps as cash flow hedges with the effective portion of the changes in fair value recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. Any ineffective portion of a cash flow hedges’ change in fair value is recorded immediately into earnings. Our cash flow hedges are determined using Level 2 inputs under ASC 820. Level 2 inputs represent quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable. As of September 30, 2019, we consider our cash flow hedges to be highly effective.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

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Development Properties. Land, buildings and improvements are recorded at cost. Expenditures related to the development of real estate are carried at cost which includes capitalized carrying charges and development costs. Carrying charges (interest, real estate taxes, loan fees, and direct and indirect development costs related to buildings under construction), are capitalized as part of construction in progress. The capitalization of such costs ceases when the property, or any completed portion, becomes available for occupancy. For the three months ended September 30, 2019, approximately $127,000 and $77,000 in interest expense and real estate taxes, respectively, were capitalized, and for the nine months ended September 30, 2019, approximately $365,000 and $251,000 in interest expense and real estate taxes, respectively, were capitalized. For the three months ended September 30, 2018, approximately $149,000 and $145,000 in interest expense and real estate taxes, respectively, were capitalized, and for the nine months ended September 30, 2018, approximately $440,000 and $274,000 in interest expense and real estate taxes, respectively, were capitalized.

Real Estate Held for Sale and Discontinued Operations. We consider a commercial property to be held for sale when it meets all of the criteria established under ASC 205, “Presentation of Financial Statements.” For commercial properties classified as held for sale, assets and liabilities are presented separately for all periods presented.

In accordance with ASC 205, a discontinued operation may include a component of an entity or a group of components of an entity. A disposal of a component of an entity or a group of components of an entity is reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when the component of an entity or group of components of an entity is classified as held for sale, disposed of by sale or disposed of other than by sale. In addition, ASC 205 requires us to provide additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not meet the criteria for a discontinued operation.

Share-Based Compensation. From time to time, we grant nonvested restricted common share awards or restricted common share unit awards, which may be converted into common shares, to executive officers and employees under our 2018 Long-Term Equity Incentive Ownership Plan (the “2018 Plan”). The vast majority of the granted shares and units vest when certain performance conditions are met. We recognize compensation expense when achievement of the performance conditions is probable based on management’s most recent estimates using the fair value of the shares as of the grant date. We recognized $1,719,000 and $1,497,000 in share-based compensation for the three months ended September 30, 2019 and 2018, respectively, and we recognized $4,770,000 and $4,894,000 in share-based compensation for the nine months ended September 30, 2019 and 2018, respectively. We recognize forfeitures as they occur.

Noncontrolling Interests. Noncontrolling interests are the portion of equity in a subsidiary not attributable to a parent. Accordingly, we have reported noncontrolling interests in equity on the consolidated balance sheets but separate from Whitestone’s equity. On the consolidated statements of operations and comprehensive income (loss), subsidiaries are reported at the consolidated amount, including both the amount attributable to Whitestone and noncontrolling interests. The consolidated statements of changes in equity is included for quarterly financial statements, including beginning balances, activity for the period and ending balances for shareholders’ equity, noncontrolling interests and total equity.

Accrued Rents and Accounts Receivable. Included in accrued rents 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. With the adoption of ASC No. 842, Leases (“Topic 842”), as of January 1, 2019 we recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Prior to the adoption of Topic 842, we recognized an allowance for doubtful accounts and bad debt expense of the specific rents receivable. 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 September 30, 2019 and December 31, 2018, we had an allowance for uncollectible accounts of $10.7 million and $9.7 million, respectively. During the three and nine months ending September 30, 2019, we recorded an adjustment to rental revenue in the amount of $0.5 million and $0.9 million, respectively. During the three and nine months ending September 30, 2018, we recorded bad debt expense in the amount of $0.3 million and $1.0 million, respectively.

Revenue Recognition. All leases on our properties are classified as 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.

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September 30, 2019

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Percentage rents 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 consolidated statements of operations and comprehensive income (loss). Additionally, we have tenants who pay real estate taxes directly to the taxing authority. We exclude these costs paid directly by the tenant to third parties on our behalf from revenue recognized and the associated property operating expense.

Other property income primarily includes amounts recorded in connection with management fees and lease termination fees. Pillarstone OP pays us management fees for property management, leasing and day-to-day advisory and administrative services. Their obligations are satisfied over time. Pillarstone OP is billed monthly and typically pays quarterly. Revenues are governed by the Management Agreements (as defined in Note 7 (Investment in Real Estate Partnership)). Refer to Note 7 (Investment in Real Estate Partnership) for additional information regarding the Management Agreements with Pillarstone OP. Additionally, we recognize lease termination fees in the year that the lease is terminated and collection of the fee is probable. Amounts recorded within other property income are accounted for at the point in time when control of the goods or services transfers to the customer and our performance obligation is satisfied.

See our Annual Report on Form 10-K for the year ended December 31, 2018 for further discussion on significant accounting policies.

Recent Accounting Pronouncements. In May 2014, the FASB issued guidance, as amended in subsequent updates, establishing a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and superseded most of the existing revenue recognition guidance. The standard also required an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and also required certain additional disclosures. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a modified retrospective basis beginning January 1, 2018 and have derecognized the underlying assets and liabilities associated with the Contribution as of January 1, 2018 and have recognized the Company’s investment in Pillarstone OP under the equity method of accounting. The Company made an adjustment which decreased the Company’s accumulated deficit as of January 1, 2018 by $19.1 million.

In February 2016, FASB issued ASU No. 2016-2 which provided the principles for the recognition, measurement, presentation and disclosure of leases. Additional guidance and targeted improvements to Topic 842 were made through the issuance of supplementary ASUs in July 2018, December 2018 and March 2019.

Effective January 1, 2019, we adopted the new lease accounting guidance in Topic 842. As the lessee and lessor, we have elected the package of practical expedients permitted in Topic 842. Accordingly, we have accounted for our existing operating leases as operating leases under the new guidance, without reassessing (a) whether the contract contains a lease under Topic 842, (b) whether classification of the operating lease would be different in accordance with Topic 842, or (c) whether the unamortized initial direct costs before transition adjustments (as of December 31, 2018) would have met the definition of initial direct costs in Topic 842 at lease commencement. Additionally, as the lessee and lessor we will use hindsight in determining the lease term and in assessing impairment of our right-of-use assets. As a result of the adoption of the new lease accounting guidance, as the lessee, we recognized on January 1, 2019 (a) a lease liability of approximately $1.1 million, which represents the present value of the remaining lease payments of approximately $1.2 million discounted using our incremental borrowing rate of 4.5%, and (b) a right-of-use asset of approximately $1.1 million. The adoption of Topic 842 did not have a material impact to our net income and related per share amounts.

Upon adoption of Topic 842, lessees and lessors are required to apply a modified retrospective transition approach. Reporting entities are permitted to choose one of two methods to recognize and measure leases within the scope of Topic 842:

•

Apply Topic 842 to each lease that existed at the beginning of the earliest comparative period presented in the financial statements as well as leases that commenced after that date. Under this method, prior comparative periods presented are adjusted. For leases that commenced prior to the beginning of the earliest comparative period presented, a cumulative-effect adjustment is recognized at that date.

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•	Apply the guidance to each lease that had commenced as of the beginning of the reporting period in which the entity first applies the leases standard with a cumulative-effect adjustment as of that date. Prior comparative periods would not be adjusted under this method.

We have elected an optional transition method that allows entities to initially apply Topic 842 at January 1, 2019, the date of adoption, and to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As the lessor, we have not assessed unamortized legal costs as part of the package of practical expedients, and we will not make any adjustment to retained earnings at the date of adoption to write off unamortized legal costs. We will continue to amortize unamortized legal costs as of December 31, 2018 over the life of the respective leases. We did not have a cumulative-effect adjustment as of the adoption date. Additionally, the optional transition method does allow us to not have to apply the new standard (including disclosure requirements) to comparative periods presented. Those periods can continue to be presented in accordance with prior generally accepted accounting principles.

Topic 842 requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases and operating leases. Based on our election of the package of practical expedients, our existing commercial leases, where we are the lessor, continue to be accounted for as operating leases under the new standard. However, Topic 842 changed certain requirements regarding the classification of leases that could result in us recognizing certain long-term leases entered into or modified after January 1, 2019 as sales-type leases or finance leases, as opposed to operating leases. We will continue to monitor our leases following the adoption date to ensure that they are classified in accordance with the new lease standards.

We elected a practical expedient which allows lessors to not separate non-lease components from the lease component when the timing and pattern of transfer for the lease components and non-lease components are the same and if the lease component is classified as an operating lease. As a result, we now present all rentals and reimbursements from tenants as a single line item, Rental, within the consolidated statements of operations and comprehensive income (loss). For the three months ended September 30, 2019, we had rent revenues of $21.6 million and rental recoveries of $8.2 million compared to $22.0 million and $8.1 million for the three months ended September 30, 2018, respectively. For the nine months ended September 30, 2019, we had rent revenues of $64.8 million and rental recoveries of $23.7 million compared to $65.0 million and $23.2 million for the nine months ended September 30, 2018, respectively.

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. With the adoption of Topic 842, we will recognize an adjustment to rental revenue if we deem it probable that the receivable will not be collected. Prior to the adoption of Topic 842, we recognized an allowance for doubtful accounts and bad debt expense of the specific rents receivable. Our review of collectability under our operating leases includes any accrued rental revenues related to the straight-line method of reporting rental revenue.

In November 2016, the FASB issued guidance requiring that the statement of cash flows explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance effective January 1, 2018, and we have reconciled cash and cash equivalents and restricted cash and restricted cash equivalents on a retrospective basis, whereas under the previous guidance, we reported restricted cash and restricted cash equivalents under cash flows from financing activities.

In January 2017, the FASB issued guidance clarifying the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or dispositions) of assets or businesses. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a prospective basis beginning January 1, 2018 and believe the majority of our future acquisitions will qualify as asset acquisitions and the associated transaction costs will be capitalized as opposed to expensed under previous guidance.

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In February 2017, the FASB issued guidance clarifying the scope of asset derecognition guidance, adding guidance for partial sales of nonfinancial assets and clarifying recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. This guidance became effective for the reporting periods beginning on or after December 15, 2017, and interim periods within those fiscal years. We adopted this guidance on a modified retrospective basis beginning January 1, 2018 and have derecognized the underlying assets and liabilities associated with the Contribution as of January 1, 2018 and have recognized the Company’s investment in Pillarstone OP under the equity method of accounting. The Company made an adjustment which decreased the Company’s accumulated deficit as of January 1, 2018 by $19.1 million.

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 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 consolidated statements of operations and comprehensive income (loss).

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 September 30, 2019 is as follows (in thousands)):



Years Ended December 31,	Minimum Future Rents⁽¹⁾
2019	$	20,984
2020	78,204
2021	66,964
2022	55,423
2023	43,924
Thereafter	135,616
Total	$	401,115

⁽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. We have office space, automobile, and office machine leases, which qualify as operating leases, with remaining lease terms of one to four years.

The following table summarizes the fixed, future minimum rental payments, excluding variable costs, which are discounted by our weighted average incremental borrowing rates to calculate the lease liabilities for our operating leases in which we are the lessee (in thousands):



Years Ended December 31,	September 30, 2019
2019	$	122
2020	362
2021	243
2022	6
Total undiscounted rental payments	733
Less imputed interest	32
Total lease liabilities	$	701

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For the three months ended September 30, 2019, the total lease costs were $245,000, and for the nine months ended September 30, 2019, the total lease costs were $740,000. The weighted average remaining lease term for our operating leases was 1.9 years at September 30, 2019. We do not include renewal options in the lease term for calculating the lease liability unless we are reasonably certain we will exercise the option or the lessor has the sole ability to exercise the option. The weighted average incremental borrowing rate was 4.5% at September 30, 2019.

4. MARKETABLE SECURITIES

In January 2018, we sold all of our remaining marketable securities and had no marketable securities as of September 30, 2019. All of our marketable securities were classified as available-for-sale securities as of December 31, 2017.

During the nine months ended September 30, 2018, available-for-sale securities were sold for total proceeds of $30,000. The gross realized loss on these sales during the nine months ended September 30, 2018 was $20,000. For purposes of determining gross realized gains and losses, the cost of securities sold is based on specific identification.

5. 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):



	September 30, 2019			December 31, 2018

Tenant receivables	$	16,376		$	14,686
Accrued rents and other recoveries	16,334			16,423
Allowance for doubtful accounts	(10,681		)	(9,746		)
Other receivables	203			279
Total	$	22,232		$	21,642

6. UNAMORTIZED LEASE COMMISSIONS, LEGAL FEES AND LOAN COSTS

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



	September 30, 2019			December 31, 2018

Leasing commissions	$	9,499		$	8,789
Deferred legal cost	395			406
Deferred financing cost	3,916			4,076
Total cost	13,810			13,271
Less: leasing commissions accumulated amortization	(4,011		)	(3,534		)
Less: deferred legal cost accumulated amortization	(166		)	(125		)
Less: deferred financing cost accumulated amortization	(622		)	(2,914		)
Total cost, net of accumulated amortization	$	9,011		$	6,698

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7. 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: 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,” and together with CP Woodland, Industrial-Office and Whitestone Offices, the “Entities”) that own 14 non-core properties that do 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”), issued at a price of $1.331 per Pillarstone OP Unit; and (2) the assumption of approximately $65.9 million of liabilities, consisting of (a) approximately $15.5 million of our liability under the 2018 Facility (as defined in Note 8); (b) an approximately $16.3 million promissory note of Uptown Tower under the Loan Agreement, dated as of September 26, 2013, between Uptown Tower, as borrower, and U.S. Bank, National Association, as successor to Morgan Stanley Mortgage Capital Holdings LLC, as lender; and (c) an approximately $34.1 million promissory note (the “Industrial-Office Promissory Note”) of Industrial-Office issued under the Loan Agreement, dated as of November 26, 2013 (the “Industrial-Office Loan Agreement”), between Industrial-Office, as borrower, and Jackson National Life Insurance Company, as lender (collectively, the “Contribution”).

In connection with the Contribution, (1) with respect to each Pillarstone Property (other than Uptown Tower), Whitestone TRS, Inc., a subsidiary of the Company (“Whitestone TRS”), entered into a Management Agreement with the Entity that owns such Pillarstone Property and (2) with respect to Uptown Tower, Whitestone TRS entered into a Management Agreement with Pillarstone OP (collectively, the “Management Agreements”). Pursuant to the Management Agreements with respect to each Pillarstone Property (other than Uptown Tower), Whitestone TRS agreed to provide certain property management, leasing and day-to-day advisory and administrative services to such Pillarstone Property in exchange for (x) a monthly property management fee equal to 5.0% of the monthly revenues of such Pillarstone Property and (y) a monthly asset management fee equal to 0.125% of GAV (as defined in each Management Agreement as, generally, the purchase price of the respective Pillarstone Property based upon the purchase price allocations determined pursuant to the Contribution Agreement, excluding all indebtedness, liabilities or claims of any nature) of such Pillarstone 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 to Pillarstone OP in exchange for (x) a monthly property management fee equal to 3.0% of the monthly revenues of Uptown Tower and (y) a monthly asset management fee equal to 0.125% of GAV of Uptown Tower. The initial term of each Management Agreement expired on December 31, 2017, after which each Management Agreement became automatically renewable on a month to month basis; provided that each Management Agreement can be terminated by either party thereto upon not less than thirty days’ prior written notice to the other party. None of the Management Agreements had been terminated as of September 30, 2019.

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.

As a result of the adoption of Topic 606 and ASC 610, the Company derecognized the underlying assets and liabilities associated with the Contribution as of January 1, 2018 and recognized the Company’s investment in Pillarstone OP under the equity method.

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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, 2019		December 31, 2018
Real estate partnership	Ownership Interest
Pillarstone OP⁽¹⁾	81.4%	$	26,423	$	26,236
Total real estate partnership⁽²⁾		$	26,423	$	26,236

⁽¹⁾ The Company manages these real estate partnership investments and, where applicable, earns acquisition fees, leasing commissions, property management fees, and asset management fees.

⁽²⁾ Representing 11 property interests and 1.3 million square feet of GLA, as of September 30, 2019 and December 31, 2018.

The table below presents the Company’s share of net income 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 (loss) (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018

Pillarstone OP	$	524	$	502	$	1,480	$	1,762

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



	September 30,		December 31,
	2019		2018

Assets:
Real estate, net	$	72,096	$	72,661
Other assets	7,548		6,617
Total assets	79,644		79,278
Liabilities and equity:
Notes payable	46,281		47,064
Other liabilities	4,676		4,322
Equity	28,687		27,892
Total liabilities and equity	79,644		79,278
Company’s share of equity	23,365		22,717
Cost of investment in excess of the Company’s share of underlying net book value	3,058		3,519
Carrying value of investment in real estate partnership	$	26,423	$	26,236

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018

Revenues	$	3,863		$	4,550		$	11,536		$	12,991
Operating expenses	(2,410		)	(2,935		)	(7,218		)	(7,857		)
Other expenses	(776		)	(967		)	(2,341		)	(2,872		)
Net income	$	677		$	648		$	1,977		$	2,262

The amortization of the basis difference between the cost of investment and the Company's share of underling net book value for both of the three months periods ended September 30, 2019 and 2018 is $27,000 and for both of the nine months periods ended September 30, 2019 and 2018 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 (loss).

The Company has evaluated its guarantee to Pillarstone OP pursuant to ASC 460, Guarantees, and has determined the guarantee to be a performance guarantee, for which ASC 460 contains initial recognition and measurement requirements, and related disclosure requirements. The Company is obligated in two respects: (i) a noncontingent liability, which represents the Company’s obligation to stand ready to perform under the terms of the guarantee in the event that the specified triggering event(s) occur; and (ii) the contingent liability, which represents the Company’s obligation to make future payments if those triggering events occur. The fair value of our loan guarantee to Pillarstone OP is estimated on a Level 3 basis (as provided by ASC 820, “Fair Value Measurements and Disclosures”), 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, 2019 and 2018, the amortization of the guarantee liability was $23,000 and $18,000, respectively, and for the nine months ended September 30, 2019 and 2018, the amortization of the guarantee liability was $140,000 and $55,000, respectively.

8. DEBT

Certain subsidiaries of Whitestone are the borrowers under various financing arrangements. These subsidiaries are separate legal entities, and their respective assets and credit are not available to satisfy the debt of Whitestone or any of its other subsidiaries.

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Debt consisted of the following as of the dates indicated (in thousands):



Description	September 30, 2019			December 31, 2018
Fixed rate notes
$10.5 million, 4.85% Note, due September 24, 2020 ⁽¹⁾	$	9,320		$	9,500
$50.0 million, 1.75% plus 1.35% to 1.90% Note, due October 30, 2020 ⁽²⁾	—			50,000
$50.0 million, 1.50% plus 1.35% to 1.90% Note, due January 29, 2021 ⁽³⁾	—			50,000
$100.0 million, 1.73% plus 1.35% to 1.90% Note, due October 30, 2022 ⁽⁴⁾	100,000			100,000
$165.0 million, 2.24% plus 1.35% to 1.90% Note, due January 31, 2024 ⁽⁵⁾	165,000			—
$80.0 million, 3.72% Note, due June 1, 2027	80,000			80,000
$6.5 million 3.80% Note, due January 1, 2019	—			5,657
$19.0 million 4.15% Note, due December 1, 2024	19,000			19,000
$20.2 million 4.28% Note, due June 6, 2023	18,713			18,996
$14.0 million 4.34% Note, due September 11, 2024	13,542			13,718
$14.3 million 4.34% Note, due September 11, 2024	14,300			14,300
$15.1 million 4.99% Note, due January 6, 2024	14,469			14,643
$2.6 million 5.46% Note, due October 1, 2023	2,397			2,430
$50.0 million, 5.09% Note, due March 22, 2029	50,000			—
$50.0 million, 5.17% Note, due March 22, 2029	50,000			—
$1.2 million 4.35% Note, due November 28, 2019	248			—
Floating rate notes
Unsecured line of credit, LIBOR plus 1.40% to 1.90%, due January 1, 2023 ⁽⁶⁾	86,000			241,200
Total notes payable principal	622,989			619,444
Less deferred financing costs, net of accumulated amortization	(1,252		)	(1,239		)
Total notes payable	$	621,737		$	618,205


⁽¹⁾	Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term through September 24, 2018 and 4.85% beginning September 24, 2018 through September 24, 2020.


⁽²⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 1 (as defined below) at 0.84% through February 3, 2017 and 1.75% beginning February 3, 2017 through October 30, 2020.


⁽³⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 2 (as defined below) at 1.50%.


⁽⁴⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of the interest rate at 1.73%.


⁽⁵⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of the interest rate at an average rate of 2.24% for the duration of the term through January 31, 2024.


⁽⁶⁾	Unsecured line of credit includes certain Pillarstone Properties as of December 31, 2018, in determining the amount of credit available under the 2018 Facility which were released from collateral during 2019.

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LIBOR is expected to be discontinued after 2021. A number of our current debt agreements have an interest rate tied to LIBOR. Some of these agreements provide procedures for determining an alternative base rate in the event that LIBOR is discontinued, but not all do so. Regardless, there can be no assurances as to what alternative base rates may be and whether such base rate will be more or less favorable than LIBOR and any other unforeseen impacts of the potential discontinuation of LIBOR. The Company intends to monitor the developments with respect to the potential phasing out of LIBOR after 2021 and work with its lenders to ensure any transition away from LIBOR will have minimal impact on its financial condition, but can provide no assurances regarding the impact of the discontinuation of LIBOR.

On March 22, 2019, we, through our Operating Partnership, entered into a Note Purchase and Guarantee Agreement (the “Note Agreement”) together with certain subsidiary guarantors as initial guarantor parties thereto (the “Subsidiary Guarantors”) and The Prudential Insurance Company of America and the various other purchasers named therein (collectively, the “Purchasers”) providing for the issuance and sale of $100 million of senior unsecured notes of the Operating Partnership, of which (i) $50 million are designated as 5.09% Series A Senior Notes due March 22, 2029 (the “Series A Notes”) and (ii) $50 million are designated as 5.17% Series B Senior Notes due March 22, 2029 (the “Series B Notes” and, together with the Series A Notes, the “Notes”) pursuant to a private placement that closed on March 22, 2019 (the “Private Placement”). Obligations under the Notes are unconditionally guaranteed by the Company and by the Subsidiary Guarantors.

The principal of the Series A Notes will begin to amortize on March 22, 2023 with annual principal payments of approximately $7.1 million. The principal of the Series B Notes will begin to amortize on March 22, 2025 with annual principal payments of $10.0 million. The Notes will pay interest quarterly on the 22nd day of March, June, September and December in each year until maturity.

The Operating Partnership may prepay at any time all, or from time to time part of, the Notes, in an amount not less than $1,000,000 in the case of a partial prepayment, at 100% of the principal amount so prepaid, plus a make-whole amount. The make-whole amount is equal to the excess, if any, of the discounted value of the remaining scheduled payments with respect to the Notes being prepaid over the aggregate principal amount of such Notes (as described in the Note Agreement). In addition, in connection with a Change of Control (as defined in the Note Purchase Agreement), the Operating Partnership is required to offer to prepay the Notes at 100% of the principal amount plus accrued and unpaid interest thereon.

The Note Agreement contains representations, warranties, covenants, terms and conditions customary for transactions of this type and substantially similar to the Operating Partnership’s existing senior revolving credit facility, including limitations on liens, incurrence of investments, acquisitions, loans and advances and restrictions on dividends and certain other restricted payments. In addition, the Note Agreement contains certain financial covenants substantially similar to the Operating Partnership’s existing senior revolving credit facility, including the following:


•	maximum total indebtedness to total asset value ratio of 0.60 to 1.00;


•	maximum secured debt to total asset value ratio of 0.40 to 1.00;


•	minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges ratio of 1.50 to 1.00;


•	maximum other recourse debt to total asset value ratio of 0.15 to 1.00; and


•	maintenance of a minimum tangible net worth (adjusted for accumulated depreciation and amortization) of $372 million plus 75% of the net proceeds from additional equity offerings (as defined therein).

In addition, the Note Agreement contains a financial covenant requiring that maximum unsecured debt not exceed the lesser of (i) an amount equal to 60% of the aggregate unencumbered asset value and (ii) the debt service coverage amount (as described in the Note Agreement). That covenant is substantially similar to the borrowing base concept contained in the Operating Partnership’s existing senior revolving credit facility.

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obligations under the Notes. The financial and restrictive covenants and default provisions in the Note Agreement are substantially similar to those contained in the Operating Partnership’s existing credit facility.

Net proceeds from the Private Placement were used to refinance existing indebtedness. The Notes have not been and will not be registered under the Securities Act of 1933, as amended (the “Securities Act”), and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the Securities Act. The Notes were sold in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act.

On January 31, 2019, we, through our Operating Partnership, entered into an unsecured credit facility (the “2019 Facility”) with the lenders party thereto, Bank of Montreal, as administrative agent (the “Agent”), SunTrust Robinson Humphrey, as syndication agent, and BMO Capital Markets Corp., U.S. Bank National Association, SunTrust Robinson Humphrey and Regions Capital Markets, as co-lead arrangers and joint book runners. The 2019 Facility amended and restated the 2018 Facility (as defined below).

The 2019 Facility is comprised of the following three tranches:


•	$250.0 million unsecured revolving credit facility with a maturity date of January 1, 2023 (the “2019 Revolver”);


•	$165.0 million unsecured term loan with a maturity date of January 31, 2024 (“Term Loan A”); and


•	$100.0 million unsecured term loan with a maturity date of October 30, 2022 (“Term Loan B” and together with Term Loan A, the “2019 Term Loans”).

The 2019 Facility includes an accordion feature that will allow the Operating Partnership to increase the borrowing capacity by $200.0 million, upon the satisfaction of certain conditions. As of September 30, 2019, $351.0 million was drawn on the 2019 Facility and our unused borrowing capacity was $164.0 million, assuming that we use the proceeds of the 2019 Facility to acquire properties, or to repay debt on properties, that are eligible to be included in the unsecured borrowing base. The Company used $446.2 million of proceeds from the 2019 Facility to repay amounts outstanding under the 2018 Facility and intends to use the remaining proceeds from the 2019 Facility for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and re-tenanting of properties in its portfolio and working capital.

The Company, each direct and indirect material subsidiary of the Operating Partnership and any other subsidiary of the Operating Partnership that is a guarantor under any unsecured ratable debt will serve as a guarantor for funds borrowed by the Operating Partnership under the 2019 Facility. The 2019 Facility contains customary terms and conditions, including, without limitation, customary representations and warranties and affirmative and negative covenants including, without limitation, information reporting requirements, limitations on investments, acquisitions, loans and advances, mergers, consolidations and sales, incurrence of liens, dividends and restricted payments. In addition, the 2019 Facility contains certain financial covenants including the following:

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•	maximum total indebtedness to total asset value ratio of 0.60 to 1.00;


•	maximum secured debt to total asset value ratio of 0.40 to 1.00;


•	minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges ratio of 1.50 to 1.00;


•	maximum other recourse debt to total asset value ratio of 0.15 to 1.00; and


•	maintenance of a minimum tangible net worth (adjusted for accumulated depreciation and amortization) of $372 million plus 75% of the net proceeds from additional equity offerings (as defined therein).

We serve as the guarantor for funds borrowed by the Operating Partnership under the 2019 Facility. The 2019 Facility contains customary terms and conditions, including, without limitation, affirmative and negative covenants such as information reporting requirements, maximum secured indebtedness to total asset value, minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges, and maintenance of a minimum net worth. The 2019 Facility also contains customary events of default with customary notice and cure, including, without limitation, nonpayment, breach of covenant, misrepresentation of representations and warranties in a material respect, cross-default to other major indebtedness, change of control, bankruptcy and loss of REIT tax status.

On November 7, 2014, we, through our Operating Partnership, entered into an unsecured revolving credit facility (the “2014 Facility”) with the lenders party thereto, with BMO Capital Markets Corp., Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and U.S. Bank, National Association, as co-lead arrangers and joint book runners, and Bank of Montreal, as administrative agent (the “Agent”). The 2014 Facility amended and restated our previous unsecured revolving credit facility. On October 30, 2015, we, through our Operating Partnership, entered into the First Amendment to the 2014 Facility (the “First Amendment”) with the guarantors party thereto, the lenders party thereto and the Agent. We refer to the 2014 Facility, as amended by the First Amendment, as the “2018 Facility.”

Pursuant to the First Amendment, the Company made the following amendments to the 2014 Facility:


•	extended the maturity date of the $300 million unsecured revolving credit facility under the 2014 Facility (the “2018 Revolver”) to October 30, 2019 from November 7, 2018;


•	converted $100 million of outstanding borrowings under the Revolver to a new $100 million unsecured term loan under the 2014 Facility (“Term Loan 3”) with a maturity date of October 30, 2022;


•	extended the maturity date of the first $50 million unsecured term loan under the 2014 Facility (“Term Loan 1”) to October 30, 2020 from February 17, 2017; and


•	extended the maturity date of the second $50 million unsecured term loan under the 2014 Facility (“Term Loan 2” and together with Term Loan 1 and Term Loan 3, the “2018 Term Loans”) to January 29, 2021 from November 7, 2019.

Borrowings under the 2018 Facility accrued interest (at the Operating Partnership's option) at a Base Rate or an Adjusted LIBOR plus an applicable margin based upon our then existing leverage. The applicable margin for Adjusted LIBOR borrowings ranged from 1.40% to 1.95% for the 2018 Revolver and 1.35% to 2.25% for the 2018 Term Loans. Base Rate means the higher of: (a) the Agent’s prime commercial rate, (b) the sum of (i) the average rate quoted by the Agent by two or more federal funds brokers selected by the Agent for sale to the Agent at face value of federal funds in the secondary market in an amount equal or comparable to the principal amount for which such rate is being determined, plus (ii) 1/2 of 1.00%, and (c) the LIBOR rate for such day plus 1.00%. Adjusted LIBOR means LIBOR divided by one minus the Eurodollar Reserve Percentage. The Eurodollar Reserve Percentage means the maximum reserve percentage at which reserves are imposed by the Board of Governors of the Federal Reserve System on eurocurrency liabilities.

Proceeds from the 2018 Facility were used for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and re-tenanting of properties in our portfolio and working capital.

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On May 26, 2017, we, through our subsidiary, Whitestone BLVD Place LLC, a Delaware limited liability company, issued a $80.0 million promissory note to American General Life Insurance Company (the “BLVD Note”). The BLVD Note has a fixed interest rate of 3.72% and a maturity date of June 1, 2027. Proceeds from the BLVD Note were used to fund a portion of the purchase price of the acquisition of BLVD Place.

On December 8, 2016, in connection with the Contribution, the Operating Partnership entered into the Second Amendment to the 2018 Facility and Reaffirmation of Guaranties (the “Second Amendment”) with Pillarstone OP, the Company and the other Guarantors party thereto, the lenders party thereto and the Agent. Pursuant to the Second Amendment, following the Contribution, Whitestone Offices, LLC and Whitestone CP Woodland Ph. 2, LLC were permitted to remain Material Subsidiaries (as defined in the 2018 Facility) and Guarantors under the 2018 Facility and their respective Pillarstone Properties were each permitted to remain an Eligible Property (as defined in the 2018 Facility) and be included in the Borrowing Base (as defined in the 2018 Facility) under the 2018 Facility. In addition, on December 8, 2016, Pillarstone OP entered into the Limited Guarantee (the “Limited Guarantee”) with the Agent, pursuant to which Pillarstone OP agreed to be joined as a party to the 2018 Facility to provide a limited guarantee up to the amount of availability generated by the Pillarstone Properties owned by Whitestone Offices, LLC and Whitestone CP Woodland Ph. 2, LLC.

As of September 30, 2019, our $171.7 million in secured debt was collateralized by 8 properties with a carrying value of $271.4 million. Our loans contain restrictions that would require the payment of prepayment penalties for the acceleration of outstanding debt and are secured by deeds of trust on certain of our properties and by assignment of the rents and leases associated with those properties. In 2018, we were not in compliance with respect to the tangible Net Worth covenant as defined in the 2018 Facility and had received two waivers in 2018. Had we been unable to obtain a waiver or other suitable relief from the lenders under the 2018 Facility, an Event of Default (as defined in the 2018 Facility) would have occurred, permitting the lenders holding a majority of the commitments under the 2018 Facility to, among other things, accelerate the outstanding indebtedness, which would make it immediately due and payable. The 2019 Facility and the Notes contain similar tangible Net Worth covenants that reset at a new threshold and change the definition of Net Worth to add back accumulated depreciation. However, we can make no assurances that we will be in compliance with these covenants or other covenants under the 2019 Facility or the Notes in future periods or, if we are not in compliance, that we will be able to obtain a waiver. As of September 30, 2019, we were in compliance with all loan covenants.

Scheduled maturities of our outstanding debt as of September 30, 2019 were as follows (in thousands):



Year	Amount Due

2019	$	743
2020	10,801
2021	1,611
2022	101,683
2023	113,863
Thereafter	394,288
Total	$	622,989

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9. DERIVATIVES AND HEDGING ACTIVITIES

The fair value of our interest rate swaps is as follows (in thousands):



	September 30, 2019
Balance Sheet Location	Estimated Fair Value
Prepaid expenses and other assets		$	62
Accounts payable and accrued expenses		$	(7,574	)



	December 31, 2018
Balance Sheet Location	Estimated Fair Value
Prepaid expenses and other assets		$	4,286
Accounts payable and accrued expenses		$	(59	)

On January 31, 2019, we, through our Operating Partnership, entered into an interest rate swap of $65 million with Bank of Montreal that fixed the LIBOR portion of Term Loan A under the 2019 Facility at 2.43%. Pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $12.9 million of the swap to U.S. Bank, National Association, $11.6 million of the swap to Regions Bank, $15.7 million of the swap to SunTrust Bank, and $5.9 million of the swap to Associated Bank. See Note 8 (Debt) for additional information regarding the 2019 Facility. The swap began on February 7, 2019 and will mature on November 9, 2020. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

On January 31, 2019, we, through our Operating Partnership, entered into an interest rate swap of $115 million with Bank of Montreal that fixed the LIBOR portion of Term Loan A under the 2019 Facility at 2.43%. Pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $22.7 million of the swap to U.S. Bank, National Association, $20.5 million of the swap to Regions Bank, $27.9 million of the swap to SunTrust Bank, and $10.5 million of the swap to Associated Bank. See Note 8 (Debt) for additional information regarding the 2019 Facility. The swap will begin on November 9, 2020 and will mature on February 8, 2021. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

On January 31, 2019, we, through our Operating Partnership, entered into an interest rate swap of $165 million with Bank of Montreal that fixed the LIBOR portion of Term Loan A under the 2019 Facility at 2.43%. Pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $32.6 million of the swap to U.S. Bank, National Association, $29.4 million of the swap to Regions Bank, $40.0 million of the swap to SunTrust Bank, and $15.0 million of the swap to Associated Bank. See Note 8 (Debt) for additional information regarding the 2019 Facility. The swap will begin on February 8, 2021 and will mature on January 31, 2024. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

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On September 5, 2018, we, through our Operating Partnership, entered into an interest rate swap with Bank of America that fixed the LIBOR portion of the $9.6 million extension loan on the Whitestone Terravita Marketplace property at 2.85%. The swap began on September 24, 2018 and will mature on September 24, 2020. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap with Bank of Montreal that fixed the LIBOR portion of Term Loan B at 1.73%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $35.0 million of the swap to U.S. Bank, National Association, and $15.0 million of the swap to SunTrust Bank. See Note 8 (Debt) for additional information regarding the 2018 Facility. The swap began on November 30, 2015 and will mature on October 28, 2022. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap of $50 million with Bank of Montreal that fixed the LIBOR portion of Term Loan A at 1.75%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $3.8 million of the swap to Regions Bank, $6.5 million of the swap to U.S. Bank, National Association, $14.0 million of the swap to Wells Fargo Bank, National Association, $14.0 million of the swap to Bank of America, N.A., and $5.0 million of the swap to SunTrust Bank. The swap began on February 3, 2017 and will mature on October 30, 2020. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

On November 19, 2015, we, through our Operating Partnership, entered into an interest rate swap of $50 million with Bank of Montreal that fixed the LIBOR portion of Term Loan A at 1.50%. In the fourth quarter of 2015, pursuant to the terms of the agreement governing the interest rate swap, Bank of Montreal assigned $3.8 million of the swap to Regions Bank, $6.5 million of the swap to U.S. Bank, National Association, $14.0 million of the swap to Wells Fargo Bank, National Association, $14.0 million of the swap to Bank of America, N.A., and $5.0 million of the swap to SunTrust Bank. The swap began on December 7, 2015 and will mature on January 29, 2021. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value to be recorded in comprehensive income and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value, if any, will be recognized directly in earnings. The Company does not expect any amount of the existing gains or losses to be reclassified into earnings within the next 12 months.

A summary of our interest rate swap activity is as follows (in thousands):



	Amount Recognized as Comprehensive Income (Loss)				Location of Income (Loss) Recognized in Earnings	Amount of Income (Loss) Recognized in Earnings ⁽¹⁾
Three months ended September 30, 2019	$	(2,235	)		Interest expense	$	274
Three months ended September 30, 2018	$	606			Interest expense	$	231

Nine months ended September 30, 2019	$	(11,740	)		Interest expense	$	1,091
Nine months ended September 30, 2018	$	4,163		—	Interest expense	$	335


⁽¹⁾	There was no ineffective portion of our interest rate swaps to recognize in earnings for the three and nine months ended September 30, 2019 and 2018.

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10. EARNINGS PER SHARE

Basic earnings per share for our common shareholders is calculated by dividing income from continuing operations excluding the net income attributable to unvested restricted common shares and the net income attributable to noncontrolling interests, by our weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing the net income attributable to common shareholders, excluding the net income attributable to unvested restricted common shares and the net income attributable to noncontrolling interests, by the weighted average number of common shares including any dilutive unvested restricted common shares.

Certain of our performance-based restricted common shares are considered participating securities that require the use of the two-class method for the computation of basic and diluted earnings per share. During the three months ended September 30, 2019 and 2018, 926,639 and 1,002,026 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive, and during the nine months ended September 30, 2019 and 2018, 926,986 and 1,039,147 OP units, respectively, were excluded from the calculation of diluted earnings per share because their effect would be anti-dilutive.

For the three months ended September 30, 2018, distributions of $121,000 were made to holders of certain restricted common shares, $4,000 of which were charged against earnings, and for the nine months ended September 30, 2019 and 2018, distributions of $41,000 and $237,000, respectively, were made to holders of certain restricted common shares, $12,000 of which were charged against earnings during the nine months ending September 30, 2018. See Note 13 (Incentive Share Plan) for information related to restricted common shares under the 2018 Plan and the 2008 Plan.

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	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(in thousands, except per share data)	2019			2018			2019			2018
Numerator:
Income from continuing operations	$	1,849		$	8,033		$	7,391		$	13,307
Less: Net income attributable to noncontrolling interests	(42		)	(198		)	(168		)	(342		)
Distributions paid on unvested restricted shares	—			(117		)	(41		)	(225		)
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares	1,807			7,718			7,182			12,740
Income from discontinued operations	—			—			701			—
Less: Net income attributable to noncontrolling interests	—			—			(16		)	—
Income from discontinued operations attributable to Whitestone REIT	—			—			685			—
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares	$	1,807		$	7,718		$	7,867		$	12,740

Denominator:
Weighted average number of common shares - basic	40,187			39,327			39,942			39,200
Effect of dilutive securities:
Unvested restricted shares	1,259			1,308			1,142			1,341
Weighted average number of common shares - dilutive	41,446			40,635			41,084			40,541

Earnings Per Share:
Basic:
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares	$	0.04		$	0.20		$	0.18		$	0.33
Income from discontinued operations attributable to Whitestone REIT	0.00			0.00			0.02			0.00
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares	$	0.04		$	0.20		$	0.20		$	0.33
Diluted:
Income from continuing operations attributable to Whitestone REIT excluding amounts attributable to unvested restricted shares	$	0.04		$	0.19		$	0.17		$	0.31
Income from discontinued operations attributable to Whitestone REIT	0.00			0.00			0.02			0.00
Net income attributable to common shareholders excluding amounts attributable to unvested restricted shares	$	0.04		$	0.19		$	0.19		$	0.31

11. INCOME TAXES

With the exception of our taxable REIT subsidiaries, federal income taxes are generally not provided because we intend to and believe we continue to qualify as a REIT under the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), and because we have distributed and intend to continue to distribute all of our taxable income to our shareholders. As a REIT, we must distribute at least 90% of our REIT taxable income to our shareholders and meet certain income sources and investment restriction requirements. In addition, REITs are subject to a number of organizational and operational requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (0.75% for us) to the profit margin, which generally will be determined for us as total revenue less a 30% standard deduction. Although the Texas Margin Tax is not an income tax, FASB ASC 740, “Income Taxes” applies to the Texas Margin Tax. For the three months ended September 30, 2019 and 2018, we recognized approximately $101,000 and $89,000 in margin tax provision, respectively, and for the nine months ended September 30, 2019 and 2018, we recognized approximately $324,000 and $263,000 in margin tax provision, respectively.

12. EQUITY

Common Shares

Under our declaration of trust, as amended, we have authority to issue up to 400,000,000 common shares of beneficial interest, $0.001 par value per share, and up to 50,000,000 preferred shares of beneficial interest, $0.001 par value per share.

Equity Offerings

On June 4, 2015, we entered into nine amended and restated equity distribution agreements for an at-the-market equity distribution program (the “2015 equity distribution agreements”) providing for the issuance and sale of up to an aggregate of $50 million of our common shares pursuant to our Registration Statement on Form S-3 (File No. 333-203727), which expired on April 29, 2018. Actual sales depended on a variety of factors determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and were made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act. We had no obligation to sell any of our common shares and could at any time suspend offers under the 2015 equity distribution agreements or terminate the 2015 equity distribution agreements. We did not sell any common shares under the 2015 equity distribution agreements during the nine months ended September 30, 2018.

On May 31, 2019, we entered into nine equity distribution agreements for an at-the-market equity distribution program (the “2019 equity distribution agreements”) providing for the issuance and sale of up to an aggregate of $100 million of the Company’s common shares pursuant to our Registration Statement on Form S-3 (File No. 333-225007). Actual sales will depend on a variety of factors determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and were made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act. We have no obligation to sell any of our common shares and can at any time suspend offers under the 2019 equity distribution agreements or terminate the 2019 equity distribution agreements. During the nine months ended September 30, 2019, we sold 679,216 common shares under the 2019 equity distribution agreements, with net proceeds to us of approximately $8.7 million. In connection with such sales, we paid compensation of approximately $132,000 to the sales agents. During the three months ended September 30, 2019, we sold 374,077 common shares under the 2019 equity distribution agreements, with net proceeds to us of approximately $4.8 million. In connection with such sales, we paid compensation of approximately $74,000 to the sales agents.

Operating Partnership Units

Substantially all of our business is conducted through our Operating Partnership. We are the sole general partner of the Operating Partnership. As of September 30, 2019, we owned a 97.8% interest in the Operating Partnership.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Limited partners in the Operating Partnership holding OP units have the right to redeem their OP units for cash or, at our option, common shares at a ratio of one OP unit for one common share. Distributions to OP unit holders are paid at the same rate per unit as distributions per share to holders of Whitestone common shares. As of September 30, 2019 and December 31, 2018, there were 41,321,272 and 40,585,688 OP units outstanding, respectively. We owned 40,396,729 and 39,657,207 OP units as of September 30, 2019 and December 31, 2018, respectively. The balance of the OP units is owned by third parties, including certain members of our board of trustees. Our weighted average share ownership in the Operating Partnership was approximately 97.7% and 97.5% for the three months ended September 30, 2019 and 2018, respectively, and approximately 97.7% and 97.4% for the nine months ended September 30, 2019 and 2018, respectively. During the three months ended September 30, 2019 and 2018, 2,857 and 79,565 OP units, respectively, were redeemed for an equal number of common shares, and during the nine months ended September 30, 2019 and 2018, 3,938 and 154,974 OP units, respectively, were redeemed for an equal number of common shares.

Distributions

The following table summarizes the cash distributions paid or payable to holders of common shares and to holders of noncontrolling OP units during each quarter of 2018 and the nine months ended September 30, 2019 (in thousands, except per share/per OP unit data):



	Common Shares				Noncontrolling OP Unit Holders				Total
Quarter Paid	Distributions Per Common Share		Amount Paid		Distributions Per OP Unit		Amount Paid		Amount Paid
2019
Third Quarter	$	0.2850	$	11,430	$	0.2850	$	264	$	11,694
Second Quarter	0.2850		11,316		0.2850		265		11,581
First Quarter	0.2850		11,301		0.2850		264		11,565
Total	$	0.8550	$	34,047	$	0.8550	$	793	$	34,840

2018
Fourth Quarter	$	0.2850	$	11,302	$	0.2850	$	265	$	11,567
Third Quarter	0.2850		11,294		0.2850		286		11,580
Second Quarter	0.2850		11,203		0.2850		295		11,498
First Quarter	0.2850		11,145		0.2850		309		11,454
Total	$	1.1400	$	44,944	$	1.1400	$	1,155	$	46,099

13. INCENTIVE SHARE PLAN

On July 29, 2008, our shareholders approved the 2008 Plan. On December 22, 2010, our board of trustees amended the 2008 Plan to allow for awards in or related to Class B common shares pursuant to the 2008 Plan. On June 27, 2012, our Class B common shares were redesignated as “common shares.” The 2008 Plan, as amended, expired on July 29, 2018 and provided that awards may be made with respect to common shares of Whitestone or OP units, which may be redeemed for cash or, at our option, common shares of Whitestone. The maximum aggregate number of common shares issuable under the 2008 Plan was increased upon each issuance of common shares by Whitestone so that at any time the maximum number of common shares issuable under the 2008 Plan equaled 12.5% of the aggregate number of common shares of Whitestone and OP units issued and outstanding (other than common shares and/or OP units issued to or held by Whitestone).

The Compensation Committee of our board of trustees administered the 2008 Plan, except with respect to awards to non-employee trustees, for which the 2008 Plan was administered by our board of trustees. The Compensation Committee is authorized to grant share options, including both incentive share options and non-qualified share options, as well as share appreciation rights, either with or without a related option. The Compensation Committee is also authorized to grant restricted common shares, restricted common share units, performance awards and other share-based awards.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

On April 2, 2014, the Compensation Committee approved the modification of the vesting provisions with respect to awards of an aggregate of 633,704 restricted common shares and restricted common share units granted under the 2008 Plan to certain of our employees. The modified time-based shares vested annually in three equal installments. The modified performance-based restricted common shares and restricted common share units were modified to include performance-based vesting based on achievement of certain absolute financial goals, as well as one to two years of time-based vesting post achievement of financial goals. Continued employment was required through the applicable vesting date. Additionally, 2,049,116 restricted performance-based common share units were granted with the same vesting conditions as the modified performance-based grants described above. The performance targets were not met prior to December 31, 2018, any unvested performance-based restricted common shares and restricted common share units were forfeited.

The Compensation Committee approved the grant of an aggregate of 320,000 and 143,000 time-based restricted common share units under the 2008 Plan on June 30, 2016 and 2015, respectively, to James C. Mastandrea and David K. Holeman.

At the Company’s annual meeting of shareholders on May 11, 2017, its shareholders voted to approve the 2018 Long-Term Equity Incentive Ownership Plan (the “2018 Plan”). The 2018 Plan provides for the issuance of up to 3,433,831 common shares and OP units pursuant to awards under the 2018 Plan. The 2018 Plan became effective on July 30, 2018, which was the day after the 2008 Plan expired.

The Compensation Committee administers the 2018 Plan, except with respect to awards to non-employee trustees, for which the 2018 Plan is administered by the board of trustees. The Compensation Committee is authorized to grant share options, including both incentive share options and non-qualified share options, as well as share appreciation rights, either with or without a related option. The Compensation Committee is also authorized to grant restricted common shares, restricted common share units, performance awards and other share-based awards.

On September 6, 2017, the Compensation Committee approved the grant of an aggregate of 267,783 performance-based restricted common share units under the 2008 Plan with market-based vesting conditions (the “TSR Units”) to certain of our employees. Vesting is contingent upon achieving Total Shareholder Return relative to the peer group defined in the TSR Unit award agreements over a three-year performance period. At the end of the performance period, the number of common shares awarded for each vested TSR Unit will vary from 0% to 200% depending on the Company’s ranking in the peer group (the “TSR Peer Group Ranking”). Continued employment is required through the vesting date. The grant date fair value for each TSR Unit of $12.37 was determined using the Monte Carlo simulation method and is being recognized as share-based compensation expense ratably from the September 30, 2017 grant date to the end of the performance period, December 31, 2019. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. Expected volatilities utilized in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant.

On September 6, 2017, the Compensation Committee approved the grant of an aggregate of 965,000 performance-based restricted common share units under the 2008 Plan which only vest immediately prior to the consummation of a Change in Control (as defined in the 2008 Plan) that occurs on or before September 30, 2024 (the “CIC Units”) to certain of our employees. Continued employment is required through the vesting date. If a Change in Control does not occur on or before September 30, 2024, the CIC Units shall be immediately forfeited. The Company considers a Change in Control on or before September 30, 2024 to be improbable, and no expense has been recognized for the CIC Units. If a Change in Control occurs, any outstanding CIC Units would be expensed immediately on the date of the Change in Control using the grant date fair value. The grant date fair value for each CIC Unit of $13.05 was determined based on the Company’s closing share price on the grant date.

On March 16, 2018, the Compensation Committee approved the grant of an aggregate of 387,499 time-based restricted common share units under the 2008 Plan, which vest annually in three equal installments, and 4,300 performance-based restricted common share units to certain of our employees.

On December 1, 2018, the Compensation Committee approved the grant of an aggregate of 229,684 TSR Units under the 2018 Plan to certain of our employees. Vesting is contingent upon achieving Total Shareholder Return relative to the peer group defined in the TSR Unit award agreements over a three-year performance period. At the end of the performance period,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

the number of common shares awarded for each vested TSR Unit will vary from 0% to 200% depending on the Company’s TSR Peer Group Ranking. Continued employment is required through the vesting date. The grant date fair value for each TSR Unit of $14.89 was determined using the Monte Carlo simulation method and is being recognized as share-based compensation expense ratably from the December 1, 2018 grant date to the end of the performance period, December 31, 2020. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. Expected volatilities utilized in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant.

On June 30, 2019, the Compensation Committee approved the grant of an aggregate of 405,417 TSR Units and 317,184 time-based restricted common share units under the 2018 Plan to certain of our employees. Vesting of the TSR Units is contingent upon achieving Total Shareholder Return relative to the peer group defined in the TSR Unit award agreements over a three-year performance period. At the end of the performance period, the number of common shares awarded for each vested TSR Unit will vary from 0% to 200% depending on the Company’s TSR Peer Group Ranking. Continued employment is required through the vesting date. The grant date fair value for each TSR Unit of $8.22 was determined using the Monte Carlo simulation method and is being recognized as share-based compensation expense ratably from the June 30, 2019 grant date to the end of the performance period, December 31, 2021. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market condition stipulated in the award grant and calculates the fair value of the award. Expected volatilities utilized in the model were estimated using a historical period consistent with the performance period of approximately three years. The risk-free interest rate was based on the United States Treasury rate for a term commensurate with the expected life of the grant. The time-based restricted common share units have a grant date fair value of $10.63 and vest annually in three equal installments.

A summary of the share-based incentive plan activity as of and for the nine months ended September 30, 2019 is as follows:



	Shares		Weighted Average Grant Date Fair Value
Non-vested at January 1, 2019	1,923,382		$	12.41
Granted	739,670		9.33
Vested	(262,004	)	11.61
Forfeited	(61,116	)	12.62
Non-vested at September 30, 2019	2,339,932		$	11.52
Available for grant at September 30, 2019	2,449,942

A summary of our non-vested and vested shares activity for the nine months ended September 30, 2019 and years ended December 31, 2018 and 2017 is presented below:



	Shares Granted			Shares Vested
	Non-Vested Shares Issued	Weighted Average Grant-Date Fair Value		Vested Shares		Total Vest-Date Fair Value
						(in thousands)
Nine Months Ended September 30, 2019	739,670	$	9.33	(262,004	)	$	3,041
Year Ended December 31, 2018	653,472	$	11.07	(560,126	)	$	7,978
Year Ended December 31, 2017	1,354,534	$	12.92	(881,710	)	$	12,829

Total compensation recognized in earnings for share-based payments was $1,719,000 and $1,497,000 for the three months ended September 30, 2019 and 2018, respectively, and $4,770,000 and $4,894,000 for the nine months ended September 30, 2019 and 2018, respectively.

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WHITESTONE REIT AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Based on our current financial projections, we expect approximately 100% of the unvested awards, exclusive of 895,000 CIC Units, to vest over the next 36 months. As of September 30, 2019, there was approximately $5.2 million in unrecognized compensation cost related to outstanding non-vested TSR Units, which are expected to vest over a period of 27 months, and approximately $4.8 million in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a period of approximately 36 months beginning on October 1, 2019.

We expect to record approximately $6.4 million in non-cash share-based compensation expense in 2019 and $8.4 million subsequent to 2019. The unrecognized share-based compensation cost is expected to vest over a weighted average period of 25 months. The dilutive impact of the performance-based shares will be included in the denominator of the earnings per share calculation beginning in the period that the performance conditions are expected to be met. The dilutive impact of the TSR Units is based on the Company’s TSR Peer Group Ranking as of the reporting date and weighted according to the number of days outstanding in the period. As of September 30, 2019, the TSR Peer Group Ranking called for 200% attainment for the shares issued in 2017, 100% attainment for the shares issued in 2018, and 0% attainment for the shares issued in 2019. The dilutive impact of the CIC Units is based on the probability of a Change in Control. Because the Company considers a Change in Control on or before September 30, 2024 to be improbable, no CIC Units are included in the Company’s dilutive shares.

14. GRANTS TO TRUSTEES

On December 28, 2018, each of our six independent trustees and one trustee emeritus were granted 3,000 common shares, which vest immediately and are prorated based on date appointed. The 21,000 common shares granted to our trustees had a grant fair value of $12.42 per share. On December 28, 2018, two of our independent trustees each elected to receive a total of 4,186 common shares with a grant date fair value of $12.42 in lieu of cash for board fees. The fair value of the shares granted during the year ended December 31, 2018 was determined using quoted prices available on the date of grant.

On December 12, 2017, each of our six independent trustees and one trustee emeritus were granted 3,000 common shares, which vested immediately and were prorated based on date appointed. The 16,281 common shares granted to our trustees had a grant date fair value of $14.46 per share. On December 12, 2017, three of our independent trustees each elected to receive a total of 2,320 common shares with a grant date fair value of $14.46 in lieu of cash for board fees. The fair value of the shares granted were determined using quoted prices available on the date of grant.

15. SEGMENT INFORMATION

Historically, our management has not differentiated results of operations by property type or location and, therefore, does not present segment information.

16. REAL ESTATE

Development. As of September 30, 2019, we had substantially completed construction at our Anthem Marketplace Phase II property. As of September 30, 2019, we had incurred approximately $1.4 million in construction costs. The 6,853 square foot Community Centered Property^® was 81% occupied as of September 30, 2019 and is located in Phoenix, Arizona, and adjacent to Anthem Marketplace.

Property dispositions. On September 24, 2018, we completed the sale of Torrey Square, located in Houston, Texas, for $8.7 million. We recorded a gain on sale of $4.4 million. We have not included Torrey Square in discontinued operations as it did not meet the definition of discontinued operations.

On February 27, 2018, we completed the sale of Bellnott Square, located in Houston, Texas, for $4.7 million. We recorded a gain on sale of $0.3 million. We have not included Bellnott Square in discontinued operations as it did not meet the definition of discontinued operations.

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WHITESTONE REIT AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

17. RELATED PARTY TRANSACTIONS

Pillarstone OP. For the periods prior to December 31, 2017, Pillarstone OP was accounted for under the profit-sharing method, and related party transactions between the Company and Pillarstone OP were eliminated. As a result of the adoption of Topic 606 and ASC 610 as of January 1, 2018, the Company derecognized the underlying assets and liabilities associated with the Contribution as of January 1, 2018 and recognized the Company’s investment in Pillarstone OP under the equity method.

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

The following table presents the revenue and expenses with Pillarstone OP included in our consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2019 (in thousands):



		Three Months Ended September 30,						Nine Months Ended September 30,
	Location of Revenue (Expense)	2019			2018			2019			2018
Rent	Operating and maintenance	$	(213	)	$	(201	)	$	(628	)	$	(606	)
Property management fee income	Management, transaction, and other fees	$	228		$	249		$	693		$	755
Interest income	Interest, dividend and other investment income	$	52		$	149		$	161		$	435

On December 8, 2016, we received a $15.4 million financed receivable from Pillarstone OP to provide the financing for the ordinary course of business transactions for Pillarstone OP. The financed receivable has a interest rate of 1.4%-1.95% plus Libor and a maturity date of December 31, 2019. As of September 30, 2019, the balance of the financed receivable is $5.7 million.

18. COMMITMENTS AND CONTINGENCIES

We are subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, management believes the final outcome of such matters will not have a material adverse effect on our financial position, results of operations or liquidity.

On April 16, 2019, a purported shareholder of the Company filed a class action lawsuit in the United States District Court for the Southern District of Texas against the Company, James C. Mastandrea, and David K. Holeman, entitled Clark v. Whitestone REIT, et al., Case 4:19-cv-01379. A second class action lawsuit was filed but was consolidated into the Clark case. The complaint alleges, among other things, that the Company and the individual defendants violated certain federal securities laws by making materially false and misleading statements in the Company’s Forms 10-Q for the first three quarterly periods of the year ended December 31, 2018 as a result of the accounting errors that required the restatement of our consolidated financial statements for the first three quarterly periods of the year ended December 31, 2018. The purported class period runs from May 9, 2018 through February 27, 2019. The complaint sought, among other things, compensatory damages in an amount to be proven at trial, plus interest, attorneys’ fees, and costs. In August 2019, the complainants in these purported class actions withdrew their claims and the Court issued an order dismissing them with prejudice. On July 17, 2019, the Company received a demand letter from a purported shareholder containing allegations similar to those contained in the purported class actions. Subsequent to the dismissal of the purported class actions, in September 2019, counsel for the purported shareholder withdrew its demand.

On December 12, 2017, a property owner that owns a land parcel adjacent to a Whitestone property filed suit against Whitestone Pinnacle of Scottsdale - Phase II, LLC (“Whitestone Pinnacle”) alleging breach of contract and resulting in the delay of the construction of the their assisted living facility. In May 2019, the claimant amended their report of damages and seeks approximately $2.7 million in restitution from Whitestone Pinnacle. The Company intends to vigorously defend the matter as it believes that these claims are without merit and that it has substantial legal and factual defenses to the claims and

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WHITESTONE REIT AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

allegations contained in the complaint. Based upon the present status of this matter, the Company does not believe it is probable that a loss will be incurred. Accordingly, the Company has not recorded a charge as a result of this action.

19. SUBSEQUENT EVENTS

On October 8, 2019, Pillarstone OP, through its indirect wholly owned subsidiary, Whitestone Industrial-Office, LLC, sold a portfolio of three properties in Houston, Texas to an unaffiliated third party for $39.7 million in cash. Pillarstone OP used the net proceeds, after customary closing deductions, to pay off mortgage debt on the three properties, and repay the remaining $5.7 million outstanding under its $15.5 million loan from Whitestone. In addition to the $5.7 million loan repayment, Whitestone received a $5.3 million cash distribution from its stake in Pillarstone OP as a result of the sale, and expects to recycle the capital into development and redevelopment of existing assets, acquisitions and general corporate purposes.

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

You should read the following discussion of our financial condition and results of operations in conjunction with our unaudited consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q (the “Report”), and the consolidated financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2018. For more detailed information regarding the basis of presentation for the following information, you should read the notes to the unaudited consolidated financial statements included in this Report.

This Report contains forward-looking statements within the meaning of the federal securities laws, including discussion and analysis of our financial condition, pending acquisitions and the impact of such acquisitions on our financial condition and results of operations, 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 Report. 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:


•	the imposition of federal income taxes if we fail to qualify as a real estate investment trust (“REIT”) in any taxable year or forego an opportunity to ensure REIT status;


•	uncertainties related to the national economy, the real estate industry in general and in our specific markets;


•	legislative or regulatory changes, including changes to laws governing REITs and the impact of the legislation commonly known as the Tax Cuts and Jobs Act;


•	adverse economic or real estate developments or natural disasters in Texas, Arizona or Illinois;


•	increases in interest rates, operating costs or general and administrative expenses, including those incurred in connection with the nomination of trustees by a shareholder;


•	availability and terms of capital and financing, both to fund our operations and to refinance our indebtedness as it matures;


•	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;


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


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


•	the need to fund tenant improvements or other capital expenditures out of operating cash flow;


•	the risk that we are unable to raise capital for working capital, acquisitions or other uses on attractive terms or at all;


•	our inability to improve our internal control over financial reporting and disclosure controls and procedures, including the remediation of such controls; and


•	risks relating to the restatement of our consolidated financial statements for the first three quarterly periods of the year ended December 31, 2018 and related legal proceedings.

The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2018, as previously filed with the Securities and Exchange Commission (“SEC”) and of this Report below.

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Overview

We are a fully-integrated real estate company that owns and operates commercial properties in culturally diverse markets in major metropolitan areas. Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.

In October 2006, our current management team joined the Company and adopted a strategic plan to acquire, redevelop, own and operate Community Centered Properties^®. We define Community Centered Properties^® as visibly located properties in established or developing culturally diverse neighborhoods in our target markets. We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood. Those needs may include specialty retail, grocery, restaurants and medical, educational and financial services. Our goal is for each property to become a Whitestone-branded retail community that serves a neighboring five-mile radius around our property. We employ and develop a diverse group of associates who understand the needs of our multicultural communities and tenants.

We serve as the general partner of Whitestone REIT Operating Partnership, L.P. (the “Operating Partnership”), which was formed on December 31, 1998 as a Delaware limited partnership. We currently conduct substantially all of our operations and activities through the Operating Partnership. As the general partner of the Operating Partnership, we have the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain customary exceptions.

As of September 30, 2019, we wholly-owned 57 commercial properties consisting of:

Consolidated Operating Portfolio


•	52 wholly-owned properties that meet our Community Centered Properties^® strategy containing approximately 4.8 million square feet of gross leasable area (“GLA”) and having a total carrying amount (net of accumulated depreciation) of $912.6 million;

Redevelopment, New Acquisitions Portfolio


•	five parcels of land held for future development that meet our Community Centered Properties^® strategy having a total carrying value of $18.2 million.

As of September 30, 2019, we had an aggregate of 1,364 tenants. We have a diversified tenant base with our largest tenant comprising only 2.9% of our annualized rental revenues for the nine months ended September 30, 2019. Lease terms for our properties range from less than one year for smaller tenants to over 15 years for larger tenants. Our leases include minimum monthly lease payments and generally provide for tenant reimbursements for payment of taxes, insurance and maintenance. We completed 241 new and renewal leases during the nine months ended September 30, 2019, totaling 659,134 square feet and approximately $60.6 million in total lease value. This compares to 233 new and renewal leases totaling 581,201 square feet and approximately $65.0 million in total lease value during the same period in 2018.

We employed 103 full-time employees as of September 30, 2019. As an internally managed REIT, we bear our own expenses of operations, including the salaries, benefits and other compensation of our employees, office expenses, legal, accounting and investor relations expenses and other overhead costs.

Real Estate Partnership

As of September 30, 2019, we, through our investment in Pillarstone OP, owned a majority interest in 11 properties that do not meet our Community Centered Property® strategy containing approximately 1.3 million square feet of GLA (the “Pillarstone Properties”). We own 81.4% of the total outstanding units of Pillarstone OP, which we account for using the equity method. We also manage the day-to-day operations of Pillarstone OP.

How We Derive Our Revenue

Substantially all of our revenue is derived from rents received from leases at our properties. We had total revenues of approximately $29.9 million and $30.7 million for the three months ended September 30, 2019 and 2018, respectively, and $89.2 million and $90.0 million for the nine months ended September 30, 2019 and 2018, respectively.

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Known Trends in Our Operations; Outlook for Future Results

Rental Income

We expect our rental income to increase year-over-year due to the addition of properties and rent increases on renewal leases. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space, newly acquired properties with vacant space, and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in our submarkets. Over the past three years, we have seen modest improvement in the overall economy in our markets, which has allowed us to maintain overall occupancy rates, with slight increases in occupancy at certain of our properties, and to recognize modest increases in rental rates. We expect this trend to continue in 2019 and 2020.

Scheduled Lease Expirations

We tend to lease space to smaller businesses that desire shorter term leases. As of September 30, 2019, approximately 21% of our GLA was subject to leases that expire prior to December 31, 2020. Over the last three years, we have renewed expiring leases with respect to approximately 80% of our GLA. We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 24 months prior to the expiration date of the existing lease. Inasmuch as our early renewal program and other leasing and marketing efforts target these expiring leases, we hope to re-lease most of that space prior to expiration of the leases. In the markets in which we operate, we obtain and analyze market rental rates through review of third-party publications, which provide market and submarket rental rate data and through inquiry of property owners and property management companies as to rental rates being quoted at properties that are located in close proximity to our properties and we believe display similar physical attributes as our nearby properties. We use this data to negotiate leases with new tenants and renew leases with our existing tenants at rates we believe to be competitive in the markets for our individual properties. Due to the short term nature of our leases, and based upon our analysis of market rental rates, we believe that, in the aggregate, our current leases are at market rates. Market conditions, including new supply of properties, and macroeconomic conditions in our markets and nationally affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could adversely impact our renewal rate and/or the rental rates we are able to negotiate. We continue to monitor our tenants’ operating performances as well as overall economic trends to evaluate any future negative impact on our renewal rates and rental rates, which could adversely affect our cash flow and ability to make distributions to our shareholders.

Acquisitions

We seek to grow our GLA through the acquisition of additional properties, and we expect to actively pursue and consummate additional acquisitions in the foreseeable future. We believe that over the next few years we will continue to have excellent opportunities to acquire quality properties at historically attractive prices. We have extensive relationships with community banks, attorneys, title companies and others in the real estate industry, which we believe enables us to take advantage of these market opportunities and maintain an active acquisition pipeline.

Property Acquisitions, Dispositions and Development

We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered Properties^® strategy. We may acquire properties in other high-growth cities in the future.

Property Dispositions. On September 24, 2018, we completed the sale of Torrey Square, located in Houston, Texas, for $8.7 million. We recorded a gain on sale of $4.4 million. We have not included Torrey Square in discontinued operations as it did not meet the definition of discontinued operations.

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Leasing Activity

As of September 30, 2019, we owned 57 properties with 4,848,652 square feet of GLA and our occupancy rate for all properties was approximately 90% and 92% occupied as of September 30, 2019 and 2018, respectively. The following is a summary of the Company’s leasing activity for the nine months ended September 30, 2019:



	Number of Leases Signed	GLA Signed	Weighted Average Lease Term ⁽²⁾	TI and Incentives per Sq. Ft. ⁽³⁾		Contractual Rent Per Sq. Ft. ⁽⁴⁾		Prior Contractual Rent Per Sq. Ft. ⁽⁵⁾		Straight-lined Basis Increase (Decrease) Over Prior Rent
Comparable ⁽¹⁾
Renewal Leases	150	456,070	3.4	$	1.62	$	18.51	$	18.26	8.7	%
New Leases	40	68,907	5.0	9.81		23.00		23.47		6.5	%
Total	190	524,977	3.6	$	2.70	$	19.10	$	18.95	8.4	%

	Number of Leases Signed	GLA Signed	Weighted Average Lease Term ⁽²⁾	TI and Incentives per Sq. Ft. ⁽³⁾		Contractual Rent Per Sq. Ft. ⁽⁴⁾
Non-Comparable
Renewal Leases	3	12,736	3.6	$	6.70	$	12.60
New Leases	48	121,421	5.1	17.27		19.35
Total	51	134,157	5.0	$	16.26	$	18.71


⁽¹⁾	Comparable leases represent leases signed on spaces for which there was a former tenant within the last twelve months and the new or renewal square footage was within 25% of the expired square footage.


⁽²⁾	Weighted average lease term is determined on the basis of square footage.


⁽³⁾	Estimated amount per signed leases. Actual cost of construction may vary. Does not include first generation costs for tenant improvements (“TI”) and leasing commission costs needed for new acquisitions or redevelopment of a property to bring to operating standards for its intended use.


⁽⁴⁾	Contractual minimum rent under the new lease for the first month, excluding concessions.


⁽⁵⁾	Contractual minimum rent under the prior lease for the final month.

Capital Expenditures

The following is a summary of the Company's capital expenditures for the three and nine months ended September 30, 2019 and 2018 (in thousands):



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
Capital expenditures:
Tenant improvements and allowances	$	1,790	$	1,526	$	3,185	$	3,536
Developments / redevelopments	728		296		3,576		3,038
Leasing commissions and costs	625		685		1,993		1,454
Maintenance capital expenditures	1,205		1,014		3,190		2,159
Total capital expenditures	$	4,348	$	3,521	$	11,944	$	10,187

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Critical Accounting Policies

In preparing the consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. Actual results may differ from these estimates. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2018, under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Except for the adoption of Topic 842, there have been no significant changes to these policies during the nine months ended September 30, 2019. For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2018.

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Results of Operations

Comparison of the Three Months Ended September 30, 2019 and 2018

The following table provides a summary comparison of our results of operations and other metrics for the three months ended September 30, 2019 and 2018 (dollars in thousands, except per share and per OP unit amounts):



	Three Months Ended September 30,
	2019			2018
Number of properties owned and operated	57			57
Aggregate GLA (sq. ft.)⁽¹⁾	4,848,652			4,843,519
Ending occupancy rate - operating portfolio⁽¹⁾	90		%	92		%
Ending occupancy rate	90		%	92		%

Total revenues	$	29,879		$	30,704
Total operating expenses	21,914			21,290
Total other expense	6,538			1,791
Income from operations before equity investments in real estate partnerships and income tax	1,427			7,623
Equity in earnings of real estate partnership	524			502
Provision for income taxes	(102		)	(92		)
Income from continuing operations	1,849			8,033
Less: Net income attributable to noncontrolling interests	42			198
Net income attributable to Whitestone REIT	$	1,807		$	7,835

Funds from operations⁽²⁾	$	9,231		$	10,773
Funds from operations core⁽³⁾	10,950			12,270
Property net operating income⁽⁴⁾	22,051			22,700
Distributions paid on common shares and OP units	11,694			11,580
Distributions per common share and OP unit	$	0.2850		$	0.2850
Distributions paid as a percentage of funds from operations core	107		%	94		%


⁽¹⁾	Excludes (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redevelopment or re-tenanting.


⁽²⁾	For a reconciliation of funds from operations to net income, see “—Reconciliation of Non-GAAP Financial Measures—Funds From Operations (“FFO”)” below.


⁽³⁾	For a reconciliation of funds from operations core to net income, see “—Reconciliation of Non-GAAP Financial Measures—FFO Core” below.


⁽⁴⁾	For a reconciliation of property net operating income to net income, see “—Reconciliation of Non-GAAP Financial Measures—Property Net Operating Income (“NOI”)” below.

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We define “Same Stores” as properties that have been owned for the entire period being compared. For purposes of comparing the three months ended September 30, 2019 to the three months ended September 30, 2018, Same Stores include properties owned during the entire period from July 1, 2018 to September 30, 2019. We define “Non-Same Stores” as properties acquired since the beginning of the period being compared and properties that have been sold, but not classified as discontinued operations.

Revenues. The primary components of revenue are detailed in the table below (in thousands, except percentages):



	Three Months Ended September 30,
Revenue	2019			2018		Change			% Change
Same Store
Rental revenues ⁽¹⁾	$	21,623		$	21,781	$	(158	)	(1	)%
Recoveries⁽²⁾	8,240			8,026		214			3	%
Bad debt⁽³⁾	(495		)	—		(495		)	Not meaningful
Total rental	29,368			29,807		(439		)	(1	)%
Other revenues ⁽⁴⁾	283			369		(86		)	(23	)%
Same Store Total	29,651			30,176		(525		)	(2	)%

Non-Same Store and Management Fees
Rental revenues	—			183		(183		)	Not meaningful
Recoveries	—			95		(95		)	Not meaningful
Bad debt	—			—		—			Not meaningful
Total rental ⁽⁵⁾	—			278		(278		)	Not meaningful
Other revenues	—			—		—			Not meaningful
Management fees	228			250		(22		)	(9	)%
Non-Same Store and Management Fees Total	228			528		(300		)	(57	)%

Total revenue	$	29,879		$	30,704	$	(825	)	(3	)%


⁽¹⁾	The Same Store tenant rent decrease of $158,000 resulted from a decrease of $387,000 from the decrease in the average leased square feet to 4,360,443 from 4,437,872, offset by increase of $229,000 from the average rent per leased square foot increasing from $19.63 to $19.84.


⁽²⁾	The Same Store recoveries revenue increase of $214,000 is primarily attributable to increases in Same Store real estate taxes and repair costs.

⁽³⁾

Bad debt of $495,000 is included as a reduction of revenue for the three months ended September 30, 2019. Prior to our adoption of Topic 842 in 2019, we recognized bad debt in total operating expenses. For the three months ended September 30, 2018, the Same Store bad debt expense recognized in total operating expenses was $372,000. No bad debt expense is recognized in total operating expenses for 2019.


⁽⁴⁾	The decrease in Same Store other revenues is primarily comprised of decreased lease termination fees.


⁽⁵⁾	Non-Same Store total rental revenue decreased due to the sales of the Torrey Square and Bellnot Square properties in 2018. Please refer to Note 16 (Real Estate) to the accompanying consolidated financial statements for more information regarding the property sales.

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Operating expenses. The primary components of operating expenses for the three months ended September 30, 2019 and 2018 are detailed in the table below (in thousands, except percentages):



	Three Months Ended September 30,
Operating Expenses	2019		2018			Change			% Change
Same Store
Operating and maintenance, excluding bad debt	$	4,888	$	4,895		$	(7	)	—	%
Bad debt ⁽¹⁾	—		372			(372		)	(100	)%
Real estate taxes	4,410		4,306			104			2	%
Same Store total	9,298		9,573			(275		)	(3	)%

Non-Same Store and affiliated company rents
Operating and maintenance	16		(16		)	32			Not meaningful
Real estate taxes ⁽²⁾	—		73			(73		)	(100	)%
Affiliated company rents ⁽³⁾	214		201			13			6	%
Non-Same Store and affiliated company rents total	230		258			(28		)	(11	)%

Depreciation and amortization	6,789		6,477			312			5	%

General and administrative ⁽⁵⁾	5,597		4,982			615			12	%

Total operating expenses	$	21,914	$	21,290		$	624		3	%

⁽¹⁾

Prior to our adoption of Topic 842 in 2019, we recorded an allowance for bad debt as a component of operating and maintenance expense. Subsequent to the adoption of Topic 842, we included the impact of tenant allowances as a reduction of revenue. Bad debt expense was $372,000 for the three months ended September 30, 2018, and for the three months ended September 30, 2019, we recorded a $495,000 reduction to Same Store revenue for tenant rent allowances.


⁽²⁾	Non-Same Store real estate tax decreases were attributable to the sales of our Torrey Square and Bellnot Square properties in 2018. Please refer to Note 16 (Real Estate) to the accompanying consolidated financial statements for more information regarding the property sales.


⁽³⁾	Affiliated company rents are spaces that we lease from Pillarstone OP.

⁽⁵⁾

The general and administrative expense increase was attributable to a $342,000 increase in legal fees, a $222,000 increase in share-based compensation expense, and $51,000 increase in other general and administrative expenses. Please refer to Note 18 (Commitments and Contingencies) and Note 13 (Incentive Share Plan) to the accompanying consolidated financial statements for more information regarding legal fees and share-based compensation expense.

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Other expenses (income). The primary components of other expenses (income) for the three months ended September 30, 2019 and 2018 are detailed in the table below (in thousands, except percentages):



	Three Months Ended September 30,
Other Expenses (Income)	2019			2018			Change		% Change

Interest expense⁽¹⁾	$	6,679		$	6,419		$	260	4	%
Gain on sale of properties	(37		)	(4,380		)	4,343		(99	)%
Loss on sale or disposal of assets	37			3			34		1,133	%
Interest, dividend and other investment income	(141		)	(251		)	110		(44	)%
Total other expense	$	6,538		$	1,791		$	4,747	265	%


⁽¹⁾	The increase in interest expense is primarily attributable to an increase in our average interest rate from 4.0% for the three months ended September 30, 2018 to 4.1% for the three months ended September 30, 2019.

Equity in earnings of real estate partnership. Our equity in earnings of real estate partnership, which is generated from our 81.4% ownership of Pillarstone OP, increased $22,000 from $502,000 for the three months ended September 30, 2018 to $524,000 for the three months ended September 30, 2019. Please refer to Note 7 (Investment in Real Estate Partnership) to the accompanying consolidated financial statements for more information regarding our investment in Pillarstone OP.

Gain on sale of property from discontinued operations. On September 24, 2018, we completed the sale of Torrey Square, located in Houston, Texas, for $8.7 million. We recorded a gain on sale of $4.4 million. We have not included Torrey Square in discontinued operations as it did not meet the definition of discontinued operations.

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Same Store, Non-Same Store and Pillarstone OP net operating income. The components of Same Store, Non-Same Store, Pillarstone OP and total property net operating income and net income are detailed in the table below (in thousands):



	Three Months Ended September 30,									Percent
	2019			2018			Change			Change
Same Store (51 properties excluding development land)
Property revenues
Rental	$	29,368		$	29,807		$	(439	)	(1	)%
Management, transaction and other fees	283			369			(86		)	(23	)%
Total property revenues	29,651			30,176			(525		)	(2	)%

Property expenses
Property operation and maintenance	4,888			5,267			(379		)	(7	)%
Real estate taxes	4,410			4,306			104			2	%
Total property expenses	9,298			9,573			(275		)	(3	)%

Total same store net operating income	20,353			20,603			(250		)	(1	)%

Non-Same Store (2 Properties excluding development land)
Property revenues
Rental	—			278			(278		)	Not meaningful
Total property revenues	—			278			(278		)	Not meaningful

Property expenses
Property operation and maintenance	16			(16		)	32			Not meaningful
Real estate taxes	—			73			(73		)	Not meaningful
Total property expenses	16			57			(41		)	Not meaningful

Total Non-Same Store net operating income (loss)	(16		)	221			(237		)	Not meaningful

Pro rata share of real estate partnership	1,714			1,875			(161		)	(9	)%

Total property net operating income	22,051			22,699			(648		)	(3	)%

Less total other expenses, excluding pro rata share of real estate partnership net operating income, provision for income taxes, gain on sale of properties, gain (loss) on disposal of assets and gain on sale of properties from discontinued operations	20,202			14,666			5,536			38	%

Net income	$	1,849		$	8,033		$	(6,184	)	(77	)%

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Results of Operations

Comparison of the Nine Months Ended September 30, 2019 and 2018

The following table provides a summary comparison of our results of operations and other metrics for the nine months ended September 30, 2019 and 2018 (dollars in thousands, except per share and per OP unit amounts):



	Nine Months Ended September 30,
	2019			2018
Number of properties owned and operated	57			57
Aggregate GLA (sq. ft.)⁽¹⁾	4,848,652			4,843,519
Ending occupancy rate - operating portfolio⁽¹⁾	90		%	92		%
Ending occupancy rate	90		%	92		%

Total revenues	$	89,151		$	89,962
Total operating expenses	63,613			64,616
Total other expense	19,303			13,540
Income from operations before equity investments in real estate partnerships and income tax	6,235			11,806
Equity in earnings of real estate partnership	1,480			1,762
Provision for income taxes	(324		)	(261		)
Income from continuing operations	7,391			13,307
Gain on sale of property from discontinued operations	701			—
Net Income	8,092			13,307
Less: Net income attributable to noncontrolling interests	184			342
Net income attributable to Whitestone REIT	$	7,908		$	12,965

Funds from operations⁽²⁾	$	29,104		$	29,907
Funds from operations core⁽³⁾	33,874			37,335
Property net operating income⁽⁴⁾	67,005			68,113
Distributions paid on common shares and OP units	34,840			34,532
Distributions per common share and OP unit	$	0.8550		$	0.8550
Distributions paid as a percentage of funds from operations core	103		%	92		%


⁽¹⁾	Excludes (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redevelopment or re-tenanting.


⁽²⁾	For a reconciliation of funds from operations to net income, see “—Reconciliation of Non-GAAP Financial Measures—Funds From Operations (“FFO”)” below.


⁽³⁾	For a reconciliation of funds from operations core to net income, see “—Reconciliation of Non-GAAP Financial Measures—FFO Core” below.


⁽⁴⁾	For a reconciliation of property net operating income to net income, see “—Reconciliation of Non-GAAP Financial Measures—Property Net Operating Income (“NOI”)” below.

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We define “Same Stores” as properties that have been owned for the entire period being compared. For purposes of comparing the nine months ended September 30, 2019 to the nine months ended September 30, 2018, Same Stores include properties owned during the entire period from January 1, 2018 to September 30, 2019. We define “Non-Same Stores” as properties acquired since the beginning of the period being compared and properties that have been sold, but not classified as discontinued operations.

Revenues. The primary components of revenue are detailed in the table below (in thousands, except percentages):



	Nine Months Ended September 30,
Revenue	2019			2018		Change			% Change
Same Store
Rental revenues⁽¹⁾	$	64,752		$	64,422	$	330		1	%
Recoveries⁽²⁾	23,701			22,961		740			3	%
Bad debt⁽³⁾	(926		)	—		(926		)	Not meaningful
Total rental	87,527			87,383		144			—	%
Other revenues	932			992		(60		)	(6	)%
Same Store Total	88,459			88,375		84			—	%

Non-Same Store and Management Fees
Rental revenues	—			596		(596		)	Not meaningful
Recoveries	—			232		(232		)	Not meaningful
Bad debt	—			—		—			Not meaningful
Total rental ⁽⁴⁾	—			828		(828		)	Not meaningful
Other revenues	—			3		(3		)	Not meaningful
Management fees	692			756		(64		)	(8	)%
Non-Same Store and Management Fees Total	692			1,587		(895		)	(56	)%

Total revenue	$	89,151		$	89,962	$	(811	)	(1	)%


⁽¹⁾	The Same Store tenant rent increase of $330,000 resulted from the average rent per leased square foot increasing from $19.38 to $19.70 for an increase in Same Store tenant rent of $1,052,000, offset by a decrease in the average leased square feet to 4,381,957 from 4,433,239 for a decrease in Same Store tenant rent of $722,000.


⁽²⁾	The Same Store recoveries revenue increase of $740,000 resulted from an increase of $876,000 in Same Store operating and maintenance and real estate tax expenses, excluding bad debt. Same Store recoveries revenue typically increases and decreases at a similar rate to the rate of increase or decrease of operating and maintenance and real estate tax expenses, excluding bad debt.

⁽³⁾

Bad debt of $926,000 is included as a reduction of revenue for the nine months ended September, 2019. Prior to our adoption of Topic 842 in 2019, we recognized bad debt in total operating expenses. For the nine months ended September 30, 2018, the Same Store bad debt expense recognized in total operating expenses was $998,000. No bad debt expense is recognized in total operating expenses for 2019.


⁽⁴⁾	Non-Same Store total rental revenue decreased due to the sales of the Torrey Square and Bellnot Square properties in 2018. Please refer to Note 16 (Real Estate) to the accompanying consolidated financial statements for more information regarding the property sales.

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Operating expenses. The primary components of operating expenses for the nine months ended September 30, 2019 and 2018 are detailed in the table below (in thousands, except percentages):



	Nine Months Ended September 30,
Operating Expenses	2019		2018		Change			% Change
Same Store
Operating and maintenance, excluding bad debt⁽¹⁾	$	14,015	$	13,569	$	446		3	%
Bad debt⁽²⁾	—		998		(998		)	(100	)%
Real estate taxes	12,474		12,044		430			4	%
Same Store total	26,489		26,611		(122		)	—	%

Non-Same Store and affiliated company rents
Operating and maintenance⁽³⁾	116		152		(36		)	(24	)%
Real estate taxes⁽³⁾	—		216		(216		)	(100	)%
Affiliated company rents⁽⁴⁾	629		606		23			4	%
Non-Same Store and affiliated company rents total	745		974		(229		)	(24	)%

Depreciation and amortization	19,865		19,044		821			4	%

General and administrative⁽⁵⁾	16,514		17,987		(1,473		)	(8	)%

Total operating expenses	$	63,613	$	64,616	$	(1,003	)	(2	)%


⁽¹⁾	Increased operating and maintenance expenses, excluding bad debt, were primarily comprised of increases in roofing repairs, power washing, and plumbing costs. The majority of the costs are recovered from our tenants.

⁽²⁾

Prior to our adoption of Topic 842 in 2019, we recorded an allowance for bad debt as a component of operating and maintenance expense. Subsequent to the adoption of Topic 842, we included the impact of tenant allowances as a reduction of revenue. Bad debt expense was $998,000 for the nine months ended September 30, 2018, and for the nine months ended September 30, 2019, we recorded a $926,000 reduction to Same Store revenue for tenant rent allowances.


⁽³⁾	Non-Same Store operating and maintenance and real estate tax decreases were attributable to the sales of our Torrey Square and Bellnot Square properties in 2018. Please refer to Note 16 (Real Estate) to the accompanying consolidated financial statements for more information regarding the property sales.


⁽⁴⁾	Affiliated company rents are spaces that we lease from Pillarstone OP.

⁽⁵⁾

The general and administrative expense decrease was attributable to $2,534,000 in proxy contest fees incurred during the nine months ended September 30, 2018 that did not repeat during the nine months ended September 30, 2019 offset by increases of $935,000 in legal fees not related to the 2018 proxy contest and a $126,000 increase in other general and administrative expenses. Please refer to Note 18 (Commitments and Contingencies) to the accompanying consolidated financial statements for more information regarding legal fees.

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Other expenses (income). The primary components of other expenses (income) for the nine months ended September 30, 2019 and 2018 are detailed in the table below (in thousands, except percentages):



	Nine Months Ended September 30,
Other Expenses (Income)	2019			2018			Change			% Change

Interest expense⁽¹⁾	$	19,738		$	18,705		$	1,033		6	%
Gain on sale of properties ⁽²⁾	(37		)	(4,629		)	4,592			(99	)%
Loss on sale or disposal of assets	152			256			(104		)	(41	)%
Interest, dividend and other investment income	(550		)	(792		)	242			(31	)%
Total other expense	$	19,303		$	13,540		$	5,763		43	%


⁽¹⁾	The increase in interest expense is primarily attributable to an increase in our average interest rate from 3.8% for the nine months ended September 30, 2018 to 4.1% for the nine months ended September 30, 2019.

⁽²⁾

On September 24, 2018, we completed the sale of Torrey Square, located in Houston, Texas, for $8.7 million. We recorded a gain on sale of $4.4 million. On February 27, 2018, we completed the sale of Bellnott Square, located in Houston, Texas, for $4.7 million. We recorded a gain on sale of $0.2 million. We have not included Bellnott Square or Torrey Square in discontinued operations as neither property sales meets the definition of discontinued operations. Please refer to Note 16 (Real Estate) to the accompanying consolidated financial statements for more information regarding the property sales.

Equity in earnings of real estate partnership. Our equity in earnings of real estate partnership, which is generated from our 81.4% ownership of Pillarstone OP, decreased $282,000 from $1,762,000 for the nine months ended September 30, 2018 to $1,480,000 for the nine months ended September 30, 2019. Please refer to Note 7 (Investment in Real Estate Partnership) to the accompanying consolidated financial statements for more information regarding our investment in Pillarstone OP.

Gain on sale of property from discontinued operations. During the nine months ended September 30, 2019, we received a $0.7 million principal payment in connection with the sale of three office buildings we completed on December 31, 2014. In 2014, we provided seller-financing for the office buildings, Zeta, Royal Crest and Featherwood, and deferred a $2.5 million gain until principal payments on the seller-financed loan are received. The purchaser of the office buildings sold the Zeta property on April 24, 2019 and paid the entire principal balance of the loan related to the Zeta property. As of September 30, 2019, we had a total of $3.5 million in deferred gains for seller-financed loans to be recognized upon receipt of principal payments. The $3.5 million in deferred gains includes amounts from the sales for Royal Crest and Featherwood discussed above and amounts from the sales of Centre South and Webster Pointe that were completed in November 2016.

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	Nine Months Ended September 30,								Percent
	2019			2018		Change			Change
Same Store (51 properties excluding development land)
Property revenues
Rental	$	87,527		$	87,382	$	145		—	%
Management, transaction and other fees	931			991		(60		)	(6	)%
Total property revenues	88,458			88,373		85			—	%

Property expenses
Property operation and maintenance	14,015			14,567		(552		)	(4	)%
Real estate taxes	12,474			12,044		430			4	%
Total property expenses	26,489			26,611		(122		)	—	%

Total same store net operating income	61,969			61,762		207			—	%

Non-Same Store (2 Properties excluding development land)
Property revenues
Rental	—			828		(828		)	Not meaningful
Management, transaction and other fees	—			3		(3		)	Not meaningful
Total property revenues	—			831		(831		)	Not meaningful

Property expenses
Property operation and maintenance	116			152		(36		)	Not meaningful
Real estate taxes	—			216		(216		)	Not meaningful
Total property expenses	116			368		(252		)	Not meaningful

Total Non-Same Store net operating income (loss)	(116		)	463		(579		)	Not meaningful

Pro rata share of real estate partnership	5,152			5,885		(733		)	(12	)%

Total property net operating income	67,005			68,110		(1,105		)	(2	)%

Less total other expenses, excluding pro rata share of real estate partnership net operating income, provision for income taxes, gain on sale of properties, gain (loss) on disposal of assets and gain on sale of properties from discontinued operations	58,913			54,803		4,110			7	%

Net income	$	8,092		$	13,307	$	(5,215	)	(39	)%

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Reconciliation of Non-GAAP Financial Measures

Funds From Operations (NAREIT) (“FFO”)

The National Association of Real Estate Investment Trusts (“NAREIT”) defines FFO as net income (loss) available to common shareholders computed in accordance with GAAP, excluding depreciation and amortization related to real estate, gains or losses from the sale of certain real estate assets, gains and losses from change in control, and impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity. We calculate FFO in a manner consistent with the NAREIT definition and also include adjustments for our unconsolidated real estate partnership.

Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income (loss) alone as the primary measure of our operating performance.

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Because real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself. In addition, securities analysts, investors and other interested parties use FFO as the primary metric for comparing the relative performance of equity REITs.

FFO should not be considered as an alternative to net income or other measurements under GAAP, as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity. FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness. Although our calculation of FFO is consistent with that of NAREIT, there can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs.

Funds From Operations Core (“FFO Core”)

Management believes that the computation of FFO in accordance with NAREIT’s definition includes certain items that are not indicative of the results provided by our operating portfolio and affect the comparability of our period-over-period performance. These items include, but are not limited to, legal settlements, proxy contest fees, debt extension costs, non-cash share-based compensation expense, rent support agreement payments received from sellers on acquired assets, management fees from Pillarstone and acquisition costs. Therefore, in addition to FFO, management uses FFO Core, which we define to exclude such items. Management believes that these adjustments are appropriate in determining FFO Core as they are not indicative of the operating performance of our assets. In addition, we believe that FFO Core is a useful supplemental measure for the investing community to use in comparing us to other REITs as many REITs provide some form of adjusted or modified FFO. However, there can be no assurance that FFO Core presented by us is comparable to the adjusted or modified FFO of other REITs.

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Below are the calculations of FFO and FFO Core and the reconciliations to net income, which we believe is the most comparable U.S. GAAP financial measure (in thousands):



	Three Months Ended September 30,					Nine Months Ended September 30,
FFO (NAREIT) AND FFO-CORE	2019		2018			2019			2018
Net income attributable to Whitestone REIT	$	1,807	$	7,835		$	7,908		$	12,965
Adjustments to reconcile to FFO:⁽¹⁾
Depreciation and amortization of real estate assets	6,718		6,405			19,657			18,836
Depreciation and amortization of real estate assets of real estate partnership (pro rata)⁽²⁾	651		702			1,921			2,127
(Gain) loss on disposal of assets and properties of continuing operations, net	—		(4,377		)	115			(4,373		)
Gain on sale of assets and properties of discontinued operations, net	—		—			(701		)	—
Loss on sale or disposal of properties or assets of real estate partnership (pro rata)⁽²⁾	13		10			20			10
Net income attributable to noncontrolling interests	42		198			184			342
FFO (NAREIT)	$	9,231	$	10,773		$	29,104		$	29,907

Share-based compensation expense	$	1,719	$	1,497		$	4,770		$	4,894
Proxy contest professional fees	—		—			—			2,534
FFO Core	$	10,950	$	12,270		$	33,874		$	37,335


⁽¹⁾	Includes pro-rata share attributable to real estate partnership.


⁽²⁾	Included in equity in earnings of real estate partnership on the consolidated statements of operations and comprehensive income (loss).

Property Net Operating Income (“NOI”)

Management believes that NOI is a useful measure of our property operating performance. We define NOI as operating revenues (rental and other revenues) less property and related expenses (property operation and maintenance and real estate taxes). Other REITs may use different methodologies for calculating NOI and, accordingly, our NOI may not be comparable to other REITs. Because NOI excludes general and administrative expenses, depreciation and amortization, involuntary conversion, interest expense, interest income, provision for income taxes, gain or loss on sale or disposition of assets, and our pro rata share of NOI of equity method investments, it provides a performance measure that, when compared year over year, reflects the revenues and expenses directly associated with owning and operating commercial real estate properties and the impact to operations from trends in occupancy rates, rental rates and operating costs, providing perspective not immediately apparent from net income. We use NOI to evaluate our operating performance since NOI allows us to evaluate the impact that factors such as occupancy levels, lease structure, lease rates and tenant base have on our results, margins and returns. In addition, management believes that NOI provides useful information to the investment community about our property and operating performance when compared to other REITs since NOI is generally recognized as a standard measure of property performance in the real estate industry. However, NOI should not be viewed as a measure of our overall financial performance since it does not reflect general and administrative expenses, depreciation and amortization, involuntary conversion, interest expense, interest income, provision for income taxes and gain or loss on sale or disposition of assets, the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties.

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Below is the calculation of NOI and the reconciliations to net income, which we believe is the most comparable U.S. GAAP financial measure (in thousands):



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
PROPERTY NET OPERATING INCOME	2019			2018			2019			2018
Net income attributable to Whitestone REIT	$	1,807		$	7,835		$	7,908		$	12,965
General and administrative expenses	5,597			4,982			16,514			17,987
Depreciation and amortization	6,789			6,477			19,865			19,044
Equity in earnings of real estate partnership	(524		)	(502		)	(1,480		)	(1,762		)
Interest expense	6,679			6,419			19,738			18,705
Interest, dividend and other investment income	(141		)	(251		)	(550		)	(792		)
Provision for income taxes	102			92			324			261
Gain on sale of assets and properties of continuing operations, net	(37		)	(4,380		)	(37		)	(4,629		)
Gain on sale of assets and properties of discontinued operations, net	—			—			(701		)	—
Management fee, net of related expenses	(14		)	(48		)	(64		)	(149		)
Loss on disposal of assets and properties of continuing operations, net	37			3			152			256
NOI of real estate partnership (pro rata)	1,714			1,875			5,152			5,885
Net income attributable to noncontrolling interests	42			198			184			342
NOI	$	22,051		$	22,700		$	67,005		$	68,113

Liquidity and Capital Resources

Our short-term liquidity requirements consist primarily of distributions to holders of our common shares and OP units, including those required to maintain our REIT status and satisfy our current quarterly distribution target of $0.2850 per share and OP unit, recurring expenditures, such as repairs and maintenance of our properties, non-recurring expenditures, such as capital improvements and tenant improvements, debt service requirements, and, potentially, acquisitions of additional properties.

During the nine months ended September 30, 2019, our cash provided from operating activities was $29,976,000 and our total distributions were $34,840,000. Therefore, we had distributions in excess of cash flow from operations of approximately $4,864,000. We anticipate that cash flows from operating activities and our borrowing capacity under our unsecured revolving credit facility will provide adequate capital for our working capital requirements, anticipated capital expenditures and scheduled debt payments in the short term. We also believe that cash flows from operating activities and our borrowing capacity will allow us to make all distributions required for us to continue to qualify to be taxed as a REIT for federal income tax purposes.

We had approximately $164.0 million in borrowing capacity under our 2019 Facility as of September 30, 2019. Our long-term capital requirements consist primarily of maturities under our longer-term debt agreements, development and redevelopment costs, and potential acquisitions. We expect to meet our long-term liquidity requirements with net cash from operations, long-term indebtedness, sales of common shares, issuance of OP units, sales of underperforming properties and non-core properties and other financing opportunities, including debt financing. We believe we have access to multiple sources of capital to fund our long-term liquidity requirements, including the incurrence of additional debt and the issuance of additional equity. However, our ability to incur additional debt will be dependent on a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions that may be imposed by lenders. Our ability to access the equity markets will be dependent on a number of factors as well, including general market conditions for REITs and market perceptions about our Company.

We expect that our rental income will increase as we continue to acquire additional properties, subsequently increasing our cash flows generated from operating activities. We intend to continue acquiring such additional properties that meet our Community Centered Property^® strategy through equity issuances and debt financing.

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As discussed in Note 12 (Equity) to the accompanying consolidated financial statements, on June 4, 2015, we entered into the 2015 equity distribution agreements. Pursuant to the terms and conditions of the 2015 equity distribution agreements, we could issue and sell up to an aggregate of $50 million of our common shares into the existing trading market at current market prices or at negotiated prices through the placement agents over a period of time and from time to time, pursuant to our Registration Statement on Form S-3 (File No. 333-203727), which expired on April 29, 2018. We did not sell any common shares under the 2015 equity distribution agreements during the three and nine months ended September 30, 2018.

On May 15, 2019, our new universal shelf registration statement on Form S-3 was declared effective by the SEC, allowing us to offer up to $750 million in securities from time to time, including common shares, preferred shares, debt securities, depositary shares and subscription rights.

On May 31, 2019, we entered into the 2019 equity distribution agreements providing for the issuance and sale of up to an aggregate of $100 million of the Company’s common shares. Actual sales will depend on a variety of factors determined by us from time to time, including (among others) market conditions, the trading price of our common shares, capital needs and our determinations of the appropriate sources of funding for us, and were made in transactions that will be deemed to be “at the-market” offerings as defined in Rule 415 under the Securities Act. We have no obligation to sell any of our common shares and can at any time suspend offers under the 2019 equity distribution agreements or terminate the 2019 equity distribution agreements. During the nine months ended September 30, 2019, we sold 679,216 common shares under the 2019 equity distribution agreements, with net proceeds to us of approximately $8.7 million. In connection with such sales, we paid compensation of approximately $132,000 to the sales agents. During the three months ended September 30, 2019, we sold 374,077 common shares under the 2019 equity distribution agreements, with net proceeds to us of approximately $4.8 million. In connection with such sales, we paid compensation of approximately $74,000 to the sales agents.

We have used and anticipate using net proceeds from common shares issued pursuant to the 2019 equity distribution agreements for general corporate purposes, which may include acquisitions of additional properties, the repayment of outstanding indebtedness, capital expenditures, the expansion, redevelopment and/or re-tenanting of properties in our portfolio, working capital and other general purposes.

Our capital structure includes non-recourse mortgage debt that we have assumed or originated on certain properties. We may hedge the future cash flows of certain variable rate debt transactions principally through interest rate swaps with major financial institutions. See Note 9 (Derivatives and Hedging Activities) to the accompanying consolidated financial statements for a description of our current cash flow hedges.

As discussed in Note 8 (Debt) to the accompanying consolidated financial statements, on May 26, 2017, we, through our subsidiary, Whitestone Houston BLVD Place LLC, a Delaware limited liability company, issued a $80.0 million promissory note to American General Life Insurance Company (the “BLVD Note”). The BLVD Note has a fixed interest rate of 3.72% and a maturity date of June 1, 2027. The BLVD Notes requires interest only payments with all principal repayable upon maturity. The BLVD Note is a non-recourse loan secured by the real property located at BLVD Place, including the related equipment, fixtures, personal property and other assets, with a limited carve-out guarantee by the Operating Partnership. Proceeds from the BLVD Note were used to fund a portion of the BLVD Place acquisition.

As discussed in Note 2 (Summary of Significant Accounting Policies) to the accompanying consolidated financial statements, pursuant to the terms of our $15.1 million 4.99% Note, due January 6, 2024 (see Note 8 (Debt) to the accompanying consolidated financial statements), which is collateralized by our Anthem Marketplace property, we were required by the lenders thereunder to establish a cash management account controlled by the lenders to collect all amounts generated by our Anthem Marketplace property in order to collateralize such promissory note. Amounts in the cash management account are classified as restricted cash.

Cash, Cash Equivalents and Restricted Cash

We had cash, cash equivalents and restricted cash of approximately $5,645,000 as of September 30, 2019, as compared to $13,786,000 on December 31, 2018. The decrease of $8,141,000 was primarily the result of the following:

Sources of Cash


•	Cash flow from operations of $29,976,000 for the nine months ended September 30, 2019;


•	Net proceeds of $100,000,000 from issuance of bonds pursuant to the Note Agreement (as defined below);

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•	Proceeds from issuance of common shares, net of offering costs of $8,541,000;


•	Net cash provided from investing activities of discontinued operations of $701,000;

Uses of Cash


•	Payment of distributions to common shareholders and OP unit holders of $34,840,000;


•	Additions to real estate of $9,953,000;


•	Repurchase of common shares of $776,000;


•	Net payments of $90,200,000 to 2019 Facility (as defined below);


•	Payments of notes payable of $7,502,000; and


•	Payments of loan origination costs of $4,088,000.

We place all cash in short-term, highly liquid investments that we believe provide appropriate safety of principal.

Debt

Debt consisted of the following as of the dates indicated (in thousands):



Description	September 30, 2019			December 31, 2018
Fixed rate notes
$10.5 million, 4.85% Note, due September 24, 2020 ⁽¹⁾	$	9,320		$	9,500
$50.0 million, 1.75% plus 1.35% to 1.90% Note, due October 30, 2020 ⁽²⁾	—			50,000
$50.0 million, 1.50% plus 1.35% to 1.90% Note, due January 29, 2021 ⁽³⁾	—			50,000
$100.0 million, 1.73% plus 1.35% to 1.90% Note, due October 30, 2022 ⁽⁴⁾	100,000			100,000
$165.0 million, 2.24% plus 1.35% to 1.90% Note, due January 31, 2024 ⁽⁵⁾	165,000			—
$80.0 million, 3.72% Note, due June 1, 2027	80,000			80,000
$6.5 million 3.80% Note, due January 1, 2019	—			5,657
$19.0 million 4.15% Note, due December 1, 2024	19,000			19,000
$20.2 million 4.28% Note, due June 6, 2023	18,713			18,996
$14.0 million 4.34% Note, due September 11, 2024	13,542			13,718
$14.3 million 4.34% Note, due September 11, 2024	14,300			14,300
$15.1 million 4.99% Note, due January 6, 2024	14,469			14,643
$2.6 million 5.46% Note, due October 1, 2023	2,397			2,430
$50.0 million, 5.09% Note, due March 22, 2029	50,000			—
$50.0 million, 5.17% Note, due March 22, 2029	50,000			—
$1.2 million 4.35% Note, due November 28, 2019	248			—
Floating rate notes
Unsecured line of credit, LIBOR plus 1.40% to 1.90%, due January 1, 2023⁽⁶⁾	86,000			241,200
Total notes payable principal	622,989			619,444
Less deferred financing costs, net of accumulated amortization	(1,252		)	(1,239		)
Total notes payable	$	621,737		$	618,205


⁽¹⁾	Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term through September 24, 2018 and 4.85% beginning September 24, 2018 through September 24, 2020.

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⁽²⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 1 (as defined below) at 0.84% through February 3, 2017 and 1.75% beginning February 3, 2017 through October 30, 2020.


⁽³⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of Term Loan 2 (as defined below) at 1.50%.


⁽⁴⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion at 1.73%.


⁽⁵⁾	Promissory note includes an interest rate swap that fixed the LIBOR portion of the interest rate at an average rate of 2.24% for the duration of the term through January 31, 2024.


⁽⁶⁾	Unsecured line of credit includes certain Pillarstone Properties as of December 31, 2018, in determining the amount of credit available under the 2018 Facility (as defined and described in more detail in Note 8 (Debt) to the accompanying consolidated financial statements) which were released from collateral during 2019.

Scheduled maturities of our outstanding debt as of September 30, 2019 were as follows (in thousands):




Year	Amount Due

2019	$	743
2020	10,801
2021	1,611
2022	101,683
2023	113,863
Thereafter	394,288
Total	$	622,989

The 2019 Facility is comprised of the following three tranches:


•	$250.0 million unsecured revolving credit facility with a maturity date of January 1, 2023 (the “2019 Revolver”);


•	$165.0 million unsecured term loan with a maturity date of January 31, 2024 (“Term Loan A”); and


•	$100.0 million unsecured term loan with a maturity date of October 30, 2022 (“Term Loan B” and together with Term Loan A, the “2019 Term Loans”).

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Borrowings under the 2019 Facility accrue interest (at the Operating Partnership's option) at a Base Rate or an Adjusted LIBOR plus an applicable margin based upon our then existing leverage. As of September 30, 2019, the interest rate was 3.76%. The applicable margin for Adjusted LIBOR borrowings ranges from 1.40% to 1.90% for the 2019 Revolver and 1.35% to 1.90% for the 2019 Term Loans. Base Rate means the higher of: (a) the Agent’s prime commercial rate, (b) the sum of (i) the average rate quoted by the Agent by two or more federal funds brokers selected by the Agent for sale to the Agent at face value of federal funds in the secondary market in an amount equal or comparable to the principal amount for which such rate is being determined, plus (ii) 1/2 of 1.00%, and (c) the LIBOR rate for such day plus 1.00%. Adjusted LIBOR means LIBOR divided by one minus the Eurodollar Reserve Percentage. The Eurodollar Reserve Percentage means the maximum reserve percentage at which reserves are imposed by the Board of Governors of the Federal Reserve System on eurocurrency liabilities. Pursuant to the 2019 Facility, in the event of certain circumstances that result in the unavailability of LIBOR, including but not limited to LIBOR no longer being a widely recognized benchmark rate for newly originated dollar loans in the U.S. market, the Operating Partnership and the Agent will establish an alternate interest rate to LIBOR giving due consideration to prevailing market conventions and will amend the 2019 Facility to give effect to such alternate interest rate. LIBOR is expected to be discontinued after 2021. A number of our current debt agreements have an interest rate tied to LIBOR. Some of these agreements provide procedures for determining an alternative base rate in the event that LIBOR is discontinued, but not all do so. Regardless, there can be no assurances as to what alternative base rates may be and whether such base rate will be more or less favorable than LIBOR and any other unforeseen impacts of the potential discontinuation of LIBOR. The Company intends to monitor the developments with respect to the potential phasing out of LIBOR after 2021 and work with its lenders to ensure any transition away from LIBOR will have minimal impact on its financial condition, but can provide no assurances regarding the impact of the discontinuation of LIBOR.


•	maximum total indebtedness to total asset value ratio of 0.60 to 1.00;


•	maximum secured debt to total asset value ratio of 0.40 to 1.00;


•	minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges ratio of 1.50 to 1.00;


•	maximum other recourse debt to total asset value ratio of 0.15 to 1.00; and


•	maintenance of a minimum tangible net worth (adjusted for accumulated depreciation and amortization) of $372 million plus 75% of the net proceeds from additional equity offerings (as defined therein).

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•	maximum total indebtedness to total asset value ratio of 0.60 to 1.00;


•	maximum secured debt to total asset value ratio of 0.40 to 1.00;


•	minimum EBITDA (earnings before interest, taxes, depreciation, amortization or extraordinary items) to fixed charges ratio of 1.50 to 1.00;


•	maximum other recourse debt to total asset value ratio of 0.15 to 1.00; and


•	maintenance of a minimum tangible net worth (adjusted for accumulated depreciation and amortization) of $372 million plus 75% of the net proceeds from additional equity offerings (as defined therein).

The Note Agreement also contains default provisions, including defaults for non-payment, breach of representations and warranties, insolvency, non-performance of covenants, cross-defaults with other indebtedness and guarantor defaults. The occurrence of an event of default under the Note Agreement could result in the Purchasers accelerating the payment of all obligations under the Notes. The financial and restrictive covenants and default provisions in the Note Agreement are substantially similar to those contained in the Operating Partnership’s existing credit facility.

Net proceeds from the Private Placement will be used to refinance existing indebtedness. The Notes have not been and will not be registered under the Securities Act of 1933, as amended (the “Securities Act”), and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the Securities Act. The Notes were sold in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act.

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defined in the 2018 Facility and had received two waivers in 2018. Had we been unable to obtain a waiver or other suitable relief from the lenders under the 2018 Facility, an Event of Default (as defined in the 2018 Facility) would have occurred, permitting the lenders holding a majority of the commitments under the 2018 Facility to, among other things, accelerate the outstanding indebtedness, which would make it immediately due and payable. The 2019 Facility and the Notes contain similar tangible Net Worth covenants that reset at a new threshold and change the definition of Net Worth to add back accumulated depreciation. However, we can make no assurances that we will be in compliance with these covenants or other covenants under the 2019 Facility or the Notes in future periods or, if we are not in compliance, that we will be able to obtain a waiver. As of September 30, 2019, we were in compliance with all loan covenants.

Refer to Note 8 (Debt) to the accompanying consolidated financial statements for additional information regarding debt.

Capital Expenditures

We continually evaluate our properties’ performance and value. We may determine it is in our shareholders’ best interest to invest capital in properties that we believe have potential for increasing value. We also may have unexpected capital expenditures or improvements for our existing assets. Additionally, we intend to continue investing in similar properties outside of the markets on which we focus in cities with exceptional demographics to diversify market risk, and we may incur significant capital expenditures or make improvements in connection with any properties we may acquire.

Contractual Obligations

On March 22, 2019, we, through our Operating Partnership, entered into the Note Agreement together with the Purchasers providing for the issuance and sale of $100 million of senior unsecured notes of the Operating Partnership that mature in March 2029, with annual amortization of principal beginning in 2023 on $50 million of the senior unsecured notes in the amount of $7.1 million and in 2025 on $50 million of the senior unsecured notes in the amount of $10.0 million. Refer to Note 8 (Debt) to the accompanying consolidated financial statements for additional information regarding the Note Agreement.

On January 31, 2019, we, through our Operating Partnership, entered into the 2019 Facility. The 2019 Facility amended and restated our previous unsecured revolving credit facility, dated November 7, 2014, as amended on October 30, 2015 and December 8, 2016. Refer to Note 8 (Debt) to the accompanying consolidated financial statements for additional information regarding the 2019 Facility.

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Distributions

The following table summarizes the cash distributions paid or payable to holders of our common shares and noncontrolling OP units during each quarter of 2018 and the nine months ended September 30, 2019 (in thousands, except per share data):



	Common Shares				Noncontrolling OP Unit Holders				Total
Quarter Paid	Distributions Per Common Share		Amount Paid		Distributions Per OP Unit		Amount Paid		Amount Paid
2019
Third Quarter	$	0.2850	$	11,430	$	0.2850	$	264	$	11,694
Second Quarter	0.2850		11,316		0.2850		265		11,581
First Quarter	0.2850		11,301		0.2850		264		11,565
Total	$	0.8550	$	34,047	$	0.8550	$	793	$	34,840

2018
Fourth Quarter	$	0.2850	$	11,302	$	0.2850	$	265	$	11,567
Third Quarter	0.2850		11,294		0.2850		286		11,580
Second Quarter	0.2850		11,203		0.2850		295		11,498
First Quarter	0.2850		11,145		0.2850		309		11,454
Total	$	1.1400	$	44,944	$	1.1400	$	1,155	$	46,099

Taxes

We elected to be taxed as a REIT under the Code beginning with our taxable year ended December 31, 1999. As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates. We believe that we are organized and operate in a manner to qualify and be taxed as a REIT, and we intend to operate so as to remain qualified as a REIT for federal income tax purposes.

Environmental Matters

Our properties are subject to environmental laws and regulations adopted by various governmental authorities in the jurisdictions in which our operations are conducted. From our inception, we have incurred no significant environmental costs, accrued liabilities or expenditures to mitigate or eliminate future environmental contamination.

Off-Balance Sheet Arrangements

Guarantees. We may guarantee the debt of a real estate partnership primarily because it allows the real estate partnership to obtain funding at a lower cost than could be obtained otherwise. This results in a higher return for the real estate partnership on its investment, and a higher return on our investment in the real estate partnership. We may receive a fee from the real estate partnership for providing the guarantee. Additionally, when we issue a guarantee, the terms of the real estate partnership’s partnership agreement typically provide that we may receive indemnification from the real estate partnership or have the ability to increase our ownership interest. See Note 7 (Investment in Real Estate Partnership) to the accompanying consolidated financial statements for information related to our guarantee of our real estate partnership’s debt.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Our future income, cash flows and fair value relevant to our financial instruments depend upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Based upon the nature of our operations, we are not subject to foreign exchange rate or commodity price risk. The principal market risk to which we are exposed is the risk related to interest rate fluctuations. Many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control contribute to interest rate risk. Our interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To achieve this objective, we manage our exposure to fluctuations in market interest rates for our borrowings through the use of fixed rate debt instruments to the extent that reasonably favorable rates are obtainable.

All of our financial instruments were entered into for other than trading purposes.

Fixed Interest Rate Debt

As of September 30, 2019, $537.0 million, or approximately 86% of our total outstanding debt, was subject to fixed interest rates, which limit the risk of fluctuating interest rates. Although a change in the market interest rates affects the fair market value of our fixed interest rate debt, it does not impact net income to shareholders or cash flows. Our total outstanding fixed interest rate debt had an average effective interest rate as of September 30, 2019 of approximately 4.1% per annum with scheduled maturities ranging from 2019 to 2029 (see Note 8 (Debt) to the accompanying consolidated financial statements for further detail). Holding other variables constant, a 1% increase or decrease in interest rates would cause a $22.6 million decline or increase, respectively, in the fair value for our fixed rate debt.

Variable Interest Rate Debt

As of September 30, 2019, $86.0 million, or approximately 14% of our outstanding debt, was subject to floating interest rates of LIBOR plus 1.40% to 1.90% and not currently subject to a hedge. The impact of a 1% increase or decrease in interest rates on our non-hedged variable rate debt would result in a decrease or increase of annual net income of approximately $0.9 million, respectively.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company’s management is responsible for establishing and maintaining adequate disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Disclosure controls and procedures means controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of September 30, 2019, our principal executive and financial officers have concluded that such disclosure controls and procedures were effective.

Previously Identified Material Weakness

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

As described in additional detail in the Annual Report on Form 10-K for the year ended 2018, the Company did not maintain effective controls with respect to the application of new accounting pronouncements, including proper assessment of judgment items in complex accounting transactions. This material weakness was remediated as of June 30, 2019.

Remediation of Material Weakness

We completed and tested the following remediation efforts during the first and second quarters of 2019 with:

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•

The formation and implementation of a disclosure review committee, including outside technical advisors, the Chief Financial Officer, accounting staff, and other members of management. The committee meets quarterly, at a minimum, to provide guidance and oversight to ensure the proper implementation of the enhanced internal controls regarding the adoption of new accounting pronouncements. The committee met twice and reviewed its work with the Audit Committee prior to filing of the Quarterly Report on Form 10-Q for the three months ended March 31, 2019 and met once and reviewed its work with the Audit Committee prior to the filing of the Quarterly Report on Form 10-Q for the three and six months ended June 30, 2019.


•	Enhancements to our internal controls regarding the adoption of new accounting pronouncements, including quarterly review of new accounting pronouncements with the Audit Committee and a discussion of key judgment areas.


•	Engagement of outside technical experts to assist the Company in the application and adoption of new accounting pronouncements.


•	Completion of training of accounting personnel.


•	The hiring of additional qualified accounting staff.

As a result of the implementation of the remediation efforts above and based on our evaluation of our disclosure controls and procedures as of September 30, 2019, our principal executive and principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There have been no significant changes in our internal control over financial reporting during the nine months ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting other than the remediation of material weakness discussed above.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Item 1A. Risk Factors.

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of Whitestone’s Annual Report on Form 10-K for the year ended December 31, 2018 and Quarterly Report on Form 10-Q for the quarter ended March 31 and June 30, 2019.

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


(a)	During the period covered by this Form 10-Q, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended.


(b)	Not applicable.


(c)	During the three months ended September 30, 2019, certain of our employees tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted common shares issued under the 2018 Plan. The following table summarizes all of these repurchases during the three months ended September 30, 2019.

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Period	Total Number of Shares Purchased ⁽¹⁾	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs
July 1, 2019 through July 31, 2019	—	$	—	N/A	N/A
August 1, 2019 through August 31, 2019	—	—		N/A	N/A
September 1, 2019 through September 30, 2019	—	—		N/A	N/A
Total	—	$	—

⁽¹⁾ The number of shares purchased represents common shares held by employees who tendered owned common shares to satisfy the tax withholding on the lapse of certain restrictions on restricted common shares issued under the 2018 Plan. With respect to these shares, the price paid per share is based on the fair market value at the time of tender.

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.

The exhibits listed on the accompanying Exhibit Index are filed, furnished and incorporated by reference (as stated therein) as part of this Report.

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EXHIBIT INDEX



Exhibit No.	Description



3.1.1	Articles of Amendment and Restatement of Whitestone REIT (previously filed as and incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K, filed on July 31, 2008)



3.1.2	Articles Supplementary (previously filed as and incorporated by reference to Exhibit 3(i).1 to the Registrant's Current Report on Form 8-K, filed on December 6, 2006)



3.1.3	Articles of Amendment (previously filed as and incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K, filed on August 24, 2010)



3.1.4	Articles of Amendment (previously filed as and incorporated by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K, filed on August 24, 2010)



3.1.5	Articles Supplementary (previously filed as and incorporated by reference to Exhibit 3.3 to the Registrant's Current Report on Form 8-K, filed on August 24, 2010)



3.1.6	Articles of Amendment (previously filed as and incorporated by reference to Exhibit 3.1.1 to the Registrant's Current Report on Form 8-K, filed on June 27, 2012)



3.1.7	Articles of Amendment (previously filed as and incorporated by reference to Exhibit 3.1.2 to the Registrant's Current Report on Form 8-K, filed on June 27, 2012)



3.2	Amended and Restated Bylaws of Whitestone REIT (previously filed as and incorporated by reference to Exhibit 3.1 to the Registrant's Current Report on Form 8-K, filed on October 9, 2008)



31.1*	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



31.2*	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



32.1**	Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



32.2**	Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



101.INS***	XBRL Instance Document

101.SCH***	XBRL Taxonomy Extension Schema Document

101.CAL***	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB***	XBRL Taxonomy Extension Label Linkbase Document

101.PRE***	XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF***	XBRL Taxonomy Extension Definition Linkbase Document

________________________

* Filed herewith.

** Furnished herewith.

*** The following financial information of the Registrant for the quarter ended September 30, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018, (ii) the Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2019 and 2018 (unaudited), (iii) the Consolidated Statements of Changes in Equity for the three months ended March 31, June 30, and September 30, 2019 and 2018 (unaudited), (iv) the Consolidated Statement of Cash Flows for the nine months ended September 30, 2019 and 2018 (unaudited) and (v) the Notes to the Consolidated Financial Statements (unaudited).

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SIGNATURES

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



		WHITESTONE REIT
Date:	November 4, 2019	/s/ James C. Mastandrea
		James C. Mastandrea
		Chief Executive Officer
		(Principal Executive Officer)



Date:	November 4, 2019	/s/ David K. Holeman
		David K. Holeman
		Chief Financial Officer
		(Principal Financial and Principal Accounting Officer)

Whitestone REIT - 10-Q quarterly report FY2019 Q3

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