Item 1. Business.
General
We own and operate commercial properties in culturally diverse markets in major metropolitan areas. We are a subsidiary of Whitestone, and together, our real estate portfolio of 60 properties contains approximately 5.0 million square feet of gross leasable area, located in Texas, Arizona and Illinois. The portfolio has a gross book value of approximately $546 million and book partners' capital of approximately $221 million as of December 31, 2013.
We were formed under the terms of a limited partnership agreement, or the Agreement, dated December 31, 1998 in the state of Delaware. We are controlled and managed by Whitestone in its capacity as our sole general partner. In addition, Whitestone owned 97.5% of our outstanding units of limited partnership interest ("OP units"), as of December 31, 2013, with the remaining 2.5% of our outstanding OP units held by other limited partners.
All of our limited partners own limited partnership interests in the form of OP units, which may be redeemed for cash or, at the option of Whitestone, Whitestone common shares on a one-for-one basis. Holders of our OP units receive distributions from us at the same rate per OP unit as dividends per common share of Whitestone.
Whitestone currently conducts substantially all of its operations and activities through us and our wholly-owned subsidiaries. As our sole general partner, Whitestone has the exclusive power to manage and conduct our business, subject to certain customary exceptions. Whitestone is a Maryland REIT and was founded in 1998. Whitestone has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code").
Our OP units are not traded on a national securities exchange. Whitestone's common shares of beneficial interest, par value $0.001 per share, are traded on the New York Stock Exchange (the "NYSE") under the ticker symbol "WSR." Our offices are located at 2600 South Gessner, Suite 500, Houston, Texas 77063. Our telephone number is (713) 827-9595 and Whitestone maintains a website at www.whitestonereit.com. The contents of Whitestone's website are not incorporated into this filing.
Our Strategy
In October 2006, Whitestone's 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. We have a diversified tenant base concentrated on service offerings including medical, educational, casual dining and convenience services. Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property. Whitestone employs and develops a diverse group of associates who understand the needs of our multicultural communities and tenants.
Our primary business objective is to increase partner value by acquiring, owning and operating Community Centered Properties. The key elements of our strategy include:
•
Strategically Acquiring Properties.
◦
Seeking High Growth Markets. We seek to strategically acquire commercial properties in high-growth markets. Our acquisition targets are located in densely populated, culturally diverse neighborhoods, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston.
◦
Diversifying Geographically. Our current portfolio is concentrated in Houston and Phoenix. We believe that continued geographic diversification in markets where we have substantial knowledge and experience will help offset the economic risk from a single market concentration. We intend to continue to focus our expansion efforts on the Phoenix, Chicago, Dallas and San Antonio markets. We believe our management infrastructure and capacity can accommodate substantial growth in those markets. We may also pursue opportunities in other Southwestern and Western regions that are consistent with our Community Centered Property strategy.
◦
Capitalizing on Availability of Distressed Assets. We believe that currently and during the next several years there will continue to be excellent opportunities in our target markets to acquire quality properties at historically attractive prices. We intend to acquire distressed assets directly from owners or financial institutions holding foreclosed real estate and debt instruments that are either in default or on bank watch lists. Many of these assets may benefit from our corporate strategy and the experience of Whitestone's management team in turning around distressed properties, portfolios and companies. We have extensive relationships with community banks, attorneys, title companies, and others in the real estate industry with whom we regularly work to identify properties for potential acquisition.
•
Redeveloping and Re-tenanting Existing Properties. We “turn around” properties and seek to add value through renovating and re-tenanting our properties to create Whitestone-branded Community Centered Properties. We seek to accomplish this by (1) stabilizing occupancy, with per property occupancy goals of 90% or higher; (2) adding leasable square footage to existing structures; (3) developing and building on excess land; (4) upgrading and renovating existing structures; and (5) investing significant effort in recruiting tenants whose goods and services meet the needs of the surrounding neighborhood.
•
Recycling Capital for Greater Returns. We seek to continually upgrade our portfolio by opportunistically selling properties that do not have the potential to meet our Community Centered Property strategy and redeploying the sale proceeds into properties that better fit our strategy. Some of our properties that were acquired prior to the tenure of Whitestone's current management team may not fit our Community Centered Property strategy, and we may look for opportunities to dispose of these properties as we continue to execute our strategy.
•
Prudent Management of Capital Structure. We currently have 41 properties that are not mortgaged. We may seek to add mortgage indebtedness to existing and newly acquired unencumbered properties to provide additional capital for acquisitions. As a general policy, we intend to maintain a ratio of total indebtedness to undepreciated book value of real estate assets that is less than 60%. As of December 31, 2013, our ratio of total indebtedness to undepreciated book value of real estate assets was 48%.
•
Investing in People. We believe that our people are the heart of our culture, philosophy and strategy. Whitestone continually focuses on developing associates who are self-disciplined and motivated and display at all times a high degree of character and competence. Whitestone provides them with equity incentives to align their interests with those of its shareholders and our partners.
Our Structure
Substantially all of Whitestone's business is conducted through us. Whitestone is our sole general partner. As of December 31, 2013, Whitestone owned an approximate 97.5% interest in us.
As of December 31, 2013, we owned a real estate portfolio consisting of 60 properties located in three states. As of December 31, 2013 and 2012, our Operating Portfolio Occupancy Rate was 88% and 87%, respectively, based on gross leasable area. We define Operating Portfolio Occupancy Rate as physical occupancy on all properties, excluding (i) new acquisitions, through the earlier of attainment of 90% occupancy or 18 months of ownership, and (ii) properties that are undergoing significant redeveloping or re-tenanting.
Whitestone directly manages the operations and leasing of our properties. Substantially all of our revenues consist of base rents received under varying term leases. For the year ended December 31, 2013, our total revenues were approximately $62.1 million. Approximately 60% of our existing leases contain “step up” rental clauses that provide for increases in the base rental payments.
As of December 31, 2013, we had two properties that when combined, accounted for more than 10% of total gross revenue and real estate assets. Uptown Tower is an office building located in Dallas, Texas that accounted for 5.9% of our total revenue for the year ended December 31, 2013. Uptown Tower also accounted for 3.3% of our real estate assets, net of accumulated depreciation, for the year ended December 31, 2013. Village Square at Dana Park ("Dana Park"), a retail community purchased on September 21, 2012 and located in the Mesa submarket of Phoenix, Arizona, accounted for 9.2% of our total revenue for the year ended December 31, 2013. Dana Park also accounted for 9.5% of our real estate assets, net of accumulated depreciation, for the year ended December 31, 2013. Of our 60 properties, 31 are located in the Houston, Texas metropolitan area.
Economic Factors
The recent challenging economic conditions continue to negatively impact the volume of real estate transactions, occupancy levels, tenants’ ability to pay rent and cap rates. Each of these factors could negatively impact the value of public real estate companies, including ours. However, the majority of our retail properties are located in densely populated metropolitan areas and are occupied by tenants that generally provide basic necessity-type items and services which have tended to be less affected by economic changes. Furthermore, our portfolio is primarily positioned in metropolitan areas in Texas that have been impacted less by the economic slowdown compared to other metropolitan areas.
Competition
All of our properties are located in areas that include competing properties. The amount of competition in a particular area could impact our ability to acquire additional real estate, sell current real estate, lease space and the amount of rent we are able to charge. We may be competing with owners, developers and operators, including, but not limited to, real estate investors, REITs, insurance companies and pension funds.
Should we decide to dispose of a property, we may compete with third-party sellers of similar types of commercial properties for suitable purchasers, which may result in our receiving lower net proceeds from a sale or in our not being able to dispose of such property at a time of our choosing due to the lack of an acceptable return. In operating and managing our properties, we compete for tenants based upon a number of factors including, but not limited to, location, rental rates, security, flexibility, expertise to design space to meet prospective tenants' needs and the manner in which the property is operated, maintained and marketed. We may be required to provide rent concessions, incur charges for tenant improvements and other inducements, or we may not be able to timely lease vacant space, all of which could adversely impact our results of operations.
Many of our competitors have greater financial and other resources than us and also may have more operating experience. Generally, there are other neighborhood and community retail centers within relatively close proximity to each of our properties. There is, however, no dominant competitor in the Houston, Dallas, San Antonio, Phoenix or Chicago metropolitan areas. Our retail tenants also face increasing competition from outlet malls, internet retailers, catalog companies, direct mail and telemarketing.
Compliance with Governmental Regulations
Under various federal and state environmental laws and regulations, as an owner or operator of real estate, we may be required to investigate and clean up certain hazardous or toxic substances, asbestos-containing materials, or petroleum product releases at our properties. We may also be held liable to a governmental entity or to third parties for property damage and for investigation and cleanup costs incurred by those parties in connection with any such contamination. In addition, some environmental laws create a lien on a contaminated site in favor of the government for damages and costs the government incurs in connection with contamination on the site. The presence of contamination or the failure to remediate contaminations at any of our properties may adversely affect our ability to sell or lease the properties or to borrow using the properties as collateral. We could also be liable under common law to third parties for damages and injuries resulting from environmental contamination coming from our properties.
We will not purchase any property unless we are generally satisfied with the environmental status of the property. We may obtain a Phase I environmental site assessment, which includes a visual survey of the building and the property in an attempt to identify areas of potential environmental concerns, visually observing neighboring properties to assess surface conditions or activities that may have an adverse environmental impact on the property, and contacting local governmental agency personnel and performing a regulatory agency file search in an attempt to determine any known environmental concerns in the immediate vicinity of the property. A Phase I environmental site assessment does not generally include any sampling or testing of soil, groundwater or building materials from the property.
We believe that our properties are in compliance in all material respects with all applicable federal, state and local laws and regulations regarding the handling, discharge and emission of hazardous or toxic substances. Because release of chlorinated solvents can occur as a result of dry cleaning operations, we participate in the Texas Commission on Environmental Quality Dry Cleaner Remediation Program ("DCRP") with respect to four of our properties that currently or previously had a dry cleaning facility as a tenant. The DCRP administers the Dry Cleaning Remediation fund to assist with remediation of contamination caused by dry cleaning solvents.
We have not been notified by any governmental authority, and are not otherwise aware of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of our present or former properties. Nevertheless, it is possible that the environmental assessments conducted thus far and currently available to us do not reveal all potential environmental liabilities. It is also possible that subsequent investigations will identify material contamination or other adverse conditions, that adverse environmental conditions have arisen subsequent to the performance of the environmental assessments, or that there are material environmental liabilities of which management is unaware.
Under the Americans with Disabilities Act ("ADA"), all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons. Our properties must comply with the ADA to the extent that they are considered “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. In addition, we will continue to assess our compliance with the ADA and to make alterations to our properties as required.
Employees
As of December 31, 2013, we had no employees, and Whitestone employed 68 persons. We rely on Whitestone for management and administrative services. As the management and employees of Whitestone work for the benefit of the Operating Partnership, the costs and expenses of Whitestone have been presented in this report in a manner consistent with Whitestone's presentation in its Annual Report on Form 10-K.
Materials Available on Our Website
Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports, as well as Reports on Forms 3, 4 and 5 regarding Whitestone's management's officers, trustees or any of our 10% beneficial owners, filed or furnished pursuant to Section 13(a), 15(d) or 16(a) of the Securities Exchange Act of 1934 (the "Exchange Acts") are available on the website of the Securities and Exchange Commission's ("SEC") at www.sec.gov. You may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, on official business days during the hours of 10:00 am to 3:00 pm Eastern. You may obtain information on the operation of the SEC's Public Reference Room by calling the SEC at 1-800-SEC-0330.
Copies of Whitestone's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, as well as Reports on Forms 3, 4 and 5 regarding Whitestone's officers, trustees or 10% beneficial owners, filed or furnished pursuant to Section 13(a), 15(d) or 16(a) of the Exchange Act are also available free of charge through its website at www.whitestonereit.com, as soon as reasonably practicable after it electronically files the material with, or furnishes it to, the SEC. Whitestone has also made available on its website copies of its Audit Committee Charter, Compensation Committee Charter, Nominating and Governance Committee Charter, Insider Trading Compliance Policy, and Code of Business Conduct and Ethics Policy. In the event of any changes to these charters or the code or guidelines, changed copies will also be made available on Whitestone's website. Materials on Whitestone's website are not part of its Annual Report on Form 10-K and will not be part of our Annual Report on Form 10-K and such materials are not incorporated herein by reference.
Financial Information
Additional financial information related to us is included in Item 8 “Financial Statements and Supplementary Data.”
Item 1A.
Item 1A. Risk Factors.
In addition to the other information contained in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition, results of operations or the trading price of Whitestone's common shares could be materially adversely affected by any of these risks. Please note that additional risks not presently known to us or which we currently consider immaterial may also impair our business and operations.
Risks Associated with Real Estate
Recent market disruptions may significantly and adversely affect our financial condition and results of operations.
The U.S. economy is still experiencing weakness from recent economic conditions, which resulted in increased unemployment, weakening of tenant financial condition, large-scale business failures and tight credit markets. Our results of operations may be sensitive to changes in overall economic conditions that impact tenants of our properties or tenant leasing practices. Adverse economic conditions affecting tenant income, such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs and other matters, could reduce overall tenant leasing or cause tenants to shift their leasing practices. In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. Although the U.S. economy appears to have emerged from the worst aspects of the recent recession, high levels of unemployment have persisted, and rental rates and valuations for retail space have not fully recovered to pre-recession levels and may not for a number of years. At this time, it is difficult to determine the breadth and duration of the impact of the economic and financial market problems and the many ways in which they could affect our tenants and our business in general. A general reduction in consumer spending and the level of tenant leasing could adversely affect our ability to maintain our current tenants and gain new tenants, affecting our growth and profitability. Accordingly, continuation or further worsening of these difficult financial and macroeconomic conditions could have a significant adverse effect on our cash flows, profitability, results of operations and the trading price of Whitestone's common shares.
Real estate property investments are illiquid due to a variety of factors and therefore we may not be able to dispose of properties when appropriate or on favorable terms.
Our strategy includes opportunistically selling properties that do not have the potential to meet our Community Centered Property strategy. However, real estate property investments generally cannot be disposed of quickly. In addition, the Code imposes certain restrictions on the ability of a REIT to dispose of properties that are not applicable to other types of real estate companies. Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on favorable terms, which could cause us to incur extended losses, reduce our cash flows and adversely affect distributions to partners.
We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. To the extent we are unable to sell any properties for our book value, we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income.
We may be required to expend funds and time to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements, which may impede our ability to sell a property. Further, we may agree to transfer restrictions that materially restrict us from selling a property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These transfer restrictions could impede our ability to sell a property even if we deem it necessary or appropriate. These facts and any others that would further contribute to the illiquid character of real estate properties and impede our ability to respond to adverse changes in the performance of our properties may have a material adverse effect on our business, financial condition, results of operations, our ability to make distributions to our partners and the trading price of Whitestone's common shares.
Our business is dependent upon our tenants successfully operating their businesses, and their failure to do so could have a material adverse effect on our ability to successfully and profitably operate our business.
We depend on our tenants to operate their businesses in a manner which generates revenues sufficient to allow them to meet their obligations to us, including their obligations to pay rent, maintain certain insurance coverage, pay real estate taxes and maintain the properties in a manner so as not to jeopardize their operating licenses or regulatory status. The ability of our tenants to fulfill their obligations under our leases may depend, in part, upon the overall profitability of their operations. Cash flow generated by certain tenant businesses may not be sufficient for a tenant to meet its obligations to us. Our financial position could be weakened and our ability to fulfill our obligations under our indebtedness could be limited if a number of our tenants were unable to meet their obligations to us or failed to renew or extend their relationship with us as their lease terms expire, or if we were unable to lease or re-lease our properties on economically favorable terms. These adverse developments could arise due to a number of factors, including those described in the risk factors discussed in this Annual Report on Form 10-K.
Turmoil in capital markets could adversely impact acquisition activities and pricing of real estate assets.
Volatility in capital markets could adversely affect acquisition activities by impacting certain factors, including the tightening of underwriting standards by lenders and credit rating agencies and the significant inventory of unsold collateralized mortgage backed securities in the market. These factors directly affect a lender's ability to provide debt financing as well as increase the cost of available debt financing. As a result, we may not be able to obtain favorable debt financing in the future or at all. This may impair our ability to acquire properties or result in future acquisitions generating lower overall economic returns, which may adversely affect our results of operations and distributions to partners. Furthermore, any turmoil in the capital markets could adversely impact the overall amount of capital available to invest in real estate, which may result in price or value decreases of real estate assets.
The value of investments in our OP units will be directly affected by general economic and regulatory factors we cannot control or predict.
Investments in real estate typically involve a high level of risk as the result of factors we cannot control or predict. One of the risks of investing in real estate is the possibility that our properties will not generate income sufficient to meet operating expenses or will generate income and capital appreciation, if any, at rates lower than those anticipated or available through investments in comparable real estate or other investments. The following factors may affect income from properties and yields from investments in properties and are generally outside of our control:
•
conditions in financial markets;
•
over-building in our markets;
•
a reduction in rental income as the result of the inability to maintain occupancy levels;
•
adverse changes in applicable tax, real estate, environmental or zoning laws;
•
changes in general economic conditions or economic conditions in our markets;
•
a taking of any of our properties by eminent domain;
•
adverse local conditions (such as changes in real estate zoning laws that may reduce the desirability of real estate in the area);
•
acts of God, such as hurricanes, earthquakes or floods and other uninsured losses;
•
changes in supply of or demand for similar or competing properties in an area;
•
changes in interest rates and availability of permanent debt capital, which may render the sale of a property difficult or unattractive; and
•
periods of high interest rates, inflation or tight money supply.
Some or all of these factors may affect our properties, which could adversely affect our operations and ability to make distributions to partners.
We may face significant competition in our efforts to acquire financially distressed properties and debt.
Our acquisition strategy includes acquiring distressed commercial real estate, and we could face significant competition from other investors, REITs, hedge funds, private equity funds and other private real estate investors with greater financial resources and access to capital than us. Therefore, we may not be able to compete successfully for investments. In addition, the number of entities and the amount of purchasers competing for suitable investments may increase, all of which could result in competition for accretive acquisition opportunities and adversely affect our business plan and our ability to maintain our current distribution rate.
All of our properties are subject to property taxes that may increase in the future, which could adversely affect our cash flow.
Our properties are subject to property taxes that may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities. As the owner of the properties we are ultimately responsible for payment of the taxes to the government. If property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes. In addition, we will generally be responsible for property taxes related to any vacant space in our properties.
Our assets may be subject to impairment charges.
We periodically evaluate our real estate investments and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, tenant performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the asset, which could have a material adverse effect on our results of operations and funds from operations in the period in which the write-off occurs.
Compliance or failure to comply with laws requiring access to our properties by disabled persons could result in substantial cost.
The ADA and other federal, state and local laws generally require public accommodations be made accessible to disabled persons. Noncompliance could result in the imposition of fines by the government or the award of damages to private litigants. These laws may require us to modify our existing properties. These laws may also restrict renovations by requiring improved access to such buildings by disabled persons or may require us to add other structural features which increase our construction costs. Legislation or regulations adopted in the future may impose further obligations or restrictions on us with respect to improved access by disabled persons. We may incur unanticipated expenses that may be material to our financial condition or results of operations to comply with ADA and other federal, state and local laws, or in connection with lawsuits brought by private litigants.
We face intense competition, which may decrease, or prevent increases of, the occupancy and rental rates of our properties.
We compete with a number of developers, owners and operators of commercial real estate, many of whom own properties similar to ours in the same markets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our tenants' leases expire. This competitive environment could have a material adverse effect on our ability to lease our properties or any newly developed or acquired property, as well as on the rents charged.
Risks Associated with Our Operations
Because a majority of our gross leasable area is in the Houston and Phoenix metropolitan areas, an economic downturn in either area could adversely impact our operations and ability to make distributions to our partners.
The majority of our assets and revenues are currently derived from properties located in the Houston and Phoenix metropolitan area. As of December 31, 2013, we had 48% and 37% of our gross leasable area in Houston and Phoenix, respectively. Our results of operations are directly contingent on our ability to attract financially sound commercial tenants. A significant economic downturn in the Houston or Phoenix metropolitan area may adversely impact our ability to locate and retain financially sound tenants and could have an adverse impact on our tenants' revenues, costs and results of operations and may adversely affect their ability to meet their obligations to us. Likewise, we may be required to lower our rental rates to attract desirable tenants in such an environment. Consequently, because of the geographic concentration among our current assets, if the Houston or Phoenix metropolitan area experiences an economic downturn, our operations and ability to make distributions to our partners could be adversely impacted.
We lease our properties to approximately 1,200 tenants, with leases for approximately 10% to 20% of our gross leasable area expiring annually. Each year we face the risk of non-renewal of a material percentage of our leases and the cost of re-leasing a significant amount of our available space, and our failure to meet leasing targets and control the cost of re-leasing our properties could adversely affect our rental revenue, operating expenses and results of operations.
The nature of our business model warrants shorter term leases to smaller, non-national tenants, and substantially all of our revenues consist of base rents received under these leases. As of December 31, 2013, approximately 35% of the aggregate gross leasable area of our properties is subject to leases that expire prior to December 31, 2015. We are subject to the risk that:
•
tenants may choose not to, or may not have the financial resources to, renew these leases;
•
we may experience significant costs associated with re-leasing a significant amount of our available space;
•
we may not be able to easily re-lease the space subject to these leases, which may cause us to fail to meet our leasing targets or control the costs of re-leasing; and
•
the terms of any renewal or re-lease may be less favorable than the terms of the current leases.
We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While our early renewal program and other leasing and marketing efforts target these expiring leases, and while we hope to re-lease most of that space prior to expiration of the leases at rates comparable to or slightly in excess of the current rates, market conditions, including new supply of properties, and macroeconomic conditions in our markets and nationally could adversely impact our renewal rate and/or the rental rates we are able to negotiate. If any of these risks materialize, our rental revenue, operating expenses and results of operations could be adversely affected.
Many of our tenants are small businesses, which may have a higher risk of bankruptcy or insolvency.
Many of our tenants are small businesses that depend primarily on cash flows from their operations to pay their rent and without other resources could be at a higher risk of bankruptcy or insolvency than larger, national tenants. If tenants are unable to comply with the terms of our leases, we may be forced to modify the leases in ways that are unfavorable to us. Alternatively, the failure of a tenant to perform under a lease could require us to declare a default, repossess the space and find a suitable replacement tenant. There is no assurance that we would be able to lease the space on substantially equivalent or better terms than the prior lease, or at all, or successfully reposition the space for other uses. If one or more of our tenants files for bankruptcy relief, the Bankruptcy Code provides that a debtor has the option to assume or reject the unexpired lease within a certain period of time.
Any bankruptcy filing by or relating to one or more of our tenants could bar all efforts by us to collect pre-bankruptcy debts from that tenant or seize its property. A tenant bankruptcy could also delay our efforts to collect past due balances under the lease and could ultimately preclude collection of all or a portion of these sums. It is possible that we may recover substantially less than the full value of any unsecured claims we hold, if any. Furthermore, dealing with a tenant's bankruptcy or other default may divert management's attention and cause us to incur substantial legal and other costs. The bankruptcy or insolvency of a number of smaller tenants may have an adverse impact on our business, financial condition and results of operations, our ability to make distributions to our partners and the trading price of Whitestone's common shares.
Uninsured losses relating to real property or excessively expensive premiums for insurance coverage may adversely affect our returns.
We attempt to adequately insure all of our properties to cover casualty losses. However, there are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, which are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Our current geographic concentration in the Houston metropolitan area potentially increases the risk of damage to our portfolio due to hurricanes. Insurance risks associated with potential terrorism acts could sharply increase the premiums we pay for coverage against property and casualty claims. In some instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure you that we will have adequate coverage for these losses. Also, to the extent we must pay unexpectedly large insurance premiums, we could suffer reduced earnings that would result in less cash to be distributed to partners.
Discovery of previously undetected environmentally hazardous conditions may adversely affect our operating results.
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on, under or in its property. The costs of removal or remediation could be substantial. These laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of any hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. Environmental laws provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos containing materials into the air. In addition, third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of compliance with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distributions to our partners.
Certain of our properties currently include or have in the past included a dry cleaning facility as a tenant. See "Business - Compliance with Governmental Regulations."
We may not be successful in consummating suitable acquisitions or investment opportunities, which may impede our growth and adversely affect our results of operations.
Our ability to expand through acquisitions is integral to our business strategy and requires us to consummate suitable acquisition or investment opportunities that meet our criteria and are compatible with our growth strategy. We may not be successful in consummating acquisitions or investments in properties that meet our acquisition criteria on satisfactory terms or at all. Failure to consummate acquisitions or investment opportunities, the failure of an acquired property to perform as expected, or the failure to integrate successfully any acquired properties without substantial expense, delay or other operational or financial problems, would slow our growth, which could in turn adversely affect the trading price of Whitestone's common shares.
Our ability to acquire properties on favorable terms may be constrained by the following significant risks:
•
competition from other real estate investors with significant capital, including REITs and institutional investment funds;
•
competition from other potential acquirers which may significantly increase the purchase price for a property we acquire, which could reduce our growth prospects;
•
unsatisfactory results of our due diligence investigations or failure to meet other customary closing conditions; and
•
failure to finance an acquisition on favorable terms or at all.
If any of these risks are realized, our business, financial condition and results of operations, our ability to make distributions to our partners and the trading price of Whitestone's common shares may be materially and adversely affected.
Our success depends in part on our ability to execute our Community Centered Property strategy.
Our Community Centered Property strategy requires intensive management of a large number of small spaces and small tenant relationships. Our success depends in part upon Whitestone's management's ability to identify potential Community Centered Properties and find and maintain the appropriate tenants to create such a property. Lack of market acceptance of our Community Centered Property strategy or our inability to successfully attract and manage a large number of tenant relationships could adversely affect our occupancy rates, operating results and distribution rate.
Our business is significantly influenced by demand for retail space generally, and a decrease in such demand may have a greater adverse effect on our business than if we owned a more diversified real estate portfolio.
Because our portfolio of properties consists primarily of community and neighborhood shopping centers, a decrease in the demand for retail space, due to the economic factors discussed above or otherwise, may have a greater adverse effect on our business and financial condition than if we owned a more diversified real estate portfolio. The market for retail space has been, and could continue to be, adversely affected by weakness in the national, regional and local economies, the adverse financial conditions of some retailing companies, the ongoing consolidation in the retail sector, the excess amount of retail space in a number of markets, and increasing consumer purchases.
Loss of Whitestone's key personnel, particularly Whitestone's senior managers, could threaten our ability to execute our strategy and operate our business successfully.
We are dependent on the experience and knowledge of Whitestone's key executive personnel, particularly certain of its senior managers who have been instrumental in setting our strategic direction, operating our business, identifying, recruiting and training key personnel and arranging necessary financing. Losing the services of any of these individuals could adversely affect our business until qualified replacements could be found. We also believe that they could not quickly be replaced with managers of equal experience and capabilities and their successors may not be as effective.
Our systems may not be adequate to support our growth, and our failure to successfully oversee our portfolio of properties could adversely affect our results of operations.
We make no assurances that we will be able to adapt our portfolio management, administrative, accounting and operational systems, or hire and retain sufficient operational staff, to support our growth. Our failure to successfully oversee our current portfolio of properties or any future acquisitions or developments could have a material adverse effect on our results of operations and financial condition and our ability to make distributions.
There can be no assurance that we will be able to pay or maintain cash distributions or that distributions will increase over time.
There are many factors that can affect the availability and timing of cash distributions to partners. Distributions are based upon our funds from operations, financial condition, cash flows and liquidity, debt service requirements, capital expenditure requirements for our properties and other matters Whitestone's board of trustees may deem relevant from time to time. If we do not have sufficient cash available for distributions, we may need to fund the shortage out of working capital or borrow to provide funds for such distributions, which would reduce the amount of capital available for real estate investments and increase our future interest costs.
We can give no assurance that we will be able to continue to pay distributions or that distributions will increase over time. In addition, we can give no assurance that rents from our properties will increase, or that future acquisitions of real properties, mortgage loans or our investments in securities will increase our cash available for distributions to partners. Our actual results may differ significantly from the assumptions used by Whitstone's board of trustees in establishing the distribution rate to partners. Whitestone's inability to make distributions, or to make distributions at expected levels, could result in a decrease in the trading price of Whitestone's common shares.
Any weaknesses identified in Whitestone's system of internal controls by Whitestone and its independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 could have an adverse effect on our business.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that public companies evaluate and report on their systems of internal control over financial reporting. In addition, Whitestone's independent registered public accounting firm must report on management's evaluation of those controls. In future periods, Whitestone may identify deficiencies in its system of internal controls over financial reporting that may require remediation. There can be no assurances that any such future deficiencies identified may not be material weaknesses that would be required to be reported in future periods. Any deficiencies or material weaknesses could result in significant time and expense to remediate, which could have a material adverse effect on our financial condition, results of operations and ability to make distributions to our partners.
Risks Associated with Our Indebtedness and Financing
Current market conditions could adversely affect our ability to refinance existing indebtedness or obtain additional financing for growth on acceptable terms or at all, which could adversely affect our ability to grow, our interest cost and our results of operations.
The United States credit markets have experienced significant dislocations and liquidity disruptions, including the bankruptcy, insolvency or restructuring of certain financial institutions. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of various types of debt financing. Reductions in our available borrowing capacity, or inability to refinance our revolving credit facility when required or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. In addition, we mortgage many of our properties to secure payment of indebtedness. If we are not successful in refinancing our mortgage debt upon maturity, then the property could be foreclosed upon or transferred to the mortgagee, or we might be forced to dispose of some of our properties upon disadvantageous terms, with a consequent loss of income and asset value. A foreclosure or disadvantageous disposal on one or more of our properties could adversely affect our ability to grow, financial condition, interest cost, results of operations, cash flow and ability to make distributions to our partners.
Furthermore, if prevailing interest rates or other factors at the time of refinancing result in higher interest rates upon refinancing, then the interest expense relating to that refinanced indebtedness would increase. Higher interest rates on newly incurred debt may negatively impact us as well. If interest rates increase, our interest costs and overall costs of capital will increase, which could adversely affect our transaction and development activity, financial condition, results of operation, cash flow, our ability to pay principal and interest on our debt and our ability to make distributions to our partners.
If we invest in mortgage loans, these investments may be affected by unfavorable real estate market conditions, including interest rate fluctuations, which could decrease the value of those loans and the return on your investment.
If we invest in mortgage loans, we will be at risk of defaults by the borrowers on those mortgage loans as well as interest rate risks. To the extent we incur delays in liquidating such defaulted mortgage loans, we may not be able to recover all amounts due to us under the mortgage loans. Further, we will not know whether the values of the properties securing the mortgage loans will remain at the levels existing on the dates of origination of those mortgage loans or the dates of our investment in the loans. If the values of the underlying properties fall, our risk will increase because of the lower value of the security associated with such loans.
Our failure to hedge effectively against interest rate changes may adversely affect results of operations.
We currently have mortgages that bear interest at a variable rate and we may incur additional variable rate debt in the future. Accordingly, increases in interest rates on variable rate debt would increase our interest expense, which could reduce net earnings and cash available for payment of our debt obligations and distributions to our partners.
We may seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements, such as interest cap agreements and interest rate swap agreements. These agreements involve risks, such as the risk that counterparties may fail to honor their obligations under these arrangements, that these arrangements may not be effective in reducing our exposure to interest rate changes and that a court could rule that such an agreement is not legally enforceable. In the past, we have used derivative financial instruments to hedge interest rate risks related to our variable rate borrowings. We will not use derivatives for speculative or trading purposes and intend only to enter into contracts with major financial institutions based on their credit rating and other factors, but we may choose to change this practice in the future. As of December 31, 2013, we had fixed rate hedges on $68.4 million of our variable rate debt, including $50 million of our unsecured credit facility. We may enter into additional interest rate swap agreements for our variable rate debt not currently subject to hedges, which totaled $84.8 million as of December 31, 2013. Hedging may reduce the overall returns on our investments. Failure to hedge effectively against interest rate changes may materially adversely affect our results of operations.
We currently have and may incur additional mortgage indebtedness and other borrowings, which may increase our business risks and may adversely affect our ability to make distributions to our partners.
If we determine it to be in our best interests, we may, in some instances, acquire real properties by using either existing financing or borrowing new funds. In addition, we may incur or increase our current mortgage debt to obtain funds to acquire additional properties. We may also borrow funds if necessary to satisfy Whitestone's REIT distribution requirement described above, or otherwise as may be necessary or advisable to ensure that Whitestone maintains its qualification as a REIT for federal income tax purposes.
On February 4, 2013, we entered into an unsecured credit facility (the "2013 Facility"). We intend to use the 2013 Facility for acquisitions, redevelopment of value-add properties in our portfolio and general corporate purposes. The 2013 Facility amends and restates the $125 million unsecured revolving credit facility we entered into on February 27, 2012. In addition to retaining a $125 million unsecured revolving loan, the 2013 Facility also includes a $50 million term loan and permits us to increase the borrowing capacity under the 2013 Facility to a total of $225 million, upon the satisfaction of certain conditions. The 2013 Facility will mature on February 4, 2017. As of December 31, 2012, $69.0 million was drawn on our previous credit facility. On February 4, 2013, we drew $69.0 million on the 2013 Facility, which replaced the $69.0 million drawn on the previous credit facility. Like our previous credit facility, the 2013 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 amount available to us and our ability to borrow from time to time under the 2013 Facility is subject to our compliance with these requirements. Maintaining compliance with these covenants could limit our ability to implement our business plan effectively, or at all.
We may also incur mortgage debt on a particular property if we believe the property's projected cash flow is sufficient to service the mortgage debt. As of December 31, 2013, we had approximately $129.5 million of mortgage debt secured by 19 of our properties. If there is a shortfall in cash flow, however, the amount available for distributions to partners may be affected. In addition, incurring mortgage debt increases the risk of loss because defaults on such indebtedness may result in loss of property in foreclosure actions initiated by lenders. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds. We may give lenders full or partial guarantees for mortgage debt incurred by the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by that entity. If any mortgages contain cross-collateralization or cross-default provisions, there is a risk that more than one property may be affected by a default. If any of our properties are foreclosed upon due to a default, our ability to pay cash distributions to our partners may be adversely affected. For more discussion, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
If we set aside insufficient working capital or are unable to secure funds for future tenant improvements, we may be required to defer necessary property improvements, which could adversely impact our ability to pay cash distributions to our partners.
When tenants do not renew their leases or otherwise vacate their space, it is possible that, in order to attract replacement tenants, we may be required to expend substantial funds for tenant improvements and tenant refurbishments to the vacated space. If we have insufficient working capital reserves, we will have to obtain financing from other sources. Because most of our leases provide for tenant reimbursement of operating expenses, we have not established a permanent reserve for maintenance and repairs for our properties. However, to the extent that we have insufficient funds for such purposes, we may establish reserves for maintenance and repairs of our properties out of cash flow generated by operating properties or out of non-liquidating net sale proceeds. If these reserves or any reserves otherwise established are insufficient to meet our cash needs, we may have to obtain financing from either affiliated or unaffiliated sources to fund our cash requirements. We cannot assure you that sufficient financing will be available or, if available, will be available on economically feasible terms or on terms acceptable to us. Additional borrowing for working capital purposes will increase our interest expense, and therefore our financial condition and our ability to pay cash distributions to our partners may be adversely affected. In addition, we may be required to defer necessary improvements to our properties that may cause our properties to suffer from a greater risk of obsolescence or a decline in value, or a greater risk of decreased cash flow as a result of fewer potential tenants being attracted to our properties. If this happens, we may not be able to maintain projected rental rates for affected properties, and our results of operations may be negatively impacted.
We may structure acquisitions of property in exchange for our OP units on terms that could limit our liquidity or our flexibility.
We may acquire properties by issuing our OP units in exchange for a property owner contributing property to us. If we enter into such transactions, in order to induce the contributors of such properties to accept our OP units, rather than cash, in exchange for their properties, it may be necessary for us to provide them with additional incentives. For instance, our limited partnership agreement provides that any holder of OP units may redeem such units for cash, or, at Whitestone's option, Whitestone's common shares on a one-for-one basis. We may, however, enter into additional contractual arrangements with contributors of property under which we would agree to redeem a contributor's OP units for Whitestone's common shares or cash, at the option of the contributor, at set times. If the contributor required us to redeem OP units for cash pursuant to such a provision, it would limit our liquidity and thus our ability to use cash to make other investments, satisfy other obligations or pay distributions. Moreover, if we were required to redeem OP units for cash at a time when we did not have sufficient cash to fund the redemption, we might be required to sell one or more properties to raise funds to satisfy this obligation. Furthermore, we might agree that if distributions the contributor received as a limited partner did not provide the contributor with a defined return, then upon redemption of the contributor's OP units, we would pay the contributor an additional amount necessary to achieve that return. Such a provision could further negatively impact our liquidity and flexibility. Finally, in order to allow a contributor of a property to defer taxable gain on the contribution of property to the Operating Partnership, we might agree not to sell a contributed property for a defined period of time or until the contributor redeemed the contributor's OP units for cash or Whitestone's common shares. Such an agreement would prevent us from selling those properties, even if market conditions made such a sale favorable to us.
Whitestone may issue preferred shares with a preference in distributions over its common shares, and its ability to issue preferred shares and additional common shares may deter or prevent a sale of its common shares in which its shareholders could profit.
Whitestone's declaration of trust authorizes its board of trustees to issue up to 400,000,000 common shares and 50,000,000 preferred shares. Whitestone's board of trustees may amend its declaration of trust from time to time to increase or decrease the aggregate number of shares or the number of any class or series that it has authority to issue. In addition, Whitestone's board of trustees may classify or reclassify any unissued common shares or preferred shares and may set the preferences, rights and other terms of the classified or reclassified shares. The terms of preferred shares could include a preference in distributions senior to Whitestone's common shares. If Whitestone authorizes and issues preferred shares with a distribution preference senior to its common shares, payment of any distribution preferences of outstanding preferred shares would reduce the amount of funds available for the payment of distributions on its common shares. Further, holders of preferred shares are normally entitled to receive a preference payment in the event Whitestone liquidates, dissolves or winds up before any payment is made to its common shareholders, likely reducing the amount its common shareholders would otherwise receive upon such an occurrence. In addition, under certain circumstances, the issuance of preferred shares or a separate class or series of common shares may render more difficult or tend to discourage:
•
a merger, tender offer or proxy contest;
•
assumption of control by a holder of a large block of Whitestone's shares; or
•
removal of incumbent management.
Risks Associated with Income Tax Laws
If Whitestone fails to qualify as a REIT, our operations and distributions to our partners would be adversely impacted.
Whitestone intends to continue to be organized and to operate so as to qualify as a REIT under the Code. A REIT generally is not taxed at the corporate level on income it currently distributes to its shareholders. Qualification as a REIT involves the application of highly technical and complex rules for which there are only limited judicial or administrative interpretations. The determination of various factual matters and circumstances not entirely within Whitestone's control may affect its ability to continue to qualify as a REIT. In addition, new legislation, new regulations, administrative interpretations or court decisions could significantly change the tax laws, possibly with retroactive effect, with respect to qualification as a REIT or the federal income tax consequences of such qualification.
If Whitestone were to fail to qualify as a REIT in any taxable year:
•
Whitestone would not be allowed to deduct its distributions to shareholders when computing its taxable income;
•
Whitestone would be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates;
•
Whitestone would be disqualified from being taxed as a REIT for the four taxable years following the year during which qualification was lost, unless entitled to relief under certain statutory provisions;
•
Whitestone's cash available for distributions to shareholders would be reduced; and
•
Whitestone may be required to borrow additional funds or sell some of our assets in order to pay corporate tax obligations that it may incur as a result of its disqualification.
Whitestone may need to incur additional borrowings to meet the REIT minimum distribution requirement and to avoid excise tax.
In order to maintain its qualification as a REIT, Whitestone is required to distribute to its shareholders at least 90% of its annual real estate investment trust taxable income (excluding any net capital gain and before application of the dividends paid deduction). In addition, Whitestone is subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by Whitestone with respect to any calendar year are less than the sum of (i) 85% of its ordinary income for that year, (ii) 95% of its net capital gain for that year and (iii) 100% of its undistributed taxable income from prior years. Although Whitestone intends to pay distributions to its shareholders in a manner that allows it to meet the 90% distribution requirement and avoid this 4% excise tax, Whitestone cannot assure you that it will always be able to do so.
Whitestone's income consists almost solely of its share of our income, and the cash available for distribution by Whitestone to its shareholders consists of its share of cash distributions made by us. Because Whitestone is our sole general partner, its board of trustees determines the amount of any distributions made by us. Whitestone's board of trustees may consider a number of factors in authorizing distributions, including:
•
the amount of the cash available for distribution;
•
our financial condition;
•
our capital expenditure requirements; and
•
Whitestone's annual distribution requirements necessary to maintain its qualification as a REIT.
Differences in timing between the actual receipt of income and actual payment of deductible expenses and the inclusion of income and deduction of expenses when determining Whitestone's taxable income, as well as the effect of nondeductible capital expenditures and the creation of reserves or required debt amortization payments could require Whitestone to borrow funds on a short-term or long-term basis or make taxable distributions to its shareholders of its shares or debt securities to meet the REIT distribution requirement and to avoid the 4% excise tax described above. In these circumstances, Whitestone may need to borrow funds to avoid adverse tax consequences even if its management believes that the then prevailing market conditions generally are not favorable for borrowings or that borrowings would not be advisable in the absence of the tax consideration.
If we were classified as a “publicly traded partnership” taxable as a corporation for federal income tax purposes under the Code, Whitestone would cease to qualify as a REIT and would suffer other adverse tax consequences.
Whitestone structured the Operating Partnership so that we would be classified as a partnership for federal income tax purposes. In this regard, the Code generally classifies “publicly traded partnerships” (as defined in Section 7704 of the Code) as associations taxable as corporations (rather than as partnerships), unless substantially all of their taxable income consists of specified types of passive income. In order to minimize the risk that the Code would classify us as a “publicly traded partnership” for tax purposes, Whitestone placed certain restrictions on the transfer and/or redemption of our partnership units. If the Internal Revenue Service were to assert successfully that we are a “publicly traded partnership,” and substantially all of our gross income did not consist of the specified types of passive income, the Code would treat us as an association taxable as a corporation.
In such event, the character of Whitestone's assets and items of gross income would change and would prevent Whitestone from continuing to qualify as a REIT. In addition, the imposition of a corporate tax on us would reduce our amount of cash available for payment of distributions to Whitestone and its shareholders and our unit holders.
Complying with REIT requirements may cause Whitestone to forego otherwise attractive opportunities or liquidate otherwise attractive investments.
To qualify as a REIT for federal income tax purposes, Whitestone must continually satisfy tests concerning, among other things, the sources of its income, the nature and diversification of its assets, the amounts it distributes to its shareholders and the ownership of its shares. In order to meet these tests, Whitestone may be required to forego investments it might otherwise make. Thus, compliance with the REIT requirements may hinder Whitestone's performance.
In particular, Whitestone must ensure that at the end of each calendar quarter, at least 75% of the value of its assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of its investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of Whitestone's assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of its total assets can be represented by the securities of one or more taxable REIT subsidiaries. If Whitestone fails to comply with these requirements at the end of any calendar quarter, it must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing its REIT qualification and suffering adverse tax consequences. As a result, Whitestone may be required to liquidate otherwise attractive investments. These actions could have the effect of reducing its income and amounts available for distribution to its shareholders.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of Whitestone's common shares.
At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. We cannot predict when or if any new federal income tax law, regulation, or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation, or interpretation may take effect retroactively. Whitestone and its shareholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The American Taxpayer Relief Act of 2012 ("ATRA") was enacted on January 3, 2013. Under ATRA, for taxable years beginning in 2013, for non-corporate taxpayers the maximum tax rate applicable to “qualified dividend income” paid by regular "C" corporations to U.S. shareholders generally is 20%, and there is no certainty as to how long this rate will be applicable. Dividends payable by REITs, however, generally are not eligible for the current reduced rate. Although ATRA does not adversely affect the taxation of REITs or dividends payable by REITs, it could cause non-corporate taxpayers to perceive investments in REITs to be relatively less attractive than investments in the stocks of regular "C" corporations that pay dividends, which could adversely affect the value of the shares of REITs, including Whitestone's common shares.
Complying with REIT requirements may limit Whitestone's ability to hedge effectively and may cause it to incur tax liabilities.
The REIT provisions of the Code substantially limit Whitestone's ability to hedge its liabilities. Any income from a hedging transaction that Whitestone enters into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that Whitestone enters into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, Whitestone may need to limit its use of advantageous hedging techniques or implement those hedges through taxable REIT subsidiaries. This could increase the cost of its hedging activities because any taxable REIT subsidiary that Whitestone may form would be subject to tax on gains or expose Whitestone to greater risks associated with changes in interest rates than it would otherwise want to bear. In addition, losses in taxable REIT subsidiaries will generally not provide any tax benefit, except for being carried forward against future taxable income in the taxable REIT subsidiaries.
Risks Related to Ownership of Whitestone's Common Shares
Increases in market interest rates may result in a decrease in the value of Whitestone's common shares.
One of the factors that may influence the price of Whitestone's common shares will be the distribution rate on the common shares (as a percentage of the price of Whitestone's common shares) relative to market interest rates. If market interest rates rise, prospective purchasers of shares of Whitestone's common shares may expect a higher distribution rate. Higher interest rates would not, however, result in more funds being available for distribution and, in fact, would likely increase our borrowing costs and might decrease our funds available for distribution. Whitestone therefore may not be able, or it may not choose, to provide a higher distribution rate. As a result, prospective purchasers may decide to purchase other securities rather than Whitestone's common shares, which would reduce the demand for, and result in a decline in the market price of, its common shares.
Broad market fluctuations could negatively impact the market price of Whitestone's common shares.
The stock market has experienced extreme price and volume fluctuations that have affected the market price of many companies in industries similar or related to Whitestone's and that have been unrelated to these companies' operating performances. These broad market fluctuations could reduce the market price of Whitestone's common shares. Furthermore, Whitestone's operating results and prospects may be below the expectations of public market analysts and investors or may be lower than those of companies with comparable market capitalizations. Either of these factors could lead to a material decline in the market price of Whitestone's common shares.
Maryland takeover statutes may deter others from seeking to acquire Whitestone and prevent shareholders from making a profit in such transactions.
The Maryland General Corporation Law ("MGCL") contains many provisions, such as the business combination statute and the control share acquisition statute, that are designed to prevent, or have the effect of preventing, someone from acquiring control of Whitestone. The business combination statute, subject to limitations, prohibits certain business combinations between Whitestone and an “interested shareholder” (defined generally as any person who beneficially owns 10% or more of the voting power of Whitestone's outstanding voting shares or an affiliate or associate of Whitestone who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of Whitestone's then outstanding shares) or an affiliate of an interested shareholder for five years after the most recent date on which the person becomes an interested shareholder and thereafter imposes super-majority voting requirements on these combinations. The control share acquisition statute provides that “control shares” of Whitestone (defined as shares which, when aggregated with other shares controlled by the shareholder (except solely by virtue of a revocable proxy), entitle the shareholder to exercise one of three increasing ranges of voting power in electing trustees) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding control shares) have no voting rights except to the extent approved by Whitestone's shareholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.
Whitestone is currently subject to the control share acquisition statute, although its board of trustees may amend its Amended and Restated Bylaws, or the bylaws, without shareholder approval, to exempt any acquisition of its shares from the statute. Whitestone's board of trustees has adopted a resolution exempting any business combination with any person from the business combination statute. The business combination statute (if Whitestone's board of trustees revokes the foregoing exemption) and the control share acquisition statute could delay or prevent offers to acquire Whitestone and increase the difficulty of consummating any such offers, even if such a transaction would be in Whitestone's shareholders' best interest.
The MGCL, the Maryland REIT Law and Whitestone's organizational documents limit shareholders' rights to bring claims against its officers and trustees.
The MGCL and the Maryland REIT Law provide that a trustee will not have any liability as a trustee so long as he performs his duties in good faith, in a manner he reasonably believes to be in Whitestone's best interests, and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, Whitestone's declaration of trust provides that no trustee or officer will be liable to Whitestone or to any shareholder for money damages except to the extent that (a) the trustee or officer actually received an improper benefit or profit in money, property or services, for the amount of the benefit or profit in money, property, or services actually received; or (b) a judgment or the final adjudication adverse to the trustee or officer is entered in a proceeding based on a finding in the proceeding the trustee's or officer's action or failure to act was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding. Finally, Whitestone's declaration of trust authorizes it to obligate itself, and its bylaws obligate it, to indemnify and advance expenses to its trustees and officers to the maximum extent permitted by Maryland law.
Whitestone's classified board of trustees may prevent others from effecting a change in the control of its board of trustees.
We believe that classification of Whitestone's board of trustees will help to assure the continuity and stability of our business strategies and policies as determined by its board of trustees. However, the classified board provision could have the effect of making the replacement of incumbent trustees more time-consuming and difficult. At least two annual meetings of shareholders, instead of one, will generally be required to effect a change in a majority of Whitestone's board of trustees. Thus, the classified board provision could increase the likelihood that incumbent trustees will retain their positions. The staggered terms of trustees may delay, defer or prevent a transaction or a change in control that might involve a premium price for Whitestone's common shares or otherwise be in the best interest of Whitestone's shareholders.
Future offerings of debt, which would be senior to Whitestone's common shares upon liquidation, and/or preferred equity securities that may be senior to Whitestone's common shares for purposes of distributions or upon liquidation, may adversely affect the market price of Whitestone's common shares.
In the future, Whitestone may attempt to increase its capital resources by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred shares. Upon liquidation, holders of Whitestone's debt securities and preferred shares and lenders with respect to other borrowings will receive distributions of Whitestone's available assets prior to the holders of its common shares. Additional equity offerings may dilute the holdings of Whitestone's existing shareholders or reduce the market price of Whitestone's common shares, or both. Holders of Whitestone's common shares are not entitled to preemptive rights or other protections against dilution. Whitestone's preferred shares, if issued, could have a preference on liquidating distributions or a preference on distribution payments that could limit its ability to pay distributions to the holders of its common shares. Because its decision to issue securities in any future offering will depend on market conditions and other factors beyond its control, Whitestone cannot predict or estimate the amount, timing or nature of its future offerings. Thus, its common shareholders bear the risk of its future offerings reducing the market price of its common shares and diluting their share holdings in Whitestone.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
General
As of December 31, 2013, we owned 60 commercial properties, including 31 properties in Houston, five properties in Dallas, one property in Windcrest, Texas, a suburb of San Antonio, 22 properties in the Scottsdale and Phoenix, Arizona metropolitan areas, and one property in Buffalo Grove, Illinois, a suburb of Chicago.
Our tenants consist of national, regional and local businesses. Our properties generally attract a mix of tenants who provide basic staples, convenience items and services tailored to the specific cultures, needs and preferences of the surrounding community. These types of tenants are the core of our strategy of creating Whitestone-branded Community Centered Properties. We also believe daily sales of these basic items are less sensitive to fluctuations in the business cycle than higher priced retail items. Our largest tenant represented only 2.0% of our total revenues for the year ended December 31, 2013.
Whitestone directly manages the operations and leasing of our properties. Substantially all of our revenues consist of base rents received under leases that generally have terms that range from less than one year to 15 years. Approximately 60% of our existing leases as of December 31, 2013 contain “step up” rental clauses that provide for increases in the base rental payments. The following table summarizes certain information relating to our properties as of December 31, 2013:
(1)
Calculated as the tenant's actual December 31, 2013 base rent (defined as cash base rents including abatements) multiplied by 12. Excludes vacant space as of December 31, 2013. Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles, historical results differ from the annualized amounts. Total abatements for leases in effect as of December 31, 2013 equaled approximately $101,000 for the month ended December 31, 2013.
(2)
Calculated as annualized base rent divided by gross leasable area leased as of December 31, 2013. Excludes vacant space as of December 31, 2013.
(3)
Includes (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.
As of December 31, 2013, we had two properties that when combined, accounted for more than 10% of total gross revenue and/or real estate assets. Uptown Tower is an office building located in Dallas, Texas that accounted for 5.9% of our total revenue for the year ended December 31, 2013. Uptown Tower also accounted for 3.3% of our real estate assets, net of accumulated depreciation, for the year ended December 31, 2013. Dana Park, a retail community purchased on September 21, 2012 and located in the Mesa submarket of Phoenix, Arizona, accounted for 9.2% of our total revenue for the year ended December 31, 2013. Dana Park also accounted for 9.5% of our real estate assets, net of accumulated depreciation, for the year ended December 31, 2013.
As of December 31, 2013, approximately $129.5 million of our total debt of $264.3 million was secured by 19 of our operating properties with a combined net book value of $161.1 million.
Location of Properties
Of our 60 properties, 31 are located in the greater Houston metropolitan statistical area. These 31 properties represent 42% of our revenue for the year ended December 31, 2013. An additional 22 properties are located in the greater Phoenix metropolitan statistical area and represent 40% of our revenue for the year ended December 31, 2013.
According to the United States Census Bureau, Houston and Phoenix ranked 5th and 12th, respectively, in the largest United States metropolitan statistical areas as of July 1, 2012. In the Census Bureau’s Estimates of Population Change for Metropolitan Statistical Areas and Rankings: July 1, 2011 to July 1, 2012, Houston and Phoenix ranked 2nd and 7th, respectively, in population growth out of 366 metropolitan statistical areas. According to the Bureau of Labor Statistics, the unemployment rate in Houston and Phoenix was frequently less than the national average during the last six months of 2013.
(1)
Seasonally adjusted.
(2)
Not seasonally adjusted.
(3)
Represents estimate.
Source: Bureau of Labor Statistics
General Physical and Economic Attributes
The following table sets forth certain information relating to each of our properties owned as of December 31, 2013.
(1)
Calculated as the tenant's actual December 31, 2013 base rent (defined as cash base rents including abatements) multiplied by 12. Excludes vacant space as of December 31, 2013. Because annualized base rental revenue is not derived from historical results that were accounted for in accordance with generally accepted accounting principles, historical results differ from the annualized amounts. Total abatements for leases in effect as of December 31, 2013 equaled approximately $101,000 for the month ended December 31, 2013.
(2)
Calculated as annualized base rent divided by gross leasable area leased as of December 31, 2013. Excludes vacant space as of December 31, 2013.
(3)
Represents (i) the contractual base rent for leases in place as of December 31, 2013, adjusted to a straight-line basis to reflect changes in rental rates throughout the lease term and amortize free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) square footage under commenced leases of December 31, 2013.
(4)
As of December 31, 2013, these parcels of land were held for development and, therefore, had no gross leasable area.
Significant Tenants
The following table sets forth information about our 15 largest tenants as of December 31, 2013, based upon annualized rental revenues at December 31, 2013.
(1)
Annualized Base Rental Revenues represents the monthly base rent as of December 31, 2013 for each applicable tenant multiplied by 12.
(2)
As of December 31, 2013, we had three leases with the same tenant occupying space at properties located in Phoenix. The annualized rental revenue for the lease that commenced on July 12, 2000, and is scheduled to expire in 2020, was $425,000, which represents 0.8% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on May 8, 1991, and is scheduled to expire in 2021, was $344,000, which represents 0.7% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on July 1, 2000, and is scheduled to expire in 2020, was $292,000, which represents 0.5% of our total annualized base rental revenue.
(3)
As of December 31, 2013, we had three leases with the same tenant occupying space at properties located in Phoenix. The annualized rental revenue for the lease that commenced on December 9, 1993, and is scheduled to expire in 2014, was $61,000, which represents 0.1% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on October 9, 2004, and is scheduled to expire in 2024, was $119,000, which represents 0.2% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on April 1, 2009, and is scheduled to expire in 2029, was $679,000, which represents 1.3% of our total annualized base rental revenue.
(4)
As of December 31, 2013, we had two leases with the same tenant occupying space at properties located in Phoenix. The annualized rental revenue for the lease that commenced on October 24, 1996, and is scheduled to expire in 2016, was $114,000, which represents 0.2% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on April 16, 1999, and is scheduled to expire in 2018, was $513,000, which represents 1.0% of our total annualized base rental revenue.
(5)
As of December 31, 2013, we had two leases with the same tenant occupying space at properties located in Phoenix. The annualized rental revenue for the lease that commenced on November 3, 1996, and is scheduled to expire in 2049, was $279,000, which represents 0.5% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on November 2, 1987, and is scheduled to expire in 2027, was $169,000, which represents 0.3% of our total annualized base rental revenue.
(6)
As of December 31, 2013, we had two leases with the same tenant occupying space at properties located in Phoenix. The annualized rental revenue for the lease that commenced on May 7, 2001, and is scheduled to expire in 2021, was $267,000, which represents 0.5% of our total annualized base rental revenue. The annualized rental revenue for the lease that commenced on July 15, 2000, and is scheduled to expire in 2035, was $55,000, which represents 0.1% of our total annualized base rental revenue.
Lease Expirations
The following table lists, on an aggregate basis, all of our scheduled lease expirations over the next 10 years.
Insurance
We believe that we have property and liability insurance with reputable, commercially rated companies. We also believe that our insurance policies contain commercially reasonable deductibles and limits, adequate to cover our properties. We expect to maintain this type of insurance coverage and to obtain similar coverage with respect to any additional properties we acquire in the near future. Further, we have title insurance relating to our properties in an aggregate amount that we believe to be adequate.
Item 3.
Item 3. Legal Proceedings.
We are a participant in various legal proceedings and claims that arise in the ordinary course of our business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, we believe that the final outcome of these matters will not have a material effect on our financial position, results of operations or cash flows.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s OP Units, Related Partner Matters and Issuer Purchases of Equity Securities.
Market Information
OP Units
There is no established trading market for our OP units. As of February 26, 2014, we had 22,389,134 OP units outstanding, including 553,666 OP units not held by Whitestone, which are held by a total of approximately 370 limited partners.
As of December 31, 2013, there were no outstanding options, warrants to purchase our OP units or securities convertible into our OP units. In addition, as of December 31, 2013, there were no OP units that could be sold pursuant to Rule 144 under the Securities Act or that we have agreed to register under the Securities Act for sale by our participants and there were no OP units that were being, or were publicly proposed to be, publicly offered by us.
Distributions
Distributions are generally not taxable to our partners; however, our partners generally must recognize their allocable share of our income, gain, deductions and losses in computing their federal income tax liabilities. We currently accrue distributions in three monthly installments following the end of the quarter. In order to remain qualified as a REIT, Whitestone is required to distribute at least 90% of its annual taxable income to its shareholders. For a discussion of our cash flow as compared to distributions, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
The timing and frequency of our distributions are authorized and declared by Whitestone's board of trustees in exercise of its business judgment based upon a number of factors, including:
•
our funds from operations;
•
our debt service requirements;
•
our capital expenditure requirements for our properties;
•
Whitestone's taxable income, combined with its annual distribution requirements necessary to maintain REIT qualification;
•
requirements of applicable law;
•
our overall financial condition; and
•
other factors deemed relevant by Whitestone's board of trustees.
Any distributions we make will be at the discretion of Whitestone's board of trustees and we cannot provide assurance that our distributions will be made or sustained in the future. Whitestone pays distributions to holders of its common shares based on distributions we make to it.
The following table reflects the total distributions we have paid (including the total amount paid and the amount paid per unit) in each indicated quarter (in thousands, except per unit data):
Equity Compensation Plan Information
Please refer to Item 12 of this report for information concerning securities authorized under Whitestone's equity incentive plan.
Performance Graph
The following graph compares the total shareholder returns of Whitestone's common shares to the Standard & Poor's 500 Index (“S&P 500”) and to the Morgan Stanley Capital International US REIT Index ("REIT Index") from August 25, 2010 to December 31, 2013. The graph assumes that the value of the investment in Whitestone's common shares and in the S&P 500 and REIT indices was $100 at August 25, 2010 and that all dividends were reinvested. The price of Whitestone's common shares on August 25, 2010 (on which the graph is based) was $12.00. The past shareholder return shown on the following graph is not necessarily indicative of future performance. The performance graph and related information shall not be deemed "filed" with the SEC, nor shall such information be incorporated by reference into any future filing, except to the extent Whitestone specifically incorporates it by reference into such filing.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth our selected consolidated financial information and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the notes thereto, both of which appear elsewhere in this report.
(1) The distributions per unit represent total cash payments divided by weighted average units.
(2) We believe that Funds From Operations (“FFO”) is an appropriate supplemental measure of operating performance because it helps our investors compare our operating performance relative to other REITs. 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 gains or losses from sales of operating properties and extraordinary items, plus depreciation and amortization of real estate assets, including our share of unconsolidated partnerships and joint ventures. We calculate FFO in a manner consistent with the NAREIT definition. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Reconciliation of Non-GAAP Financial Measures."
The following table sets forth a reconciliation of net income to FFO, the nearest GAAP measure, for the periods presented:
(1) Including amounts for discontinued operations.
Item 7.
Item 7. 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 audited consolidated financial statements and the notes thereto included in this annual report. For more detailed information regarding the basis of presentation for the following information, you should read the notes to our audited consolidated financial statements included in this Annual Report on Form 10-K.
Overview of Our Company
We are a Delaware limited partnership and majority-owned subsidiary of Whitestone, a fully integrated real estate company that owns and operates commercial properties in culturally diverse markets in major metropolitan areas. Founded in 1998, Whitestone is internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.
In October 2006, Whitestone's current management team joined Whitestone 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. We have a diversified tenant base concentrated on service offerings including medical, educational, casual dining and convenience services. Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property. Whitestone employs and develops a diverse group of associates who understand the needs of our multicultural communities and tenants.
As of December 31, 2013, we owned and operated 60 commercial properties consisting of:
Operating Portfolio
•
31 retail properties containing approximately 2.3 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $270.1 million;
•
seven office properties containing approximately 0.6 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $42.3 million; and
•
11 office/flex properties containing approximately 1.2 million square feet of gross leasable area and having a total carrying amount (net of accumulated depreciation) of $38.5 million.
Redevelopment, New Acquisitions Portfolio
•
five retail properties containing approximately 0.8 million square feet of leasable space and having a total carrying amount (net of accumulated depreciation) of $120.8 million; and
•
six parcels of land held for future development having a total carrying amount of $8.6 million.
As of December 31, 2013, we had an aggregate of 1,243 tenants. We have a diversified tenant base with our largest tenant comprising only 2.0% of our total revenues for the year ended December 31, 2013. Lease terms for our properties range from less than one year for smaller tenants to more than 15 years for larger tenants. Our leases generally include minimum monthly lease payments and tenant reimbursements for payment of taxes, insurance and maintenance. We completed 347 new and renewal leases during 2013, totaling 834,920 square feet and $44.2 million in total lease value.
As of December 31, 2013, we had no employees, and Whitestone employed 68 full-time employees. As an internally managed REIT, Whitestone bears its own expenses of operations, including the salaries, benefits and other compensation of its employees, office expenses, legal, accounting and investor relations expenses and other overhead costs. As the management and employees of Whitestone work for the benefit of the Operating Partnership, the costs and expenses of Whitestone have been presented in this report in a manner consistent with Whitestone's presentation in its Annual Report on Form 10-K for the period ended December 31, 2013.
How We Derive Our Revenue
Substantially all of our revenue is derived from rents received from leases at our properties. We had rental income and tenant reimbursements of approximately $62,145,000 for the year ended December 31, 2013 as compared to $46,554,000 for the year ended December 31, 2012, an increase of $15,591,000, or 33%. The twelve months ended December 31, 2013 included $15,179,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired during the period being compared. For the purposes of comparing the twelve months ended December 31, 2013 to the twelve months ended December 31, 2012, this includes properties acquired between January 1, 2012 and December 31, 2013. During the twelve months ended December 31, 2013, Same Store revenues increased $412,000 in the aggregate. We define "Same Stores" as properties that were owned at the beginning of the period being compared. For the purposes of comparing the twelve months ended December 31, 2013 to the twelve months ended December 31, 2012, this includes properties owned before January 1, 2012. Same Store average occupancy increased from 85.2% for the twelve months ended December 31, 2012 to 86.7% for the twelve months ended December 31, 2013, increasing Same Store revenue $786,000. Partially offsetting the increase in Same Store average occupancy, the Same Store revenue rate per average leased square foot decreased $0.12 for the twelve months ended December 31, 2013 to $14.02 per average leased square foot as compared to the twelve months ended December 31, 2012 revenue rate per average leased square foot of $14.14, decreasing Same Store revenue $374,000.
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. 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. Negative trends in one or more of these factors could adversely affect our rental income in future periods, although we expect modest continued improvement in the overall economy in our markets to provide slight increases in occupancy at certain of our properties.
Scheduled Lease Expirations
We tend to lease space to smaller businesses that desire shorter term leases. As of December 31, 2013, approximately 35% of our gross leasable area was subject to leases that expire prior to December 31, 2015. Over the last three years we have renewed approximately 74% of our square footage expiring as a result of lease maturities. We routinely seek to renew leases with our existing tenants prior to their expiration and typically begin discussions with tenants as early as 18 months prior to the expiration date of the existing lease. While 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 partners.
Acquisitions
We expect to actively seek 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
We seek to acquire commercial properties in high-growth markets. Our acquisition targets are properties that fit our Community Centered Properties strategy. We define Community Centered Properties as visibly located properties in established or developing, culturally diverse neighborhoods in our target markets, primarily in and around Phoenix, Chicago, Dallas, San Antonio and Houston. We market, lease and manage our centers to match tenants with the shared needs of the surrounding neighborhood. We have a diversified tenant base concentrated on service offerings including medical, educational, casual dining and convenience services. Our goal is for each property to become a Whitestone-branded business center or retail community that serves a neighboring five-mile radius around our property.
Property Acquisitions. On December 5, 2013, we acquired Market Street at DC Ranch, a property that meets our Community Centered Property strategy, for approximately $37.4 million in cash and net prorations. The 241,280 square foot property was 80% leased at the time of purchase and is located in Scottsdale, Arizona. The property is located in the DC Ranch master planned community with a mix of retail and office space with national credit tenants including Safeway Supermakets, Wells Fargo, Grimaldi's Pizza, McCormick & Co., Edward Jones and Fleming's Steakhouse.
On October 17, 2013, we acquired a 2.50 acre parcel for $2.8 million in cash and net prorations. The parcel is located in Spring, Texas, a suburb of Houston, and is contiguous to our Corporate Park Woodland property. At the time of purchase, the parcel had 16,220 square feet and was 63% leased. The property is located on Interstate 45 in north Houston and is in close proximity to the 385-acre Exxon Mobil campus scheduled to bring approximately 10,000 employees by 2015.
On October 7, 2013, we acquired Fountain Hills Plaza, a property that meets our Community Centered Property strategy, for approximately $20.6 million in cash and net prorations. The 111,289 square foot property was 87% leased at the time of purchase and is located in Fountain Hills, Arizona, a suburb of Phoenix. The property is located in the 10,000 household master-planned community of Fountain Hills and is dual-anchored by a 49,000 square foot Bashas' and a 27,000 square foot Ace Hardware.
On June 28, 2013, we acquired Anthem Marketplace, a property that meets our Community Centered Property strategy, for approximately $23.3 million in cash and net prorations. The 113,293 square foot property was 100% leased at the time of purchase and is located in Phoenix, Arizona. In the same purchase, we also acquired an adjacent development pad site of 0.83 acres. The property serves the Anthem and adjacent Tramonto family-oriented master-planned communities in North Phoenix and includes a broad tenant mix of dining establishments and personal care services and retailers and is anchored by Safeway Supermarket.
On June 19, 2013, we acquired Mercado at Scottsdale Ranch, a property that meets our Community Centered Property strategy, for approximately $21.3 million, including the assumption of a $11.1 million non-recourse loan, a $0.9 million interest rate supplement and cash of $9.3 million. The 118,730 square foot property was 100% leased at the time of purchase and is located in Scottsdale, Arizona. The property is located within the upscale Scottsdale Ranch neighborhood and is anchored by A.J's Fine Foods, a 13,000 square foot fitness center and Walgreens.
On March 28, 2013, we acquired Headquarters Village Shopping Center, a property that meets our Community Centered Property strategy, for approximately $25.7 million in cash and net prorations. The 89,134 square foot property was 100% leased at the time of purchase and is located in Plano, Texas. The property is located within the Preston Road Retail Corridor, adjacent to the 2,665 acre Legacy in Plano master-planned community and serves the north Dallas trade area, home to several Fortune 500 companies.
Summary of Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. We prepared these financial statements in conformity with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements required us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We based our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. Our results may differ from these estimates. Currently, we believe that our accounting policies do not require us to make estimates using assumptions about matters that are highly uncertain. For a better understanding of our accounting policies, you should read Note 2, “Summary of Significant Accounting Policies,” to our accompanying consolidated financial statements in conjunction with this "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
We have described below the critical accounting policies that we believe could impact our consolidated financial statements most significantly.
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. 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 have established an allowance for doubtful accounts against the portion of tenant accounts receivable which is estimated to be uncollectible.
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, primarily interest, real estate taxes and loan acquisition costs, 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 thereof, becomes available for occupancy. Prior to that time, we expense these costs as acquisition expense. For the year ended December 31, 2013, approximately $114,000 and $100,000 in interest expense and real estate taxes, respectively, were capitalized. For the year ended December 31, 2012, approximately $176,000 and $147,000 in interest expense and real estate taxes, respectively, were capitalized. No interest or real estate taxes were capitalized for the year ended December 31, 2011.
Acquired Properties and Acquired Lease Intangibles. We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt.
Depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings, respectively. Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter.
Impairment. We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value. Management has determined that there has been no impairment in the carrying value of our real estate assets as of December 31, 2013.
Accrued Rents and Accounts Receivable. Included in accrued rent and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. An allowance for the uncollectible portion of accrued rents and accounts receivable is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends. As of December 31, 2013 and 2012, we had an allowance for uncollectible accounts of $3.7 million and $2.3 million, respectively. As of December 31, 2013, 2012 and 2011, we recorded bad debt expense in the amount of $1.7 million, $1.0 million and $0.6 million, respectively, related to tenant receivables that we specifically identified as potentially uncollectible based on our assessment of each tenant’s credit-worthiness. Bad debt expenses and any related recoveries are included in property operation and maintenance expense.
Unamortized Lease Commissions and Loan Costs. Leasing commissions are amortized using the straight-line method over the terms of the related lease agreements. Loan costs are amortized on the straight-line method over the terms of the loans, which approximates the interest method. Costs allocated to in-place leases whose terms differ from market terms related to acquired properties are amortized over the remaining life of the respective leases.
Prepaids and Other Assets. Prepaids and other assets include escrows established pursuant to certain mortgage financing arrangements for real estate taxes and insurance and acquisition deposits which include earnest money deposits on future acquisitions. As part of our executive relocation arrangement, as discussed in Note 12 to our accompanying consolidated financial statements, we issued a note receivable for $975,000 to the buyer, with an interest rate of 4.5% and a maturity of December 31, 2013. On December 5, 2013, the note was renewed through June 30, 2014 and bears interest at a rate of 5.2% during the renewal period.
Federal Income Taxes. As a partnership, any federal income tax liability is passed through to our partners. Whitestone elected to be taxed as a REIT under the Code beginning with its taxable year ended December 31, 1999. As a REIT, Whitestone generally is not subject to federal income tax on income that it distributes to its shareholders. If it fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates. Whitestone believes that it is organized and operates in such a manner as to qualify to be taxed as a REIT, and it intends to operate so as to remain qualified as a REIT for federal income tax purposes.
State Taxes. We are subject to the Texas Margin Tax which is computed by applying the applicable tax rate (1% 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, Financial Accounting Standards Board (“FASB”) ASC 740, “Income Taxes” (“ASC 740”) applies to the Texas Margin Tax. We have recorded a margin tax expense of $0.3 million for the Texas Margin Tax for each of the years ended December 31, 2013, and 2012 and $0.2 million for the year ended December 31, 2011.
Fair Value of Financial Instruments. Our financial instruments consist primarily of cash, cash equivalents, accounts receivable, accounts and notes payable and investments in marketable securities. The carrying value of cash, cash equivalents, accounts receivable and accounts payable are representative of their respective fair values due to their short-term nature. The fair value of our long-term debt, consisting of fixed rate secured notes, variable rate secured notes and an unsecured revolving credit facility aggregate to approximately $262.0 million and $192.4 million as compared to the book value of approximately $264.3 million and $190.6 million as of December 31, 2013 and 2012, respectively. The fair value of our long-term debt is estimated on a Level 2 basis (as provided by ASC 820, "Fair Value Measurements and Disclosures"), using a discounted cash flow analysis based on the borrowing rates currently available to us for loans with similar terms and maturities, discounting the future contractual interest and principal payments.
Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 2013 and 2012. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since December 31, 2013 and current estimates of fair value may differ significantly from the amounts presented herein.
Derivative Instruments and Hedging Activities. We occasionally 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 (loss) 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 whose inputs are observable. As of December 31, 2013, we consider our cash flow hedges to be highly effective.
Recent accounting pronouncements. In February 2013, the FASB issued guidance requiring entities to disclose certain information relating to amounts reclassified out of accumulated other comprehensive income. The guidance was effective prospectively for reporting periods beginning on or after December 15, 2012. We do not expect the pronouncement to have a significant impact on our consolidated financial statements.
In July 2013, the FASB issued guidance permitting the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815 ("Derivatives and Hedging"), in addition to the interest rates on direct Treasury obligations of the U.S. government and LIBOR. This guidance is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. We do not expect the pronouncement to have a significant impact on our consolidated financial statements.
Liquidity and Capital Resources
Our short-term liquidity requirements consist primarily of distributions to holders of our OP units, including those required for Whitestone, our general partner, to maintain its REIT status and satisfy its current quarterly distribution target of $0.2850 per share, 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 year ended December 31, 2013, our cash provided from operating activities was $23,884,000 and our total distributions paid were $20,985,000. Therefore, we had cash flow from operations in excess of distributions of approximately $2,899,000. On February 4, 2013, we entered into the 2013 Facility. In addition to a $125 million unsecured borrowing capacity under the revolving loan, the 2013 Facility also includes a $50 million term loan and permits the Operating Partnership to increase the borrowing capacity under the 2013 Facility to a total of $225 million, upon the satisfaction of certain conditions. We anticipate that cash flows from operating activities and our borrowing capacity under the 2013 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 Whitestone to continue to qualify to be taxed as a REIT for federal income tax purposes.
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, Whitestone's sales of common shares, issuances of OP units, sales of underperforming 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 by Whitestone. 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. Whitestone's 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 finance the continued acquisition of such additional properties through Whitestone's equity issuances and through debt financing.
Our capital structure includes non-recourse secured debt that we assumed or originated on certain properties. We may hedge the future cash flows of certain debt transactions principally through interest rate swaps with major financial institutions.
Cash and Cash Equivalents
We had cash and cash equivalents of approximately $6,491,000 at December 31, 2013, as compared to $6,544,000 at December 31, 2012. The decrease of $53,000 was primarily the result of the following:
Sources of Cash
•
Cash flow from operations of $23,884,000 for the year ended December 31, 2013;
•
Net proceeds of $63,887,000 from Whitestone's issuance of common shares;
•
Net proceeds of $65,800,000 from our revolving credit facility;
•
Net proceeds of $102,914,000 from issuance of notes payable net of origination costs;
•
Proceeds from sales of marketable securities of $747,000;
Uses of Cash
•
Payment of distributions to OP unit holders of $20,985,000;
•
Real estate acquisitions of $119,102,000;
•
Additions to real estate of $6,291,000;
•
Payments of loans of $110,867,000;
•
Payments of exchange offer costs of $40,000.
We place all cash in short-term, highly liquid investments that we believe provide appropriate safety of principal.
Equity Offerings
On October 8, 2013, Whitestone completed the sale of 4,000,000 common shares, $0.001 par value per share, and on October 28, 2013, upon the underwriters' exercise of the over-allotment option, Whitestone completed the sale of 600,000 additional common shares, at a price to the public of $13.54 per share. Total net proceeds from the offering, including the over-allotment shares, and after deducting the underwriting discount and offering expenses, were approximately $59.7 million, which Whitestone contributed to us in exchange for OP units. We used the net proceeds from this offering for general corporate purposes, which included acquisitions of additional properties, the repayment of outstanding indebtedness, capital expenditures (including tenant improvements), the expansion, redevelopment and/or re-tenanting of properties in our portfolio, working capital and other general purposes.
On June 19, 2013, Whitestone entered into five equity distribution agreements for an at-the-market distribution program. Pursuant to the terms and conditions of the agreements, Whitestone can issue and sell up to an aggregate of $50 million of its common shares. Actual sales will depend on a variety of factors to be determined by Whitestone from time to time, including (among others) market conditions, the trading price of its common shares, capital needs and its determinations of the appropriate sources of funding for Whitestone, and will be made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. Whitestone has no obligation to sell any of its common shares, and could at any time suspend offers under the agreements or terminate the agreements. For the year ended December 31, 2013, Whitestone sold 282,239 common shares under the equity distribution program, with net proceeds to it of approximately $4.2 million, which Whitestone contributed to us in exchange for OP units. In connection with such sales, Whitestone paid compensation of $0.2 million to the sales agents.
Debt
Mortgages and other notes payable consist of the following (in thousands):
(1)
Promissory note had an original balance of $14.1 million and an interest rate of 5.695%, due in 2013, which was refinanced in May 2013. See below for further discussion of the Pinnacle Note.
(2)
The 6.00% interest rate is fixed through March 30, 2016. On March 31, 2016, the interest rate will reset to the rate of interest for a five-year balloon note with a thirty-year amortization as published by the Federal Home Loan Bank.
(3)
Promissory note includes an interest rate swap that fixed the interest rate at 5.72% for the duration of the term.
(4)
Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term.
(5)
We have entered into an interest rate swap that fixed the LIBOR portion of our $50 million term loan under our unsecured credit facility at 0.84%. The swap began on January 7, 2014.
Our mortgage debt was collateralized by 19 operating properties as of December 31, 2013 with a combined net book value of $161.1 million and 27 operating properties as of December 31, 2012 with a combined net book value of $161.8 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 the assignment of certain rents and leases associated with those properties.
On December 23, 2013, we, operating through our subsidiary, Whitestone Woodlake Plaza, LLC, a Delaware limited liability company, entered into a $6.5 million promissory note (the "Woodlake Note"), with a fixed interest rate of 3.80% payable to Western Reserve Life Assurance Company of Ohio and a maturity of January 1, 2019. Proceeds from the Woodlake Note were used to repay a portion of our unsecured revolving credit facility.
On December 16, 2013, we, operating through our subsidiary, Whitestone Anthem Marketplace, LLC, a Delaware limited liability company, entered into a $15.1 million promissory note (the "Anthem Note"), with a fixed interest rate of 4.99% payable to Citigroup Global Markets Realty Corporation and a maturity of January 6, 2024. Proceeds from the Anthem Note were used to repay a portion of our unsecured revolving credit facility.
On November 26, 2013, we, operating through our subsidiary, Whitestone Industrial-Office LLC, a Texas limited liability company ("Whitestone Industrial"), entered into a $37.0 million promissory note (the "Industrial Note"), with a fixed interest rate of 3.76% payable to Jackson Life National Insurance Company and a maturity of December 1, 2020. Proceeds from the Industrial Note were used to repay our existing $26.9 million floating rate loan that matured on December 1, 2013. The remainder of the proceeds were used to pay off approximately $10.1 million in fixed rate indebtedness maturing in 2014.
On September 26, 2013, we, operating through our subsidiary, Whitestone Uptown Tower, LLC, a Delaware limited liability company ("Whitestone Uptown"), entered into a $16.5 million promissory note (the "Uptown Note"), with a fixed interest rate of 4.97% payable to Morgan Stanley Capital Holdings LLC and a maturity of September 26, 2023. Proceeds from the Uptown Note were used to repay a portion of our unsecured revolving credit facility.
On September 24, 2013, we, operating through our subsidiary, Whitestone Terravita Marketplace, LLC, a Delaware limited liability company ("Whitestone Terravita"), entered into a $10.5 million promissory note (the "Terravita Note"), with an applicable interest rate of LIBOR plus 2.00%, payable to Bank of America, N.A. and a maturity of September 24, 2018. Proceeds from the Terravita Note were used to repay a portion of our unsecured revolving credit facility.
On June 19, 2013, we assumed a $11.1 million promissory note as part of our acquisition of Mercado at Scottsdale Ranch (see Note 8 to our accompanying consolidated financial statements). The 5.87% fixed interest rate note matures on August 16, 2016. In conjunction with our acquisition, we received an interest rate supplement from the seller in the amount of $932,000, which we will accrete into expense over the life of the note. As a result of the supplement, the imputed interest rate is 3.052%, which we consider to be an appropriate market rate.
On May 31, 2013, we, operating through our subsidiary, Whitestone Pinnacle of Scottsdale, LLC, a Delaware limited liability company ("Whitestone Pinnacle"), refinanced our $14.1 million promissory note, with an applicable interest rate of 5.695% and a maturity of June 1, 2013, with a $20.2 million promissory note (the "Pinnacle Note") payable to Cantor Commercial Real Estate Lending, L.P. with an applicable interest rate of 4.2805%, and a maturity of June 6, 2023.
The 2013 Facility, which is available to us for acquisitions of properties and working capital, is our primary source of additional credit. As of December 31, 2013, $134.8 million was drawn on the 2013 Facility, and our borrowing capacity was $40.2 million, assuming that we use proceeds of the 2013 Facility to acquire properties, or to repay debt on properties, that are eligible to be included in the unsecured borrowing base. Proceeds from the 2013 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. Additional proceeds from the 2013 Facility will be 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. The 2013 Facility currently bears interest at our election, at a rate of LIBOR plus 1.75% to 2.50%, and matures on February 3, 2017. As of December 31, 2013, the interest rate was 2.167%. We have an interest rate swap that fixes the LIBOR portion of our $50 million term loan under the 2013 Facility at 0.84%. The swap began on January 7, 2014 and will mature on February 3, 2017.
Certain other of our loans are subject to customary covenants. As of December 31, 2013, we were in compliance with all loan covenants.
Annual maturities of notes payable as of December 31, 2013 are due during the following years:
Capital Expenditures
We continually evaluate our properties’ performance and value. We may determine it is in our partners’ best interest to invest capital in properties 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 Texas 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
As of December 31, 2013, we had the following contractual obligations (see Note 8 of our accompanying consolidated financial statements for further discussion regarding the specific terms of our debt):
(1)
As of December 31, 2013, we had one loan totaling $84.8 million which bore interest at a floating rate. The variable interest rate payments are based on LIBOR plus 1.75% to LIBOR plus 2.50%, which reflects our new interest rates under our 2013 Facility. The information in the table above reflects our projected interest rate obligations for the floating rate payments based on one-month LIBOR as of December 31, 2013, of 0.17%.
(2)
The unused commitment fees on our unsecured credit facility, payable quarterly, are based on the average daily unused amount of our unsecured credit facility. The fees are 0.25% for facility usage greater than 50% or 0.35% for facility usage less than 50%. The information in the table above reflects our projected obligations for our unsecured credit facility based on our December 31, 2013 balance of $134.8 million.
Distributions
During 2013, we paid distributions to our OP unit holders of $21.0 million, compared to $16.3 million in 2012. OP unit holders receive monthly distributions. Payments of distributions are declared quarterly and paid monthly. The distributions paid to OP unit holders were as follows (in thousands, except per unit data) for the years ended December 31, 2013 and 2012:
Results of Operations
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
The following table provides a general comparison of our results of operations for the years ended December 31, 2013 and December 31, 2012 (dollars in thousands, except per unit data):
(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 an explanation and reconciliation of funds from operations to net income, see "Funds From Operations" below.
(3)
For an explanation and reconciliation of property net operating income to net income, see "Property Net Operating Income" below.
Property revenues. We had rental income and tenant reimbursements of approximately $62,145,000 for the year ended December 31, 2013 as compared to $46,554,000 for the year ended December 31, 2012, an increase of $15,591,000, or 33%. The year ended December 31, 2013 included $15,179,000 in increased revenues from New Store operations. During the twelve months ended December 31, 2013, Same Store revenues increased $412,000 in the aggregate. Same Store average occupancy increased from 85.2% for the year ended December 31, 2012 to 86.7% for the year ended December 31, 2013, increasing Same Store revenue $786,000. Partially offsetting the increase in Same Store average occupancy, the Same Store revenue rate per average leased square foot decreased $0.12 for the year ended December 31, 2013 to $14.02 per average leased square foot as compared to the year ended December 31, 2012 revenue rate per average leased square foot of $14.14, decreasing Same Store revenue $374,000. The revenue rate per average leased square feet is calculated by dividing the total revenue by the average square feet leased during the period.
Property expenses. Our property expenses were $23,510,000 for the year ended December 31, 2013, as compared to $17,639,000 for the year ended December 31, 2012, an increase of $5,871,000, or 33%. The primary components of total property expenses, Same Store property expenses and New Store property expenses are detailed in the tables below (in thousands):
Real estate taxes. Real estate taxes increased $2,383,000, or 37%, during the year ended December 31, 2013 as compared to 2012, primarily as a result of New Stores real estate taxes, which increased $2,170,000. Same Store real estate taxes increased $213,000 for the year ended December 31, 2013 as compared to the year ended December 31, 2012. The Same Store increase was primarily attributable to increases in 2013 property values of several of our Houston properties. We actively work to keep our valuations and resulting taxes low because a majority of these taxes are charged to our tenants through triple net leases, and we strive to keep these charges to our tenants as low as possible.
Utilities. Utilities increased $658,000, or 22%, during the year ended December 31, 2013 as compared to 2012. The increase in utility expenses was primarily attributed to New Store increases of $605,000 for the year ended December 31, 2013. Same Store utilities expenses increased approximately $53,000, or 2%, during the year ended December 31, 2013 as compared to 2012. The majority of the Same Store increase was attributable to increased electricity usage and related charges.
Contract services. Contract services increased $973,000, or 35%, during the year ended December 31, 2013 as compared to 2012, primarily as a result of New Store contract services, which increased $855,000. Same Store contract services increased $118,000, or 5%.
Repairs and maintenance. Repairs and maintenance increased $468,000, or 26%, during the year ended December 31, 2013 as compared to 2012. New Store repairs and maintenance increased $419,000 for the year ended December 31, 2013 as compared to 2012. Same Store repairs and maintenance increased $49,000, or 3%, during year ended December 31, 2013 as compared to 2012.
Bad debt. Bad debt for the year ended December 31, 2013 increased $665,000, or 66%, as compared to 2012. The increase for the year ended December 31, 2013 as compared to the year ended December 31, 2012 was comprised of $250,000 from New Store bad debt and $415,000 from Same Store bad debt. The overall bad debt expense was approximately 3% of revenue for the year ended December 31, 2013 and approximately 2% of revenue for the year ended December 31, 2012. We vigorously pursue past due accounts, but expect collection of rents to continue to be challenging for the foreseeable future.
Labor and other. Labor and other expenses increased $724,000, or 27%, for year ended December 31, 2013 as compared to 2012. New Store labor and other expenses increased $654,000 for the year ended December 31, 2013 as compared to 2012. Same Store labor and other expenses increased $70,000, or 3%, during year ended December 31, 2013 as compared to 2012.
Same Store and New Store net operating income. The components of Same Store, New Store and total property net operating income are detailed in the table below (in thousands):
Other expenses. Our other expenses were $34,355,000 for the year ended December 31, 2013, as compared to $28,464,000 for the year ended December 31, 2012, an increase of $5,891,000, or 21%. The primary components of other expenses, net are detailed in the table below (in thousands):
General and administrative. General and administrative expenses increased approximately $3,296,000, or 43%, for the year ended December 31, 2013 as compared to 2012. The increase in general and administrative expenses included increased share-based compensation costs of $1,573,000, increased payroll of costs of $732,000, increased office expenses of $368,000, increased travel expenses of $316,000, increased legal fees of $240,000 and increased other expenses of $67,000. The increase in share-based compensation is due to expense related to additional employee grants and expenses related to the expected vesting of performance-based shares. As of December 31, 2013, there was approximately $1.9 million in unrecognized compensation cost related to outstanding nonvested performance-based and time-based shares that are expected to be recognized over a weighted-average period of approximately 13 months.
Executive relocation expense. The executive relocation expense of $2,177,000 for the year ended December 31, 2012 relates to the disposition of an executive's residence and our obligation to pay certain expenses incurred in connection therewith pursuant to the relocation arrangement entered into with such executive. See Note 12 to the accompanying consolidated financial statements for further discussion.
Depreciation and amortization. Depreciation and amortization increased $3,200,000, or 31%, for the year ended December 31, 2013 as compared to 2012. New Store depreciation increased $2,385,000 and Same Store depreciation increased $793,000. The increase in Same Store depreciation is attributable to redevelopment and re-tenanting investments. Depreciation on corporate assets and amortization of commission costs increased $22,000.
Interest expense. Interest expense increased $1,418,000, or 16%, for the year ended December 31, 2013 as compared to 2012. An increase in our average outstanding notes payable balance of $88,782,000 accounted for $4,505,000 in increased interest expense, offset by a decrease in our effective interest rate to 3.71% for the year ended December 31, 2013 versus 5.07% for the year ended December 31, 2012, resulting in a $3,289,000 decrease in interest expense. Early extinguishment of debt fees of $169,000 and increased amortized loan fees of $33,000 both increased interest expense for the year ended December 31, 2013 as compared to the year ended December 31, 2012.
Interest, dividend and other investment income. Interest, dividend and other investment income decreased $154,000, or 53%, for the year ended December 31, 2013 as compared to 2012. During the year ended December 31, 2013, our gains on sales of investments in available-for-sale securities decreased $70,000, our dividend income decreased $122,000 and our interest income increased $38,000 as compared to the amounts realized during the year ended December 31, 2012.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
The following table provides a general comparison of our results of operations for the years ended December 31, 2012 and December 31, 2011 (dollars in thousands, except per unit data):
(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 an explanation and reconciliation of funds from operations to net income, see "Funds From Operations" below.
(3)
For an explanation and reconciliation of property net operating income to net income, see "Property Net Operating Income" below.
Property revenues. We had rental income and tenant reimbursements of approximately $46,554,000 for the year ended December 31, 2012 as compared to $34,915,000 for the year ended December 31, 2011, an increase of $11,639,000, or 33%. The year ended December 31, 2012 included $11,164,000 in increased revenues from New Store operations. Same Store revenues increased $475,000 in the aggregate. Same Store average occupancy increased from 83.9% for the year ended December 31, 2011 to 84.8% for the year ended December 31, 2012, increasing Same Store revenue $262,000. The Same Store revenue rate per average leased square foot increased $0.08 for the year ended December 31, 2012 to $12.60 per average leased square foot as compared to the year ended December 31, 2011 revenue rate per average leased square foot of $12.52, increasing Same Store revenue $213,000. The revenue rate per average leased square feet is calculated by dividing the total revenue by the average square feet leased during the period.
Property expenses. Our property expenses were $17,639,000 for the year ended December 31, 2012, as compared to $13,327,000 for the year ended December 31, 2011, an increase of $4,312,000, or 32%. The primary components of total property expenses, Same Store property expenses and New Store property expenses are detailed in the tables below (in thousands):
Real estate taxes. Real estate taxes increased $1,716,000, or 37%, during the year ended December 31, 2012 as compared to 2011, primarily as a result of New Stores real estate taxes, which increased $1,517,000. Same Store real estate taxes increased $199,000 for the year ended December 31, 2012 as compared to the year ended December 31, 2011. The Same Store increase was the result of increases in 2011 property values of several of our Houston properties that were under dispute with the taxing authority and increased assessed values from the various appraisal districts during 2012. Approximately $100,000 of the increase related to 2011 valuations, which we do not expect to repeat in future periods. We actively work to keep our valuations and resulting taxes low because a majority of these taxes are charged to our tenants through triple net leases, and we strive to keep these charges to our tenants as low as possible.
Utilities. Utilities increased $515,000, or 21%, during the year ended December 31, 2012 as compared to 2011. The increase in utility expenses was primarily attributed to New Store increases of $441,000 for the year ended December 31, 2012. Same Store utilities expenses increased approximately $74,000 during the year ended December 31, 2012 as compared to 2011. The majority of the Same Store increase was attributable to a new drainage utility fee with respect to our Houston properties charged by the City of Houston, which took effect July 1, 2011.
Contract services. Contract services increased $474,000, or 21%, during the year ended December 31, 2012 as compared to 2011, primarily as a result of New Store contract services, which increased $435,000. Same Store contract services increased $39,000, or 2%.
Repairs and maintenance. Repairs and maintenance increased $578,000, or 47%, during the year ended December 31, 2012 as compared to 2011. New Store repairs and maintenance increased $460,000 for the year ended December 31, 2012 as compared to 2011. Same Store repairs and maintenance increased $118,000, or 10%, during year ended December 31, 2012 as compared to 2011. The increase is primarily comprised of increases in electrical and lighting repairs of $40,000, HVAC repair and supply costs of $31,000, and roofing repairs of $28,000 and other net increased repair and maintenance costs of $19,000.
Bad debt. Bad debt for the year ended December 31, 2012 increased $389,000, or 63%, as compared to 2011. The increase for the year ended December 31, 2012 as compared to the year ended December 31, 2011 was comprised of $224,000 from New Store bad debt and $165,000 from Same Store bad debt. The overall bad debt expense was approximately 2% of revenue for both years. We vigorously pursue past due accounts, but expect collection of rents to continue to be challenging for the foreseeable future.
Labor and other. Labor and other expenses increased $640,000, or 32%, for year ended December 31, 2012 as compared to 2011. New Store labor and other expenses increased $311,000 for the year ended December 31, 2012 as compared to 2011. Same Store labor and other expenses increased $329,000, or 17%, during year ended December 31, 2012 as compared to 2011. The increase in Same Store labor and other expenses is primarily comprised of increased insurance premiums of $197,000, increased non-recoverable repairs of $49,000, increased office expenses of $44,000 and other net increased labor and other expenses of $39,000.
Same Store and New Store net operating income. The components of Same Store, New Store and total property net operating income are detailed in the table below (in thousands):
Other expenses. Our other expenses were $28,464,000 for the year ended December 31, 2012, as compared to $20,281,000 for the year ended December 31, 2011, an increase of $8,183,000, or 40%. The primary components of other expenses, net are detailed in the table below (in thousands):
General and administrative. General and administrative expenses increased approximately $968,000, or 15%, for the year ended December 31, 2012 as compared to 2011. The increase in general and administrative expenses included increased share-based compensation costs of $401,000, increased payroll of costs of $390,000, a separation arrangement cost of $107,000 and other expenses of $70,000. The increase in share-based compensation is due to expense related to additional employee grants and expenses related to the expected vesting of performance-based shares. As of December 31, 2012, there was approximately $1,092,000 in unrecognized compensation cost related to outstanding non-vested performance-based shares, which are expected to to vest over a period of twelve months and approximately $60,000 in unrecognized compensation cost related to outstanding non-vested time-based shares, which are expected to be recognized over a weighted-average period of approximately eight months. The increase in payroll costs is due to an increase in the number of employees from 62 as of December 31, 2011 to 68 as of December 31, 2012.
Executive relocation expense. The executive relocation expense of $2,177,000 relates to the disposition of an executive's residence and our obligation to pay certain expenses incurred in connection therewith pursuant to the relocation arrangement entered into with such executive. See Note 12 to the accompanying consolidated financial statements for further discussion.
Depreciation and amortization. Depreciation and amortization increased $2,480,000, or 32%, for the year ended December 31, 2012 as compared to 2011. New Store depreciation increased $1,716,000 and Same Store depreciation increased $749,000. The increase in Same Store depreciation is attributable to redevelopment and re-tenanting investments, most notably at our Windsor and Lion Square locations. Depreciation on corporate assets and amortization of commission costs increased $15,000.
Interest expense. Interest expense increased $2,388,000, or 38%, for the year ended December 31, 2012 as compared to 2011. An increase in our average outstanding notes payable balance of $44,540,000 accounted for $2,372,000 in increased interest expense, offset by a decrease in our effective interest rate to 5.07% for the year ended December 31, 2012 versus 5.32% for the year ended December 31, 2011, resulting in a $381,000 decrease in interest expense. Amortized loan fees included in interest expense increased $397,000 for the year ended December 31, 2012 with the addition of new debt and our 2012 Facility to $1,013,000 as compared to $616,000 for the year ended December 31, 2011.
Interest, dividend and other investment income. Interest, dividend and other investment income decreased $170,000, or 37%, for the year ended December 31, 2012 as compared to 2011. During the year ended December 31, 2012, our gains on sales of investments in available-for-sale securities decreased $82,000, our dividend income decreased $57,000 and our interest income decreased $31,000 as compared to the amounts realized during the year ended December 31, 2011.
Reconciliation of Non-GAAP Financial Measures
Funds From Operations ("FFO")
The National Association of Real Estate Investment Trusts ("NAREIT") defines FFO as net income (loss) available to common shareholders computed in accordance with U.S. GAAP, excluding gains or losses from sales of operating real estate assets, impairment charges on properties held for investment and extraordinary items, plus depreciation and amortization of operating properties, including our share of unconsolidated real estate joint ventures and partnerships. We calculate FFO in a manner consistent with the NAREIT definition.
Management uses FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using U.S. GAAP net income (loss) alone as the primary measure of our operating performance.
Historical cost accounting for real estate assets in accordance with U.S. 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 U.S. 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.
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, non-cash share-based compensation expense, rent support agreement payments received from sellers on acquired assets 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 Whitestone 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.
Below are the calculations of FFO and FFO Core and the reconciliations to net income, which we believe is the most comparable GAAP financial measure (in thousands):
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 and gain or loss on sale or disposition of assets, 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.
Below is the calculation of NOI and the reconciliation to net income, which we believe is the most comparable GAAP financial measure (in thousands):
Taxes
As a partnership, any federal income tax liability is passed through to our partners. Whitestone elected to be taxed as a REIT under the Internal Revenue Code beginning with its taxable year ended December 31, 1999. As a REIT, Whitestone generally is not subject to federal income tax on income that it distributes to its shareholders. If Whitestone fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates. Whitestone believes that it is organized and operates in a manner to qualify and be taxed as a REIT, and it intends to operate so as to remain qualified as a REIT for federal income tax purposes.
Inflation
We anticipate that the majority of our leases will continue to be triple-net leases or otherwise provide that tenants pay for increases in operating expenses and will contain provisions that we believe will mitigate the effect of inflation. In addition, many of our leases are for terms of less than five years, which allows us to adjust rental rates to reflect inflation and other changing market conditions when the leases expire. Consequently, increases due to inflation, as well as ad valorem tax rate increases, generally do not have a significant adverse effect upon our operating results.
Off-Balance Sheet Arrangements
We had no significant off-balance sheet arrangements as of December 31, 2013.
Item 7A.
Item 7A. 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 December 31, 2013, $179.5 million, or approximately 68%, of our outstanding debt was subject to fixed interest rates, which limit the risk of fluctuating interest rates. Though a change in the market interest rates affects the fair market value, it does not impact net income or cash flows. Our total outstanding fixed interest rate debt has an average effective interest rate at this time of approximately 3.50% per annum with expirations ranging from 2013 to 2024 (see Note 8 to our accompanying consolidated financial statements for further detail). Holding other variables constant, a 1% increase or decrease in interest rates would cause a $7.9 million decline or increase, respectively, in the fair value for our fixed rate debt.
Variable Interest Rate Debt
As of December 31, 2013, $84.8 million, or approximately 32%, of our outstanding debt was subject to floating interest rates of LIBOR plus 1.75% to 2.50% and not currently subject to a hedge. The impact of a 1% increase or decrease in interest rates on our floating rate debt would result in a decrease or increase of annual net income of approximately $0.8 million, respectively. We have an interest rate swap that fixes the LIBOR portion of our $50 million term loan under the 2013 Facility at 0.84%. The swap began on January 7, 2014 and will mature on February 3, 2017.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The information required by this Item 8 is incorporated by reference to our Financial Statements beginning on page of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of this Annual Report on Form 10-K, as of December 31, 2013, an evaluation was performed under the supervision and with the participation of Whitestone's management, including Whitestone's Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. In performing this evaluation, management reviewed the selection, application and monitoring of our historical accounting policies. Based on that evaluation, Whitestone's CEO and CFO concluded that as of December 31, 2013, these disclosure controls and procedures were effective and designed to ensure that the information required to be disclosed in our reports filed with the SEC is recorded, processed, summarized and reported on a timely basis. In designing and evaluating disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Management is required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Management’s Annual Report on Internal Control Over Financial Reporting
The management of Whitestone is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of Whitestone's management, it conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under this framework, Whitestone's management concluded that our internal control over financial reporting was effective as of December 31, 2013.
Changes in Internal Control Over Financial Reporting
There have been no changes during the Operating Partnership's quarter ended December 31, 2013, in the Operating Partnership's internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Operating Partnership's internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Trustees, Executive Officers and Corporate Governance.
The information required by Item 10 of Form 10-K is incorporated herein by reference to such information as set forth in Whitestone's definitive proxy statement for its 2014 annual meeting of shareholders.
Item 11.
Item 11. Executive Compensation.
The information required by Item 11 of Form 10-K is incorporated herein by reference to such information as set forth in Whitestone's definitive proxy statement for its 2014 annual meeting of shareholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
The following table provides information regarding Whitestone's equity compensation plans, pursuant to which Whitestone common shares, OP units or other equity securities may be granted from time to time, as of December 31, 2013:
(1)
Excludes 1,060,291 common shares subject to outstanding restricted common share units granted pursuant to Whitestone's 2008 Long-Term Equity Incentive Ownership Plan, as amended (the "Plan").
(2)
Pursuant the Plan, the maximum aggregate number of common shares that may be issued under the Plan will be increased upon each issuance of common shares by Whitestone so that at any time the maximum number of shares that may be issued under the Plan shall equal 12.5% of the aggregate number of common shares of Whitestone and our OP units issued and outstanding (other than units issued to or held by Whitestone).
(3)
Excludes 8,333 restricted common shares issued to trustees outside the Plan.
The remaining information required by Item 12 of Form 10-K is incorporated by reference to such information as set forth in Whitestone's definitive proxy statement for its 2014 annual meeting of shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by Item 13 of Form 10-K is incorporated herein by reference to such information as set forth in Whitestone's definitive proxy statement for its 2014 annual meeting of shareholders.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information required by Item 14 of Form 10-K is incorporated herein by reference to such information as set forth in Whitestone's definitive proxy statement for its 2014 annual meeting of shareholders.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
1.
Financial Statements. The list of our financial statements filed as part of this Annual Report on Form 10-K is set forth on page herein.
2.
Financial Statement Schedules.
a.
Schedule II - Valuation and Qualifying Accounts
b.
Schedule III - Real Estate and Accumulated Depreciation
All other financial statement schedules have been omitted because the required information of such schedules is not present, is not present in amounts sufficient to require a schedule or is included in the consolidated financial statements.
3.
Exhibits. The list of exhibits filed as part of this Annual Report on Form 10-K in response to Item 601 of Regulation S-K is submitted on the Exhibit Index attached hereto and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 OPERATING PARTNERSHIP, L.P.
(Registrant)
By:
Whitestone REIT, its General Partner
Date:
March 14, 2014
By:
/s/ James C. Mastandrea
James C. Mastandrea, Chairman and CEO
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints James C. Mastandrea and David K. Holeman, and each of them, acting individually, as his attorney-in-fact, each with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
F- 1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partners of
Whitestone REIT Operating Partnership, L.P.:
We have audited the accompanying consolidated balance sheets of Whitestone REIT Operating Partnership, L.P. and subsidiaries (the “Partnership”) as of December 31, 2013 and 2012, and the related consolidated statements of operations and comprehensive income, partners' capital and cash flows for each of the years in the three year period ended December 31, 2013. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Partnership as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 2013 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ Pannell Kerr Forster of Texas, P.C.
Houston, Texas
March 14, 2014
F- 2
See the accompanying notes to consolidated financial statements.
F- 3
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per unit data)
See the accompanying notes to consolidated financial statements.
F- 4
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per unit data)
See the accompanying notes to consolidated financial statements.
F- 5
(1)
Net of offering costs of $4.0 million.
(2)
Net of offering costs of $3.1 million.
(3)
Net of offering costs of $0.2 million.
(4)
Net of offering costs of $2.6 million.
See the accompanying notes to consolidated financial statements.
F- 6
See the accompanying notes to consolidated financial statements.
F- 7
See the accompanying notes to consolidated financial statements.
F- 8
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
1. DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS
Whitestone REIT Operating Partnership, L.P., a Delaware limited partnership, together with its subsidiaries (collectively, the "Partnership"), was formed on December 31, 1998 to conduct substantially all of the operations for its sole general partner, Whitestone REIT ("Whitestone" or the "General Partner"). 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, Whitestone changed its state of organization from Texas to Maryland pursuant to a merger of Whitestone directly with and into a Maryland real estate investment trust formed for the sole purpose of the reorganization and the conversion of each outstanding common share of beneficial interest of the Texas entity into 1.42857 common shares of beneficial interest of the Maryland entity. As the general partner of the Partnership, Whitestone has the exclusive power to manage and conduct the business of the Partnership, subject to certain customary exceptions. As of December 31, 2013, 2012 and 2011, we owned and operated 60, 51, and 45 properties, respectively, including retail, warehouse and office properties in and around Houston, Dallas, San Antonio, Chicago and Phoenix.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation. The accompanying consolidated financial statements include the accounts of the Partnership and its subsidiaries. All net income or loss is allocated between the General Partner and the limited partners based on the weighted-average percentage ownership of the Partnership during the year. Issuances of additional common shares of beneficial interest in Whitestone (the “common shares”) and units of limited partnership interest in the Partnership ("OP units") that are convertible into cash or, at Whitestone's option, common shares on a one-for-one basis changes the basis of ownership interests of both the Partnership and Whitestone.
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. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at 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 year amounts in the accompanying consolidated financial statements in order to be consistent with the current fiscal year presentation. These reclassifications had no effect on net income, total assets, total liabilities or partners' capital. During 2012, we reclassified the amortization of our loan fees, previously classified as general and administrative expenses, to interest expense for all periods presented.
Share-Based Compensation. From time to time, Whitestone awards nonvested restricted common share awards or restricted common share unit awards, which may be converted into common shares, to its trustees, to executive officers and employees under its 2008 Long-Term Equity Incentive Ownership Plan (the “2008 Plan”). The vast majority of the awarded shares and units vest when certain performance conditions are met. We recognize compensation expense when achievement of the performance conditions is probable based on Whitestone's management’s most recent estimates using the fair value of the shares as of the grant date. We recognized $2.3 million, $0.7 million and $0.3 million in share-based compensation expense for the years ended December 31, 2013, 2012 and 2011, 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. 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 have established an allowance for doubtful accounts against the portion of tenant accounts receivable which is estimated to be uncollectible.
F- 9
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
Cash and Cash Equivalents. We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents as of December 31, 2013 and 2012 consisted of demand deposits at commercial banks and brokerage accounts.
Marketable Securities. We classify our existing marketable equity securities as available-for-sale in accordance with the Financial Accounting Standards Board's ("FASB") Investments-Debt and Equity Securities guidance. These securities are carried at fair value with unrealized gains and losses reported in partners' capital as a component of accumulated other comprehensive income or loss. The fair value of the marketable securities is determined using Level 1 inputs under FASB Accounting Standards Codification ("ASC") 820, "Fair Value Measurements and Disclosures." Level 1 inputs represent quoted prices available in an active market for identical investments as of the reporting date. Gains and losses on securities sold are based on the specific identification method, and are reported as a component of interest, dividend and other investment income.
Real Estate
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, primarily interest, real estate taxes and loan acquisition costs, 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. Prior to that time, we expense these costs as acquisition expense. For the year ended December 31, 2013, approximately $114,000 and $100,000 in interest expense and real estate taxes, respectively, were capitalized. For the year ended December 31, 2012, approximately $176,000 and $147,000 in interest expense and real estate taxes, respectively, were capitalized. No interest or real estate taxes were capitalized for the year ended December 31, 2011.
Acquired Properties and Acquired Lease Intangibles. We allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values at the time of purchase. Identifiable intangibles include amounts allocated to acquired out-of-market leases, the value of in-place leases and customer relationship value, if any. We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property. Factors considered by management in our analysis of determining the as-if-vacant property value include an estimate of carrying costs during the expected lease-up periods considering market conditions, and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions. Whitestone's management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses. Intangibles related to out-of-market leases and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases. Premiums or discounts on acquired out-of-market debt are amortized to interest expense over the remaining term of such debt.
Depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for improvements and buildings, respectively. Tenant improvements are depreciated using the straight-line method over the life of the improvement or remaining term of the lease, whichever is shorter.
Impairment. We review our properties for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value. Whitestone's management has determined that there has been no impairment in the carrying value of our real estate assets as of December 31, 2013.
F- 10
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
Accrued Rents and Accounts Receivable. Included in accrued rent and accounts receivable are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. An allowance for the uncollectible portion of accrued rents and accounts receivable is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends. As of December 31, 2013 and 2012, we had an allowance for uncollectible accounts of $3.7 million and $2.3 million, respectively. As of December 31, 2013, 2012 and 2011, we recorded bad debt expense in the amount of $1.7 million, $1.0 million and $0.6 million, respectively, related to tenant receivables that we specifically identified as potentially uncollectible based on our assessment of each tenant’s credit-worthiness. Bad debt expenses and any related recoveries are included in property operation and maintenance expense.
Unamortized Lease Commissions and Loan Costs. Leasing commissions are amortized using the straight-line method over the terms of the related lease agreements. Loan costs are amortized on the straight-line method over the terms of the loans, which approximates the interest method. Costs allocated to in-place leases whose terms differ from market terms related to acquired properties are amortized over the remaining life of the respective leases.
Prepaids and Other Assets. Prepaids and other assets include escrows established pursuant to certain mortgage financing arrangements for real estate taxes and insurance and acquisition deposits which include earnest money deposits on future acquisitions. As part of the executive relocation arrangement discussed in Note 12, we issued a note receivable for $975,000 to the buyer, with an interest rate of 4.5% and a maturity of December 31, 2013. On December 5, 2013, the note was renewed through June 30, 2014 and bears interest at a rate of 5.2% during the renewal period.
Federal Income Taxes. As a partnership, any federal income tax liability is passed through to our partners. Whitestone elected to be taxed as a REIT under the Code beginning with our taxable year ended December 31, 1999. As a REIT, Whitestone generally is not subject to federal income tax on income that it distributes to its shareholders. If Whitestone fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates. We believe that Whitestone is organized and operates in such a manner as to qualify to be taxed as a REIT, and that it intends to operate so as to remain qualified as a REIT for federal income tax purposes.
State Taxes. We are subject to the Texas Margin Tax, which is computed by applying the applicable tax rate (1% 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 considered an income tax, FASB ASC 740, “Income Taxes” (“ASC 740”) applies to the Texas Margin Tax. We have recorded a margin tax expense of $0.3 million for the Texas Margin Tax for each of the years ended December 31, 2013, and 2012 and $0.2 million for the year ended December 31, 2011.
Fair Value of Financial Instruments. Our financial instruments consist primarily of cash, cash equivalents, accounts receivable, accounts and notes payable and investments in marketable securities. The carrying value of cash, cash equivalents, accounts receivable and accounts payable are representative of their respective fair values due to their short-term nature. The fair value of our long-term debt, consisting of fixed rate secured notes, variable rate secured notes and an unsecured revolving credit facility aggregate to approximately $262.0 million and $192.4 million as compared to the book value of approximately $264.3 million and $190.6 million as of December 31, 2013 and 2012, respectively. The fair value of our long-term debt is estimated on a Level 2 basis (as provided by ASC 820, "Fair Value Measurements and Disclosures"), using a discounted cash flow analysis based on the borrowing rates currently available to us for loans with similar terms and maturities, discounting the future contractual interest and principal payments.
Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 2013 and 2012. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since December 31, 2013 and current estimates of fair value may differ significantly from the amounts presented herein.
F- 11
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
Derivative Instruments and Hedging Activities. We occasionally 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 (loss) 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 whose inputs are observable. As of December 31, 2013, we consider our cash flow hedges to be highly effective.
Concentration of Risk. Substantially all of our revenues are obtained from office, warehouse and retail locations in the Houston, Dallas, San Antonio, Phoenix and Chicago metropolitan areas. We maintain cash accounts in major U.S. financial institutions. The terms of these deposits are on demand to minimize risk. The balances of these accounts sometimes exceed the federally insured limits, although no losses have been incurred in connection with these deposits.
Recent accounting pronouncements. In February 2013, the FASB issued guidance requiring entities to disclose certain information relating to amounts reclassified out of accumulated other comprehensive income. This guidance was effective prospectively for reporting periods beginning on or after December 15, 2012. We do not expect the pronouncement to have a significant impact on our consolidated financial statements.
In July 2013, the FASB issued guidance permitting the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815 ("Derivatives and Hedging"), in addition to the interest rates on direct Treasury obligations of the U.S. government and LIBOR. This guidance is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. We do not expect the pronouncement to have a significant impact on our consolidated financial statements.
3. MARKETABLE SECURITIES
All of our marketable securities were classified as available-for-sale securities as of December 31, 2013, 2012 and 2011. Available-for-sale securities consist of the following (in thousands):
F- 12
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
During the years ended December 31, 2013, 2012 and 2011, available-for-sale securities were sold for total proceeds of $747,000, $5,508,000 and $7,252,000, respectively. The gross realized gains and losses on these sales totaled $44,000 and $3,000, respectively, in 2013, $152,000 and $42,000, respectively, in 2012, and $302,000 and $110,000, respectively, in 2011. For the purpose of determining gross realized gains and losses, the cost of securities sold is based on specific identification. A net unrealized holding loss on available-for-sale securities in the amount of $229,000 and $408,000 for the years ended December 31, 2013 and 2012, respectively, has been included in accumulated other comprehensive income.
4. REAL ESTATE
As of December 31, 2013, we owned 60 commercial properties in the Houston, Dallas, San Antonio, Phoenix and Chicago areas comprised of approximately 5.0 million square feet of gross leasable area.
Property Acquisitions. On December 5, 2013, we acquired Market Street at DC Ranch, a property that meets our Community Centered Property strategy, for approximately $37.4 million in cash and net prorations. The 241,280 square foot property was 80% leased at the time of purchase and is located in Scottsdale, Arizona. Revenue and income of $282,000 and $155,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On October 17, 2013, we acquired a 2.50 acre parcel for $2.8 million in cash and net prorations. The parcel is located in Spring, Texas, a suburb of Houston, and is contiguous to our Corporate Park Woodland property. At the time of purchase, the parcel had 16,220 square feet and was 63% leased. Revenue and income of $30,000 and $16,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On October 7, 2013, we acquired Fountain Hills Plaza, a property that meets our Community Centered Property strategy, for approximately $20.6 million in cash and net prorations. The 111,289 square foot property was 87% leased at the time of purchase and is located in Fountain Hills, Arizona, a suburb of Phoenix. Revenue and income of $487,000 and $300,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On June 28, 2013, we acquired Anthem Marketplace, a property that meets our Community Centered Property strategy, for approximately $23.3 million in cash and net prorations. The 113,293 square foot property was 100% leased at the time of purchase and is located in Phoenix, Arizona. In the same purchase, we also acquired an adjacent development pad site of 0.83 acres. Revenue and income of $1,054,000 and $454,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On June 19, 2013, we acquired Mercado at Scottsdale Ranch, a property that meets our Community Centered Property strategy, for approximately $21.3 million, including the assumption of a $11.1 million non-recourse loan, a $0.9 million interest rate supplement and cash of $9.3 million. The 118,730 square foot property was 100% leased at the time of purchase and is located in Scottsdale, Arizona. Revenue and income of $1,185,000 and $610,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On March 28, 2013, we acquired Headquarters Village Shopping Center, a property that meets our Community Centered Property strategy, for approximately $25.7 million in cash and net prorations. The 89,134 square foot property was 100% leased at the time of purchase and is located in Plano, Texas. Revenue and income of $2,423,000 and $1,221,000, respectively, have been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On December 28, 2012, we acquired the Shops at Pecos Ranch, a property that meets our Community Centered Property strategy, for approximately $19.0 million in cash and net prorations. The 78,767 square foot property was 100% leased at the time of purchase and is located in Chandler, Arizona, a suburb of Phoenix.
On September 21, 2012, we acquired Village Square at Dana Park, a property that meets our Community Centered Property strategy, for approximately $46.5 million in cash and net prorations. The 310,979 square foot property was 71% leased at the time of purchase and is located in the Mesa submarket of Phoenix, Arizona. In the same purchase, we also acquired an adjacent development parcel of 4.7 acres for approximately $4.0 million in cash.
F- 13
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
On September 21, 2012, we acquired Fountain Square, a property that meets our Community Centered Property strategy, for approximately $15.4 million in cash and net prorations. The 118,209 square foot property was 76% leased at the time of purchase and is located in Scottsdale, Arizona.
On August 8, 2012, we acquired Paradise Plaza, a property that meets our Community Centered Property strategy, for approximately $16.3 million, including the assumption of a $9.2 million non-recourse loan, and cash of $7.1 million. The 125,898 square foot property was 100% leased at the time of purchase and is located in Paradise Valley, Arizona, a suburb of Phoenix.
On May 29, 2012, we acquired Sunset at Pinnacle Peak, formerly the Shops at Pinnacle Peak, a property that meets our Community Centered Property strategy, for approximately $6.4 million in cash and net prorations. The 41,530 square foot property was 76% leased at the time of purchase and is located in North Scottsdale, Arizona.
On December 28, 2011, we acquired the Shops at Starwood, a property that meets our Community Centered Property strategy, for approximately $15.7 million in cash and net prorations. The 55,385 square foot Class A property was 98% leased at the time of purchase and is located in Frisco, Texas, a northern suburb of Dallas. The Shops at Starwood has a complementary tenant mix of restaurants, fashion boutiques, salons and second-level office space.
On December 28, 2011, we acquired Starwood Phase III, a 2.73 acre parcel of undeveloped land adjacent to the Shops at Starwood for approximately $1.9 million, including a non-recourse loan we assumed for $1.4 million, secured by the land, and cash of $0.5 million. The Phase III development site fronts the Dallas North Tollway within the Tollway Overlay District, which grants the highest allowed density of any zoning district. No revenue or income has been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On December 28, 2011, we acquired Pinnacle of Scottsdale Phase II ("Pinnacle Phase II"), a 4.45 acre parcel of developed land adjacent to Pinnacle for approximately $1.0 million in cash and net prorations. Pinnacle Phase II has approximately 400 linear feet of frontage on Scottsdale Road and the potential for additional retail and office development. No revenue or income has been included in our results of operations for the year ended December 31, 2013 since the date of acquisition.
On December 22, 2011, we acquired Phase I of Pinnacle of Scottsdale ("Pinnacle"), a property that meets our Community Centered Property strategy, for approximately $28.8 million, including a non-recourse loan we assumed for $14.1 million that is secured by the property and cash of $14.7 million. The 113,108 square foot Class A property was 100% leased at the time of purchase and is located in North Scottsdale, Arizona.
On August 16, 2011, we acquired Ahwatukee Plaza Shopping Center, a property that meets our Community Centered Property strategy, for approximately $9.3 million in cash and net prorations. The 72,650 square foot property was 100% leased at the time of purchase and is located in the Ahwatukee Foothills neighborhood in south Phoenix, Arizona.
On August 8, 2011, we acquired Terravita Marketplace, a property that meets our Community Centered Property strategy, for approximately $16.1 million in cash and net prorations. The 102,733 square foot property, inclusive of 51,434 square feet leased to two tenants pursuant to ground leases, was 100% leased at the time of purchase and is located in Scottsdale, Arizona.
On June 28, 2011, we acquired Gilbert Tuscany Village, a property that meets our Community Centered Property strategy, for approximately $5.0 million in cash and net prorations. The 49,415 square foot property was 16% leased at the time of purchase and is located in Gilbert, Arizona.
On April 13, 2011, we acquired Desert Canyon Shopping Center, a property that meets our Community Centered Property strategy, for approximately $3.7 million in cash and net prorations. The 62,533 square foot property, inclusive of 12,960 square feet leased to two tenants pursuant to ground leases, was 65% leased at the time of purchase and is located in McDowell Mountain Ranch in northern Scottsdale, Arizona.
F- 14
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
Unaudited pro forma results of operations. The pro forma unaudited results summarized below reflect our consolidated pro forma results of operations as if our acquisitions for the years ended December 31, 2013, 2012 and 2011 were acquired on January 1, 2011 and includes no other material adjustments:
Acquisition costs. Acquisition-related costs of $1,010,000, $698,000 and $666,000 are included in general and administrative expenses in our income statements for the years ended December 31, 2013, 2012 and 2011, respectively.
Property dispositions. On July 22, 2011, we sold Greens Road Plaza, located in Houston, Texas, for $1.8 million in cash and net prorations. We have reinvested the proceeds from the sale of the 20,607 square foot property located in northeast Houston in acquisitions of Community Centered Properties in our target markets. As a result of the transaction, we recorded a gain on sale of property of $0.4 million for the year ended December 31, 2011.
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):
6. UNAMORTIZED LEASE COMMISSIONS AND LOAN COSTS
Costs which have been deferred consist of the following (in thousands):
F- 15
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
A summary of expected future amortization of deferred costs is as follows (in thousands):
7. FUTURE MINIMUM LEASE INCOME
We lease the majority of our properties under noncancelable operating leases, which provide for minimum base rents plus, in some instances, contingent rents based upon a percentage of the tenants’ gross receipts. A summary of minimum future rents to be received (exclusive of renewals, tenant reimbursements, and contingent rents) under noncancelable operating leases in existence as of December 31, 2013 is as follows (in thousands):
F- 16
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
8. DEBT
Mortgages and other notes payable consist of the following (in thousands):
(1)
Promissory note had an original balance of $14.1 million and an interest rate of 5.695%, due in 2013, which was refinanced in May 2013. See below for further discussion of the Pinnacle Note.
(2)
The 6.00% interest rate is fixed through March 30, 2016. On March 31, 2016, the interest rate will reset to the rate of interest for a five-year balloon note with a thirty-year amortization as published by the Federal Home Loan Bank.
(3)
Promissory note includes an interest rate swap that fixed the interest rate at 5.72% for the duration of the term.
(4)
Promissory note includes an interest rate swap that fixed the interest rate at 3.55% for the duration of the term.
(5)
We have entered into an interest rate swap that fixed the LIBOR portion of our $50 million term loan under our unsecured credit facility at 0.84%. The swap began on January 7, 2014.
Our mortgage debt was collateralized by 19 operating properties as of December 31, 2013 with a combined net book value of $161.1 million and 27 operating properties as of December 31, 2012 with a combined net book value of $161.8 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 the assignment of certain rents and leases associated with those properties.
F- 17
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
On December 23, 2013, we, operating through our subsidiary, Whitestone Woodlake Plaza, LLC, a Delaware limited liability company, entered into a $6.5 million promissory note (the "Woodlake Note"), with a fixed interest rate of 3.80% payable to Western Reserve Life Assurance Company of Ohio and a maturity of January 1, 2019. Proceeds from the Woodlake Note were used to repay a portion of our unsecured revolving credit facility.
On December 16, 2013, we, operating through our subsidiary, Whitestone Anthem Marketplace, LLC, a Delaware limited liability company, entered into a $15.1 million promissory note (the "Anthem Note"), with a fixed interest rate of 4.99% payable to Citigroup Global Markets Realty Corporation and a maturity of January 6, 2024. Proceeds from the Anthem Note were used to repay a portion of our unsecured revolving credit facility.
On November 26, 2013, we, operating through our subsidiary, Whitestone Industrial-Office LLC, a Texas limited liability company ("Whitestone Industrial"), entered into a $37.0 million promissory note (the "Industrial Note"), with a fixed interest rate of 3.76% payable to Jackson Life National Insurance Company and a maturity of December 1, 2020. Proceeds from the Industrial Note were used to repay our existing $26.9 million floating rate loan that matured on December 1, 2013. The remainder of the proceeds were used to pay off approximately $10.1 million in fixed rate indebtedness maturing in 2014.
The Industrial Note is a non-recourse loan secured by Whitestone Industrial's nine properties, including Corporate Park Woodland, Holly Hall Industrial Park, Interstate 10 Warehouse, Main Park, Plaza Park, Westbelt Plaza, Westgate Service Center, Corporate Park West and Dairy Ashford.
On September 26, 2013, we, operating through our subsidiary, Whitestone Uptown Tower, LLC, a Delaware limited liability company ("Whitestone Uptown"), entered into a $16.5 million promissory note (the "Uptown Note"), with a fixed interest rate of 4.97% payable to Morgan Stanley Capital Holdings LLC and a maturity of September 26, 2023. Proceeds from the Uptown Note were used to repay a portion of our unsecured revolving credit facility.
On September 24, 2013, we, operating through our subsidiary, Whitestone Terravita Marketplace, LLC, a Delaware limited liability company ("Whitestone Terravita"), entered into a $10.5 million promissory note (the "Terravita Note"), with an applicable interest rate of LIBOR plus 2.00%, payable to Bank of America, N.A. and a maturity of September 24, 2018. Proceeds from the Terravita Note were used to repay a portion of our unsecured revolving credit facility.
The Terravita Note is a non-recourse loan secured by Whitestone Terravita's Terravita Marketplace property, located in Scottsdale, Arizona, and a limited guarantee by the Partnership. In conjunction with the Terravita Note, a deed of trust was executed by Whitestone Terravita that contains customary terms and conditions, including representations, warranties and covenants by Whitestone Terravita that include, without limitation, assignment of rents, warranty of title, insurance requirements and maintenance, use and management of the property.
On June 19, 2013, we assumed a $11.1 million promissory note as part of our acquisition of Mercado at Scottsdale Ranch (see Note 8). The 5.87% fixed interest rate note matures on August 16, 2016. In conjunction with our acquisition, we received an interest rate supplement from the seller in the amount of $932,000, which we will accrete into expense over the life of the note. As a result of the supplement, the imputed interest rate is 3.052%, which we consider to be an appropriate market rate.
On May 31, 2013, we, operating through our subsidiary, Whitestone Pinnacle of Scottsdale, LLC, a Delaware limited liability company ("Whitestone Pinnacle"), refinanced our $14.1 million promissory note, with an applicable interest rate of 5.695% and a maturity of June 1, 2013, with a $20.2 million promissory note (the "Pinnacle Note") payable to Cantor Commercial Real Estate Lending, L.P. with an applicable interest rate of 4.2805%, and a maturity of June 6, 2023.
The Pinnacle Note is a non-recourse loan secured by Whitestone Pinnacle's Pinnacle of Scottsdale property, located in Scottsdale, Arizona, and a limited guarantee by Whitestone and us. In conjunction with the Pinnacle Note, a deed of trust was executed by Whitestone Pinnacle that contains customary terms and conditions, including representations, warranties and covenants by Whitestone Pinnacle that include, without limitation, assignment of rents, warranty of title, insurance requirements and maintenance, use and management of the property.
F- 18
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
The Pinnacle Note contains events of default that include, among other things, non-payment and default under the deed of trust. Upon occurrence of an event of default, the lender is entitled to accelerate all obligations of Whitestone Pinnacle. The lender will also be entitled to receive the entire unpaid balance and unpaid interest at a default rate.
On February 4, 2013, we entered into an unsecured credit facility (the “2013 Facility”) with the lenders party thereto, with BMO Capital Markets and Wells Fargo Securities, LLC, as co-lead arrangers and joint book runners, Bank of Montreal, as administrative agent (the "Agent"), Wells Fargo Bank, National Association, as syndication agent, and U.S. Bank National Association, as documentation agent. The 2013 Facility amended and restated our previous unsecured credit facility. We plan to use the 2013 Facility for property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and re-tenanting of properties in our portfolio.
In addition to a $125 million unsecured borrowing capacity under the revolving loan, the 2013 Facility also includes a $50 million term loan and permits the Partnership to increase the borrowing capacity under the 2013 Facility to a total of $225 million, upon the satisfaction of certain conditions. The 2013 Facility will mature on February 3, 2017, and provides that the Partnership may extend the maturity date for one year subject to certain conditions, including the payment of an extension fee.
Borrowings under the 2013 Facility accrue interest (at the Partnership's option) at a Base Rate or an Adjusted LIBOR plus an applicable margin based upon our then-existing leverage. Base Rate means the higher of: (a) the Agent's prime commercial rate, (b) the sum of (i) average rate quoted 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) 0.5%, 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.
Whitestone serves as the guarantor for funds borrowed by the Partnership under the 2013 Facility. The 2013 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 and extraordinary items) to fixed charges and maintenance of net worth. The 2013 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 August 8, 2012, we assumed a $9.2 million variable rate note as part of our acquisition of Paradise Plaza (See Note 4). The variable rate is based on the prime rate less 2.00% and matures on December 29, 2017. We consider the variable rate to be below-market and have imputed an interest rate of 4.13%, which we consider to be an appropriate market rate. As a result, we recorded a discount on the note of $1.3 million, which will amortize into interest expense over the life of the loan. See Note 9 for a discussion of the interest rate swap included with this note.
On December 22, 2011, we, through our subsidiary, Whitestone Pinnacle, assumed a promissory note in the amount of $14.1 million payable to U.S. Bank National Association with an applicable interest rate of 5.965% per annum. Monthly payments of $91,073 began on January 1, 2012 and continue thereafter on the first day of each calendar month until maturity on June 1, 2013. As discussed above, this note was refinanced and replaced with the Pinnacle Note maturing on June 6, 2023.
On December 28, 2011, we, operating through our subsidiary, Whitestone Shops at Starwood-Phase III LLC, a Delaware limited liability company ("Whitestone Starwood"), assumed a promissory note (the "Starwood Note") in the amount of $1.4 million payable to Sovereign Bank, with an applicable interest rate of 5.0% per annum. Monthly payments of $5,780 became due on January 1, 2012 and continued thereafter on the first day of each calendar month until December 31, 2012. On December 28, 2012, we extended the term of the Starwood Note through December 31, 2013. Under the terms of the extension, we made a principal payment in the amount of $300,000 plus approximately $52,000 in prepaid interest, an effective interest rate of 4.71% per annum. The interest was recorded as an asset and will be amortized into expense over the life of the loan.
F- 19
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
The Starwood Note is a non-recourse loan secured by Whitestone Starwood's future development of the land parcel adjacent to our Shops at Starwood property, located in Frisco, Texas, and a limited guarantee by Whitestone and us. In conjunction with the Starwood Note, a deed of trust was executed by Whitestone Starwood which contains customary terms and conditions, including representations, warranties and covenants by Whitestone Starwood that include, without limitation, assignment of rents, warranty of title, insurance requirements and maintenance, use and management of the properties.
The Starwood Note contains events of default that include, among other things, non-payment and default under the deed of trust. Upon occurrence of an event of default, the lender is entitled to accelerate all obligations of Whitestone Starwood. The lender will also be entitled to receive the entire unpaid balance and unpaid interest at a default rate.
As of December 31, 2013, $134.8 million was drawn on the 2013 Facility, and our remaining borrowing capacity was $40.2 million, assuming that we use proceeds of the 2013 Facility to acquire properties, or to repay debt on properties, that are eligible to be included in the unsecured borrowing base.
Certain other of our loans are subject to customary covenants. As of December 31, 2013, we were in compliance with all loan covenants.
Annual maturities of notes payable as of December 31, 2013 are due during the following years:
Contractual Obligations
As of December 31, 2013, we had the following contractual obligations:
(1)
As of December 31, 2013, we had one loan totaling $84.8 million which bore interest at a floating rate. The variable interest rate payments are based on LIBOR plus 1.75% to LIBOR plus 2.50%, which reflects our new interest rates under our 2013 Facility. The information in the table above reflects our projected interest rate obligations for the floating rate payments based on one-month LIBOR as of December 31, 2013, of 0.17%.
F- 20
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
(2)
The unused commitment fees on our unsecured credit facility, payable quarterly, are based on the average daily unused amount of our unsecured credit facility. The fees are 0.25% for facility usage greater than 50% or 0.35% for facility usage less than 50%. The information in the table above reflects our projected obligations for our unsecured credit facility based on our December 31, 2013 balance of $134.8 million.
9. DERIVATIVES AND HEDGING ACTIVITIES
The fair value of our interest rate swaps is as follows (in thousands):
On November 1, 2013, we, through our subsidiary, Whitestone Terravita, entered into an interest rate swap with Bank of America, N.A. that fixed the LIBOR portion of our $10.5 million term loan at 1.55%. See Note 8 for additional information regarding the Terravita Note. The swap began on November 1, 2013 and will mature on September 24, 2018. 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 (loss) 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.
On March 8, 2013, we entered into an interest rate swap with U.S. Bank National Association that fixed the LIBOR portion of our $50.0 million term loan under our unsecured credit facility at 0.84%. See Note 8 for additional information regarding our credit facility. The swap began on January 7, 2014 and will mature on February 3, 2017. 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 (loss) 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.
On August 8, 2012, as part of our acquisition of Paradise Plaza (see Note 4), we assumed a $9.2 million variable rate note (see Note 8). The note included an interest rate swap that had a fixed interest rate of 5.72%. We have designated the interest rate swap as a cash flow hedge with the effective portion of the changes in fair value recorded in comprehensive income (loss) 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, is recognized directly in earnings.
A summary of our interest rate swap activity is as follows (in thousands):
(1)
Amounts represent the effective portions of our interest rate swaps. We did not recognize any ineffective portion of our interest rate swaps in earnings for the years ended December 31, 2013, 2012 and 2011.
F- 21
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
10. EARNINGS PER UNIT
Basic earnings per unit for the Partnership's unit holders is calculated by dividing net income excluding amounts attributable to unvested restricted shares by the Partnership's weighted-average units outstanding during the period. Diluted earnings per unit for the Partnership's unit holders is calculated by dividing net income excluding amounts attributable to unvested restricted shares by the Partnership's weighted-average units outstanding during the period including any dilutive unvested restricted shares.
Certain of Whitestone's performance-based restricted common shares are considered participating securities, which require the use of the two-class method for the computation of basic and diluted earnings per OP unit.
For the years ended December 31, 2013, 2012 and 2011, distributions of $177,000, $194,000 and $213,000, respectively, were made to the holders of certain restricted common shares, $127,000, $172,000 and $196,000 of which were charged against earnings, respectively. See Note 14 for information related to restricted common shares under the 2008 Plan.
11. FEDERAL INCOME TAXES
Federal income taxes are not provided because we are taxed as a partnership and the liability incurred is that of our partners. As our general partner, Whitestone intends to and believes it qualifies as a REIT under the provisions of the Internal Revenue Code and because it distributed and intends to continue to distribute all of its taxable income to its shareholders. Whitestone's shareholders include their proportionate taxable income in their individual tax returns. As a REIT, Whitestone must distribute at least 90% of its real estate investment trust taxable income to its shareholders and meet certain income sources and investment restriction requirements. In addition, REITs are subject to a number of organizational and operational requirements. If Whitestone fails to qualify as a REIT in any taxable year, Whitestone will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates.
Taxable income differs from net income for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation and rental revenue.
F- 22
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
For federal income tax purposes, the cash distributions to Whitestone's shareholders are characterized as follows for the years ended December 31:
12. RELATED PARTY TRANSACTIONS
Executive Relocation. On July 9, 2010, upon the unanimous recommendation of Whitestone's Compensation Committee, Whitestone entered into an arrangement with Mr. Mastandrea with respect to the disposition of his residence in Cleveland, Ohio. Mr. Mastandrea listed the residence in the second half of 2007 and has had to pay for security, taxes, insurance and maintenance expenses related to the residence. Under the relocation arrangement as amended on August 9, 2012, we agreed to pay Mr. Mastandrea the shortfall, if any, in the amount realized from the sale of the Cleveland residence, below $2,450,000, plus tax on the amount of such payment at the maximum federal income tax rate. The amount of the shortfall was to be paid in a combination of cash and Whitestone's common shares at the market value of the shares, as determined upon agreement between Mr. Mastandrea and Whitestone's Compensation Committee.
In addition, the arrangement required us to continue paying the previously agreed upon cost of housing expenses for the Mastandrea family in Houston, Texas for a period of one year following the date of sale of the residence. We had previously agreed to reimburse Mr. Mastandrea for out-of-pocket moving costs including packing, temporary storage, transportation and moving supplies.
On December 21, 2012, Mr. Mastandrea sold the residence to a third party for a price of $1,125,000. Pursuant to the relocation arrangement, we paid cash of $1,325,000, representing the shortfall of the amount realized from the sale of the property, and $852,000, which represented moving expenses and closing costs incurred by Mr. Mastandrea and federal taxes. No Whitestone common shares were issued. The total expense incurred by us of $2,177,000 is shown separately in our consolidated financial statements. In addition, we issued a note receivable for $975,000 to the buyer, with an interest rate of 4.5% and a maturity of December 31, 2013. On December 5, 2013, the note was renewed through June 30, 2014 and bears interest at a rate of 5.2% during the renewal period. As a result of this transaction, we also recorded a related party receivable of $652,000, which represents the federal income tax withholding not deducted from our payment to Mr. Mastandrea. Subsequent to December 31, 2012, we received the $652,000 and paid it to the federal government on behalf of Mr. Mastandrea.
13. PARTNERS' CAPITAL
Under its declaration of trust, as amended, Whitestone has the authority to issue up to 400 million common shares of beneficial interest, $0.001 par value per share, and up to 50 million preferred shares of beneficial interest, $0.001 par value per share.
Operating Partnership Units
The Partnership conducts substantially all of Whitestone's business. Whitestone is the sole general partner of the Partnership and as of December 31, 2013, owned a 97.5% interest in the Partnership.
Limited partners in the Operating Partnership holding OP units have the right to redeem their OP units for cash or, at Whitestone's option, common shares at a ratio of one OP unit for one Whitestone common share. Distributions to OP unit holders are paid at the same rate per unit as distributions per share to Whitestone common shares. As of December 31, 2013 and 2012, there were 22,384,970 and 17,507,779 OP units outstanding, respectively. Whitestone owned 21,822,878 and 16,822,293 OP units as of December 31, 2013 and 2012, respectively. The balance of OP units is owned by third parties, including certain trustees of Whitestone. Whitestone's weighted-average share ownership in the Operating Partnership was approximately 96.8%, 94.1% and 84.2% for the years ended December 31, 2013, 2012 and 2011, respectively.
F- 23
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
On October 9, 2012, Whitestone filed with the SEC a prospectus supplement covering the issuance of up to 786,191 of its common shares of beneficial interest, par value $0.001 per share, to certain holders of OP units. The common shares may be issued to the extent that OP unit holders tender their OP units for redemption in accordance with the terms of the limited partnership agreement of the Operating Partnership and Whitestone elects, in its sole discretion, to issue common shares to the tendering OP unit holders. The prospectus supplement supplements a base prospectus, dated July 25, 2012, relating to Whitestone's effective shelf registration statement on Form S-3 (File No. 333-182667). During the years ended December 31, 2013 and 2012, 123,394 and 100,705 OP units, respectively, were redeemed for an equal number of common shares.
Reclassification of Whitestone's common shares and transfer of listing
On June 27, 2012, Whitestone filed with the State Department of Assessments and Taxation of Maryland amendments to its declaration of trust that (i) reclassified each issued and unissued Class A common share of beneficial interest, par value $0.001 per share (the "Class A common shares") into one Class B common share of beneficial interest, par value $0.001 per share (the "Class B common shares") and (ii) changed the designation of all of the Class B common shares to "common shares." The amendment setting forth the reclassification of the Class A common shares into Class B common shares was approved by its shareholders at the 2012 annual meeting of shareholders held on May 22, 2012. The amendment approving the redesignation of the Class B common shares to common shares was approved by Whitestone's board of trustees and did not require shareholder approval. On June 29, 2012, Whitestone transferred the listing of its common shares to the New York Stock Exchange under its existing ticker symbol "WSR." As a result of the transfer, Whitestone voluntarily delisted its common shares from the NYSE MKT LLC effective June 28, 2012.
Equity Offerings
On October 8, 2013, Whitestone completed the sale of 4,000,000 common shares, $0.001 par value per share, and on October 28, 2013, upon the underwriters' exercise of the over-allotment option, Whitestone completed the sale of 600,000 additional common shares, at a price to the public of $13.54 per share. Total net proceeds from the offering, including the over-allotment shares, and after deducting the underwriting discount and offering expenses, were approximately $59.7 million, which Whitestone contributed to the Partnership for 4,600,000 OP units. We used the net proceeds from this offering for general corporate purposes, which included acquisitions of additional properties, the repayment of outstanding indebtedness, capital expenditures (including tenant improvements), the expansion, redevelopment and/or re-tenanting of properties in our portfolio, working capital and other general purposes.
On June 19, 2013, Whitestone entered into five equity distribution agreements for an at-the-market distribution program. Pursuant to the terms and conditions of the agreements, Whitestone can issue and sell up to an aggregate of $50 million of its common shares. Actual sales will depend on a variety of factors to be determined by Whitestone from time to time, including (among others) market conditions, the trading price of its common shares, capital needs and Whitestone's determination of the appropriate sources of funding for it, and will be made in transactions that will be deemed to be “at-the-market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended. Whitestone has no obligation to sell any of its common shares, and could at any time suspend offers under the agreements or terminate the agreements. For the year ended December 31, 2013, Whitestone sold 282,239 common shares under the equity distribution program, with net proceeds of approximately $4.2 million, which Whitestone contributed to the Partnership for 282,239 OP units. In connection with such sales, Whitestone paid compensation of $0.2 million to the sales agents.
On August 28, 2012, Whitestone completed the sale of 4,830,000 common shares, $0.001 par value per share, including 630,000 common shares pursuant to the exercise of the underwriters' over-allotment option, at a price to the public of $12.80 per share. Total net proceeds from the offering, including over-allotment shares, and after deducting the underwriting discount and offering expenses, were approximately $58.7 million, which Whitestone contributed to the Partnership for 4,830,000 OP units. Whitestone used the proceeds for general corporate purposes, including property acquisitions, debt repayment, capital expenditures, the expansion, redevelopment and/or re-tenanting of properties in its portfolio, working capital and other general purposes.
F- 24
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
On May 10, 2011, Whitestone completed a public offering of 5,310,000 common shares, including 310,000 common shares pursuant to the exercise of the underwriters' over-allotment option at a public offering price of $12.00 per share. Net proceeds, after payment of underwriting commissions and transaction costs, were approximately $59.7 million, which Whitestone contributed to the Partnership for 5,310,000 OP units. Whitestone used the net proceeds to acquire properties in its target markets and to redevelop and re-tenant its existing properties, as well as for general corporate purposes.
Exchange Offers
On May 10, 2012, Whitestone commenced a third offer to exchange Class B common shares on a one-for-one basis for (i) up to 867,789 outstanding Class A common shares; and (ii) up to 453,642 outstanding OP units (the "Third Exchange Offer"). The Third Exchange Offer expired on June 8, 2012, and 426,986 Class A common shares and 121,156 OP units were accepted for change.
On December 9, 2011, Whitestone commenced a second offer to exchange common shares on a one-for-one basis for up to 453,642 outstanding OP units (the “Second Exchange Offer”). The Second Exchange Offer expired on January 11, 2012, and 453,580 OP units were accepted for exchange.
On September 2, 2011, Whitestone commenced an offer to exchange common shares on a one-for-one basis for up to 453,642 outstanding OP units (the “First Exchange Offer”). The First Exchange Offer expired on October 3, 2011, and 453,642 OP units were accepted for exchange.
Distributions
The following table reflects the total distributions we have paid (including the total amount paid and the amount paid per unit) in each indicated quarter (in thousands, except per unit data):
14. INCENTIVE SHARE PLAN
On July 29, 2008, Whitestone's shareholders approved the 2008 Long-Term Equity Incentive Ownership Plan (the “Plan”). On December 22, 2010, Whitestone's board of trustees amended the Plan to allow for the issuance of common shares pursuant to the Plan. The Plan, as amended, provides that awards may be made with respect to common shares of Whitestone or OP units. The maximum aggregate number of common shares that may be issued under the Plan is increased upon each issuance of common shares by Whitestone so that at any time the maximum number of shares that may be issued under the Plan shall equal 12.5% of the aggregate number of common shares of Whitestone and OP units issued and outstanding (other than shares and/or units issued to or held by Whitestone).
F- 25
WHITESTONE REIT OPERATING PARTNERSHIP, L.P. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013
The Compensation Committee of Whitestone's board of trustees administers the Plan, except with respect to awards to non-employee trustees, for which the Plan is administered by its 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 January 6, 2009, the Compensation Committee, pursuant to the Plan, granted to certain of Whitestone's officers restricted common shares and restricted common share units subject to certain restrictions. The restricted common shares and restricted common share units will vest upon achieving certain performance goals (as specified in the award agreement). The grantee is the record owner of the restricted common shares and has all rights of a shareholder with respect to the restricted common shares, including the right to vote the restricted common shares and to receive distributions with respect to the restricted common shares. The grantee has no rights of a shareholder with respect to the restricted common share units, including no right to vote the restricted common share units and no right to receive current distributions with respect to the restricted common share units until the restricted common share units are fully vested and convertible to common shares of Whitestone.
A summary of the share-based incentive plan activity as of and for the year ended December 31, 2013 is as follows:
(1)
The fair value of the shares granted were determined based on observable market transactions occurring near the date of the grants.
A summary of nonvested and vested share activity for the years ended December 31, 2013, 2012 and 2011 is presented below:
Total compensation recognized in earnings for share-based payments for the years ended December 31, 2013, 2012 and 2011 was $2.3 million, $0.7 million and $0.3 million, respectively. Taking into account the acquisitions occurring during the years ended December 31, 2013 and 2012 (see Note 4), Whitestone expects additional performance-based shares to vest due to the achievement of certain performance goals. As a result, as of December 31, 2013, there was approximately $1.9 million in unrecognized compensation cost related to outstanding nonvested performance-based and time-based shares that are expected to be recognized over a weighted-average period of approximately 13 months.
F- 26
15. GRANTS TO TRUSTEES
On September 16, 2013, each of Whitestone's four independent trustees and one trustee emeritus was granted 1,500 common shares, which vested immediately. The 7,500 common shares granted to its trustees had a grant date fair value of $14.52 per share. On January 31, 2013, two of Whitestone's independent trustees elected to receive a total of 1,172 common shares with a grant date fair value of $14.50 in lieu of cash for board fees. The fair value of the shares granted during the year ended December 31, 2013 was determined using quoted prices available on the date of grant.
16. COMMITMENTS AND CONTINGENCIES
We are a participant in various legal proceedings and claims that arise in the ordinary course of our business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, we believe that the final outcome of these matters will not have a material effect on our financial position, results of operations, or cash flows.
17. SEGMENT INFORMATION
Whitestone's management historically has not differentiated by property types and therefore does not present segment information.
18. SELECT QUARTERLY FINANCIAL DATA (unaudited)
The following is a summary of our unaudited quarterly financial information for the years ended December 31, 2013 and 2012 (in thousands, except per unit data):
(1)
The sum of individual quarterly basic and diluted earnings per unit amounts may not agree with the year-to-date basic and diluted earning per unit amounts as the result of each period's computation being based on the weighted average number of units outstanding during that period.
F- 27
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
December 31, 2013
F- 28
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2013
F- 29
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2013
F- 30
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2013
F- 31
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2013
F- 32
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Schedule III - Real Estate and Accumulated Depreciation
December 31, 2013
(1)
Reconciliations of total real estate carrying value for the three years ended December 31, follows:
(2)
The aggregate cost of real estate (in thousands) for federal income tax purposes is $569,902.
(3)
Formerly known as Shops at Pinnacle Peak.
(4)
This property secures a $15.1 million mortgage note.
(5)
This property secures a $11.1 million mortgage note.
(6)
This property secures a $9.2 million mortgage note.
(7)
This property secures a $14.1 million mortgage note.
(8)
This property secures a $10.5 million mortgage note.
(9)
These properties secure a $37.0 million mortgage note.
(10)
This property secures a $3.0 million mortgage note.
(11)
This property secures a $16.5 million mortgage note.
(12)
This property secures a $6.5 million mortgage note.
(13)
This property secures a $1.1 million mortgage note.
F- 33
Whitestone REIT Operating Partnership, L.P. and Subsidiaries
Index to Exhibits
Exhibit No.
Description
Exhibit No.
Description
Exhibit No.
Description
Exhibit No.
Description
12.1*
Statement of Calculation of Consolidated Ratio of Earnings to Fixed Charges
________________________
* Filed herewith.
*** Attached as Exhibit 101 to this Annual Report on Form 10-K are the following materials, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets as of December 31, 2013 and 2012, (ii) the Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2013, 2012 and 2011, (iii) the Consolidated Statements of Changes in Equity for the years ended December 31, 2013, 2012 and 2011, (iv) the Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011 and (v) the Notes to Consolidated Financial Statements.
Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
+ Denotes management contract or compensatory plan or arrangement.