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WSR > SEC Filings for WSR > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for WHITESTONE REIT

Form 10-Q for WHITESTONE REIT


8-Nov-2012

Quarterly Report


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

You should read the following discussion of our financial condition and results of operations in conjunction with our unaudited consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q (the "Report"), and the consolidated financial statements and the notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K for the year ended December 31, 2011. For more detailed information regarding the basis of presentation for the following information, you should read the notes to the unaudited consolidated financial statements included in this Report.

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

Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. You are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this Report. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. Factors that could cause actual results to differ materially from any forward-looking statements made in this Report include:

         the imposition of federal taxes if we fail to qualify as a REIT in any
          taxable year or forego an opportunity to ensure REIT status;


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

legislative or regulatory changes, including changes to laws governing REITs;

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

increases in interest rates and operating costs;

inability to obtain necessary outside financing;

decreases in rental rates or increases in vacancy rates;

litigation risks;

lease-up risks;

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


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


         the potential need to fund tenant improvements or other capital
          expenditures out of operating cash flow.

The forward-looking statements should be read in light of these factors and the factors identified in the "Risk Factors" sections of our Annual Report on Form 10-K for the year ended December 31, 2011, as previously filed with the Securities and Exchange Commission ("SEC") and of this Report below.

Overview

We are a fully integrated real estate company that owns and operates Community Centered Properties in culturally diverse markets in major metropolitan areas. We define Community Centered Properties as visibly located properties in established or developing culturally diverse neighborhoods in our target markets. Founded in 1998, we are internally managed with a portfolio of commercial properties in Texas, Arizona and Illinois.

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


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As of September 30, 2012, we owned and operated 50 commercial properties consisting of:

Operating Portfolio
            twenty-four retail centers containing approximately 1.8 million
             square feet of gross leasable area and having a total carrying value
             (net of accumulated depreciation) of $170.2 million;


            seven office centers containing approximately 0.6 million square
             feet of gross leasable area and having a total carrying value (net
             of accumulated depreciation) of $43.3 million; and


            eleven office/flex centers containing approximately 1.2 million
             square feet of gross leasable area and having a total carrying value
             (net of accumulated depreciation) of $40.1 million.

Redevelopment, New Acquisitions Portfolio

            five retail Community Centered Properties containing approximately
             0.6 million square feet of gross leasable area and having a total
             carrying value (net of accumulated depreciation) of $77.2 million;
             and


            three parcels of land held for future development having a total
             carrying value of $7.1 million.

As of September 30, 2012, we had a total of 1,051 tenants. We have a diversified tenant base with our largest tenant comprising only 1.2% of our annualized rental revenues for the nine months ended September 30, 2012. Lease terms for our properties range from less than one year for smaller tenants to over 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 245 new and renewal leases during the nine months ended September 30, 2012, totaling approximately 493,000 square feet and approximately $24.0 million in total lease value. This compares to 224 new and renewal leases totaling approximately 636,000 square feet and approximately $25.1 million in total lease value during the same period in 2011.

We employed 59 full-time employees as of September 30, 2012. As an internally managed REIT, we bear our own expenses of operations, including the salaries, benefits and other compensation of our employees, office expenses, legal, accounting and investor relations expenses and other overhead costs.

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 $11.6 million and $8.8 million for the three months ended September 30, 2012 and 2011, respectively, and $33.0 million and $24.9 million for the nine months ended September 30, 2012 and 2011, respectively.

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. We expect modest continued improvement in the economic conditions in our markets to provide slight increases in occupancy at certain of our properties.


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Scheduled Lease Expirations

We tend to lease space to smaller businesses that desire shorter term leases. As of September 30, 2012, approximately 29% of our gross leasable area was subject to leases that expire prior to December 31, 2013. Over the last two years, we have renewed leases covering approximately 75% of our square footage 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. In the markets in which we operate, we obtain and analyze market rental rates by reviewing third-party publications, which provide market and submarket rental rate data, and by inquiring of property owners and property management companies as to rental rates being quoted at properties located in close proximity to our properties that we believe display similar physical attributes as our properties. We utilize 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. During the year ended December 31, 2011, our revenue rate per square foot for new and renewal comparable spaces increased 1% when compared to the expiring revenue rate per square foot for the previous leases in the same spaces. As such, we expect to renew our leases expiring in the near term at rates which are at, or near, their current 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 pay dividends to our shareholders.

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 will enable 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. Those needs may include specialty retail, grocery, restaurants, medical, educational and financial 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.

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 center 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.

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. Paradise Plaza was 100% occupied at the time of purchase with 125,898 of square feet of gross leasable area, and is located in Paradise Valley, Arizona, a suburb of Phoenix.

On May 29, 2012, we acquired 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 center was 76% leased at the time of purchase and is located in North Scottsdale, Arizona.


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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 Class A center, which was 98% occupied at the time of purchase, contains 55,385 square feet of gross leasable area 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 that is 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.

On December 28, 2011, we acquired Pinnacle of Scottsdale Phase II, or Pinnacle Phase II, a 4.45 acre parcel of developed land adjacent to Pinnacle, described below, for approximately $1.0 million in cash and net prorations. Pinnacle Phase II has approximately 400 linear feet of frontage on Scottsdale Road, in North Scottsdale, Arizona and the potential for additional retail and office development.

On December 22, 2011, we acquired Phase I of Pinnacle of Scottsdale, or 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. Pinnacle is a 100% occupied Class A Community Center with 113,108 square feet of gross leasable area 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 center contains 72,650 square feet of gross leasable area, 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, containing 102,733 square feet of gross leasable area, including 51,434 square feet leased to two tenants pursuant to ground leases, for approximately $16.1 million in cash and net prorations. Terravita Marketplace is located in North Scottsdale, Arizona and adjacent to the gated golf course residential community of Terravita, which was developed by DelWebb Corporation/Pulte, with homes ranging in price from $250,000 to $1 million.

On June 28, 2011, we acquired Gilbert Tuscany Village, a property that meets our Community Centered Property strategy, containing 49,415 square feet of gross leasable area, located in Gilbert, Arizona for approximately $5.0 million in cash and net prorations. Gilbert Tuscany Village is surrounded by densely populated, high-end residential developments and is located approximately one mile from Banner Gateway Medical Center, a 60-acre medical complex that is partnering with MD Anderson to add a new 120,000 square foot cancer outpatient center.

On April 13, 2011, we acquired Desert Canyon Shopping Center, a property that meets our Community Centered Property strategy, for approximately $3.65 million in cash and net prorations. The center contains 62,533 square feet of gross leasable area, including 12,960 square feet leased to two tenants pursuant to ground leases, and is located in Mcdowell Mountain Ranch in northern Scottsdale, Arizona. Situated at a prime intersection at East McDowell Mountain Ranch Road and 105th Street, Desert Canyon is the nearest retail and office space to McDowell Mountain Elementary and Junior High Schools. Located adjacent to the Sonora Mountain Desert Preserve, a lighted trail and jogging path wind directly into the Desert Canyon site and provide access from the surrounding upscale residential neighborhoods.

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 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.


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Critical Accounting Policies

In preparing the consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reported periods. Actual results may differ from these estimates. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2011, under "Management's Discussion and Analysis of Financial Condition and Results of Operations." There have been no significant changes to these policies during the nine months ended September 30, 2012. For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, please refer to Note 2 in our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

Comparison of the Three Months Ended September 30, 2012 and 2011

The following table provides a summary comparison of our results of operations
for the three months ended September 30, 2012 and 2011 (dollars in thousands,
except per share and OP unit amounts):
                                                        Three Months Ended September 30,
                                                            2012                 2011
Number of properties owned and operated                           50                    41
Aggregate gross leasable area (sq. ft.)(1)                 4,195,924             3,428,844
Ending occupancy rate - operating portfolio(2)                    87 %                  86 %
Ending occupancy rate - all properties                            85 %                  84 %

Total property revenues                              $        11,618       $         8,791
Total property expenses                                        4,598                 3,638
Total other expenses                                           6,694                 4,822
Provision for income taxes                                        77                    54
Gain (loss) on disposal of assets                                 77                    (1 )
Income before gain on sale of property                           172                   278
Gain on sale of property                                           -                   397
Net income                                                       172                   675
Less: Net income attributable to noncontrolling
interests                                                          9                    97
Net income attributable to Whitestone REIT           $           163       $           578

Funds from operations (3)                            $         2,906       $         2,210
Property net operating income (4)                              7,020                 5,153
Distributions paid on common shares and OP units               4,083                 3,629
Distributions per common share and OP unit           $        0.2850       $        0.2850
Distributions paid as a % of funds from operations               141 %                 164 %

(1) During the first quarter of 2012, we concluded that approximately 2,029 square feet at our Lion Square location was no longer leasable, therefore, such area is no longer included in the gross leasable area as of March 31, 2012.

(2) 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.

(3) For a reconciliation of funds from operations to net income, see "Funds From Operations" below.

(4) For a reconciliation of property net operating income to net income, see "Property Net Operating Income" below.


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Property revenues. We had rental income and tenant reimbursements of approximately $11,618,000 for the three months ended September 30, 2012 as compared to $8,791,000 for the three months ended September 30, 2011, an increase of $2,827,000, or 32%. The three months ended September 30, 2012 included $2,458,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired since the beginning of the the period being compared. For purposes of comparing the three months ended September 30, 2012 to the three months ended September 30, 2011, New Stores include properties acquired between July 1, 2011 and September 30, 2012. Same Store revenues increased $369,000 for the three months ended September 30, 2012 as compared to the same period in the prior year. We define "Same Stores" as properties that were owned at the beginning of the period being compared. For purposes of comparing the three months ended September 30, 2012 to the three months ended September 30, 2011, Same Stores include properties owned before July 1, 2011. Same Store average occupancy increased from 81.8% for the three months ended September 30, 2011 to 85.0% for the three months ended September 30, 2012, increasing Same Store revenue $321,000. The Same Store average revenue per leased square foot increased $0.07 for the three months ended September 30, 2012 to $12.72 per leased square foot as compared to the average revenue per leased square foot of $12.65 for the three months ended September 30, 2011, resulting in an increase of Same Store revenues of $48,000.

Property expenses. Our property expenses were approximately $4,598,000 for the three months ended September 30, 2012 as compared to $3,638,000 for the three months ended September 30, 2011, an increase of $960,000, or 26%. The primary components of total property expenses are detailed in the table below (in thousands, except percentages):

                              Three Months Ended September 30,
                                   2012                2011              Change           % Change
Real estate taxes           $           1,629     $       1,262     $          367               29 %
Utilities                                 810               678                132               19 %
Contract services                         657               594                 63               11 %
Repairs and maintenance                   476               396                 80               20 %
Bad debt                                  362               165                197              119 %
Labor and other                           664               543                121               22 %
Total property expenses     $           4,598     $       3,638     $          960               26 %

Real estate taxes. Real estate taxes increased $367,000, or 29%, during the three months ended September 30, 2012 as compared to the same period in 2011. Real estate taxes for New Store properties were approximately $360,000 for the three months ended September 30, 2012. Same Store real estate taxes increased approximately $7,000 during the three months ended September 30, 2012 as compared to the same period in 2011. 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 expenses increased $132,000, or 19%, during the three months ended September 30, 2012 as compared to the same period in 2011. Utilities expenses for New Store properties were approximately $99,000 for the three months ended September 30, 2012. Same Store utilities expenses increased approximately $33,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The majority of the Same Store increase was attributable to water and drainage fees charged to our Houston properties by the City of Houston.

Contract services. Contract services increased $63,000, or 11%, during the three months ended September 30, 2012 as compared to the same period in 2011. The increase in contract services expenses included $77,000 in contract expenses increases for New Store properties for the three months ended September 30, 2012. Same Store contract service expenses decreased approximately $14,000 during the three months ended September 30, 2012 as compared to the same period in 2011.

Repairs and maintenance. Repairs and maintenance expenses increased $80,000, or 20%, during the three months ended September 30, 2012 as compared to the same period in 2011. Repairs and maintenance expenses for the three months ended September 30, 2012 included approximately $150,000 in increases for New Store properties. Same Store repairs and maintenance expenses decreased approximately $70,000 during the three months ended September 30, 2012 as compared to the same period in 2011. The decrease in Same Store repair expenses was primarily attributable to parking lot repairs completed during 2011.


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Bad debt. Bad debt expenses increased $197,000, or 119%, during the three months ended September 30, 2012 as compared to the same period in 2011. Bad debt . . .

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