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WSR > SEC Filings for WSR > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for WHITESTONE REIT


6-Nov-2013

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, 2012. 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;

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

decreases in rental rates or increases in vacancy rates;

litigation risks;

         lease-up risks, including leasing risks arising from exclusivity and
          consent provisions in leases with significant tenants;


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


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


         the 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, 2012, 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.


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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.

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

As of September 30, 2013, we owned and operated 55 commercial properties consisting of:

Operating Portfolio
            30 retail centers containing approximately 2.3 million square feet
             of gross leasable area and having a total carrying value (net of
             accumulated depreciation) of $255.2 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 $42.6 million; and


            11 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 $38.8 million.

Redevelopment, New Acquisitions Portfolio

            three retail Community Centered Properties containing approximately
             0.5 million square feet of gross leasable area and having a total
             carrying value (net of accumulated depreciation) of $76.7 million;
             and


            four parcels of land held for future development having a total
             carrying value of $7.4 million.

As of September 30, 2013, we had an aggregate of 1,168 tenants. We have a diversified tenant base with our largest tenant comprising only 1.6% of our annualized rental revenues for the nine months ended September 30, 2013. 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 256 new and renewal leases during the nine months ended September 30, 2013, totaling approximately 599,000 square feet and approximately $33.4 million in total lease value. This compares to 245 new and renewal leases totaling approximately 493,000 square feet and approximately $24.0 million in total lease value during the same period in 2012.

We employed 69 full-time employees as of September 30, 2013. 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 $16.3 million and $11.6 million for the three months ended September 30, 2013 and 2012, respectively, and $45.0 million and $33.0 million for the nine months ended September 30, 2013 and 2012, 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, although


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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 September 30, 2013, approximately 22.6% of our gross leasable area was subject to leases that expire prior to December 31, 2014. Over the last two years, we have renewed leases covering approximately 68% of our expiring 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 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. During the year ended December 31, 2012, our revenue rate per square foot for new and renewal comparable spaces increased 2% when compared to the expiring revenue rate per square foot for the previous leases in the same spaces. As such, we expect the 2013 and 2014 expiring square footage to lease 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 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. 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 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.

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.

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.


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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.

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 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.

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, 2012, 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, 2013. 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, 2012.

Results of Operations

Comparison of the Three Months Ended September 30, 2013 and 2012

The following table provides a summary comparison of our results of operations
for the three months ended September 30, 2013 and 2012 (dollars in thousands,
except per share and OP unit amounts):

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                                                        Three Months Ended September 30,
                                                            2013                 2012
Number of properties owned and operated                           55                    50
Aggregate gross leasable area (sq. ft.)                    4,597,541             4,195,924
Ending occupancy rate - operating portfolio(1)                    86 %                  87 %
Ending occupancy rate - all properties                            85 %                  85 %

Total property revenues                              $        16,291       $        11,618
Total property expenses                                        6,818                 4,598
Total other expenses                                           8,748                 6,694
Provision for income taxes                                        90                    77
Loss on disposal of assets                                         -                    77
Net income                                                       635                   172
Less: Net income attributable to noncontrolling
interests                                                         21                     9
Net income attributable to Whitestone REIT           $           614       $           163

Funds from operations (2)                            $         4,062       $         2,906
Property net operating income (3)                              9,473                 7,020
Distributions paid on common shares and OP units               5,030                 4,083
Distributions per common share and OP unit           $        0.2850       $        0.2850
Distributions paid as a % of funds from operations               124 %                 141 %

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

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

(3) 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 $16,291,000 for the three months ended September 30, 2013 as compared to $11,618,000 for the three months ended September 30, 2012, an increase of $4,673,000, or 40%. The three months ended September 30, 2013 included $4,618,000 in increased revenues from New Store operations. We define "New Stores" as properties acquired since the beginning of the period being compared. For purposes of comparing the three months ended September 30, 2013 to the three months ended September 30, 2012, New Stores include properties acquired between July 1, 2012 and September 30, 2013. Same Store revenues increased $55,000 for the three months ended September 30, 2013 as compared to the same period in the prior year. We define "Same Stores" as properties that have been owned since the beginning of the period being compared. For purposes of comparing the three months ended September 30, 2013 to the three months ended September 30, 2012, Same Stores include properties currently owned that were acquired before July 1, 2012. Same Store average occupancy decreased from 86.0% for the three months ended September 30, 2012 to 84.7% for the three months ended September 30, 2013, decreasing Same Store revenue $146,000. The Same Store average revenue per leased square foot increased $0.26 for the three months ended September 30, 2013 to $14.53 per leased square foot as compared to the average revenue per leased square foot of $14.27 for the three months ended September 30, 2012, resulting in a increase of Same Store revenues of $201,000.

Property expenses. Our property expenses were approximately $6,818,000 for the three months ended September 30, 2013 as compared to $4,598,000 for the three months ended September 30, 2012, an increase of $2,220,000, or 48%. The primary components of total property expenses are detailed in the table below (in thousands, except percentages):

                              Three Months Ended September 30,
Overall Property Expenses          2013                2012             Change            % Change
Real estate taxes           $           2,673     $       1,629     $       1,044               64 %
Utilities                               1,047               810               237               29 %
Contract services                         955               657               298               45 %
Repairs and maintenance                   535               476                59               12 %
Bad debt                                  719               362               357               99 %
Labor and other                           889               664               225               34 %
Total property expenses     $           6,818     $       4,598     $       2,220               48 %



                                 Three Months Ended September 30,
Same Store Property Expenses          2013                2012              Change            % Change
Real estate taxes              $           1,851     $       1,557     $          294               19  %
Utilities                                    802               797                  5                1  %
Contract services                            688               642                 46                7  %
Repairs and maintenance                      412               471                (59 )            (13 )%
Bad debt                                     567               360                207               58  %
Labor and other                              724               659                 65               10  %
Total property expenses        $           5,044     $       4,486     $          558               12  %



                                 Three Months Ended September 30,
New Store Property Expenses           2013                 2012             Change           % Change
Real estate taxes             $               822     $          72     $         750     Not meaningful
Utilities                                     245                13               232     Not meaningful
Contract services                             267                15               252     Not meaningful
Repairs and maintenance                       123                 5               118     Not meaningful
Bad debt                                      152                 2               150     Not meaningful
Labor and other                               165                 5               160     Not meaningful
Total property expenses       $             1,774     $         112     $       1,662     Not meaningful


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Real estate taxes. Real estate taxes increased $1,044,000, or 64%, during the three months ended September 30, 2013 as compared to the same period in 2012. Real estate taxes for New Store properties increased approximately $750,000 for the three months ended September 30, 2013. Same Store real estate taxes increased approximately $294,000 during the three months ended September 30, 2013 as compared to the same period in 2012. The Same Store increase in real estate taxes was primarily attributable to increases in the assessed values to our Texas properties for 2013. We are currently litigating the assessed values of our properties and expect to see some reduction in the assessed values, but can not determine the amount of the reductions until the cases have been settled with the taxing authorities. 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 $237,000, or 29%, during the three months ended September 30, 2013 as compared to the same period in 2012. Utilities expense increases attributable to New Store properties were approximately $232,000 for the three months ended September 30, 2013. Same Store utilities expenses increased approximately $5,000 during the three months ended September 30, 2013 as compared to the same period in 2012.

Contract services. Contract services increased $298,000, or 45%, during the three months ended September 30, 2013 as compared to the same period in 2012. The increase in contract services expenses included $252,000 in increases for New Store properties for the three months ended September 30, 2013. Same Store contract service expenses increased approximately $46,000 during the three months ended September 30, 2013 as compared to the same period in 2012.

Repairs and maintenance. Repairs and maintenance expenses increased $59,000, or 12%, during the three months ended September 30, 2013 as compared to the same period in 2012. Repairs and maintenance expenses for the three months ended September 30, 2013 included approximately $118,000 in increases for New Store properties. Same Store repairs and maintenance expenses decreased approximately $59,000 during the three months ended September 30, 2013 as compared to the same period in 2012.

Bad debt. Bad debt expenses increased $357,000, or 99%, during the three months ended September 30, 2013 as compared to the same period in 2012. Bad debt expenses for the three months ended September 30, 2013 included approximately $150,000 in increases for New Store properties. Same Store bad debt increased approximately $207,000 during the three months ended September 30, 2013 as compared to the same period in 2012. The increase in bad debt expense is primarily due to an increase in our tenant allowance for uncollectible accounts and tenant defaults. 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 $225,000, or 34%, during the three months ended September 30, 2013 as compared to the same period in 2012. Labor and other expenses for the three months ended September 30, 2013 included approximately $160,000 in increased cost for New Store properties. Same Store labor and other expenses increased approximately $65,000 during the three months . . .

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