UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K


[Mark
      One]x
              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the fiscal year ended December 31, 2008
                
                ORo
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the transition period from ______________ to
  ______________Commission
      File Number: 000-50256









(Exact
Name of Registrant as Specified in Its Charter)


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





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




Registrant’s
telephone number, including area code: (713) 827-9595




Securities
registered pursuant to section 12(b) of the Act:None




Securities
registered pursuant to section 12(g) of the Act:


Common
Shares of Beneficial Interest, par value $0.001 per share


(Title
of Class)


Indicate
      by check mark if the Registrant is a well-known seasoned issuer, as
      defined in Rule 405 of the Securities Act.
            Yes
      o No xIndicate
      by check mark if the Registrant is not required to file reports pursuant
      to Section 13 or 15(d) of the Act.
            Yes
      o No x




Indicate
by check mark whether the Registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes x No o




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
or Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o




Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “accelerated filer,” “large accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one)


Large
      accelerated filer o
            Accelerated
      filer o
            Non-accelerated
      filer x
            Smaller
      reporting company o(Do
      not check if smaller reporting
company)




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




The
aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of June 30, 2008 (the last business day of the Registrant’s most
recently completed second fiscal quarter) was $49,992,632 assuming a market
value of $5.15 per share.




As of
March 9, 2009, the Registrant had 10,312,307 common shares of beneficial
interest outstanding.




DOCUMENTS
INCORPORATED BY REFERENCE: We incorporate by reference into Part III portions of
our proxy statement for the 2009 Annual Meeting of Shareholders to be filed
subsequently with the Securities and Exchange Commission.














WHITESTONE
REIT


FORM
10-K


Year
Ended December 31, 2008




TABLE
OF CONTENTS


PagePART I
              
              1Item 1.
              Business
              1Item 1A.
              Risk Factors
              5Item 1B.
              Unresolved Staff Comments
              13Item 2.
              Properties
              13Item 3.
              Legal Proceedings
              16Item 4.
              Submission of Matters to a Vote of Security
      Holders
              16PART II
              
              17Item 5.
              Market for Registrant’s Common Equity, Related Shareholder
      Matters and Issuer Purchases of Equity Securities
              17Item 6.
              Selected Financial Data
              19Item 7.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              20Item 7A.
              Quantitative and Qualitative Disclosures About Market
      Risk
              42Item 8.
              Consolidated Financial Statements and Supplementary
      Data
              42Item 9.
              Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
              42Item 9A(T).
              Controls and Procedures
              42Item 9B.
              Other Information
              43PART III
              
              44Item 10.
              Trust Managers, Executive Officers and Corporate
      Governance
              44Item 11.
              Executive Compensation
              44Item 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Shareholder Matters
              44Item 13.
              Certain Relationships and Related Transactions, and
      Director Independence
              45Item 14.
              Principal Accountant Fees and Services
              45PART IV
              
              46Item 15.
              Exhibits and Financial Statement
    Schedules
              46SIGNATURES
              47









Unless the context otherwise
requires, all references in this report to “we,” “us” or “our” are to Whitestone
REIT and its subsidiaries.




Forward-Looking
Statements




This
Form 10-K contains forward-looking statements, 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. 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 to not place undue reliance on forward-looking
statements, which reflect our management’s view only as of the date of this Form
10-K. 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 Form 10-K
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;●
                construction
      costs that may exceed estimates or construction delays;●
                increases
      in interest rates;●
                availability
      of credit or significant disruption in the credit
  markets;●
                litigation
      risks;●
                lease-up
      risks;●
                inability
      to 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 this Form
10-K.







PART I




Item 1.
Business.




General




We
are a Maryland real estate investment trust (“REIT”) engaged in owning and
operating income-producing real properties. We invest in and operate retail,
office and warehouse properties located in the Houston, Dallas, San Antonio and
Phoenix metropolitan areas.




We
own a real estate portfolio of 35 properties containing approximately 3.0
million square feet of leasable space, located in Texas and Arizona. The
portfolio has a gross book value of approximately $180 million and book equity,
including minority interest, of approximately $67 million at December 31,
2008.




We
were organized in December 2003 for the purpose of merging with Hartman
Commercial Properties REIT, a Texas real estate investment trust organized in
August 1998. We are the surviving entity resulting from the merger, which was
consummated on July 28, 2004. We have elected to be taxed as a REIT under the
Internal Revenue Code of 1986, as amended (the “code”).




Our
common shares are currently not traded on a stock exchange. Our offices are
located at 2600 South Gessner, Suite 500, Houston, Texas 77063. Our telephone
number is (713) 827-9595 and we maintain an internet site at
www.whitestonereit.com.




Our
Strategy




Our
primary business objective is to increase shareholder value by employing a
“value-add” strategy. We seek well-located small properties in major cities that
are income producing with renovation potential or other upside potential, and
add-value through our management and leasing expertise. The key elements of our
strategy include:


●
              Maximize
      value in current properties through operational focus and
      redevelopment.●
              Grow
      through strategic acquisitions of commercial properties in high potential
      markets, including properties outside of Texas.●
              Selectively
      dispose of properties that have little or no growth potential and reinvest
      the capital into properties having potential for greater
      returns.●
              Raise
      capital using a combination of the private and public equity and debt
      markets, as well as joint ventures.●
              Bring
      liquidity to our stock by listing on a national stock
      exchange.




We
believe that our people are the heart of our company, our strategy and our
structure. We are focused on developing a team of people that display at all
times a high degree of character and competence. We believe that our people are
key to our ability to generate long term shareholder value.







Our
Structure




Substantially
all of our business is conducted through Whitestone REIT Operating Partnership,
L.P., a Delaware limited partnership organized in 1998 (the “Operating
Partnership”). We are the sole general partner of the Operating Partnership. As
of December 31, 2008, we owned a 66.4% interest in the Operating
Partnership.




As
of December 31, 2008, we owned a real estate portfolio consisting of 35
properties located in two states. Leased to national, regional and local
tenants, our retail, office and warehouse properties are primarily located
throughout Texas. As of December 31, 2008, the occupancy rate at our operating
properties was 84.3% based on leasable square footage compared to 86.2% as of
December 31, 2007.




We
invest in commercial properties with upside potential, where our leasing and
operating strategies can improve the existing properties’ value while providing
superior economic returns. We believe that investment in and operation of
commercial retail real estate is a local business and we focus our investments
in areas where we have strong knowledge of the local markets. Our properties are
located in densely populated areas in and around Houston, Dallas, San Antonio
and Phoenix. We plan to further expand into markets outside of Texas and will
continue to maintain our hands-on management philosophy. We look for markets
with strong demographic characteristics similar to those of
Houston.




Our
retail properties are primarily strip centers whose tenants consist of national,
regional and local retailers. Our properties generally attract tenants who
provide basic staples and convenience items to local customers. We believe sales
of these items are less sensitive to fluctuations in the business cycle than
higher priced retail items. No single retail tenant represented more than 2.0%
of total revenues for the year ended December 31, 2008.




During
2008 we commenced the leasing of a 33,400 square ft garden office property
located in Phoenix, Arizona. We take a very hands-on approach to ownership, and
directly manage the operations and leasing of our properties. Substantially all
of our revenues consist of base rents received under long-term leases. For the
year ended December 31, 2008, our total revenues were approximately $31.2
million. Approximately 76% of our existing leases contain “step up” rental
clauses that provide for increases in the base rental payments.




As
of December 31, 2008, 2007 and 2006, we had one property that accounted for more
than 10% of total gross revenue and real estate assets. Uptown Tower is an
office building located in Dallas, Texas that was acquired during 2005 and
accounts for 12.8%, 12.0% and 11.9% of our total revenue during 2008, 2007 and
2006, respectively. Uptown Tower also accounts for 11.5%, 10.8% and 11.2% of our
real estate assets, net of accumulated depreciation, for the years ended
December 31, 2008, 2007 and 2006, respectively. Of our 35 properties, 31 are
located in the Houston, Texas metropolitan area. See “Location of Properties” in
Item 2 for further discussion regarding Houston’s economy.




Economic
Factors




The
national economy contracted in 2008 at a pace consistent with a severe
recession. During the fourth quarter of 2008, real gross domestic product (GDP)
fell at an annualized rate of 3.8%. The Index of Leading Economic Indicators
suggests a moderate decline of GDP will continue into the first half of 2009.
Payroll employment dropped by about 3 million since the recession started in
December 2007, and housing starts decreased 44% during 2008.


2




The
credit crisis spread to the commercial credit markets during 2008 negatively
impacting the commercial real estate industry. Obtaining financing for new
projects and refinancing existing debt became increasingly difficult with the
tightening of credit.




These
factors may negatively impact the volume of real estate transactions, occupancy
levels, tenants’ ability to pay rent and cap rates, which could negatively
impact the value of public real estate companies, including ours. The vast
majority of our retail properties are located in densely populated metropolitan
areas and are occupied by tenants which generally provide basic necessity-type
items and tend to be less affected by economic changes. Furthermore, our
portfolio is primarily positioned in metropolitan areas in Texas which have been
impacted less by the economic slow down 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, including but not
limited to, other REITs, insurance companies and pension funds, with access to
greater resources than those available to us.




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 the contamination. In
addition, some environmental laws create a lien on the contaminated site in
favor of the government for damages and costs it incurs in connection with the
contamination. 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 and until we obtain what is generally
referred to as a “Phase I” environmental site assessment and are generally
satisfied with the environmental status of the property. A Phase I environmental
site assessment basically consists of 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. Certain properties that we
have acquired contain, or contained, dry-cleaning establishments utilizing
solvents. Where believed to be warranted, samplings of building materials or
subsurface investigations were undertaken with respect to these and other
properties. To date, the costs associated with these investigations and any
subsequent remedial measures taken have not been material to
us.


3




We
believe that our properties are in compliance in all material respects with all
federal, state and local ordinances and regulations regarding the handling,
discharge and emission of hazardous or toxic substances. 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. We have
not recorded in our financial statements any material liability in connection
with environmental matters. Nevertheless, it is possible that the environmental
assessments we have obtained or reviewed have not revealed all potential
environmental liabilities. It is also possible that subsequent environmental
assessments or investigations will identify material contamination, that adverse
environmental conditions have arisen subsequent to the performance of the
environmental assessments, or that there are material environmental liabilities
of which our management is unaware.




Employees




As
of December 31, 2008, we had 48 employees.




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 amendments to those reports, as well as Reports on
Forms 3, 4 and 5 regarding our officers, trust managers or 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 Act”) are available free of
charge through our website (www.whitestonereit.com) as soon as
reasonably practicable after we electronically file the material with, or
furnish it to, the Securities and Exchange Commission (“SEC”). We have also made
available on our website copies of our 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 our website. 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. Materials on our website are not part of our Annual
Report on Form 10-K.




Recent
Developments




On
January 16, 2009, we, through our Operating Partnership, acquired Spoerlein
Commons, a mixed-use garden style complex of retail, medical and professional
office tenants located in Buffalo Grove, Illinois.




Financial
Information




Additional
financial information related to Whitestone REIT is included in Item 8
‘Consolidated Financial Statements and Supplementary Data.”


4




Item 1A. Risk
Factors.




In
addition to the other information contained in this Form 10-K the following risk
factors should be considered carefully in evaluating our business. Our business,
financial condition, or results of operations could be materially adversely
affected by any of these risks. Please note 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




Adverse
macroeconomic and business conditions may significantly and negatively affect
our cash flows, profitability and results of operations.




The
United States is currently in a deep recession that has resulted in higher
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 tenant leasing practices. A
continuation of ongoing 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. At this time, it is difficult to
determine the breadth and duration of the economic and financial market problems
and the many ways in which they may affect our tenants and our business in
general. A general reduction in 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 and results of
operations.




Real
estate property investments are illiquid, and therefore we may not be able to
dispose of properties when appropriate or on favorable terms.




Real
estate property investments generally cannot be disposed of quickly. In
addition, the Code imposes 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 and reduce our cash flows and adversely affect distributions to
shareholders.




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 result in future acquisitions
generating lower overall economic returns, which may adversely affect our
results of operations and distributions to shareholders. 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.


5




The
value of investments in our common shares will be directly affected by general
economic and regulatory factors we cannot control or predict.




We
only own commercial real estate. 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;●
            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 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 mortgage funds, which may
      render the sale of a property difficult or unattractive;
    and●
            periods
      of high interest rates and tight money
supply.




Some
or all of these factors may affect our properties, which could adversely affect
our operations and ability to pay dividends to shareholders.




Compliance or failure to comply with
laws requiring access to our properties by disabled persons could result in
substantial cost.




The
Americans with Disabilities Act (“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 burdens 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.


6




Competition could limit our ability
to lease our properties or increase or maintain rental
income.




There
are numerous alternatives which compete with our properties in attracting
tenants. Our properties compete directly with other commercial properties which
are available for rent or purchase in the markets in which our properties are
located. 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




There
can be no assurance that we will be able to pay or maintain cash dividends or
that dividends will increase over time.




There
are many factors that can affect the availability and timing of cash dividends
to shareholders. Dividends will be based principally on cash available from our
properties, real estate securities, mortgage loans and other investments. The
amount of cash available for dividends will be affected by many factors, such as
our ability to buy properties, the yields on securities of other real estate
programs that we invest in, and our operating expense levels, as well as many
other variables. We can give no assurance that we will be able to pay or
maintain dividends or that dividends will increase over time. In addition, we
can give no assurance that rents from the properties will increase, that the
securities we buy will increase in value or provide constant or increased
dividends over time, or that future acquisitions of real properties, mortgage
loans or our investments in securities will increase our cash available for
dividends to shareholders. Our actual results may differ significantly from the
assumptions used by our Board of Trustees (the “Board”) in establishing the
dividend rate to shareholders.




If
we experience decreased cash flows, we may need to use other sources of cash to
fund dividends or we may be unable to pay dividends.




Actual
cash available for dividends may vary substantially from estimates. If our cash
dividends exceed the amount of cash available for dividends, we may need to fund
the shortage out of working capital, borrowings under our lines of credit or by
obtaining other debt, which would reduce the amount of proceeds available for
real estate investments. During the year ended December 31, 2008, our cash
provided from operating activities was $2.6 million and our total distributions
were $8.7 million. Therefore we had distributions in excess of cash flow for
operations of approximately $6.1 million. Our primary funding for paying
dividends in excess of cash flow from operations was proceeds from additional
notes payable during 2008.




Because
of the lack of geographic diversification of our portfolio, an economic downturn
in the Texas metropolitan areas could adversely impact our operations and
ability to pay dividends to our shareholders.




The
majority of our assets and revenues are currently derived from properties
located in Texas metropolitan areas. Our results of operations are directly
contingent on our ability to attract financially sound commercial tenants. If
Texas experiences a significant economic downturn, our ability to locate and
retain financially sound tenants may be adversely impacted. Likewise, we may be
required to lower our rental rates to attract desirable tenants in such an
environment. Consequently, because of the lack of geographic diversity among our
current assets, if Texas experiences an economic downturn, our operations and
ability to pay dividends to our shareholders could be adversely
impacted.


7




Uninsured
losses relating to real property or excessively expensive premiums for insurance
coverage may adversely affect our returns.




We
will attempt to ensure that all of our properties are adequately insured 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. 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 dividends to be distributed to
shareholders.




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 payments of dividends to our
shareholders.




We have acquired a majority of our
properties, on a non “arms-length” basis, from entities controlled by our former
advisor and chief executive officer.




We
acquired 25 of our 35 properties we owned as of December 31, 2008, from entities
controlled by our former advisor and chief executive officer, who did not make
any representations or warranties in regard to the properties or the selling
entities (neither personally nor in his capacity as a general partner) in the
documents evidencing the transactions. No third parties were retained to
represent or advise these selling entities or us, and the transactions were not
conducted on an “arm’s-length” basis. Consequently, we essentially acquired the
properties on an “as is” basis. Therefore, we will bear the risk associated with
any characteristics of or deficiencies in these properties unknown at the
closing of the acquisitions that may affect their valuation or revenue
potential.


8




There
is no public trading market for our shares of common stock, making it difficult
for shareholders to sell their shares.




There
is no current public market for our common shares of beneficial interest. If you
are able to find a buyer for your shares, you may not sell your shares to that
buyer unless the buyer meets the suitability standards applicable to him or her,
including any suitability standards imposed by the potential purchaser’s state
of residence. Our declaration of trust also imposes restrictions on the
ownership of common shares that will apply to potential transferees that may
restrict your ability to sell your shares. In addition, our Board has delayed
the implementation of our share redemption program. Even if this program is
implemented in the future, our Board may reject any request for redemption of
shares or amend, suspend or terminate the program at any time. Therefore, it
will be difficult for you to sell your shares promptly or at all. You may not be
able to sell your shares in the event of an emergency, and, if you are able to
sell your shares, you may have to sell them at a substantial
discount.




Approximately
41% of our gross leasable area is subject to leases that expire prior to
December 31, 2011.




As
of December 31, 2008, approximately 41% of the aggregate gross leasable area of
our properties is subject to leases that expire prior to December 31, 2011. We
are subject to the risk that:


●
            tenants
      may choose not to renew these leases;●
            we
      may not be able to re-lease the space subject to these leases;
      and●
            the
      terms of any renewal or re-lease may be less favorable than the terms of
      the current leases.




If
any of these risks materialize, our cash flow and ability to pay dividends could
be adversely affected.




Loss of our key personnel could
adversely affect the value of our common shares of beneficial interest and
operations.




We
are dependent on the efforts of our key executive personnel. Although we believe
qualified replacements could be found for these key executives, the loss of
their services could adversely affect the value of our common shares of
beneficial interest and operations.




Risks
Associated with Our Indebtedness and Financing




Current
market conditions could affect our ability to refinance existing indebtedness or
obtain additional financing on acceptable terms and may have other adverse
effects on us.




The
United States credit markets have recently 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 certain
types of debt financing. Any reductions in our available borrowing capacity, or
our inability to renew or replace our current credit facilities 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 most 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 financial
condition, results of operations, cash flow and ability to pay dividends to our
shareholders.


9




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 pay dividends to our shareholders.




Our
debt agreements impose limits on our operations and our ability to make
distributions to our shareholders.




The
agreements relating to the debt we incur contain financial and operating
covenants that may limit our ability to make distributions or other payments to
our shareholders. Our existing credit facilities contain financial and operating
covenants, including:


●
            maintenance
      of specific levels of insurance;●
            lendor
      approval required for certain leases; and●
            limitations
      on our ability to make distributions or other payments to our
      shareholders, sell assets or engage in mergers, consolidation or make
      certain acquisitions.




Failure
to comply with these covenants could result from, among other things, changes in
our results of operations, incurrence of debt or changes in general economic
conditions. These covenants may restrict our ability to fund our operations and
conduct our business. Failure to comply with any of these covenants could result
in a default under our credit agreement or other debt agreements we may enter
into in the future. A default could cause one or more of our lenders to
accelerate the timing of payments which could force us to dispose of one or more
of our properties, possibly on disadvantageous terms. As of December 31, 2008,
we were not in compliance with one such covenant, in connection with our $6.4
million term loan agreement with KeyBank. As this non-compliance constitutes an
event of default, the lender has the right to accelerate payment. While we are
currently in discussions with the lender to obtain a waiver, there can be no
assurance that we will be successful in obtaining such waiver. Should we not
receive the waiver, we will seek to obtain other financing for the loan or pay
off the loan from our cash reserves. For more discussion, see Management’s Discussion and Analysis
of Financial ConditionandResults of Operations - Liquidity
and Capital Resources.




We may incur losses on interest rate
hedging arrangements.




Periodically,
we have entered into agreements to reduce the risks associated with increases in
interest rates, and may continue to do so. Although these agreements may
partially protect against rising interest rates, they also may reduce the
benefits to us if interest rates decline. If a hedging arrangement is not
indexed to the same rate as the indebtedness which is hedged, we may be exposed
to losses to the extent which the rate governing the indebtedness and the rate
governing the hedging arrangement change independently of each other. Finally,
nonperformance by the other party to the hedging arrangement may subject us to
increased credit risks.




We
may incur mortgage indebtedness and other borrowings, which may increase our
business risks.




If
it is determined 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 real properties. We may also borrow funds if necessary to
satisfy the REIT distribution requirement described above, or otherwise as may
be necessary or advisable to assure that we maintain our qualification as a REIT
for federal income tax purposes.


10




We
may incur mortgage debt on a particular piece of real property if we believe the
property’s projected cash flow is sufficient to service the mortgage debt. If
there is a shortfall in cash flow, however, the amount available for dividends
to shareholders 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 real property may
be affected by a default. If any of our properties are foreclosed upon due to a
default, our ability to pay cash dividends to our shareholders will be adversely
affected.




Risks
Associated with Income Tax Laws




If
we fail to qualify as a REIT, our operations and dividends to shareholders would
be adversely impacted.




We
intend to continue 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 our control may affect our 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 with respect to qualification as a REIT or the federal income tax
consequences of qualification.




If
we were to fail to qualify as a REIT in any taxable year:


●
            we
      would not be allowed to deduct our distributions to shareholders when
      computing our taxable income;●
            we
      would be subject to federal income tax (including any applicable
      alternative minimum tax) on our taxable income at regular corporate
      rates;●
            we
      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;●
            our
      cash available for dividends would be reduced and we would have less cash
      to pay dividends to shareholders; and●
            we
      may be required to borrow additional funds or sell some of our assets in
      order to pay corporate tax obligations we may incur as a result of our
      disqualification.


11




We
may need to incur additional borrowings to meet REIT minimum distribution
requirements.




In
order to maintain our qualification as a REIT, we are required to distribute to
our shareholders at least 90% of our annual real estate investment trust taxable
income (excluding any net capital gain). In addition we are subject to a 4%
nondeductible excise tax on the amount, if any, by which certain distributions
paid by us with respect to any calendar year are less than the sum of (i) 85% of
our ordinary income for that year, (ii) 95% of our net capital gain for that
year and (iii) 100% of our undistributed taxable income from prior years.
Although we intend to pay dividends to our shareholders in a manner that allows
us to meet the distribution requirement and avoid this 4% excise tax, we cannot
assure you that we will always be able to do so.




Our
income consists almost solely of our share of the Operating Partnership’s
income, and the cash available for distribution by us to our shareholders
consists of our share of cash distributions made by the Operating Partnership.
Because we are the sole general partner of the Operating Partnership, our Board
determines the amount of any distributions made by it. Our Board may consider a
number of factors in making distributions, including:


●
              the
      amount of the cash available for distribution;●
              the
      Operating Partnership’s financial condition;●
              the
      Operating Partnership’s capital expenditure requirements;
    and●
              our
      annual distribution requirements necessary to maintain our 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
our taxable income, as well as the effect of nondeductible capital expenditures
and the creation of reserves or required debt amortization payments could
require us to borrow funds on a short-term or long-term basis to meet the REIT
distribution requirement and to avoid the 4% excise tax described above. In
these circumstances, we may need to borrow funds to avoid adverse tax
consequences even if our 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.




Changes
in the tax law may adversely affect our REIT status




The
discussions of the federal income tax considerations are based on current tax
laws. Changes in the tax laws could result in tax treatment that differs
materially and adversely from that described herein.


12




Item 1B.
Unresolved Staff Comments




None.




Item 2.
Properties.




General




At
December 31, 2008, we owned 35 commercial properties located in two states. We
own 31 properties located in the Houston, Texas, two properties located in
Dallas, Texas, one property located in San Antonio, Texas and one property in
Phoenix, Arizona. Our properties consist of 17 retail centers with approximately
1,157,000 square feet of gross leasable area, 11 warehouse properties with
approximately 1,202,000 square feet of gross leasable area and 7 office
buildings with approximately 673,000 square feet of gross leasable area. Each
property is designed to meet the needs of surrounding local communities. As of
December 31, 2008, our properties contain approximately 2,991,000 square feet of
gross leasable area. As of December 31, 2008, our retail, warehouse and office
properties were approximately 80.4%, 88.7% and 82.9% leased,
respectively.




As
of December 31, 2008, we had one property that accounted for more than 10% of
total gross revenue. Uptown Tower is an office building located in Dallas, Texas
that was acquired during 2005 and accounts for 12.8% of our total revenue and
11.4% of real estate assets, net of accumulated depreciation.




Location
of Properties




Of
our 35 properties, 34 are located in Texas, with 31 being located in the greater
Houston metropolitan statistical area. These 31 represent 73% of our rental
income for the year ended December 31, 2008.




We
believe the Houston market has been impacted less drastically than many areas of
the country by the global economic and credit crisis. The Houston workforce is
concentrated in energy, chemicals, information technology, aerospace sciences
and medical sciences. The U.S. Bureau of Labor Statistics ranked Houston as
having the fastest job  to growth from the period of December 2007 to
December 2008.




Houston
Highlights


●
              Houston
      is the largest city in Texas and the 4th largest city in the
      U.S.●
              Houston
      ranks 3rd
      among U.S. metro areas in number of corporate headquarters for Fortune 500
      companies.●
              More
      than half of the world's 100 largest non-U.S.-based coperations have
      operations in Houston


13


General
Physical and EconomicAttributes




The
following table sets forth certain information relating to each of our
properties owned as of December 31, 2008.


Property
      Name
                                
                                Location
                                
                                Year
      Built/
                                  Renovated
                                
                                Leasable
      Square
                                  Feet
                                
                                Percent
                                  Occupied
      at
                                  12/31/08
                                
                                Annualized
      Base
                                  Rental
      Revenue
                                  (in.thousands)
      (1)
                                
                                Average
      Base
                                  Rental
      Revenue
                                  Per
      Sq. Ft.(2)Retail
      Properties:Bellnott
      Square
                                
                                Houston
                                
                                1982
                                
                                73,930
                                
                                36.8
                                %
                                
                                $
                                271
                                
                                $
                                9.96Bissonnet/Beltway
                                
                                Houston
                                
                                1978
                                
                                29,205
                                
                                70.0
                                %
                                
                                
                                284
                                
                                
                                13.89Centre
      South
                                
                                Houston
                                
                                1974
                                
                                44,543
                                
                                68.0
                                %
                                
                                
                                259
                                
                                
                                8.55Greens
      Road
                                
                                Houston
                                
                                1979
                                
                                20,507
                                
                                90.2
                                %
                                
                                
                                201
                                
                                
                                10.87Holly
      Knight
                                
                                Houston
                                
                                1984
                                
                                20,015
                                
                                100.0
                                %
                                
                                
                                321
                                
                                
                                16.04Kempwood
      Plaza
                                
                                Houston
                                
                                1974
                                
                                112,359
                                
                                70.6
                                %
                                
                                
                                746
                                
                                
                                9.40Lion
      Square
                                
                                Houston
                                
                                1980
                                
                                119,621
                                
                                94.6
                                %
                                
                                
                                1,006
                                
                                
                                8.89Providence
                                
                                Houston
                                
                                1980
                                
                                90,327
                                
                                91.2
                                %
                                
                                
                                747
                                
                                
                                9.07South
      Richey
                                
                                Houston
                                
                                1980
                                
                                69,928
                                
                                96.1
                                %
                                
                                
                                504
                                
                                
                                7.50South
      Shaver
                                
                                Houston
                                
                                1978
                                
                                21,926
                                
                                88.4
                                %
                                
                                
                                218
                                
                                
                                11.25SugarPark
      Plaza
                                
                                Houston
                                
                                1974
                                
                                95,032
                                
                                98.6
                                %
                                
                                
                                912
                                
                                
                                9.73Sunridge
                                
                                Houston
                                
                                1979
                                
                                49,359
                                
                                91.2
                                %
                                
                                
                                396
                                
                                
                                8.80Torrey
      Square
                                
                                Houston
                                
                                1983
                                
                                105,766
                                
                                91.3
                                %
                                
                                
                                755
                                
                                
                                7.82Town
      Park
                                
                                Houston
                                
                                1978
                                
                                43,526
                                
                                100.0
                                %
                                
                                
                                718
                                
                                
                                16.50Webster
      Point
                                
                                Houston
                                
                                1984
                                
                                26,060
                                
                                74.1
                                %
                                
                                
                                220
                                
                                
                                11.39Westchase
                                
                                Houston
                                
                                1978
                                
                                42,924
                                
                                63.6
                                %
                                
                                
                                308
                                
                                
                                11.28Windsor
      Park
                                
                                San
      Antonio
                                
                                1992
                                
                                192,458
                                
                                66.0
                                %
                                
                                
                                1,114
                                
                                
                                8.771,157,486
                                
                                80.4
                                %
                                
                                $
                                8,980
                                
                                $
                                9.65Warehouse
      Properties:Brookhill
                                
                                Houston
                                
                                1979
                                
                                74,757
                                
                                100.0
                                %
                                
                                
                                261
                                
                                
                                3.49Corporate
      Park Northwest
                                
                                Houston
                                
                                1981
                                
                                185,627
                                
                                74.6
                                %
                                
                                
                                1,467
                                
                                
                                10.59Corporate
      Park West
                                
                                Houston
                                
                                1999
                                
                                175,665
                                
                                86.6
                                %
                                
                                
                                1,408
                                
                                
                                9.26Corporate
      Park Woodland
                                
                                Houston
                                
                                2000
                                
                                99,937
                                
                                96.4
                                %
                                
                                
                                894
                                
                                
                                9.28Dairy
      Ashford
                                
                                Houston
                                
                                1981
                                
                                42,902
                                
                                89.2
                                %
                                
                                
                                136
                                
                                
                                3.55Holly
      Hall
                                
                                Houston
                                
                                1980
                                
                                90,000
                                
                                100.0
                                %
                                
                                
                                624
                                
                                
                                6.93Interstate
      10
                                
                                Houston
                                
                                1980
                                
                                151,000
                                
                                94.4
                                %
                                
                                
                                711
                                
                                
                                4.99Main
      Park
                                
                                Houston
                                
                                1982
                                
                                113,410
                                
                                100.0
                                %
                                
                                
                                679
                                
                                
                                5.99Plaza
      Park
                                
                                Houston
                                
                                1982
                                
                                105,530
                                
                                95.3
                                %
                                
                                
                                1,112
                                
                                
                                11.06Westbelt
      Plaza
                                
                                Houston
                                
                                1978
                                
                                65,619
                                
                                81.3
                                %
                                
                                
                                754
                                
                                
                                14.13Westgate
                                
                                Houston
                                
                                1984
                                
                                97,225
                                
                                68.4
                                %
                                
                                
                                443
                                
                                
                                6.661,201,672
                                
                                88.7
                                %
                                
                                $
                                8,489
                                
                                $
                                7.96Office
      Properties:9101
      LBJ Freeway
                                
                                Dallas
                                
                                1985
                                
                                125,874
                                
                                78.3
                                %
                                
                                
                                1,580
                                
                                
                                16.03Featherwood
                                
                                Houston
                                
                                1983
                                
                                49,670
                                
                                90.2
                                %
                                
                                
                                792
                                
                                
                                17.68Pima
      Norte
                                
                                Phoenix
                                
                                2007
                                
                                33,400
                                
                                2.0
                                %
                                
                                
                                20
                                
                                
                                29.94Royal
      Crest
                                
                                Houston
                                
                                1984
                                
                                24,900
                                
                                89.4
                                %
                                
                                
                                281
                                
                                
                                12.62Uptown
      Tower
                                
                                Dallas
                                
                                1982
                                
                                253,981
                                
                                89.8
                                %
                                
                                
                                3,834
                                
                                
                                16.81Woodlake
      Plaza
                                
                                Houston
                                
                                1974
                                
                                106,169
                                
                                97.4
                                %
                                
                                
                                1,420
                                
                                
                                13.73Zeta
      Building
                                
                                Houston
                                
                                1982
                                
                                37,740
                                
                                97.4
                                %
                                
                                
                                603
                                
                                
                                16.40631,734
                                
                                82.9
                                %
                                
                                $
                                8,530
                                
                                $
                                16.29Grand
      Totals
                                
                                
                                
                                
                                
                                2,990,892
                                
                                84.3
                                %
                                
                                $
                                25,999
                                
                                $
                                10.31




(1)Calculated as base rental revenues as of December 31, 2008
      annualized to reflect a twelve month period. Excludes vacant space at
      December 31, 2008.(2)Calculated as annualized base rent divided by net rentable square
      feet leased at December 31, 2008. Excludes vacant space at December 31,
      2008.


14




Significant
Tenants




The
following table sets forth information about our fifteen largest tenants as of
December 31, 2008, based upon annualized rental revenues at December 31,
2008.


Tenant
      Name
                
                Location
                
                Annualized
                  Rental
      Revenue
                  (in
      thousands)
                
                Percentage
      of
                  Total
      Annualized
                  Base
      Rental
                  Revenues
                
                Initial
                  Lease
      Date
                
                Year
                  ExpiringUS
      Census
                
                Houston
                
                $
                711
                
                
                2.7
                %
                8/15/2008
                
                2010Sports
      Authority
                
                San
      Antonio
                
                
                450
                
                
                1.7
                %
                1/1/2004
                
                2015Brockett
      Davis Drake Inc.
                
                Dallas
                
                
                380
                
                
                1.5
                %
                3/14/1994
                
                2011Air
      Liquide America, L.P.
                
                Dallas
                
                
                352
                
                
                1.4
                %
                8/1/2001
                
                2013X-Ray
      X-Press Corporation
                
                Houston
                
                
                316
                
                
                1.2
                %
                7/1/1998
                
                2019Kroger
                
                Houston
                
                
                265
                
                
                1.0
                %
                9/1/1999
                
                2011Petsmart,
      Inc
                
                San
      Antonio
                
                
                255
                
                
                1.0
                %
                1/1/2004
                
                2013Asian
      Supermarket, Llc
                
                Houston
                
                
                253
                
                
                1.0
                %
                7/3/2008
                
                2023Marshall’s
                
                Houston
                
                
                248
                
                
                1.0
                %
                5/12/1983
                
                2013Compass
      Insurance
                
                Dallas
                
                
                232
                
                
                0.9
                %
                9/1/2005
                
                2011Merrill
      Corporation
                
                Dallas
                
                
                220
                
                
                0.8
                %
                12/10/2001
                
                2014Amberton
      Business Center
                
                Dallas
                
                
                219
                
                
                0.8
                %
                3/11/2004
                
                2014Tecon
      Corporation
                
                Dallas
                
                
                207
                
                
                0.8
                %
                7/11/2003
                
                2009New
      Lifestyles, Inc.
                
                Dallas
                
                
                182
                
                
                0.7
                %
                5/5/1998
                
                2013Region
      IV Education
                
                Houston
                
                
                172
                
                
                0.7
                %
                9/1/2001
                
                2011$
                4,462
                
                
                17.2
                %




Lease Expirations




The
following table lists, on an aggregate basis, all of our scheduled lease
expirations over the next 10 years.


Gross
      Leasable Area
                  
                  Annualized
      Base Rent
                    as
      of December 31, 2008Year
                  
                  NumberofLeases
                  
                  Approximate
                    Square
      Feet
                  
                  Percentof
                    Total
                  
                  Amount
                    (in
      thousands)
                  
                  Percent
      of
                    Total2009
                  
                  161
                  
                  442,321
                  
                  15
                  %
                  $
                  4,308
                  
                  17.4
                  %2010
                  
                  101
                  
                  256,444
                  
                  9
                  %
                  
                  3,490
                  
                  14.1
                  %2011
                  
                  134
                  
                  514,223
                  
                  17
                  %
                  
                  5,262
                  
                  21.3
                  %2012
                  
                  96
                  
                  333,018
                  
                  11
                  %
                  
                  3,211
                  
                  13.0
                  %2013
                  
                  84
                  
                  348,555
                  
                  12
                  %
                  
                  3,802
                  
                  15.4
                  %2014
                  
                  32
                  
                  239,629
                  
                  8
                  %
                  
                  1,572
                  
                  6.3
                  %2015
                  
                  19
                  
                  121,499
                  
                  4
                  %
                  
                  1,107
                  
                  4.5
                  %2016
                  
                  6
                  
                  36,755
                  
                  1
                  %
                  
                  307
                  
                  1.2
                  %2017
                  
                  4
                  
                  34,042
                  
                  1
                  %
                  
                  290
                  
                  1.2
                  %2018
                  
                  5
                  
                  28,466
                  
                  1
                  %
                  
                  244
                  
                  1.0
                  %Total
                  
                  642
                  
                  2,354,952
                  
                  79
                  %
                  $
                  23,593
                  
                  95.4
                  %


15




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.




Regulations




Our
properties, as well as any other properties that we may acquire in the future,
are subject to various federal, state and local laws, ordinances and
regulations. They include, among other things, zoning regulations, land use
controls, environmental controls relating to air and water quality, noise
pollution and indirect environmental impacts such as increased motor vehicle
activity. We believe that we have all permits and approvals necessary under
current law to operate our properties.




Item 3. Legal
Proceedings.




We
are a participant in various other 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.
Submission of Matters to a Vote of Security Holders.




None.


16




PART II


Item 5.Market for
      Registrant’s Common Equity, Related Shareholder Matters and Issuer
      Purchases of Equity
Securities.




Market
Information




There
is no established trading market for our common shares of beneficial interest.
As of March 9, 2009, we had 10,312,307 common shares of beneficial interest
outstanding held by a total of approximately 1,429 shareholders.




Dividend
Reinvestment Plan




Our
dividend reinvestment plan allowed our shareholders to elect to have dividends
from our common shares reinvested in additional common shares. The purchase
price per share under our dividend reinvestment plan was $9.50. On March 27,
2007, we gave the required ten day notice to participants informing them that we
intend to terminate our dividend reinvestment plan. As a result, our dividend
reinvestment plan terminated on April 6, 2007. Shares issued under our dividend
reinvestment plan were registered on our Registration Statement on Form S-11. We
did not amend or supplement our Registration Statement following our change in
management on October 2, 2006, and the events that occurred thereafter. As a
result, shareholders that received approximately 64,000 shares issued under our
dividend reinvestment plan on or after that date could be entitled to recission
rights. These rights would entitle these shareholders to recovery of their
purchase price less any income received on their shares. These shares have been
reclassified from Shareholders’ equity to Accounts payable and accrued expenses
during 2008.




Issuer
Repurchases




We
did not repurchase any of our equity securities during 2008 under a share
redemption program. Our Board has approved (but delayed the implementation of) a
share redemption program that would enable shareholders to sell shares to us
after holding them for at least one year under limited circumstances. Our Board
could choose to amend the provisions of the share redemption program without
shareholder approval. Our Board has chosen not to implement the share redemption
program at this time.




We
received 293,962 of our common shares and 1,068,451 units of the Operating
Partnership in exchange for the transfer of two properties to Allen R. Hartman
and Hartman Management, L.P. as part of a settlement agreement. The settlement
agreement is detailed in Note 11 to the consolidated financial
statements.




Dividends




In
order to remain qualified as a REIT, we are required to distribute at least 90%
of our annual taxable income to our shareholders. We currently accrue dividends
quarterly and pay dividends in three monthly installments following the end of
the quarter. We intend to continue paying dividends in this manner. For a
discussion of our cash flow as compared to dividends, see Management’s Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources.


17




The
following table reflects the total dividends we have paid (including the total
amount paid and the amount paid per share) in each indicated quarter. The
amounts provided give effect to our reorganization as a Maryland real estate
investment trust and the concurrent recapitalization of our common shares on
July 28, 2004.


Quarter
      Paid
                
                Total
      Amount of
                  Dividends
      Paid
                  (in
      thousands)
                
                Dividends
      per
                  Share1st
      Quarter 2007
                
                1,522
                
                
                $
                0.15002nd
      Quarter 2007
                
                1,500
                
                
                
                0.15003rd
      Quarter 2007
                
                1,500
                
                
                
                0.15004th
      Quarter 2007
                
                1,500
                
                
                
                0.15001st
      Quarter 2008
                
                1,500
                
                
                
                0.15002nd
      Quarter 2008
                
                1,529
                
                
                
                0.15003rd
      Quarter 2008
                
                1,456
                
                
                
                0.15004th
      Quarter 2008
                
                1,093
                
                
                
                0.11251st
      Quarter 2009
                
                1,154
                
                
                
                0.1125Average
      Per Quarter
                
                
                
                
                $
                0.1417




Equity
Compensation Plan Information




Please
refer to Item 12 of this report for information concerning securities authorized
under our incentive share plan.


18





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.


Year
      Ended December 31,
                (in
      thousands, except per share data)2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004Operating
      Data:Revenues
              
              $
              31,201
              
              
              $
              29,374
              
              
              $
              28,378
              
              
              $
              23,490
              
              
              $
              21,814Property
      expenses
              
              
              13,193
              
              
              
              12,236
              
              
              
              11,438
              
              
              
              8,624
              
              
              
              6,847General
      and administrative (1)
              
              
              6,708
              
              
              
              6,721
              
              
              
              2,299
              
              
              
              567
              
              
              
              571Property
      and other asset management fees to an affiliate
              
              
              —
              
              
              
              —
              
              
              
              1,482
              
              
              
              1,319
              
              
              
              1,253Depreciation
      and amortization
              
              
              6,859
              
              
              
              6,048
              
              
              
              6,181
              
              
              
              5,733
              
              
              
              4,925Interest
      expense, net
              
              
              5,675
              
              
              
              4,825
              
              
              
              4,910
              
              
              
              3,469
              
              
              
              2,459Other
      expense (income), net
              
              
              442
              
              
              
              256
              
              
              
              (227
              )
              
              
              —
              
              
              
              —Income
      (loss) from continuing operations before minority interest
              
              
              (1,676
              )
              
              
              (712
              )
              
              
              2,295
              
              
              
              3,778
              
              
              
              5,759Loss
      (income) allocated to minority interest
              
              
              627
              
              
              
              268
              
              
              
              (855
              )
              
              
              (1,652
              )
              
              
              (2,685
              )Income
      (loss) from continuing operations
              
              
              (1,049
              )
              
              
              (444
              )
              
              
              1,440
              
              
              
              2,126
              
              
              
              3,074Income
      (loss) from discontinued operations
              
              
              (188
              )
              
              
              589
              
              
              
              554
              
              
              
              561
              
              
              
              655Gain
      on sale of property from discontinued operations
              
              
              3,619
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Income
      allocated to minority interest
              
              
              (1,248
              )
              
              
              (222
              )
              
              
              (213
              )
              
              
              (239
              )
              
              
              (305
              )Net
      income (loss)
              
              $
              1,134
              
              
              $
              (77
              )
              
              $
              1,781
              
              
              $
              2,448
              
              
              $
              3,424Income
      (loss) from continuing operations per common share
              
              $
              (0.11
              )
              
              $
              (0.04
              )
              
              $
              0.15
              
              
              $
              0.27
              
              
              $
              0.41Income
      from discontinued operations per common share
              
              
              0.23
              
              
              
              0.03
              
              
              
              0.03
              
              
              
              0.04
              
              
              
              0.08Net
      income (loss) per common share
              
              $
              0.12
              
              
              $
              (0.01
              )
              
              $
              0.18
              
              
              $
              0.31
              
              
              $
              0.49Balance
      Sheet Data:Real
      estate (net)
              
              $
              150,847
              
              
              $
              146,460
              
              
              $
              141,236
              
              
              $
              145,581
              
              
              $
              117,995Real
      estate (net), discontinued operations
              
              
              —
              
              
              
              7,932
              
              
              
              8,252
              
              
              
              8,384
              
              
              
              8,552Other
      assets
              
              
              27,098
              
              
              
              20,752
              
              
              
              17,599
              
              
              
              17,497
              
              
              
              16,070Total
      assets
              
              $
              177,945
              
              
              $
              175,144
              
              
              $
              167,087
              
              
              $
              171,462
              
              
              $
              142,617Liabilities
              
              $
              110,773
              
              
              $
              94,262
              
              
              $
              76,464
              
              
              $
              83,462
              
              
              $
              66,299Minority
      interests in Operating Partnership
              
              
              21,281
              
              
              
              28,039
              
              
              
              31,709
              
              
              
              34,272
              
              
              
              36,489Shareholders’
      equity
              
              
              45,891
              
              
              
              52,843
              
              
              
              58,914
              
              
              
              53,728
              
              
              
              39,829$
              177,945
              
              
              $
              175,144
              
              
              $
              167,087
              
              
              $
              171,462
              
              
              $
              142,617Other
      Data:Proceeds
      from issuance of common shares
              
              $
              —
              
              
              $
              261
              
              
              $
              9,453
              
              
              $
              17,035
              
              
              $
              1,472Additions
      to real estate
              
              
              5,153
              
              
              
              10,205
              
              
              
              1,833
              
              
              
              31,712
              
              
              
              10,277Dividends
      and distributions per share (2)
              
              
              0.58
              
              
              
              0.60
              
              
              
              0.63
              
              
              
              0.70
              
              
              
              0.70Funds
      from operations (3)
              
              
              4,236
              
              
              
              6,001
              
              
              
              8,993
              
              
              
              9,851
              
              
              
              11,138Occupancy
      at year end
              
              
              84
              %
              
              
              86
              %
              
              
              83
              %
              
              
              82
              %
              
              
              86
              %





(1)  General
and administrative expenses for the years ended December 31, 2008, 2007 and 2006
include approximately $1.5 million, $2.2 million and $0.9 million, respectively,
of legal costs resulting from litigation with Allen Hartman and Hartman
Management, LP.





(2)The
dividends per share represent total cash payments divided by weighted average
common shares.





(3)  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.


19





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.




Overview




We
are a real estate investment trust (“REIT”) engaged in owning and operating
income-producing real properties. Our investments include retail, office and
warehouse properties located in the Houston, Dallas, San Antonio and Phoenix
metropolitan areas. Our properties consist of:


●
              17
      retail properties containing approximately 1.2 million square feet of
      leasable space and having a total carrying amount (net of accumulated
      depreciation) of $61.0 million.●
              7
      office properties containing approximately 0.7 million square feet of
      leasable space and having a total carrying amount (net of accumulated
      depreciation) of $46.6 million.●
              11
      office/warehouse properties containing approximately 1.2 million square
      feet of leasable space and having a total carrying amount (net of
      accumulated depreciation) of $43.2
million.




Our
primary source of income and cash is rents associated with commercial leases.
Our business objective is to increase shareholder value by employing a value-add
investment strategy. This strategy is focused on owning and renovating
commercial real estate assets in markets with positive demographic trends,
achieving diversification by property type and location, and acquiring
properties within our targeted returns.




As
of December 31, 2008, we had 658 total tenants. We have a diversified tenant
base with our largest tenant compromising approximately 1.8% of our total
revenues for 2008. 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
are a self-managed REIT, employing 48 full-time employees as of December 31,
2008. As a self-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.




Prior
to November 14, 2006, our properties and day-to-day operations were externally
managed by Hartman Management, LP (“the External Manager”) under an advisory
agreement and a management agreement. Under this arrangement we were charged
fees based on percentages of gross revenues, asset values, capital raised, and
expenses submitted for reimbursement. Our advisory agreement expired at the end
of September 2006 and our Board terminated our property management agreement in
October 2006. The External Manager turned over all property management functions
to us on November 14, 2006.




We
believe that one of the most key measures of our performance is property
occupancy. Occupancy for the total portfolio was 84.3% at December 31, 2008,
compared to 86.2% at December 31, 2007. We completed 199 new and renewal leases
during 2008 totaling 0.7 million square feet and $23.0 million in total lease
value.


20




In
the fourth quarter of 2008, our Board approved an updated five year business
plan. The key elements of the plan are as follows:


●
                Maximize
      value in current properties through operational focus and
      redevelopment;●
                Grow
      through strategic acquisitions of commercial properties in high potential
      markets, including properties outside of Texas;●
                Dispose
      of non-core properties and reinvest the capital in redevelopment of
      existing properties or acquisition of core properties in high potential
      markets;●
                Raise
      capital using a combination of the private and public equity and debt
      markets, as well as joint ventures, and●
                Bring
      liquidity to our stock by listing on a national stock
      exchange.




During
2008, we have begun progress on the execution of this five year plan as
described in the following sections on redevelopment, acquisitions and
dispositions.




Redevelopment




We
continued redevelopment in 2008 to add 5,000 square feet of office space and
upgrade the Westchase Plaza Retail and Office Center located in Houston, Texas.
The total redevelopment of this center is projected to cost approximately $1.7
million and be completed by early 2009.




Acquisitions




In
October of 2007, we acquired a 33,400 square foot commercial property in the
Phoenix, Arizona metropolitan area, for approximately $8.3 million. The
property, Pima Norte, is a newly constructed one and two story class “A”
professional, executive and medical office building. We began leasing Pima Norte
during 2008. The total cost of the property is approximately $9.5
million.




Dispositions




On
May 30, 2008, we transferred two properties known as Garden Oaks and Northeast
Square in Houston, Texas to Allen R. Hartman and Hartman Management, L.P. as
part of a legal settlement. See Note 11 to the consolidated financial statements
for more information on the settlement.




On
July 26, 2007, we sold a 2.4 acre parcel of vacant land next to our South Shaver
retail property located in Houston, Texas for a sales price of $0.3
million.


21




On
December 1, 2006, we sold Northwest Place II, a 27,974 square foot
office/warehouse building located in Houston, Texas for a sales price of $1.2
million.




We
continue to monitor our properties to identify assets that should be disposed
of. We also consider the overall market conditions to determine when to dispose
of properties.




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. 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. You should read Note 2, Summary of Significant Accounting Policies,
to our 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 rent 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, acquisition costs 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. The Company capitalizes acquisition costs once
the acquisition of the property becomes probable. Prior to that time, we expense
these costs as acquisition expense. During the year ended December 31, 2008,
$0.4 million of interest was capitalized on properties under development.
Approximately $0.1 million in interest was capitalized for the year ended
December 31, 2007, and no interest was capitalized in 2006.




22




Acquired
Properties and Acquired Lease Intangibles. We account for real estate
acquisitions pursuant to Statement of Financial Accounting Standards (“SFAS”)
No. 141, Business Combinations.
Accordingly, 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. 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 five to 39 years for the buildings and improvements.
Tenant improvements are depreciated using the straight-line method over the life
of the lease.




Impairment.We review our properties for impairment 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, 2008.




Accrued
Rent 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, 2008 and 2007, we had an allowance for
uncollectible accounts of $1.5 million and $0.9 million, respectively. During
2008, 2007 and 2006, we recorded bad debt expense in the amount of $0.7 million,
$0.4 million and $0.3 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.




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


23




Derivative
Instruments.We have initiated a program designed to manage exposure to
interest rate fluctuations by entering into financial derivative instruments.
The primary objective of this program is to comply with debt covenants on a
credit facility. We have entered into an interest rate swap agreement with
respect to amounts borrowed under certain of our credit facilities, which
effectively exchanges existing obligations to pay interest based on floating
rates for obligations to pay interest based on fixed LIBOR rates.




We
have adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as subsequently amended by SFAS No. 138, “Accounting for Certain Derivative
Instruments and Certain Hedging Activities,”and SFAS No. 149, “Amendment of Statement 133 on
Derivative Instruments and Hedging Activities,” which require for items
appropriately classified as cash flow hedges that changes in the market value of
the instrument and in the market value of the hedged item be recorded as other
comprehensive income with the exception of the portion of the hedged items that
are considered ineffective. The derivative instruments are reported at fair
value as other assets or other liabilities as applicable. As of December 31,
2008, we did not have any interest rate swaps in place. As of December 31, 2007,
we had an interest rate swap with a $70.0 million notional which was designated
as a cash flow hedge. The fair value of this interest rate swap as of December
31, 2007 was approximately ($0.4) million and is included in accounts payable
and accrued expenses in the consolidated balance sheet. Additionally, for a
previous interest rate swap which was not designated as a cash flow hedge,
approximately ($0.03) million and $0.03 million are included in other expense
and other income on the consolidated statements of income for the year ended
December 31, 2007 and 2006, respectively.




New
Accounting Pronouncements




In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value
Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a
framework for measuring fair value under U.S. generally accepted accounting
principles and requires enhanced disclosures about fair value measurements. It
does not require any new fair value measurements. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities—Including an amendment of FASB Statement No. 115”
(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is effective for financial statements issued for fiscal
years beginning after November 15, 2007 and interim periods within those fiscal
years. We currently do not plan to measure any eligible financial assets and
liabilities at fair value under the provisions of SFAS No. 159.




In
September 2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue
07-6, “Accounting for the Sale
of Real Estate Subject to the Requirements of FASB Statement No. 66 When
the Agreement Includes a Buy-Sell Clause,”which clarifies that a
buy-sell clause, in and of itself, does not constitute a prohibited form of
continuing involvement that would preclude partial sale treatment under
Statement 66 (“EITF 07-6”). EITF 07-6 applies prospectively to new arrangements
entered into in fiscal years beginning after December 15,
2007.




In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,”which replaces SFAS No. 141, “ Business Combinations,”which, among other things, establishes principles and requirements for
how an acquirer entity recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed (including intangibles)
and any noncontrolling interests in the acquired entity (“SFAS
No. 141(R)”). SFAS No. 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. SFAS
141(R) could have a material effect on our accounting for future property
acquisitions.


24




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS No. 160”). SFAS No. 160 amends ARB 51 to establish accounting
and reporting standards for the noncontrolling interest in a subsidiary and for
the deconsolidation of a subsidiary. It also amends certain of ARB 51’s
consolidation procedures for consistency with the requirements of SFAS
No. 141(R). SFAS No. 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008.
Management believes that these statements will not have a material impact on the
Company’s consolidated results of operations or cash flows. However, management
is currently evaluating whether the adoption of SFAS 160 could have a material
impact on the consolidated balance sheets and statements of shareholders’
equity.




In
March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No.
133” (“SFAS No. 161”). SFAS No. 161 changes the disclosure requirements
for derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS No. 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. SFAS No. 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008. We are currently evaluating what impact, if any, our adoption
of SFAS No. 161 will have on our financial statements.




In
June 2008, the FASB issued FASB Staff Position No. 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities”
(“FSP No. 03-6-1”). FSP No. 03-6-1 affects entities which accrue non-returnable
cash dividends on share-based payment awards during the awards’ service period.
The FASB concluded unvested share-based payment awards which are entitled to
cash dividends, whether paid or unpaid, are participating securities any time
the common shareholders receive dividends. Because the awards are considered
participating securities, the issuing entity is required to apply the two-class
method of computing basic and diluted earnings per share. FSP No. 03-6-1 is
effective for fiscal years beginning after December 15, 2008, and early adoption
is not permitted. We are currently evaluating what impact, if any, our adoption
of FSP No. 03-6-1 will have on our financial statements.




Liquidity
and Capital Resources




Our
primary liquidity demands are distributions to the holders of our common shares
and holders of units of limited partnership interest in the Operating
Partnership (“OP Units”), capital improvements and repairs and maintenance for
our properties, acquisition of additional properties, tenant improvements and
debt repayments.




Primary
sources of capital for funding our acquisitions and redevelopment programs are
cash flows generated from operating activities, issuance of notes payable, sales
of common shares, sales of partnership operating units and sales of
underperforming properties.




Our
capital structure includes recourse and 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.


25




During
the year ended December 31, 2008, our cash provided from operating activities
was $2.6 million and our total distributions were $8.7 million. Therefore we had
distributions in excess of cash flow from operations of approximately $6.1
million. Our primary funding for paying dividends in excess of cash flow from
operations was proceeds from bank debt.




During
the year ended December 31, 2008, we incurred approximately $1.5 million in
legal costs as a result of the litigation with Mr. Hartman and Hartman
Management, LP. For a full discussion of the settlement with Mr. Hartman and
Hartman Management see Note 11.We anticipate that cash
flows from operating activities and our borrowing capacity will provide adequate
capital for our working capital requirements, anticipated capital expenditures
and scheduled debt payments during the next 12 months. We also believe that cash
flows from operating activities and our borrowing capacity will allow us to make
all distributions required for us to continue to qualify to be taxed as a
REIT.




Cash and Cash
Equivalents




We
had cash and cash equivalents of approximately $13.0 million at December 31,
2008, as compared to $10.8 million on December 31, 2007. The increase of $2.2
million was primarily the result of the following:


Sources of
      Cash●
              Cash
      flow from operations of $2.6 million for the year ended December 31,
      2008.●
              Net
      proceeds of $13.4 million from issuance of notes
  payable.Uses of
      Cash●
              Payment
      of dividends and distributions to common shareholders and OP Unit holders
      of $8.7 million.●
              Additions
      to real estate of $5.1
million.





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


26


DebtMortgages
      and other notes payable consist of the following (in
      thousands):Description
                                
                                December
      31, 2008
                                
                                December
      31, 2007Revolving
      credit facility$75.0
      million LIBOR +2.63%, due 2008
                                
                                $
                                —
                                
                                $
                                73,525Fixed
      rate notes$10.0
      million 6.04% Note, due 2014
                                
                                
                                9,782
                                
                                
                                9,899$11.2
      million 6.52% Note, due 2015
                                
                                
                                11,159
                                
                                
                                —$21.4
      million 6.53% Notes, due 2013
                                
                                
                                21,263
                                
                                
                                —$24.5
      million 6.56% Note, due 2013
                                
                                
                                24,500
                                
                                
                                —$0.5
      million 5.05% Notes, due 2009
                                
                                
                                40
                                
                                
                                37Floating
      rate notes$6.4
      million LIBOR + 2.00% Note, due 2009
                                
                                
                                6,400
                                
                                
                                —$26.9
      million LIBOR + 2.60% Note, due 2013
                                
                                
                                26,859
                                
                                
                                —$
                                100,003
                                
                                $
                                83,461




Revolving Credit
Facility




On
October 3, 2008, we paid in full our $75 million revolving credit facility with
a consortium of banks, (the “Revolving Credit Facility”). The interest rate was
based on the one month LIBOR rate plus 2.625%. The Revolving Credit Facility was
secured by a pledge of the partnership interests in Whitestone REIT Operating
Partnership III, L.P. (“WROP III”), a wholly owned subsidiary of the Operating
Partnership that was formed to hold title to the properties comprising the
borrowing base pool for the facility. As of December 31, 2007, the balance
outstanding under the Revolving Credit Facility was $73.5 million, and the
availability to draw was $1.5 million.




Fixed Rate Notes




On
March 1, 2007, we, operating through our subsidiary, Whitestone REIT Operating
Company IV LLC (“WROP IV”) executed a promissory note for $10.0 million payable
to to MidFirst Bank with an applicable interest rate of 6.04% per annum and a
maturity date of March 1, 2014.




On
August 5, 2008, we, operating through our subsidiary, Whitestone Corporate Park
West, LLC (“Whitestone Corporate”) executed a promissory note for $11.2 million
payable to MidFirst Bank with an applicable interest rate of 6.52% per annum and
a maturity date of September 15, 2015 (the “MidFirst Bank Loan”). The MidFirst
Bank Loan is a non-recourse loan secured by the Whitestone Corporate’s Corporate
Park West property, which is located in Houston, Texas, and a limited guarantee
by us.




On
October 1, 2008, we, operating through our subsidiary, Whitestone Centers LLC,
executed five promissory notes (the “Sun Life Promissory Notes”) totaling $21.4
million payable to Sun Life Assurance Company of Canada with an applicable
interest rate of 6.53% per annum and a maturity date of October 1, 2013. The Sun
Life Promissory Notes are non-recourse loans secured by the Whitestone Centers
LLC’s properties, and a limited guarantee by us.


27




On
October 1, 2008, we, operating through our subsidiary, Whitestone Offices LLC,
executed a promissory note (the “Nationwide Promissory Note”) for $24.5 million
payable to Nationwide Life Insurance Company with an applicable interest rate of
6.56% per annum and a maturity date of October 1, 2013. Interest only is due
through October 1, 2009. The Nationwide Promissory Note is a non-recourse loan
secured by Whitestone Offices LLC’s properties, and a limited guarantee by
us.




Floating Rate
Notes




On
January 25, 2008 we entered into a $6.4 million term loan agreement with
KeyBank. The term loan is secured by a pledge of the partnership interests in
WROP III, and Whitestone Pima Norte LLC (“WPN”), a wholly owned subsidiary of
the Operating Partnership that was formed to hold title to our Pima Norte
property that was purchased in October 2007. At December 31, 2007, WROP III owns
35 properties and WPN owns 1 property.




Outstanding
amounts under the term loan accrue interest computed at the LIBOR Rate on the
basis of a 360 day year, plus 2%. Interest only is payable monthly under the
loan with the total amount of principal due at maturity in July
2009.




On
October 3, 2008, we, operating through our subsidiary, Whitestone
Industrial-Office LLC, (“Whitestone Industrial Office”) executed a floating rate
promissory note (the “Jackson Life Loan”) for $26.9 million payable to Jackson
Life Insurance Company (“Jackson Life”) with a floating interest rate of 2.6%
over the one month LIBOR (the “Index”). The floating interest rate will be
adjusted monthly by Jackson Life based on the Index as published on the last
business day of the month. As of February 23, 2009, the floating interest rate
was 3.07%. The Jackson Life Loan has a maturity date of November 1, 2013. The
Jackson Life Loan is a non-recourse loan secured by Whitestone Industrial Office
properties and a limited guarantee by us.




Our
loans are subject to various customary financial covenants. In order to pay off
our $75 million revolving credit facility in 2008, we entered into non-recourse
mortgages secured by various properties and a limited guarantee by us. As a
result of these secured mortgages, we are not in compliance with our secured
debt to fair market value ratio covenant of our $6.4 million loan with KeyBank
as of December 31, 2008. As this non-compliance constitutes an event of default,
the lender has the right to accelerate payment. We are in discussions with
KeyBank regarding an extension of this loan, which matures in July 2009, and
have requested a waiver from KeyBank. As of the date of this filing, we have not
received the waiver. Should we not receive a waiver we will attempt to obtain
other financing or pay off the loan from cash reserves. As of December 31, 2008,
we are in compliance with all loan covenants other than the Pima Norte
non-compliance. For further discussion of our loan covenants and Pima Norte’s
non-compliance see Note 8 to the consolidated financial
statements.


28




Annual maturities of notes
payable as of December 31, 2008 are due during the following
years:


Year
                                
                                
                                Amount
      Due
                                  (in
      thousands)2009
                                
                                $
                                8,0272010
                                
                                
                                2,0142011
                                
                                
                                2,1212012
                                
                                
                                2,2362013
                                
                                
                                66,1452014
      and thereafter
                                
                                
                                19,460Total
                                
                                $
                                100,003




For
further discussion regarding specific terms of our debt, see Note 8 of the
Consolidated Financial Statements.




Capital
Expenditures




We
continually evaluate our properties’ performance and value. We may
determine it is best 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 invest 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.


29




Contractual
Obligations




As
of December 31, 2008, we had the following contractual debt obligations (see
Note 8 of the Consolidated Financial Statements for further discussion regarding
the specific terms of our debt):


Payment
      due by period (in thousands)Contractual
      Obligations
                          
                          Total
                          
                          
                          Less
      than 1
                            year
      (2009)
                          
                          
                          1
      - 3 years
                            (2010
      - 2011)
                          
                          
                          3
      - 5 years
                            (2012
      - 2013)
                          
                          
                          More
      than
                            5
      years
                            (after
      2013)Long-Term
      Debt - Principal
                          
                          $
                          100,003
                          
                          
                          $
                          8,027
                          
                          
                          $
                          4,135
                          
                          
                          $
                          68,381
                          
                          
                          $
                          19,460Long-Term
      Debt - Fixed Interest
                          
                          
                          21,631
                          
                          
                          
                          4,409
                          
                          
                          
                          8,359
                          
                          
                          
                          7,552
                          
                          
                          
                          1,311Long-Term
      Debt - Variable Interest (1)
                          
                          
                          3,740
                          
                          
                          
                          806
                          
                          
                          
                          1,544
                          
                          
                          
                          1,390
                          
                          
                          
                          —Operating
      Lease Obligations
                          
                          
                          95
                          
                          
                          
                          62
                          
                          
                          
                          32
                          
                          
                          
                          1
                          
                          
                          
                          —Purchase
      Obligations
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Other
      Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under
      GAAP
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Total
                          
                          $
                          125,469
                          
                          
                          $
                          13,304
                          
                          
                          $
                          14,070
                          
                          
                          $
                          77,324
                          
                          
                          $
                          20,771




(1) As of
December 31, 2008, we had two loans totaling $33.3 million which bore interest
at floating rates. The variable interest rate payments are based on LIBOR plus a
spread which ranged from 2.0% to 2.6%. The information in the table above
reflects our projected interest rate obligations for these floating rate
payments based on LIBOR at December 31, 2008. At December 31, 2008, one-month
LIBOR was 0.44%.




Distributions




During 2008, we paid dividends to our common shareholders and distributions to
our OP Unit holders of $8.7 million, compared to $9.5 million in 2007. Common
shareholders and OP Unit holders receive monthly dividends and distributions,
respectively. Payments of dividends and distributions are declared quarterly and
paid monthly. The dividends paid to common shareholders and distributions paid
to OP Unit holders follow (in thousands):


Common
                Shareholders
              
              Minority
      Interest
                OP
      Unit
                Holders2008Fourth
      Quarter
              
              $
              1,093
              
              $
              533Third
      Quarter
              
              
              1,456
              
              
              712Second
      Quarter
              
              
              1,529
              
              
              978First
      Quarter
              
              
              1,500
              
              
              8712007Fourth
      Quarter
              
              $
              1,500
              
              $
              871Third
      Quarter
              
              
              1,500
              
              
              871Second
      Quarter
              
              
              1,500
              
              
              871First
      Quarter
              
              
              1,522
              
              
              871




30




Results
of Operations




Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007




The
following table provides a general comparison of our results of operations for
the years ended December 31, 2008 and December 31, 2007:


December
      31, 2008
              
              December
      31, 2007Number
      of properties owned and operated (1)
              
              
              35
              
              
              37Aggregate
      gross leasable area (sq. ft.) (1)
              
              
              2,990,892
              
              
              3,093,063Ending
      occupancy rate (1)
              
              
              84
              %
              
              86
              %(in
      thousands, except per share data)Total
      property revenues
              
              $
              31,201
              
              $
              29,374Total
      property expenses
              
              
              13,193
              
              
              12,236Other
      expense, net
              
              
              19,057
              
              
              17,582Income
      (loss) from continuing operations
              
              
              (1,049
              )
              
              (444
              )Income
      (loss) from discontinued operations
              
              
              2,183
              
              
              367Net
      income (loss)
              
              $
              1,134
              
              $
              (77
              )Funds
      from operations (2)
              
              $
              4,236
              
              $
              6,001Dividends
      paid on common shares and OP Units
              
              
              8,673
              
              
              9,507Per
      common share and OP Unit
              
              $
              0.58
              
              $
              0.60Dividends
      paid as a % of FFO
              
              
              205
              %
              
              158
              %




(1)
      Two properties disposed in May of 2008 with a total area of 135,571 sq.
      ft. are included in the (i) number of properties owned and operated; (ii)
      aggregate gross leasable area (sq. ft.), and (iii) ending occupancy rate
      for the year ended December 31, 2007, but are excluded from continuing
      operations revenues and expenses.(2)
      In accordance with Regulation G, “reconciliation of non-GAAP measures,”
      see “Funds From Operations”
following.




Revenues




Substantially
all of our revenue is derived from rents received from leases at our
properties.We had
rental income, tenant reimbursements and other property revenue of approximately
$31.2 million for the year ended December 31, 2008, as compared to $29.4 million
for the year ended December 31, 2007, an increase of $1.8 million or 6%. Our
year end occupancy rate in 2008 was 84%, as compared to 86% at year end 2007.
The majority of the decrease in occupancy occurred near the end of the year in
2008 and did not have a material impact on revenue in 2008. We lost several
large retail tenants towards the end of the year in 2008 either to bankruptcy or
to expiring leases that were not renewed. We expect that raising occupancy
percentages to acceptable levels will be difficult in 2009, given the contracted
credit markets and the challenging economy. However, most of our tenants do not
operate nationally, and we believe the impact of the economic downturn will be
less severe to businesses in the Texas economy in 2009 than to the national
average. Our gross leaseable area was approximately 2,991,000 square feet in
2008 versus 3,093,000 square feet in 2007. Our revenue was $10.43 per square
foot in 2008, as compared to our revenue of $9.93 per square foot in
2007.


31




Property
expenses




Our
property expenses were $13.2 million for the year ended December 31, 2008, as
compared to $12.2 million for the year ended December 31, 2007, an increase of
$1.0 million, or 8%. The primary components of total operating expense are
detailed in the table below (in thousands):


Year
      Ended December 31,2008
              
              2007Real
      estate taxes
              
              $
              3,973
              
              $
              3,629Utilities
              
              
              2,679
              
              
              2,481Contract
      services
              
              
              2,138
              
              
              1,945Repairs
      and maintenance
              
              
              1,633
              
              
              1,947Bad
      debt
              
              
              731
              
              
              440Repairs
      related to Hurricane Ike
              
              
              358
              
              
              —Labor
      and other
              
              
              1,681
              
              
              1,794Total
      property expenses
              
              $
              13,193
              
              $
              12,236




Real
estate taxes increased $0.3 million or approximately 9% during 2008. Assessed
values on many of our properties increased significantly in 2008. We actively
work with various appraisel districts to keep our assessed values low and
litigate the assessments if necessary. Utilities increased $0.2 million or
approximately 8% during 2008. Contract services and repairs and maintenance
combined decreased $0.1 million or 3% during 2008. Bad debt expense increased
$0.3 million or 66% during 2008. The tightening credit markets and slowing
economy have impacted many of our tenants negatively in 2008. During 2008, we
added a full time collector to constantly monitor deliquencies and improve our
collections efforts. We anticipate another challenging year in 2009 as the
impact of the softening economy continues to impact our tenants. Hurricane Ike
came ashore in September 2008, impacting 31 of our properties with varying
degrees of damage. During 2008, we incurred approximately $0.4 million in
expenses to repair properties impacted by the Hurricane.


32




Other (income) and
expense




Our
other expense, net was $19.1 million for the year ended December 31, 2008, as
compared to $17.6 million for the year ended December 31, 2007, an increase of
$1.5 million, or 8%. The primary components of other (income) and expense are
detailed in the table below (in thousands):


Year
      Ended December 31,2008
                    
                    
                    2007General
      and administrative
                    
                    $
                    6,708
                    
                    
                    $
                    6,721Depreciation
      & amortization
                    
                    
                    6,859
                    
                    
                    
                    6,048Interest
      expense
                    
                    
                    5,857
                    
                    
                    
                    5,402Interest
      income
                    
                    
                    (182
                    )
                    
                    
                    (577
                    )Provision
      for income taxes
                    
                    
                    219
                    
                    
                    
                    217Loss
      on sale or disposal of assets
                    
                    
                    223
                    
                    
                    
                    9Change
      in fair value of derivative instrument
                    
                    
                    —
                    
                    
                    
                    30Loss
      allocated to minority interest
                    
                    
                    (627
                    )
                    
                    
                    (268
                    )Total
      other expense, net
                    
                    $
                    19,057
                    
                    
                    $
                    17,582




Depreciation
and amortization increased $0.8 million or 13% during 2008. Amortization of loan
fees are included in amortization, and the extension of the revolving credit
facilitate included a $0.9 million fee that was amortized during 2008. During
2008 we incurred an additional $1.7 million in fees related to new debt, which
will be amortized over five to seven years. Interest expense increased
approximately $0.5 million during 2008. An increase in the average outstanding
note payable balance of $12.9 million accounted for an increase of approximately
$0.9 million in interest expense in 2008, while a decreased effective interest
rate of 0.5% per annum (excluding amortized loan fees) accounted for a decrease
of approximately $0.4 million in interest expense during 2008. The decrease in
interest income of approximately $0.4 million is primarily due lower interest
rates. Legal expenses are included in general and administrative for the years
ending December 31, 2008 and 2007 and were $1.5 million and $2.2 million,
respectively. The majority of our legal fees were due to the litigation with
Allen R. Hartman and Hartman Management, L.P., which was settled in May 2008
(See Note 11 to the consolidated financial statements). We expect legal fees to
decrease in 2009.


33




Discontinued
operations




Discontinued
operations are comprised of the two properties known as Garden Oaks and
Northeast Square. The two properties were transfered to Allen R. Hartman and
Hartman Management, L.P. as part of a legal settlement on May 30, 2008. See Note
11 to the consolidated financial statements for more information on the
settlement. The primary components of discontinued operations are detailed in
the table below (in thousands):


Year
      Ended December 31,2008
                
                
                2007Rental
      income
                
                $
                333
                
                
                $
                1,181Tenants’
      reimbursements and other property revenue
                
                
                225
                
                
                
                427Total
      property revenues
                
                
                558
                
                
                
                1,608Property
      operation and maintenance
                
                
                391
                
                
                
                558Real
      estate taxes
                
                
                133
                
                
                
                159Depreciation
      & amortization
                
                
                218
                
                
                
                295Total
      property and other expenses
                
                
                742
                
                
                
                1,012Income
      (loss) before income taxes, gain (loss) on sales of assets and income
      allocated to minority interest
                
                
                (184
                )
                
                
                596Provision
      for income taxes
                
                
                (4
                )
                
                
                —Gain
      (loss) on sales of assets
                
                
                3,619
                
                
                
                (7
                )Income
      allocated to minority interest
                
                
                (1,248
                )
                
                
                (222
                )Income
      from discontinued operations, net
                
                $
                2,183
                
                
                $
                367




The
gain on sales of assets of $3.6 million is the result of the settlement with
Allen R. Hartman and Hartman Management, L.P. (See Note 11 to the consolidated
financial statements).




Net
income (loss)




Net
income was $1.1 million for the year ended December 31, 2008, as compared to a
net loss of $0.1 million for the year ended December 31, 2007. The increase is
the result of the items discussed above.


34




Result
of Operations




Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006




The
following table provides a general comparison of our results of operations for
the years ended December 31, 2007 and December 31, 2006 (dollars in
thousands):


December
      31, 2007
            
            December
      31, 2006Number
      of properties owned and operated (1)
            
            
            37
            
            
            36Aggregate
      gross leasable area (sq. ft.) (1)
            
            
            3,093,063
            
            
            3,093,063Ending
      occupancy rate (1)
            
            
            86
            %
            
            83
            %(in
      thousands, except per share data)Total
      property revenues
            
            $
            29,374
            
            $
            28,378Total
      property expenses
            
            
            12,236
            
            
            11,438Other
      expense, net
            
            
            17,582
            
            
            15,500Income
      (loss) from continuing operations
            
            
            (444
            )
            
            1,440Income
      (loss) from discontinued operations
            
            
            367
            
            
            341Net
      income (loss)
            
            $
            (77
            )
            $
            1,781Funds
      from operations (2)
            
            $
            6,001
            
            $
            8,993Dividends
      paid on common shares and OP Units
            
            
            9,507
            
            
            9,831Per
      common share and OP unit
            
            $
            0.60
            
            $
            0.63Dividends
      paid as a % of FFO
            
            
            158
            %
            
            109
            %




(1)
      Two properties disposed in May of 2008 with a total area of 135,571 sq.
      ft. are included in the (i) number of properties owned and operated; (ii)
      aggregate gross leasable area (sq. ft.), and (iii) ending occupancy rate
      for the years ended December 31, 2007 and 2006, but are excluded from
      continuing operations revenues and expenses.(2)
      In accordance with Regulation G, “reconciliation of non-GAAP measures,”
      see “Funds From Operations”
following.




Revenues




Substantially
all of our revenue is derived from rents received for leases at our
properties.We had
rental income and tenant reimbursements of approximately $29.4 million for the
year ended December 31, 2007 as compared to $28.4 million for the year ended
December 31, 2006, an increase of $1.0 million or 3.5%. Our average occupancy
rate in 2007 was 85%, as compared to 83% in 2006, and our revenue was $9.93 per
square foot in 2007, as compared to our revenue of $9.51 per square foot in
2006.


35




Property
Expenses




Our
property expenses were $12.2 million for the year ended December 31, 2007, as
compared to $11.4 million for the year ended December 31, 2006, an increase of
$0.8 million, or 7%. The primary components of operating expense are detailed in
the table below (in thousands):


Year
      Ended December 31,2007
                
                
                2006Real
      estate taxes
                
                $
                3,629
                
                
                $
                3,765Utilities
                
                
                2,481
                
                
                
                2,334Contract
      services
                
                
                1,945
                
                
                
                2,358Repairs
      and maintenance
                
                
                1,947
                
                
                
                959Bad
      debt
                
                
                440
                
                
                
                337Labor
      and other
                
                
                1,794
                
                
                
                1,685Total
      property expenses
                
                $
                12,236
                
                
                $
                11,438




Contract
services combined with repairs and maintenance increased $0.6 million or 12%
during 2007. The majority of these costs relate to work that was deferred prior
to our managing our own properties.


36




Other (income)
expense




Other
expense, net was $17.6 million for the year ended December 31, 2007, as compared
to $15.5 million for the year ended December 31, 2006, an increase of $2.1
million or 14%. The primary components are detailed in the table below (in
thousands):


Year
      Ended December 31,2007
                    
                    
                    2006General
      and administrative
                    
                    $
                    6,721
                    
                    
                    $
                    2,299Property
      management and other asset management fees to an
affliliate
                    
                    
                    —
                    
                    
                    
                    1,482Depreciation
      & amortization
                    
                    
                    6,048
                    
                    
                    
                    6,181Interest
      expense
                    
                    
                    5,402
                    
                    
                    
                    5,296Interest
      income
                    
                    
                    (577
                    )
                    
                    
                    (386
                    )Provision
      for income taxes
                    
                    
                    217
                    
                    
                    
                    —Loss
      (gain) on sale or disposal of assets
                    
                    
                    9
                    
                    
                    
                    (197
                    )Change
      in fair value of derivative instrument
                    
                    
                    30
                    
                    
                    
                    (30
                    )Income
      (loss) allocated to minority interest
                    
                    
                    (268
                    )
                    
                    
                    855Total
      other expense, net
                    
                    $
                    17,582
                    
                    
                    $
                    15,500




Prior
to October 2, 2006, we were externally managed, which makes a comparison of
costs difficult given the different nature of the expenses incurred by an
externally-managed REIT versus an internally-managed one. As an
externally-managed REIT, we were charged fees based on percentages of gross
revenues, asset values, capital raised, and expenses submitted for
reimbursement. Generally accepted accounting principles allowed for many of
theses fees to be capitalized as an asset or accounted for as a reduction in
equity.




Subsequent
to October 2, 2006, we operated as an internally-managed REIT and many of the
costs that were previously capitalized or recorded as a reduction in equity are
now charged to general and administrative expense and reflected in the
Consolidated Statement of Operations.




During
the years ended December 31, 2007 and 2006, we executed new and renewal leases
with a total lease value of $42.0 million and $20.0 million, respectively. Prior
to October 2, 2006, we paid our former management company 6.0% of the total
value of new leases and 4.0% of the total value of renewal leases. If we had
executed the same volume of leases in 2006, we estimate that we would have paid
an additional $1.1 million in leasing commission cost to our External Manager in
2006. Additionally, significant legal expense was incurred in 2007 related to
the ongoing litigation with our former External Manager (See Note 11 to the
consolidated financial statements).


37




The
chart below is a comparison of the total costs incurred for general and
administrative services in the years ended December 31, 2007 and 2006. In order
to be a meaningful comparison, the chart contains a pro forma adjustment to 2006
to show the increased lease commission cost assuming the same volume of leasing
activity as 2007. Excluding legal costs related to the litigation with our
former External Manager and adjusting for the incremental leasing commission
that would have been paid in 2006, costs for general and administrative services
in 2007 were slightly lower than in 2006.


Capitalized
      in
                      Balance
      Sheet
                    
                    
                    Charged
      to
                      Statement
      of Operations
                    
                    
                    Pro
      Forma (1)
                    
                    
                    Total,
      including Pro FormaYear
      Ended December 31,
                    
                    
                    Year
      Ended December 31,
                    
                    
                    
                    
                    
                    Year
      Ended December 31,2007
                    
                    
                    2006
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2006
                    
                    
                    2007
                    
                    
                    2006
      (1)(Unaudited)
                    
                    
                    (Unaudited)
                    
                    
                    
                    
                    
                    (Unaudited)Personnel
      Cost
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    2,799
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    2,799
                    
                    
                    $
                    —Office
      Expense
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    860
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    860
                    
                    
                    
                    —Professional
      Fees (Acctg, etc.)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    855
                    
                    
                    
                    1,396
                    
                    
                    
                    —
                    
                    
                    
                    855
                    
                    
                    
                    1,396Offering
      Costs:Selling
      Commissions
                    
                    
                    —
                    
                    
                    
                    378
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    378Discounts
                    
                    
                    —
                    
                    
                    
                    15
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    15Dealer
      Manager Fee
                    
                    
                    —
                    
                    
                    
                    139
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    139Expense
      Reimbursements
                    
                    
                    —
                    
                    
                    
                    139
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    139Acquisition
      Fees
                    
                    
                    —
                    
                    
                    
                    111
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    111Leasing
      Fees
                    
                    
                    1,197
                    
                    
                    
                    983
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,116
                    
                    
                    
                    1,197
                    
                    
                    
                    2,099Property
      Management Fees
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,482
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,482Total,
      excluding litigation cost
                    
                    $
                    1,197
                    
                    
                    $
                    1,765
                    
                    
                    $
                    4,514
                    
                    
                    $
                    2,878
                    
                    
                    $
                    1,116
                    
                    
                    $
                    5,711
                    
                    
                    $
                    5,759Litigation
      Cost (2)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    2,207
                    
                    
                    
                    903
                    
                    
                    
                    
                    
                    
                    
                    2,207
                    
                    
                    
                    903Total,
      including litigation cost
                    
                    $
                    1,197
                    
                    
                    $
                    1,765
                    
                    
                    $
                    6,721
                    
                    
                    $
                    3,781
                    
                    
                    $
                    1,116
                    
                    
                    $
                    7,918
                    
                    
                    $
                    6,662




(1) 
      In
      order to be comparable, a pro forma adjustment is made to the 2006 lease
      fees to relect the additional fees that would have been paid to the former
      management company if they had executed the same volume of leases, as
      defined by total lease value, in 2006 as we executed in 2007 with our
      internal leasing staff.(2) 
      Litigation
      cost represent fees paid as a result of our litigation with Allen R.
      Hartman and Hartman Managment L.P. (Note
11).


38




Discontinued
operations




Discontinued
operations are comprised of the two properties known as Garden Oaks and
Northeast Square. The two properties were transfered to Allen R. Hartman and
Hartman Management, L.P. as part of a legal settlement on May 30, 2008. See Note
11 to the consolidated financial statements for more information on the
settlement. The primary components of discontinued operations are detailed in
the table below (in thousands):


Year
      Ended December 31,2007
                  
                  
                  2006Rental
      income
                  
                  $
                  1,181
                  
                  
                  $
                  1,123Tenants’
      reimbursements and other property revenue
                  
                  
                  427
                  
                  
                  
                  339Total
      property revenues
                  
                  
                  1,608
                  
                  
                  
                  1,462Property
      operation and maintenance
                  
                  
                  558
                  
                  
                  
                  428Real
      estate taxes
                  
                  
                  159
                  
                  
                  
                  185Depreciation
      & amortization
                  
                  
                  295
                  
                  
                  
                  295Total
      property and other expenses
                  
                  
                  1,012
                  
                  
                  
                  908Loss
      before income taxes, loss on sales of assets and income allocated to
      minority interest
                  
                  
                  596
                  
                  
                  
                  554Loss
      on sales of assets
                  
                  
                  (7
                  )
                  
                  
                  —Income
      allocated to minority interest
                  
                  
                  (222
                  )
                  
                  
                  (213
                  )Income
      from discontinued operations, net
                  
                  $
                  367
                  
                  
                  $
                  341




Net income
(loss)




Net
loss was $0.1 million for the year ended December 31, 2007, as compared to net
income of $1.8 million for the year ended December 31, 2006. The decrease is the
result of the items discussed above.


39




Funds From
Operations




The
National Association of Real Estate Investment Trusts (“NAREIT”) defines funds
from operations (“FFO”) as net income (loss) available to common shareholders
computed in accordance with generally accepted accounting principles (“GAAP”),
excluding gains or losses from sales of operating real estate assets and
extraordinary items, plus real estate-related depreciation and amortization
(excluding amortization of deferred financing costs and depreciation of non-real
estate assets), 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 GAAP net income by itself as
the primary measure of our operating performance. Historical cost accounting for
real estate assets in accordance with GAAP implicitly assumes that the value of
real estate assets diminishes predictably over time. Since 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 uses historical cost accounting is insufficient by itself. There can be no
assurance that FFO presented by us is comparable to similarly titled measures of
other REITs.




FFO
should not be considered as an alternative to net income or other measurements
under GAAP as an indicator of our operating performance or to cash flows from
operating, investing or financing activities as a measure of liquidity. FFO does
not reflect working capital changes, cash expenditures for capital improvements
or principal payments on indebtedness.




Below
is the calculation of FFO and the reconciliation to net income, which we believe
is the most comparable GAAP financial measure (in thousands):




Reconciliation
of Non-GAAP Financial Measures


Year
      Ended December 31,2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006Net
      income (loss)
                                                
                                                $
                                                1,134
                                                
                                                
                                                $
                                                (77
                                                )
                                                
                                                $
                                                1,781Depreciation
      and amortization of real estate assets (1)
                                                
                                                
                                                5,877
                                                
                                                
                                                
                                                6,108
                                                
                                                
                                                
                                                6,341(Gain)
      loss on sale or disposal of assets (1)
                                                
                                                
                                                (3,396
                                                )
                                                
                                                
                                                16
                                                
                                                
                                                
                                                (197
                                                )Income
      (loss) allocated to minority interest (1)
                                                
                                                
                                                621
                                                
                                                
                                                
                                                (46
                                                )
                                                
                                                
                                                1,068FFO
                                                
                                                $
                                                4,236
                                                
                                                
                                                $
                                                6,001
                                                
                                                
                                                $
                                                8,993





(1)Including
      amounts for discontinued operations




Taxes




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


40




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
have no significant off-balance sheet arrangements as of December 31,
2008.




Subsequent
Events




On
January 16, 2009, we acquired a 41,396 square foot garden style mixed use
property in Buffalo Grove, Illinois for approximately $9.4 million. The
property, Spoerlein Commons, is a two story complex of retail, medical, and
professional office tenants. James C. Mastandrea, our Chairman, President and
Chief Executive Officer, is the controlling limited partner of in Midwest
Development Venture IV, the seller of Spoerlein Commons, and had an ownership
interest in the property and is entitled to a portion of the proceeds from the
sale of the property to the Operating Partnership. Because of Mr. Mastandrea’s
relationship with the seller, a special committee of the independent members of
the Board of Trustees including Donald F. Keating, Jack L. Mahaffey, and Chris
A. Minton determined the terms of the transaction, which included the use of an
independent appraiser to value the property. For more details regarding this
transaction, (See Note 11 to the consolidated financial
statements).




On
February 3, 2009 we, operating through our subsidiary, Whitestone Centers LLC,
executed four promissory notes (the “Sun Life Promissory Notes II”) totaling
$9.9 million payable to Sun Life Assurance Company of Canada with an applicable
interest rate of 6.63% per annum and a maturity date of March 1, 2014. The Sun
Life Promissory Notes II are non-recourse loans secured by the Whitestone
Centers LLC’s properties, and a limited guarantee by us.




41




Item 7A.
Quantitative and Qualitative Disclosures About Market
Risk.




Market
risk is the risk of loss arising from adverse changes in market rates and
prices. The principal market risk to which we are exposed is the risk related to
interest rate fluctuations. Based upon the nature of our operations, we are not
subject to foreign exchange or commodity risk. We will be exposed to changes in
interest rates as a result of our debt facilities that have floating interest
rates. As of December 31, 2008, we had $33.3 million of indebtedness outstanding
under facilities with floating interest rates. The impact of a 1% increase in
interest rates on our debt would result in an increase in interest expense and a
decrease in income before minority interests of approximately $0.3 million
annually.




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 F-1 of this Annual Report on Form
10-K.




Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.




None.




Item 9A(T).
Controls and Procedures.




Evaluation
of Disclosure Controls and Procedures




In
connection with the preparation of this Form 10-K, as of December 31, 2008, an
evaluation was performed under the supervision and with the participation of the
Company’s management, including the CEO and 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, the CEO and CFO concluded that as of
December 31, 2008, 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 judgement in
evaluating the cost-benefit relationship of possible controls and
procedures.




Management’s
Annual Report on Internal Control Over Financial Reporting and Attestation
Report of the Independent Registered Public Accounting Firm




Our
management 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 our management,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated
Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2008.


42




This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the SEC that permit the
Company to provide only management’s report in this annual report.




Changes
in Internal Control Over Financial Reporting




There
have been no changes during the Company’s quarter ended December 31, 2008, in
the Company’s internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financing reporting.




Item 9B.
Other Information.




None.


43




PART III




Item 10.
Trust Managers, 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 the proxy statement for our 2009 annual
meeting.




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 the proxy statement for our 2009 annual
meeting.




Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Shareholder Matters.




The following table
provides information regarding our equity compensation plans as of December 31,
2008:


Plan
      Category
                                        
                                        Number
      of securities to be
                                          issued
      upon exercise of
                                          outstanding
      options,
                                          warrants
      and rights
                                        
                                        
                                        Weighted-averageexercise
                                          price
      ofoutstanding
      options,
                                          warrants
      and rights
                                        
                                        
                                        Number
      of securitiesremaining
      available for futureissuance
                                          under
      equitycompensation
                                          plans1Equity
      compensation plans approved by security holders
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        2,063,885Equity
      compensation plans not approved by security holders
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —Total
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        2,063,885




(1)
              Pursuant
      to our 2008 Long-Term Equity Incentive Ownership Plan (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 the Company
      (including issuances pursuant to the Plan) 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 the Company and units of the
      Operating Partnership issued and outstanding (other than treasury shares
      and/or units issued to or held by the
Company).




The
remaining information required by Item 12 of Form 10-K is incorporated by
reference to such information as set forth in the proxy statement for our 2009
annual meeting.


44




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 the proxy statement for our 2009 annual
meeting.




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 the proxy statement for our 2009 annual
meeting.


45




PART IV




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 F-1 herein.2.
                Financial
      Statement Schedules.a.
                Schedule
      II – Valuation and Qualifying Amountsb.
                Schedule
      III – Real Estate and Accumulated DepreciationAll
      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.


46




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
      REITDated:
      March 16, 2009
              By:
              /s/
      James C. MastandreaJames
      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.


March
      16, 2009
              
              /s/
      James C. MastandreaJames
      C. Mastandrea, Chairman and CEO(Principal
      Executive Officer)March
      16, 2009
              
              /s/
      David K. HolemanDavid
      K. Holeman, Chief Financial Officer(Principal
      Financial and Principal Accounting Officer)March
      16, 2009
              
              /s/
      Daryl J. CarterDaryl
      J. Carter, TrusteeMarch
      16, 2009
              
              /s/
      Daniel G. DeVosDaniel
      G. DeVos, TrusteeMarch
      16, 2009
              
              /s/
      Donald F. KeatingDonald
      F. Keating, TrusteeMarch
      16, 2009
              
              /s/
      Jack L. MahaffeyJack
      L. Mahaffey, TrusteeMarch
      16, 2009
              
              /s/
      Chris A. MintonChris
      A. Minton, Trustee


47




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS


PageReport of Independent Registered Public Accounting
      Firm
            F-2Consolidated Balance Sheets as of December 31, 2008
      and 2007
            F-3Consolidated Statements of Operations and
      Comprehensive Income (Loss) for the Years Ended December 31, 2008, 2007
      and 2006
            F-4Consolidated Statements of Changes in
      Shareholders’ Equity for the Years Ended December 31, 2008, 2007 and
      2006
            F-5Consolidated Statements of Cash Flows for the Years
      Ended December 31, 2008, 2007 and 2006
            F-6Notes to Consolidated Financial
    Statements
            F-7Schedule II – Valuation and Qualifying
      Accounts
            F-24Schedule III – Real Estate and Accumulated
      Depreciation
            F-25




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
Board of Trustees and Shareholders of Whitestone REIT




We
have audited the accompanying consolidated balance sheets of Whitestone REIT and
subsidiary (the “Company”) as of December 31, 2008 and 2007, and the related
consolidated statements of operations and comprehensive income (loss),
shareholders’ equity and cash flows, for each of the three years in the period
ended December 31, 2008. 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 Company’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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purposes of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 Whitestone REIT and
subsidiary as of December 31, 2008 and 2007, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2008 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 16,
2009


F-2




Whitestone REIT and Subsidiary


CONSOLIDATED
BALANCE SHEETS


(in
thousands, except share data)


December
      31,2008
                    
                    
                    2007ASSETSProperty
                    
                    $
                    180,397
                    
                    
                    $
                    163,923Accumulated
      depreciation
                    
                    
                    (29,550
                    )
                    
                    
                    (25,855
                    )Net
      operating real estate assets
                    
                    
                    150,847
                    
                    
                    
                    138,068Properties
      under development, including land
                    
                    
                    —
                    
                    
                    
                    8,392Properties
      - discontinued operations
                    
                    
                    —
                    
                    
                    
                    7,932Total
      real estate assets
                    
                    
                    150,847
                    
                    
                    
                    154,392Cash
      and cash equivalents
                    
                    
                    12,989
                    
                    
                    
                    10,811Escrows
      and acquisition deposits
                    
                    
                    4,076
                    
                    
                    
                    486Accrued
      rent and accounts receivable, net of allowance for doubtful
      accounts
                    
                    
                    4,880
                    
                    
                    
                    5,386Unamortized
      lease commissions and loan costs
                    
                    
                    4,338
                    
                    
                    
                    2,839Prepaid
      expenses and other assets
                    
                    
                    815
                    
                    
                    
                    881Other
      assets - discontinued operations
                    
                    
                    —
                    
                    
                    
                    349TOTAL
      ASSETS
                    
                    $
                    177,945
                    
                    
                    $
                    175,144LIABILITIES
      AND SHAREHOLDERS’ EQUITYNotes
      payable
                    
                    $
                    100,003
                    
                    
                    $
                    83,461Accounts
      payable and accrued expenses
                    
                    
                    7,422
                    
                    
                    
                    6,560Tenants’
      security deposits
                    
                    
                    1,629
                    
                    
                    
                    1,598Dividends
      and distributions payable
                    
                    
                    1,719
                    
                    
                    
                    2,371Other
      liabilities - discontinued operations
                    
                    
                    —
                    
                    
                    
                    272Total
      liabilities
                    
                    
                    110,773
                    
                    
                    
                    94,262Commitments
      and Contingencies
                    
                    
                    —
                    
                    
                    
                    —Minority
      interests of unit holders in Operating Partnership:4,739,886
      and 5,808,337 units at December 31, 2008 and 2007,
      respectively
                    
                    
                    21,281
                    
                    
                    
                    28,039Shareholders’
      equityPreferred
      shares, $0.001 par value per share; 50,000,000 shares authorized; none
      issued and outstanding at December 31, 2008 and 2007
                    
                    
                    —
                    
                    
                    
                    —Common
      shares, $0.001 par value per share; 400,000,000 shares authorized;
      9,707,307 and 10,001,269 issued and outstanding at December 31, 2008 and
      2007, respectively
                    
                    
                    10
                    
                    
                    
                    10Additional
      paid-in capital
                    
                    
                    69,188
                    
                    
                    
                    72,273Accumulated
      deficit
                    
                    
                    (23,307
                    )
                    
                    
                    (19,210
                    )Accumulated
      other comprehensive loss
                    
                    
                    —
                    
                    
                    
                    (230
                    )Total
      shareholders’ equity
                    
                    
                    45,891
                    
                    
                    
                    52,843TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
                    
                    $
                    177,945
                    
                    
                    $
                    175,144




See notes
to consolidated financial statements.


F-3




Whitestone REIT and Subsidiary


CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)


(in
thousands, except per share data)


Year
      Ended December 31,2008
              
              
              2007
              
              
              2006Property
      revenuesRental
      income
              
              $
              24,999
              
              
              $
              23,769
              
              
              $
              23,521Tenants’
      reimbursements and other property revenue
              
              
              6,202
              
              
              
              5,605
              
              
              
              4,857Total
      property revenues
              
              
              31,201
              
              
              
              29,374
              
              
              
              28,378Property
      expensesProperty
      operation and maintenance
              
              
              9,220
              
              
              
              8,607
              
              
              
              7,673Real
      estate taxes
              
              
              3,973
              
              
              
              3,629
              
              
              
              3,765Total
      property expenses
              
              
              13,193
              
              
              
              12,236
              
              
              
              11,438Other
      expenses (income)General
      and administrative
              
              
              6,708
              
              
              
              6,721
              
              
              
              2,299Property
      management and other asset management fees to an
affliliate
              
              
              —
              
              
              
              —
              
              
              
              1,482Depreciation
      & amortization
              
              
              6,859
              
              
              
              6,048
              
              
              
              6,181Interest
      expense
              
              
              5,857
              
              
              
              5,402
              
              
              
              5,296Interest
      income
              
              
              (182
              )
              
              
              (577
              )
              
              
              (386
              )Total
      other expenses (income)
              
              
              19,242
              
              
              
              17,594
              
              
              
              14,872Income
      (loss) from continuing operations before loss on disposal of assets,
      minority interest, change in fair value of derivative instrument and
      income taxes
              
              
              (1,234
              )
              
              
              (456
              )
              
              
              2,068Provision
      for income taxes
              
              
              (219
              )
              
              
              (217
              )
              
              
              —Gain
      (loss) on sale or disposal of assets
              
              
              (223
              )
              
              
              (9
              )
              
              
              197Change
      in fair value of derivative instrument
              
              
              —
              
              
              
              (30
              )
              
              
              30Loss
      (income) allocated to minority interest
              
              
              627
              
              
              
              268
              
              
              
              (855
              )Income
      (loss) from continuing operations
              
              
              (1,049
              )
              
              
              (444
              )
              
              
              1,440Income
      (loss) from discontinued operations
              
              
              (188
              )
              
              
              589
              
              
              
              554Gain
      on sale of property from discontinued operations
              
              
              3,619
              
              
              
              —
              
              
              
              —Income
      allocated to minority interest from discontinued
operations
              
              
              (1,248
              )
              
              
              (222
              )
              
              
              (213
              )Net
      income (loss)
              
              $
              1,134
              
              
              $
              (77
              )
              
              $
              1,781Earnings
      per share - basic and dilutedIncome
      (loss) from continuing operations
              
              $
              (0.11
              )
              
              $
              (0.04
              )
              
              $
              0.15Income
      from discontinued operations
              
              
              0.23
              
              
              
              0.03
              
              
              
              0.03Net
      income (loss)
              
              $
              0.12
              
              
              $
              (0.01
              )
              
              $
              0.18Dividends
      declared per common share
              
              $
              0.53
              
              
              $
              0.60
              
              
              $
              0.63Weighted
      average number of common shares outstanding
              
              
              9,830
              
              
              
              9,999
              
              
              
              9,652Condensed
      Consolidated Statements of Comprehensive Income (Loss)Net
      income (loss)
              
              $
              1,134
              
              
              $
              (77
              )
              
              $
              1,781Other
      comprehensive income (loss)
                Unrealized
      income (loss) on cash flow hedging activities
              
              
              230
              
              
              
              (230
              )
              
              
              —Comprehensive
      income (loss)
              
              $
              1,364
              
              
              $
              (307
              )
              
              $
              1,781




See notes
to consolidated financial statements.


F-4






Whitestone REIT and Subsidiary


CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


(in
thousands except per share data)


Accumulated
                  Deficit
                
                
                Accumulated
                  Other
                  Comprehensive
                  (Loss)
      / Income
                
                
                TotalAdditional
                  Paid-in
                  CapitalCommon
      SharesShares
                
                
                AmountBalance,
      December 31, 2005
                
                
                8,914
                
                
                $
                9
                
                
                $
                62,560
                
                
                $
                (8,841
                )
                
                $
                —
                
                
                $
                53,728Issuance
      of common stock for cash, net of offering costs
                
                
                960
                
                
                
                1
                
                
                
                8,501
                
                
                
                —
                
                
                
                —
                
                
                
                8,502Issuance
      of shares under dividend reinvestment plan at $9.50 per
    share
                
                
                100
                
                
                
                —
                
                
                
                951
                
                
                
                —
                
                
                
                —
                
                
                
                951Net
      income
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,781
                
                
                
                —
                
                
                
                1,781Dividends
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (6,048
                )
                
                
                —
                
                
                
                (6,048
                )Balance,
      December 31, 2006
                
                
                9,974
                
                
                $
                10
                
                
                $
                72,012
                
                
                $
                (13,108
                )
                
                $
                —
                
                
                $
                58,914Issuance
      of shares under dividend reinvestment plan at $9.50 per
    share
                
                
                27
                
                
                
                —
                
                
                
                261
                
                
                
                —
                
                
                
                —
                
                
                
                261Net
      loss
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (77
                )
                
                
                —
                
                
                
                (77
                )Unrealized
      loss on change in fair value of cash flow hedges
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (230
                )
                
                
                (230
                )Dividends
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (6,025
                )
                
                
                —
                
                
                
                (6,025
                )Balance,
      December 31, 2007
                
                
                10,001
                
                
                $
                10
                
                
                $
                72,273
                
                
                $
                (19,210
                )
                
                $
                (230
                )
                
                $
                52,843Repurchase
      of common stock at $8.43 per share
                
                
                (294
                )
                
                
                —
                
                
                
                (2,479
                )
                
                
                —
                
                
                
                —
                
                
                
                (2,479
                )Reclassification
      of dividend reinvestment plan shares with recission rights to to
      liabilities @ $9.50 per share
                
                
                —
                
                
                
                —
                
                
                
                (606
                )
                
                
                —
                
                
                
                —
                
                
                
                (606
                )Net
      income
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,134
                
                
                
                —
                
                
                
                1,134Unrealized
      loss on change in fair value of cash flow hedges
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                230
                
                
                
                230Dividends
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (5,231
                )
                
                
                —
                
                
                
                (5,231
                )Balance,
      December 31, 2008
                
                
                9,707
                
                
                $
                10
                
                
                $
                69,188
                
                
                $
                (23,307
                )
                
                $
                —
                
                
                $
                45,891




See notes
to consolidated financial statements.


F-5




Whitestone REIT and Subsidiary


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


Year
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006(Revised)
                      
                      
                      (Revised)Cash
      flows from operating activities:Net
      income (loss) from continuing operations
                      
                      $
                      (1,049
                      )
                      
                      $
                      (444
                      )
                      
                      $
                      1,440Net
      income from discontinued operations
                      
                      
                      2,183
                      
                      
                      
                      367
                      
                      
                      
                      3411,134
                      
                      
                      
                      (77
                      )
                      
                      
                      1,781Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                      
                      
                      6,859
                      
                      
                      
                      6,048
                      
                      
                      
                      6,181Minority
      interests in Operating Partnership
                      
                      
                      (627
                      )
                      
                      
                      (268
                      )
                      
                      
                      855(Gain)
      loss on sale or disposal of assets
                      
                      
                      223
                      
                      
                      
                      9
                      
                      
                      
                      (197
                      )Bad
      debt expense
                      
                      
                      731
                      
                      
                      
                      440
                      
                      
                      
                      337Change
      in fair value of derivative instrument
                      
                      
                      —
                      
                      
                      
                      30
                      
                      
                      
                      (30
                      )Changes
      in operating assets and liabilities:Escrows
      and acquisition deposits
                      
                      
                      (3,590
                      )
                      
                      
                      (104
                      )
                      
                      
                      4,956Receivables
                      
                      
                      (225
                      )
                      
                      
                      (1,292
                      )
                      
                      
                      (1,196
                      )Due
      from affiliates
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      2,933Deferred
      costs
                      
                      
                      (813
                      )
                      
                      
                      (1,210
                      )
                      
                      
                      (925
                      )Prepaid
      expenses and other assets
                      
                      
                      417
                      
                      
                      
                      205
                      
                      
                      
                      22Accounts
      payable and accrued expenses
                      
                      
                      655
                      
                      
                      
                      115
                      
                      
                      
                      1,537Tenants’
      security deposits
                      
                      
                      31
                      
                      
                      
                      201
                      
                      
                      
                      10Net
      cash provided by operating activities
                      
                      
                      2,612
                      
                      
                      
                      3,730
                      
                      
                      
                      15,923Net
      cash provided by operating activities of discontinued
      operations
                      
                      
                      8
                      
                      
                      
                      901
                      
                      
                      
                      812Cash
      flows from investing activities:Additions
      to real estate
                      
                      
                      (5,153
                      )
                      
                      
                      (10,205
                      )
                      
                      
                      (1,833
                      )Proceeds
      from sale of real estate
                      
                      
                      —
                      
                      
                      
                      265
                      
                      
                      
                      1,065Proceeds
      from legal settlement
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      288Repayment
      of note receivable
                      
                      
                      —
                      
                      
                      
                      604
                      
                      
                      
                      25Net
      cash used in investing activities
                      
                      
                      (5,153
                      )
                      
                      
                      (9,336
                      )
                      
                      
                      (455
                      )Net
      cash used in investing activities of discontinued
    operations
                      
                      
                      (8
                      )
                      
                      
                      (29
                      )
                      
                      
                      (111
                      )Cash
      flows from financing activities:Dividends
      paid
                      
                      
                      (5,578
                      )
                      
                      
                      (6,022
                      )
                      
                      
                      (6,078
                      )Distributions
      paid to OP unit holders
                      
                      
                      (3,094
                      )
                      
                      
                      (3,485
                      )
                      
                      
                      (3,753
                      )Proceeds
      from issuance of common shares
                      
                      
                      —
                      
                      
                      
                      261
                      
                      
                      
                      9,453Decrease
      in stock offering proceeds escrowed
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      (1,560
                      )Proceeds
      from notes payable
                      
                      
                      95,053
                      
                      
                      
                      22,392
                      
                      
                      
                      35,281Repayments
      of notes payable
                      
                      
                      (78,990
                      )
                      
                      
                      (5,752
                      )
                      
                      
                      (41,943
                      )Payments
      of loan origination costs
                      
                      
                      (2,672
                      )
                      
                      
                      (147
                      )
                      
                      
                      (120
                      )Net
      cash provided by (used in) financing activities
                      
                      
                      4,719
                      
                      
                      
                      7,247
                      
                      
                      
                      (8,720
                      )Net
      increase in cash and cash equivalents
                      
                      
                      2,178
                      
                      
                      
                      2,513
                      
                      
                      
                      7,449Cash
      and cash equivalents at beginning of period
                      
                      
                      10,811
                      
                      
                      
                      8,298
                      
                      
                      
                      849Cash
      and cash equivalents at end of period
                      
                      $
                      12,989
                      
                      
                      $
                      10,811
                      
                      
                      $
                      8,298Supplemental
      disclosure of cash flow informationDisposal
      of fully depreciated real estate
                      
                      $
                      698
                      
                      
                      $
                      1,844
                      
                      
                      $
                      570Cash
      paid for interest
                      
                      
                      5,189
                      
                      
                      
                      5,344
                      
                      
                      
                      4,981Financed
      insurance premiums
                      
                      
                      476
                      
                      
                      
                      458
                      
                      
                      
                      491Disposal
      of real estate in settlement of lawsuit
                      
                      
                      7,844
                      
                      
                      
                      —
                      
                      
                      
                      —




See notes
to consolidated financial statements.


F-6




WHITESTONE REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




1.
DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS




Whitestone
REIT (“Whitestone”) was formed as a real estate investment trust, 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. Whitestone
serves as the general partner of Whitestone REIT Operating Partnership, L.P.
(the “Operating Partnership” or “WROP” or “OP”), formerly known as Hartman REIT
Operating Partnership L.P., which was formed on December 31, 1998 as a Delaware
limited partnership. Whitestone currently conducts substantially all of its
operations and activities through the Operating Partnership. As the general
partner of the Operating Partnership, Whitestone has the exclusive power to
manage and conduct the business of the Operating Partnership, subject to certain
customary exceptions. As of December 31, 2008, 2007 and 2006 we owned and
operated 35, 37, and 36 retail, warehouse and office properties in and around
Houston, Dallas, San Antonio and Phoenix.




2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Basis of
Consolidation




We
are the sole general partner of the Operating Partnership and possess full legal
control and authority over the operations of the Operating Partnership. As of
December 31, 2008, 2007 and 2006, we owned a majority of the partnership
interests in the Operating Partnership. Consequently, the accompanying
consolidated financial statements include the accounts of the Operating
Partnership. All significant inter-company balances have been eliminated.
Minority interest in the accompanying consolidated financial statements
represents the share of equity and earnings of the Operating Partnership
allocable to holders of partnership interests other than us. Net income or loss
is allocated to minority interests based on the weighted-average percentage
ownership of the Operating Partnership during the year. Issuance of additional
common shares of beneficial interest in Whitestone (“common shares”) and units
of limited partnership interest in the Operating Partnership that are
convertible into common shares on a one for one basis (“OP Units”) changes the
ownership interests of both the minority interests 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 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 fiscal 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 or
shareholders’ equity.


F-7




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




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 rent 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.




Cash and Cash
Equivalents




We
consider all highly liquid debt instruments purchased with an original maturity
of three months or less to be cash equivalents. Cash and cash equivalents at
December 31, 2008 and 2007 consist of demand deposits at commercial banks and
money market funds.




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, acquisition costs 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. The Company capitalizes acquisition costs once
the acquisition of the property becomes probable. Prior to that time, we expense
these costs as acquisition expense. During the year ended December 31, 2008,
interest in the amount of $0.4 million was capitalized on properties under
development. Approximately $0.1 million was capitalized for the year ended
December 31, 2007 and no interest was capitalized for the year ended December
31, 2006.




Acquired
Properties and Acquired Lease Intangibles.We account for real estate
acquisitions pursuant to Statement of Financial Accounting Standards (“SFAS”)
No. 141, “Business
Combinations.” Accordingly, 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.
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 the buildings and improvements.
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 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, 2008.


F-8




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




Accrued Rent 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, 2008
and 2007, we had an allowance for uncollectible accounts of $1.5 million and
$0.9 million respectively. During 2008, 2007 and 2006, we recorded bad debt
expense in the amount of $0.7 million, $0.4 million and $0.3 million
respectively, related to tenant receivables that we specifically identified as
potentially uncollectible based on our assessment of the tenant’s
credit-worthiness. Bad debt expenses and any related recoveries are included in
property operation and maintenance expense in the consolidated statements of
operations.




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.




Income Taxes




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




State
- In May 2006, the State of Texas adopted House Bill 3, which modified the
state’s franchise tax structure, replacing the previous tax based on capital or
earned surplus with one based on margin (often referred to as the “Texas Margin
Tax”) effective with franchise tax reports filed on or after January 1, 2008.
The Texas Margin Tax 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 House Bill 3 states that the
Texas Margin Tax is not an income tax, SFAS No. 109, “Accounting for Income Taxes,”applies to the Texas Margin Tax. We have recorded a margin tax provision
of $0.2 million for the Texas Margin Tax for each of the years ended December
31, 2008 and 2007.




Derivative
Instruments




We
have initiated a program designed to manage exposure to interest rate
fluctuations by entering into financial derivative instruments. The primary
objective of this program is to comply with debt covenants on a credit facility.
We entered into an interest rate swap agreement with respect to amounts borrowed
under certain of our credit facilities, which effectively exchanges existing
obligations to pay interest based on floating rates for obligations to pay
interest based on fixed LIBOR rates.




We
have adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as subsequently amended by SFAS No. 138, “Accounting for Certain Derivative
Instruments and Certain Hedging Activities,”and SFAS No. 149, “Amendment of Statement 133 on
Derivative Instruments and Hedging Activities,” which require for items
appropriately classified as cash flow hedges that changes in the market value of
the instrument and in the market value of the hedged item be recorded as other
comprehensive income or loss with the exception of the portion
of


F-9




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




the
hedged items that are considered ineffective. The derivative instruments are
reported at fair value as other assets or other liabilities as applicable. As of
December 31, 2008 we did not have any interest rate swaps. As of December 31,
2007, we have a $70 million dollar interest rate swap which was designated as a
cash flow hedge. The fair value of this interest rate swap as of December 31,
2007 was approximately ($0.4) million and is included in accounts payable and
accrued expenses in the consolidated balance sheets. Additionally for a previous
interest rate swap which was not designated as a cash flow hedge, approximately
($0.03) million and $0.03 million are included in other expense and other income
on the consolidated statements of operations for the years ended December 31,
2007 and 2006, respectively.




Fair Value of
Financial Instruments




Our
financial instruments consist primarily of cash, cash equivalents, accounts
receivable, derivative instruments, accounts and notes payable. The carrying
value of cash, cash equivalents, accounts receivable and accounts payable are
representative of their respective fair values due to the short-term nature of
these instruments. The fair value of our debt obligations is representative of
its carrying value based upon current rates offered for similar types of
borrowing arrangements. The fair value of interest rate swaps (used for hedging
purposes) is the estimated amount that the financial institution would receive
or pay to terminate the swap agreements at the reporting date, taking into
account current interest rates and the current credit worthiness of the swap
counterparties.




Concentration of
Risk




Substantially
all of our revenues are obtained from office, warehouse and retail locations in
the Houston, Dallas and San Antonio, Texas 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 occasionally exceed
the federally insured limits, although no losses have been incurred in
connection with these deposits.




Comprehensive
Loss




We
follow SFAS No. 130, “Reporting Comprehensive
Income,” which establishes standards for reporting and display of
comprehensive income and its components. In October 2007 we entered into an
interest rate swap which was designated as a cash flow hedge. The fair value of
this cash flow hedge was $0 and ($0.4) million at December 31, 2008 and 2007,
respectively. This amount has been recorded as an increase to minority interest
and other comprehensive income in 2008 and a reduction to minority interest and
to other comprehensive loss in 2007. This swap matured in October
2008.




New Accounting
Pronouncements




In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value
Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a
framework for measuring fair value under U.S. generally accepted accounting
principles and requires enhanced disclosures about fair value measurements. It
does not require any new fair value measurements. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities—Including an amendment of FASB Statement No.
115”(“SFAS 159”). SFAS 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. The objective is to
improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is effective for financial statements issued for fiscal
years beginning after November 15, 2007 and interim periods within those fiscal
years. We currently do not plan to measure any eligible financial assets and
liabilities at fair value under the provisions of SFAS No. 159.




In
September 2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue
07-6, “Accounting for the Sale
of Real Estate Subject to the Requirements of FASB Statement No. 66 When the
Agreement Includes a Buy-Sell Clause,”which clarifies that a buy-sell
clause, in and of itself, does not constitute a prohibited form of continuing
involvement that would preclude partial sale treatment under Statement 66 (“EITF
07-6”). EITF 07-6 applies prospectively to new arrangements entered into in
fiscal years beginning after December 15, 2007.


F-10




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,”which replaces SFAS No. 141, “ Business Combinations,”which, among other things, establishes principles and requirements for
how an acquirer entity recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed (including intangibles)
and any noncontrolling interests in the acquired entity (“SFAS No. 141(R)”).
SFAS No. 141(R) applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. SFAS 141(R) could have a
material effect on our accounting for future property acquisitions.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS No.
160”). SFAS No. 160 amends ARB 51 to establish accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. It also amends certain of ARB 51’s
consolidation procedures for consistency with the requirements of SFAS No.
141(R). SFAS No. 160 is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008. We are currently
evaluating what impact our adoption of SFAS No. 160 will have on our financial
statements. Management believes that these statements will not have a material
impact on the Company’s consolidated results of operations or cash flows.
However, management is currently evaluating whether the adoption of SFAS 160
could have a material impact on the consolidated balance sheets and statements
of shareholders’ equity.




In
March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No.
133” (“SFAS No. 161”). SFAS No. 161 changes the disclosure requirements
for derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under SFAS No. 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. SFAS No. 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008. We are currently evaluating what impact, if any, our adoption
of SFAS No. 161 will have on our financial statements.




In
June 2008, the FASB issued FASB Staff Position No. 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities”
(“FSP No. 03-6-1”). FSP No. 03-6-1 affects entities which accrue non-returnable
cash dividends on share-based payment awards during the awards’ service period.
The FASB concluded unvested share-based payment awards which are entitled to
cash dividends, whether paid or unpaid, are participating securities any time
the common shareholders receive dividends. Because the awards are considered
participating securities, the issuing entity is required to apply the two-class
method of computing basic and diluted earnings per share. FSP No. 03-6-1 is
effective for fiscal years beginning after December 15, 2008, and early adoption
is not permitted. We are currently evaluating what impact, if any, our adoption
of FSP No. 03-6-1 will have on our financial statements.




3.
DERIVATIVES AND HEDGING




On
September 28, 2007, we entered into an interest rate swap transaction which was
designated as a cash flow hedge. The effective date of the swap transaction is
October 1, 2007, has a total notional amount of $70 million, and fixed the swap
rate at 4.77% plus the LIBOR margin (see Note 8) through October 1, 2008. The
purpose of this swap is to mitigate the risk of future fluctuations in interest
rates on our variable rate debt. We have determined that this swap is highly
effective in offsetting future variable interest cash flows on variable rate
debt.




As
of December 31, 2008 and 2007, the balance in Accumulated Other Comprehensive
Loss relating to derivatives was $0 million and $0.2 million, respectively.
During 2008, the balance in other comprehensive loss as of December 31, 2007 was
amortized to interest expense.


F-11




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




On
September 28, 2007, in conjunction with the execution of the $70 million
interest rate swap transaction, we terminated an interest rate swap transaction
that was initiated on March 16, 2006. This swap transaction had a total notional
amount of $30 million, was at a fixed rate of 5.09% plus the LIBOR margin (see
Note 8) and was set to mature on March 11, 2008. As a result of this termination
($0.03) million is included in other income in our consolidated statements of
operations for the year ended December 31, 2007.




4.
REAL ESTATE




During
2006, we sold Northwest Place II, a 27,974 square foot office/warehouse building
located in Houston, Texas, for a sales price of $1.2 million. A gain of $0.2
million was generated from this sale, which is reflected in our consolidated
financial statements for the year ended December 31, 2006. It was determined
that “discontinued operations” classification was not required due to the
immateriality of this property to our overall results.




During
2007, we sold a 2.4 acre parcel of vacant land adjacent to our South Shaver
retail property located in Houston, Texas for a sales price of $0.3 million. A
gain of $0.1 million was generated from this sale, which is reflected in our
consolidated financial statements for the three and nine months ended September
30, 2007




During
2007, we acquired from an unrelated party, one office building under
development. The property was acquired for cash in the amount of approximately
$8.2 million plus closing costs. We expect to have invested approximately $10.0
million in the building which will contain approximately 33,400 square feet of
gross leaseable area.




During
2008, we transferred two properties known as Garden Oaks and Northeast Square to
Allen R. Hartman and Hartman Management, L.P. as part of a legal settlement. See
Note 11 for more information on the settlement.




At
December 31, 2008, we owned 35 commercial properties in the Houston, Dallas, San
Antonio and Phoenix comprising approximately 3.0 million square feet of gross
leasable area.




5.
ACCRUED RENT AND ACCOUNTS RECEIVABLE, NET




Accrued
rent and accounts receivable, net, consists of amounts accrued, billed and due
from tenants, amounts due from insurance claims, allowance for doubtful accounts
and other receivables as follows (in thousands):


December
      31,2008
                  
                  
                  2007Tenant
      receivables
                  
                  $
                  2,733
                  
                  
                  $
                  2,186Accrued
      rent
                  
                  
                  3,644
                  
                  
                  
                  3,196Allowance
      for doubtful accounts
                  
                  
                  (1,497
                  )
                  
                  
                  (865
                  )Insurance
      claim receivables
                  
                  
                  —
                  
                  
                  
                  550Other
      receivables
                  
                  
                  —
                  
                  
                  
                  319Totals
                  
                  $
                  4,880
                  
                  
                  $
                  5,386


F-12




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




6.
UNAMORTIZED LEASING COMMISSIONS AND LOAN COSTS




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


December
      31,2008
                
                
                2007Leasing
      commissions
                
                $
                4,412
                
                
                $
                4,512Deferred
      financing costs
                
                
                1,921
                
                
                
                2,096Total
      cost
                
                
                6,333
                
                
                
                6,608Less:
      leasing commissions accumulated amortization
                
                
                (1,842
                )
                
                
                (1,842
                )Less:
      deferred financing cost accumulated
                
                
                (153
                )
                
                
                (1,927
                )Total
      cost, net of accumulated amortization
                
                $
                4,338
                
                
                $
                2,839




A
summary of expected future amortization of deferred costs is as follows (in
thousands):


Years
      Ended
                      December
      31,
                    
                    Leasing
                      Commissions
                    
                    
                    Deferred
                      Financing
      Costs
                    
                    
                    Total2009
                    
                    $
                    710
                    
                    
                    $
                    379
                    
                    
                    $
                    1,0892010
                    
                    
                    586
                    
                    
                    
                    345
                    
                    
                    
                    9312011
                    
                    
                    448
                    
                    
                    
                    345
                    
                    
                    
                    7932012
                    
                    
                    319
                    
                    
                    
                    345
                    
                    
                    
                    6642013
                    
                    
                    194
                    
                    
                    
                    270
                    
                    
                    
                    464Thereafter
                    
                    
                    313
                    
                    
                    
                    84
                    
                    
                    
                    397Total
                    
                    $
                    2,570
                    
                    
                    $
                    1,768
                    
                    
                    $
                    4,338




7.
FUTURE MINIMUM LEASE INCOME




We
lease the majority of our properties under noncancelable operating leases which
provide for minimum base rentals plus, in some instances, contingent rentals
based upon a percentage of the tenants’ gross receipts.




A
summary of minimum future rentals to be received (exclusive of renewals, tenant
reimbursements, and contingent rentals) under noncancelable operating leases in
existence at December 31, 2008 is as follows (in thousands):


Years
      Ended
                  December
      31,2009
                
                $
                23,5512010
                
                
                20,1422011
                
                
                15,6692012
                
                
                11,8092013
                
                
                7,499Thereafter
                
                
                12,697Total
                
                $
                91,367




F-13




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




8.
DEBT




Notes
payable




Notes
payable consists of the following (in thousands):


December
      31,2008
                      
                      
                      2007Mortgages
      and other notes payable
                      
                      $
                      100,003
                      
                      
                      $
                      9,936Revolving
      loan secured by properties
                      
                      
                      —
                      
                      
                      
                      73,525Totals
                      
                      $
                      100,003
                      
                      
                      $
                      83,461




Below
is a more detailed explanation of notes payable including key terms and
maturities (in thousands):


December
      31,Description
                  
                  2008
                  
                  
                  2007Revolving
      credit facility$75.0
      million LIBOR +2.63%, due 2008
                  
                  $
                  —
                  
                  
                  $
                  73,525Fixed
      rate notes$10.0
      million 6.04% Note, due 2014
                  
                  
                  9,782
                  
                  
                  
                  9,899$11.2
      million 6.52% Note, due 2015
                  
                  
                  11,159
                  
                  
                  
                  —$21.4
      million 6.53% Notes, due 2013
                  
                  
                  21,263
                  
                  
                  
                  —$24.5
      million 6.56% Note, due 2013
                  
                  
                  24,500
                  
                  
                  
                  —$0.5
      million 5.05% Notes, due 2009
                  
                  
                  40
                  
                  
                  
                  37Floating
      rate notes$6.4
      million LIBOR + 2.00% Note, due 2009
                  
                  
                  6,400
                  
                  
                  
                  —$26.9
      million LIBOR + 2.60% Note, due 2013
                  
                  
                  26,859
                  
                  
                  
                  —$
                  100,003
                  
                  
                  $
                  83,461




Revolving
Credit Facility




On
October 3, 2008, we paid in full our $75 million revolving credit facility with
a consortium of banks, (the “Revolving Credit Facility”). The interest rate was
based on the one month LIBOR rate plus 2.63%. The Revolving Credit Facility was
secured by a pledge of the partnership interests in Whitestone REIT Operating
Partnership III, L.P. (“WROP III”), a wholly owned subsidiary of the Operating
Partnership that was formed to hold title to the properties comprising the
borrowing base pool for the facility. As of December 31, 2007, the balance
outstanding under the Revolving Credit Facility was $73.5 million, and the
availability to draw was $1.5 million.




Fixed
Rate Notes




On
March 1, 2007, we, operating through our subsidiary, Whitestone REIT Operating
Company IV LLC (“WROP IV”) executed a promissory note for $10.0 million payable
to to MidFirst Bank with an applicable interest rate of 6.04% per annum and a
maturity date of March 1, 2014.




F-14




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




On
August 5, 2008, we, operating through our subsidiary, Whitestone Corporate Park
West, LLC (“Whitestone Corporate”) executed a promissory note for $11.2 million
payable to MidFirst Bank with an applicable interest rate of 6.52% per annum and
a maturity date of September 15, 2015 (the “MidFirst Bank Loan”). The MidFirst
Bank Loan is a non-recourse loan secured by the Whitestone Corporate’s Corporate
Park West property, which is located in Houston, Texas, and a limited guarantee
by us.




On
October 1, 2008, we, operating through our subsidiary, Whitestone Centers LLC,
executed five promissory notes (the “Sun Life Promissory Notes”) totaling $21.4
million payable to Sun Life Assurance Company of Canada with an applicable
interest rate of 6.53% per annum and a maturity date of October 1, 2013. The Sun
Life Promissory Notes are non-recourse loans secured by the Whitestone Centers
LLC’s properties, and a limited guarantee by us.




On
October 1, 2008, we, operating through our subsidiary, Whitestone Offices LLC,
executed a promissory note (the “Nationwide Promissory Note”) for $24.5 million
payable to Nationwide Life Insurance Company with an applicable interest rate of
6.56% per annum and a maturity date of October 1, 2013. Interest only is due
through October 1, 2009. The Nationwide Promissory Note is a non-recourse loan
secured by Whitestone Offices LLC’s properties, and a limited guarantee by
us.




Floating
Rate Notes




On
January 25, 2008, we entered into a $6.4 million term loan agreement with
KeyBank. The term loan is secured by a pledge of the partnership interests in
WROP III, and Whitestone Pima Norte LLC (“WPN”), a wholly owned subsidiary of
the Operating Partnership that was formed to hold title to our Pima Norte
property that was purchased in October 2007. At December 31, 2008 and 2007, WROP
III owned 17 and 35 properties, respectively, and WPN owned 1
property.




Outstanding
amounts under the note accrue interest computed at the LIBOR Rate on the basis
of a 360 day year, plus 2%. Interest only is payable monthly under the loan with
the total amount of principal due at maturity in July 2009. The covenants of
this agreement mirror those in our $75 million revolving credit agreement which
was paid in full on October 3, 2008. They are as follows:


●
              We
      will not permit our total indebtedness to exceed 60% of the fair market
      value of our real estate assets at the end of any quarter. Total
      indebtedness is defined as all our liabilities, including this loan and
      all other secured and unsecured debt, including letters of credit and
      guarantees. Fair market value of real estate assets is defined as
      aggregate net operating income for the preceding four quarters, less a
      $0.15 per square foot per annum capital expenditure reserve, divided by a
      9.25% capitalization rate.●
              The
      ratio of consolidated rolling four-quarter earnings before interest,
      income tax, depreciation and amortization expenses to total interest
      expense, including capitalized interest, shall not be less than 2.0 to
      1.0.●
              The
      ratio of consolidated earnings before interest, income tax, depreciation
      and amortization expenses to total interest expense, including capitalized
      interest, principal amortization, capital expenditures and preferred stock
      dividends shall not be less than 1.5 to 1.0. Capital expenditures shall be
      deemed to be $0.15 per square foot per annum.●
              The
      ratio of secured debt to fair market value of real estate assets shall not
      be greater than 40%.●
              We
      must maintain a consolidated tangible net worth of not less than $30
      million plus 75% of the value of stock and OP units issued in conjunction
      with an offering or with the acquisition of an asset or stock.
      Consolidated tangible net worth is defined as shareholders equity less
      intangible assets.




In
order to pay off our $75 million revolving credit facility in 2008, we entered
into non-recourse mortgages secured by various properties and a limited
guarantee by us. As a result of these secured mortgages, we are not in
compliance with our secured debt to fair market value ratio covenant of our $6.4
million loan with KeyBank as of December 31, 2008. As this non-compliance
constitutes an event of default, the lender has the right to accelerate payment.
We are in discussions with KeyBank regarding an extension of this loan, which
matures in July 2009, and have requested a waiver from KeyBank. As of the date
of this filing, we have not received the waiver. Should we not receive a waiver
we will attempt to obtain other financing or pay off the loan from cash
reserves.




F-15




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




On
October 3, 2008, we, operating through our subsidiary, Whitestone
Industrial-Office LLC, ( “Whitestone Industrial Office”) executed a floating
rate promissory note (the “Jackson Life Loan”) for $26.9 million payable to
Jackson Life Insurance Company ( “Jackson Life”) with a floating interest rate
of 2.63% over the one month LIBOR (the “Index”). The floating interest rate will
be adjusted monthly by Jackson Life based on the Index as published on the last
business day of the month. As of February 23, 2009 the floating interest rate
was 3.07%. The Jackson Life Loan has a maturity date of November 1, 2013. The
Jackson Life Loan is a non-recourse loan secured by Whitestone Industrial Office
properties and a limited guarantee by us.




Our
loans are subject to customary financial covenants. As of December 31, 2008, we
are in compliance with all loan covenants other than the Pima Norte non
compliance described above.




Annual
maturities of notes payable as of December 31, 2008 are due during the following
years (in thousands):


Year2009
                          
                          $
                          8,0272010
                          
                          
                          2,0142011
                          
                          
                          2,1212012
                          
                          
                          2,2362013
                          
                          
                          66,1452014
      and thereafter
                          
                          
                          19,460Total
                          
                          $
                          100,003




F-16




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




9.
EARNINGS PER SHARE




Basic
earnings per share is computed using net income to common shareholders and the
weighted average number of common shares outstanding. Diluted earnings per share
reflects common shares issuable from the assumed conversion of OP Units
convertible into common shares. Only those items that have a dilutive impact on
basic earnings per share are included in the diluted earnings per share.
Accordingly, excluded from the earnings per share calculation for each of the
years ended December 31, 2008, 2007 and 2006 are 4,739,886, 5,808,337 and
5,808,337, respectively, of OP units as their inclusion would be
anti-dilutive.


Year
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Numerator:Income
      (loss) from continuing operations
                  
                  $
                  (1,049
                  )
                  
                  $
                  (444
                  )
                  
                  $
                  1,440Income
      from discontinued operations
                  
                  
                  2,183
                  
                  
                  
                  367
                  
                  
                  
                  341Net
      income (loss)
                  
                  $
                  1,134
                  
                  
                  $
                  (77
                  )
                  
                  $
                  1,781Denominator:Basic
      and diluted weighted average shares outstanding
                  
                  
                  9,830
                  
                  
                  
                  9,999
                  
                  
                  
                  9,652Basic
      and diluted earnings per share:Income
      (loss) from continuing operations
                  
                  $
                  (0.11
                  )
                  
                  $
                  (0.04
                  )
                  
                  $
                  0.15Income
      from discontinued operations
                  
                  
                  0.23
                  
                  
                  
                  0.03
                  
                  
                  
                  0.03Net
      income (loss)
                  
                  $
                  0.12
                  
                  
                  $
                  (0.01
                  )
                  
                  $
                  0.18




10.
FEDERAL INCOME TAXES




Federal
income taxes are not provided because we intend to and believe we qualify as a
REIT under the provisions of the Internal Revenue Code and because we have
distributed and intend to continue to distribute all of our taxable income to
our shareholders. Our shareholders include their proportionate taxable income in
their individual tax returns. As a REIT, we must distribute at least 90% of our
real estate investment trust taxable income to our shareholders and meet certain
income sources and investment restriction requirements. In addition, REITs are
subject to a number of organizational and operational requirements. If we fail
to qualify as a REIT in any taxable year, we will be subject to federal income
tax (including any applicable alternative minimum tax) on our taxable income at
regular corporate tax rates.




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.




For
Federal income tax purposes, the cash dividends distributed to shareholders are
characterized as follows for the years ended December 31:


2008
                
                
                2007
                
                
                2006Ordinary
      income (unaudited)
                
                
                3.8
                %
                
                
                15.0
                %
                
                
                36.2
                %Return
      of capital (unaudited)
                
                
                67.6
                %
                
                
                84.1
                %
                
                
                59.9
                %Capital
      gain distributions (unaudited)
                
                
                28.6
                %
                
                
                0.9
                %
                
                
                3.9
                %Total
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %


F-17


WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




11.
RELATED PARTY TRANSACTIONS




Spoerlein
Commons Acquisition




On
January 16, 2009, Whitestone, operating through the Operating Partnership,
acquired Spoerlein Commons, a mixed use-garden style complex of retail, medical,
and professional office tenants located in Buffalo Grove, Illinois. The
Operating Partnership acquired Spoerlein Commons pursuant to the terms and
conditions of the purchase, sale and contribution agreement dated December 18,
2008 (the “Agreement”) between the Operating Partnership and Bank One, Chicago,
NA, as trustee under the Trust Agreement dated January 29, 1986 and known as
Trust Number TWB-0454 (“Seller”). Midwest Development Venture IV, an Illinois
limited partnership (“Midwest”), is the sole beneficiary of the Seller under the
Trust Agreement.




Spoerlein
Commons represents an acquisition for Whitestone, and a substantial equity
investment on behalf of the Seller. In exchange for Spoerlein Commons, the
Operating Partnership paid Seller $5,500,000, received credit for net prorations
of $275,854 and issued 703,912 Operating Partnership Units, valued at $5.15 per
Unit, for a total purchase price of $9,401,000.




Midwest,
the sole beneficiary of the Seller, is entitled to all earnings and proceeds
from the sale of Spoerlein Commons. James C. Mastandrea, our Chairman, President
and Chief Executive Officer, is the controlling limited partner in Midwest and
as such, had an ownership interest in Spoerlein Commons and is entitled to a
portion of the proceeds from the sale of Spoerlein Commons to the Operating
Partnership. Because of Mr. Mastandrea’s relationship with the Seller, a special
committee of the independent members of the Board of Trustees including Donald
F. Keating, Jack L. Mahaffey, and Chris A. Minton determined the terms of the
transaction, which included the use of an independent appraiser to value
Spoerlein Commons.




No
brokerage commission was paid by the Company for this acquisition, and in
relation to Mr. Mastandrea’s investment, there was no front end load, meaning
that 100% of the amount paid is working for the benefit of Whitestone’s
shareholders.




In
connection with the closing of Spoerlein Commons and the investment on behalf of
the Seller, the Operating Partnership issued 703,912 Operating Partnership Units
to Midwest for its contribution of Spoerlein Commons to the Operating
Partnership. The Operating Partnership Units were issued in reliance on the
exemption from registration provided by Section 4(2) under the Securities Act of
1933, as amended. The issuance was not effected using any form of general
advertising or general solicitation and the issuance was made to a qualified
investor.




The
Operating Partnership Units are convertible on a one-for-one basis into Common
Shares of the Company at any time after July 1, 2009 in accordance with the
terms of the Operating Partnership’s Limited Partnership Agreement, as amended
(the “Limited Partnership Agreement”). The Seller will not be entitled to any
dividends or distributions with respect to the Units prior to June 30,
2009.




In
the event James C. Mastandrea is not re-elected as a trustee of Whitestone at
the 2009 Annual Meeting of Shareholders and appointed Chairman, President and
Chief Executive Officer for any reason, the Operating Partnership would be
obligated to repurchase the Operating Partnership Units or any Common Shares
issued upon conversion of the Units (as the case may be), in cash for $5.15 for
each Operating Partnership Unit or Common Share issued to Midwest in connection
with the sale of Spoerlein Commons discussed above.




Settlement
between Whitestone REIT and Allen R. Hartman and Hartman Management,
L.P.




On
May 30, 2008, Whitestone together with Allen R. Hartman and Hartman Management,
L.P. (“Hartman”), issued a press release announcing that Whitestone and Hartman
had settled their ongoing dispute and agreed to sever their relationship.
Whitestone and Hartman entered into a settlement agreement and mutual release
bringing resolution to two law suits between the parties. Both suits, one of
which was pending in Federal Court in Houston and the other suit pending in
Harris County District Court, were filed in the fall of 2006.


F-18


WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




The
settlement agreement provided for, among other things:


●
                The
      transfer of two properties known as Garden Oaks and Northeast Square from
      Whitestone to Hartman. The properties had a net book value of
      approximately $7.8 million as May 30, 2008.●
                The
      transfer of 293,961.54 common shares of Whitestone and 1,068,451.271
      Operating Partnership Units from Hartman to Whitestone.●
                A
      five-year standstill agreement between Whitestone and Hartman, wherein,
      among other things, neither party will acquire or invest in the voting
      securities of the other party; enter into a merger or combination with the
      other party; propose a plan of liquidation, dissolution, or
      recapitalization of the other party; nor participate in any solicitation
      or proxies of voting securities of the other party.The
      mutual release provided for, among other things:●
                The
      dismissal, with prejudice, of Hartman by Whitestone, and Whitestone by
      Hartman.●
                The
      release of Hartman, Hartman Income REIT, Whitestone, Whitestone REIT
      Operating Partnership, L.P., James C. Mastandrea, John J. Dee, Paragon and
      its Trustees, and the law firm of Bass Berry & Sims PLC including John
      A. Good who is a partner with that law firm.●
                The
      retraction of the Preliminary Proxy Statement of Hartman filed on November
      29, 2006, the Definitive Additional Materials filed by Hartman on December
      1, 2006, and the Non-Management Revised Preliminary Proxy Soliciting
      Materials filed by Hartman on February 1, 2007.Whitestone recorded a gain on this transaction of approximately $3.6
      million in the second quarter of
2008.




12.
SHAREHOLDERS’ EQUITY




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




On
September 15, 2004, our Registration Statement on Form S-11, with respect to our
public offering of up to 10 million common shares of beneficial interest offered
at a price of $10 per share was declared effective under the Securities Act of
1933. The Registration Statement also covered up to 1 million shares available
pursuant to our dividend reinvestment plan offered at a price of $9.50 per
share. The shares were offered to investors on a best efforts basis.
Post-Effective Amendments No. 1, 2 and 3 to the Registration Statement were
declared effective by the SEC on June 27, 2005, March 9, 2006 and May 3, 2006,
respectively.




On
October 2, 2006, our Board terminated the public offering. On March 27, 2007, we
gave the required ten day notice to participants informing them that we intend
to terminate our dividend reinvestment plan. As a result, our dividend
reinvestment plan terminated on April 6, 2007.




As
of December 31, 2007, 2.8 million shares had been issued pursuant to our public
offering with net offering proceeds received of $24.6 million. An additional
165,000 shares had been issued pursuant to the dividend reinvestment plan in
lieu of dividends totaling $1.6 million. Shareholders that received shares
pursuant to our dividend reinvestment plan on or after October 2, 2006 may have
rescission rights.




All
net proceeds of our public offering were contributed to the Operating
Partnership in exchange for OP Units. The Operating Partnership used the
proceeds to acquire additional properties and for general working capital. In
accordance with the Operating Partnership’s Agreement of Limited Partnership, in
exchange for the contribution of net proceeds from sales of stock, we received
an equivalent number of OP Units as shares of stock that are sold.




At
December 31, 2008 and December 31, 2007, Mr. Hartman owned 0.0% and 2.9%,
respectively, of our outstanding shares. At December 31, 2008 and December 31,
2007, our Board collectively owned 1.6% and 2.6% of our outstanding shares,
respectively.


F-19


WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




Operating Partnership
Units




Substantially
all of our business is conducted through the Operating Partnership. We are the
sole general partner of the Operating Partnership. As of December 31, 2008, we
owned a 66.4% interest in the Operating Partnership.




Limited
partners in the Operating Partnership holding OP Units have the right to convert
their OP Units into common shares at a ratio of one OP Unit for one common
share. Distributions to OP Unit holders are paid at the same rate per unit as
dividends per share of Whitestone. Subject to certain restrictions, OP Units are
not convertible into common shares until the later of one year after acquisition
or an initial public offering of the common shares. As of December 31, 2008 and
December 31, 2007, there were 14,085,705 and 15,448,118 OP Units outstanding,
respectively. We owned 9,345,820 and 9,639,781 OP Units as of December 31, 2008
and December 31, 2007, respectively. The balance of the OP Units is owned by
third parties, including certain trustees. Our weighted-average share ownership
in the Operating Partnership was approximately 64.62%, 62.40% and 61.53% for the
years ended December 31, 2008, 2007 and 2006, respectively. At December 31, 2008
and December 31, 2007, Mr. Hartman owned 0.0% and 6.9%, respectively, of the
Operating Partnership’s outstanding units. At December 31, 2008 and December 31,
2007, our Board collectively owned 0.6% and 0.4% of the Operating Partnership’s
outstanding units, respectively.


F-20




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




Dividends and
distributions




The
following tables summarize the cash dividends/distributions paid to holders of
common shares and holders of OP Units (after giving effect to the
recapitalization) during the years ended December 31, 2008 and 2007 and the
quarter ended March 31, 2009.


Whitestone
      ShareholdersDividend
                  
                  Date
      Dividend
                  
                  Total
      Amountper
      Common Share
                  
                  Paid
                  
                  Paid
      (in thousands)$
                  0.1500
                  
                  
                  Qtr
      ended 03/31/07
                  
                  
                  $
                  1,5220.1500
                  
                  
                  Qtr
      ended 06/30/07
                  
                  
                  
                  1,5000.1500
                  
                  
                  Qtr
      ended 09/30/07
                  
                  
                  
                  1,5000.1500
                  
                  
                  Qtr
      ended 12/31/07
                  
                  
                  
                  1,5000.1500
                  
                  
                  Qtr
      ended 03/31/08
                  
                  
                  
                  1,5000.1500
                  
                  
                  Qtr
      ended 06/30/08
                  
                  
                  
                  1,5290.1500
                  
                  
                  Qtr
      ended 09/30/08
                  
                  
                  
                  1,4560.1125
                  
                  
                  Qtr
      ended 12/31/08
                  
                  
                  
                  1,0930.1125
                  
                  
                  Qtr
      ended 03/31/09
                  
                  
                  
                  1,154





OP
      Unit Holders Including Minority Unit HoldersDistribution
                    
                    Date
      Distribution
                    
                    Total
      Amountper
      OP Unit
                    
                    Paid
                    
                    Paid
      (in thousands)$
                    0.1500
                    
                    
                    Qtr
      ended 03/31/07
                    
                    
                    $
                    2,3170.1500
                    
                    
                    Qtr
      ended 06/30/07
                    
                    
                    
                    2,3170.1500
                    
                    
                    Qtr
      ended 09/30/07
                    
                    
                    
                    2,3170.1500
                    
                    
                    Qtr
      ended 12/31/07
                    
                    
                    
                    2,3170.1500
                    
                    
                    Qtr
      ended 03/31/08
                    
                    
                    
                    2,3170.1500
                    
                    
                    Qtr
      ended 06/30/08
                    
                    
                    
                    2,4230.1500
                    
                    
                    Qtr
      ended 09/30/08
                    
                    
                    
                    2,1130.1125
                    
                    
                    Qtr
      ended 12/31/08
                    
                    
                    
                    1,5850.1125
                    
                    
                    Qtr
      ended 03/31/09
                    
                    
                    
                    1,646




13.
INCENTIVE SHARE PLAN




On July
29, 2008, our shareholders approved the 2008 Long-Term Equity Incentive
Ownership Plan (the “Plan”). The Plan provides that awards may be made with
respect to common shares of Whitestone or units in the Operating Partnership,
which may be converted into common shares of Whitestone. The Plan authorizes
awards in respect of an aggregate of 2,063,885 common shares. 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 (including issuances
pursuant to the Plan) 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 units of the Operating Partnership issued and
outstanding (other than treasury shares and/or units issued to or held by
Whitestone).




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 Whitestone’s Board of Trustees. The Committee is authorized to
grant stock options, including both incentive stock options and non-qualified
stock options, as well as stock appreciation rights, either with or without a
related option. The Committee is also authorized to grant restricted common
shares, restricted common share units, performance awards and other share-based
awards. No single participant may receive options or stock appreciation rights
in any calendar year that, taken together, relate to more than 500,000 common
shares, subject to adjustment in certain circumstances. As of December 31, 2008,
no awards have been issued under the Plan.


F-21




WHITESTONE
REIT AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2008




14.
COMMITMENTS AND CONTINGENCIES




We are a
participant in various other 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.




15.
SEGMENT INFORMATION




Our
management historically has not differentiated by property types and therefore
does not present segment information.




16.
SELECT QUARTERLY FINANCIAL DATA (unaudited)




The
following is a summary of our unaudited quarterly financial information for the
years ended December 31, 2008 and 2007 (in thousands, except per share
data):





First
                
                
                Second
                
                
                Third
                
                
                FourthQuarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter2008Revenues
      from continuing operations
                
                $
                7,756
                
                
                $
                7,750
                
                
                $
                7,643
                
                
                $
                8,052Income
      (loss) from continuing operations
                
                
                (191
                )
                
                
                (529
                )
                
                
                (173
                )
                
                
                (156
                )Income
      from discontinued operations
                
                
                122
                
                
                
                2,061
                
                
                
                —
                
                
                
                —Net
      income (loss)
                
                
                (69
                )
                
                
                1,532
                
                
                
                (173
                )
                
                
                (156
                )Basic
      and diluted earnings per share:Income
      (loss) from continuing operations
                
                $
                (0.02
                )
                
                $
                (0.05
                )
                
                $
                (0.02
                )
                
                $
                (0.02
                )Income
      from discontinued operations
                
                
                0.02
                
                
                
                0.21
                
                
                
                —
                
                
                
                —Net
      income (loss)
                
                $
                —
                
                
                $
                0.16
                
                
                $
                (0.02
                )
                
                $
                (0.02
                )2007Revenues
      from continuing operations
                
                $
                7,123
                
                
                $
                7,183
                
                
                $
                7,382
                
                
                $
                7,686Income
      (loss) from continuing operations
                
                
                (262
                )
                
                
                37
                
                
                
                98
                
                
                
                (317
                )Income
      from discontinued operations
                
                
                124
                
                
                
                96
                
                
                
                74
                
                
                
                73Net
      income (loss)
                
                
                (138
                )
                
                
                133
                
                
                
                172
                
                
                
                (244
                )Basic
      and diluted earnings per share:Income
      (loss) from continuing operations
                
                $
                (0.02
                )
                
                $
                —
                
                
                $
                0.01
                
                
                $
                (0.03
                )Income
      from discontinued operations
                
                
                0.01
                
                
                
                0.01
                
                
                
                0.01
                
                
                
                —Net
      income (loss)
                
                $
                (0.01
                )
                
                $
                0.01
                
                
                $
                0.02
                
                
                $
                (0.03
                )




F-22




WHITESTONE
REIT AND SUBSIDIARY


Notes to
Consolidated Financial Statements


December
31, 2008




17. SUBSEQUENT
EVENTS




On
January 6, 2009, the Compensation Committee of the Board of Trustees of
Whitestone, pursuant to Whitestone’s 2008 Long-Term Equity Incentive Ownership
Plan, approved the form of award agreements to be used to grant performance
based restricted share and unit awards to certain employees and executive
officers of Whitestone and the form of award agreement for restricted share
awards to be granted to trustees of Whitestone (See Note 13).




On
January 16, 2009, Whitestone, operating through the Operating Partnership
acquired Spoerlein Commons, a mixed use-garden style complex of retail, medical,
and professional office tenants located in Buffalo Grove, Illinois (See Note
11).




On
February 1, 2009, Daniel G. DeVos and Daryl J. Carter joined the Board of
Trustees of Whitestone. Whitestone’s Board of Trustees elected Mr. DeVos and Mr.
Carter on December 18, 2008. On February 26, 2009, Whitestone’s Board of
Trustees appointed Mr. DeVos to the Nominating and Corporate Governance
Committee and Mr. Carter to the Audit Committee.




On
February 3, 2009, Whitestone, operating through its subsidiary, Whitestone
Centers LLC, executed four promissory notes (the “Sun Life Promissory Notes II”)
totaling $9.9 million payable to Sun Life Assurance Company of Canada with an
applicable interest rate of 6.63% per annum and a maturity date of March 1,
2014. The Sun Life Promissory Notes II are non-recourse loans secured by the
Whitestone Centers LLC’s properties, and a limited guarantee by
Whitestone.


F-23




Whitestone REIT and Subsidiary




Schedule
II - Valuation and Qualifying Accounts


(in
      thousands)Balance
      at
                  
                  
                  
                  Deductions
                  
                  Balance
      atBeginning
                  
                  Charged
                  
                  from
                  
                  End
      ofDescription
                  
                  of
      Period
                  
                  to
      Income
                  
                  Reserves
                  
                  PeriodAllowance
      for doubtful accounts:Year
      ended December 31, 2008
                  
                  $
                  865
                  
                  $
                  731
                  
                  $
                  (99
                  )
                  $
                  1,497Year
      ended December 31, 2007
                  
                  
                  586
                  
                  
                  440
                  
                  
                  (161
                  )
                  
                  865Year
      ended December 31, 2006
                  
                  
                  445
                  
                  
                  337
                  
                  
                  (196
                  )
                  
                  586


F-24




Whitestone REIT and Subsidiary




Schedule
III - Real Estate and Accumulated Depreciation




December
31, 2008


Initial
      Cost (in thousands)
                
                Costs
      Capitalized Subsequent
                  to
      Acquisition (in thousands)
                
                Gross
      Amount at which Carried at
                  End
      of Period (in thousands)(1)
      (2)Property
      Name
                
                Land
                
                Building
      and
                  Improvements
                
                Improvements
                  (net)
                
                Carrying
                  Costs
                
                Land
                
                Building
      and
                  Improvements
                
                TotalRetail
      Properties:Bellnot
      Square
                
                $
                1,154
                
                $
                4,638
                
                $
                257
                
                $
                —
                
                $
                1,154
                
                $
                4,895
                
                $
                6,049Bissonnet
      Beltway
                
                
                415
                
                
                1,947
                
                
                250
                
                
                —
                
                
                415
                
                
                2,197
                
                
                2,612Centre
      South
                
                
                481
                
                
                1,596
                
                
                344
                
                
                —
                
                
                481
                
                
                1,940
                
                
                2,421Greens
      Road
                
                
                354
                
                
                1,284
                
                
                117
                
                
                —
                
                
                354
                
                
                1,401
                
                
                1,755Holly
      Knight
                
                
                320
                
                
                1,293
                
                
                152
                
                
                —
                
                
                320
                
                
                1,445
                
                
                1,765Kempwood
      Plaza
                
                
                733
                
                
                1,798
                
                
                889
                
                
                —
                
                
                733
                
                
                2,687
                
                
                3,420Lion
      Square
                
                
                1,546
                
                
                4,289
                
                
                808
                
                
                —
                
                
                1,546
                
                
                5,097
                
                
                6,643Providence
                
                
                918
                
                
                3,675
                
                
                577
                
                
                —
                
                
                918
                
                
                4,252
                
                
                5,170South
      Richey
                
                
                778
                
                
                2,584
                
                
                308
                
                
                —
                
                
                778
                
                
                2,892
                
                
                3,670South
      Shaver
                
                
                184
                
                
                633
                
                
                (5
                )
                
                —
                
                
                184
                
                
                628
                
                
                812SugarPark
      Plaza
                
                
                1,781
                
                
                7,125
                
                
                267
                
                
                —
                
                
                1,781
                
                
                7,392
                
                
                9,173Sunridge
                
                
                276
                
                
                1,186
                
                
                139
                
                
                —
                
                
                276
                
                
                1,325
                
                
                1,601Torrey
      Square
                
                
                1,981
                
                
                2,971
                
                
                773
                
                
                —
                
                
                1,981
                
                
                3,744
                
                
                5,725Town
      Park
                
                
                850
                
                
                2,911
                
                
                244
                
                
                —
                
                
                850
                
                
                3,155
                
                
                4,005Webster
      Point
                
                
                720
                
                
                1,150
                
                
                154
                
                
                —
                
                
                720
                
                
                1,304
                
                
                2,024Westchase
                
                
                423
                
                
                1,751
                
                
                1,474
                
                
                —
                
                
                423
                
                
                3,225
                
                
                3,648Windsor
      Park
                
                
                2,621
                
                
                10,482
                
                
                363
                
                
                —
                
                
                2,621
                
                
                10,845
                
                
                13,466$
                15,535
                
                $
                51,313
                
                $
                7,111
                
                $
                —
                
                $
                15,535
                
                $
                58,424
                
                $
                73,959Warehouse
      Properties:Brookhill
                
                
                186
                
                
                788
                
                
                169
                
                $
                —
                
                
                186
                
                
                957
                
                
                1,143Corporate
      Park Northwest
                
                
                1,534
                
                
                6,306
                
                
                751
                
                
                —
                
                
                1,534
                
                
                7,057
                
                
                8,591Corporate
      Park West
                
                
                2,555
                
                
                10,267
                
                
                752
                
                
                —
                
                
                2,555
                
                
                11,019
                
                
                13,574Corporate
      Park Woodland
                
                
                652
                
                
                5,330
                
                
                622
                
                
                —
                
                
                652
                
                
                5,952
                
                
                6,604Dairy
      Ashford
                
                
                226
                
                
                1,211
                
                
                109
                
                
                —
                
                
                226
                
                
                1,320
                
                
                1,546Holly
      Hall
                
                
                608
                
                
                2,516
                
                
                94
                
                
                —
                
                
                608
                
                
                2,610
                
                
                3,218Interstate
      10
                
                
                208
                
                
                3,700
                
                
                427
                
                
                —
                
                
                208
                
                
                4,127
                
                
                4,335Main
      Park
                
                
                1,328
                
                
                2,721
                
                
                356
                
                
                —
                
                
                1,328
                
                
                3,077
                
                
                4,405Plaza
      Park
                
                
                902
                
                
                3,294
                
                
                520
                
                
                —
                
                
                902
                
                
                3,814
                
                
                4,716West
      Belt Plaza
                
                
                568
                
                
                2,165
                
                
                477
                
                
                —
                
                
                568
                
                
                2,642
                
                
                3,210Westgate
                
                
                672
                
                
                2,776
                
                
                228
                
                
                —
                
                
                672
                
                
                3,004
                
                
                3,676$
                9,439
                
                $
                41,074
                
                $
                4,505
                
                $
                —
                
                $
                9,439
                
                $
                45,579
                
                $
                55,018Office
      Properties:9101
      LBJ Freeway
                
                $
                1,597
                
                $
                6,078
                
                $
                962
                
                $
                —
                
                $
                1,597
                
                $
                7,040
                
                $
                8,637Featherwood
                
                
                368
                
                
                2,591
                
                
                514
                
                
                —
                
                
                368
                
                
                3,105
                
                
                3,473Pima
      Norte
                
                
                1,086
                
                
                7,162
                
                
                899
                
                
                517
                
                
                1,086
                
                
                8,578
                
                
                9,520Royal
      Crest
                
                
                509
                
                
                1,355
                
                
                121
                
                
                —
                
                
                509
                
                
                1,476
                
                
                1,985Uptown
      Tower
                
                
                1,621
                
                
                15,551
                
                
                1,616
                
                
                —
                
                
                1,621
                
                
                17,167
                
                
                18,788Woodlake
      Plaza
                
                
                1,107
                
                
                4,426
                
                
                785
                
                
                —
                
                
                1,107
                
                
                5,211
                
                
                6,318Zeta
      Building
                
                
                636
                
                
                1,819
                
                
                244
                
                
                —
                
                
                636
                
                
                2,063
                
                
                2,699$
                6,924
                
                $
                38,982
                
                $
                5,141
                
                $
                517
                
                $
                6,924
                
                $
                44,640
                
                $
                51,420Grand
      Totals
                
                $
                31,898
                
                $
                131,369
                
                $
                16,757
                
                $
                517
                
                $
                31,898
                
                $
                148,643
                
                $
                180,397


F-25




Whitestone
REIT and Subsidiary




Schedule
III - Real Estate and Accumulated Depreciation




December
31, 2008




(Continued)


Property
      Name
            
            Accumulated
      Depreciation
              (in
      thousands)
            
            Date
      of
              Construction
            
            Date
      Acquired
            
            Depreciation
      LifeRetail
      Properties:Bellnot
      Square
            
            $
            879
            
            
            
            1/1/2002
            
            5-39
      yearsBissonnet
      Beltway
            
            
            834
            
            
            
            1/1/1999
            
            5-39
      yearsCentre
      South
            
            
            619
            
            
            
            1/1/2000
            
            5-39
      yearsGreens
      Road
            
            
            508
            
            
            
            1/1/1999
            
            5-39
      yearsHolly
      Knight
            
            
            512
            
            
            
            8/1/2000
            
            5-39
      yearsKempwood
      Plaza
            
            
            1,100
            
            
            
            2/2/1999
            
            5-39
      yearsLion
      Square
            
            
            1,215
            
            
            
            1/1/2000
            
            5-39
      yearsProvidence
            
            
            907
            
            
            
            3/30/2001
            
            5-39
      yearsSouth
      Richey
            
            
            738
            
            
            
            8/25/1999
            
            5-39
      yearsSouth
      Shaver
            
            
            195
            
            
            
            12/17/1999
            
            5-39
      yearsSugarPark
      Plaza
            
            
            806
            
            
            
            9/8/2004
            
            5-39
      yearsSunridge
            
            
            297
            
            
            
            1/1/2002
            
            5-39
      yearsTorrey
      Square
            
            
            1,070
            
            
            
            1/1/2000
            
            5-39
      yearsTown
      Park
            
            
            1,076
            
            
            
            1/1/1999
            
            5-39
      yearsWebster
      Point
            
            
            372
            
            
            
            1/1/2000
            
            5-39
      yearsWestchase
            
            
            503
            
            
            
            1/1/2002
            
            5-39
      yearsWindsor
      Park
            
            
            1,349
            
            
            
            12/16/2003
            
            5-39
      years$
            12,980Warehouse
      Properties:Brookhill
            
            $
            295
            
            
            
            1/1/2002
            
            5-39
      yearsCorporate
      Park Northwest
            
            
            1,485
            
            
            
            1/1/2002
            
            5-39
      yearsCorporate
      Park West
            
            
            2,321
            
            
            
            1/1/2002
            
            5-39
      yearsCorporate
      Park Woodland
            
            
            1,830
            
            11/1/2000
            
            
            
            5-39
      yearsDairy
      Ashford
            
            
            403
            
            
            
            1/1/1999
            
            5-39
      yearsHolly
      Hall
            
            
            532
            
            
            
            1/1/2002
            
            5-39
      yearsInterstate
      10
            
            
            1,539
            
            
            
            1/1/1999
            
            5-39
      yearsMain
      Park
            
            
            871
            
            
            
            1/1/1999
            
            5-39
      yearsPlaza
      Park
            
            
            995
            
            
            
            1/1/2000
            
            5-39
      yearsWest
      Belt Plaza
            
            
            910
            
            
            
            1/1/1999
            
            5-39
      yearsWestgate
            
            
            610
            
            
            
            1/1/2002
            
            5-39
      years$
            11,791Office
      Properties:9101
      LBJ Freeway
            
            $
            688
            
            
            
            8/10/2005
            
            5-39
      yearsFeatherwood
            
            
            940
            
            
            
            1/1/2000
            
            5-39
      yearsPima
      Norte
            
            
            90
            
            
            
            10/4/2007
            
            5-39
      yearsRoyal
      Crest
            
            
            381
            
            
            
            1/1/2000
            
            5-39
      yearsUptown
      Tower
            
            
            1,504
            
            
            
            11/22/2005
            
            5-39
      yearsWoodlake
      Plaza
            
            
            623
            
            
            
            3/14/2005
            
            5-39
      yearsZeta
      Building
            
            
            553
            
            
            
            1/1/2000
            
            5-39
      years$
            4,779Grand
      Total
            
            $
            29,550


F-26




Whitestone
REIT and Subsidiary




Schedule
III - Real Estate and Accumulated Depreciation




December
31, 2008




(Continued)


(1)
      Reconciliations
      of total real estate carrying value for the three years ended December 31
      follows:





(
      In thousands)2008
                        
                        
                        2007
                        
                        
                        2006Balance
      at beginning of period
                        
                        $
                        172,315
                        
                        
                        $
                        164,132
                        
                        
                        $
                        164,278Additions
      during the period:Acquisitions
                        
                        
                        —
                        
                        
                        
                        8,248
                        
                        
                        
                        —Improvements
                        
                        
                        9,402
                        
                        
                        
                        1,957
                        
                        
                        
                        1,8339,402
                        
                        
                        
                        10,205
                        
                        
                        
                        1,833Deductions
      - cost of real estate sold or retired
                        
                        
                        (1,320
                        )
                        
                        
                        (2,022
                        )
                        
                        
                        (1,979
                        )Balance
      at close of period
                        
                        $
                        180,397
                        
                        
                        $
                        172,315
                        
                        
                        $
                        164,132
  (2)
                        The
      aggregate cost of real estate (in thousands) for federal income tax
      purposes is
$150,777




F-27




Whitestone
REIT and Subsidiary




Index
to Exhibits


Exhibit
      No.
                
                Description3.1
                
                Amended
      and Restated Declaration of Trust of Whitestone REIT (previously filed as
      and incorporated by reference to Exhibit 3.1 to the Registrant’s Current
      Report on Form 8-K, filed on July 31, 2008)3.3
                
                Articles
      Supplementary (previously filed as and incorporated by reference to
      Exhibit 3(i).1 to the Registrant’s Current Report on Form 8-K, filed
      December 6, 2006)3.2
                
                Amended
      and Restated Bylaws of Whitestone REIT (previously filed as and
      incorporated by reference to Exhibit 3.1 to the Registrant’s Current
      Report on Form 8-K, filed October 9, 2008)4.1
                
                Specimen
      certificate for common shares of beneficial interest, par value $.001
      (previously filed as and incorporated by reference to Exhibit 4.2 to the
      Registrant’s Registration Statement on Form S-11, Commission File No.
      333-111674, filed on December 31, 2003)10.1
                
                Agreement
      of Limited Partnership of Hartman REIT Operating Partnership, L.P.
      (previously filed as and incorporated by reference to Exhibit 10.1 to the
      Registrant’s General Form for Registration of Securities on Form 10, filed
      on April 30, 2003)10.2
                
                Certificate
      of Formation of Hartman REIT Operating Partnership II GP, LLC (previously
      filed as and incorporated by reference to Exhibit 10.3 to the Registrant’s
      General Form for Registration of Securities on Form 10, filed on April 30,
      2003)10.3
                
                Limited
      Liability Company Agreement of Hartman REIT Operating Partnership II GP,
      LLC (previously filed as and incorporated by reference to Exhibit 10.4 to
      the Registrant’s General Form for Registration of Securities on Form 10,
      filed on April 30, 2003)10.4
                
                Agreement
      of Limited Partnership of Hartman REIT Operating Partnership II, L.P.
      (previously filed as and incorporated by reference to Exhibit 10.6 to the
      Registrant’s General Form for Registration of Securities on Form 10, filed
      on April 30, 2003)10.5
                
                Loan
      Agreement between Hartman REIT Operating Partnership, L.P. and Union
      Planter’s Bank, N.A., dated June 30, 2003 (previously filed as and
      incorporated by reference to Exhibit 10.10 to Amendment No. 2 to the
      Registrant’s General Form for Registration of Securities on Form 10, filed
      on August 6, 2003)10.6+
                
                Summary
      Description of Whitestone REIT Trustee Compensation Arrangements
      (previously filed and incorporated by reference to Exhibit 10.11 of the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2004, filed on March 31, 2005)10.7
                
                Form
      of Agreement and Plan of Merger and Reorganization (previously filed as
      and incorporated by reference to the Registrant’s Proxy Statement, filed
      on April 29, 2004)10.8
                
                Escrow
      Agreement (previously filed as and incorporated by reference to Exhibit
      10.14 to the Registrant’s Annual Report on Form 10-K for the year ended
      December 31, 2004, filed on March 31,
2005)









Whitestone
REIT and Subsidiary




Index
to Exhibits


Exhibit
      No.
              
              Description10.9
              
              Form
      of Amendment to the Agreement of Limited Partnership of Hartman REIT
      Operating Partnership, L.P. (previously filed in and incorporated by
      reference to Exhibit 10.1 to the Registrant’s Registration Statement on
      Form S-11, Commission File No. 333-111674, filed on December 31,
      2003)10.10
              
              Revolving
      Credit Agreement among Hartman REIT Operating Partnership, L.P., Hartman
      REIT Operating Partnership III LP, and KeyBank National Association
      (together with other participating lenders), dated March 11, 2005
      (previously filed as and incorporated by reference to Exhibit 10.13 to
      Post-Effective Amendment No. 1 to the Registrant’s Registration Statement
      on Form S-11, Commission File No. 333-111674, filed on June 17,
      2005)10.11
              
              Form
      of Revolving Credit Note under Revolving Credit Agreement among Hartman
      REIT Operating Partnership, L.P., Hartman REIT Operating Partnership III
      LP, and KeyBank National Association (together with other participating
      lenders) (previously filed as and incorporated by reference to Exhibit
      10.14 to Post-Effective Amendment No. 1 to the Registrant’s Registration
      Statement on Form S-11, Commission File No. 333-111674, filed on June 17,
      2005)10.12
              
              Guaranty
      under Revolving Credit Agreement among Hartman REIT Operating Partnership,
      L.P., Hartman REIT Operating Partnership III LP, and KeyBank National
      Association (together with other participating lenders), dated March 11,
      2005 (previously filed as and incorporated by reference to Exhibit 10.15
      to Post-Effective Amendment No. 1 to the Registrant’s Registration
      Statement on Form S-11, Commission File No. 333-111674, filed on June 17,
      2005)10.13
              
              Form
      of Negative Pledge Agreement under Revolving Credit Agreement among
      Hartman REIT Operating Partnership, L.P., Hartman REIT Operating
      Partnership III LP, and KeyBank National Association (together with other
      participating lenders) (previously filed as and incorporated by reference
      to Exhibit 10.16 to Post-Effective Amendment No. 1 to the Registrant’s
      Registration Statement on Form S-11, Commission File No. 333-111674, filed
      on June 17, 2005)10.14
              
              Form
      of Collateral Assignment of Partnership Interests under Revolving Credit
      Agreement among Hartman REIT Operating Partnership, L.P., Hartman REIT
      Operating Partnership III LP, and KeyBank National Association (together
      with other participating lenders) (previously filed as and incorporated by
      reference to Exhibit 10.17 to Post-Effective Amendment No. 1 to the
      Registrant’s Registration Statement on Form S-11, Commission File No.
      333-111674, filed on June 17, 2005)10.15
              
              Waiver
      and Amendment No. 1 between Hartman REIT Operating Partnership, L.P.,
      Hartman REIT Operating Partnership III, L.P., and KeyBank National
      Association, as agent for the consortium of lenders, dated May 8, 2006
      (previously filed and incorporated by reference to Exhibit 10.23 to the
      Registrant’s Quarterly Report on Form 10-Q, filed on May 12,
      2006)10.16
              
              Amendment
      No. 2 between Hartman REIT Operating Partnership, L.P., Hartman REIT
      Operating Partnership III, L.P., and KeyBank National Association, as
      agent for the consortium of lenders, dated May 19, 2006 (previously filed
      and incorporated by reference to Exhibit 10.24 to the Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2006, filed on March
      30, 2007)10.17
              
              Promissory
      Note between HCP REIT Operating Company IV LLC and MidFirst Bank, dated
      March 1, 2007 (previously filed and incorporated by reference to Exhibit
      10.25 to the Registrant’s Annual Report on Form 10-K for the year ended
      December 31, 2006, filed on March 30,
2007)









Whitestone
REIT and Subsidiary




Index
to Exhibits


Exhibit
      No.
                  
                  Description10.18
                  
                  Amendment
      No. 3 between Hartman REIT Operating Partnership, L.P., Hartman REIT
      Operating Partnership III, L.P., and KeyBank National Association, as
      agent for the consortium of lenders, dated March 26, 2007 (previously
      filed and incorporated by reference to Exhibit 10.26 to the Registrant’s
      Annual Report on Form 10-K for the year ended December 31, 2006, filed on
      March 30, 2007)10.19
                  
                  Amendment
      No. 5 between Hartman REIT Operating Partnership, L.P., Hartman REIT
      Operating Partnership III, L.P., and KeyBank National Association, as
      agent for the consortium of lenders, dated October 31, 2007 (previously
      filed and incorporated by reference to Exhibit 10.27 to the Registrant’s
      Quarterly Report on Form 10-Q, filed on November 14,
  2007)10.20
                  
                  Amendment
      No.6 between Whitestone REIT Operating Partnership, L.P., Whitestone REIT
      Operating Partnership III, L.P., and KeyBank National Association, as
      agent for the consortium of lenders, dated March 11, 2008 (previously
      filed as and incorporated by reference to Exhibit 10.28 to the
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2007, filed on March 31, 2008)10.21
                  
                  Term
      Loan Agreement among Whitestone REIT Operating Partnership, L.P.,
      Whitestone Pima Norte LLC, Whitestone REIT Operating Partnership III LP,
      Hartman REIT Operating Partnership III LP LTD, Whitestone REIT Operating
      Partnership III GP LLC and KeyBank National Association, dated January 25,
      2008 (previously filed as and incorporated by reference to Exhibit 10.29
      to the Registrant’s Annual Report on Form 10-K for the year ended December
      31, 2007, filed on March 31, 2008)10.22
                  
                  Settlement
      Agreement between Whitestone and Hartman dated May 30, 2008 (previously
      filed and incorporated by reference to Exhibit 99.2 to the Registrant’s
      Current Report on Form 8-K, filed May 30, 2008)10.23
                  
                  Mutual
      Release between Whitestone and Hartman dated May 30, 2008 (previously
      filed and incorporated by reference to Exhibit 99.2 to the Registrant’s
      Current Report on Form 8-K, filed May 30, 2008)10.24+
                  
                  Whitestone
      REIT 2008 Long-Term Equity Incentive Ownership Plan (previously filed and
      incorporated by reference to Exhibit 10.1 to the Registrant’s Current
      Report on Form 8-K, filed July 31, 2008)10.25
                  
                  Promissory
      Note among Whitestone Corporate Park West, LLC and MidFirst Bank dated
      August 5, 2008 (previously filed and incorporated by reference to Exhibit
      99.1 to the Registrant’s Current Report on Form 8-K, filed August 8,
      2008)10.26
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.1 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)10.27
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.2 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)10.28
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.3 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)












Whitestone
REIT and Subsidiary




Index
to Exhibits


Exhibit
      No.
                  
                  Description10.29
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.4 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)10.30
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.5 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)10.31
                  
                  Promissory
      Note among Whitestone Offices LLC and Nationwide Life Insurance Company
      dated October 1, 2008 (previously filed and incorporated by reference to
      Exhibit 99.6 to the Registrant’s Current Report on Form 8-K, filed October
      7, 2008)10.32
                  
                  Extension
      of Revolving Credit Agreement among Whitestone REIT Operating Partnership,
      L.P., Whitestone REIT Operating Partnership III, L.P., and KeyBank
      National Association (together with other participating lenders), dated
      October 1, 2008 (previously filed and incorporated by reference to Exhibit
      99.7 to the Registrant’s Current Report on Form 8-K, filed October 7,
      2008)10.33
                  
                  Promissory
      Note among Whitestone Industrial-Office LLC and Jackson Life Insurance
      Company dated October 3, 2008 (previously filed and incorporated by
      reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K,
      filed October 9, 2008)10.34+
                  
                  Form
      of Restricted Common Share Award Agreement (Performance Vested)
      (previously filed and incorporated by reference to Exhibit 10.1 to the
      Registrant’s Current Report on Form 8-K, filed January 7,
      2009)10.35+
                  
                  Form
      of Restricted Common Share Award Agreement (Time Vested) (previously filed
      and incorporated by reference to Exhibit 10.2 to the Registrant’s Current
      Report on Form 8-K, filed January 7, 2009)10.36+
                  
                  Form
      of Restricted Unit Award Agreement (previously filed and incorporated by
      reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K,
      filed January 7, 2009)10.37
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated February 3, 2009 (previously filed and incorporated by reference to
      Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed
      February 10, 2009)10.38
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated February 3, 2009 (previously filed and incorporated by reference to
      Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed
      February 10, 2009)10.39
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated February 3, 2009 (previously filed and incorporated by reference to
      Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed
      February 10, 2009)10.40
                  
                  Promissory
      Note among Whitestone Centers LLC and Sun Life Assurance Company of Canada
      dated February 3, 2009 (previously filed and incorporated by reference to
      Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed
      February 10,
2009)









Whitestone
REIT and Subsidiary




Index
to Exhibits


Exhibit
      No.
                  
                  Description14.1
                  
                  Code
      of Business Conduct and Ethics effective May 14, 2007 (previously filed
      and incorporated by reference to Exhibit 14.1 to the Registrant’s
      Quarterly Report on Form 10-Q, filed on November 14,
  2007)21.1*
                  
                  List
      of subsidiaries of Whitestone REIT23.1*
                  
                  Consent
      of Pannel Kerr Forster of Texas, P.C.24.1
                  
                  Power
      of Attorney (included on the Signatures page hereto)31.1*
                  
                  Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2*
                  
                  Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1*
                  
                  Certificate
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 200232.2*
                  
                  Certificate
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002







*
                    Filed
      herewith.+
                    Denotes
      management contract or compensatory plan or
  arrangement.