HIGHLANDS REIT: Management Report and Analysis of Financial Condition and Results of Operations (Form 10-K)


References to "Highlands," "the Company," "we" or "us" are to Highlands REIT,
Inc., as well as all of Highlands' wholly-owned and consolidated subsidiaries.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with "Part I-Item 1A. Risk Factors,"
"Part I-Item 1. Business," "Part I-Item 2. Properties" and the historical
consolidated financial statements, and related notes included elsewhere in this
Annual Report. The following discussion and analysis contains forward-looking
statements based upon our current expectations, estimates and assumptions that
involve risks and uncertainties. Our actual results could differ materially from
those discussed in these forward-looking statements due to a variety of risks,
uncertainties and other factors, including but not limited to, factors discussed
in "Part I-Item 1A. Risk Factors" and "Disclosure Regarding Forward-Looking
Statements." The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and accompanying notes,
which appear elsewhere in this Annual Report on Form 10-K.
Overview
We are a self-advised and self-administered real estate investment trust
("REIT") created to own and manage substantially all of the "non-core" assets
previously owned and managed by our former parent, InvenTrust Properties Corp.,
a Maryland corporation ("InvenTrust"). On April 28, 2016, we were spun-off from
InvenTrust through a pro rata distribution (the "Distribution") by InvenTrust of
100% of the outstanding shares of our common stock to holders of InvenTrust's
common stock. Prior to or concurrent with the separation, we and InvenTrust
engaged in certain reorganization transactions that were designed to consolidate
substantially all of InvenTrust's remaining "non-core" assets in Highlands.
This portfolio of "non-core" assets, which were acquired by InvenTrust between
2005 and 2008, included assets that are special use, single-tenant or
build-to-suit; face unresolved legal issues; are in undesirable locations or in
weak markets or submarkets; are aging or functionally obsolete; and/or have
sub-optimal leasing metrics. A number of our assets are retail properties
located in tertiary markets, which are particularly susceptible to the negative
trends affecting retail real estate, including the severe effects of the
COVID-19 pandemic. As a result of these characteristics, such assets are
difficult to lease, finance and refinance and are relatively illiquid compared
to other types of real estate assets. These factors also significantly limit our
asset disposition options, impact the timing of such dispositions and restrict
the viable options available to the Company for a future potential liquidity
option.
Our strategy is focused on preserving, protecting and maximizing the total value
of our portfolio with the long-term objective of providing stockholders with a
return of their investment. We engage in rigorous asset management, and seek to
sustain and enhance our portfolio, and improve the quality and income-producing
ability of our portfolio, by engaging in selective dispositions, acquisitions,
capital expenditures, financing, refinancing and enhanced leasing. We are also
focused on cost containment efforts across our portfolio, improving our overall
capital structure and making select investments in our existing "non-core"
assets to maximize their value. To the extent we are able to generate cash flows
from operations or dispositions of assets, in addition to the cash uses outlined
above, our board of directors has determined that it is in the best interests of
the Company to seek to reinvest in assets that are more likely to generate more
reliable and stable cash flows, such as multi-family assets, as part of the
Company's overall strategy to optimize the value of the portfolio, enhance our
options for a future potential liquidity option and maximize shareholder value.
Given the nature and quality of the "non-core" assets in our portfolio as well
as current market conditions, a definitive timeline for execution of our
strategy cannot be made. The impact of the COVID-19 pandemic on our business has
disrupted our efforts to implement a liquidity option and, although we cannot
predict when circumstances will improve, we will continue to evaluate options to
implement a liquidity option during 2022. However, we may be unable to execute
on such a transaction on terms we would find attractive for our stockholders and
our ability to do so will be influenced by external and macroeconomic factors,
including, among others, the effects and duration of the COVID-19 pandemic and
future resurgences, the timing and nature of recovery of the COVID-19 pandemic,
interest rate movements, local, regional, national and global economic
performance, government policy changes and competitive factors.
As of December 31, 2020, our portfolio of assets consisted of one office asset,
two industrial assets, four retail assets, twelve multi-family assets, one
correctional facility and one parcel of unimproved land. We currently have four
business segments, consisting of (i) net lease, (ii) retail, (iii) multi-tenant
office and (iv) multi-family. Our unimproved land asset is presented in "other."
We may have additional or fewer segments in the future to the extent we enter
into additional real property sectors, dispose of property sectors, or change
the character of our assets. For the complete presentation of our reportable
segments, see Note 11 to our consolidated financial statements for the years
ended December 31, 2020 and 2019.
Basis of Presentation

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The accompanying consolidated financial statements reflect the accounts of
Highlands and its consolidated subsidiaries (collectively, the "Company").
Highlands consolidates its wholly-owned subsidiaries and any other entities
which it controls (i) through voting rights or similar rights or (ii) by means
other than voting rights if Highlands is the primary beneficiary of a variable
interest entity ("VIE"). The portions of the equity and net income of
consolidated subsidiaries that are not attributable to the Company are presented
separately as amounts attributable to non-controlling interests in our
consolidated financial statements. Entities which Highlands does not control and
entities which are VIEs in which Highlands is not a primary beneficiary, if any,
are accounted for under appropriate GAAP. Highlands' subsidiaries generally
consist of limited liability companies. The effects of all significant
intercompany transactions have been eliminated.
Our Revenues and Expenses
Revenues
Our revenues are primarily derived from rental income and expense recoveries we
receive from our tenants under leases with us, including monthly rent and other
property income pursuant to tenant leases. Tenant recovery income primarily
consists of reimbursements for real estate taxes, common area maintenance costs,
management fees and insurance costs.
Expenses
Our expenses consist of property operating expenses, real estate taxes,
depreciation and amortization expense, general and administrative expenses and
provision for asset impairment. Property operating expenses primarily consist of
repair and maintenance, management fees, utilities and insurance (in each case,
some of which are recoverable from the tenant).
Key Indicators of Operating Performance
In evaluating our financial condition and operating performance, management
focuses on the following financial and non-financial indicators, discussed in
further detail herein:
•Cash flow from operations as determined in accordance with GAAP;
•Economic and physical occupancy and rental rates;
•Leasing activity and lease rollover;
•Management of operating expenses;
•Management of general and administrative expenses;
•Debt maturities and leverage ratios;
•Liquidity levels;
•Funds From Operations ("FFO"), a supplemental non-GAAP measure; and
•Adjusted Funds From Operations ("AFFO"), a supplemental non-GAAP measure.
Impact of COVID-19
The following discussion is intended to provide certain information regarding
the impacts of the COVID-19 pandemic on our business and our efforts to respond
to those impacts. The COVID-19 pandemic, the significant and wide-ranging
responses of international, federal, state and local public health and
governmental authorities in regions across the United States and the world to
the COVID-19 pandemic, and the volatile economic, business and financial market
conditions resulting therefrom, have negatively impacted our business, financial
condition and results of operations and we anticipate that such factors will
continue to negatively impact our business, financial condition and results of
operations during 2021 and in future periods.
Unless otherwise specified, the information set forth below regarding the
Company's portfolio and tenants is based on estimates and other data available
to the Company as of December 31, 2020. As a result of the high degree of
uncertainty surrounding the ongoing COVID-19 pandemic and its impact on our
business, we expect that such information will change,

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potentially significantly, going forward and may not be indicative of the actual
impact of the COVID-19 pandemic on our business, financial condition and results
of operations for 2021 and future periods.
During the year ended December 31, 2020, we received rent relief requests from
certain tenants at our retail properties, most often in the form of rent
deferral and abatement requests. We have evaluated each tenant relief request on
an individual basis and granted deferrals in the aggregate of approximately $0.3
million to nine of our tenants. In exchange, such tenants agreed to various
repayment periods, ranging from three and 24 months. As of December 31, 2020,
approximately $0.1 million had been repaid and approximately $0.2 million is
expected to be repaid during 2021. The remaining $0.1 million is due from
tenants who have either not yet reopened since the beginning of the pandemic,
have permanently gone out of business or who filed for bankruptcy and collection
of theses outstanding amounts is unlikely. In accordance with the terms set
forth in the document issued by FASB on April 10, 2020, titled "Staff Q&A, Topic
842 and Topic 840: Accounting for Lease Concessions Related to the Effects of
the COVID-19 pandemic," we have accounted for the concessions as if no changes
to the lease contract were made. Under that accounting, we increased our lease
receivable as receivables accrued in our statements of operations and recognized
rental income during the deferral period. In connection with these lease
receivables, we increased our allowance for bad debt by approximately $0.3
million during the year ended December 31, 2020, which includes amounts where
deferral agreements had previously been entered into, for receivables where
collection was determined not probable.
Additionally, during the year ended December 31, 2020, we granted abatements in
the aggregate of approximately $0.8 million, to ten tenants, the largest of
which is LA Fitness at the Sherman Plaza property which accounted for $0.5
million of the total abatement amount for that period. We reviewed each lease
agreement in connection with the abatement to determine whether such abatement,
including any lease extension related thereto, qualified as a "lease
modification" under the applicable lease agreement, and, after determining that
two such abatements constituted "lease modifications" under the respective lease
agreement, we accounted for each abatement as such.
Our multi-family portfolio was also impacted by the pandemic. While our
multi-family portfolio experienced higher collection rates than on our retail
portfolio, we had a decrease in occupancy during the year ended December 31,
2020, which resulted in decreased rental income for that period. In some
circumstances, we granted deferrals to residents who were impacted by the
pandemic and offered payment plans for repayment in three to six months. Many
state and local municipalities have placed a moratorium on evictions and
housing-related litigation limiting the actions we can take with respect to
residents who are not making their rental payments, some of which have been
extended into 2021. In addition to the decreased rental income, our bad debt
expense increased as a result of reserves recorded on balances that were
outstanding for residents impacted by the pandemic.
We may receive additional rent deferral or abatement requests, or requests to
modify existing lease agreements, as a result of the COVID-19 pandemic and
recovery related thereto. We will evaluate each tenant rent relief request on an
individual basis and consider a number of factors in determining whether to
grant such request. Additionally, as tenants that have been granted some form of
rent relief enter into their rent repayment periods, such tenants may be unable
to pay the outstanding monthly rent payments, and, as a result, we may see a
further increase in our bad debt. Our 2020 rent collections may not be
indicative of collections in any future period and may be influenced by factors
such as (i) whether tenants have received loans pursuant to the Coronavirus Aid,
Relief, and Economic Security Act (the "CARES Act"), (ii) whether "stay-at-home"
orders have been eased, and (iii) whether we have granted rent assistance
requests.
As previously reported, some of the tenants at our retail properties (including
Market at Hilliard, State Street and Buckhorn Plaza) failed to make the payments
due under their leases. As a result, we did not pay the monthly payments due
under the mortgages encumbering these properties beginning in April 2020. As of
December 31, 2020, the Company has made the required monthly payments on the
State Street, Buckhorn Plaza and Market at Hilliard mortgages to bring the loans
current through the December 2020 payment date. We intend to continue to make
all monthly mortgage payments when due for each of the Market at Hilliard,
Buckhorn Plaza and State Street properties, but our ability and willingness to
make payments under these mortgages may change if some or all of the tenants at
these properties fail to make their monthly rental payments.
The loan documents governing the mortgage encumbering the State Street property
include a "cash trap" provision that is triggered if DICK'S Sporting Goods,
which is an anchor tenant at the State Street property, fails to renew its lease
agreement. During September 2020, we were informed that DICK'S Sporting Goods
would not renew its lease at the State Street property. As a result, we received
notice that the lender under the State Street mortgage exercised its right to
trigger this "cash trap" provision, and, during the fourth quarter of 2020, all
of the cash flows from the State Street property which would otherwise have been
available for our use was trapped into a blocked account controlled by the
lender pending approval of a substitute lease. If, during that period, the terms
of the loan agreement are not satisfied, those funds will be swept by the lender
in mandatory prepayment of the mortgage.


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On November 6, 2020, the Company entered into the Third Amendment to the Credit
Agreement, pursuant to which the Company "right-sized" the Credit Agreement by
eliminating the Term Loan (as defined in the Third Amendment) previously
available under the Credit Agreement. In connection with the execution of the
Third Amendment, the Company borrowed sufficient funds under the Revolving
Credit Loan (as defined in the Third Amendment) to repay all of its obligations
under the Term Loan. Additionally, pursuant to the Third Amendment, the lender
under the Credit Agreement waived the Company's obligation to comply with
certain financial covenants for the period from July 1, 2020 to December 31,
2020 (the "Waiver Period") and restricted the Company from drawing on the
Revolving Credit Loan in amounts in excess of $20.0 million until the Company is
in compliance with all such covenants. See also Note 8 (Debt) in the
accompanying consolidated financial statements for additional discussion.
The largest anchor tenant at our State Street property, Burlington Coat Factory,
suffered property damage in May 2020 as a result of recent civil unrest. This
tenant occupies approximately 72,600 square feet (37.5%) of the total gross
leasable area at State Street and reopened for business on September 14, 2020.
We have taken a number of proactive measures to maintain the strength of our
business and manage the impact of the COVID-19 pandemic on our business,
operations and liquidity, including adapting our operations to protect
employees, implementing a work-from-home policy and cancelling most corporate
travel. We believe the remote-work technology we have provided to our workforce
has enabled a smooth transition to working from home with minimal impact to our
operations. The health and safety of our employees and their families remains a
top priority for us.
We also maintain frequent communication with our tenants, and we are assisting
them in identifying state and federal resources that may be available to support
their businesses and employees during the pandemic.
Further discussion of the potential risks facing our business from the COVID-19
pandemic is provided under "Part I - Item 1A. Risk Factors."
Acquisition and Disposition Activity
During the year ended December 31, 2020, we continued to invest in multi-family
assets with the following acquisition of properties:
                                                                                (in thousands)
     Property          Location                   Acquisition Date           Acquisition Price
     The Sterling      San Diego, California      April 22, 2020          $            7,372

During the year ended December 31, 2020, we continued to implement our strategy of disposing of legacy “non-core” assets by selling the following asset:

                                                                                                                         (in thousands)
                                                                                                  Gross Disposition       Sale Proceeds,
Property                     Location                               Disposition Date              Price                   Net                  Gain on Sale
Citizens                     Providence, Rhode Island               March 31, 2020                $        1,425          $     1,287          $         82

Operating results Comparison of closed years December 31, 2020 and the 2019 key performance indicators are as follows:

                               As of December 31,
                               2020           2019
Economic occupancy (a)          72.8  %       87.4  %
Rent per square foot (b)   $   14.54       $ 17.56



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(a) Economic occupancy is defined as the percentage of total gross leasable area
for which a tenant is obligated to pay rent under the terms of its lease
agreement, regardless of the actual use or occupation by the tenant of the area
being leased. Actual use may be less than economic square footage.
(b) Rent per square foot is computed as annualized base rent divided by the
total occupied square footage at the end of the period. Annualized rent is
computed as revenue for the last month of the period multiplied by twelve
months. Annualized rent includes the effect of rent abatements, lease
inducements and straight-line rent GAAP adjustments.
The decrease in occupancy and rent per square foot in 2020 is primarily due to
the termination of the lease with The GEO Group, Inc. ("GEO") at our
correctional facility. See also Note 6 in the consolidated financial statements
for additional discussion.
Consolidated Results of Operations
                                                (in thousands)
                                        For the Year ended December 31,
                           2020              2019               Increase/(Decrease)
Net (loss) income   $    (33,659)          $ 4,814      $          (38,473)       (799.2) %


Net loss during the year ended December 31, 2020 was $33.7 million compared to
net income of $4.8 million during the year ended December 31, 2019. Factors
contributing to the net loss include the provision for asset impairment related
to the correctional facility, termination of the lease with GEO, a reduction in
gain on sale of investment properties, impact of rent concessions related to the
COVID-19 pandemic at the retail properties, termination of the Alta lease at the
Trimble office asset and a reduction in interest income. These impacts were
partially offset by income from operations related to the multi-family asset
acquisitions.
Operating Income and Expenses
                                                                                      (in thousands)
                                                                              For the Year ended December 31,
                                                         2020                   2019                      Increase/(Decrease)
Property income:
Rental income                                     $    27,230               $  36,626          $           (9,396)               (25.7) %
Other property income                                   1,712                     727                         985                135.5  %
                                                       28,942                  37,353                      (8,411)               (22.5) %

Operating expenses:
Property operating expenses                             8,702                   7,489                       1,213                 16.2  %
Real estate taxes                                       6,029                   5,691                         338                  5.9  %
Depreciation and amortization                          12,774                  13,014                        (240)                (1.8) %
General and administrative expenses                    14,131                  12,907                       1,224                  9.5  %
Provision for asset impairment                         16,804                       -                      16,804                    -  %
Gain on sale of investment properties                      82                   8,841                      (8,759)               (99.1) %


Property Income and Operating Expenses
Rental income consists of monthly rent, straight-line rent adjustments, tenant
recovery income and amortization of acquired above and below market leases
pursuant to tenant leases. Tenant recovery income consists of reimbursements for
real estate taxes, common area maintenance costs, management fees, and insurance
costs. Other property income consists of lease termination fees and other
miscellaneous property income. Property operating expenses consist of regular
repair and maintenance, management fees, utilities, and insurance (in each case,
some of which are recoverable from the tenant).
Total revenues decreased by $8.4 million in the year ended December 31,
2020 compared to the same period in 2019 as a result of termination of the lease
with GEO, disposition of Lincoln Mall in June, 2019, termination of the Alta

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lease at the Trimble office asset, rent concessions and lease terminations
related to the retail assets, partially offset by income from the acquisition of
multi-family assets.
Property operating expenses increased by $1.2 million in the year ended
December 31, 2020 compared to the same period in 2019 primarily as a result of
the acquisition of multi-family assets, termination of the lease with GEO and an
increase in bad debt expense related to the retail properties where, in the
opinion of management, collection of substantially all lease payments is not
probable.
Real estate taxes increased $0.3 million for the year ended December 31, 2020
compared to the same period in 2019 related to the multi-family asset
acquisitions and the GEO lease, partially offset by the disposition of Lincoln
Mall.
Depreciation and Amortization
Depreciation and amortization decreased by $0.2 million for the year ended
December 31, 2020 compared to the same period in 2019 primarily as a result of
the write-off of lease related assets at one of the office assets and
disposition of Lincoln Mall during 2019, partially offset by the acquisition of
multi-family assets.
General Administrative Expenses
General and administrative expenses increased by $1.2 million, or 9.5%, for the
year ended December 31, 2020, due to severance related expenses incurred upon
the departure of one of our executive officers.
Provision for Asset Impairment
For the year ended December 31, 2020, we identified a reduction in fair market
value related to the correctional facility and recorded an impairment of
investment properties of $16.8 million. No such impairments were recorded during
the year ended December 31, 2019.
Gain on Sale of Investment Properties
During the year ended December 31, 2020, the gain on sale of investment
properties was $0.1 million, which was attributed to Highlands' sale of the bank
branch asset.
During the year ended December 31, 2019, the gain on sale of investment
properties was $8.8 million, which was attributed to Highlands' sale of Lincoln
Mall and the RDU land parcel.
Non-Operating Income and Expenses
                                                                                (in thousands)
                                                                       For the Year ended December 31,
                                                  2020                2019                        Increase/(Decrease)
Non-operating income and expenses:
Interest income                              $       242          $    1,650          $           (1,408)                (85.3) %
Interest expense                                  (4,485)             (3,929)                        556                  14.2  %


Interest Income
Interest income decreased by $1.4 million during the year ended December 31,
2020 compared to the same period in 2019 as a result of a decrease in average
cash balances during 2020 compared to 2019, as well as a decrease in interest
rates during 2020.
Interest Expense
Interest expense increased by $0.6 million to $4.5 million for the year ended
December 31, 2020 from $3.9 million for the year ended December 31, 2019
primarily attributable to borrowings related to one multi-family asset
acquisition, The Locale, during the third quarter of 2019, write-off of loan
fees related to the Credit Agreement and the mortgage encumbered by State
Street, one of the retail assets. See also Note 8, to the consolidated financial
statements for additional discussion.

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Leasing Activity
Our primary source of funding for our property-level operating activities and
debt payments is rent collected pursuant to our tenant leases. The following
table represents lease expirations, excluding multi-family leases, as of
December 31, 2020:

                                                                                                       Annualized
                                                             Gross Leasable Area (GLA) of                Rent of                                                       Percent of Total                  Expiring
                                    Number of                       Expiring Leases                  Expiring Leases               Percent of Total                       Annualized                   Rent/Square
Lease Expiration Year            Expiring Leases                       (Sq. Ft.)                     (in thousands)                       GLA                                Rent                          Foot
2021                                        3                             81,072                   $            787                                 8.0  %                              7.5  %       $        9.70
2022                                        7                            161,633                              2,341                                15.9  %                             22.4  %               14.49
2023                                        3                              9,337                                119                                 0.9  %                              1.1  %               12.70
2024                                        5                             48,148                                775                                 4.7  %                              7.4  %               16.10
2025                                       14                             84,250                              1,231                                 8.3  %                             11.8  %               14.61
2026                                        4                             20,191                                397                                 2.0  %                              3.8  %               19.68
2027                                        5                            502,632                              2,435                                49.5  %                             23.3  %                4.84
2028                                        7                             46,419                                819                                 4.6  %                              7.8  %               17.64
2029                                        3                             26,542                                308                                 2.6  %                              2.9  %               11.60
2030                                        1                              2,790                                  -                                 0.3  %                                -  %                   -
Month to Month                              1                              2,875                                 42                                 0.3  %                              0.4  %               14.61
Thereafter                                  1                             29,333                              1,189                                 2.9  %                             11.6  %               40.54
                                           54                          1,015,222                   $         10,443                               100.0  %                            100.0  %       $       10.29

The following table represents new and renewed leases that began (excluding multi-family leases) during the year ended. December 31, 2020.

                                                                            Weighted
                               Gross Leasable             Rent              Average
             # of Leases            Area            per square foot        Lease Term
New                3               6,986           $          25.80          7.85
Renewals          11              66,100           $          14.75          5.28
Total             14              73,086           $          15.81          5.53


During the year ended December 31, 2020, 14 new leases and renewals commenced
with gross leasable area totaling 73,086 square feet. The weighted average lease
term for new and renewal leases was 7.85 and 5.28 years, respectively.
As of December 31, 2019, 13 new leases and renewals commenced with gross
leasable area totaling 115,990 square feet. The weighted average lease term for
new and renewal leases was 7.44 and 4.19 years, respectively.
Critical Accounting Policies and Estimates
Revenue Recognition
The Company commences revenue recognition on our leases based on a number of
factors. In most cases, revenue recognition under a lease begins when the lessee
takes possession of, or controls, the physical use of the leased asset.
Generally, this occurs on the lease commencement date. The determination of who
is the owner, for accounting purposes, of the tenant improvements determines the
nature of the leased asset and when revenue recognition under a lease begins. If
we are the owner, for accounting purposes, of the tenant improvements, then the
leased asset is the finished space and revenue recognition begins when the
lessee takes possession of the finished space, typically when the improvements
are substantially complete. If we conclude we are not the owner, for accounting
purposes, of the tenant improvements (the lessee is the owner), then the leased
asset is the unimproved space and any tenant improvement allowances funded under
the lease are treated as lease incentives which reduces revenue recognized over
the term of the lease. In these circumstances, we begin revenue recognition when
the lessee takes possession of the unimproved space for the lessee to construct
their own improvements. We consider a number of different factors to evaluate
whether it or the lessee is the owner of the tenant improvements for accounting
purposes. These factors include:

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•whether the lease stipulates how and on what a tenant improvement allowance may
be spent;
•whether the tenant or landlord retains legal title to the improvements;
•the uniqueness of the improvements;
•the expected economic life of the tenant improvements relative to the length of
the lease; and
•who constructs or directs the construction of the improvements.
The determination of who owns the tenant improvements, for accounting purposes,
is subject to significant judgment. In making that determination, we consider
all of the above factors. No one factor, however, necessarily establishes its
determination.
Rental income is recognized on a straight-line basis over the term of each
lease. The difference between rental income earned on a straight-line basis and
the cash rent due under the provisions of the lease agreements is recorded as
deferred rent receivable and is included as a component of accounts and rents
receivable in the accompanying consolidated balance sheets.
Rental income related receivables, which include contractual amounts accrued and
unpaid from tenants and accrued straight-line rents receivable, are reduced for
credit losses. Such amounts are recognized as a reduction to real estate rental
revenues. The Financial Accounting Standards Board ("FASB") clarified in July
2019 that, under ASC 842, lessors can continue to recognize a reserve (i.e.,
allowance for uncollectible operating lease receivables) under the loss
contingency guidance in ASC 450-20 after applying the collectibility guidance in
ASC 842. We evaluate the collectability of lease receivables monthly using
several factors including a lessee's creditworthiness. We recognize the credit
loss on lease related receivables when, in the opinion of management, collection
of substantially all lease payments is not probable. When collectability is
determined not probable, any lease income subsequent to recognizing the credit
loss is limited to the lesser of the lease income reflected on a straight-line
basis or cash collected. The adoption of ASU 2016-02 resulted in an adjustment
of $92 to rental income and property operating expenses, associated with lease
related receivables where collection of substantially all operating lease
payments is not probable during the year ended December 31, 2019.
The Company records lease termination income if there is a signed termination
agreement, all of the conditions of the agreement have been met and amounts due
are considered collectible.
Real Estate
  We allocate the purchase price of real estate to land, building, other
building improvements, tenant improvements, and intangible assets and
liabilities (such as the value of above- and below-market leases, in-place
leases and origination costs associated with in-place leases). The values of
above- and below-market leases are recorded as intangible assets, net, and
intangible liabilities, net, respectively, in the consolidated balance sheets,
and are amortized as either a decrease (in the case of above-market leases) or
an increase (in the case of below-market leases) to rental income over the
remaining term of the associated tenant lease. The values associated with
in-place leases are recorded in intangible assets, net in the consolidated
balance sheets and are amortized to depreciation and amortization expense in the
consolidated statements of operations and comprehensive income over the
remaining lease term.
  The difference between the contractual rental rates and our estimate of market
rental rates is measured over a period equal to the remaining non-cancelable
term of the leases, including below-market renewal options for which exercise of
the renewal option appears to be reasonably assured. The remaining term of
leases with renewal options at terms below market reflect the assumed exercise
of such below-market renewal options and assume the amortization period would
coincide with the extended lease term.
  We perform, with the assistance of a third-party certified valuation
specialist, the following procedures for properties we acquire:
•Determine the accounting of the transaction as either a business combination or
an asset acquisition;
•Estimate the value of the property "as if vacant" as of the acquisition date;
•Allocate the value of the property among land, building, and other building
improvements and determine the associated useful life for each;

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•Calculate the value and associated life of above- and below-market leases on a
tenant-by-tenant basis. The difference between the contractual rental rates and
our estimate of market rental rates is measured over a period equal to the
remaining term of the leases (using a discount rate which reflects the risks
associated with the leases acquired, including geographical location, size of
leased area, tenant profile and credit risk);
•Estimate the fair value of the tenant improvements, legal expenses and leasing
commissions incurred to obtain the leases and calculate the associated useful
life for each;
•Estimate the fair value of assumed debt, if any, and value the favorable or
unfavorable debt position acquired; and
•Estimate the intangible value of the in-place leases based on lease execution
costs of similar leases as well as lost rent payments during an assumed lease-up
period and their associated useful lives on a tenant-by-tenant basis.
  We recognize gains and losses from sales of investment properties and land in
accordance with FASB ASC 610-20, "Gains and Losses From the Derecognition of
Nonfinancial Assets." We recognize gains and losses from sales of investment
properties and land when we transfer control of a property and when it is
probable that we will collect substantially all of the related consideration.
Impairment
The Company assesses the carrying values of the respective long-lived assets,
whenever events or changes in circumstances indicate that the carrying amounts
of these assets may not be fully recoverable, such as a reduction in the
expected holding period of the asset. If it is determined that the carrying
value is not recoverable because the undiscounted cash flows do not exceed
carrying value, the Company records an impairment loss to the extent that the
carrying value exceeds fair value. The valuation and possible subsequent
impairment of investment properties is a significant estimate that can and does
change based on the Company's continuous process of analyzing each asset and
reviewing assumptions about uncertain inherent factors, as well as the economic
condition of the asset at a particular point in time.
The use of projected future cash flows and related holding period is based on
assumptions that are consistent with the estimates of future expectations and
the strategic plan the Company uses to manage its underlying business. However,
assumptions and estimates about future cash flows and capitalization rates are
complex and subjective. Changes in economic and operating conditions and the
Company's ultimate investment intent that occur subsequent to the impairment
analyses could impact these assumptions and result in future impairment charges
of the real estate assets.
Liquidity and Capital Resources
As of December 31, 2020, we had $50.2 million of cash and cash equivalents, and
$3.4 million of restricted escrows.
Our principal demands for funds have been or will be:
•to pay the operating expenses of our assets;
•to pay our general and administrative expenses;
•to pay for acquisitions;
•to pay for capital commitments;
•to pay for short-term obligations;
•to service or pay-down our debt; and
•to fund capital expenditures and leasing related costs.
Generally, our cash needs have been and will be funded from:
•cash flows from our investment assets;
•proceeds from sales of assets; and

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•proceeds from debt.
Our assets have lease maturities within the next two years that we expect to
reduce our cash flows from operations. Significant lease maturities include the
Dick's Sporting Goods and Burlington Coat Factory leases at State Street and
Fitness International at the Sherman Plaza retail assets expiring in April 2021,
August 2022 and April 2022, respectively.
We may, from time to time, repurchase our outstanding equity and/or debt
securities, if any, through cash purchases or via other transactions. Such
repurchases or transactions, if any, will depend on our liquidity requirements,
contractual restrictions, and other factors. The amounts involved may be
material.
Borrowings
The table below presents, on a consolidated basis, the principal amount,
weighted average interest rates and maturity date (by year) on our mortgage debt
and debt from our credit facility, as of December 31, 2020 (dollar amounts are
stated in thousands).

Fixed and variable rate debt maturing within the year In December

            Weighted average
                   ended December 31,                        31, 2020                   interest rate
2021                                                      $          -                                    -  %
2022                                                            28,957                                 3.35  %
2023                                                            18,282                                 3.28  % (1)
2024                                                                 -                                    -  %
2025                                                                 -                                    -  %
Thereafter                                                      36,659                                 4.38  %
Total                                                     $     83,898                                 3.78  %


(1) See Note 9 in the accompanying consolidated financial statements for
discussion of the swap agreement entered into with the mortgage loan obtained in
connection with the acquisition of The Locale. The weighted average interest
rate reflected is the strike rate.
As of December 31, 2020 and 2019, none of our mortgage debt was recourse to the
Company, although we have provided certain customary, non-recourse carve-out
guarantees in connection with obtaining mortgage loans on certain of our
properties.
Our ability to pay off our mortgages when they become due is, in part, dependent
upon our ability either to refinance the related mortgage debt or to sell the
related asset. With respect to each loan, if we are unable to refinance or sell
the related asset, or in the event that the estimated asset value is less than
the mortgage balance, we may, if appropriate, satisfy a mortgage obligation by
transferring title of the asset to the lender or permitting a lender to
foreclose.
Volatility in the capital markets could expose us to the risk of not being able
to borrow on terms and conditions acceptable to us for refinancing.
Total debt outstanding as of December 31, 2020 and 2019 was $83.9 million and
$94.9 million, respectively, and had a weighted average interest rate of 3.78%
and 4.00% per annum, respectively.

We assumed a mortgage loan in the principal amount of $11.4 million in
connection with the acquisition of The Detroit and Detroit Terraces on January
8, 2019. According to the terms of the note agreement, the contractual fixed
interest rate is 3.99% and payments are interest only through September 30,
2022. The maturity date of the mortgage loan is on August 31, 2027.
On November 6, 2020, the Company entered into the Third Amendment to the Credit
Agreement, pursuant to which the Company "right-sized" the Credit Agreement by
eliminating the Term Loan previously available under the Credit Agreement. In
connection with the execution of the Third Amendment, the Company borrowed
sufficient funds under the Revolving Credit Loan to repay all of its obligations
under the Term Loan. Additionally, pursuant to the Third Amendment, the lender
under the Revolving Credit Loan waived the Company's obligation to comply with
certain financial covenants for the Waiver Period and restricted the Company
from drawing on the Revolving Credit Loan in amounts in excess of $20.0 million
until the Company is in compliance with all such covenants.

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The Company currently expects to use borrowings under the Credit Agreement for
working capital purposes, which may include repayment of indebtedness, capital
expenditures, lease up costs, redevelopment costs, property acquisitions and
other general corporate purposes. As of December 31, 2020, we had borrowed $20.0
million under the Revolving Credit Loan.
The Company obtained a mortgage loan in the principal amount of $18.8 million in
connection with the acquisition of The Locale on August 16, 2019. We entered
into a swap agreement with respect to the loan, effective through August 31,
2023, to swap the variable interest rate to a fixed rate of
approximately 3.27% per annum. The interest rate is based on the London
Interbank Offered Rate ("LIBOR") plus the applicable spread. The effective
interest rate as of December 31, 2020, is approximately 1.90%.
In July 2017, the Financial Conduct Authority ("FCA") that regulates LIBOR
announced it intends to stop compelling banks to submit rates for the
calculation of LIBOR after 2021. As a result, the Federal Reserve Board and the
Federal Reserve Bank of New York organized the Alternative Reference Rates
Committee ("ARRC"), which identified the Secured Overnight Financing Rate
("SOFR") as its preferred alternative rate for USD LIBOR in derivatives and
other financial contracts. The Company is not able to predict when LIBOR will
cease to be available or when there will be sufficient liquidity in the SOFR
markets. Any changes adopted by the FCA or other governing bodies in the method
used for determining LIBOR may result in a sudden or prolonged increase or
decrease in reported LIBOR. If that were to occur, our interest payments could
change. In addition, uncertainty about the extent and manner of future changes
may result in interest rates and/or payments that are higher or lower than if
LIBOR were to remain available in its current form.
The Company has contracts associated with the credit facility and the mortgage
encumbered by The Locale that are indexed to LIBOR and is monitoring and
evaluating the related risks, which include interest on loans. These risks arise
in connection with transitioning contracts to an alternative rate, including any
resulting value transfer that may occur, and are likely to vary by contract. The
value of derivative instruments tied to LIBOR, as well as interest rates on our
current or future indebtedness, may also be impacted if LIBOR is limited or
discontinued. For some instruments the method of transitioning to an alternative
reference rate may be challenging, especially if we cannot agree with the
respective counterparty about how to make the transition.
While we expect LIBOR to be available in substantially its current form until at
least the end of 2021, it is possible that LIBOR will become unavailable prior
to that point. This could result, for example, if sufficient banks decline to
make submissions to the LIBOR administrator. In that case, the risks associated
with the transition to an alternative reference rate will be accelerated and
magnified.
Alternative rates and other market changes related to the replacement of LIBOR,
including the introduction of financial products and changes in market
practices, may lead to risk modeling and valuation challenges, such as adjusting
interest rate accrual calculations and building a term structure for an
alternative rate.
The introduction of an alternative rate also may create additional basis risk
and increased volatility as alternative rates are phased in and utilized in
parallel with LIBOR.
Adjustments to systems and mathematical models to properly process and account
for alternative rates will be required, which may strain the model risk
management and information technology functions and result in substantial
incremental costs for the company.
Capital Expenditures and Reserve Funds
  During the year ended December 31, 2020, we made total capital expenditures of
$2.8 million. Our total capital expenditures in 2019 was $1.0 million.
Summary of Cash Flows
Comparison of the years ended December 31, 2020 and 2019:

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                                                                               (in thousands)
                                                                      For the Year ended December 31,
                                                                         2020                    2019
Cash (used in) provided by operating activities                   $         (2,106)         $    16,809
Cash used in investing activities                                           (9,398)             (68,351)
Cash (used in) provided by financing activities                            (12,914)              45,856

Decrease in cash and cash equivalents and restricted cash and escrow

                                                                    (24,418)              (5,686)

Cash and cash equivalents and restricted and escrow cash, at the start of the year

                                                           78,055               83,741

Cash and cash equivalents and restricted and escrow cash at year end

                                                           $         

53 637 $ 78,055


Cash used in operating activities was $2.1 million for the year ended
December 31, 2020. Cash provided by operating activities was $16.8 million for
the same period in 2019. Cash used in operating activities increased by $18.9
million when comparing the year ended December 31, 2020 to the same period in
2019 primarily as a result of the GEO lease termination, which has caused cash
flows from operations to be lower year over year. Additional factors include the
impact on retail properties of the pandemic and civil unrest as well as the Alta
lease termination discussed in Note 6 to the accompanying consolidated financial
statements. There was also an increase in cash paid for interest expense during
the year ended December 31, 2020 compared to the same period last year.
Cash used in investing activities was $9.4 million for the year ended
December 31, 2020 compared to $68.4 million for the year ended December 31,
2019. Cash used in investing activities decreased $59.0 million when comparing
the year ended December 31, 2020 to the same period in 2019. During the year
ended December 31, 2020, cash was used to purchase The Sterling for $7.4
million, payments for capital expenditures of $2.8 million and payments for
leasing fees of $0.5 million. Partially offsetting cash used during the year
ended December 31, 2020 was cash provided by proceeds from the sale of
investment properties, net in the amount of $1.3 million. In the year ended
December 31, 2019, cash provided by proceeds received from the sale of Lincoln
Mall and the RDU land parcel was $53.2 million offset by cash used to purchase
multi-family assets for $119.7 million, payments for capital expenditures of
$1.0 million and payments for leasing fees of $0.8 million.
Cash used in financing activities was $12.9 million for the year ended
December 31, 2020. Cash used in financing activities for the year ended
December 31, 2020 was related to principal payments on the term loan portion of
the Credit Facility in the amount of $30.0 million, principal payments on
mortgage debt in the amount of $1.0 million, payments of tax withholding for
share-based compensation in the amount of $1.1 million, payments for common
stock repurchased for $0.6 million and payments for debt issuance costs in the
amount of $0.1 million. Partially offsetting cash used for these activities was
borrowings in the amount of $20.0 million related to the Credit Facility. Cash
provided by financing activities in the amount of $45.9 million for the year
ended December 31, 2019 was primarily related to borrowings in the amount of
$30.0 million related to the Credit Facility and borrowings related to the
acquisition of multi-family assets in the amount of $18.7 million. See also Note
8 to the consolidated financial statements for a summary of the Credit Agreement
and mortgage debt.
We consider all demand deposits, money market accounts and investments in
certificates of deposit and repurchase agreements with a maturity of three
months or less, at the date of purchase, to be cash equivalents. We maintain our
cash and cash equivalents at financial institutions. The combined account
balances at one or more institutions exceed the Federal Depository Insurance
Corporation ("FDIC") insurance coverage and, as a result, there is a
concentration of credit risk related to amounts on deposit in excess of FDIC
insurance coverage.
Funds From Operations and Adjusted Funds From Operations
The National Association of Real Estate Investment Trusts ("NAREIT"), an
industry trade group, has promulgated a non-GAAP financial measure known as
Funds From Operations, or FFO. As defined by NAREIT, FFO is net income (loss) in
accordance with GAAP excluding gains (or losses) resulting from dispositions of
properties, plus depreciation and amortization and impairment charges on
depreciable property. We have adopted the NAREIT definition in our calculation
of FFO as management considers FFO a widely accepted and appropriate measure of
performance for REITs. FFO is not equivalent to our net income or loss as
determined under GAAP.
Since the definition of FFO was promulgated by NAREIT, management and many
investors and analysts have considered the presentation of FFO alone to be
insufficient. Accordingly, in addition to FFO, we also use Adjusted Funds From
Operations, or AFFO as a measure of our operating performance. We define AFFO, a
non-GAAP financial measure, to exclude from FFO adjustments for gains or losses
related to early extinguishment of debt instruments as these items are not
related to our continuing operations. By excluding these items, management
believes that AFFO provides supplemental information

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related to sustainable operations that will be more comparable between other
reporting periods and to other public, non-traded REITs. AFFO is not equivalent
to our net income or loss as determined under GAAP.
In calculating FFO and AFFO, impairment charges of depreciable real estate
assets are added back even though the impairment charge may represent a
permanent decline in value due to decreased operating performance of the
applicable property. Further, because gains and losses from sales of property
are excluded from FFO and AFFO, it is consistent and appropriate that
impairments, which are often early recognition of losses on prospective sales of
property, also be excluded.
We believe that FFO and AFFO are useful measures of our properties' operating
performance because they exclude noncash items from GAAP net income. Neither FFO
nor AFFO is intended to be an alternative to "net income" nor to "cash flows
from operating activities" as determined by GAAP as a measure of our capacity to
pay distributions. Other REITs may use alternative methodologies for calculating
similarly titled measures, which may not be comparable to our calculation of FFO
and AFFO.
The following section presents our calculation of FFO and AFFO to net income (in
thousands):
                                                                Year Ended December 31,
                                                                   2020             2019

Net income (loss) attributable to Highlands REIT, Inc.
common shareholders

                                         $      (33,589) 

$ 4,849
Depreciation and amortization related to investment assets (a)

                                                                 12,538  

12,907

Impairment of investment properties                                 16,804              -
Gain on sale of investment properties, net                             (82) 

(8,841)

Adjusted operating funds and operating funds $ (4,329)

       $ 8,915
(a) The depreciation and amortization addback excludes the portion of expense attributable
to the non-controlling interest.


The table below reflects additional information related to certain items that
significantly impact the comparability of our FFO and AFFO and net income or
significant non-cash items from the periods presented (in thousands).We have
included this table because these items are not included in NAREIT's definition
of FFO, but we believe these items provide useful supplemental information that
may facilitate comparisons of our ongoing operating performance between periods,
as well as between REITs that include similar disclosure.
                                                              Year Ended 

the 31st of December,

                                                                  2020      

2019

Amortization of mark to market debt discounts and
financing costs                                          $         348              $ 290


Distributions
For the years ended December 31, 2020 and 2019, no cash distributions were paid
by Highlands.
Inflation
A number of our leases contain provisions designed to partially mitigate any
adverse impact of inflation. With respect to current economic conditions and
governmental fiscal policy, inflation may become a greater risk. Our commercial
leases typically require the tenant to pay its share of operating expenses,
including common area maintenance, real estate taxes and insurance. By sharing
these costs with our tenants, we may reduce our exposure to increases in costs
and operating expenses resulting from inflation. A portion of our leases also
include clauses enabling us to receive percentage rents based on a tenant's
gross sales above predetermined levels or escalation clauses which are typically
related to increases in the Consumer Price Index or similar inflation indices.
Off-Balance Sheet Arrangements
As of December 31, 2020 and 2019, we had no off-balance sheet arrangements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk

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We are subject to market risk associated with changes in interest rates both in
terms of variable-rate debt and the price of new fixed-rate debt upon maturity
of existing debt and for acquisitions.
Interest Rate Risk
Our interest rate risk management objectives are to limit the impact of interest
rate changes on earnings and cash flows and to lower our overall borrowing
costs. As of December 31, 2020, our debt included an outstanding variable-rate
revolving loan of $20.0 million and a variable rate mortgage loan of $18.8
million, which has been swapped to a fixed rate. If market rates of interest on
all variable-rate debt as of December 31, 2020, that is not under a swap
agreement, permanently increased or decreased by 1%, the annual increase or
decrease in interest expense on the variable-rate debt and future earnings and
cash flows would be approximately $0.2 million.
With regard to our variable-rate financing, we assess interest rate cash flow
risk by identifying and monitoring changes in interest rate exposures that may
adversely impact expected future cash flows and by evaluating hedging
opportunities. We maintain risk management control systems to monitor interest
rate cash flow risk attributable to both outstanding or forecasted debt
obligations.
We may use financial instruments to hedge exposures to changes in interest rates
on loans. To the extent we do, we are exposed to credit risk and market risk.
Credit risk is the risk of failure of the counterparty to perform under the
terms of the derivative contract. When the fair value of a derivative contract
is positive, the counterparty owes us, which creates a credit risk for us. When
the fair value of a derivative contract is negative, we owe the counterparty
and, therefore, it does not pose credit risk. We seek to minimize the credit
risk in derivative instruments by entering into transactions with what we
believe are high-quality counterparties. Market risk is the adverse effect on
the value of a financial instrument resulting from a change in interest rates.
In the event that LIBOR is discontinued, the interest rate for certain of our
debt instruments, including our unsecured Revolving Credit Loan due 2022 and
interest rate swap agreements that are indexed to LIBOR, will be based on a
replacement rate or an alternate base rate as specified in the applicable
documentation governing such debt or swaps or as otherwise agreed upon. Such an
event would not affect our ability to borrow or maintain already outstanding
borrowings or swaps, but the replacement rate or alternate base rate could be
higher or more volatile than LIBOR prior to its discontinuance. We understand
that LIBOR is expected to remain available through the end of 2021, but may be
discontinued or otherwise become unavailable thereafter.
Our credit facilities and interest rate swaps are indexed to USD-LIBOR. However,
as our Credit Facility and interest rate swap agreements have provisions that
allow for a transition to a new alternative rate, we believe that the transition
from USD-LIBOR to the alternative rate will not have a material impact on our
consolidated financial statements.
As of December 31, 2020, we had one derivative financial instrument designated
as a cash flow hedge, with a notional amount of $18.8 million and a maturity
date of September 1, 2023. The fair value of the derivative was $0.6 million as
of December 31, 2020 and is included in other liabilities in the accompanying
consolidated balance sheets. The gains or losses resulting from
marking-to-market our derivative financial instruments during the periods
presented are recognized as an increase or decrease in comprehensive income on
our consolidated statements of operations and comprehensive income.

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