UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018



¨	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: 1-9900

PACIFIC OFFICE PROPERTIES TRUST, INC.

(Exact name of registrant as specified in its charter)



Maryland	86-0602478
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

841 Bishop Street, Suite 1700

Honolulu, Hawaii 96813

(Address of principal executive offices) (Zip Code)

(Registrant’s telephone number, including area code): (808) 521-7444

(Former name, former address and former fiscal year, if changed since last report)

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 þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

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



Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company þ	Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of November 8, 2018, there were issued and outstanding 4,067,334 shares of Class A Common Stock, par value $0.0001 per share; 100 shares of Class B Common Stock, par value $0.0001 per share; and 2,398,220 shares of Senior Common Stock, par value $0.0001 per share.

PACIFIC OFFICE PROPERTIES TRUST, INC.

TABLE OF CONTENTS

FORM 10-Q



	Page No.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)	1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
Item 4. Controls and Procedures	40

PART II – OTHER INFORMATION
Item 1. Legal Proceedings	41
Item 1A. Risk Factors	41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3. Defaults Upon Senior Securities	41
Item 4. Mine Safety Disclosures	41
Item 5. Other Information	41
Item 6. Exhibits	42
Signature	43

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited).

Pacific Office Properties Trust, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share data)



	September 30, 2018			December 31, 2017
ASSETS	(unaudited)
Investments in real estate, net	$	130,100		$	131,566
Real estate and other assets held for sale	—			58,179
Cash and cash equivalents	1,667			1,588
Restricted cash	10,487			12,418
Rents and other receivables, net	1,005			856
Deferred rents	2,922			2,882
Intangible assets, net	4,911			4,285
Prepaid expenses	1,932			988
Goodwill	28,399			37,665
Investments in unconsolidated joint ventures	174			298
Total assets	$	181,597		$	250,725

LIABILITIES AND EQUITY (DEFICIT)
Liabilities:
Mortgage and other loans, net	$	224,298		$	301,181
Unsecured notes payable to current and former related parties	35,933			32,433
Accounts payable and other liabilities	57,753			49,805
Accrued interest payable to current and former related parties (Note 8)	26,103			23,001
Liabilities of real estate assets held for sale	—			4,291
Total liabilities	344,087			410,711

Commitments and contingencies (Note 9)
Equity (cumulative deficit):
Preferred Stock, $0.0001 par value per share, 100,000,000 shares authorized, one share of Proportionate Voting Preferred Stock issued and outstanding at September 30, 2018 and December 31, 2017	—			—
Senior Common Stock, $0.0001 par value per share (liquidation preference $10 per share, $23,982 and $24,057 as of September 30, 2018 and December 31, 2017, respectively) 40,000,000 shares authorized, 2,398,220 and 2,405,739 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively	21,333			21,408
Class A Common Stock, $0.0001 par value per share, 599,999,900 shares authorized, 4,067,334 and 3,992,142 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively	185			185
Class B Common Stock, $0.0001 par value per share, 100 shares authorized, issued and outstanding at September 30, 2018 and December 31, 2017	—			—
Additional paid-in capital	236			161
Cumulative deficit	(183,308		)	(182,747		)
Total stockholders’ equity (deficit)	(161,554		)	(160,993		)
Non-controlling interests:
Preferred unitholders in the Operating Partnership	127,268			127,268
Common unitholders in the Operating Partnership	(128,204		)	(126,261		)
Total equity (deficit)	(162,490		)	(159,986		)
Total liabilities and equity (deficit)	$	181,597		$	250,725

See accompanying notes to consolidated financial statements.

Pacific Office Properties Trust, Inc.

Consolidated Statements of Operations

(in thousands, except share and per share data)

(unaudited)



	For the three months ended September 30,						For the nine months ended September 30,
	2018			2017			2018			2017
Revenue
Rental	$	4,272		$	4,406		$	12,697		$	13,019
Tenant reimbursements	3,230			3,362			9,614			10,205
Parking	1,357			1,359			4,108			4,053
Other	159			184			306			331
Total revenue	9,018			9,311			26,725			27,608
Expenses
Rental property operating	5,687			5,251			16,403			16,212
General and administrative	486			439			1,308			1,595
Depreciation and amortization	1,896			2,157			5,630			6,262
Interest	4,897			4,383			14,118			12,643
Total expenses	12,966			12,230			37,459			36,712

Loss from continuing operations before equity in net (loss) income of unconsolidated joint ventures	(3,948		)	(2,919		)	(10,734		)	(9,104		)
Equity in net (loss) income of unconsolidated joint ventures	(65		)	(46		)	(200		)	1,426
Loss from continuing operations	(4,013		)	(2,965		)	(10,934		)	(7,678		)
Discontinued Operations:
Loss from discontinued operations before gain on sale of property	(193		)	(808		)	(1,193		)	(2,142		)
Gain on sale of property	12,615			—			12,615			—
Income (loss) from discontinued operations	12,422			(808		)	11,422			(2,142		)

Net income (loss)	8,409			(3,773		)	488			(9,820		)
Net (income) loss attributable to non-controlling interests:
Preferred unitholders in the Operating Partnership	(568		)	(568		)	(1,704		)	(1,704		)
Common unitholders in the Operating Partnership	(5,749		)	3,712			1,943			10,010
Net (income) loss attributable to non-controlling interests	(6,317		)	3,144			239			8,306

Net income (loss) attributable to common stockholders before dividends accrued on Senior Common Stock	2,092			(629		)	727			(1,514		)
Dividends accrued on Senior Common Stock	(434		)	(430		)	(1,288		)	(1,305		)
Net income (loss) attributable to common stockholders	$	1,658		$	(1,059	)	$	(561	)	$	(2,819	)

Income (loss) per common share:
Loss from continuing operations	$	(0.27	)	$	(0.23	)	$	(0.78	)	$	(0.60	)
Income (loss) from discontinued operations	0.68			(0.04		)	0.64			(0.12		)
Net income (loss) per common share - basic and diluted	$	0.41		$	(0.27	)	$	(0.14	)	$	(0.72	)

Weighted average number of common shares outstanding - basic and diluted	4,067,434			3,945,481			4,020,241			3,942,671

See accompanying notes to consolidated financial statements.

Pacific Office Properties Trust, Inc. Consolidated Statements of Cash Flows (in thousands and unaudited)

	For the nine months ended September 30,
	2018			2017
Operating activities
Net income (loss)	$	488		$	(9,820	)
Income (loss) from discontinued operations	11,422			(2,142		)
Loss from continuing operations	(10,934		)	(7,678		)
Adjustments to reconcile loss from continuing operations to net cash provided by operating activities - continuing operations:
Depreciation and amortization	5,630			6,262
Deferred rent	(40		)	486
Deferred ground rents	931			931
Interest amortization	4,230			4,029
Equity in net loss (income) of unconsolidated joint ventures	200			(1,426		)
Bad debt expense	(30		)	247
Changes in operating assets and liabilities:
Rents and other receivables	—			(264		)
Prepaid expenses	(944		)	(790		)
Accounts payable and other liabilities	1,119			577
Net cash provided by operating activities - continuing operations	162			2,374
Net cash used in operating activities - discontinued operations	(1,279		)	(27		)
Net cash (used in) provided by operating activities	(1,117		)	2,347

Investing activities
Additions to and improvement of real estate	(2,776		)	(2,916		)
Distributions from unconsolidated joint ventures	—			1,887
Contributions to unconsolidated joint ventures	(75		)	(40		)
Net sales proceeds from the sale of property	77,912			—
Payment of leasing commissions	(377		)	(306		)
Net cash provided by (used in) investing activities	74,684			(1,375		)

Financing activities
Repayment of mortgage notes payable	(78,500		)	(676		)
Borrowing from related party	3,500			—
Security deposits	(419		)	77
Net cash used in financing activities	(75,419		)	(599		)

Pacific Office Properties Trust, Inc. Consolidated Statements of Cash Flows, continued (in thousands and unaudited)

	For the nine months ended September 30,
	2018			2017
(Decrease) increase in cash, cash equivalents and restricted cash	(1,852		)	373
Cash, cash equivalents and restricted cash at beginning of period	14,006			15,496
Cash, cash equivalents and restricted cash at end of period	$	12,154		$	15,869


Supplemental cash flow information
Interest paid	$	13,231		$	11,859

Supplemental disclosure of non-cash investing and financing activities
Accrued dividends and distributions	$	2,992		$	3,009
Change in accrued capital expenditures	$	2,651		$	249

See accompanying notes to consolidated financial statements.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements

(unaudited)

1. Organization and Ownership, Presentation and Going Concern

Pacific Office Properties -

The terms “Pacific Office Properties,” “us,” “we,” and “our” as used in this Quarterly Report on Form 10-Q refer to Pacific Office Properties Trust, Inc., a Maryland corporation (the “Company”), and its subsidiaries and joint ventures. Through our controlling interest in Pacific Office Properties, L.P. (the “Operating Partnership”), of which we are the sole general partner, and the subsidiaries of the Operating Partnership, we own and operate primarily institutional-quality office properties in Hawaii. We operate in a manner that permits us to satisfy the requirements for taxation as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”).

We are externally advised by Shidler Pacific Advisors, LLC (“Shidler Pacific Advisors”), an entity that is owned and controlled by Jay H. Shidler (“Mr. Shidler”), our Chairman of the Board. Lawrence J. Taff, our President, Chief Executive Officer, Chief Financial Officer and Treasurer, also serves as President of Shidler Pacific Advisors. Shidler Pacific Advisors is responsible for the day-to-day operation and management of the Company, including management of our wholly-owned properties.

Through our Operating Partnership, as of September 30, 2018, we owned two office properties comprising 0.9 million rentable square feet in Honolulu, Hawaii, and were partners with third parties in joint ventures holding one office property and a vacant building, which was previously a sports club, associated with that property in Phoenix, Arizona. Our ownership interest percentage in these joint ventures is 5.0%.

Basis of Presentation

The accompanying consolidated financial statements and related disclosures included herein are presented in accordance with United States generally accepted accounting principles (“GAAP”) and include the account balances and transactions of consolidated subsidiaries, which are wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Certain amounts in the consolidated balance sheets and consolidated statements of operations for the prior period have been reclassified to conform to the current period presentation pursuant to Accounting Standards Update No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity with no corresponding net effect on the previously reported consolidated results of operations of the Company.

Certain amounts in the consolidated statements of cash flows for the prior period have been reclassified to conform to the current period presentation pursuant to the adoption of Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash (a consensus of the Emerging Issues Task Force) with no corresponding effect on the previously reported consolidated results of operations, or financial position of the Company. See Recent Accounting Pronouncements in Note 2 for more discussion on the adoption of this pronouncement.

We have also prepared the accompanying unaudited consolidated financial statements in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X and, consequently, they do not include all of the annual disclosures required by GAAP. Reference is made to our Annual Report on Form 10-K for the year ended December 31, 2017 for additional disclosures, including a summary of our significant accounting policies. There have been no changes to our significant accounting policies during the nine months ended September 30, 2018, except as disclosed in Note 2. In our opinion, the accompanying unaudited consolidated financial statements contain all adjustments, consisting of normal and recurring items, except as otherwise noted, necessary for the fair presentation of our financial position, results of operations and cash flows for the interim periods presented. The results of operations and cash flows for the nine months ended September 30, 2018 are not necessarily indicative of future results.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

Going Concern

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We generated net income of $0.5 million for the nine months ended September 30, 2018 and incurred a net loss of $13.8 million for the year ended December 31, 2017. We have incurred cumulative net losses since inception of $256.3 million. We have not consistently achieved positive cash flow from operations since our formation transactions were contemplated in March 2008.

At September 30, 2018, we expect that our cash flows from operations, including existing cash on hand, will be insufficient to meet working capital requirements and to fund required capital expenditures and leasing costs beyond the fourth quarter of 2018. This condition raises substantial doubt about our ability to continue as a going concern.

Because we have not identified, and we do not believe we will identify, a course of action to achieve profitability in the foreseeable future, our board of directors is currently considering alternatives for the future of the Company, including a sale of our remaining assets, merger, recapitalization and/or dissolution of the Company.

See “Liquidity” in Note 2 for additional information regarding our financial condition.

The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary if we are unable to continue as a going concern.

2. Summary of Significant Accounting Policies

Use of Estimates in Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.

Liquidity

Our business is capital intensive and our ability to maintain our operations depends on our cash flow from operations and our ability to raise additional capital on acceptable terms. Our primary focus is to preserve and generate cash.

As discussed above, we expect that our cash flows from operations, including existing cash on hand, will be insufficient to meet working capital requirements and to fund required capital expenditures and leasing costs beyond the fourth quarter of 2018. The mortgage debt on our wholly-owned properties is scheduled to mature on August 11, 2019. We do not have any committed financing sources available to refinance our debt as it matures. If we are unable to repay, extend or refinance our existing mortgage debt, we may be forced to give back these properties to our mortgage lenders.

Our primary source of cash in recent years has been the opportunistic sale of properties and borrowings from related parties. In March 2017, we completed the sale of our Pacific Business News Building joint venture property to an unrelated third party. In August 2018, we completed the sale of our Pan Am Building property to one of the lenders under our loan agreement. To assist with closing costs and working capital, we issued a promissory note in the principal amount of $3.5 million to Shidler Equities, L.P., a Hawaii limited partnership controlled by Mr. Shidler (“Shidler LP”), in consideration of a loan in that amount made by Shidler LP to the Operating Partnership. See Note 11 for more discussion on the sale of these properties and Note 8 for more discussion on the new promissory note.

Following the completion of the sale of the Pan Am Building property, our property portfolio consists of two wholly-owned office properties (Waterfront Plaza and Davies Pacific Center) and our 5% interests in joint ventures holding one office property and a vacant building, previously a sports club, associated with that property.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

We conduct substantially all of our operations through the Operating Partnership, therefore our ability to make liquidating distributions to our stockholders depends almost entirely on distributions received on our interests in the Operating Partnership after satisfaction of the outstanding indebtedness and other liabilities of the Operating Partnership. If the Company were to dissolve this quarter, based on our management’s current estimate of the value of the Operating Partnership assets, no assurance can be given that our stockholders will receive any liquidating distribution.

We are focused on ensuring our properties are operating as efficiently as possible. We have taken steps to identify opportunities to reduce discretionary operating costs wherever possible and at the same time maintaining the quality of our buildings and the integrity of our management services. We have no employees and rely upon our advisor to provide substantially all of our day-to-day management. We believe that Shidler Pacific Advisors can provide adequate personnel resources, at lower cost to us, for our business. At September 30, 2018, we have $2.2 million, primarily related to outstanding corporate management fees, owed to Shidler Pacific Advisors included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets.

Capital expenditures fluctuate in any given period, subject to the nature, extent and timing of improvements required to maintain our properties. Leasing costs also fluctuate in any given period, depending upon such factors as the type of property, the term of the lease, the type of lease and overall market conditions. Our costs for capital expenditures and leasing fall into two categories: (1) amounts that we are contractually obligated to spend and (2) discretionary amounts. As of September 30, 2018, we had cash reserves of $6.6 million to fund capital expenditures and leasing costs, of which we were contractually obligated to spend $9.6 million with other projected discretionary obligations of $0.7 million through 2019. We intend to mitigate any capital project overages and continue to request the maximum amount of reimbursements from our reserves on a timely basis.

As of September 30, 2018, our total consolidated debt (which includes our mortgage and other loans with a carrying value of $224.3 million and our unsecured promissory notes with a carrying value of $35.9 million) was $260.2 million, with a weighted average interest rate of 6.04% and a weighted average remaining term of 0.95 years.

As of September 30, 2018, we had a fully-drawn $25.0 million unsecured credit facility scheduled to mature on December 31, 2019. We also had promissory notes payable to certain current and former affiliates in the aggregate outstanding principal amount of $35.9 million (together with accrued and unpaid interest of $26.1 million) scheduled to mature the earlier of (i) December 31, 2019 and (ii) the date on which the Operating Partnership has fully satisfied, or is released from, any liability under the Indemnification Agreement, dated as of September 2, 2009 (as subsequently amended), between the Operating Partnership and Shidler Equities, L.P., a Hawaii limited partnership controlled by Mr. Shidler (“Shidler LP”).

While we may be able to anticipate and plan for certain liquidity needs, there may be unexpected increases in uses of cash that are beyond our control and which would affect our financial condition and results of operations. For example, we may be required to comply with new laws or regulations that cause us to incur unanticipated capital expenditures for our properties, thereby increasing our liquidity needs. Even if there are no material changes to our anticipated liquidity requirements, our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or needed.

Investments in Real Estate

Investments in real estate properties are stated at cost, less accumulated depreciation, amortization and impairment. Our wholly-owned properties, all of which were contributed to us at the time of our formation transactions in 2008, are stated at their historical net cost basis in an amount attributable to the ownership interests in such properties owned by Mr. Shidler prior to the formation transactions. Additions to land, buildings and improvements, furniture, fixtures and equipment and construction in progress are recorded at cost.

Estimates of future cash flows and other valuation techniques are used to allocate the acquisition cost of acquired properties among land, buildings and improvements, and identifiable intangible assets and liabilities such as amounts related to in-place at-market leases, acquired below-market leases, and acquired above- and below-market ground leases.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

The fair values of real estate assets acquired are determined on an “as-if-vacant” basis. The “as-if-vacant” fair value is allocated to land, and where applicable, buildings, tenant improvements and equipment based on comparable sales and other relevant information obtained in connection with the acquisition of the property.

Fair value is assigned to below-market leases based on the difference between (a) the contractual amounts to be paid by the tenant based on the existing lease and (b) management’s estimate of current market lease rates for the corresponding in-place leases, over the remaining terms of the in-place leases. Capitalized below-market lease amounts are reflected in “Acquired below-market leases, net,” in the consolidated balance sheets and are amortized as an increase in rental revenue over the remaining initial non-cancellable lease terms plus the terms of any below-market fixed rate renewal options that are considered bargain renewal options. If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance, net of the security deposit, of the related intangible is written off.

Fair value is also assigned to tenant relationships. Capitalized tenant relationship amounts are included in “Intangible assets, net” in the accompanying consolidated balance sheets and are amortized to “Depreciation and amortization” in the accompanying consolidated statements of operations. Amounts are amortized over the remaining terms of the respective leases even if a tenant vacates prior to the contractual termination of the lease. An adjustment to tenant relationship amounts occurs should the property experience an impairment loss.

The aggregate value of other acquired intangible assets consists of acquired in-place leases. The fair value allocated to acquired in-place leases consists of a variety of components including, but not necessarily limited to: (a) the value associated with avoiding the cost of originating the acquired in-place lease (i.e. the market cost to execute a lease, including leasing commissions and legal fees, if any); (b) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed lease-up period (i.e. real estate taxes, insurance and other operating expenses); (c) the value associated with lost rental revenue from existing leases during the assumed lease-up period; and (d) the value associated with any other inducements to secure a tenant lease. The value assigned to acquired in-place leases is amortized over the remaining lives of the related leases.

We record the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed as goodwill. Goodwill is not amortized but is tested for impairment at a level of reporting referred to as a reporting unit on an annual basis, during the fourth quarter of each calendar year, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. See “Goodwill” below. An impairment loss for an asset group is allocated to the long-lived assets of the group on a pro-rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset shall not reduce the carrying amount of that asset below its fair value. A description of our testing policy is set forth in “Impairment of Long-Lived Assets” below.

Impairment of Long-Lived Assets

In accordance with the provisions of the Impairment or Disposal of Long-Lived Assets Subsections of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, Property, Plant and Equipment, we assess the potential for impairment of our long-lived assets, including real estate properties, whenever events occur or a change in circumstances indicate that the recorded carrying value might not be fully recoverable. Indicators of potential impairment include significant decreases in occupancy levels and/or rental rates or a change in strategy that results in a decreased holding period. We determine whether impairment in value has occurred by comparing the estimated future cash flows, undiscounted and excluding interest, expected from the use and eventual disposition of the asset to its carrying value. If the undiscounted cash flows do not exceed the carrying value, the real estate or intangible carrying value is reduced to fair value and impairment loss is recognized. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. No impairment charges for our wholly-owned properties were recorded for the three and nine month periods ended September 30, 2018 or 2017.

Investments in Unconsolidated Joint Ventures

Our investments in joint ventures are accounted for under the equity method of accounting because we exercise significant influence over, but do not control, our joint ventures. Our joint venture partners have substantive participating

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

rights, including approval of and participation in setting operating budgets. Accordingly, we have determined that the equity method of accounting is appropriate for our investments in joint ventures.

Investments in unconsolidated joint ventures are initially recorded at cost and are subsequently adjusted for our proportionate equity in the net income or net loss of the joint ventures, contributions made to, or distributions received from, the joint ventures and other adjustments. Our distributions from our investments in unconsolidated joint ventures are recorded using the nature of the distribution approach. Under this approach, we record distributions of operating profit as part of cash flows from operating activities and distributions related to a capital transaction, such as a refinancing transaction or sale, as investing activities in the consolidated statements of cash flows.

We evaluate all investments in accordance with the guidance of FASB Accounting Standards Update No. 2015-02, Consolidation (Topic 810), Amendments to the Consolidation Analysis, which we adopted on January 1, 2016 and which requires us to re-evaluate our joint venture investments to determine whether or not the joint ventures are variable interest entities (“VIEs”) and if they are VIEs, whether or not we are determined to be the primary beneficiary. We would consolidate a VIE if it is determined that we are the primary beneficiary. We use qualitative analyses to determine whether we are the primary beneficiary of a VIE. Consideration of various factors could include, but is not limited to, the purpose and design of the VIE, risks that the VIE was designed to create and pass through, the form of our ownership interest, our representation on the entity’s governing body, the size and seniority of our investment, our ability to participate in policy making decisions, and the rights of the other investors to participate in the decision making process and to replace the manager and/or liquidate the venture, if applicable. Under the amended standards, our joint ventures were determined to be VIEs based on our inability to control the joint ventures due to our lack of substantive kick-out and participating rights over our joint venture partners; however, we are not the primary beneficiaries of these VIEs because we lack the power to direct the activities of the joint ventures and do not have rights to significant financial benefits from each of our joint ventures. As of September 30, 2018, our maximum exposure to loss with respect to this arrangement is limited to the $0.2 million carrying value of our investments in the unconsolidated joint ventures.

Impairment of Investments in Unconsolidated Joint Ventures

Our investment in unconsolidated joint ventures is subject to a periodic impairment review and is considered to be impaired when a decline in fair value is judged to be other-than-temporary. An investment in an unconsolidated joint venture that we identify as having an indicator of impairment is subject to further analysis to determine if the investment is other than temporarily impaired, in which case we write down the investment to its estimated fair value. No impairment charges were recorded in our investments in unconsolidated joint ventures for the three and nine month periods ended September 30, 2018 or 2017.

Discontinued Operations

The revenue, expenses, impairment and/or gain on sale of operating properties that meet the applicable criteria of FASB Accounting Standards Update No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity are reported as discontinued operations in the consolidated statement of operations. A gain on sale, if any, is recognized in the period the property is disposed of.

In determining whether to report the results of operations, impairment and/or gain on sale of operating properties as discontinued operations, we evaluate whether the property that has been disposed of by sale, disposed of other than by sale or is classified as held for sale represents a strategic shift that has or will have a major effect on our operations and financial results. A strategic shift could include the disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of an entity.

We classify properties as held for sale when certain criteria set forth in the Long-Lived Assets Classified as Held for Sale Subsections of FASB ASC 360, Property, Plant and Equipment, are met, including when we receive cash deposits towards the purchase of our properties. At that time, we present the non-cash assets and liabilities of the property held for sale separately in our consolidated balance sheets. We cease recording depreciation and amortization expense at the time a property is classified as held for sale. Properties held for sale are reported at the lower of their carrying amount or their estimated fair value, less estimated costs to sell. In the event that a property classified as held for sale no longer meets the

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

criteria for held for sale classification, the property is reclassified as held for use at the lower of the fair value or the depreciated basis as if the property had continued to be used.

In August 2016, we entered into a purchase and sale agreement to sell our Pan Am Building property, located in Honolulu, Hawaii. The completion of the sale transaction occurred on August 13, 2018. Accordingly, the associated assets and liabilities have been removed from our consolidated balance sheets as of September 30, 2018. The results of its operations for the three and nine month periods ended September 30, 2018 and 2017 are included in “Discontinued Operations” in the accompanying consolidated statements of operations, in accordance with the discontinued operations criteria of FASB ASC 205, Presentation of Financial Statements - Discontinued Operations, as the sale represented a strategic shift in our operations.

Goodwill

We record the excess cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed as goodwill. Goodwill is not amortized but is tested for impairment on an annual basis during the fourth quarter of each calendar year, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. Impairment testing is performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment, or a business that is one level below the operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The reporting unit’s fair value is calculated as the discounted future cash flows based on management’s best estimate of the applicable capitalization and discount rates. If the carrying value of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. An impairment charge is recognized as a charge against income equal to the excess of the carrying value of goodwill over its implied value on the date of the impairment. Factors that may cause goodwill to be impaired include, but may not be limited to, a sustained decline in our stock price and the occurrence, or sustained existence, of adverse economic conditions or decreased cash flow from our properties.

We consider our wholly-owned properties one reporting unit due to similar geographic and economic characteristics. As of September 30, 2018, goodwill of our wholly-owned properties amounted to $28.4 million, after writing off approximately $9.3 million of goodwill associated with the sale of the Pan Am Building property in August 2018.

Revenue Recognition

The following four criteria must be met before we recognize revenue and gains:


•	persuasive evidence of an arrangement exists;


•	the delivery has occurred or services rendered;


•	the fee is fixed and determinable; and


•	collectability is reasonably assured.

All of our tenant leases are classified as operating leases. For all leases with scheduled rent increases or other adjustments, minimum rental income is recognized on a straight-line basis over the terms of the related leases. Straight-line rent receivable represents rental revenue recognized on a straight-line basis in excess of billed rents and this amount is included in “Deferred rents” on the accompanying consolidated balance sheets. The straight line rent adjustment included in “Rental revenues” in the accompanying consolidated statements of operations was $(0.55) million and $(0.13) million for the three months ended September 30, 2018 and 2017, respectively, and $0.40 million and $(0.56) million for the nine months ended September 30, 2018 and 2017, respectively. Reimbursements from tenants for real estate taxes, excise taxes and other recoverable operating expenses are recognized as revenues in the period the applicable costs are incurred.

Capitalized below-market lease amounts are amortized as an increase to rental revenue over the remaining initial non-cancellable lease terms plus the terms of any below-market fixed rate renewal options that are considered bargain renewal options.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

We have leased space to certain tenants under non-cancellable operating leases, which provide for percentage rents based upon tenant revenues. Percentage rental income is recorded in “Rental revenues” in the accompanying consolidated statements of operations.

Rental revenue from parking operations and month-to-month leases or leases with no scheduled rent increases or other adjustments is recognized on a monthly basis when earned.

Lease termination fees, which are included in “Other” revenues of the accompanying consolidated statements of operations, are recognized when the related leases are canceled and we have no continuing obligation to provide services to such former tenants.

“Other” revenue on the accompanying consolidated statements of operations generally includes income incidental to our operations and is recognized when earned.

Tenant Receivables

Tenant receivables are recorded and carried at the amount billable per the applicable lease agreement, less any allowance for doubtful accounts. An allowance for doubtful accounts is made when collection of the full amounts is no longer considered probable. Tenant receivables are included in “Rents and other receivables, net,” in the accompanying consolidated balance sheets. If a tenant fails to make contractual payments beyond any allowance, we may recognize bad debt expense in future periods equal to the amount of unpaid rent. We take into consideration factors including historical termination, default activity and current economic conditions to evaluate the level of reserve necessary. We had an allowance for doubtful accounts of $0.04 million and $0.4 million, as of September 30, 2018 and December 31, 2017, respectively.

We had a total of $1.4 million of lease security available in security deposits, as of both September 30, 2018 and December 31, 2017.

Cash and Cash Equivalents

We consider all short-term cash investments with maturities of three months or less when purchased to be cash equivalents. Restricted cash is excluded from cash and cash equivalents due to its restriction on withdrawal or use.

We maintain cash balances in various financial institutions. At times, the amounts of cash held in financial institutions may exceed the maximum amount insured by the Federal Deposit Insurance Corporation. We do not believe that we are exposed to any significant credit risk on our cash and cash equivalents.

Restricted Cash

Restricted cash primarily includes escrow accounts for real property taxes, insurance, capital expenditures, tenant improvements, ground lease payments, leasing commissions held by our lenders and tenant security deposits.

Mortgage and Other Loans

Mortgage and other loans assumed upon acquisition of related real estate properties are stated at estimated fair value upon their respective dates of assumption, net of unamortized discounts or premiums and deferred loan fees to their outstanding contractual balances. Amortization of discount and the accretion of premiums on mortgage and other loans assumed upon acquisition of related real estate properties are recognized from the date of assumption through their contractual maturity date using the straight line method, which approximates the effective interest method. Deferred loan fees include fees and costs incurred in conjunction with long-term financings and are amortized over the terms of the related debt using a method that approximates the effective interest method. Deferred loan fees are included in “Mortgage and other loans, net” in the accompanying consolidated balance sheets, in accordance with Accounting Standards Update No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs. Amortization of deferred loan fees is included in “Interest” in the accompanying consolidated statements of operations.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

Repairs, Maintenance and Major Improvements

The costs of ordinary repairs and maintenance are included when incurred in “Rental property operating” expenses in the accompanying consolidated statements of operations. Major improvements that extend the life of an asset are capitalized and depreciated over the remaining useful life of the asset. Our lenders have required us to maintain reserve accounts for the funding of future repairs and capital expenditures, and the balances of these accounts are included in “Restricted cash” on the accompanying consolidated balance sheets.

Leasing Commissions

Leasing commissions are capitalized and amortized on a straight line basis over the life of the related lease. The payment of leasing commissions is included in “Investing activities” on the accompanying consolidated statements of cash flows because we believe that paying leasing commissions for good tenants is a prudent investment in increasing the value of our income-producing assets.

Depreciation and Amortization

Depreciation and amortization are computed using the straight-line method for financial reporting purposes. Buildings and improvements are depreciated over their estimated useful lives which range from five to 42 years. Tenant improvement costs recorded as capital assets are depreciated over the shorter of the tenant’s remaining lease term or the life of the improvement. Furniture, fixtures and equipment are depreciated over three to seven years. Properties that are acquired that are subject to ground leases are depreciated over the lesser of the useful life or the remaining life of the related leases as of the date of assumption of the lease.

Non-Controlling Interests

We account for non-controlling interests in accordance with FASB ASC 810, Consolidation. In accordance with FASB ASC 810, we report non-controlling interests in subsidiaries within equity in the consolidated financial statements, but separate from the parent stockholders’ equity. Net income attributable to non-controlling interests is presented as a reduction from net income in calculating net income available to common stockholders on the statement of operations. Acquisitions or dispositions of non-controlling interests that do not result in a change of control are accounted for as equity transactions. In addition, FASB ASC 810 requires that a parent company recognize a gain or loss in net income when a subsidiary is deconsolidated upon a change in control. In accordance with FASB ASC 480-10, Distinguishing Liabilities from Equity, non-controlling interests that are determined to be redeemable are carried at their redemption value as of the balance sheet date and reported as temporary equity. We periodically evaluate individual non-controlling interests for the ability to continue to recognize the non-controlling interest as permanent equity in the consolidated balance sheets. Any non-controlling interest that fails to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (a) the carrying amount, or (b) its redemption value as of the end of the period in which the determination is made, the resulting adjustment is recorded in the consolidated statement of operations. See Note 10 for a more detailed discussion.

Preferred Units

The Class A convertible preferred units of the Operating Partnership (“Preferred Units”) have fixed rights to distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit. Accordingly, income or loss of the Operating Partnership is allocated among the general partner interest and limited partner common interests after taking into consideration distribution rights allocable to the Preferred Units.

Earnings (Loss) per Share

We present both basic and diluted earnings (loss) per share (“EPS”). Basic EPS is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during each period.

Diluted EPS is computed by dividing net income (loss) available to common stockholders for the period by the weighted average number of common shares that would have been outstanding for the period, assuming the issuance of common shares for all potentially dilutive common shares outstanding during such period.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

Income Taxes

We have elected to be taxed as a REIT under the Code. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we currently distribute at least 90% of our REIT taxable income to our stockholders. Also, at least 95% of gross income in any year must be derived from qualifying sources. We intend to adhere to these requirements and maintain our REIT status. As a REIT, we generally will not be subject to corporate level federal income tax on taxable income that we distribute currently to our stockholders. However, we may be subject to certain state and local taxes on our income and property, and to federal income and excise taxes on our undistributed taxable income, if any. Because we did not have any taxable income to distribute for the year ended December 31, 2017 and the nine months ended September 30, 2018, we have not recognized any provision for income taxes.

The Company is subject to the provisions of FASB ASC 740, Income Taxes which prescribes a more-likely-than-not threshold for the financial statement recognition of uncertain tax positions. ASC 740 clarifies the accounting for income taxes by prescribing a minimum recognition threshold and measurement attribute for the recognition and measurement of a tax position taken or expected to be taken in a tax return. On a quarterly basis, the Company evaluates the need for income tax accruals in accordance with ASC 740, and has not recorded any such liabilities.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 establishes that companies may recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This pronouncement is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. We adopted this pronouncement on January 1, 2018. We evaluated the impact of this pronouncement on our consolidated financial statements by reviewing our revenue streams and concluded that only certain amounts of our parking revenue stream fall under the scope of this pronouncement. We also evaluated the impact of this pronouncement on the timing and recognition of revenues of our parking arrangements and determined there was no change in the recognition of revenues from our current accounting practice. As a result, the adoption of this pronouncement did not have a material effect on our consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842): Section A - Leases: Amendments to the FASB Accounting Standards Codification; Section B - Conforming Amendments Related to Leases: Amendments to the FASB Accounting Standards Codification; and Section C - Background Information and Basis for Conclusions (“ASU 2016-02”). ASU 2016-02 requires lessees to establish a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term on their balance sheets. Lessees will continue to recognize lease expenses on their income statements in a manner similar to current accounting. The guidance also eliminates current real estate-specific provisions for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of ASU 2016-02 as of its issuance is permitted. The new leases standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief. We are currently evaluating the impact of this standard on our leases where we are the lessor. However, for leases where we are the lessee, as with our Waterfront Plaza ground lease, we believe the adoption of this standard will have a material impact on our consolidated balance sheets since we will be required to recognize a right-of-use asset and lease liability for this lease. Our evaluation on the impact of adopting the new leases standard on our consolidated financial statements is still ongoing.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15 Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”). ASU No. 2016-15 provides specific guidance on eight cash flow classification issues, including how debt prepayments or debt extinguishment costs and distributions received from equity method investees are presented. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted this pronouncement on January 1, 2018. The adoption of this pronouncement did not have a material effect on our consolidated financial statements.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

In November 2016, the FASB issued Accounting Standards Update No. 2016-18 Statement of Cash Flows (Topic 230), Restricted Cash (a consensus of the Emerging Issues Task Force) (“ASU 2016-18”). ASU No. 2016-18 clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted this pronouncement on January 1, 2018. As a result of this adoption, we retrospectively reclassified $0.6 million of cash flows related to changes in restricted cash from operating activities and $0.2 million of cash flows related to changes in restricted cash from investing activities on our consolidated statement of cash flows to the cash, cash equivalents and restricted cash balances for the nine months ended September 30, 2017.

In January 2017, the FASB issued Accounting Standards Update No. 2017-01 Business Combinations (Topic 805), Clarifying the Definition of a Business (“ASU 2017-01”). ASU No. 2017-01 changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. ASU No. 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. We adopted this pronouncement on January 1, 2018. The adoption of this pronouncement did not have a material effect on our consolidated financial statements since each of our wholly-owned properties is defined as a business under ASU 2017-01.

3. Investments in Real Estate, net

Our investments in real estate, net, at September 30, 2018 (unaudited), and at December 31, 2017, are summarized as follows (in thousands):



	September 30, 2018			December 31, 2017
Land and land improvements	$	16,062		$	16,062
Building and building improvements	153,496			150,517
Tenant improvements	28,163			27,950
Construction in progress	2,486			2,950
Furniture, fixtures and equipment	1,626			1,592
Investments in real estate	201,833			199,071
Less: accumulated depreciation	(71,733		)	(67,505		)
Investments in real estate, net	$	130,100		$	131,566

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

4. Intangible Assets, net

Our identifiable intangible assets, net, at September 30, 2018 (unaudited), and at December 31, 2017, are summarized as follows (in thousands):



	September 30, 2018			December 31, 2017
Acquired leasing commissions:
Gross amount	$	6,204		$	5,534
Accumulated amortization	(3,095		)	(3,115		)
Acquired leasing commissions, net	3,109			2,419

Acquired tenant relationship costs:
Gross amount	5,579			5,579
Accumulated amortization	(5,565		)	(5,550		)
Acquired tenant relationship costs, net	14			29

Acquired other intangibles:
Gross amount	2,910			2,910
Accumulated amortization	(1,122		)	(1,073		)
Acquired other intangibles, net	1,788			1,837

Intangible assets, net	$	4,911		$	4,285

5. Investments in Unconsolidated Joint Ventures

In March 2017, one of our unconsolidated joint ventures sold the Pacific Business News Building property, located in Honolulu, Hawaii, to an unaffiliated third party. See Note 11 for additional information.

At September 30, 2018, we were partners with third parties in joint ventures holding one office property and a vacant building, which was previously a sports club, associated with that property in Phoenix, Arizona. Our ownership interest percentage in these joint ventures is 5.0%.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

The following tables summarize financial information for our unconsolidated joint ventures (in thousands and unaudited):



	For the three months ended September 30,						For the nine months ended September 30,
	2018			2017			2018			2017
Revenues:
Rental	$	1,755		$	1,867		$	5,268		$	6,007
Other	215			215			599			1,200
Total revenues	1,970			2,082			5,867			7,207
Expenses:
Rental operating	1,784			1,795			5,385			5,802
Depreciation and amortization	726			621			2,336			2,111
Interest	742			712			2,136			2,102
Total expenses	3,252			3,128			9,857			10,015
Loss before gain on sale of property	(1,282		)	(1,046		)	(3,990		)	(2,808		)
Gain (loss) on sale of property	—			—			—			11,421
Net (loss) income	$	(1,282	)	$	(1,046	)	$	(3,990	)	$	8,613

Equity in net (loss) income of unconsolidated joint ventures	$	(65	)	$	(46	)	$	(200	)	$	1,426



	September 30, 2018		December 31, 2017
Investment in real estate, net	$	42,516	$	43,531
Other assets	4,294		4,689
Total assets	$	46,810	$	48,220

Mortgage and other loans	$	40,565	$	40,440
Other liabilities	2,764		2,085
Total liabilities	$	43,329	$	42,525

Investments in unconsolidated joint ventures	$	174	$	298

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

6. Accounts Payable and Other Liabilities

Accounts payable and other liabilities at September 30, 2018 (unaudited), and at December 31, 2017, consist of the following (in thousands):



	September 30, 2018		December 31, 2017
Accounts payable	$	1,919	$	1,378
Interest payable	776		751
Deferred revenue	714		684
Security deposits	1,447		1,433
Deferred straight-line ground rent	22,081		21,150
Accrued distributions attributable to Preferred Units	17,613		15,909
Accrued expenses	12,506		7,829
Asset retirement obligations	697		671
Total accounts payable and other liabilities	$	57,753	$	49,805

7. Mortgage and Other Loans

The following table sets forth a summary of our mortgage and other loans, net of deferred loan fees, at September 30, 2018 (unaudited), and at December 31, 2017 (in thousands):



	September 30, 2018			December 31, 2017			Interest Rate	Maturity Date
Consolidated property loan	$	200,551		$	279,051		(1)	8/11/2019
Revolving line of credit	25,000			25,000			(2)	12/31/2019
Outstanding principal balance	225,551			304,051
Less: unamortized deferred loan fees, net	(1,253		)	(2,870		)
Mortgage and other loans, net	$	224,298		$	301,181

___________________________

(1)

The loan is subject to monthly interest payments bearing interest at a floating rate per annum equal to the One-Month LIBOR Rate plus 4.5% and monthly partial principal payments based on the availability of cash after making required distributions for operating costs and reserves pursuant to a payment waterfall and other terms and conditions under the loan agreement and a balloon remaining principal payment at maturity. The LIBOR portion of the interest rate is subject to a floor of 0.50% and a cap of 4.0%, pursuant to an interest rate cap agreement. As of September 30, 2018, the applicable One-Month LIBOR Rate was 2.133%.

(2)

Amounts borrowed under the revolving line of credit require monthly interest only payments at a fluctuating annual rate equal to the effective rate of interest paid by the lender on time certificates of deposit, plus 1.00% and a balloon principal payment at maturity. As of September 30, 2018, the effective rate of interest paid by the lender on time certificates of deposit was 0.10%. See “Revolving Line of Credit” below.

The consolidated property loan agreement contains customary covenants including, among other things, restrictions on the ability to incur additional indebtedness, transfer or dispose of assets, create liens and make certain investments. Our obligations under the loan agreement are secured by mortgages on the leasehold and fee (as applicable) interests in both of our wholly-owned properties as well as assignments of all leases, rents, contracts, revenues, permits and service agreements with respect to the properties and ownership interests in all equity interests and accounts of the borrowers. The loan is non-recourse to our Operating Partnership, except for customary recourse carve-outs for borrower misconduct and environmental liabilities. The recourse liability for borrower misconduct and environmental liabilities was guaranteed by Mr. Shidler. Our Operating Partnership has agreed to indemnify Mr. Shidler to the extent of his guaranty liability.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

In connection with entering into the loan agreement, in August 2016, we entered into a Purchase and Sale Agreement to sell our Pan Am Building property, located in Honolulu, Hawaii, to one of the lenders under the loan agreement, for cash consideration of $78.5 million. The completion of the sale transaction occurred on August 13, 2018. In accordance with the loan agreement and Purchase and Sale Agreement, the proceeds from the sale of the property were used to prepay (with no prepayment premium) $78.5 million of the principal amount outstanding under the loan agreement.

Revolving Line of Credit

We are party to a Credit Agreement (the “FHB Credit Facility”) with First Hawaiian Bank (the “Lender”) which provides us with a revolving line of credit in the maximum principal amount of $25.0 million and has a maturity date of December 31, 2019. Amounts borrowed under the FHB Credit Facility bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the lender on time certificates of deposit, plus 1.00%. We are permitted to use the proceeds of the line of credit for working capital and general corporate purposes, consistent with our real estate operations and for such other purposes as the Lender may approve. As of September 30, 2018 and December 31, 2017, we had outstanding borrowings of $25.0 million under the FHB Credit Facility. During each of the three month periods ended September 30, 2018 and 2017, we recognized $0.1 million in interest to the Lender. During each of the nine month periods ended September 30, 2018 and 2017, we recognized $0.2 million in interest to the Lender.

As security for the FHB Credit Facility, as amended, Shidler LP has pledged to the Lender a certificate of deposit in the principal amount of $25.0 million. As a condition to this pledge, the Operating Partnership and Shidler LP entered into an indemnification agreement pursuant to which the Operating Partnership agreed to indemnify Shidler LP from any losses, damages, costs and expenses incurred by Shidler LP in connection with the pledge. In addition, to the extent that all or any portion of the certificate of deposit is withdrawn by the Lender and applied to the payment of principal, interest and/or charges under the FHB Credit Facility, the Operating Partnership agreed to pay to Shidler LP interest on the withdrawn amount at a rate of 7.0% per annum from the date of the withdrawal until the date of repayment in full by the Operating Partnership to Shidler LP. Pursuant to this indemnification agreement, as amended, the Operating Partnership also agreed to pay to Shidler LP an annual fee of 2.0% of the entire $25.0 million principal amount of the certificate of deposit. During each of the three month periods ended September 30, 2018 and 2017, we recognized $0.1 million in interest to Shidler LP for the annual fee. During each of the nine month periods ended September 30, 2018 and 2017, we recognized $0.4 million in interest to Shidler LP for the annual fee. As of September 30, 2018, we have accrued approximately $1.3 million of interest payments owed to Shidler LP for this annual fee included in “Accrued interest payable to current and former related parties” in the accompanying consolidated balance sheets.

The FHB Credit Facility contains various customary covenants, including covenants relating to disclosure of financial and other information to the Lender, maintenance and performance of our material contracts, our maintenance of adequate insurance, payment of the Lender’s fees and expenses, and other customary terms and conditions.

8. Unsecured Notes Payable to Current and Former Related Parties

At September 30, 2018 and December 31, 2017, we had promissory notes payable by the Operating Partnership to certain current and former affiliates in the aggregate outstanding principal amounts of $35.9 million and $32.4 million, respectively.

In 2008, we issued $21.1 million of promissory notes as consideration for having funded certain capital improvements prior to the completion of our formation transactions and upon the exercise of an option granted to us by POP Venture, LLC (“Venture”), a Delaware limited liability company controlled by Mr. Shidler, and its affiliates as part of our formation transactions in 2008. The promissory notes accrue interest at a rate of 7%, per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity. The promissory notes were originally scheduled to mature on various dates commencing on March 19, 2013 through August 31, 2013, but the Operating Partnership elected to extend the maturity for one additional year. The maturity date of these promissory notes has subsequently been extended to December 31, 2019.

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

interest at a rate of 5% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity, and were originally scheduled to mature on December 31, 2015. The maturity date of these promissory notes has subsequently been extended to December 31, 2019.

In September 2016, we issued a promissory note in the principal amount of $3.0 million to Shidler LP in consideration of a loan in that amount made by Shidler LP to the Operating Partnership. The promissory note accrues interest at a rate of 5% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity. The promissory note was originally scheduled to mature on December 31, 2017. The maturity date of this promissory note has subsequently been extended to December 31, 2019.

In August 2018, we issued a promissory note in the principal amount of $3.5 million to Shidler LP in consideration of a loan in that amount made by Shidler LP to the Operating Partnership. The promissory note accrues interest at a rate of 5% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity. The promissory note is scheduled to mature on December 31, 2019.

The maturity of the Operating Partnership’s promissory notes will accelerate upon the occurrence of an underwritten public offering of at least $75 million of the Company’s common stock, the sale of all or substantially all of the Company’s assets or the merger or consolidation of the Company with another entity. The promissory notes are unsecured obligations of the Operating Partnership and (except for the September 2016 and August 2018 notes) are subordinated to borrowings under the FHB Credit Facility and our indemnification obligations to Shidler LP in connection with its pledge in support of the FHB Credit Facility.

For the period from March 20, 2008 through September 30, 2018, interest payments on these unsecured notes payable have been deferred with the exception of $0.3 million which was related to the notes exchanged for shares of common stock in 2009. At September 30, 2018 and December 31, 2017, $26.1 million and $23.0 million, respectively, of accrued interest attributable to these promissory notes is included in the accompanying consolidated balance sheets.

9. Commitments and Contingencies

Minimum Future Ground Rents

We hold a long-term ground leasehold interest in our Waterfront Plaza property. The Waterfront Plaza ground lease expires December 31, 2060. The annual rental obligation has fixed increases at 5-year intervals until it resets on January 1, 2036, 2041, 2046, 2051, and 2056 to an amount equal to the greater of (i) 8.0% of the fair market value of the land or (ii) the ground rent payable for the prior period.

Contingencies

From time to time, we may be subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance, subject to deductibles and other customary limitations on recoveries. We believe that the ultimate settlement of these actions will not have a material adverse effect on our consolidated financial position and results of operations or cash flows.

Concentration of Credit Risk

Our wholly-owned operating properties are located in Honolulu. Our operating properties owned in joint ventures are located in Phoenix. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate. As of September 30, 2018, no single tenant accounts for 10% or more of our total annualized base rents. We perform credit evaluations on new tenants by requesting and reviewing their financial statements and recent tax returns. During the terms of our leases, we monitor the credit quality of our tenants by reviewing the timeliness of their lease payments. In addition, we may review financial statements, operating statements and/or performance of other financial covenants as allowed for under their lease.

Financial instruments that subject us to credit risk consist primarily of cash, accounts receivable and deferred rents receivable. We maintain our cash and cash equivalents and restricted cash on deposit with what management believes are

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

relatively stable financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to the maximum amount; and, to date, we have not experienced any losses on our invested cash. Restricted cash held by our lenders is maintained in escrow accounts at a major financial institution.

Conditional Asset Retirement Obligations

We record a liability for a conditional asset retirement obligation, defined as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within a company’s control, when the fair value of the obligation can be reasonably estimated. Depending on the age of the construction, certain properties in our portfolio may contain non-friable asbestos. If these properties undergo major renovations or are demolished, certain environmental regulations are in place, which specify the manner in which the asbestos, if present, must be handled and disposed. Based on our evaluation of the physical condition and attributes of certain of our properties, we recorded conditional asset retirement obligations related to asbestos removal. As of September 30, 2018 and December 31, 2017, the liability in our consolidated balance sheets for conditional asset retirement obligations was $0.7 million as of both dates. The accretion expense for the three and nine month periods ended September 30, 2018 and 2017 was not significant.

Waterfront Plaza Ground Lease

We are subject to a surrender clause under the Waterfront Plaza ground lease that provides the lessor with the right to require us, at our own expense, to raze and remove all improvements from the leased land, contingent on the lessor’s decision at the time the ground lease expires on December 31, 2060. Accordingly, as of September 30, 2018 and December 31, 2017, the liability in our consolidated balance sheets for this asset retirement obligation was $0.5 million as of both dates. The accretion expense for the three and nine month periods ended September 30, 2018 and 2017 was not significant.

Environmental Matters

We follow the policy of monitoring our properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to the properties that would have a material effect on our financial condition, results of operations, and cash flows. Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability other than our conditional asset retirement obligations that we believe would require additional disclosure or the recording of a loss contingency.

Capital Commitments

We are required by certain leases and other contractual obligations to complete tenant and building improvements. As of September 30, 2018, we had cash reserves of $6.6 million to fund capital expenditures and leasing costs, of which we were contractually obligated to spend $9.6 million with other projected discretionary obligations of $0.7 million through 2019. We anticipate that our reserves, as well as other sources of liquidity, including existing cash on hand, our cash flows from operations, financing and investing activities may not be sufficient to fund our capital expenditure obligations. See Note 1 for discussion on our ability to continue as a going concern.

Tax Protection Arrangements

The sale of any of our wholly-owned properties that would not provide continued tax deferral to Venture was contractually restricted until March 18, 2018, which was 10 years after the closing of the transaction related to such properties. In addition, we had agreed that, during such 10-year period, we would not prepay or defease any mortgage indebtedness of such properties, other than in connection with a concurrent refinancing with non-recourse mortgage debt of an equal or greater amount and subject to certain other restrictions. Furthermore, if such a sale or defeasance was foreseeable, we were required to notify Venture and to cooperate with it in considering strategies to defer or mitigate the recognition of gain under the Code by any of the equity interest holders of the recipient of the Operating Partnership units.

In June 2012, we completed the sale of our fee and leasehold interests in our First Insurance Center property, located in Honolulu, Hawaii, to an unaffiliated third party. As a result of the sale, certain contract parties claimed they were entitled

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

to a make-whole cash payment under tax protection agreements relating to the property. In February 2014, we issued $8.3 million of subordinated promissory notes in settlement of the majority of such claims (see Note 8), and paid cash settlements totaling approximately $0.4 million in settlement of the remainder of such claims. Each party receiving a promissory note or cash payment released us from any other claims under the tax protection agreements arising out of the sale of the First Insurance Center property and the foreclosure of our Sorrento Technology Center property in January 2012, as applicable.

In March 2017, one of our unconsolidated joint ventures sold the Pacific Business News Building property, located in Honolulu, Hawaii, to an unaffiliated third party. We originally contributed the Pacific Business News Building to our unconsolidated joint venture in April 2011. Potential claims for a make-whole cash payment under tax protection agreements relating to the sale of this property have been waived.

Indemnities

The mortgage debt outstanding under our loan agreement is non-recourse to our Operating Partnership, except for customary recourse carve-outs for borrower misconduct and environmental liabilities. The recourse liability for borrower misconduct and environmental liabilities was guaranteed by Mr. Shidler. Our Operating Partnership has agreed to indemnify Mr. Shidler to the extent of his guaranty liability. In management’s judgment, it would be unlikely for us to incur any material liability under these indemnities that would have a material adverse effect on our financial condition, results of operations or cash flows.

10. Equity (Deficit) and Earnings (Loss) per Share

Total Equity (Deficit)

The changes in total equity (deficit) for the period from December 31, 2017 to September 30, 2018 (unaudited) are shown below (in thousands):



	Pacific Office Properties Trust, Inc.			Non-controlling interest - Preferred			Non-controlling interest - Common			Total
Balance at December 31, 2017	$	(160,993	)	$	127,268		$	(126,261	)	$	(159,986	)
Net income (loss)	727			1,704			(1,943		)	488
Dividends and distributions	(1,288		)	(1,704		)	—			(2,992		)
Balance at September 30, 2018	$	(161,554	)	$	127,268		$	(128,204	)	$	(162,490	)

Stockholders’ Equity (Deficit)

Our Class A Common Stock (which is quoted in the OTCQB tier of the OTC Marketplace) and our Class B Common Stock are identical in all respects, except that in the event of liquidation the Class B Common Stock will not be entitled to any portion of our net assets, which would, if any, be allocated and distributed to the holders of the Class A Common Stock. Shares of our Class A Common Stock and Class B Common Stock vote together as a single class and each share is entitled to one vote on each matter to be voted upon by our stockholders. Dividends on the Class A Common Stock and Class B Common Stock are payable at the discretion of our Board of Directors.

Our Senior Common Stock ranks senior to our Class A Common Stock and Class B Common Stock with respect to dividends and distribution of amounts upon liquidation. It has a $10.00 per share (plus accrued and unpaid dividends) liquidation preference. Subject to the preferential rights of any future series of preferred shares, holders of Senior Common Stock are entitled to receive, when and as authorized by the Company’s Board of Directors, and declared by us, cumulative cash dividends in an amount per share equal to a minimum of $0.725 per share per annum, payable monthly. Dividends on the Senior Common Stock are cumulative and accrue to the extent not declared or paid by us. Should the dividend payable on the Class A Common Stock exceed the rate of $0.20 per share per annum, the Senior Common Stock dividend would increase by 25% of the amount by which the Class A Common Stock dividend exceeds $0.20 per share per annum. Holders of Senior Common Stock have the right to vote on all matters presented to stockholders as a single class with holders of the Class A Common Stock, the Class B Common Stock and the Company’s outstanding share of Proportionate Voting

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

Preferred Stock (as discussed below). Each share of the Company’s Class A Common Stock, the Class B Common Stock and the Senior Common Stock is entitled to one vote on each matter to be voted upon by the Company’s stockholders. Shares of Senior Common Stock may be exchanged, at the option of the holder, for shares of Class A Common Stock after the fifth anniversary of the issuance of such shares of Senior Common Stock. The exchange ratio is to be calculated using a value for our Class A Common Stock based on the average of the trailing 30-day closing price of the Class A Common Stock on the date the shares are submitted for exchange, but in no event less than $1.00 per share, and a value for the Senior Common Stock of $10.00 per share. There were no exchanges of Senior Common Stock for Class A Common Stock in the third quarter of 2018. For the nine months ended September 30, 2018, 75,192 shares of Class A Common Stock were issued in exchange for 7,519 shares of Senior Common Stock. Unless full cumulative dividends on the Senior Common Stock have been paid for all past dividend periods, we may not repurchase or redeem any shares of Senior Common Stock (or Class A Common Stock) unless all outstanding shares of Senior Common Stock are simultaneously repurchased or redeemed. As of September 30, 2018 and December 31, 2017, we had a total of 2,398,220 and 2,405,739, respectively, shares of Senior Common Stock issued and outstanding. We terminated our continuous public offering of Senior Common Stock in February 2011 and do not expect to issue any additional shares of Senior Common Stock.

General Partnership Interest

The Company’s general partnership interest in the Operating Partnership is denominated in a number of Common Units equal to the number of shares of our Class A Common Stock and Class B Common Stock outstanding. Our general partnership interest includes the right to participate in distributions of the Operating Partnership to holders of Common Units in a percentage equal to the quotient obtained by dividing (a) the number of shares of our Class A Common Stock and Class B Common Stock outstanding by (b) the sum of shares of our Class A Common Stock and Class B Common Stock outstanding plus the number of shares of our Class A Common Stock for which the outstanding Common Units of the Operating Partnership may be redeemed. We also hold a number of Senior Common Units corresponding to the number of shares of Senior Common Stock outstanding, which entitle us to receive distributions from the Operating Partnership in an amount per Senior Common Unit equal to the per share dividend payable to holders of our Senior Common Stock.

Non-controlling Interests

Non-controlling interests include the interests in the Operating Partnership that are not owned by the Company, which amounted to all of the Preferred Units and 77.61% of the Common Units outstanding as of September 30, 2018. During the nine months ended September 30, 2018 and 2017, no Common Units or Preferred Units were redeemed or issued. As of September 30, 2018, 46,698,532 shares of our Class A Common Stock were reserved for issuance upon redemption of outstanding Common Units and Preferred Units.

The Common Units issued upon the completion of our formation transactions on March 19, 2008 are designated as Class B Common Units, which are redeemable by the holder on a one-for-one basis for shares of Class A Common Stock or a new class of Common Units, designated as Class C Common Units, which have no redemption rights, as elected by a majority of our independent directors. All other outstanding Common Units are designated as Class A Common Units, which are redeemable by the holders on a one-for-one basis for shares of Class A Common Stock or cash, as elected by a majority of our independent directors. Each Preferred Unit is convertible by the holder into 7.1717 Class B Common Units, but not before the date we consummate an underwritten public offering (of at least $75 million) of our common stock. Class B Common Units received upon conversion of Preferred Units will not be redeemable by the holder as described above for a period of one year after the date of conversion from Preferred Units to Class B Common Units.

The Preferred Units have fixed rights to annual distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit and priority over Common Units in the event of a liquidation of the Operating Partnership. At September 30, 2018, the cumulative unpaid distributions attributable to Preferred Units were $17.6 million. We anticipate continuing to accrue these distributions.

Common Units of all classes and Preferred Units of the Operating Partnership do not have any right to vote on any matters presented to our stockholders. We have outstanding one share of Proportionate Voting Preferred Stock, which is held by Pacific Office Holding, Inc., a corporation owned by Mr. Shidler and certain of our current and former executive officers and other affiliates. The Proportionate Voting Preferred Stock has no dividend rights and minimal rights to distributions in the event of liquidation, but it entitles its holder to vote on all matters for which the holders of Class A

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

Common Stock are entitled to vote. The Proportionate Voting Preferred Stock entitles its holder to cast a number of votes equal to the total number of shares of Class A Common Stock issuable upon redemption for shares of the Class B Common Units and Preferred Units issued in connection with the completion of our formation transactions on March 19, 2008. This number will decrease to the extent that these Class B Common Units are redeemed for shares of Class A Common Stock in the future, but will not increase in the event of future unit issuances by the Operating Partnership. As of September 30, 2018, that share of Proportionate Voting Preferred Stock represented 88% of our voting power. Pacific Office Holding, Inc. has agreed to cast its Proportionate Voting Preferred Stock votes on any matter in direct proportion to votes that are cast by limited partners of our Operating Partnership holding the Class B Common Units and Preferred Units issued in the formation transactions.

As of September 30, 2018, Venture owned 46,173,693 shares of our Class A Common Stock assuming that all Operating Partnership units were fully redeemed for shares on such date, notwithstanding the restrictions on redemption noted above. Assuming the immediate redemption of all the Operating Partnership units held by Venture, Venture and its related parties control 91.3% of the total voting power in the Company.

Earnings (Loss) per Share

We present both basic and diluted earnings (loss) per share (“EPS”). Basic EPS is computed by dividing net income or loss attributable to common stockholders by the weighted average number of shares of Class A Common Stock and Class B Common Stock outstanding during each period. Diluted EPS is computed by dividing net income or loss attributable to common stockholders for the period by the number of shares of Class A Common Stock and Class B Common Stock that would have been outstanding assuming the issuance of shares of Class A Common Stock for all potentially dilutive shares of Class A Common Stock outstanding during each period. Net income or loss in the Operating Partnership is allocated in accordance with the Partnership Agreement among our general partner and limited partner Common Unit holders in accordance with their weighted average ownership percentages in the Operating Partnership of 22.39% and 77.61%, respectively, as of September 30, 2018, after taking into consideration the priority distributions allocated to the limited partner preferred unit holders in the Operating Partnership.

The following is the basic and diluted income (loss) per share (in thousands, except share and per share amounts, and unaudited):



	For the three months ended September 30,					For the nine months ended September 30,
	2018		2017			2018			2017
Net income (loss) attributable to common stockholders - basic and diluted⁽¹⁾	$	1,658	$	(1,059	)	$	(561	)	$	(2,819	)

Weighted average number of common shares	4,067,434		3,945,481			4,020,241			3,942,671
Potentially dilutive common shares⁽²⁾	—		—			—			—
Weighted average number of common shares outstanding - basic and diluted	4,067,434		3,945,481			4,020,241			3,942,671
Net income (loss) per common share - basic and diluted	$	0.41	$	(0.27	)	$	(0.14	)	$	(0.72	)

___________________________

(1)

For each of the three month periods ended September 30, 2018 and 2017, net loss attributable to common stockholders includes $0.6 million of priority allocation to Preferred Unit holders. For each of the nine month periods ended September 30, 2018 and 2017, net loss attributable to common stockholders includes $1.7 million of priority allocation to Preferred Unit holders. These allocations are included in non-controlling interests in the consolidated statements of operations. The Company continues to accrue the distributions but does not anticipate paying the distributions in the foreseeable future. See below for additional detail.


(2)	For the three months ended September 30, 2018, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon conversion of Preferred Units and subsequent redemption, and 2,398,220 shares of Senior Common Stock

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss position;

For the nine months ended September 30, 2018, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon conversion of Preferred Units and subsequent redemption, and 2,402,939 shares of Senior Common Stock were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss position;

For the three months ended September 30, 2017, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon conversion of Preferred Units and subsequent redemption, and 2,410,415 shares of Senior Common Stock were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss position; and

For the nine months ended September 30, 2017, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon conversion of Preferred Units and subsequent redemption, and 2,410,696 shares of Senior Common Stock were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss position.

Refer to “Non-controlling Interests” and “Stockholders’ Equity (Deficit)” in this footnote for the redemption and conversion terms and conditions of the Preferred Units and Senior Common Stock.

Dividends and Distributions

Beginning December 2016, we ceased payment of dividends on the Senior Common Stock. We continue to accrue the stated dividend on our outstanding shares of Senior Common Stock (which amounted to $6.3 million in aggregate as of September 30, 2018) until paid in full, although we do not expect to resume the payment of dividends in the foreseeable future.

At September 30, 2018, the cumulative unpaid distributions attributable to Preferred Units were $17.6 million, which we do not anticipate paying in the foreseeable future.

Dividends accrued on the Senior Common Stock are included in “Cumulative deficit” in the accompanying consolidated balance sheets. Accrued distributions on Preferred Units are included in “Non-controlling interests” in the accompanying consolidated balance sheets.

11. Disposition Activity

Disposition of Unconsolidated Joint Venture Investments

In March 2017, the Pacific Business News Building property, located in Honolulu, Hawaii, was sold to an unaffiliated third party. Net proceeds from the sale of the property, which was owned by one of our unconsolidated joint ventures, were used to repay the mortgage note payable and other transaction related expenses, and then distributed to the members of the joint venture, including us. Our share of the distributed net proceeds amounted to $2.0 million.

Pan Am Building Sale

In August 2016, we entered into a Purchase and Sale Agreement to sell our Pan Am Building property, located in Honolulu, Hawaii, to Don Quijote (USA) Co., Ltd. (“Don Quijote”), one of the lenders under the loan agreement. On August 13, 2018, we completed the sale of the Pan Am Building property for cash consideration of $78.5 million. Accordingly, the associated assets and liabilities have been removed from our consolidated balance sheets as of September 30, 2018. The results of its operations for the three and nine month periods ended September 30, 2018 and 2017 are included in “Discontinued Operations” in the accompanying consolidated statements of operations, in accordance with the discontinued

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

operations criteria of FASB ASC 205, Presentation of Financial Statements - Discontinued Operations, as the sale represented a strategic shift in our operations.

The following table summarizes the major classes of assets and liabilities of the Pan Am Building property that are classified as held for sale at December 31, 2017 (in thousands):



	December 31, 2017
Investment in real estate, net	$	57,046
Rents and other receivables, net	121
Deferred rents	480
Intangible assets, net	480
Prepaid expenses	52
Total real estate and other assets held for sale	$	58,179

Accounts payable and other liabilities	$	1,513
Acquired below-market leases, net	2,778
Total liabilities of real estate assets held for sale	$	4,291

We wrote-off approximately $9.3 million of associated goodwill upon the sale of the Pan Am Building property.

The following table summarizes the operating results of the Pan Am Building property that comprise income (loss) from discontinued operations (in thousands and unaudited):



	For the three months ended September 30,						For the nine months ended September 30,
	2018			2017			2018			2017
Revenue	$	948		$	2,160		$	5,224		$	6,441
Expenses	1,141			2,968			6,417			8,583
Loss from discontinued operations before gain on sale of property	(193		)	(808		)	(1,193		)	(2,142		)
Gain on sale of property	12,615			—			12,615			—
Income (loss) from discontinued operations	$	12,422		$	(808	)	$	11,422		$	(2,142	)

Proceeds from the sale of the property were used to prepay $78.5 million of principal amount of the loan. The prepayment was not subject to a spread maintenance prepayment premium pursuant to the loan agreement.

12. Related Party Transactions

We are externally advised by Shidler Pacific Advisors, an entity that is owned and controlled by Mr. Shidler. Shidler Pacific Advisors is responsible for the day to day operations and management of the Company, including management of our wholly-owned properties. For its services, Shidler Pacific Advisors earned a corporate management fee of $0.2 million per quarter, which is reflected in “General and administrative” expenses in the accompanying consolidated statements of operations for the three and nine month periods ended September 30, 2018 and 2017, and property management fees of 2.5% to 3.0% of the rental cash receipts collected by the wholly-owned properties, and related fees; however, such property management and related fees are required to be consistent with prevailing market rates for similar services provided on an arms-length basis in the area in which the subject property is located.

The fees that were earned by Shidler Pacific Advisors for services relating to property management, corporate management, construction management and other services are summarized in the table below (in thousands and unaudited):

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)



	For the three months ended September 30,				For the nine months ended September 30,
	2018		2017		2018		2017
Property management	$	443	$	464	$	1,395	$	1,416
Corporate management	175		175		525		525
Construction management and other	15		17		170		62
Total	$	633	$	656	$	2,090	$	2,003

Shidler Pacific Advisors leases space from us at each of our wholly-owned properties for building management and corporate offices. The rents from these leases totaled $0.1 million and $0.2 million for the three month periods ended September 30, 2018 and 2017, respectively, and $0.5 million for each of the nine month periods ended September 30, 2018 and 2017. At September 30, 2018, we have $2.2 million, primarily related to outstanding corporate management fees, owed to Shidler Pacific Advisors included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets.

During each of the three month periods ended September 30, 2018 and 2017, we recognized $0.1 million in interest to Shidler LP for the annual fee related to its security pledge for the FHB Credit Facility. During each of the nine month periods ended September 30, 2018 and 2017, we recognized $0.4 million in interest to Shidler LP for the annual fee related to its security pledge for the FHB Credit Facility. As of September 30, 2018, we have accrued approximately $1.3 million of interest payments owed to Shidler LP for this annual fee included in “Accrued interest payable to current and former related parties” in the accompanying consolidated balance sheets. See Note 7 for more discussion on the FHB Credit Facility, including the security pledge made by Shidler LP.

The mortgage debt outstanding under our loan agreement is non-recourse to our Operating Partnership, except for customary recourse carve-outs for borrower misconduct and environmental liabilities. The recourse liability for borrower misconduct and environmental liabilities was guaranteed by Mr. Shidler. Our Operating Partnership has agreed to indemnify Mr. Shidler to the extent of his guaranty liability. See Note 9 for additional discussion on these indemnities.

At September 30, 2018 and December 31, 2017, $26.1 million and $23.0 million, respectively, of accrued interest attributable to unsecured notes payable to current and former related parties is included in the accompanying consolidated balance sheets. See Note 8 for a detailed discussion on these unsecured notes payable.

13. Fair Value of Financial Instruments

We are required to disclose fair value information about all financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate fair value. We measure and disclose the estimated fair value of financial assets and liabilities utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. This hierarchy consists of three broad levels as follows:

Level 1 - using quoted prices in active markets for identical assets or liabilities.

Level 2 - using quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.

Level 3 - using unobservable inputs that reflect an entity’s own assumptions that market participants would use when pricing of the asset or liability, to the extent observable inputs are not available.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The fair market value of debt is determined using the trading price of public debt or a discounted cash flow

Pacific Office Properties Trust, Inc.

Notes to Consolidated Financial Statements (continued)

technique that incorporates a market interest yield curve with adjustments for duration, optionality and risk profile, including the Company’s non-performance risk (Level 3). Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

The carrying amounts for cash and cash equivalents, restricted cash, rents and other receivables, accounts payable and other liabilities approximate fair value because of the short-term nature of these instruments. We calculate the fair value of our mortgage and other loans by using available market information and discounted cash flows analyses based on borrowing rates we believe we could obtain with similar terms and maturities. Because the valuations of our financial instruments are based on these types of estimates, the actual fair value of our financial instruments may differ materially if our estimates do not prove to be accurate. Additionally, the use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts. The carrying value of the unsecured related party notes approximates its fair value due to the short-term maturity of these liabilities. The carrying value of the revolving line of credit borrowings approximates its fair value since the borrowings bear interest at a variable market rate.

At September 30, 2018 , the carrying value (excluding accrued interest and unamortized deferred loan fees) and estimated fair value of the mortgage and other loans were $225.6 million. At December 31, 2017, the carrying value (excluding accrued interest and unamortized deferred loan fees) and estimated fair value of the mortgage and other loans were $304.1 million.

14. Subsequent Events

On October 10, 2018, our unconsolidated joint venture that owns the City Square property, located in Phoenix, Arizona, consented with the lender of the mortgage loan encumbering the property of the appointment of a receiver to manage the property. Our investment in the unconsolidated joint venture that owned this property amounted to $0.2 million as of September 30, 2018, and will be written off in the fourth quarter of 2018. Following the completion of this transaction, our investment in unconsolidated joint ventures will consist of a 5% interest in a joint venture holding a 35,000 square foot vacant building, which was previously a sports club, associated with the City Square property.

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

The following discussion should be read in conjunction with the other sections of this Quarterly Report on Form 10-Q, including the consolidated financial statements and the related notes thereto that appear in Item 1 of this Quarterly Report on Form 10-Q. Historical results set forth in the consolidated financial statements included in Item 1 and this Section should not be taken as indicative of our future operations.

Note Regarding Forward-Looking Statements

Our disclosure and analysis in this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which include information relating to future events, future financial performance, strategies, expectations, risks and uncertainties. From time to time, we also provide forward-looking statements in other materials we release to the public as well as oral forward-looking statements. These forward-looking statements include, without limitation, statements regarding: projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance; statements regarding strategic transactions such as mergers or acquisitions or a possible dissolution of the Company; and statements of management’s goals and objectives and other similar expressions. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. Words such as “believe,” “assume,” “may,” “will,” “should,” “could,” “would,” “predict,” “potential,” “continue,” “plan,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “strive” and similar expressions, as well as statements in future tense, identify forward-looking statements.

Certain matters discussed in this Quarterly Report on Form 10-Q are forward-looking statements. The risks and uncertainties inherent in such statements may cause actual future events or results to differ materially and adversely from those described in the forward-looking statements.

Pacific Office Properties Trust, Inc.

We cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. These factors include the risks and uncertainties described in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017. You should bear this in mind as you consider forward-looking statements.

We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K filed with the SEC.

Overview

We are an externally advised REIT that owns and operates primarily institutional-quality office properties in Hawaii. As of September 30, 2018, we owned two office properties comprising 0.9 million rentable square feet in Honolulu, Hawaii, and were partners with third parties in joint ventures holding one office property and a vacant building, which was previously a sports club, associated with that property in Phoenix, Arizona. Our ownership interest percentage in these joint ventures is 5.0%.

Our advisor is Shidler Pacific Advisors, LLC (“Shidler Pacific Advisors”), an entity that is owned and controlled by Jay H. Shidler, our Chairman of the Board. Lawrence J. Taff, our President, Chief Executive Officer, Chief Financial Officer and Treasurer, also serves as President of Shidler Pacific Advisors. Shidler Pacific Advisors is responsible for the day-to-day operation and management of the Company, including management of our wholly-owned properties.

We generated net income of $0.5 million for the nine months ended September 30, 2018 and incurred a net loss of $13.8 million for the year ended December 31, 2017. We have incurred cumulative net losses since inception of $256.3 million. We have not consistently achieved positive cash flow from operations since our formation transactions were contemplated in March 2008.

We maintain a website at www.pacificofficeproperties.com. The information on or accessible through our website is not part of this Quarterly Report on Form 10-Q. Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to such reports are available without charge on our website or upon request to us. In addition, our Code of Business Conduct and Ethics is available without charge on our website or upon request to us. Amendments to, or waivers from, our Code of Business Conduct and Ethics that apply to our executive officers will be posted to our website. We also post or otherwise make available on our website from time to time other information that may be of interest to our investors.

Critical Accounting Policies

This discussion and analysis of the historical financial condition and results of operations is based upon the accompanying consolidated financial statements which have been prepared in accordance with United States generally

Pacific Office Properties Trust, Inc.

accepted accounting principles, or GAAP. The preparation of these consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions in certain circumstances that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses in the reporting period. Actual amounts may differ from these estimates and assumptions. These estimates have been evaluated on an ongoing basis, based upon information currently available and on various assumptions that management believes are reasonable as of the date hereof. In addition, other companies in similar businesses may use different estimation policies and methodologies, which may impact the comparability of the results of operations and financial conditions to those of other companies.

In addition, we identified certain critical accounting policies that affect our more significant estimates and assumptions used in preparing our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2017. We have not made any material changes to those policies during the period covered by this Quarterly Report on Form 10-Q.

Results of Operations

Our results of operations for the three and nine month periods ended September 30, 2018 and 2017 include the results of our wholly-owned properties (Waterfront Plaza and Davies Pacific Center), including the results of our wholly-owned property we sold in August 2018 (Pan Am Building), and our equity in the net income (loss) of our unconsolidated joint ventures.

Overview

As of September 30, 2018, our wholly-owned properties were 87.1% leased, with 116,804 square feet available, under a total of 219 leases. As of that date, 2.9% of our leased square footage was scheduled to expire during 2018 and another 15.8% of our leased square footage was scheduled to expire during 2019.

As of December 31, 2017, our wholly-owned properties were 85.1% leased, with 167,539 square feet available, under a total of 312 leases. As of that date, 18.4% of our leased square footage was scheduled to expire during 2018 and another 14.0% of our leased square footage was scheduled to expire during 2019.

The following table summarizes the changes in vacant space for our wholly-owned properties for the three and nine month periods ended September 30, 2018 (in rentable square feet):



	For the three months ended September 30, 2018		For the nine months ended September 30, 2018
Vacant space available at the beginning of the period	188,124		167,539
Sale of Pan Am Building property	(26,134	)	(26,134	)
Expired or terminated during the period⁽¹⁾	31,656		134,297
Square footage adjustments and exclusions⁽²⁾	38,741		21,882
Total space available for lease	232,387		297,584
New leases	100,133		111,949
Renewed leases	15,450		68,831
Total space leased during the period	115,583		180,780
Vacant space available at the end of the period	116,804		116,804

___________________________


(1)	Includes leases that expired on the last day of the prior period.


(2)	Includes adjustments for remeasured square footage, right-to-use leases, month-to-month storage leases and leases executed in the period but not yet occupied.

Pacific Office Properties Trust, Inc.

We receive income primarily from rental revenue (including tenant reimbursements) from our office properties and, to a lesser extent, from our parking revenues. Our office properties are typically leased to tenants with good credit for terms ranging from two to 20 years. We perform credit evaluations on new tenants by requesting and reviewing their financial statements and recent tax returns. During the terms of our leases, we monitor the credit quality of our tenants by reviewing the timeliness of their lease payments. In addition, we may review financial statements, operating statements and/or performance of other financial covenants as allowed for under their lease.

Comparison of the three months ended September 30, 2018 to

the three months ended September 30, 2017 (in thousands)



	2018			2017			$ Change			% Change
Revenue:
Rental	$	4,272		$	4,406		$	(134	)	(3.0	)%
Tenant reimbursements	3,230			3,362			(132		)	(3.9	)%
Parking	1,357			1,359			(2		)	(0.1	)%
Other	159			184			(25		)	(13.6	)%
Total revenue	9,018			9,311			(293		)	(3.1	)%
Expenses:
Rental property operating	5,687			5,251			436			8.3	%
General and administrative	486			439			47			10.7	%
Depreciation and amortization	1,896			2,157			(261		)	(12.1	)%
Interest	4,897			4,383			514			11.7	%
Total expenses	12,966			12,230			736			6.0	%
Loss from continuing operations before equity in net loss of unconsolidated joint ventures	(3,948		)	(2,919		)	(1,029		)	35.3	%
Equity in net loss of unconsolidated joint ventures	(65		)	(46		)	(19		)	41.3	%
Loss from continuing operations	(4,013		)	(2,965		)	(1,048		)	35.3	%
Discontinued operations:
Loss from discontinued operations before gain on sale of property	(193		)	(808		)	615			(76.1	)%
Gain on sale of property	12,615			—			12,615			100.0	%
Income (loss) from discontinued operations	12,422			(808		)	13,230			NM

Net income (loss)	$	8,409		$	(3,773	)	$	12,182		(322.9	)%

___________________________

NM Not meaningful.

Revenues

Rental revenue. Total rental revenue decreased by $0.1 million, or 3.0%, primarily due to a decrease in rental revenues at Waterfront Plaza as a result of a significant tenant renewing its lease for less space in the current year period.

Tenant reimbursements. Total tenant reimbursements decreased by $0.1 million, or 3.9%, primarily due to decreases in tenant recoveries for common area maintenance expenses at Davies Pacific Center ($0.1 million) and Waterfront Plaza ($0.1 million) as compared to the prior year period, partially offset by an increase in electricity reimbursements at Waterfront Plaza ($0.1 million) compared to the prior year period.

Parking revenue. Total parking revenue decreased by an insignificant amount compared to the prior year period.

Pacific Office Properties Trust, Inc.

Other revenue. Total other revenue decreased by an insignificant amount compared to the prior year period.

Expenses

Rental property operating expenses. Total rental property operating expenses increased by $0.4 million, or 8.3%, primarily due to reimbursements received for janitorial maintenance expenses at Davies Pacific Center ($0.2 million) in the prior year period and increases in electricity expenses at Davies Pacific Center ($0.1 million) and Waterfront Plaza ($0.1 million) as compared to the prior year period.

General and administrative expense. Total general and administrative expenses increased by an insignificant amount compared to the prior year period.

Depreciation and amortization expense. Total depreciation and amortization expenses decreased by $0.3 million, or 12.1%, primarily due to a decrease in depreciation expenses at Waterfront Plaza as a result of assets being fully depreciated ($0.1 million) and write-offs of tenant improvements and deferred leasing costs related to tenants at Waterfront Plaza that vacated their leased premises in the prior year period ($0.1 million).

Interest expense. Total interest expense increased by $0.5 million, or 11.7%, primarily due to increases in interest rates attributable to Davies Pacific Center ($0.2 million) and Waterfront Plaza ($0.2 million) and an increase in accrued interest on the unsecured notes payable to current and former related parties ($0.1 million) as compared to the prior year period.

Equity in net loss of unconsolidated joint ventures

Equity in net loss of unconsolidated joint ventures increased by an insignificant amount compared to the prior year period.

Loss from discontinued operations before gain on sale of property

For the three month periods ended September 30, 2018 and 2017, discontinued operations reflect the net results of operations of the Pan Am Building property, which met the criteria to be classified as an asset held for sale beginning March 2018. Loss from discontinued operations before gain on the sale of property decreased, as compared to the prior year period, primarily resulting from the termination of recording depreciation expense at the time the Pan Am Building was classified as held for sale.

Gain on sale of property

We recognized a gain related to the sale of our Pan Am Building property in August 2018. We previously classified the assets and liabilities related to this property as held for sale on our consolidated balance sheets and the net results of its operations as discontinued operations on our consolidated statements of operations.

Pacific Office Properties Trust, Inc.

Comparison of the nine months ended September 30, 2018 to

the nine months ended September 30, 2017 (in thousands)



	2018			2017			$ Change			% Change
Revenue:
Rental	$	12,697		$	13,019		$	(322	)	(2.5	)%
Tenant reimbursements	9,614			10,205			(591		)	(5.8	)%
Parking	4,108			4,053			55			1.4	%
Other	306			331			(25		)	(7.6	)%
Total revenue	26,725			27,608			(883		)	(3.2	)%
Expenses:
Rental property operating	16,403			16,212			191			1.2	%
General and administrative	1,308			1,595			(287		)	(18.0	)%
Depreciation and amortization	5,630			6,262			(632		)	(10.1	)%
Interest	14,118			12,643			1,475			11.7	%
Total expenses	37,459			36,712			747			2.0	%
Loss from continuing operations before equity in net (loss) income of unconsolidated joint ventures	(10,734		)	(9,104		)	(1,630		)	17.9	%
Equity in net (loss) income of unconsolidated joint ventures	(200		)	1,426			(1,626		)	(114.0	)%
Loss from continuing operations	(10,934		)	(7,678		)	(3,256		)	42.4	%
Discontinued operations:
Loss from discontinued operations before gain on sale of property	(1,193		)	(2,142		)	949			(44.3	)%
Gain on sale of property	12,615			—			12,615			100.0	%
Income (loss) from discontinued operations	11,422			(2,142		)	13,564			NM

Net income (loss)	$	488		$	(9,820	)	$	10,308		(105.0	)%

___________________________

NM Not meaningful.

Revenues

Rental revenue. Total rental revenue decreased by $0.3 million, or 2.5%, primarily due to a decrease in rental revenues at Waterfront Plaza as a result of a significant tenant renewing its lease for less space ($0.5 million) and negotiated lease incentives for two significant tenants in the current year period ($0.2 million), partially offset by a write-off of deferred rent revenues related to a significant tenant at Waterfront Plaza that vacated its leased premises in the prior year period ($0.3 million).

Tenant reimbursements. Total tenant reimbursements decreased by $0.6 million, or 5.8%, primarily due to decreases in tenant recoveries for common area maintenance expenses at Davies Pacific Center ($0.3 million) and Waterfront Plaza ($0.4 million) as compared to the prior year period, partially offset by an increase in electricity reimbursements at Waterfront Plaza ($0.1 million) compared to the prior year period.

Parking revenue. Total parking revenue increased by $0.1 million, or 1.4%, primarily due to an increase in parking revenues at Waterfront Plaza as compared to the prior year period.

Other revenue. Total other revenue decreased by an insignificant amount compared to the prior year period.

Pacific Office Properties Trust, Inc.

Expenses

Rental property operating expenses. Total rental property operating expenses increased by $0.2 million, or 1.2%, primarily due to increases in electricity expenses ($0.2 million) and real property taxes ($0.1 million) at Waterfront Plaza as compared the prior year period, an increase in general excise taxes due to a refund at Waterfront Plaza ($0.1 million) in the prior year period, and a reimbursement in the prior year period for janitorial maintenance expenses at Davies Pacific Center ($0.1 million), partially offset by and a decrease in bad debt expense at Waterfront Plaza ($0.3 million) as compared to the prior year period.

General and administrative expense. Total general and administrative expenses decreased by $0.3 million, or 18.0%, primarily due to a decrease in professional services fees compared to the prior year period.

Depreciation and amortization expense. Total depreciation and amortization expenses decreased by $0.6 million, or 10.1%, primarily due to decreases in depreciation and amortization expenses at Davies Pacific Center ($0.1 million) and Waterfront Plaza ($0.3 million) as a result of assets being fully depreciated and write-offs of tenant improvements and deferred leasing costs related to tenants at Waterfront Plaza that vacated their leased premises in the prior year period ($0.2 million).

Interest expense. Total interest expense increased by $1.5 million, or 11.7%, primarily due to increases in interest rates attributable to Davies Pacific Center ($0.5 million) and Waterfront Plaza ($0.8 million) and an increase in accrued interest on the unsecured notes payable to current and former related parties ($0.2 million) as compared to the prior year period.

Equity in net (loss) income of unconsolidated joint ventures

Equity in net loss of unconsolidated joint ventures was $0.2 million for the nine months ended September 30, 2018 compared to equity in net income of unconsolidated joint ventures of $1.4 million for the nine months ended September 30, 2017. The decrease was primarily attributable to the gain on the sale of the Pacific Business News Building joint venture property in March 2017.

Loss from discontinued operations before gain on sale of property

For the nine month periods ended September 30, 2018 and 2017, discontinued operations reflect the net results of operations of the Pan Am Building property, which met the criteria to be classified as an asset held for sale beginning March 2018. Loss from discontinued operations decreased, as compared to the prior year period, primarily resulting from the termination of recording depreciation expense at the time the Pan Am Building was classified as held for sale.

Gain on sale of property

Cash Flows

Net cash used in operating activities for the Company for the nine months ended September 30, 2018 was $1.1 million compared to net cash provided by operating activities of $2.3 million for the nine months ended September 30, 2017. The decrease was primarily the result of an increase in total interest payments ($1.4 million) over the prior year period, a decrease in accounts payable and accrued expenses attributable to the Pan Am Building as compared to the prior year period ($0.8 million) and a decrease in revenues from Waterfront Plaza and Davies Pacific Center as compared to the prior year period.

Net cash provided by investing activities for the Company for the nine months ended September 30, 2018 was $74.7 million compared to net cash used in investing activities of $1.4 million for the nine months ended September 30, 2017. The decrease was primarily the result of net proceeds from the sale of our Pan Am Building property in August 2018 ($77.9 million), partially offset by a one-time distribution from one of our joint ventures which sold the Pacific Business News Building property in March 2017 ($1.9 million).

Pacific Office Properties Trust, Inc.

Net cash used in financing activities for the nine months ended September 30, 2018 was $75.4 million compared to $0.6 million for the nine months ended September 30, 2017. The increase was primarily due to the repayment of mortgage notes payable primarily related to the Pan Am Building property as a result of the sale of the property in August 2018 ($77.8 million) and a decrease in security deposits ($0.5 million) as compared to the prior year period, partially offset by borrowings from a related party in the current year period ($3.5 million).

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs.

We expect that our cash flows from operations, including existing cash on hand, will be insufficient to meet working capital requirements and to fund required capital expenditures and leasing costs beyond the fourth quarter of 2018. The mortgage debt on our wholly-owned properties is scheduled to mature on August 11, 2019. We do not have any committed financing sources available to refinance our debt as it matures. If we are unable to repay, extend or refinance our existing mortgage debt, we may be forced to give back these properties to our mortgage lenders.

Our primary source of cash in recent years has been the opportunistic sale of properties and borrowings from related parties. In March 2017, we completed the sale of our Pacific Business News Building joint venture property to an unrelated third party. In August 2018, we completed the sale of our Pan Am Building property to one of the lenders under our loan agreement. To assist with closing costs and working capital, we issued a promissory note in the principal amount of $3.5 million to Shidler Equities, L.P. in consideration of a loan in that amount made by Shidler LP to the Operating Partnership. See Note 11 for more discussion on the sale of these properties and Note 8 for more discussion on the new promissory note.

Following the completion of the sale of the Pan Am Building property, our property portfolio consists of two wholly-owned office properties (Waterfront Plaza and Davies Pacific Center) and our 5% interests in joint ventures holding one office property and a vacant building, which was previously a sports club, associated with that property.

Pacific Office Properties Trust, Inc.

requirements, our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or needed.

Actual and Potential Sources of Liquidity

Listed below are our actual and potential sources of liquidity in the near term:


•	Unrestricted and restricted cash on hand;


•	Net cash flow generated from operations;


•	Distributions from joint ventures; and/or


•	Asset dispositions.

These sources are essential to our short-term liquidity and financial position, and we cannot assure you that we will be able to successfully access them. If we are unable to generate adequate cash from these sources, we will have liquidity-related problems and may be exposed to significant risks. For a further discussion of such risks, see Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017.

Unrestricted and restricted cash on hand

As of September 30, 2018, we had $1.7 million in unrestricted cash and cash equivalents. In addition, we had restricted cash balances of $10.5 million. A summary of our restricted cash reserves is as follows (in thousands):



	September 30, 2018
Leasing and capital expenditure reserves	$	6,550
Ground lease reserves	—
Tax, insurance and other working capital reserves	874
Collateral accounts	1,616
Tenant security deposits	1,447
Total restricted cash	$	10,487

The leasing and capital expenditure, ground lease, tax, insurance and other working capital reserves and collateral accounts are held in restricted accounts by our lenders in accordance with the terms of our mortgage loan. These restricted cash accounts are expected to fund (1) anticipated leasing expenditures (primarily commissions and tenant improvement costs) for existing and prospective tenants, (2) non-recurring discretionary capital expenditures, (3) payments for properties subject to ground leases, (4) property taxes and insurance and (5) other obligations. We maintain our tenant security deposits in a separate account at our financial institution.

Net cash flow generated from operations

Our cash flows from operations depend significantly on market rents and the ability of our tenants to make rental payments. While we believe the diversity and high credit quality of our tenants help to mitigate the risk of a significant interruption of our cash flows from operations, the challenging Honolulu office market conditions that we are continuing to experience, increases in interest rates, or the possibility of a downturn or return to recessionary conditions could adversely impact our operating cash flows. Competition to attract and retain high credit-quality tenants remains intense. At the same time, a significant number of our leases at our properties are scheduled to expire over the next several years, and the capital requirements necessary to maintain our current occupancy levels, including payment of leasing commissions, tenant concessions, and anticipated leasing expenditures, could increase. As such, we will continue to closely monitor our tenant renewals, rental rates, competitive market conditions and our cash flows.

We have not consistently achieved positive cash flow from operations since our formation transactions were contemplated in March 2008.

Pacific Office Properties Trust, Inc.

Distributions from joint ventures

Following the sale of the Pacific Business News Building property, we are currently partners with third parties in two joint ventures, holding one office property and a vacant building, previously a sports club, associated with that property in Phoenix, Arizona. Distributions from our joint ventures depend significantly on our joint ventures’ ability to generate positive cash flow from their rental operations or the sale of properties held by them. Our joint ventures’ ability to successfully manage their operations or identify, negotiate and close sale transactions on acceptable terms or at all is uncertain. We do not expect distributions from joint ventures to be a significant source of liquidity for us in the future.

Asset dispositions

We may seek to raise additional capital by selling our wholly-owned assets, but, following the completion of the sale of our Pan Am Building as discussed below, we have only two such assets that could be sold to generate net cash proceeds and our ability to do so on acceptable terms or at all is highly uncertain.

In August 2016, we entered into a Purchase and Sale Agreement to sell our Pan Am Building property, located in Honolulu, Hawaii, to a third party buyer for cash consideration of $78.5 million. In August 2018, we completed the sale of the Pan Am Building property. Proceeds from the sale of the property was used to prepay $78.5 million of principal amount of the loan. The prepayment was not subject to a spread maintenance prepayment premium pursuant to the loan agreement. See Note 7 for more discussion on the loan agreement and Note 11 for more discussion on the sale of our Pan Am Building.

Actual and Potential Uses of Liquidity

The following are the actual and potential uses of our cash in the near term. There may be other uses of our cash that are unexpected (and that are not identified below):


•	Property operating and corporate expenses;


•	Capital expenditures (including building and tenant improvements and leasing commissions); and/or


•	Debt service and financing costs.

Property operating and corporate expenses

Capital expenditures (including building and tenant improvements and leasing commissions)

Pacific Office Properties Trust, Inc.

contractually obligated to spend $9.6 million with other projected discretionary obligations of $0.7 million through 2019. We intend to mitigate any capital project overages and continue to request the maximum amount of reimbursements from our reserves on a timely basis.

The following table summarizes tenant improvement and leasing commission costs related to new and renewed leases of our wholly-owned properties:



	For the nine months ended September 30, 2018
	New Leases		Renewed Leases		Total Leases
Square feet⁽¹⁾	111,452		54,681		166,133
Tenant improvement costs per square foot⁽²⁾	$	32.93	$	9.30	$	25.15
Leasing commission costs per square foot	18.64		5.53		14.32
Total tenant improvement and leasing commission costs per square foot	$	51.57	$	14.83	$	39.47

___________________________


(1)	Excludes the Pan Am Building property which was sold in August 2018, right-to-use leases and month-to-month storage leases.


(2)	Based on the negotiated tenant improvement cost budget at the time of lease execution, which may be incurred in a subsequent year and different than actual costs incurred.

Debt service and financing costs

Dividends or Other Distributions

Because we conduct substantially all of our operations through our Operating Partnership, our ability to pay dividends or other distributions (including liquidating distributions) to our stockholders depends almost entirely on distributions received on our interests in our Operating Partnership, the payment of which depends in turn on our ability to operate profitably and generate cash flow from our operations. Our ability to pay dividends or other distributions to holders of our Class A Common Stock depends on our Operating Partnership’s ability first to satisfy its obligations to its creditors and preferred unitholders (including us with respect to the outstanding Senior Common Units of our Operating Partnership, and then to the holder of the outstanding Preferred Units of our Operating Partnership) and then to make distributions to us with respect to our general partnership interest. Our Operating Partnership may not make distributions to the holders of its outstanding Common Units (including us with respect to our general partnership interest) unless full cumulative distributions have been paid on its outstanding Senior Common Units and Preferred Units, and we may not pay dividends on our Class A Common Stock unless full cumulative dividends have been paid on our outstanding Senior Common Stock.

We did not declare a dividend on our Class A Common Stock during 2017, and do not expect to declare a dividend on our Class A Common Stock in 2018. Furthermore, our Operating Partnership did not pay a distribution with respect to its outstanding Preferred Units or Common Units during 2017, and does not expect to do so for 2018. As noted above, unless full cumulative distributions have been paid on the outstanding Senior Common Units and Preferred Units, our Operating Partnership may not pay a distribution on its outstanding Common Units (including us with respect to our general partnership interest), which effectively means that we will be unable to pay dividends or other distributions on our Class A Common Stock unless and until all cumulative dividends and distributions have been paid with respect to the Senior Common Stock and the Preferred Units.

Pacific Office Properties Trust, Inc.

September 30, 2018) until paid in full, although we do not expect to resume the payment of dividends in the foreseeable future.

At September 30, 2018, the cumulative unpaid distributions attributable to Preferred Units were $17.6 million, which we do not anticipate paying in the foreseeable future.

We do not expect that we will be able to resume the payment of dividends (including dividends on our Senior Common Stock) in the foreseeable future. Our ability to pay dividends or other distributions in the future will depend upon our legal and contractual restrictions, including the provisions of the Senior Common Stock, as well as actual results of operations, economic conditions, debt service requirements and other factors. Our actual results of operations will be affected by a number of factors, including the revenue we receive from our properties, our operating expenses, interest expense, the ability of our tenants to meet their obligations and unanticipated expenditures. For a further discussion of such risks, see Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017.

Indebtedness

Mortgage and Other Loans

The following table sets forth information relating to our borrowings with respect to our consolidated property loan and our revolving line of credit as of September 30, 2018:



	Amount			Maturity Date
Consolidated property loan⁽¹⁾	$	200,551		8/11/2019
Revolving line of credit⁽²⁾	25,000			12/31/2019
Outstanding principal balance	225,551
Less: unamortized deferred loan fees, net	(1,253		)
Mortgage and other loans, net	$	224,298

___________________________

(1)

The loan is subject to monthly interest payments bearing interest at a floating rate per annum equal to the One-Month LIBOR Rate plus 4.5% and monthly partial principal payments based on the availability of cash after making required distributions for operating costs and reserves pursuant to a payment waterfall and other terms and conditions under the loan agreement. The loan may be prepaid in whole prior to its maturity date, subject to a spread maintenance prepayment premium and by providing a 30-day prepayment notice and complying with certain prepayment conditions. As of September 30, 2018, the applicable One-Month LIBOR Rate was 2.133%.

(2)

In connection with entering into the loan agreement, in August 2016, we entered into a Purchase and Sale Agreement to sell our Pan Am Building property, located in Honolulu, Hawaii, to one of the lenders under the loan agreement, for cash consideration of $78.5 million. The completion of the sale transaction occurred on August 13, 2018. In accordance with the loan agreement and Purchase and Sale Agreement, the proceeds from the sale of the property was used to prepay (with no prepayment premium) $78.5 million of the principal amount outstanding under the loan agreement.

Pacific Office Properties Trust, Inc.

Revolving Line of Credit

We are party to a Credit Agreement, referred to as the FHB Credit Facility, with First Hawaiian Bank, or the Lender, which provides us with a revolving line of credit in the maximum principal amount of $25.0 million and has a maturity date of December 31, 2019. Amounts borrowed under the FHB Credit Facility bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the Lender on time certificates of deposit, plus 1.00%. We are permitted to use the proceeds of the line of credit for working capital and general corporate purposes, consistent with our real estate operations and for such other purposes as the Lender may approve. As of September 30, 2018 and December 31, 2017, we had outstanding borrowings of $25.0 million under the FHB Credit Facility.

Subordinated Promissory Notes

In 2008, we issued $21.1 million of promissory notes as consideration for having funded certain capital improvements prior to the completion of our formation transactions and upon the exercise of an option granted to us by Venture and its affiliates as part of our formation transactions in 2008. The promissory notes accrue interest at a rate of 7%, per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity. The promissory notes were originally scheduled to mature on various dates commencing on March 19, 2013 through August 31, 2013, but the Operating Partnership elected to extend the maturity for one additional year. The maturity date of the promissory notes has subsequently been extended to December 31, 2019.

In February 2014, we issued to certain current and former affiliates additional promissory notes in the aggregate principal amount of $8.3 million to settle claims under tax protection agreements relating to the sale of our First Insurance Center property in 2012. See “Tax Protection Arrangements” in Note 9 for additional information. These promissory notes accrue interest at a rate of 5% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity, and were originally scheduled to mature on December 31, 2015. The maturity date of the promissory notes has subsequently been extended to December 31, 2019.

Pacific Office Properties Trust, Inc.

5% per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods until the date of maturity. The promissory note is scheduled to mature on December 31, 2019.

For the period from March 20, 2008 through September 30, 2018, interest payments on these promissory notes have been deferred with the exception of $0.3 million which was related to notes exchanged for shares of common stock in 2009. At September 30, 2018 and December 31, 2017, $26.1 million and $23.0 million, respectively, of accrued interest attributable to these promissory notes is included in the accompanying consolidated balance sheets.

Off-Balance Sheet Arrangements

Inflation

We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. Because the majority of our leases require tenants to pay most operating expenses, including real estate taxes, utilities, insurance, and increases in common area maintenance expenses, we do not believe our exposure to increases in costs and operating expenses resulting from inflation is material. Furthermore, the majority of our existing leases contain contractual annual rental rate increases, which will at least partially offset the effect of inflation on our operating results.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not required.

Item 4. Controls and Procedures.

Evaluation of disclosure controls and procedures -

As required by Rule 13a-15(b) of the Exchange Act, in connection with the filing of this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2018, the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting -

There have been no changes in our internal control over financial reporting that occurred during the quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Pacific Office Properties Trust, Inc.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently a party, as plaintiff or defendant, to any legal proceedings which, individually or in the aggregate, are expected by us to have a material effect on our business, financial condition or results of operation if determined adversely to us.

Item 1A. Risk Factors.

Important factors that could cause our actual results to be materially different from the forward-looking statements include the risks factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017. There have been no material changes to the risk factors set forth in those reports. In addition to the other information set forth in this report, you should carefully consider those risk factors, which could materially affect our business, financial condition and results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Pacific Office Properties Trust, Inc.

Item 6. Exhibits.



Exhibit No.		Description

3.1		Articles of Amendment and Restatement of the Company (previously filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 (File No. 001-09900) and incorporated herein by reference).

3.2		Articles Supplementary of the Company dated November 20, 2009 (previously filed as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 (File No. 001-09900) and incorporated herein by reference).

3.3		Articles of Amendment of the Company dated November 20, 2009 (previously filed as Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 (File No. 001-09900) and incorporated herein by reference).

3.4		Articles of Amendment of the Company dated January 5, 2010 (previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed January 5, 2010 (File No. 001-09900) and incorporated herein by reference).

3.5		Articles Supplementary of Board of Directors Reclassifying and Designating a series of common stock as Senior Common Stock, dated March 4, 2010 (previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed March 9, 2010 (File No. 001-09900) and incorporated herein by reference).

3.6		Certificate of Correction to Articles Supplementary, dated April 30, 2010 (previously filed as Exhibit 3.6 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (File No. 001-09900) and incorporated herein by reference).

3.7		Articles of Amendment of the Company dated November 1, 2010 (previously filed as Exhibit 3.7 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 (File No. 001-09900) and incorporated herein by reference).

3.8		Articles of Amendment of the Company dated May 21, 2012 (previously filed as Exhibit 3.8 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 (File No. 001-09900) and incorporated herein by reference).

3.9		Second Amended and Restated Bylaws dated April 5, 2017 (previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed April 25, 2017 (File No. 001-09900) and incorporated herein by reference).

10.1		Fifth Amendment to Subordinated Promissory Notes, dated as of August 7, 2018, among Pacific Office Properties, L.P. and the holders named therein (Filed herewith).

31.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)

32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Furnished herewith.)

101		Interactive Data File. (Filed herewith.)

SIGNATURE

Pursuant to the requirements 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.



		PACIFIC OFFICE PROPERTIES TRUST, INC.


Date:	November 9, 2018	By:	/s/ Lawrence J. Taff
			Lawrence J. Taff
			Chief Executive Officer and Chief Financial Officer
			(Principal Executive Officer and Principal Financial Officer)

PACIFIC OFFICE PROPERTIES TRUST, INC. 10-Q