Highlands REIT, Inc. - FORM 10-Q

Highlands REIT, Inc. - FORM 10-Q - November 10, 2016

Attached files

Attached files

Highlands REIT, Inc. Reports

file	filename
EX-32.2 - EXHIBIT 32.2 - Highlands REIT, Inc.	exhibit32220160930.htm
EX-32.1 - EXHIBIT 32.1 - Highlands REIT, Inc.	exhibit32120160930.htm
EX-31.2 - EXHIBIT 31.2 - Highlands REIT, Inc.	exhibit31220160930.htm
EX-31.1 - EXHIBIT 31.1 - Highlands REIT, Inc.	exhibit31120160930.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________

FORM 10-Q

_____________________________

(Mark One)

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

For the quarterly period ended September 30, 2016

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

For the transition period from to

Commission file number 000-55580

HIGHLANDS REIT, INC.

(Exact Name of Registrant as Specified in Its Charter)




Maryland		81-0862795
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

332 S Michigan Avenue, Ninth Floor Chicago, Illinois		60604
(Address of Principal Executive Offices)		(Zip Code)

(312) 583-7990

(Registrant’s telephone number, including area code)

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. þ Yes ¨ 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). þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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). o Yes þ No

As of November 2, 2016 there were 864,890,967 shares of the registrant’s common stock outstanding.

Table of Contents

TABLE OF CONTENTS




	Part I - Financial Information
Item 1.	Condensed Combined Consolidated Financial Statements (unaudited)
	Condensed Combined Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015	1
	Condensed Combined Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015	2
	Condensed Combined Consolidated Statements of Equity for the nine months ended September 30, 2016 and 2015	3
	Condensed Combined Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015	4
	Notes to Condensed Combined Consolidated Financial Statements	6

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	37

	Part II - Other Information
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	38
Item 4.	Mine Safety Disclosures	38
Item 5.	Other Information	38
Item 6.	Exhibits	38
	Signatures	39

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Condensed Combined Consolidated Balance Sheets

As of September 30, 2016 and December 31, 2015

(Dollar amounts in thousands, except per share amounts)



	September 30, 2016			December 31, 2015
	(unaudited)
Assets
Investment properties
Land	$	121,832		$	153,646
Building and other improvements	417,100			711,262
Construction in progress	126			—
Total	539,058			864,908
Less accumulated depreciation	(80,738		)	(185,100		)
Net investment properties	458,320			679,808
Cash and cash equivalents	34,181			26,972
Restricted cash and escrows	3,152			3,647
Accounts and rents receivable (net of allowance of $363 and $104)	10,769			12,554
Intangible assets, net	7,343			12,547
Deferred costs and other assets	4,247			3,626
Total assets	$	518,012		$	739,154
Liabilities
Debt, net	$	389,955		$	437,032
Accounts payable and accrued expenses	31,138			28,298
Intangible liabilities, net	3,931			5,074
Other liabilities	2,269			1,897
Total liabilities	$	427,293		$	472,301
Commitments and contingencies
Stockholder’s Equity
Preferred stock, $0.01 par value, 50,000,000 shares authorized, zero shares issued and outstanding as of September 30, 2016	—			—
Common stock, $0.01 par value, 1,000,000,000 shares authorized, 864,890,967 shares issued and outstanding as of September 30, 2016	8,649			—
Additional paid in capital	1,405,504			1,534,018
Accumulated distributions in excess of net income (loss)	(1,323,434		)	(1,267,165		)
Total stockholders’ equity	90,719			266,853
Total liabilities and equity	$	518,012		$	739,154

See accompanying notes to the condensed combined consolidated financial statements

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Condensed Combined Consolidated Statements of Operations

(Dollar amounts in thousands, except per share amounts)

For the three and nine months ended September 30, 2016 and 2015

(unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Revenues
Rental income	$	17,272		$	23,918		$	62,987		$	72,126
Tenant recovery income	2,917			3,094			8,352			10,939
Other property income	168			381			449			747
Total revenues	$	20,357		$	27,393		$	71,788		$	83,812
Expenses
Property operating expenses	3,023			2,000			7,124			7,728
Real estate taxes	2,886			2,525			7,149			8,156
Depreciation and amortization	6,168			9,034			21,413			27,261
General and administrative expenses	3,508			3,075			10,590			9,212
Provision for asset impairment	18,967			—			61,582			—
Total expenses	$	34,552		$	16,634		$	107,858		$	52,357
Operating (loss) income	$	(14,195	)	$	10,759		$	(36,070	)	$	31,455
Loss on sale of investment properties	—			(197		)	—			(197		)
Other loss	—			(1		)	(113		)	(10		)
Interest expense	(7,143		)	(7,238		)	(19,847		)	(21,062		)
(Loss) income before income taxes	$	(21,338	)	$	3,323		$	(56,030	)	$	10,186
Income tax expense	(2		)	(9		)	(239		)	(24		)
Net (loss) income	$	(21,340	)	$	3,314		$	(56,269	)	$	10,162
Less: Net income attributable to non-controlling interests	—			(8		)	—			(16		)
Net (loss) income attributable to Company	$	(21,340	)	$	3,306		$	(56,269	)	$	10,146
Net (loss) income per common share, basic and diluted	$	(0.02	)	$	0.00		$	(0.07	)	$	0.01
Weighted average number of common shares outstanding, basic and diluted	864,890,967			862,014,421			864,515,587			862,014,421

See accompanying notes to the condensed combined consolidated financial statements.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Condensed Combined Consolidated Statements of Equity

(Dollar amounts in thousands)

For the nine months ended September 30, 2016 and 2015

(unaudited)



	Common Stock
	Shares		Amount			Additional Paid in Capital			Accumulated Distributions in Excess of Net (Loss) Income			Non- Controlling Interests			Total
Balance at January 1, 2016	—		$	—		$	1,534,018		$	(1,267,165	)	$	—		$	266,853
Net loss	—		—			—			(56,269		)	—			(56,269		)
Issuance of common shares and reduction in carryover basis in connection with separation from InvenTrust	862,205,672		8,622			(85,205		)	—			—			(76,583		)
Repurchase of common shares, net	(191,251	)	(2		)	(67		)	—			—			(69		)
Share-based compensation	2,876,546		29			1,253			—			—			1,282
Distributions to InvenTrust	—		—			(129,853		)	—			—			(129,853		)
Contributions from InvenTrust	—		—			85,358			—			—			85,358
Balance at September 30, 2016	864,890,967		$	8,649		$	1,405,504		$	(1,323,434	)	$	—		$	90,719

	Common Stock
	Shares		Amount			Additional Paid in Capital			Accumulated Distributions in Excess of Net (Loss) Income			Non- Controlling Interests			Total
Balance at January 1, 2015	—		$	—		$	1,593,858		$	(1,276,875	)	$	125		$	317,108
Net income	—		—			—			10,146			16			10,162
Dividends paid						—			(4,620		)	—			(4,620		)
Distributions to non-controlling interests	—		—			—			—			(16		)	(16		)
Distributions to InvenTrust	—		—			(132,459		)	—			—			(132,459		)
Contributions from InvenTrust	—		—			93,459			—			—			93,459
Balance at September 30, 2015	—		$	—		$	1,554,858		$	(1,271,349	)	$	125		$	283,634

See accompanying notes to the condensed combined consolidated financial statements.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Condensed Combined Consolidated Statements of Cash Flow

(Dollar amounts in thousands)

For the nine months ended September 30, 2016 and 2015

(unaudited)



	Nine months ended September 30,
	2016			2015
Cash flows from operating activities:
Net (loss) income	$	(56,269	)	$	10,162
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization	21,354			27,280
Amortization of above and below market leases, net	(728		)	(312		)
Amortization of debt discounts and financing costs	160			166
Straight-line rental income	2,361			1,927
Loss on sale of investment properties, net	—			197
Provision for asset impairment	61,582			—
Non-cash stock-based compensation expense	2,319			—
Changes in assets and liabilities:
Accounts and rents receivable	(933		)	(153		)
Deferred costs and other assets	(2,676		)	593
Accounts payable and accrued expenses	4,464			556
Other liabilities	775			(214		)
Net cash flows provided by operating activities	$	32,409		$	40,202
Cash flows from investing activities:
Capital expenditures and tenant improvements	(548		)	(1,985		)
Proceeds from sale of investment properties, net	—			7,860
Payment of leasing fees	(624		)	(2,021		)
Restricted escrows and other assets	1,941			(552		)
Net cash flows provided by investing activities	$	769		$	3,302
Cash flows from financing activities:
Distributions to InvenTrust	(63,206		)	(77,893		)
Contributions from InvenTrust	67,444			67,773
Payoff of note payable	(15,062		)	—
Principal payments of mortgage debt	(14,192		)	(15,464		)
Payment of loan fees and deposits	(70		)	—
Dividends paid	—			(4,620		)
Distributions paid to non-controlling interests	—			(16		)
Repurchase of common shares	(69		)	—
Payment for tax withholding for share-based compensation	(814		)	—
Net cash flows used in financing activities	$	(25,969	)	$	(30,220	)
Net increase in cash and cash equivalents	7,209			13,284
Cash and cash equivalents, at beginning of period	26,972			10,291
Cash and cash equivalents, at end of period	$	34,181		$	23,575

See accompanying notes to the condensed combined consolidated financial statements.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Condensed Combined Consolidated Statements of Cash Flow

(Dollar amounts in thousands)

For the nine months ended September 30, 2016 and 2015

(unaudited)



	Nine Months Ended September 30,
	2016			2015
Supplemental disclosure of cash flow information:
Cash paid for interest	$	15,078		$	23,220
Supplemental schedule of non-cash investing and financing activities:
Change in allocation of InvenTrust unsecured credit facility	$	(17,914	)	$	(25,686	)
Distribution of assets and liabilities of four and three assets, respectively, to InvenTrust, net	$	66,647		$	54,566
Reduction in carryover basis in connection with separation from InvenTrust	$	76,583		$	—

See accompanying notes to the condensed combined consolidated financial statements.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

The accompanying Condensed Combined Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Readers of this Quarterly Report should refer to the audited Combined Consolidated financial statements of Highlands REIT, Inc. for the year ended December 31, 2015, which are included in the Registration Statement on Form 10, as amended, as filed with the U.S. Securities and Exchange Commission by Highlands REIT, Inc. on April 13, 2016, as certain note disclosures contained in such audited consolidated financial statements have been omitted from this Report. In the opinion of management, all adjustments (consisting of normal recurring accruals, except as otherwise noted) necessary for a fair presentation have been included in these financial statements.

1. Organization

Highlands REIT, Inc. ("Highlands") is a Maryland corporation with a portfolio of single- and multi-tenant office assets, industrial assets, retail assets, correctional facilities, unimproved land and a bank branch. Prior to April 28, 2016, Highlands was a wholly owned subsidiary of InvenTrust Properties Corp. ("InvenTrust" and formerly known as Inland American Real Estate Trust, Inc.), its former parent.

On April 28, 2016, Highlands was spun-off from InvenTrust through a pro rata distribution by InvenTrust of 100% of the outstanding shares of common stock, $0.01 par value per share (the "Common Stock"), of Highlands to holders of record of InvenTrust's common stock as of the close of business on April 25, 2016 (the "Record Date"). Each holder of record of InvenTrust's common stock received one share of Common Stock for every one share of InvenTrust's common stock held at the close of business on the Record Date (the "Distribution"). As a result, Highlands became an independent, self-advised, non-traded public company. Highlands intends to be taxed as, and operate in a manner that will allow it to qualify as, a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code") for U.S. federal income tax purposes commencing with Highlands' short taxable year ending December 31, 2016. In connection with the Distribution, Highlands entered into a Separation and Distribution Agreement, Transition Services Agreement and Employee Matters Agreement with InvenTrust. Refer to Notes 4 and 11 for more details.

Prior to the Distribution, Highlands had not conducted any business as a separate company and had no material assets or liabilities. The operations transferred to Highlands by InvenTrust are presented as if the transferred business was Highlands’ business for all historical periods presented in the accompanying condensed combined consolidated financial statements and at the carrying value of such assets and liabilities reflected in InvenTrust’s books and records. Upon the Distribution, Highlands recorded the assets acquired and liabilities assumed based on InvenTrust's basis as of the date of the Distribution. Accordingly, Highlands recorded a reduction in the basis of investment properties of $76,583. The reduction in basis was related to an impairment loss that InvenTrust recorded upon the disposal of Highlands as part of the Distribution.

The accompanying condensed combined consolidated financial statements include the accounts of Highlands and its predecessors, as well as all of Highlands' wholly owned subsidiaries (collectively, the “Company”). Wholly owned subsidiaries generally consist of limited liability companies (LLCs) and limited partnerships (LPs). The effects of all significant intercompany transactions have been eliminated.

Each asset is owned by a separate legal entity, which maintains its own books and financial records, and each entity’s assets are not available to satisfy the liabilities of other affiliated entities, except as otherwise disclosed in Note 5.

As of September 30, 2016, the Company owned 18 assets and four parcels of unimproved land, for which the operating activity is reflected on the condensed combined consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015. As of December 31, 2015, the Company owned 22 assets and four parcels of land.

2. Summary of Significant Accounting Policies

The accompanying condensed combined consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and require 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 condensed

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

combined consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Refer to the Company’s audited combined consolidated financial statements for the year ended December 31, 2015 included in the Company's Registration Statement on Form 10-12G, as amended, filed with the U.S. Securities and Exchange Commission on April 13, 2016 (the "Registration Statement"), as certain note disclosures contained in such audited financial statements have been omitted from these interim condensed combined consolidated financial statements.

Basis of Presentation

As described in Note 1, on April 28, 2016, Highlands was spun off from InvenTrust. Prior to the Distribution, the accompanying historical condensed combined consolidated financial statements did not represent the financial position and results of a single legal entity, but rather a combination of entities under common control that had been “carved out” of InvenTrust’s consolidated financial statements and reflected significant assumptions and allocations. The condensed combined consolidated financial statements reflect the operations of certain assets and liabilities that had been historically held by InvenTrust, but which were specifically identifiable or attributable to the Company. Prior to the Distribution, the accompanying condensed combined consolidated financial statements included allocations of costs from certain corporate and shared functions provided to the Company by InvenTrust. InvenTrust allocated to the Company a portion of corporate overhead costs incurred by InvenTrust based upon the Company’s percentage share of the average invested assets of InvenTrust, which is reflected in general and administrative expense. As InvenTrust managed various asset portfolios, the extent of services and benefits a portfolio received was based on the size of its assets. Therefore, using average invested assets to allocate costs was a reasonable reflection of the services and other benefits received by the Company and complied with applicable accounting guidance. InvenTrust also allocated to the Company a portion of InvenTrust’s unsecured credit facility and the related interest expense. The unsecured credit facility was subject to a borrowing base consisting of a pool of unencumbered assets. To the extent the Company’s assets were included within the pool of unencumbered assets, the Company was allocated a portion of the unsecured credit facility. However, actual costs may have differed from allocated costs if the Company had operated as a standalone entity during such period and those differences may have been material.

Prior to the Distribution, the condensed combined consolidated financial statements included transactions in which ordinary course cash transactions were processed by InvenTrust due to InvenTrust’s centralized cash management process on behalf of the Company, such as the repayment of debt, rental receipts and payables in the ordinary course of business, resulting in intercompany transactions between the Company and InvenTrust. These ordinary course intercompany transactions are considered to be effectively settled at the time of the Company’s separation from InvenTrust. Accordingly, these transactions are reflected as distributions to and contributions from InvenTrust in the condensed combined consolidated statements of cash flow as a financing activity. For the period subsequent to the spin-off from InvenTrust, the condensed consolidated financial statements reflect the Company's financial position, results of operations and cash flows in conformity with GAAP.

Share Based Compensation

In accordance with FASB ASC Topic 718, Accounting for Share Based Compensation, companies are required to recognize in the income statement the grant-date fair value of stock options and other equity based compensation issued to employees. Under Topic 718, the way an award is classified will affect the measurement of compensation cost. Equity classified awards are measured at grant date fair value, and amortized on a straight-line basis over the vesting period of the stock and are not subsequently re-measured. The cost of the share based payments that are fully vested at the grant date are measured and recognized at that date. Liability classified awards are measured at the grant date and are subsequently re-measured at the end of each period. The fair value of the stock awards for the purposes of recognizing stock-based compensation expense is based on the estimated fair value per share of Highlands’ Common Stock as determined by the Highlands' board of directors on the grant date.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing the net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period plus any additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Any anti-dilutive securities are excluded from the diluted earnings per-share calculation.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective, although it will not affect the accounting for rental related revenues. In April 2015, the FASB approved an amendment to the ASU, deferring the effective date one year to annual reporting periods beginning after December 15, 2017 for public entities. The standard permits the use of either the retrospective or cumulative effect transition method. Early adoption is prohibited. The Company is evaluating the effect that ASU No. 2014-09 will have on its condensed combined consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

In February 2016, the FASB issued ASU 2016-02, Leases, amending the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-02 will be effective for annual reporting periods beginning after December 15, 2018, and early adoption is permitted as of the standard’s issuance date. The new 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. The Company does not expect that its adoption will have a material effect on its condensed combined consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing diversity in practice. The cash flow issues include debt prepayment or debt extinguishment costs and proceeds from the settlement of insurance claims. The ASU is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017. We are currently evaluating the impact the new standard may have on our condensed combined consolidated financial statements.

Recently Adopted Accounting Pronouncements

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. The Company adopted ASU 2015-03 effective as of January 1, 2016 with retrospective application to the Company's December 31, 2015 combined consolidated balance sheet. The effect of the adoption of ASU 2015-03 was to reclassify debt issuance costs of approximately $1,938 as of December 31, 2015 from deferred costs and other assets in the condensed combined consolidated balance sheets to a contra account as a deduction from debt in the condensed combined consolidated balance sheets.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Accounting, which requires that all excess tax benefits and tax deficiencies related to stock based compensation arrangements must be recognized in the income statement as they occur as opposed to the current guidance where excess tax benefits are recorded in equity. ASU 2016-09 also allows entities to make an accounting policy election to either continue to estimate forfeitures on stock based compensation arrangements or to account for forfeitures as they occur. ASU 2016-09 also allows an employer with statutory income tax withholding obligations to withhold shares with a fair value up to the amount of tax owed using the maximum statutory tax rate in the employee’s applicable jurisdiction. The Company adopted ASU 2016-09 effective as of April 1, 2016.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

3. Disposed Assets

During the three and nine months ended September 30, 2016, the Company did not sell any assets.

On February 19, 2016, the Company distributed the assets and liabilities associated with four retail assets to InvenTrust. The distribution was recorded at carrying value due to common control, and the Company did not realize any gain or loss on disposal. The distribution is reflected as a non-cash distribution in the condensed combined consolidated statements of cash flow for the nine months ended September 30, 2016.

The Company sold one net lease asset during the nine months ended September 30, 2015 for an aggregate gross disposition price of $8,200. The table below reflects sales activity for the nine months ended September 30, 2015 for the one asset included in continuing operations on the condensed combined consolidated statements of operations.



Property	Date	Gross Disposition Price		Square Feet (unaudited)
Citizens Manchester	7/9/2015	$	8,200	148,000	Square Feet

On January 28, 2015, the Company distributed the assets and liabilities associated with three retail assets to InvenTrust. The distribution was recorded at carrying value due to common control, and the Company did not realize any gain or loss on disposal. The distribution is reflected as a non-cash distribution in the condensed combined consolidated statements of cash flow for the nine months ended September 30, 2015.

There were no assets that qualified as discontinued operations during the nine months ended September 30, 2015 and 2016. All asset dispositions and asset distributions to Inventrust are included as a component of income from continuing operations.

4. Transactions with Related Parties

The following table summarizes the Company’s related party transactions for the three and nine months ended September 30, 2016 and 2015.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
General and administrative expense allocation (a)	$	—	$	2,913	$	3,324	$	8,689
Transition services fees (b)	$	33	$	—	$	84	$	—

(a)

Prior to the Distribution, general and administrative expense includes allocations of costs from certain corporate and shared functions provided to the Company by InvenTrust. InvenTrust allocated to the Company a portion of corporate overhead costs incurred by InvenTrust, which was based upon the Company’s percentage share of the average invested assets of InvenTrust. As InvenTrust managed various asset portfolios, the extent of services and benefits a portfolio received was based on the size of its assets. The Company believes that using average invested assets to allocate costs is a reasonable reflection of the services and other benefits received by the Company and complies with applicable accounting guidance. However, actual costs may have differed from allocated costs if the Company had operated as a standalone entity during such period and those differences may have been material. Subsequent to the Distribution, the Company was not allocated any costs.

(b)

In connection with the Distribution, the Company entered into the Transition Services Agreement with InvenTrust, under which InvenTrust has agreed to provide certain transition services to the Company, including services related to information technology systems, financial reporting and accounting and legal services. There is a flat monthly fee per service and the total amount paid to InvenTrust will not be greater than approximately $100. The expiration date varies by service provided and the agreement will terminate on the earlier of December 31, 2016 or the termination of the last service provided under it.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

As of December 31, 2015, the Company was allocated a portion of InvenTrust's unsecured credit facility of $17,914. Subsequent to the Distribution, the Company is no longer allocated any portion of Inventrust's debt. In addition, as of September 30, 2016 and December 31, 2015, the Company had a note payable with InvenTrust of $0 and $15,062, respectively. Refer to Note 5 for additional detail.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

5. Debt

Mortgages Payable

Mortgage loans outstanding as of September 30, 2016 and December 31, 2015 were $391,802 and $405,994, respectively, and had a weighted average interest rate of 6.05% and 6.09% per annum, respectively. Deferred financing costs, net, as of September 30, 2016 and December 31, 2015 were $1,847 and $1,938, respectively. As of September 30, 2016, scheduled maturities for the Company’s outstanding mortgage indebtedness had various due dates through May 2037, as follows:



For the year ended December 31,	As of September 30, 2016		Weighted average interest rate
2016	$	202,790	6.51	%
2017	30,275		5.57	%
2018	—		—	%
2019	—		—	%
2020	—		—	%
Thereafter	158,737		5.57	%
Total	$	391,802	6.05	%

The amount maturing in 2016 represents four mortgage loans, two of which relate to retail assets and mature in December 2016, the third relates to our Dulles Executive Plaza asset, and the fourth relates to the AT&T-Hoffman Estates asset. The Company's ability to pay off mortgages when they become due is dependent upon the Company's ability either to refinance the related mortgage debt or to sell the related asset. With respect to each loan, if the applicable wholly owned property-owning subsidiary is unable to refinance or sell the related asset, or in the event that the estimated asset value is less than the mortgage balance, the applicable wholly owned property-owning subsidiary may, if appropriate, satisfy a mortgage obligation by transferring title of the asset to the lender or permitting a lender to foreclose. As of September 30, 2016 and December 31, 2015, no debt is recourse to the Company, although Highlands or its subsidiaries may act as guarantor under customary, non-recourse carveout clauses in our wholly owned property-owning subsidiaries' mortgage loans.

Some of the mortgage loans require compliance with certain covenants, such as debt service ratios, investment restrictions and distribution limitations. As of September 30, 2016 and December 31, 2015, other than otherwise disclosed in this Note 5, the company is in compliance with such covenants in all material respects. As of September 30, 2016, the mortgage loan on the AT&T-Cleveland asset is in “hyper-amortization,” and, as a result, all net operating income from this asset, less management operating expenses, is used to pay down the principal amount of the loan. Net cash generated is not available for general use of the Company and is classified as restricted. The loan on the Company's Dulles Executive Plaza asset matured on September 1, 2016. On August 23, 2016, we received notice from the special servicer that loan went into maturity default. The Company is having further discussions with the special servicer regarding the future of the asset. In addition, all rental payments, less certain expenses, for Dulles Executive Plaza are currently being “swept” and held by the lender pursuant to the loan agreement; as a result, net cash generated is not available for general use of the Company and is classified as restricted. For Sherman Plaza, all rental payments are being “swept” and held by the lender; however, the lender remits excess cash to the Company for its general use after the debt service payment has been paid. On October 1, 2016, the Company's AT&T-St. Louis property went into "cash trap." All income from the asset is being "swept" by the lender, used to pay debt service and other charges, and to the extent income exceeds such charges the Company receives a lender-approved reimbursement for operating expenses associated with the property. Additional funds, if any, are held by the lender as additional collateral for the loan.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

On June 29, 2016, the Company received notice that the loan in respect of the AT&T-Hoffman Estates asset had been transferred to the special servicer, C-III Asset Management, LLC. On August 9, 2016, the Company received written notice from the lender that an event of default has occurred under the loan agreement relating to the AT&T-Hoffman Estates asset for failure to pay required installments of principal and interest, and that, as a result, the entire loan amount is now due and payable. On August 19, 2016, C-III Asset Management LLC filed a foreclosure complaint in respect of AT&T-Hoffman Estates in the Circuit Court of Cook County, Illinois. On September 12, 2016, the Circuit Court entered an order appointing a receiver to manage the property during the pendency of the foreclosure proceedings. As of September 30, 2016, AT&T-Hoffman Estates is unoccupied. The Company intends to satisfy its mortgage obligations for AT&T-Hoffman Estates of $113,810 by permitting the lender to foreclose on the property, which would result in a gain on the extinguishment of debt.

In January 2015, the assets and liabilities associated with three retail assets were distributed to InvenTrust. Two of these assets were encumbered by a mortgage. As part of the distribution of these assets to InvenTrust, the mortgage payables of $19,893 were also distributed at carrying value due to common control.

Unsecured credit facility

On November 5, 2015, InvenTrust entered into a term loan credit agreement for a $300,000 unsecured credit facility. The term loan credit facility consists of two tranches: a five-year tranche maturing on January 15, 2021, and a seven-year tranche maturing on November 5, 2022. Based upon InvenTrust's total leverage ratio at December 31, 2015, the five-year tranche bears an interest rate of LIBOR plus 1.30% and the seven-year tranche bears an interest rate of LIBOR plus 1.60%. The term loan credit facility is subject to a borrowing base consisting of a pool of unencumbered assets. To the extent the Company’s assets were included within the pool of unencumbered assets, the Company was allocated a portion of the unsecured credit facility. As of the Distribution, the Company no longer has an allocated portion of the unsecured credit facility; therefore, as of September 30, 2016, the Company’s allocated portion of the term loan was $0. As of December 31, 2015, the Company’s allocated portion of the term loan was $17,914 and the interest rate was 1.59%.

On February 3, 2015, InvenTrust entered into an amended and restated credit agreement for a $300,000 unsecured revolving line of credit, which matures on February 2, 2019. The unsecured revolving line of credit bears interest at a rate equal to LIBOR plus 1.40% and requires the maintenance of certain financial covenants. The unsecured credit facility is subject to a borrowing base consisting of a pool of unencumbered assets. To the extent the Company’s assets were included within the pool of unencumbered assets, the Company was allocated its proportionate share of the revolving line of credit. As of December 31, 2015, the Company’s allocated portion of the revolving line of credit was $0. As of the Distribution, the Company no longer has an allocated portion of the unsecured credit facility.

Note Payable

On May 1, 2014, the Company entered into a note payable in the amount of $32,908 with InvenTrust, which matured on demand. The note payable was non-amortizing with an interest rate of 8.50%. Such interest was payable on demand or, until such time as demand was made, monthly in arrears, beginning on June 1, 2014 and continuing on the first day of each month thereafter until the note had been paid in full. On March 25, 2016, the outstanding principal balance of $15,062 and accrued interest of $89 was repaid in full. As of December 31, 2015, the balance of this note payable was $15,062.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

6. Fair Value Measurements

In accordance with ASC 820, Fair Value Measurement and Disclosures, the Company defines fair value based on the price that would be received upon sale of an asset or the exit price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:


•	Level 1 - Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.


•	Level 2 - Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.


•	Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The Company has estimated fair value using available market information and valuation methodologies the Company believes to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that would be realized upon disposition.

Non-Recurring Measurements

During the three and nine months ended September 30, 2016, the Company identified certain assets which may have a reduction in the expected holding period, or a major tenant moving out or not renewing an expiring lease, which represented an impairment trigger, and recorded an impairment of investment properties of $18,967 on one net lease asset and $61,582 on three net lease assets, respectively. The following table presents these assets measured at fair value on a nonrecurring basis for the nine months ended September 30, 2016 aggregated by the level within the fair value hierarchy in which those measurements fall. Methods and assumptions used to estimate the fair value of these assets are described after the table.



	Fair Value
	Level 1	Level 2	Level 3			Total		Provision for impairment
September 30, 2016
Investment Properties	—	—	$	69,654	(a)	$	69,654	$	61,582

(a)

Represents the fair values of three net lease assets. The estimated fair value relating to the investment properties’ impairment analysis was based on 10-year discounted cash flow models, which includes contractual inflows and outflows over a specific holding period. The cash flows consist of observable inputs such as contractual revenues and unobservable inputs such as forecasted revenues and expenses. These unobservable inputs are based on market conditions and the Company’s expected growth rates. Capitalization rates were 7.50% and discount rates ranging from 7.50% to 9.50% were utilized in the model and are based upon observable rates that the Company believes to be within a reasonable range of current market rates.

The Company did not have any assets measured at fair value on a nonrecurring basis as of December 31, 2015.

During the three and nine months ended September 30, 2015, the Company recognized no provision for asset impairment.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

Financial Instruments Not Measured at Fair Value

The table below represents the fair value of financial instruments presented at carrying values in the condensed combined consolidated financial statements as of September 30, 2016 and as of December 31, 2015.



	September 30, 2016				December 31, 2015
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Mortgages payable	$	391,802	$	396,905	$	405,994	$	410,888
Unsecured credit facility	—		—		17,914		17,914
Note payable	—		—		15,062		15,062

The Company estimates the fair value of its debt instruments using a weighted average market effective interest rate of 4.68% and 4.52% per annum as of September 30, 2016 and December 31, 2015. The Company estimates the fair value of its mortgages payable by discounting the anticipated future cash flows of each instrument at rates currently offered to the Company by its lenders for similar debt instruments of comparable maturities. The rates used are based on credit spreads observed in the marketplace during the quarter for similar debt instruments, and a floor rate that the Company has derived using its subjective judgment for each asset segment. Based on this, the Company determines the appropriate rate for each of its individual mortgages payable based upon the specific terms of the agreement, including the term to maturity, the quality and nature of the underlying property and its leverage ratio. The weighted average market effective interest rates used range from 4.10% to 5.58% and 3.99% to 4.99% as of September 30, 2016 and December 31, 2015, respectively. The fair value estimate of the unsecured credit facility approximated the carrying value due to limited market volatility in pricing. The assumptions reflect the terms currently available on similar borrowing terms to borrowers with credit profiles similar to the Company’s. The Company has determined that its debt instrument valuations are classified in Level 2 of the fair value hierarchy.

7. Income Taxes

The Company intends to be taxed as, and operate in a manner that will allow the Company to qualify as a REIT for U.S. federal income tax purposes beginning with the Company’s short taxable year commencing immediately prior to the Company’s separation from InvenTrust and ending on December 31, 2016. So long as it qualifies as a REIT, the Company generally will not be subject to federal income tax on taxable income that is distributed currently to stockholders. A REIT is subject to a number of organizational and operational requirements including a requirement that it currently distribute at least 90% of its REIT taxable income (excluding capital gains) to its stockholders each year. If the Company fails to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, the Company will be subject to federal and state income tax on its taxable income at regular corporate tax rates and would not be able to re-elect REIT status during the four years following the year of the failure. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income, property or net worth and federal income and excise taxes on its undistributed income.

Prior to the Distribution, the Company was a qualified REIT subsidiary (“QRS”) of InvenTrust, which had elected to be taxed as a REIT and had operated in a manner intended to qualify as a REIT under the Code. As a QRS, the Company was disregarded as a separate entity from InvenTrust for U.S. federal income tax purposes. All assets, liabilities and items of income, deduction and credit of the Company were treated for federal income tax purposes as those of InvenTrust.

The Company’s subsidiary, MB REIT (Florida), Inc. (“MB REIT”), previously elected and operated so as to qualify to be taxed as a REIT under the Code. On December 15, 2015, MB REIT redeemed all of the outstanding shares of its Series B Preferred Stock and became a wholly owned subsidiary of InvenTrust. At that time, MB REIT became a QRS of InvenTrust and ceased to be treated as a separate REIT for U.S. federal income tax purposes. As a result of certain pre-Distribution reorganization transactions, following the Distribution, MB REIT is currently disregarded as a separate entity from the Company for federal income tax purposes and is a QRS of the Company. All assets, liabilities and items of income, deduction and credit of MB REIT are treated for federal income tax purposes as those of the Company.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

During the three months ended September 30, 2016 and 2015, an income tax expense of $2 and $9, respectively, was included on the condensed combined consolidated statements of operations.

During the nine months ended September 30, 2016 and 2015, an income tax expense of $239 and $24, respectively, was included on the condensed combined consolidated statements of operations.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

8. Segment Reporting

The Company currently has three business segments, consisting of (i) Net Lease, (ii) Retail and (iii) Multi-Tenant Office. The net lease segment consists of single-tenant office and industrial assets, as well as the Company’s correctional facilities. The Company’s unimproved land is presented in Other.

For the nine months ended September 30, 2016, approximately 45% of the Company’s revenue from continuing operations was generated by three net lease assets leased to AT&T, Inc. As a result of the concentration of revenue generated from these assets, if AT&T, Inc. were to cease paying rent or fulfilling its other monetary obligations, the Company would have significantly reduced revenues and/or higher expenses until the defaults were cured or the assets were leased to a new tenant or tenants, if at all. Approximately 21% of the Company’s revenue from continuing operations for the nine months ended September 30, 2016 was generated by the Company’s AT&T-Hoffman Estates asset. The term of the lease on the AT&T-Hoffman Estates asset expired on August 15, 2016 and the asset is no longer generating revenue for the Company. As of September 30, 2016, the asset is unoccupied. Approximately 17% of the Company’s revenue from continuing operations for the nine months ended September 30, 2016 was generated by the Company’s AT&T-St. Louis asset. The term of the lease on the AT&T-St. Louis asset is scheduled to expire on September 30, 2017 and the Company did not receive notice that the tenant intends to renew the lease during the contractual renewal period, which expired September 1, 2016.

The following table summarizes net property operations income by segment for the three months ended September 30, 2016.



	Total			Net Lease		Retail		Multi-Tenant Office			Other
Rental income	$	17,272		$	12,299	$	4,211	$	762		$	—
Tenant recovery income	2,917			904		1,936		77			—
Other property income	168			143		18		1			6
Total income	20,357			13,346		6,165		840			6
Operating expenses	5,909			1,831		2,597		1,078			403
Net operating income (loss)	$	14,448		$	11,515	$	3,568	$	(238	)	$	(397	)
Non-allocated expenses (a)	(9,676		)
Other income and expenses (b)	(7,145		)
Provision for asset impairment (c)	(18,967		)
Net loss attributable to the Company	$	(21,340	)


(a)	Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.


(b)	Other income and expenses consists of other loss, interest expense, and income tax expense.


(c)	Provision for asset impairment includes $18,967 related to one net lease asset.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

The following table summarizes net property operations income by segment for the three months ended September 30, 2015.



	Total			Net Lease		Retail		Multi-Tenant Office		Other
Rental income	$	23,918		$	15,294	$	5,928	$	2,696	$	—
Tenant recovery income	3,094			865		2,030		199		—
Other property income	381			123		199		57		2
Total income	27,393			16,282		8,157		2,952		2
Operating expenses	4,525			954		2,740		711		120
Net operating income (loss)	$	22,868		$	15,328	$	5,417	$	2,241	$	(118	)
Non-allocated expenses (a)	(12,109		)
Other income and expenses (b)	(7,445		)
Net income	$	3,314
Less: net income attributable to non-controlling interests	(8		)
Net income attributable to Company	$	3,306


(a)	Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.


(b)	Other income and expenses consists of loss on sale of investment properties, other loss, interest expense, and income tax expense.

The following table summarizes net property operations income by segment for the nine months ended September 30, 2016.



	Total			Net Lease		Retail		Multi-Tenant Office			Other
Rental income	$	62,987		$	42,791	$	13,630	$	6,566		$	—
Tenant recovery income	8,352			2,452		5,466		434			—
Other property income	449			421		79		(75		)	24
Total income	71,788			45,664		19,175		6,925			24
Operating expenses	14,273			3,770		7,022		2,732			749
Net operating income (loss)	$	57,515		$	41,894	$	12,153	$	4,193		$	(725	)
Non-allocated expenses (a)	(32,003		)
Other income and expenses (b)	(20,199		)
Provision for asset impairment (c)	(61,582		)
Net loss attributable to the Company	$	(56,269	)
Balance Sheet Data
Real estate assets, net (d)	$	465,663		$	185,483	$	155,063	$	93,490		$	31,627
Non-segmented assets (e)	52,349
Total assets	518,012
Capital expenditures	$	548		$	—	$	422	$	126		$	—


(a)	Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.


(b)	Other income and expenses consists of other loss, interest expense, and income tax expense.


(c)	Provision for asset impairment includes $61,582 related to three net lease assets.


(d)	Real estate assets include intangible assets, net of amortization.


(e)	Non-segmented assets include cash and cash equivalents, restricted cash and escrows, accounts and rents receivable and deferred costs and other assets.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

The following table summarizes net property operations income by segment for the nine months ended September 30, 2015.



	Total			Net Lease		Retail		Multi-Tenant Office		Other
Rental income	$	72,126		$	46,051	$	18,247	$	7,828	$	—
Tenant recovery income	10,939			2,754		7,599		586		—
Other property income	747			415		229		89		14
Total income	83,812			49,220		26,075		8,503		14
Operating expenses	15,884			3,688		9,523		2,326		347
Net operating income (loss)	$	67,928		$	45,532	$	16,552	$	6,177	$	(333	)
Non-allocated expenses (a)	(36,473		)
Other income and expenses (b)	(21,293		)
Net income	$	10,162
Less: net income attributable to non-controlling interests	(16		)
Net income attributable to Company	$	10,146


(a)	Non-allocated expenses consists of general and administrative expenses and depreciation and amortization.


(b)	Other income and expenses consists of loss on sale of investment properties, other income, interest expense and income tax expense.

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

9. Earnings Per Share

Basic earnings per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the period, plus any additional common shares that would have been outstanding if the dilutive potential common shares had been issued.

For periods prior to the Distribution, basic and diluted earnings per share was calculated by dividing net income attributable to the Company by the 862.0 million shares of Common Stock outstanding upon the completion of the Distribution.

The following table reconciles net (loss) income attributable to the Company to basic and diluted EPS (in thousands, except share and per share data):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Numerator:
Net (loss) income	$	(21,340	)	$	3,314		$	(56,269	)	$	10,162
Less: Net income attributable to non-controlling interests	—			(8		)	—			(16		)
Net (loss) income attributable to Company	$	(21,340	)	$	3,306		$	(56,269	)	$	10,146

Denominator:
Weighted average shares outstanding - basic and diluted	864,890,967			862,014,421			864,515,587			862,014,421

Basic and diluted (loss) income per share:
Net (loss) income per common share	$	(0.02	)	$	0.00		$	(0.07	)	$	0.01

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

10. Share Based Compensation

Incentive Award Plan

On April 28, 2016, the board of directors adopted, ratified and approved the Highlands REIT, Inc. 2016 Incentive Award Plan (the "Incentive Award Plan"), under which the Company may grant cash and equity-based incentive awards to eligible employees, directors, and consultants. Prior to the Company’s spin-off from InvenTrust, the board of directors of the Company (then a wholly owned subsidiary of InvenTrust) adopted, and InvenTrust, as the sole stockholder of Highlands, approved, the Incentive Awards Plan. To date, the Company has granted 5,138,889 shares of fully vested stock awards. Additionally, pursuant to employment agreements with certain of its executive officers, the Company has granted shares with an aggregate value of $1.1 million that will fully vest on March 15, 2017, subject to applicable executives continued employment with the Company through the vest date. Under the Incentive Award Plan, the Company is authorized to grant up to 43,000,000 shares of the Company's common stock pursuant to awards under the plan. At September 30, 2016, 34,944,444 shares were available for future issuance under the Incentive Award Plan. A summary of the Company's stock awards activity as of September 30, 2016 is as follows:



Non-Vested stock awards	Stock Awards (#)		Weighted Average Grant Date Fair Value
Balance at January 1, 2016	—		—
Granted	8,055,556		$	0.36
Vested	(5,138,889	)	0.36
Forfeited	—		—
Balance at September 30, 2016	2,916,667		$	—

For the three and nine months ended September 30, 2016, the Company recognized stock-based compensation expense of $469 and $2,319 related to the Incentive Award Plan, respectively. At September 30, 2016, there was approximately $581 of total unrecognized compensation expense related to these awards; that cost is expected to be recognized through March 15, 2017. No stock-based compensation expense was recognized for the three and nine months ended September 30, 2015. For the three and nine months ended September 30, 2016, the Company paid $814 related to tax withholding for share-based compensation.

11. Commitments and Contingencies

The Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of these matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material adverse effect on the financial statements of the Company.

In addition, in connection with the Company’s separation from InvenTrust, on April 14, 2016, the Company entered into a Separation and Distribution Agreement, and on April 28, 2016, the Company entered into a Transition Services Agreement and Employee Matters Agreement, each with InvenTrust. Pursuant to the Separation and Distribution Agreement, Highlands has agreed to indemnify, defend and hold harmless InvenTrust and its affiliates and each of their respective current or former stockholders, directors, officers, agents and employees and their respective heirs, executors, administrators, successors and assigns from and against all liabilities relating to, arising out of or resulting from (i) the liabilities assumed by Highlands in the Separation and Distribution Agreement, Transition Services Agreement and Employee Matters Agreement, (ii) any breach by Highlands or any of its subsidiaries of the Separation and Distribution Agreement, Transition Services Agreement and Employee Matters Agreement (iii) losses arising from third party claims relating to the separation and distribution and (iv) any untrue statement or alleged untrue statement of a material fact or omission or alleged omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, with respect to all information contained in the Registration Statement, other than specified information relating to and provided by InvenTrust (the “Specified InvenTrust Information”). Similarly, InvenTrust has agreed to indemnify, defend and hold harmless Highlands

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HIGHLANDS REIT, INC. AND ITS PREDECESSORS

Notes to Condensed Combined Consolidated Financial Statements (unaudited)

(Dollar amounts stated in thousands)

September 30, 2016

and its affiliates and each of their respective current or former stockholders, directors, officers, agents and employees and their respective heirs, executors, administrators, successors and assigns from and against all liabilities relating to, arising out of or resulting from (i) the liabilities assumed by InvenTrust in the Separation and Distribution Agreement, Transition Services Agreement and Employee Matters Agreement, (ii) any breach by InvenTrust or any of its subsidiaries of the Separation and Distribution Agreement, Transition Services Agreement and Employee Matters Agreement and (iii) the Specified InvenTrust Information. InvenTrust and Highlands will not be deemed to be affiliates of the other for purposes of determining the above described indemnification obligations.

Highlands has also agreed to indemnify InvenTrust against all taxes related to the Company, its subsidiaries and its assets, including taxes attributable to periods prior to the separation and distribution. InvenTrust has agreed to indemnify the Company for any taxes attributable to InvenTrust’s or MB REIT’s failure to qualify as a REIT for any taxable year ending on or before December 31, 2016.

12. Subsequent Events

On November 4, 2016, the Company completed a $10,500 refinancing of a retail asset. The loan matures in November 2026, has a fixed rate of 4.35%, is interest only for the first year and amortizes based on a 30-year schedule beginning on November 4, 2017. The property was previously encumbered by a $9,071 mortgage with an interest rate of 5.99% maturing in December, 2016, which the company paid off in November of 2016.

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

Certain statements in this Quarterly Report on Form 10-Q, other than purely historical information, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, 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”). These statements include statements about Highlands’ plans, objectives, strategies, financial performance and outlook, trends, the amount and timing of future cash distributions, prospects or future events and involve known and unknown risks that are difficult to predict. As a result, our actual financial results, performance, achievements or prospects may differ materially from those expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “guidance,” “predict,” “potential,” “continue,” “likely,” “will,” “would,” “illustrative” and variations of these terms and similar expressions, or the negative of these terms or similar expressions. Such forward-looking statements are necessarily based upon estimates and assumptions that, while considered reasonable by Highlands and its management based on their knowledge and understanding of the business and industry, are inherently uncertain. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q. Such risks, uncertainties and other important factors include, among others: the risks, uncertainties and factors set forth in our filings with the U.S. Securities and Exchange Commission, including our Registration Statement on Form 10-12G, as amended; business, financial and operating risks inherent to real estate investments and the industry; our ability to renew leases, lease vacant space, or re-let space as leases expire; our ability to repay or refinance our debt as it comes due; business, financial and operating risks inherent to real estate investments; contraction in the global economy or low levels of economic growth; our ability to sell our assets at a price and on a timeline consistent with our investment objectives, or at all; our ability to service our debt; changes in interest rates and operating costs; compliance with regulatory regimes and local laws; uninsured or underinsured losses, including those relating to natural disasters or terrorism; our status as an emerging growth company; the

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amount of debt that we currently have or may incur in the future; provisions in our debt agreements that may restrict the operation of our business; our separation from InvenTrust and our ability to operate as a stand-alone public reporting company; our organizational and governance structure; our status as a REIT; the cost of compliance with and liabilities under environmental, health and safety laws; adverse litigation judgments or settlements; changes in real estate and zoning laws and increase in real property tax rates; changes in federal, state or local tax law, including legislative, administrative, regulatory or other actions affecting REITs; changes in governmental regulations or interpretations thereof; and estimates relating to our ability to make distributions to our stockholders in the future.

These factors are not necessarily all of the important factors that could cause our actual financial results, performance, achievements or prospects to differ materially from those expressed in or implied by any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Forward-looking statements speak only as of the date they are made, and we do not undertake or assume any obligation to update publicly any of these forward-looking statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

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The following discussion and analysis should be read in conjunction with the Company's Condensed Combined Consolidated Financial Statements and accompanying notes, which appear elsewhere in this Quarterly Report on Form 10-Q.

Overview

On April 28, 2016, Highlands REIT, Inc., a Maryland corporation ("Highlands"), was spun-off from InvenTrust Properties Corp., a Maryland corporation ("InvenTrust"), its former parent, through a pro rata distribution by InvenTrust of 100% of the outstanding shares of common stock, $0.01 par value per share (the "Common Stock"), of Highlands to holders of record of InvenTrust's common stock as of the close of business on April 25, 2016 (the "Record Date"). Each holder of record of InvenTrust's common stock received one share of Common Stock for every one share of InvenTrust's common stock held at the close of business on the Record Date (the "Distribution"). As a result, the Company became an independent, self-advised, non-traded public company. Highlands intends to be taxed as, and operate in a manner that will allow the Company to qualify as a real estate investment trust ("REIT") for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2016.

As of September 30, 2016, our portfolio of assets consisted of seven office assets, two industrial assets, six retail assets, two correctional facilities, four parcels of unimproved land and one bank branch. References to the "Company," "we" or "us" are to Highlands and its predecessors, as well as all of Highlands' wholly owned subsidiaries.

Our investment objectives are to preserve, protect and maximize the total value of our portfolio in connection with our evaluation of various strategic opportunities while seeking to provide stockholders with a return of their investment by liquidating and distributing net sales proceeds. We may seek to sustain and enhance the values of our portfolio through selective acquisitions, additional leasing or capital expenditures, where necessary, while identifying and implementing disposition strategies for the assets in our portfolio. We intend to hold our assets until such time as we determine that a sale or other disposition achieves our investment objectives or until it appears such objectives will not be met.

We currently have three business segments, consisting of (i) net lease, (ii) retail and (iii) multi-tenant office. Our unimproved land is presented in “other.” We may have additional or fewer segments in the future to the extent we enter into additional real property sectors, dispose of property sectors, or change the character of our assets. For the complete presentation of our reportable segments, see Note 8 to our Condensed Combined Consolidated Financial Statements for the three and nine months ended September 30, 2016 and 2015.

Separation from InvenTrust

As a result of the Distribution, we and InvenTrust operate separately, each as an independent company. In connection with and in order to effectuate our separation from InvenTrust and the Distribution, we and InvenTrust entered into a Separation and Distribution Agreement. In addition, we entered into various other agreements with InvenTrust to effect the separation and provide a framework for our relationship with InvenTrust post-separation, such as a Transition Services Agreement and an Employee Matters Agreement. These agreements provide for the allocation between us and InvenTrust of InvenTrust’s assets, liabilities and obligations (including its properties, employees and tax-related assets and liabilities) attributable to periods prior to, at and after our separation from InvenTrust and govern certain relationships between us and InvenTrust after the Distribution.

Basis of Presentation

Highlands was formed in December 2015 as a wholly owned subsidiary of InvenTrust. Prior to the Distribution, we and InvenTrust effectuated certain reorganization transactions which were designed to consolidate the ownership of Highlands' current asset portfolio into Highlands, transfer four retail assets previously owned directly or indirectly by legal entities that are now subsidiaries of Highlands to Inventrust, facilitate our separation from InvenTrust and the distribution and enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2016. The accompanying combined condensed consolidated financial statements for periods prior to the spin-off have been “carved out” of InvenTrust’s consolidated financial statements and give effect to the completion of the reorganization transactions other than, for periods prior to February 19, 2016, the distribution of four retail assets by a current Highlands subsidiary to InvenTrust. The distribution of the four retail assets was completed on February 19, 2016, and is reflected in the accompanying combined condensed consolidated financial statements as having occurred on such date. The accompanying combined condensed consolidated financial statements prior to the Distribution reflect significant assumptions and allocations, which, among other things, includes allocations of costs from certain corporate and shared functions provided to us by InvenTrust. The allocation methods for corporate and shared services costs vary by function but were generally based on historical costs of

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assets. InvenTrust allocated to us a portion of corporate overhead costs incurred by InvenTrust based upon our percentage share of the average invested assets of InvenTrust, which is reflected in general and administrative expense. As InvenTrust managed various asset portfolios, the extent of services and benefits a portfolio received was based on the size of its assets. We believe that using average invested assets to allocate costs was a reasonable reflection of the services and other benefits received by us and complies with applicable accounting guidance. InvenTrust also allocated to us a portion of InvenTrust’s unsecured credit facility and the related interest expense. The unsecured credit facility was subject to a borrowing base consisting of a pool of unencumbered assets. To the extent our assets were included within the pool of unencumbered assets, we were allocated a portion of the unsecured credit facility. However, actual costs may have differed from allocated costs if we had operated as a stand-alone entity during such period and those differences may have been material.

Prior to the Distribution, our financial statements also include transactions in which ordinary course cash transactions have been processed by InvenTrust due to InvenTrust’s centralized cash management process on our behalf, such as the repayment of debt, rental receipts and payables in the ordinary course of business, resulting in intercompany transactions between InvenTrust and us. These ordinary course intercompany transactions are considered to be effectively settled at the time of our separation from InvenTrust. Accordingly, these transactions are reflected as distributions to and contributions from InvenTrust in the financial statements.

Based on these presentation matters, our financial position, results of operations and cash flows may not be comparable as if we had operated as a stand-alone public reporting company. Accordingly, our historical results should not be relied upon as an indicator of future performance.

Our Revenues and Expenses

Revenues

Our revenues are primarily derived from rental income and expense recoveries we receive from our tenants under leases with us, including monthly rent and other property income pursuant to tenant leases. Tenant recovery income primarily consists of reimbursements for real estate taxes, common area maintenance costs, management fees and insurance costs.

Expenses

Our expenses consist of property operating expenses, real estate taxes, depreciation and amortization expense, general and administrative expenses and provision for asset impairment. Property operating expenses primarily consist of repair and maintenance, management fees, utilities and insurance (in each case, some of which are recoverable from the tenant).

Key Indicators of Operating Performance

We measure results of operations and the operating performance of our business by evaluating funds from operations (“FFO”). See “Selected Financial Data” for further discussion of the Company’s use, definitions and limitations of FFO.

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Results of Operations

Comparison of the three and nine months ended September 30, 2016 and 2015

Key performance indicators are as follows:



	As of September 30,
	2016			2015
Economic occupancy (a)	66.3		%	94.4		%
Rent per square foot (b)	$	13.54		$	13.88


(a)	Economic occupancy is defined as the percentage of total gross leasable area for which a tenant is obligated to pay rent under the terms of its lease agreement, regardless of the actual use or occupation by the tenant of the area being leased. Actual use may be less than economic square footage.


(b)	Rent per square foot is computed as annualized rent divided by the total occupied square footage at the end of the period. Annualized rent is computed as revenue for the last month of the period multiplied by twelve months. Annualized rent includes the effect of rent abatements, lease inducements and straight-line rent GAAP adjustments.

Condensed Combined Consolidated Results of Operations



	(in thousands)								(in thousands)
	For the Three months ended September 30,								For the Nine months ended September 30,
	2016			2015		Decrease			2016			2015		Decrease
Net (loss) income	$	(21,340	)	$	3,314	$	(24,654	)	$	(56,269	)	$	10,162	$	(66,431	)
Net (loss) income attributable to Company	(21,340		)	3,306		(24,646		)	(56,269		)	10,146		(66,415		)

Net (loss) income decreased by $24.6 million to a net loss of $21.3 million for the three months ended September 30, 2016 from net income $3.3 million for the three months ended September 30, 2015 primarily as a result of an increase in asset impairment charges of $19.0 million related to one net lease asset and a decrease in occupancy and rental income at a multi-tenant office asset and AT&T-Hoffman Estates.

Net (loss) income decreased by $66.4 million to a net loss of $56.3 million for the nine months ended September 30, 2016 from net income of $10.2 million for the nine months ended September 30, 2015, primarily as a result of an increase in asset impairment charges of $61.6 million related to three assets and an decrease in rental income.

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Operating Income and Expenses



	(in thousands)									(in thousands)
	For the Three months ended September 30,				Increase					For the Nine months ended September 30,				Increase
	2016		2015		(Decrease)			Variance		2016		2015		(Decrease)			Variance
Income:
Rental income	$	17,272	$	23,918	$	(6,646	)	(27.8	)%	$	62,987	$	72,126	$	(9,139	)	(12.7	)%
Tenant recovery income	2,917		3,094		(177		)	(5.7	)%	8,352		10,939		(2,587		)	(23.6	)%
Other property income	168		381		(213		)	(55.9	)%	449		747		(298		)	(39.9	)%
Operating Expenses:
Property operating expenses	3,023		2,000		1,023			51.2	%	7,124		7,728		(604		)	(7.8	)%
Real estate taxes	2,886		2,525		361			14.3	%	7,149		8,156		(1,007		)	(12.3	)%
Depreciation and amortization	6,168		9,034		(2,866		)	(31.7	)%	21,413		27,261		(5,848		)	(21.5	)%
General and administrative expenses	3,508		3,075		433			14.1	%	10,590		9,212		1,378			15.0	%
Provision for asset impairment	18,967		—		18,967			—	%	61,582		—		61,582			—	%

Property Income and Operating Expenses

Rental income consists of monthly rent, straight-line rent adjustments, amortization of acquired above and below market leases, and other property income pursuant to tenant leases. Tenant recovery income consists of reimbursements for real estate taxes, common area maintenance costs, management fees, and insurance costs. Other property income consists of lease termination fees and other miscellaneous property income. Property operating expenses consist of regular repair and maintenance, management fees, utilities, and insurance (in each case, some of which are recoverable from the tenant).

There was a decrease in property income for the three months ended September 30, 2016 compared to 2015. Total property income decreased by $7.0 million in the three months ended September 30, 2016 compared to the same period in 2015 as a result of changes in occupancy at a multi-tenant office asset and AT&T-Hoffman Estates, in addition to four assets that were transferred to InvenTrust during the first quarter of 2016.

There was a decrease in property income for the nine months ended September 30, 2016 compared to 2015. Total property income decreased by $12.0 million in the nine months ended September 30, 2016 compared to the same period in 2015 as a result of changes in occupancy at a multi-tenant office asset and AT&T-Hoffman Estates. In addition, property income decreased due to four assets that were transferred to InvenTrust during the first quarter of 2016 and three assets that were transferred to InvenTrust during the first quarter of 2015. This transfer activity also caused property operating expenses to decrease $0.6 million, or 7.8%, when comparing the three and nine months ended September 30, 2016 to the same period in 2015.

Real Estate Taxes

Real estate taxes increased $0.4 million for the three months ended September 30, 2016 compared to the same period in 2015 as a result of taxes at the now unoccupied AT&T-Hoffman Estates, which were previously paid by the tenant.

Real estate taxes decreased $1.0 million for the nine months ended September 30, 2016 compared to the same period in 2015 as a result of four assets that were transferred to InvenTrust during the first quarter of 2016 and three assets that were transferred to InvenTrust during the first quarter of 2015.

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Depreciation and Amortization

Depreciation and amortization decreased by $2.9 million for the three months ended September 30, 2016 compared to the same period in 2015 as a result of four assets that were transferred to InvenTrust during the first quarter of 2016 and the decrease in asset basis related to the reduction in carrying value of the basis of investment properties in connection with separation from InvenTrust and asset impairment charges recorded on one net lease asset.

Depreciation and amortization decreased by $5.8 million for the nine months ended September 30, 2016 compared to the same period in 2015 as a result of four assets that were transferred to InvenTrust during the first quarter of 2016, three assets that were transferred to InvenTrust during the first quarter of 2015 and the decrease in asset basis related to the reduction in carrying value of the basis of investment properties in connection with separation from InvenTrust and asset impairment charges recorded on three net lease assets.

General Administrative Expenses

General and administrative expenses increased by 0.4 million to $3.5 million for the three months ended September 30, 2016 from $3.1 million for the three months ended September 30, 2015. The increase was the result of an increase in corporate general and administrative expense primarily related to additional expenses incurred as a result of our operating as a stand-alone company, including stock administration expenses, professional fees, and stock-based compensation expenses for the three months ended September 30, 2016. We were also allocated costs by InvenTrust for certain corporate services and other expenses. For the three months ended September 30, 2016, no allocation of such expenses was recognized. For the three months ended September 30, 2015, we were allocated three months of such expenses based upon our percentage share of the average invested assets of InvenTrust. The allocation includes costs related to corporate overhead expenses, such as payroll costs for certain of InvenTrust’s employees (accounting, finance, tax, treasury and legal) and outside professional services.

General and administrative expenses increased by 1.4 million to $10.6 million for the nine months ended September 30, 2016 from $9.2 million for the nine months ended September 30, 2015. The increase was the result of an increase in corporate general and administrative expense primarily related to additional expenses incurred as a result of our operating as a stand-alone company, including stock administration expenses, professional fees, and stock-based compensation expenses for the nine months ended September 30, 2016. We were also allocated costs by InvenTrust for certain corporate services and other expenses. For the nine months ended September 30, 2016, we were only allocated four months of such expenses based upon our percentage share of the average invested assets of InvenTrust. For the nine months ended September 30, 2015, we were allocated nine months of such expenses based upon our percentage share of the average invested assets of InvenTrust. The allocation includes costs related to corporate overhead expenses, such as payroll costs for certain of InvenTrust’s employees (accounting, finance, tax, treasury and legal) and outside professional services.

Provision for Asset Impairment

For the three and nine months ended September 30, 2016, we identified certain assets that may have a reduction in the expected holding period or a major tenant moving out or not renewing an expiring lease, and reviewed the probability of these properties' disposition. We recorded an impairment of investment properties of $18,967 on one net lease asset and $61,582 on three net lease assets for the three and nine months ended September 30, 2016, respectively.

For the three and nine months ended September 30, 2015, we recorded no asset impairment charges.

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Non-Operating Income and Expenses



	(in thousands)								(in thousands)
	For the Three months ended September 30,								For the Nine months ended September 30,				Increase
	2016		2015		Decrease		Variance		2016		2015		(Decrease)		Variance
Non-operating income and expenses:
Loss on sale of investment properties	—		(197	)	(197	)	100.0	%	—		(197	)	(197	)	100.0	%
Other loss	—		(1	)	(1	)	100.0	%	(113	)	(10	)	103		(1,030.0	)%
Interest expense	(7,143	)	(7,238	)	(95	)	1.3	%	(19,847	)	(21,062	)	(1,215	)	5.8	%

Loss on Sale of Investment Properties

There was no loss on the sale of investment properties during the nine months ended September 30, 2016.

During the nine months ended September 30, 2015, the loss on sale of investment properties was $0.2 million, which is attributed to one net lease asset sold during 2015.

Interest Expense

Interest expense decreased to $7.1 million for the three months ended September 30, 2016 from $7.2 million for the three months ended September 30, 2015. Interest expense decreased to $19.8 million for the nine months ended September 30, 2016 from $21.1 million for the nine months ended September 30, 2015. This was primarily driven by a decrease in the principal amount of our debt (including mortgages, the note payable with InvenTrust and the allocation of lines of credit from InvenTrust) to $390.0 million as of September 30, 2016 from $434.0 million as of September 30, 2015, offset by an increase in default interest on the AT&T-Hoffman Estates and Dulles loans.

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Leasing Activity

Our primary source of funding for our property-level operating activities and debt payments is rent collected pursuant to our tenant leases. The following table represents lease expirations as of September 30, 2016:



Lease Expiration Year	Number of Expiring Leases	Gross Leasable Area (GLA) of Expiring Leases (Sq. Ft.)	Annualized Rent of Expiring Leases (in thousands)		Percent of Total GLA		Percent of Total Annualized Rent		Expiring Rent/Square Foot
2016	5	116,872	$	2,111	2.5	%	3.0	%	$	18.06
2017	16	1,715,020	22,019		37.4	%	31.3	%	12.84
2018	16	192,406	2,342		4.2	%	3.3	%	12.17
2019	23	603,174	10,316		13.1	%	14.7	%	17.10
2020	37	533,995	13,783		11.6	%	19.6	%	25.81
2021	31	513,454	10,619		11.2	%	15.1	%	20.68
2022	7	170,698	2,565		3.7	%	3.7	%	15.03
2023	5	49,984	1,295		1.1	%	1.8	%	25.91
2024	2	63,200	493		1.4	%	0.7	%	7.80
2025	8	41,830	592		0.9	%	0.8	%	14.15
Month to Month	3	11,700	232		0.3	%	0.3	%	19.83
Thereafter	17	577,187	3,896		12.6	%	5.5	%	6.75
	170	4,589,520	$	70,263	100.0	%	100.0	%	$	15.31

As of September 30, 2016, the largest lease expiring in the last quarter of 2016 accounts for approximately 3% of our annualized rent in the aggregate. The current tenant has signed a new lease for only a portion of the space previously leased. The asset has therefore become multi-tenant during the third quarter. We have entered into leases with the former sub-tenants. Refer to the risk factors set forth under "Risk Factors - Risks Related to Our Business and Industry" included in our Registration Statement on Form 10-12G for additional information.

For the nine months ended September 30, 2016, approximately 21% of the Company’s annualized rent in the aggregate was generated by the Company’s AT&T-Hoffman Estates asset. The term of the lease on the AT&T-Hoffman Estates property expired on August 15, 2016 and the property is no longer generating revenue for the Company. As of September 30, 2016, the property is unoccupied. The Company intends to satisfy its mortgage obligations for AT&T-Hoffman Estates by permitting the lender to foreclose on the property.

The following table represents renewed leases that commenced in the nine months ended September 30, 2016.



	# of Leases	Gross Leasable Area	Rent per square foot		Weighted Average Lease Term
New	6	22,087	$	19.01	4.58
Renewals	15	413,086	$	16.39	3.24
Total	21	435,173	$	16.52	3.31

During the nine months ended September 30, 2016, 15 new leases and renewals commenced with gross leasable area totaling 435,173 square feet. The weighted average lease term for new and renewal leases was 4.58 and 3.24 years, respectively.

As of December 31, 2015, we had gross leasable area totaling 2,701,953 square feet set to expire in the first nine months of 2016, of which 272,116 square feet, or 9 leases, were renewed. This achieved a retention rate of 10%. The renewed leases include a correctional facility in Haskell, Texas, which initially expired in May 2016. We reached a renewal agreement with this tenant to extend the lease on similar terms through January 2017.

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Liquidity and Capital Resources

As of September 30, 2016, we had $34.2 million of cash and cash equivalents, and $3.2 million of restricted escrows.

Our principal demands for funds have been and will continue to be:


•	to pay the operating expenses of our assets;


•	to pay our general and administrative expenses;


•	to make distributions to our stockholders;


•	to service or pay-down our debt; and


•	to fund capital expenditures and leasing related costs.

Generally, our cash needs have been and will be funded from:


•	cash flows from our investment assets;


•	proceeds from sales of assets; and


•	proceeds from debt.

As of September 30, 2016, the mortgage loan on our AT&T-Cleveland asset is in “hyper-amortization,” and, as a result, all net operating income from this asset, less management operating expenses, is used to pay down the principal amount of the loan. Net cash generated is not available for general use of the Company and is classified as restricted. In addition, all rental payments, less certain expenses, for Dulles Executive Plaza are currently being “swept” and held by the lender pursuant to the loan agreement; as a result, net cash generated is not available for general use of the Company and is classified as restricted. The Company's Dulles - Executive Plaza asset, matured on September 1, 2016. On August 23, 2016, we received notice from the special servicer that loan went into maturity default. The Company is having further discussions with the special servicer regarding the future of the asset. For Sherman Plaza, all rental payments are being “swept” and held by the lender; however, the lender remits excess cash to the Company for its general use after the debt service payment has been paid. On October 1, 2016, the Company's AT&T-St. Louis property went into "cash trap." All income from the property is being "swept" by the lender, used to pay debt service and other charges, and to the extent income exceeds such charges the Company receives a lender-approved reimbursement for operating expenses associated with the property. Additional funds, if any, are held by the lender as additional collateral for the loan.

On June 29, 2016, the Company received notice that the loan in respect of the AT&T-Hoffman Estates asset had been transferred to the special servicer, C-III Asset Management, LLC. On August 9, 2016, the Company received written notice from the lender that an event of default occurred under the loan agreement relating to the AT&T-Hoffman Estates asset for failure to pay required installments of principal and interest, and that, as a result, the entire loan amount was due and payable. On August 19, 2016, C-III Asset Management LLC filed a foreclosure complaint in respect of AT&T-Hoffman Estates in the Circuit Court of Cook County, Illinois. On September 12, 2016, the Circuit Court entered an order appointing a receiver to manage the property during the pendency of the foreclosure proceedings. As of September 30, 2016, AT&T-Hoffman Estates is unoccupied. The Company intends to satisfy its mortgage obligations for AT&T-Hoffman Estates by permitting the lender to foreclose on the property.

Our assets have lease maturities within the next two years that are likely to reduce our cash flows from operations. There is no assurance that we will be able to re-lease these assets at comparable rates or on comparable terms, or at all.

We may, from time to time, repurchase our outstanding equity and/or debt securities, if any, through cash purchases or via other transactions. Such repurchases or transactions, if any, will depend on our liquidity requirements, contractual restrictions, and other factors. The amounts involved may be material.

Borrowings

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The table below presents, on a condensed combined consolidated basis, the principal amount, weighted average interest rates and maturity date (by year) on our mortgage debt, as of September 30, 2016 (dollar amounts are stated in thousands).



Fixed rate mortgage debt maturing during the year ended December 31,	As of September 30, 2016		Weighted average interest rate, fixed
2016	$	202,790	6.51	%
2017	30,275		5.57	%
2018	—		—	%
2019	—		—	%
2020	—		—	%
Thereafter	158,737		5.57	%
Total	$	391,802	6.05	%

As of September 30, 2016 and December 31, 2015, no debt is recourse to the Company, although the Company or its subsidiaries may act as guarantor under customary, non-recourse carveout clauses in our wholly owned property owning subsidiaries' mortgage loans.

As of September 30, 2016, we had $202.8 million of mortgage debt maturing through the remainder of 2016, and $30.3 million in mortgage debt maturing in 2017. The amount maturing in 2016 represents one mortgage that became due in August 2016 due to a default event as disclosed in the notes to the condensed combined consolidated financial statements, one mortgage with a maturity date in September 2016 and two mortgages with maturity dates in December 2016.

Our ability to pay off our mortgages when they become due is dependent upon our ability either to refinance the related mortgage debt or to sell the related asset. With respect to each loan, if the applicable wholly owned property-owning subsidiary is unable to refinance or sell the related asset, or in the event that the estimated asset value is less than the mortgage balance, the applicable wholly owned property-owning subsidiary may, if appropriate, satisfy a mortgage obligation by transferring title of the asset to the lender or permitting a lender to foreclose. As further described under Liquidity and Capital Resources, one of our mortgage loans is currently subject to foreclosure proceedings, and the lenders of certain other mortgage loans have exercised their rights with respect to cash generated by mortgaged assets.

Volatility in the capital markets could expose us to the risk of not being able to borrow on terms and conditions acceptable to us for refinancing.

Mortgage loans outstanding as of September 30, 2016 and December 31, 2015 were $391.8 million and $406.0 million and had a weighted average interest rate of 6.05% and 6.09% per annum, respectively. For the nine months ended September 30, 2016 and 2015, we had no additional borrowings secured by mortgages on our assets.

On May 1, 2014, a subsidiary of the Company entered into a note payable in the amount of $32.9 million with InvenTrust. On March 25, 2016, the outstanding principal balance of $15.1 million and accrued interest of $0.1 million was repaid in full. As of December 31, 2015, the balance of this note payable was $15.1 million.

On November 5, 2015, InvenTrust entered into a term loan credit agreement for a $300 million unsecured credit facility. The term loan credit facility consists of two tranches: a five-year tranche maturing on January 15, 2021, and a seven-year tranche maturing on November 5, 2022. Based upon the InvenTrust’s total leverage ratio at December 31, 2015, the five-year tranche bears an interest rate of LIBOR plus 1.30% and the seven-year tranche bears an interest rate of LIBOR plus 1.60%. The term loan credit facility is subject to a borrowing base consisting of a pool of unencumbered assets. To the extent the Company’s assets were included within the pool of unencumbered assets, the Company was allocated a portion of the unsecured credit facility. As of the Distribution, the Company no longer has an allocated portion of the unsecured credit facility, therefore, as of September 30, 2016, the Company’s allocated portion of the term loan was $0. As of December 31, 2015, the Company’s allocated portion of the unsecured credit facility was $17.9 million and the interest rate was 1.59%.

On February 3, 2015, InvenTrust entered into an amended and restated credit agreement for a $300 million unsecured revolving line of credit, which matures on February 2, 2019. The unsecured revolving line of credit bears interest at a rate equal to LIBOR plus 1.40% and requires the maintenance of certain financial covenants. The unsecured credit facility is subject to a borrowing base consisting of a pool of unencumbered assets. To the extent the Company’s assets were included within the pool of unencumbered assets, the Company was allocated its proportionate share of the revolving line of credit. As of December 31, 2015, the Company’s allocated portion of the revolving line of credit was $0. As of the Distribution, we no longer have an allocated portion of the unsecured credit facility.

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Summary of Cash Flows

Comparison of the nine months ended September 30, 2016 and September 30, 2015



	(in thousands)
	For the Nine months ended September 30,
	2016			2015
Cash provided by operating activities	$	32,409		$	40,202
Cash provided by investing activities	769			3,302
Cash used in financing activities	(25,969		)	(30,220		)
Increase in cash and cash equivalents	7,209			13,284
Cash and cash equivalents, at beginning of period	26,972			10,291
Cash and cash equivalents, at end of period	$	34,181		$	23,575

Cash provided by operating activities was $32.4 million and $40.2 million for the nine months ended September 30, 2016 and 2015, respectively, and was generated primarily from operating income from property operations. The decrease is primarily the result of four assets that were transferred to InvenTrust during the first quarter of 2016.

Cash provided by investing activities was $0.8 million and $3.3 million for the nine months ended September 30, 2016 and 2015, respectively. The cash provided by investing activities is primarily related to capital expenditures, payment of leasing fees and restricted escrows. During the nine months ended September 30, 2016, cash provided by restricted escrows was $1.9 million primarily from previously restricted escrows for a multi-tenant office asset, payments for capital expenditures were $0.5 million and payments for leasing fees were $0.6 million. In the nine months ended September 30, 2015, cash provided by proceeds from sale of investment properties, net was $7.9 million. Cash used in restricted escrows was $0.6 million primarily for lender required escrows, payments for capital expenditures were $2.0 million and payments for leasing fees were $2.0 million.

Cash used in financing activities was $26.0 million and $30.2 million for the nine months ended September 30, 2016 and 2015, respectively. Cash used in financing activities for the nine months ended September 30, 2016 was primarily related to principal payments on mortgage debt of $14.2 million and the payoff of a note payable of $15.1 million. Cash used in financing activities for the nine months ended September 30, 2015 was primarily due to principal payments of mortgage debt of $15.5 million, net distributions to Inventrust of $10.1 million and cash dividends paid of $4.6 million.

We consider all demand deposits, money market accounts and investments in certificates of deposit and repurchase agreements with a maturity of three months or less, at the date of purchase, to be cash equivalents. We maintain our cash and cash equivalents at financial institutions. The combined account balances at one or more institutions exceed the Federal Depository Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage.

Distributions

For the three and nine months ended September 30, 2016 and 2015, other than distributions prior to the Distribution, no cash distributions were paid by Highlands.

On December 15, 2015, MB REIT, currently a subsidiary of Highlands REIT, Inc., became a “qualified REIT subsidiary” of InvenTrust and ceased to be treated as a REIT for U.S. federal income tax purposes. Prior to that time, MB REIT made distributions to its stockholders in order to qualify as a REIT. As of September 30, 2015, MB REIT had issued and outstanding 943,000 shares of common stock having a par value of $1.00 per share, 207,000 shares of 3.5% Series A Cumulative Redeemable Preferred Stock, $0.01 par value per share, and 125 shares of 12.5% Series B Cumulative Non-Voting Preferred Stock, $0.01 par value per share. For the three and nine months ended September 30, 2016 and 2015, $0 million and $4.6 million dividends, respectively were paid by MB REIT.

Off-Balance Sheet Arrangements

As of September 30, 2016 and December 31, 2015, we have no off-balance sheet arrangements.

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Selected Financial Data

The following table shows our condensed combined consolidated selected financial data relating to our condensed combined consolidated historical financial condition and results of operations. Such selected data should be read in conjunction with the condensed combined consolidated financial statements and related notes appearing elsewhere in this report (dollar amounts are stated in thousands, except per share amounts).



	As of
	September 30, 2016		December 31, 2015
Balance Sheet Data:
Total assets	$	518,012	$	739,154
Debt, net	389,955		437,032



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Operating Data:
Total revenues	$	20,357		$	27,393		$	71,788		$	83,812
Net (loss) income	$	(21,340	)	$	3,314		$	(56,269	)	$	10,162
Net (loss) income attributable to Company	$	(21,340	)	$	3,306		$	(56,269	)	$	10,146
Supplemental Measures:
Funds from operations (a)	$	3,720		$	12,544		$	26,667		$	37,623
Cash Flow Data:
Net cash flows provided by operating activities	$	11,010		$	12,772		$	32,409		$	40,202
Net cash flows provided by investing activities	$	1,868		$	6,434		$	769		$	3,302
Net cash flows used in financing activities	$	(3,199	)	$	(14,317	)	$	(25,969	)	$	(30,220	)

(a)

The National Association of Real Estate Investment Trusts ("NAREIT"), an industry trader group, has promulgated a standard known as FFO, or Funds from Operations. As defined by NAREIT, FFO is net income (loss) in accordance with GAAP excluding gains (or losses) resulting from dispositions of properties, plus depreciation and amortization and impairment charges on depreciable property. We have adopted the NAREIT definition in our calculation of FFO as management considers FFO a widely accepted and appropriate measure of performance for REITs.

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In calculating FFO, impairment charges of depreciable real estate assets are added back even though the impairment charge may represent a permanent decline in value due to decreased operating performance of the applicable property. Further, because gains and losses from sales of property are excluded from FFO, it is consistent and appropriate that impairments, which are often early recognition of losses on prospective sales of property, also be excluded.

We believe that FFO is a better measure of our properties’ operating performance because FFO excludes non-cash items from GAAP net income. FFO is neither intended to be an alternative to "net income" nor to "cash flows from operating activities" as determined by GAAP as a measure of our capacity to pay distributions. Other REITs may use alternative methodologies for calculating similarly titled measures, which may not be comparable to our calculation of FFO. A reconciliation of FFO to net income is as follows (in thousands):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net (loss) income	$	(21,340	)	$	3,314		$	(56,269	)	$	10,162
Less: Net income attributable to non-controlling interests	—			(8		)	—			(16		)
Net (loss) income attributable to Company	$	(21,340	)	$	3,306		$	(56,269	)	$	10,146
Depreciation and amortization related to investment properties	6,093			9,041			21,354			27,280
Impairment of investment properties	18,967			—			61,582			—
Loss on sale of investment properties, net	—			197			—			197
Funds from operations	$	3,720		$	12,544		$	26,667		$	37,623

FFO does not reflect a reduction for funds withheld by lenders (and therefore not available to the Company) because the Company still has rights to such funds even though they are subject to the terms of "cash trap," "cash sweep," or "hyper amortization" under the loan agreements with lenders. As of September 30, 2016, the mortgage loan on our AT&T-Cleveland asset is in “hyper-amortization,” and, as a result, all net operating income from this asset, less management operating expenses, is used to pay down the principal amount of the loan. Net cash generated is not available for general use of the Company and is classified as restricted. In addition, all rental payments, less certain expenses, for Dulles Executive Plaza are currently being “swept” and held by the lender pursuant to the loan agreement; as a result, net cash generated is not available for general use of the Company and is classified as restricted. For Sherman Plaza, all rental payments are being “swept” and held by the lender; however, the lender remits excess cash to the Company for its general use after the debt service payment has been paid. On October 1, 2016, the Company's AT&T-St. Louis property went into "cash trap." All income from the property is being "swept" by the lender, used to pay debt service and other charges, and to the extent income exceeds such charges the Company receives a lender-approved reimbursement for operating expenses associated with the property. Additional funds, if any, are held by the lender as additional collateral for the loan.

For the nine months ended September 30, 2016, cash amounts withheld by lenders used to pay debt service and other charges (and therefore unavailable to the Company) because of these restrictions amounted to $12.6 million, $1.5 million, and $0.8 million for AT&T-Hoffman Estates, Dulles Executive Plaza, and AT&T-Cleveland, respectively.

The table below reflects additional information related to certain items that significantly impact the comparability of our FFO and net income or significant non-cash items from the periods presented (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Amortization of mark to market debt discounts and financing costs	$	52	$	54	$	160	$	166

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Use and Limitations of Non-GAAP Financial Measures

FFO does not represent cash generated from operating activities under GAAP and should not be considered as an alternative to net income or loss, operating profit, cash flows from operations or any other operating performance measure prescribed by GAAP. Although we present and use FFO because we believe it is useful to investors in evaluating and facilitating comparisons of our operating performance between periods and between REITs that report similar measures, the use of this non-GAAP measure has certain limitations as an analytical tool. This non-GAAP financial measure is not a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to fund capital expenditures, contractual commitments, working capital, service debt or make cash distributions. This measurement does not reflect cash expenditures for long-term assets and other items that we have incurred and will incur. This non-GAAP financial measure may include funds that may not be available for management’s discretionary use due to functional requirements to conserve funds for capital expenditures, property acquisitions and other commitments and uncertainties. This non-GAAP financial measure, as presented, may not be comparable to non-GAAP financial measures as calculated by other real estate companies. Additionally, the Company believes the information included in the above table provides useful supplemental information that may facilitate comparisons of the Company's ongoing operating performance between periods, as well as between REITs that include similar disclosure.

We compensate for these limitations by separately considering the impact of these excluded items to the extent they are material to operating decisions or assessments of our operating performance. Our reconciliation to the most comparable GAAP financial measures, and our condensed combined consolidated statements of operations and cash flows, include interest expense, capital expenditures and other excluded items, all of which should be considered when evaluating our performance, as well as the usefulness of our non-GAAP financial measure. This non-GAAP financial measure reflects an additional way of viewing our operations that we believe, when viewed with our GAAP results and the reconciliation to the corresponding GAAP financial measure, provides a more complete understanding of factors and trends affecting our business than could be obtained absent this disclosure. We strongly encourage investors to review our financial information in its entirety and not to rely on a single financial measure.

Subsequent Events

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk associated with changes in interest rates in terms of the price of new fixed-rate debt upon maturity of existing debt and for acquisitions.

Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs.

Existing fixed rate loans that are scheduled to mature in the next year or two are evaluated for possible early refinancing and/or extension due to consideration given to current interest rates. Refer to Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation - Borrowings for mortgage debt principal amounts and weighted average interest rates by year and expected maturity to evaluate the expected cash flows. As of September 30, 2016, we did not have any variable rate loans outstanding.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As required by Rule 13a-15(b) and Rule 15d-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our principal executive officer and our principal financial officer evaluated, as of September 30, 2016, the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and Rule 15d-15(e) of the Exchange Act. Based on that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures, as of September 30, 2016, were effective at a reasonable assurance level for the purpose of ensuring that information required to be disclosed by us in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II - Other Information

Item 1. Legal Proceedings

Our AT&T-Hoffman Estates asset is currently in foreclosure proceedings. Please see Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources above for additional information. We are from time to time involved in legal actions arising in the ordinary course of business. We are not currently involved in any other legal or administrative proceedings that we believe are likely to have a materially adverse effect on our business, results of operations or financial condition.

Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in our Registration Statement on Form 10-12G (File No. 000-55580) under the heading "Risk Factors."

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

On November 3, 2016, in connection with the continuing development of our compensation program as an independent company following our separation from InvenTrust Properties Corp., the compensation committee of the board of directors approved an increase to the annual base salary of Richard Vance, our President and Chief Executive Officer, from $385,000 to $525,000, effective as of March 1, 2017. In addition, on November 3, 2016, the compensation committee approved a 2016 target annual bonus level for Mr. Vance equal to 100% of his annual base salary, and established threshold and maximum 2016 annual bonus levels for Mr. Vance equal to 50% of his annual base salary and 200% of his annual base salary, respectively.

Item 6. Exhibits

The exhibits filed in response to Item 601 of Regulation S-K are listed on the Exhibit Index attached hereto and are incorporated herein by reference.

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SIGNATURES

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.

Highlands REIT, Inc.



Date:	November 10, 2016	By:	/s/ Richard Vance

			Richard Vance
			President and Chief Executive Officer (Principal Executive Officer)



Date:	November 10, 2016	By:	/s/ Joseph Giannini

			Joseph Giannini
			Senior Vice President, Principal Accounting Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT NO.		DESCRIPTION
3.1		Articles of Amendment and Restatement of Highlands REIT, Inc. (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8, filed with the Securities and Exchange Commission on April 27, 2016)
3.2		Amended and Restated Bylaws of Highlands REIT, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 28, 2016)
10.10		Highlands REIT, Inc. Retention Bonus Plan (incorporated by reference to Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q, filed with the Securities Exchange Commission on August 12, 2016)
10.11		Change in Control Severance Agreement between Highlands REIT, Inc. and Joseph Giannini, dated as of August 9, 2016 (incorporated by reference to Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q, filed with the Securities Exchange Commission on August 12, 2016)
31.1*		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*		Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*		Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Link Document


*	Filed as part of this Quarterly Report on Form 10-Q.

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