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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------



FOR THE QUARTER ENDED SEPTEMBER 30, 2004



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



Commission File Number 1-15663



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AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Nevada                                                         |  | 75-2847135                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|1800 Valley View Lane, Suite 300, Dallas, Texas                |  | 75234                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          



(469) 522-4200

(Registrants Telephone Number, Including Area Code)



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Indicate by
check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes ̈.    No  x.



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



APPLICABLE ONLY TO CORPORATE ISSUERS:



Indicate
the number of shares outstanding of each of the issuers classes of Common Stock, as of the latest practicable date.



|                             |  |                                    
|---------------------------- |  | -----------------------------------
|Common Stock, $.01 par value |  | 10,484,900                         
|(Class)                      |  | (Outstanding at November 12, 2004)*



|* | Does not include 746,972 shares issued to and owned by Transcontinental Realty Investors, Inc.
|- | ----------------------------------------------------------------------------------------------



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AMERICAN REALTY INVESTORS, INC.



PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but, in the opinion of the management of American
Realty Investors, Inc. (ARI), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated balance sheets and consolidated cash flows at the dates and for
the periods indicated, have been included.



AMERICAN REALTY
INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share)



|                                                                                   |  |                   |           |   |                   |   |           |  
|---------------------------------------------------------------------------------- |  | ----------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                   |  | September 30,2004 |           |   | December 31, 2003 |  
|                                                                                   |  |                   |           |   | As Restated       |  
|Assets                                                                             |  |                   |           |   |                   |   |           |  
|Real estate held for investment                                                    |  | $                 | 965,189   |   |                   | $ | 1,014,452 |  
|Lessaccumulated depreciation                                                      |  |                   | (162,629  | ) |                   |   | (171,659  | )
|                                                                                   |  |                   |           |   |                   |   |           |  
|                                                                                   |  |                   | 802,560   |   |                   |   | 842,793   |  
|                                                                                   |  |                  
|Real estate held for sale                                                          |  |                   | 255,017   |   |                   |   | 211,942   |  
|                                                                                   |  |                  
|Notes and interest receivable:                                                     |  |                   |           |   |                   |   |           |  
|Performing ($37,421 in 2004 and $37,697 in 2003 from affiliates)                   |  |                   | 69,186    |   |                   |   | 64,296    |  
|Nonperforming                                                                      |  |                   | 10,934    |   |                   |   | 10,932    |  
|                                                                                   |  |                   |           |   |                   |   |           |  
|                                                                                   |  |                   | 80,120    |   |                   |   | 75,228    |  
|Lessallowance for estimated losses                                                |  |                   | (4,633    | ) |                   |   | (4,633    | )
|                                                                                   |  |                   |           |   |                   |   |           |  
|                                                                                   |  |                   | 75,487    |   |                   |   | 70,595    |  
|                                                                                   |  |                  
|Pizza parlor equipment                                                             |  |                   | 13,220    |   |                   |   | 12,237    |  
|Lessaccumulated depreciation                                                      |  |                   | (6,300    | ) |                   |   | (5,385    | )
|                                                                                   |  |                   |           |   |                   |   |           |  
|                                                                                   |  |                   | 6,920     |   |                   |   | 6,852     |  
|                                                                                   |  |                  
|Marketable equity securities, at market value                                      |  |                   | 5,838     |   |                   |   | 5,020     |  
|Cash and cash equivalents                                                          |  |                   | 11,155    |   |                   |   | 9,543     |  
|Investments in equity investees                                                    |  |                   | 5,787     |   |                   |   | 4,987     |  
|Goodwill, net of accumulated amortization ($1,763 in 2004 and 2003)                |  |                   | 11,858    |   |                   |   | 11,858    |  
|Other intangibles, net of accumulated amortization ($859 in 2004 and $822 in 2003) |  |                   | 1,492     |   |                   |   | 1,529     |  
|Other assets ($19,504 in 2004 and $8,098 in 2003 from affiliates)                  |  |                   | 91,049    |   |                   |   | 75,761    |  
|                                                                                   |  |                   |           |   |                   |   |           |  
|                                                                                   |  | $                 | 1,267,163 |   |                   | $ | 1,240,880 |  
|                                                                                   |  |                   |           |   |                   |   |           |  



The accompanying notes
are an integral part of these Consolidated Financial Statements.



2



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETSContinued

(dollars in thousands, except per
share)



|                                                                                                                                                                 |  |                   |           |   |                   |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                 |  | September 30,2004 |           |   | December 31, 2003 |  
|                                                                                                                                                                 |  |                   |           |   | As Restated       |  
|Liabilities and Stockholders Equity                                                                                                                             |  |                   |           |   |                   |   |           |  
|Liabilities:                                                                                                                                                     |  |                   |           |   |                   |   |           |  
|Notes and interest payable ($36,695 in 2004 and $34,775 in 2003 to affiliates)                                                                                   |  | $                 | 834,608   |   |                   | $ | 886,615   |  
|Liabilities related to assets held for sale                                                                                                                      |  |                   | 204,071   |   |                   |   | 100,154   |  
|Margin borrowings                                                                                                                                                |  |                   | 18,773    |   |                   |   | 21,194    |  
|Accounts payable and other liabilities ($5,828 in 2004 and $2,934 in 2003 to affiliates)                                                                         |  |                   | 94,230    |   |                   |   | 96,360    |  
|                                                                                                                                                                 |  |                   |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                   | 1,151,682 |   |                   |   | 1,104,323 |  
|                                                                                                                                                                 |  |                  
|Minority interest                                                                                                                                                |  |                   | 55,720    |   |                   |   | 59,686    |  
|                                                                                                                                                                 |  |                  
|Commitments and contingencies                                                                                                                                    |  |                   |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                  
|Stockholders equity:                                                                                                                                            |  |                   |           |   |                   |   |           |  
|Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding:                                                                          |  |                   |           |   |                   |   |           |  
|Series A, 3,475,370 shares in 2004 and 3,225,370 shares in 2003 (liquidation preference $34,754), including 900,000 shares in 2004 and 2003
held by subsidiaries |  |                   | 5,151     |   |                   |   | 4,651     |  
|Series E, 50,000 shares in 2004 and 2003 (liquidation preference $500)                                                                                           |  |                   | 100       |   |                   |   | 100       |  
|Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,392,272 shares in 2004 and 2003                                                           |  |                   | 114       |   |                   |   | 114       |  
|Paid-in capital                                                                                                                                                  |  |                   | 92,513    |   |                   |   | 92,464    |  
|Treasury stock, at cost, 907,372 shares in 2004 and 746,972 shares in 2003                                                                                       |  |                   | (11,367   | ) |                   |   | (9,924    | )
|Accumulated deficit                                                                                                                                              |  |                   | (25,690   | ) |                   |   | (10,635   | )
|Accumulated other comprehensive income (loss)                                                                                                                    |  |                   | (1,060    | ) |                   |   | 101       |  
|                                                                                                                                                                 |  |                   |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                   | 59,761    |   |                   |   | 76,871    |  
|                                                                                                                                                                 |  |                   |           |   |                   |   |           |  
|                                                                                                                                                                 |  | $                 | 1,267,163 |   |                   | $ | 1,240,880 |  
|                                                                                                                                                                 |  |                   |           |   |                   |   |           |  



The accompanying notes
are an integral part of these Consolidated Financial Statements.



3



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share)



|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | --------------------------------------- | ------- | - | -------------------------------------- | - | ------ | ---- |  | - | ----------- | - |  | - | ------- | -
|                                                                                                             |  | For the Three MonthsEnded September 30, |         |   | For the Nine MonthsEnded September 30, |  
|                                                                                                             |  | 2004                                    |         |   | 2003                                   |   |        | 2004 |  |   | 2003        |  
|                                                                                                             |  |                                         |         |   | As Restated                            |   |        |      |  |   | As Restated |  
|Property revenue:                                                                                            |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Rents ($933 in nine months of 2004 and $1,059 in nine months of 2003 from affiliates)                        |  | $                                       | 45,646  |   |                                        | $ | 41,903 |      |  | $ | 132,478     |   |  | $ | 100,701 |  
|Property operations expenses ($3,895 in nine months of 2004 and $3,873 in nine months of 2003 to affiliates) |  |                                         | 32,416  |   |                                        |   | 29,945 |      |  |   | 96,360      |   |  |   | 72,089  |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Operating income                                                                                             |  |                                         | 13,230  |   |                                        |   | 11,958 |      |  |   | 36,118      |   |  |   | 28,612  |  
|                                                                                                             |  |                                         |         |  
|Land operations:                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Sales                                                                                                        |  |                                         | 2,910   |   |                                        |   | 27,551 |      |  |   | 34,592      |   |  |   | 39,654  |  
|Cost of sales                                                                                                |  |                                         | 2,610   |   |                                        |   | 12,080 |      |  |   | 24,801      |   |  |   | 23,150  |  
|Deferral of gains on current period sales                                                                    |  |                                         | 220     |   |                                        |   |       |      |  |   | 5,212       |   |  |   |        |  
|Recognition of previously deferred gains                                                                     |  |                                         | 747     |   |                                        |   | 27     |      |  |   |            |   |  |   | 19,924  |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Gain on land sales                                                                                           |  |                                         | 827     |   |                                        |   | 15,498 |      |  |   | 4,579       |   |  |   | 36,428  |  
|                                                                                                             |  |                                         |         |  
|Pizza parlor operations:                                                                                     |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Sales                                                                                                        |  |                                         | 8,667   |   |                                        |   | 8,330  |      |  |   | 25,659      |   |  |   | 24,267  |  
|Cost of sales                                                                                                |  |                                         | 6,788   |   |                                        |   | 6,592  |      |  |   | 19,925      |   |  |   | 19,357  |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Gross margin                                                                                                 |  |                                         | 1,879   |   |                                        |   | 1,738  |      |  |   | 5,734       |   |  |   | 4,910   |  
|                                                                                                             |  |                                         |         |  
|Income from operations                                                                                       |  |                                         | 15,936  |   |                                        |   | 29,194 |      |  |   | 46,431      |   |  |   | 69,950  |  
|                                                                                                             |  |                                         |         |  
|Other income:                                                                                                |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Interest income ($1,915 in nine months of 2004 and $3,076 in nine months of 2003 from affiliates)            |  |                                         | 1,151   |   |                                        |   | 1,795  |      |  |   | 3,514       |   |  |   | 7,431   |  
|Equity in income (loss) of investees                                                                         |  |                                         | 56      |   |                                        |   | (204   | )    |  |   | (144        | ) |  |   | (4,279  | )
|Gain (loss) on foreign currency transaction                                                                  |  |                                         | 543     |   |                                        |   | (966   | )    |  |   | 1,791       |   |  |   | (966    | )
|Gain on extinguishment of debt                                                                               |  |                                         | 2,268   |   |                                        |   |       |      |  |   | 2,268       |   |  |   |        |  
|Other                                                                                                        |  |                                         | 72      |   |                                        |   | 55     |      |  |   | (136        | ) |  |   | 307     |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|                                                                                                             |  |                                         | 4,090   |   |                                        |   | 680    |      |  |   | 7,293       |   |  |   | 2,493   |  
|                                                                                                             |  |                                         |         |  
|Other expenses:                                                                                              |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Interest ($1,845 in nine months of 2004 and $519 in nine months of 2003 to affiliates)                       |  |                                         | 17,142  |   |                                        |   | 16,236 |      |  |   | 50,152      |   |  |   | 41,608  |  
|Depreciation and amortization                                                                                |  |                                         | 6,641   |   |                                        |   | 5,413  |      |  |   | 19,597      |   |  |   | 12,849  |  
|Discount on sale of notes receivable                                                                         |  |                                         | (9      | ) |                                        |   | (1     | )    |  |   | 389         |   |  |   | 1,557   |  
|General and administrative ($3,290 in nine months of 2004 and 4,456 in nine months of 2003 to affiliates)    |  |                                         | 2,583   |   |                                        |   | 5,205  |      |  |   | 11,474      |   |  |   | 15,899  |  
|Advisory fee to affiliate                                                                                    |  |                                         | 2,934   |   |                                        |   | 3,740  |      |  |   | 8,162       |   |  |   | 8,468   |  
|Net income fee to affiliate                                                                                  |  |                                         |        |   |                                        |   | 675    |      |  |   |            |   |  |   | 675     |  
|Incentive fee to affiliate                                                                                   |  |                                         |        |   |                                        |   | 1,091  |      |  |   |            |   |  |   | 1,091   |  
|Litigation settlement                                                                                        |  |                                         | 50      |   |                                        |   |       |      |  |   | 50          |   |  |   |        |  
|Writedown of assets held for sale                                                                            |  |                                         | 3,444   |   |                                        |   |       |      |  |   | 3,444       |   |  |   | 2,352   |  
|Minority interest                                                                                            |  |                                         | (1,474  | ) |                                        |   | 145    |      |  |   | 155         |   |  |   | 1,490   |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|                                                                                                             |  |                                         | 31,311  |   |                                        |   | 32,504 |      |  |   | 93,423      |   |  |   | 85,989  |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Net loss from continuing operations                                                                          |  |                                         | (11,285 | ) |                                        |   | (2,630 | )    |  |   | (39,699     | ) |  |   | (13,546 | )
|                                                                                                             |  |                                         |         |  
|Discontinued operations:                                                                                     |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Loss from operations                                                                                         |  |                                         | (999    | ) |                                        |   | (3,749 | )    |  |   | (2,137      | ) |  |   | (7,311  | )
|Gain on sale of real estate                                                                                  |  |                                         | 5,306   |   |                                        |   | 18,222 |      |  |   | 25,895      |   |  |   | 34,042  |  
|Equity in gain (loss) on sale of real estate by equity investees                                             |  |                                         | (9      | ) |                                        |   | (165   | )    |  |   | 886         |   |  |   | (165    | )
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Net income from discontinued operations                                                                      |  |                                         | 4,298   |   |                                        |   | 14,308 |      |  |   | 24,644      |   |  |   | 26,566  |  
|                                                                                                             |  |                                         |         |  
|Net income (loss)                                                                                            |  |                                         | (6,987  | ) |                                        |   | 11,678 |      |  |   | (15,055     | ) |  |   | 13,020  |  
|Preferred dividend requirement                                                                               |  |                                         | (651    | ) |                                        |   | (587   | )    |  |   | (1,951      | ) |  |   | (1,763  | )
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  
|Net income (loss) applicable to Common shares                                                                |  | $                                       | (7,638  | ) |                                        | $ | 11,091 |      |  | $ | (17,006     | ) |  | $ | 11,257  |  
|                                                                                                             |  |                                         |         |   |                                        |   |        |      |  |   |             |   |  |   |         |  



4



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONSContinued

(dollars in thousands,
except per share)



|                                                                          |  |                                          |            |   |                                         |   |            |      |  |   |             |   |  |   |            |  
|------------------------------------------------------------------------- |  | ---------------------------------------- | ---------- | - | --------------------------------------- | - | ---------- | ---- |  | - | ----------- | - |  | - | ---------- | -
|                                                                          |  | For the Three Months Ended September 30, |            |   | For the Nine Months Ended September 30, |  
|                                                                          |  | 2004                                     |            |   | 2003                                    |   |            | 2004 |  |   | 2003        |  
|                                                                          |  |                                          |            |   | As Restated                             |   |            |      |  |   | As Restated |  
|Basic and diluted income (loss) per share:                                |  |                                          |            |   |                                         |   |            |      |  |   |             |   |  |   |            |  
|Net loss from continuing operations                                       |  | $                                        | (1.14      | ) |                                         | $ | (.30       | )    |  | $ | (3.93       | ) |  | $ | (1.41      | )
|Discontinued operations                                                   |  |                                          | .41        |   |                                         |   | 1.34       |      |  |   | 2.33        |   |  |   | 2.45       |  
|                                                                          |  |                                          |            |   |                                         |   |            |      |  |   |             |   |  |   |            |  
|Net income (loss) applicable to Common shares                             |  | $                                        | (.73       | ) |                                         | $ | 1.04       |      |  | $ | (1.60       | ) |  | $ | 1.04       |  
|                                                                          |  |                                          |            |   |                                         |   |            |      |  |   |             |   |  |   |            |  
|Weighted average Common shares used in computing income (loss) per share: |  |                                          |            |   |                                         |   |            |      |  |   |             |   |  |   |            |  
|Basic and diluted                                                         |  |                                          | 10,532,796 |   |                                         |   | 10,628,155 |      |  |   | 10,596,902  |   |  |   | 10,838,839 |  



Convertible Preferred Stock (2,575,370
shares) and options to purchase 101,250 shares of ARIs Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2004, because the effect of their inclusion would be
antidilutive.



Convertible Preferred Stock (2,326,610 shares) and options to
purchase 108,750 shares of ARIs Common Stock were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2003, because the effect of their inclusion would be antidilutive.



The accompanying notes are an integral part of these Consolidated Financial
Statements.



5



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

For the Nine Months
Ended September 30, 2004

(dollars in thousands, except per share)



|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------------ | ----- | ------------------------ | - | ----------- |  | -------------- | --- |  | -------------- | ------ | - | ------------------ | - | ------- | ----------------------------------- |  | - | ------------------------- | - |  | - | ------ | - |  | - | ------- | -
|                                                              |  | Series A Preferred Stock |       | Series E Preferred Stock |   | CommonStock |  | Paid-inCapital |     |  | Treasury Stock |        |   | AccumulatedDeficit |   |         | AccumulatedOtherComprehensiveIncome |  |   | Total StockholdersEquity |  
|Balance, January 1, 2004, as previously reported              |  | $                        | 4,651 |                          | $ | 100         |  | $              | 114 |  | $              | 92,464 |   |                    | $ | (9,924  | )                                   |  | $ | (11,826                   | ) |  | $ | 101    |   |  | $ | 75,680  |  
|Correction of accounting error in prior period (see Note. 11) |  |                          |      |                          |   |            |  |                |    |  |                |       |   |                    |   |        |                                     |  |   | 1,191                     |   |  |   |       |   |  |   | 1,191   |  
|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|Adjusted balance, January 1, 2004                             |  |                          | 4,651 |                          |   | 100         |  |                | 114 |  |                | 92,464 |   |                    |   | (9,924  | )                                   |  |   | (10,635                   | ) |  |   | 101    |   |  |   | 76,871  |  
|Comprehensive income:                                         |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|Unrealized loss on foreign currency translation               |  |                          |      |                          |   |            |  |                |    |  |                |       |   |                    |   |        |                                     |  |   |                          |   |  |   | (1,943 | ) |  |   | (1,943  | )
|Unrealized gain on marketable securities                      |  |                          |      |                          |   |            |  |                |    |  |                |       |   |                    |   |        |                                     |  |   |                          |   |  |   | 782    |   |  |   | 782     |  
|Net loss                                                      |  |                          |      |                          |   |            |  |                |    |  |                |       |   |                    |   |        |                                     |  |   | (15,055                   | ) |  |   |       |   |  |   | (15,055 | )
|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   | (16,216 | )
|Repurchase of Common Stock                                    |  |                          |      |                          |   |            |  |                |    |  |                |       |   |                    |   | (1,443  | )                                   |  |   |                          |   |  |   |       |   |  |   | (1,443  | )
|Issuance of Preferred Stock                                   |  |                          | 500   |                          |   |            |  |                |    |  |                | 2,000  |   |                    |   |        |                                     |  |   |                          |   |  |   |       |   |  |   | 2,500   |  
|Preferred dividends                                           |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|Series A Preferred Stock ($.75 per share)                     |  |                          |      |                          |   |            |  |                |    |  |                | (1,929 | ) |                    |   |        |                                     |  |   |                          |   |  |   |       |   |  |   | (1,929  | )
|Series E Preferred Stock ($.45 per share)                     |  |                          |      |                          |   |            |  |                |    |  |                | (22    | ) |                    |   |        |                                     |  |   |                          |   |  |   |       |   |  |   | (22     | )
|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  
|Balance, September 30, 2004                                   |  | $                        | 5,151 |                          | $ | 100         |  | $              | 114 |  | $              | 92,513 |   |                    | $ | (11,367 | )                                   |  | $ | (25,690                   | ) |  | $ | (1,060 | ) |  | $ | 59,761  |  
|                                                              |  |                          |       |                          |   |             |  |                |     |  |                |        |   |                    |   |         |                                     |  |   |                           |   |  |   |        |   |  |   |         |  



The accompanying notes
are an integral part of these Consolidated Financial Statements.



6



---

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)



|                                                                                        |  |                                        |          |   |             |   |          |  
|--------------------------------------------------------------------------------------- |  | -------------------------------------- | -------- | - | ----------- | - | -------- | -
|                                                                                        |  | For the Nine MonthsEnded September 30, |         
|                                                                                        |  | 2004                                   |          |   | 2003        |  
|                                                                                        |  |                                        |          |   | As Restated |  
|Cash Flows From Operating Activities:                                                   |  |                                        |          |   |             |   |          |  
|Net income (loss)                                                                       |  | $                                      | (15,055  | ) |             | $ | 13,020   |  
|Adjustments to reconcile net income to net cash used in operating activities:           |  |                                        |          |   |             |   |          |  
|Gain on sale of land and real estate                                                    |  |                                        | (31,360  | ) |             |   | (70,304  | )
|Depreciation and amortization                                                           |  |                                        | 22,644   |   |             |   | 17,204   |  
|Amortization of deferred borrowing costs                                                |  |                                        | 6,073    |   |             |   | 5,774    |  
|Discount on sale of notes receivable                                                    |  |                                        | 389      |   |             |   | 1,557    |  
|Gain on forgiveness of debt                                                             |  |                                        | (2,268   | ) |             |   |         |  
|Litigation settlement                                                                   |  |                                        | 50       |   |             |   |         |  
|Equity in loss of investees                                                             |  |                                        | 144      |   |             |   | 4,279    |  
|Writedown of assets held for sale                                                       |  |                                        | 3,444    |   |             |   | 2,352    |  
|(Gain) loss on foreign currency transaction                                             |  |                                        | (1,791   | ) |             |   | 963      |  
|(Increase) decrease in accrued interest receivable                                      |  |                                        | 680      |   |             |   | (4,015   | )
|Decrease in other assets                                                                |  |                                        | 6,088    |   |             |   | 2,856    |  
|Increase in accrued interest payable                                                    |  |                                        | 1,798    |   |             |   | 269      |  
|Increase (decrease) in accounts payable and other liabilities                           |  |                                        | 3,481    |   |             |   | (626     | )
|Decrease in minority interest                                                           |  |                                        | (1,125   | ) |             |   | (191     | )
|                                                                                        |  |                                        |          |   |             |   |          |  
|Net cash used in operating activities                                                   |  |                                        | (6,808   | ) |             |   | (26,862  | )
|                                                                                        |  |                                       
|Cash Flows From Investing Activities:                                                   |  |                                        |          |   |             |   |          |  
|Collections on notes receivable                                                         |  |                                        | 2,361    |   |             |   | 26,015   |  
|Proceeds from sale of notes receivable                                                  |  |                                        | 6,227    |   |             |   | 26,346   |  
|Acquisition of real estate (including $498 in 2004 from affiliates and related parties) |  |                                        | (26,084  | ) |             |   | (12,000  | )
|Pizza parlor equipment purchased                                                        |  |                                        | (983     | ) |             |   | (1,397   | )
|Proceeds from sale of real estate                                                       |  |                                        | 108,637  |   |             |   | 134,535  |  
|Notes receivable funded                                                                 |  |                                        | (90      | ) |             |   | (615     | )
|Earnest money/escrow deposits                                                           |  |                                        | (3,344   | ) |             |   | (13,311  | )
|Investment in real estate entities, net of cash acquired                                |  |                                        | (2,625   | ) |             |   | (24,218  | )
|Real estate improvements                                                                |  |                                        | (137,501 | ) |             |   | (21,425  | )
|Payments under interest rate swap contract                                              |  |                                        |         |   |             |   | (31      | )
|Distributions from (to) equity investees                                                |  |                                        | 47       |   |             |   | (650     | )
|                                                                                        |  |                                        |          |   |             |   |          |  
|Net cash (used in) provided by investing activities                                     |  |                                        | (53,355  | ) |             |   | 113,249  |  
|                                                                                        |  |                                       
|Cash Flows From Financing Activities:                                                   |  |                                        |          |   |             |   |          |  
|Proceeds from notes payable                                                             |  |                                        | 314,612  |   |             |   | 82,275   |  
|Payments on notes payable                                                               |  |                                        | (237,042 | ) |             |   | (186,142 | )
|Deferred borrowing costs                                                                |  |                                        | (6,354   | ) |             |   | (5,440   | )
|Net (payments to) advances from affiliates                                              |  |                                        | (6,465   | ) |             |   | 7,815    |  
|Repurchase of Common Stock                                                              |  |                                        | (1,443   | ) |             |   |         |  
|Margin payments, net                                                                    |  |                                        | (623     | ) |             |   | 15,890   |  
|Preferred dividends paid                                                                |  |                                        | (910     | ) |             |   | (1,763   | )
|Repurchase of Preferred Stock                                                           |  |                                        |         |   |             |   | (3       | )
|                                                                                        |  |                                        |          |   |             |   |          |  
|Net cash provided by (used in) financing activities                                     |  |                                        | 61,775   |   |             |   | (87,368  | )
|                                                                                        |  |                                       
|Net decrease in cash and cash equivalents                                               |  |                                        | 1,612    |   |             |   | (981     | )
|                                                                                        |  |                                       
|Cash and cash equivalents, beginning of period                                          |  |                                        | 9,543    |   |             |   | 8,432    |  
|                                                                                        |  |                                        |          |   |             |   |          |  
|Cash and cash equivalents, end of period                                                |  | $                                      | 11,155   |   |             | $ | 7,451    |  
|                                                                                        |  |                                        |          |   |             |   |          |  



The accompanying notes
are an integral part of these Consolidated Financial Statements.



7



---

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWSContinued

(dollars in thousands)



|                                                      |  |                                        |        |      |   |       
|----------------------------------------------------- |  | -------------------------------------- | ------ | ---- | - | ------
|                                                      |  | For the Nine MonthsEnded September 30,
|                                                      |  | 2004                                   |        | 2003
|Supplemental Disclosures of Cash Flow Information:    |  |                                        |        |      |   |       
|Cash paid for interest                                |  | $                                      | 52,478 |      | $ | 84,815
|                                                      |  |                                       
|Schedule of noncash investing and financing:          |  |                                        |        |      |   |       
|Notes payable assumed by buyer on sale of real estate |  | $                                      | 25,607 |      | $ | 43,815
|Notes payable assumed on purchase of real estate      |  |                                        | 5,027  |      |   |      
|Notes receivable from sale of real estate             |  |                                        | 10,448 |      |   | 46,394
|Disposal of property to satisfy debt                  |  |                                        |       |      |   | 6,000 
|Issuance of Preferred Stock                           |  |                                        | 2,500  |      |   |      
|Note payable paid by affiliate                        |  |                                        | 10,823 |      |   |      
|Funds collected by affiliate for property financing   |  |                                        | 20,037 |      |   | 1,500 
|Acquisition of property to satisfy debt               |  |                                        | 2,585  |      |   | 2,671 
|Assumed debt of seller on purchase of real estate     |  |                                        |       |      |   | 13,375
|Exchange of interest in note receivable for stock     |  |                                        |       |      |   | 5,764 
|Note receivable from exchange of stock with affiliate |  |                                        |       |      |   | 526   
|Funds collected by affiliate on sale of real estate   |  |                                        |       |      |   | 4,599 



The accompanying notes
are an integral part of these Consolidated Financial Statements.



8



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1. BASIS OF PRESENTATION



The accompanying Consolidated Financial Statements have been prepared in conformity with
accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America for complete financial statements. Dollar amounts in tables and accompanying footnotes are in thousands, except per share amounts. Certain balances for 2003 have
been reclassified to conform to the 2004 presentation. Hereafter in this document, American Realty Investors, Inc. is referred to as ARI.



Operating results for the nine-month period ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31,
2004. For further information, refer to the Consolidated Financial Statements and Notes thereto included in ARIs Annual Report on Form 10-K for the year ended December 31, 2003 (the 2003 Form 10-K).



On November 15, 2002, ARI, through wholly-owned subsidiaries, commenced a tender offer for
the common shares of Transcontinental Realty Investors, Inc. (TCI) and Income Opportunity Realty Investors, Inc. (IORI) not already owned by ARI. The tender offer was completed on March 19, 2003. ARI paid $19.00 cash per IORI
share and $17.50 cash per TCI share for the stock of non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares.



After the tender offer, ARI subsidiaries owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9%
owned directly by ARI subsidiaries and 15.6% through TCIs ownership of IORI shares). ARI began consolidation of TCIs and IORIs accounts and operations effective March 31, 2003. The effect of consolidating TCIs and IORIs
operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the same board of directors. At September 30, 2004, ARI
and TCI have the same advisor and Board of Directors. One Director of ARI (Ted Stokely) also serves as a Director of IORI.



On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (BCM), receiving 650,000 TCI shares from BCM.
In addition, BCM executed a promissory note in favor of ARI in the amount of $0.5 million (see NOTE 3. NOTES AND INTEREST RECEIVABLE). After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003,
ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (One Realco) to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. NOTES AND INTEREST
RECEIVABLE). After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in market transactions and 204,633 TCI shares in transactions with related
parties for a total of $1.4 million. At December 31, 2003 and September 30, 2004, ARI subsidiaries owned 80.0% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At December 31, 2003 and September 30, 2004, ARI
subsidiaries owned 19.2% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



Effective July 1, 2003, Prime Asset Management, Inc. (PAMI) became the advisor to ARI and TCI. PAMI is owned by Realty Advisors,
Inc. (Realty Advisors) (79%) and Syntek West, Inc. (Syntek West) (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc.
(PIAMI). On October 1, 2003, Prime Income Asset Management, LLC (Prime), which is 100% owned by PIAMI, replaced PIAMI as the advisor to ARI and TCI.



The following pro forma information reflects the results of operations for ARI as though the consolidation of TCIs operations had
begun on January 1 of 2003.



|                               |  |                                      |        
|------------------------------ |  | ------------------------------------ | -------
|                               |  | Nine Months Ended September 30, 2003
|Revenue, as reported           |  | $                                    | 164,622
|Revenue, pro forma             |  |                                      | 189,083
|                               | 
|Net income, as reported        |  |                                      | 13,020 
|Net income, pro forma          |  |                                      | 12,087 
|                               | 
|Income (loss) per share:       |  |                                      |        
|Basic and diluted, as reported |  | $                                    | 1.04   
|Basic and diluted, pro forma   |  | $                                    | .95    



9



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 1. BASIS OF PRESENTATION (Continued)



Stock-based employee compensation. ARI accounts for stock options using the intrinsic
method pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations. In December 2002, the Financial Accounting Standards Board issued SFAS No. 148,
Accounting for Stock-Based CompensationTransition and Disclosure (SFAS No. 148), which amended SFAS 123, Accounting for Stock-Based Compensation (SFAS 123). The new standard provides alternative
methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in the
annual and interim financial statements for fiscal years ending after December 15, 2002. In compliance with SFAS 148, ARI has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation
arrangement as defined by APB 25. If ARI had elected to recognize compensation cost for the issuance of options based on the fair value at the grant dates for awards consistent with the fair value method prescribed by SFAS No. 123, net income (loss)
and income (loss) per share would have been impacted as follows:



|                                                                                                                                             |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |       
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | ---- | - | ------ |  | - | ------- | - |  | - | ------
|                                                                                                                                             |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                                                                                                                             |  | 2004                            |        |                                | 2003 |   | 2004   |  |   | 2003   
|Net income (loss) applicable to common shares, as reported                                                                                   |  | $                               | (7,638 | )                              |      | $ | 11,091 |  | $ | (17,006 | ) |  | $ | 11,257
|Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax
effects |  |                                 |       |                                |      |   |       |  |   | 22      |   |  |   | 19    
|                                                                                                                                             |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |       
|Pro forma net income (loss) applicable to common shares                                                                                      |  | $                               | (7,638 | )                              |      | $ | 11,091 |  | $ | (17,028 | ) |  | $ | 11,238
|                                                                                                                                             |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |       
|Net income (loss) per share:                                                                                                                 |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |       
|Basic and diluted, as reported                                                                                                               |  | $                               | (.73   | )                              |      | $ | 1.04   |  | $ | (1.60   | ) |  | $ | 1.04  
|Basic and diluted, pro forma                                                                                                                 |  | $                               | (.73   | )                              |      | $ | 1.04   |  | $ | (1.60   | ) |  | $ | 1.04  



NOTE 2. REAL ESTATE



In 2004, ARI purchased the following
property:



|                           |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|-------------------------- |  | --------------- |  | ----------- |  | ------------- | ----- | ------------------------ | - | ---- | ------------ |  | - | ------------ | --- |  | ------------ | --- |  | -----
|Property                   |  | Location        |  | Units/Acres |  | PurchasePrice |       | Net CashPaid/ (Received) |   |      | DebtIncurred |  |   | InterestRate |     |  | MaturityDate
|First Quarter              |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|Apartments                 |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|288 City Park(1)           |  | Houston, TX     |  | 240 Units   |  | $             | 3,056 |                          | $ | 612  |              |  | $ | 2,444        |     |  | 5.95         | %   |  | 04/45
|Blue Lake Villas II(1)     |  | Waxahachie, TX  |  | 70 Units    |  |               | 729   |                          |   | (164 | )            |  |   | 729          |     |  | 5.80         |     |  | 04/45
|Bridges on Kinsey(1)       |  | Tyler, TX       |  | 232 Units   |  |               | 2,291 |                          |   | 596  |              |  |   | 1,687        |     |  | 5.74         |     |  | 08/45
|Dakota Arms(1)             |  | Lubbock, TX     |  | 208 Units   |  |               | 2,472 |                          |   | 681  |              |  |   | 1,791        |     |  | 5.85         |     |  | 06/45
|Lake Forest(1)             |  | Houston, TX     |  | 240 Units   |  |               | 2,316 |                          |   | (470 | )            |  |   | 2,316        |     |  | 5.60         |     |  | 03/45
|Vistas of Vance Jackson(1) |  | San Antonio, TX |  | 240 Units   |  |               | 3,550 |                          |   | 771  |              |  |   | 2,779        |     |  | 5.78         |     |  | 06/45
|                           |  |                 |  |             |  |               |      
|Land                       |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|Lubbock                    |  | Lubbock, TX     |  | 2.9 Acres   |  |               | 224   |                          |   | 224  |              |  |   |             |     |  |             |     |  |     
|Meloy Road                 |  | Kent, OH        |  | 54.2 Acres  |  |               | 4,900 |                          |   | 343  |              |  |   | 4,900        |     |  | 5.00         | (2) |  | 01/06
|Railroad                   |  | Dallas, TX      |  | .3 Acres    |  |               | 708   |                          |   | 704  |              |  |   |             |     |  |             |     |  |     
|                           |  |                 |  |             |  |               |      
|Second Quarter             |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|Apartments                 |  |                 |  |             |  |               |       |                          |   |      |              |  |   |              |     |  |              |     |  |      
|Treehouse(3)               |  | Irving, TX      |  | 160 Units   |  |               | 7,519 |                          |   | (498 | )            |  |   | 5,027        | (4) |  | 5.00         |     |  | 08/13
|Wildflower Villas(1)       |  | Temple, TX      |  | 220 Units   |  |               | 2,045 |                          |   | 79   |              |  |   | 1,966        |     |  | 5.99         |     |  | 10/45



10



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                 |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|---------------- |  | ------------------ |  | ----------- |  | ------------- | ----- | ------------------------ | - | ------------ |  | ------------ | ----- |  | ------------ | --- |  | -----
|Property         |  | Location           |  | Units/Acres |  | PurchasePrice |       | Net CashPaid/ (Received) |   | DebtIncurred |  | InterestRate |       |  | MaturityDate
|Land             |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|Cooks Lane(1)    |  | Ft. Worth, TX      |  | 23.2 Acres  |  | $             | 1,000 |                          | $ | 1,034        |  | $            |      |  |             |     |  |     
|Rogers(1)        |  | Rogers, AR         |  | 20.1 Acres  |  |               | 1,390 |                          |   | 619          |  |              | 1,130 |  | 10.50        | %   |  | 04/05
|                 |  |                    |  |             |  |               |      
|Third Quarter    |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|Land             |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|Ladue            |  | Farmers Branch, TX |  | 8.0 Acres   |  |               | 1,743 |                          |   | 659          |  |              | 1,206 |  | 6.65         | (2) |  | 06/06
|Granbury Station |  | Ft. Worth, TX      |  | 15.7 Acres  |  |               | 923   |                          |   | 236          |  |              | 738   |  | 7.00         |     |  | 09/07
|                 |  |                    |  |             |  |               |      
|Fourth Quarter   |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|Land             |  |                    |  |             |  |               |       |                          |   |              |  |              |       |  |              |     |  |      
|Denton-Coonrod   |  | Denton, TX         |  | 82.2 Acres  |  |               | 1,644 |                          |   | 1,046        |  |              | 840   |  | 6.25         |     |  | 11/06
|DeSoto           |  | DeSoto, TX         |  | 21.9 Acres  |  |               | 2,516 |                          |   | 1,364        |  |              | 1,265 |  | 6.25         |     |  | 11/06
|West End         |  | Dallas, TX         |  | 0.2 Acres   |  |               | 71    |                          |   | 71           |  |              |      |  |             |     |  |     

---

|(1) | Land purchased for apartment construction.
|--- | ------------------------------------------

|(2) | Variable interest rate.
|--- | -----------------------

|(3) | Purchased from IORI, a related party, for assumption of debt and a note receivable, less $498 in cash received.
|--- | ---------------------------------------------------------------------------------------------------------------

|(4) | Assumed debt of seller.
|--- | -----------------------



In 2003, ARI purchased the following property:



|                  |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|----------------- |  | ------------------ |  | ----------- |  | -------------- | ----- | ------------ | - | ------------- |  | - | ------------ | --- |  | ------------ | --- |  | -----
|Property          |  | Location           |  | Units/Acres |  | Purchase Price |       | Net CashPaid |   | Debt Incurred |  |   | InterestRate |     |  | MaturityDate
|First Quarter     |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Apartments        |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Capitol Hill(1)   |  | Little Rock, AR    |  | 156 Units   |  | $              | 1,904 |              | $ | 615           |  | $ | 1,289        |     |  | 5.50         | %   |  | 10/44
|                  |  |                    |  |             |  |                |      
|Second Quarter    |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Apartments        |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Breakwater Bay(1) |  | Beaumont, TX       |  | 176 Units   |  |                | 1,979 |              |   | 383           |  |   | 1,554        |     |  | 5.50         |     |  | 08/44
|Longwood          |  | Long Beach, MS     |  | 200 Units   |  |                | 6,349 |              |   | 334           |  |   | 6,349        | (2) |  | 7.60         |     |  | 04/12
|                  |  |                    |  |             |  |                |      
|Land              |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Pulaski           |  | Pulaski County, AR |  | 21.9 Acres  |  |                | 2,000 |              |   | 695           |  |   | 1,400        |     |  | 6.50         |     |  | 05/05
|                  |  |                    |  |             |  |                |      
|Third Quarter     |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Land              |  |                    |  |             |  |                |       |              |   |               |  |   |              |     |  |              |     |  |      
|Sheffield Village |  | Grand Prairie, TX  |  | 13.9 Acres  |  |                | 1,500 |              |   | 632           |  |   | 975          |     |  | 5.50         | (3) |  | 09/04

---

|(1) | Land purchased for apartment construction.
|--- | ------------------------------------------

|(2) | Assumed debt of seller.
|--- | -----------------------

|(3) | Variable interest rate
|--- | ----------------------



In 2004, ARI sold the following property:



|               |  |                  |  |                     |  |            |        |                  |   |                |  |   |                  |     |  |   |   
|-------------- |  | ---------------- |  | ------------------- |  | ---------- | ------ | ---------------- | - | -------------- |  | - | ---------------- | --- |  | - | --
|Property       |  | Location         |  | Units/Sq. Ft./Acres |  | SalesPrice |        | Net CashReceived |   | DebtDischarged |  |   | Gain/Losson Sale
|First Quarter  |  |                  |  |                     |  |            |        |                  |   |                |  |   |                  |     |  |   |   
|Apartments     |  |                  |  |                     |  |            |        |                  |   |                |  |   |                  |     |  |   |   
|Tiberon Trails |  | Merrillville, IN |  | 376 Units           |  | $          | 10,325 |                  | $ | 2,869          |  | $ | 6,189            | (1) |  | $ | 49



11



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                       |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|---------------------- |  | ----------------- |  | ------------------- |  | ---------- | ------ | ---------------- | - | ----- | -------------- |  | - | ------------------ | --- |  | - | ----- | ---
|Property               |  | Location          |  | Units/Sq. Ft./Acres |  | SalesPrice |        | Net CashReceived |   |       | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|Industrial Warehouses  |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Kelly (Pinewood)       |  | Dallas, TX        |  | 100,000 Sq. Ft.     |  | $          | 1,650  |                  | $ | 65    |                |  | $ | 1,376              |     |  | $ | 153   |    
|Ogden Industrial       |  | Ogden, UT         |  | 107,112 Sq. Ft.     |  |            | 2,600  |                  |   | 668   |                |  |   | 1,775              |     |  |   | 1,474 |    
|Texstar Warehouse      |  | Arlington, TX     |  | 97,846 Sq. Ft.      |  |            | 2,400  |                  |   |      |                |  |   | 1,148              | (1) |  |   |      | (3)
|                       |  |                   |  |                     |  |           
|Land                   |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Allen                  |  | Collin County, TX |  | 492.5 Acres         |  |            | 19,962 |                  |   | 7,956 |                |  |   | 4,088              |     |  |   | 3,503 | (2)
|Marine Creek           |  | Ft. Worth, TX     |  | 10.7 Acres          |  |            | 1,488  |                  |   | 1,198 |                |  |   | 991                |     |  |   |      | (7)
|Mason Goodrich         |  | Houston, TX       |  | 5.7 Acres           |  |            | 686    |                  |   | 45    |                |  |   | 588                |     |  |   | 379   |    
|Mason Goodrich         |  | Houston, TX       |  | 8.0 Acres           |  |            | 1,045  |                  |   | 251   |                |  |   | 200                |     |  |   | 617   |    
|Red Cross              |  | Dallas, TX        |  | 2.9 Acres           |  |            | 8,500  |                  |   | 2,842 |                |  |   | 4,450              |     |  |   |      |    
|                       |  |                   |  |                     |  |           
|Office Buildings       |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Brandeis(6)            |  | Omaha, NE         |  | 319,234 Sq. Ft.     |  |            |       |                  |   |      |                |  |   | 8,750              |     |  |   | (92   | )  
|Countryside Harmon     |  | Sterling, VA      |  | 5,000 Sq. Ft.       |  |            | 2,650  |                  |   | 216   |                |  |   | 2,200              |     |  |   | 1,861 |    
|Countryside Retail     |  | Sterling, VA      |  | 133,422 Sq. Ft.     |  |            | 27,100 |                  |   | 3,408 |                |  |   | 22,800             |     |  |   | 6,807 |    
|                       |  |                   |  |                     |  |           
|Shopping Centers       |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|K-Mart                 |  | Cary, NC          |  | 92,033 Sq. Ft.      |  |            | 3,200  |                  |   |      |                |  |   | 1,677              | (1) |  |   |      | (3)
|Plaza on Bachman Creek |  | Dallas, TX        |  | 80,278 Sq. Ft.      |  |            | 7,850  |                  |   | 1,808 |                |  |   | 5,358              |     |  |   | 4,011 |    
|                       |  |                   |  |                     |  |           
|Second Quarter         |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Cliffs of El Dorado(5) |  | McKinney, TX      |  | 208 Units           |  |            | 13,442 |                  |   | 10    |                |  |   | 10,323             | (1) |  |   |      |    
|Park Avenue            |  | Tallahassee, FL   |  | 121 Units           |  |            | 6,225  |                  |   | 876   |                |  |   | 4,320              | (1) |  |   | 3,922 |    
|Sandstone              |  | Mesa, AZ          |  | 238 Units           |  |            | 8,650  |                  |   | 2,920 | (4)            |  |   | 5,531              |     |  |   | 1,688 |    
|                       |  |                   |  |                     |  |           
|Office Buildings       |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|4135 Beltline          |  | Addison, TX       |  | 90,000 Sq. Ft.      |  |            | 4,900  |                  |   | 2,472 |                |  |   | 2,009              |     |  |   | 337   |    
|Atrium                 |  | Palm Beach, FL    |  | 74,603 Sq. Ft.      |  |            | 5,775  |                  |   | 1,842 |                |  |   | 3,772              |     |  |   | 708   |    
|                       |  |                   |  |                     |  |           
|Third Quarter          |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Falcon House           |  | Ft. Walton, FL    |  | 82 Units            |  |            | 3,330  |                  |   | 1,178 |                |  |   | 1,950              | (1) |  |   | 1,209 |    
|                       |  |                   |  |                     |  |           
|Industrial Warehouses  |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Kelly (Cash Road)      |  | Dallas, TX        |  | 97,150 Sq. Ft.      |  |            | 1,500  |                  |   | 1,077 |                |  |   | 422                |     |  |   | 454   |    
|                       |  |                   |  |                     |  |           
|Land                   |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Rasor                  |  | Plano, TX         |  | 24.5 Acres          |  |            | 2,600  |                  |   | 2,600 |                |  |   |                   |     |  |   |      | (8)
|Vista Ridge            |  | Lewisville, TX    |  | 1.3 Acres           |  |            | 310    |                  |   | 259   |                |  |   |                   |     |  |   | 131   |    
|                       |  |                   |  |                     |  |           
|Shopping Centers       |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Collection             |  | Denver, CO        |  | 267,812 Sq. Ft.     |  |            | 21,200 |                  |   | 6,703 |                |  |   | 13,153             |     |  |   | 3,314 |    
|                       |  |                   |  |                     |  |           
|Fourth Quarter         |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|In the Pines           |  | Gainesville, FL   |  | 242 Units           |  |            | 11,300 |                  |   | 3,247 |                |  |   | 5,201              |     |  |   | 5,517 |    
|La Mirada              |  | Jacksonville, FL  |  | 320 Units           |  |            | 10,500 |                  |   | 2,576 |                |  |   | 7,098              |     |  |   | 7,576 |    
|                       |  |                   |  |                     |  |           
|Land                   |  |                   |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Mason Goodrich         |  | Houston, TX       |  | 4.0 Acres           |  |            | 523    |                  |   | 33    |                |  |   | 436                |     |  |   | 306   |    
|Mason Goodrich         |  | Houston, TX       |  | 2.4 Acres           |  |            | 250    |                  |   | 15    |                |  |   | 200                |     |  |   | 115   |    



12



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                          |  |              |  |                     |  |            |        |                  |   |                |  |                    |       |  |   |      
|------------------------- |  | ------------ |  | ------------------- |  | ---------- | ------ | ---------------- | - | -------------- |  | ------------------ | ----- |  | - | -----
|Property                  |  | Location     |  | Units/Sq. Ft./Acres |  | SalesPrice |        | Net CashReceived |   | DebtDischarged |  | Gain/(Loss)on Sale
|Office Buildings          |  |              |  |                     |  |            |        |                  |   |                |  |                    |       |  |   |      
|Ambulatory Surgery Center |  | Sterling, VA |  | 33,832 Sq. Ft.      |  | $          | 8,675  |                  | $ | 5,448          |  | $                  | 2,899 |  | $ | 805  
|One Steeplechase          |  | Sterling, VA |  | 103,376 Sq. Ft.     |  |            | 11,900 |                  |   | 3,743          |  |                    | 7,654 |  |   | 6,227

---

|(1) | Debt assumed by purchaser.
|--- | --------------------------

|(2) | A portion of the land was sold on a contingent basis for a secured note receivable of $7,150. See Note 3. NOTES AND INTEREST RECEIVABLE. Additional gain of $4,412
deferred until the contingency period expires. $747 of deferred gain recognized in September 2004 upon receipt of $1,072 principal payment on the note receivable.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Sold to BCM, a related party, for assumption of debt and a secured note receivable. See Note 3. NOTES AND INTEREST RECEIVABLE. Gain of $1,157 (Textar) and $521 (K-Mart)
deferred until sale to unrelated party.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes a $1,971 deposit received in February 2004.
|--- | ----------------------------------------------------

|(5) | Sold to Unified Housing Foundation, Inc. (UHF), a related party, in 2003. See Note 8. RELATED PARTY TRANSACTIONS. Gain of $2,542 deferred until sale to
unrelated party.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Returned to lender. See Note 6. NOTES AND INTEREST PAYABLE.
|--- | -------------------------------------------------------------

|(7) | Sold to UHF. Gain of $581 deferred until sale to unrelated party.
|--- | -----------------------------------------------------------------

|(8) | Sold to BCM. Gain of $220 deferred until sale to unrelated party.
|--- | -----------------------------------------------------------------



In 2003, ARI sold the following property:



|                      |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|--------------------- |  | ----------------- |  | ------------------------- |  | ---------- | ------ | ----------------------- | - | ----- | -------------- |  | - | ------------------ | --- |  | - | ----- | ----
|Property              |  | Location          |  | Units/Sq. Ft./Acres/Rooms |  | SalesPrice |        | Net CashReceived/(Paid) |   |       | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|First Quarter         |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Apartments            |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Bay Anchor            |  | Panama City, FL   |  | 12 Units                  |  | $          | 369    |                         | $ |      |                |  | $ | 291                |     |  | $ | 174   |     
|Georgetown            |  | Panama City, FL   |  | 44 Units                  |  |            | 1,175  |                         |   | 323   |                |  |   | 789                | (2) |  |   | 72    |     
|Northside Villas      |  | Tallahassee, FL   |  | 81 Units                  |  |            | 5,575  |                         |   | 1,806 |                |  |   | 2,784              |     |  |   | 915   |     
|Rolling Hills         |  | Tallahassee, FL   |  | 134 Units                 |  |            | 5,061  |                         |   | 1,361 |                |  |   | 2,785              |     |  |   | 1,182 |     
|Seville               |  | Tallahassee, FL   |  | 62 Units                  |  |            | 2,795  |                         |   |      |                |  |   | 2,360              |     |  |   | 697   |     
|                      |  |                   |  |                           |  |           
|Hotels                |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Grand Hotel Sofia     |  | Sofia, Bulgaria   |  | 136 Rooms                 |  |            | 24,750 |                         |   | 6,258 |                |  |   | 4,209              | (2) |  |   | (31   | )(3)
|                      |  |                   |  |                           |  |           
|Land                  |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Katrina               |  | Palm Desert, CA   |  | 89.3 Acres                |  |            | 8,550  |                         |   | (410  | )              |  |   | 2,800              |     |  |   | (40   | )   
|Nashville             |  | Nashville, TN     |  | 8.8 Acres                 |  |            | 235    |                         |   | (11   | )              |  |   | 217                |     |  |   | 114   |     
|                      |  |                   |  |                           |  |           
|Shopping Centers      |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Bridgeview Plaza      |  | LaCrosse, WI      |  | 116,008 Sq. Ft.           |  |            | 8,700  |                         |   |      |                |  |   |                   |     |  |   |      | (1) 
|Cullman               |  | Cullman, AL       |  | 92,466 Sq. Ft.            |  |            | 2,000  |                         |   |      |                |  |   | 2,650              | (2) |  |   |      | (8) 
|                      |  |                   |  |                           |  |           
|Second Quarter        |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Apartments            |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Greenbriar            |  | Tallahassee, FL   |  | 50 Units                  |  |            | 1,700  |                         |   | 594   |                |  |   | 976                | (2) |  |   | 1,025 |     
|Lake Chateau          |  | Thomasville, GA   |  | 98 Units                  |  |            | 1,600  |                         |   | 460   |                |  |   | 1,033              |     |  |   | 147   |     
|Pinecrest             |  | North Augusta, SC |  | 120 Units                 |  |            | 2,707  |                         |   | 1,136 |                |  |   | 1,429              |     |  |   | (304  | )   
|Regency               |  | Lincoln, NE       |  | 106 Units                 |  |            | 4,880  |                         |   | 838   |                |  |   | 3,179              |     |  |   | 2,815 |     
|Willow Wick           |  | North Augusta, SC |  | 104 Units                 |  |            | 2,707  |                         |   | 255   |                |  |   | 1,943              |     |  |   | 1,140 |     
|                      |  |                   |  |                           |  |           
|Hotels                |  |                   |  |                           |  |            |        |                         |   |       |                |  |   |                    |     |  |   |       |     
|Clarion KC Airport(6) |  | Kansas City, MO   |  | 196 Rooms                 |  |            | 2,070  |                         |   |      |                |  |   | 4,888              |     |  |   |      |     



13



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                       |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|---------------------- |  | ------------------ |  | ------------------------- |  | ---------- | ------ | ------------------------ | - | ----- | --------------- |  | - | ------------------ | --- |  | - | ------ | -
|Property               |  | Location           |  | Units/Sq. Ft./Acres/Rooms |  | SalesPrice |        | Net Cash Received/(Paid) |   |       | Debt Discharged |  |   | Gain/(Loss) onSale |    
|Industrial Warehouses  |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|McLeod                 |  | Orlando, FL        |  | 110,914 Sq. Ft.           |  | $          | 5,450  |                          | $ | 2,980 |                 |  | $ | 1,902              |     |  | $ | 2,805  |  
|Tricon                 |  | Atlanta, GA        |  | 570,877 Sq. Ft.           |  |            | 13,084 |                          |   | 3,364 |                 |  |   | 9,395              |     |  |   | 5,579  |  
|                       |  |                    |  |                           |  |           
|Land                   |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Mason Goodrich         |  | Houston, TX        |  | 8.0 Acres                 |  |            | 210    |                          |   |      | (4)             |  |   |                   |     |  |   | (149   | )
|Mason Goodrich         |  | Houston, TX        |  | 1.6 Acres                 |  |            | 209    |                          |   | 12    |                 |  |   | 169                |     |  |   | 113    |  
|Mason Goodrich         |  | Houston, TX        |  | 7.7 Acres                 |  |            | 900    |                          |   | 36    |                 |  |   | 764                |     |  |   | 466    |  
|Solco-Valley Ranch     |  | Farmers Branch, TX |  | 6.1 Acres                 |  |            | 1,999  |                          |   | (90   | )(5)            |  |   |                   |     |  |   | 529    |  
|                       |  |                    |  |                           |  |           
|Third Quarter          |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Apartments             |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Landing & Marina       |  | Pensacola, FL      |  | 52 Units                  |  |            | 1,825  |                          |   | 576   |                 |  |   | 1,162              |     |  |   | 492    |  
|Lincoln Court          |  | Dallas, TX         |  | 55 Units                  |  |            | 3,038  |                          |   | 1,834 |                 |  |   | 1,208              |     |  |   | 1,895  |  
|Quail Creek            |  | Lawrence, KS       |  | 95 Units                  |  |            | 4,700  |                          |   | 1,188 |                 |  |   | 3,260              |     |  |   | 1,683  |  
|Stone Oak              |  | San Antonio, TX    |  | 252 Units                 |  |            | 6,930  |                          |   | 3,670 |                 |  |   | 2,699              |     |  |   | 4,490  |  
|                       |  |                    |  |                           |  |           
|Land                   |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Nashville              |  | Nashville, TN      |  | 1.1 Acres                 |  |            | 201    |                          |   | 9     |                 |  |   | 170                |     |  |   | 135    |  
|Palm Desert            |  | Palm Desert, CA    |  | 25.1 Acres                |  |            | 2,600  |                          |   | (88   | )(7)            |  |   |                   |     |  |   | 797    |  
|Pioneer Crossing       |  | Austin, TX         |  | 367.4 Acres               |  |            | 22,500 |                          |   | 4,948 |                 |  |   |                   |     |  |   | 13,916 |  
|Vista Ridge            |  | Lewisville, TX     |  | 14.5 Acres                |  |            | 2,250  |                          |   | 713   |                 |  |   | 1,343              |     |  |   | 622    |  
|                       |  |                    |  |                           |  |           
|Office Buildings       |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Bonita Plaza           |  | Bonita, CA         |  | 47,777 Sq. Ft.            |  |            | 8,034  |                          |   | 1,698 |                 |  |   | 5,944              |     |  |   | 2,798  |  
|Encino Executive Plaza |  | Encino, CA         |  | 177,211 Sq. Ft.           |  |            | 37,040 |                          |   | 1,947 |                 |  |   | 33,145             | (2) |  |   | (67    | )
|                       |  |                    |  |                           |  |           
|Shopping Centers       |  |                    |  |                           |  |            |        |                          |   |       |                 |  |   |                    |     |  |   |        |  
|Oak Tree Village       |  | Lubbock, TX        |  | 45,623 Sq. Ft.            |  |            | 3,366  |                          |   | 1,527 |                 |  |   | 1,328              |     |  |   | 820    |  
|Sheboygan              |  | Sheboygan, WI      |  | 74,532 Sq. Ft.            |  |            | 1,225  |                          |   | 669   |                 |  |   | 569                |     |  |   | 181    |  
|Westwood               |  | Tallahassee, FL    |  | 149,855 Sq. Ft.           |  |            | 8,950  |                          |   | 5,045 |                 |  |   | 1,880              |     |  |   | 5,787  |  

---

|(1) | Sold to TCI to satisfy affiliate debt. Gain of $8,700 deferred until sale to unrelated party.
|--- | ---------------------------------------------------------------------------------------------

|(2) | Debt assumed by purchaser.
|--- | --------------------------

|(3) | Includes recognition of $3,117 of accumulated foreign currency translation gains.
|--- | ---------------------------------------------------------------------------------

|(4) | Cash of $210 was received by BCM and applied to ARIs affiliate debt.
|--- | ---------------------------------------------------------------------

|(5) | Cash of $1,999 was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------

|(6) | Sold at foreclosure auction. Impairment of $3,343 and debt forgiveness of $2,818 were recognized in the fourth quarter of 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------

|(7) | Cash of $2,600 was received by Prime and applied to ARIs affiliate debt.
|--- | -------------------------------------------------------------------------

|(8) | Sold to TCI to satisfy affiliate debt. Gain of $1,118 deferred until sale to unrelated party.
|--- | ---------------------------------------------------------------------------------------------



At September 30, 2004, ARI had the following properties under construction:



|                      |  |                |  |           |  |                |        |                            |   |                           |  |   |       
|--------------------- |  | -------------- |  | --------- |  | -------------- | ------ | -------------------------- | - | ------------------------- |  | - | ------
|Property              |  | Location       |  | Units     |  | AmountExpended |        | AdditionalAmount to Expend |   | Construction Loan Funding
|Apartments            |  |                |  |           |  |                |        |                            |   |                           |  |   |       
|Blue Lake Villas II   |  | Waxahachie, TX |  | 76 Units  |  | $              | 3,209  |                            | $ | 1,462                     |  | $ | 4,234 
|Bluffs at Vista Ridge |  | Lewisville, TX |  | 272 Units |  |                | 16,227 |                            |   | 4,359                     |  |   | 15,500
|Bridges on Kinsey     |  | Tyler, TX      |  | 232 Units |  |                | 6,290  |                            |   | 9,790                     |  |   | 14,477
|Dakota Arms           |  | Lubbock, TX    |  | 208 Units |  |                | 10,858 |                            |   | 3,079                     |  |   | 12,549



14



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                                                  |  |                 |  |           |  |                |  |                            |  |                          
|------------------------------------------------- |  | --------------- |  | --------- |  | -------------- |  | -------------------------- |  | -------------------------
|Property                                          |  | Location        |  | Units     |  | AmountExpended |  | AdditionalAmount to Expend |  | Construction Loan Funding
|Kingsland Ranch                                   |  | Houston, TX     |  | 398 Units |  | 24,247         |  | 1,227                      |  | 23,000                   
|Lake Forest                                       |  | Houston, TX     |  | 240 Units |  | 11,668         |  | 2,769                      |  | 12,815                   
|Stonebridge at City Park (formerly 288 City Park) |  | Houston, TX     |  | 240 Units |  | 14,971         |  | 1,716                      |  | 15,005                   
|Vistas of Vance Jackson                           |  | San Antonio, TX |  | 240 Units |  | 9,994          |  | 8,108                      |  | 16,056                   
|Wildflower Villas                                 |  | Temple, TX      |  | 220 Units |  | 5,233          |  | 10,364                     |  | 14,073                   



For the nine months ended September
30, 2004, ARI completed the 248 unit DeSoto Ranch Apartments in DeSoto, Texas; the 314 unit Verandas at Cityview Apartments in Fort Worth, Texas; the 216 unit Mariposa Villas (Echo Valley) in Dallas, Texas; the 176 unit Breakwater Bay Apartments in
Beaumont, Texas; the 156 unit Capitol Hill Apartments in Little Rock, Arkansas; and the 332 unit Vistas of Pinnacle Park Apartments in Dallas, Texas.



NOTE 3. NOTES AND INTEREST RECEIVABLE



Unless noted, all of ARIs notes receivable are secured by real estate assets or ownership in or membership rights of the purchasers entity.



In March 2004, ARI sold an 8.0 acre tract of its Mason Goodrich land parcel for $1.0 million,
receiving $0.2 million after payment of closing costs and providing purchase money financing of $0.5 million. The secured loan bears interest at 10.0% per annum, requires monthly payments of accrued interest and matures in March 2006. All principal
and accrued but unpaid interest is due at maturity.



In March 2004, ARI sold
492.5 acres in Collin County, Texas for $20.0 million, receiving $8.0 million after payment of debt and closing costs, and providing purchase money financing of $7.2 million for a portion of the land on a contingent basis. The secured note bears
interest at 7.0% per annum and matured in September 2004. The buyer has the option to convey the contingent land back to ARI for cancellation of the note. The purchaser extended the note to December 2004 with a $1.1 million extension payment in
September 2004. ARI recognized $0.7 million of the $5.2 million deferred gain from this sale upon receipt of this payment.



In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchasers closing costs
as seller financing. The note bore interest at 5.0% per annum and required all interest and principal payments be paid at maturity in December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. The note,
including accrued and unpaid interest, was paid in June 2004. ARI agreed to discount the note $2,000 and recognized a loss of $2,000.



In October 2004, ARI sold the In The Pines apartments for $11.3 million, receiving $3.2 million after payment of debt and closing costs, and providing purchase money
financing of $1.0 million. The note bears interest at 7.0% per annum, requires monthly interest payments and matures in January 2005. Purchaser is entitled to extend the note 60 days by paying 1.0% of the outstanding principal balance 10 days prior
to the maturity date. The purchaser is entitled to extend the note an additional 30 days by paying 0.5% of the outstanding principal balance 10 days prior to the extended maturity date. In the event of a default, the note is also secured by
membership rights in the purchasers entity.



In August 2001, ARI agreed
to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bore interest at a variable rate, required monthly payments of accrued interest and matured in January 2003. As of September 2004, ARI
has funded a total of $4.3 million and the note is classified as nonperforming. The collateral used to secure ARIs second lien was seized by the first lien holder. In March 2004, ARI agreed to accept an assignment of claims in litigation as
security for the note. ARI is also working to secure additional collateral for this note and restructuring the terms of the note, but a new agreement has not been reached. The current agreement requires interest to accrue at the default rate of
18.0%.



In March 2002, ARI sold the 174,513 sq.ft. Hartford Office Building in
Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a
variable interest rate, currently 7.0% per annum, requires monthly payments of accrued interest and matures in March 2007. As of September 2004, ARI has funded $0.4 million of the additional line of credit.



15



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In July 2002, ARI entered into an agreement to fund up to $0.3 million under a revolving line of credit secured by
100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum, requires monthly payments of accrued interest, and matures in June 2005. ARI has funded the entire $0.3 million.



In October 2002, ARI sold its Varner Road land parcel for $3.7 million, receiving $0.7
million after payment of closing costs and providing purchase money financing of $2.8 million. The loan bore interest at 9.0% per annum, matured in October 2004 and required quarterly interest payments. All principal and accrued but unpaid interest
were due at maturity. In October 2004, the note was collected in full, including accrued but unpaid interest.



In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The
note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest
in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of closing costs and debt paydown. In February 2004, ARI sold an additional interest in $6.6 million of the note for $6.2 million, receiving $6.2 million in
cash after payment of closing costs.



In September 1999, in conjunction with
the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required
monthly payments of interest only at 6.0% per annum beginning in February 2000, required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyers general and
limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a
payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory
note for the remaining note balance of $1.0 million, which was unsecured, non-interest bearing and matured in April 2003. In April 2004, a demand letter was sent to the debtor. ARI initiated legal action in June 2004.



Related Party.In March 2001, ARI funded $13.6 million of a $15.0 million unsecured
line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.1% of the outstanding shares of ARIs Common Stock. The line of credit bore interest at 12.0% per annum. All principal and interest were due at maturity
in February 2002. The line of credit is guaranteed by BCM. In June 2001, $0.8 million in principal and interest was collected. In December 2001, $0.8 million in principal and interest was collected. In February 2002, the line of credit was increased
to $18.0 million, accrued but unpaid interest of $0.2 million was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5
million. In October 2002, $0.9 million in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM, receiving 314,141
TCI shares from BCM (see NOTE 1. BASIS OF PRESENTATION.) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of $0.2 million was added to the principal, the maturity date was extended to February 2007,
and the interest rate was changed to 2.0% over the prime rate, currently at 7.0%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI
until May 31, 2004, was a 10% shareholder of One Realco until July 31, 2004. Mr. Kimbrough did not participate in the day-to-day operations or management of One Realco.



In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5
million of the purchase price as seller financing. The secured note bears interest at 2.0% over the prime rate, currently 7.0%, and matures in April 2005.



In March 2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the
purchase price as seller financing. The secured note bears interest at 2.0% over the prime rate, currently 7.0%, and matures in April 2005.



In October 2004, ARI sold the common stock of TCI Lexington Corporation, which owns the Lexington Center office building in Colorado Springs, Colorado, to One Realco
Office Investors, Inc., a related party, for $5.1 million. One Realco Office Investors, Inc. assumed liabilities of $4.9 million and ARI provided $237,000 as seller financing. The note bears interest at a fixed rate of 6.5%, requires quarterly
interest only payments and matures in October 2006.



In October 1999, ARI
funded a $4.7 million loan to Realty Advisors. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore



16



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



interest at 10.25% per annum and matured in November 2001. In January 2000, $100,000 was collected. In November 2001,
the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARIs behalf. The interest rate was changed to
2.0% over the prime rate, currently 7.0% per annum, and the accrued but unpaid interest of $1.0 million was added to the principal. The new principal balance is $5.6 million. In September 2003, $0.7 million in accrued interest was collected. In
August 2004, $0.3 million in accrued interest was collected. In November 2004, the maturity date was extended to November 2006. All principal and accrued interest are due at maturity.



NOTE 4. INVESTMENTS IN EQUITY INVESTEES



Real estate entities. Before 2003, ARIs investment in real estate entities
included equity securities of IORI and TCI, and interests in real estate joint venture partnerships. Prime, ARIs advisor after June 30, 2003, also serves as advisor to TCI.



Through March 31, 2003, ARI accounted for its investment in IORI and TCI and the joint venture partnerships using the equity method. ARI
began consolidation of TCIs and IORIs accounts and operations effective March 31, 2003. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003. See NOTE 1. BASIS OF PRESENTATION.



ARIs investment in real estate entities, accounted for using the equity method, at
September 30, 2004, was as follows:



|         |  |                                                    |   |  |                                                   |       |                                                  |   |      
|-------- |  | -------------------------------------------------- | - |  | ------------------------------------------------- | ----- | ------------------------------------------------ | - | -----
|Investee |  | Percentage of ARIs Ownership atSeptember 30, 2004 |   |  | Carrying Value of Investment atSeptember 30, 2004 |       | Market Value of Investment at September 30, 2004
|IORI     |  | 19.2                                               | % |  | $                                                 | 5,212 |                                                  | $ | 5,082
|Other    |  |                                                    |   |  |                                                   | 575   |                                                  |   |      
|         |  |                                                    |   |  |                                                   |       |                                                  |   |      
|         |  |                                                    |   |  | $                                                 | 5,787 |                                                  |   |      
|         |  |                                                    |   |  |                                                   |       |                                                  |   |      



Management continues to believe that
the market value of IORI undervalues its assets and, therefore, ARI may continue to increase its ownership in IORI.



Set forth below are summarized results of operations of equity investees for the nine months ended September 30, 2004:



|                                        |  |      |        |  
|--------------------------------------- |  | ---- | ------ | -
|                                        |  | 2004 |       
|Revenues                                |  | $    | 8,284  |  
|Equity in loss of partnerships          |  |      | (10    | )
|Property operating and other expenses   |  |      | (4,817 | )
|Depreciation                            |  |      | (886   | )
|Interest                                |  |      | (2,979 | )
|                                        |  |      |        |  
|Loss before gain on sale of real estate |  |      | (408   | )
|Gain on sale of real estate             |  |      | 3,689  |  
|                                        |  |      |        |  
|Net income                              |  | $    | 3,281  |  
|                                        |  |      |        |  



ARIs share of equity
investees loss before gains on the sale of discontinued operations was $0.1 million for the nine months ended September 30, 2004. ARIs share of equity investees gain on sale of real estate was $0.9 million for the nine months ended
September 30, 2004.



ARIs cash flow from IORI is dependent on the ability
of IORI to make distributions. In the fourth quarter of 2000, IORI suspended distributions.



NOTE 5. MARKETABLE EQUITY SECURITIES



Since 1994, ARI has been purchasing equity securities of entities other than those of IORI and TCI to diversify and increase the liquidity of its margin accounts. Trading
and available-for-sale portfolio securities are carried at market value. In the first nine months of 2004, ARI did not purchase or sell any marketable securities. At September 30, 2004, ARI recognized an unrealized increase in the market value of
its trading portfolio securities of $0.05 million. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the accompanying Consolidated Statements of Operations. Also at September 30, 2004,



17



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



ARI recorded an unrealized increase in the market value of its available-for-sale portfolio securities of $0.8
million. Unrealized gains and losses on available-for-sale portfolio securities are included in accumulated other comprehensive income in the accompanying Consolidated Balance Sheets.



NOTE 6. NOTES AND INTEREST PAYABLE



In January 2004, the lender on three of ARIs land properties located in Texas notified ARI the loans on the properties were in default
due to ARIs failure to make timely debt service payments. The balance owed on the loans was $10.3 million. In September 2004, ARI obtained new financing of $9.7 million and settled the original loans and accrued but unpaid interest for $9.1
million. ARI recognized debt forgiveness of $2.3 million.



In February 2004,
the Brandeis office building was returned to the lender via a Deed in Lieu of Foreclosure process. The outstanding debt and accrued interest was $8.8 million. ARI recorded a net impairment of $4.4 million in the fourth quarter of 2003 for this
transaction.



In February 2003, the lender on one of ARIs hotel
properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties were in default, due to ARIs failure to make timely debt service payments. The balance owed on the loans was $21.2 million. In
April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lenders Loan Modification Offer (the Offer), and the Offer was
revoked. In August 2003, the hotels were sold to a related party which then filed for bankruptcy in an effort to restructure the debt on the properties. ARI expected the hotels to emerge as viable assets. The sales were not recorded due to ARI
retaining control and having continuing involvement. In March 2004, ARI paid off these loans through other refinancings. The Virginia hotel was released from bankruptcy protection in March 2004. In August 2004, the Chicago hotels were released from
bankruptcy protection.



In September 2004, the lender on one of ARIs
commercial properties located in Colorado notified ARI that the loan on the property was in default due to ARIs failure to make timely debt service payments. The balance owed on the loan is $3.9 million. In October 2004, ARI sold this asset to
a related party for assumption of debt and seller financing. At November 2004, negotiations with the lender are ongoing.



In October 2004, the lender on one of ARIs land properties located in Tennessee notified ARI that the loan on the property was in default due to ARIs failure
to pay or extend the loan at maturity. The balance owed on the loan is $6.8 million. ARI continues to make monthly interest payments. At November 2004, negotiations with the lender are ongoing.



In May 2003, the lenders on one of ARIs commercial properties located in Texas notified
ARI that the loans on the property were in default, due to ARIs failure to make timely debt service payments. The balance owed on the loans is $18.7 million. In December 2003, ARI sold the property to a related entity, which then filed for
bankruptcy, in an effort to restructure the debt on the property. ARI expects to reacquire the property after the debt is restructured. This transaction was not accounted for as a sale by ARI. The property and related debt remain on ARIs
balance sheet. In November 2004, ARI settled with one of the lenders, paying $4.3 million in satisfaction of $6.9 million in principal and accrued but unpaid interest. ARI will recognize a $2.6 million gain from forgiveness of debt from this
transaction.



In 2004, ARI financed/refinanced or obtained second mortgage
financing on the following property:



|                               |  |                    |  |                          |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|------------------------------ |  | ------------------ |  | ------------------------ |  | ------------ | ------ | -------------- | - | ----------------------- |  | - | ------------ | ---- |  | ------------ | ---- |  | -----
|Property                       |  | Location           |  | Units/Sq. Ft.Rooms/Acres |  | DebtIncurred |        | DebtDischarged |   | Net CashReceived/(Paid) |  |   | InterestRate |      |  | MaturityDate
|First Quarter                  |  |                    |  |                          |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Hotels                         |  |                    |  |                          |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms                |  | $            | 11,500 |                | $ | 12,332                  |  | $ | (13,689      | )(3) |  | 7.00         | %(1) |  | 03/05
|                               |  |                    |  |                          |  |              |       
|Land                           |  |                    |  |                          |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura                        |  | Farmers Branch, TX |  | 8.8 Acres                |  |              | 4,485  |                |   | 4,000                   |  |   | (183         | )    |  | 7.00         | (1)  |  | 11/04
|Dominion/Hollywood             |  | Farmers Branch, TX |  | 66.1 Acres               |  |              | 6,985  |                |   | 6,222                   |  |   | (67          | )    |  | 7.00         | (1)  |  | 02/05
|Katy                           |  | Harris County, TX  |  | 130.6 Acres              |  |              | 7,500  |                |   |                        |  |   | (75          | )(4) |  | 6.00         | (1)  |  | 02/07
|                               |  |                    |  |                          |  |              |       
|Office Buildings               |  |                    |  |                          |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura Tower                  |  | Farmers Branch, TX |  | 410,901 Sq. Ft.          |  |              | 34,000 |                |   | 36,889                  |  |   | (4,588       | )    |  | 5.50         | (1)  |  | 04/06



18



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                       |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|---------------------- |  | ------------------ |  | ------------------------ |  | ------------ | ------ | --- | -------------- | - | ------ | ----------------------- |  | - | ------------ | --- |  | ------------ | --- |  | -----
|Property               |  | Location           |  | Units/Sq. Ft.Rooms/Acres |  | DebtIncurred |        |     | DebtDischarged |   |        | Net CashReceived/(Paid) |  |   | InterestRate |     |  | MaturityDate
|Second Quarter         |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Apartments             |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Paramount Terrace      |  | Amarillo, TX       |  | 181 Units                |  | $            | 3,176  |     |                | $ | 2,663  |                         |  | $ | 323          |     |  | 5.15         | %   |  | 06/37
|Treehouse              |  | Irving, TX         |  | 160 Units                |  |              | 5,780  |     |                |   | 5,027  |                         |  |   | 138          |     |  | 5.06         |     |  | 07/34
|                       |  |                    |  |                          |  |              |       
|Land                   |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Lacy Longhorn          |  | Farmers Branch, TX |  | 17.1 Acres               |  |              | 1,965  |     |                |   | 1,800  |                         |  |   | 78           |     |  | 4.03         | (1) |  | 07/07
|Mason/Goodrich         |  | Houston, TX        |  | 39.4 Acres               |  |              | 2,133  |     |                |   | 714    |                         |  |   | 1,345        |     |  | 6.00         | (1) |  | 08/05
|Walker                 |  | Dallas County, TX  |  | 132.6 Acres              |  |              | 8,750  |     |                |   | 7,950  |                         |  |   | 264          |     |  | 5.90         | (1) |  | 06/06
|                       |  |                    |  |                          |  |              |       
|Office Buildings       |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|1010 Common            |  | New Orleans, LA    |  | 494,579 Sq. Ft.          |  |              | 16,250 |     |                |   | 8,000  |                         |  |   | 7,829        |     |  | 4.03         | (1) |  | 07/07
|Two Hickory Centre     |  | Farmers Branch, TX |  | 96,127 Sq. Ft.           |  |              | 7,500  |     |                |   | 7,500  |                         |  |   | (164         | )   |  | 3.60         | (1) |  | 05/06
|                       |  |                    |  |                          |  |              |       
|Third Quarter          |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Apartments             |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Villager               |  | Fort Walton, FL    |  | 33 Units                 |  |              | 804    |     |                |   | 507    |                         |  |   | 129          |     |  | 5.15         |     |  | 06/34
|Waters Edge III        |  | Gulfport, MS       |  | 238 Units                |  |              | 3,250  |     |                |   |       |                         |  |   |             | (5) |  | 12.50        |     |  | 12/04
|                       |  |                    |  |                          |  |              |       
|Hotels                 |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|City Suites            |  | Chicago, IL        |  | 45 Rooms                 |  |              | 3,640  |     |                |   |       |                         |  |   | 3,548        |     |  | 6.75         | (1) |  | 09/09
|Willows                |  | Chicago, IL        |  | 52 Rooms                 |  |              | 3,500  |     |                |   |       |                         |  |   | 3,411        |     |  | 6.75         | (1) |  | 09/09
|                       |  |                    |  |                          |  |              |       
|Land                   |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Bonneau                |  | Dallas County, TX  |  | 8.4 Acres                |  |              | 9,661  | (6) |                |   | 10,283 | (7)                     |  |   | 76           |     |  | 6.75         | (1) |  | 09/05
|Chase Oaks             |  | Plano, TX          |  | 5.8 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|Dalho                  |  | Farmers Branch, TX |  | 2.9 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|HSM                    |  | Farmers Branch, TX |  | 6.2 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|JHL Connell            |  | Carrollton, TX     |  | 7.6 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|Las Colinas            |  | Las Colinas, TX    |  | 1.5 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|Stagliano              |  | Farmers Branch, TX |  | 3.2 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|Vista Ridge            |  | Lewisville, TX     |  | 64.9 Acres               |  |              |       | (6) |                |   |       |                         |  |   |             |     |  |             |     |  |     
|                       |  |                    |  |                          |  |              |       
|Office Buildings       |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Centura Tower          |  | Farmers Branch, TX |  | 410,901 Sq. Ft.          |  |              | 50,000 |     |                |   | 37,594 |                         |  |   | 2,989        |     |  | 4.94         |     |  | 10/09
|Cooley                 |  | Farmers Branch, TX |  | 27,000 Sq. Ft.           |  |              | 2,600  |     |                |   | 1,726  |                         |  |   | 811          |     |  | 5.50         | (1) |  | 09/06
|                       |  |                    |  |                          |  |              |       
|Warehouses             |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Addison Hangers I & II |  | Addison, TX        |  | 52,650 Sq. Ft.           |  |              | 4,500  |     |                |   | 2,592  |                         |  |   | 1,635        |     |  | 10.00        |     |  | 09/14
|                       |  |                    |  |                          |  |              |       
|Fourth Quarter         |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Hotels                 |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Majestic Inn           |  | San Francisco, CA  |  | 57 Rooms                 |  |              | 2,000  | (8) |                |   | 5,138  |                         |  |   | (1,238       | )   |  | 5.75         | (1) |  | 10.05
|                       |  |                    |  |                          |  |              |       
|Land                   |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|Cooks Lane             |  | Ft. Worth, TX      |  | 23.2 Acres               |  |              | 550    |     |                |   |       |                         |  |   |             |     |  | 6.25         |     |  | 11/06
|                       |  |                    |  |                          |  |              |       
|Office Buildings       |  |                    |  |                          |  |              |        |     |                |   |        |                         |  |   |              |     |  |              |     |  |      
|225 Baronne            |  | New Orleans, LA    |  | 416,834 Sq. Ft.          |  |              | 500    | (8) |                |   |       |                         |  |   |             |     |  | 5.75         | (1) |  | 10/05
|Amoco                  |  | New Orleans, LA    |  | 378,244 Sq. Ft.          |  |              | 1,500  | (8) |                |   |       |                         |  |   |             |     |  | 5.75         | (1) |  | 10/05

---

|(1) | Variable interest rate
|--- | ----------------------



19



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|(2) | Construction loan for apartment construction.
|--- | ---------------------------------------------

|(3) | Cash of $10,961 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | ------------------------------------------------------------------------------------

|(4) | Cash of $7,400 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | -----------------------------------------------------------------------------------

|(5) | Cash of $3,250 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | -----------------------------------------------------------------------------------

|(6) | Single note, with all properties as collateral.
|--- | -----------------------------------------------

|(7) | Debt forgiveness of $2,268 recognized.
|--- | --------------------------------------

|(8) | The Majestic Inn, 225 Baronne Office Building and Amoco Office Building are cross collateralized. The debt incurred on 225 Baronne and Amoco are 2nd lien loans.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



In July 2004, the stock securing a $2.6 million security loan
was released, following substitution of additional collateral (see NOTE 7. MARGIN BORROWINGS). Accordingly, this loan has been reclassified from Margin borrowings to Notes and interest payable in the
Consolidated Balance Sheets.



In July 2004, ARI received an advance of $3.8
million, less fees, on a $10.0 million second lien note on the Centura Tower building. This note bears interest at 1.0% over the prime rate, currently 6.0%, requires interest-only payments until all of the note is advanced, and matures in April
2006.



Also in July 2004, ARI received a loan of $2.5 million, less fees, that
is secured by ARIs $7.2 million note receivable from the sale of 492 acres of land in Allen, Texas in March 2004. The loan bears interest at 1.5% over the prime rate, currently 6.5%, requires interest-only payments, and matures in December
2004.



In 2003, ARI financed/refinanced or obtained second mortgage financing
on the following property:



|                      |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|--------------------- |  | ------------------ |  | ------------------- |  | ------------- | ----- | --- | -------------- | - | ----------------------- |  | - | ------------ | --- |  | ------------ | --- |  | -----
|Property              |  | Location           |  | Sq. Ft. Units/Acres |  | Debt Incurred |       |     | DebtDischarged |   | Net CashReceived/(Paid) |  |   | InterestRate |     |  | MaturityDate
|First Quarter         |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Apartments            |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Arlington Place       |  | Pasadena, TX       |  | 230 Units           |  | $             | 1,500 |     |                | $ |                        |  | $ |             | (2) |  | 5.00         | %   |  | 05/03
|                      |  |                    |  |                     |  |               |      
|Land                  |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Elm Fork              |  | Denton County, TX  |  | 101.0 Acres         |  |               | 5,000 |     |                |   | 1,551                   |  |   | 2,885        |     |  | 10.75        |     |  | 03/04
|Nashville             |  | Nashville, TN      |  | 113.8 Acres         |  |               | 6,059 |     |                |   | 807                     |  |   | 4,725        |     |  | 14.00        |     |  | 03/04
|Vineyards II          |  | Tarrant County, TX |  | 18.6 Acres          |  |               | 3,280 |     |                |   | 3,750                   |  |   | (583         | )   |  | 6.75         | (1) |  | 02/06
|                      |  |                    |  |                     |  |               |      
|Second Quarter        |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Apartments            |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Plantation            |  | Tulsa, OK          |  | 138 Units           |  |               | 2,320 |     |                |   | 1,924                   |  |   | 173          |     |  | 5.60         |     |  | 06/29
|                      |  |                    |  |                     |  |               |      
|Industrial Warehouses |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Ogden Industrial      |  | Ogden, UT          |  | 107,112 Sq. Ft.     |  |               | 1,800 |     |                |   |                        |  |   | 1,722        |     |  | 6.25         | (1) |  | 04/05
|                      |  |                    |  |                     |  |               |      
|Land                  |  |                    |  |                     |  |               |       |     |                |   |                         |  |   |              |     |  |              |     |  |      
|Katrina               |  | Palm Desert, CA    |  | 52.0 Acres          |  |               | 5,100 |     |                |   | 3,000                   |  |   | 1,795        |     |  | 6.25         | (1) |  | 05/05
|Keller                |  | Tarrant County, TX |  | 30.1 Acres          |  |               | 2,016 | (3) |                |   | 450                     |  |   | 1,494        |     |  | 7.50         |     |  | 07/04
|Lacy Longhorn         |  | Farmers Branch, TX |  | 17.1 Acres          |  |               |      | (3) |                |   |                        |  |   |             |     |  |             |     |  |     
|Las Colinas           |  | Las Colinas, TX    |  | 13.0 Acres          |  |               |      | (3) |                |   |                        |  |   |             |     |  |             |     |  |     
|Mason Goodrich        |  | Houston, TX        |  | 84.0 Acres          |  |               | 3,750 |     |                |   | 757                     |  |   | 2,850        |     |  | 6.25         | (1) |  | 06/04
|McKinney Corners II   |  | Collin County, TX  |  | 11.0 Acres          |  |               |      | (3) |                |   |                        |  |   |             |     |  |             |     |  |     
|Nashville             |  | Nashville, TN      |  | 113.8 Acres         |  |               | 941   |     |                |   |                        |  |   | 737          |     |  | 14.00        |     |  | 03/04
|Thompson              |  | Farmers Branch, TX |  | 3.3 Acres           |  |               |      | (3) |                |   |                        |  |   |             |     |  |             |     |  |     
|Tomlin                |  | Farmers Branch, TX |  | 9.0 Acres           |  |               |      | (3) |                |   |                        |  |   |             |     |  |             |     |  |     



20



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                 |  |              |  |                     |  |               |       |                |   |                         |  |   |              |   |  |              |      |  |      
|---------------- |  | ------------ |  | ------------------- |  | ------------- | ----- | -------------- | - | ----------------------- |  | - | ------------ | - |  | ------------ | ---- |  | -----
|Property         |  | Location     |  | Sq. Ft. Units/Acres |  | Debt Incurred |       | DebtDischarged |   | Net CashReceived/(Paid) |  |   | InterestRate |   |  | MaturityDate
|Shopping Centers |  |              |  |                     |  |               |       |                |   |                         |  |   |              |   |  |              |      |  |      
|Bridgeview       |  | LaCrosse, WI |  | 116,008 Sq. Ft.     |  | $             | 6,500 |                | $ |                        |  | $ | 6,152        |   |  | 6.25         | %(1) |  | 04/05
|Cullman          |  | Cullman, AL  |  | 92,433 Sq. Ft.      |  |               | 1,700 |                |   | 2,650                   |  |   | (1,048       | ) |  | 6.25         | (1)  |  | 04/05
|                 |  |              |  |                     |  |               |      
|Third Quarter    |  |              |  |                     |  |               |       |                |   |                         |  |   |              |   |  |              |      |  |      
|Apartments       |  |              |  |                     |  |               |       |                |   |                         |  |   |              |   |  |              |      |  |      
|Tree House       |  | Irving, TX   |  | 160 Units           |  |               | 5,100 |                |   | 2,518                   |  |   | 2,132        |   |  | 5.00         | (1)  |  | 08/13
|Windsor Tower    |  | Ocala, FL    |  | 64 Units            |  |               | 2,000 |                |   | 1,989                   |  |   | (104         | ) |  | 4.75         |      |  | 08/08

---

|(1) | Variable interest rate.
|--- | -----------------------

|(2) | Cash of $1,500 was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------

|(3) | Single note, with all properties as collateral.
|--- | -----------------------------------------------



NOTE 7. MARGIN BORROWINGS



ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing of up to 50% of the market value of marketable equity
securities. The borrowings under such margin arrangements are secured by equity securities of TCI and ARIs trading portfolio securities and bear interest rates ranging from 6.0% to 24.0%. Margin borrowing totaled $18.8 million at September 30,
2004.



In September 2003, ARI obtained a security loan in the amount of $12.5
million from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 14.0%, requires monthly payments of interest only and matured in September 2004. The loan is secured by 1,656,537 shares of TCI common stock
held by ARI. In September 2004, the maturity date was extended to December 2004.



In September 2003, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 14.0%, requires monthly payments of interest only and matured
in September 2004. The loan is secured by 250,000 shares of IORI common stock held by ARI. In September 2004, the maturity date was extended to December 2004.



In October 2003, ARI obtained a security loan in the amount of $2.6 million from a financial institution. The loan bears interest at 9.0% over the six-month LIBOR
rate, currently 11.3% (not to exceed 10.5%), requires monthly interest payments, and matures in November 2004. In 2003, $1.8 million was advanced to ARI. In April 2004, an additional $0.8 million was advanced. The loan was partially secured by
825,666 shares of TCI common stock held by ARI. In July 2004, additional collateral provided by an affiliate of ARI was substituted for the TCI shares, and the shares were returned to ARI. Accordingly, this loan has been reclassified from
Margin borrowings to Notes and interest payable in the Consolidated Balance Sheets.



In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial institution. The loan bears interest at 1.0% over the prime rate, currently 6.0% per annum, required monthly payments of
interest only and matured in October 2003. The loan is callable upon 60 days prior notice, and is secured by 250,000 shares of ARI Common Stock held by BCM. In October 2003, the maturity date was extended to December 2003. In February 2004, ARI paid
$0.4 million in principal, and the maturity date was extended to February 2005. At November 2004, the remaining balance is $0.1 million.



NOTE 8. RELATED PARTY TRANSACTIONS



In October 2003, ARI obtained a security loan in the amount of $2.6 million from a financial institution. The loan bears interest at 9.0% over the six-month LIBOR rate,
currently 11.3% (not to exceed 10.5%), requires monthly interest payments, and matures in November 2004. In 2003, $1.8 million was advanced to ARI. In April 2004, an additional $0.8 million was advanced. The proceeds were paid to an affiliate,
increasing ARIs affiliate receivable.



In January 2004, ARI issued
200,000 shares of Series A 10% Cumulative Convertible Preferred Stock to Prime, ARIs advisor. In February 2004, 50,000 additional shares were issued to Prime. ARIs affiliate receivable was increased by $2.5 million.



21



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In February 2004, ARI obtained an unsecured loan of $5.0 million. The proceeds of $5.0 million were received by an
affiliate, increasing ARIs affiliate receivable.



In February 2004, ARI
obtained financing of $7.5 million on the Katy land tract. The funds, along with additional cash of $6.3 million, were sent to an affiliate. Subsequently, the affiliate paid off the existing loan balance on an ARI property.



Also In February 2004, ARI recorded the sale of a tract of Marine Creek land originally sold
to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003 and was recorded as an ARI refinancing transaction in February 2004. ARI received $1.2 million in cash from the related party
in February 2004 as payment on the land. ARI still has a note receivable balance of $290,000 remaining that bears interest at 12.0% and matures in April 2009. ARI recorded the sale of the Marine Creek land tract due to the payment received on the
note receivable.



In March 2001, ARI funded $13.6 million of a $15.0 million
unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.1% of the outstanding shares of ARIs Common Stock. The line of credit bore interest at 12.0% per annum. All principal and interest were due at
maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $0.8 million in principal and interest was collected. In December 2001, $0.8 million in principal and interest was collected. In February 2002, the line of credit was
increased to $18.0 million, accrued but unpaid interest of $0.2 million was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal
balance to $15.5 million. In October 2002, $0.9 million in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM,
receiving 314,141 TCI shares from BCM (see NOTE 1. BASIS OF PRESENTATION.) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of $0.2 million was added to the principal, the maturity date was extended
to February 2007, and the interest rate was changed to 2.0% over the prime rate, currently at 7.0%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial
Officer of ARI until May 31, 2004, was a 10% shareholder of One Realco until July 31, 2004. Mr. Kimbrough did not participate in the day-to-day operations or management of One Realco.



In March 2004, ARI obtained financing of $11.5 million on a hotel property. The proceeds of $11.0 million were received by an affiliate,
increasing ARIs affiliate receivable.



In March 2004, a related party
purchased the loans on ARIs three Chicago hotels for $10.8 million, decreasing ARIs affiliate receivable.



In May 2004, ARI purchased the Treehouse Apartments from an affiliate, with a net purchase price of $7.5 million after assumption of debt and a note receivable, less cash
received of $0.5 million. The note receivable was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado was not recorded as a sale for accounting purposes. ARI recorded the
sale of the Cliffs of El Dorado in May 2004, due to payment received for the Cliffs of El Dorado note receivable.



In July, 2004, ARI obtained a loan of $3.2 million secured by a contract for sale of the Waters Edge III Apartments. The proceeds of $3.2 million were received by an
affiliate, increasing ARIs affiliate receivable.



In September 2004, ARI
sold 10.0 acres of land to an affiliate for a purchase price of $0.7 million. Due to no cash received and common control, ARI has elected to continue consolidating this tract of land until the requirements for a sale have been met.



In October 1999, ARI funded a $4.7 million loan to Realty Advisors. The loan, to provide
funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000,
$100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARIs
behalf. The interest rate was changed to 2.0% over the prime rate, currently 7.0% per annum, and the accrued but unpaid interest of $1.0 million was added to the principal. The new principal balance is $5.6 million. In September 2003, $0.7 million
in accrued interest was collected. In August 2004, $0.3 million in accrued interest was collected. In November 2004, the maturity date was extended to November 2006. All principal and accrued interest are due at maturity.



22



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



During 2002, ARIs Board of Directors authorized ARIs Chief Financial Officer to advance funds either to
or from ARI, through the advisor, in an amount up to $10.0 million and, subsequent to that, authorized ARIs Chief Financial Officer to make additional advances, on the condition that such advances shall be repaid in cash or transfers of assets
within 90 days. These advances are unsecured and bear no interest and generally have not had specific repayment terms, and have been reflected in ARIs financial statements as other assets and other liabilities.



The following table reconciles the beginning and ending balances of accounts receivable from
and (accounts payable to) affiliates as of September 30, 2004.



|                                              |  |     |        |   |       |   |          |      |  |   |      |  
|--------------------------------------------- |  | --- | ------ | - | ----- | - | -------- | ---- |  | - | ---- | -
|                                              |  | BCM |        |   | PRIME |   |          | IORI | 
|Balance, December 31, 2003                    |  | $   | 1,999  |   |       | $ | 4,393    |      |  | $ | (627 | )
|Cash transfers to affiliates                  |  |     |       |   |       |   | 130,197  |      |  |   |     |  
|Cash transfers from affiliates                |  |     |       |   |       |   | (126,210 | )    |  |   |     |  
|Advance through receipt of financing proceeds |  |     |       |   |       |   | 10,214   |      |  |   |     |  
|Transfer of payable from BCM to Prime         |  |     | (2,072 | ) |       |   | 2,072    |      |  |   |     |  
|Payables clearing through Prime               |  |     |       |   |       |   | (4,544   | )    |  |   | 367  |  
|                                              |  |     |        |   |       |   |          |      |  |   |      |  
|Balance, September 30, 2004                   |  | $   | (73    | ) |       | $ | 16,122   |      |  | $ | (260 | )
|                                              |  |     |        |   |       |   |          |      |  |   |      |  



At September 30, 2004, ARIs
other assets includes advances of $1.8 million to affiliated management companies during 2004 to cover operating shortfalls on residential properties and $1.5 million due from Regis Property Management, a related party, for rent. In addition to the
$1.7 million payable related to apartment sales that is noted in a following paragraph, at September 2004, ARI also owed $2.4 million to Regis Property Management for management fees and $1.4 million to limited partners and preferred stockholders
for distributions and dividends that were not distributed until October 2004.



In April 2002, ARI and TCI sold 21 apartment properties to partnerships controlled by Metra Capital, LLC (Metra). Innovo Group, Inc. (Innovo) is a limited partner in the partnerships that purchased the properties.
Joseph Mizrachi, then a director of ARI, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and ARI and TCI continue to report the assets and the new debt
incurred by Metra on their financial statements. The partnership agreements for each of these partnerships state that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a
15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These
distributions to the Metra Partners have priority over distributions to any other partners. At September 30, 2004, 16 of the properties remained on ARIs balance sheet, and ARIs other liabilities included $1.7 million owed to the Metra
Partners related to cash received by ARI upon the sale of these apartments in April 2002. As of September 2004, ARI and Metra were involved in a lawsuit concerning certain details of this transaction. See ITEM 1. LEGAL PROCEEDINGS under
Part II. Other Information for additional details.



NOTE 9. OPERATING SEGMENTS



Significant
differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of
the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income that are not reflected in the segments are equity in income (loss) of investees, gain (loss) on foreign currency transaction,
gain on extinguishment of debt, equity in gain on sale of real estate by equity investees and other income which totaled $2.9 million and $4.7 million for the three and nine months ended September 30, 2004 and $(1.3) million and $(5.1) million for
2003. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, advisory fees, net income fees, incentive fees, litigation settlement, writedown of assets held for sale, minority
interest, and income (loss) from discontinued operations which totaled $8.5 million and $25.8 million for the three and nine months ended September 30, 2004 and $14.6 million and $38.8 million for 2003. Excluded from operating segment assets are
assets of $113.3 million in 2004 and $104.6 million in 2003, which are not identifiable with an operating segment. There are no intersegment revenues and expenses, and ARI conducted all of its business within the United States, with the exception of
Hotel Sofia (Bulgaria), which began operations in 2001 and was sold in March 2003; Realty Advisors Korea, Ltd. (South Korea), which ARI acquired in 2002 and sold in 2003, and Hotel Akademia (Poland), which began operations in 2002.



23



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



Presented below are ARIs reportable segments operating income for the three and nine months ended
September 30, 2004 and 2003, and segment assets at September 30, 2004 and 2003.



|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|------------------------------------- |  | -------------------- | ------- | ---------- | - | ------- |  | ---- | ------ |  | ------------ | ------- | ----------------- |  | - | ------ |  | - | ------ | - |  | - | ---------
|Three Months Ended September 30,
2004 |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|Operating revenue                     |  | $                    | 13,463  |            | $ | 21,163  |  | $    | 10,898 |  | $            | 115     |                   |  | $ | 8,667  |  | $ | 7      |   |  | $ | 54,313   
|Interest income                       |  |                      |        |            |   |        |  |      |       |  |              |        |                   |  |   |       |  |   | 1,151  |   |  |   | 1,151    
|Operating expenses                    |  |                      | 9,476   |            |   | 14,259  |  |      | 7,861  |  |              | 820     |                   |  |   | 6,788  |  |   |       |   |  |   | 39,204   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss)               |  | $                    | 3,987   |            | $ | 6,904   |  | $    | 3,037  |  | $            | (705    | )                 |  | $ | 1,879  |  | $ | 1,158  |   |  | $ | 16,260   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation                          |  | $                    | 3,150   |            | $ | 2,161   |  | $    | 977    |  | $            |        |                   |  | $ | 337    |  | $ | 16     |   |  | $ | 6,641    
|Interest                              |  |                      | 3,348   |            |   | 7,657   |  |      | 1,327  |  |              | 3,131   |                   |  |   | 368    |  |   | 1,311  |   |  |   | 17,142   
|Capital expenditures                  |  |                      | 2,654   |            |   | 28,572  |  |      | 610    |  |              | 1,426   |                   |  |   | 258    |  |   |       |   |  |   | 33,520   
|Assets                                |  |                      | 261,466 |            |   | 491,409 |  |      | 86,974 |  |              | 217,728 |                   |  |   | 20,797 |  |   | 75,487 |   |  |   | 1,153,861
|                                      |  |                      |         |            |   |         | 
|Property Sales:                       |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Sales price                           |  | $                    | 22,700  |            | $ | 3,330   |  | $    |       |  | $            | 2,910   |                   |  | $ |       |  | $ |       |   |  | $ | 28,940   
|Cost of sale                          |  |                      | 18,932  |            |   | 2,121   |  |      |       |  |              | 2,610   |                   |  |   |       |  |   |       |   |  |   | 23,663   
|Deferred current gain                 |  |                      |        |            |   |        |  |      |       |  |              | 220     |                   |  |   |       |  |   |       |   |  |   | 220      
|Recognized prior deferred gain        |  |                      | 329     |            |   |        |  |      |       |  |              | 747     |                   |  |   |       |  |   |       |   |  |   | 1,076    
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Gain on sale                          |  | $                    | 4,097   |            | $ | 1,209   |  | $    |       |  | $            | 827     |                   |  | $ |       |  | $ |       |   |  | $ | 6,133    
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|                                      |  |                      |         |            |   |         | 
|Three Months Ended September 30,
2003 |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|Operating revenue                     |  | $                    | 13,997  |            | $ | 18,364  |  | $    | 9,375  |  | $            | 138     |                   |  | $ | 8,330  |  | $ | 29     |   |  | $ | 50,233   
|Interest income                       |  |                      |        |            |   |        |  |      |       |  |              |        |                   |  |   |       |  |   | 1,795  |   |  |   | 1,795    
|Operating expenses                    |  |                      | 8,410   |            |   | 13,758  |  |      | 6,363  |  |              | 1,416   |                   |  |   | 6,592  |  |   | (2     | ) |  |   | 36,537   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss)               |  | $                    | 5,587   |            | $ | 4,606   |  | $    | 3,012  |  | $            | (1,278  | )                 |  | $ | 1,738  |  | $ | 1,826  |   |  | $ | 15,491   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation                          |  | $                    | 2,753   |            | $ | 1,563   |  | $    | 738    |  | $            |        |                   |  | $ | 347    |  | $ | 12     |   |  | $ | 5,413    
|Interest                              |  |                      | 3,609   |            |   | 5,852   |  |      | 1,129  |  |              | 4,271   |                   |  |   | 336    |  |   | 1,039  |   |  |   | 16,236   
|Capital expenditures                  |  |                      | 2,621   |            |   | 3,948   |  |      | 1,154  |  |              | 607     |                   |  |   | 111    |  |   |       |   |  |   | 8,441    
|Assets                                |  |                      | 345,044 |            |   | 357,543 |  |      | 57,214 |  |              | 250,857 |                   |  |   | 22,316 |  |   | 81,716 |   |  |   | 1,114,690
|                                      |  |                      |         |            |   |         | 
|Property Sales:                       |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Sales price                           |  | $                    | 58,615  |            | $ | 16,493  |  | $    | 33,000 |  | $            | 27,551  |                   |  | $ |       |  | $ |       |   |  | $ | 135,659  
|Cost of sale                          |  |                      | 49,095  |            |   | 7,928   |  |      | 28,507 |  |              | 12,080  |                   |  |   |       |  |   |       |   |  |   | 97,610   
|Deferred current gain                 |  |                      |        |            |   |        |  |      | 4,356  |  |              |        |                   |  |   |       |  |   |       |   |  |   | 4,356    
|Recognized prior deferred gain        |  |                      |        |            |   |        |  |      |       |  |              | 27      |                   |  |   |       |  |   |       |   |  |   | 27       
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Gain (loss) on sale                   |  | $                    | 9,520   |            | $ | 8,565   |  | $    | 137    |  | $            | 15,498  |                   |  | $ |       |  | $ |       |   |  | $ | 33,720   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|                                      |  |                      |         |            |   |         | 
|Nine Months Ended September 30,
2004  |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|Operating revenue                     |  | $                    | 39,975  |            | $ | 61,960  |  | $    | 29,737 |  | $            | 429     |                   |  | $ | 25,659 |  | $ | 377    |   |  | $ | 158,137  
|Interest income                       |  |                      |        |            |   |        |  |      |       |  |              |        |                   |  |   |       |  |   | 3,514  |   |  |   | 3,514    
|Operating expenses                    |  |                      | 29,061  |            |   | 40,858  |  |      | 22,594 |  |              | 3,502   |                   |  |   | 19,925 |  |   | 345    |   |  |   | 116,285  
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss)               |  | $                    | 10,914  |            | $ | 21,102  |  | $    | 7,143  |  | $            | (3,073  | )                 |  | $ | 5,734  |  | $ | 3,546  |   |  | $ | 45,366   
|                                      |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation                          |  | $                    | 9,131   |            | $ | 6,466   |  | $    | 2,958  |  | $            |        |                   |  | $ | 1,001  |  | $ | 41     |   |  | $ | 19,597   
|Interest                              |  |                      | 10,847  |            |   | 20,921  |  |      | 4,088  |  |              | 9,277   |                   |  |   | 1,129  |  |   | 3,890  |   |  |   | 50,152   
|Capital expenditures                  |  |                      | 5,509   |            |   | 127,392 |  |      | 988    |  |              | 3,612   |                   |  |   | 983    |  |   |       |   |  |   | 138,484  
|Assets                                |  |                      | 261,466 |            |   | 491,409 |  |      | 86,974 |  |              | 217,728 |                   |  |   | 20,797 |  |   | 75,487 |   |  |   | 1,153,861



24



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|------------------------------------ |  | -------------------- | ------- | ---------- | - | ------- |  | - | ------ | - |  | ------------ | ------- | ----------------- |  | ----- | ------ |  | - | ------ |  | - | ---------
|Nine Months Ended September 30,
2004 |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  | PizzaParlors |         | Receivables/Other |  | Total
|Property Sales:                      |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Sales price                          |  | $                    | 80,825  |            | $ | 46,972  |  | $ |       |   |  | $            | 34,592  |                   |  | $     |       |  | $ |       |  | $ | 162,389  
|Cost of sale                         |  |                      | 60,449  |            |   | 37,067  |  |   |       |   |  |              | 24,801  |                   |  |       |       |  |   |       |  |   | 122,317  
|Deferred current gain                |  |                      | 1,678   |            |   | 3,037   |  |   |       |   |  |              | 5,212   |                   |  |       |       |  |   |       |  |   | 9,927    
|Recognized prior deferred gain       |  |                      | 329     |            |   |        |  |   |       |   |  |              |        |                   |  |       |       |  |   |       |  |   | 329      
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Gain on sale                         |  | $                    | 19,027  |            | $ | 6,868   |  | $ |       |   |  | $            | 4,579   |                   |  | $     |       |  | $ |       |  | $ | 30,474   
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|                                     |  |                      |         |            |   |         | 
|Nine Months Ended September 30,
2003 |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  | PizzaParlors |         | Receivables/Other |  | Total
|Operating revenue                    |  | $                    | 33,195  |            | $ | 40,581  |  | $ | 24,954 |   |  | $            | 322     |                   |  | $     | 24,267 |  | $ | 1,649  |  | $ | 124,968  
|Interest income                      |  |                      |        |            |   |        |  |   |       |   |  |              |        |                   |  |       |       |  |   | 7,431  |  |   | 7,431    
|Operating expenses                   |  |                      | 20,653  |            |   | 29,112  |  |   | 17,657 |   |  |              | 4,636   |                   |  |       | 19,357 |  |   | 31     |  |   | 91,446   
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Operating income (loss)              |  | $                    | 12,542  |            | $ | 11,469  |  | $ | 7,297  |   |  | $            | (4,314  | )                 |  | $     | 4,910  |  | $ | 9,049  |  | $ | 40,953   
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Depreciation                         |  | $                    | 6,452   |            | $ | 3,285   |  | $ | 2,055  |   |  | $            |        |                   |  | $     | 1,041  |  | $ | 16     |  | $ | 12,849   
|Interest                             |  |                      | 8,865   |            |   | 12,128  |  |   | 2,953  |   |  |              | 12,098  |                   |  |       | 738    |  |   | 4,826  |  |   | 41,608   
|Capital expenditures                 |  |                      | 4,316   |            |   | 13,532  |  |   | 2,245  |   |  |              | 1,332   |                   |  |       | 1,397  |  |   |       |  |   | 22,822   
|Assets                               |  |                      | 345,044 |            |   | 357,543 |  |   | 57,214 |   |  |              | 250,857 |                   |  |       | 22,316 |  |   | 81,716 |  |   | 1,114,690
|                                     |  |                      |         |            |   |         | 
|Property Sales:                      |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Sales price                          |  | $                    | 87,849  |            | $ | 45,064  |  | $ | 63,062 |   |  | $            | 39,654  |                   |  | $     |       |  | $ |       |  | $ | 235,629  
|Cost of sale                         |  |                      | 60,127  |            |   | 28,874  |  |   | 58,758 |   |  |              | 23,150  |                   |  |       |       |  |   |       |  |   | 170,909  
|Deferred current gain                |  |                      | 9,818   |            |   |        |  |   | 4,356  |   |  |              |        |                   |  |       |       |  |   |       |  |   | 14,174   
|Recognized prior deferred gain       |  |                      |        |            |   |        |  |   |       |   |  |              | 19,924  |                   |  |       |       |  |   |       |  |   | 19,924   
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          
|Gain (loss) on sale                  |  | $                    | 17,904  |            | $ | 16,190  |  | $ | (52    | ) |  | $            | 36,428  |                   |  | $     |       |  | $ |       |  | $ | 70,470   
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                   |  |       |        |  |   |        |  |   |          



NOTE 10. DISCONTINUED
OPERATIONS



Effective January 1, 2002, ARI adopted Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which established a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. This
statement requires that the operations related to properties that have been sold, or properties that are intended to be sold, be presented as discontinued operations in the statement of operations for all periods presented, and the properties
intended to be sold are to be designated as held for sale on the balance sheet. In the event of a future asset sale, ARI is required to reclassify portions of previously reported operations to discontinued operations within the
Statements of Operations.



For the nine months ended September 30, 2004 and
2003, income from discontinued operations relates to 24 properties that ARI sold or are pending sale during 2004 and 32 properties that ARI sold during 2003. The following table summarizes revenue and expense information for these properties sold
and held-for-sale.



|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------- |  | --------------------------------------- | ----- | - | -------------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                 |  | For the Three monthsEnded September 30, |       |   | For the Nine monthsEnded September 30, |  
|                                                                 |  | 2004                                    |       |   | 2003                                   |   |        | 2004 |  |   | 2003   |  
|Revenue:                                                         |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Rental                                                           |  | $                                       | 5,106 |   |                                        | $ | 12,236 |      |  | $ | 18,680 |   |  | $ | 32,995 |  
|Property operations                                              |  |                                         | 2,839 |   |                                        |   | 8,416  |      |  |   | 9,893  |   |  |   | 20,762 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|                                                                 |  |                                         | 2,267 |   |                                        |   | 3,820  |      |  |   | 8,787  |   |  |   | 12,233 |  
|Expenses:                                                        |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Interest                                                         |  |                                         | 2,472 |   |                                        |   | 5,963  |      |  |   | 7,877  |   |  |   | 15,188 |  
|Depreciation                                                     |  |                                         | 794   |   |                                        |   | 1,606  |      |  |   | 3,047  |   |  |   | 4,356  |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|                                                                 |  |                                         | 3,266 |   |                                        |   | 7,569  |      |  |   | 10,924 |   |  |   | 19,544 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Net loss from discontinued operations                            |  |                                         | (999  | ) |                                        |   | (3,749 | )    |  |   | (2,137 | ) |  |   | (7,311 | )
|                                                                 |  |                                         |       |  
|Gain on sale of real estate                                      |  |                                         | 5,306 |   |                                        |   | 18,222 |      |  |   | 25,895 |   |  |   | 34,042 |  
|Equity in gain (loss) on sale of real estate by equity investees |  |                                         | (9    | ) |                                        |   | (165   | )    |  |   | 886    |   |  |   | (165   | )
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Net income from discontinued operations                          |  | $                                       | 4,298 |   |                                        | $ | 14,308 |      |  | $ | 24,644 |   |  | $ | 26,566 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  



25



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



Discontinued operations have not been segregated in the consolidated statements of cash flows. Therefore, amounts for
certain captions will not agree with respective consolidated statements of operations.



NOTE 11. CORRECTION OF ACCOUNTING ERROR IN PRIOR PERIOD



Subsequent to March 31, 2004, but prior to filing the Form 10-Q for the quarter ended June 30, 2004, an 80%-owned subsidiary of ARI
discovered an error in the depreciation calculation for a commercial property the subsidiary purchased in March 2003 for $8.7 million. The amount subject to depreciation was $7.8 million and was to be depreciated straight-line over 40 years (480
months). Instead, the property was being depreciated over 40 months, resulting in depreciation expense being overstated by $1.8 million for 2003 and $1.1 million for 2004. The Consolidated Balance Sheet as of December 31, 2003 has been revised to
reflect the correction of the error through an increase in total real estate, net of accumulated depreciation, of $0.7 million, a decrease in minority interest of $0.5 million, and a decrease in accumulated deficit and corresponding increase in
total stockholders equity of $1.2 million. The unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2003, reflect the correction of the impact of this error on depreciation expense of $0.4 million
and $1.0 million, respectively. The Consolidated Statement of Stockholders Equity for December 31, 2003, has been revised to reflect the correction of the error through a decrease in the December 31, 2003 balance of accumulated deficit and
increase in total stockholders equity of $1.2 million. ARI does not intend to restate any previously issued Forms 10-Q or Form 10-K for previous periods, because, in the opinion of management, the effect is not material to the results of
operations for any period previously reported on.



NOTE 12. COMMITMENTS AND
CONTINGENCIES



Liquidity. Management expects that excess cash
generated from operations during the remainder of 2004 will not be sufficient to discharge all of ARIs debt obligations as they mature. Therefore, ARI will rely on aggressive land sales, selected income producing property sales and, to the
extent necessary, additional borrowings to meet its cash requirements.



Partnership Buyouts. ARI is the limited partner in 12 partnerships formed to construct residential properties. As permitted in the respective partnership agreements, ARI intends to purchase the interests of the general and any other
limited partners in these partnerships subsequent to the completion of these projects. The amounts paid to buy out the nonaffiliated partners are limited to development fees earned by the nonaffiliated partners, and are set forth in the respective
partnership agreements. The total amount of the expected buyouts as of September 30, 2004, is approximately $2.1 million.



Commitments.During 2002, Milano Restaurants International, Inc. (MRI), a then wholly-owned subsidiary of ARI, sold two restaurants to a corporation
owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time
as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1.0 million at September 30, 2004.



Litigation. ARI is involved in various lawsuits arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not
have a material impact on ARIs financial condition, results of operations or liquidity. See ITEM 1. LEGAL PROCEEDINGS under Part II. Other Information for information regarding the Innovo and Sunset lawsuits.



NOTE 13. SUBSEQUENT EVENTS



Events occurring after the date of these financial statements not already reflected
elsewhere are disclosed below.



In November 2004, ARI agreed to exchange 69,903
square feet of Centura land for 71,393 square feet of land that TXU Electric Delivery Company (TXU) owns adjacent to Centura land, for the relocation of electric transmission and distribution facilities. ARI has agreed to pay the actual
costs of relocation, which is estimated at $453,000. ARI will also pay an additional $36,000 to TXU for the difference in the value of the ARI property and the TXU property.



26



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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



This quarterly report on Form 10-Q and ARIs 2003 Form 10-K,
referred to herein, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These statements concern the intent, belief or expectations of ARIs officers with
respect to ARIs ability to lease its properties, tenants ability to pay rents, purchase of additional properties, ability to pay interest and debt principal and make distributions, policies and plans regarding investments and financings,
and other matters. Also, words such as believe, expect, anticipate, intend, plan, estimate, or similar expressions identify forward-looking statements. Actual results may differ
materially from those contained in or implied by the forward-looking statements as a result of various factors. Such factors include, without limitation, the impact of changes in the economy and the capital markets on ARI and its tenants,
competition within the real estate industry or those industries in which its tenants operate, and changes in federal, state and local legislation. For example: Some of ARIs tenants may not renew expiring leases and ARI may be unable to locate
new tenants to maintain the historical occupancy rates of the properties; rents which ARI can achieve at its properties may decline; tenants may experience losses and become unable to pay rents; and ARI may be unable to identify or to negotiate
acceptable purchase prices for new properties. These results could occur due to many different circumstances, some of which, such as changes in ARIs tenants financial conditions or needs for leased space, or changes in the capital
markets or the economy, generally, are beyond ARIs control. Forward-looking statements are only expressions of ARIs present expectations and intentions. Forward-looking statements are not guaranteed to occur, and they may not occur. You
should not place undue reliance upon forward-looking statements.



Introduction



ARI was organized in 1999. In August 2000, ARI
acquired American Realty Trust, Inc. (ART) and National Realty, L.P. (NRLP). ART was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments
selected to provide opportunities for capital appreciation as well as current income. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the
liabilities of 35 public and private limited partnerships. NRLP also owns a portfolio of real estate and mortgage loan investments.



On November 15, 2002, ARI commenced a tender offer for the common shares of Transcontinental Realty Investors, Inc. (TCI) and Income Opportunity Realty
Investors, Inc. (IORI) not already owned by ARI. The tender offer was completed on March 19, 2003. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares.



After the tender offer, ARI subsidiaries owned 64.8% of the outstanding shares of TCI and
62.5% of the outstanding shares of IORI (46.9% owned directly by ARI subsidiaries and 15.6% through TCIs ownership of IORI shares). ARI began consolidation of TCIs and IORIs accounts and operations effective March 31, 2003. The
effect of consolidating TCIs and IORIs operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the
same board of directors. At September 30, 2004, ARI and TCI have the same advisor and Board of Directors. One Director of ARI (Ted Stokely) also serves as a director of IORI.



On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (BCM),
receiving 650,000 TCI shares from BCM. In addition, BCM executed a promissory note in favor of an ARI subsidiary in the amount of $0.5 million. After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI
sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (One Realco) to BCM, receiving 314,141 TCI shares from BCM. After the transaction, ARI subsidiaries owned 76.8% of
the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in open market transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At September 30, 2004, ARI
subsidiaries owned 80.0% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2004, TCI owned 24.0% of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



Critical Accounting Policies



Critical accounting policies are those that are both important to the presentation of
ARIs financial condition and results of operations and require managements most difficult, complex or subjective judgments. ARIs critical accounting policies relate to the evaluation of impairment of long-lived assets and the
evaluation of the collectibility of accounts and notes receivable.



If events
or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be
generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides
to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation



27



---

indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to
estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARIs estimates of cash flow and fair values of the properties are based on current market conditions and consider matters
such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARIs estimates are subject
to revision as market conditions and ARIs assessments of them change.



ARIs allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such
information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARIs assessment of its ability to meet its lease or interest obligations.
ARIs estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.



ARIs management periodically discusses criteria for estimates and disclosures of its
estimates with the Audit Committee of its Board of Directors.



Liquidity and
Capital Resources



Net cash used in operating activities amounted to $6.8
million for the nine months ended September 30, 2004. ARI reported a net loss of $15.1 million for the nine months ended September 30, 2004, which included the following non-cash charges and credits: gain on sale of real estate of $31.4 million,
depreciation and amortization from real estate held for investment of $22.6 million, amortization of deferred borrowing costs of $6.1 million, writedown of assets held for sale of $3.4 million, gain on forgiveness of debt of $2.3 million, gain on
foreign currency transaction of $1.8 million, discount on sale of notes receivable of $0.4 million, and equity in loss of equity investees of $0.1 million. Other assets decreased by $6.1 million primarily due to a reduction in escrows and deposits,
other liabilities increased by $3.5 million primarily due to an increase in accrued expenses, interest receivable decreased by $0.7 million due to collection of accrued interest receivable, minority interest decreased by $1.1 million and interest
payable increased by $1.8 million.



Net cash used in investing activities of
$53.4 million was primarily due to real estate improvements of $137.5 million, acquisitions of real estate of $26.1 million, investment in real estate entities of $2.6 million, earnest money deposits of $3.3 million, and purchases of pizza parlor
equipment of $1.0 million. These outflows for investing activities were offset by $108.6 million from the sale of real estate, $6.2 million from the sale of notes receivable, and $2.4 million from collection of notes receivable.



Net cash provided by financing activities of $61.8 million was comprised of proceeds received
from the funding or refinancing of notes payable of $314.6 million, offset by cash payments of $237.0 million to paydown existing notes payable, payments to affiliates of $6.5 million, $6.4 million for financing costs, $0.9 million in dividends on
Preferred Stock, net payments on stock loans of $0.6 million and $1.4 million to repurchase common stock.



In 2004, ARI purchased the following property:



|                           |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|-------------------------- |  | --------------- |  | ----------- |  | ------------- | ----- | ------------------------ | - | ---- | ------------ |  | ------------ | ----- |  | ------------ | --- |  | -----
|Property                   |  | Location        |  | Units/Acres |  | PurchasePrice |       | Net CashPaid/ (Received) |   |      | DebtIncurred |  | InterestRate |       |  | MaturityDate
|First Quarter              |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Apartments                 |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|288 City Park(1)           |  | Houston, TX     |  | 240 Units   |  | $             | 3,056 |                          | $ | 612  |              |  | $            | 2,444 |  | 5.95         | %   |  | 04/45
|Blue Lake Villas II(1)     |  | Waxahachie, TX  |  | 70 Units    |  |               | 729   |                          |   | (164 | )            |  |              | 729   |  | 5.80         |     |  | 04/45
|Bridges on Kinsey(1)       |  | Tyler, TX       |  | 232 Units   |  |               | 2,291 |                          |   | 596  |              |  |              | 1,687 |  | 5.74         |     |  | 08/45
|Dakota Arms(1)             |  | Lubbock, TX     |  | 208 Units   |  |               | 2,472 |                          |   | 681  |              |  |              | 1,791 |  | 5.85         |     |  | 06/45
|Lake Forest(1)             |  | Houston, TX     |  | 240 Units   |  |               | 2,316 |                          |   | (470 | )            |  |              | 2,316 |  | 5.60         |     |  | 03/45
|Vistas of Vance Jackson(1) |  | San Antonio, TX |  | 240 Units   |  |               | 3,550 |                          |   | 771  |              |  |              | 2,779 |  | 5.78         |     |  | 06/45
|                           |  |                 |  |             |  |               |      
|Land                       |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Lubbock                    |  | Lubbock, TX     |  | 2.9 Acres   |  |               | 224   |                          |   | 224  |              |  |              |      |  |             |     |  |     
|Meloy Road                 |  | Kent, OH        |  | 54.2 Acres  |  |               | 4,900 |                          |   | 343  |              |  |              | 4,900 |  | 5.00         | (2) |  | 01/06
|Railroad                   |  | Dallas, TX      |  | .3 Acres    |  |               | 708   |                          |   | 704  |              |  |              |      |  |             |     |  |     



28



---

|                     |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|-------------------- |  | ------------------ |  | ----------- |  | ------------- |  | ------------------------ | - |  | ------------ | --- |  | ------------ | --- |  | ------------
|Property             |  | Location           |  | Units/Acres |  | PurchasePrice |  | Net CashPaid/ (Received) |   |  | DebtIncurred |     |  | InterestRate |     |  | MaturityDate
|Second Quarter       |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Apartments           |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Treehouse(3)         |  | Irving, TX         |  | 160 Units   |  | 7,519         |  | (498                     | ) |  | 5,027        | (4) |  | 5.00         |     |  | 08/13       
|Wildflower Villas(1) |  | Temple, TX         |  | 220 Units   |  | 2,045         |  | 79                       |   |  | 1,966        |     |  | 5.99         |     |  | 10/45       
|                     |  |                    |  |             |  |               | 
|Land                 |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Cooks Lane(1)        |  | Ft. Worth, TX      |  | 23.2 Acres  |  | 1,000         |  | 1,034                    |   |  |             |     |  |             |     |  |            
|Rogers(1)            |  | Rogers, AR         |  | 20.1 Acres  |  | 1,390         |  | 506                      |   |  | 1,130        |     |  | 10.50        |     |  | 04/05       
|                     |  |                    |  |             |  |               | 
|Third Quarter        |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Land                 |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Granbury Station     |  | Ft. Worth, TX      |  | 15.7 Acres  |  | 923           |  | 236                      |   |  | 738          |     |  | 7.00         |     |  | 09/07       
|Ladue                |  | Farmers Branch, TX |  | 8.0 Acres   |  | 1,743         |  | 659                      |   |  | 1,206        |     |  | 6.65         | (2) |  | 06/06       
|                     |  |                    |  |             |  |               | 
|Fourth Quarter       |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Land                 |  |                    |  |             |  |               |  |                          |   |  |              |     |  |              |     |  |             
|Denton-Coonrod       |  | Denton, TX         |  | 82.2 Acres  |  | 1,644         |  | 1,046                    |   |  | 840          |     |  | 6.25         |     |  | 11/06       
|DeSoto               |  | DeSoto, TX         |  | 21.9 Acres  |  | 2,516         |  | 1,364                    |   |  | 1,265        |     |  | 6.25         |     |  | 11/06       
|West End             |  | Dallas, TX         |  | 0.2 Acres   |  | 71            |  | 71                       |   |  |             |     |  |             |     |  |            

---

|(1) | Land purchased for apartment construction.
|--- | ------------------------------------------

|(2) | Variable interest rate.
|--- | -----------------------

|(3) | Purchased from IORI, a related party, for assumption of debt and a note receivable, less $498 in cash received.
|--- | ---------------------------------------------------------------------------------------------------------------

|(4) | Assumed debt of seller.
|--- | -----------------------



In 2004, ARI sold the following property:



|                       |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|---------------------- |  | ----------------- |  | ------------------- |  | ---------- | ------ | ---------------- | - | -------------- |  | - | ------------------ | --- |  | - | ----- | ---
|Property               |  | Location          |  | Units/Sq. Ft./Acres |  | SalesPrice |        | Net CashReceived |   | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|First Quarter          |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|Tiberon Trails         |  | Merrillville, IN  |  | 376 Units           |  | $          | 10,325 |                  | $ | 2,869          |  | $ | 6,189              | (1) |  | $ | 49    |    
|                       |  |                   |  |                     |  |           
|Industrial Warehouses  |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|Kelly (Pinewood)       |  | Dallas, TX        |  | 100,000 Sq. Ft.     |  |            | 1,650  |                  |   | 65             |  |   | 1,376              |     |  |   | 153   |    
|Ogden Industrial       |  | Ogden, UT         |  | 107,112 Sq. Ft.     |  |            | 2,600  |                  |   | 668            |  |   | 1,775              |     |  |   | 1,474 |    
|Texstar Warehouse      |  | Arlington, TX     |  | 97,846 Sq. Ft.      |  |            | 2,400  |                  |   |               |  |   | 1,148              | (1) |  |   |      | (3)
|                       |  |                   |  |                     |  |           
|Land                   |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|Allen                  |  | Collin County, TX |  | 492.5 Acres         |  |            | 19,962 |                  |   | 7,956          |  |   | 4,088              |     |  |   | 3,503 | (2)
|Marine Creek           |  | Ft. Worth, TX     |  | 10.7 Acres          |  |            | 1,488  |                  |   | 1,198          |  |   | 991                |     |  |   |      | (7)
|Mason Goodrich         |  | Houston, TX       |  | 5.7 Acres           |  |            | 686    |                  |   | 45             |  |   | 588                |     |  |   | 379   |    
|Mason Goodrich         |  | Houston, TX       |  | 8.0 Acres           |  |            | 1,045  |                  |   | 251            |  |   | 200                |     |  |   | 617   |    
|Red Cross              |  | Dallas, TX        |  | 2.9 Acres           |  |            | 8,500  |                  |   | 2,842          |  |   | 4,450              |     |  |   |      |    
|                       |  |                   |  |                     |  |           
|Office Buildings       |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|Brandeis(6)            |  | Omaha, NE         |  | 319,234 Sq. Ft.     |  |            |       |                  |   |               |  |   | 8,750              |     |  |   | (92   | )  
|Countryside Harmon     |  | Sterling, VA      |  | 5,000 Sq. Ft.       |  |            | 2,650  |                  |   | 216            |  |   | 2,200              |     |  |   | 1,861 |    
|Countryside Retail     |  | Sterling, VA      |  | 133,422 Sq. Ft.     |  |            | 27,100 |                  |   | 3,408          |  |   | 22,800             |     |  |   | 6,807 |    
|                       |  |                   |  |                     |  |           
|Shopping Centers       |  |                   |  |                     |  |            |        |                  |   |                |  |   |                    |     |  |   |       |    
|K-Mart                 |  | Cary, NC          |  | 92,033 Sq. Ft.      |  |            | 3,200  |                  |   |               |  |   | 1,677              | (1) |  |   |      | (3)
|Plaza on Bachman Creek |  | Dallas, TX        |  | 80,278 Sq. Ft.      |  |            | 7,850  |                  |   | 1,808          |  |   | 5,358              |     |  |   | 4,011 |    



29



---

|                          |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|------------------------- |  | ---------------- |  | ------------------- |  | ---------- | ------ | ---------------- | - | ----- | -------------- |  | - | ------------------ | --- |  | - | ----- | ---
|Property                  |  | Location         |  | Units/Sq. Ft./Acres |  | SalesPrice |        | Net CashReceived |   |       | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|Second Quarter            |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments                |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Cliffs of El Dorado(5)    |  | McKinney, TX     |  | 208 Units           |  | $          | 13,442 |                  | $ | 10    |                |  | $ | 10,323             | (1) |  | $ |      |    
|Park Avenue               |  | Tallahassee, FL  |  | 121 Units           |  |            | 6,225  |                  |   | 876   |                |  |   | 4,320              | (1) |  |   | 3,922 |    
|Sandstone                 |  | Mesa, AZ         |  | 238 Units           |  |            | 8,650  |                  |   | 2,920 | (4)            |  |   | 5,531              |     |  |   | 1,688 |    
|                          |  |                  |  |                     |  |           
|Office Buildings          |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|4135 Beltline             |  | Addison, TX      |  | 90,000 Sq. Ft.      |  |            | 4,900  |                  |   | 2,472 |                |  |   | 2,009              |     |  |   | 337   |    
|Atrium                    |  | Palm Beach, FL   |  | 74,603 Sq. Ft.      |  |            | 5,775  |                  |   | 1,842 |                |  |   | 3,772              |     |  |   | 708   |    
|                          |  |                  |  |                     |  |           
|Third Quarter             |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments                |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Falcon House              |  | Ft. Walton, FL   |  | 82 Units            |  |            | 3,330  |                  |   | 1,178 |                |  |   | 1,950              | (1) |  |   | 1,209 |    
|                          |  |                  |  |                     |  |           
|Industrial Warehouses     |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Kelly (Cash Road)         |  | Dallas, TX       |  | 97,150 Sq. Ft.      |  |            | 1,500  |                  |   | 1,077 |                |  |   | 422                |     |  |   | 454   |    
|                          |  |                  |  |                     |  |           
|Land                      |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Rasor                     |  | Plano, TX        |  | 24.5 Acres          |  |            | 2,600  |                  |   | 2,600 |                |  |   |                   |     |  |   |      | (8)
|Vista Ridge               |  | Lewisville, TX   |  | 1.3 Acres           |  |            | 310    |                  |   | 259   |                |  |   |                   |     |  |   | 131   |    
|                          |  |                  |  |                     |  |           
|Shopping Centers          |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Collection                |  | Denver, CO       |  | 267,812 Sq. Ft.     |  |            | 21,200 |                  |   | 6,703 |                |  |   | 13,153             |     |  |   | 3,314 |    
|                          |  |                  |  |                     |  |           
|Fourth Quarter            |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Apartments                |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|In the Pines              |  | Gainesville, FL  |  | 242 Units           |  |            | 11,300 |                  |   | 3,247 |                |  |   | 5,201              |     |  |   | 5,517 |    
|La Mirada                 |  | Jacksonville, FL |  | 320 Units           |  |            | 10,500 |                  |   | 2,576 |                |  |   | 7,098              |     |  |   | 7,576 |    
|                          |  |                  |  |                     |  |           
|Land                      |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Mason Goodrich            |  | Houston, TX      |  | 4.0 Acres           |  |            | 523    |                  |   | 33    |                |  |   | 436                |     |  |   | 306   |    
|Mason Goodrich            |  | Houston, TX      |  | 2.4 Acres           |  |            | 250    |                  |   | 15    |                |  |   | 200                |     |  |   | 115   |    
|                          |  |                  |  |                     |  |           
|Office Buildings          |  |                  |  |                     |  |            |        |                  |   |       |                |  |   |                    |     |  |   |       |    
|Ambulatory Surgery Center |  | Sterling, VA     |  | 33,832 Sq. Ft.      |  |            | 8,675  |                  |   | 5,448 |                |  |   | 2,899              |     |  |   | 805   |    
|One Steeplechase          |  | Sterling, VA     |  | 103,376 Sq. Ft.     |  |            | 11,900 |                  |   | 3,743 |                |  |   | 7,654              |     |  |   | 6,227 |    

---

|(1) | Debt assumed by purchaser.
|--- | --------------------------

|(2) | A portion of the land was sold on a contingent basis for a secured note receivable of $7,150. See Note 3. NOTES AND INTEREST RECEIVABLE. Additional gain of $4,412
deferred until the contingency period expires. $747 of deferred gain recognized in September 2004 upon receipt of $1,072 principal payment on the note receivable.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Sold to BCM, a related party, for assumption of debt and a secured note receivable. See Note 3. NOTES AND INTEREST RECEIVABLE. Gain of $1,157 (Texstar) and $521 (K-Mart)
deferred until sale to unrelated party.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes a $1,971 deposit received in February 2004.
|--- | ----------------------------------------------------

|(5) | Sold to Unified Housing Foundation Inc. (UHF), a related party, in 2003. See Note 8. RELATED PARTY TRANSACTIONS. Gain of $2,542 deferred until sale to
unrelated party.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Returned to lender. See Note 6. NOTES AND INTEREST PAYABLE.
|--- | -------------------------------------------------------------

|(7) | Sold to a UHF. Gain of $581 deferred until sale to unrelated party.
|--- | -------------------------------------------------------------------

|(8) | Sold to BCM. Gain of $220 deferred until sale to related party.
|--- | ---------------------------------------------------------------



In January 2004, the lender on three of ARIs land properties located in Texas notified ARI that the loans on the properties were in default due to ARIs
failure to make timely debt service payments. The balance owed on the loans was $10.3 million. In September 2004, ARI obtained new financing of $9.7 million and settled the original loans and accrued but unpaid interest for $9.1 million. ARI
recognized debt forgiveness of $2.3 million.



In February 2004, the Brandeis
office building was returned to the lender via a Deed in Lieu of Foreclosure process. The outstanding debt and accrued interest was $8.8 million. ARI recorded a net impairment of $4.4 million in the fourth quarter of 2003 for this transaction.



30



---

In February 2003, the lender on one of ARIs hotel properties located in Virginia and three hotel properties in
Chicago notified ARI that the loans on the properties were in default, due to ARIs failure to make timely debt service payments. The balance owed on the loans was $21.2 million. In April 2003, the lender and ARI agreed to terms to cure the
default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lenders Loan Modification Offer (the Offer), and the Offer was revoked. In August 2003, the hotels were sold to a related
party which then filed for bankruptcy in an effort to restructure the debt on the properties. ARI expected the hotels to emerge as viable assets. The sales were not recorded due to ARI retaining control and having continuing involvement. In March
2004, ARI paid off these loans through other refinancings. The Virginia hotel was released from bankruptcy protection in March 2004. In August 2004, the Chicago hotels were released from bankruptcy protection.



In September 2004, the lender on one of ARIs commercial properties located in Colorado
notified ARI that the loan on the property was in default due to ARIs failure to make timely debt service payments. The balance owed on the loan is $3.9 million. In October 2004, ARI sold this asset to a related party for assumption of debt
and seller financing. At November 2004, negotiations with the lender are ongoing.



In October 2004, the lender on one of ARIs land properties located in Tennessee notified ARI that the loan on the property was in default due to ARIs failure to pay or extend the loan at maturity. The balance owed on the loan is
$6.8 million. ARI continues to make monthly interest payments. At November 2004, negotiations with the lender are ongoing.



In 2004, ARI financed/refinanced or obtained second mortgage financing on the following:



|                               |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|------------------------------ |  | ------------------ |  | ------------------------- |  | ------------ | ------ | -------------- | - | ----------------------- |  | - | ------------ | ---- |  | ------------ | ---- |  | -----
|Property                       |  | Location           |  | Units/Sq. Ft. Rooms/Acres |  | DebtIncurred |        | DebtDischarged |   | Net CashReceived/(Paid) |  |   | InterestRate |      |  | MaturityDate
|First Quarter                  |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Hotels                         |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms                 |  | $            | 11,500 |                | $ | 12,332                  |  | $ | (13,689      | )(3) |  | 7.00         | %(1) |  | 03/05
|Land                           |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura                        |  | Farmers Branch, TX |  | 8.8 Acres                 |  |              | 4,485  |                |   | 4,000                   |  |   | (183         | )    |  | 7.00         | (1)  |  | 11/04
|Dominion/Hollywood             |  | Farmers Branch, TX |  | 66.1 Acres                |  |              | 6,985  |                |   | 6,222                   |  |   | (67          | )    |  | 7.00         | (1)  |  | 02/05
|Katy                           |  | Harris County, TX  |  | 130.6 Acres               |  |              | 7,500  |                |   |                        |  |   | (75          | )(4) |  | 6.00         | (1)  |  | 02/07
|                               |  |                    |  |                           |  |              |       
|Office Buildings               |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura Tower                  |  | Farmers Branch, TX |  | 410,901 Sq. Ft.           |  |              | 34,000 |                |   | 36,889                  |  |   | (4,588       | )    |  | 5.50         | (1)  |  | 04/06
|                               |  |                    |  |                           |  |              |       
|Second Quarter                 |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Apartments                     |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Paramount Terrace              |  | Amarillo, TX       |  | 181 Units                 |  |              | 3,176  |                |   | 2,663                   |  |   | 323          |      |  | 5.15         |      |  | 06/37
|Treehouse                      |  | Irving, TX         |  | 160 Units                 |  |              | 5,780  |                |   | 5,027                   |  |   | 138          |      |  | 5.06         |      |  | 07/34
|                               |  |                    |  |                           |  |              |       
|Land                           |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|                               |  |                    |  |                           |  |              |       
|Lacy Longhorn                  |  | Farmers Branch, TX |  | 17.1 Acres                |  |              | 1,965  |                |   | 1,800                   |  |   | 78           |      |  | 4.03         | (1)  |  | 07/07
|Mason Goodrich                 |  | Houston, TX        |  | 39.4 Acres                |  |              | 2,133  |                |   | 714                     |  |   | 1,345        |      |  | 6.00         | (1)  |  | 08/05
|Walker                         |  | Dallas County, TX  |  | 132.6 Acres               |  |              | 8,750  |                |   | 7,950                   |  |   | 264          |      |  | 5.90         | (1)  |  | 06/06
|                               |  |                    |  |                           |  |              |       
|Office Buildings               |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|1010 Common                    |  | New Orleans, LA    |  | 494,579 Sq. Ft.           |  |              | 16,250 |                |   | 8,000                   |  |   | 7,829        |      |  | 4.03         | (1)  |  | 07/07
|Two Hickory Centre             |  | Farmers Branch, TX |  | 96,127 Sq. Ft.            |  |              | 7,500  |                |   | 7,500                   |  |   | (164         | )    |  | 3.60         | (1)  |  | 05/06
|                               |  |                    |  |                           |  |              |       
|Third Quarter                  |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Apartments                     |  |                    |  |                           |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Villager                       |  | Fort Walton, FL    |  | 33 Units                  |  |              | 804    |                |   | 507                     |  |   | 129          |      |  | 5.15         |      |  | 06/34
|Waters Edge III                |  | Gulfport, MS       |  | 238 Units                 |  |              | 3,250  |                |   |                        |  |   |             | (5)  |  | 12.50        |      |  | 12/04



31



---

|                       |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|---------------------- |  | ------------------ |  | ------------------------- |  | ------------ | ------ | --- | -------------- | - | ------ | ----------------------- |  | - | ------------ | - |  | ------------ | ---- |  | -----
|Property               |  | Location           |  | Units/Sq. Ft. Rooms/Acres |  | DebtIncurred |        |     | DebtDischarged |   |        | Net CashReceived/(Paid) |  |   | InterestRate |   |  | MaturityDate
|Hotels                 |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|City Suites            |  | Chicago, IL        |  | 45 Rooms                  |  | $            | 3,640  |     |                | $ |       |                         |  | $ | 3,548        |   |  | 6.75         | %(1) |  | 09/09
|Willows                |  | Chicago, IL        |  | 52 Rooms                  |  |              | 3,500  |     |                |   |       |                         |  |   | 3,411        |   |  | 6.75         | (1)  |  | 09/09
|                       |  |                    |  |                           |  |              |       
|Land                   |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Bonneau                |  | Dallas County, TX  |  | 8.4 Acres                 |  |              | 9,661  | (6) |                |   | 10,283 | (7)                     |  |   | 76           |   |  | 6.75         | (1)  |  | 09/05
|Chase Oaks             |  | Plano, TX          |  | 5.8 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|Dalho                  |  | Farmers Branch, TX |  | 2.9 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|HSM                    |  | Farmers Branch, TX |  | 6.2 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|JHL Connell            |  | Carrollton, TX     |  | 7.6 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|Las Colinas            |  | Las Colinas, TX    |  | 1.5 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|Stagliano              |  | Farmers Branch, TX |  | 3.2 Acres                 |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|Vista Ridge            |  | Lewisville, TX     |  | 64.9 Acres                |  |              |       | (6) |                |   |       |                         |  |   |             |   |  |             |      |  |     
|                       |  |                    |  |                           |  |              |       
|Office Buildings       |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Centura Tower          |  | Farmers Branch, TX |  | 410,901 Sq. Ft.           |  |              | 50,000 |     |                |   | 37,594 |                         |  |   | 2,989        |   |  | 4.94         |      |  | 10/09
|Cooley                 |  | Farmers Branch, TX |  | 27,000 Sq. Ft.            |  |              | 2,600  |     |                |   | 1,726  |                         |  |   | 811          |   |  | 5.50         | (1)  |  | 09/06
|                       |  |                    |  |                           |  |              |       
|Warehouses             |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Addison Hangers I & II |  | Addison, TX        |  | 52,650 Sq. Ft.            |  |              | 4,500  |     |                |   | 2,592  |                         |  |   | 1,635        |   |  | 10.00        |      |  | 09/14
|                       |  |                    |  |                           |  |              |       
|Fourth Quarter         |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Hotels                 |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Majestic Inn           |  | San Francisco, CA  |  | 57 Rooms                  |  |              | 2,000  | (8) |                |   | 5,138  |                         |  |   | (1,238       | ) |  | 5.75         | (1)  |  | 10.05
|                       |  |                    |  |                           |  |              |       
|Land                   |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|Cooks Lane             |  | Ft. Worth, TX      |  | 23.2 Acres                |  |              | 550    |     |                |   |       |                         |  |   |             |   |  | 6.25         |      |  | 11/06
|                       |  |                    |  |                           |  |              |       
|Office Buildings       |  |                    |  |                           |  |              |        |     |                |   |        |                         |  |   |              |   |  |              |      |  |      
|225 Baronne            |  | New Orleans, LA    |  | 416,834 Sq. Ft.           |  |              | 500    | (8) |                |   |       |                         |  |   |             |   |  | 5.75         | (1)  |  | 10/05
|Amoco                  |  | New Orleans, LA    |  | 378,244 Sq. Ft.           |  |              | 1,500  | (8) |                |   |       |                         |  |   |             |   |  | 5.75         | (1)  |  | 10/05

---

|(1) | Variable interest rate.
|--- | -----------------------

|(2) | Construction loan for apartment construction.
|--- | ---------------------------------------------

|(3) | Cash of $10,961 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | ------------------------------------------------------------------------------------

|(4) | Cash of $7,400 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | -----------------------------------------------------------------------------------

|(5) | Cash of $3,250 was received by an affiliate, increasing ARIs affiliate receivable.
|--- | -----------------------------------------------------------------------------------

|(6) | Single note with all properties as collateral.
|--- | ----------------------------------------------

|(7) | Debt forgiveness of $2,268 recognized.
|--- | --------------------------------------

|(8) | The Majestic Inn, 225 Baronne Office Building and Amoco Office Building are cross collateralized. The debt incurred on 225 Baronne and Amoco are 2nd lien loans.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



ARI has margin arrangements with various financial institutions
and brokerage firms which provide for borrowing up to 50% of the market value of ARIs marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of IORI and TCI and ARIs trading portfolio
and bear interest rates ranging from 6.0% to 24.0%. Margin borrowing totaled $18.8 million at September 30, 2004.



Management expects that it will be necessary for ARI to sell or refinance $60.2 million, $10.5 million and $31.6 million of its land holdings during each of the next
three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum

amount of land to satisfy the debt obligations on
such land as it matures, or, if it is not able to extend such debt, ARI intends to sell other of its assets, specifically income producing properties, to pay the debt.



32



---

Management reviews the carrying values of ARIs properties and mortgage notes receivable at least annually and
whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying
amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge
against earnings to the extent that the investment in the note exceeds managements estimate of the fair value of the collateral property securing each note. The mortgage note receivable review includes an evaluation of the collateral property
securing such note. The property review generally includes: (1) selective property inspections; (2) a review of the propertys current rents compared to market rents; (3) a review of the propertys expenses; (4) a review of maintenance
requirements; (5) a review of the propertys cash flow; (6) discussions with the manager of the property; and (7) a review of properties in the surrounding area.



Related Party Transactions



In January 2004, ARI issued 200,000 shares of Series A 10% Cumulative Convertible Preferred Stock to Prime, ARIs advisor. In February 2004, 50,000 additional shares
were issued to Prime. ARIs affiliate receivable was increased by $2.5 million.



In February 2004, ARI obtained an unsecured loan of $5.0 million. The proceeds of $5.0 million were received by an affiliate of ARI, increasing ARIs affiliate receivable.



In February 2004, ARI obtained financing of $7.5 million on the Katy land tract. The funds, along with additional cash of $6.3 million, were
sent to an affiliate. Subsequently, the affiliate paid off the existing loan balance on an ARI property.



Also In February 2004, ARI recorded the sale of a tract of Marine Creek land originally sold to a related party in December 2003. This transaction was not recorded as a sale for accounting purposes in December 2003
and was recorded as an ARI refinancing transaction in February 2004. ARI received $1.2 million in cash from the related party in February 2004 as payment on the land. ARI still has a note receivable balance of $290,000 remaining that bears interest
at 12.0% and matures in April 2009. ARI recorded the sale of the Marine Creek land tract due to the payment received on the note receivable.



In March 2004, ARI obtained financing of $11.5 million on a hotel property. The proceeds of $11.0 million were received by an affiliate, increasing ARIs affiliate
receivable.



In March 2004, a related party purchased the loans on ARIs
three Chicago hotels for $10.8 million. This amount increased the affiliate payable balance by $10.8 million.



In May 2004, ARI purchased the Treehouse Apartments from an affiliate, with a net purchase price of $7.5 million after assumption of debt and a note receivable, less cash received of $0.5 million. The note receivable
was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado was not recorded as a sale for accounting purposes. ARI recorded the sale of the Cliffs of El Dorado in May 2004,
due to payment received for the Cliffs of El Dorado note receivable.



In July
2004, ARI obtained a loan of $3.2 million secured by a contract for sale of the Waters Edge III Apartments. The proceeds of $3.2 million were received by an affiliate, increasing ARIs affiliate receivable.



In September 2004, ARI sold 10.0 acres of land to an affiliate for a purchase price of $0.7
million. Due to no cash received and common control, ARI has elected to continue consolidating this tract of land until the requirements for a sale have been met.



In October 1999, ARI funded a $4.7 million loan to Realty Advisors. The loan, to provide funds for acquisitions or working capital needs,
was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the
maturity date was extended to November 2004. The collateral was changed to a subordinate pledge of 850,000 shares of ARI Common Stock owned by BCM. The shares are also pledged to a lender on ARIs behalf. The interest rate was changed to 2%
over the prime rate, currently 7.0% per annum, and the accrued but unpaid interest of $1.0 million was added to the principal. The new principal balance is $5.6 million. In September 2003, $0.7 million in accrued interest was collected. In August
2004, $0.3 million in accrued interest was collected. In November 2004, the maturity date was extended to November 2006. All principal and accrued interest are due at maturity.



33



---

In April 2002, ARI and TCI sold 21 apartment properties to partnerships controlled by Metra Capital, LLC
(Metra). Innovo Group, Inc. (Innovo) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, then a director of ARI, controlled approximately 11.67% of the outstanding common stock of Innovo.
Management determined to treat the sales as financing transactions, and ARI and TCI continue to report the assets and the new debt incurred by Metra on their financial statements. The partnership agreements for each of these partnerships state that
the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual
amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These distributions to the Metra Partners have priority over distributions to any other partners. At September 30, 2004, 16 of the
properties remained on ARIs balance sheet, and ARIs other liabilities included $1.7 million owed to the Metra Partners related to cash received by ARI upon the sale of these apartments in April 2002.



Commitments and Contingencies



ARI has contractual obligations and commitments primarily with regards to payment of
mortgages.



Results of Operations



For the nine months ended September 30, 2004, ARI reported a net loss of $15.1 million,
compared to net income of $13.0 million for the nine months ended September 30, 2003. The primary factors contributing to ARIs net income or loss are discussed in the following paragraphs.



ARI began consolidating TCIs operations effective March 31, 2003. The consolidation is
the principal factor for the increase during the nine months ended September 30, 2004 in the following areas: rents, property operations expense, interest expense, depreciation and amortization, general and administrative expense, advisory fees, and
gain on sale of real estate. For these items, results for the nine months ended September 30, 2004 are also presented without the effect of the consolidation of TCIs operations for the first three months of 2004.



Rents (dollars in thousands)



|           |  |                                 |        |                                 |   |          |  |               |         |            |   |         |  |   |        
|---------- |  | ------------------------------- | ------ | ------------------------------- | - | -------- |  | ------------- | ------- | ---------- | - | ------- |  | - | -------
|           |  | Three Months EndedSeptember 30, |        | Nine Months Ended September 30,
|           |  | 2004                            |        | 2003                            |   | 2004     |  | 2003         
|           |  |                                 |        | AsRestated                      |   | With TCI |  | Without1Q TCI |         | AsRestated
|Commercial |  | $                               | 13,463 |                                 | $ | 13,997   |  | $             | 39,975  |            | $ | 32,296  |  | $ | 33,195 
|Apartments |  |                                 | 21,163 |                                 |   | 18,364   |  |               | 61,960  |            |   | 47,233  |  |   | 40,581 
|Hotels     |  |                                 | 10,898 |                                 |   | 9,375    |  |               | 29,737  |            |   | 28,258  |  |   | 24,954 
|Land       |  |                                 | 115    |                                 |   | 138      |  |               | 429     |            |   | 288     |  |   | 322    
|Other      |  |                                 | 7      |                                 |   | 29       |  |               | 377     |            |   | 377     |  |   | 1,649  
|           |  |                                 |        |                                 |   |          |  |               |         |            |   |         |  |   |        
|           |  | $                               | 45,646 |                                 | $ | 41,903   |  | $             | 132,478 |            | $ | 108,452 |  | $ | 100,701
|           |  |                                 |        |                                 |   |          |  |               |         |            |   |         |  |   |        



The increase in apartment rents was
primarily attributable to completed construction. The increase in hotel rents was primarily attributable to increased occupancy. The decrease in other rents was primarily attributable to the sale of ARIs interest in Realty Advisors Korea, Ltd.
as of June 30, 2003. Total rents are expected to increase in 2004, as a result of completed apartment construction.



Property Operations Expenses (dollars in thousands)



|           |  |                                 |        |            |                                 |        |          |  |               |        |            |   |        |  |   |       
|---------- |  | ------------------------------- | ------ | ---------- | ------------------------------- | ------ | -------- |  | ------------- | ------ | ---------- | - | ------ |  | - | ------
|           |  | Three Months EndedSeptember 30, |        |            | Nine Months Ended September 30,
|           |  | 2004                            |        | 2003       |                                 |        | 2004     |  | 2003         
|           |  |                                 |        | AsRestated |                                 |        | With TCI |  | Without1Q TCI |        | AsRestated
|Commercial |  | $                               | 9,476  |            | $                               | 8,410  |          |  | $             | 29,061 |            | $ | 24,423 |  | $ | 20,653
|Apartments |  |                                 | 14,259 |            |                                 | 13,758 |          |  |               | 40,858 |            |   | 31,888 |  |   | 29,112
|Hotels     |  |                                 | 7,861  |            |                                 | 6,363  |          |  |               | 22,594 |            |   | 21,186 |  |   | 17,657
|Land       |  |                                 | 820    |            |                                 | 1,416  |          |  |               | 3,502  |            |   | 3,124  |  |   | 4,636 
|Other      |  |                                 |       |            |                                 | (2     | )        |  |               | 345    |            |   | 345    |  |   | 31    
|           |  |                                 |        |            |                                 |        |          |  |               |        |            |   |        |  |   |       
|           |  | $                               | 32,416 |            | $                               | 29,945 |          |  | $             | 96,360 |            | $ | 80,966 |  | $ | 72,089
|           |  |                                 |        |            |                                 |        |          |  |               |        |            |   |        |  |   |       



34



---

The increase in commercial operations expense for the three and nine months ended September 30, 2004, without the effect
of the consolidation of TCIs operations was primarily attributable to increased management fees. The increase in apartment operations expense, without the effect of the consolidation of TCIs operations, was primarily attributable to
property replacements and completed apartment construction. The increase in hotel operations expense was primarily attributable to increased personnel costs and an increase in repairs and replacement expenses. The decrease in land operations expense
for the nine months ended September 30, 2004, without the effect of the consolidation of TCIs operations, was primarily attributable to lower property taxes due to land sales. Property operations expenses are expected to increase in 2004, as a
result of completed apartment construction.



Pizza parlor sales and cost of
sales increased to $8.7 million and $6.8 million, respectively, in the three months ended September 30, 2004 and $25.7 million and $19.9 million in the nine months ended September 30, 2004 from $8.3 million and $6.6 million, respectively, in the
three months ended September 30, 2003 and $24.3 million and $19.4 million in the nine months ended September 30, 2003. The increase was primarily attributable to a 7.95% increase in same store sales and a 31% increase in the average price of cheese
in 2004.



Interest income from notes receivable decreased to $1.1 million and
$3.5 million in the three and nine months ended September 30, 2004 from $1.8 million and $7.4 million in 2003, due to the collection of $34.3 million of notes receivable in 2003.



Equity in income (loss) of investees improved to $0.1 million and $(0.1) million in the three and nine months ended September 30, 2004, from
$(0.2) million and $(4.3) million in 2003. Prior to March 31, 2003, ARIs equity in income (loss) of investees included equity in TCIs operations.



Gain (loss) on foreign currency transaction improved to $0.6 million and $1.8 million in the three and nine months ended September 30, 2004, from $(1.0) million in the
three and nine months ended September 30, 2003, due to a strengthening of the Polish zloty against the euro for Hotel Akademia during 2004. Hotel Akademias long-term debt is denominated in euros, and the impact of the translation of euros into
zlotys prior to translation into US dollars is recorded as a gain or loss in the Consolidated Statements of Operations.



Gain on extinguishment of debt was $2.3 million in the three and nine months ended September 30, 2004. In September 2004, ARI settled $10.3 million of debt, plus $1.1
million of accrued but unpaid interest, for $9.1 million.



Interest Expense
(dollars in thousands)



|              |  |                                 |        |                                 |   |          |  |               |        |            |   |        |  |   |       
|------------- |  | ------------------------------- | ------ | ------------------------------- | - | -------- |  | ------------- | ------ | ---------- | - | ------ |  | - | ------
|              |  | Three Months EndedSeptember 30, |        | Nine Months Ended September 30,
|              |  | 2004                            |        | 2003                            |   | 2004     |  | 2003         
|              |  |                                 |        | AsRestated                      |   | With TCI |  | Without1Q TCI |        | AsRestated
|Commercial    |  | $                               | 3,348  |                                 | $ | 3,609    |  | $             | 10,847 |            | $ | 9,201  |  | $ | 8,865 
|Apartments    |  |                                 | 7,657  |                                 |   | 5,852    |  |               | 20,921 |            |   | 15,425 |  |   | 12,128
|Hotels        |  |                                 | 1,327  |                                 |   | 1,129    |  |               | 4,088  |            |   | 3,534  |  |   | 2,953 
|Land          |  |                                 | 3,131  |                                 |   | 4,271    |  |               | 9,277  |            |   | 8,775  |  |   | 12,098
|Pizza parlors |  |                                 | 368    |                                 |   | 336      |  |               | 1,129  |            |   | 1,129  |  |   | 738   
|Other         |  |                                 | 1,311  |                                 |   | 1,039    |  |               | 3,890  |            |   | 3,890  |  |   | 4,826 
|              |  |                                 |        |                                 |   |          |  |               |        |            |   |        |  |   |       
|              |  | $                               | 17,142 |                                 | $ | 16,236   |  | $             | 50,152 |            | $ | 41,954 |  | $ | 41,608
|              |  |                                 |        |                                 |   |          |  |               |        |            |   |        |  |   |       



The increase in apartment interest
expense was primarily attributable to increased loan balances due to completed apartment construction. The decrease in land interest expense was primarily attributable to reduced principal balances payable and reduced interest rates on land
mortgages.



Depreciation and Amortization (dollars in thousands)



|              |  |                                 |       |                                 |   |          |  |               |        |            |   |        |  |   |       
|------------- |  | ------------------------------- | ----- | ------------------------------- | - | -------- |  | ------------- | ------ | ---------- | - | ------ |  | - | ------
|              |  | Three Months EndedSeptember 30, |       | Nine Months Ended September 30,
|              |  | 2004                            |       | 2003                            |   | 2004     |  | 2003         
|              |  |                                 |       | AsRestated                      |   | With TCI |  | Without1Q TCI |        | AsRestated
|Commercial    |  | $                               | 3,150 |                                 | $ | 2,753    |  | $             | 9,131  |            | $ | 7,007  |  | $ | 6,452 
|Apartments    |  |                                 | 2,161 |                                 |   | 1,563    |  |               | 6,466  |            |   | 4,680  |  |   | 3,285 
|Hotels        |  |                                 | 977   |                                 |   | 738      |  |               | 2,958  |            |   | 2,620  |  |   | 2,055 
|Pizza parlors |  |                                 | 337   |                                 |   | 347      |  |               | 1,001  |            |   | 1,000  |  |   | 1,041 
|Other         |  |                                 | 16    |                                 |   | 12       |  |               | 41     |            |   | 29     |  |   | 16    
|              |  |                                 |       |                                 |   |          |  |               |        |            |   |        |  |   |       
|              |  | $                               | 6,641 |                                 | $ | 5,413    |  | $             | 19,597 |            | $ | 15,336 |  | $ | 12,849
|              |  |                                 |       |                                 |   |          |  |               |        |            |   |        |  |   |       



35



---

The increase in apartment depreciation and amortization was primarily due to completed construction.



Discount on sale of notes receivable decreased to $0.4 million in the nine months ended
September 30, 2004, from $1.6 million in 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable.



General and administrative expenses decreased to $2.6 million and $11.5 million in the three and nine months ended September 30, 2004, from $5.2 million and $15.9 million
in 2003. Without the effect of the consolidation of TCIs first quarter 2004 operations, general and administrative expenses decreased to $8.5 million in the nine months ended September 30, 2004. The decrease was primarily attributable to
reduced legal fees and reduced expense charges from ARIs advisors.



Advisory fees decreased to $2.9 million and $8.2 million in the three and nine months ended September 30, 2004, from $3.7 million and $8.5 million in 2003. Without the effect of the consolidation of TCIs first quarter 2004 operations,
advisory fees decreased to $6.5 million in the nine months ended September 30, 2004. The decrease was primarily attributable to a reduction in ARIs net assets, upon which the fee is based. Also, in 2003, one additional month of fees was
recorded.



Net income fee to affiliate was $0.7 million in the three and nine
months ended September 30, 2003. The net income fee payable to ARIs advisor is 10% of the year-to-date net income, in excess of a 10% return on shareholders equity.



Incentive fee to affiliate was $1.1 million in the three and nine months ended September 30, 2003. The incentive fee is only due if ARI is
also subject to the net income fee. This fee represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of this fee for the remainder of 2004 will be dependent on the number of operating
properties sold, the net capital gains realized and whether the net income fee is due.



Writedown of assets held for sale was $3.4 million in the three and nine months ended September 30, 2004, compared to $2.4 million in the nine months ended September 30, 2003. The carrying values of two office buildings in Sterling,
Virginia, under contract for sale in the fourth quarter of 2004, were reduced to their net realizable value in the third quarter of 2004. The carrying value of an office building in Encino, California, sold in the third quarter of 2003, was reduced
to its net realizable value in the second quarter of 2003.



Minority interest
decreased to $(1.5) million and $0.2 million in the three and nine months ended September 30, 2004, from $0.1 million and $1.5 million in 2003. The changes are primarily attributable to the consolidation of TCIs operations by ARI, as the
19.99% minority share of TCIs net income (loss) is recorded as minority interest expense by ARI.



Net income from discontinued operations decreased to $4.3 million and $24.6 million in the three and nine months ended September 30, 2004 from $14.3 million and $26.6 million in 2003. The net income relates to 24
properties that ARI sold or are pending sale during 2004 and 32 properties that ARI sold during 2003. The following table summarizes revenue and expense information for the properties sold and held-for-sale.



|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------- |  | --------------------------------------- | ----- | - | -------------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                 |  | For the Three monthsEnded September 30, |       |   | For the Nine monthsEnded September 30, |  
|                                                                 |  | 2004                                    |       |   | 2003                                   |   |        | 2004 |  |   | 2003   |  
|Revenue:                                                         |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Rental                                                           |  | $                                       | 5,106 |   |                                        | $ | 12,236 |      |  | $ | 18,680 |   |  | $ | 32,995 |  
|Property operations                                              |  |                                         | 2,839 |   |                                        |   | 8,416  |      |  |   | 9,893  |   |  |   | 20,762 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|                                                                 |  |                                         | 2,267 |   |                                        |   | 3,820  |      |  |   | 8,787  |   |  |   | 12,233 |  
|                                                                 |  |                                         |       |  
|Expenses:                                                        |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Interest                                                         |  |                                         | 2,472 |   |                                        |   | 5,963  |      |  |   | 7,877  |   |  |   | 15,188 |  
|Depreciation                                                     |  |                                         | 794   |   |                                        |   | 1,606  |      |  |   | 3,047  |   |  |   | 4,356  |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|                                                                 |  |                                         | 3,266 |   |                                        |   | 7,569  |      |  |   | 10,924 |   |  |   | 19,544 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Net loss from discontinued operations                            |  |                                         | (999  | ) |                                        |   | (3,749 | )    |  |   | (2,137 | ) |  |   | (7,311 | )
|                                                                 |  |                                         |       |  
|Gain on sale of real estate                                      |  |                                         | 5,306 |   |                                        |   | 18,222 |      |  |   | 25,895 |   |  |   | 34,042 |  
|Equity in gain (loss) on sale of real estate by equity investees |  |                                         | (9    | ) |                                        |   | (165   | )    |  |   | 886    |   |  |   | (165   | )
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  
|Net income from discontinued operations                          |  | $                                       | 4,298 |   |                                        | $ | 14,308 |      |  | $ | 24,644 |   |  | $ | 26,566 |  
|                                                                 |  |                                         |       |   |                                        |   |        |      |  |   |        |   |  |   |        |  



36



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Tax Matters



Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses
from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. ARI had a loss for federal income tax purposes for the first nine months of 2004
and had a loss for federal income tax purposes after the use of net operating loss carryforwards in the first nine months of 2003; therefore, it recorded no provision for income taxes.



At September 30, 2004, ARI had a net deferred tax asset of $113.4 million due to tax deductions available to it in future years. However, as
management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.



TCI had a loss for federal income tax purposes after the use of net operating loss carryforwards in the first nine months of 2004 and a loss
for federal income tax purposes in the first nine months of 2003; therefore, it recorded no provision for income taxes.



At September 30, 2004, TCI had a net deferred tax asset of $26.5 million due to tax deductions available to it in future years. However, as management cannot determine
that it is more likely than not that TCI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.



Environmental Matters



Under various federal, state and local environmental laws, ordinances and regulations, ARI may be potentially liable for removal or remediation costs, as well as certain
other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances.
In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.



Management is not aware of any environmental liability relating to the above matters that
would have a material adverse effect on ARIs business, assets or results of operations.



Inflation



The effects of inflation on
ARIs operations are not quantifiable. Revenues from apartment operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and
the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new borrowings as well as the cost of variable interest rate debt will be affected.



37



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



At September 30, 2004, ARIs exposure to a change in interest rates on its debt is as
follows:



|                                          |  |         |         |                               |       |   |                                    |   |      
|----------------------------------------- |  | ------- | ------- | ----------------------------- | ----- | - | ---------------------------------- | - | -----
|                                          |  | Balance |         | WeightedAverage Interest Rate |       |   | Effect of 1%Increase In Base Rates
|Notes payable:                            |  |         |         |                               |       |   |                                    |   |      
|Variable rate                             |  | $       | 215,962 |                               | 5.703 | % |                                    | $ | 2,160
|                                          |  |         |         |                               |       |   |                                    |   |      
|Total decrease in ARIs annual net income |  |         |         |                               |       |   |                                    | $ | 2,160
|Per share                                 |  |         |         |                               |       |   |                                    | $ | .20  



ITEM 4. CONTROLS AND
PROCEDURES



|(a) | As of the end of the period covered by this report, ARI carried out an evaluation, under the supervision and with the participation of ARIs management, including ARIs
Acting Principal Executive Officer and principal accounting officer, of the effectiveness of the design and operation of ARIs disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon the evaluation,
ARIs Acting Principal Executive Officer and principal accounting officer concluded that ARIs disclosure controls and procedures are effective in timely alerting him to material information relating to ARI (including its consolidated
subsidiaries) required to be included in ARIs periodic SEC filings.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) | There have been no significant changes in ARIs internal controls or in other factors that could significantly affect ARIs internal controls subsequent to the date ARI
carried out this evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



On August 10, 2004, American Realty Investors, Inc., Transcontinental Realty Investors, Inc. and Income Opportunity Realty Investors, Inc. instituted an action in Texas
State District Court as Cause No. 2004-60231-393 styled American Realty Investors, Inc., Transcontinental Realty Investors, Inc. and Income Opportunity Realty Investors, Inc., Plaintiffs v. Innovo Realty, Inc. and Innovo Group, Inc.,
Involuntary Plaintiffs v. Innovo Realty, Inc., Metra Capital LLC, Innovo Group, Inc., Joseph Mizrachi, Simon Mizrachi, Hubert Guez, Third Millennium Partners LLC, Third Millennium Partners, Inc., Third Millennium Group, LLC and Sunridge Management
Group, Inc., Defendants.Plaintiffs complaint alleges that Joseph Mizrachi, a former director of ARI and others, offered a plan to the Plaintiffs to create one or more joint venture arrangements with one or more of the Plaintiffs to pursue
alternative forms of financing or refinancing portions of Plaintiffs real estate portfolios, which entailed the creation of 22 separate limited partnerships to acquire 28 separate apartment complexes in three states (Texas, Florida and
Louisiana), the general partners of which are affiliates of, or controlled by, Joseph Mizrachi. Plaintiffs complaint alleges that the overall transaction required the establishment of a sinking fund by the Defendants and the 22 limited
partnerships as a trust for the benefit of certain preferred shareholders of Innovo Group, Inc. and the payment of certain proceeds to the Plaintiffs. Plaintiffs assert that payments have not been made pursuant to the agreement of the parties.
Plaintiffs allege that Defendants conduct constituted a common business enterprise, alleges breach of contract and derivative claims on behalf of Innovo Group, Inc. against Joseph Mizrachi and others and requests declaratory relief involving
the Plaintiffs rights in the partnerships, an accounting of proceeds, and the creation of a constructive trust. Plaintiffs complaint also alleges that Joseph Mizrachi engaged in fraud, negligent misrepresentation and/or breach of
fiduciary duty and seeks unspecified damages, attorneys fees, a constructive trust be established, and other relief.



On October 5, 2004, Sunset Management, LLC (Sunset) filed a complaint as a purported stockholders derivative action on behalf of Transcontinental Realty
Investors, Inc. (TCI) in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc. (ARI), Basic Capital Management, Inc. (BCM), Prime Income
Asset Management, Inc. (PIAMI), Prime Income Asset Management LLC (Prime), Income Opportunity Realty Investors, Inc. (IORI), United Housing Foundation, Inc. (United), Regis Realty, Inc.
(Regis), TCI, TCIs current directors and officers and others. Sunsets complaint was instituted as Case No. 304CV20162-B styled Sunset Management, LLC, derivatively on behalf of Transcontinental Realty Investors, Inc. v.
American Realty Investors, Inc., et al. Sunsets complaint alleges (i) Sunset is the owner of ten shares of Common Stock of TCI, and Sunset is the pledgee and beneficial owner of 3,673,115 shares of Common Stock of TCI, (ii) Sunset is a
single-member limited liability company, (iii) that all of the defendants have in their various capacities breached fiduciary duties to TCI and (iv) unjust enrichment of the various defendants. Sunsets complaint seeks an injunction prohibiting
TCI from entering into any related-party transactions that are not fair to TCI and approved by disinterested directors and/or the stockholders with full knowledge of the common interest of the directors and/or officers, unspecified damages,
attorneys fees and costs. Individual directors and officers of TCI do not believe their interests are adverse to TCI in this matter. All defendants believe



38



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the action is not properly brought as a derivative action on behalf of TCI, as Sunsets interests are adverse to the
interests of TCI. The current action brought by Sunset contains many of the same allegations raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunsets requested relief.



The Defendants intend to vigorously defend the action and have filed a Motion to Dismiss the
case pursuant to Rules 12 and 23.1 of the Federal Rules of Civil Procedure on the basis that Sunsets allegations are insufficient to evade the stringent demand requirement under the futility exception for stockholder derivative actions, and
that Sunset cannot fairly and adequately represent the interests of other stockholders.



The current Sunset complaint is the fifth in a continuing series of actions involving Sunset, certain subsidiaries of ARI, and ARI resulting from a loan in September 2001 to BCM and three subsidiaries of ARI in the original amount of $30
million ($19.5 million of which bore interest at 24% per annum, while the remaining $10.5 million of which bore interest at 20% per annum). In September 2002, $15 million in principal was repaid leaving a $15 million balance, which Sunset orally
agreed to extend the maturity date and accept substitute collateral, an arrangement which Sunset did not honor, resulting in original litigation filed in Texas state court during October 2002 styled American Realty Trust, Inc. ART Williamsburg,
Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v Sunset Management, LLC, et al., Cause No. 02-09433-I in the 162nd Judicial District Court of Dallas County, Texas (the Texas Litigation). The Texas Litigation alleged
breach of contract, misrepresentation, breach of duty of good faith and fair dealing and slander of title by Sunset and sought certain declaratory relief against Sunset, as well as a temporary and permanent anti-suit injunction against Sunset.



During January 2003, without notice to the plaintiffs in the Texas Litigation,
Sunset instituted an action in federal district court in Las Vegas, Nevada against Commonwealth Land Title (Commonwealth) seeking disposition of certain shares of Common Stock of TCI held by Commonwealth as Pledge Holder. On January 31,
2003 after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instituted a separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc., et al., Cause No. A462587 pending in
District Court of Clark County, Nevada (the Nevada Litigation). On February 12, 2003, the Nevada state court held a hearing on Sunsets request for emergency relief and denied all Sunsets requested relief and indicated that a
stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset has continued to attempt to re-litigate the underlying
fact issues already determined in the Texas Litigation and the Nevada Litigation through cross claims and counterclaims in the Texas Litigation and renewed motions for injunctions and appointment of a receiver in the Nevada Litigation. During
September 2003, the Texas Litigation was removed to the bankruptcy court for the Northern District of Texas and subsequently transferred to the Eastern District of Texas. Sunset and the Plaintiffs have filed cross-motions for partial summary
judgment in the bankruptcy court which have been briefed but remain pending at this time. The parties have also filed an agreed motion to withdraw the reference and have the case transferred to a United States District Judge for trial, which has
been denied without prejudice pending the resolution of pretrial motions, including the motions for summary judgment.



On February 10, 2004, Sunset filed yet another lawsuit in Nevada styled Sunset Management L.L.C. v. Transcontinental Realty Investors, Inc.,Case No. CV04-00345 in
the Superior Court of Washoe County, seeking to compel a new election of directors, alleging that Sunset was improperly denied voting rights with respect to certain pledged shares at the 2003 stockholders meeting of TCI. TCI responded to that
action by informing the Nevada Court that the issue of the validity and effectiveness of proxies purportedly held by Sunset in connection with the loan was already pending before the bankruptcy court. On May 12, 2004, the Nevada District Court
denied Sunsets motion to compel an election of corporate directors because of the dispute pending in the Texas bankruptcy court concerning the status of the loan. Subsequently, the Nevada Court denied two motions for reconsideration filed by
Sunset. Sunset is currently appealing the rulings of the Washoe District Court.



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



The following table sets forth information regarding purchases made by ARI of shares of ARI Common Stock on a monthly basis during the third quarter of 2004:



|               |  |                                      |  |                                  |      |                                                                                         |         |                                                                                       |        
|-------------- |  | ------------------------------------ |  | -------------------------------- | ---- | --------------------------------------------------------------------------------------- | ------- | ------------------------------------------------------------------------------------- | -------
|Period         |  | (a) Total Number of Shares Purchased |  | (b) Average Price Paid per Share |      | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1) |         | (d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(1)
|July 2004      |  |                                     |  | $                                |     |                                                                                         |        |                                                                                       | 587,793
|August 2004    |  | 122,400                              |  |                                  | 9.01 |                                                                                         | 122,400 |                                                                                       | 465,393
|September 2004 |  |                                     |  |                                  |     |                                                                                         |        |                                                                                       | 465,393
|               |  |                                      |  |                                  |      |                                                                                         |         |                                                                                       |        
|Total          |  | 122,400                              |  | $                                | 9.01 |                                                                                         | 122,400 |                                                                                       |        
|               |  |                                      |  |                                  |      |                                                                                         |         |                                                                                       |        

---

|(1) | The repurchase program was announced in September, 2000. A total of 1,000,000 shares may be repurchased through the program. The program has no expiration date.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



39



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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



The Annual Meeting of Stockholders was held on September 15, 2004, at which meeting
stockholders were asked to consider and vote upon the election of Directors and the ratification of the selection of the independent public accountants for ARI for the fiscal year ending December 31, 2004. At the Meeting, stockholders elected the
following individuals as Directors:



|                |  |               |  |                   
|--------------- |  | ------------- |  | ------------------
|                |  | Shares Voting
|Director        |  | For           |  | Withheld Authority
|Henry A. Butler |  | 10,476,859    |  | 47,636            
|Sharon Hunt     |  | 10,477,730    |  | 46,765            
|Ted R. Munselle |  | 10,478,284    |  | 46,211            
|Ted P. Stokeley |  | 10,476,809    |  | 47,686            
|Martin L. White |  | 10,477,799    |  | 46,696            



There were no abstentions or broker
non-votes on the election of Directors. With respect to the ratification of the appointment of Farmer, Fuqua & Huff, P.C. as independent auditors of the Company for the fiscal year ending December 31, 2004, and any interim period, at least
10,481,628 votes were received in favor of such proposal, 25,059 votes were received against such proposal, and 17,808 votes abstained.



ITEM 6. EXHIBITS



|The | following exhibits are filed herewith or incorporated by reference as indicated:
|--- | --------------------------------------------------------------------------------



|               |  |                                                                                                                   
|-------------- |  | ------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                       
|31.1           |  | Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, filed herewith.
|               | 
|31.2           |  | Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, filed herewith.
|               | 
|32.1           |  | Certification Pursuant to 18 U.S.C. Section 1350, filed herewith.                                                 



40



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SIGNATURE PAGE



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.



|                        |  |                                 |  |                                                                                                                          
|----------------------- |  | ------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------
|                        |  | AMERICAN REALTY INVESTORS, INC.
|                        |  |                                
|Date: November 15, 2004 |  | By:                             |  | /s/ J. C. Lowenberg, III                                                                                                 
|                        |  |                                 |  | J. C. Lowenberg, III                                                                                                     
|                        |  |                                 |  | Executive Vice President and Chief Financial Officer (Principal Financial Officer and Acting Principal Executive Officer)
|                        |  |                                
|                        |  | By:                             |  | /s/ Scott T. Lewis                                                                                                       
|                        |  |                                 |  | Scott T. Lewis                                                                                                           
|                        |  |                                 |  | Vice President and Chief Accounting Officer                                                                              



41



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AMERICAN REALTY INVESTORS, INC.



EXHIBITS TO



QUARTERLY REPORT ON FORM 10-Q



For the Quarter ended September 30, 2004



|              |  |                                                                                                    |  |            
|------------- |  | -------------------------------------------------------------------------------------------------- |  | -----------
|ExhibitNumber |  | Description                                                                                        |  | Page Number
|31.1          |  | Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934. |  |            
|              |  |                                                                                                   
|31.2          |  | Certification Required by Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934. |  |            
|              |  |                                                                                                   
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350.                                                  |  |            



42