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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE QUARTER ENDED SEPTEMBER 30, 2003
|- | -------------------------------------------------------------------------------------------------------------------------



Commission File Number 1-15663



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AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its
Charter)



|Nevada                                                        |  | 75-2847135                         
|------------------------------------------------------------- |  | -----------------------------------
|(State or Other Jurisdiction ofIncorporation or Organization) |  | (I.R.S. EmployerIdentification 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 |  | 10,645,300                        
|---------------------------- |  | ----------------------------------
|(Class)                      |  | (Outstanding at October 31, 2003)*



|* | 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 financial position and consolidated cash flows at the dates and for the periods indicated, have been
included.



AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS



|                                                                                   |  | September 30,2003                       |           |   | December 31,2002 |  
|---------------------------------------------------------------------------------- |  | --------------------------------------- | --------- | - | ---------------- | -
|                                                                                   |  | (dollars in thousands,except per share) |          
|Assets                                                                             |  |                                         |           |   |                  |  
|Real estate held for investment                                                    |  | $                                       | 1,019,991 |   |                  | $
|Lessaccumulated depreciation                                                      |  |                                         | <166,652  | > |                  |  
|                                                                                   |  |                                         |           |   |                  |  
|                                                                                   |  |                                         | 853,339   |   |                  |  
|Real estate held for sale                                                          |  |                                         | 157,319   |   |                  |  
|Notes and interest receivable                                                      |  |                                         |           |   |                  |  
|Performing ($28,416 in 2003 and $34,442 in 2002 from affiliates)                   |  |                                         | 71,976    |   |                  |  
|Nonperforming ($5,085 in 2003 and $6,838 in 2002 from affiliates)                  |  |                                         | 14,373    |   |                  |  
|                                                                                   |  |                                         |           |   |                  |  
|                                                                                   |  |                                         | 86,349    |   |                  |  
|Lessallowance for estimated losses                                                |  |                                         | <4,633    | > |                  |  
|                                                                                   |  |                                         |           |   |                  |  
|                                                                                   |  |                                         | 81,716    |   |                  |  
|Pizza parlor equipment                                                             |  |                                         | 13,845    |   |                  |  
|Lessaccumulated depreciation                                                      |  |                                         | <5,454    | > |                  |  
|                                                                                   |  |                                         |           |   |                  |  
|                                                                                   |  |                                         | 8,391     |   |                  |  
|Marketable equity securities, at market value                                      |  |                                         | 5,078     |   |                  |  
|Cash and cash equivalents                                                          |  |                                         | 7,451     |   |                  |  
|Investments in equity investees                                                    |  |                                         | 4,193     |   |                  |  
|Goodwill, net of accumulated amortization ($1,763 in 2003 and 2002)                |  |                                         | 11,858    |   |                  |  
|Other intangibles, net of accumulated amortization ($810 in 2003 and $773 in 2002) |  |                                         | 1,541     |   |                  |  
|Other assets ($11,130 in 2003 to affiliate)                                        |  |                                         | 88,370    |   |                  |  
|                                                                                   |  |                                         |           |   |                  |  
|                                                                                   |  | $                                       | 1,219,256 |   |                  | $
|                                                                                   |  |                                         |           |   |                  |  



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



|                                                                                                                                                                 |  | September 30,2003                       |           |   | December 31,2002 |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | --------- | - | ---------------- | -
|                                                                                                                                                                 |  | (dollars in thousands,except per share) |          
|Liabilities and Stockholders Equity                                                                                                                             |  |                                         |           |   |                  |  
|Liabilities                                                                                                                                                      |  |                                         |           |   |                  |  
|Notes and interest payable ($15,600 in 2002 to affiliates)                                                                                                       |  | $                                       | 852,368   |   |                  | $
|Liabilities related to assets held for sale                                                                                                                      |  |                                         | 104,856   |   |                  |  
|Margin borrowings                                                                                                                                                |  |                                         | 25,198    |   |                  |  
|Accounts payable and other liabilities ($27,207 in 2003 and $41,085 in 2002 to affiliates)                                                                       |  |                                         | 108,576   |   |                  |  
|                                                                                                                                                                 |  |                                         |           |   |                  |  
|                                                                                                                                                                 |  |                                         | 1,090,998 |   |                  |  
|Minority interest                                                                                                                                                |  |                                         | 53,948    |   |                  |  
|Commitments and contingencies                                                                                                                                    |  |                                         |           |   |                  |  
|Stockholders equity                                                                                                                                             |  |                                         |           |   |                  |  
|Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding                                                                           |  |                                         |           |   |                  |  
|Series A, 3,226,610 shares in 2003 and 3,226,858 shares in 2002 (liquidation preference $32,266), including 900,000 shares in 2003
and 2002 held by subsidiaries |  |                                         | 4,653     |   |                  |  
|Series E, 50,000 shares in 2003 and 2002 (liquidation preference $500)                                                                                           |  |                                         | 100       |   |                  |  
|Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,375,127 shares in 2003 and 2002                                                           |  |                                         | 114       |   |                  |  
|Paid-in capital                                                                                                                                                  |  |                                         | 92,289    |   |                  |  
|Treasury stock, at cost, 746,972 shares in 2003                                                                                                                  |  |                                         | <9,924    | > |                  |  
|Accumulated deficit                                                                                                                                              |  |                                         | <12,564   | > |                  |  
|Accumulated other comprehensive income                                                                                                                           |  |                                         | <358      | > |                  |  
|                                                                                                                                                                 |  |                                         |           |   |                  |  
|                                                                                                                                                                 |  |                                         | 74,310    |   |                  |  
|                                                                                                                                                                 |  |                                         |           |   |                  |  
|                                                                                                                                                                 |  | $                                       | 1,219,256 |   |                  | $
|                                                                                                                                                                 |  |                                         |           |   |                  |  



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



|                                                                 |  | For the Three MonthsEnded September 30,  |        |   | For the Nine MonthsEnded September 30, |  
|---------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | -------------------------------------- | -
|                                                                 |  | 2003                                     |        |   | 2002                                   |  
|                                                                 |  | (dollars in thousands, except per share) |       
|Property revenue                                                 |  |                                          |        |   |                                        |  
|Rents                                                            |  | $                                        | 49,891 |   |                                        | $
|Property operations expenses                                     |  |                                          | 34,350 |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Operating income                                                 |  |                                          | 15,541 |   |                                        |  
|                                                                 |  |                                          |        |  
|Land operations                                                  |  |                                          |        |   |                                        |  
|Sales                                                            |  |                                          | 27,551 |   |                                        |  
|Cost of sales                                                    |  |                                          | 12,080 |   |                                        |  
|Deferred current gain                                            |  |                                          |       |   |                                        |  
|Recognition of previously deferred gains                         |  |                                          | 27     |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Gain on land sales                                               |  |                                          | 15,498 |   |                                        |  
|                                                                 |  |                                          |        |  
|Pizza parlor operations                                          |  |                                          |        |   |                                        |  
|Sales                                                            |  |                                          | 8,330  |   |                                        |  
|Cost of sales                                                    |  |                                          | 6,592  |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Gross margin                                                     |  |                                          | 1,738  |   |                                        |  
|                                                                 |  |                                          |        |  
|Income from operations                                           |  |                                          | 32,777 |   |                                        |  
|                                                                 |  |                                          |        |  
|Other income                                                     |  |                                          |        |   |                                        |  
|Interest income                                                  |  |                                          | 1,795  |   |                                        |  
|Equity in loss of investees                                      |  |                                          | <204   | > |                                        |  
|Loss on sale of investments in equity investees                  |  |                                          |       |   |                                        |  
|Other                                                            |  |                                          | 55     |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|                                                                 |  |                                          | 1,646  |   |                                        |  
|Other expenses                                                   |  |                                          |        |   |                                        |  
|Interest                                                         |  |                                          | 20,925 |   |                                        |  
|Depreciation and amortization                                    |  |                                          | 7,137  |   |                                        |  
|Discount on sale of notes receivable                             |  |                                          | <1     | > |                                        |  
|General and administrative                                       |  |                                          | 6,171  |   |                                        |  
|Advisory fee to affiliate                                        |  |                                          | 3,740  |   |                                        |  
|Net income fee to affiliate                                      |  |                                          | 675    |   |                                        |  
|Incentive fee to affiliate                                       |  |                                          | 1,091  |   |                                        |  
|Writedown of assets held for sale                                |  |                                          |       |   |                                        |  
|Minority interest                                                |  |                                          | 20     |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|                                                                 |  |                                          | 39,758 |   |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Net loss from continuing operations                              |  |                                          | <5,335 | > |                                        |  
|                                                                 |  |                                          |        |  
|Discontinued operations:                                         |  |                                          |        |   |                                        |  
|Loss from operations                                             |  |                                          | <1,457 | > |                                        |  
|Gain on sale of real estate                                      |  |                                          | 18,222 |   |                                        |  
|Equity in gain <loss> on sale of real estate by equity investees |  |                                          | <165   | > |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Net income from discontinued operations                          |  |                                          | 16,600 |   |                                        |  
|                                                                 |  |                                          |        |  
|Net income <loss>                                                |  |                                          | 11,265 |   |                                        |  
|Preferred dividend requirement                                   |  |                                          | <587   | > |                                        |  
|                                                                 |  |                                          |        |   |                                        |  
|Net income <loss> applicable to Common shares                    |  | $                                        | 10,678 |   |                                        | $
|                                                                 |  |                                          |        |   |                                        |  



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



4



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONSContinued



|                                                                    |  | For the Three MonthsEnded September 30, |            |   | For the Nine MonthsEnded September 30, |  
|------------------------------------------------------------------- |  | --------------------------------------- | ---------- | - | -------------------------------------- | -
|                                                                    |  | 2003                                    |            |   | 2002                                   |  
|Basic and diluted earnings per share                                |  |                                         |            |   |                                        |  
|Net loss from continuing operations                                 |  | $                                       | <.56       | > |                                        | $
|Discontinued operations                                             |  |                                         | 1.56       |   |                                        |  
|                                                                    |  |                                         |            |   |                                        |  
|Net income <loss> applicable to Common shares                       |  | $                                       | 1.00       |   |                                        | $
|                                                                    |  |                                         |            |   |                                        |  
|Weighted average Common shares used in computing earnings per share |  |                                         | 10,628,155 |   |                                        |  



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.



Convertible Preferred Stock (2,326,858 shares) and options to
purchase 186,750 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, 2002, 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, 2003



|                                             |  | Series APreferredStock                   |       |   | Series EPreferredStock |   | CommonStock |  | Paid-inCapital |     |  | TreasuryStock |        |   | AccumulatedDeficit |   |        | AccumulatedOtherComprehensiveIncome/<Loss> |  |   | StockholdersEquity |  
|-------------------------------------------- |  | ---------------------------------------- | ----- | - | ---------------------- | - | ----------- |  | -------------- | --- |  | ------------- | ------ | - | ------------------ | - | ------ | ------------------------------------------ |  | - | ------------------- | -
|                                             |  | (dollars in thousands, except per share) |      
|                                             |  |                                          |       |   |                        |   |             | 
|Balance, January 1, 2003                     |  | $                                        | 4,654 |   |                        | $ | 100         |  | $              | 114 |  | $             | 93,954 |   |                    | $ |       |                                            |  | $ | <24,784             | >
|Comprehensive income                         |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  
|Unrealized foreign currency translation loss |  |                                          |      |   |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |   |                    |  
|Sale of foreign operations                   |  |                                          |      |   |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |   |                    |  
|Net income                                   |  |                                          |      |   |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |   | 12,220              |  
|                                             |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  
|                                             |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  
|Repurchase of Series A Preferred stock       |  |                                          | <1    | > |                        |   |            |  |                |    |  |               | <2     | > |                    |   |       |                                            |  |   |                    |  
|Common shares held by acquired company       |  |                                          |      |   |                        |   |            |  |                |    |  |               |       |   |                    |   | <9,924 | >                                          |  |   |                    |  
|Exchange of investments with affiliates      |  |                                          |      |   |                        |   |            |  |                |    |  |               | 100    |   |                    |   |       |                                            |  |   |                    |  
|Preferred dividends                          |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  
|Series A Preferred Stock ($.75 per share)    |  |                                          |      |   |                        |   |            |  |                |    |  |               | <1,741 | > |                    |   |       |                                            |  |   |                    |  
|Series E Preferred Stock ($.45 per share)    |  |                                          |      |   |                        |   |            |  |                |    |  |               | <22    | > |                    |   |       |                                            |  |   |                    |  
|                                             |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  
|Balance, September 30, 2003                  |  | $                                        | 4,653 |   |                        | $ | 100         |  | $              | 114 |  | $             | 92,289 |   |                    | $ | <9,924 | >                                          |  | $ | <12,564             | >
|                                             |  |                                          |       |   |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |   |                     |  



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



6



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                             |  | For the Nine MonthsEnded September 30, |         
|---------------------------------------------------------------------------- |  | -------------------------------------- | --------
|                                                                             |  | 2003                                   |         
|                                                                             |  | (dollars in thousands)                 |         
|Cash Flows From Operating Activities                                         |  |                                        |         
|Net income <loss>                                                            |  | $                                      | 12,220  
|Reconciliation of net income <loss> to net cash used in operating activities |  |                                        |         
|Adjustments to reconcile net income to net cash used in operating activities |  |                                        |         
|Depreciation and amortization                                                |  |                                        | 18,281  
|Gain on sale of land and real estate                                         |  |                                        | <70,304 
|Equity in <income> loss of investees                                         |  |                                        | 4,279   
|Distributions to minority interest holders                                   |  |                                        |        
|Loss on sale of investments in equity investees                              |  |                                        |        
|Loss allocated to minority interest                                          |  |                                        | <333    
|Writedown of assets held for sale                                            |  |                                        | 2,352   
|Loss on foreign currency transaction                                         |  |                                        | 963     
|Increase in accrued interest receivable                                      |  |                                        | <4,015  
|<Increase> decrease in other assets                                          |  |                                        | 10,185  
|Increase in accrued interest payable                                         |  |                                        | 269     
|Increase <decrease> in accounts payable and other liabilities                |  |                                        | <759    
|                                                                             |  |                                        |         
|Net cash used in operating activities                                        |  |                                        | <26,862 
|                                                                             |  |                                       
|Cash Flows From Investing Activities                                         |  |                                        |         
|Collections on notes receivable                                              |  |                                        | 26,015  
|Proceeds from sale of notes receivable                                       |  |                                        | 26,346  
|Pizza parlor equipment purchased                                             |  |                                        | <1,397  
|Proceeds from sale of real estate                                            |  |                                        | 134,535 
|Notes receivable funded                                                      |  |                                        | <615    
|Earnest money deposits                                                       |  |                                        | <13,311 
|Investment in real estate entities, net of cash acquired                     |  |                                        | <24,218 
|Acquisition of real estate                                                   |  |                                        | <12,000 
|Distributions to equity investees                                            |  |                                        | <650    
|Payments under interest rate swap contract                                   |  |                                        | <31     
|Real estate improvements                                                     |  |                                        | <21,425 
|                                                                             |  |                                        |         
|Net cash provided by investing activities                                    |  |                                        | 113,249 
|                                                                             |  |                                       
|Cash Flows from Financing Activities                                         |  |                                        |         
|Proceeds from notes payable                                                  |  |                                        | 82,275  
|Payments on notes payable                                                    |  |                                        | <186,142
|Deferred borrowing costs                                                     |  |                                        | <5,440  
|Net <payments to>/advances from affiliates                                   |  |                                        | 7,815   
|Margin borrowings, net                                                       |  |                                        | 15,890  
|Stock sale profits received from affiliate                                   |  |                                        |        
|Preferred dividends paid                                                     |  |                                        | <1,763  
|Common dividends paid                                                        |  |                                        |        
|Repurchase of Preferred shares                                               |  |                                        | <3      
|                                                                             |  |                                        |         
|Net cash used in financing activities                                        |  |                                        | <87,368 
|                                                                             |  |                                       
|Net <decrease> increase in cash and cash equivalents                         |  |                                        | <981    
|                                                                             |  |                                       
|Cash and cash equivalents, beginning of period                               |  |                                        | 8,432   
|                                                                             |  |                                        |         
|Cash and cash equivalents, end of period                                     |  | $                                      | 7,451   
|                                                                             |  |                                        |         



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



7



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWSContinued



|                                                      |  | For the Nine MonthsEnded September 30,
|----------------------------------------------------- |  | --------------------------------------
|                                                      |  | 2003                                  
|                                                      |  | (dollars in thousands)                
|Supplemental Disclosures of Cash Flow Information     |  |                                       
|Cash paid for interest                                |  | $                                     
|                                                      |  |                                       
|Schedule of noncash investing and financing           |  |                                       
|Notes payable assumed by buyer on sale of real estate |  | $                                     
|Notes receivable from sale of real estate             |  |                                       
|Disposal of property to satisfy debt                  |  |                                       
|Cancellation of Series F Preferred Stock              |  |                                       
|Note receivable from sale of leasehold interests      |  |                                       
|Acquisition of property to satisfy debt               |  |                                       
|Assumed debt of seller on purchase of real estate     |  |                                       
|Exchange of interest in note receivable for stock     |  |                                       
|Note receivable from exchange of stock with affiliate |  |                                       
|Funds collected by affiliate for property financing   |  |                                       
|Funds collected by affiliate on sale of real estate   |  |                                       



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





8



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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 are in thousands,
except per share amounts. Certain balances for 2002 have been reclassified to conform to the 2003 presentation.



Operating results for the nine month period ended September 30, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31,
2003. 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, 2002 (the 2002 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 owned 64.8% of the outstanding shares of TCI and
62.5% of the outstanding shares of IORI (46.9% owned directly by ARI 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. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc.
(BCM), a related party and the contractual advisor to ARI until June 30, 2003, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. NOTES
RECEIVABLE). After the exchange, ARI 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 RECEIVABLE). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI
owned 18.4% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



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 each year
presented.



|                               |  | Three MonthsEnded September 30, |        | Nine MonthsEnded September 30, |  
|------------------------------ |  | ------------------------------- | ------ | ------------------------------ | -
|                               |  | 2002                            |        | 2003                           |  
|Revenue, as reported           |  | $                               | 44,877 |                                | $
|Revenue, pro forma             |  |                                 | 73,103 |                                |  
|Net income <loss>, as reported |  |                                 | 6,898  |                                |  
|Net income <loss>, pro forma   |  |                                 | 6,173  |                                |  
|Earnings per share:            |  |                                 |        |                                |  
|Basic, as reported             |  | $                               | .55    |                                | $
|Basic, pro forma               |  | $                               | .49    |                                | $
|Diluted, as reported           |  | $                               | .55    |                                | $
|Diluted, pro forma             |  | $                               | .49    |                                | $



On June 30, 2003, ARI sold its 74.31%
interest in Realty Advisors Korea, Ltd. (RAK) to Realty Advisors, Inc. (Realty Advisors), a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0
million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARIs affiliate debt. The $600,000 interest was received in cash in August 2003. ARI ceased consolidation of RAKs accounts and
operations effective June 30, 2003.



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



In July 2003, ARI sold its interest in Milano Restaurants International Corporation
(MRI) to Gruppa Florentina, LLC (Gruppa), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. NOTES RECEIVABLE). ARI owns 20%
of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the



9



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 1. BASIS OF PRESENTATION (Continued)



debt guarantees and ARIs continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction.
In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt. No gain or loss was recorded in this transaction.



Recent accounting pronouncements.In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46), which requires the consolidation of variable interest entities, as defined. FIN 46 is applicable to financial statements to be issued by ARI after 2003; however, disclosures are required currently if ARI expects
to consolidate any variable interest entities. ARI does not currently believe that any entities will be consolidated as a result of FIN 46.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires the issuer to classify a financial instrument that is within the scope of the standard as
a liability if such financial instrument embodies an obligation of the issuer. The adoption of SFAS No. 150 is not expected to require ARI to reclass any financial instruments currently on its balance sheet.



Stock-based employee compensation. Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees, and related Interpretations are utilized by management in accounting for the option plans. All share options issued have exercise prices equal to the market price of the shares at the dates of
grant. Accordingly, no compensation cost has been recognized for the option plans. Had compensation cost for the option plans been determined based on the fair value at the grant dates consistent with the method of Statement of Financial Accounting
Standards No. 123 Accounting for Stock-Based Compensation, net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below.



|                                                                                                                                             |  | Three Months EndedSeptember 30,                 |        | Nine Months EndedSeptember 30, |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------- | ------ | ------------------------------ | -
|                                                                                                                                             |  | 2003                                            |        | 2002                           |  
|                                                                                                                                             |  | (dollars in thousands,except per share amounts) |       
|Net income <loss>, as reported                                                                                                               |  | $                                               | 11,265 |                                | $
|Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related
tax effects |  |                                                 |       |                                |  
|                                                                                                                                             |  |                                                 |        |                                |  
|Pro forma net income <loss>                                                                                                                  |  | $                                               | 11,265 |                                | $
|                                                                                                                                             |  |                                                 |        |                                |  
|Income <loss> per share:                                                                                                                     |  |                                                 |        |                                |  
|Basic, as reported                                                                                                                           |  | $                                               | 1.00   |                                | $
|Basic, pro forma                                                                                                                             |  | $                                               | 1.00   |                                | $
|Diluted, as reported                                                                                                                         |  | $                                               | 1.00   |                                | $
|Diluted, pro forma                                                                                                                           |  | $                                               | 1.00   |                                | $



NOTE 2. REAL ESTATE



In 2003, ARI purchased the following
properties:



|Property          |  | Location           |  | Units/Acres |  | PurchasePrice |       | Net CashPaid |   | DebtIncurred |  |   | InterestRate |     |  | MaturityDate
|----------------- |  | ------------------ |  | ----------- |  | ------------- | ----- | ------------ | - | ------------ |  | - | ------------ | --- |  | ------------
|First Quarter     |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Apartments        |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Capitol Hill(1)   |  | Little Rock, AR    |  | 156 Units   |  | $             | 1,904 |              | $ | 615          |  | $ | 1,289        |     |  | 5.50        
|                  |  |                    |  |             |  |               |      
|Second Quarter    |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Apartments        |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Breakwater Bay(1) |  | Beaumont, TX       |  | 176 Units   |  |               | 1,979 |              |   | 383          |  |   | 1,554        |     |  | 5.50        
|Longwood          |  | Long Beach, MS     |  | 200 Units   |  |               | 6,349 |              |   | 334          |  |   | 6,349        | (2) |  | 7.60        
|                  |  |                    |  |             |  |               |      
|Land              |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Pulaski           |  | Pulaski County, AR |  | 21.9 Acres  |  |               | 2,000 |              |   | 695          |  |   | 1,400        |     |  | 6.50        



10



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Property          |  | Location           |  | Units/Acres |  | PurchasePrice |        | NetCashPaid |   | DebtIncurred |  | InterestRate |        |  | MaturityDate
|----------------- |  | ------------------ |  | ----------- |  | ------------- | ------ | ----------- | - | ------------ |  | ------------ | ------ |  | ------------
|Third Quarter     |  |                    |  |             |  |               |        |             |   |              |  |              |        |  |             
|Land              |  |                    |  |             |  |               |        |             |   |              |  |              |        |  |             
|Sheffield Village |  | Grand Prairie, TX  |  | 13.9 Acres  |  | $             | 1,500  |             | $ | 632          |  | $            | 975    |  | 5.50        
|Fourth Quarter    |  |                    |  |             |  |               |        |             |   |              |  |              |        |  |             
|Land              |  |                    |  |             |  |               |        |             |   |              |  |              |        |  |             
|Travelers(4)      |  | Farmers Branch, TX |  | 202.0 Acres |  |               | 25,000 |             |   | 1,947        |  |              | 22,802 |  |            

---

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



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



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



|(4) | Purchased from IORI.
|--- | --------------------



|(5) | No stated interest rate.
|--- | ------------------------



In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in LaCrosse, Wisconsin, providing purchase money financing of $5.0 million in the form of a wrap
mortgage. In 1996, the first lienholder called a default under the ARI wrap note, and directed future payments be made directly to them. ARI began legal proceedings against the first lienholder. In December 1999, ARI sold the note to BCM at its
carrying value of $489,000, retaining the right to receive any amounts collected by BCM in excess of the amount paid, plus accrued interest. In 2002, ARI prevailed in its litigation and ARIs lien on the property was restored. The borrower
continued in default, and ARI foreclosed on the property in March 2003. The property was subsequently sold to TCI. See NOTE 8. RELATED PARTY TRANSACTIONS.



In 2002, ARI purchased the following property:



|Property                  |  | Location          |  | Sq.Ft./Units/Acres |  | PurchasePrice |        | NetCashPaid |   | DebtIncurred |  |   | InterestRate |     |  | MaturityDate
|------------------------- |  | ----------------- |  | ------------------ |  | ------------- | ------ | ----------- | - | ------------ |  | - | ------------ | --- |  | ------------
|First Quarter             |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Shopping Center           |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Plaza on Bachman Creek(1) |  | Dallas, TX        |  | 80,278 Sq.Ft.      |  | $             | 3,103  |             | $ |             |  | $ |             |     |  |            
|                          |  |                   |  |                    |  |               |       
|Second Quarter            |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Apartments                |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Pinecrest(2)              |  | North Augusta, SC |  | 120 Units          |  |               | 2,986  |             |   |             |  |   | 1,423        | (3) |  | 8.75        
|Tiberon Trails(2)         |  | Merrillville, IN  |  | 376 Units          |  |               | 12,000 |             |   |             |  |   | 6,417        | (3) |  | 9.00        
|                          |  |                   |  |                    |  |               |       
|Shopping Center           |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Alta Mesa(2)              |  | Ft. Worth, TX     |  | 59,933 Sq.Ft.      |  |               | 4,000  |             |   |             |  |   | 1,804        | (3) |  | 10.43       
|                          |  |                   |  |                    |  |               |       
|Land                      |  |                   |  |                    |  |               |        |             |   |              |  |   |              |     |  |             
|Pioneer Crossing          |  | Austin, TX        |  | 79.4 Acres         |  |               | 1,165  |             |   | 1,213        |  |   |             |     |  |            
|Willow Springs            |  | Beaumont, CA      |  | 20.7 Acres         |  |               | 140    |             |   | 146          |  |   |             |     |  |            

---

|(1) | Exchanged with TCI for the Oaktree Village Shopping Center, Rasor land parcel and Lakeshore
Villas land parcel.
|--- | ---------------------------------------------------------------------------------------------------------------



|(2) | Property received from BCM for forgiveness of debt.
|--- | ---------------------------------------------------



|(3) | Assumed debt of seller.
|--- | -----------------------



11



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In 2003, ARI sold the following properties:



|Property               |  | Location           |  | Units/Sq.Ft./Acres/Rooms |  | SalesPrice |        | NetCashReceived/(Paid) |   |       | DebtDischarged |  |   | Gain/(Loss)onSale |    
|---------------------- |  | ------------------ |  | ------------------------ |  | ---------- | ------ | ---------------------- | - | ----- | -------------- |  | - | ----------------- | ---
|First Quarter          |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Apartments             |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Bay Anchor             |  | Panama City, FL    |  | 12 Units                 |  | $          | 369    |                        | $ |      |                |  | $ | 291               |    
|Georgetown             |  | Panama City, FL    |  | 44 Units                 |  |            | 1,175  |                        |   | 323   |                |  |   | 789               | (3)
|Northside Villas       |  | Tallahassee, FL    |  | 81 Units                 |  |            | 5,575  |                        |   | 1,806 |                |  |   | 2,784             |    
|Rolling Hills          |  | Tallahassee, FL    |  | 134 Units                |  |            | 5,061  |                        |   | 1,361 |                |  |   | 2,785             |    
|Seville                |  | Tallahassee, FL    |  | 62 Units                 |  |            | 2,795  |                        |   |      |                |  |   | 2,360             |    
|                       |  |                    |  |                          |  |           
|Shopping Centers       |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Bridgeview Plaza       |  | LaCrosse, WI       |  | 116,008 Sq.Ft.           |  |            | 8,700  |                        |   |      |                |  |   |                  |    
|Cullman                |  | Cullman, AL        |  | 92,466 Sq.Ft.            |  |            | 2,000  |                        |   |      |                |  |   | 2,650             | (3)
|                       |  |                    |  |                          |  |           
|Office Building        |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|4135 Beltline Road     |  | Addison, TX        |  | 90,000 Sq.Ft.            |  |            | 4,358  |                        |   |      |                |  |   | 2,858             | (3)
|                       |  |                    |  |                          |  |           
|Land                   |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Katrina                |  | Palm Desert, CA    |  | 89.3 Acres               |  |            | 8,550  |                        |   | <410  | >              |  |   | 2,840             |    
|Nashville              |  | Nashville, TN      |  | 8.8 Acres                |  |            | 235    |                        |   | <11   | >              |  |   | 217               |    
|                       |  |                    |  |                          |  |           
|Hotel                  |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Grand Hotel Sofia      |  | Sofia, Bulgaria    |  | 136 Rooms                |  |            | 24,750 |                        |   | 6,258 |                |  |   | 4,209             | (3)
|                       |  |                    |  |                          |  |           
|Second Quarter         |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Apartments             |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Greenbriar             |  | Tallahassee, FL    |  | 50 Units                 |  |            | 1,700  |                        |   | 594   |                |  |   | 976               |    
|Lake Château           |  | Thomasville, GA    |  | 98 Units                 |  |            | 1,600  |                        |   | 460   |                |  |   | 1,033             |    
|Pinecrest              |  | North Augusta, SC  |  | 120 Units                |  |            | 2,707  |                        |   | 1,136 |                |  |   | 1,429             |    
|Regency                |  | Lincoln, NE        |  | 106 Units                |  |            | 4,880  |                        |   | 838   |                |  |   | 3,179             |    
|Willow Wick            |  | North Augusta, SC  |  | 104 Units                |  |            | 2,707  |                        |   | 255   |                |  |   | 1,943             |    
|                       |  |                    |  |                          |  |           
|Industrial Warehouses  |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|McLeod                 |  | Orlando, FL        |  | 110,914 Sq.Ft.           |  |            | 5,450  |                        |   | 2,980 |                |  |   | 1,902             |    
|Tricon                 |  | Atlanta, GA        |  | 570,877 Sq.Ft.           |  |            | 13,084 |                        |   | 3,364 |                |  |   | 9,395             |    
|                       |  |                    |  |                          |  |           
|Land                   |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Mason Goodrich         |  | Houston, TX        |  | 8.0 Acres                |  |            | 210    |                        |   |      | (5)            |  |   |                  |    
|Mason Goodrich         |  | Houston, TX        |  | 1.6 Acres                |  |            | 209    |                        |   | 12    |                |  |   | 169               |    
|Mason Goodrich         |  | Houston, TX        |  | 7.7 Acres                |  |            | 900    |                        |   | 36    |                |  |   | 764               |    
|Solco-Valley Ranch     |  | Farmers Branch, TX |  | 6.1 Acres                |  |            | 1,999  |                        |   | <90   | >(7)           |  |   |                  |    
|                       |  |                    |  |                          |  |           
|Hotel                  |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Clarion KC Airport(6)  |  | Kansas City, MO    |  | 196 Rooms                |  |            | 5,312  |                        |   |      |                |  |   | 4,888             | (3)
|                       |  |                    |  |                          |  |           
|Third Quarter          |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Apartments             |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Landing & Marina       |  | Pensacola, FL      |  | 52 Units                 |  |            | 1,825  |                        |   | 576   |                |  |   | 1,162             |    
|Lincoln Court          |  | Dallas, TX         |  | 55 Units                 |  |            | 3,038  |                        |   | 1,834 |                |  |   | 1,208             |    
|Quail Creek            |  | Lawrence, KS       |  | 95 Units                 |  |            | 4,700  |                        |   | 1,188 |                |  |   | 3,260             |    
|Stone Oak              |  | San Antonio, TX    |  | 252 Units                |  |            | 6,930  |                        |   | 3,670 |                |  |   | 2,699             |    
|                       |  |                    |  |                          |  |           
|Office Buildings       |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                   |    
|Bonita Plaza           |  | Bonita, CA         |  | 47,777 Sq.Ft.            |  |            | 8,034  |                        |   | 1,698 |                |  |   | 5,944             |    
|Encino Executive Plaza |  | Encino, CA         |  | 177,211 Sq.Ft.           |  |            | 37,040 |                        |   | 1,947 |                |  |   | 33,145            | (3)



12



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Property                       |  | Location           |  | Sq. Ft./ Rooms/Units/Acres |  | SalesPrice |        | Net CashReceived/ (Paid) |   |       | DebtDischarged |  |   | Gain/(Loss) onSale |    
|------------------------------ |  | ------------------ |  | -------------------------- |  | ---------- | ------ | ------------------------ | - | ----- | -------------- |  | - | ------------------ | ---
|Third Quarter (Continued)      |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Shopping Centers               |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Oak Tree Village               |  | Lubbock, TX        |  | 45,623 Sq.Ft.              |  | $          | 3,366  |                          | $ | 1,527 |                |  | $ | 1,328              |    
|Sheboygan                      |  | Sheboygan, WI      |  | 74,532 Sq.Ft.              |  |            | 1,225  |                          |   | 669   |                |  |   | 569                |    
|Westwood                       |  | Tallahassee, FL    |  | 149,855 Sq.Ft.             |  |            | 8,950  |                          |   | 5,045 |                |  |   | 1,880              |    
|                               |  |                    |  |                            |  |           
|Land                           |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Nashville                      |  | Nashville, TN      |  | 1.1 Acres                  |  |            | 201    |                          |   | 9     |                |  |   | 170                |    
|Palm Desert                    |  | Palm Desert, CA    |  | 25.1 Acres                 |  |            | 2,600  |                          |   | <88   | >(9)           |  |   |                   |    
|Pioneer Crossing               |  | Austin, TX         |  | 367.4 Acres                |  |            | 22,500 |                          |   | 4,948 |                |  |   |                   |    
|Vista Ridge                    |  | Lewisville, TX     |  | 14.5 Acres                 |  |            | 2,250  |                          |   | 713   |                |  |   | 1,343              |    
|                               |  |                    |  |                            |  |           
|Hotels                         |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|City Suites                    |  | Chicago, IL        |  | 45 Rooms                   |  |            | 4,806  |                          |   | 89    |                |  |   | 4,081              | (3)
|Majestic                       |  | Chicago, IL        |  | 52 Rooms                   |  |            | 3,550  |                          |   | 66    |                |  |   | 2,448              | (3)
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms                  |  |            | 19,500 |                          |   | 250   |                |  |   | 12,332             | (3)
|Willows                        |  | Chicago, IL        |  | 55 Rooms                   |  |            | 5,144  |                          |   | 95    |                |  |   | 4,054              | (3)
|                               |  |                    |  |                            |  |           
|Fourth Quarter                 |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Apartments                     |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Summerfield                    |  | Orlando, FL        |  | 224 Units                  |  |            | 9,415  |                          |   | 4,845 |                |  |   | 4,476              |    
|                               |  |                    |  |                            |  |           
|Land                           |  |                    |  |                            |  |            |        |                          |   |       |                |  |   |                    |    
|Keller                         |  | Tarrant County, TX |  | 30.0 Acres                 |  |            | 2,800  |                          |   | 2,676 |                |  |   |                   |    
|Pioneer Crossing               |  | Austin, TX         |  | 343.7 Acres                |  |            | 8,136  |                          |   | 3,479 |                |  |   |                   |    

---

|(1) | Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.
|--- | -------------------------------------------------------------------------

|(2) | Sold to Tacco Office Investors, Inc., a related party. Gain deferred until sale to unrelated party.
|--- | ---------------------------------------------------------------------------------------------------

|(3) | Debt assumed by purchaser.
|--- | --------------------------

|(4) | Includes recognition of $3.1 million of accumulated foreign currency translation gains.
|--- | ---------------------------------------------------------------------------------------

|(5) | Cash of $210,000 was received by BCM and applied to ARIs affiliate debt.
|--- | -------------------------------------------------------------------------

|(6) | Sold to One Realco Hotel Investors, Inc. (One Realco Hotel), a related party.
|--- | -------------------------------------------------------------------------------

|(7) | Cash of $2.0 million was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------------

|(8) | Sold to One Realco Hotel. Gain deferred until sale to unrelated party.
|--- | ----------------------------------------------------------------------

|(9) | Cash of $2.6 million was received by Prime and applied to ARIs affiliate debt.
|--- | -------------------------------------------------------------------------------



In 2002, ARI sold the following properties:



|Property            |  | Location          |  | Units/Acres/Sq.Ft. |  | SalesPrice |        | Net CashReceived/(Paid) |   |       | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|------------------- |  | ----------------- |  | ------------------ |  | ---------- | ------ | ----------------------- | - | ----- | -------------- |  | - | ------------------ | ---
|First Quarter       |  |                   |  |                    |  |            |        |                         |   |       |                |  |   |                    |    
|Apartments          |  |                   |  |                    |  |            |        |                         |   |       |                |  |   |                    |    
|Mallard Lake(1)     |  | Greensboro, NC    |  | 336 Units          |  | $          | 14,400 |                         | $ |      |                |  | $ | 7,362              |    
|Villas              |  | Plano, TX         |  | 208 Units          |  |            | 8,525  |                         |   | 3,701 |                |  |   | 4,023              |    
|                    |  |                   |  |                    |  |           
|Land                |  |                   |  |                    |  |            |        |                         |   |       |                |  |   |                    |    
|Katrina             |  | Palm Desert, CA   |  | 2.1 Acres          |  |            | 1,323  |                         |   | <40   | >              |  |   | 1,237              |    
|Lakeshore Villas(2) |  | Harris County, TX |  | 16.9 Acres         |  |            | 1,499  |                         |   | 215   |                |  |   |                   |    
|Rasor(2)            |  | Plano, TX         |  | 24.5 Acres         |  |            | 1,211  |                         |   | 174   |                |  |   |                   |    
|Thompson II         |  | Dallas County, TX |  | .2 Acres           |  |            | 21     |                         |   | 20    |                |  |   |                   |    
|Vista Ridge         |  | Lewisville, TX    |  | 10.0 Acres         |  |            | 1,525  |                         |   | 130   |                |  |   | 1,220              |    
|                    |  |                   |  |                    |  |           
|Shopping Center     |  |                   |  |                    |  |            |        |                         |   |       |                |  |   |                    |    
|Oaktree Village(2)  |  | Lubbock, TX       |  | 45,623 Sq.Ft.      |  |            | 2,302  |                         |   | 131   |                |  |   | 1,389              | (3)



13



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Property         |  | Location           |  | Sq. Ft./Units/Acres |  | SalesPrice |        | Net CashReceived/(Paid) |   |        | DebtDischarged |  |   | Gain/(Loss) onSale |    
|---------------- |  | ------------------ |  | ------------------- |  | ---------- | ------ | ----------------------- | - | ------ | -------------- |  | - | ------------------ | ---
|Second Quarter   |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Apartments       |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Oak Hill         |  | Tallahassee, FL    |  | 92 Units            |  | $          | 3,200  |                         | $ | 156    | (4)            |  | $ | 2,550              |    
|Regency          |  | Tampa, FL          |  | 78 Units            |  |            | 3,200  |                         |   | 851    |                |  |   | 1,710              |    
|Stonebridge      |  | Florissant, MO     |  | 100 Units           |  |            | 4,340  |                         |   | 1,142  |                |  |   | 2,893              |    
|Office Building  |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Centura          |  | Dallas, TX         |  | 410,901 Sq.Ft.      |  |            | 50,000 |                         |   |       |                |  |   | 43,739             | (3)
|                 |  |                    |  |                     |  |           
|Land             |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Hollywood Casino |  | Farmers Branch, TX |  | 42.8 Acres          |  |            | 16,987 |                         |   |       |                |  |   | 6,222              | (3)
|Marine Creek     |  | Ft. Worth, TX      |  | 54.2 Acres          |  |            | 3,700  |                         |   |       |                |  |   | 1,500              | (3)
|Mason Goodrich   |  | Houston, TX        |  | 7.9 Acres           |  |            | 672    |                         |   | 46     |                |  |   | 554                |    
|Mason Goodrich   |  | Houston, TX        |  | 10.3 Acres          |  |            | 1,444  |                         |   | 93     |                |  |   | 1,225              |    
|Mason Goodrich   |  | Houston, TX        |  | 18.0 Acres          |  |            | 2,790  |                         |   |       |                |  |   | 2,690              | (3)
|Monterrey        |  | Riverside, CA      |  | 61.0 Acres          |  |            | 4,625  |                         |   |       |                |  |   |                   |    
|Nashville        |  | Nashville, TN      |  | 16.6 Acres          |  |            | 1,890  |                         |   |       |                |  |   | 955                | (3)
|                 |  |                    |  |                     |  |           
|Third Quarter    |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Apartments       |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Conradi House    |  | Tallahassee, FL    |  | 98 Units            |  |            | 1,809  |                         |   | 388    |                |  |   | 1,047              |    
|Lee Hills        |  | Tallahassee, FL    |  | 16 Units            |  |            | 445    |                         |   | 355    |                |  |   |                   |    
|Morning Star     |  | Tallahassee, FL    |  | 82 Units            |  |            | 2,217  |                         |   | 718    |                |  |   | 1,187              |    
|Pheasant Ridge   |  | Bellevue, NE       |  | 264 Units           |  |            | 10,400 |                         |   | 2,576  |                |  |   | 6,237              |    
|Stonegate        |  | Tallahassee, FL    |  | 83 Units            |  |            | 1,785  |                         |   | 486    |                |  |   | 1,026              |    
|Valley Hi        |  | Tallahassee, FL    |  | 54 Units            |  |            | 1,452  |                         |   | 75     |                |  |   | 1,159              |    
|White Pines      |  | Tallahassee, FL    |  | 85 Units            |  |            | 764    |                         |   | 10     |                |  |   | 593                |    
|Woodsong         |  | Smyrna, GA         |  | 190 Units           |  |            | 9,200  |                         |   | <45    | >              |  |   | 8,196              |    
|                 |  |                    |  |                     |  |           
|Land             |  |                    |  |                     |  |            |        |                         |   |        |                |  |   |                    |    
|Elm Fork         |  | Denton County, TX  |  | 14.5 Acres          |  |            | 2,745  |                         |   | <105   | >              |  |   | 2,633              |    
|Elm Fork         |  | Denton County, TX  |  | 14.2 Acres          |  |            | 1,526  |                         |   | <54    | >              |  |   | 701                |    
|Elm Fork         |  | Denton County, TX  |  | 16.7 Acres          |  |            | 1,617  |                         |   | <299   | >              |  |   | 1,554              |    
|Katrina          |  | Palm Desert, CA    |  | 80.0 Acres          |  |            | 6,778  |                         |   | <1,382 | >              |  |   | 2,500              |    
|Messick          |  | Palm Desert, CA    |  | 71.0 Acres          |  |            | 6,015  |                         |   | <163   | >              |  |   | 1,300              |    

---

|(1) | Exchanged for Governors Square, Grand Lagoon, Park Avenue, Greenbriar, Regency and Westwood Apartments.
|--- | --------------------------------------------------------------------------------------------------------

|(2) | Exchanged with TCI for the Plaza on Bachman Creek Shopping Center.
|--- | ------------------------------------------------------------------

|(3) | Debt assumed by purchaser.
|--- | --------------------------

|(4) | Represents dividends on and redemption of Innovo Preferred Stock. See NOTE 6. NOTES PAYABLE.
|--- | ----------------------------------------------------------------------------------------------

|(5) | Sold to TCI. Gain deferred until sales to unrelated parties in the third quarter of 2002 ($34,000 gain recognized) and the third quarter of 2003 ($27,000 gain
recognized).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



At September 30, 2003, ARI had the following properties under construction:



|Property                |  | Location        |  | Units     |  | AmountExpended |        | AdditionalAmountto Expend |   | ConstructionLoanFunding
|----------------------- |  | --------------- |  | --------- |  | -------------- | ------ | ------------------------- | - | -----------------------
|Apartments              |  |                 |  |           |  |                |        |                           |   |                        
|Breakwater Bay          |  | Beaumont, TX    |  | 176 Units |  | $              | 2,487  |                           | $ | 7,980                  
|Capitol Hill            |  | Little Rock, AR |  | 156 Units |  |                | 3,111  |                           |   | 7,468                  
|DeSoto Ranch            |  | DeSoto, TX      |  | 248 Units |  |                | 15,872 |                           |   | 2,348                  
|Echo Valley             |  | Dallas, TX      |  | 216 Units |  |                | 10,031 |                           |   | 4,189                  
|Heather Creek           |  | Mesquite, TX    |  | 200 Units |  |                | 3,073  |                           |   | 10,229                 
|Kingsland Ranch         |  | Houston, TX     |  | 398 Units |  |                | 4,323  |                           |   | 21,332                 
|Verandas at City View   |  | Fort Worth, TX  |  | 314 Units |  |                | 13,745 |                           |   | 9,098                  
|Vistas at Pinnacle Park |  | Dallas, TX      |  | 322 Units |  |                | 2,788  |                           |   | 18,394                 



During the nine months ended September
30, 2003, ARI completed the 186 unit Blue Lake Villas in Waxahachie, Texas, the 284 unit Falcon Lakes in Arlington, Texas, the 180 unit River Oaks Apartments in Wiley, Texas, the 384 unit Sendero Ridge Apartments in San Antonio, Texas and the 256
unit Spyglass Apartments in Mansfield, Texas.



NOTE 3. NOTES RECEIVABLE



In February 2003, ARI sold an 89.3
acre tract of its Katrina land parcel for $8.5 million, paying $410,000 after payment of closing costs and debt paydown and providing purchase money financing of $5.6 million. The note bears interest at 8.0% per annum and matures three years after
the recording of the Deed of Trust. Interest will begin accruing after improvements to the site have been completed by ARI. ARI expects that the improvements will be completed by the end of February 2004. The future costs to ARI to complete the
improvements, estimated to be $2.5 million, were accrued in 2002. A principal payment of $450,000 is due within ten days after a Tentative Parcel Map (the Map) is recorded. ARI expects that the Map will be recorded by the end of November
2003. Interest payments will be due on the first day of each calendar quarter, beginning with the first quarter following the completion of the site improvements.



In March 2003, ARI sold the Grand Hotel Sofia for $24.8 million, receiving $6.3 million in cash after paying closing costs and debt
assumption and providing purchase money financing of $13.5 million. The note was non-interest-bearing for 90 days, then bore interest at 9.0% per annum for the next 90 days and matured in September 2003. In September 2003, the note was collected in
full.



In March 2003, ARI sold the 90,000 sq. ft., 4135 Beltline Office
Building in Addison, Texas, for $4.4 million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $1.5 million. The note bears interest at 12.0% per annum, requires quarterly payments of accrued
interest and matures in March 2004.



In June 2003, ARI sold the 104 unit Willow
Wick Apartments in North Augusta, South Carolina, for $2.7 million, receiving $255,000 after payment of closing costs and debt pay down and providing purchase money financing of $42,000. The note bears interest at 5.0% per annum and requires all
interest and principal be paid at maturity in December 2003.



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 September 2002, ARI sold its Messick land parcel and an 80.0 acre tract of its Katrina land parcel for $12.8 million, paying $1.5 million after payment of closing costs and debt paydown and providing purchase money
financing of $9.6 million. The note bore interest at 8.0% per annum, matured in September 2004 and required quarterly payments of accrued interest. All principal and accrued interest were due at maturity. In February 2003, ARI accepted $7.4 million
as full payment for $7.7 million in principal and accrued interest. In March 2003, the remaining $1.9 million note balance was sold to an unrelated party for $1.8 million plus accrued and unpaid interest.



In December 2002, ARI sold its Willow Springs land parcel for $9.8 million, paying $1.3
million after payment of closing costs and debt paydown and providing purchase money financing of $7.8 million. The note bore interest at 8.0% per annum, matured in December 2005 and required periodic interest payments beginning in June 2003. In
March 2003, the note was sold to an unrelated party for $7.5 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARIs



15



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



Katrina land, in event of default by the borrower. ARI recognized a previously deferred gain of $4.9 million upon completion of the sale of the note.



In December 2002, ARI sold a 238.0 acre tract of its Desert Wells land parcel
for $23.8 million, receiving $321,000 after payment of closing costs and debt paydown and providing purchase money financing of $21.4 million. The first lien financing of $17.8 million bore interest at 8.0% per annum, matured in December 2004 and
required payments beginning in March 2003. In March 2003, the note was sold to an unrelated party for $17.1 million plus accrued and unpaid interest. The buyer of the note has limited recourse against a 53 acre parcel of ARIs Katrina land, in
event of default by the borrower. ARI recognized a previously deferred gain of $15.0 million upon completion of the sale of the note. The second lien financing of $3.6 million bore interest at 8.0% per annum and matured on March 31, 2003. All
principal and interest were due at maturity. At November 2003, negotiations are underway to modify and extend the terms of the note. In July 2003, ARI advanced an additional $357,000 to the borrower. The new note bears interest at 8.0% per annum and
matures in July 2004. All principal and interest are due at maturity.



In
December 2002, ARI sold a 171.1 acre tract of its Desert Wells land parcel for $11.9 million receiving $1.4 million after payment of closing costs and debt paydown and providing purchase money financing of $8.9 million. The note bore no interest and
matured in March 2003. The principal was due at maturity. In December 2002, an interest in $7.7 million of the note was sold to an unrelated party for $7.7 million. ARI retained a junior interest in $1.2 million of the note. In March 2003, the note
was collected in full.



In July 2001, ARI agreed to fund a $4.4 million line of
credit secured by a second lien on 1,714.16 acres of unimproved land in Tarrant Country, Texas. As of April 2003, ARI had funded $2.9 million of the line of credit and it was classified as nonperforming. In May 2003, ARI received a $433,000
principal paydown. Also during May 2003, ARI received 14.373 acres of unimproved land in Tarrant County, Texas, valued at $1.1 million, as a principal paydown. As of July 2003, the line of credit has been paid in full.



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 and 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. At November 2003, negotiations are underway to modify the terms of the note.



Related Party.In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3 million. No cash was received or paid by ARI, after debt
assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August 2003, the hotel was sold through foreclosure
proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.



On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor
of ARI in the amount of $526,000. The note bears interest at 2% over the prime rate, currently 6.00% per annum, matures in June 2004 and requires monthly interest payments beginning in June 2003 and quarterly principal payments beginning in
September 2003.



In July 2003, ARI sold its interest in MRI to Gruppa for $18.5
million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 1. BASIS OF PRESENTATION). The note bore interest at 10.0% per annum, matured in August 2013 and required
monthly payments of principal and interest beginning in September 2003. ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARIs continuing ownership interest in MRI, management has determined that this
should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.



In August 2003, ARI sold the Williamsburg Hospitality House to One Realco Hotel for $19.5 million, receiving $250,000 after debt assumption
and providing purchase money financing of $5.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed
for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as nonperforming.



16



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In August 2003, ARI sold the City Suites, Majestic, and Willows hotels to One Realco Hotel for $13.5 million in a
single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest
beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note
as nonperforming.



In October 2003, ARI advanced $1.6 million to the Class A
Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A
Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.



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.
One Realco periodically borrows money to meet its cash obligations. The line of credit bears 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,
$394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000
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, $856,900 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). All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One Realco. Mr. Kimbrough does not
participate in the day-to-day operations or management of One Realco.



In
December 2000, an unsecured loan with a remaining principal balance of $1.8 million to Warwick of Summit, Inc. (Warwick) matured. The loan was made to provide funds to purchase, renovate and expand a shopping center property in Warwick,
Rhode Island. All principal and interest were due at maturity. In February 2002, $275,000 of interest was received. In March 2003, $27,000 of principal and $223,000 of interest was received. In April 2003, $149,000 of principal and $26,000 of
interest was received. In July 2003, $10,000 of interest was received. At November 2003, the loan, and $97,000 of accrued interest, remained unpaid. Richard D. Morgan, a Warwick shareholder, served as a director of ARI until October 2001.



In December 2000, a loan with a principal balance of $1.6 million to Bordeaux
Investments Two, L.L.C. (Bordeaux), matured. The loan, to provide funds to purchase and renovate a shopping center property in Oklahoma City, Oklahoma, was secured by (1) a 100% interest in Bordeaux, which owns a shopping center in
Oklahoma City, Oklahoma; (2) 100% of the stock of Bordeaux Investments One, Inc., which owns 6.5 acres of undeveloped land in Oklahoma City, Oklahoma; and (3) the personal guarantees of the Bordeaux members. Richard D. Morgan, a Bordeaux member
until July 2003, served as a director of ARI until October 2001. In July 2003, the members of Bordeaux assigned 100% of the membership interest in Bordeaux to ARI in payment of the note. ARI recorded real estate assets of $8.8 million and assumed
$7.2 million of mortgage debt and other liabilities on the shopping center and the undeveloped land. No gain or loss was recorded on this transaction.



In March 2000, a loan with a remaining principal balance of $2.6 million to Lordstown, L.P., matured. The loan, to provide funds to purchase for resale various parcels of
land, is secured by a second lien on land in Ohio and Florida, by 100% of the general and limited partner interest in Partners Capital, Ltd., the limited partner of Lordstown, L.P., and a profits interest in subsequent land sales. At November 2003,
the loan, and $1.3 million of accrued interest, remained unpaid. A corporation controlled by Richard D. Morgan is the general partner of Lordstown, L.P. Mr. Morgan served as a director of ARI until October 2001.



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. BCM, ARIs advisor until June 30, 2003, served as advisor to IORI and TCI until June 30, 2003.



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. See NOTE 1. BASIS OF PRESENTATION. 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. On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI shares from BCM. In addition, BCM
has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. NOTES RECEIVABLE). After the exchange, ARI 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 to BCM, receiving 314,141



17



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



TCI shares from BCM (see NOTE 3. NOTES RECEIVABLE). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer
directly owns any IORI shares. At June 30, 2003, ARI owned 18.4% 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 became the advisor to ARI and TCI. Prime is owned by Realty
Advisors (79%) and Syntek West (21%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, Prime changed its name to Prime Income Asset Management, Inc. On October 1, 2003, Prime LLC, which is 100% owned by Prime,
replaced Prime as the advisor to ARI and TCI.



ARIs investment in real
estate entities, accounted for using the equity method, at September 30, 2003 was as follows:



|Investee |  | Percentage ofARIsOwnership atSept. 30, 2003 |   |  | CarryingValue ofInvestment atSept. 30, 2003 |       | EquivalentInvesteeBook Value atSept. 30, 2003 |   | Market Valueof Investment atSept. 30, 2003
|-------- |  | -------------------------------------------- | - |  | ------------------------------------------- | ----- | --------------------------------------------- | - | ------------------------------------------
|IORI     |  | 18.4                                         | % |  | $                                           | 3,660 |                                               | $ | 8,642                                     
|Other    |  |                                              |   |  |                                             | 533   |                                               |   |                                           
|         |  |                                              |   |  |                                             |       |                                               |   |                                           
|         |  |                                              |   |  | $                                           | 4,193 |                                               |   |                                           
|         |  |                                              |   |  |                                             |       |                                               |   |                                           



Set forth below are summarized results
of operations of TCI and IORI for the three months ended March 31, 2003, prior to their consolidation by ARI:



|Revenues                                           |  | $ | 31,321 |  
|-------------------------------------------------- |  | - | ------ | -
|Property operating expenses                        |  |   | 23,746 |  
|Depreciation                                       |  |   | 5,460  |  
|Interest                                           |  |   | 11,528 |  
|                                                   |  |   |        |  
|Loss from continuing operations                    |  |   | <9,413 | >
|Loss from discontinued operations                  |  |   | <459   | >
|Equity in investees gain from sale of real estate |  |   | 1,509  |  
|                                                   |  |   |        |  
|Net loss                                           |  | $ | <8,363 | >
|                                                   |  |   |        |  



Set forth below are summarized results
of operations of IORI for the four months of JuneSeptember 2003, following ARIs exchange of its IORI shares:



|Revenues                              |  | $ | 4,712 |  
|------------------------------------- |  | - | ----- | -
|Property operating expenses           |  |   | 2,697 |  
|Depreciation                          |  |   | 189   |  
|Interest                              |  |   | 1,018 |  
|                                      |  |   |       |  
|Net income from continuing operations |  |   | 808   |  
|Loss from discontinued operations     |  |   | <541  | >
|                                      |  |   |       |  
|Net income                            |  | $ | 267   |  
|                                      |  |   |       |  



ARIs share of equity
investees loss before gains on the sale of discontinued operations was $4.3 million for the nine months ended September 30, 2003, and its share of equity investees loss on sale of real estate was $165,000 for the nine months ended
September 30, 2003.



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.



ART Florida Portfolio II, Ltd. In January 2002, Investors Choice Florida Public Funds II, in which ART Florida Portfolio II, Ltd., a subsidiary of ARI, owned an interest, sold Villas Continental Apartments. ARI
initially received $1.0 million in cash from the sale. In the nine months ended September 30, 2002, ARI recognized a $531,000 loss on the sale, which is included in loss on sale of investments in equity investees in the Consolidated Statements of
Operations. Subsequently, ARI received an additional $245,000 in sales proceeds, reducing the total loss to $286,000.



NOTE 5. MARKETABLE EQUITY SECURITIES



Since 1994, ARI has been purchasing equity securities to diversify and increase the liquidity of its margin accounts. These equity securities are considered a trading
portfolio and are carried at market value. In the first nine months of 2003, ARI purchased $1.6 million and sold $1.7 million of equity securities. At September 30, 2003, ARI recognized an unrealized increase in the market value



18



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



of its trading portfolio securities of $7,000. Unrealized and realized gains and losses on trading portfolio securities are included in other income in the
accompanying Consolidated Statements of Operations.



In March 2003, ARI
obtained a loan in the amount of $5.0 million to acquire equity securities of Realty Korea CR-REIT Co., Ltd. No 1 representing approximately a 9.2% ownership interest. As of May 2003, the loan was paid in full. This investment is considered an
available-for-sale security. The change in market value between the date of purchase and September 30, 2003 was not material.



NOTE 6. NOTES PAYABLE



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 is $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, ARI sold the hotels to a related party (see NOTE 2. REAL ESTATE).



In May 2003, the lender on one of ARIs commercial properties located in Texas 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 $6.5 million. In July 2003, the maturity date of the note was extended to December 2003.



In August 2003, ARI received a loan for $5.0 million that is secured by its investment in
equity securities of Realty Korea CR-REIT Co., Ltd. No. 1. The loan is also secured by a second deed of trust on commercial properties in North Carolina and Texas. The loan bears interest at the prime rate plus 1%, currently 5.0%, requires monthly
interest only payments and matures in August 2004.



In September 2003, the
lender on one of ARIs commercial properties located in Oklahoma 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 $3.3 million. At
November 2003, negotiations with the lender are ongoing.



In October 2003, ARI
received a construction loan for $15.5 million for the construction of a new apartment development in Lewisville, Texas.



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





|Property             |  | Location           |  | Units/ Acres/Sq.Ft. |  | DebtIncurred |       |     | DebtDischarged |   | Net CashReceived/<Paid> |  |   | InterestRate |     |  | MaturityDate |    
|-------------------- |  | ------------------ |  | ------------------- |  | ------------ | ----- | --- | -------------- | - | ----------------------- |  | - | ------------ | --- |  | ------------ | ---
|First Quarter        |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Land                 |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Elm Fork             |  | Denton County, TX  |  | 101.0 Acres         |  | $            | 5,000 |     |                | $ | 1,551                   |  | $ | 2,885        |     |  | 10.750       | %  
|Nashville            |  | Nashville,TN       |  | 113.8 Acres         |  |              | 6,059 |     |                |   | 807                     |  |   | 4,725        |     |  | 14.000       |    
|Vineyards II         |  | Tarrant County, TX |  | 18.6 Acres          |  |              | 3,280 |     |                |   | 3,750                   |  |   | <583         | >   |  | 6.750        | (1)
|                     |  |                    |  |                     |  |              |      
|Apartments           |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Arlington Place      |  | Pasadena, TX       |  | 230 Units           |  |              | 1,500 |     |                |   |                        |  |   |             | (2) |  | 5.000        |    
|                     |  |                    |  |                     |  |              |      
|Second Quarter       |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Shopping Centers     |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Bridgeview           |  | LaCrosse, WI       |  | 116,008 Sq.Ft.      |  |              | 6,500 |     |                |   |                        |  |   | 6,152        |     |  | 6.250        | (1)
|Cullman              |  | Cullman, AL        |  | 92,433 Sq.Ft.       |  |              | 1,700 |     |                |   | 2,650                   |  |   | 1,048        |     |  | 6.250        | (1)
|                     |  |                    |  |                     |  |              |      
|Apartments           |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Plantation           |  | Tulsa, OK          |  | 138 Units           |  |              | 2,320 |     |                |   | 1,924                   |  |   | 173          |     |  | 5.600        |    
|                     |  |                    |  |                     |  |              |      
|Industrial Warehouse |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Ogden Industrial     |  | Ogden, UT          |  | 107,112 Sq.Ft.      |  |              | 1,800 |     |                |   |                        |  |   | 1,722        |     |  | 6.250        | (1)
|                     |  |                    |  |                     |  |              |      
|Land                 |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Katrina              |  | Palm Desert, CA    |  | 52.0 Acres          |  |              | 5,100 |     |                |   | 3,000                   |  |   | 1,795        |     |  | 6.250        | (1)
|Keller               |  | Tarrant County, TX |  | 30.1 Acres          |  |              | 2,016 | (4) |                |   | 450                     |  |   | 1,494        |     |  | 7.500        |    



19



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Property                  |  | Location           |  | Units/ Acres/Sq. Ft. |  | DebtIncurred |       |     | DebtDischarged |   | Net CashReceived/<Paid> |  |   | InterestRate |   |  | MaturityDate
|------------------------- |  | ------------------ |  | -------------------- |  | ------------ | ----- | --- | -------------- | - | ----------------------- |  | - | ------------ | - |  | ------------
|Second Quarter(Continued) |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Land(Continued)           |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Lacy Longhorn             |  | Farmers Branch, TX |  | 17.1 Acres           |  | $            |      | (4) |                | $ |                        |  | $ |             |   |  |            
|Las Colinas               |  | Las Colinas, TX    |  | 13.0 Acres           |  |              |      | (4) |                |   |                        |  |   |             |   |  |            
|Mason Goodrich            |  | Houston, TX        |  | 84.0 Acres           |  |              | 3,750 |     |                |   | 757                     |  |   | 2,850        |   |  | 6.250       
|McKinney Corners II       |  | Collin County, TX  |  | 11.0 Acres           |  |              |      | (4) |                |   |                        |  |   |             |   |  |            
|Nashville                 |  | Nashville, TN      |  | 113.8 Acres          |  |              | 941   |     |                |   |                        |  |   | 737          |   |  | 14.000      
|Thompson                  |  | Farmers Branch, TX |  | 3.3 Acres            |  |              |      | (4) |                |   |                        |  |   |             |   |  |            
|Tomlin                    |  | Farmers Branch, TX |  | 9.0 Acres            |  |              |      | (4) |                |   |                        |  |   |             |   |  |            
|                          |  |                    |  |                      |  |              |      
|Third Quarter             |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Apartments                |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Tree House                |  | Irving, TX         |  | 160 Units            |  |              | 5,100 |     |                |   | 2,518                   |  |   | 2,132        |   |  | 5.000       
|Windsor Tower             |  | Ocala, FL          |  | 64 Units             |  |              | 2,000 |     |                |   | 1,989                   |  |   | <104         | > |  | 4.750       
|                          |  |                    |  |                      |  |              |      
|Fourth Quarter            |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Land                      |  |                    |  |                      |  |              |       |     |                |   |                         |  |   |              |   |  |             
|Las Colinas               |  | Las Colinas, TX    |  | 55.7 Acres           |  |              | 6,885 |     |                |   | 17,338                  |  |   | <11,622      | > |  | 7.000       
|Rasor                     |  | Plano, TX          |  | 23.7 Acres           |  |              | 1,260 |     |                |   |                        |  |   | 1,214        |   |  | 7.000       
|Valwood                   |  | Dallas County, TX  |  | 235.0 Acres          |  |              | 8,100 |     |                |   | 5,400                   |  |   | 1,745        |   |  | 7.000       

---

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



|(2) | Cash of $1.5 million was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------------



|(3) | Paid in July 2003.
|--- | ------------------



|(4) | Single note, with all properties as collateral.
|--- | -----------------------------------------------



In 2002, ARI financed/refinanced or obtained second mortgage financing on the following:



|Property               |  | Location           |  | Units/ Acres/Sq.Ft. |  | DebtIncurred |        |     | DebtDischarged |   | Net CashReceived/<Paid> |  |   | InterestRate |   |  | MaturityDate
|---------------------- |  | ------------------ |  | ------------------- |  | ------------ | ------ | --- | -------------- | - | ----------------------- |  | - | ------------ | - |  | ------------
|First Quarter          |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Land                   |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Walker                 |  | Dallas County,TX   |  | 90.6 Acres          |  | $            | 8,500  |     |                | $ | 8,500                   |  | $ | <1,411       | > |  | 11.250      
|                       |  |                    |  |                     |  |              |       
|Shopping Center        |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Plaza on Bachman Creek |  | Dallas, TX         |  | 80,278 Sq.Ft.       |  |              | 5,000  |     |                |   |                        |  |   | 4,444        |   |  | 6.625       
|                       |  |                    |  |                     |  |              |       
|Second Quarter         |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Apartments             |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Lee Hills              |  | Tallahassee, FL    |  | 16 Units            |  |              | 1,750  | (2) |                |   | 117                     |  |   | 590          |   |  | 6.625       
|Valley Hi              |  | Tallahassee, FL    |  | 54 Units            |  |              |       | (2) |                |   | 878                     |  |   |             |   |  |            
|White Pines            |  | Tallahassee, FL    |  | 85 Units            |  |              |       | (2) |                |   |                        |  |   |             |   |  |            
|                       |  |                    |  |                     |  |              |       
|Office Buildings       |  |                    |  |                     |  |              |        |     |                |   |                         |  |   |              |   |  |             
|Four Hickory Centre    |  | Farmers Branch, TX |  | 221,000 Sq.Ft.      |  |              | 12,500 | (3) |                |   |                        |  |   | 3,399        |   |  | 13.000      



Related Party
Transactions. In each of the following transactions, except those footnoted as (6), a related party purchased an entity, which owns the listed property asset, from ARI. ARI guaranteed that the asset will produce at least a 12% return on the
purchase price for a period of three years from the purchase date. If the asset fails to produce the 12% return, ARI will pay the purchaser any shortfall. In addition, if the asset fails to produce the 12% return for a calendar year, the purchaser
may require ARI to repurchase the entity for the purchase price. Management has classified these related party transactions as notes payable.



20



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Property           |  | Location           |  | Sq.Ft./Units   |  | DebtIncurred |       | Debt Discharged |   | NetCash Received |  | InterestRate |       |  | MaturityDate |  
|------------------ |  | ------------------ |  | -------------- |  | ------------ | ----- | --------------- | - | ---------------- |  | ------------ | ----- |  | ------------ | -
|First Quarter      |  |                    |  |                |  |              |       |                 |   |                  |  |              |       |  |              |  
|Office Building    |  |                    |  |                |  |              |       |                 |   |                  |  |              |       |  |              |  
|Rosedale Towers    |  | Minneapolis, MN    |  | 84,798 Sq.Ft.  |  | $            | 5,109 |                 | $ |                 |  | $            | 5,109 |  | 12.000       | %
|Two Hickory Centre |  | Farmers Branch, TX |  | 96,127 Sq.Ft.  |  |              | 4,448 |                 |   |                 |  |              | 4,448 |  | 12.000       |  
|                   |  |                    |  |                |  |              |      
|Second Quarter     |  |                    |  |                |  |              |       |                 |   |                  |  |              |       |  |              |  
|Apartments         |  |                    |  |                |  |              |       |                 |   |                  |  |              |       |  |              |  
|Bay Anchor         |  | Panama City, FL    |  | 12 Units       |  |              | 255   |                 |   |                 |  |              | 203   |  | 5.000        |  
|Confederate Point  |  | Jacksonville, FL   |  | 206 Units      |  |              | 1,929 |                 |   |                 |  |              |      |  | 12.000       |  
|Foxwood            |  | Memphis, TN        |  | 220 Units      |  |              | 1,093 |                 |   |                 |  |              |      |  | 12.000       |  
|Governor Square    |  | Tallahassee, FL    |  | 168 Units      |  |              | 4,480 |                 |   | 3,196            |  |              | 611   |  | 7.120        |  
|Grand Lagoon       |  | Panama City, FL    |  | 54 Units       |  |              | 2,083 |                 |   | 1,209            |  |              | 655   |  | 5.000        |  
|Oak Hill           |  | Tallahassee, FL    |  | 92 Units       |  |              | 2,550 |                 |   | 1,875            |  |              | 478   |  | 5.000        |  
|Park Avenue        |  | Tallahassee, FL    |  | 121 Units      |  |              | 4,400 |                 |   | 2,756            |  |              | 1,341 |  | 7.120        |  
|Seville            |  | Tallahassee, FL    |  | 62 Units       |  |              | 1,955 |                 |   | 1,263            |  |              | 473   |  | 5.000        |  
|Westwood           |  | Mary Ester, FL     |  | 120 Units      |  |              | 3,382 |                 |   | 2,327            |  |              | 1,023 |  | 7.570        |  
|Windsor Tower      |  | Ocala, FL          |  | 64 Units       |  |              | 1,989 |                 |   | 1,128            |  |              | 702   |  | 5.000        |  
|Woodhollow         |  | San Antonio, TX    |  | 546 Units      |  |              | 8,160 |                 |   | 5,349            |  |              | 2,775 |  | 7.120        |  
|Woodsong           |  | Smyrna, GA         |  | 190 Units      |  |              | 2,544 |                 |   |                 |  |              |      |  | 12.000       |  
|                   |  |                    |  |                |  |              |      
|Office Building    |  |                    |  |                |  |              |       |                 |   |                  |  |              |       |  |              |  
|One Hickory Centre |  | Farmers Branch, TX |  | 102,615 Sq.Ft. |  |              | 4,468 |                 |   |                 |  |              |      |  | 12.000       |  

---

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



|(2) | Single note with all properties as collateral.
|--- | ----------------------------------------------



|(3) | $10.1 million funded at September 30, 2002.
|--- | -------------------------------------------



|(4) | IORI purchased 100% of the outstanding common shares of Rosedale Corporation
(Rosedale), a wholly-owned subsidiary of ARI, for $5.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Rosedale owned the Rosedale Towers
Office Building. The business purpose of this transaction was for IORI to make an equity investment in Rosedale, anticipating a profitable return, and for ARI to receive cash for its equity investment. After the property was sold to an unrelated
buyer in December 2002, ARI owed $2.1 million to IORI for remaining principal and 12% return. In April 2003, ARI repaid $2.0 million in principal and accrued interest. In August 2003, ARI repaid the remaining principal and accrued interest.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | TCI purchased 100% of the common shares of ART Two Hickory Corporation (Two
Hickory), a wholly-owned subsidiary of ARI, for $4.4 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Two Hickory owns the Two Hickory Centre Office
Building. The business purpose of this transaction was for TCI to make an equity investment in Two Hickory, anticipating a profitable return, and for ARI to receive cash for its equity investment.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Properties sold 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, a Director of ARI until July 2003, controls approximately 11.67% of the outstanding common stock of Innovo. Management has
determined to treat this sale as a refinancing transaction. ARI will continue to report the assets and the new debt incurred by Metra on its financial statements. ARI also received $6.3 million of 8% non-recourse, non-convertible Series A Preferred
Stock (Preferred Shares) of Innovo.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The dividend on the Preferred Shares will be funded entirely and solely through member distributions from cash flows generated by the operation and subsequent sale of the sold properties. In the event the cash flows for the properties are
insufficient to cover the 8% annual dividend, Innovo will have no obligation to cover any shortfall.



The Preferred Shares have a mandatory redemption feature, and are redeemable from the cash proceeds received by Innovo from the operation and sale of the
properties. All member distributions that are in excess of current and accrued 8% dividends



21



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



| | must be used by Innovo to redeem the Preferred Shares. Since redemption of these shares is subject to the above future events, management has elected to
record no basis in the Preferred Shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | TCI purchased all of the general and limited partnership interests in Garden Confederate
Point, L.P. (Confederate Point) from ARI for $1.9 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Confederate Point owns the Confederate Point
Apartments. The business purpose of this transaction was for TCI to make an equity investment in Confederate Point, anticipating a profitable return, and to reduce ARIs payable to BCM.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | TCI purchased all of the general and limited partnership interests in Garden Foxwood, L.P.
(Foxwood) from ARI for $1.1 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Foxwood owns the Foxwood Apartments. The business purpose of this
transaction was for TCI to make an equity investment in Foxwood, anticipating a profitable return, and to reduce ARIs payable to BCM.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) | TCI purchased all of the general and limited partnership interests in Garden Woodsong, L.P.
(Woodsong) from ARI for $2.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. Woodsong owns the Woodsong Apartments. The business purpose of
this transaction was for TCI to make an equity investment in Woodsong, anticipating a profitable return, and to reduce ARIs payable to BCM. TCI sold the Woodsong Apartments in July 2002.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Sold to unrelated buyer in December 2002.
|---- | -----------------------------------------



|(11) | TCI purchased 100% of the common shares of ART One Hickory Corporation (One
Hickory), a wholly-owned subsidiary of ARI, for $4.5 million. The purchase price was determined based upon the market value of the property, using a market rate multiple of net operating income. One Hickory owns the One Hickory Centre Office
Building. The business purpose of this transaction was for TCI to make an equity investment in One Hickory, anticipating a profitable return, and to reduce ARIs payable to BCM.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) | Sold to unrelated party in June 2002.
|---- | -------------------------------------



|(13) | Sold to unrelated party in January 2003.
|---- | ----------------------------------------



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 5.00% to 24.0%. Margin borrowing totaled $25.2 million at September 30, 2003.



Sunset Management Loan. In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (Sunset). ARI received net cash of $16.1 million after the payment of various closing
costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The
loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (AWI). The loan required monthly payments of
interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares of TCI common stock
after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in 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 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 a federal district court in Las Vegas, Nevada against
Commonwealth Land Title (Commonwealth) seeking disposition of the TCI common stock held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instigated a
separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc. et al., Case No. A462587 pending in the 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



22



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



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 continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and a renewed motion
for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.



Sunset has sought expedited relief and an expedited hearing of the Texas Litigation, which the court refused to grant. The matter was set for a jury trial on December 8, 2003. In addition, the borrowers on the loan
have sought to tender cash collateral to the court in lieu of the TCI stock, which motion was denied. TCI has only recently been added to the Texas Litigation as a party.



Even though the relief sought by Sunset in the Texas Litigation and the Nevada Litigation has either been denied or stayed, on June 10,
2003, an attorney representing Sunset appeared at the Annual Meeting of Shareholders of TCI attempting to vote 3,673,115 Shares of common stock of TCI under purported irrevocable proxies against the election of the four directors nominated in favor
of the election of four affiliates of Sunset that Sunset seeks to nominate to serve as directors of TCI. The Inspector of Election at the Annual Meeting advised that Sunsets attempt to exercise voting rights under proxies for the 3,673,115
shares was improper and would not be allowed, advising that BCM and the ARI subsidiaries held the absolute right to vote the 3,673,115 shares of TCI common stock so long as there was no event of default under the Sunset loan agreement. The Inspector
of Election also observed at the Stockholders meeting that no evidence was before the Inspector from a court of law finding an event of default had occurred with respect the Sunset loan documents, and therefore, such proxies would not be honored at
that time. Subsequently, representatives of Sunset delivered on July 7, 2003 to TCI a form captioned Schedule 13D for an event occurring June 10, 2003, making certain disclosures, including an allegation that Sunset acquired voting rights to
3,673,115 shares of TCI to protect the value of Sunsets security interest in the 3,673,115 shares of TCI pledged as collateral for . . . obligations to Sunset. Actually, only 3,672,305 shares of TCI common stock were pledged [810 shares
less than Sunset alleges]. Such schedule 13D also provides that Sunset plans to foreclose on the pledged TCI shares as soon as possible. Such Schedule 13D advises that Sunset would prefer to replace the four management directors
[of TCI] with neutral individuals . . . or if neutral individuals are unavailable, Sunset intends to nominate and [vote] for the election of affiliates of Sunset as directors of TCI on an interim basis until neutral individuals with satisfactory
backgrounds and knowledge can be elected as directors.



On September 10,
2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern District of Texas. On September 25, 2003, the Texas Litigation was transferred to the Eastern District of Texas. A scheduling conference on this matter is set for
December 3, 2003.



Security Loans. In August 2003, ARI obtained a
security loan in the amount of 5.0 million from a financial institution in Bulgaria. The funds were used for earnest money for a potential property acquisition in Bulgaria. The loan bore interest at 4.33% over the six-month EURIBOR rate,
currently 6.583%, and matured in November 2003. Principal and accrued interest were due at maturity. The loan was secured by 825,666 shares of TCI common stock held by ARI. In October 2003, the earnest money was returned to ARI. In November, the
loan was repaid.



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% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 1,656,537 shares of TCI
common stock held by ARI.



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% over the 30-day LIBOR rate, currently 13.12%, requires monthly payments of interest only and matures in September 2004. The loan is secured by 250,000 shares of
IORI common stock held by ARI.



In October 2001, ARI obtained a security loan
in the amount of $1.0 million from a financial institution. The loan bore interest at 1% over the prime rate, currently 5.00% 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.



NOTE 8. RELATED PARTY TRANSACTIONS



In March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman. TCI
received $5.1 million cash on the subsequent financing of the shopping centers.



In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI, in partial payment of a note payable on the Rosedale Tower Office Building. See NOTE 6. NOTES PAYABLE.



23



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel, a related party, for $5.3 million.
No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003. In August
2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.



On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI
shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. NOTES RECEIVABLE). After the exchange, ARI 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 to BCM, receiving 314,141 TCI shares from BCM (see NOTE 3. NOTES RECEIVABLE). After the transaction, ARI owned 76.8% of the outstanding
shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



In June 2003, ARI received funds of $757,000 from an affiliate reducing the
affiliate receivable. The funds paid down a note secured by undeveloped land in Harris County, Texas.



On June 30, 2003, ARI sold its 74.31% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price
paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price reduced ARIs affiliate debt. The $600,000 interest was received in cash in August 2003.



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



In July 2003, ARI sold its interest in MRI to Gruppa, for $18.5 million, receiving $7.4
million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. NOTES RECEIVABLE). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of
assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARIs continuing ownership interest in MRI, management has determined that this should be accounted for as a financing
transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest.



In July 2003, ARI paid $3.1 million to BCM for prior years legal fees incurred by Gene Phillips. Mr. Phillips is a related party and advisor to ARI.



In August 2003, ARI sold the Williamsburg Hospitality House to One Realco Hotel for $19.5
million, receiving $250,000 after debt assumption and providing purchase money financing of $5.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal and interest beginning in
June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or classified the note as
nonperforming.



In August 2003, ARI sold the City Suites, Majestic, and Willows
hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires
semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has
not established reserves or classified the note as nonperforming.



In October
2003, ARI advanced $1.6 million to the Class A Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006. Interest due to ARI will be deducted from the
quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.



In October 2003, ARI purchased the Travelers land from IORI for $25.0 million, paying $1.9 million in cash and giving a wrap note payable to IORI for $22.8 million. The
note does not have a stated interest rate, requires monthly payments sufficient to pay the installments due on the underlying debt and matures in October 2006. The principal is due at maturity.



24



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



The following table reconciles the beginning and ending balances of accounts payable to affiliates as of September
30, 2003.



|                                           |  | BCM |          |   | PRIME |   |         | IORI | 
|------------------------------------------ |  | --- | -------- | - | ----- | - | ------- | ---- | 
|Balance, December 31, 2002                 |  | $   | <15,245  | > |       | $ |        |      | 
|Cash transfers to affiliates               |  |     | 103,018  |   |       |   | 76,125  |      | 
|Cash transfers from affiliates             |  |     | <108,894 | > |       |   | <80,519 | >    | 
|Fees and reimbursements payable to Advisor |  |     | <2,446   | > |       |   |        |      | 
|Other additions                            |  |     | 63,640   |   |       |   | 8,030   |      | 
|Other repayments                           |  |     | <28,943  | > |       |   | <26,583 | >    | 
|                                           |  |     |          |   |       |   |         |      | 
|Balance, September 30, 2003 (Update)       |  | $   | 11,130   |   |       | $ | <22,947 | >    | 
|                                           |  |     |          |   |       |   |         |      | 



Also at September 30, 2003, ARI owed
$1.5 million to affiliates related to cash received upon the sale of apartments to Metra.



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 loss of investees, equity in gain <loss> on sale of real estate by equity investees, loss on sale of investments in equity investees and other income which totaled $314,000 and $<4.1> million for the three and nine
months ended September 30, 2003 and $2.0 million and $858,000 for 2002. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, incentive fees, advisory fees,
net income fees, writedown of assets held for sale and discontinued operations which totaled $13.2 million and $35.2 million for the three and nine months ended September 30, 2003 and $6.2 million and $21.1 million for 2002. Excluded from operating
segment assets are assets of $93.4 million in 2003 and $125.8 million in 2002, 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 June 2003, and Hotel Academia (Poland), which began operations
in 2002.



Presented below are ARIs reportable segments operating income
for the three and nine months ended September 30, 2003 and 2002, and segment assets at September 30, 2003 and 2002.



|Three Months EndedSeptember 30, 2003 |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|------------------------------------ |  | -------------------- | ------- | ---------- | - | ------- |  | ---- | ------ |  | ------------ | ------- | ----------------- |  | - | ------
|Operating revenue                    |  | $                    | 20,838  |            | $ | 22,076  |  | $    | 6,736  |  | $            | 212     |                   |  | $ | 8,330 
|Interest income                      |  |                      |        |            |   |        |  |      |       |  |              |        |                   |  |   |      
|Operating expenses                   |  |                      | 11,595  |            |   | 16,383  |  |      | 4,929  |  |              | 1,445   |                   |  |   | 6,592 
|                                     |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |       
|Operating income <loss>              |  | $                    | 9,243   |            | $ | 5,693   |  | $    | 1,807  |  | $            | <1,233  | >                 |  | $ | 1,738 
|                                     |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |       
|Depreciation                         |  | $                    | 4,708   |            | $ | 1,587   |  | $    | 494    |  | $            |        |                   |  | $ | 347   
|Interest                             |  |                      | 6,787   |            |   | 7,066   |  |      | 738    |  |              | 4,959   |                   |  |   | 336   
|Capital expenditures                 |  |                      | 2,621   |            |   | 3,948   |  |      | 1,154  |  |              | 607     |                   |  |   | 111   
|Assets                               |  |                      | 345,044 |            |   | 357,543 |  |      | 57,214 |  |              | 250,857 |                   |  |   | 22,316
|                                     |  |                      |         |            |   |         | 
|Property Sales:                      |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  |              |         |                   |  |   | Total 
|Sales price                          |  | $                    | 58,615  |            | $ | 16,493  |  | $    | 33,000 |  | $            | 27,551  |                   |  |   |       
|Cost of sale                         |  |                      | 49,095  |            |   | 7,928   |  |      | 28,507 |  |              | 12,080  |                   |  |   |       
|Deferred current gain                |  |                      |        |            |   |        |  |      | 4,356  |  |              |        |                   |  |   |       
|Recognized prior deferred gain       |  |                      |        |            |   |        |  |      |       |  |              | 27      |                   |  |   |       
|                                     |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |       
|Gain on sale                         |  | $                    | 9,520   |            | $ | 8,565   |  | $    | 137    |  | $            | 15,498  |                   |  |   |       
|                                     |  |                      |         |            |   |         |  |      |        |  |              |         |                   |  |   |       



25



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



|Three Months EndedSeptember 30, 2002 |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  | PizzaParlors |         | Receivables/Other  |  |   | Total 
|------------------------------------ |  | -------------------- | ------- | ---------- | - | ------- |  | - | ------ | - |  | ------------ | ------- | ------------------ |  | - | ------
|Operating revenue                    |  | $                    | 5,380   |            | $ | 6,902   |  | $ | 5,759  |   |  | $            | 16      |                    |  | $ | 8,157 
|Interest income                      |  |                      |        |            |   |        |  |   |       |   |  |              |        |                    |  |   |      
|Operating expenses                   |  |                      | 2,976   |            |   | 4,695   |  |   | 4,196  |   |  |              | 1,358   |                    |  |   | 6,528 
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Operating income <loss>              |  | $                    | 2,404   |            | $ | 2,207   |  | $ | 1,563  |   |  | $            | <1,342  | >                  |  | $ | 1,629 
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Depreciation                         |  | $                    | 888     |            | $ | 528     |  | $ | 421    |   |  | $            |        |                    |  | $ | 295   
|Interest                             |  |                      | 1,664   |            |   | 1,766   |  |   | 850    |   |  |              | 4,617   |                    |  |   | 212   
|Capital expenditures                 |  |                      | 5,194   |            |   | 211     |  |   | 387    |   |  |              | 759     |                    |  |   | 810   
|Assets                               |  |                      | 139,870 |            |   | 92,294  |  |   | 90,084 |   |  |              | 181,791 |                    |  |   | 21,877
|                                     |  |                      |         |            |   |         | 
|Property Sales:                      |  |                      |         | Apartments |   |         |  |   | Land   |   |  |              |         |                    |  |   | Total 
|Sales price                          |  |                      |         |            | $ | 28,072  |  |   |        |   |  | $            | 18,681  |                    |  |   |       
|Cost of sale                         |  |                      |         |            |   | 12,697  |  |   |        |   |  |              | 16,097  |                    |  |   |       
|Deferred current gain                |  |                      |         |            |   |        |  |   |        |   |  |              |        |                    |  |   |       
|Recognized prior deferred gain       |  |                      |         |            |   |        |  |   |        |   |  |              | 34      |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Gain on sale                         |  |                      |         |            | $ | 15,375  |  |   |        |   |  | $            | 2,618   |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|                                     |  |                      |         |            |   |         | 
|Nine Months Ended September 30, 2003 |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  | PizzaParlors |         | Receivables/ Other |  |   | Total 
|Operating revenue                    |  | $                    | 47,092  |            | $ | 49,596  |  | $ | 18,003 |   |  | $            | 400     |                    |  | $ | 24,267
|Interest income                      |  |                      |        |            |   |        |  |   |       |   |  |              |        |                    |  |   |      
|Operating expenses                   |  |                      | 26,764  |            |   | 35,535  |  |   | 13,307 |   |  |              | 4,705   |                    |  |   | 19,357
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Operating income <loss>              |  | $                    | 20,328  |            | $ | 14,061  |  | $ | 4,696  |   |  | $            | <4,305  | >                  |  | $ | 4,910 
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Depreciation                         |  | $                    | 10,133  |            | $ | 3,817   |  | $ | 1,134  |   |  | $            |        |                    |  | $ | 1,041 
|Interest                             |  |                      | 15,735  |            |   | 15,597  |  |   | 1,547  |   |  |              | 13,074  |                    |  |   | 738   
|Capital expenditures                 |  |                      | 4,316   |            |   | 13,532  |  |   | 2,245  |   |  |              | 1,332   |                    |  |   | 1,397 
|Assets                               |  |                      | 345,044 |            |   | 357,543 |  |   | 57,214 |   |  |              | 250,857 |                    |  |   | 22,316
|                                     |  |                      |         |            |   |         | 
|Property Sales:                      |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  |              |         |                    |  |   | Total 
|Sales price                          |  | $                    | 87,849  |            | $ | 45,063  |  | $ | 63,062 |   |  | $            | 39,654  |                    |  |   |       
|Cost of sale                         |  |                      | 60,127  |            |   | 28,874  |  |   | 58,758 |   |  |              | 23,150  |                    |  |   |       
|Deferred current gain                |  |                      | 9,818   |            |   |        |  |   | 4,356  |   |  |              |        |                    |  |   |       
|Recognized prior deferred gain       |  |                      |        |            |   |        |  |   |       |   |  |              | 19,924  |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Gain <loss> on sale                  |  | $                    | 17,904  |            | $ | 16,189  |  | $ | <52    | > |  | $            | 36,428  |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|                                     |  |                      |         |            |   |         | 
|Nine Months EndedSeptember 30, 2002  |  | CommercialProperties |         | Apartments |   | Hotels  |  |   | Land   |   |  | PizzaParlors |         | Receivables/ Other |  |   | Total 
|Operating revenue                    |  | $                    | 17,462  |            | $ | 19,283  |  | $ | 15,664 |   |  | $            | 76      |                    |  | $ | 23,979
|Interest income                      |  |                      |        |            |   |        |  |   |       |   |  |              |        |                    |  |   |      
|Operating expenses                   |  |                      | 10,504  |            |   | 12,653  |  |   | 11,799 |   |  |              | 5,438   |                    |  |   | 18,821
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Operating income <loss>              |  | $                    | 6,958   |            | $ | 6,630   |  | $ | 3,865  |   |  | $            | <5,362  | >                  |  | $ | 5,158 
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Depreciation                         |  | $                    | 2,431   |            | $ | 1,556   |  | $ | 1,131  |   |  | $            |        |                    |  | $ | 835   
|Interest                             |  |                      | 5,279   |            |   | 6,238   |  |   | 1,852  |   |  |              | 16,013  |                    |  |   | 631   
|Capital expenditures                 |  |                      | 12,227  |            |   | 759     |  |   | 745    |   |  |              | 2,064   |                    |  |   | 2,034 
|Assets                               |  |                      | 139,870 |            |   | 92,294  |  |   | 90,084 |   |  |              | 181,791 |                    |  |   | 21,877
|                                     |  |                      |         |            |   |         | 
|Property Sales:                      |  | CommercialProperties |         | Apartments |   |         |  |   | Land   |   |  |              |         |                    |  |   | Total 
|Sales price                          |  | $                    | 52,302  |            | $ | 50,769  |  |   |        |   |  | $            | 55,980  |                    |  |   |       
|Cost of sale                         |  |                      | 46,540  |            |   | 27,629  |  |   |        |   |  |              | 38,916  |                    |  |   |       
|Deferred current gain                |  |                      | 5,762   |            |   |        |  |   |        |   |  |              | 11,913  |                    |  |   |       
|Recognized prior deferred gain       |  |                      |        |            |   |        |  |   |        |   |  |              | 830     |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       
|Gain on sale                         |  | $                    |        |            | $ | 23,140  |  |   |        |   |  | $            | 5,981   |                    |  |   |       
|                                     |  |                      |         |            |   |         |  |   |        |   |  |              |         |                    |  |   |       



26



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 10. DISCONTINUED OPERATIONS



Effective January 1, 2002, ARI adopted Financial Accounting Standards Board Statement 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 properties intended to be sold are to be designated
as held-for-sale on the balance sheet.



For the three and nine
months ended September 30, 2003 and 2002, income from discontinued operations relates to 23 properties and leasehold interest in oil and gas properties that ARI sold during 2002 and 29 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, |  
|--------------------------------------------------------- |  | --------------------------------------- | ------ | - | -------------------------------------- | -
|                                                          |  | 2003                                    |        |   | 2002                                   |  
|Revenue                                                   |  |                                         |        |   |                                        |  
|Rental                                                    |  | $                                       | 4,248  |   |                                        | $
|Property operations                                       |  |                                         | 4,009  |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|                                                          |  |                                         | 239    |   |                                        |  
|Expenses                                                  |  |                                         |        |   |                                        |  
|Interest                                                  |  |                                         | 1,276  |   |                                        |  
|Depreciation                                              |  |                                         | 420    |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|                                                          |  |                                         | 1,696  |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|Net loss from discontinued operations                     |  |                                         | <1,457 | > |                                        |  
|Gain on sale of real estate                               |  |                                         | 18,222 |   |                                        |  
|                                                          |  |                                         |        |  
|Equity in gain on sale of real estate by equity investees |  |                                         | <165   | > |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|Net income from discontinued operations                   |  | $                                       | 16,600 |   |                                        | $
|                                                          |  |                                         |        |   |                                        |  



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. COMMITMENTS AND CONTINGENCIES



Liquidity. Management expects that excess cash generated from operations during the
remainder of 2003 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.



Commitments.During 2002, 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 $1.2 million at September 30, 2003. In July 2003, ARI sold its
interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million (see NOTE 3. NOTES RECEIVABLE). ARI owns 20% of Gruppa, thereby retaining a 20%
interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARIs continuing ownership interest in MRI, management has
determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.



ARI has entered into an agreement with one of the investors in the Realty Korea CR-REIT Co.
Ltd. No. 1 (REIT), that is advised by RAK, whereby the investor has been granted the opportunity to require ARI to buy their shares in the REIT twelve months after the closing of the REIT offering for their original investment amount.
Their investment is approximately $4.2 million.



Litigation.In August
2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (Matisse). However, the judge set aside the jury verdict and imposed a judgment against ARI in excess of
$6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARIs management and legal counsel, there is a



27



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



reasonable probability that the adverse judgment will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor
established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In
April 2003, an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003. ARI has not recognized any expense nor established any reserve for this
additional judgment.



In September 2001, ARI obtained a security loan in the
amount of $20.0 million from Sunset Management, LLC (Sunset). ARI received net cash of $16.1 million after the payment of various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the
same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20% per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries
of ARI. The loan required monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute
collateral for the shares of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in litigation filed in Texas state court during October 2002, styled American Realty Trust, Inc., ARTWilliamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management, LLC, et al.,Cause No. 02-09433-I in the 162nd Judicial Court of Dallas County, Texas. See NOTE 7. MARGIN BORROWINGS.



In addition to Matisse and Sunset, 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.



28



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



Introduction



ARIs predecessor was organized in 1961 to provide investors with a professionally managed, diversified portfolio of equity real estate
and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income.



On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. (TCI), and Income Opportunity Realty Investors, Inc. (IORI) jointly announced a
preliminary agreement with the plaintiffs legal counsel of the derivative action entitled Olive et al. V. National Income Realty Trust, et al. for complete settlement of all disputes in the lawsuit (the Olive Litigation). In
February 2002, the court granted final approval of the proposed settlement (the Olive Settlement). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for
a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offer for the IORI and TCI shares. 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 held by non-affiliated stockholders. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares. The
completion of the tender offer fulfills the obligations under the Olive Settlement, and the Olive Litigation has been dismissed with prejudice.



After the tender offer, ARI owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI 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. Four of the directors of TCI and three of the directors of IORI also serve as
directors of ARI. Effective July 1, 2003, ARI and TCI have the same advisor.



On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with Basic Capital Management, Inc. (BCM), receiving 650,000 TCI shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of
$526,000 (see NOTE 3. NOTES RECEIVABLE). After the exchange, ARI 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 RECEIVABLE). After the transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI
shares. At September 30, 2003, ARI owned 18.4% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



On June 30, 2003, ARI sold its 74.31% interest in Realty Advisors Korea, Ltd. (RAK) to Realty Advisors, Inc. (Realty
Advisors), a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price paid by ARI to purchase the 74.31% interest in RAK in 2002. The $6.0 million sales price
reduced ARIs affiliate debt. The $600,000 interest was received in cash in August 2003.



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



In July 2003, ARI sold its
interest in Milano Restaurants International Corporation (MRI) to Gruppa Florentina, LLC (Gruppa), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million
(see NOTE 3. NOTES RECEIVABLE). ARI owns 20% of Gruppa, thereby retaining a 20% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa.
Due to the debt guarantees and ARIs continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus
accrued and unpaid interest, to reduce affiliate debt.



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 judgements. 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.



29



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



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 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.



Liquidity and Capital Resources



ARI reported net income of $12.2 million for the nine months ended September 30, 2003, which included the following non-cash charges and credits: depreciation and
amortization from real estate held for investment of $18.3 million, gain on sale of real estate of $70.3 million and equity in loss of equity investees of $4.3 million. Net cash used in operating activities amounted to $26.9 million for the nine
months ended September 30, 2003, interest receivable increased by $4.0 million due to additional notes receivable from seller financings, other assets decreased by $10.2 million primarily due to reduced escrow deposits, interest payable increased by
$269,000 due to an increased balance of notes payable and other liabilities decreased by $759,000 primarily due to a decrease in security deposits and property taxes.



Net cash provided by investing activities of $113.2 million was primarily due to real estate acquisitions of $12.0 million, payments made
under interest rate swap contract of $31,000, additional fundings of notes receivable of $615,000, distributions to equity investees of $650,000, real estate improvements of $21.4 million, investments in real estate entities of $24.2 million,
earnest money deposits of $13.3 million and purchases of pizza parlor equipment of $1.4 million. These outflows for investing activities were offset by the collection of $26.0 million on notes receivable, $134.5 million from the sale of real estate
and $26.3 million from the sale of notes receivable.



Net cash used in
financing activities of $87.4 million was comprised of proceeds received from the funding or refinancing of notes payable of $82.3 million and advances from affiliates of $7.8 million; offset by cash payments of $186.1 million to paydown existing
notes payable, $5.4 million for financing costs and $1.8 million in dividends on Preferred Stock.



In 2003, ARI purchased the following properties:



|Property          |  | Location           |  | Units/Acres |  | PurchasePrice |       | NetCash Paid |   | DebtIncurred |  |   | InterestRate |     |  | MaturityDate
|----------------- |  | ------------------ |  | ----------- |  | ------------- | ----- | ------------ | - | ------------ |  | - | ------------ | --- |  | ------------
|First Quarter     |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Apartments        |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Capitol Hill(1)   |  | Little Rock, AR    |  | 156 Units   |  | $             | 1,904 |              | $ | 615          |  | $ | 1,289        |     |  | 5.50        
|                  |  |                    |  |             |  |               |      
|Second Quarter    |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Apartments        |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Breakwater Bay(1) |  | Beaumont, TX       |  | 176 Units   |  |               | 1,979 |              |   | 383          |  |   | 1,554        |     |  | 5.50        
|Longwood          |  | Long Beach, MS     |  | 200 Units   |  |               | 6,349 |              |   | 334          |  |   | 6,349        | (2) |  | 7.60        
|                  |  |                    |  |             |  |               |      
|Land              |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Pulaski           |  | Pulaski County, AR |  | 21.9 Acres  |  |               | 2,000 |              |   | 695          |  |   | 1,400        |     |  | 6.50        
|                  |  |                    |  |             |  |               |      
|Third Quarter     |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Land              |  |                    |  |             |  |               |       |              |   |              |  |   |              |     |  |             
|Sheffield Village |  | Grand Prairie, TX  |  | 13.9 Acres  |  |               | 1,500 |              |   | 632          |  |   | 975          |     |  | 5.50        

---

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



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



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



30



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



Liquidity and Capital Resources (Continued)



In February 1990, ARI sold the Bridgeview Plaza Shopping Center, located in LaCrosse,
Wisconsin, providing purchase money financing of $5.0 million in the form of a wrap mortgage. In 1996, the first lienholder called a default under the ARI wrap note, and directed future payments be made directly to them. ARI began legal proceedings
against the first lienholder. In December 1999, ARI sold the note to BCM at its carrying value of $489,000, retaining the right to receive any amounts collected by BCM in excess of the amount paid, plus accrued interest. In 2002, ARI prevailed in
its litigation and ARIs lien on the property was restored. The borrower continued in default, and ARI foreclosed on the property in March 2003. The property was subsequently sold to TCI. See NOTE 8. RELATED PARTY TRANSACTIONS.



In 2003, ARI sold the following properties:



|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                |    
|Georgetown            |  | Panama City, FL   |  | 44 Units                 |  |            | 1,175  |                         |   | 323   |                |  |   | 789                | (3)
|Northside Villas      |  | Tallahassee, FL   |  | 81 Units                 |  |            | 5,575  |                         |   | 1,806 |                |  |   | 2,784              |    
|Rolling Hills         |  | Tallahassee, FL   |  | 134 Units                |  |            | 5,061  |                         |   | 1,361 |                |  |   | 2,785              |    
|Seville               |  | Tallahassee, FL   |  | 62 Units                 |  |            | 2,795  |                         |   |      |                |  |   | 2,360              |    
|                      |  |                   |  |                          |  |           
|Shopping Centers      |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Bridgeview Plaza      |  | LaCrosse, WI      |  | 116,008 Sq.Ft.           |  |            | 8,700  |                         |   |      |                |  |   |                   |    
|Cullman               |  | Cullman, AL       |  | 92,466 Sq.Ft.            |  |            | 2,000  |                         |   |      |                |  |   | 2,650              | (3)
|                      |  |                   |  |                          |  |           
|Office Building       |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|4135 Beltline Road    |  | Addison, TX       |  | 90,000 Sq.Ft.            |  |            | 4,358  |                         |   |      |                |  |   | 2,858              | (3)
|                      |  |                   |  |                          |  |           
|Land                  |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Katrina               |  | Palm Desert, CA   |  | 89.3 Acres               |  |            | 8,550  |                         |   | <410  | >              |  |   | 2,840              |    
|Nashville             |  | Nashville, TN     |  | 8.8 Acres                |  |            | 235    |                         |   | <11   | >              |  |   | 217                |    
|                      |  |                   |  |                          |  |           
|Hotel                 |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Grand Hotel Sofia     |  | Sofia, Bulgaria   |  | 136 Rooms                |  |            | 24,750 |                         |   | 6,258 |                |  |   | 4,209              | (3)
|                      |  |                   |  |                          |  |           
|Second Quarter        |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Apartments            |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Greenbriar            |  | Tallahassee, FL   |  | 50 Units                 |  |            | 1,700  |                         |   | 594   |                |  |   | 976                |    
|Lake Chateau          |  | Thomasville, GA   |  | 98 Units                 |  |            | 1,600  |                         |   | 460   |                |  |   | 1,033              |    
|Pinecrest             |  | North Augusta, SC |  | 120 Units                |  |            | 2,707  |                         |   | 1,136 |                |  |   | 1,429              |    
|Regency               |  | Lincoln, NE       |  | 106 Units                |  |            | 4,880  |                         |   | 838   |                |  |   | 3,179              |    
|Willow Wick           |  | North Augusta, SC |  | 104 Units                |  |            | 2,707  |                         |   | 255   |                |  |   | 1,943              |    
|                      |  |                   |  |                          |  |           
|Industrial Warehouses |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|McLeod                |  | Orlando, FL       |  | 110,914 Sq.Ft.           |  |            | 5,450  |                         |   | 2,980 |                |  |   | 1,902              |    
|Tricon                |  | Atlanta, GA       |  | 570,877 Sq.Ft.           |  |            | 13,084 |                         |   | 3,364 |                |  |   | 9,395              |    
|                      |  |                   |  |                          |  |           
|Land                  |  |                   |  |                          |  |            |        |                         |   |       |                |  |   |                    |    
|Mason Goodrich        |  | Houston, TX       |  | 8.0 Acres                |  |            | 210    |                         |   |      | (5)            |  |   |                   |    
|Mason Goodrich        |  | Houston, TX       |  | 1.6 Acres                |  |            | 209    |                         |   | 12    |                |  |   | 169                |    
|Mason Goodrich        |  | Houston, TX       |  | 7.7 Acres                |  |            | 900    |                         |   | 36    |                |  |   | 764                |    



31



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



Liquidity and Capital Resources (Continued)



|Property                       |  | Location           |  | Units/Sq.Ft./Acres/Rooms |  | SalesPrice |        | NetCashReceived/(Paid) |   |       | DebtDischarged |  |   | Gain/(Loss)on Sale |    
|------------------------------ |  | ------------------ |  | ------------------------ |  | ---------- | ------ | ---------------------- | - | ----- | -------------- |  | - | ------------------ | ---
|Second Quarter (Continued)     |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Land (Continued)               |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Solco-Valley                   |  | Farmers Branch, TX |  | 6.1 Acres                |  | $          | 1,999  |                        | $ | <90   | >(7)           |  | $ |                   |    
|                               |  |                    |  |                          |  |           
|Hotel                          |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Clarion KC Airport(6)          |  | Kansas City, MO    |  | 196 Rooms                |  |            | 5,312  |                        |   |      |                |  |   | 4,888              | (3)
|                               |  |                    |  |                          |  |           
|Third Quarter                  |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Apartments                     |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Landings & Marina              |  | Pensacola, FL      |  | 52 Units                 |  |            | 1,825  |                        |   | 576   |                |  |   | 1,162              |    
|Lincoln Court                  |  | Dallas, TX         |  | 55 Units                 |  |            | 3,038  |                        |   | 1,834 |                |  |   | 1,208              |    
|Quail Creek                    |  | Lawrence, KS       |  | 95 Units                 |  |            | 4,700  |                        |   | 1,188 |                |  |   | 3,260              |    
|Stone Oak                      |  | San Antonio, TX    |  | 252 Units                |  |            | 6,930  |                        |   | 3,670 |                |  |   | 2,699              |    
|                               |  |                    |  |                          |  |           
|Office Buildings               |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Bonita Plaza                   |  | Bonita, CA         |  | 47,777 Sq.Ft.            |  |            | 8,034  |                        |   | 1,698 |                |  |   | 5,944              |    
|Encino Executive Plaza         |  | Encino, CA         |  | 177,211 Sq.Ft.           |  |            | 37,040 |                        |   | 1,946 |                |  |   | 33,145             | (3)
|                               |  |                    |  |                          |  |           
|Shopping Center                |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Oak Tree Village               |  | Lubbock, TX        |  | 45,623 Sq.Ft.            |  |            | 3,366  |                        |   | 1,527 |                |  |   | 1,328              |    
|Sheboygan                      |  | Sheboygan, WI      |  | 74,532 Sq.Ft.            |  |            | 1,225  |                        |   | 669   |                |  |   | 569                |    
|Westwood                       |  | Tallahassee, FL    |  | 149, 855 Sq.Ft.          |  |            | 8,950  |                        |   | 5,045 |                |  |   | 1,880              |    
|                               |  |                    |  |                          |  |           
|Land                           |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Nashville                      |  | Nashville, TN      |  | 1.1 Acres                |  |            | 201    |                        |   | 9     |                |  |   | 170                |    
|Palm Desert                    |  | Palm Desert, CA    |  | 25.1 Acres               |  |            | 2,600  |                        |   | <88   | >(9)           |  |   |                   |    
|Pioneer Crossing               |  | Austin, TX         |  | 367.4 Acres              |  |            | 22,500 |                        |   | 4,948 |                |  |   |                   |    
|Vista Ridge                    |  | Lewisville, TX     |  | 14.5 Acres               |  |            | 2,250  |                        |   | 713   |                |  |   | 1,343              |    
|                               |  |                    |  |                          |  |           
|Property                       |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Hotels                         |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|City Suites                    |  | Chicago, IL        |  | 45 Rooms                 |  |            | 4,806  |                        |   | 89    |                |  |   | 4,081              | (3)
|Majestic                       |  | Chicago, IL        |  | 52 Rooms                 |  |            | 3,550  |                        |   | 66    |                |  |   | 2,448              | (3)
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms                |  |            | 19,500 |                        |   | 250   |                |  |   | 12,332             | (3)
|Willows                        |  | Chicago, IL        |  | 55 Rooms                 |  |            | 5,144  |                        |   | 95    |                |  |   | 4,054              | (3)
|                               |  |                    |  |                          |  |           
|Fourth Quarter                 |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Apartments                     |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Summerfield                    |  | Orlando, FL        |  | 224 Units                |  |            | 9,415  |                        |   | 4,845 |                |  |   | 4,476              |    
|                               |  |                    |  |                          |  |           
|Land                           |  |                    |  |                          |  |            |        |                        |   |       |                |  |   |                    |    
|Keller                         |  | Tarrant County, TX |  | 30.0 Acres               |  |            | 2,800  |                        |   | 2,676 |                |  |   |                   |    
|Pioneer Crossing               |  | Austin, TX         |  | 343.7 Acres              |  |            | 8,136  |                        |   | 3,479 |                |  |   |                   |    

|(1) | Sold to TCI to satisfy debt. Gain deferred until sale to unrelated party.
|--- | -------------------------------------------------------------------------



|(2) | Sold to Tacco Office Investors, Inc., a related party. Gain deferred until sale to unrelated
party.
|--- | ---------------------------------------------------------------------------------------------------



|(3) | Debt assumed by purchaser.
|--- | --------------------------



|(4) | Includes recognition of $3.1 million of accumulated foreign currency translation gains.
|--- | ---------------------------------------------------------------------------------------



|(5) | Cash of $210,000 was received by BCM and applied to ARIs affiliate debt.
|--- | -------------------------------------------------------------------------



|(6) | Sold to One Realco Hotel Investors, Inc. (One Realco Hotel), a related party.
|--- | -------------------------------------------------------------------------------



|(7) | Cash of $2.0 million was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------------



|(8) | Sold to One Realco Hotel. Gain deferred until sale to unrelated party.
|--- | ----------------------------------------------------------------------



|(9) | Cash of $2.6 million was received by Prime and applied to ARIs affiliate debt.
|--- | -------------------------------------------------------------------------------



32



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



Liquidity and Capital Resources (Continued)



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 is $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, ARI sold the
hotels to a related party (see NOTE 2. REAL ESTATE).



In May 2003,
the lender on one of ARIs commercial properties located in Texas 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 $6.5 million. In July
2003, the maturity date of the note was extended to December 2003.



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



|Property             |  | Location           |  | Units/ Acres/Sq. Ft |  | DebtIncurred |       |     | DebtDischarged |   | Net CashReceived/<Paid> |  |   | InterestRate |     |  | MaturityDate |    
|-------------------- |  | ------------------ |  | ------------------- |  | ------------ | ----- | --- | -------------- | - | ----------------------- |  | - | ------------ | --- |  | ------------ | ---
|First Quarter        |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Land                 |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Elm Fork             |  | Denton County, TX  |  | 101.0 Acres         |  | $            | 5,000 |     |                | $ | 1,551                   |  | $ | 2,885        |     |  | 10.750       | %  
|Nashville            |  | Nashville, TN      |  | 113.8 Acres         |  |              | 6,059 |     |                |   | 807                     |  |   | 4,725        |     |  | 14.000       |    
|Vineyards II         |  | Tarrant County, TX |  | 18.6 Acres          |  |              | 3,280 |     |                |   | 3,750                   |  |   | <583         | >   |  | 6.750        | (1)
|                     |  |                    |  |                     |  |              |      
|Apartments           |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Arlington Place      |  | Pasadena, TX       |  | 230 Units           |  |              | 1,500 |     |                |   |                        |  |   |             | (2) |  | 5.000        |    
|                     |  |                    |  |                     |  |              |      
|Second Quarter       |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Apartments           |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Plantation           |  | Tulsa, OK          |  | 138 Units           |  |              | 2,320 |     |                |   | 1,924                   |  |   | 173          |     |  | 5.600        |    
|                     |  |                    |  |                     |  |              |      
|Industrial Warehouse |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Ogden Industrial     |  | Ogden, UT          |  | 107,112 Sq.Ft.      |  |              | 1,800 |     |                |   |                        |  |   | 1,722        |     |  | 6.250        |    
|                     |  |                    |  |                     |  |              |      
|Shopping Centers     |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Bridgeview           |  | LaCrosse, WI       |  | 116,008 Sq.Ft.      |  |              | 6,500 |     |                |   |                        |  |   | 6,152        |     |  | 6.250        | (1)
|Cullman              |  | Cullman, AL        |  | 92,433 Sq.Ft.       |  |              | 1,700 |     |                |   | 2,650                   |  |   | 1,048        |     |  | 6.250        | (1)
|                     |  |                    |  |                     |  |              |      
|Land                 |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Katrina              |  | Palm Desert, CA    |  | 110.6 Acres         |  |              | 5,100 |     |                |   | 3,000                   |  |   | 1,795        |     |  | 6.250        | (1)
|Keller               |  | Tarrant County, TX |  | 30.1 Acres          |  |              | 2,016 | (4) |                |   | 450                     |  |   | 1,494        |     |  | 7.500        |    
|Lacy Longhorn        |  | Farmers Branch, TX |  | 17.1 Acres          |  |              |      | (4) |                |   |                        |  |   |             |     |  |             |    
|Las Colinas          |  | Las Colinas, TX    |  | 13.0 Acres          |  |              |      | (4) |                |   |                        |  |   |             |     |  |             |    
|Mason Goodrich       |  | Houston, TX        |  | 84.0 Acres          |  |              | 3,750 |     |                |   | 757                     |  |   | 2,850        |     |  | 6.250        | (1)
|McKinney Corners II  |  | Collin County, TX  |  | 11.0 Acres          |  |              |      | (4) |                |   |                        |  |   |             |     |  |             |    
|Nashville            |  | Nashville, TN      |  | 113.8 Acres         |  |              | 941   |     |                |   |                        |  |   | 737          |     |  | 14.000       |    
|Thompson             |  | Farmers Branch, TX |  | 3.3 Acres           |  |              |      | (4) |                |   |                        |  |   |             |     |  |             |    
|Tomlin               |  | Farmers Branch, TX |  | 9.0 Acres           |  |              |      | (4) |                |   |                        |  |   |             |     |  |             |    
|                     |  |                    |  |                     |  |              |      
|Third Quarter        |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Apartments           |  |                    |  |                     |  |              |       |     |                |   |                         |  |   |              |     |  |              |    
|Tree House           |  | Irving, TX         |  | 160 Units           |  |              | 5,100 |     |                |   | 2,518                   |  |   | 2,132        |     |  | 5.000        | (1)
|Windsor Tower        |  | Ocala, FL          |  | 64 Units            |  |              | 2,000 |     |                |   | 1,989                   |  |   | <104>        |     |  | 4.750        |    



33



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



Liquidity and Capital Resources (Continued)



|Property       |  | Location          |  | Units/ Acres/Sq. Ft |  | DebtIncurred |       | DebtDischarged |   | Net CashReceived/<Paid> |  |   | InterestRate |   |  | MaturityDate
|-------------- |  | ----------------- |  | ------------------- |  | ------------ | ----- | -------------- | - | ----------------------- |  | - | ------------ | - |  | ------------
|Fourth Quarter |  |                   |  |                     |  |              |       |                |   |                         |  |   |              |   |  |             
|Land           |  |                   |  |                     |  |              |       |                |   |                         |  |   |              |   |  |             
|Las Colinas    |  | Las Colinas, TX   |  | 55.7 Acres          |  | $            | 6,885 |                | $ | 17,338                  |  | $ | <11,622      | > |  | 7.000       
|Rasor          |  | Plano, TX         |  | 23.7 Acres          |  |              | 1,260 |                |   |                        |  |   | 1,214        |   |  | 7.000       
|Valwood        |  | Dallas County, TX |  | 235.0 Acres         |  |              | 8,100 |                |   | 5,400                   |  |   | 1,745        |   |  | 7.000       

---

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

|(2) | Cash of $1.5 million was received by BCM and applied to ARIs affiliate debt.
|--- | -----------------------------------------------------------------------------

|(3) | Paid in July 2003.
|--- | ------------------

|(4) | Single note, with all properties as collateral.
|--- | -----------------------------------------------



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 5.00% to 24.0%. Margin borrowing totaled $25.2 million at
September 30, 2003.



Management expects that it will be necessary for ARI to
sell $102.0 million, $34.1 million and $1.2 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 was not able to extend such debt, ARI would either sell other of its assets to pay such debt or transfer the property to the lender.



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 March 2003, ARI sold the Bridgeview Plaza and Cullman shopping centers to TCI for $10.7 million to satisfy debt. TCI assumed debt of $2.7 million on Cullman. TCI
received $5.1 million cash on the subsequent financing of the shopping centers.



In April 2003, ARI paid $2.0 million in principal and accrued interest to IORI, in partial payment of a note payable on the Rosedale Tower Office Building. See NOTE 6. NOTES PAYABLE.



In May 2003, ARI sold the Clarion Kansas City Airport Hotel to One Realco Hotel for $5.3
million. No cash was received or paid by ARI, after debt assumption and providing purchase money financing of $400,000. The note bore interest at 12.0% per annum, matured in May 2004 and required quarterly interest payments beginning in June 2003.
In August 2003, the hotel was sold through foreclosure proceedings. ARI is pursuing collection of the note from One Realco Hotel. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11.



On June 2, 2003, ARI exchanged all of its 674,971 IORI shares with BCM, receiving 650,000 TCI
shares from BCM. In addition, BCM has executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. NOTES RECEIVABLE). After the exchange, ARI 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 RECEIVABLE). After the
transaction, ARI owned 76.8% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At September 30, 2003, ARI owned 18.4% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts
and operations effective June 2, 2003.



34



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



Related Party Transactions (Continued)



In June 2003, ARI received funds of $757,000 from an affiliate reducing the affiliate
receivable. The funds paid down a note secured by undeveloped land in Harris County, Texas.



On June 30, 2003, ARI sold its 73.41% interest in RAK to Realty Advisors, a related party. The sales price was $6.0 million. Realty Advisors also paid ARI $600,000, representing 10% interest on the $6.0 million price
paid by ARI to purchase the 73.41% interest in RAK in 2002. The $6.0 million sales price reduced ARIs affiliate debt. The $600,000 interest was received in cash in August 2003.



In July 2003, ARI sold its interest in MRI to Gruppa for $18.5 million, receiving $7.4 million in cash after debt assumption and providing
purchase money financing of $2.3 million (see NOTE 1. BASIS OF PRESENTATION). The loan bears interest at 10.0% per annum, matures in August 2013 and requires monthly payments of principal and interest beginning in September 2003. ARI
owns 20% of Gruppa, thereby retaining a 20% interest in MRI. Due to debt guarantees and ARIs continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI
sold the note to Syntek West for $2.3 million, plus accrued but unpaid interest, to reduce affiliate debt.



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



In July 2003, ARI paid $3.1 million to BCM for prior years legal fees incurred by Gene Phillips. Mr. Phillips is a related party and
advisor to ARI.



In August 2003, ARI sold the Williamsburg Hospitality House to
One Realco Hotel for $19.5 million, receiving $250,000 after debt assumption and providing purchase money financing of $5.7 million. The note bears interest at 12.0% per annum, matures in August 2006 and requires semi-annual payments of principal
and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note; therefore, management has not established reserves or
classified the note as nonperforming.



In August 2003, ARI sold the City
Suites, Majestic and Willows hotels to One Realco Hotel for $13.5 million in a single transaction, receiving $250,000 after debt assumption and providing purchase money financing of $2.7 million. The note bears interest at 12.0% per annum, matures
in August 2006 and requires semi-annual payments of principal and interest beginning in June 2004. In September 2003, One Realco Hotel filed for bankruptcy protection under Chapter 11. The parent company of One Realco Hotel has guaranteed the note;
therefore, management has not established reserves or classified the note as nonperforming.



In October 2003, ARI advanced $1.6 million to the Class A Limited Partners of Encino Executive Plaza, Ltd., of which ARI is the general partner. The loans bear interest at 8.5% per annum and mature in June 2006.
Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principle is due at maturity.



In October 2003, ARI purchased the Travelers land from IORI for $25.0 million, paying $1.9
million in cash and giving a wrap note payable to IORI for $22.8 million. The note does not have a stated interest rate, requires monthly payments sufficient to pay the installments due on the underlying debt and matures in October 2006. The
principle is due at maturity.



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, 2003, ARI reported net income of
$12.2 million, compared to a net loss of $16.7 million for the nine months ended September 30, 2002. The primary factors contributing to ARIs net income are discussed in the following paragraphs.



Rents increased to $49.9 million and $116.7 million in the three and nine months ended
September 30, 2003, from $18.0 million and $52.9 million in 2002. Rents from commercial properties increased to $47.1 million for the nine months ended September 30, 2003, from $17.5 million in 2002, rent from hotels increased to $18.0 million in
the nine months ended September 30, 2003, from $15.7 million in 2002 and rent from apartments increased to $49.6 million in the nine months ended September 30, 2003, from $19.3 million in 2002. The increase in rents was primarily attributable to the
consolidation of TCIs operations by ARI effective March 31, 2003,



35



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



Results of Operations (Continued)



following ARIs acquisition of more than 50% of TCIs common stock. Without the effect of the consolidation of TCIs operations, rents
increased to $20.0 million and $58.9 million in the three and nine months ended September 20, 2003. The increase was primarily attributable to increased apartment rents, due to the acquisition of two apartments and the construction of an apartment
in 2002.



Property operations expense increased to $34.4 million and $80.3
million in the three and nine months ended September 30, 2003, from $13.2 million and $40.5 million in 2002. Property operations expense for commercial properties increased to $26.8 million in the nine months ended September 30, 2003, from $10.5
million in 2002. For hotels, property operations expense increased to $13.3 million in the nine months ended September 30, 2003, from $11.8 million in 2002. For land, property operations expense decreased to $4.7 million in the nine months ended
September 30, 2003 from $5.4 million in 2002. For apartments, property operations expense increased to $35.5 million in the nine months ended September 30, 2003, from $12.7 million in 2002. The increase in commercial, hotel and apartment property
operations expense was primarily attributable to the consolidation of TCIs operations by ARI effective March 31, 2003, following ARIs acquisition of more than 50% of TCIs common shares. The decrease in land property operations
expense was primarily attributable to decreased real estate taxes as a result of land sales in 2002. Without the effect of the consolidation of TCIs operations, property operations expense increased to $14.6 million and $43.1 million in the
three and nine months ended September 30, 2003. The increase was primarily attributable to increased apartment operating expenses, due to the acquisition of two apartments and the construction of one apartment in 2002.



Pizza parlor sales and cost of sales of $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 approximated the $8.2 million and $6.5 million, respectively, in the three months ended September 30, 2002 and $24.0 million and
$18.8 million in the nine months ended September 30, 2002.



Interest income
increased to $1.8 million and $7.4 million in the three and nine months ended September 30, 2003 from $509,000 and $1.9 million in 2002. The increase was primarily attributable to the addition of $67.5 million of mortgage notes receivable in 2002.



Equity in loss of investees improved to $<204,000> and $<4.3>
million in the three and nine months ended September 30, 2003, from $<4.8> million and $<14.0> million in 2002. The improvement was primarily attributable to the consolidation of TCIs operations by ARI effective March 31, 2003,
following ARIs acquisition of more than 50% of TCIs common shares. Prior to March 31, 2003, and in 2002, ARIs equity in loss of investees included equity in TCIs operations.



Loss on the sale of investments in equity investees was $531,000 for the nine months ended
September 30, 2002. See NOTE 4. INVESTMENTS IN EQUITY INVESTEES.



Other income of $55,000 and $307,000 in the three and nine months ended September 30, 2003 approximated the $190,000 and $516,000 in the three and nine months ended September 30, 2002.



Interest expense increased to $20.9 million and $51.5 million in the three and nine months
ended September 30, 2003 from $12.0 million and $39.2 million in 2002. The increase is primarily attributable to the consolidation of TCIs operations by ARI effective March 31, 2003, following ARIs acquisition of more than 50% of
TCIs common shares. Without the effect of consolidation of TCIs operations, interest expense decreased to $10.0 million and $30.9 million in the three and nine months ended September 30, 2003. The decrease was primarily attributable to
reduced balances payable on stock loans and land mortgages.



Depreciation and
amortization expense increased to $7.1 million and $16.1 million in the three and nine months ended September 30, 2003, from $2.1 million and $6.0 million in 2002. The increase is primarily attributable to the consolidation of TCIs operations
by ARI effective March 31, 2003, following ARIs acquisition of more than 50% of TCIs common shares.



Discount on sale of notes receivable was $1.6 million in the nine months ended September 30, 2003. This represents the discount from the face amount given by ARI to
purchasers of notes receivable. See NOTE 3. NOTES RECEIVABLE.



General and administrative expenses increased to $6.1 million and $16.9 million in the three and nine months ended September 30, 2003, from $3.3 million and $9.8 million in 2002. The increase is primarily attributable to the consolidation
of TCIs operations by ARI effective March 31, 2003, following ARIs acquisition of more than 50% of TCIs common shares. In addition, the three and nine months of 2003 include $3.1 million of one-time reimbursements to BCM for legal
fees and $1.0 million for loss on foreign currency transaction.



36



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



Results of Operations (Continued)



Advisory fees increased to $3.7 million and $8.5 million in the three and nine months ended
September 30, 2003 from $1.6 million and $4.8 million in 2002. The increase is primarily attributable to the consolidation of TCIs operations by ARI effective March 31, 2003, following ARIs acquisition of more than 50% of TCIs
common shares.



Net income fee to affiliate was $675,000 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 2003 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 $2.4 million in the nine months ended September 30, 2003. 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 $20,000 and $1.2
million in the three and nine months ended September 30, 2003, from $436,000 and $2.0 million in 2002. The decrease is primarily attributable to reduced minority participation in ARI partnerships and in the consolidation of TCIs operations by
ARI effective March 31, 2003, following ARIs acquisition of more than 50% of TCIs common shares.



Net income from discontinued operations decreased to $16.6 million and $30.9 million in the three and nine months ended September 30, 2003 from $21.8 million and $34.1 million in 2002. The net income relates to 23
properties and leasehold interests in oil and gas properties that ARI sold during 2002 and 29 properties that ARI sold in 2003. The following table summarizes revenue and expense information for the properties sold.



|                                                          |  | For the Three MonthsEnded September 30, |        |   | For the Nine MonthsEnded September 30, |  
|--------------------------------------------------------- |  | --------------------------------------- | ------ | - | -------------------------------------- | -
|                                                          |  | 2003                                    |        |   | 2002                                   |  
|Revenue                                                   |  |                                         |        |   |                                        |  
|Rental                                                    |  | $                                       | 4,248  |   |                                        | $
|Property operations                                       |  |                                         | 4,009  |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|                                                          |  |                                         | 239    |   |                                        |  
|Expenses                                                  |  |                                         |        |   |                                        |  
|Interest                                                  |  |                                         | 1,276  |   |                                        |  
|Depreciation                                              |  |                                         | 420    |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|                                                          |  |                                         | 1,696  |   |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|Net loss from discontinued operations                     |  |                                         | <1,457 | > |                                        |  
|Gain on sale of real estate                               |  |                                         | 18,222 |   |                                        |  
|Equity in gain on sale of real estate by equity investees |  |                                         | <165   | > |                                        |  
|                                                          |  |                                         |        |   |                                        |  
|Net income from discontinued operations                   |  | $                                       | 16,600 |   |                                        | $
|                                                          |  |                                         |        |   |                                        |  



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 no taxable income after the use of NOL carryforwards or provision for income taxes in the three and nine months ended September 30, 2003 or 2002.



At September 30, 2003, ARI had a net deferred tax asset of $113.8 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.



37



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



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.



|ITEM 3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
|------- |  | -----------------------------------------------------------



At September 30, 2003, ARIs exposure to a change in interest rates on its debt is as follows:



|                                          |  | Balance |         | WeightedAverageInterest Rate |       |   | Effect of 1%Increase InBase Rates
|----------------------------------------- |  | ------- | ------- | ---------------------------- | ----- | - | ---------------------------------
|Notes payable:                            |  |         |         |                              |       |   |                                  
|Variable rate                             |  | $       | 226,737 |                              | 7.116 | % |                                  
|                                          |  |         |         |                              |       |   |                                  
|Total decrease in ARIs annual net income |  |         |         |                              |       |   |                                  
|                                          |  |         |         |                              |       |   |                                  
|Per share                                 |  |         |         |                              |       |   |                                  
|                                          |  |         |         |                              |       |   |                                  



|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-14. 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
|------- |  | -----------------



Matisse. In August 2002, ARI obtained a favorable jury verdict in the legal action entitled American Realty Trust v. Matisse Partners, L.L.C. (Matisse). However, the judge set aside the jury
verdict and imposed a judgment against ARI in excess of $6.0 million, including interest. The judgment is being appealed, and, in the opinion of ARIs management and legal counsel, there is a reasonable probability that the adverse judgment
will be set aside and the jury verdict reinstated. Therefore, ARI has not recognized any expense nor established any reserve for this judgment. In November 2002, ARI posted a $6.0 million supercedeas bond. In July 2003, ARI obtained a letter of
credit, which was substituted for the $6.0 million bond. The $6.0 million cash was returned to ARI. In April 2003,



38



---

an additional judgment was issued against ARI for $1.4 million in legal fees. ARI is also appealing this judgment and posted a $1.4 million bond in May 2003.
ARI has not recognized any expense nor established any reserve for this additional judgment.



Sunset Management.In September 2001, ARI obtained a security loan in the amount of $20.0 million from Sunset Management, LLC (Sunset). ARI received net cash of $16.1 million after the payment of
various closing costs and $3.4 million repayment of principal and accrued interest on an existing loan with the same lender. Of the total loan amount, $19.5 million bears interest at 24% per annum, while the remaining $500,000 bears interest at 20%
per annum. The loan is secured by 3,672,305 shares of TCI common stock held by BCM and wholly-owned subsidiaries of ARI. The loan was also secured by a lien on real property owned by ART Williamsburg, Inc. (AWI). The loan required
monthly payments of interest only and matured in September 2002. In September 2002, $15.0 million in principal was repaid. Sunset orally agreed in September 2002 to extend the maturity date of the loan and accept substitute collateral for the shares
of TCI common stock after the $15.0 million paydown. Sunset did not honor the agreement, which resulted in 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 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 a federal district court in Las Vegas, Nevada against
Commonwealth Land Title (Commonwealth) seeking disposition of the TCI common stock held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation, Sunset instigated a
separate lawsuit in state court in Nevada styled Sunset Management, LLC v. American Realty Trust, Inc. et al., Case No. A462587 pending in the 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 continued to seek to relitigate the underlying fact issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims
and counterclaims in the Texas Litigation and a renewed motion for preliminary injunction and appointment of receiver over TCI in the Nevada Litigation.



Sunset has sought expedited relief and an expedited hearing of the Texas Litigation, which the court refused to grant. The matter was set for a jury trial on December 8,
2003. In addition, the borrowers on the loan have sought to tender cash collateral to the court in lieu of the TCI stock, which motion was denied. TCI has only recently been added to the Texas Litigation as a party.



Even though the relief sought by Sunset in the Texas Litigation and the Nevada Litigation has
either been denied or stayed, on June 10, 2003, an attorney representing Sunset appeared at the Annual Meeting of Shareholders of TCI attempting to vote 3,673,115 Shares of common stock of TCI under purported irrevocable proxies against the election
of the four directors nominated in favor of the election of four affiliates of Sunset that Sunset seeks to nominate to serve as directors of TCI. The Inspector of Election at the Annual Meeting advised that Sunsets attempt to exercise voting
rights under proxies for the 3,673,115 shares was improper and would not be allowed, advising that BCM and the ARI subsidiaries held the absolute right to vote the 3,673,115 shares of TCI common stock so long as there was no event of default under
the Sunset loan agreement. The Inspector of Election also observed at the Stockholders meeting that no evidence was before the Inspector from a court of law finding an event of default had occurred with respect the Sunset loan documents, and
therefore, such proxies would not be honored at that time. Subsequently, representatives of Sunset delivered on July 7, 2003 to TCI a form captioned Schedule 13D for an event occurring June 10, 2003, making certain disclosures, including an
allegation that Sunset acquired voting rights to 3,673,115 shares of TCI to protect the value of Sunsets security interest in the 3,673,115 shares of TCI pledged as collateral for . . . obligations to Sunset. Actually, only
3,672,305 shares of TCI common stock were pledged [810 shares less than Sunset alleges]. Such schedule 13D also provides that Sunset plans to foreclose on the pledged TCI shares as soon as possible. Such Schedule 13D advises that
Sunset would prefer to replace the four management directors [of TCI] with neutral individuals . . . or if neutral individuals are unavailable, Sunset intends to nominate and [vote] for the election of affiliates of Sunset as directors of TCI
on an interim basis until neutral individuals with satisfactory backgrounds and knowledge can be elected as directors.



On September 10, 2003, AWI removed the Texas Litigation to the bankruptcy court for the Northern Division of Texas. On September 25, 2003, the Texas Litigation was
transferred to the Eastern District of Texas. The scheduling conference in this matter is set for December 3, 2003.



39



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



The annual meeting was held on August 26, 2003, at which stockholders were asked to consider and vote upon the election of Directors and a proposal that Article Fourth of
the Restated Articles of Incorporation of ARI be amended to eliminate the designation for Series B Convertible Preferred Stock. At the meeting, stockholders elected the following individuals as Directors:



|                |  | Shares Voting
|--------------- |  | -------------
|Director        |  | For          
|Henry A. Butler |  | 10,453,124   
|Earl D. Cecil   |  | 10,453,258   
|Ted P. Stokely  |  | 10,453,589   
|Martin L. White |  | 10,453,953   



There were no abstentions or broker
non-votes on the election of Directors.



Also at the meeting, the shareholders
voted on the amendment of Articles of Incorporation:



|Shares Voting
|-------------
|For          
|10,511,605   



|ITEM 6. |  | EXHIBITS AND REPORTS ON FORM 8-K
|------- |  | --------------------------------



|(a) | Exhibits:
|--- | ---------



|ExhibitNumber |  | Description                                                                                                                                                                                                                                                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|              | 
|3.3           |  | Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series B
Cumulative Convertible Preferred Stock dated as of August 26, 2003, filed herewith.
|              | 
|3.4           |  | Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series I
Cumulative Preferred Stock dates as of October 1, 2003, filed herewith.            
|              | 
|31.1          |  | Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
herewith.                                                                           
|              | 
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.                                                                                                                      



|(b) | Reports on Form 8-K as follows:
|--- | -------------------------------



A Current Report on Form 8-K, dated July 1, 2003, was filed with respect to Item 5. Other Events and Item 7. Financial Statements and
Exhibits, which reports the termination of ARIs Advisory Agreement with BCM, the establishment of ARIs Advisory Agreement with Prime Asset Management, Inc., the resignation of Richard W. Humphrey from the ARI Board of Directors and
the election of Henry A. Butler and Martin L. White as directors of ARI.



A Current Report on Form 8-K, dated July 7, 2003, was filed with respect to Item 5. Other Events, which reports the current litigation filed in Texas 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 pending in the 162nd Judicial District Court of Dallas County, Texas.



A Current Report on Form 8-K, dated July 14, 2003, was filed with respect to
Item 5. Other Events, which reports the resignation of Joseph Mizrachi from the ARI Board of Directors.



A Current Report on Form 8-K, dated August 11, 2003, was filed with respect to Item 2. Acquisition or Disposition of Assets and Item 7.
Financial Statements and Exhibits, which reports the disposition of 10 apartments, one commercial property, three hotels and five land parcels.



A Current Report on Form 8-K, dated October 1, 2003, was filed with respect to Item 5. Other Events and Item 7. Financial Statements and
Exhibits, which reports the assignment of ARIs Advisory Agreement with Prime to Prime LLC effective October 1, 2003.



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 14, 2003 |  |  |  | By:                            
|                        |  |  |  |                                
|                        |  |  |  |                                



41



---

AMERICAN REALTY INVESTORS, INC.



EXHIBITS TO



QUARTERLY REPORT ON FORM 10-Q



For the Quarter ended September 30, 2003



|ExhibitNumber |  | Description                                                                                                                                                                                                                                                   |  | PageNumber
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------
|              |  |                                                                                                                                                                                                                                                              
|3.3           |  | Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series B
Cumulative Convertible Preferred Stock dates as of August 26, 2003, filed herewith. |  |           
|              |  |                                                                                                                                                                                                                                                              
|3.4           |  | Articles of Amendment to the Restated Articles of Incorporation of American Realty Investors, Inc. decreasing the number of authorized shares of and eliminating Series I
Cumulative Preferred Stock dated as of October 1, 2003, filed herewith.             |  |           
|              |  |                                                                                                                                                                                                                                                              
|31.1          |  | Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                            |  |           
|              |  |                                                                                                                                                                                                                                                              
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                       |  |           



42