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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



FOR THE QUARTER ENDED MARCH 31, 2005



or



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



Commission File Number 001-15663



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AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Nevada                                                         |  | 75-2847135                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



|                                                |  |           
|----------------------------------------------- |  | ----------
|1800 Valley View Lane, Suite 300, Dallas, Texas |  | 75234     
|(Address of Principal Executive Offices)        |  | (Zip Code)



(469) 522-4200

(Registrants Telephone Number, Including Area Code)



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



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



APPLICABLE ONLY TO CORPORATE ISSUERS:



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



|                             |  |                               
|---------------------------- |  | ------------------------------
|Common Stock, $.01 par value |  | 10,149,000                    
|(Class)                      |  | (Outstanding at May 13, 2005)*



|* | 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



|                                                                                   |  |                                          |           |   |                   |   |           |  
|---------------------------------------------------------------------------------- |  | ---------------------------------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                   |  | March 31, 2005                           |           |   | December 31, 2004 |  
|                                                                                   |  | (dollars in thousands, except per share) |          
|Assets                                                                             |  |                                          |           |   |                   |   |           |  
|Real estate held for investment                                                    |  | $                                        | 883,380   |   |                   | $ | 877,677   |  
|Lessaccumulated depreciation                                                      |  |                                          | (157,376  | ) |                   |   | (157,138  | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 726,004   |   |                   |   | 720,539   |  
|                                                                                   |  |                                         
|Real estate held for sale, net of depreciation                                     |  |                                          | 175,284   |   |                   |   | 192,533   |  
|Real estate subject to sales contract                                              |  |                                          | 69,947    |   |                   |   | 70,350    |  
|                                                                                   |  |                                         
|Notes and interest receivable                                                      |  |                                          |           |   |                   |   |           |  
|Performing ($44,085 in 2005 and $43,605 in 2004 from affiliates)                   |  |                                          | 68,292    |   |                   |   | 67,894    |  
|Non-performing                                                                     |  |                                          | 2,449     |   |                   |   | 6,632     |  
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 70,741    |   |                   |   | 74,526    |  
|Lessallowance for estimated losses                                                |  |                                          | (1,865    | ) |                   |   | (1,865    | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 68,876    |   |                   |   | 72,661    |  
|                                                                                   |  |                                         
|Restaurant equipment                                                               |  |                                          | 13,535    |   |                   |   | 13,747    |  
|Lessaccumulated depreciation                                                      |  |                                          | (6,627    | ) |                   |   | (6,608    | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 6,908     |   |                   |   | 7,139     |  
|                                                                                   |  |                                         
|Marketable equity securities, at market value                                      |  |                                          | 7,344     |   |                   |   | 6,670     |  
|Cash and cash equivalents                                                          |  |                                          | 39,692    |   |                   |   | 22,401    |  
|Investments in equity investees                                                    |  |                                          | 8,577     |   |                   |   | 8,212     |  
|Goodwill, net of accumulated amortization ($1,763 in 2005 and 2004)                |  |                                          | 11,858    |   |                   |   | 11,858    |  
|Other intangibles, net of accumulated amortization ($883 in 2005 and $871 in 2004) |  |                                          | 1,507     |   |                   |   | 1,480     |  
|Other assets ($26,440 in 2005 and $27,704 in 2004 from affiliate)                  |  |                                          | 82,211    |   |                   |   | 77,000    |  
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  | $                                        | 1,198,208 |   |                   | $ | 1,190,843 |  
|                                                                                   |  |                                          |           |   |                   |   |           |  



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



|                                                                                                                                                                  |  |                                          |           |   |                   |   |           |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                  |  | March 31,2005                            |           |   | December 31, 2004 |  
|                                                                                                                                                                  |  | (dollars in thousands, except per share) |          
|Liabilities and Stockholders Equity                                                                                                                              |  |                                          |           |   |                   |   |           |  
|Liabilities                                                                                                                                                       |  |                                          |           |   |                   |   |           |  
|Notes and interest payable ($36,800 in 2005 and $36,298 in 2004 to affiliates)                                                                                    |  | $                                        | 735,843   |   |                   | $ | 722,985   |  
|Liabilities related to assets held for sale                                                                                                                       |  |                                          | 131,238   |   |                   |   | 156,959   |  
|Liabilities subject to sales contract                                                                                                                             |  |                                          | 59,808    |   |                   |   | 59,977    |  
|Margin borrowings                                                                                                                                                 |  |                                          | 18,627    |   |                   |   | 18,663    |  
|Accounts payable and other liabilities ($6,025 in 2005 and $2,557 in 2004 to affiliates)                                                                          |  |                                          | 69,531    |   |                   |   | 71,357    |  
|                                                                                                                                                                  |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                  |  |                                          | 1,015,047 |   |                   |   | 1,029,941 |  
|                                                                                                                                                                  |  |                                         
|Minority interest                                                                                                                                                 |  |                                          | 58,749    |   |                   |   | 57,893    |  
|                                                                                                                                                                  |  |                                         
|Commitments and contingencies                                                                                                                                     |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                  |  |                                         
|Stockholders equity                                                                                                                                              |  |                                          |           |   |                   |   |           |  
|Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding                                                                            |  |                                          |           |   |                   |   |           |  
|Series A, 3,469,346 shares in 2005 and 3,469,350 shares in 2004 (liquidation preference $34,693), including 900,000 shares in 2005 and 2004
held by subsidiaries. |  |                                          | 5,139     |   |                   |   | 5,139     |  
|Series E, 50,000 shares in 2005 and 2004 (liquidation preference $500)                                                                                            |  |                                          | 100       |   |                   |   | 100       |  
|Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,392,272 shares in 2005 and 2004                                                            |  |                                          | 114       |   |                   |   | 114       |  
|Treasury stock, at cost, 1,243,272 shares in 2005 and 2004                                                                                                        |  |                                          | (15,146   | ) |                   |   | (15,146   | )
|Paid-in capital                                                                                                                                                   |  |                                          | 91,139    |   |                   |   | 91,789    |  
|Retained earnings                                                                                                                                                 |  |                                          | 43,239    |   |                   |   | 22,561    |  
|Accumulated other comprehensive income (loss)                                                                                                                     |  |                                          | (173      | ) |                   |   | (1,548    | )
|                                                                                                                                                                  |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                  |  |                                          | 124,412   |   |                   |   | 103,009   |  
|                                                                                                                                                                  |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                  |  | $                                        | 1,198,208 |   |                   | $ | 1,190,843 |  
|                                                                                                                                                                  |  |                                          |           |   |                   |   |           |  



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 Months Ended March 31,     |       
|                                                                             |  | 2005                                     |        |   | 2004        |  
|                                                                             |  |                                          |        |   | As Restated |  
|                                                                             |  | (dollars in thousands, except per share) |       
|Property revenue                                                             |  |                                          |        |   |             |   |         |  
|Rents ($182 in 2005 and $321 in 2004 from affiliates)                        |  | $                                        | 40,957 |   |             | $ | 39,712  |  
|Property operations expenses ($1,644 in 2005 and $900 in 2004 to affiliates) |  |                                          | 28,819 |   |             |   | 27,779  |  
|                                                                             |  |                                          |        |   |             |   |         |  
|Operating income                                                             |  |                                          | 12,138 |   |             |   | 11,933  |  
|                                                                             |  |                                         
|Land operations                                                              |  |                                          |        |   |             |   |         |  
|Sales                                                                        |  |                                          | 52,305 |   |             |   | 30,194  |  
|Cost of sales                                                                |  |                                          | 28,127 |   |             |   | 21,283  |  
|Deferral of gains on current period sales                                    |  |                                          |       |   |             |   | 5,159   |  
|                                                                             |  |                                          |        |   |             |   |         |  
|Gain on land sales                                                           |  |                                          | 24,178 |   |             |   | 3,752   |  
|                                                                             |  |                                         
|Restaurant operations                                                        |  |                                          |        |   |             |   |         |  
|Sales                                                                        |  |                                          | 8,620  |   |             |   | 8,169   |  
|Cost of sales                                                                |  |                                          | 6,754  |   |             |   | 6,213   |  
|                                                                             |  |                                          |        |   |             |   |         |  
|Gross margin                                                                 |  |                                          | 1,866  |   |             |   | 1,956   |  
|                                                                             |  |                                         
|Income from operations                                                       |  |                                          | 38,182 |   |             |   | 17,641  |  
|                                                                             |  |                                         
|Other income                                                                 |  |                                          |        |   |             |   |         |  
|Interest income ($859 in 2005 and $688 in 2004 from affiliates)              |  |                                          | 1,590  |   |             |   | 1,049   |  
|Equity in income (loss) of investees                                         |  |                                          | 60     |   |             |   | (145    | )
|Other                                                                        |  |                                          | 106    |   |             |   | 627     |  
|                                                                             |  |                                          |        |   |             |   |         |  
|                                                                             |  |                                          | 1,756  |   |             |   | 1,531   |  
|                                                                             |  |                                         
|Other expenses                                                               |  |                                          |        |   |             |   |         |  
|Interest ($501 in 2005 and $642 in 2004 to affiliates)                       |  |                                          | 16,127 |   |             |   | 16,134  |  
|Depreciation and amortization                                                |  |                                          | 5,812  |   |             |   | 5,958   |  
|Discount on sale of notes receivable                                         |  |                                          |       |   |             |   | 398     |  
|General and administrative ($899 in 2005 and $857 in 2004 to affiliates)     |  |                                          | 2,736  |   |             |   | 4,634   |  
|Advisory fee to affiliate                                                    |  |                                          | 2,906  |   |             |   | 2,852   |  
|Net income fee to affiliate                                                  |  |                                          | 1,477  |   |             |   | 79      |  
|Minority interest                                                            |  |                                          | 921    |   |             |   | 1,184   |  
|                                                                             |  |                                          |        |   |             |   |         |  
|                                                                             |  |                                          | 29,979 |   |             |   | 31,239  |  
|                                                                             |  |                                          |        |   |             |   |         |  
|Net income (loss) from continuing operations                                 |  |                                          | 9,959  |   |             |   | (12,067 | )
|                                                                             |  |                                         
|Discontinued operations:                                                     |  |                                          |        |   |             |   |         |  
|Loss from operations                                                         |  |                                          | (268   | ) |             |   | (1,267  | )
|Gain on sale of real estate                                                  |  |                                          | 10,987 |   |             |   | 13,934  |  
|Equity in gain on sale of real estate by equity investees                    |  |                                          |       |   |             |   | 783     |  
|                                                                             |  |                                          |        |   |             |   |         |  
|Net income from discontinued operations                                      |  |                                          | 10,719 |   |             |   | 13,450  |  
|                                                                             |  |                                         
|Net income                                                                   |  |                                          | 20,678 |   |             |   | 1,383   |  
|Preferred dividend requirement                                               |  |                                          | (650   | ) |             |   | (650    | )
|                                                                             |  |                                          |        |   |             |   |         |  
|Net income applicable to Common shares                                       |  | $                                        | 20,028 |   |             | $ | 733     |  
|                                                                             |  |                                          |        |   |             |   |         |  



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 Months Ended March 31,     |           
|                                                                     |  | 2005                                     |            | 2004        |  
|                                                                     |  |                                          |            | As Restated |  
|                                                                     |  | (dollars in thousands, except per share) |           
|Basic earnings per share                                             |  |                                          |            |             |   |            |  
|Net income (loss) from continuing operations                         |  | $                                        | .91        |             | $ | (1.24      | )
|Correction of accounting error in prior (See Note 11.)               |  |                                          |           |             |   | .05        |  
|Discontinued operations                                              |  |                                          | 1.06       |             |   | 1.26       |  
|                                                                     |  |                                          |            |             |   |            |  
|Net income applicable to Common shares                               |  | $                                        | 1.97       |             | $ | .07        |  
|                                                                     |  |                                          |            |             |   |            |  
|Diluted earnings per share                                           |  |                                          |            |             |   |            |  
|Net income (loss) from continuing operations                         |  | $                                        | .77        |             | $ | (1.24      | )
|Correction of accounting error in prior (See Note 11.)               |  |                                          |           |             |   | .05        |  
|Discontinued operations                                              |  |                                          | .83        |             |   | 1.26       |  
|                                                                     |  |                                          |            |             |   |            |  
|Net income applicable to Common shares                               |  | $                                        | 1.60       |             | $ | .07        |  
|                                                                     |  |                                          |            |             |   |            |  
|Weighted average Common shares used in computing earnings per share: |  |                                          |            |             |   |            |  
|Basic                                                                |  |                                          | 10,149,000 |             |   | 10,644,666 |  
|Diluted                                                              |  |                                          | 12,907,309 |             |   | 10,644,666 |  



Convertible Preferred Stock (2,575,370
shares) and options to purchase 101,250 shares of ARIs Common Stock were excluded from the computation of diluted earnings per share for the three months ended March 31, 2004, 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 Three Months Ended March
31, 2005



|                                                |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  
|----------------------------------------------- |  | ---------------------------------------- | ----- | ------------------------ | - | ----------- |  | -------------- | --- |  | -------------- | ------- | - | ----------------- | - | ------------------------------------------ | - |  | ------------------- | ------ |  | - | ------ | - |  | - | ------- | -
|                                                |  | Series A Preferred Stock                 |       | Series E Preferred Stock |   | CommonStock |  | Treasury Stock |     |  | Paid-inCapital |         |   | Retained Earnings |   | AccumulatedOtherComprehensiveIncome/(Loss) |   |  | StockholdersEquity |       
|                                                |  | (dollars in thousands, except per share) |      
|Balance, January 1, 2005                        |  | $                                        | 5,139 |                          | $ | 100         |  | $              | 114 |  | $              | (15,146 | ) |                   | $ | 91,789                                     |   |  | $                   | 22,561 |  | $ | (1,548 | ) |  | $ | 103,009 |  
|                                                |  |                                          |       |                          |   |             |  |               
|Comprehensive income                            |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  
|Unrealized gain on foreign currency translation |  |                                          |      |                          |   |            |  |                |    |  |                |        |   |                   |   |                                           |   |  |                     |       |  |   | 706    |   |  |   | 706     |  
|Unrealized gain on marketable securities        |  |                                          |      |                          |   |            |  |                |    |  |                |        |   |                   |   |                                           |   |  |                     |       |  |   | 669    |   |  |   | 669     |  
|Net income                                      |  |                                          |      |                          |   |            |  |                |    |  |                |        |   |                   |   |                                           |   |  |                     | 20,678 |  |   |       |   |  |   | 20,678  |  
|                                                |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  
|                                                |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   | 22,053  |  
|                                                |  |                                          |       |                          |   |             |  |               
|Preferred dividends                             |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  
|Series A Preferred Stock ($.25 per share)       |  |                                          |      |                          |   |            |  |                |    |  |                |        |   |                   |   | (642                                       | ) |  |                     |       |  |   |       |   |  |   | (642    | )
|Series E Preferred Stock ($.15 per share)       |  |                                          |      |                          |   |            |  |                |    |  |                |        |   |                   |   | (8                                         | ) |  |                     |       |  |   |       |   |  |   | (8      | )
|                                                |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  
|Balance, March 31, 2005                         |  | $                                        | 5,139 |                          | $ | 100         |  | $              | 114 |  | $              | (15,146 | ) |                   | $ | 91,139                                     |   |  | $                   | 43,239 |  | $ | (173   | ) |  | $ | 124,412 |  
|                                                |  |                                          |       |                          |   |             |  |                |     |  |                |         |   |                   |   |                                            |   |  |                     |        |  |   |        |   |  |   |         |  



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 Three MonthsEnded March 31, |        
|                                                                                           |  | 2005                                |         |   | 2004 |  
|                                                                                           |  | (dollars in thousands)              |        
|Cash Flows From Operating Activities                                                       |  |                                     |         |   |      |   |          |  
|Net income                                                                                 |  | $                                   | 20,678  |   |      | $ | 1,383    |  
|Reconciliation of net income to net cash provided by (used in) operating activities        |  |                                     |         |   |      |   |          |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities |  |                                     |         |   |      |   |          |  
|Gain on sale of land and real estate                                                       |  |                                     | (35,165 | ) |      |   | (18,469  | )
|Depreciation and amortization                                                              |  |                                     | 5,861   |   |      |   | 7,694    |  
|Amortization of deferred borrowing costs                                                   |  |                                     | 2,072   |   |      |   | 1,832    |  
|Discount on sale of notes receivable                                                       |  |                                     |        |   |      |   | 398      |  
|Equity in (income) loss of investees                                                       |  |                                     | (60     | ) |      |   | 145      |  
|Decrease in accrued interest receivable                                                    |  |                                     | (336    | ) |      |   | 1,496    |  
|Decrease in other assets                                                                   |  |                                     | 3,613   |   |      |   | 3,994    |  
|Decrease in accrued interest payable                                                       |  |                                     | (888    | ) |      |   | (625     | )
|Increase (decrease) in accounts payable and other liabilities                              |  |                                     | (2,362  | ) |      |   | 9,300    |  
|Increase in minority interest                                                              |  |                                     | 619     |   |      |   | 324      |  
|                                                                                           |  |                                     |         |   |      |   |          |  
|Net cash (used in) provided by operating activities                                        |  |                                     | (5,968  | ) |      |   | 7,472    |  
|                                                                                           |  |                                    
|Cash Flows From Investing Activities                                                       |  |                                     |         |   |      |   |          |  
|Collections on notes receivable                                                            |  |                                     | 1,433   |   |      |   | 39       |  
|Proceeds from sale of notes receivable                                                     |  |                                     | 27,242  |   |      |   | 6,227    |  
|Acquisition of real estate                                                                 |  |                                     | (7,806  | ) |      |   | (19,943  | )
|Restaurant equipment purchased                                                             |  |                                     | (65     | ) |      |   | (467     | )
|Proceeds from sale of real estate                                                          |  |                                     | 38,869  |   |      |   | 64,442   |  
|Notes receivable funded                                                                    |  |                                     | (647    | ) |      |   | (65      | )
|Earnest money/escrow deposits                                                              |  |                                     | (671    | ) |      |   | (2,325   | )
|Real estate improvements                                                                   |  |                                     | (16,350 | ) |      |   | (55,836  | )
|Purchase of marketable securities                                                          |  |                                     |        |   |      |   | (321     | )
|Distribution from equity investees                                                         |  |                                     | 406     |   |      |   | 4        |  
|                                                                                           |  |                                     |         |   |      |   |          |  
|Net cash provided by (used in) investing activities                                        |  |                                     | 42,411  |   |      |   | (8,245   | )
|                                                                                           |  |                                    
|Cash Flows From Financing Activities                                                       |  |                                     |         |   |      |   |          |  
|Proceeds from notes payable                                                                |  |                                     | 38,688  |   |      |   | 129,181  |  
|Payments on notes payable                                                                  |  |                                     | (43,072 | ) |      |   | (126,661 | )
|Deferred borrowing costs                                                                   |  |                                     | (1,212  | ) |      |   | (2,934   | )
|Net advances from (payments to) affiliates                                                 |  |                                     | (13,288 | ) |      |   | 933      |  
|Repurchase of Common Stock                                                                 |  |                                     |        |   |      |   | (42      | )
|Margin borrowings (payments), net                                                          |  |                                     | (38     | ) |      |   | (447     | )
|Preferred dividends paid                                                                   |  |                                     | (230    | ) |      |   | (650     | )
|                                                                                           |  |                                     |         |   |      |   |          |  
|Net cash used in financing activities                                                      |  |                                     | (19,152 | ) |      |   | (620     | )
|                                                                                           |  |                                    
|Net increase (decrease) in cash and cash equivalents                                       |  |                                     | 17,291  |   |      |   | (1,393   | )
|                                                                                           |  |                                    
|Cash and cash equivalents, beginning of period                                             |  |                                     | 22,401  |   |      |   | 9,543    |  
|                                                                                           |  |                                     |         |   |      |   |          |  
|Cash and cash equivalents, end of period                                                   |  | $                                   | 39,692  |   |      | $ | 8,150    |  
|                                                                                           |  |                                     |         |   |      |   |          |  



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



7



---

AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWSContinued



|                                                        |  |                                     |        |      |   |       
|------------------------------------------------------- |  | ----------------------------------- | ------ | ---- | - | ------
|                                                        |  | For the Three MonthsEnded March 31,
|                                                        |  | 2005                                |        | 2004
|                                                        |  | (dollars in thousands)             
|Supplemental Disclosures of Cash Flow Information       |  |                                     |        |      |   |       
|Cash paid for interest                                  |  | $                                   | 17,068 |      | $ | 17,652
|                                                        |  |                                    
|Schedule of noncash investing and financing activities  |  |                                     |        |      |   |       
|Notes payable assumed by buyer on sale of real estate   |  | $                                   | 14,422 |      | $ | 9,014 
|Notes receivable from sale of real estate               |  |                                     | 27,242 |      |   | 10,448
|Acquisition of property in exchange for note receivable |  |                                     | 4,714  |      |   |      
|Issuance of Preferred Stock                             |  |                                     |       |      |   | 2,500 
|Note payable paid by affiliate                          |  |                                     | 700    |      |   | 10,823
|Refinancing proceeds received by affiliate              |  |                                     |       |      |   | 10,962



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



8



---

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 2004 have been reclassified to conform to the 2005 presentation. Hereafter in this
document, American Realty Investors, Inc. is referred to as ARI.



Operating
results for the three month period ended March 31, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004 (the 2004 Form 10-K).



At December 31, 2004 and March 31, 2005, ARI subsidiaries owned 82.2% of the outstanding shares of Transcontinental Realty Investors, Inc. (TCI). At March 31,
2005, ARI and TCI have the same advisor and Board of Directors.



At December
31, 2004 and March 31, 2005, ARI subsidiaries owned 20.4% of Income Opportunity Realty Investors, Inc. (IORI) through TCIs ownership of 24.9% of IORI shares. One director of ARI (Ted Stokely) also serves as a director of IORI.



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



|                                                                                                                                             |  |                             |        |      |   |    
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | ---- | - | ---
|                                                                                                                                             |  | Three Months EndedMarch 31,
|                                                                                                                                             |  | 2005                        |        | 2004
|Net income applicable to common shares, as reported                                                                                          |  | $                           | 20,028 |      | $ | 733
|                                                                                                                                             |  |                            
|Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax
effects |  |                             | 26     |      |   | 22 
|                                                                                                                                             |  |                             |        |      |   |    
|Pro forma net income applicable to common shares                                                                                             |  | $                           | 20,002 |      | $ | 711
|                                                                                                                                             |  |                             |        |      |   |    
|Earnings per share:                                                                                                                          |  |                             |        |      |   |    
|Basic, as reported                                                                                                                           |  | $                           | 1.97   |      | $ | .07
|Basic, pro forma                                                                                                                             |  | $                           | 1.97   |      | $ | .07
|                                                                                                                                             |  |                            
|Diluted, as reported                                                                                                                         |  | $                           | 1.60   |      | $ | .07
|Diluted, pro forma                                                                                                                           |  | $                           | 1.60   |      | $ | .07



9



---

NOTE 2. REAL ESTATE



In 2005, ARI purchased the following properties:



|                        |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|----------------------- |  | ------------------ |  | ------------------- |  | -------------- | ------ | ------------------------ | - | ----- | ------------ |  | ------------- | ----- |  | ------------- | --- |  | -----
|Property                |  | Location           |  | Units/Sq. Ft./Acres |  | Purchase Price |        | Net CashPaid/ (Received) |   |       | DebtIncurred |  | Interest Rate |       |  | Maturity Date
|First Quarter           |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Land                    |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Katrina(1)              |  | Palm Desert, CA    |  | 23.0 Acres          |  | $              | 4,184  |                          | $ |      |              |  | $             |      |  |              |     |  |     
|Keenan Bridge(2)        |  | Farmers Branch, TX |  | 7.5 Acres           |  |                | 510    |                          |   | 14    |              |  |               |      |  |              |     |  |     
|Mandahl Bay             |  | US Virgin Islands  |  | 50.8 Acres          |  |                | 7,000  |                          |   | 4,101 |              |  |               | 3,500 |  | 7.00          | %   |  | 07/05
|Mandahl Bay (Gilmore)   |  | US Virgin Islands  |  | 1.0 Acres           |  |                | 96     |                          |   | 104   |              |  |               |      |  |              |     |  |     
|Mandahl Bay (Chung)     |  | US Virgin Islands  |  | .7 Acres            |  |                | 95     |                          |   | 101   |              |  |               |      |  |              |     |  |     
|                        |  |                    |  |                     |  |                |       
|Second Quarter          |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Apartments              |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Parc at Metro Center(4) |  | Nashville, TN      |  | 144 Units           |  |                | 817    |                          |   | (378  | )            |  |               | 817   |  | 5.65          |     |  | 09/46
|                        |  |                    |  |                     |  |                |       
|Land                    |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Centurion               |  | Tarrant County, TX |  | 12.7 Acres          |  |                | 850    |                          |   | 892   |              |  |               |      |  |              |     |  |     
|                        |  |                    |  |                     |  |                |       
|Office Buildings        |  |                    |  |                     |  |                |        |                          |   |       |              |  |               |       |  |               |     |  |      
|Park West               |  | Farmers Branch, TX |  | 243,416 Sq.Ft.      |  |                | 10,000 |                          |   | 4,715 |              |  |               | 6,500 |  | 7.50          | (3) |  | 05/06

---

|(1) | Exchanged for note receivable. See NOTE 3. NOTES AND INTEREST RECEIVABLE.
|--- | ---------------------------------------------------------------------------

|(2) | Exchanged for the Bee Street and 2524 Valley View Land Parcels.
|--- | ---------------------------------------------------------------

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

|(4) | Initial construction loan funding to purchase land and begin apartment construction. Does not represent actual units purchased.
|--- | -------------------------------------------------------------------------------------------------------------------------------



In 2004, ARI purchased the following properties:



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

---

|(1) | Initial construction loan funding to purchase land and begin apartment construction. Does not represent actual units purchased.
|--- | -------------------------------------------------------------------------------------------------------------------------------

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



10



---

In 2005, ARI sold the following properties:



|                              |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|----------------------------- |  | --------------- |  | ------------------- |  | ---------- | ------ | ----------------------- | - | ----- | -------------- |  | - | ------------ | --- |  | - | ------
|Property                      |  | Location        |  | Units/Acres/Sq. Ft. |  | SalesPrice |        | Net CashReceived/(Paid) |   |       | DebtDischarged |  |   | Gain on Sale
|First Quarter                 |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Apartments                    |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Longwood                      |  | Long Beach, MS  |  | 200 Units           |  | $          | 6,456  |                         | $ | 9     |                |  | $ | 6,253        | (1) |  | $ | 56    
|                              |  |                 |  |                     |  |           
|Land                          |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Granbury Station              |  | Ft. Worth, TX   |  | 15.7 Acres          |  |            | 1,003  |                         |   | 265   |                |  |   | 738          | (1) |  |   | 10    
|Katrina                       |  | Palm Desert, CA |  | 9.9 Acres           |  |            | 2,616  |                         |   | 574   |                |  |   |             |     |  |   | 1,323 
|Katrina                       |  | Palm Desert, CA |  | 13.6 Acres          |  |            | 3,703  |                         |   | 591   |                |  |   |             |     |  |   | 1,706 
|Katrina                       |  | Palm Desert, CA |  | 5.5 Acres           |  |            | 1,325  |                         |   | 1,281 |                |  |   |             |     |  |   | 619   
|Katrina                       |  | Palm Desert, CA |  | 6.5 Acres           |  |            | 1,695  |                         |   | 340   |                |  |   |             |     |  |   | 818   
|Katrina                       |  | Palm Desert, CA |  | 7.4 Acres           |  |            | 2,028  |                         |   | 455   |                |  |   |             |     |  |   | 1,072 
|Katrina                       |  | Palm Desert, CA |  | 81.2 Acres          |  |            | 19,878 |                         |   | (814  | )              |  |   | 5,100        |     |  |   | 9,387 
|Katrina                       |  | Palm Desert, CA |  | 24.8 Acres          |  |            | 6,402  |                         |   | 1,027 |                |  |   |             |     |  |   | 2,947 
|Katy                          |  | Katy, TX        |  | 130.6 Acres         |  |            | 12,400 |                         |   | 4,981 |                |  |   | 6,601        |     |  |   | 5,630 
|Nashville                     |  | Nashville, TN   |  | 1.2 Acres           |  |            | 304    |                         |   | 236   |                |  |   |             |     |  |   | 226   
|Vista Ridge                   |  | Lewisville, TX  |  | 4.4 Acres           |  |            | 950    |                         |   | (92   | )              |  |   | 914          |     |  |   | 440   
|                              |  |                 |  |                     |  |           
|Office Building               |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Institute Place               |  | Chicago, IL     |  | 144,915 Sq. Ft.     |  |            | 14,460 |                         |   | 4,843 |                |  |   | 7,792        |     |  |   | 10,603
|                              |  |                 |  |                     |  |           
|Industrial Warehouse          |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|5700 Tulane                   |  | Atlanta, GA     |  | 67,850 Sq. Ft.      |  |            | 816    |                         |   | 738   |                |  |   |             |     |  |   | 329   
|                              |  |                 |  |                     |  |           
|Second Quarter                |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Land                          |  |                 |  |                     |  |            |        |                         |   |       |                |  |   |              |     |  |   |       
|Lemmon Carlisle/Alamo Springs |  | Dallas, TX      |  | 2.8 Acres           |  |            | 7,674  |                         |   | 5,627 |                |  |   | 1,744        |     |  |   | 2,729 
|Vista Ridge                   |  | Lewisville, TX  |  | 17.9 Acres          |  |            | 4,291  |                         |   | (129  | )              |  |   | 4,096        |     |  |   | 2,185 

---

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



In 2004, ARI sold the following properties:



|                       |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|---------------------- |  | ----------------- |  | ------------------- |  | ---------- | ------ | ---------------- | - | -------------- |  | - | ------------ | --- |  | - | ----- | ---
|Property               |  | Location          |  | Units/Acres/Sq. Ft. |  | SalesPrice |        | Net CashReceived |   | DebtDischarged |  |   | Gain on Sale |    
|First Quarter          |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Tiberon Trails         |  | Merrillville, IN  |  | 376 Units           |  | $          | 10,325 |                  | $ | 2,618          |  | $ | 6,189        | (1) |  | $ | 48    |    
|                       |  |                   |  |                     |  |           
|Industrial Warehouse   |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Kelly (Pinewood)       |  | Dallas, TX        |  | 100,000 Sq. Ft.     |  |            | 1,650  |                  |   | 65             |  |   | 1,376        |     |  |   | 153   |    
|Ogden Industrial       |  | Ogden, UT         |  | 107,112 Sq. Ft.     |  |            | 2,600  |                  |   | 668            |  |   | 1,775        |     |  |   | 1,474 |    
|Texstar Warehouse      |  | Arlington, TX     |  | 97,846 Sq. Ft.      |  |            | 2,400  |                  |   |               |  |   | 1,148        | (1) |  |   | 1,157 | (3)
|                       |  |                   |  |                     |  |           
|Land                   |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Allen                  |  | Collin County, TX |  | 492.5 Acres         |  |            | 19,962 |                  |   | 7,956          |  |   | 4,088        |     |  |   | 7,915 | (2)
|Mason Goodrich         |  | Houston, TX       |  | 5.7 Acres           |  |            | 686    |                  |   | 45             |  |   | 588          |     |  |   | 379   |    
|Mason Goodrich         |  | Houston, TX       |  | 8.0 Acres           |  |            | 1,045  |                  |   | 248            |  |   | 200          |     |  |   | 617   |    
|Red Cross              |  | Dallas, TX        |  | 2.9 Acres           |  |            | 8,500  |                  |   | 2,842          |  |   | 4,450        |     |  |   |      |    
|                       |  |                   |  |                     |  |           
|Shopping Centers       |  |                   |  |                     |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Countryside Harmon     |  | Sterling, VA      |  | 72,062 Sq. Ft.      |  |            | 2,650  |                  |   | 216            |  |   | 2,200        |     |  |   | 1,861 |    
|Countryside Retail     |  | Sterling, VA      |  | 133,422 Sq. Ft.     |  |            | 27,100 |                  |   | 3,407          |  |   | 22,800       |     |  |   | 6,807 |    
|K-Mart                 |  | Cary, NC          |  | 92,033 Sq. Ft.      |  |            | 3,200  |                  |   |               |  |   | 1,677        | (1) |  |   | 521   | (3)
|Plaza on Bachman Creek |  | Dallas, TX        |  | 80,278 Sq. Ft.      |  |            | 7,850  |                  |   | 1,808          |  |   | 5,358        |     |  |   | 3,682 |    

---

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



11



---

|(2) | Includes deferred gain of $5.2 million, which was recognized in the third and fourth quarters of 2004, upon collection of seller financing.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Property sold to BCM, a related party, for assumption of debt and a note receivable. Gain deferred until sale to unrelated party. Failure to notify and receive approval from the
lender for this transaction may constitute an event of default under the terms of the debt.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



At March 31, 2005, ARI had the following properties under construction:



|                                                  |  |                    |  |           |  |                 |        |                            |   |                          |  |   |       
|------------------------------------------------- |  | ------------------ |  | --------- |  | --------------- | ------ | -------------------------- | - | ------------------------ |  | - | ------
|Property                                          |  | Location           |  | Units     |  | Amount Expended |        | AdditionalAmount to Expend |   | ConstructionLoan Funding
|Apartments                                        |  |                    |  |           |  |                 |        |                            |   |                          |  |   |       
|Bluffs at Vista Ridge                             |  | Lewisville, TX     |  | 272 Units |  | $               | 19,458 |                            | $ | 1,128                    |  | $ | 15,500
|Bridges on Kinsey                                 |  | Tyler, TX          |  | 232 Units |  |                 | 15,612 |                            |   | 469                      |  |   | 14,477
|Dakota Arms                                       |  | Lubbock, TX        |  | 208 Units |  |                 | 12,970 |                            |   | 967                      |  |   | 12,549
|Kingsland Ranch                                   |  | Houston, TX        |  | 398 Units |  |                 | 24,573 |                            |   | 1,081                    |  |   | 23,000
|Laguna Vista                                      |  | Farmers Branch, TX |  | 206 Units |  |                 | 3,790  |                            |   | 17,315                   |  |   | 17,741
|Lake Forest                                       |  | Houston, TX        |  | 240 Units |  |                 | 14,137 |                            |   | 300                      |  |   | 12,815
|Parc at Maumelle                                  |  | Maumelle, AR       |  | 240 Units |  |                 | 3,717  |                            |   | 14,981                   |  |   | 16,829
|Stonebridge at City Park (formerly 288 City Park) |  | Houston, TX        |  | 240 Units |  |                 | 15,528 |                            |   | 1,158                    |  |   | 15,005
|Vistas of Vance Jackson                           |  | San Antonio, TX    |  | 240 Units |  |                 | 16,761 |                            |   | 1,341                    |  |   | 16,056
|Wildflower Villas                                 |  | Temple, TX         |  | 220 Units |  |                 | 11,806 |                            |   | 3,790                    |  |   | 14,073



For the three months ended March 31,
2005, ARI completed the 70 unit Blue Lake Villas II in Waxahachie, Texas.



NOTE 3. NOTES AND INTEREST RECEIVABLE



In August 2001, ARI
agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bore interest at a variable rate (then 9.0% per annum), required monthly interest only payments, and originally matured in January
2003. As of March 2004, ARI had funded a total of $4.3 million. On January 22, 2003, ARI agreed to extend the maturity date until May 1, 2003. The collateral used to secure ARIs second lien was seized by the first lien holder. On March 11,
2004, ARI agreed to accept an assignment of claims in litigation as additional security for the note. In December 2004, ARI agreed to a Modification Agreement with the borrower, which was effective November 1, 2003. As of the modified effective
date, accrued interest of $582,000 was added to the principal balance of the note, the interest rate fixed at 9.0% per annum and all principal and interest is due November 2005. ARI also received Pledge and Security Agreements in various partnership
interests belonging to the borrower and received various Assignments of Proceeds from sales in certain entities owned by the borrower. ARI reduced accrued interest and principal by $1.5 million from the receipt of notes receivable assigned to ARI by
borrower and by $605,000 from cash received. ARI also received $1.4 million in January 2005 that was applied to accrued interest and principal effective December 30, 2004.



In February 2005, ARI received a loan in the amount of $4,975,000 that is guaranteed by Basic Capital Management, Inc. (BCM) and
Prime Income Asset Management, LLC (Prime). The note bears interest at 8.25% per annum, requires semi-annual interest payments, and matures in July 2006. The loan is collateralized by partnership interests in various apartments owned by
ARI. At maturity, the lender has the option to convert the outstanding loan balance into general and limited partnership units in each of the partnerships, subject to HUD approval.



In February 2005, ARI sold a 9.9 acre tract of its Katrina land parcel for $2.6 million, receiving $574,000 after payment of closing costs
and providing purchase money financing of $2.0 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In March 2005, ARI sold the loan for $2.0 million, receiving $2.0 million in cash after
payment of closing costs.



In February 2005, ARI sold a 13.6 acre tract of its
Katrina land parcel for $3.7 million, receiving $548,000 after payment of closing costs and providing purchase money financing of $2.8 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2008. In
March 2005, ARI sold the loan for $2.8 million, receiving $2.8 million in cash after payment of closing costs.



In February 2005, ARI sold a 6.5 acre tract of its Katrina land parcel for $1.7 million, receiving $322,000 after payment of closing costs and providing purchase money financing of $1.3 million. The loan bore interest
at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.3 million, receiving $1.3 million in cash after payment of closing costs.



12



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In February 2005, ARI sold a 7.4 acre tract of its Katrina land parcel for $2.0 million, receiving $203,000 after payment
of closing costs and providing purchase money financing of $1.5 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in February 2007. In March 2005, ARI sold the loan for $1.5 million, receiving $1.5 million
in cash after payment of closing costs.



In February 2005, ARI sold an 81.2
acre tract of its Katrina land parcel for $19.9 million, paying $582,000 after payment of debt and closing costs and providing purchase money financing of $14.9 million. The loan bore interest at 8.0%, required quarterly payments of interest, and
matured in February 2007. In March 2005, ARI sold the loan for $14.9 million, receiving $14.9 million in cash after payment of closing costs.



In March 2005, ARI sold a 24.8 acre tract of its Katrina land parcel for $6.4 million, receiving $1.0 million after payment of closing costs and providing purchase money
financing of $4.8 million. The loan bore interest at 8.0%, required quarterly payments of interest, and matured in March 2007. In March 2005, ARI sold the loan for $4.8 million, receiving $4.8 million in cash after payment of closing costs.



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 was sold to an unrelated party in March 2003. 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. In February 2005, the note was exchanged for 23.0 acres of land in Palm Desert, California. See NOTE 2.
REAL ESTATE.



In March 2005, ARI entered into an agreement to
advance a third party $3.2 million for development costs relating to land lots in Austin, Texas. These advances are secured by stock in the borrower and hold a second lien on the undeveloped land. The secured note bears interest at 10%, requires
semi-annual payments and matures in March 2008. As of March 31, 2005, ARI had not advanced any funds to the borrower. ARI also guaranteed, with full recourse to ARI, an $18 million loan for the borrower which loan is secured by a first lien on the
undeveloped land.



In October 2004, ARI sold the In The Pines apartments to a
third party and provided $1.0 million of the purchase price as seller financing in the form of two notes. The first note bears interest at 7.0% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this
note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. In the event of a
default, the note is also secured by membership rights in the purchasers entity. The second note is unsecured, bears interest at 8.5% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note
to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. Both loans were extended to
October 2005 with the payment of a 2.0% extension fee.



In March 2002, ARI sold
the 174,513 sq. ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien
mortgage note. The note bears interest at a variable interest rate, currently 7.5% per annum, requires monthly interest only payments and matures in March 2007. As of March 2005, ARI has funded $768,000 of the additional line of credit.



Related Parties.In March 2004, TCI sold a K-Mart in Cary, North Carolina to BCM
for $3.2 million, including the assumption of debt. TCI also provided $1.5 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2.0%, currently 8.0%, and matured in April 2005. This note was
extended to April 2008.



In March 2004, TCI sold the Texstar Warehouse in
Arlington, Texas to BCM for $2.4 million, including the assumption of debt. TCI also provided $1.3 million of the purchase price as seller financing. The unsecured note bears interest at the prime rate plus 2.0%, currently 8.0%, and matured in April
2005. This note was extended to April 2008.



13



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NOTE 4. INVESTMENTS IN EQUITY INVESTEES



ARIs investment in real estate entities at March 31, 2005, was as follows:



|         |  |                                               |   |  |                                              |       |                                             |   |      
|-------- |  | --------------------------------------------- | - |  | -------------------------------------------- | ----- | ------------------------------------------- | - | -----
|Investee |  | Percentage of ARIsOwnership atMarch 31, 2005 |   |  | Carrying Value ofInvestment atMarch 31, 2005 |       | Market Value of Investment atMarch 31, 2005
|IORI     |  | 20.4                                          | % |  | $                                            | 5,825 |                                             | $ | 5,635
|Other    |  |                                               |   |  |                                              | 2,752 |                                             |   |      
|         |  |                                               |   |  |                                              |       |                                             |   |      
|         |  |                                               |   |  | $                                            | 8,577 |                                             |   |      
|         |  |                                               |   |  |                                              |       |                                             |   |      



Set forth below are
summarized results of operations of IORI for the three months ended March 31, 2005:



|                                        |  |      |        |  
|--------------------------------------- |  | ---- | ------ | -
|                                        |  | 2005 |       
|Revenues                                |  | $    | 2,503  |  
|Equity in loss of partnership           |  |      | (9     | )
|Property operating expenses             |  |      | (1,142 | )
|Depreciation                            |  |      | (177   | )
|Interest                                |  |      | (936   | )
|                                        |  |      |        |  
|Loss before gain on sale of real estate |  |      | 239    |  
|Gain on sale of real estate             |  |      |       |  
|                                        |  |      |        |  
|Net income                              |  | $    | 239    |  
|                                        |  |      |        |  



ARIs share of equity
investees income before gains on the sale of discontinued operations was $60,000 for the three months ended March 31, 2005. ARI did not recognize any gain on equity investees sale of real estate for the three months ended March 31, 2005.



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



NOTE 5. MARKETABLE EQUITY SECURITIES



Since 1994, ARI has been
purchasing equity securities of entities other than those of IORI and TCI to diversify and increase the liquidity of its margin accounts. Trading and available-for-sale portfolio securities are carried at market value. In the first quarter of 2005,
ARI did not purchase or sell any marketable securities. At March 31, 2005, ARI recognized an unrealized increase in the market value of its trading portfolio securities of $5,000. Unrealized and realized gains and losses on trading portfolio
securities are included in other income in the accompanying Consolidated Statements of Operations. Also at March 31, 2005, ARI recorded an unrealized increase in the market value of its available-for-sale portfolio securities of $669,000. Unrealized
gains and losses on available-for-sale portfolio securities are included in accumulated other comprehensive income in the accompanying Consolidated Balance Sheets.



NOTE 6. NOTES PAYABLE



In February 2005, ARI received a loan in the amount of $5.0 million. The note bears interest at 8.0% per annum, requires semi-annual interest payments and matures in July
2006. The loan is collateralized by certain partnership interests that hold apartments owned by ARI. At maturity, the lender has the option to convert the outstanding loan balance into general and limited partnership units in each of the
partnerships, subject to HUD approval.



In 2005, ARI financed/refinanced or
obtained second mortgage financing on the following:



|                 |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|---------------- |  | ----------------- |  | ------------------- |  | ------------ | ----- | -------------- | - | ---------------- |  | ------------ | ----- |  | ------------ | --- |  | -----
|Property         |  | Location          |  | Acres/Sq. Ft./Units |  | DebtIncurred |       | DebtDischarged |   | Net CashReceived |  | InterestRate |       |  | MaturityDate
|First Quarter    |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|Land             |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|Nashville        |  | Nashville, TN     |  | 109.6 Acres         |  | $            | 7,000 |                | $ |                 |  | $            | 6,341 |  | 7.50         | %   |  | 2/07 
|                 |  |                   |  |                     |  |              |      
|Shopping Centers |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|Bridgeview Plaza |  | LaCrosse, WI      |  | 116,008 Sq. Ft.     |  |              | 7,197 |                |   | 6,304            |  |              | 649   |  | 7.25         | (1) |  | 03/10
|Dunes Plaza      |  | Michigan City, IN |  | 223,869 Sq. Ft.     |  |              | 3,750 |                |   | 2,685            |  |              | 658   |  | 7.50         | (1) |  | 01/10
|                 |  |                   |  |                     |  |              |      
|Second Quarter   |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|Apartments       |  |                   |  |                     |  |              |       |                |   |                  |  |              |       |  |              |     |  |      
|Autumn Chase     |  | Midland, TX       |  | 64 Units            |  |              | 1,166 |                |   | 797              |  |              | 317   |  | 5.88         | (1) |  | 05/35
|Courtyard        |  | Midland, TX       |  | 133 Units           |  |              | 1,342 |                |   | 966              |  |              | 266   |  | 5.88         | (1) |  | 05/35
|Southgate        |  | Odessa, TX        |  | 180 Units           |  |              | 1,879 |                |   | 1,712            |  |              | 61    |  | 5.88         | (1) |  | 05/35

---

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



14



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



|                               |  |                    |  |                     |  |              |        |                |   |                          |  |   |              |      |  |              |      |  |      
|------------------------------ |  | ------------------ |  | ------------------- |  | ------------ | ------ | -------------- | - | ------------------------ |  | - | ------------ | ---- |  | ------------ | ---- |  | -----
|Property                       |  | Location           |  | Sq.Ft./Rooms/ Acres |  | DebtIncurred |        | DebtDischarged |   | Net CashReceived/ (Paid) |  |   | InterestRate |      |  | MaturityDate
|First Quarter                  |  |                    |  |                     |  |              |        |                |   |                          |  |   |              |      |  |              |      |  |      
|Hotel                          |  |                    |  |                     |  |              |        |                |   |                          |  |   |              |      |  |              |      |  |      
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms           |  | $            | 11,500 |                | $ | 12,332                   |  | $ | (13,689      | )(2) |  | 7.00         | %(1) |  | 03/05
|                               |  |                    |  |                     |  |              |       
|Land                           |  |                    |  |                     |  |              |        |                |   |                          |  |   |              |      |  |              |      |  |      
|Centura                        |  | Farmers Branch, TX |  | 8.8 Acres           |  |              | 4,485  |                |   | 4,000                    |  |   | (183         | )    |  | 7.00         | (1)  |  | 11/04
|Dominion/Hollywood             |  | Farmers Branch, TX |  | 66.1 Acres          |  |              | 6,985  |                |   | 6,222                    |  |   | (67          | )    |  | 7.00         | (1)  |  | 02/05
|Katy                           |  | Harris County, TX  |  | 130.6 Acres         |  |              | 7,500  |                |   |                         |  |   | 18           |      |  | 6.00         |      |  | 02/07
|Marine Creek                   |  | Ft. Worth, TX      |  | 54.0 Acres          |  |              | 1,286  |                |   | 991                      |  |   | 192          |      |  | 5.75         |      |  | 06/05
|                               |  |                    |  |                     |  |              |       
|Office Building                |  |                    |  |                     |  |              |        |                |   |                          |  |   |              |      |  |              |      |  |      
|Centura Tower                  |  | Farmers Branch, TX |  | 410,901 Sq. Ft.     |  |              | 34,000 |                |   | 36,889                   |  |   | (4,588       | )    |  | 5.50         | (1)  |  | 04/06

---

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

|(2) | Cash of $10,961 million was received by an affiliate, increasing ARIs affiliate receivable.
|--- | --------------------------------------------------------------------------------------------



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 15.1% to 24.0%. Margin borrowings totaled $18.6 million at March 31,
2005.



Sunset Management LLC. On October 5, 2004, Sunset Management LLC
(Sunset) filed a complaint as a purported stockholders derivative action on behalf of TCI in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc., Basic
Capital Management, Inc., Prime Income Asset Management, Inc., Prime Income Asset Management LLC, Income Opportunity Realty Investors, Inc., United Housing Foundation (United), Inc., Regis Realty, Inc., TCI, TCIs current directors
and officers and others. Sunsets complaint filed as Case No. 3:04-CV-02162-B styled Sunset Management LLC, derivatively on behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al., raises a number of
allegations previously raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunsets requested relief. The Defendants on November 8, 2004 filed a Motion to Dismiss pursuant to Rules 12 and 23.1 of
the Federal Rules of Civil Procedure on the basis that Sunsets allegations are insufficient to evade the stringent demand requirement under the futility exceptions for stockholder derivative actions, and that Sunset cannot fairly and
adequately represent the interests of other stockholders. One of the individual Defendants also filed on January 4, 2005 a Motion to Disqualify Sunsets Counsel. On January 4, 2005, the Defendants filed a Motion to Stay Discovery and for
Protective Order, which Motion was granted on March 30, 2005 by the issuance of an Order of the Court granting the Motion for Protective Order and staying all discovery in the action pending further Order of the Court, if appropriate, following the
Courts ruling on the Defendants Motion to Dismiss. On March 28, 2005, Sunset also filed a Petition for Writ of Mandamus in the United States District Court for the Eastern District of Texas, Sherman Division, seeking a Writ of Mandamus
to be issued by the Court directing the bankruptcy judge in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, in the case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11, and American
Realty Trust, Inc., et al. v. Sunset Management LLC, Adversary Proceeding No. 03-4256, to rule on pending Motions for Summary Judgment within twenty days thereof. On April 11, 2005, the United States District Court for the Eastern District of
Texas, Sherman Division, entered its Order denying Sunsets Petition for Writ of Mandamus. On May 6, 2005, in the bankruptcy case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11 pending in the United States Bankruptcy Court



15



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for the Eastern District of Texas, Sherman Division, Sunset filed a Motion for Allowance of Claim, Determination of the
Value of its Lien, Allowance of Deficiency as an Unsecured Claim and Abandonment of Cash Collateral to Sunset. Such Motion seeks an Order (i) estimating and determining the allowed amount of Sunsets claim for purposes of distribution, (ii)
determining the method of value in Sunsets secured claim, (iii) determining the value of the lien held by Sunset, (iv) declaring that Sunsets claim is secured in the amount determined, (v) allowing Sunset a deficiency claim for the
unsecured portion of its claim, and (vi) ordering a distribution to Sunset of the proceeds received by the Debtor from a specified note.



At March 31, 2005, ARIs margin borrowings include $5.0 million payable to Sunset. Interest is accrued at the stated rates of 20.0% and 24.0%. The loan matured in
September 2002.



Other Security Loans. In September 2003, ARI obtained a
security loan in the amount of $12.5 million from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 15.1%, requires monthly payments of interest only and matured in September 2004. The loan is secured by
1,656,537 shares of TCI common stock held by ARI. In September 2004, the maturity date was extended to December 2004. In December 2004, the maturity date was extended to March 2005. In March 2005, the maturity date was extended to March 2006.



In September 2003, ARI obtained a security loan in the amount of $1.0 million
from a financial institution. The loan bears interest at 12.0% over the 30-day LIBOR rate, currently 15.1%, requires monthly payments of interest only and matured in September 2004. The loan is secured by 250,000 shares of IORI common stock held by
ARI. In September 2004, the maturity date was extended to December 2004. In December 2004, the maturity date was extended to March 2005. In March 2005, the maturity date was extended to March 2006.



In October 2001, ARI obtained a security loan in the amount of $1.0 million from a financial
institution. The loan bore interest at 1.0% over the prime rate, required monthly payments of interest only, and matured in October 2003. The loan was secured by 250,000 shares of ARI Common Stock held by BCM. In October 2003, the maturity date was
extended to December 2003. In February 2004, ARI paid $450,000 in principal, and the maturity date was extended to February 2005. In February 2005, the note was paid in full.



NOTE 8. RELATED PARTY TRANSACTIONS



In January 2005, an affiliate made a $700,000 note payment on ARIs behalf, reducing ARIs affiliate receivable.



The following table reconciles the beginning and ending balances of accounts receivable from
and (accounts payable to) affiliates as of March 31, 2005.



|                                       |  |       |         |   |      |   |      |  
|-------------------------------------- |  | ----- | ------- | - | ---- | - | ---- | -
|                                       |  | PRIME |         |   | IORI |  
|Balance, December 31, 2004             |  | $     | 13,579  |   |      | $ | (260 | )
|Cash transfers to affiliates           |  |       | 38,907  |   |      |   |     |  
|Cash transfers from affiliates         |  |       | (25,619 | ) |      |   |     |  
|Payments by affiliates on ARIs behalf |  |       | (700    | ) |      |   |     |  
|Payables clearing through Prime        |  |       | (1,008  | ) |      |   |     |  
|                                       |  |       |         |   |      |   |      |  
|Balance, March 31, 2005                |  | $     | 25,159  |   |      | $ | (260 | )
|                                       |  |       |         |   |      |   |      |  



At March 31, 2005, ARIs other
assets includes $1.3 million due from an affiliate for rent. In addition to the $1.6 million payable related to apartment sales that is noted in a following paragraph, at March 2005, ARI also owed $2.5 milllion to Regis Property Management for
management fees and sales commissions, and $1.7 million to Prime for advisory fees and reimbursable costs.



In April 2002, ARI and TCI sold 21 apartments properties to partnerships controlled by Metra Capital, LLC (Metra). Innovo Group, Inc. (Innovo) is a limited partner in the partnerships that
purchased the properties. Joseph Mizrachi, then a director of ARI, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and ARI and TCI continue to report the
assets and the new debt incurred by Metra on their financial statements. The partnership agreements for each of these partnerships state that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient
to provide them with a 15% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these
properties. These distributions to the Metra Partners have priority over distributions to any other partners. At March 31, 2005, 16 of the properties remained on ARIs balance sheet, and ARIs other liabilities included $1.6 million owed
to the Metra Partners related to cash received by ARI upon the sale of these apartments in April 2002. During April 2005, resolution of the litigation occurred, settling all liabilities remaining from the original partnership arrangements which
included a return of investor equity, prospective asset management fees and miscellaneous fees and transactions costs from the Plaintiffs as a prepayment of a preferred return, along with a delegation of management to another entity, and a motion to
dismiss the action as a part of the resolution. Of the prepayment, the Company will recognize expense of $525,000 and a reduction in liabilities of $3.2 million during the second quarter of 2005.



16



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NOTE 9. OPERATING SEGMENTS



Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements
principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income
that are not reflected in the segments are equity in income (loss) of investees, equity in gain on sale of real estate by equity investees, and other income, which totaled $181,000 for the three months ended March 31, 2005 and $1.3 million for the
three months ended March 31, 2004. Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, advisory fees, net income fees, and loss from discontinued
operations, which totaled $8.3 million for the three months ended March 31, 2005 and $10.4 million for the three months ended March 31, 2004. Excluded from operating segment assets are assets of $137.7 million in 2005 and $94.0 million in 2004,
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 Akademia (Poland), which began operations in 2002.



Presented below are ARIs reportable segments income and expenses
for the three months ended March 31, and segment assets at March 31.



|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|----------------------- |  | -------------------- | ------- | ---------- | - | ------- |  | ---- | ------ |  | ----------- | ------- | ----------------- |  | - | ------ |  | - | ------ | - |  | - | ---------
|2005                    |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | Restaurants |         | Receivables/Other |  |   | Total 
|Operating revenue       |  | $                    | 12,120  |            | $ | 21,315  |  | $    | 7,313  |  | $           | 198     |                   |  | $ | 8,620  |  | $ | 11     |   |  | $ | 49,577   
|Interest income         |  |                      |        |            |   |        |  |      |       |  |             |        |                   |  |   |       |  |   | 1,636  |   |  |   | 1,636    
|Operating expenses      |  |                      | 7,067   |            |   | 13,423  |  |      | 6,446  |  |             | 1,899   |                   |  |   | 6,754  |  |   | (16    | ) |  |   | 35,573   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss) |  | $                    | 5,053   |            | $ | 7,892   |  | $    | 867    |  | $           | (1,701  | )                 |  | $ | 1,866  |  | $ | 1,663  |   |  | $ | 15,640   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation            |  | $                    | 2,516   |            | $ | 2,284   |  | $    | 697    |  | $           |        |                   |  | $ | 302    |  | $ | 13     |   |  | $ | 5,812    
|Interest                |  |                      | 3,572   |            |   | 7,091   |  |      | 1,546  |  |             | 2,474   |                   |  |   | 348    |  |   | 1,096  |   |  |   | 16,127   
|Capital expenditures    |  |                      | 2,270   |            |   | 13,774  |  |      | 123    |  |             | 183     |                   |  |   | 65     |  |   |       |   |  |   | 16,415   
|Assets                  |  |                      | 183,453 |            |   | 488,578 |  |      | 83,564 |  |             | 215,640 |                   |  |   | 20,351 |  |   | 68,876 |   |  |   | 1,060,462
|                        |  |                      |         |            |   |         | 
|                        |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | Restaurants |         | Receivables/Other |  |   | Total 
|Property Sales:         |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Sales price             |  | $                    | 15,276  |            | $ | 6,207   |  | $    |       |  | $           | 52,305  |                   |  | $ |       |  | $ |       |   |  | $ | 73,788   
|Cost of sale            |  |                      | 4,345   |            |   | 6,151   |  |      |       |  |             | 28,127  |                   |  |   |       |  |   |       |   |  |   | 38,623   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Gain on sale            |  | $                    | 10,931  |            | $ | 56      |  | $    |       |  | $           | 24,178  |                   |  | $ |       |  | $ |       |   |  | $ | 35,165   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|                        |  |                      |         |            |   |         | 
|2004                    |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | Restaurants |         | Receivables/Other |  |   | Total 
|Operating revenue       |  | $                    | 13,305  |            | $ | 18,223  |  | $    | 7,666  |  | $           | 156     |                   |  | $ | 8,169  |  | $ | 362    |   |  | $ | 47,881   
|Interest income         |  |                      |        |            |   |        |  |      |       |  |             |        |                   |  |   |       |  |   | 1,049  |   |  |   | 1,049    
|Operating expenses      |  |                      | 8,184   |            |   | 11,838  |  |      | 6,972  |  |             | 1,004   |                   |  |   | 6,213  |  |   | (219   | ) |  |   | 33,992   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss) |  | $                    | 5,121   |            | $ | 6,385   |  | $    | 694    |  | $           | (848    | )                 |  | $ | 1,956  |  | $ | 1,630  |   |  | $ | 14,938   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation            |  | $                    | 2,784   |            | $ | 1,898   |  | $    | 928    |  | $           |        |                   |  | $ | 328    |  | $ | 20     |   |  | $ | 5,958    
|Interest                |  |                      | 3,458   |            |   | 6,343   |  |      | 1,586  |  |             | 2,994   |                   |  |   | 386    |  |   | 1,367  |   |  |   | 16,134   
|Capital expenditures    |  |                      | 1,893   |            |   | 53,503  |  |      | 261    |  |             | 179     |                   |  |   | 467    |  |   |       |   |  |   | 56,303   
|Assets                  |  |                      | 293,270 |            |   | 451,587 |  |      | 87,607 |  |             | 209,927 |                   |  |   | 20,906 |  |   | 72,949 |   |  |   | 1,136,246
|                        |  |                      |         |            |   |         | 
|                        |  | CommercialProperties |         | Apartments |   | Hotels  |  | Land |        |  | Restaurants |         | Receivables/Other |  |   | Total 
|Property Sales:         |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Sales price             |  | $                    | 47,450  |            | $ | 10,325  |  | $    |       |  | $           | 30,194  |                   |  | $ |       |  | $ |       |   |  | $ | 87,969   
|Cost of sale            |  |                      | 31,886  |            |   | 10,277  |  |      |       |  |             | 21,283  |                   |  |   |       |  |   |       |   |  |   | 63,446   
|Deferred current gain   |  |                      | 1,678   |            |   |        |  |      |       |  |             | 5,159   |                   |  |   |       |  |   |       |   |  |   | 6,837    
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          
|Gain on sale            |  | $                    | 13,886  |            | $ | 48      |  | $    |       |  | $           | 3,752   |                   |  | $ |       |  | $ |       |   |  | $ | 17,686   
|                        |  |                      |         |            |   |         |  |      |        |  |             |         |                   |  |   |        |  |   |        |   |  |   |          



17



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NOTE 10. DISCONTINUED OPERATIONS



For the three months ended March 31, 2005 and 2004, income from discontinued operations relates to 27 properties ARI sold during 2004 and
ten properties ARI sold or held-for-sale in 2005. The following table summarizes revenue and expense information for these properties sold and held-for-sale.



|                                                          |  |                                     |        |   |      |   |        |  
|--------------------------------------------------------- |  | ----------------------------------- | ------ | - | ---- | - | ------ | -
|                                                          |  | For the Three MonthsEnded March 31, |       
|                                                          |  | 2005                                |        |   | 2004 |  
|Revenue                                                   |  |                                     |        |   |      |   |        |  
|Rental                                                    |  | $                                   | 3,059  |   |      | $ | 11,435 |  
|Property operations                                       |  |                                     | 2,199  |   |      |   | 6,448  |  
|                                                          |  |                                     |        |   |      |   |        |  
|                                                          |  |                                     | 860    |   |      |   | 4,987  |  
|                                                          |  |                                    
|Expenses                                                  |  |                                     |        |   |      |   |        |  
|Interest                                                  |  |                                     | 1,079  |   |      |   | 4,519  |  
|Depreciation                                              |  |                                     | 49     |   |      |   | 1,735  |  
|                                                          |  |                                     |        |   |      |   |        |  
|                                                          |  |                                     | 1,128  |   |      |   | 6,254  |  
|                                                          |  |                                    
|Net loss from operations                                  |  |                                     | (268   | ) |      |   | (1,267 | )
|                                                          |  |                                    
|Gain on sale of real estate                               |  |                                     | 10,987 |   |      |   | 13,934 |  
|Equity in gain on sale of real estate by equity investees |  |                                     |       |   |      |   | 783    |  
|                                                          |  |                                     |        |   |      |   |        |  
|Net income from discontinued operations                   |  | $                                   | 10,719 |   |      | $ | 13,450 |  
|                                                          |  |                                     |        |   |      |   |        |  



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



NOTE 11. CORRECTION OF ACCOUNTING ERROR IN PRIOR PERIOD



During the second quarter of 2004, an 80%-owned subsidiary of ARI discovered an error in the depreciation calculation for a commercial
property the subsidiary purchased in March 2003 for $8.7 million. The amount subject to depreciation was $7.8 million and was to be depreciated straight-line over 40 years (480 months). Instead, the property was being depreciated over 40 months,
resulting in depreciation expense being overstated since March 2003. The unaudited Consolidated Statements of Operations for the three months ended March 31, 2004, reflect the correction of the impact of this error on depreciation expense of
$538,000. ARI does not intend to restate any previously issued Forms 10-Q or Form 10-K, because, in the opinion of management, the effect is not material to the results of operations for any period previously reported.



NOTE 12. COMMITMENTS AND CONTINGENCIES



Partnership Obligations. ARI is the limited partner in 11 partnerships that are
currently constructing residential properties. As permitted in the respective partnership agreements, ARI intends to purchase the interests of the general and any other limited partners in these partnerships subsequent to the completion of these
projects. The amounts paid to buyout the non-affiliated partners are limited to development fees earned by the non-affiliated partners, and are set forth in the respective partnership agreements. The total amount of the expected buyouts as of March
31, 2005 is approximately $2.1 million. ARI is a non-controlling general and limited partner in a real estate partnership and is obligated to fund approximately $2.3 million through March 31, 2006 for certain partnership obligations.



Liquidity. Management expects that excess cash generated from operations during the
remainder of 2005 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, Milano
Restaurants International, Inc. (MRI), a then wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt
incurred by the related party. The guaranty applies to all current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $913,000
at March 31, 2005.



Litigation.ARI is involved in various lawsuits
arising in the ordinary course of business. In the opinion of management the outcome of these lawsuits will not have a material impact on ARIs financial condition, results of operations or liquidity.



18



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



This quarterly report on Form 10-Q and ARIs 2004 Form 10-K, referred
to herein, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act or 1934. These statements concern the
intent, belief, or expectations of ARIs officers with respect to ARIs ability to lease its properties, tenants ability to pay rents, purchase of additional properties, ability to pay interest and debt principal and make
distributions, policies and plans regarding investments and financings, and other matters. Also, words such as believe, expect, anticipate, intend, plan, estimate, or similar
expressions identify forward-looking statements. Actual results may differ materially from those contained in or implied by the forward-looking statements as a result of various factors. Such factors include, without limitation, the impact of
changes in the economy and the capital markets on ARI and its tenants, competition within the real estate industry or those industries in which its tenants operate, and changes in federal, state, and local legislation. For example: Some of
ARIs tenants may not renew expiring leases and ARI may be unable to locate new tenants to maintain the historical occupancy rates of the properties; rents which ARI can achieve at its properties may decline; tenants may experience losses and
become unable to pay rents; and ARI may be unable to identify or to negotiate acceptable purchase prices for new properties. These results could occur due to many different circumstances, some of which, such as changes in ARIs tenants
financial conditions or needs for leased space, or changes in the capital markets or the economy, generally, are beyond ARIs control. Forward-looking statements are only expressions of ARIs present expectations and intentions.
Forward-looking statements are not guaranteed to occur, and they may not occur. You should not place undue reliance upon forward-looking statements.



Introduction



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



At December 31, 2004 and March 31, 2005, ARI subsidiaries owned 82.2% of the outstanding
shares of TCI. At March 31, 2005, ARI and TCI have the same advisor and Board of Directors.



At December 31, 2004 and March 31, 2005, ARI subsidiaries owned 20.4% of IORI through TCIs ownership of 24.9% of IORI shares. One director of ARI (Ted Stokely) also serves as a director of IORI.



Critical Accounting Policies



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



If events
or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be
generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides
to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the
property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. ARIs estimates of cash flow and fair values of the properties are based on current market
conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers.
ARIs estimates are subject to revision as market conditions and ARIs assessments of them change.



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



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



19



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Liquidity and Capital Resources



ARI reported net income of $20.7 million for the three months ended March 31, 2005, which included the following non-cash charges and
credits: depreciation and amortization from real estate held for investment of $5.9 million, gain on sale of real estate of $35.2 million and equity in income of equity investees of $60,000. Net cash used in operating activities amounted to $6.0
million for the three months ended March 31, 2005, interest receivable increased by $336,000, other assets decreased by $3.6 million primarily due to a reduction in escrows, interest payable decreased by $888,000 due to a decreased balance of notes
payable, and other liabilities decreased by $2.4 million primarily due to a decrease in accrued expenses.



Net cash provided by investing activities of $42.4 million was primarily due to real estate improvements of $16.3 million, acquisitions of real estate of $7.8 million, earnest money deposits of $671,000, and purchases
of restaurant equipment of $65,000. These outflows for investing activities were offset by the collection of $1.4 million on notes receivable, $38.9 million from the sale of real estate, $27.2 million from the sale of notes receivable, and $406, 000
distributed from equity investees.



Net cash used in financing activities of
$19.2 million was comprised of proceeds received from the funding or refinancing of notes payable of $38.7 million, offset by cash payments of $43.1 million to paydown existing notes payable, $1.2 million for financing costs, payments to affiliates
of $13.3 million, net payments on stock loans of $38,000, and $230,000 in dividends on Preferred Stock.



In the first three months of 2005, ARI purchased five parcels of unimproved land for a total of $11.9 million. ARI paid $4.3 million in cash, including various closing costs, and incurred $3.5 million in debt. ARI
also expended $13.8 million on property construction, of which $12.3 million was funded by debt. For the remainder of 2005 and the first half of 2006, ARI expects to spend an additional $42.5 million on property construction projects, of which $42.1
million will be funded by debt.



In the first three months of 2005, ARI sold
one apartment property, eleven land parcels, one industrial warehouse, and one office building for a total of $74.0 million, receiving $14.4 million in cash and discharging debt of $27.4 million after the payment of various closing costs and
providing seller financing of $27.2 million.



In the first three months of
2005, ARI financed or refinanced one land parcel and two shopping centers for a total of $17.9 million, discharging $9.0 million in debt and receiving $7.6 million in cash.



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 15.1% to 24.0%. Margin borrowing
totaled $18.6 million at March 31, 2005.



Management expects that it will be
necessary for ARI to sell $44.6 million, $47.1 million and $10.8 million of its land holdings during each of the next three years to satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy
the debt obligations on such land as it matures, or, if it is not able to extend such debt, ARI intends to sell other of its assets, specifically income producing properties, to pay the debt.



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



Related Party Transactions



In January 2005, an affiliate made a $700,000 note payment on ARIs behalf, reducing
ARIs affiliate receivable.



Commitments and Contingencies



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



20



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Results of Operations



For the three months ended March 31, 2005, ARI reported net income of $20.7 million compared to net income of $1.4 million for the three months ended March 31, 2004. The
primary factors contributing to ARIs net income are discussed in the following paragraphs.



Rents (dollars in thousands)



|           |  |      |        |      |   |       
|---------- |  | ---- | ------ | ---- | - | ------
|           |  | 2005 |        | 2004
|Commercial |  | $    | 12,120 |      | $ | 13,305
|Apartments |  |      | 21,315 |      |   | 18,223
|Hotels     |  |      | 7,313  |      |   | 7,666 
|Land       |  |      | 198    |      |   | 156   
|Other      |  |      | 11     |      |   | 362   
|           |  |      |        |      |   |       
|           |  | $    | 40,957 |      | $ | 39,712
|           |  |      |        |      |   |       



The decrease in commercial rents was
primarily attributable to lower occupancy. The increase in apartment rents was primarily attributable to completed construction. Rents are expected to increase in 2005, as a result of continued apartment construction.



Property Operations Expenses (dollars in thousands)



|           |  |      |        |   |      |   |        |  
|---------- |  | ---- | ------ | - | ---- | - | ------ | -
|           |  | 2005 |        |   | 2004 |  
|Commercial |  | $    | 7,067  |   |      | $ | 8,184  |  
|Apartments |  |      | 13,423 |   |      |   | 11,838 |  
|Hotels     |  |      | 6,446  |   |      |   | 6,972  |  
|Land       |  |      | 1,899  |   |      |   | 1,004  |  
|Other      |  |      | (16    | ) |      |   | (219   | )
|           |  |      |        |   |      |   |        |  
|           |  | $    | 28,819 |   |      | $ | 27,779 |  
|           |  |      |        |   |      |   |        |  



The decrease in commercial operations
expenses was primarily attributable to lower occupancy. The increase in apartment operations expense was primarily attributable to completed construction. Property operations expense is expected to increase in 2005, as a result of completed
apartment construction.



Restaurants sales and cost of sales increased to of
$8.6 million and $6.8 million, respectively, in the three months ended March 31, 2005, from $8.2 million and $6.2 million in the three months ended March 31, 2004. Same-store sales increased by 2.0% in 2005. Also, two new concepts opened in 2004.
The increase in cost of sales is primarily due to increased sales, increased raw product costs, and fuel surcharges that have been added in some cases.



Interest income from notes receivable increased to $1.6 million in the three months ended March 31, 2005 from $1.0 million in 2004, primarily due to new notes receivable
related to seller financing of land sales and advances to partners in the fourth quarter of 2004 and the first quarter of 2005.



Equity in income (loss) of investees improved to $60,000 in the three months ended March 31, 2005, from $(145,000) in 2004.



Interest Expense (dollars in thousands)



|           |  |      |        |      |   |       
|---------- |  | ---- | ------ | ---- | - | ------
|           |  | 2005 |        | 2004
|Commercial |  | $    | 3,572  |      | $ | 3,458 
|Apartments |  |      | 7,091  |      |   | 6,343 
|Hotels     |  |      | 1,546  |      |   | 1,586 
|Land       |  |      | 2,474  |      |   | 2,994 
|MRI        |  |      | 348    |      |   | 386   
|Other      |  |      | 1,096  |      |   | 1,367 
|           |  |      |        |      |   |       
|           |  | $    | 16,127 |      | $ | 16,134
|           |  |      |        |      |   |       



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



21



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Depreciation and Amortization (dollars in thousands)



|           |  |      |       |             |   |      
|---------- |  | ---- | ----- | ----------- | - | -----
|           |  | 2005 |       | 2004       
|           |  |      |       | As Restated
|Commercial |  | $    | 2,516 |             | $ | 2,784
|Apartments |  |      | 2,284 |             |   | 1,898
|Hotels     |  |      | 697   |             |   | 928  
|MRI        |  |      | 302   |             |   | 328  
|Other      |  |      | 13    |             |   | 20   
|           |  |      |       |             |   |      
|           |  | $    | 5,812 |             | $ | 5,958
|           |  |      |       |             |   |      



The increase in apartment depreciation
and amortization was primarily attributable to completed constructions.



Discount on sale of notes receivable was $398,000 in the three months ended March 31, 2004. This represents the discount from the face amount given by ARI to purchasers of notes receivable.



General and administrative expenses decreased to $2.7 million in the three months ended March
31, 2005, from $4.6 million in 2004. The decrease was primarily attributable to reduced legal fees and reduced expense reimbursements paid to Prime.



Advisory fees of $2.9 million in the three months ended March 31, 2005, approximate the $2.9 million in 2004.



Net income fee to affiliate increased to $1.5 million in the three months ended March 31,
2005, from $79,000 in 2004. 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.



Minority interest of $921,000 in the three months ended March 31, 2005, approximated the $1.2 million in 2004.



In the three months ended March 31, 2005, ARI recognized gains on sale of real estate of
$35.2 million: $10.9 million on the sale of two commercial properties, $56,000 on the sale of one apartment property, and $24.2 million on the sale of eleven land parcels.



Net income from discontinued operations decreased to $10.7 million in the three months ended March 31, 2005 from $13.5 million in 2004. The
net income relates to 27 properties that ARI sold during 2003 and ten properties that ARI sold or held-for-sale during 2005. The following table summarizes revenue and expense information for the properties sold and held-for-sale.



|                                                          |  |                                     |        |   |      |   |        |  
|--------------------------------------------------------- |  | ----------------------------------- | ------ | - | ---- | - | ------ | -
|                                                          |  | For the Three MonthsEnded March 31, |       
|                                                          |  | 2005                                |        |   | 2004 |  
|Revenue                                                   |  |                                     |        |   |      |   |        |  
|Rental                                                    |  | $                                   | 3,059  |   |      | $ | 11,435 |  
|Property operations                                       |  |                                     | 2,199  |   |      |   | 6,448  |  
|                                                          |  |                                     |        |   |      |   |        |  
|                                                          |  |                                     | 860    |   |      |   | 4,987  |  
|                                                          |  |                                    
|Expenses                                                  |  |                                     |        |   |      |   |        |  
|Interest                                                  |  |                                     | 1,079  |   |      |   | 4,519  |  
|Depreciation                                              |  |                                     | 49     |   |      |   | 1,735  |  
|                                                          |  |                                     |        |   |      |   |        |  
|                                                          |  |                                     | 1,128  |   |      |   | 6,254  |  
|                                                          |  |                                    
|Net loss from operations                                  |  |                                     | (268   | ) |      |   | (1,267 | )
|Gain on sale of real estate                               |  |                                     | 10,987 |   |      |   | 13,934 |  
|Equity in gain on sale of real estate by equity investees |  |                                     |       |   |      |   | 783    |  
|                                                          |  |                                     |        |   |      |   |        |  
|Net income from discontinued operations                   |  | $                                   | 10,719 |   |      | $ | 13,450 |  
|                                                          |  |                                     |        |   |      |   |        |  



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 for
federal income tax purposes after the use of net operating loss carryforwards in the first three months of 2005 and a federal taxable loss in the first three months of 2004; therefore, it recorded no provision for income taxes.



22



---

At March 31, 2005, ARI had a net deferred tax asset of $68.4 million due to tax deductions available to it in future
years. However, as management cannot determine that it is more likely than not that ARI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.



TCI had a loss for federal income tax purposes after the use of net operating loss
carryforwards in the first three months of 2005 and the first three months of 2004; therefore, it recorded no provision for income taxes.



At March 31, 2005, TCI had a net deferred tax asset of $45.7 million due to tax deductions available to it in future years. However, as management cannot determine that
it is more likely than not that TCI will realize the benefit of the deferred tax assets, a 100% valuation allowance has been established.



Environmental Matters



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



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



Inflation



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



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS



At March 31, 2005, ARIs exposure to a change in interest rates on its debt is as
follows:



|                                          |  |         |         |                               |       |   |                                    |   |      
|----------------------------------------- |  | ------- | ------- | ----------------------------- | ----- | - | ---------------------------------- | - | -----
|                                          |  | Balance |         | WeightedAverage Interest Rate |       |   | Effect of 1%Increase In Base Rates
|Notes payable:                            |  |         |         |                               |       |   |                                    |   |      
|Variable rate                             |  | $       | 195,724 |                               | 6.658 | % |                                    | $ | 1,957
|                                          |  |         |         |                               |       |   |                                    |   |      
|Total decrease in ARIs annual net income |  |         |         |                               |       |   |                                    | $ | 1,957
|                                          |  |         |         |                               |       |   |                                    |   |      
|Per share                                 |  |         |         |                               |       |   |                                    | $ | .19  
|                                          |  |         |         |                               |       |   |                                    |   |      



ITEM 4. CONTROLS AND
PROCEDURES



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



| | (31) | 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.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



---

PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



Innovo Realty, Inc. On August 10, 2004, three entities, including American Realty Investors, Inc. (the Company), instituted an action in Texas State
District Court as Cause No. 2004-60231-393 styled American Realty Investors, Inc., Transcontinental Realty Investors, Inc. and Income Opportunity Realty Investors, Inc., Plaintiffs v. Innovo Realty, Inc. and Innovo Group, Inc., Involuntary
Plaintiffs v. Innovo Realty, Inc., Metra Capital LLC, Innovo Group, Inc., Joseph Mizrachi, Simon Mizrachi, Herbert Guez, Third Millennium Partners LLC, Third Millennium Partners, Inc., Third Millennium Group LLC and Sunridge Management, Inc.,
Defendants. The Plaintiffs complaint alleges that a former director of the Company, and others, offered a plan to the Plaintiffs to create one or more joint venture arrangements with one or more of the Plaintiffs to pursue alternative
forms of financing or refinancing portions of Plaintiffs real estate portfolios, which entailed the creation of 22 separate limited partnerships to acquire 28 separate apartment complexes in three states (Texas, Florida and Louisiana), the
general partners of which were affiliates of, or are controlled by, the former director of the Company. During April 2005, resolution of the litigation occurred, settling all liabilities remaining from the original partnership arrangements which
included a return of investor equity, prospective asset management fees and miscellaneous fees and transactions costs from the Plaintiffs as a prepayment of a preferred return, along with a delegation of management to another entity, and a motion to
dismiss the action as a part of the resolution. Of the prepayment, the Company will recognize expense of $525,000 and a reduction in liabilities of $3.2 million during the second quarter of 2005.



Sunset Management LLC. On October 5, 2004, Sunset Management LLC (Sunset)
filed a complaint as a purported stockholders derivative action on behalf of TCI in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc., Basic Capital Management, Inc.,
Prime Income Asset Management, Inc., Prime Income Asset Management LLC, Income Opportunity Realty Investors, Inc., United Housing Foundation (United), Inc., Regis Realty, Inc., TCI, TCIs current directors and officers and others.
Sunsets complaint filed as Case No. 3:04-CV-02162-B styled Sunset Management LLC, derivatively on behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al., raises a number of allegations previously
raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunsets requested relief. The Defendants on November 8, 2004 filed a Motion to Dismiss pursuant to Rules 12 and 23.1 of the Federal Rules of
Civil Procedure on the basis that Sunsets allegations are insufficient to evade the stringent demand requirement under the futility exceptions for stockholder derivative actions, and that Sunset cannot fairly and adequately represent the
interests of other stockholders. One of the individual Defendants also filed on January 4, 2005 a Motion to Disqualify Sunsets Counsel. On January 4, 2005, the Defendants filed a Motion to Stay Discovery and for Protective Order, which Motion
was granted on March 30, 2005 by the issuance of an Order of the Court granting the Motion for Protective Order and staying all discovery in the action pending further Order of the Court, if appropriate, following the Courts ruling on the
Defendants Motion to Dismiss. On March 28, 2005, Sunset also filed a Petition for Writ of Mandamus in the United States District Court for the Eastern District of Texas, Sherman Division, seeking a Writ of Mandamus to be issued by the Court
directing the bankruptcy judge in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, in the case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11, and American Realty Trust, Inc., et al. v.
Sunset Management LLC, Adversary Proceeding No. 03-4256, to rule on pending Motions for Summary Judgment within twenty days thereof. On April 11, 2005, the United States District Court for the Eastern District of Texas, Sherman Division, entered
its Order denying Sunsets Petition for Writ of Mandamus. On May 6, 2005, in the bankruptcy case styled In Re: ART Williamsburg, Inc., Case No. 03-43909BTR-11 pending in the United States Bankruptcy Court for the Eastern District of
Texas, Sherman Division, Sunset filed a Motion for Allowance of Claim, Determination of the Value of its Lien, Allowance of Deficiency as an Unsecured Claim and Abandonment of Cash Collateral to Sunset. Such Motion seeks an Order (i) estimating and
determining the allowed amount of Sunsets claim for purposes of distribution, (ii) determining the method of value in Sunsets secured claim, (iii) determining the value of the lien held by Sunset, (iv) declaring that Sunsets claim
is secured in the amount determined, (v) allowing Sunset a deficiency claim for the unsecured portion of its claim, and (vi) ordering a distribution to Sunset of the proceeds received by the Debtor from a specified note.



The ownership of property and provision of services to the public as tenants entails an
inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of management, the outcome of such litigation will not have a
material adverse impact upon the Companys financial condition, results of operations or liquidity.



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



The following table sets forth information regarding purchases made by ARI of shares of ARI
Common Stock on a monthly basis during the first quarter of 2005:



|              |  |                                     |  |                                 |   |                                                                                     |   |                                                                                    |        
|------------- |  | ----------------------------------- |  | ------------------------------- | - | ----------------------------------------------------------------------------------- | - | ---------------------------------------------------------------------------------- | -------
|Period        |  | (a) Total Number ofShares Purchased |  | (b) Average Price Paidper Share |   | (c) Total Number ofShares Purchased asPart of PubliclyAnnounced Plans orPrograms(1) |   | (d) Maximum Number ofShares that May Yet BePurchased Under thePlans or Programs(1)
|January 2005  |  |                                    |  | $                               |  |                                                                                     |  |                                                                                    | 129,493
|February 2005 |  |                                    |  |                                 |  |                                                                                     |  |                                                                                    | 129,493
|March 2005    |  |                                    |  |                                 |  |                                                                                     |  |                                                                                    | 129,493
|              |  |                                     |  |                                 |   |                                                                                     |   |                                                                                    |        
|Total         |  |                                    |  | $                               |  |                                                                                     |  |                                                                                    |        
|              |  |                                     |  |                                 |   |                                                                                     |   |                                                                                    |        

---

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



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ITEM 6. EXHIBITS



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



|              |  |                                                                                                                                                                                         
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                             
|31.1          |  | Certification Pursuant to Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
herewith.
|              | 
|31.2          |  | Certification Pursuant to Rules 13a-14(a) and 15d-14(a) 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.                                                 



26



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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: May 16, 2005 |  | /s/ Ted P. Stokely                                            
|                   |  | Ted P. Stokely                                                
|                   |  | Chairman of the Board                                         
|                   | 
|                   |  | /s/ Allen M. Wilson, Jr.                                      
|                   |  | Allen M. Wilson, Jr.                                          
|                   |  | Controller (Acting Principal Financial and Accounting Officer)



27



---

AMERICAN REALTY INVESTORS, INC.



EXHIBITS TO



QUARTERLY REPORT ON FORM 10-Q



For the Quarter ended March 31, 2005



|              |  |                                                                                                                                                                                          |  |            
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------
|ExhibitNumber |  | Description                                                                                                                                                                              |  | Page Number
|31.1          |  | Certification Pursuant to Rules 13a-14(a) and 15d-14(a) Under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
herewith. |  |            
|              |  |                                                                                                                                                                                         
|31.2          |  | Certification Pursuant to Rules 13a-14(a) and 15d-14(a) 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.                                                  |  |            



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