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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, 2004



Commission File Number 1-15663



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AMERICAN REALTY INVESTORS, INC.

(Exact Name of Registrant as Specified in Its
Charter)



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



(469) 522-4200

(Registrants Telephone Number, Including Area Code)



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



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



APPLICABLE ONLY TO CORPORATE ISSUERS:



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



|                             |  |                               
|---------------------------- |  | ------------------------------
|Common Stock, $.01 par value |  | 10,618,600                    
|(Class)                      |  | (Outstanding at May 12, 2004)*



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



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AMERICAN REALTY INVESTORS, INC.



PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but, in the opinion of the management of American
Realty Investors, Inc. (ARI), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated 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, 2004                           |           |   | December 31, 2003 |  
|                                                                                   |  | (dollars in thousands, except per share) |          
|Assets                                                                             |  |                                          |           |   |                   |   |           |  
|Real estate held for investment                                                    |  | $                                        | 1,056,860 |   |                   | $ | 1,015,385 |  
|Lessaccumulated depreciation                                                      |  |                                          | (178,587  | ) |                   |   | (173,453  | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 878,273   |   |                   |   | 841,932   |  
|                                                                                   |  |                                         
|Real estate held for sale                                                          |  |                                          | 164,118   |   |                   |   | 212,104   |  
|                                                                                   |  |                                         
|Notes and interest receivable                                                      |  |                                          |           |   |                   |   |           |  
|Performing ($37,083 in 2004 and $37,697 in 2003 from affiliates)                   |  |                                          | 66,650    |   |                   |   | 64,296    |  
|Nonperforming                                                                      |  |                                          | 10,932    |   |                   |   | 10,932    |  
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 77,582    |   |                   |   | 75,228    |  
|Lessallowance for estimated losses                                                |  |                                          | (4,633    | ) |                   |   | (4,633    | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 72,949    |   |                   |   | 70,595    |  
|                                                                                   |  |                                         
|Pizza parlor equipment                                                             |  |                                          | 12,688    |   |                   |   | 12,237    |  
|Lessaccumulated depreciation                                                      |  |                                          | (5,684    | ) |                   |   | (5,385    | )
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  |                                          | 7,004     |   |                   |   | 6,852     |  
|                                                                                   |  |                                         
|Marketable equity securities, at market value                                      |  |                                          | 5,772     |   |                   |   | 5,020     |  
|Cash and cash equivalents                                                          |  |                                          | 8,150     |   |                   |   | 9,543     |  
|Investments in equity investees                                                    |  |                                          | 5,628     |   |                   |   | 4,987     |  
|Goodwill, net of accumulated amortization ($1,763 in 2004 and 2003)                |  |                                          | 11,858    |   |                   |   | 11,858    |  
|Other intangibles, net of accumulated amortization ($834 in 2004 and $822 in 2003) |  |                                          | 1,517     |   |                   |   | 1,529     |  
|Other assets ($13,730 in 2004 and $8,098 in 2003 from affiliate)                   |  |                                          | 74,964    |   |                   |   | 75,761    |  
|                                                                                   |  |                                          |           |   |                   |   |           |  
|                                                                                   |  | $                                        | 1,230,233 |   |                   | $ | 1,240,181 |  
|                                                                                   |  |                                          |           |   |                   |   |           |  



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 31,2004                            |           |   | December 31, 2003 |  
|                                                                                                                                                                 |  | (dollars in thousands, except per share) |          
|Liabilities and Stockholders Equity                                                                                                                             |  |                                          |           |   |                   |   |           |  
|Liabilities                                                                                                                                                      |  |                                          |           |   |                   |   |           |  
|Notes and interest payable ($36,611 in 2004 and $34,775 in 2003 to affiliates)                                                                                   |  | $                                        | 857,821   |   |                   | $ | 886,615   |  
|Liabilities related to assets held for sale                                                                                                                      |  |                                          | 120,153   |   |                   |   | 100,154   |  
|Margin borrowings                                                                                                                                                |  |                                          | 20,747    |   |                   |   | 21,194    |  
|Accounts payable and other liabilities ($2,795 in 2004 and $2,934 in 2003 to affiliates)                                                                         |  |                                          | 92,881    |   |                   |   | 96,360    |  
|                                                                                                                                                                 |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                                          | 1,091,602 |   |                   |   | 1,104,323 |  
|                                                                                                                                                                 |  |                                         
|Minority interest                                                                                                                                                |  |                                          | 59,804    |   |                   |   | 60,178    |  
|                                                                                                                                                                 |  |                                         
|Commitments and contingencies                                                                                                                                    |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                                         
|Stockholders equity                                                                                                                                             |  |                                          |           |   |                   |   |           |  
|Preferred Stock, $2.00 par value, authorized 50,000,000 shares, issued and outstanding                                                                           |  |                                          |           |   |                   |   |           |  
|Series A, 3,475,370 shares in 2004 and 3,225,370 shares in 2003 (liquidation preference $32,254), including 900,000 shares in 2004 and 2003
held by subsidiaries |  |                                          | 5,151     |   |                   |   | 4,651     |  
|Series E, 50,000 shares in 2004 and 2003 (liquidation preference $500)                                                                                           |  |                                          | 100       |   |                   |   | 100       |  
|Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,392,272 shares in 2004 and 2003                                                           |  |                                          | 114       |   |                   |   | 114       |  
|Paid-in capital                                                                                                                                                  |  |                                          | 93,814    |   |                   |   | 92,464    |  
|Treasury stock, at cost, 752,072 shares in 2004 and 746,972 shares in 2003                                                                                       |  |                                          | (9,966    | ) |                   |   | (9,924    | )
|Accumulated deficit                                                                                                                                              |  |                                          | (10,981   | ) |                   |   | (11,826   | )
|Accumulated other comprehensive income                                                                                                                           |  |                                          | 595       |   |                   |   | 101       |  
|                                                                                                                                                                 |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                 |  |                                          | 78,827    |   |                   |   | 75,680    |  
|                                                                                                                                                                 |  |                                          |           |   |                   |   |           |  
|                                                                                                                                                                 |  | $                                        | 1,230,233 |   |                   | $ | 1,240,181 |  
|                                                                                                                                                                 |  |                                          |           |   |                   |   |           |  



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



3



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                           |  |                                         |         |   |      |   |        |  
|-------------------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---- | - | ------ | -
|                                                                           |  | For the Three MonthsEnded March 31,     |        
|                                                                           |  | 2004                                    |         |   | 2003 |  
|                                                                           |  | (dollars in thousands,except per share) |        
|Property revenue                                                           |  |                                         |         |   |      |   |        |  
|Rents ($321 in 2004 and $447 in 2003 from affiliates)                      |  | $                                       | 49,273  |   |      | $ | 18,117 |  
|Property operations expenses ($900 in 2004 and $213 in 2003 to affiliates) |  |                                         | 32,958  |   |      |   | 13,812 |  
|                                                                           |  |                                         |         |   |      |   |        |  
|Operating income                                                           |  |                                         | 16,315  |   |      |   | 4,305  |  
|                                                                           |  |                                        
|Land operations                                                            |  |                                         |         |   |      |   |        |  
|Sales                                                                      |  |                                         | 30,194  |   |      |   | 8,785  |  
|Cost of sales                                                              |  |                                         | 21,283  |   |      |   | 8,711  |  
|Deferral of gains on current period sales                                  |  |                                         | 5,159   |   |      |   |       |  
|Recognition of previously deferred gains                                   |  |                                         |        |   |      |   | 19,897 |  
|                                                                           |  |                                         |         |   |      |   |        |  
|Gain on land sales                                                         |  |                                         | 3,752   |   |      |   | 19,971 |  
|                                                                           |  |                                        
|Pizza parlor operations                                                    |  |                                         |         |   |      |   |        |  
|Sales                                                                      |  |                                         | 8,169   |   |      |   | 7,867  |  
|Cost of sales                                                              |  |                                         | 6,213   |   |      |   | 6,407  |  
|                                                                           |  |                                         |         |   |      |   |        |  
|Gross margin                                                               |  |                                         | 1,956   |   |      |   | 1,460  |  
|                                                                           |  |                                        
|Income from operations                                                     |  |                                         | 22,023  |   |      |   | 25,736 |  
|                                                                           |  |                                        
|Other income (loss)                                                        |  |                                         |         |   |      |   |        |  
|Interest income ($688 in 2004 and $890 in 2003 from affiliates)            |  |                                         | 1,049   |   |      |   | 2,230  |  
|Equity in loss of investees                                                |  |                                         | (145    | ) |      |   | (4,339 | )
|Other                                                                      |  |                                         | 627     |   |      |   | 8      |  
|                                                                           |  |                                         |         |   |      |   |        |  
|                                                                           |  |                                         | 1,531   |   |      |   | (2,101 | )
|                                                                           |  |                                        
|Other expenses                                                             |  |                                         |         |   |      |   |        |  
|Interest ($642 in 2004 and $520 in 2003 to affiliates)                     |  |                                         | 19,675  |   |      |   | 9,531  |  
|Depreciation and amortization                                              |  |                                         | 7,864   |   |      |   | 1,982  |  
|Discount on sale of notes receivable                                       |  |                                         | 398     |   |      |   | 1,558  |  
|General and administrative ($857 in 2004 and $972 in 2003 to affiliates)   |  |                                         | 4,634   |   |      |   | 3,308  |  
|Advisory fee to affiliate                                                  |  |                                         | 2,852   |   |      |   | 2,028  |  
|Net income fee to affiliate                                                |  |                                         | 79      |   |      |   | 452    |  
|Incentive fee to affiliate                                                 |  |                                         |        |   |      |   | 261    |  
|Minority interest                                                          |  |                                         | 1,184   |   |      |   | 550    |  
|                                                                           |  |                                         |         |   |      |   |        |  
|                                                                           |  |                                         | 36,686  |   |      |   | 19,670 |  
|                                                                           |  |                                         |         |   |      |   |        |  
|Net income (loss) from continuing operations                               |  |                                         | (13,132 | ) |      |   | 3,965  |  
|                                                                           |  |                                        
|Discontinued operations:                                                   |  |                                         |         |   |      |   |        |  
|Income (loss) from operations                                              |  |                                         | (740    | ) |      |   | 213    |  
|Gain on sale of real estate                                                |  |                                         | 13,934  |   |      |   | 3,013  |  
|Equity in gain on sale of real estate by equity investees                  |  |                                         | 783     |   |      |   |       |  
|                                                                           |  |                                         |         |   |      |   |        |  
|Net income from discontinued operations                                    |  |                                         | 13,977  |   |      |   | 3,226  |  
|                                                                           |  |                                        
|Net income                                                                 |  |                                         | 845     |   |      |   | 7,191  |  
|Preferred dividend requirement                                             |  |                                         | (650    | ) |      |   | (588   | )
|                                                                           |  |                                         |         |   |      |   |        |  
|Net income applicable to Common shares                                     |  | $                                       | 195     |   |      | $ | 6,603  |  
|                                                                           |  |                                         |         |   |      |   |        |  



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,    
|                                                                     |  | 2004                                     |            |   | 2003
|                                                                     |  | (dollars in thousands, except per share)
|Basic earnings per share                                             |  |                                          |            |   |      |   |           
|Net income (loss) from continuing operations                         |  | $                                        | (1.29      | ) |      | $ | .30       
|Discontinued operations                                              |  |                                          | 1.31       |   |      |   | .28       
|                                                                     |  |                                          |            |   |      |   |           
|Net income applicable to Common shares                               |  | $                                        | .02        |   |      | $ | .58       
|                                                                     |  |                                          |            |   |      |   |           
|Diluted earnings per share                                           |  |                                          |            |   |      |   |           
|Net income (loss) from continuing operations                         |  | $                                        | (1.29      | ) |      | $ | .23       
|Discontinued operations                                              |  |                                          | 1.31       |   |      |   | .22       
|                                                                     |  |                                          |            |   |      |   |           
|Net income applicable to Common shares                               |  | $                                        | .02        |   |      | $ | .45       
|                                                                     |  |                                          |            |   |      |   |           
|Weighted average Common shares used in computing earnings per share: |  |                                          |            |   |      |   |           
|Basic                                                                |  |                                          | 10,644,666 |   |      |   | 11,375,127
|Diluted                                                              |  |                                          | 10,644,666 |   |      |   | 14,522,530



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.



Options to purchase 105,750 shares of ARIs Common Stock were excluded
from the computation of diluted earnings per share for the three months ended March 31, 2003, because of the effect of their inclusion would be antidilutive.



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



5



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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

For the Nine Months Ended March
31, 2004



|                                                |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  
|----------------------------------------------- |  | ---------------------------------------- | ----- | ---------------------- | - | ----------- |  | -------------- | --- |  | ------------- | ------ | - | ------------------ | - | ------ | ------------------------------------------ |  | ------------------- | ------- | - |  | - | --- |  | - | ------ | -
|                                                |  | Series APreferredStock                   |       | Series EPreferredStock |   | CommonStock |  | Paid-inCapital |     |  | TreasuryStock |        |   | AccumulatedDeficit |   |        | AccumulatedOtherComprehensiveIncome/(Loss) |  | StockholdersEquity |        
|                                                |  | (dollars in thousands, except per share) |      
|Balance, January 1, 2004                        |  | $                                        | 4,651 |                        | $ | 100         |  | $              | 114 |  | $             | 92,464 |   |                    | $ | (9,924 | )                                          |  | $                   | (11,826 | ) |  | $ | 101 |  | $ | 75,680 |  
|                                                |  |                                          |       |                        |   |             |  |               
|Comprehensive income                            |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  
|Unrealized gain on foreign currency translation |  |                                          |      |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |                     |        |   |  |   | 97  |  |   | 97     |  
|Unrealized gain on marketable securities        |  |                                          |      |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |                     |        |   |  |   | 397 |  |   | 397    |  
|Net income                                      |  |                                          |      |                        |   |            |  |                |    |  |               |       |   |                    |   |       |                                            |  |                     | 845     |   |  |   |    |  |   | 845    |  
|                                                |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  
|                                                |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   | 1,339  |  
|                                                |  |                                          |       |                        |   |             |  |               
|Repurchase of Common Stock                      |  |                                          |      |                        |   |            |  |                |    |  |               |       |   |                    |   | (42    | )                                          |  |                     |        |   |  |   |    |  |   | (42    | )
|                                                |  |                                          |       |                        |   |             |  |               
|Issuance of Preferred Stock                     |  |                                          | 500   |                        |   |            |  |                |    |  |               | 2,000  |   |                    |   |       |                                            |  |                     |        |   |  |   |    |  |   | 2,500  |  
|                                                |  |                                          |       |                        |   |             |  |               
|Preferred dividends                             |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  
|Series A Preferred Stock ($.25 per share)       |  |                                          |      |                        |   |            |  |                |    |  |               | (642   | ) |                    |   |       |                                            |  |                     |        |   |  |   |    |  |   | (642   | )
|Series E Preferred Stock ($.15 per share)       |  |                                          |      |                        |   |            |  |                |    |  |               | (8     | ) |                    |   |       |                                            |  |                     |        |   |  |   |    |  |   | (8     | )
|                                                |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  
|Balance, March 31, 2004                         |  | $                                        | 5,151 |                        | $ | 100         |  | $              | 114 |  | $             | 93,814 |   |                    | $ | (9,966 | )                                          |  | $                   | (10,981 | ) |  | $ | 595 |  | $ | 78,827 |  
|                                                |  |                                          |       |                        |   |             |  |                |     |  |               |        |   |                    |   |        |                                            |  |                     |         |   |  |   |     |  |   |        |  



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, |         
|                                                                                           |  | 2004                                |          |   | 2003 |  
|                                                                                           |  | (dollars in thousands)              |         
|Cash Flows From Operating Activities                                                       |  |                                     |          |   |      |   |         |  
|Net income                                                                                 |  | $                                   | 845      |   |      | $ | 7,191   |  
|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                                                       |  |                                     | (18,469  | ) |      |   | (22,984 | )
|Depreciation and amortization                                                              |  |                                     | 8,232    |   |      |   | 2,566   |  
|Amortization of deferred borrowing costs                                                   |  |                                     | 1,832    |   |      |   | 1,105   |  
|Discount on sale of notes receivable                                                       |  |                                     | 398      |   |      |   | 1,558   |  
|Equity in loss of investees                                                                |  |                                     | 145      |   |      |   | 4,339   |  
|(Increase) decrease in accrued interest receivable                                         |  |                                     | 1,496    |   |      |   | (1,099  | )
|(Increase) decrease in other assets                                                        |  |                                     | 3,994    |   |      |   | (1,271  | )
|Increase (decrease) in accrued interest payable                                            |  |                                     | (625     | ) |      |   | 766     |  
|Increase (decrease) in accounts payable and other liabilities                              |  |                                     | 9,300    |   |      |   | (437    | )
|Increase (decrease) in minority interest                                                   |  |                                     | 324      |   |      |   | (32     | )
|                                                                                           |  |                                     |          |   |      |   |         |  
|Net cash provided by (used in) operating activities                                        |  |                                     | 7,472    |   |      |   | (8,298  | )
|                                                                                           |  |                                    
|Cash Flows From Investing Activities                                                       |  |                                     |          |   |      |   |         |  
|Collections on notes receivable                                                            |  |                                     | 39       |   |      |   | 9,304   |  
|Proceeds from sale of notes receivable                                                     |  |                                     | 6,227    |   |      |   | 26,346  |  
|Acquisition of real estate                                                                 |  |                                     | (19,943  | ) |      |   |        |  
|Pizza parlor equipment purchased                                                           |  |                                     | (467     | ) |      |   | (767    | )
|Proceeds from sale of real estate                                                          |  |                                     | 64,442   |   |      |   | 27,172  |  
|Notes receivable funded                                                                    |  |                                     | (65      | ) |      |   |        |  
|Earnest money/escrow deposits                                                              |  |                                     | (2,325   | ) |      |   | (34     | )
|Investment in real estate entities, net of cash acquired                                   |  |                                     |         |   |      |   | (22,417 | )
|Short-term advances funded                                                                 |  |                                     |         |   |      |   | (24,723 | )
|Real estate improvements                                                                   |  |                                     | (55,836  | ) |      |   | (1,308  | )
|Purchase of marketable securities                                                          |  |                                     | (321     | ) |      |   |        |  
|Distribution from equity investees                                                         |  |                                     | 4        |   |      |   |        |  
|                                                                                           |  |                                     |          |   |      |   |         |  
|Net cash (used in) provided by investing activities                                        |  |                                     | (8,245   | ) |      |   | 13,573  |  
|                                                                                           |  |                                    
|Cash Flows From Financing Activities                                                       |  |                                     |          |   |      |   |         |  
|Proceeds from notes payable                                                                |  |                                     | 129,181  |   |      |   | 42,494  |  
|Payments on notes payable                                                                  |  |                                     | (126,661 | ) |      |   | (37,912 | )
|Deferred borrowing costs                                                                   |  |                                     | (2,934   | ) |      |   | (1,555  | )
|Net advances from (payments to) affiliates                                                 |  |                                     | 933      |   |      |   | (7,413  | )
|Repurchase of Common Stock                                                                 |  |                                     | (42      | ) |      |   |        |  
|Margin borrowings (payments), net                                                          |  |                                     | (447     | ) |      |   |        |  
|Preferred dividends paid                                                                   |  |                                     | (650     | ) |      |   | (581    | )
|                                                                                           |  |                                     |          |   |      |   |         |  
|Net cash used in financing activities                                                      |  |                                     | (620     | ) |      |   | (4,967  | )
|                                                                                           |  |                                    
|Net increase (decrease) in cash and cash equivalents                                       |  |                                     | (1,393   | ) |      |   | 308     |  
|                                                                                           |  |                                    
|Cash and cash equivalents, beginning of period                                             |  |                                     | 9,543    |   |      |   | 8,432   |  
|                                                                                           |  |                                     |          |   |      |   |         |  
|Cash and cash equivalents, end of period                                                   |  | $                                   | 8,150    |   |      | $ | 8,740   |  
|                                                                                           |  |                                     |          |   |      |   |         |  



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,
|                                                      |  | 2004                                |        | 2003
|                                                      |  | (dollars in thousands)             
|Supplemental Disclosures of Cash Flow Information     |  |                                     |        |      |   |       
|Cash paid for interest                                |  | $                                   | 17,652 |      | $ | 9,610 
|                                                      |  |                                    
|Schedule of noncash investing and financing           |  |                                     |        |      |   |       
|Notes payable assumed by buyer on sale of real estate |  | $                                   | 9,014  |      | $ | 3,439 
|Notes receivable from sale of real estate             |  |                                     | 10,448 |      |   | 19,178
|Disposal of property to satisfy debt                  |  |                                     |       |      |   | 8,050 
|Issuance of Preferred Stock                           |  |                                     | 2,500  |      |   |      
|Note payable paid by affiliate                        |  |                                     | 10,823 |      |   |      
|Refinancing proceeds received by affiliate            |  |                                     | 10,962 |      |   |      



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



8



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1. BASIS OF PRESENTATION



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



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



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



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



On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic
Capital Management, Inc. (BCM), receiving 650,000 TCI shares from BCM. In addition, BCM executed a promissory note in favor of ARI in the amount of $526,000 (see NOTE 3. NOTES AND INTEREST RECEIVABLE). After the exchange, ARI
subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (One Realco) to BCM, receiving
314,141 TCI shares from BCM (see NOTE 3. NOTES AND INTEREST RECEIVABLE). After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in market
transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At December 31, 2003 and March 31, 2004, ARI subsidiaries owned 80.0% of the outstanding shares of TCI. ARI no longer directly owns any IORI
shares. At December 31, 2003 and March 31, 2004, ARI subsidiaries owned 19.2% of IORI through TCIs ownership of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



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



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



|                        |  |                                  |       
|----------------------- |  | -------------------------------- | ------
|                        |  | Three Months EndedMarch 31, 2003
|Revenue, as reported    |  | $                                | 34,769
|Revenue, pro forma      |  |                                  | 59,230
|                        | 
|Net income, as reported |  |                                  | 7,191 
|Net income, pro forma   |  |                                  | 6,258 
|                        | 
|Earnings per share:     |  |                                  |       
|Basic, as reported      |  | $                                | .58   
|Basic, pro forma        |  | $                                | .53   
|                        | 
|Diluted, as reported    |  | $                                | .45   
|Diluted, pro forma      |  | $                                | .41   



9



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 1. BASIS OF PRESENTATION (Continued)



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



|                                                                                                                                             |  |                             |     |      |   |      
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- | --- | ---- | - | -----
|                                                                                                                                             |  | Three Months EndedMarch 31,
|                                                                                                                                             |  | 2004                        |     | 2003
|Net income applicable to common shares, as reported                                                                                          |  | $                           | 195 |      | $ | 6,603
|                                                                                                                                             |  |                            
|Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax
effects |  |                             | 22  |      |   | 19   
|                                                                                                                                             |  |                             |     |      |   |      
|Pro forma net income applicable to common shares                                                                                             |  | $                           | 173 |      | $ | 6,584
|                                                                                                                                             |  |                             |     |      |   |      
|Earnings per share:                                                                                                                          |  |                             |     |      |   |      
|Basic, as reported                                                                                                                           |  | $                           | .02 |      | $ | .58  
|Basic, pro forma                                                                                                                             |  | $                           | .02 |      | $ | .58  
|                                                                                                                                             |  |                            
|Diluted, as reported                                                                                                                         |  | $                           | .02 |      | $ | .45  
|Diluted, pro forma                                                                                                                           |  | $                           | .02 |      | $ | .45  



NOTE 2. REAL ESTATE



In 2004, ARI purchased the following
property:



|                           |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|-------------------------- |  | -------------- |  | ----------- |  | ------------- | ----- | ------------------------ | - | ---- | ------------ |  | ------------ | ----- |  | ------------ | --- |  | -----
|Property                   |  | Location       |  | Units/Acres |  | PurchasePrice |       | Net CashPaid/ (Received) |   |      | DebtIncurred |  | InterestRate |       |  | MaturityDate
|First Quarter              |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Apartments                 |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|288 City Park(1)           |  | Houston, TX    |  | 240 Units   |  | $             | 3,056 |                          | $ | 612  |              |  | $            | 2,444 |  | 5.95         | %   |  | 04/45
|Blue Lake Villas II(1)     |  | Waxahachie, TX |  | 70 Units    |  |               | 729   |                          |   | (164 | )            |  |              | 729   |  | 5.80         |     |  | 04/45
|Bridges on Kinsey(1)       |  | Tyler, TX      |  | 232 Units   |  |               | 2,291 |                          |   | 596  |              |  |              | 1,687 |  | 5.74         |     |  | 08/45
|Dakota Arms(1)             |  | Lubbock, TX    |  | 208 Units   |  |               | 2,472 |                          |   | 681  |              |  |              | 1,791 |  | 5.85         |     |  | 06/45
|Lake Forest(1)             |  | Houston, TX    |  | 240 Units   |  |               | 2,316 |                          |   | (470 | )            |  |              | 2,316 |  | 5.60         |     |  | 03/45
|Vistas of Vance Jackson(1) |  | San Antonio,TX |  | 240 Units   |  |               | 3,550 |                          |   | 771  |              |  |              | 2,779 |  | 5.78         |     |  | 06/45
|Land                       |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Lubbock 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  |              |  |              |      |  |             |     |  |     
|                           |  |                |  |             |  |               |      
|Second Quarter             |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Apartments                 |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Wildflower Villas(1)       |  | Temple, TX     |  | 220 Units   |  |               | 2,045 |                          |   | 79   |              |  |              | 1,966 |  |             |     |  |     
|                           |  |                |  |             |  |               |      
|Land                       |  |                |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Rogers land(1)             |  | Rogers, AR     |  | 20.1 Acres  |  |               | 1,390 |                          |   | 506  |              |  |              | 1,130 |  | 10.50        |     |  | 04/05

---

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

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



10



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In 2003, ARI purchased the following property:



|                |  |                 |  |           |  |                |       |              |   |              |  |              |       |  |              |   |  |      
|--------------- |  | --------------- |  | --------- |  | -------------- | ----- | ------------ | - | ------------ |  | ------------ | ----- |  | ------------ | - |  | -----
|Property        |  | Location        |  | Units     |  | Purchase Price |       | Net CashPaid |   | DebtIncurred |  | InterestRate |       |  | MaturityDate
|First Quarter   |  |                 |  |           |  |                |       |              |   |              |  |              |       |  |              |   |  |      
|Apartments      |  |                 |  |           |  |                |       |              |   |              |  |              |       |  |              |   |  |      
|Capitol Hill(1) |  | Little Rock, AR |  | 156 Units |  | $              | 1,904 |              | $ | 615          |  | $            | 1,289 |  | 5.50         | % |  | 10/44

---

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



In 2004, ARI sold the following property:



|                       |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|---------------------- |  | ----------------- |  | ------------------- |  | ---------- | ------ | --------------- | - | -------------- |  | - | ----------- | --- |  | - | ----- | ---
|Property               |  | Location          |  | Units/Sq. Ft./Acres |  | SalesPrice |        | NetCashReceived |   | DebtDischarged |  |   | Gain onSale |    
|First Quarter          |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|Apartments             |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|Tiberon Trails         |  | Merrillville, IN  |  | 376 Units           |  | $          | 10,325 |                 | $ | 2,618          |  | $ | 6,189       | (1) |  | $ | 48    |    
|                       |  |                   |  |                     |  |           
|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 |    
|Plaza on Bachman Creek |  | Dallas, TX        |  | 80,278 Sq. Ft.      |  |            | 7,850  |                 |   | 1,808          |  |   | 5,358       |     |  |   | 3,682 |    
|                       |  |                   |  |                     |  |           
|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       |     |  |   |      |    
|                       |  |                   |  |                     |  |           
|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)
|                       |  |                   |  |                     |  |           
|Shopping Center        |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|K-Mart                 |  | Cary, NC          |  | 92,033 Sq. Ft.      |  |            | 3,200  |                 |   |               |  |   | 1,677       | (1) |  |   | 521   | (3)
|                       |  |                   |  |                     |  |           
|Second Quarter         |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|Office Building        |  |                   |  |                     |  |            |        |                 |   |                |  |   |             |     |  |   |       |    
|Atrium                 |  | Palm Beach, FL    |  | 74,603 Sq. Ft.      |  |            | 5,775  |                 |   | 1,667          |  |   | 3,750       |     |  |   | 740   |    

---

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

|(2) | Includes deferred gain of $5.2 million. A portion of the land was sold on a contingent basis
for a note receivable of $7.2 million. See Note 3. NOTES AND INTEREST RECEIVABLE.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Property sold to BCM, a related party, for assumption of debt and a note receivable. See Note
3. NOTES AND INTEREST 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.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



11



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In 2003, ARI sold the following properties:



|                  |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|----------------- |  | --------------- |  | ------------------------ |  | ---------- | ------ | ----------------------- | - | ----- | --------------- |  | - | ------------------ | --- |  | - | ----- | ----
|Property          |  | Location        |  | Units/Sq.Ft./Acres/Rooms |  | SalesPrice |        | Net CashReceived/(Paid) |   |       | Debt Discharged |  |   | Gain/(Loss)on Sale |    
|First Quarter     |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|Apartments        |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|Bay Anchor        |  | Panama City, FL |  | 12 Units                 |  | $          | 369    |                         | $ |      |                 |  | $ | 291                |     |  | $ | 174   |     
|Georgetown        |  | Panama City, FL |  | 44 Units                 |  |            | 1,175  |                         |   | 323   |                 |  |   | 789                | (2) |  |   | 72    |     
|Northside Villas  |  | Tallahassee, FL |  | 81 Units                 |  |            | 5,575  |                         |   | 1,806 |                 |  |   | 2,784              |     |  |   | 915   |     
|Rolling Hills     |  | Tallahassee, FL |  | 134 Units                |  |            | 5,061  |                         |   | 1,361 |                 |  |   | 2,785              |     |  |   | 1,182 |     
|Seville           |  | Tallahassee, FL |  | 62 Units                 |  |            | 2,795  |                         |   |      |                 |  |   | 2,360              |     |  |   | 697   |     
|                  |  |                 |  |                          |  |           
|Shopping Centers  |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|Bridgeview Plaza  |  | LaCrosse, WI    |  | 116,008 Sq. Ft.          |  |            | 8,700  |                         |   |      |                 |  |   |                   |     |  |   | 8,700 | (1) 
|Cullman           |  | Cullman, AL     |  | 92,466 Sq. Ft.           |  |            | 2,000  |                         |   |      |                 |  |   | 2,650              | (2) |  |   | 1,118 | (1) 
|                  |  |                 |  |                          |  |           
|Land              |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|Katrina           |  | Palm Desert, CA |  | 89.3 Acres               |  |            | 8,550  |                         |   | (410  | )               |  |   | 2,800              |     |  |   | (40   | )   
|Nashville         |  | Nashville, TN   |  | 8.8 Acres                |  |            | 235    |                         |   | (11   | )               |  |   | 217                |     |  |   | 114   |     
|                  |  |                 |  |                          |  |           
|Hotel             |  |                 |  |                          |  |            |        |                         |   |       |                 |  |   |                    |     |  |   |       |     
|Grand Hotel Sofia |  | Sofia, Bulgaria |  | 136 Rooms                |  |            | 24,750 |                         |   | 6,258 |                 |  |   | 4,209              | (2) |  |   | (31   | )(3)

---

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

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

|(3) | Includes recognition of $3.1 million of accumulated foreign currency translation gains.
|--- | ---------------------------------------------------------------------------------------



At March 31, 2004, ARI had the following properties under construction:



|                        |  |                 |  |           |  |                |        |                           |   |                         |  |   |       
|----------------------- |  | --------------- |  | --------- |  | -------------- | ------ | ------------------------- | - | ----------------------- |  | - | ------
|Property                |  | Location        |  | Units     |  | AmountExpended |        | AdditionalAmountto Expend |   | ConstructionLoanFunding
|Apartments              |  |                 |  |           |  |                |        |                           |   |                         |  |   |       
|288 City Park           |  | Houston, TX     |  | 240 Units |  | $              | 4,748  |                           | $ | 11,939                  |  | $ | 15,005
|Blue Lake Villas II     |  | Waxahachie, TX  |  | 70 Units  |  |                | 407    |                           |   | 4,264                   |  |   | 4,234 
|Bluffs at Vista Ridge   |  | Lewisville, TX  |  | 272 Units |  |                | 8,423  |                           |   | 12,162                  |  |   | 15,500
|Breakwater Bay          |  | Beaumont, TX    |  | 176 Units |  |                | 7,701  |                           |   | 2,765                   |  |   | 9,545 
|Bridges on Kinsey       |  | Tyler, TX       |  | 232 Untis |  |                | 1,643  |                           |   | 14,437                  |  |   | 14,477
|Capitol Hill            |  | Little Rock, AR |  | 156 Units |  |                | 9,029  |                           |   | 1,550                   |  |   | 9,500 
|Dakota Arms             |  | Lubbock, TX     |  | 208 Units |  |                | 1,930  |                           |   | 12,007                  |  |   | 12,549
|Kingsland Ranch         |  | Houston, TX     |  | 398 Units |  |                | 21,925 |                           |   | 3,729                   |  |   | 23,000
|Lake Forest             |  | Houston, TX     |  | 240 Units |  |                | 3,230  |                           |   | 11,207                  |  |   | 12,815
|Vistas at Pinnacle Park |  | Dallas, TX      |  | 322 Units |  |                | 17,529 |                           |   | 3,652                   |  |   | 19,149
|Vistas of Vance Jackson |  | San Antonio, TX |  | 240 Units |  |                | 3,044  |                           |   | 15,058                  |  |   | 16,056



For the three months ended March 31,
2004, ARI completed the 248 unit DeSoto Ranch Apartments in DeSoto, Texas, the 314 unit Verandas at Cityview Apartments in Fort Worth, Texas and the 216 unit Mariposa Villas (Echo Valley) in Dallas, Texas.



NOTE 3. NOTES RECEIVABLE



In March 2004, ARI sold an 8.0 acre tract of its Mason Goodrich land parcel for $1.0
million, receiving $248,000 after payment of closing costs and providing purchase money financing of $523,000. The loan bears interest at 10.0% per annum, requires monthly payments of accrued interest and matures in March 2006. All principal and
accrued but unpaid interest is due at maturity.



12



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



In March 2004, ARI sold 492.5 acres in Collin County, Texas to a third party for $20.0 million. ARI provided $7.2
million of the purchase price as seller financing for a portion of the land on a contingent basis. The note bears interest at 7.0% and matures in September 2004. The buyer has the option to convey the contingent land back to ARI for cancellation of
the note. The purchaser also has the option to extend the note to December 2004 with a $1.1 million extension payment prior to the maturity date.



In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchasers closing costs
as seller financing. The note bears interest at a fixed rate of 5% and requires all interest and principal payments be paid at maturity on December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. Current
negotiations are ongoing to extend the loan or collect payment.



In July 2003,
an unsecured loan of $22,000 was made to an individual. The note bears interest at a fixed rate of 12% and requires all interest and principal payments be paid at maturity in January 2004. This note, including accrued and unpaid interest, was paid
in full in March 2004.



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 bears interest at a variable rate, currently 9.0% per annum, requires monthly interest only payments and matured in January 2003. As of September 2003, ARI has
funded a total of $4.3 million and the note is classified as nonperforming. The collateral used to secure ARIs second lien was seized by the first lien holder. On March 11, 2004, ARI agreed to accept an assignment of claims in litigation as
security for the note. ARI is also working on securing additional collateral for this note and restructuring the terms of the note but a new agreement has not been reached. The current agreement requires interest to accrue at the default rate of
18.0%.



In March 2002, ARI sold the 174,513 sq.ft. Hartford Office Building in
Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a
variable interest rate, currently 6.0% per annum, requires monthly interest only payments of $14,667 and matures in March 2007. As of March 2004, ARI funded $354,000 of the additional line of credit.



In July 2002, ARI entered into an agreement to fund up to $300,000 under a revolving line of
credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum and requires monthly interest only payments, and matures in June 2005. As of March 2004, ARI has funded $300,000 of the line of
credit.



In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing
land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of
accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of
closing costs and debt paydown. In February 2004, ARI sold an additional interest in $6.6 million of the note for $6.3 million, receiving $6.3 million in cash after payment of closing costs.



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



Related Party.In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns
approximately 2.1% of the outstanding shares of ARIs Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bore interest at 12.0% per annum. All principal and interest were due at maturity in
February 2002. The line of credit is guaranteed by BCM. In June 2001, $394,000 in principal and $416,000 in interest was collected. In December 2001, $21,000 in principal and $804,000 in interest was collected. In February 2002, the line of credit
was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal
balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM,
receiving 314,141 TCI shares from BCM (see NOTE 1. BASIS OF PRESENTATION.) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of



13



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



$161,000 was added to the principal, the maturity date was extended to February 2007, and the interest rate was
changed to 2.0% over the prime rate, currently at 6.0%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI, is a 10% shareholder of One
Realco. Mr. Kimbrough does not participate in the day-to-day operations or management of One Realco.



In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5 million of the purchase price as seller financing. The note bears interest at
2.0% over the prime rate, currently 6.0%, and matures in April 2005.



In March
2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the purchase price as seller financing. The note bears interest at 2.0% over prime rate, currently
6.0%, and matures in April 2005.



NOTE 4.
INVESTMENTS IN EQUITY INVESTEES



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



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



ARIs investment in real estate
entities, accounted for using the equity method, at March 31, 2004, was as follows:



|         |  |                                               |   |  |                                              |       |                                              |   |      
|-------- |  | --------------------------------------------- | - |  | -------------------------------------------- | ----- | -------------------------------------------- | - | -----
|Investee |  | Percentage of ARIsOwnership atMarch 31, 2004 |   |  | Carrying Value ofInvestment atMarch 31, 2004 |       | Market Value of Investment at March 31, 2004
|IORI     |  | 19.2                                          | % |  | $                                            | 5,062 |                                              | $ | 5,376
|Other    |  |                                               |   |  |                                              | 566   |                                              |   |      
|         |  |                                               |   |  |                                              |       |                                              |   |      
|         |  |                                               |   |  | $                                            | 5,628 |                                              |   |      
|         |  |                                               |   |  |                                              |       |                                              |   |      



Set forth below are summarized results
of operations of equity investees for the three months ended March 31, 2004:



|                                        |  |      |        |  
|--------------------------------------- |  | ---- | ------ | -
|                                        |  | 2004 |       
|Revenues                                |  | $    | 2,914  |  
|Property operating expenses             |  |      | (2,064 | )
|Depreciation                            |  |      | (347   | )
|Interest                                |  |      | (1,097 | )
|                                        |  |      |        |  
|Loss before gain on sale of real estate |  |      | (594   | )
|Gain on sale of real estate             |  |      | 3,257  |  
|                                        |  |      |        |  
|Net income                              |  | $    | 2,663  |  
|                                        |  |      |        |  



ARIs share of equity
investees loss before gains on the sale of discontinued operations was $145,000 for the three months ended March 31, 2004. ARIs share of equity investees gain on sale of real estate was $783,000 for the three months ended March 31,
2004.



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



NOTE 5. MARKETABLE EQUITY SECURITIES



Since 1994, ARI has been purchasing equity securities of entities other than those of IORI and TCI to diversify and increase the liquidity of its margin accounts. Trading
and available-for-sale portfolio securities are carried at market value. In the first quarter of 2004, ARI purchased $321,000 of marketable securities. No securities were sold. At March 31, 2004, ARI recognized an unrealized increase in the market
value of its trading portfolio securities of $34,000. 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, 2004, ARI



14



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



recorded an unrealized increase in the market value of its available-for-sale portfolio securities of $397,000.
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 2004, the Brandeis office building was returned to the lender via a Deed in Lieu of Foreclosure process. The outstanding debt
and accrued interest was $8.8 million. ARI recorded a net impairment of $4.4 million in the fourth quarter of 2003 for this transaction.



In February 2003, the lender on one of ARIs hotel properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties
were in default, due to ARIs failure to make timely debt service payments. The balance owed on the loans was $21.2 million. In April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In
May 2003, ARI failed to satisfy the conditions in the lenders Loan Modification Offer (the Offer), and the Offer was revoked. In March 2004, ARI paid off these loans through other refinancings.



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
|Hotel                          |  |                    |  |                    |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms          |  | $            | 11,500 |                | $ | 12,332                  |  | $ | (13,689      | )(3) |  | 7.00         | %(1) |  | 03/05
|                               |  |                    |  |                    |  |              |       
|Office Building                |  |                    |  |                    |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura Tower                  |  | Farmers Branch, TX |  | 410,901 Sq. Ft.    |  |              | 34,000 |                |   | 36,889                  |  |   | (4,588       | )    |  | 5.50         | (1)  |  | 04/06
|                               |  |                    |  |                    |  |              |       
|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(2)                |  | Ft. Worth, TX      |  | 54.0 Acres         |  |              | 1,286  |                |   | 991                     |  |   | 192          |      |  | 5.75         |      |  | 06/05

---

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

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

|(3) | Cash of $11.0 million was received by an affiliate, increasing ARIs affiliate receivable.
|--- | ------------------------------------------------------------------------------------------



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



|                |  |                    |  |             |  |               |       |                |   |                         |  |   |              |     |  |              |     |  |       |    
|--------------- |  | ------------------ |  | ----------- |  | ------------- | ----- | -------------- | - | ----------------------- |  | - | ------------ | --- |  | ------------ | --- |  | ----- | ---
|Property        |  | Location           |  | Units/Acres |  | Debt Incurred |       | DebtDischarged |   | Net CashReceived/(Paid) |  |   | InterestRate |     |  | MaturityDate |    
|First Quarter   |  |                    |  |             |  |               |       |                |   |                         |  |   |              |     |  |              |     |  |       |    
|Land            |  |                    |  |             |  |               |       |                |   |                         |  |   |              |     |  |              |     |  |       |    
|Elm Fork        |  | Denton County, TX  |  | 101.0 Acres |  | $             | 5,000 |                | $ | 1,551                   |  | $ | 2,885        |     |  | 10.750       | %   |  | 03/04 |    
|Nashville       |  | Nashville,TN       |  | 113.8 Acres |  |               | 6,059 |                |   | 807                     |  |   | 4,725        |     |  | 14.000       |     |  | 03/04 |    
|Vineyards II    |  | Tarrant County, TX |  | 18.6 Acres  |  |               | 3,280 |                |   | 3,750                   |  |   | (583         | )   |  | 6.750        | (1) |  | 02/06 |    
|                |  |                    |  |             |  |               |      
|Apartments      |  |                    |  |             |  |               |       |                |   |                         |  |   |              |     |  |              |     |  |       |    
|Arlington Place |  | Pasadena, TX       |  | 230 Units   |  |               | 1,500 |                |   |                        |  |   |             | (2) |  | 5.000        |     |  | 05/03 | (3)

---

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



15



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 7. MARGIN BORROWINGS



ARI has margin arrangements with various financial institutions and brokerage firms which provide for borrowing of up to 50% of the market
value of marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of TCI and ARIs trading portfolio securities and bear interest rates ranging from 5.0% to 24.0%. Margin borrowing totaled
$20.7 million at March 31, 2004.



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, currently 5.0% per annum, required monthly payments of interest only and matured in October 2003. The loan is callable upon 60 days prior
notice, and is secured by 250,000 shares of ARI Common Stock held by BCM, ARIs advisor. 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
January 2005. At April 2004, the remaining balance is $338,000.



NOTE 8.
RELATED PARTY TRANSACTIONS



In January 2004, ARI issued 200,000 shares of
Series A 10% Cumulative Convertible Preferred Stock to Prime, ARIs advisor. In February 2004, 50,000 additional shares were issued to Prime.



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



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



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



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



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



The following table reconciles the beginning and ending balances of accounts receivable from and (accounts payable to) affiliates as of March 31, 2004.



|                                                |  |     |       |   |       |   |         |      |  |   |      |  
|----------------------------------------------- |  | --- | ----- | - | ----- | - | ------- | ---- |  | - | ---- | -
|                                                |  | BCM |       |   | PRIME |   |         | IORI | 
|Balance, December 31, 2003                      |  | $   | 1,999 |   |       | $ | 4,393   |      |  | $ | (627 | )
|Cash transfers to affiliates                    |  |     | 1     |   |       |   | 46,216  |      |  |   |     |  
|Cash transfers from affiliates                  |  |     | (574  | ) |       |   | (47,040 | )    |  |   |     |  
|Advance through receipt of refinancing proceeds |  |     |      |   |       |   | (10,823 | )    |  |   |     |  
|Other additions                                 |  |     |      |   |       |   | 44,934  |      |  |   | 367  |  
|Other repayments                                |  |     |      |   |       |   | (26,581 | )    |  |   |     |  
|                                                |  |     |       |   |       |   |         |      |  |   |      |  
|Balance, March 31, 2004                         |  | $   | 1,426 |   |       | $ | 11,099  |      |  | $ | (260 | )
|                                                |  |     |       |   |       |   |         |      |  |   |      |  



Also at March 31, 2004, ARI owed $1.4
million to affiliates related to cash received upon the sale of apartments to Metra.



16



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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 9. OPERATING SEGMENTS



Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements
principally involve the calculation and allocation of administrative expenses. Management evaluates the performance of each of the operating segments and allocates resources to them based on their net operating income and cash flow. Items of income
that are not reflected in the segments are equity in loss of investees, equity in gain on sale of real estate by equity investees and other income which totaled $1.3 million for the three months ended March 31, 2004 and $(4.3) million for 2003.
Expenses that are not reflected in the segments are discount on sale of notes receivable, general and administrative expenses, minority interest, incentive fees, advisory fees, net income fees, and income (loss) from discontinued operations which
totaled $9.9 million for the three months ended March 31, 2004 and $7.9 million for 2003. Excluded from operating segment assets are assets of $94.0 million in 2004 and $134.0 million in 2003, which are not identifiable with an operating segment.
There are no intersegment revenues and expenses, and ARI conducted all of its business within the United States, with the exception of Hotel Sofia (Bulgaria), which began operations in 2001 and was sold in March 2003; Realty Advisors Korea, Ltd.
(South Korea), which ARI acquired in 2002 and sold in 2003, and Hotel Akademia (Poland), which began operations in 2002.



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



|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|------------------------------ |  | -------------------- | ------- | ---------- | - | ------- | ------ |  | ---- | ------ |  | ------------ | ------- | ----------------- |  | - | ------ |  | - | ------ | - |  | - | ---------
|2004                           |  | CommercialProperties |         | Apartments |   |         | Hotels |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|Operating revenue              |  | $                    | 18,791  |            | $ | 21,982  |        |  | $    | 7,982  |  | $            | 156     |                   |  | $ | 8,169  |  | $ | 362    |   |  | $ | 57,442   
|Interest income                |  |                      |        |            |   |        |        |  |      |       |  |              |        |                   |  |   |       |  |   | 1,049  |   |  |   | 1,049    
|Operating expenses             |  |                      | 10,843  |            |   | 14,608  |        |  |      | 6,772  |  |              | 954     |                   |  |   | 6,213  |  |   | (219   | ) |  |   | 39,171   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss)        |  | $                    | 7,948   |            | $ | 7,374   |        |  | $    | 1,210  |  | $            | (798    | )                 |  | $ | 1,956  |  | $ | 1,630  |   |  | $ | 19,320   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation                   |  | $                    | 3,393   |            | $ | 3,251   |        |  | $    | 880    |  | $            |        |                   |  | $ | 328    |  | $ | 12     |   |  | $ | 7,864    
|Interest                       |  |                      | 5,819   |            |   | 7,666   |        |  |      | 1,486  |  |              | 2,951   |                   |  |   | 386    |  |   | 1,367  |   |  |   | 19,675   
|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 |   |         |        |  | Land |        |  |              |         |                   |  |   | 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   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|                               |  |                      |         |            |   |         |       
|2003                           |  | CommercialProperties |         | Apartments |   |         | Hotels |  | Land |        |  | PizzaParlors |         | Receivables/Other |  |   | Total 
|Operating revenue              |  | $                    | 6,524   |            | $ | 6,022   |        |  | $    | 5,525  |  | $            | 13      |                   |  | $ | 7,867  |  | $ | 33     |   |  | $ | 25,984   
|Interest income                |  |                      |        |            |   |        |        |  |      |       |  |              |        |                   |  |   |       |  |   | 2,230  |   |  |   | 2,230    
|Operating expenses             |  |                      | 3,670   |            |   | 3,691   |        |  |      | 4,875  |  |              | 1,570   |                   |  |   | 6,407  |  |   | 6      |   |  |   | 20,219   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Operating income (loss)        |  | $                    | 2,854   |            | $ | 2,331   |        |  | $    | 650    |  | $            | (1,557  | )                 |  | $ | 1,460  |  | $ | 2,257  |   |  | $ | 7,995    
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Depreciation                   |  | $                    | 633     |            | $ | 418     |        |  | $    | 482    |  | $            |        |                   |  | $ | 446    |  | $ | 3      |   |  | $ | 1,982    
|Interest                       |  |                      | 1,586   |            |   | 2,076   |        |  |      | 982    |  |              | 4,138   |                   |  |   | 206    |  |   | 543    |   |  |   | 9,531    
|Capital expenditures           |  |                      | 700     |            |   | (70     | )      |  |      | 335    |  |              | 343     |                   |  |   | 767    |  |   |       |   |  |   | 2,075    
|Assets                         |  |                      | 411,679 |            |   | 396,262 |        |  |      | 92,978 |  |              | 238,830 |                   |  |   | 22,033 |  |   | 76,578 |   |  |   | 1,268,360
|                               |  |                      |         |            |   |         |       
|                               |  |                      |         | Apartments |   |         | Hotels |  | Land |        |  |              |         |                   |  |   | Total 
|Property Sales:                |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Sales price                    |  |                      |         |            | $ | 14,975  |        |  | $    | 24,750 |  | $            | 8,785   |                   |  |   |        |  |   |        |   |  | $ | 48,510   
|Cost of sale                   |  |                      |         |            |   | 12,174  |        |  |      | 24,538 |  |              | 8,711   |                   |  |   |        |  |   |        |   |  |   | 45,423   
|Recognized prior deferred gain |  |                      |         |            |   |        |        |  |      |       |  |              | 19,897  |                   |  |   |        |  |   |        |   |  |   | 19,897   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          
|Gain on sale                   |  |                      |         |            | $ | 2,801   |        |  | $    | 212    |  | $            | 19,971  |                   |  |   |        |  |   |        |   |  | $ | 22,984   
|                               |  |                      |         |            |   |         |        |  |      |        |  |              |         |                   |  |   |        |  |   |        |   |  |   |          



17



---

AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued



NOTE 10. DISCONTINUED OPERATIONS



For the three months ended March 31, 2004 and 2003, income from discontinued operations relates to 32 properties that ARI sold during 2003
and nine properties that ARI sold during 2004. The following table summarizes revenue and expense information for these properties sold and held-for-sale.



|                                                          |  |                                     |        |   |      |   |      
|--------------------------------------------------------- |  | ----------------------------------- | ------ | - | ---- | - | -----
|                                                          |  | For the Three MonthsEnded March 31,
|                                                          |  | 2004                                |        |   | 2003
|Revenue                                                   |  |                                     |        |   |      |   |      
|Rental                                                    |  | $                                   | 1,874  |   |      | $ | 6,988
|Property operations                                       |  |                                     | 1,267  |   |      |   | 4,241
|                                                          |  |                                     |        |   |      |   |      
|                                                          |  |                                     | 607    |   |      |   | 2,747
|Expenses                                                  |  |                                     |        |   |      |   |      
|Interest                                                  |  |                                     | 979    |   |      |   | 1,950
|Depreciation                                              |  |                                     | 368    |   |      |   | 584  
|                                                          |  |                                     |        |   |      |   |      
|                                                          |  |                                     | 1,347  |   |      |   | 2,534
|                                                          |  |                                     |        |   |      |   |      
|Net income (loss) from discontinued operations            |  |                                     | (740   | ) |      |   | 213  
|Gain on sale of real estate                               |  |                                     | 13,934 |   |      |   | 3,013
|Equity in gain on sale of real estate by equity investees |  |                                     | 783    |   |      |   |     
|                                                          |  |                                     |        |   |      |   |      
|Net income from discontinued operations                   |  | $                                   | 13,977 |   |      | $ | 3,226
|                                                          |  |                                     |        |   |      |   |      



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



NOTE 11. COMMITMENTS AND CONTINGENCIES



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



Commitments.During 2002, Milano Restaurants International, Inc. (MRI), a
then wholly-owned subsidiary of ARI, sold two restaurants to a corporation owned in part by an officer of MRI. In conjunction with the sale of these restaurants, MRI guaranteed the bank debt incurred by the related party. The guaranty applies to all
current debt, and to all future debt of the related party until such time as the guaranty is terminated by MRI. The amount of the debt outstanding that is subject to the guaranty is $1.1 million at March 31, 2004.



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



18



---

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



Introduction



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



On November 15, 2002, ARI commenced a tender offer for the common
shares of TCI and IORI not already owned by ARI. The tender offer was completed on March 19, 2003. Pursuant to the tender offer, ARI acquired 265,036 IORI shares and 1,213,226 TCI shares.



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



On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (BCM), receiving 650,000 TCI shares from BCM.
In addition, BCM executed a promissory note in favor of an ARI subsidiary in the amount of $526,000. After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8
million of its $15.5 million line of credit receivable from One Realco Corporation (One Realco) to BCM, receiving 314,141 TCI shares from BCM. After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In
December 2003, ARI subsidiaries purchased 88,600 TCI shares in open market transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At March 31, 2004, ARI subsidiaries owned 80.0% of the outstanding
shares of TCI. ARI no longer directly owns any IORI shares. At March 31, 2004, TCI owned 24.0% of IORI shares. ARI ceased consolidation of IORIs accounts and operations effective June 2, 2003.



Critical Accounting Policies



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



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



---

Liquidity and Capital Resources



ARI reported net income of $845,000 for the three months ended March 31, 2004, which included the following non-cash charges and credits:
depreciation and amortization from real estate held for investment of $8.2 million, gain on sale of real estate of $18.5 million and equity in loss of equity investees of $145,000. Net cash provided by operating activities amounted to $7.5 million
for the three months ended March 31, 2004, interest receivable decreased by $1.5 million due to collection of accrued interest receivable, other assets decreased by $4.0 million primarily due to a reduction in escrows, interest payable decreased by
$625,000 due to a decreased balance of notes payable and other liabilities increased by $9.3 million primarily due to an increase in deferred gains on property sales.



Net cash used in investing activities of $8.2 million was primarily due to real estate improvements of $55.8 million, acquisitions of real
estate of $19.9 million, earnest money deposits of $2.3 million, $321,000 for the purchase of marketable securities and purchases of pizza parlor equipment of $467,000. These outflows for investing activities were offset by the collection of $39,000
on notes receivable, $64.4 million from the sale of real estate and $6.2 million from the sale of notes receivable.



Net cash used in financing activities of $620,000 was comprised of proceeds received from the funding or refinancing of notes payable of $129.2 million and advances from
affiliates of $933,000; offset by cash payments of $126.7 million to paydown existing notes payable, $2.9 million for financing costs, net payments on stock loans of $447,000, $42,000 to repurchase common stock, and $650,000 in dividends on
Preferred Stock.



In 2004, ARI purchased the following property:



|                           |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|-------------------------- |  | --------------- |  | ----------- |  | ------------- | ----- | ------------------------ | - | ---- | ------------ |  | ------------ | ----- |  | ------------ | --- |  | -----
|Property                   |  | Location        |  | Units/Acres |  | PurchasePrice |       | Net CashPaid/ (Received) |   |      | DebtIncurred |  | InterestRate |       |  | MaturityDate
|First Quarter              |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Apartments                 |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|288 City Park(1)           |  | Houston, TX     |  | 240 Units   |  | $             | 3,056 |                          | $ | 612  |              |  | $            | 2,444 |  | 5.95         | %   |  | 04/45
|Blue Lake Villas II(1)     |  | Waxahachie, TX  |  | 70 Units    |  |               | 729   |                          |   | (164 | )            |  |              | 729   |  | 5.80         |     |  | 04/45
|Bridges on Kinsey(1)       |  | Tyler, TX       |  | 232 Units   |  |               | 2,291 |                          |   | 596  |              |  |              | 1,687 |  | 5.74         |     |  | 08/45
|Dakota Arms(1)             |  | Lubbock, TX     |  | 208 Units   |  |               | 2,472 |                          |   | 681  |              |  |              | 1,791 |  | 5.85         |     |  | 06/45
|Lake Forest(1)             |  | Houston, TX     |  | 240 Units   |  |               | 2,316 |                          |   | (470 | )            |  |              | 2,316 |  | 5.60         |     |  | 03/45
|Vistas of Vance Jackson(1) |  | San Antonio, TX |  | 240 Units   |  |               | 3,550 |                          |   | 771  |              |  |              | 2,779 |  | 5.78         |     |  | 06/45
|                           |  |                 |  |             |  |               |      
|Land                       |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Lubbock 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  |              |  |              |      |  |             |     |  |     
|                           |  |                 |  |             |  |               |      
|Second Quarter             |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Apartments                 |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Wildflower Villas(1)       |  | Temple, TX      |  | 220 Units   |  |               | 2,045 |                          |   | 79   |              |  |              | 1,966 |  |             |     |  |     
|                           |  |                 |  |             |  |               |      
|Land                       |  |                 |  |             |  |               |       |                          |   |      |              |  |              |       |  |              |     |  |      
|Rogers land(1)             |  | Rogers, AR      |  | 20.1 Acres  |  |               | 1,390 |                          |   | 506  |              |  |              | 1,130 |  | 10.50        |     |  | 04/05

---

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

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



20



---

In 2004, ARI sold the following properties:



|                       |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|---------------------- |  | ----------------- |  | -------------------- |  | ---------- | ------ | ---------------- | - | -------------- |  | - | ------------ | --- |  | - | ----- | ---
|Property               |  | Location          |  | Units/Sq. Ft./ Acres |  | SalesPrice |        | Net CashReceived |   | DebtDischarged |  |   | Gain on Sale |    
|First Quarter          |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Apartments             |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Tiberon Trails         |  | Merrillville, IN  |  | 376 Units            |  | $          | 10,325 |                  | $ | 2,618          |  | $ | 6,189        | (1) |  | $ | 48    |    
|                       |  |                   |  |                      |  |           
|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 |    
|Plaza on Bachman Creek |  | Dallas, TX        |  | 80,278 Sq. Ft.       |  |            | 7,850  |                  |   | 1,808          |  |   | 5,358        |     |  |   | 3,682 |    
|                       |  |                   |  |                      |  |           
|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        |     |  |   |      |    
|                       |  |                   |  |                      |  |           
|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 | (2)
|                       |  |                   |  |                      |  |           
|Shopping Center        |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|K-Mart                 |  | Cary, NC          |  | 92,033 Sq. Ft.       |  |            | 3,200  |                  |   |               |  |   | 1,677        | (1) |  |   | 521   | (3)
|                       |  |                   |  |                      |  |           
|Second Quarter         |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Office Building        |  |                   |  |                      |  |            |        |                  |   |                |  |   |              |     |  |   |       |    
|Atrium                 |  | Palm Beach, FL    |  | 74,603 Sq. Ft.       |  |            | 5,775  |                  |   | 1,667          |  |   | 3,750        |     |  |   | 740   |    

---

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

|(2) | Includes deferred gain of $5.2 million. A portion of the land was sold on a contingent basis
for a note receivable of $7.2 million. See Note 3. NOTES AND INTEREST RECEIVABLE.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Property sold to BCM, a related party, for assumption of debt and a note receivable. See Note
3. NOTES AND INTEREST 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.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In February 2003, the lender on one of ARIs hotel
properties located in Virginia and three hotel properties in Chicago notified ARI that the loans on the properties were in default, due to ARIs failure to make timely debt service payments. The balance owed on the loans was $21.2 million. In
April 2003, the lender and ARI agreed to terms to cure the default and extend the maturity dates of the loans. In May 2003, ARI failed to satisfy the conditions in the lenders Loan Modification Offer (the Offer), and the Offer was
revoked. In March 2004, ARI paid off these loans through other refinancings.



21



---

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
|Hotel                          |  |                    |  |                    |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Williamsburg Hospitality House |  | Williamsburg, VA   |  | 296 Rooms          |  | $            | 11,500 |                | $ | 12,332                  |  | $ | (13,689      | )(3) |  | 7.00         | %(1) |  | 03/05
|                               |  |                    |  |                    |  |              |       
|Office Building                |  |                    |  |                    |  |              |        |                |   |                         |  |   |              |      |  |              |      |  |      
|Centura Tower                  |  | Farmers Branch, TX |  | 410,901 Sq. Ft.    |  |              | 34,000 |                |   | 36,889                  |  |   | (4,588       | )    |  | 5.50         | (1)  |  | 04/06
|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(2)                |  | Ft. Worth, TX      |  | 54.0 Acres         |  |              | 1,286  |                |   | 991                     |  |   | 192          |      |  | 5.75         |      |  | 06/05

---

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

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

|(3) | Cash of $11.0 million was received by an affiliate, increasing ARIs affiliate
receivable.
|--- | ------------------------------------------------------------------------------------------



ARI has margin arrangements with
various financial institutions and brokerage firms which provide for borrowing up to 50% of the market value of ARIs marketable equity securities. The borrowings under such margin arrangements are secured by equity securities of IORI and TCI
and ARIs trading portfolio and bear interest rates ranging from 5.0% to 24.0%. Margin borrowing totaled $20.7 million at March 31, 2004.



Management expects that it will be necessary for ARI to sell $60.2 million, $10.5 million and $31.6 million of its land holdings during each of the next three years to
satisfy the debt on such land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the debt obligations on such land as it matures, or, if it is not able to extend such debt, ARI intends to sell other of its assets,
specifically income producing properties, to pay the debt.



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



Related Party Transactions



In January 2004, ARI issued 200,000 shares of Series A 10% Cumulative Convertible Preferred
Stock to Prime, ARIs advisor. In February 2004, 50,000 additional shares were issued to Prime.



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



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



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



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



22



---

Commitments and Contingencies



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



Results of Operations



For the three months ended March 31, 2004, ARI reported net income of $845,000, compared to net income of $7.2 million for the three months
ended March 31, 2003. The primary factors contributing to ARIs net income are discussed in the following paragraphs.



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



Rents
(dollars in thousands)



|           |  |          |        |             |   |        |  |   |       
|---------- |  | -------- | ------ | ----------- | - | ------ |  | - | ------
|           |  | 2004     |        | 2003       
|           |  | with TCI |        | without TCI |  
|Commercial |  | $        | 18,791 |             | $ | 6,546  |  | $ | 6,524 
|Apartments |  |          | 21,982 |             |   | 6,301  |  |   | 6,022 
|Hotels     |  |          | 7,982  |             |   | 6,503  |  |   | 5,525 
|Land       |  |          | 156    |             |   | 15     |  |   | 13    
|Other      |  |          | 362    |             |   | 362    |  |   | 33    
|           |  |          |        |             |   |        |  |   |       
|           |  | $        | 49,273 |             | $ | 19,727 |  | $ | 18,117
|           |  |          |        |             |   |        |  |   |       



The increase in hotel rents, without
the effect of the consolidation of TCIs operations, was primarily attributable to increased occupancy. Rents are expected to increase in 2004, as a result of completed apartment construction.



Property Operations Expenses (dollars in thousands)



|           |  |          |        |   |             |   |        |   |  |   |       
|---------- |  | -------- | ------ | - | ----------- | - | ------ | - |  | - | ------
|           |  | 2004     |        |   | 2003       
|           |  | With TCI |        |   | without TCI |   |       
|Commercial |  | $        | 10,843 |   |             | $ | 3,896  |   |  | $ | 3,670 
|Apartments |  |          | 14,608 |   |             |   | 5,202  |   |  |   | 3,691 
|Hotels     |  |          | 6,772  |   |             |   | 5,364  |   |  |   | 4,875 
|Land       |  |          | 954    |   |             |   | 576    |   |  |   | 1,570 
|Other      |  |          | (219   | ) |             |   | (219   | ) |  |   | 6     
|           |  |          |        |   |             |   |        |   |  |   |       
|           |  | $        | 32,958 |   |             | $ | 14,819 |   |  | $ | 13,812
|           |  |          |        |   |             |   |        |   |  |   |       



The increase in apartment operations
expense, without the effect of the consolidation of TCIs operations, was primarily attributable to property replacements. The increase in hotel operations expense was primarily attributable to increased personnel costs and an increase in
repairs and replacement expenses. The decrease in land operations expense was primarily attributable to lower property taxes due to land sales. Property operations expense is expected to increase in 2004, as a result of completed apartment
construction.



Pizza parlor sales and cost of sales of $8.2 million and $6.2
million, respectively, in the three months ended March 31, 2004, approximated the $7.9 million and $6.4 million in the three months ended March 31, 2003.



Interest income from notes receivable decreased to $1.0 million in the three months ended March 31, 2004 from $2.2 million in 2003, due to the collection of $34.3 million
of notes receivable in 2003.



Equity in loss of investees improved to
$(145,000) in the three months ended March 31, 2004, from $(4.3) million in 2003. Prior to March 31, 2003, ARIs equity in loss of investees included equity in TCIs operations.



Interest Expense (dollars in thousands)



|           |  |          |        |             |   |       |  |   |      
|---------- |  | -------- | ------ | ----------- | - | ----- |  | - | -----
|           |  | 2004     |        | 2003       
|           |  | with TCI |        | without TCI |  
|Commercial |  | $        | 5,819  |             | $ | 2,219 |  | $ | 1,586
|Apartments |  |          | 7,666  |             |   | 2,029 |  |   | 2,076
|Hotels     |  |          | 1,486  |             |   | 932   |  |   | 982  
|Land       |  |          | 2,951  |             |   | 2,373 |  |   | 4,138
|MRI        |  |          | 386    |             |   | 386   |  |   | 206  
|Other      |  |          | 1,367  |             |   | 1,367 |  |   | 543  
|           |  |          |        |             |   |       |  |   |      
|           |  | $        | 19,675 |             | $ | 9,306 |  | $ | 9,531
|           |  |          |        |             |   |       |  |   |      



23



---

The increase in commercial interest expense, without the effect of the consolidation of TCIs operations, was
primarily attributable to the completion of Four Hickory Centre during the third quarter of 2003. During construction, mortgage loan interest was capitalized as part of the cost of the building. The decrease in land interest expense was primarily
attributable to reduced principal balances payable and interest rates on land mortgages. The increase in other interest expense was primarily attributable to increased stock loans.



Depreciation and Amortization (dollars in thousands)



|           |  |          |       |             |   |       |  |   |      
|---------- |  | -------- | ----- | ----------- | - | ----- |  | - | -----
|           |  | 2004     |       | 2003       
|           |  | with TCI |       | without TCI |  
|Commercial |  | $        | 3,393 |             | $ | 890   |  | $ | 633  
|Apartments |  |          | 3,251 |             |   | 512   |  |   | 418  
|Hotels     |  |          | 880   |             |   | 555   |  |   | 482  
|MRI        |  |          | 328   |             |   | 328   |  |   | 446  
|Other      |  |          | 12    |             |   | 1     |  |   | 3    
|           |  |          |       |             |   |       |  |   |      
|           |  | $        | 7,864 |             | $ | 2,286 |  | $ | 1,982
|           |  |          |       |             |   |       |  |   |      



The increase in commercial
depreciation and amortization, without the effect of the consolidation of TCIs operations, was primarily attributable to the completion of Four Hickory Centre during the third quarter of 2003.



Discount on sale of notes receivable decreased to $398,000 in the three months ended March
31, 2004, from $1.6 million in 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable.



General and administrative expenses increased to $4.6 million in the three months ended March 31, 2004, from $3.3 million in 2003. Without the effect of the consolidation
of TCIs operations, general and administrative expenses decreased to $1.7 million. The decrease was primarily attributable to reduced legal fees and reduced expense reimbursements paid to ARIs advisors.



Advisory fees increased to $2.9 million in the three months ended March 31, 2004, from $2.0
million in 2003. Without the effect of the consolidation of TCIs operations, advisory fees decreased to $1.2 million. In 2003, an additional month of fees was recorded.



Net income fee to affiliate decreased to $79,000 in the three months ended March 31, 2004, from $452,000 in 2003. The net income fee payable
to ARIs advisor is 10% of the year-to-date net income, in excess of a 10% return on shareholders equity.



Incentive fee to affiliate was $261,000 in the three months ended March 31, 2003. The incentive fee is only due if ARI is also subject to the net income fee. This fee
represents 10% of the excess of net capital gains over net capital losses from sales of operating properties. The amount of this fee for the remainder of 2004 will be dependent on the number of operating properties sold, the net capital gains
realized and whether the net income fee is due.



Minority interest increased to
$1.2 million in the three months ended March 31, 2004, from $550,000 in 2003. The increase is primarily attributable to the consolidation of TCIs operations by ARI, as the 19.99% minority share of TCIs net income is recorded as minority
interest expense by ARI.



Net income from discontinued operations increased to
$14.0 million in the three months ended March 31, 2004 from $3.2 million in 2003. The net income relates to 32 properties that ARI sold during 2003 and nine properties that ARI sold during 2004. The following table summarizes revenue and expense
information for the properties sold and held-for-sale.



|                                                          |  |                                      |        |   |      |   |      
|--------------------------------------------------------- |  | ------------------------------------ | ------ | - | ---- | - | -----
|                                                          |  | For the Three Months Ended March 31,
|                                                          |  | 2004                                 |        |   | 2003
|Revenue                                                   |  |                                      |        |   |      |   |      
|Rental                                                    |  | $                                    | 1,874  |   |      | $ | 6,988
|Property operations                                       |  |                                      | 1,267  |   |      |   | 4,241
|                                                          |  |                                      |        |   |      |   |      
|                                                          |  |                                      | 607    |   |      |   | 2,747
|Expenses                                                  |  |                                      |        |   |      |   |      
|Interest                                                  |  |                                      | 979    |   |      |   | 1,950
|Depreciation                                              |  |                                      | 368    |   |      |   | 584  
|                                                          |  |                                      |        |   |      |   |      
|                                                          |  |                                      | 1,347  |   |      |   | 2,534
|                                                          |  |                                      |        |   |      |   |      
|Net income (loss) from discontinued operations            |  |                                      | (740   | ) |      |   | 213  
|Gain on sale of real estate                               |  |                                      | 13,934 |   |      |   | 3,013
|Equity in gain on sale of real estate by equity investees |  |                                      | 783    |   |      |   |     
|                                                          |  |                                      |        |   |      |   |      
|Net income from discontinued operations                   |  | $                                    | 13,977 |   |      | $ | 3,226
|                                                          |  |                                      |        |   |      |   |      



24



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Tax Matters



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



At March 31, 2004, ARI had a net deferred tax asset of $77.2 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 2004 and a loss for federal income tax purposes in the first three months of 2003; therefore, it recorded no provision for income taxes.



At March 31, 2004, TCI had a net deferred tax asset of $7.0 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, 2004, ARIs exposure to a change in interest rates on
its debt is as follows:



|                                          |  |         |         |                               |       |   |                                   |   |      
|----------------------------------------- |  | ------- | ------- | ----------------------------- | ----- | - | --------------------------------- | - | -----
|                                          |  | Balance |         | WeightedAverage Interest Rate |       |   | Effect of 1%Increase InBase Rates
|Notes payable:                            |  |         |         |                               |       |   |                                   |   |      
|Variable rate                             |  | $       | 212,916 |                               | 6.412 | % |                                   | $ | 2,129
|                                          |  |         |         |                               |       |   |                                   |   |      
|Total decrease in ARIs annual net income |  |         |         |                               |       |   |                                   | $ | 2,129
|                                          |  |         |         |                               |       |   |                                   |   |      
|Per share                                 |  |         |         |                               |       |   |                                   | $ | .20  
|                                          |  |         |         |                               |       |   |                                   |   |      



ITEM 4. CONTROLS AND
PROCEDURES



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



25



---

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



26



---

PART II. OTHER INFORMATION



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES



|              |  |                                     |  |                                 |      |                                                                                     |       |                                                                                    |        
|------------- |  | ----------------------------------- |  | ------------------------------- | ---- | ----------------------------------------------------------------------------------- | ----- | ---------------------------------------------------------------------------------- | -------
|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 2004  |  |                                    |  | $                               |     |                                                                                     |      |                                                                                    | 625,793
|February 2004 |  |                                    |  |                                 |     |                                                                                     |      |                                                                                    | 625,793
|March 2004    |  | 5,100                               |  |                                 | 8.42 |                                                                                     | 5,100 |                                                                                    | 620,693
|              |  |                                     |  |                                 |      |                                                                                     |       |                                                                                    |        
|Total         |  | 5,100                               |  | $                               | 8.42 |                                                                                     | 5,100 |                                                                                    | 620,693
|              |  |                                     |  |                                 |      |                                                                                     |       |                                                                                    |        

---

|(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.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



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



|              |  |                                                                                                                                                                                         
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                             
|31.1          |  | Certification Required by 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.                                                 



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



A Current Report on Form 8-K, dated February 19, 2004, was filed with respect to Item 5. Other Events and Regulation FD Disclosure which
reports an increase in the number of directors, the election of two new independent directors, and the resignation of one director.



27



---

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 17, 2004 |  | By:                             |  | /s/ Ronald E. Kimbrough                                                                                                                 
|                   |  |                                 |  | Ronald E. Kimbrough                                                                                                                     
|                   |  |                                 |  | Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Acting Principal Executive Officer)



28



---

AMERICAN REALTY INVESTORS, INC.



EXHIBITS TO



QUARTERLY REPORT ON FORM 10-Q



For the Quarter ended March 31, 2004



|              |  |                                                                                                                                                                          |  |           
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------
|ExhibitNumber |  | Description                                                                                                                                                              |  | PageNumber
|31.1          |  | Certification Required by 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. |  |           
|              |  |                                                                                                                                                                         
|32.1          |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                  |  |           



29