**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**
| **(Mark One)**                             | ** ** | ** **                                                                                              |
|--------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| **x**                                      | ** ** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
| For  the year ended December 31, 2005 |
| OR                                         |
| **o**                                      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

***COMMISSIONFILE NUMBER 001-16785***

**American Spectrum Realty, Inc.**

(Exact name of Registrantas specified in its charter)
| **State of Maryland**                                            | ** ** | **52-2258674**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
| **5850 San Felipe, Suite 450  Houston, Texas**              | ** ** | **     77057**         |
| (Address of  principal executive offices)                        |       | (Zip Code)                            |

 

**(713) 706-6200**

(Registrant’stelephone number, including area code)

Securities registered underSection 12(b) of the Act:
| Title of each class           | ** ** | **Name of each exchange on which registered** |
|-------------------------------|------------|-----------------------------------------------|
| Common Stock, $.01  par value |       | American Stock  Exchange                      |

 

Securities registeredpursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o   No x

Indicate by check mark if the Registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o   No x

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K o

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer x |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by check mark whether the Registrant is ashell company (as defined in Rule 12b-2 of the Act). o Yes   x No

As of June 30, 2005, the last business day of theRegistrant’s most recent completed second quarter, the aggregate market valueof the voting stock held by non-affiliates of the Registrant was approximately$7,628,443. The aggregate market value was computed with reference to the priceon the American Stock Exchange at which the voting stock was last sold as ofsuch date. For this purpose, 529,112 shares of Common Stock held by officersand directors are deemed to be held by affiliates but exclusion of shares heldby any person should not be construed to indicate that such person is anaffiliate of the Registrant for any other purpose.

As of March 15, 2006, 1,393,026 shares of CommonStock ($.01 par value) were outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE:**

Part III:  Portions of the Registrant’s definitive proxystatement to be issued in connection with the Registrant’s annual stockholder’smeeting to be held May 5, 2006, which will be filed on or before March 24,2006.

 

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**TABLE OF CONTENTS**

|         | ** ** | ** **                                                                                                          | ** ** | **Page No.** | ** ** |
|---------|------------|---------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
|    |       | PART I                                                                                                         |       |              |       |   |   |
| Item 1  |       | Business                                                                                                            |       |              | 3          |   |   |
| Item 1A |       | Risk Factors                                                                                                        |       |              | 7          |   |   |
| Item 1B |       | Unresolved Staff  Comments                                                                                          |       |              | 9          |   |   |
| Item 2  |       | Properties                                                                                                          |       |              | 10         |   |   |
| Item 3  |       | Legal Proceedings                                                                                                   |       |              | 13         |   |   |
| Item 4  |       | Submission of  Matters to a Vote of Security Holders                                                                |       |              | 13         |   |   |
|    |       | PART II                                                                                                        |       |              |       |   |   |
| Item 5  |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       |              | 14         |   |   |
| Item 6  |       | Selected Financial  Data                                                                                            |       |              | 15         |   |   |
| Item 7  |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       |              | 16         |   |   |
| Item 7A |       | Quantitative  and Qualitative Disclosure About Market Risk                                                          |       |              | 26         |   |   |
| Item 8  |       | Financial  Statements and Supplementary Data                                                                        |       |              | 27         |   |   |
| Item 9  |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               |       |              | 27         |   |   |
| Item 9A |       | Controls and  Procedures                                                                                            |       |              | 28         |   |   |
| Item 9B |       | Other Information                                                                                                   |       |              | 28         |   |   |
|    |       | PART III                                                                                                       |       |              |       |   |   |
| Item 10 |       | Directors and  Executive Officers of the Registrant                                                                 |       |              | 29         |   |   |
| Item 11 |       | Executive  Compensation                                                                                             |       |              | 29         |   |   |
| Item 12 |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       |              | 29         |   |   |
| Item 13 |       | Certain  Relationships and Related Transactions                                                                     |       |              | 29         |   |   |
| Item 14 |       | Principal  Accountant Fees and Services                                                                             |       |              | 29         |   |   |
|    |       | PART IV                                                                                                        |       |              |       |   |   |
| Item 15 |       | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                                               |       |              | 30         |   |   |

 

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**PART I**

**ITEM 1.**                BUSINESS

**General Description of Business**

American Spectrum Realty, Inc. (“ASR” or,collectively, as a consolidated entity with its subsidiaries, the “Company”) isa Maryland corporation established on August 8, 2000. The Company is afull-service real estate corporation, which owns, manages and operatesincome-producing properties. Substantially all of the Company’s assets are heldthrough an operating partnership (the “Operating Partnership”) in which theCompany, as of December 31, 2005, held the sole general partner interestof .97% and a limited partnership interest totaling 85.68%. As of December 31,2005, through its majority-owned subsidiary, the Operating Partnership, theCompany owned and operated 22 properties, which consisted of 18 officebuildings, three industrial properties, and one shopping center. The 22properties are located in seven states.

During 2005, the Company sold three properties, whichconsisted of a vacant single tenant industrial property located in San Diego,California, a shopping center located in Columbia, South Carolina and anapartment complex located in Hazelwood, Missouri. During 2004, the Company soldthree properties, which consisted of an office building, an industrial propertyand a parcel of undeveloped land, and acquired two office buildings in Houston,Texas. During 2003, the Company sold eleven properties, which consisted of twoapartment complexes, two office buildings, six industrial properties and oneshopping center, and acquired four office buildings in Houston, Texas. Theproperty sales are part of the Company’s strategy to sell its non-core propertytypes—apartment and shopping center properties—and to sell its propertieslocated in the Midwest and Carolina’s, its non-core markets. The Company intendsto focus primarily on multi-tenant office and industrial properties located inTexas, California and Arizona.

The Company is the sole general partner of theOperating Partnership. As the sole general partner of the OperatingPartnership, the Company generally has the exclusive power to manage andconduct the business of the Operating Partnership under its partnershipagreement. The Company’s interest as a limited partner in the OperatingPartnership entitles it to share in any cash distributions from, and in profitsand losses of, the Operating Partnership. If the Company receives anydistributions from the Operating Partnership, it intends, in turn, if permittedby law, to pay dividends to its common stockholders so that the amount ofdividends paid on each share of common stock equals four times the amount ofdistributions paid on each limited partnership unit in the OperatingPartnership (“OP Unit”). The intended dividend of four times the distributionfrom each limited partnership unit is a result of the Company’s one-for-fourreverse stock split in March 2004. Most of the properties are owned by theOperating Partnership through subsidiary limited partnerships or limitedliability companies.

Holders of the OP Units have the option to redeemtheir units and to receive, at the option of the Company, in exchange for eachfour OP Units (i) one share of Common Stock of the Company, or (ii) cashequal to the market value of one share of Common Stock of the Company at thedate of conversion, but no fractional shares will be issued.

The Board of Directors has concluded that it is not inthe best interests of the Company to elect to be treated as a real estateinvestment trust (or REIT), as defined under the Internal Revenue Code of 1986,as amended, and it intends to seek stockholder approval of an amendment to itsArticles of Incorporation which would delete a provision which restricts theability of stockholders to acquire shares in excess of certain ownershiplimitations. This provision was included in the Articles to preserve theCompany’s ability to elect to be taxed as a REIT in the future, since one ofthe requirements of REIT status is that not more than 50% of a REIT’s equitysecurities may be held by 5 or fewer stockholders.

In general, a REIT is a company that owns or providesfinancing for real estate and pays annual distributions to investors of atleast 90% of its taxable income. A REIT typically is not subject to federal 

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income taxation on its netincome, provided applicable income tax requirements are satisfied, butdividends paid by a REIT are generally taxed at ordinary income rates, ratherthan at capital gain rates, as are other corporate dividends.  Since its inception, the Company has beentaxed as a C corporation.

The Company expects to meet its short-term liquidityrequirements for normal property operating expenses and general andadministrative expenses from cash generated by operations and cash currentlyheld. In addition, the Company anticipates capital costs to be incurred relatedto leasing space and improvements to properties provided the estimated leasingof space is complete. The Company anticipates meeting these obligations withthe net cash proceeds generated during the first quarter of 2006 from the saleof three properties and from the use of funds held in escrow by lenders. Basedon current analysis, the Company expects the cash generated from the threesales will be adequate to meet these obligations.

The Company has paid,refinanced or extended all material debt which was due to mature in 2005 and2006 with the exception of a mortgage loan due to mature in July 2006 onits one remaining shopping center property. The lender was a major tenant atanother shopping center property sold in 2005. The Company anticipates eitherrefinancing the debt, negotiating a loan extension or selling this property.

**Business Objectives and Strategy**

The Company’s fundamental business objective is tomaximize stockholder value. The Company intends to achieve its businessobjective through opportunistic investments and by executing its otheroperating strategies.

The Company’s future growth will be focused onmulti-tenant suburban office and industrial properties in the high growthmarkets of Texas, Arizona and California. Properties in non-core markets areexpected to be sold and the net proceeds redeployed into funding futureacquisitions in core markets and to pay for capital expenditures and reducedebt.

*Opportunitiesto Acquire Undervalued and Undermanaged Properties.**  *The Company believes it is positionedto invest in properties, either individually or in portfolios, at attractiveprices, often at costs lower than replacement cost. This will be accomplishedusing the Company’s knowledge of its core geographical markets and coreproperty types, as well as its established capability to identify, andnegotiate with, highly-motivated sellers, which include individuals as well assuch institutions as banks, insurance companies and pension funds. The Companywill not set a maximum target purchase price but rather it will tailor itsacquisitions to under performing properties, which the Company believes areattractively priced due to relative physical or operating deficiencies. TheCompany believes that its real estate expertise will allow it to, when necessary,reposition, renovate or redevelop these properties to make them competitive intheir local markets.

*Competitive Advantages.**  *The Company believes it hascompetitive advantages that will enable it to be selective with respect to realestate investment opportunities and allow it to successfully pursue its growthstrategy. Based on its management’s experience, the Company expects that itspresence in geographically diverse markets will increase its exposure toopportunities for attractive acquisitions of various types of propertiesthroughout its operating region and provide it with competitive advantageswhich enhance its ability to do so, including:

·       stronglocal market expertise;

·       long-standingrelationships with tenants, real estate brokers, institutions and other ownersof real estate in each local market;

·       fullyintegrated real estate operations which allow quick response to acquisitionopportunities;

·       accessto capital markets at competitive rates as a public company;

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·       abilityto acquire properties in exchange for ASR shares or OP Units which may make ita more attractive purchaser when compared to purchasers who are not similarlystructured or are unable to make similar use of equity to purchase properties.

*PropertyManagement Strategies.*   The Company hasprocedures and expertise which permit it to manage effectively a variety oftypes of properties throughout the United States. The decentralized structurewith strong local management enables it to operate efficiently. In seeking tomaximize revenues, minimize costs and increase the value of the properties, theCompany follows aggressive property management policies. Among the propertymanagement techniques emphasized are regular and comprehensive maintenanceprograms, regular and comprehensive financial analyses, the use of a masterproperty and casualty insurance program, aggressive restructuring or conversionof tenant spaces and frequent appearances before property tax assessors,planning commissions and other local governmental bodies. The Company believesthat its management of the properties will be a substantial factor in itsability to realize its objectives of maximizing earnings.

*Managing and MonitoringInvestments.*   The Company has actively managedthe property portfolio and administered its investments. The Company willmonitor issues including the financial advantages of property sales,minimization of real estate taxes, and insurance costs. Also, the Company willactively analyze diversification, review tenant financial statements to dealwith potential problems quickly and will restructure investments in the case ofunderperforming and non-performing properties.

**Competition**

The Company competes withother entities both to locate suitable properties for acquisition and to locatepurchasers for its properties. While the markets in which it competes arehighly fragmented with no dominant competitors, the Company faces substantialcompetition in both its leasing and property acquisition activities. There arenumerous other similar types of properties located in close proximity to eachof its properties. The amount of leasable space available in any market couldhave a material adverse effect on the Company’s ability to rent space and onthe rents charged. Competition for acquisition of existing properties frominstitutional investors and publicly traded REITs has increased substantiallyin the past several years. In many of the Company’s markets, institutionalinvestors and owners and developers of properties compete vigorously for the acquisition,development and leasing of space. Many of these competitors have greaterresources and more experience than the Company.

**Employees**

As of December 31,2005, ASR employed 28 individuals, including on-site property management andmaintenance personnel.

**Environmental Matters**

Various federal, state and local laws and regulationssubject property owners and operators to liability for reporting,investigating, remediating, and monitoring of regulated hazardous substancesreleased on or from a property. These laws and regulations often impose strictliability without regard to whether the owner or operator knew of, or actuallycaused, the release. The presence of, or the failure to properly report,investigate, remediate, or monitor hazardous substances could adversely affectthe financial condition of the Company or the ability of the Company to operatethe properties. In addition, these factors could hinder the Company’s abilityto borrow against the properties. The presence of hazardous substances on aproperty also could result in personal injury or similar claims by privateplaintiffs. In addition, there are federal, state and local laws andregulations which impose requirements on the storage, use, management anddisposal of regulated hazardous materials or substances. The failure to complywith those requirements could result in the imposition of liability, includingpenalties or fines, on the owner or 

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operator of the properties.Future laws or regulations could also impose unanticipated material environmentalliabilities on the Company in connection with any of the properties.

The Company is aware that two of its properties maycontain hazardous substances above reportable levels. Both properties arelocated in their respective state’s environmental funds. During 2005, theCompany accrued a $75,000 liability for future environmental cleanup effortsfor one of the properties. These efforts, which have been approved by theregulatory authorities, will take place over the next two years. The accrual isreflected on the Company’s consolidated financial statements as of December 31,2005. It is anticipated that cleanup costs for the other property will be paidby the state. Consequently, no amount has been accrued in the Company’sconsolidated financial statements for the other property.

The Company may decide toacquire a property with known or suspected environmental contamination after itevaluates that business risk, the potential costs of investigation orremediation, and the potential costs to cure identified non-compliances withenvironmental laws or regulations. In connection with its acquisition ofproperties, the Company may seek to have the seller indemnify it againstenvironmental conditions or non-compliances existing as of the date ofpurchase, and under appropriate circumstances, it may obtain environmentalinsurance. In some instances, the Company may become the assignee of orsuccessor to the seller’s indemnification rights arising from the seller’sacquisition agreement for the property. Additionally, the Company may try tostructure its leases for the property to require the tenant to assume all orsome of the responsibility for environmental compliance and remediation, and toprovide that material non-compliance with environmental laws or regulationswill be deemed a default under the lease. However, there can be no assurancesthat, despite these efforts, liability will not be imposed on the Company underapplicable federal, state, or local environmental laws or regulations relatingto the properties.

**Insurance**

The Company currently carries comprehensive liability,fire, terrorism, extended coverage and rental loss insurance covering all ofits properties, with policy specifications and insured limits which the Companybelieves are adequate and appropriate under the circumstances. There are,however, types of losses that are not generally insured because they are eitheruninsurable or not economically feasible to insure. In addition, costs to carryall of the types of insurance above may not always be economically feasible.

Should an uninsured lossor a loss in excess of insured limits occur, the Company could lose its capitalinvested in the property, as well as the anticipated future revenues from theproperty and, in the case of debt which is with recourse to the Company, wouldremain obligated for any mortgage debt or other financial obligations relatedto the property. Any such loss would adversely affect the Company. Moreover,the Company will generally be liable for any unsatisfied obligations other thannon-recourse obligations. The Company believes that its properties areadequately insured. No assurance can be given that material losses in excess ofinsurance proceeds will not occur in the future.

**Capital Expenditures**

Capital expenditurerequirements include both normal recurring capital expenditures, and tenantimprovements and lease commissions relating to the leasing of space to new orrenewing tenants. The Company has a history of acquiring properties whichrequired renovation, repositioning or management changes to improve theirperformance and to enable them to compete effectively. The Company plans tocontinue to invest in these types of properties. These properties may requiremajor capital expenditures or significant tenant improvements in order tomaximize their cash flows.

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**Acquisitions**

No properties were acquired during 2005.

On February 10, 2006, the Company purchased 2470Gray Falls, a 41,475 square foot office property located in Houston, Texas. Acquisitioncosts of approximately $2,600,000 consisted of seller financing and proceedsfrom a tax-deferred exchange.

On February 2, 2006,the Company purchased 2401 Fountainview, a 174,369 square foot office propertylocated in Houston, Texas. Acquisition costs of approximately $17,000,000consisted of a new mortgage loan and proceeds from a tax deferred exchange.

**Dispositions**

The Company sold three properties during 2005. On October 27,2005, the Company sold The Lakes, a 311,912 square foot/408 unit apartmentcomplex located in Hazelwood, Missouri for a sales price of $17,125,000. On September 22, 2005, the Company soldRichardson Plaza a 107,827 square foot shopping center located in Columbia,South Carolina for a sales price of $5,000,000. On March 1, 2005, theCompany sold Sorrento I, a vacant 43,036 square foot single tenant industrialproperty located in San Diego, California for a sales price of $4,918,000.

A gain of $7,895,000 was generated in connection withthe three sales, which is reflected as discontinued operations in the Company’sconsolidated financial statements for the year ended December 31, 2005. Thesales generated proceeds of $15,298,000, of which $5,210,000 was held in escrow as of December 31, 2005. Itis anticipated that the proceeds held in escrow will be used as a source tofacilitate the funding of future acquisitions in tax-deferred exchanges.

The Company sold threeproperties during the first quarter of 2006. On January 13, 2006, theCompany sold Mira Mesa, an 88,295 square foot office property located in SanDiego, California for a sales price of $20,250,000. On January 6, 2006,the Company sold Sorrento II, an 88,073 square foot industrial property locatedin San Diego, California for a sales price of $18,300,000. On March 14,2006, the Company sold Countryside, an 82,873 square foot office propertylocated in Palatine, Illinois for a sales price of $7,950,000. Proceeds ofapproximately $11,300,000 were received as a result of the three transactions,of which approximately $8,900,000 is being held in escrow to assist the fundingof future acquisitions in tax-deferred exchanges. The Company anticipates gainswill be recorded in the first quarter of 2006 as a result of the sales.

**ITEM 1A.**        RISKFACTORS

**TheCompany’s high level of debt increases its risk of default and may have anegative impact on the results of operations. This could adversely affect theCompany’s ability to make distributions and the market price of its CommonStock.**

The Company’s high levelof debt increases the Company’s risk of default on its obligations andadversely affects the Company’s funds from operations and its ability to makedistributions to its stockholders. Further,due to the high level of debt, the Company may be restricted in its ability torefinance some or all of its indebtedness and the terms of any new orrefinanced debt may not be as favorable as those of some of its existingindebtedness. The Company has a higher ratio of indebtedness to assets thanmany other real estate companies. This could adversely affect the market pricefor the Company’s Common Stock.

**TheCompany may need to refinance mortgage loans and sell properties to meet itsobligations.**

**TheCompany expects to require substantial cash to meet its operating requirements,including budgeted capital expenditures if the leasing projections are met. Tomeet these obligations, the Company**

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**maybe required to refinance mortgage indebtedness and/or sell certain assets toprovide cash. The Company cannot provide assurance that it will be successfulin refinancing the mortgage indebtedness and that it will have sufficient cashto meet its obligations.**The Company has paid, refinanced or extended allmaterial debt which was due to mature in 2005 and 2006 with the exception of amortgage loan due to mature in July 2006 on its one remaining shoppingcenter property. The Company anticipates either refinancing the debt,negotiating a loan extension or selling this property. In addition, to fulfill the Company’s growthstrategy, the Company may be required to raise additional cash through debt orequity financing.

**Thereare risks inherent in the Company’s acquisition and development strategy. TheCompany may not make profitable investments.**

The Company plans topursue its growth strategy through the acquisition and development ofadditional properties. The Company does not know that this strategy willsucceed. The Company may have difficulty finding new properties, negotiatingwith new or existing tenants or securing acceptable financing. In addition,investing in additional properties is subject to many risks. Also, the Company’sacquisition strategy of investing in under-valued assets subjects the Companyto increased risks. The Company may not succeed in turning around these properties.The Company may not make a profit on these investments.

**TheCompany has a history of losses. The Company cannot assure the stockholdersthat it will become profitable in the future.**

**TheCompany has incurred losses in each of the three years ended December 31,2005. The Company cannot assure the stockholders that it will not continue tohave losses after depreciation and amortization under generally acceptedaccounting principles.**

**Realproperty investments entail risk. The Company’s properties may not beprofitable, may not result in distributions and/or may depreciate.**

Properties acquired by theCompany: (i) may not operate at a profit; (ii) may not perform to the Company’s expectations;  (iii) may not appreciate in value; (iv) maydepreciate in value; (v) may not ever be sold at a profit; and/or (vi) maynot result in dividends. The marketability and value of any properties willdepend upon many factors beyond the Company’s control, including but notlimited to general economic conditions, zoning laws, tax laws and theavailability of financing.

**TheCompany may not be able to enter into favorable leases upon the expiration ofcurrent leases and on current vacant space.**

**Overthe next three years, approximately 60% of the square footage of the Company’s totalrentable square footage of industrial, office and shopping center propertieswill expire. In addition, 14% of the Company’s total rentable square footagewas vacant as of December 31,2005. The Company may be unable to enter intoleases for all or a portion of this space.  If the Company enters into leases, the Companymay not do so at comparable lease rates, without incurring additional expenses.If the Company is unsuccessful in leasing the space, or cannot re-lease thespace at current rental rates or higher rental rates, it could reduce thedistributions to shareholders and adversely affect the market price of theCompany’s Common Stock.**

**TheCompany may invest in joint ventures, which adds another layer of risk to itsbusiness.**

The Company may acquire properties through jointventures, which could subject the Company to certain risks that may nototherwise be present if investments were made directly by the Company. Theserisks include: (i) the potential that the Company’s joint venture partnermay not perform; (ii) the joint venture partner may have economic orbusiness interests or goals which are inconsistent with or adverse to 

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those of the Company; (iii) thejoint venture partner may take actions contrary to the requests or instructionsof the Company or contrary to the Company’s objectives or policies; and  (iv) the joint venturers may not be ableto agree on matters relating to the property they jointly own.

The Company also mayparticipate with other investors, including possibly investment programs orother entities affiliated with management, in investments as tenants-in-commonor in some other joint ownership or venture. The risks of such joint ownershipmay be similar to those mentioned above for joint ventures and, in the case ofa tenancy-in-common, each co-tenant normally has the right, if an unresolvabledispute arises, to seek partition of the property, which partition mightdecrease the value of each portion of the divided property.

**TheCompany could incur unforeseen environmental liabilities.**

Various federal, state andlocal laws and regulations subject property owners and operators to liabilityfor reporting, investigating, remediating, and monitoring regulated hazardoussubstances released on or from a property. These laws and regulations oftenimpose strict liability without regard to whether the owner or operator knewof, or actually caused, the release. The presence of, or the failure toproperly report, investigate, remediate, or monitor hazardous substances couldadversely affect the financial condition of the Company or the ability of theCompany to operate the properties. In addition, these factors could hinder theCompany’s ability to borrow against the properties. The presence of hazardoussubstances on a property also could result in personal injury or similar claimsby private plaintiffs. In addition, there are federal, state and local laws andregulations which impose requirements on the storage, use, management anddisposal of regulated hazardous materials or substances. The failure to complywith those requirements could result in the imposition of liability, includingpenalties or fines, on the owner or operator of the properties. Future laws orregulations could also impose unanticipated material environmental liabilitieson the Company in connection with any of the properties. The costs of complyingwith these environmental laws and regulations for the Company’s propertiescould adversely affect the Company’s operating costs and, if contamination ispresent, the value of those properties.

**TheCompany faces intense competition in all of its markets.**

Numerous propertiescompete with the Company’s properties in attracting tenants to lease space.  Additional properties may be built in themarkets in which the Company’s properties are located. The number and qualityof competitive properties in a particular area will have a material effect onthe Company’s ability to lease space at existing properties or at newlyacquired properties and on the rents charged. Some of these competingproperties may be newer or better located than the Company’s properties. Thereare a significant number of buyers of properties, including institutionalinvestors and publicly traded REITs. Many of these competitors havesignificantly greater financial resources and experience than the Company. Thishas resulted in increased competition in acquiring attractive properties. Thiscompetition can adversely affect the Company’s ability to acquire propertiesand increase its distributions.

**TheCompany does not intend to elect REIT status.**

The Board of Directors hasdetermined that it is not in the Company’s best interests to make a REITelection. The Company is currently taxed as a C corporation and subject to acorporate income tax and expects to be for the foreseeable future.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

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**ITEM 2. PROPERTIES**

**TheLocation and Type of the Company’s Properties**

TheCompany’s 22 properties consist of 18 office, three industrial and one shoppingcenter located in four geographic regions in seven states. The following tablesets forth the location, type and size of the properties (by rentable squarefeet and/or units) along with annualized net rent, rented square feet,occupancy, and rent per square foot as of December 31, 2005. Allproperties listed below are encumbered by debt.

| **Property/State**              | ** ** | ** **       | ** ** | **Type** | ** ** | **Total Gross  Leasable  Area  (Square Feet)** | ** ** | **Percent of  Gross  Leasable Area  Occupied(1)** | ** ** | **Rented  Square Feet** | ** ** | **Annualized  Net Rent  (in thousands)(3)** | ** ** | **Rent per  Square  Foot(4)** | ** ** |
|---------------------------------|------------|------------------|------------|----------|------------|----------------------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------------------------|------------|------------------------------------|------------|
| *Arizona/California Region*     |       |             |       |     |       |                                                     |       |                                                        |       |                         |       |                                                  |       |                               |       |   |   |   |   |   |   |   |   |
| 7700 Building, CA               |       | Office           |       |     | 208,815    |                                                     |       |                                                        | 85         | %                            |       |                                                  | 177,512    |                               |       |   | $ | 4,736 |   |   |   | $ | 26.68 |   |   |
| Bristol Bay, CA                 |       | Office           |       |     | 50,073     |                                                     |       |                                                        | 100        | %                            |       |                                                  | 50,073     |                               |       |   | 1,255 |   |   |   | 25.07 |   |   |
| Creekside Office, CA            |       | Office           |       |     | 47,810     |                                                     |       |                                                        | 97         | %                            |       |                                                  | 46,409     |                               |       |   | 1,215 |   |   |   | 26.18 |   |   |
| Mira Mesa, CA (2)               |       | Office           |       |     | 88,295     |                                                     |       |                                                        | 88         | %                            |       |                                                  | 78,028     |                               |       |   | 1,632 |   |   |   | 20.92 |   |   |
| Pacific Spectrum, AZ            |       | Office           |       |     | 71,012     |                                                     |       |                                                        | 68         | %                            |       |                                                  | 48,107     |                               |       |   | 604 |   |   |   | 12.55 |   |   |
| Sorrento II, CA (2)             |       | Office           |       |     | 88,073     |                                                     |       |                                                        | 51         | %                            |       |                                                  | 44,838     |                               |       |   | 714 |   |   |   | 15.93 |   |   |
| Arizona/California Region Total |       |             |       |     | 554,078    |                                                     |       |                                                        | 80         | %                            |       |                                                  | 444,967    |                               |       |   | 10,156 |   |   |   | 22.83 |   |   |
| *Upper Midwest Region*          |       |             |       |     |       |                                                     |       |                                                        |       |                         |       |                                                  |       |                               |       |   |   |   |   |   |   |   |   |
| Countryside, IL (2)             |       | Office           |       |     | 92,873     |                                                     |       |                                                        | 90         | %                            |       |                                                  | 83,874     |                               |       |   | $ | 1,346 |   |   |   | $ | 16.04 |   |   |
| Northwest Corporate Center, MO  |       | Office           |       |     | 86,449     |                                                     |       |                                                        | 86         | %                            |       |                                                  | 74,494     |                               |       |   | 1,138 |   |   |   | 15.28 |   |   |
| Morenci Professional Park, IN   |       | Industrial       |       |     | 105,600    |                                                     |       |                                                        | 71         | %                            |       |                                                  | 74,400     |                               |       |   | 359 |   |   |   | 4.83 |   |   |
| Upper Midwest Region Total      |       |             |       |     | 284,922    |                                                     |       |                                                        | 82         | %                            |       |                                                  | 232,768    |                               |       |   | 2,843 |   |   |   | 12.21 |   |   |
| *Carolina Region*               |       |             |       |     |       |                                                     |       |                                                        |       |                         |       |                                                  |       |                               |       |   |   |   |   |   |   |   |   |
| Columbia, SC                    |       | Shopping  Center |       |     | 56,487     |                                                     |       |                                                        | 89         | %                            |       |                                                  | 50,475     |                               |       |   | $ | 265 |   |   |   | $ | 5.25 |   |   |
| Carolina Region Total           |       |             |       |     | 56,487     |                                                     |       |                                                        | 89         | %                            |       |                                                  | 50,475     |                               |       |   | 265 |   |   |   | 5.25 |   |   |
| *Texas Region*                  |       |             |       |     |       |                                                     |       |                                                        |       |                         |       |                                                  |       |                               |       |   |   |   |   |   |   |   |   |
| 888 Sam Houston Parkway, TX     |       | Office           |       |     | 45,596     |                                                     |       |                                                        | 99         | %                            |       |                                                  | 45,036     |                               |       |   | $ | 593 |   |   |   | $ | 13.17 |   |   |
| 800 Sam Houston Parkway, TX     |       | Office           |       |     | 42,744     |                                                     |       |                                                        | 97         | %                            |       |                                                  | 41,389     |                               |       |   | 521 |   |   |   | 12.58 |   |   |
| 11500 Northwest Freeway, TX     |       | Office           |       |     | 81,498     |                                                     |       |                                                        | 84         | %                            |       |                                                  | 68,241     |                               |       |   | 956 |   |   |   | 14.01 |   |   |
| 5450 Northwest Central, TX      |       | Office           |       |     | 56,350     |                                                     |       |                                                        | 98         | %                            |       |                                                  | 55,125     |                               |       |   | 778 |   |   |   | 14.12 |   |   |
| 5850 San Felipe, TX             |       | Office           |       |     | 102,141    |                                                     |       |                                                        | 98         | %                            |       |                                                  | 100,155    |                               |       |   | 1,595 |   |   |   | 15.93 |   |   |
| 8100 Washington, TX             |       | Office           |       |     | 44,060     |                                                     |       |                                                        | 100        | %                            |       |                                                  | 44,060     |                               |       |   | 534 |   |   |   | 12.12 |   |   |
| 8300 Bissonnet, TX              |       | Office           |       |     | 91,167     |                                                     |       |                                                        | 86         | %                            |       |                                                  | 78,520     |                               |       |   | 965 |   |   |   | 12.28 |   |   |
| 12000 Westheimer, TX            |       | Office           |       |     | 57,977     |                                                     |       |                                                        | 99         | %                            |       |                                                  | 57,586     |                               |       |   | 823 |   |   |   | 14.29 |   |   |
| 16350 Park Ten Place, TX        |       | Office           |       |     | 72,806     |                                                     |       |                                                        | 85         | %                            |       |                                                  | 61,703     |                               |       |   | 940 |   |   |   | 15.24 |   |   |
| 16360 Park Ten Place, TX        |       | Office           |       |     | 68,313     |                                                     |       |                                                        | 93         | %                            |       |                                                  | 63,341     |                               |       |   | 955 |   |   |   | 15.08 |   |   |
| Southwest Pointe, TX            |       | Industrial       |       |     | 101,156    |                                                     |       |                                                        | 89         | %                            |       |                                                  | 89,955     |                               |       |   | 597 |   |   |   | 6.63 |   |   |
| Technology, TX                  |       | Industrial       |       |     | 109,012    |                                                     |       |                                                        | 85         | %                            |       |                                                  | 92,752     |                               |       |   | 980 |   |   |   | 10.56 |   |   |
| Texas Region Total              |       |             |       |     | 872,820    |                                                     |       |                                                        | 91         | %                            |       |                                                  | 797,863    |                               |       |   | 10,237 |   |   |   | 12.83 |   |   |
| Total/Weighted  Average         |       |             |       |     | 1,768,307  |                                                     |       |                                                        | 86         | %                            |       |                                                  | 1,526,073  |                               |       |   | $ | 23,501 |   |   |   | $ | 15.40 |   |   |

----

(1)             Includes gross leasable area for leases that have beenexecuted and have commenced as of December 31, 2005.

(2)             At December 31, 2005, Mira Mesa, Sorrento II andCountryside Office Park were classified as “Real estate held for sale”.

(3)             Represents base rent at December 31, 2005 foroccupied square footage.

(4)             Represents Annualized Net Rent divided by Rented SquareFeet.

For the year ended December 31,2005, no tenant contributed 10% or more of the total rental revenue of theCompany. A complete listing of properties owned by the Company at December 31,2005, is included as part of Schedule III in Item 15.

10

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**Office Properties**

The Company owns 18 office properties with totalrentable square footage of 1,396,052. The office properties range in size from42,744 square feet to 208,815 square feet, and have remaining lease termsranging from less than one to 10 years. Three of the office properties (MiraMesa, Sorrento II and Countryside) were classified as “Real estate held forsale as of December 31, 2005.

The office leases generally require the tenant toreimburse the Company for increases in building operating costs over a baseamount. Certain of the leases provide for rent increases that are either fixedor based on a consumer price index. As of December 31, 2005, the weightedaverage occupancy of the office properties was 87%. The weighted average baserent per square foot, calculated as total annualized base rents divided bygross leasable area actually occupied as of December 31, 2005, was $17.48as of such date.

Thefollowing table sets forth, for the periods specified, the number of expiringleases, the total rentable area subject to expiring leases, average occupancyrepresented by expiring leases, and total effective annual base rentrepresented by expiring leases.

**OFFICEPROPERTIESLEASE EXPIRATIONS**

| **Expiration Year** | ** ** | ** ** | ** ** | **Number of  Expiring  Leases** | ** ** | **Rented Square  Footage Subject  to Expiring  Leases** | ** ** | **Annual Base Rent  Under Expiring Leases  (in thousands)** | ** ** | **Percentage of Total  Annual Base Rent  Represented by  Expiring Leases(1)** | ** ** |
|--------------------------|------------|------------|------------|--------------------------------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| 2006(2)                  |       |       | 177        |                                 |       |                                                                   | 270,954    |                                                                                 |       |                                                                                                        | $          | 4,965 |   |   |   | 28 | % |   |
| 2007                     |       |       | 112        |                                 |       |                                                                   | 216,894    |                                                                                 |       |                                                                                                        | 3,246      |   |   |   | 18 | % |   |
| 2008                     |       |       | 74         |                                 |       |                                                                   | 140,340    |                                                                                 |       |                                                                                                        | 2,196      |   |   |   | 12 | % |   |
| 2009                     |       |       | 43         |                                 |       |                                                                   | 134,175    |                                                                                 |       |                                                                                                        | 2,864      |   |   |   | 16 | % |   |
| 2010                     |       |       | 35         |                                 |       |                                                                   | 175,077    |                                                                                 |       |                                                                                                        | 3,574      |   |   |   | 20 | % |   |
| Thereafter               |       |       | 7          |                                 |       |                                                                   | 64,364     |                                                                                 |       |                                                                                                        | 1,072      |   |   |   | 6 | % |   |
| Total                    |       |       | 448        |                                 |       |                                                                   | 1,001,804  | (3)                                                                                  |       |                                                                                                        | $          | 17,917 | (4) |   |   | 100 | % |   |

----

(1)          Annual base rentexpiring during each period, divided by total annual base rent (both adjustedfor contractual increases).

(2)          Includes leases thathave initial terms of less than one year.

(3)          This figure is based onsquare footage actually occupied (which excludes vacant space), which accountsfor the difference between this figure and total gross leasable area (whichincludes vacant space).

(4)          Thisfigure is based on square footage actually occupied and incorporatescontractual rent increases arising after 2005, and thus differs from annualizednet rent in the preceding table, which is based on 2005 rents.

**Industrial Properties**

The Company owns three industrial propertiesaggregating 315,768 square feet. The industrial properties are primarilydesigned for warehouse, distribution and light manufacturing and range in sizefrom 101,056 square feet to 109,012 square feet. As of December 31, 2005,multiple tenants occupied two of the industrial properties and one of theproperties was partially occupied by a single tenant. As of December 31,2005, the weighted average occupancy of the industrial properties held forinvestment was 81%. The weighted average base rent per square foot, calculatedas total annualized base rents divided by gross leasable area actually occupiedas of December 31, 2005, was $7.53 as of such date.

11

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The industrial properties have leases whose remainingterms range from less than one to seven years. Most of the leases areindustrial gross leases whereby the tenant pays as additional rent its pro ratashare of common area maintenance and repair costs and its share of the increasein taxes and insurance over a base amount. Certain of these leases call forfixed or consumer-price-index-based rent increases. Some of the leases aretriple net leases whereby the tenants are required to pay their pro rata shareof the properties’ operating costs, common area maintenance, property taxes,insurance and non-structural repairs.

Thefollowing table sets forth, for the periods specified, the number of expiringleases, the total rentable area subject to expiring leases, average occupancyrepresented by expiring leases and total effective annual base rent representedby expiring leases.

**INDUSTRIALPROPERTIESLEASE EXPIRATIONS**

| **Expiration  Year** | ** ** | ** ** | ** ** | **Number of  Expiring  Leases** | ** ** | **Rented Square  Footage Subject  to Expiring  Leases** | ** ** | **Annual Base Rent  Under Expiring Leases  (in thousands)** | ** ** | **Percentage of Total  Annual Base Rent  Represented by  Expiring Leases(1)** | ** ** |
|----------------------|------------|------------|------------|--------------------------------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| 2006(2)              |       |       | 38         |                                 |       |                                                                   | 66,611     |                                                                                 |       |                                                                                                        | $          | 461 |   |   |   | 25 | % |   |
| 2007                 |       |       | 12         |                                 |       |                                                                   | 105,910    |                                                                                 |       |                                                                                                        | 486        |   |   |   | 26 | % |   |
| 2008                 |       |       | 15         |                                 |       |                                                                   | 61,588     |                                                                                 |       |                                                                                                        | 577        |   |   |   | 32 | % |   |
| 2009                 |       |       | 5          |                                 |       |                                                                   | 25,664     |                                                                                 |       |                                                                                                        | 154        |   |   |   | 8 | % |   |
| 2010                 |       |       | 1          |                                 |       |                                                                   | 2,994      |                                                                                 |       |                                                                                                        | 19         |   |   |   | 1 | % |   |
| Thereafter           |       |       | 2          |                                 |       |                                                                   | 14,256     |                                                                                 |       |                                                                                                        | 135        |   |   |   | 8 | % |   |
| Total                |       |       | 73         |                                 |       |                                                                   | 277,023    | (3)                                                                                  |       |                                                                                                        | $          | 1,832 | (4) |   |   | 100 | % |   |

----

(1)          Annual base rentexpiring during each period, divided by total annual base rent (both adjustedfor contractual increases).

(2)          Includes leases thathave initial terms of less than one year.

(3)          This figure is based onsquare footage actually occupied (which excludes vacant space), which accountsfor the difference between this figure and total gross leasable area (whichincludes vacant space).

(4)          Thisfigure is based on square footage actually leased and incorporates contractualrent increases arising after 2005, and thus differs from annualized net rent inthe table under “The Location and Type of the Company’s Properties”, which isbased on 2005 rents.

**Shopping Center Property**

The Company owns one shopping center property withtotal rentable square footage of 56,487. The shopping center property hasremaining lease terms ranging from less than one to ten years. The shoppingcenter leases generally require the tenant to reimburse the Company forincreases in certain building operating costs over a base amount. Certain ofthe leases provide for rent increases that are either fixed or based on apercentage of tenants’ sales. As of December 31, 2005, the occupancy ofthe shopping center property was 89%. The average base rent per square foot,calculated as total annualized base rents divided by gross leasable areaactually occupied as of December 31, 2005, was $5.25 as of such date.

12

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Thefollowing table sets forth, for the periods specified, the number of expiringleases, the total rentable area subject to expiring leases, average occupancyrepresented by expiring leases and total effective annual base rent representedby expiring leases.

**SHOPPINGCENTER PROPERTYLEASE EXPIRATIONS**

| **Expiration  Year** | ** ** | ** ** | ** ** | **Number of  Expiring  Leases** | ** ** | **Rented Square  Footage Subject  to Expiring  Leases** | ** ** | **Annual Base Rent  Under Expiring Leases  (in thousands)** | ** ** | **Percentage of Total  Annual Base Rent  Represented by  Expiring Leases(1)** | ** ** |
|----------------------|------------|------------|------------|--------------------------------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| 2006(2)              |       |       | 2          |                                 |       |                                                                   | 11,342     |                                                                                 |       |                                                                                                        | $          | 55 |   |   |   | 15 | % |   |
| 2007                 |       |       | 0          |                                 |       |                                                                   | —     |                                                                                 |       |                                                                                                        | —     |   |   |   | — |   |   |
| 2008                 |       |       | 2          |                                 |       |                                                                   | 24,300     |                                                                                 |       |                                                                                                        | 119        |   |   |   | 33 | % |   |
| 2009                 |       |       | 1          |                                 |       |                                                                   | 7,000      |                                                                                 |       |                                                                                                        | 80         |   |   |   | 22 | % |   |
| 2010                 |       |       | 1          |                                 |       |                                                                   | —     |                                                                                 |       |                                                                                                        | 38         |   |   |   | 10 | % |   |
| Thereafter           |       |       | 2          |                                 |       |                                                                   | 7,833      |                                                                                 |       |                                                                                                        | 72         |   |   |   | 20 | % |   |
| Total                |       |       | 8          |                                 |       |                                                                   | 50,475     | (3)                                                                                  |       |                                                                                                        | $          | 364 | (4) |   |   | 100 | % |   |

----

(1)          Annual base rentexpiring during each period, divided by total annual base rent (both adjustedfor contractual increases).

(2)          Includes leases that haveinitial terms of less than one year.

(3)          This figure is based onsquare footage actually occupied (which excludes vacant space), which accountsfor the difference between this figure and total gross leasable area (whichincludes vacant space).

(4)          Thisfigure is based on square footage actually occupied and incorporatescontractual rent increases arising after 2005, and thus differs from annualizednet rent in the table under “The Location and Type of the Company’s Properties”,which is based on 2005 rents.

**ITEM 3. LEGAL PROCEEDINGS**

The following is information concerning legalproceedings to which the Company or its subsidiaries is a party or of which anyof their property is subject:

The Company is a defendant in a lawsuit related to thesale of Van Buren, a parcel of undeveloped land sold in September 2004. Thelawsuit, filed January 21, 2005 in the United States District Court forthe Southern District of California, is associated with a participating profitsagreement. The plaintiff, Warren F. Ryan, seeks general damages, includinginterest, of $700,000 or according to proof at trial; special damages in anunspecified amount; declaratory relief, and miscellaneous relief such asattorney’s fees and costs. Discovery has commenced in this action and, underthe current schedule, discovery is set to close on May 31, 2006. The Courthas not set a trial date. The Company believes that this claim is without meritand is vigorously defending itself.

Certain claims andlawsuits have arisen against the Company in its normal course of business. TheCompany believes that such claims and lawsuits will not have a material adverseeffect on the Company’s financial position, cash flow or results of operations.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

No matters were submitted during the fourth quarter of2005 to a vote of the holders of the Company’s common stock, through thesolicitation of proxies or otherwise.

13

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**PART II**

**ITEM5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS ANDISSUER PURCHASES OF EQUITY SECURITIES**

**Market Information**

TheCompany’s Common Stock trades on the American Stock Exchange under the symbolAQQ. The following table sets forth the high and low closing prices per shareof the Company’s Common Stock for the periods indicated, as reported by theAmerican Stock Exchange.

| ** **     | ** ** | **Common Stock** | ** ** |
|----------------|------------|-----------------------|------------|
| *2004*         |       |                  |       |   |   |
| First Quarter  |       | $                     | 14.10      |   | $ | 12.48 |   |
| Second Quarter |       | 12.56                 |       | 8.00 |   |
| Third Quarter  |       | 8.75                  |       | 5.00 |   |
| Fourth Quarter |       | 9.80                  |       | 5.70 |   |
| *2005*         |       |                  |       |   |   |
| First Quarter  |       | $                     | 9.63       |   | $ | 7.80 |   |
| Second Quarter |       | 9.75                  |       | 7.50 |   |
| Third Quarter  |       | 11.40                 |       | 8.25 |   |
| Fourth Quarter |       | 16.91                 |       | 10.00 |   |

 

**CompanyPurchases of Equity Securities**

| **Period**                   | ** ** | ** ** | ** ** | **(1) Total Number of  Shares Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of Shares  Purchased as Part of  Publicly Announced  Plans or Programs** | ** ** | **Maximum Number (or  Approximate Dollar  Value) of Shares that  May Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|------------------------------|------------|------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1-31,  2005     |       |       | —     |                                                          |       |                                             | $          | —                                                                                                                               |       |                                                                                                                                                                              |       | — |   |   |   | — |   |   |
| November 1-30,  2005    |       |       | 23,474     |                                                          |       |                                             | 11.18      |                                                                                                                                 |       |                                                                                                                                                                              | —     |   |   |   | — |   |   |
| December 1-31,  2005(2) |       |       | 19,432     |                                                          |       |                                             | 26.61      |                                                                                                                                 |       |                                                                                                                                                                              | —     |   |   |   | — |   |   |
| Total                        |       |       | 42,906     |                                                          |       |                                             | $          | 18.61                                                                                                                                |       |                                                                                                                                                                              |       | — |   |   |   | — |   |   |

 

----

(1)          Represents 35,280 sharespurchased in open market transactions and 7,626 in private transactions.

(2)          Includes5,000 shares purchased for $60.00 per share pursuant to a put and callagreement dated October 23, 2001.

**Holders**

The approximate number ofholders of the shares of the Company’s Common Stock was 4,600 as of March 1,2006.

**Distributions**

No dividends were declared to holders of the Company’sCommon Stock in 2005 or 2004.

In 2003, the Company’s Board of Directors establisheda policy of meeting on or about the 45th day after the end of each calendar quarter toconsider the declaration and payment of a dividend.

The Board has concluded that it is not in the bestinterests of the Company to elect to be treated as a real estate investmenttrust (or REIT), as defined under the Internal Revenue Code of 1986, asamended, 

14

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and it intends to seekstockholder approval of an amendment to its Articles of Incorporation whichwould delete a provision which restricts the ability of stockholders to acquireshares in excess of certain ownership limitations. This provision was includedin the Articles to preserve the Company’s ability to elect to be taxed as aREIT in the future, since one of the requirements of REIT status is that notmore than 50% of a REIT’s equity securities may be held by 5 or fewerstockholders.

In general, a REIT is acompany that owns or provides financing for real estate and pays annualdistributions to investors of at least 90% of its taxable income. A REITtypically is not subject to federal income taxation on its net income, providedapplicable income tax requirements are satisfied, but dividends paid by a REITare generally taxed at ordinary income rates, rather than at capital gainrates, as are other corporate dividends.  Since its inception, the Company has beentaxed as a C corporation.

**RecentSales of Unregistered Securities**

In 2004, the Company issued 10,000 shares to theseller of an office property as part of the Company’s consideration for theacquisition of the property. The consideration for the shares amounted to$70,700 based on a value of $7.07 per share. In 2005, the Company repurchasedthe shares in a private transaction for $85,000, or $8.50 per share. In 2003,the Company issued 129,945 shares to two directors in connection with thecancellation of debt and issued 15,243 shares to John N. Galardi, a directorand principal stockholder of the Company, for a purchase price of $250,000. Theseissuances of the Common Stock by the Company were exempt from the registrationrequirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) andRule 506 of Regulation D promulgated thereunder.

Thefollowing table provides information as of December 31, 2005 regarding thecompensation plan under which equity securities of the Company are authorizedfor issuance:

| **Number of Securities to  Be Issued Upon Exercise of  Outstanding Options** | ** ** | **Weighted Average  Per Share Exercise  Price of Outstanding  Options** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation Plan  (excluding securities  reflected in first column)** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 39,875                                                                                                               |       |                                                                                             | $          | 23.84                                                                                                                                                                                                             |       |   |   | 120,563 |   |   |
|                                                                                                                      |            |                                                                                                  |            |                                                                                                                                                                                                                   |            |  |  |  |  |  |

 

See Note 16—Stock Optionand Restricted Share Plans—in the Consolidated Financial Statements forinformation regarding the material features of the above plan.

**ITEM 6.**                SELECTEDFINANCIAL DATA

Set forth below is selected financial data for theCompany. Consolidated balance sheet and operating data are presented as of andfor each of the five years ended December 31. For 2001, operating dataincludes the results of operations of Sierra Pacific Pension Investors ‘84(“SPPI84”), which is treated as having acquired the properties in the Company’s2001 consolidation transaction for accounting purposes, for the entire year,and the acquired entities from October 20, 2001, through December 31,2001. Prior year amounts have been reclassified to conform with current yearpresentation.

15

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Thisselected financial data should be read in conjunction with the financialstatements of the Company, including the notes thereto, included in Item 15.

| ** **                                   | ** ** | **2005**                                                                                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                   | ** ** | **(Dollars in thousands, except for per share and per unit data)** | ** ** |
| OPERATING DATA:                              |       |                                                                                                                 |       |     |       |     |       |     |       |     |       |
| Total revenues                               |       | $                                                                                                                    | 20,269     |     | $          | 19,733   |       | $        | 17,513     |     | $          | 16,198 |   | $ | 3,291 |   |
| Property operating expense                   |       | 8,716                                                                                                                |       | 7,113    |       | 6,419    |       | 5,808    |       | 1,072    |       |
| General and administrative                   |       | 3,703                                                                                                                |       | 4,438    |       | 6,801    |       | 8,586    |       | 2,863    |       |
| Depreciation and amortization                |       | 8,464                                                                                                                |       | 7,534    |       | 6,444    |       | 5,720    |       | 1,016    |       |
| Interest expense                             |       | 8,824                                                                                                                |       | 9,273    |       | 7,843    |       | 7,267    |       | 1,456    |       |
| Litigation settlement                        |       | —                                                                                                               |       | —   |       | —   |       | 1,200    |       | —   |       |
| Impairment of real estate asset              |       | —                                                                                                               |       | —   |       | —   |       | 472      |       | —   |       |
| Deferred income tax benefit (expense)        |       | 3,360                                                                                                                |       | 2,222    |       | (278     | )          | 5,591    |       | —   |       |
| Net loss from continuing operations          |       | (5,853                                                                                                               | )          | (5,220   | )          | (8,293   | )          | (6,245   | )          | (2,355   | )          |
| Net loss                                     |       | (2,266                                                                                                               | )          | (9,107   | )          | (14,348  | )          | (7,130   | )          | (2,038   | )          |
| Basic and diluted  per share data:(1)        |       |                                                                                                                 |       |     |       |     |       |     |       |     |       |
| Net loss from continuing operations          |       | $                                                                                                                    | (4.02      | )        | $          | (3.37    | )          | $        | (5.59      | )        | $          | (4.52 | ) | $ | (1.71 | ) |
| Net loss                                     |       | (1.56                                                                                                                | )          | (5.87    | )          | (9.67    | )          | (5.16    | )          | (1.48    | )          |
| Dividends per share                          |       | N/A                                                                                                                  |       | N/A      |       | N/A      |       | 2.00     |       | N/A      |       |
| BALANCE SHEET DATA:                          |       |                                                                                                                 |       |     |       |     |       |     |       |     |       |
| Real estate held for investment, net         |       | $                                                                                                                    | 126,711    |     | $          | 130,630  |       | $        | 126,234    |     | $          | 116,607 |   | $ | 109,873 |   |
| Total assets                                 |       | 169,185                                                                                                              |       | 187,545  |       | 208,003  |       | 253,557  |       | 266,205  |       |
| Total long term debt                         |       | 114,543                                                                                                              |       | 113,230  |       | 109,228  |       | 93,960   |       | 83,642   |       |
| Stockholders’ and partners’ equity |       | 9,014                                                                                                                |       | 11,427   |       | 20,435   |       | 30,857   |       | 53,104   |       |
| OTHER DATA:                                  |       |                                                                                                                 |       |     |       |     |       |     |       |     |       |
| Cash flow  provided by (used in):            |       |                                                                                                                 |       |     |       |     |       |     |       |     |       |
| Operating activities                         |       | $                                                                                                                    | (1,471     | )        | $          | (2,628   | )          | $        | (3,468     | )        | $          | 446 |   | $ | (6,472 | ) |
| Investing activities                         |       | 5,202                                                                                                                |       | 5,540    |       | 27,518   |       | (3,566   | )          | 2,421    |       |
| Financing  activities                        |       | (4,020                                                                                                               | )          | (5,260   | )          | (21,901  | )          | 1,624    |       | 6,301    |       |

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(1)          Thenet loss data was based upon the weighted average shares of 1,457,079 for 2005,1,551,189 for 2004, 1,483,675 for 2003, 1,381,860 for 2002 and 1,380,261 for2001.

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**OVERVIEW**

American Spectrum Realty, Inc. (“ASR” or,collectively, as a consolidated entity with its subsidiaries, the “Company”) isa Maryland corporation established on August 8, 2000. The Company is afull-service real estate corporation, which owns, manages and operates income-producingproperties. Substantially all of the Company’s assets are held through anoperating partnership (the “Operating Partnership”) in which the Company, as ofDecember 31, 2005, held the sole general partner interest of .97% and alimited partnership interest totaling 85.68%. As of December 31, 2005,through its majority-owned subsidiary, the Operating Partnership, the Companyowned and operated 22 properties, which consisted of 18 office buildings, threeindustrial properties, and one shopping center. The 22 properties are locatedin seven states.

During 2005, the Company sold three properties, whichconsisted of a vacant single tenant industrial property located in San Diego,California, a shopping center located in Columbia, South Carolina and an apartmentcomplex located in Hazelwood, Missouri. During 2004, the Company sold threeproperties, 

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which consisted of anoffice building, an industrial property and a parcel of undeveloped land, andacquired two office buildings in Houston, Texas. During 2003, the Company soldeleven properties, which consisted of two apartment complexes, two officebuildings, six industrial properties and one shopping center, and acquired fouroffice buildings in Houston, Texas. The property sales are part of the Company’sstrategy to sell its non-core property types—apartment and shopping centerproperties—and to sell its properties located in the Midwest and Carolina’s,its non-core markets. The Company intends to focus primarily on multi-tenantoffice and industrial properties located in Texas, California and Arizona.

The properties owned by the Company were 86% occupiedat December 31, 2005 and 2004. Properties held for investment at December 31,2005 and 2004 were 88% and 89% occupied, respectively. Properties held forinvestment considered stabilized, not undergoing major redevelopment, were 89%occupied at December 31, 2005 and 90% occupied at December 31, 2004and properties under redevelopment were 77% occupied at December 31, 2005compared to 72% at December 31, 2004. The Company continues toaggressively pursue prospective tenants to increase its occupancy, which shouldhave the effect of improving operational results.

In the accompanying financial statements, propertiessold or held for sale are classified as “Real estate held for sale” as of December 31,2005, and their results of operations for the three years ended December 31,2005 are shown in the section “Discontinued operations”. Therefore the revenuesand expenses reported for the fiscal years ended December 31, 2003, 2004and 2005 reflect results from properties currently held for investment by theCompany. The following discussion and analysis of the financial condition andresults of operations of the Company should be read in conjunction with theselected financial data in Item 6 and the consolidated financial statements ofthe Company, including the notes thereto, included in Item 15.

During 2006 through thedate of this Annual Report on Form 10-K, the Company acquired twoproperties and had two more in escrow for purchase. All four of theseproperties are located in Houston, Texas, a core market. Three properties,which were classified as “Real estate held for sale” as of December 31,2005, were sold during the first quarter of 2006 as of the date of this AnnualReport on Form 10-K. The Company intends to continue to seek toacquire additional properties in core markets and further reduce its non-coreassets while focusing on an aggressive leasing program during 2006.

**CRITICAL ACCOUNTING POLICIES**

The major accounting policies followed by the Companyare listed in Note 2—Summary of Significant Accounting Policies—of the Notes tothe Consolidated Financial Statements. The consolidated financial statements ofthe Company are prepared in accordance with accounting principles generallyaccepted in the United States of America, which requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the results of operations during the reportingperiod. Actual results could differ materially from those estimates.

The Companybelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its consolidated financialstatements:

·       Certainleases provide for tenant occupancy during periods for which no rent is due orwhere minimum rent payments increase during the term of the lease. The Companyrecords rental income for the full term of each lease on a straight-line basis.Accordingly, a receivable, if deemed collectible, is recorded from tenantsequal to the excess of the amount that would have been collected on astraight-line basis over the amount collected and currently due (Deferred RentReceivable). When a property is acquired, the term of existing leases isconsidered to commence as of the acquisition date for purposes of thiscalculation.

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·       Manyof the Company’s leases provide for Common Area Maintenance (“CAM”)/Escalations(“ESC”) as the additional tenant revenue amounts due to the Company in additionto base rent. CAM/ESC represents increases in certain property operatingexpenses (as defined in each respective lease agreement) over the actualoperating expense of the property in the base year. The base year is stated inthe lease agreement; typically, the year in which the lease commenced. Generally,each tenant is responsible for his prorated share of increases in operatingexpenses. Tenants are billed an estimated CAM/ESC charge based on the budgetedoperating expenses for the year. Within 90 days after the end of each fiscalyear, a reconciliation and true up billing of CAM/ESC charges is performedbased on actual operating expenses.

·       Rentalproperties are stated at cost, net of accumulated depreciation, unlesscircumstances indicate that cost, net of accumulated depreciation, cannot berecovered, in which case the carrying value of the property is reduced toestimated fair value. Estimated fair value (i) is based upon the Company’splans for the continued operation of each property and (ii) is computedusing estimated sales price, as determined by prevailing market values forcomparable properties and/or the use of capitalization rates multiplied byannualized net operating income based upon the age, construction and use of thebuilding. The fulfillment of the Company’s plans related to each of itsproperties is dependent upon, among other things, the presence of economicconditions which will enable the Company to continue to hold and operate theproperties prior to their eventual sale. Due to uncertainties inherent in thevaluation process and in the economy, the actual results of operating anddisposing of the Company’s properties could be materially different thancurrent expectations.

·       Gains on property sales areaccounted for in accordance with the provisions of SFAS No. 66, “Accountingfor Sales of Real Estate”. Gains are recognized in full when real estate issold, provided (i) the gain is determinable, that is, the collectibilityof the sales price is reasonably assured or the amount that will not becollectible can be estimated, and (ii) the earnings process is virtuallycomplete, that is, the Company is not obligated to perform significantactivities after the sale to earn the gain. Losses on property sales arerecognized immediately.

**RESULTS OF OPERATIONS**

***Comparison of the year ended December 31, 2005 tothe year ended December 31, 2004***

Thefollowing table shows a comparison of rental revenues and certain expenses:

| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$$**       | ** ** | **%** | ** ** |
| Rental revenue                |       | $          | 19,919,000 |       | $          | 19,498,000   |       | 421,000 |   | 2.2 | % |
| Operating expenses:           |       |       |       |       |       |         |       |   |   |
| Property operating expenses   |       | 8,716,000  |       | 7,113,000  |       | 1,603,000    |       | 22.5 | % |
| General and administrative    |       | 3,703,000  |       | 4,438,000  |       | (735,000     | )          | (16.6 | )% |
| Depreciation and amortization |       | 8,464,000  |       | 7,534,000  |       | 930,000      |       | 12.3 | % |
| Interest expense              |       | 8,824,000  |       | 9,273,000  |       | (449,000     | )          | (4.8 | )% |
|                               |            |            |            |            |            |              |            |  |  |  |  |

 

*Rental revenue.*   Rentalrevenue for the year ended December 31, 2005 increased $421,000, or 2.2%,in comparison to the year ended December 31, 2004. This increase wasattributable to $1,001,000 in revenue generated from two office propertiesacquired in August and October 2004, offset by $580,000 in fewerrevenues from properties owned on December 31, 2004 and 2005 (“SameProperties”). This decrease in Same Properties revenue was primarily due to$293,000 in lease buyout revenue obtained at an office property in Californiaduring 2004 and due to a decrease in overall occupancy. Weighted average occupancyof properties held for investment decreased from 89% at December 31, 2004to 88% at 

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December 31, 2005. Rentalrevenue from the acquired properties was included in the Company’s resultssince their respective dates of acquisition.

*Property operating expenses.*   Theincrease of $1,603,000, or 22.5%, was principally due to $871,000 in expensesrelated to the two acquired properties mentioned above. In addition, SameProperties utilities increased $413,000 as a result of higher electricity rates.Property general and administrative expenses increased in large part due tocosts associated with an environmental matter at the Company’s industrialproperty in Indiana. Further, property taxes rose as a result of an increase inthe assessed value of several properties.

*General and administrative.*   Thedecrease of $735,000, or 16.6%, was in large part due to a decrease incompensation expense of $422,000, primarily due to an overall reduction of corporate staff. Further, non-recurringcosts of $183,000 associated with the Company’s March 2004 reverse stocksplit and a $75,000 treasury management fee were incurred during 2004. Thedecrease was also attributable to a cost reduction related to the printing ofthe Company’s Annual Report, a decrease in corporate insurance expense, andother cost cutting measures implemented by management.

*Depreciation andamortization.*   The increase of $930,000, or12.3%, was in large part due to the depreciation of capital improvements andamortization of capitalized lease costs. During 2005 and 2004, the Companyincurred $4,886,000 and $4,516,000, respectively, in capital improvements onits existing properties, primarily for renovations and tenant improvements. Theincrease was also attributable to depreciation and amortization of $296,000related to the two acquired properties mentioned above.

*Interest expense.*   Thedecrease of $449,000, or 4.8%, was primarily due to refinancing activities. Lowerinterest rates were obtained on several loans refinanced subsequent to December 31,2004. The refinancing of a property in August 2004 resulted in a $179,000decrease in amortized loan fees during 2005. In addition, a principal pay-downof $4,635,000 in October 2005 on one of the Company’s litigation notespayable attributed to the decrease.  Thedecrease was partially offset by additional interest expense of $285,000related to one of the acquired properties mentioned above.

*Income taxes.*   TheCompany recognized a deferred income tax benefit of $3,360,000 for 2005compared to $2,222,000 for 2004. This increase was due to an increase intaxable losses for 2005.

*Minority interest.**  *The share of loss for the yearended December 31, 2005 for the holders of OP Units was $320,000 comparedto $1,299,000 for the year ended December 31, 2004. The 2005 lossrepresents an average of 13.4% limited partner interest in the OperatingPartnership not held by the Company during 2005. The 2004 loss represents the12.5% limited partner interest in the Operating Partnership not held by theCompany during 2004.

*Loss on extinguishment ofdebt.*   During 2005, the Company recorded a lossof $95,000 on early extinguishment of debt on the write-off off unamortizedloan costs in connection with the refinance of debt on 800 and 888 Sam HoustonParkway. During 2004, the Company recorded a net loss on early extinguishmentof debt of $116,000. The net loss in 2004 consisted of a prepayment penalty of$120,000 and the write-off of unamortized loan costs of $94,000 in connectionwith the 2004 refinance debt on San Felipe, and a $98,000 gain related to thepurchase of interests of former limited partners of Fund II in the $8,800,000promissory note related to the settlement of the previously disclosed Teachoutlitigation. The Company purchased 2,347 of the 86,653 interests outstanding at$60 per unit, which reduced its debt obligation related to the settlement$238,338. See Note 9—Notes Payable, Litigation Settlement—of the Notes toConsolidated Financial Statements.

*Discontinued operations.*   TheCompany recorded a loss from operations of discontinued operations of$2,110,000 during 2005 related to the three properties classified as “Realestate held for sale” at December 31, 2005 and the three properties soldduring 2005. The Company recorded a loss from operations of discontinuedoperations of $2,574,000 during 2004 related to three properties classified as 

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“Real estate held for sale”at December 31, 2005, the three properties sold during 2005 and threeproperties sold during 2004. See Note 5—Discontinued Operations—of the Notes toConsolidated Financial Statements.

Thenet loss from discontinued operations before net (loss) gain on sale,impairment of real estate assets and income tax benefit is summarized below.

| ** **                             | ** ** | **Year Ended**             | ** ** | **Year Ended**             | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| Rental revenue                         |       |                            | $          | 6,927                           |       |   |   | $ | 8,848 |   |   |
| Total expenses                         |       |                            | 9,037      |                            |       |   | 11,422 |   |   |
| Net loss from  discontinued operations |       |                            | $          | (2,110                          | )          |   |   | $ | (2,574 | ) |   |

 

*Gain on sale ofdiscontinued operations.*   The Company sold threeproperties—one shopping center, one industrial property and one apartmentcomplex—during 2005 for an aggregate sales price of $27,043,000. The threeproperties sold during 2005 generated a net gain on sale of discontinuedoperations of $7,895,000. The Company sold three properties—one officebuilding, one industrial property and a parcel of undeveloped land—during 2004for an aggregate sales price of $12,214,000. Losses totaling $2,597,000 wererecorded on the sale of the office building and the parcel of undeveloped land.The sale of the industrial property generated a gain of $299,000. An income taxexpense on discontinued operations of $2,198,000 was recorded during the yearended December 31, 2005 compared to an income tax benefit of $985,000during the year ended December 31, 2004.

***Comparison of the year ended December 31, 2004 tothe year ended December 31, 2003***

Thefollowing table shows a comparison of rental revenues and certain expenses:

| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Variance** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **$$**       | ** ** | **%** | ** ** |
| Rental revenue                |       | $          | 19,498,000 |       | $          | 17,374,000   |       | 2,124,000 |   | 12.2 | % |
| Operating expenses:           |       |       |       |       |       |         |       |   |   |
| Property operating expenses   |       | 7,113,000  |       | 6,419,000  |       | 694,000      |       | 10.8 | % |
| General and administrative    |       | 4,438,000  |       | 6,801,000  |       | (2,363,000   | )          | (34.7 | )% |
| Depreciation and amortization |       | 7,534,000  |       | 6,444,000  |       | 1,090,000    |       | 16.9 | % |
| Interest expense              |       | 9,273,000  |       | 7,843,000  |       | 1,430,000    |       | 18.2 | % |
|                               |            |            |            |            |            |              |            |  |  |  |  |

 

*Rental revenue.*   Theincrease of $2,124,000, or 12.2%, was attributable to (i) $2,273,000 inrevenue generated from six office properties acquired in May 2003 through October 2004,(ii) higher revenues of $637,000 for properties owned on December 31,2004 and 2003 and (iii) a $196,000 payment received from the owner of aneighboring property for past use of common parking areas. The increase in revenuefor properties owned on December 31, 2004 and 2003 was primarilyattributable to the Company’s office properties, particularly to an officeproperty located in San Diego, California in which, as a result of aggressivelease up efforts, occupancy rose to 76% at December 31, 2004 from 35% at December 31,2003. Rental revenue from the six acquired office properties was included inthe Company’s results since their respective dates of acquisition. The weightedaverage occupancy of properties held for investment increased to 89% at December 31,2004 from 88% at December 31, 2003.

*Property operatingexpenses.*   The increase of $694,000, or 10.8%,was due to the expenses of $1,271,000 related to the six acquired officeproperties mentioned above, offset in part by a reduction in operating expensesfor other properties owned by the Company due to the continued monitoring andcontrolling of expenses.

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*General and administrative.*   Thedecrease of $2,363,000 was in large part due to a decrease in compensationexpense of $1,335,000, primarily due tothe closure of the Company’s offices in New York and San Diego and the downsizingof its administrative staff, especially in the St. Louis and California offices.The closure of these offices and the downsizing resulted in a decrease in otheradministrative costs of approximately $400,000. Further, professionalfees decreased approximately $500,000 due to the settlement of two majorlawsuits in 2003 and the hiring of in-house legal counsel. Both of these factors contributed to thereduced fees for outside legal services incurred during 2004 compared to 2003.

*Depreciation and amortization.*   Theincrease of $1,090,000 was related to depreciation of capital improvements andamortization of capitalized lease costs incurred in 2004 and 2003 and also thedepreciation related to the six acquired properties mentioned above. During2004 and 2003, the Company incurred approximately $8,295,000 in capitalimprovements, primarily for renovations and tenant improvements, and $2,380,000in capitalized lease costs. The tenant improvement and leasing costscorresponded with the Company’s increased occupancy.

*Interest expense.*   Theincrease of $1,430,000 was primarily due to (i) the interest expenseassociated with the six acquired properties mentioned of approximately$700,000, (ii) higher interest expense and fees on increased debt on threeof its properties of approximately $800,000, and (iii) the Companyrecording additional interest of approximately $350,000 at the default rate ondebt related to one of its shopping center properties.

*Income taxes.*   TheCompany recognized a deferred income tax benefit of $2,222,000 for 2004 comparedto a deferred income tax expense of $278,000 for 2003, primarily due to anincrease in taxable losses for 2004.

*Minority interest.**  *The share of loss for the yearended December 31, 2004 for the holders of OP Units was $1,299,000compared to $2,124,000 for the year ended December 31, 2003. The 2004 lossrepresents an average of 12.5% limited partner interest in the OperatingPartnership not held by the Company during 2004. The 2003 loss represents the12.9% limited partner interest in the Operating Partnership not held by theCompany during 2003.

*Loss on extinguishment ofdebt*   During 2004, the Company recorded a netloss on early extinguishment of debt of $116,000. The net loss consisted of (i) aprepayment penalty of $120,000 and the write-off of unamortized loan costs of$94,000 in connection with the 2004 refinance of San Felipe, and (ii) a$98,000 gain related to the purchase of interests of former limited partners ofFund II in the $8,800,000 promissory note related to the settlement of theTeachout litigation.. The Company purchased 2,347 of the 86,653 interestsoutstanding at $60 per unit, which reduced its debt obligation related to thesettlement $238,338. During 2003, in connection with the 2003 refinance of SanFelipe, the Company recorded a loss on early extinguishments of debt of$145,000 related to the write-off of an unamortized loan discount andprepayment penalty.

*Discontinued operations.*   TheCompany recorded a loss from operations of discontinued operations of$2,574,000 during 2004 related to the three properties sold in 2004 and sixproperties classified as “Real estate held for sale” at December 31, 2004.The Company recorded a loss from operations of discontinued operations of$2,751,000 during 2003 related to fourteen properties sold in 2003 and 2004 andsix properties classified as “Real estate held for sale” as of December 31,2004.

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Thenet loss from discontinued operations before net (loss) gain on sale,impairment of real estate assets and income tax benefit is summarized below.

| ** **                             | ** ** | **Year Ended**             | ** ** | **Year Ended**             | ** ** |
|----------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
| Rental revenue                         |       |                            | $          | 8,848                           |       |   |   | $ | 15,075 |   |   |
| Total expenses                         |       |                            | 11,422     |                            |       |   | 17,826 |   |   |
| Net loss from  discontinued operations |       |                            | $          | (2,574                          | )          |   |   | $ | (2,751 | ) |   |

 

*Gain on sale ofdiscontinued operations.*   The Company sold threeproperties—one office building, one industrial property one parcel ofundeveloped land—during 2004 for an aggregate sales price of $12,214,000.Losses totaling $2,597,000 were recorded on the sale of the office building andthe parcel of undeveloped land. The sale of the industrial property generated again of $299,000. The Company sold eleven properties during 2003 for anaggregate sales price of $61,162,000 and recognized a net gain of $2,540,000,after taking into consideration an impairment charge totaling $7,500,000relating to four of the eleven properties. The impairment charges were based onthe anticipated sales prices less costs to sell as compared to the carryingvalue of the assets. An income tax benefit on discontinued operations of$985,000 was recorded during the year ended December 31, 2004 compared to$1,656,000 during the year ended December 31, 2003.

**LIQUIDITY AND CAPITAL RESOURCES**

During 2005, the Company derived cash from collectionof rents, net proceeds received from refinances and property sales. Major usesof cash included payment for capital improvements to real estate assets,primarily for tenant improvements, payment of operational expenses, repaymentof borrowings, which included a partial pay-down on one of the Company’slitigation notes payable, and the repurchase of common stock.

TheCompany reported net losses of $2,266,000, $9,107,000 and $14,348,000 for theyears ended December 31, 2005, 2004 and 2003, respectively. These resultsinclude the following non-cash items:

| ** **                                                         | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Non-Cash Charges:                                                  |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                     |       | $                                           | 11,190     |   | $ | 10,946 |   | $ | 11,435 |   |
| Impairment of  real estate assets                                  |       | —                                      |       | — |   | 7,500 |   |
| Mark-to-market  adjustments on interest rate protection agreements |       | —                                      |       | — |   | 162 |   |
| Deferred  compensation expense                                     |       | 55                                          |       | 101 |   | 332 |   |
| Non-Cash Items:                                                    |       |                                        |       |   |   |   |   |
| Deferred income  tax benefit                                       |       | (1,162                                      | )          | (3,207 | ) | (1,378 | ) |
| Deferred rental  income                                            |       | (137                                        | )          | (520 | ) | (495 | ) |
| Minority interest                                                  |       | (320                                        | )          | (1,299 | ) | (2,124 | ) |
| Interest on  receivable from principal stockholders                |       | (39                                         | )          | (66 | ) | (57 | ) |
| Amortization of  loan premiums                                     |       | (459                                        | )          | (564 | ) | (569 | ) |
| Amortization of  note receivable discount                          |       | —                                      |       | (58 | ) | (17 | ) |
| Mark-to-market  adjustments on interest rate protection agreements |       | —                                      |       | (65 | ) | — |   |
|                                                                    |            |                                             |            |  |  |  |  |  |  |  |

 

Net cash used in operating activities amounted to$1,471,000, $2,628,000 and $3,468,000 for the years ended December 31,2005, 2004 and 2003, respectively. Cash was used in operating activities forthe years ended December 31, 2005 and 2004 primarily to (i) fundoperations and ii) fund prepaid and other assets, which included contributionsto lenders for funds held in escrow, mainly for payment of taxes, insurance andcapital improvements. Cash was used in operating activities for the year ended December 31,2003 

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primarily to (i) fundoperations, ii) pay real estate taxes and iii) pay $1,000,000 on an obligationto a related party.

Net cash provided by investing activities for the yearended December 31, 2005 amounted to $5,202,000. This amount was due toproceeds of $15,298,000 (included $5,210,000 held in escrow for futureacquisitions) received from the sale of three properties during the year,offset by funds used for capital improvements (primarily tenant improvements)of $4,886,000. Net cash provided by investing activities for the year ended December 31,2004 amounted to $5,540,000. This amount was primarily attributable to proceedsof $11,357,000 (included $1,191,000 held in escrow) received from the sale ofthree properties during the period, partially offset by funds used for capitalexpenditures of $4,516,000. Net cash provided by investing activities of$27,518,000 during 2003 consisted of $40,179,000 in proceeds generated fromproperty sales, partially offset by (i) funding of capital expenditures of$3,779,000, primarily for tenant improvements, (ii) acquisition ofproperties of $7,174,000 and (iii) acquisition of a note receivablesecured by a property adjacent to a property owned by the Company of$1,730,000.

Net cash used by financing activities amounted to$4,020,000 for the year ended December 31, 2005. These uses were comprisedof i) repayments of borrowings on property sales of $5,570,000, ii) a principalpay-down of $4,635,000 on the Company’s note payable to the former limitedpartners of Sierra Pacific Development Fund II, LP (“Fund II”), iii) repaymentof a $532,000 loan from John N. Galardi, a director and principal stockholder,iv) scheduled principal payments of $2,072,000 and v) repurchases of commonstock of $1,403,000. These amounts were offset by net proceeds provided by loanrefinances of $9,242,000 and the collection of a $950,000 receivable fromprincipal shareholders of the Company.  Net cash used by financing activities amountedto $5,260,000 for the year ended December 31, 2004. Net funds providedfrom borrowings totaled $21,009,000, which consisted of $19,976,000 torefinance debt on four properties and $1,133,000 from other borrowings. Scheduledprincipal payments for the year ended December 31, 2004 amounted to$2,859,000. Repayment of borrowings on property sales and refinances for theyear ended December 31, 2004 totaled $7,041,000 and $15,796,000,respectively. Net cash used in financing activities amounted to $21,901,000during 2003. Repayments of borrowings of $36,937,000 during 2003 consisted ofscheduled principal payments of $3,468,000, payment of refinanced loans of$4,300,000, and repayment of loans in connection with the sale of properties of$29,169,000. Proceeds from borrowings in 2003, which totaled $15,793,000,consisted of (i) $8,215,000 to fund the acquisition of two properties andthe note receivable referred to above, (ii) $6,690,000 to refinance debton two properties, (iii) $858,000 to fund insurance premiums and servicefees and (iv) $30,000 from an affiliate of a related party which completedthe funding of an $830,000 loan on Valencia (an industrial property located inArizona sold in April 2003) entered into in December of 2002. Themortgage of $830,000 was repaid in conjunction with the sale of the property inApril 2003. In addition, funds were used to pay amounts due related to theTeachout settlement of $250,000, to acquire units in the Operating Partnershipfor $223,000, to pay off notes to former limited partners of $237,000 and topurchase shares of common stock of the Company for $297,000 pursuant to a stockrepurchase plan. Also, Mr. Galardi purchased from the Company 15,243shares of the Company’s common stock for $250,000 in May 2003.

The following details the Company’s significantborrowings and repayment of borrowings activity during the two years ended December 31,2005 and 2004.

On December 14, 2005, the Company refinanced itsdebt on 800 and 888 Sam Houston Parkway debt with a short-term $4,200,000revolving credit promissory note with a bank. The balance due on the debtwas  $1,884,000 and $1,725,000,respectively, at the time of the refinance. Net proceeds of $518,000 werereceived as a result of the refinance. On December 29, 2005, the Companyentered into a long-term loan agreement in the amount of $4,400,000 with acredit union and paid the balance due on the revolving credit promissory note. Thenew loan bears interest at a fixed rate of 6.25% and matures in December 2015.

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On October 28, 2005, the Company made a principalpay-down of $4,634,630 on its note payable to the former limited partners ofFund II. The payment reduced the principal amount due on the note from$8,561,662 to $3,927,032. The payment represented a $55.00 per unit pay-down onthe original obligation of $101.55 per unit.

On October 14, 2005, the Company entered into aloan modification agreement with a bank that provided the Company an additional$3,500,000 (exclusive of loan costs) on Mira Mesa, an office property locatedin San Diego California. The modification increased the Company’s debt on theproperty from $9,000,000 to $12,500,000. The interest rate on the loan waschanged from prime plus 1% to the one-year treasury constant maturity rate plus3%. All other loan terms and conditions remained unchanged.  The Company also entered into a $2,500,000loan agreement with the bank secured by three of the Company’s other assets. The  $2,500,000 note bears interest at theone-year treasury constant maturity rate plus 3% and matures in October 2008.In January 2006, the $12,500,000 loan was paid in full in connection withthe sale of Mira Mesa and a $500,000 pay-down was made on the $2,500,000 loanin connection with the sale of the Company’s Sorrento II property.

On August 27, 2005, the Company financed therepurchase of 10,000 shares of restricted stock for $85,000 ($8.50 per share)and consideration of $10,000 for the cancellation of a participating profitagreement with a $95,000 note. The note bears interest at prime plus 1% perannum and matures in July 2006.

On August 24, 2005, the Company entered into aloan agreement in the amount of $2,800,000 on 5450 Northwest Central, one ofits office properties and repaid debt of $2,844,000. The loan bears interest ata fixed rate of 5.38% per annum and matures in September 2015. Net cashpaid to refinance the debt amounted to $167,000.

On April 6, 2005, the Company refinanced a$4,574,000 loan on 8300 Bissonnet, one of its office properties, due to maturein November 2005, and entered into a fixed rate promissory note in theamount of $4,758,000. The note bears interest at 5.51% per annum and matures inMay 2015. Net cash paid to refinance the debt amounted to $65,000.

In February 2005, the Company refinanced debt of$2,385,000 on 8100 Washington, one of its office properties, with a new loan inthe amount of $2,350,000 and cash. The new loan bears interest at a fixed rateof 5.59% per annum and matures in February 2015. Net cash paid torefinance the debt amounted to $167,000.

In December 2004, the Company received a $532,000loan from John N. Galardi. The note, which bore interest at a fixed interestrate of 12% per annum, was paid in April 2005.

In October 2004, in connection with theacquisition of an office property in Houston, Texas, the Company assumed a loanin the amount of $4,384,000. The loan bears interest at a fixed rate of 5.93%per annum and matures in June 2014. The Company also entered into anagreement that provided for seller financing of $316,000, bearing interest at afixed rate of 5.93% per annum and maturing in June 2014.

In October 2004, the Company refinanced a$1,176,000 loan on 888 Sam Houston Parkway, one of its office properties, andentered into a revolving credit promissory note in the amount of $2,250,000, ofwhich $1,226,000 has been drawn to cover the repayment of existing debt andfinancing costs. The availability on the note as of December 31, 2004 was$1,024,000. The note bore interest at prime plus 1% per annum and was due tomature in December 2006. The loan was paid in December 2005 inconnection with a refinance.

In August 2004, the Company refinanced a$5,350,000 loan on San Felipe, one of its office properties, with a new loanagreement in the amount of $5,500,000. The new loan bears interest at a fixedrate of 5.65% per annum and matures in August 2014.  The Company funded closing costs ofapproximately $178,000 and escrowed $327,000 for future capital expenditures,real estate taxes and insurance related to 

24

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the August 2004refinance. Net proceeds of $2,059,000 were received in December 2003related to the December 2003 refinance of the original $3,000,000 loan onthe property.

In July 2004, the Company refinanced a $5,330,000loan on Northwest Corporate Center, one of its office properties, with a newloan agreement in the amount of $5,750,000. The new loan bears interest at afixed rate of 6.26% per annum and matures in August 2014. No proceeds werereceived directly as a result of the refinance, however $350,000 is being heldin escrow by the lender to assist the funding of future capital expenditures atthe property.

In May 2004, the Company refinanced a $3,132,000loan on Mira Mesa, with a new one-year loan agreement in the amount of$7,500,000. The new loan, which contained two six-month extension options, boreinterest at a fixed rate of 7.95% per annum. Net proceeds of $3,440,000 werereceived as a result of the refinance. The loan was paid in January 2006in connection with the sale of the property.

In May 2004, the Company financed insurancepremiums of $373,000 on its properties and agreed to pay a service fee of$85,000 over one year. The insurance premium note was paid in full in February 2005.The Company financed an additional insurance premium during 2004 of $133,000,with scheduled payments through June 2005. The balance was paid during thesecond quarter of 2005.

In 2002, the lender under a loan agreement related tothe South Carolina shopping center properties notified the Company it wastechnically in default under its loan agreement for non-compliance with certaincovenants, including covenants requiring improvements to shopping centerproperties. Thereafter, the lender notified the Company that it was in defaultfor failure to pay a matured portion of the loan, which matured in November 2002.In early 2003, the lender sold the loan to the major tenant in two of theshopping centers. In December 2003, the Company sold one of the shoppingcenter properties and repaid $3,935,000, which included the pay-off of thematured portion of the loan. As of December 31, 2005, the remainingbalance of the loan was approximately $2,756,000.  The Company continues to discuss thenon-compliance matter with the new lender. The new lender has not acceleratedthe loan.

The Company expects to meet its short-term liquidityrequirements for normal property operating expenses and general andadministrative expenses from cash generated by operations and cash currentlyheld. In addition, the Company anticipates capital costs to be incurred relatedto leasing space and improvements to properties provided the estimated leasingof space is complete. The Company anticipates meeting these obligations withthe net cash proceeds generated during the first quarter of 2006 from the saleof three properties and from the use of funds held in escrow by lenders. Basedon current analysis, the Company expects the cash generated from the threesales will be adequate to meet these obligations.

The Company has paid,refinanced or extended all material debt which was due to mature in 2005 and2006 with the exception of a mortgage loan due to mature in July 2006 onits one remaining shopping center property.  The lender was a major tenant at anothershopping center property sold in 2005. The Company anticipates eitherrefinancing the debt, negotiating a loan extension or selling this property.

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**CONTRACTUAL OBLIGATIONS**

Thefollowing table aggregates the Company’s contractual obligations as ofDecember 31, 2005 (in thousands):

| ** **                 | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
|----------------------------|------------|-----------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|
| Long-term debt(1)          |       | $         | 112,643    |                            |       | $                  | 4,244      |               |       |                             | $          | 5,458 |   |   | $ | 41,181 |   |   | $ | 61,760 |   |   |
| Litigation  settlements(2) |       | 4,877     |       |                            | 4,877      |               |       |               | —     |                             |       | — |   |   | — |   |   |
| Capital  expenditures(3)   |       | 1,193     |       |                            | 1,193      |               |       |               | —     |                             |       | — |   |   | — |   |   |
| Total                      |       | $         | 118,713    |                            |       | $                  | 10,314     |               |       |                             | $          | 5,458 |   |   | $ | 41,181 |   |   | $ | 61,760 |   |   |

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(1)          See Note 8—NotesPayable. These amounts do not include interest associated with the debt.

(2)          Represents obligationsrelated to the settlement of the Teachout litigation at December 31, 2005.This obligation was paid in full in January 2006.

(3)          Representsestimated cost of commitments for tenant improvements and lease commissionsrelated to the leasing of space to new or renewing tenants.

**INFLATION**

Substantially all of theleases at the industrial and shopping center properties provide forpass-through to tenants of certain operating costs, including real estatetaxes, common area maintenance expenses, and insurance. Leases at the officeproperties typically provide for rent adjustment and pass-through of increasesin operating expenses during the term of the lease. All of these provisions maypermit the Company to increase rental rates or other charges to tenants inresponse to rising prices and therefore, serve to reduce the Company’s exposureto the adverse effects of inflation.

**FORWARD-LOOKING STATEMENTS**

This Report onForm 10-K contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities and Exchange Act of 1934. These forward-looking statements are basedon management’s beliefs and expectations, which may not be correct. Importantfactors that could cause actual results to differ materially from theexpectations reflected in these forward-looking statements include thefollowing: the Company’s level of indebtedness and ability to refinance itsdebt; the fact that the Company’s predecessors have had a history of losses inthe past; unforeseen liabilities which could arise as a result of the prioroperations of companies or properties acquired in the Consolidation; risksinherent in the Company’s acquisition and development of properties in thefuture, including risks associated with the Company’s strategy of investing inunder-valued assets; general economic, business and market conditions,including the impact of the current economic downturn; changes in federal andlocal laws and regulations; increased competitive pressures; and other factors,including the factors set forth below, as well as factors set forth elsewherein this Report on Form 10-K.

**ITEM 7A.**   QUANTITATIVE ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK

**INTEREST RATES**

The Company’s primary market risk exposure is tochanges in interest rates obtainable on its secured and unsecured borrowings.

It is the Company’s policy to manage its exposure tofluctuations in market interest rates for its borrowings through the use of fixedrate debt instruments to the extent that reasonably favorable rates are 

26

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obtainable with sucharrangements. In order to maximize financial flexibility when sellingproperties and minimize potential prepayment penalties on fixed rate loans, theCompany has also entered into variable rate debt arrangements.

The Company had no swap contracts at December 31,2005 or December 31, 2004. During the year ended December 31, 2004,the Company recorded a benefit of $65,000 attributable to changes in the fairvalue of its derivatives financial instruments.

At December 31, 2005, the Company’s totalindebtedness included fixed-rate debt of approximately $119,094,000 andfloating-rate indebtedness of approximately $326,000. The Company continuallyreviews the portfolio’s interest rate exposure in an effort to minimize therisk of interest rate fluctuations. The Company does not have any othermaterial market-sensitive financial instruments.

Thetable below provides information about the Company’s financial instruments thatare sensitive to changes in interest rates. For debt obligations, the tablepresents principal cash flows and related weighted average interest rates byexpected maturity dates. Weighted average variable rates are based on rates ineffect at the reporting date. 

| ** **             | ** ** | **Expected Maturity Date** | ** ** |
|------------------------|------------|--------------------------------------|------------|
| ** **             | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Loan  Premiums** | ** ** | **Total** | ** ** | **Fair Value** | ** ** |
| ** **             | ** ** | **(dollars in thousands)** | ** ** |
| Secured Fixed          |       | $                                    | 8,935      |   | $ | 1,839 |   | $ | 3,419 |   | $ | 8,272 |   | $ | 32,909 |   |   | $ | 61,760 |   |   |   | $ | 1,900 |   |   | $ | 119,034 |   |   | $ | 119,034 |   |   |
| Average interest rate  |       | 7.41                                 | %          | 7.97 | % | 7.04 | % | 7.64 | % | 8.45 | % |   | 6.73 | % |   |   |   |   |   | 7.36 | % |   |   |   |   |
| Secured Variable       |       | $                                    | 31         |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   | $ | 31 |   |   | $ | 31 |   |   |
| Average interest rate  |       | 9.50                                 | %          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 9.50 | % |   |   |   |   |
| Unsecured Fixed        |       | $                                    | 60         |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   | $ | 60 |   |   | $ | 60 |   |   |
| Average interest rate  |       | 7.15                                 | %          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 7.15 | % |   |   |   |   |
| Unsecured Variable     |       | $                                    | 95         |   | $ | — |   | $ | 200 |   | $ | — |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   | $ | 295 |   |   | $ | 295 |   |   |
| Average interest  rate |       | 8.25                                 | %          |   |   | 8.25 | % |   |   |   |   |   |   |   |   |   |   |   |   | 8.25 | % |   |   |   |   |

 

The Company believes that the fair values of suchinstruments approximate carrying value at December 31, 2005.

A change of 1.00% in theindex rate to which the Company’s variable rate debt is tied would change theannual interest incurred by the Company by $3,264, with no change per share,based upon the balances outstanding on variable rate instruments and the numberof common shares outstanding at December 31, 2005.

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

The response to this itemis submitted as a separate section of this Form 10-K. See Item 15.—Exhibits,Financial Statement Schedules And Reports On Form 8-K.

**ITEM 9.   CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

The Company’s Audit Committee has authorized theengagement of Hein & Associates, LLP to serve as the Company’sindependent registered public accounting firm for the year ending December 31,2006. BDO Seidman, LLP, who has served as the Company’s independent registeredaccounting firm since February 22, 2001, was informed on March 2,2006 that they will be dismissed subsequent to completion of the audit of theCompany’s financial statements for the year ended December 31, 2005.

BDO Seidman, LLP’s reportson the Company’s financial statements for each of the years ended December 31,2005 and 2004 did not contain an adverse or disclaimer of opinion nor was itqualified as to uncertainty, audit scope or accounting principles. BDO Seidman’sreport for the year ended December 31, 

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2004 wasmodified to include an emphasis paragraph related to the Company’s need to sellassets to fund its cash requirements for other than normal property operationsand refinance or extend debt as it matures. During the years ended December 31,2005 and 2004 and interim period up to and including the date of this filing,there have been no disagreements with BDO Seidman, LLP on any matters ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedure of the type referred to in Item 304 of Regulation S-K.

**ITEM 9A.   CONTROLS AND PROCEDURES**

Management, including the Company’s Chief ExecutiveOfficer and Acting Chief Financial Officer, have evaluated the effectiveness ofthe Company’s disclosure controls and procedures as of the end of the quartercovered by this report. Based on, and as of the date of, that evaluation, theChief Executive Officer and Acting Chief Financial Officer concluded that thedisclosure controls and procedures were effective, in all material respects, toensure that information required to be disclosed in the reports the Companyfiles and submits under the Exchange Act is recorded, processed, summarized andreported as and when required.

There were no changes madein the Company’s internal control over financial reporting during the fourthquarter of 2005 that materially affected or is likely to materially affect theCompany’s internal control over financial reporting.

**ITEM 9B.   OTHER INFORMATION**

None.

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**PART III**

**ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

The information requiredby Item 10 is incorporated by reference from the Company’s definitive proxystatement to be filed on or before March 24, 2006 for its annualstockholder’s meeting to be held May 5, 2006.

**ITEM 11.   EXECUTIVE COMPENSATION**

The information requiredby Item 11 is incorporated by reference from the Company’s definitive proxystatement to be filed on or before March 24, 2006 for its annual stockholder’smeeting to be held May 5, 2006.

**ITEM12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

The information requiredby Item 12 is incorporated by reference from the Company’s definitive proxystatement to be filed on or before March 24, 2006 for its annualstockholder’s meeting to be held May 5, 2006.

**ITEM13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

The information requiredby Item 13 is incorporated by reference from the Company’s definitive proxy statementto be filed on or before March 24, 2006 for its annual stockholder’smeeting to be held May 5, 2006.

**ITEM14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information requiredby Item 14 is incorporated by reference from the Company’s definitive proxystatement to be filed on or before March 24, 2006 for its annualstockholder’s meeting to be held May 5, 2006.

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**PART IV**

**ITEM15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

|                                                                                                                 | ** ** | **Page No.** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| (a)  (1) Financial  Statements                                                                             |       |              |       |
| Report of Independent Registered Public Accounting  Firm                                                        |       | 31                |       |
| Consolidated Balance Sheets at December 31,  2005, and 2004                                                |       | 32                |       |
| Consolidated Statements of Operations for the years  ended December 31, 2005, 2004 and 2003                |       | 33                |       |
| Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2005, 2004 and 2003 |       | 34                |       |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2005, 2004, and 2003               |       | 35                |       |
| Notes to Consolidated Financial Statements                                                                      |       | 36                |       |
|    (2) Financial Statement Schedules                                                                       |       |              |       |
| Schedule II—Valuation and Qualifying Accounts                                                              |       | 63                |       |
| Schedule III—Real Estate and Accumulated  Depreciation                                                     |       | 64                |       |
|    (3) Exhibits to Financial Statements                                                                    |       |              |       |
| The Exhibit Index attached hereto is hereby  incorporated by reference to this Item.                       |       | 68                |       |
| On  November 2, 2005, a report on Form 8-K was filed with respect  to Item 2.02.                      |       |              |       |
| On  November 9, 2005, a report on Form 8-K was filed with respect  to Item 2.01.                      |       |              |       |
| (b) Exhibits                                                                                                    |       |              |       |

 

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**Reportof Independent Registered Public Accounting Firm**

Board of Directors and StockholdersAmerican Spectrum Realty, Inc.Houston, Texas

We have audited the accompanying consolidated balancesheets of American Spectrum Realty, Inc. as of December 31, 2005 and2004 and the related consolidated statements of operations, stockholders’equity, and cash flows for each of the three years in the period ended December 31,2005. We have also audited the schedules listed in the accompanying index. Thesefinancial statements and schedules are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedules based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements and schedules are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements andschedules, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall presentation of thefinancial statements and schedules. We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of American Spectrum Realty, Inc. at December 31, 2005 and2004, and the results of its operations and its cash flows for each of thethree years in the period ended December 31, 2005, in conformity withaccounting principles generally accepted in the United States of America.

Also, in our opinion, theschedules present fairly, in all material respects, the information set forththerein.

/s/ BDO Seidman, LLP

Dallas, Texas

March 14, 2006

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**AMERICAN SPECTRUM REALTY, INC.CONSOLIDATED BALANCE SHEETS(Dollars in thousands, except share amounts)**

| ** **                                                                                                                                                                       | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **ASSETS**                                                                                                                                                                       |       |                            |       |                            |       |   |   |   |   |
| Real estate held for investment                                                                                                                                                  |       |                            | $          | 154,826                         |       |   |   | $ | 150,769 |   |   |
| Accumulated  depreciation                                                                                                                                                        |       |                            | 28,115     |                            |       |   | 20,139 |   |   |
| Real estate held  for investment, net                                                                                                                                            |       |                            | 126,711    |                            |       |   | 130,630 |   |   |
| Real estate held for sale                                                                                                                                                        |       |                            | 22,272     |                            |       |   | 43,198 |   |   |
| Cash and cash  equivalents                                                                                                                                                       |       |                            | 300        |                            |       |   | 589 |   |   |
| Tenant and other  receivables, net of allowance for doubtful accounts of $60 and $135, respectively  (including $0 and $244, respectively, from related party)                   |       |                            | 455        |                            |       |   | 539 |   |   |
| Deferred rents  receivable                                                                                                                                                       |       |                            | 1,245      |                            |       |   | 1,138 |   |   |
| Deferred tax  asset                                                                                                                                                              |       |                            | 53         |                            |       |   | — |   |   |
| Deposits held in  escrow for tax-deferred exchanges                                                                                                                              |       |                            | 5,210      |                            |       |   | — |   |   |
| Investment in  management company                                                                                                                                                |       |                            | 4,000      |                            |       |   | 4,000 |   |   |
| Prepaid and other  assets, net                                                                                                                                                   |       |                            | 8,939      |                            |       |   | 7,451 |   |   |
| Total Assets                                                                                                                                                                     |       |                            | $          | 169,185                         |       |   |   | $ | 187,545 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |                            |       |                            |       |   |   |   |   |
| Liabilities:                                                                                                                                                                     |       |                            |       |                            |       |   |   |   |   |
| Notes payable,  including premiums of $1,900 and $2,355, respectively                                                                                                       |       |                            | $          | 114,543                         |       |   |   | $ | 113,230 |   |   |
| Notes payable,  litigation settlement                                                                                                                                            |       |                            | 4,877      |                            |       |   | 9,512 |   |   |
| Liabilities  related to real estate held for sale                                                                                                                                |       |                            | 27,953     |                            |       |   | 39,549 |   |   |
| Accounts payable                                                                                                                                                                 |       |                            | 2,194      |                            |       |   | 2,040 |   |   |
| Deferred tax  liability                                                                                                                                                          |       |                            | —     |                            |       |   | 1,109 |   |   |
| Accrued and other  liabilities (including $331 and $185, respectively, to related parties)                                                                                       |       |                            | 5,468      |                            |       |   | 5,186 |   |   |
| Total Liabilities                                                                                                                                                                |       |                            | 155,035    |                            |       |   | 170,626 |   |   |
| Minority interest                                                                                                                                                                |       |                            | 5,136      |                            |       |   | 5,492 |   |   |
| Stockholders’  Equity:                                                                                                                                                      |       |                            |       |                            |       |   |   |   |   |
| Preferred stock,  $.01 par value; authorized, 25,000,000 shares, none issued and outstanding                                                                                     |       |                            | —     |                            |       |   | — |   |   |
| Common stock,  $.01 par value; authorized, 100,000,000 shares; issued, 1,598,615 and  1,597,160 shares, respectively; outstanding, 1,390,214 and 1,509,801 shares,  respectively |       |                            | 16         |                            |       |   | 16 |   |   |
| Additional  paid-in capital                                                                                                                                                      |       |                            | 46,367     |                            |       |   | 46,031 |   |   |
| Accumulated  deficit                                                                                                                                                             |       |                            | (34,889    | )                               |       |   | (32,623 | ) |   |
| Receivable from  principal stockholders                                                                                                                                          |       |                            | —     |                            |       |   | (950 | ) |   |
| Deferred  compensation                                                                                                                                                           |       |                            | —     |                            |       |   | (55 | ) |   |
| Treasury stock,  at cost, 208,401 and 87,359 shares, respectively                                                                                                                |       |                            | (2,480     | )                               |       |   | (992 | ) |   |
| Total Stockholders’ Equity                                                                                                                                                  |       |                            | 9,014      |                            |       |   | 11,427 |   |   |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                 |       |                            | $          | 169,185                         |       |   |   | $ | 187,545 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements

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**AMERICAN SPECTRUM REALTY, INC.CONSOLIDATED STATEMENTSOF OPERATIONS(Dollars in thousands, except per share amounts)**

| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUES:**                                                                |       |                                        |       |   |   |   |   |
| Rental revenue                                                               |       | $                                           | 19,919     |   | $ | 19,498 |   | $ | 17,374 |   |
| Interest and  other income                                                   |       | 350                                         |       | 235 |   | 139 |   |
| Total revenues                                                               |       | 20,269                                      |       | 19,733 |   | 17,513 |   |
| **EXPENSES:**                                                                |       |                                        |       |   |   |   |   |
| Property  operating expense                                                  |       | 8,716                                       |       | 7,113 |   | 6,419 |   |
| General and  administrative                                                  |       | 3,703                                       |       | 4,438 |   | 6,801 |   |
| Depreciation and  amortization                                               |       | 8,464                                       |       | 7,534 |   | 6,444 |   |
| Interest expense                                                             |       | 8,824                                       |       | 9,273 |   | 7,843 |   |
| Total expenses                                                               |       | 29,707                                      |       | 28,358 |   | 27,507 |   |
| **OTHER  LOSS:**                                                             |       |                                        |       |   |   |   |   |
| Net loss on  extinguishment of debt                                          |       | (95                                         | )          | (116 | ) | (145 | ) |
| Total other loss                                                             |       | (95                                         | )          | (116 | ) | (145 | ) |
| Net loss before deferred income tax benefit  (expense) and minority interest |       | (9,533                                      | )          | (8,741 | ) | (10,139 | ) |
| Deferred income  tax benefit (expense)                                       |       | 3,360                                       |       | 2,222 |   | (278 | ) |
| Net loss before  minority interest                                           |       | (6,173                                      | )          | (6,519 | ) | (10,417 | ) |
| Minority interest                                                            |       | 320                                         |       | 1,299 |   | 2,124 |   |
| Net loss from  continuing operations                                         |       | (5,853                                      | )          | (5,220 | ) | (8,293 | ) |
| Discontinued  operations:                                                    |       |                                        |       |   |   |   |   |
| Loss from operations                                                         |       | (2,110                                      | )          | (2,574 | ) | (2,751 | ) |
| Gain (loss) on sale of discontinued operations                               |       | 7,895                                       |       | (2,298 | ) | 2,540 |   |
| Impairment of real estate assets                                             |       | —                                      |       | — |   | (7,500 | ) |
| Income tax (expense) benefit                                                 |       | (2,198                                      | )          | 985 |   | 1,656 |   |
| Income (loss) from discontinued operations                                   |       | 3,587                                       |       | (3,887 | ) | (6,055 | ) |
| Net loss                                                                     |       | $                                           | (2,266     | ) | $ | (9,107 | ) | $ | (14,348 | ) |
| Basic and diluted  per share data:                                           |       |                                        |       |   |   |   |   |
| Net loss from continuing operations                                          |       | $                                           | (4.02      | ) | $ | (3.37 | ) | $ | (5.59 | ) |
| Income (loss) from discontinued operations                                   |       | 2.46                                        |       | (2.50 | ) | (4.08 | ) |
| Net loss                                                                     |       | $                                           | (1.56      | ) | $ | (5.87 | ) | $ | (9.67 | ) |
| Basic weighted average  shares used                                          |       | 1,457,079                                   |       | 1,551,189 |   | 1,483,675 |   |

 

The accompanying notes are an integral part of these consolidated financial statements

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**AMERICANSPECTRUM REALTY INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands, except share amounts)**

 

| ** **                                                          | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Deferred  Compensation** | ** ** | **Receivable  from  Principal  Stockholders** | ** ** | **Treasury  Stock** | ** ** | **Total  Equity** | ** ** |
|---------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|----------------------------|------------|-----------------------------------------------|------------|---------------------|------------|-------------------|------------|
| Balance, December 31, 2002                                     |       | 1,382,521          |       |              | $          | 14                               |       |                     |       | $                          | 41,850     |                                          |       |                | $          | (9,168            | )          |   |   | $ | (651 | ) |   |   | $ | (1,188 | ) |   |   | — |   |   | $ | 30,857 |   |
| Issuance of common stock                                            |       | 15,243             |       |              | —     |                             |       |                     | 250        |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 250 |   |
| Conversion of operating partnership units to common  stock          |       | 129,946            |       |              | 1          |                             |       |                     | 1,681      |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 1,682 |   |
| Conversion of debt to common stock                                  |       | 50,514             |       |              | 1          |                             |       |                     | 2,130      |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 2,131 |   |
| Restricted stock forfeited                                          |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | 124        |   |   |   | — |   |   |   | (124 | ) |   | — |   |
| Acquisition of minority interest in the operating  partnership      |       |               |       |              | —     |                             |       |                     | (147       | )                          |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | (147 | ) |
| Common stock repurchase                                             |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | (297 | ) |   | (297 | ) |
| Amortization of deferred compensation                               |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | 332        |   |   |   | — |   |   |   | — |   |   | 332 |   |
| Accrued interest on receivable from principal  stockholders         |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | —     |   |   |   | (3 | ) |   |   | — |   |   | (3 | ) |
| Fractional shares payments due on one-for-four  reverse stock split |       |               |       |              | —     |                             |       |                     | (22        | )                          |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | (22 | ) |
| Net loss                                                            |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | (14,348    | )                   |       |              | —     |   |   |   | — |   |   |   | — |   |   | (14,348 | ) |
| Balance, December 31, 2003                                     |       | 1,578,224          |       |              | 16         |                             |       |                     | 45,742     |                       |       |                                          | (23,516    | )                   |       |              | (195       | ) |   |   | (1,191 | ) |   |   | (421 | ) |   | 20,435 |   |
| Issuance of common stock                                            |       | 10,000             |       |              | —     |                             |       |                     | 71         |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 71 |   |
| Conversion of operating partnership units to common  stock          |       | 8,936              |       |              | —     |                             |       |                     | 218        |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 218 |   |
| Common stock repurchase                                             |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | (532 | ) |   | (532 | ) |
| Restricted stock forfeited                                          |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | 39         |   |   |   | — |   |   |   | (39 | ) |   | — |   |
| Amortization of deferred compensation                               |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | 101        |   |   |   | — |   |   |   | — |   |   | 101 |   |
| Payments on receivable from principal stockholders                  |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | —     |   |   |   | 241 |   |   |   | — |   |   | 241 |   |
| Net loss                                                            |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | (9,107     | )                   |       |              | —     |   |   |   | — |   |   |   | — |   |   | (9,107 | ) |
| Balance, December 31, 2004                                     |       | 1,597,160          |       |              | 16         |                             |       |                     | 46,031     |                       |       |                                          | (32,623    | )                   |       |              | (55        | ) |   |   | (950 | ) |   |   | (992 | ) |   | 11,427 |   |
| Conversion of operating partnership units to common  stock          |       | 1,455              |       |              | —     |                             |       |                     | 36         |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | — |   |   | 36 |   |
| Common stock repurchase                                             |       |               |       |              | —     |                             |       |                     | 300        |                       |       |                                          | —     |                |       |              | —     |   |   |   | — |   |   |   | (1,488 | ) |   | (1,188 | ) |
| Amortization of deferred compensation                               |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | 55         |   |   |   | — |   |   |   | — |   |   | 55 |   |
| Payments on receivable from principal stockholders                  |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | —     |                |       |              | —     |   |   |   | 950 |   |   |   | — |   |   | 950 |   |
| Net loss                                                            |       |               |       |              | —     |                             |       |                     | —     |                       |       |                                          | (2,266     | )                   |       |              | —     |   |   |   | — |   |   |   | — |   |   | (2,266 | ) |
| Balance,  December 31, 2005                                    |       | 1,598,615          |       |              | $          | 16                               |       |                     |       | $                          | 46,367     |                                          |       |                | $          | (34,889           | )          |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | (2,480 | ) |   | $ | 9,014 |   |
|                                                                     |            |                    |            |                   |            |                                  |            |                          |            |                            |            |                                               |            |                     |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidated financial statements

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**AMERICAN SPECTRUM REALTY, INCCONSOLIDATED STATEMENTS OF CASH FLOWS(Dollars in thousands)**

| ** **                                                                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                 |       |                                        |       |   |   |   |   |
| Net loss                                                                                  |       | $                                           | (2,266     | ) | $ | (9,107 |   | $ | (14,348 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities:              |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                            |       | 11,190                                      |       | 10,946 |   | 11,435 |   |
| Net (gain) loss on  sales of real estate assets                                           |       | (7,895                                      | )          | 2,298 |   | (2,540 | ) |
| Impairment of real  estate assets                                                         |       | —                                      |       | — |   | 7,500 |   |
| Loss on extinguishment  of debt                                                           |       | 95                                          |       | 729 |   | 145 |   |
| Deferred income  tax benefit                                                              |       | (1,162                                      | )          | (3,207 | ) | (1,378 | ) |
| Deferred rental  income                                                                   |       | (137                                        | )          | (520 | ) | (495 | ) |
| Minority interest                                                                         |       | (320                                        | )          | (1,299 | ) | (2,124 | ) |
| Deferred  compensation expense                                                            |       | 55                                          |       | 101 |   | 332 |   |
| Mark to market  adjustments on swap agreements                                            |       | —                                      |       | (65 | ) | 162 |   |
| Interest on  receivable from principal stockholders                                       |       | (39                                         | )          | (66 | ) | (57 | ) |
| Amortization of  note payable premiums, included in interest expense                      |       | (459                                        | )          | (564 | ) | (569 | ) |
| Amortization of  note receivable discount, included in interest income                    |       | —                                      |       | (58 | ) | (17 | ) |
| Changes in operating assets and liabilities:                                              |       |                                        |       |   |   |   |   |
| Decrease  (increase) in tenant and other receivables                                      |       | 44                                          |       | (272 | ) | 215 |   |
| Increase  (decrease) in accounts payable                                                  |       | 915                                         |       | (217 | ) | (439 | ) |
| (Increase)  decrease in prepaid and other assets                                          |       | (2,136                                      | )          | (1,765 | ) | 1,589 |   |
| Increase  (decrease) in accrued and other liabilities                                     |       | 644                                         |       | 438 |   | (2,879 | ) |
| Net cash used in  operating activities:                                                   |       | (1,471                                      | )          | (2,628 | ) | (3,468 | ) |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                 |       |                                        |       |   |   |   |   |
| Capital  improvements to real estate assets                                               |       | (4,886                                      | )          | (4,516 | ) | (3,779 | ) |
| Real estate  acquisitions                                                                 |       | —                                      |       | (138 | ) | (7,174 | ) |
| Proceeds received  from sales of real estate assets                                       |       | 15,298                                      |       | 11,357 |   | 40,179 |   |
| Deposits held in  escrow for future acquisitions                                          |       | (5,210                                      | )          | (1,191 | ) | — |   |
| Collections on  mortgage loan receivable                                                  |       | —                                      |       | 28 |   | 22 |   |
| Mortgage loan  receivable acquisition                                                     |       | —                                      |       | — |   | (1,730 | ) |
| Net cash provided  by investing activities:                                               |       | 5,202                                       |       | 5,540 |   | 27,518 |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                 |       |                                        |       |   |   |   |   |
| Proceeds from  borrowings—refinances                                                 |       | 31,053                                      |       | 19,976 |   | 6,690 |   |
| Proceeds from  borrowings—real estate acquisitions                                   |       | —                                      |       | — |   | 8,215 |   |
| Proceeds from  borrowings—other                                                      |       | —                                      |       | 1,133 |   | 888 |   |
| Repayment of  borrowings—property sales                                              |       | (5,570                                      | )          | (7,041 | ) | (29,169 | ) |
| Repayment of  borrowings—refinances                                                  |       | (21,811                                     | )          | (15,796 | ) | (4,300 | ) |
| Repayment of  borrowings—scheduled payments                                          |       | (2,072                                      | )          | (2,859 | ) | (3,468 | ) |
| Repayment of  borrowings from principal stockholder and director                          |       | (532                                        | )          | — |   | — |   |
| Note payments to  former limited partners                                                 |       | —                                      |       | (141 | ) | (237 | ) |
| Repurchase of  common stock                                                               |       | (1,403                                      | )          | (532 | ) | (297 | ) |
| Note payments on  litigation settlement                                                   |       | (4,635                                      | )          | — |   | (250 | ) |
| Collection of  receivable from principal stockholders                                     |       | 950                                         |       | — |   | — |   |
| Issuance of common  stock                                                                 |       | —                                      |       | — |   | 250 |   |
| Acquisition of  minority interest in the operating partnership                            |       | —                                      |       | — |   | (223 | ) |
| Net cash used in  financing activities:                                                   |       | (4,020                                      | )          | (5,260 | ) | (21,901 | ) |
| Decrease  (increase) in cash                                                              |       | (289                                        | )          | (2,348 | ) | 2,149 |   |
| Cash and cash  equivalents, beginning of period                                           |       | 589                                         |       | 2,937 |   | 788 |   |
| Cash and cash  equivalents, end of period                                                 |       | $                                           | 300        |   | $ | 589 |   | $ | 2,937 |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:**                                   |       |                                        |       |   |   |   |   |
| Cash paid for  interest                                                                   |       | $                                           | 11,252     |   | $ | 11,628 |   | $ | 12,632 |   |
| Cash paid for  income taxes                                                               |       | 91                                          |       | 268 |   | 36 |   |
| **SUPPLEMENTAL DISCLOSURE  OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**              |       |                                        |       |   |   |   |   |
| Financing in  connection with acquisitions of real estate assets                          |       | $                                           | —     |   | $ | 4,384 |   | $ | 6,909 |   |
| Note receivable  settled through acquisition of real estate asset                         |       | —                                      |       | 1,722 |   | — |   |
| Financing settled  through divestitures                                                   |       | 11,238                                      |       | — |   | 16,885 |   |
| Conversion of debt  to related parties into common stock                                  |       | —                                      |       | — |   | 2,131 |   |
| Conversion of  operating partnership units into common stock                              |       | 36                                          |       | 218 |   | 1,682 |   |
| Financing in  connection with the repurchase of common stock                              |       | 85                                          |       | — |   | — |   |
| Financing in  connection with the cancellation of participating profits agreement         |       | 10                                          |       | — |   | — |   |
| Issuance of common  stock in acquisition of real estate asset                             |       | —                                      |       | 71 |   | — |   |
| Issuance of  operating partnership units in acquisitions of real estate assets            |       | —                                      |       | — |   | 1,572 |   |
| Payable to  principal shareholders offset against receivable from principal shareholders  |       | —                                      |       | 241 |   | — |   |
| Receivable from  related party regarding certain issues asserted by principal shareholder |       | —                                      |       | — |   | 270 |   |

 

The accompanying notes are an integral part of these consolidated financial statements

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**AMERICAN SPECTRUMREALTY, INC.Notes to Consolidated Financial Statements**

**NOTE 1. DESCRIPTION OF BUSINESS**

**GENERAL**

American Spectrum Realty, Inc. (“ASR” or,collectively, as a consolidated entity with its subsidiaries, the “Company”) isa Maryland corporation established on August 8, 2000. The Company is afull-service real estate corporation, which owns, manages and operatesincome-producing properties. Substantially all of the Company’s assets are heldthrough an operating partnership (the “Operating Partnership”) in which theCompany, as of December 31, 2005, held the sole general partner interestof .97% and a limited partnership interest totaling 85.68%. As of December 31,2005, through its majority-owned subsidiary, the Operating Partnership, theCompany owned and operated 22 properties, which consisted of 18 officebuildings, three industrial properties, and one shopping center. The 22properties are located in seven states.

During 2005, the Company sold three properties, whichconsisted of a vacant single tenant industrial property located in San Diego,California, a shopping center located in Columbia, South Carolina and anapartment complex located in Hazelwood, Missouri. During 2004, the Company soldthree properties, which consisted of an office building, an industrial propertyand a parcel of undeveloped land, and acquired two office buildings in Houston,Texas. During 2003, the Company sold eleven properties, which consisted of twoapartment complexes, two office buildings, six industrial properties and oneshopping center, and acquired four office buildings in Houston, Texas.

The Company is the sole general partner of theOperating Partnership. As the sole general partner of the OperatingPartnership, the Company generally has the exclusive power to manage andconduct the business of the Operating Partnership under its partnershipagreement. The Company’s interest as a limited partner in the OperatingPartnership entitles it to share in any cash distributions from, and in profitsand losses of, the Operating Partnership

Holders of the OP Units have the option to redeemtheir units and to receive, at the option of the Company, in exchange for eachfour OP Units (i) one share of Common Stock of the Company, or (ii) cashequal to the market value of one share of Common Stock of the Company at thedate of conversion, but no fractional shares will be issued.

The Company expects to meet its short-term liquidityrequirements for normal property operating expenses and general andadministrative expenses from cash generated by operations. In addition, theCompany anticipates capital costs to be incurred related to leasing space andimprovements to properties provided the estimated leasing of space is complete.The Company anticipates meeting these obligations with the net cash proceedsgenerated during the first quarter of 2006 from the sale of three propertiesand from the use of funds held in escrow by lenders. Based on current analysis,the Company expects the cash generated from the three sales will be adequate tomeet these obligations.

The Company has paid,refinanced or extended all material debt which was due to mature in 2005 and2006 with the exception of a mortgage loan due to mature in July 2006 onits one remaining shopping center property. The lender was a major tenant atanother shopping center property sold in 2005. The Company anticipates eitherrefinancing the debt, negotiating a loan extension or selling this property.

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**NOTE2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**BASIS OF PRESENTATION**

The accompanying consolidated financial statementshave been prepared pursuant to the rules and regulations of the Securitiesand Exchange Commission.

The financial statementsinclude the accounts of the Operating Partnership and all other subsidiaries ofthe Company. All significant intercompany transactions, receivables andpayables have been eliminated in consolidation.

**RECLASSIFICATIONS**

Certain prior year balances have been reclassified toconform with the current year presentation.  In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, real estate designated asheld for sale are accounted for in accordance with the provisions of SFAS No. 144and the results of operations of these properties are included in income fromdiscontinued operations. Prior periods have been reclassified forcomparability, as required.

Pursuant to a one-for-fourreverse stock split of the Company’s Common Stock, every four shares of CommonStock outstanding as of the close of business on March 1, 2004 became oneshare of new post-split Common Stock. Share and per share data (except parvalue) in the consolidated financial statements and notes for all periodspresented have been adjusted to reflect the reverse stock split.

**USE OF ESTIMATES**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the results of operations during the reporting period. Actualresults could materially differ from those estimates.

**NEW ACCOUNTING PRONOUNCEMENTS**

In February 2006, the FASB issued SFAS No. 155,*Accounting for Certain Hybrid FinancialInstruments* SFAS No. 155 is an amendment of SFAS No. 140and SFAS No. 133. SFAS No. 155 permits the election to measure anyhybrid financial instrument at fair value (with changes in fair value recognizedin earnings) if the hybrid instrument contains an embedded derivative thatwould otherwise be required to be bifurcated and accounted for separately underSFAS No. 133. The election to measure the hybrid instrument at fair valueis made on an instrument-by-instrument basis and is irreversible. SFAS No. 155will be effective for all instruments acquired, issued, or subject to aremeasurement event occurring after the beginning of the Company’s fiscal yearthat begins after September 15, 2006, with earlier adoption permitted asof the beginning of the Company’s 2006 fiscal year, provided that financialstatements for any interim period of that fiscal year have not yet been issued.The adoption of SFAS No. 155 is not expected to have a material impact onthe Company’s consolidated financial statements.

In June 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20,Accounting Changes, and Statement No. 3, Reporting Accounting Changes inInterim Financial Statement.* SFAS No. 154 changes therequirements for the accounting for, and reporting of, a change in accountingprinciple. Previously, most voluntary changes in accounting principles wererequired to be recognized by way of a cumulative effect adjustment within netincome during the period of the change. SFAS No. 154 requiresretrospective application to prior periods’ financial statements, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS No. 154 is effective for accountingchanges made in fiscal years 

37

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beginning after December 15,2005; however, the Statement does not change the transition provisions of anyexisting accounting pronouncements. The adoption of SFAS No. 154 couldhave a material effect on the Company’s consolidated financial statements ifthe Company changes an accounting principle.

In December 2004, the FASB issued SFAS No. 153,*Exchanges of Nonmonetary Assets—an amendmentof APB Opinion No. 29,* to address the measurement of exchangesof nonmonetary assets. SFAS No. 153 eliminates the exception from fairvalue measurement for nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance. A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. SFAS No. 153 is effective fornonmonetary exchanges occurring after December 31, 2005. The adoption ofSFAS No. 153 is not expected to have a material impact on the Company’sconsolidated financial statements.

In December 2004, theFASB revised SFAS No. 123, *Share—BasedPayment*(“SFAS No. 123R”). SFAS No. 123R is a revision ofSFAS No. 123 and supersedes APB No. 25. SFAS No. 123R requires apublic entity to measure the cost of employee services received in exchange foran award of equity instruments based on the grant-date fair value of the award.That cost will be recognized over the period in which an employee is requiredto provide service in exchange for the award. SFAS No. 123R also requiresa public entity to initially measure the cost of employee services rendered inexchange for an award of liability instruments at its current fair value. Thefair value of that award is to be remeasured subsequently at each reportingdate through the settlement date. Changes in the fair value during the requiredservice period are to be recognized as compensation cost over that period. TheCompany will adopt SFAS No. 123R January 1, 2006. The adoption ofSFAS No. 123R is not expected to have a material impact on the Company’sconsolidated financial statements.

**REAL ESTATE**

Rental properties are stated at cost, net ofaccumulated depreciation, unless circumstances indicate that cost, net ofaccumulated depreciation, cannot be recovered, in which case the carrying valueof the property is reduced to estimated fair value. Estimated fair value (i) isbased upon the Company’s plans for the continued operation of each property and(ii) is computed using estimated sales price, as determined by prevailingmarket values for comparable properties and/or the use of capitalization ratesmultiplied by annualized net operating income based upon the age, constructionand use of the building. The fulfillment of the Company’s plans related to eachof its properties is dependent upon, among other things, the presence ofeconomic conditions which will enable the Company to continue to hold andoperate the properties prior to their eventual sale. Due to uncertaintiesinherent in the valuation process and in the economy, actual results ofoperating and disposing of the Company’s properties could be materiallydifferent from current expectations.

Depreciationis provided using the straight-line method over the useful lives of therespective assets. The useful lives are as follows:

| Building and  Improvements |   | 5 to 40 years              |
|----------------------------|--------|----------------------------|
| Tenant Improvements        |   | Term of the related  lease |
| Furniture and Equipment    |   | 3 to 5 years               |

 

**CASH EQUIVALENTS**

Cash equivalents includeall highly liquid investments with a maturity of three months or less at thedate of purchase.

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**FAIR VALUE OF FINANCIAL INSTRUMENTS**

The Company’s financialinstruments consist of cash and cash equivalents, tenant and other receivables,deposits held in escrow, notes payable, accounts payable and accrued expenses. Managementbelieves that the carrying value of the Company’s financial instrumentsapproximate their respective fair market values at December 31, 2005 and December 31,2004.

**DERIVATIVE FINANCIAL INSTRUMENTS**

The Company follows Statement of Financial AccountingStandard No. 133, as amended, which establishes accounting and reportingstandards for derivative financial instruments, including certain derivativeinstruments embedded in other contracts and hedging activities. Allderivatives, whether designed as hedging relationships or not, are required tobe recorded on the balance sheet at fair value. If the derivative is designatedas a fair value hedge, the changes in the fair value of the derivative and ofthe hedged item attributable to the hedged risk are recognized in earnings. Ifthe derivative is designated as a cash flow hedge, the effective portions ofchanges in the fair value of the derivative are recorded in other comprehensiveincome and ineffective portions of changes in the fair value of cash flowhedges are recognized in earnings.

The Company had nointerest rate swaps to hedge against fluctuations in interest rates on specificborrowings at December 31, 2005 or December 31, 2004. During the yearended December 31, 2004 the Company recorded a benefit of $65,000attributable to changes in the fair value of its derivative financialinstruments.

**DEFERRED FINANCING AND OTHER FEES**

Fees paid in connectionwith the financing and leasing of the Company’s properties are amortized overthe term of the related note payable or lease and are included in other assets.

**STOCK-BASED COMPENSATION**

The Financial Accounting Standards Board issued SFAS No. 123,“Accounting for Stock-Based Compensation” (“FAS 123”) in October 1995. Thisstandard establishes a fair value approach to valuing stock options awarded toemployees as compensation. In December 2002, FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure” (“FAS 148”),which amended FAS 123. FAS 148 provides alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation. In compliance with FAS 148, the Company has elected tocontinue to follow the intrinsic value method in accounting for its stock-basedemployee compensation arrangement as defined by APB No. 25 “Accounting forStock Issued to Employees”.

The Company has in effect its Omnibus Stock IncentivePlan (the “Plan”), which is described more fully in Note 16. The Company haselected, as permitted by FAS 123, to use the intrinsic value based method ofaccounting for stock options consistent with Accounting Principles BoardOpinions No. 25, “Accounting for Stock Issued to Employees”. The intrinsicvalue method measures compensation cost for stock options as the excess, ifany, of the quoted market price of the Company’s stock at the measurement dateover the exercise price. No stock-based employee compensation cost is reflectedin net income related to stock options, as all options granted under the Planhad an exercise price equal to the fair market value of the underlying commonstock on the date of grant.

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Thefollowing table illustrates the effect on net income (loss) and earnings pershare if the Company had applied the fair value recognition of the provisionsof FAS 123 to stock-based employee compensation (thousands of dollars):

| ** **                                                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss, as  reported                                                                                              |       | $                                           | (2,266     | ) | $ | (9,107 | ) | $ | (14,348 | ) |
| Deduct: Employee  compensation expense for stock option grants under fair value method, net of  related tax effects |       | (63                                         | )          | (145 | ) | (280 | ) |
| Pro forma net  loss                                                                                                 |       | $                                           | (2,329     | ) | $ | (9,252 | ) | $ | (14,628 | ) |
| Per share data:                                                                                                     |       |                                        |       |   |   |   |   |
| Basic and diluted, as reported                                                                                      |       | $                                           | (1.56      | ) | $ | (5.87 | ) | $ | (9.67 | ) |
| Basic and  diluted, proforma                                                                                        |       | $                                           | (1.60      | ) | $ | (5.96 | ) | $ | (9.86 | ) |

 

**MINORITY INTEREST**

Unit holders in theOperating Partnership (other than the Company) held a 13.35% and 12.50% limitedpartnership interest in the Operating Partnership at December 31, 2005 andDecember 31, 2004, respectively. Each of the holders of the interests inthe Operating Partnership (other than the Company) has the option (exercisableafter the first anniversary of the issuance of the OP Units) to redeem its OPUnits and to receive, at the option of the Company, in exchange for each fourOP Units, either (i) one share of Common Stock of the Company, or (ii) cashequal to the value of one share of Common Stock of the Company at the date ofconversion, but no fractional shares will be issued.

**RENTAL REVENUE**

Certain leases provide for tenant occupancy duringperiods for which no rent is due or where minimum rent payments increase duringthe term of the lease. The Company records rental income for the full term ofeach lease on a straight-line basis. Accordingly, a receivable is recorded fromtenants equal to the excess of the amount that would have been collected on astraight-line basis over the amount collected and currently due (Deferred RentReceivable). When a property is acquired, the term of existing leases isconsidered to commence as of the acquisition date for purposes of thiscalculation.

Many of the Company’s leases provide for Common AreaMaintenance/Escalations (“CAM/ESC”) as additional tenant revenue amounts due tothe Company in addition to base rent. CAM/ESC represents increases in certainproperty operating expenses (as defined in each respective lease agreement)over the actual operating expense of the property in the base year. The baseyear is stated in the lease agreement; typically, the year in which the leasecommenced. Generally, each tenant is responsible for their prorated share ofincreases in operating expenses. Tenants are billed an estimated CAM/ESC chargebased on the budgeted operating expenses for the year. Within 90 days after theend of each fiscal year, a reconciliation and true up billing of CAM/ESCcharges is performed based on actual operating expenses.

The Company’s portfolio of leases turns over continuously,with the number and value of expiring leases varying from year to year. TheCompany’s ability to re-lease the space to existing or new tenants at ratesequal to or greater than those realized historically is impacted by, amongother things, the economic conditions of the market in which a property islocated, the availability of competing space, and the level of improvementswhich may be required at the property. No assurance can be given that therental rates that the Company will obtain in the future will be equal to orgreater than those obtained under existing contractual commitments.

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For each of the threeyears ended December 31, 2005 no tenants represented 10% or more of rentalrevenue of the Company.

**NET LOSS PER SHARE**

Net loss per share iscalculated based on the weighted average number of common shares outstanding. Stockoptions outstanding of 39,875 at December 31, 2005 and OP Units (otherthan those held by the Company) outstanding of 857,159 (convertible intoapproximately 214,289 shares of common stock) at December 31, 2005 havenot been included in the net loss per share calculation since their effectwould be antidilutive.

**INCOME TAXES**

In preparing the Company’sconsolidated financial statements, management estimates the income tax in eachof the jurisdictions in which the Company operates. This process includes anassessment of current tax expense, the results of tax examinations, and theeffects of temporary differences resulting from the different treatment oftransactions for tax and financial accounting purposes. These differences mayresult in deferred tax assets or liabilities which are included in theconsolidated balance sheet. The realization of deferred tax assets as a resultof future taxable income must be assessed and to the extent that therealization is doubtful, a valuation allowance is established. The Company’sincome tax provision is based on calculations and assumptions that will besubject to examination by the taxing authorities in the jurisdictions in whichthe Company operates. Should the actual results differ from the Company’sestimates, the Company would have to adjust the income tax provision in theperiod in which the facts and circumstances that give rise to the revisionbecome known. Tax law and rate changes are reflected in the income taxprovision in the period in which such changes are enacted.

**SEGMENTS**

The Company owns a diverseportfolio of properties primarily comprised of office and industrial properties.The Company also owns one shopping center. Each of these property typesrepresents a reportable segment with distinct uses and tenant types andrequires the Company to employ different management strategies. The propertiescontained in the segments are located in various regions and markets within theUnited States. The office portfolio consists primarily of suburban officebuildings. The industrial portfolio consists of properties designed forwarehouse, distribution and light manufacturing for single-tenant ormulti-tenant use.

**ALLOWANCE FOR DOUBTFUL ACCOUNTS**

The Company maintains anallowance reserve for accounts receivable which may not be ultimately collected.The allowance balance maintained is based upon historical collectionexperience, current aging of amounts due and specific evaluations of thecollectibility of individual balances. All tenant account balances over 90 dayspast due are fully reserved.  Accountsare written off against the reserve when they are deemed to be uncollectible.

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**NOTE 3. REAL ESTATE**

Thecost and accumulated depreciation of rental property held for investment as ofDecember 31, 2005 and 2004 are as follows (dollars in thousands):

| ** **                | ** ** | **Land** | ** ** | **Buildings and  Improvements** | ** ** | **Total Cost** | ** ** | **Accumulated  Depreciation** | ** ** | **Net Recorded  Value** | ** ** |
|---------------------------|------------|----------|------------|--------------------------------------|------------|---------------------|------------|-------------------------------|------------|------------------------------|------------|
| 2005:                     |       |     |       |                                 |       |                |       |                          |       |                         |       |   |   |   |   |   |   |
| Office properties         |       | $        | 29,444     |                                 |       | $                   | 105,760    |                          |       | $                            | 135,204    |   |   | $ | 24,021 |   |   |   | $ | 111,183 |   |   |
| Industrial  properties    |       | 3,170    |       |                                 | 13,977     |                |       | 17,147                        |       |                         | 3,287      |   |   |   | 13,860 |   |   |
| Shopping center  property |       | 1,050    |       |                                 | 1,161      |                |       | 2,211                         |       |                         | 576        |   |   |   | 1,635 |   |   |
| Other                     |       | —   |       |                                 | 264        |                |       | 264                           |       |                         | 231        |   |   |   | 33 |   |   |
| Total                     |       | $        | 33,664     |                                 |       | $                   | 121,162    |                          |       | $                            | 154,826    |   |   | $ | 28,115 |   |   |   | $ | 126,711 |   |   |
| 2004:                     |       |     |       |                                 |       |                |       |                          |       |                         |       |   |   |   |   |   |   |
| Office properties         |       | $        | 29,444     |                                 |       | $                   | 101,824    |                          |       | $                            | 131,268    |   |   | $ | 17,010 |   |   |   | $ | 114,258 |   |   |
| Industrial  properties    |       | 3,170    |       |                                 | 13,932     |                |       | 17,102                        |       |                         | 2,484      |   |   |   | 14,618 |   |   |
| Shopping center  property |       | 1,050    |       |                                 | 1,098      |                |       | 2,148                         |       |                         | 444        |   |   |   | 1,704 |   |   |
| Other                     |       | —   |       |                                 | 251        |                |       | 251                           |       |                         | 201        |   |   |   | 50 |   |   |
| Total                     |       | $        | 33,664     |                                 |       | $                   | 117,105    |                          |       | $                            | 150,769    |   |   | $ | 20,139 |   |   |   | $ | 130,630 |   |   |

 

**ACQUISITIONS**

*2005.*

No properties wereacquired in 2005. As of the date of this Form 10-K, the Company hasacquired two properties during 2006 (See Note 20—Subsequent Events).

*2004.*

On October 21, 2004, the Company acquired anoffice property in Houston, Texas, consisting of approximately 81,538 rentablesquare feet. The aggregate acquisition costs of approximately $5,900,000included proceeds from a previously sold property, the assumption of existingdebt and seller financing.

On August 2, 2004, the Company acquired a 42,860square foot office property in Houston, Texas, which is adjacent to an officeproperty owned by the Company. The Company previously held the note on theproperty. Acquisition costs of approximately $2,084,000 included the settlementof the note, the issuance of 10,000 shares of restricted Common Stock and cash.

**DISPOSITIONS**

*2005.*

The Company sold three properties during 2005. On October 27,2005, the Company sold The Lakes, a 311,912 square foot/408 unit apartmentcomplex located in Hazelwood, Missouri for a sales price of $17,125,000. On September 22, 2005, the Company soldRichardson Plaza a 107,827 square foot shopping center located in Columbia,South Carolina for a sales price of $5,000,000. On March 1, 2005, theCompany sold Sorrento I, a vacant 43,036 square foot single tenant industrialproperty located in San Diego, California for a sales price of $4,918,000.

A gain of $7,895,000 wasgenerated in connection with the three sales, which is reflected asdiscontinued operations in the Company’s consolidated financial statements forthe year ended December 31, 2005. The sales generated proceeds of$15,298,000 of which$5,210,000 was held in escrow as of December 31, 2005. It is anticipatedthat the proceeds held in escrow will be used as a source to facilitate thefunding of future acquisitions in tax-deferred exchanges.

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*2004.*

During 2004, the Company sold three properties for anaggregate sales price of $12,214,000. The properties, which totaled 316,054square feet, consisted of one office property, one industrial property and a16.65 acre parcel of undeveloped land. These three sales generated proceeds of approximately $11,357,000 ofwhich $1,191,000 was used to assist the funding of an office propertyacquisition in a tax-deferred exchange. A net loss of $2,298,000 was incurredin connection with the transactions.

In the accompanying consolidated statement ofoperations for the years ended December 31, 2005, 2004 and 2003, theresults of operations for the sold properties mentioned above are shown in the section“Discontinued operations” through their respective sale date.

As of the date of this Form 10-K,the Company has sold three properties during 2006  (See Note 20—Subsequent Events).

**INTANGIBLE ASSETS PURCHASED**

Upon acquisitions of real estate, the Company assessesthe fair value of acquired tangible and intangible assets (including land,buildings, tenant improvements, above and below market leases, originationcosts, acquired in-place leases, other identified intangible assets and assumedliabilities in accordance with Statement of Financial Accounting Standards No. 141),and allocates the purchase price to the acquired assets and assumed liabilities.The Company also considers an allocation of purchase price of other acquiredintangibles, including acquired in-place leases.

The Company evaluatesacquired “above and below” market leases at their fair value (using a discountrate which reflects the risks associated with the leases acquired) equal to thedifference between (i) the contractual amounts to be paid pursuant to eachin-place lease and (ii) management’s estimate of fair market lease ratesfor each corresponding in-place lease, measured over a period equal to theremaining term of the lease for above-market leases and the initial term plusthe term of any below-market fixed rate renewal options for below-market leases.Based on its acquisitions to date, the Company’s allocation to intangibleassets for assets purchased has been immaterial.

**FUTURE MINIMUM RENTS**

TheCompany leases its office, industrial and shopping center properties undernon-cancelable operating lease agreements. Future minimum rents to be receivedas of December 31, 2005, are as follows (dollars in thousands): 

| **Year Ending December 31,** | ** ** | ** ** | ** ** | **Future Minimum Rents** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------------------|------------|
| 2006                                        |       |       | $17,719    |                               |       |
| 2007                                        |       |       | 13,130     |                               |       |
| 2008                                        |       |       | 9,650      |                               |       |
| 2009                                        |       |       | 7,071      |                               |       |
| 2010                                        |       |       | 3,837      |                               |       |
| Thereafter                                  |       |       | 3,475      |                               |       |
|                                        |       |       | $54,882    |                               |       |

 

**NOTE 4. DISCONTINUED OPERATIONS**

*Real estate assetsheld for sale.*

As of December 31, 2005, Mira Mesa, Sorrento IIand Countryside were classified as “Real estate held for sale”. Mira Mesa andSorrento II, both office properties located in San Diego, California, were 

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sold January 6, 2006and January 13, 2006, respectively. Countryside, an office propertylocated in Palatine, Illinois, was sold March 14, 2006.

As of December 31, 2004, Mira Mesa, Sorrento II,Countryside and the three properties sold during 2005 were classified as “Realestate held for sale”. The three properties sold during 2005 consisted of a311,912 square foot/408 unit apartment complex located in Hazelwood, Missouri,a 107,827 square foot shopping center located in Columbia, South Carolina and avacant 43,036 square foot single tenant industrial property located in SanDiego, California. The sales generated net proceeds of approximately$15,298,000 of which $5,210,000 held in escrow as of December 31, 2005. It is anticipated  the proceeds held in escrow will be used as asource to facilitate the funding of future acquisitions in tax-deferredexchanges.

Thecarrying amounts of the properties classified as “Real estate held for sale” atDecember 31, 2005 and 2004 are summarized below (dollars in thousands).

**Condensed Consolidated Balance Sheet**

| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Real estate                                       |       | $                     | 19,984     |   | $ | 40,322 |   |
| Other                                             |       | 2,288                 |       | 2,876 |   |
| Real estate  assets held for sale                 |       | $                     | 22,272     |   | $ | 43,198 |   |
| Notes payable,  net                               |       | $                     | 26,186     |   | $ | 38,053 |   |
| Accounts payable                                  |       | 755                   |       | 295 |   |
| Accrued and other  liabilities                    |       | 1,012                 |       | 1,201 |   |
| Liabilities related to  real estate held for sale |       | $                     | 27,953     |   | $ | 39,549 |   |

 

*Net income (loss)from discontinued operations.*

Net income from discontinued operations for the yearended December 31, 2005 includes the operations of the three propertiesclassified as “Real estate held for sale” at December 31, 2005 and thethree properties sold during 2005. The three properties sold during 2005generated a net gain on sale of discontinued operations of $7,895,000. Incometax expense on discontinued operations of $2,198,000 was recorded during theyear ended December 31, 2005.

Net loss from discontinued operations for the yearended December 31, 2004 includes the operations of the three propertiesclassified as “Real estate held for sale” at December 31, 2005, the threeproperties sold during 2005 and three properties sold during 2004. The threeproperties sold during 2004 generated a net loss on sale of discontinuedoperations of $2,298,000. An income tax benefit on discontinued operations of$985,000 was recorded during the year ended December 31, 2004.

Net loss from discontinued operations for the yearended December 31, 2003 includes the operations of the three propertiesclassified as “Real estate held for sale” at December 31, 2005, the threeproperties sold during 2005, three properties sold during 2004 and elevenproperties sold during 2003. The eleven properties sold in 2003 generated a netgain on sale of discontinued operations of $2,540,000. The net gain recognizedfor 2003 was after taking into consideration an impairment charge totaling$7,500,000 recorded in 2003 related to four of the eleven properties. Theimpairment was based on the anticipated sales price less cost to sell ascompared to the carrying value of the assets. An income tax benefit ondiscontinued operations of $1,656,000 was recorded during the year ended December 31,2003.

The condensed consolidatedstatements of operations of discontinued operations are summarized below(dollars in thousands):

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**CondensedConsolidated Statements of Operations**

| ** **                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Rental revenue                                                                                      |       | $                                          | 6,927      |   | $ | 8,848 |   | $ | 15,075 |   |
| Total expenses(1)                                                                                   |       | 9,037                                      |       | 10,809 |   | 17,826 |   |
| Loss on early  extinguishment of debt                                                               |       | —                                     |       | (613 | ) | — |   |
| Net loss from  discontinued operations before net gain (loss) on sale, impairment and income  taxes |       | (2,110                                     | )          | (2,574 | ) | (2,751 | ) |
| Net gain (loss)  on sale of discontinued operations                                                 |       | 7,895                                      |       | (2,298 | ) | 2,540 |   |
| Impairment of  real estate assets                                                                   |       | —                                     |       | — |   | (7,500 | ) |
| Income tax  (expense) benefit                                                                       |       | (2,198                                     | )          | 985 |   | 1,656 |   |
| Net gain (loss) from  discontinued operations                                                       |       | $                                          | 3,587      |   | $ | (3,887 | ) | $ | (6,055 | ) |

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(1)          Includesinterest expense of $2,671, $3,156 and $5,135 for the years ended December 31,2005, 2004 and 2003, respectively. Mortgage debt related to each of the Company’sproperties included in discontinued operations was individually secured. Assuch, interest expense was based on each property’s respective loan.

**NOTE 5. MORTGAGE LOAN RECEIVABLE**

On October 27, 2003,the Company acquired a note secured by a property adjacent to an officeproperty owned by the Company. The property consists of 42,860 square feet andis located in Houston, Texas. The purchase of this note was funded with a newloan to the Company from the lender that owned the note. Loan costs ofapproximately $41,000 were incurred in connection with the transaction. Thenote bore interest at 7.5% per annum. On August 2, 2004 the Companyacquired the property. Acquisition costs of approximately $2,084,000 includedsettlement of the note, the issuance of 10,000 shares of restricted CommonStock and cash.

**NOTE6. INVESTMENT IN MANAGEMENT COMPANY**

Pursuant to the Company’s 2001 consolidationtransaction (“the Consolidation”), the Company acquired a portion of theproperty management business of CGS Real Estate Company, Inc (“CGS”). TheCompany recorded a $4,000,000 investment in the property management business asdetermined by an exchange value computation.

SFAS No. 142—“Goodwill and Other IntangibleAssets”—requires intangible assets that are not subject to amortization betested for impairment annually, or more frequently if events or changes incircumstances indicate that the asset might be impaired. If the carrying amountof the intangible asset exceeds its fair value, an impairment loss shall berecognized in an amount equal to that excess. After an impairment loss isrecognized, the adjusted carrying amount of the intangible asset shall be itsnew accounting basis. Subsequent reversal of a previously recognized impairmentloss is prohibited.

At December 31, 2005,the Company evaluated its investment in the management company in accordancewith SFAS No. 142 and determined that the fair value had not decreasedbelow carrying value and that no impairment was necessary.

**NOTE 7. RELATED PARTY TRANSACTIONS**

In December 2004, the Company received a $532,000loan from John N. Galardi, a director and a principal stockholder of theCompany. The note, which bore interest at a fixed interest rate of 12% perannum, was paid in April 2005.

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In September 2004, the Company began managing anapartment complex owned by an affiliated entity of William J. Carden. Mr. Cardenis the Chief Executive Officer, a director and a principal stockholder of theCompany. During the year ended December 31, 2005 and 2004, the Companyreceived management fees of $16,000 and $20,000 from this entity, respectively. In April 2005, the Company receiveda commission of $176,400 from this entity in connection with the sale of theapartment complex.

In March 2004, the Company paid $224,520 (“GuaranteeFee”) to Mr. Carden, Mr. Galardi and CGS Real Estate Company, Inc.(“the Guarantors”) in consideration for their guarantees of certain obligationsof the Company as of December 31, 2003.   The Company has agreed to pay the Guarantorsan annual guarantee fee equal to between .25% and .75% (depending on the natureof the guarantee) of the outstanding balance as of December 31 of theguaranteed obligations. The Guarantee Fee is to be paid for a maximum of threeyears on any particular obligation. In December 2004, the Company paid$187,944 related to the Guarantee Fee payable for the 2004 year. The paymentswere made in the form of an offset against certain sums owed to the Company bythe Guarantors. For the year ended December 31, 2005, the Company hasaccrued $161,000 related to the Guarantee Fee payable for the 2005 year.

During 2004 and 2003, the Company made paymentstotaling $81,000 and $1,000,000, respectively, on its indebtedness to an entityaffiliated with Mr. Carden and Mr. Galardi, reducing the balance dueto $170,321 as of December 31, 2005.

During 2003, the Company acquired three officeproperties from an entity affiliated with Mr. Carden and Mr. Galardi.The properties are located in Houston, Texas and consist of approximately160,742 rentable square feet. Acquisition costs of approximately $10,703,000included assumed or new mortgage indebtedness, the issuance of 382,537 OPUnits, deferred payments of $190,469 and cash.

In May 2003, the successor of Brown Parker andLeahy, LLP cancelled its $199,180 note, plus $45,891 of accrued interestthereon, in exchange for 14,943 shares of the Company’s common stock. TimothyR. Brown, a director of the Company, was a partner of Brown Parker Leahy, LLP.

In May 2003, Mr. Galardi cancelled his$1,600,000 note, plus $286,036 of accrued interest thereon, in exchange for115,002 shares of the Company’s common stock.

In May 2003, Mr. Galardi purchased a totalof 15,243 shares of the Company’s common stock from the Company for $16.40 pershare.

In February 2003, the Company reached anagreement with CGS Real Estate Company, Inc. (“CGS”) whereby CGSacknowledged that it owed the Company a net amount of $270,375 which related toseveral issues asserted by William J. Carden that were owed by CGS to theCompany and by the Company to CGS.   Anaffiliate of Mr. Carden is a principal stockholder of CGS. Mr. Cardenis an officer and a director of CGS, and an affiliate of Mr. Galardi is aprincipal stockholder of CGS. Mr. Carden and Mr. Galardi had agreedto guarantee this obligation of CGS, and they had secured this guarantee withan assignment to the Company of their right to receive $270,375 of principalpayments on the notes payable to them and their affiliates by reason of thesettlement of the Teachout litigation, plus all interest payable on suchprincipal amount of notes. This amount, with accrued interest of 6% per annum, wasdue and payable to the Company on March 15, 2006.   In March 2004, as part of the payment ofthe 2003 Guarantee Fee, interest due on this obligation for 2004 was paid inadvance and $26,606 was applied to the principal due on this obligation. In December 2004,as part of the payment of the 2004 Guarantee Fee, interest due on thisobligation for 2005 was paid in advance. The principal balance due as of December 31,2004 was $243,858. In October 2005, CGS paid this balance in full.

In connection with the settlement of the Teachoutlitigation in 2003, Mr. Galardi and Mr. Carden acknowledged that theyowed the Company the sum of $1,187,695 as indemnification against a portion ofthe Company’s settlement obligation. Mr. Galardi and certain affiliates ofMr. Carden and/or Mr. Galardi are beneficiaries, in part, of thesettlement of the Teachout litigation and are owed an amount in excess of 

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this obligation pursuantto that settlement. Mr. Galardi and Mr. Carden agreed to pay theCompany the principal sum of this obligation, plus interest thereon at theannual rate of 6% in the form of an assignment to the Company of their right toreceive $1,187,695 of principal payments on the notes payable to them and theiraffiliates by reason of the settlement of the Teachout litigation, plus allinterest payable on such principal amount of notes. The receivable of$1,187,695 and accrued interest were reflected as a component of equity in theCompany’s consolidated financial statements. In March 2004, as part of thepayment of the 2003 Guarantee Fee, interest due on this obligation for 2004 waspaid in advance and $116,875 was applied to the principal due on thisobligation. In December 2004, as part of the payment of the 2004 GuaranteeFee, interest due on this obligation for 2005 was paid in advance and $120,340was applied to the principal due on this obligation. The balance due as of December 31,2004 was $950,480. In October 2005, pursuant to the 2003 agreement, Mr. Carden,Mr. Galardi and CGS paid this balance due to the Company in full.

For the years ended December 31, 2005, 2004 and2003, the Company paid $37,645, $134,890 and $98,763, respectively, for realestate related services to a firm in which Patricia A. Nooney, a formerexecutive officer of the Company, holds an ownership interest. Ms. Nooney’semployment with the Company ceased in January 2006.

For the years ended December 31, 2005, 2004 and2003, the Company incurred professional fees of $2,878, $54,505 and $19,240,respectively, to a law firm in which Timothy R. Brown, a director of theCompany, is a partner.

 

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**NOTE 8. NOTES PAYABLE**

TheCompany had the following notes payable outstanding as of December 31,2005, and 2004 (dollars in thousands): 

| ** **                                           | ** ** | ** ** | ** ** | **2005**           | ** ** | **2004**               | ** ** |
|------------------------------------------------------|------------|------------|------------|--------------------|------------|------------------------|------------|
| **Property (unless otherwise noted)** | ** ** | ** ** | ** ** | **Maturity  Date** | ** ** | **Principal  Balance** | ** ** | **Interest  Rate** | ** ** | **Principal  Balance** | ** ** | **Interest  Rate** | ** ** |
| *Fixed Rate*                                         |       |       |       |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Columbia                                             |       |       | 7/1/2006   |               |       |                   | 2,756      |   |   |   | 10.50 | % |   |   | 2,756 |   |   |   | 10.50 | % |   |
| 12000 Westheimer                                     |       |       | 5/7/2007   |               |       |                   | 452        |   |   |   | 6.80 | % |   |   | 457 |   |   |   | 6.80 | % |   |
| Pacific Spectrum                                     |       |       | 6/10/2009  |               |       |                   | 5,571      |   |   |   | 8.02 | % |   |   | 5,637 |   |   |   | 8.02 | % |   |
| Morenci Professional  Park                           |       |       | 12/1/2009  |               |       |                   | 1,786      |   |   |   | 6.60 | % |   |   | 1,875 |   |   |   | 6.60 | % |   |
| 7700 Building                                        |       |       | 7/10/2010  |               |       |                   | 33,498     |   |   |   | 8.50 | % |   |   | 33,820 |   |   |   | 8.50 | % |   |
| Bristol Bay                                          |       |       | 8/1/2011   |               |       |                   | 7,276      |   |   |   | 7.58 | % |   |   | 7,354 |   |   |   | 7.58 | % |   |
| Technology                                           |       |       | 8/1/2011   |               |       |                   | 7,533      |   |   |   | 7.44 | % |   |   | 7,616 |   |   |   | 7.44 | % |   |
| Creekside                                            |       |       | 12/1/2011  |               |       |                   | 6,149      |   |   |   | 7.17 | % |   |   | 6,219 |   |   |   | 7.17 | % |   |
| 16350 Park Ten  Place                                |       |       | 5/11/2012  |               |       |                   | 4,694      |   |   |   | 7.45 | % |   |   | 4,743 |   |   |   | 7.45 | % |   |
| 16360 Park Ten  Place                                |       |       | 5/11/2012  |               |       |                   | 3,678      |   |   |   | 7.45 | % |   |   | 3,716 |   |   |   | 7.45 | % |   |
| Southwest Pointe                                     |       |       | 6/1/2012   |               |       |                   | 2,855      |   |   |   | 7.33 | % |   |   | 2,885 |   |   |   | 7.33 | % |   |
| 12000 Westheimer                                     |       |       | 8/11/2012  |               |       |                   | 3,090      |   |   |   | 6.80 | % |   |   | 3,126 |   |   |   | 6.80 | % |   |
| 16350 Park Ten  Place                                |       |       | 8/11/2012  |               |       |                   | 518        |   |   |   | 7.45 | % |   |   | 524 |   |   |   | 7.45 | % |   |
| 16360 Park Ten  Place                                |       |       | 8/11/2012  |               |       |                   | 406        |   |   |   | 7.45 | % |   |   | 411 |   |   |   | 7.45 | % |   |
| 11500 Northwest  Freeway                             |       |       | 6/1/2014   |               |       |                   | 4,323      |   |   |   | 5.93 | % |   |   | 4,375 |   |   |   | 5.93 | % |   |
| 11500 Northwest  Freeway                             |       |       | 6/1/2014   |               |       |                   | 312        |   |   |   | 5.93 | % |   |   | 316 |   |   |   | 5.93 | % |   |
| 5850 San Felipe                                      |       |       | 8/1/2014   |               |       |                   | 5,415      |   |   |   | 5.65 | % |   |   | 5,483 |   |   |   | 5.65 | % |   |
| Northwest  Corporate Center                          |       |       | 8/1/2014   |               |       |                   | 5,667      |   |   |   | 6.26 | % |   |   | 5,730 |   |   |   | 6.26 | % |   |
| 8100 Washington                                      |       |       | 2/22/2015  |               |       |                   | 2,329      |   |   |   | 5.59 | % |   |   | 2,390 |   |   |   | 7.41 | % |   |
| 8300 Bissonnet                                       |       |       | 5/1/2015   |               |       |                   | 4,758      |   |   |   | 5.51 | % |   |   | 4,574 |   |   |   | 8.00 | % |   |
| 5450 Northwest  Central                              |       |       | 9/1/2015   |               |       |                   | 2,791      |   |   |   | 5.38 | % |   |   | 2,769 |   |   |   | 6.00 | % |   |
| 800/888 Sam  Houston Parkway                         |       |       | 12/29/2015 |               |       |                   | 4,400      |   |   |   | 6.25 | % |   |   | 2,920 |   |   |   | 6.00 | % |   |
| Corporate—Secured                               |       |       | 10/1/2008  |               |       |                   | 2,000      |   |   |   | 6.83 | % |   |   | — |   |   |   | — |   |   |
| Corporate—Unsecured                             |       |       | 9/30/2006  |               |       |                   | 60         |   |   |   | 7.15 | % |   |   | 54 |   |   |   | 5.45 | % |   |
| Corporate—Unsecured                             |       |       |       |               |       |                   | —     |   |   |   | — |   |   |   | 66 |   |   |   | 7.27 | % |   |
| Corporate—Unsecured                             |       |       |       |               |       |                   | —     |   |   |   | — |   |   |   | 532 |   |   |   | 12.00 | % |   |
| Corporate—Unsecured                             |       |       |       |               |       |                   | —     |   |   |   | — |   |   |   | 59 |   |   |   | 8.00 | % |   |
|                                                 |       |       | Subtotal   |               |       |                   | $          | 112,317 |   |   |   |   |   |   |   | $ | 110,407 |   |   |   |   |   |   |
| *Variable Rate*                                      |       |       |       |               |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Columbia                                             |       |       | 4/15/2006  |               |       |                   | $          | 31 |   |   |   | 9.50 | % |   |   | $ | 110 |   |   |   | 7.50 | % |   |
| Corporate—Unsecured                             |       |       | 7/27/2006  |               |       |                   | 95         |   |   |   | 8.25 | % |   |   | — |   |   |   | — |   |   |
| Corporate—Unsecured                             |       |       | 5/31/2008  |               |       |                   | 200        |   |   |   | 8.25 | % |   |   | 300 |   |   |   | 20.00 | % |   |
| Corporate—Unsecured                             |       |       |       |               |       |                   | —     |   |   |   | — |   |   |   | 58 |   |   |   | 0.00 | % |   |
|                                                 |       |       | Subtotal   |               |       |                   | $          | 326 |   |   |   |   |   |   |   | $ | 468 |   |   |   |   |   |   |
| Loan Premiums                                        |       |       |       |               |       |                   | 1,900      |   |   |   |   |   |   |   | 2,355 |   |   |   |   |   |   |
|                                                 |       |       | Total      |               |       |                   | $          | 114,543 |   |   |   |   |   |   |   | $ | 113,230 |   |   |   |   |   |   |
|                                                      |            |            |            |                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Debt premiums are amortized into interest expense overthe terms of the related mortgages using the effective interest method. Theloan premium amounts amortized into interest expense totaled $455,000 and$509,000 for the years ended December 31, 2005 and 2004, respectively.

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The Company has paid, refinanced or extended allmaterial debt which was due to mature in 2005 and 2006 with the exception of amortgage loan due to mature in July 2006 on its one remaining shoppingcenter property. The lender was a major tenant at another shopping centerproperty sold in 2005. The Company anticipates either refinancing the debt,negotiating a loan extension or selling this property.

On December 14, 2005, the Company refinanced itsdebt on 800 and 888 Sam Houston Parkway debt with a short-term $4,200,000revolving credit promissory note with a bank. The balance due on the debtwas  $1,884,000 and $1,725,000,respectively, at the time of the refinance. Net proceeds of $518,000 werereceived as a result of the refinance. On December 29, 2005, the Companyentered into a long-term loan agreement in the amount of $4,400,000 with acredit union and paid the balance due on the revolving credit promissory note. Thenew loan bears interest at a fixed rate of 6.25% and matures in December 2015.

On October 14, 2005, the Company entered into aloan modification agreement with a bank that provided the Company an additional$3,500,000 (exclusive of loan costs) on Mira Mesa, an office property locatedin San Diego California. The modification increased the Company’s debt on theproperty from $9,000,000 to $12,500,000. The interest rate on the loan waschanged from prime plus 1% to the one-year treasury constant maturity rate plus3%. All other loan terms and conditions remained unchanged.  The Company also entered into a $2,500,000loan agreement with the bank secured by three of the Company’s other assets. The  $2,500,000 note bears interest at theone-year treasury constant maturity rate plus 3% and matures in October 2008.In January 2006, the $12,500,000 loan was paid in full in connection withthe sale of Mira Mesa and a $500,000 pay-down was made on the $2,500,000 loanin connection with the sale of the Company’s Sorrento II property.

On August 27, 2005, the Company financed therepurchase of 10,000 shares of restricted stock for $85,000 ($8.50 per share)and consideration of $10,000 for the cancellation of a participating profitagreement with a $95,000 note. The note bears interest at prime plus 1% perannum and matures in July 2006.

On August 24, 2005, the Company entered into aloan agreement in the amount of $2,800,000 on 5450 Northwest Central, one ofits office properties and repaid debt of $2,844,000. The loan bears interest ata fixed rate of 5.38% per annum and matures in September 2015. Net cashpaid to refinance the debt amounted to $167,000.

On April 6, 2005, the Company refinanced a$4,574,000 loan on 8300 Bissonnet, one of its office properties, due to maturein November 2005, and entered into a fixed rate promissory note in theamount of $4,758,000. The note bears interest at 5.51% per annum and matures inMay 2015. Net cash paid to refinance the debt amounted to $65,000.

On February 22, 2005, the Company refinanced debtof $2,385,000 on 8100 Washington, one of its office properties, with a new loanin the amount of $2,350,000 and cash. The new loan bears interest at a fixedrate of 5.59% per annum and matures in February 2015. Net cash paid torefinance the debt amounted to $167,000.

In December 2004, the Company received a $532,000loan from John N. Galardi. The note, which bore interest at a fixed interestrate of 12% per annum, was paid in April 2005.

In October 2004, in connection with theacquisition of an office property in Houston, Texas, the Company assumed a loanin the amount of $4,384,000. The loan bears interest at a fixed rate of 5.93%per annum and matures in June 2014. The Company also entered into anagreement that provided for seller financing of $316,000, bearing interest at afixed rate of 5.93% per annum and maturing in June 2014.

In October 2004, the Company refinanced a$1,176,000 loan on 888 Sam Houston Parkway, one of its office properties, andentered into a revolving credit promissory note in the amount of $2,250,000, ofwhich 

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$1,226,000 has been drawnto cover the repayment of existing debt and financing costs. The availabilityon the note as of December 31, 2004 was $1,024,000. The note boresinterest at prime plus 1% per annum and was due to mature in December 2006.The loan was paid in December 2005 thru a refinance.

In August 2004, the Company refinanced a$5,350,000 loan on San Felipe, one of its office properties, with a new loanagreement in the amount of $5,500,000. The new loan bears interest at a fixedrate of 5.65% per annum and matures in August 2014.  The Company funded closing costs ofapproximately $178,000 and escrowed $327,000 for future capital expenditures,real estate taxes and insurance related to the August 2004 refinance. Netproceeds of $2,059,000 were received in December 2003 related to the December 2003refinance of the original $3,000,000 loan on the property.

In July 2004, the Company refinanced a $5,330,000loan on Northwest Corporate Center, one of its office properties, with a newloan agreement in the amount of $5,750,000. The new loan bears interest at afixed rate of 6.26% per annum and matures in August 2014. No proceeds werereceived directly as a result of the refinance, however $350,000 is being heldin escrow by the lender to assist the funding of future capital expenditures atthe property.

In May 2004, the Company refinanced a $3,132,000loan on Mira Mesa, with a new one-year loan agreement in the amount of$7,500,000. The new loan, which contained two six-month extension options, boreinterest at a fixed rate of 7.95% per annum. Net proceeds of $3,440,000 werereceived as a result of the refinance. The loan was paid in January 2006in connection with the sale of the property.

In May 2004, the Company financed insurancepremiums of $373,000 on its properties and agreed to pay a service fee of$85,000 over one year. The insurance premium note was paid in full in February 2005.The Company financed an additional insurance premium during 2004 of $133,000,with scheduled payments through June 2005. The balance was paid during thesecond quarter of 2005.

In 2002, the lender under a loan agreement related tothe South Carolina shopping center properties notified the Company it wastechnically in default under its loan agreement for non-compliance with certaincovenants, including covenants requiring improvements to shopping centerproperties. Thereafter, the lender notified the Company that it was in defaultfor failure to pay a matured portion of the loan, which matured in November 2002.In early 2003, the lender sold the loan to the major tenant in two of theshopping centers. In December 2003, the Company sold one of the shoppingcenter properties and repaid $3,935,000, which included the pay-off of thematured portion of the loan. As of December 31, 2005, the remainingbalance of the loan was approximately $2,756,000.  The Company continues to discuss thenon-compliance matter with the new lender. The new lender has not acceleratedthe loan.

Therequired principal payments on the Company’s debt for the next five years andthereafter, as of December 31, 2005, including debt noted in Note 9—NotesPayable, Litigation Settlement which was paid in January 2006, are asfollows (dollars in thousands):

| **Year Ending December 31,**           | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                                  |       | $          | 9,121      |       |
| 2007                                                  |       | 1,839      |       |
| 2008                                                  |       | 3,619      |       |
| 2009                                                  |       | 8,272      |       |
| 2010                                                  |       | 32,909     |       |
| Thereafter                                            |       | 61,760     |       |
| Subtotal                                              |       | 117,520    |       |
| Premiums (net of  accumulated amortization of $1,997) |       | 1,900      |       |
| Total                                                 |       | $          | 119,420    |       |

 

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**NOTE9. NOTES PAYABLE, LITIGATION SETTLEMENT**

As the result of the settlement of the Teachoutlitigation, which was documented in the third quarter of 2003, the Companyreaffirmed its previously announced obligation to pay the former limitedpartners of Sierra Pacific Development Fund II (“Fund II”) as of the date ofthe Consolidation, or their assignees or transferees, the loans which were madeand called by the former general partner of Fund II as part of theConsolidation. Pursuant to the settlement, the Company established a repaymentplan and secured the debt with a second deed of trust on an office propertyowned by the Company. This repayment plan consisted of a promissory note in theamount of $8,800,000, which bore interest at 6% per annum and matured in March 2006.The note was payable to the former limited partners of Fund II, each of whomhas a pro-rata interest in the note. Interest-only payments, which were payablequarterly, commenced June 2, 2003. The note could be prepaid in whole orin part at any time without penalty.

As part of the settlement, the Company agreed to paylegal fees totaling $1,200,000 to the plaintiff’s counsel. The Company made ascheduled payment of $250,000 in the third quarter of 2003 with the remaining$950,000 consisting of two promissory notes. The first note, in the amount of$700,000, bore interest at 6% per annum and matured in March 2006. Interest-onlypayments, which were payable quarterly, commenced June 2, 2003.  The second promissory note, in the amount of$250,000, bore no interest and matured in March 2006. The notes, whichwere secured by a second deed of trust on an office property owned by theCompany, could be prepaid in whole or in part at any time without penalty.

During the fourth quarter of 2004, the Companypurchased 2,347 of the 86,653 interests outstanding in the $8,800,000 promissorynote. The Company paid $140,820 (or $60 per unit), which reduced it debtobligation related to the settlement by $238,338.

In October 2005, the Company made a principalpay-down of $4,634,630 on its note payable to the former limited partners ofFund II. The payment reduced the principal amount due on the note from$8,561,662 to $3,927,032. The payment represented a $55.00 per unit pay-down onthe original obligation of $101.55 per unit.

Pursuant to prior agreements, Mr. Carden, Mr. Galardiand CGS paid their balances due to the Company (See Note 7).

In January 2006, thebalance due of $3,927,032 to the former limited partners of Fund II and the$950,000 in legal fees to plaintiff’s counsel were paid in full

**NOTE10. NET LOSS ON EARLY EXTINGUISHMENT OF DEBT**

During 2005, in connection with the refinance of 800and 888 Sam Houston Parkway, the Company recorded a loss on earlyextinguishment of debt of $95,000 related to the write-off of unamortized loancosts.

During 2004, the Company recorded a net loss on earlyextinguishment of debt of $116,000. The net loss consisted of (i) aprepayment penalty of $120,000 and the write-off of unamortized loan costs of$94,000 in connection with the 2004 refinance of San Felipe, and (ii) a$98,000 gain related to the purchase of interests of former limited partners ofFund II in the $8,800,000 promissory note related to the settlement of theTeachout litigation. The Company purchased 2,347 of the 86,653 interestsoutstanding at $60 per unit, which reduced its debt obligation related to thesettlement $238,338.

During 2003, in connection with the 2003 refinance ofSan Felipe, the Company recorded a loss on early extinguishments of debt of$145,000 related to the write-off of an unamortized loan discount and prepaymentpenalty.

The net loss on earlyextinguishment of debt is included in other income in the consolidatedstatements of operations.

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**NOTE 11. MINORITY INTEREST**

Unit holders in the Operating Partnership (other thanthe Company) held a 13.35% and 12.50% limited partnership interest in theOperating Partnership at December 31, 2005 and December 31, 2004,respectively. Each of the holders of the interests in the Operating Partnership(other than the Company) has the option (exercisable after the firstanniversary of the issuance of the OP Units) to redeem its OP Units and toreceive, at the option of the Company, in exchange for each four OP Units,either (i) one share of Common Stock of the Company, or (ii) cashequal to the value of one share of Common Stock of the Company at the date ofconversion, but no fractional shares will be issued.

During the year ended December 31, 2005, a totalof 5,826 OP Units were exchanged for 1,455 shares of Common Stock.

During the year ended December 31,2004, a total of 35,772 OP Units were exchanged for 8,936 shares of CommonStock.

**NOTE 12. REDEEMABLE COMMON STOCK**

On October 23, 2001,the Company issued 5,000 shares of its Common Stock, $.01 par value per share,with the holder’s right to compel the sale of the stock back to the Company(the “Put”) at a fixed price of $60.00 per share during the period from October 31,2002 to November 30, 2002. The Put exercise period was subsequentlyextended to November 30, 2004 through December 31, 2004. In December 2004,the Company received notice that the holder exercised its right to sell theCommon Stock back to the Company for $60.00 per share or a total of $300,000and subsequently agreed to pay the sum in twelve monthly installments of$25,000 in 2005. During 2005, the Company paid the twelve installments andplaced the 5,000 shares into treasury.

**NOTE 13. REPURCHASE OF COMMON STOCK**

In January 2006, the Company’s Board of Directorsauthorized the repurchase of up to an additional 100,000 shares of its commonstock, which increased the authorized amount to 200,000 shares. The stockrepurchases would be made from time to time in open market transactions.

During 2005, a total of 79,312 shares were repurchasedin open market transactions, increasing the number of shares repurchased to95,486. The total cost of the 2005 repurchases amounted to $855,000 at anaverage price of $10.59 per share.

In December 2005, the Company repurchased 5,000shares for $300,000 ($60.00 per share) pursuant to a put and call agreemententered into in 2001 (See Note 12).

In November 2005, the Company repurchased 2,625shares from a former employee for $31,106 ($11.85 per share).

On April 4, 2005 theCompany offered to purchase up to 250,000 shares pursuant to an odd lotbuy back program. Shareholders who participated in the program received theprice-per-share equal to the average of the daily closing prices of the Company’sCommon Stock during the week in which response cards were received andprocessed. Shareholders with fewer than 100 shares were eligible to participate.The offer expired September 30, 2005.  A total of 24,104 odd lot shares were validlytendered at an average price of $8.92 per share. The total cost of the stockrepurchased amounted to $217,000.

In August 2005, the Company repurchased 10,000shares of restricted stock for $85,000 ($8.50 per share). The shares wereoriginally issued in August 2004 in connection with the purchase of anoffice property in Houston, Texas.

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On October 11, 2004 theCompany offered to purchase up to 250,000 shares at $8.25 per share toholders of fewer than 100 shares pursuant to an odd lot buy back program. Theoffer, which expired December 1, 2004, resulted in 63,327 odd lot sharesvalidly tendered. The total cost of the stock repurchased amounted to $532,000.

In September 2004, inconjunction with a resignation agreement, an employee relinquished 1,250 sharesof restricted common stock.

**NOTE 14. INCOME TAXES**

Theprovision for income taxes on income consists of the following for the periodsended December 31, 2005, 2004 and 2003 (thousands of dollars):

| ** **                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current expense  (benefit):  |       |     |       |     |       |     |       |
| Federal                      |       | —   |       | —   |       | —   |       |
| State                        |       | —   |       | —   |       | —   |       |
| Deferred expense  (benefit): |       |     |       |     |       |     |       |
| Federal                      |       | $        | (3,006     | )        | $          | (1,989   | )          | $ | 234 |   |
| State                        |       | (354     | )          | (233     | )          | 44       |       |
|                         |       | $        | (3,360     | )        | $          | (2,222   | )          | $ | 278 |   |

 

The Company has federal and state net operating losscarryforwards of approximately $12,576,000 and $10,813,000, respectively, as ofDecember 31, 2005.

The Company is a loss corporation as defined in Section 382of the Internal Revenue Code. Therefore, if certain changes in the Company’sownership should occur, there could be a significant annual limitation on theamount of loss carryforwards and future recognized losses that can be utilizedand ultimately some amount of loss carryforwards may not be available. Suchchanges could result in additional tax provision. The net operating lossexpires in 2022 through 2025.

Forthe three years ended December 31, 2005, the reported income tax (benefit)expense differs from the amount of benefit determined by applying the UnitedStates statutory federal income tax rate of 34% to loss before income taxes asa result of the following:

| ** **                                             | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Expected income  tax benefit at statutory federal rate |       |                        | $          | (3,241                      | )          |                        |       | $ | (3,747 | ) |   |   | $ | (3,991 | ) |   |
| State income tax benefit                               |       |                        | (381       | )                           |       |                        | —     |   |   |   | — |   |   |
| Income not taxable                                     |       |                        | (174       | )                           |       |                        | (478       | ) |   |   | (164 | ) |   |
| Charges not deductible                                 |       |                        | 24         |                        |       |                        | 39         |   |   |   | 118 |   |   |
| Minority interest                                      |       |                        | 162        |                        |       |                        | 578        |   |   |   | 701 |   |   |
| Losses with no current benefit                         |       |                        | —     |                        |       |                        | 1,386      |   |   |   | 3,614 |   |   |
| Adjustments to true-up prior year                      |       |                        | 238        |                        |       |                        | —     |   |   |   | — |   |   |
| Other, net                                             |       |                        | 12         |                        |       |                        | —     |   |   |   | — |   |   |
| Income tax (benefit)  expense                          |       |                        | $          | (3,360                      | )          |                        |       | $ | (2,222 | ) |   |   | $ | 278 |   |   |

 

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Thecomponents of deferred tax assets and liabilities consist of the following asof December 31, 2005 and December 31, 2004, respectively (thousandsof dollars):

| ** **                          | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred tax  assets:               |       |                        |       |                        |       |   |   |   |   |
| Net operating losses                |       |                        | $          | 4,704                       |       |   |   | $ | 4,090 |   |   |
| Allowance for bad debts             |       |                        | 68         |                        |       |   | 116 |   |   |
| Capitalized lease costs             |       |                        | 181        |                        |       |   | 276 |   |   |
| Less: Valuation  allowance          |       |                        | —     |                        |       |   | — |   |   |
| Total deferred  tax asset           |       |                        | 4,953      |                        |       |   | 4,482 |   |   |
| Deferred tax liabilities:           |       |                        |       |                        |       |   |   |   |   |
| Built-in gains                      |       |                        | (4,260     | )                           |       |   | (4,996 | ) |   |
| Straight-line rents receivable      |       |                        | (640       | )                           |       |   | (595 | ) |   |
| Total deferred  tax liabilities     |       |                        | (4,900     | )                           |       |   | (5,591 | ) |   |
| Net deferred tax  asset (liability) |       |                        | $          | 53                          |       |   |   | $ | (1,109 | ) |   |

 

SFAS No. 109, “Accounting for Income Taxes”,requires a valuation allowance against deferred tax assets if, based onavailable evidence, it is more likely than not that some or all of the deferredtax assets will not be realized. For 2001, based on management’s intent tobecome a REIT, which would make the Company not generally liable for federalcorporate income taxes, and its intent to sell real estate assets only throughtax deferred exchanges, management recorded a valuation allowance against theentire net deferred tax asset since uncertainty existed as to the ultimate taxasset to be realized.

In 2002, management reevaluated an earlier decisionand determined that it may sell certain of the Company’s real estate assetsoutside of tax-deferred exchanges. If the Company elects REIT status, duringthe 10-year period following such election, the Company will be subjectto an entity level tax on the income it recognizes upon the sale of assetscontributed by certain partnerships that it held before electing REIT status inan amount up to the amount of the built-in gains at the time the Companybecomes a REIT. The potential tax related to this built-in gain for bookpurposes is approximately $13,165,000. Therefore, in 2002, the Companyrecognized a deferred tax liability for this potential tax and has recordedthis liability as a charge to equity.  During 2002, the deferred tax liability forthe built-in gains was reduced primarily due to the tax effect of impairmentsrecorded for certain real estate assets held.

Based on the currentstrategic plans of the Company, management has determined that it was morelikely than not that future taxable income, primarily from the gain on the saleof real estate assets, would be sufficient to enable the Company to realize allof its deferred tax assets. Therefore, for the three years ended December 31,2005, no valuation allowance has been recorded and the valuation allowancepreviously recorded in 2001 has been reversed. The tax effect of theimpairments recorded and the reversal of the previously recorded allowancealong with the tax benefits of the current year tax assets have been recordedin the statement of operations as an income tax benefit.

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**NOTE 15. NET LOSSPER SHARE**

Netloss per share is calculated based on the weighted average number of commonshares outstanding. Stock options outstanding and OP Units have not beenincluded in the net loss per share calculation since their effect would be antidilutive.Net loss per share is as follows (in thousands, except for shares and per shareamounts):

| ** **                                     | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss before  discontinued operations       |       | $                                           | (5,853     | ) | $ | (5,220 | ) | $ | (8,293 | ) |
| Discontinued operations:                       |       |                                        |       |   |   |   |   |
| Loss from discontinued operations              |       | (2,110                                      | )          | (2,574 | ) | (2,751 | ) |
| Gain (loss) on sale of discontinued operations |       | 7,895                                       |       | 2,298 |   | 2,540 |   |
| Impairment of real estate asset                |       | —                                      |       | — |   | (7,500 | ) |
| Income tax (expense) benefit                   |       | (2,198                                      | )          | 985 |   | 1,656 |   |
| Income (loss)  from discontinued operations    |       | 3,587                                       |       | (3,887 | ) | (6,055 | ) |
| Net loss                                       |       | $                                           | (2,266     | ) | $ | (9,107 | ) | $ | (14,348 | ) |
| Basic and diluted  per share data:             |       |                                        |       |   |   |   |   |
| Net loss before discontinued operations        |       | $                                           | (4.02      | ) | $ | (3.37 | ) | $ | (5.59 | ) |
| Income (loss) from discontinued operations     |       | 2.46                                        |       | (2.50 | ) | (4.08 | ) |
| Net loss                                       |       | $                                           | (1.56      | ) | $ | (5.87 | ) | $ | (9.67 | ) |
| Basic weighted average  shares used            |       | 1,457,079                                   |       | 1,551,189 |   | 1,483,675 |   |

 

**NOTE16. STOCK OPTION AND RESTRICTED SHARE PLANS**

The Company has in effect the Plan, which isadministered by the Board of Directors and provides for the granting ofincentive and non-qualified stock options, stock appreciation rights,restricted stock, performance units and performance shares.  The Board has reserved a total of 180,000shares under the Plan. As of December 31, 2005, 120,563 ASR shares wereavailable for issuance to executive officers, directors or other key employeesof the Company.

Thefollowing table summarizes activity and outstanding options under the plan:

| ** **                             | ** ** | **Shares  Under  Option** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|----------------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|
| Outstanding on  January 1, 2003   |       | 47,375                    |       |                                       | $          | 41.68 |   |   |
| Granted(1)                             |       | 8,750                     |       |                                       | $          | 12.20 |   |   |
| Outstanding on  December 31, 2003 |       | 56,125                    |       |                                       | $          | 37.08 |   |   |
| Granted(1)                             |       | 6,250                     |       |                                       | $          | 11.16 |   |   |
| Forfeited                              |       | (28,750                   | )          |                                       | $          | 43.54 |   |   |
| Outstanding on  December 31, 2004 |       | 33,625                    |       |                                       | $          | 26.76 |   |   |
| Granted(1)                             |       | 6,250                     |       |                                       | $          | 8.10 |   |   |
| Outstanding on  December 31, 2005 |       | 39,875                    |       |                                       | $          | 23.84 |   |   |
| Exercisable as  of:                    |       |                      |       |                                       |       |   |   |
| December 31, 2003                 |       | 31,328                    |       |                                       | $          | 42.80 |   |   |
| December 31, 2004                 |       | 21,766                    |       |                                       | $          | 33.31 |   |   |
| December 31,  2005                |       | 29,875                    |       |                                       | $          | 28.49 |   |   |

----

(1)          The exercise price ofthe stock options granted was equal to the fair market value on the date ofgrant.

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Thefollowing table summarizes certain information for options outstanding on December 31,2005:

| **Range of Exercise Price** | ** ** | ** ** | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------|------------|
| $8.10 - $12.20                             |       |       | 21,250     |                    |       |                                                    | 8.2 years  |                                       |       |   | $ | 11.69 |   |   |
| $20.12 - $27.16                            |       |       | 11,188     |                    |       |                                                    | 6.5 years  |                                       |       |   | $ | 24.77 |   |   |
| $60.00 - $60.00                            |       |       | 7,437      |                    |       |                                                    | 5.8 years  |                                       |       |   | $ | 60.00 |   |   |

 

Thefollowing table summarizes certain information for options exercisable on December 31,2005:

| **Range of Exercise Price** | ** ** | ** ** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------|------------|--------------------------------------------|------------|
| $8.10 - $12.20                             |       |       | 11,250     |                    |       |                                       | $          | 11.34 |   |   |
| $20.12 - $27.16                            |       |       | 11,188     |                    |       |                                       | $          | 24.77 |   |   |
| $60.00 - $60.00                            |       |       | 7,437      |                    |       |                                       | $          | 60.00 |   |   |

 

The Company accounts for the Plan under APB Opinion 25.Therefore, no compensation cost has been recognized for the granting of options.The estimated fair value of options granted during the periods ended December 31,2005, 2004 and 2003, were $6.04, $6.60 and $6.96 per share, respectively. Thefair value of each option is estimated, as of the grant date, using theBlack-Scholes option pricing model with the following assumptions used for thegrants:  expected volatility of 62%, 40%and 53% the 2005, 2004 and 2003, respectively; risk-free interest rate of4.28%, 4.50% and 3.85% for 2005, 2004 and 2003, respectively; and expectedlives of 10 years. The Black-Scholes option valuation model was developed foruse in estimating the fair value of traded options, which have no vestingrestrictions and are fully transferable. In addition, option valuation modelsrequire the input of highly subjective assumptions including the expected stockprice volatility. Because the Company’s stock options have characteristicssignificantly different from those of traded options and because changes in thesubjective input assumptions can materially affect the fair value estimate, inmanagement’s opinion, the existing models do not necessarily provide a reliablesingle measure of the fair value of its employee stock options.

No shares were issuedunder the Plan as restricted stock during the three years ended December 31,2005.  The recipient of restricted stockhas the right to vote all shares, to receive and retain all cash dividendspayable to holders of ASR shares of record on or after the date of issuance andto exercise all other rights, powers and privileges of a holder of ASR shares,with the exception that the recipient may not transfer the ASR shares duringthe restriction period. Compensation expense is recognized on a straight-linebasis over the vesting period. For the period ended December 31, 2003,2004 and 2005, $332,000, $101,000 and $55,000, respectively, was recognized asexpense for restricted shares issued. As of December 31, 2005, all sharesissued as restricted stock are fully vested and compensation expense torestricted shares issued have been recognized in their entirety.

**NOTE17. COMMITMENTS AND CONTINGENCIES**

The following is information concerning legalproceedings to which the Company or its subsidiaries is a party or of which anyof their property is subject:

The Company is a defendant in a lawsuit related to thesale of Van Buren, a parcel of undeveloped land sold in September 2004. Thelawsuit, filed January 21, 2005 in the United States District Court forthe Southern District of California, is associated with a participating profitsagreement. The plaintiff, Warren F. Ryan, seeks general damages, includinginterest, of $700,000 or according to proof at trial; special damages in anunspecified amount; declaratory relief, and miscellaneous relief such asattorney’s fees and 

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costs. Discovery hascommenced in this action and, under the current schedule, discovery is set toclose on May 31, 2006. The Court has not set a trial date. The Companybelieves that this claim is without merit and is vigorously defending itself.

The Company is aware that two of its properties maycontain hazardous substances above reportable levels. Both properties are inlocated their respective state’s environmental funds. During 2005, the Companyaccrued a $75,000 liability for future environmental cleanup efforts for one ofthe properties. These efforts, which have been approved by the regulatoryauthorities, will take place over the next two years. The accrual is reflectedon the Company’s consolidated financial statements as of December 31, 2005.It is anticipated that cleanup costs for the other property will be paid by thestate. Consequently, no amount has been accrued in the Company’s consolidatedfinancial statements for the other property.

In connection with the acquisition of an officeproperty in August 2004, the Company entered into an agreement with theseller in which the seller would participate in any profits generated from thefuture sale of the property. In August 2005, the Company terminated theparticipating profits agreement for consideration of $10,000 paid by theCompany.

Certain claims andlawsuits have arisen against the Company in its normal course of business. TheCompany believes that such claims and lawsuits will not have a material adverseeffect on the Company’s financial position, cash flow or results of operations.

**NOTE 18. SEGMENT INFORMATION**

As of December 31, 2005, the Company owned adiverse portfolio of properties comprising office, industrial and a shoppingcenter property. Each of these property types represents a reportable segmentwith distinct uses and tenant types and requires the Company to employdifferent management strategies. The properties contained in the segments arelocated in various regions and markets within the United States. The officeportfolio consists primarily of suburban office buildings. The industrialportfolio consists of properties designed for warehouse, distribution and lightmanufacturing for single-tenant or multi-tenant use. The Company’s soleremaining shopping center property is located in Columbia, South Carolina.

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Theaccounting policies of the segments are the same as those described in the summaryof significant accounting policies. The Company evaluates performance of itsproperty types based on net operating income derived by subtracting propertyoperating expenses from rental revenue. Significant information used by theCompany for its reportable segments as of and for the years ended December 31,2005, 2004, and 2003 is as follows (dollars in thousands):

| ** **                   | ** ** | **Office** | ** ** | **Industrial** | ** ** | **Shopping Center** | ** ** | **Other** | ** ** | **Property Total** | ** ** |
|------------------------------|------------|------------|------------|----------------|------------|--------------------------|------------|-----------|------------|-------------------------|------------|
| **2005**                     |       |       |       |           |       |                     |       |      |       |                    |       |   |   |   |   |   |   |   |   |
| Rental revenue               |       | $          | 17,397     |           |       | $                        | 2,241      |      |       |                    | $          | 281 |   |   |   | $ | — |   |   |   | $ | 19,919 |   |   |
| Property  operating expenses |       | 7,917      |       |           | 687        |                     |       |      | 76         |                    |       |   | 36 |   |   |   | 8,716 |   |   |
| Net operating  income (NOI)  |       | $          | 9,480      |           |       | $                        | 1,554      |      |       |                    | $          | 205 |   |   |   | $ | (36 | ) |   |   | $ | 11,203 |   |   |
| Real estate  assets, net     |       | $          | 111,183    |           |       | $                        | 13,860     |      |       |                    | $          | 1,635 |   |   |   | $ | 33 |   |   |   | $ | 126,711 |   |   |
| **2004**                     |       |       |       |           |       |                     |       |      |       |                    |       |   |   |   |   |   |   |   |   |
| Rental revenue               |       | $          | 16,861     |           |       | $                        | 2,348      |      |       |                    | $          | 289 |   |   |   | $ | — |   |   |   | $ | 19,498 |   |   |
| Property  operating expenses |       | 6,483      |       |           | 528        |                     |       |      | 67         |                    |       |   | 35 |   |   |   | 7,113 |   |   |
| Net operating  income (NOI)  |       | $          | 10,378     |           |       | $                        | 1,820      |      |       |                    | $          | 222 |   |   |   | $ | (35 | ) |   |   | $ | 12,385 |   |   |
| Real estate  assets, net     |       | $          | 114,258    |           |       | $                        | 14,618     |      |       |                    | $          | 1,704 |   |   |   | $ | 50 |   |   |   | $ | 130,630 |   |   |
| **2003**                     |       |       |       |           |       |                     |       |      |       |                    |       |   |   |   |   |   |   |   |   |
| Rental revenue               |       | $          | 14,610     |           |       | $                        | 2,412      |      |       |                    | $          | 295 |   |   |   | $ | 57 |   |   |   | $ | 17,374 |   |   |
| Property  operating expenses |       | 5,630      |       |           | 595        |                     |       |      | 120        |                    |       |   | 74 |   |   |   | 6,419 |   |   |
| Net operating  income (NOI)  |       | $          | 8,980      |           |       | $                        | 1,817      |      |       |                    | $          | 175 |   |   |   | $ | (17 | ) |   |   | $ | 10,955 |   |   |
| Real estate assets, net      |       | $          | 108,968    |           |       | $                        | 15,331     |      |       |                    | $          | 1,836 |   |   |   | $ | 99 |   |   |   | $ | 126,234 |   |   |

 

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Thefollowing is a reconciliation of segment revenues, income and assets toconsolidated revenues, income and assets for the periods presented above(dollars in thousands):

| ** **                                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **REVENUES**                                                                                                           |       |     |       |     |       |     |       |
| Total revenues  for reportable segments                                                                                |       | $        | 19,919     |     | $          | 19,498   |       | $ | 17,374 |   |
| Other revenues                                                                                                         |       | 350      |       | 235      |       | 139      |       |
| Total  consolidated revenues                                                                                           |       | $        | 20,269     |     | $          | 19,733   |       | $ | 17,513 |   |
| **NET INCOME**                                                                                                         |       |     |       |     |       |     |       |
| NOI for  reportable segments                                                                                           |       | $        | 11,203     |     | $          | 12,385   |       | $ | 10,955 |   |
| Unallocated  amounts:                                                                                                  |       |     |       |     |       |     |       |
| Interest and other income                                                                                              |       | 350      |       | 235      |       | 139      |       |
| General and administrative expenses                                                                                    |       | (3,703   | )          | (4,438   | )          | (6,801   | )          |
| Depreciation and amortization                                                                                          |       | (8,464   | )          | (7,534   | )          | (6,444   | )          |
| Interest expense                                                                                                       |       | (8,824   | )          | (9,273   | )          | (7,843   | )          |
| Net loss on extinguishment of debt                                                                                     |       | (95      | )          | (116     | )          | (145     | )          |
| Net loss from  operations before deferred income tax benefit (expense), minority interest  and discontinued operations |       | (9,533   | )          | (8,741   | )          | (10,139  | )          |
| Deferred income  tax benefit (expense)                                                                                 |       | 3,360    |       | 2,222    |       | (278     | )          |
| Minority interest                                                                                                      |       | 320      |       | 1,299    |       | 2,124    |       |
| Income (loss)  from discontinued operations                                                                            |       | 3,587    |       | (3,887   | )          | (6,055   | )          |
| Net loss                                                                                                               |       | $        | (2,266     | )        | $          | (9,107   | )          | $ | (14,348 | ) |
| **ASSETS**                                                                                                             |       |     |       |     |       |     |       |
| Total assets for  reportable segments                                                                                  |       | $        | 126,711    |     | $          | 130,630  |       | $ | 126,234 |   |
| Real estate held  for sale                                                                                             |       | 22,272   |       | 43,198   |       | 59,914   |       |
| Cash and cash  equivalents                                                                                             |       | 300      |       | 589      |       | 2,937    |       |
| Tenant and other  receivables, net                                                                                     |       | 455      |       | 539      |       | 364      |       |
| Deferred rent  receivable                                                                                              |       | 1,245    |       | 1,138    |       | 784      |       |
| Deferred tax  asset                                                                                                    |       | 53       |       | —   |       | —   |       |
| Mortgage loan  receivable, net of discount                                                                             |       | —   |       | —   |       | 1,667    |       |
| Insurance  proceeds receivable                                                                                         |       | —   |       | —   |       | 6,500    |       |
| Investment in  management company                                                                                      |       | 4,000    |       | 4,000    |       | 4,000    |       |
| Deposits held in  escrow for tax-deferred exchanges                                                                    |       | 5,210    |       | —   |       | —   |       |
| Prepaid and other  assets, net                                                                                         |       | 8,939    |       | 7,451    |       | 5,603    |       |
| Total consolidated  assets                                                                                             |       | $        | 169,185    |     | $          | 187,545  |       | $ | 208,003 |   |

 

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**NOTE19. UNAUDITED QUARTERLY RESULTS OF OPERATIONS**

Thefollowing represents an unaudited summary of quarterly results of operationsfor the year ended December 31, 2005 (dollars in thousands, except for pershare amounts):

| ** **                                                         | ** ** | **Quarter Ended**   | ** ** |
|--------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **March 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
| **REVENUES:**                                                      |       |                     |       |   |   |   |   |   |   |   |   |
| Rental revenue                                                     |       |                     | $          | 4,967 |   |   | $ | 4,910 |   | $ | 5,051 |   | $ | 4,991 |   |
| Interest and  other income                                         |       |                     | 49         |   |   | 208 |   | 80 |   | 13 |   |
| Total revenues                                                     |       |                     | 5,016      |   |   | 5,118 |   | 5,131 |   | 5,004 |   |
| **EXPENSES:**                                                      |       |                     |       |   |   |   |   |   |   |   |   |
| Operating expenses                                                 |       |                     | 2,882      |   |   | 2,965 |   | 3,341 |   | 3,231 |   |
| Depreciation and  amortization                                     |       |                     | 2,032      |   |   | 2,078 |   | 2,132 |   | 2,222 |   |
| Interest expense                                                   |       |                     | 2,248      |   |   | 2,183 |   | 2,209 |   | 2,184 |   |
| Total expenses                                                     |       |                     | 7,162      |   |   | 7,226 |   | 7,682 |   | 7,637 |   |
| **OTHER  LOSS:**                                                   |       |                     |       |   |   |   |   |   |   |   |   |
| Net loss on  extinguishment of debt                                |       |                     | —     |   |   | — |   | — |   | (95 | ) |
| Total other loss                                                   |       |                     | —     |   |   | — |   | — |   | (95 | ) |
| Net loss before deferred income tax benefit and  minority interest |       |                     | (2,146     | ) |   | (2,108 | ) | (2,551 | ) | (2,728 | ) |
| Deferred income  tax benefit                                       |       |                     | —     |   |   | — |   | — |   | 3,360 |   |
| Net loss before  minority interest                                 |       |                     | (2,146     | ) |   | (2,108 | ) | (2,551 | ) | 632 |   |
| Minority interest                                                  |       |                     | 29         |   |   | 329 |   | 197 |   | (235 | ) |
| Net loss from  continuing operations                               |       |                     | (2,117     | ) |   | (1,779 | ) | (2,354 | ) | 397 |   |
| Income (loss)  from discontinued operations                        |       |                     | 1,918      |   |   | (494 | ) | 1,021 |   | 1,142 |   |
| Net (loss) income                                                  |       |                     | $          | (199 | ) |   | $ | (2,273 | ) | $ | (1,333 | ) | $ | 1,539 |   |
| Basic and diluted per  share data:                                 |       |                     |       |   |   |   |   |   |   |   |   |
| Net loss from continuing operations                                |       |                     | $          | (1.41 | ) |   | $ | (1.21 | ) | $ | (1.63 | ) | $ | 0.28 |   |
| Income (loss) from discontinued operations                         |       |                     | 1.28       |   |   | (0.33 | ) | 0.71 |   | 0.81 |   |
| Net (loss) income                                                  |       |                     | $          | (0.13 | ) |   | $ | (1.54 | ) | $ | (0.92 | ) | $ | 1.09 |   |

 

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Thefollowing represents an unaudited summary of quarterly results of operationsfor the year ended December 31, 2004 (dollars in thousands, except for pershare amounts):

| ** **                                                         | ** ** | **Quarter Ended**   | ** ** |
|--------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                         | ** ** | **March 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Sept 30,  2004** | ** ** | **Dec 31,  2004** | ** ** |
| **REVENUES:**                                                      |       |                     |       |   |   |   |   |   |   |   |   |
| Rental revenue                                                     |       |                     | $          | 4,954 |   |   | $ | 4,824 |   | $ | 4,594 |   | $ | 5,126 |   |
| Interest and  other income                                         |       |                     | 80         |   |   | 82 |   | 49 |   | 24 |   |
| Total revenues                                                     |       |                     | 5,034      |   |   | 4,906 |   | 4,643 |   | 5,150 |   |
| **EXPENSES:**                                                      |       |                     |       |   |   |   |   |   |   |   |   |
| Operating  expenses                                                |       |                     | 2,819      |   |   | 2,906 |   | 3,113 |   | 2,713 |   |
| Depreciation and  amortization                                     |       |                     | 1,819      |   |   | 1,871 |   | 1,859 |   | 1,985 |   |
| Interest expense                                                   |       |                     | 2,248      |   |   | 2,326 |   | 2,361 |   | 2,338 |   |
| Total expenses                                                     |       |                     | 6,886      |   |   | 7,103 |   | 7,333 |   | 7,036 |   |
| **OTHER  INCOME (LOSS):**                                          |       |                     |       |   |   |   |   |   |   |   |   |
| (Loss) income on  extinguishment of debt                           |       |                     | —     |   |   | — |   | (214 | ) | 98 |   |
| Total other (loss) income                                          |       |                     | —     |   |   | — |   | (214 | ) | 98 |   |
| Net loss before deferred income tax expense and  minority interest |       |                     | (1,852     | ) |   | (2,197 | ) | (2,904 | ) | (1,788 | ) |
| Deferred income  tax benefit                                       |       |                     | —     |   |   | — |   | — |   | 2,222 |   |
| Net (loss) income  before minority interest                        |       |                     | (1,852     | ) |   | (2,197 | ) | (2,904 | ) | 434 |   |
| Minority interest                                                  |       |                     | 263        |   |   | 423 |   | 704 |   | (91 | ) |
| Net (loss) income  from continuing operations                      |       |                     | (1,589     | ) |   | (1,774 | ) | (2,200 | ) | 343 |   |
| Net (loss) income  from discontinued operations                    |       |                     | (236       | ) |   | (1,157 | ) | (2,760 | ) | 266 |   |
| Net (loss) income                                                  |       |                     | $          | (1,825 | ) |   | $ | (2,931 | ) | $ | (4,960 | ) | $ | 609 |   |
| Basic and diluted per  share data:                                 |       |                     |       |   |   |   |   |   |   |   |   |
| Net (loss) income from continuing operations                       |       |                     | $          | (1.02 | ) |   | $ | (1.14 | ) | $ | (1.41 | ) | $ | 0.23 |   |
| (Loss) income from discontinued operations                         |       |                     | (0.15      | ) |   | (0.74 | ) | (1.76 | ) | 0.17 |   |
| Net (loss) income                                                  |       |                     | $          | (1.17 | ) |   | $ | (1.88 | ) | $ | (3.17 | ) | $ | 0.40 |   |

 

**NOTE 20. SUBSEQUENT EVENTS**

On March 14, 2006, the Company sold Countryside,a 82,873 square foot office property located in Palatine, Illinois for a salesprice of $7,950,000. Proceeds of approximately $1,600,000 were received as aresult of the transaction, of which approximately $1,100,000 is being held inescrow to assist the funding of a future acquisition in a tax-deferredexchange.

On February 10, 2006, the Company purchased 2470Gray Falls, a 41,475 square foot office property located in Houston, Texas. Acquisitioncosts of approximately $2,600,000 consisted of seller financing and proceedsfrom a tax-deferred exchange.

On February 2, 2006, the Company purchased 2401Fountainview, a 174,369 square foot office property located in Houston, Texas. Acquisitioncosts of approximately $17,000,000 consisted of a new mortgage loan andproceeds from a tax deferred exchange.

On January 13, 2006, the Company sold Mira Mesa,a 88,295 square foot office property located in San Diego, California for asales price of $20,258,000. Proceeds of approximately $7,000,000 were receivedas a result of the transaction, of which approximately $6,000,000 is being heldin escrow to assist the funding of a future acquisition in a tax-deferredexchange. The Company anticipates a gain will be recorded in the first quarterof 2006 as a result of the sale.

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On January 6, 2006, the Company sold Sorrento II,a 88,073 square foot industrial property located in San Diego, California for asales price of $18,300,000. Proceeds of approximately $2,700,000 were receivedas a result of the transaction, of which approximately $1,800,000 is being heldin escrow to assist the funding of a future acquisition in a tax-deferredexchange. The Company anticipates a gain will be recorded in the first quarterof 2006 as a result of the sale.

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**AMERICAN SPECTRUMREALTY, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS(Dollars in thousands)**

| **COLUMN A**                                                                          | ** ** | **COLUMN B** | ** ** | **COLUMN C**                               | ** ** | **COLUMN D**                                                | ** ** | **COLUMN E** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------|------------|-------------------|------------|
| **Description**                                                                            | ** ** | ** **        | ** ** | **Balance at  Beginning of  Year(1)** | ** ** | **Additions Charged to  Costs and Expenses** | ** ** | **Deductions**    | ** ** | **Balance at  End of Year** | ** ** |
| Year Ended December 31, 2005****Allowance for loss on real estate held for investment |       |              | $          | 472                                             |       |                                                             |       | $                 | —     |   |   |   | $ | — |   |   |   | $ | 472 |   |   |
| Year Ended December 31, 2004****Allowance for loss on real estate held for investment |       |              | $          | 472                                             |       |                                                             |       | $                 | —     |   |   |   | $ | — |   |   |   | $ | 472 |   |   |
| Year Ended December 31, 2003****Allowance for loss on real estate held for investment |       |              | $          | 472                                             |       |                                                             |       | $                 | —     |   |   |   | $ | — |   |   |   | $ | 472 |   |   |
|                                                                                            |            |                   |            |                                                 |            |                                                                  |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Valuation allowance of$472 on Columbia NE (the Company’s shopping center property) established in2002 as the estimated fair market value declined below book value.

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**AMERICAN SPECTRUM REALTY, INC. SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 2005 (Dollars in thousands)**

| COLUMN A                    | ** ** | **COLUMN B** | ** ** | **COLUMN C**                         | ** ** | **COLUMN D**                                             | ** ** | **COLUMN E**                                                          | ** ** |
|----------------------------------|------------|-------------------|------------|-------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                       | ** ** | ** **        | ** ** | **Initial Cost  to Company(1)** | ** ** | **Cost capitalized  subsequent to  acquisition(3)** | ** ** | **Gross amount carried at  December 31, 2005(4)** | ** ** |
| **Description**                  | ** ** | ** **        | ** ** | **Encumbrances**                          | ** ** | **Land**                                                      | ** ** | **Buildings  and  Improvements**                                           | ** ** | **Improvements** | ** ** | **Land** | ** ** | **Buildings  and  Improvements** | ** ** | **Total** | ** ** |
| Office Properties:               |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| San Felipe, TX                   |       |              | $          | 5,415                                     |       |                                                          | $          | 2,290                                                                      |       |   | $ | 4,290 |   |   |   | $ | 758 |   |   | $ | 2,290 |   |   | $ | 5,048 |   |   | $ | 7,338 |   |
| Creekside, CA                    |       |              | 6,149      |                                      |       | 2,790                                                         |       |                                                                       | 6,460      |   |   |   | 406 |   |   | 2,790 |   |   | 6,866 |   |   | 9,656 |   |
| Bristol Bay, CA                  |       |              | 7,276      |                                      |       | 1,620                                                         |       |                                                                       | 7,880      |   |   |   | 257 |   |   | 1,620 |   |   | 8,137 |   |   | 9,757 |   |
| 7700 Building, CA                |       |              | 33,498     |                                      |       | 9,150                                                         |       |                                                                       | 40,390     |   |   |   | 2,057 |   |   | 9,150 |   |   | 42,447 |   |   | 51,597 |   |
| Northwest Corporate Center, MO   |       |              | 5,667      |                                      |       | 1,550                                                         |       |                                                                       | 5,230      |   |   |   | 1,532 |   |   | 1,550 |   |   | 6,762 |   |   | 8,312 |   |
| 16350 Park Ten, TX               |       |              | 5,212      |                                      |       | 1,174                                                         |       |                                                                       | 5,324      |   |   |   | 299 |   |   | 1,174 |   |   | 5,623 |   |   | 6,797 |   |
| 16360 Park Ten, TX               |       |              | 4,084      |                                      |       | 900                                                           |       |                                                                       | 4,192      |   |   |   | 445 |   |   | 900 |   |   | 4,637 |   |   | 5,537 |   |
| 800 Sam Houston Parkway, TX      |       |              | 2,200      |                                      |       | 1,000                                                         |       |                                                                       | 1,121      |   |   |   | 418 |   |   | 1,000 |   |   | 1,539 |   |   | 2,539 |   |
| 888 Sam Houston Parkway, TX      |       |              | 2,200      |                                      |       | 500                                                           |       |                                                                       | 892        |   |   |   | 317 |   |   | 500 |   |   | 1,209 |   |   | 1,709 |   |
| 5450 Northwest Central, TX  |       |              | 2,791      |                                      |       | 854                                                           |       |                                                                       | 2,622      |   |   |   | 291 |   |   | 854 |   |   | 2,913 |   |   | 3,767 |   |
| 12000 Westheimer, TX             |       |              | 3,542      |                                      |       | 1,878                                                         |       |                                                                       | 2,432      |   |   |   | 150 |   |   | 1,878 |   |   | 2,582 |   |   | 4,460 |   |
| 8100 Washington, TX              |       |              | 2,329      |                                      |       | 600                                                           |       |                                                                       | 2,317      |   |   |   | 65 |   |   | 600 |   |   | 2,382 |   |   | 2,982 |   |
| 8300 Bissonnet, TX               |       |              | 4,758      |                                      |       | 1,400                                                         |       |                                                                       | 3,990      |   |   |   | 92 |   |   | 1,400 |   |   | 4,082 |   |   | 5,482 |   |
| Pacific Spectrum, AZ             |       |              | 5,571      |                                      |       | 1,460                                                         |       |                                                                       | 6,880      |   |   |   | 787 |   |   | 1,460 |   |   | 7,667 |   |   | 9,127 |   |
| 11500 NW Freeway, TX             |       |              | 4,635      |                                      |       | 2,278                                                         |       |                                                                       | 3,621      |   |   |   | 245 |   |   | 2,278 |   |   | 3,866 |   |   | 6,144 |   |
| Office Total                     |       |              | $          | 95,327                                    |       |                                                          | $          | 29,444                                                                     |       |   | $ | 97,641 |   |   |   | $ | 8,119 |   |   | $ | 29,444 |   |   | $ | 105,760 |   |   | $ | 135,204 |   |
| Industrial Properties:           |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Southwest Point, TX              |       |              | 2,855      |                                      |       | 1,800                                                         |       |                                                                       | 1,530      |   |   |   | 296 |   |   | 1,800 |   |   | 1,826 |   |   | 3,626 |   |
| Morenci Professional Park, IN    |       |              | 1,786      |                                      |       | 790                                                           |       |                                                                       | 2,680      |   |   |   | 58 |   |   | 790 |   |   | 2,738 |   |   | 3,528 |   |
| Technology, TX                   |       |              | 7,532      |                                      |       | 580                                                           |       |                                                                       | 9,360      |   |   |   | 53 |   |   | 580 |   |   | 9,413 |   |   | 9,993 |   |
| Industrial Total                 |       |              | $          | 12,173                                    |       |                                                          | $          | 3,170                                                                      |       |   | $ | 13,570 |   |   |   | $ | 407 |   |   | $ | 3,170 |   |   | $ | 13,977 |   |   | $ | 17,147 |   |
| Shopping Center Property:        |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Columbia NE, SC(2)               |       |              | 2,788      |                                      |       | 1,050                                                         |       |                                                                       | 1,530      |   |   |   | 103 |   |   | 1,050 |   |   | 1,161 |   |   | 2,211 |   |
| Shopping Center Total            |       |              | $          | 2,788                                     |       |                                                          | $          | 1,050                                                                      |       |   | $ | 1,530 |   |   |   | $ | 103 |   |   | $ | 1,050 |   |   | $ | 1,161 |   |   | $ | 2,211 |   |
| Other:                           |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| American Spectrum Realty         |       |              | 2,000      |                                      |       | —                                                        |       |                                                                       | 138        |   |   |   | 126 |   |   | — |   |   | 264 |   |   | 264 |   |
| Other Total                      |       |              | $          | 2,000                                     |       |                                                          | $          | —                                                                     |       |   | $ | 138 |   |   |   | $ | 126 |   |   | $ | — |   |   | $ | 264 |   |   | $ | 264 |   |
| Combined Total                   |       |              | $          | 112,288                                   |       |                                                          | $          | 33,664                                                                     |       |   | $ | 112,879 |   |   |   | $ | 8,755 |   |   | $ | 33,664 |   |   | $ | 121,162 |   |   | $ | 154,826 |   |
| Real Estate Held for Sale        |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Office Properties:               |       |              |       |                                      |       |                                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mira Mesa, CA                    |       |              | 12,500     |                                      |       | 810                                                           |       |                                                                       | 6,904      |   |   |   | 2,518 |   |   | 810 |   |   | 9,422 |   |   | 10,232 |   |
| Sorrento II, CA                  |       |              | 8,834      |                                      |       | 780                                                           |       |                                                                       | 7,079      |   |   |   | 1,392 |   |   | 780 |   |   | 8,471 |   |   | 9,251 |   |
| Countryside Office Park, IL      |       |              | 4,852      |                                      |       | 2,027                                                         |       |                                                                       | 4,000      |   |   |   | 680 |   |   | 2,027 |   |   | 4,680 |   |   | 6,707 |   |
| Total                            |       |              | $          | 26,186                                    |       |                                                          | $          | 3,617                                                                      |       |   | $ | 17,983 |   |   |   | $ | 4,590 |   |   | $ | 3,617 |   |   | $ | 22,573 |   |   | $ | 26,190 |   |
|                                  |            |                   |            |                                           |            |                                                               |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

64

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**AMERICAN SPECTRUM REALTY, INC. SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 2005 (Dollars in thousands)**

 

| **COLUMN A**                      | ** ** | **COLUMN F** | ** ** | **COLUMN G**             | ** ** | **COLUMN H**              | ** ** | **COLUMN I**      | ** ** |
|----------------------------------------|------------|-------------------|------------|-------------------------------|------------|--------------------------------|------------|------------------------|------------|
| **Description**                        | ** ** | ** **        | ** ** | **Accumulated  Depreciation** | ** ** | **Date of  Construction** | ** ** | **Date Acquired** | ** ** | **Life on which depreciation  in latest income statements  is computed** | ** ** |
| Office Properties:                     |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| San Felipe, TX                         |       |              | 1,158      |                          |       |                           | 1977       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Creekside, CA                          |       |              | 1,738      |                          |       |                           | 1984       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Bristol Bay, CA                        |       |              | 1,980      |                          |       |                           | 1988       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| 7700 Building CA                       |       |              | 10,708     |                          |       |                           | 1989       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Northwest Corporate Center, MO         |       |              | 1,669      |                          |       |                           | 1983-1987  |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| 16350 Park Ten, TX                     |       |              | 1,232      |                          |       |                           | 1979       |                   |       |   | 2002 |   |   |   | 5-40 |   |   |
| 16360 Park Ten, TX                     |       |              | 1,062      |                          |       |                           | 1981       |                   |       |   | 2002 |   |   |   | 5-40 |   |   |
| 800 Sam Houston Parkway, TX            |       |              | 150        |                          |       |                           | 1980       |                   |       |   | 2004 |   |   |   | 5-40 |   |   |
| 888 Sam Houston Parkway, TX            |       |              | 267        |                          |       |                           | 1979       |                   |       |   | 2002 |   |   |   | 5-40 |   |   |
| 5450 Northwest Central, TX             |       |              | 442        |                          |       |                           | 1979       |                   |       |   | 2003 |   |   |   | 5-40 |   |   |
| 12000 Westheimer, TX                   |       |              | 444        |                          |       |                           | 1981       |                   |       |   | 2003 |   |   |   | 5-40 |   |   |
| 8100 Washington, TX                    |       |              | 345        |                          |       |                           | 1980       |                   |       |   | 2003 |   |   |   | 5-40 |   |   |
| 8300 Bissonnet, TX                     |       |              | 525        |                          |       |                           | 1981       |                   |       |   | 2003 |   |   |   | 5-40 |   |   |
| Pacific Spectrum, AZ                   |       |              | 2,023      |                          |       |                           | 1986       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| 11500 NW Freeway, TX                   |       |              | 278        |                          |       |                           | 1983       |                   |       |   | 2004 |   |   |   | 5-40 |   |   |
| Office Total                           |       |              | $          | 24,021                        |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
| Industrial Properties:                 |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| Southwest Point, TX                    |       |              | 564        |                          |       |                           | 1972       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Morenci Professional Park, IN          |       |              | 692        |                          |       |                           | 1975-1979  |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Technology, TX                         |       |              | 2,031      |                          |       |                           | 1986       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Industrial Total                       |       |              | $          | 3,287                         |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
| Shopping Center Property:              |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| Columbia NE, SC(2)                     |       |              | 576        |                          |       |                           | 1991       |                   |       |   | 2001 |   |   |   | 5-25 |   |   |
| Shopping Center  Total                 |       |              | $          | 576                           |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
| Other:                                 |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| American Spectrum Realty—FF&E |       |              | 231        |                          |       |                           | —     |                   |       |   | — |   |   |   | 3-5 |   |   |
| Other Total                            |       |              | $          | 231                           |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
| Combined Total                         |       |              | $          | 28,115                        |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
| Real Estate Held for Sale              |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| Industrial Properties:                 |       |              |       |                          |       |                           |       |                   |       |   |   |   |   |   |   |   |   |
| Mira Mesa, CA                          |       |              | 2,674      |                          |       |                           | 1986       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Sorrento II, CA                        |       |              | 2,085      |                          |       |                           | 1988       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Countryside, IL                        |       |              | 1,447      |                          |       |                           | 1984       |                   |       |   | 2001 |   |   |   | 5-40 |   |   |
| Total                                  |       |              | $          | 6,206                         |       |                           |       |                   |       |   |   |   |   |   |   |   |   |   |
|                                        |            |                   |            |                               |            |                                |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |

----

(1)           Initial cost and date acquired, where applicable.

(2)           Valuation allowance of $472 established in 2002 as theestimated fair market value declined below book value.

(3)           Costs capitalized are offset by retirements andwrite-offs.

(4)           The aggregate cost for federal income tax purposes is$94,849.

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**AMERICAN SPECTRUM REALTY, INC. SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 2005 (Dollars in thousands)**

Reconciliationof gross amount at which real estate was carried for the years ended December 31:

| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Rental  Property:**               |       |     |       |     |       |     |       |
| Balance at  beginning of year       |       | $        | 150,769    |     | $          | 139,152  |       | $ | 123,309 |   |
| Additions during  year:             |       |     |       |     |       |     |       |
| Property acquisitions and additions |       | 4,118    |       | 11,640   |       | 16,128   |       |
| Retirements/sales                   |       | (61      | )          | (23      | )          | (285     | )          |
| Balance at end of  year             |       | $        | 154,826    |     | $          | 150,769  |       | $ | 139,152 |   |
| **Accumulated Depreciation:**       |       |     |       |     |       |     |       |
| Balance at  beginning of year       |       | $        | 20,139     |     | $          | 12,918   |       | $ | 6,702 |   |
| Additions during  year:             |       |     |       |     |       |     |       |
| Depreciation                        |       | 8,037    |       | 7,244    |       | 6,307    |       |
| Retirements/sales                   |       | (61      | )          | (23      | )          | (91      | )          |
| Balance at end of year              |       | $        | 28,115     |     | $          | 20,139   |       | $ | 12,918 |   |

 

66

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

**AMERICAN SPECTRUM REALTY INC**

By: American Spectrum Realty Inc.,

| Date: March 15, 2006  | * * | */s/*WILLIAM J. CARDEN                                                                                           |
|----------------------------|----------|------------------------------------------------------------------------------------------------------------------|
|                       |     | William J. Carden  Chairman of the Board, President, Chief Executive Officer and Acting Chief  Financial Officer |
| Date: March 15,  2006 |     | /s/ G. ANTHONY EPPOLITO                                                                                          |
|                       |     | G. Anthony Eppolito  Vice President, Treasurer and Secretary*(Principal Accounting Officer)*                     |
| Date: March 15,  2006 |     | /s/ TIMOTHY R. BROWN                                                                                             |
|                       |     | Timothy R. Brown                                                                                                 |
|                       | * * | Director                                                                                                         |
| Date: March 15,  2006 |     | /s/ WILLIAM W. GEARY, JR.                                                                                   |
|                       |     | William W. Geary, Jr.                                                                                       |
|                       |     | Director                                                                                                         |
| Date: March 15,  2006 |     | /s/ LAWRENCE E. FIEDLER                                                                                          |
|                       | * * | Lawrence E. Fiedler                                                                                              |
|                       |     | Director                                                                                                         |
| Date: March 15,  2006 |     | /s/ JOHN N. GALARDI                                                                                              |
|                       | * * | John N. Galardi                                                                                                  |
|                       |     | Director                                                                                                         |
| Date: March 15,  2006 |     | /s/ JOHN F. ITZEL                                                                                                |
|                       | * * | John F. Itzel                                                                                                    |
|                       |     | Director                                                                                                         |

 

67

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**EXHIBIT INDEX**

| Exhibit No.     | ** ** | **Exhibit Title**                                                                                                                                                                 |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.1 |       | Form of  Amended and Restated Articles of Incorporation of the Company(1)                                                                                                         |
|   3.2 |       | Bylaws of the  Company(1)                                                                                                                                                              |
|   3.3 |       | Amended and  Restated Bylaws of the Company are incorporated herein by reference to  Exhibit 3.01 to the Company’s Form 10-Q for the quarter ended  June 30, 2002. |
|   3.4 |       | Articles of  Amendment of the Company are incorporated herein by reference to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2003.          |
|   4.1 |       | Form of  Stock Certificate(1)                                                                                                                                                     |
| 10.1            |       | Form of  Agreement and Plan of Merger of Sierra-Pacific Development Fund(1)                                                                                                       |
| 10.2            |       | Form of  Agreement and Plan of Merger of Sierra-Pacific Development Fund II(1)                                                                                                    |
| 10.3            |       | Form of  Agreement and Plan of Merger of Sierra-Pacific Development Fund III(1)                                                                                                   |
| 10.4            |       | Form of  Agreement and Plan of Merger of Sierra Pacific Pension Investors ‘84(1)                                                                                             |
| 10.5            |       | Form of  Agreement and Plan of Merger of Sierra Pacific Institutional Properties V(1)                                                                                             |
| 10.6            |       | Form of  Agreement and Plan of Merger of Nooney Income Fund Ltd., L.P.(1)                                                                                                         |
| 10.7            |       | Form of  Agreement and Plan of Merger of Nooney Income Fund Ltd., L.P.(1)                                                                                                         |
| 10.8            |       | Form of  Agreement and Plan of Merger of Nooney Real Property Investors—Two, L.P.(1)                                                                                         |
| 10.9            |       | Omnibus Stock  Incentive Plan(1)                                                                                                                                                       |
| 10.10           |       | Agreement of  Limited Partnership of American Spectrum Realty Operating Partnership, L.P.(1)                                                                                           |
| 10.11           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and CGS  Properties (Mkt./Col.), L.P.(1)                                                                 |
| 10.12           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and  Creekside/Riverside, L.L.C.(1)                                                                      |
| 10.13           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and McDonnell  Associates, L.L.C.(1)                                                                     |
| 10.14           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and Pacific  Spectrum, L.L.C.(1)                                                                         |
| 10.15           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and Pasadena  Autumn Ridge L.P.(1)                                                                       |
| 10.16           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and Seventy  Seven, L.L.C.(1)                                                                       |
| 10.17           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and Villa  Redondo L.L.C.(1)                                                                        |
| 10.18           |       | Agreement and  Plan of Merger, dated August 6, 2000, between the Company and Third  Coast L.L.C.(1)                                                                          |
| 10.19           |       | Agreement and  Plan of Contribution, dated August 6, 2000, between the Company and No.-So., Inc.(1)                                                                          |

68

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| 10.20 |   | Form of  Restricted Stock Agreement(1)                                                                                                                                                                                                                                                          |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.21 |   | Form of  Stock Option Agreement (Incentive Stock Options)(1)                                                                                                                                                                                                                                    |
| 10.22 |   | Form of  Stock Option Agreement (Directors)(1)                                                                                                                                                                                                                                                  |
| 10.23 |   | Form of  Stock Option Agreement (Non-Qualified Options)(1)                                                                                                                                                                                                                                      |
| 10.24 |   | Form of  Indenture Relating to Notes(1)                                                                                                                                                                                                                                                         |
| 10.25 |   | Contribution  Agreement, dated May 31, 2000, between the Company and CGS Real Estate  Company, Inc.(1)                                                                                                                                                                                     |
| 10.26 |   | Contribution  Agreement, dated May 31, 2000, between the Company and American Spectrum  Real Estate Services, Inc.(1)                                                                                                                                                                      |
| 10.27 |   | Agreement and  Plan of Merger, dated May 31, 2001, between the Company and Lindbergh  Boulevard Partners (Lindbergh), L.P.(1)                                                                                                                                                                   |
| 10.28 |   | Agreement and  Plan of Merger, dated May 31, 2001, between the Company and Nooney Rider  Trail L.L.C.(1)                                                                                                                                                                                        |
| 10.29 |   | Agreement and  Plan of Merger, dated May 31, 2001, between the Company and Back Bay L.L.C.(1)                                                                                                                                                                                              |
| 10.30 |   | Contribution  Agreement, dated May 31, 2001, between American Spectrum Realty Management, Inc.  and CGS Real Estate Company, Inc., American Spectrum—Midwest, American  Spectrum—Arizona, American Spectrum—California and American  Spectrum—Texas, Inc.(1) |
| 10.31 |   | Amendment of  Agreement Plan of Merger between the Company and Villa Redondo L.L.C. is  incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2001                                                                            |
| 10.32 |   | Amendment of  Agreement Plan of Merger between the Company and Pasadena Autumn Ridge, L.P.  is incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2001                                                                |
| 10.33 |   | Amendment of  Agreement Plan of Merger between the Company and Third Coast L.L.C. is  incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2001                                                                              |
| 10.34 |   | Registration  Right’s Agreement between the Company, the Operating Partnership, and other  parties is incorporated herein by reference to the Company’s Annual Report on  Form 10-K for the year ended December 31, 2001                                                         |
| 10.35 |   | Employment  Agreement dated October 15, 2001 between the Company and Harry A.  Mizrahi is incorporated herein by reference to Exhibit 10.01 to the  Company’s Form 10-Q for the quarter ended March 31, 2002                                                                |
| 10.36 |   | Employment  Agreement dated April 3, 2002 between the Company and Paul E. Perkins is  incorporated herein by reference to Exhibit 10.02 to the Company’s  Form 10-Q for the quarter ended March 31, 2002                                                                    |
| 10.37 |   | Employment  Agreement dated April 16, 2002 between the Company and Patricia A.  Nooney is incorporated herein by reference to Exhibit 10.03 to the  Company’s Form 10-Q for the quarter ended March 31, 2002                                                                |

69

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| 10.38 |   | Employment  Agreement dated September 1, 2002 between the Company and Thomas N.  Thurber is incorporated herein by reference to Exhibit 10.04 to the  Company’s Form 1-Q for the quarter ended June 30, 2002  (Exhibits pursuant to the Agreement have not been filed by the Company, who  hereby undertakes to file such exhibits upon the request of the SEC) |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.39 |   | Employment  Agreement dated October 15, 2001 between the Company and William J.  Carden is incorporated herein by reference to Exhibit 10.5 to the  Company’s Form 10-Q for the quarter ended September 30, 2002                                                                                                                                                |
| 10.40 |   | Letter Agreement  dated February 25, 2003 between the Company and William J. Carden and  John N. Galardi is incorporated herein by reference to the Company’s Annual  Report on Form 10-K for the year ended December 31, 2002                                                                                                                                       |
| 10.41 |   | Letter Agreement  dated February 25, 2003 between the Company and CGS Real Estate  Company, Inc. is incorporated herein by reference to the Company’s  Annual Report on Form 10-K for the year ended December 31,  2002                                                                                                                                         |
| 10.42 |   | Letter Agreement  dated February 25, 2003 between the Company and William J. Carden and  John N. Galardi is incorporated herein by reference to the Company’s Annual  Report on Form 10-K for the year ended December 31, 2002                                                                                                                                       |
| 10.43 |   | Amendment  No. 1 to Employment Agreement dated October 6, 2003 between the  Company and Patricia A. Nooney incorporated herein by reference to the  Company’s Annual Report on Form 10-K for the year ended  December 31, 2003                                                                                                                                  |
| 21    |   | Significant  Subsidiaries of the Company                                                                                                                                                                                                                                                                                                                                                 |
| 23    |   | Accountants’  Consent—Form 10-K                                                                                                                                                                                                                                                                                                                                           |
| 31    |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                            |
| 32    |   | Certification  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                        |

 

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(1)          Incorporatedherein by reference to the Company’s Registration Statement on Form S-4(Registration No. 333-43686), which became effective August 8,2001.

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