<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C. 20549

                                   FORM 10-K


               [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                 For the Fiscal Year Ended: September 30, 1998

                         Commission File Number 0-21900

                              SUNDANCE HOMES, INC.
             (Exact name of registrant as specified in its charter)

                Illinois                                   36-3111764
     (State or other jurisdiction              (IRS Employer Identification No.)
   of incorporation or organization)

               150 West Center Court, Schaumburg, Illinois  60195
          (Address of principal executive offices, including zip code)

      Registrant's telephone number, including area code: (847) 255-5555

       Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:

                         Common Stock, $0.01 par value
                                (Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this From 10-K
or any amendment to this Form 10-K. [X]

On December 31, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant, based on the closing sale price of the
registrant's Common Stock as quoted on the Nasdaq Stock Market's National
Market, was approximately $2,338,506.  (For purposes of calculating this amount
only directors, executive officers, and beneficial owners of 5% or more of the
Common Stock of the registrant have been deemed affiliates).

Number of shares of the registrant's outstanding Common Stock at December 31,
1998: 7,813,144.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement for its Annual Meeting of
Shareholders, scheduled to be held on March 3, 1999, are incorporated by
reference into Part III of this Report.
<PAGE>
 
                              SUNDANCE HOMES, INC.


                                   FORM 10-K

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
 
Page
<S>            <C>                                                                    <C>
 
PART I
   Item 1.     Business.............................................................   3 - 15
 
   Item 2.     Properties...........................................................       15
 
   Item 3.     Legal Proceedings....................................................       16
 
   Item 4.     Submission of Matters to a Vote of Security Holders..................       16
 
 
PART II
   Item 5.     Market for Registrant's Common Equity and Related Stockholder Matters       17
 
   Item 6.     Selected Consolidated Financial Data.................................       18
 
   Item 7.     Management's Discussion and Analysis of Financial
               Condition and Results of Operations..................................  18 - 26
 
   Item 8.     Financial Statements and Supplementary Data..........................       26
 
   Item 9.     Changes in and Disagreements with Accountants on Accounting and
               Financial Disclosure.................................................       26
 
 
PART III
   Item 10.    Directors and Executive Officers of the Registrant...................       27
 
   Item 11.    Executive Compensation...............................................       27
 
   Item 12.    Security Ownership of Certain Beneficial Owners and Management.......       27
 
   Item 13.    Certain Relationships and Related Transactions.......................       27
 

PART IV
   Item 14.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....  28 - 29

SIGNATURES..........................................................................       30
</TABLE>

                                       2
<PAGE>
 
                                     PART I
Item 1. Business

The Company

Sundance Homes, Inc. (the "Company") is a builder of single family homes in the
Chicago metropolitan area and condominiums in the Chicago urban market.  Prior
to September 1996, the Company primarily was a builder of affordably priced,
single-family detached and attached homes in the Chicago metropolitan area.

The Chicago metropolitan area, which includes Cook County and the five
surrounding counties (McHenry, Lake, DuPage, Kane and Will Counties, commonly
referred to as the "collar counties"), is the third largest metropolitan area in
the United States.  Management believes that housing demand in these areas is
strong due in large part to their proximity to concentrated job markets which
have developed along major highways to the north, northwest, southwest and west
of Chicago.

The Chicago urban market includes the Loop area, South Loop, West Loop, New East
Side, River North, Streeterville and the Gold Coast.  Extensive development is
taking place in other areas near the traditional Loop boundaries.  These include
the areas between Roosevelt Road and Cermak Road, and Halsted Street west to the
United Center, and as far as 5800 north along the Ravenswood corridor.
Management believes that housing demand in this market is strong due to the high
rents in the markets, job growth in the downtown area, the long commute times
between the city and the suburbs and the numerous amenities available in the
Chicago downtown area to prospective home buyers.

The Company is currently operating three divisions: Sundance Suburban
Properties; Rembrandt Homes; and Chicago Urban Properties.  The Sundance
Suburban Properties Division focuses on affordably priced entry-level and first
time move-up houses primarily in the collar counties surrounding Chicago. The
Rembrandt Division focuses  primarily on the semi-custom and custom market
primarily in the north and northwest Chicago suburban counties.  The Chicago
Urban Properties Division focuses primarily on loft-conversion, townhouse and
new construction of mid and high-rise apartment condominiums in the City of
Chicago. The Company believes that the division structure allows each operating
entity to provide a focused insight into the markets, competition, subcontractor
pricing, and consumer tastes in which it operates.  Each division operating
team is responsible for the product development, sales and marketing, home
construction and customer service aspects of their projects.  Corporate office
support is provided for broad marketing and promotional strategic decisions,
accounting, finance, and information systems.

The Company currently has 23 communities in various stages of planning and
development and an additional five properties under contract or option.  At
September 30, 1998, the Company had 384 homes subject to sales contracts.  The
Company currently owns or controls sufficient land and buildings for the
development of approximately 1,852 housing units and is evaluating the purchase
of additional land and buildings, most of which is unentitled, for the possible
development of approximately 294 additional housing units.

                                       3
<PAGE>
 
In September 1996, the Company entered the urban real estate market with the
introduction of two condominium-loft conversion projects in Chicago. In 1998,
the Company continued to increase its presence in the Chicago urban market with
its Chicago Urban Properties division, which completed construction on three
condominium-loft conversion projects.  Additionally, the Company made
significant progress on completing its 24-story high rise condominium apartment
project, and opened for sale two new condominium-loft conversions and our
condominium apartment project in Chicago.

Also in 1998, the Company continued its expansion of its custom home division,
Rembrandt Homes.  The Company closed 36 custom homes in the $350,000-650,000
price range in Vernon Hills, Illinois on land that was acquired in 1997 and
1998.  The Company also acquired scattered developed and undeveloped lots in
high-demand areas for future expansion.

Across all of its divisions, the Company strives to deliver superior value to
all market segments by providing innovative designs and diverse, high-quality
products.  The Company typically broadens its appeal to various market segments
by offering one or more product lines within each suburban and urban project.
Each product offering is architecturally designed to complement other products
within the project and create a sense of community.

Business Strategy

The Company's home building strategy consists of the following key elements:

Value Pricing, Customer Satisfaction, and Commitment to Quality.  The Company
strives to deliver superior value across market segments by pricing its homes
competitively while consistently providing innovative designs and high-quality
products.  The Company's commitment to overall customer satisfaction through
quality construction is the cornerstone of its business strategy.  The Company
acts as general contractor on most of its projects and requires that its
subcontractors and suppliers use high-quality, durable materials in the
construction of its homes.  The project manager for each project is responsible
for ensuring that each home in the project meets the Company's standards for
workmanship and materials.

Growth-Oriented Markets.  The Company focuses its home-building in  suburban
communities and urban neighborhoods where land acquisition costs have remained
low and demand for entry-level, move-up, custom, and urban-style homes is
strong.  Demographic shifts in the housing market combined with the diverse and
stable economic environment in Chicago have translated into population increases
in and around the downtown area.  The Company will continue to evaluate
extending its home-building activities to other areas as opportunities
consistent with the Company's strategy arise.

Innovative Design and Effective Marketing.  The Company monitors the design and
feature preferences of home buyers in its markets and uses this market research
to provide innovative, space-efficient and desirable architectural designs and
home amenities.  In each project, the Company creates and maintains a series of
model homes representing the home plans offered.  The Company believes that the
effective use of a variety of model  homes plays an integral role in marketing
the competitive advantages of its home design to prospective buyers.

                                       4
<PAGE>
 
Property Acquisition and Development.  The Company strives to minimize its
overall property costs and the risks associated with the development of
unentitled property by, whenever possible, using options and other financing
arrangements that allow the Company to control property through the entitlement
process, but defer the payment for such property until the entitlement process
has been completed and the Company is prepared to commence construction.  For a
description of the entitlement process, see "Governmental Regulation and
Environmental Controls".

The Company has substantial experience in obtaining the entitlements necessary
to develop residential and urban properties.  In addition, the Company will
occasionally purchase entitled property to the extent that the price and terms
of such purchases are believed by the Company to be advantageous.

Cost Control.  The Company controls the cost of developing its projects by: (i)
seeking to purchase property at a low cost per unit; (ii) using its position as
a leading homebuilder in its markets to obtain favorable pricing on construction
materials and labor from its subcontractors; (iii) adhering to construction
schedules and monitoring the physical progress and costs of construction with
the use of a computerized tracking system; and (iv) striving to achieve rapid
inventory turnover by pricing its homes at competitive levels and entering into
sales contracts for a majority of its homes prior to commencement of
construction.

                                       5
<PAGE>
 
Summary of Residential Projects

Since 1983, the Company has closed sales of approximately 6,100 homes and has
completed 28 projects in the Chicago metropolitan area. The table following
presents information relating to the Company's completed projects in the Chicago
metropolitan area as of September 30, 1998.

<TABLE>
<CAPTION>
                                                             Total Number    Average
             Project                County   Year Completed    of Homes    Sales Price
----------------------------------  -------  --------------  ------------  -----------
<S>                                 <C>      <C>             <C>           <C>
 
The Orchards (Lake Zurich)........  Lake          1984            72        $116,000

Woodridge Center..................  DuPage        1984            18          81,000

Newport Trail.....................  DuPage        1985            22         116,000

The Orchards (Carol Stream).......  DuPage        1985            48          81,000

Woodale of Bartlett...............  DuPage        1985            76         116,000

Spring Valley.....................  DuPage        1986            88         126,000

University Heights................  DuPage        1986           196         122,000

Amber Lakes.......................  DuPage        1987           283          86,000

Pine Ridge South..................  DuPage        1987           135          96,000

Timber Lake Estates...............  Lake          1987            66         181,000

Chestnut Place....................  Cook          1989            20         130,000

Pine Ridge........................  DuPage        1989           220         120,000

Woodglen Village..................  DuPage        1989            63         132,000

Sussex Square.....................  Cook          1990           159         109,000

Hampton Woods.....................  McHenry       1991            78         180,000

Arbor Ridge.......................  DuPage        1992            79         247,000

Heritage At Stratford.............  DuPage        1992            99         237,000

Parkside on the Green.............  Cook          1992           308         167,000

Victoria Woods....................  McHenry       1993           116         231,000

River's Edge......................  Kane          1995            22         205,000

Lake in the Woods.................  DuPage        1995            34         247,000

Spring Lake Farm..................  McHenry       1995           432         148,000

Wildflower........................  DuPage        1997           251         199,000

Deloraine.........................  Cook          1998            23         231,000

Cherry Hill.......................  Cook          1998            29         205,000

Spring Lake Farm South............  McHenry       1998           279         247,000

Ravinia Woods.....................  Lake          1998           373         148,000

St. Paul Lofts....................  Cook          1998            82         199,000

Various model homes and odd lots..   --            --            119         254,000
</TABLE>

                                       6
<PAGE>
 
The following table presents information relating to the Company's current and
planned projects as of September 30, 1998:

<TABLE>
<CAPTION>

                                                                Estimated                            Homes
                                                                 Homes at                             in
                                             Initial Closing    Completion    Homes      Homes      Backlog         Sales
   Project               Location            (Fiscal Quarter)       (1)       Closed   Remaining      (2)      Price Ranges (3)
   -------               --------            ----------------   ----------    ------   ---------    -------    ----------------
<S>                      <C>                 <C>                <C>           <C>      <C>          <C>        <C>
Sundance Suburban Properties, Inc.

Country Walk             Round Lake Beach,     3rd Qtr. 1992       780          771         9            1     $119,900-184,990
                         Lake County

Heartland Meadows        Elgin/South Elgin,    4th Qtr. 1994       685          635        50            2     $122,990-135,990
                         Kane County

Bellchase                Lake in the Hills,    2nd Qtr. 1995       578          336       242           13     $124,500-192,900
                         McHenry County

Sutton on the Lake       Round Lake Beach,     4th Qtr. 1996       481          225       256           38     $119,990-189,490
                         Lake County

McCarty's Mill           Aurora,               4th Qtr. 1997       111           33        78           11     $142,000-153,000
                         Kane County

Georgian Court           Addison,              1st Qtr. 1998        47           15        32            1     $130,500-210,000
                         Cook County

Hometown Square          Oswego,               1st Qtr. 1998        26           15        11            5     $139,990-166,990
                         Kane County

Walnut Pointe            Bolingbrook,          3rd Qtr. 1998       166           17       149           22     $144,990-180,490
                         Will County

Cedar Creek              Matteson,             3rd Qtr. 1998       146           12       134           36     $158,990-243,490
                         Cook County

Arrowhead                Lockport,             3rd Qtr. 1998       310           21       289           28     $122,000-192,500
                         Will County

The Preserves            Orland Park,          1st Qtr. 1999       106            0       106           12     $204,990-248,490
                         Cook County

Properties Under         Algonquin,                                 71            0        71            0
Contract (4)             McHenry County                          -----        -----     -----          ---

                         Sub-total                               3,507        2,080     1,427          169

Rembrandt Homes, Inc.

Conservancy              Gurnee,               2nd Qtr. 1995       131          117        14            7     $226,990-254,990
                         Lake County

Gregg's Landing          Vernon Hills,         1st Qtr. 1998       135           36        89           12     $350,000-650,000
                         Lake County

Lakeside Estates         Palatine,             3rd Qtr. 1998         2            1         1            0     $385,000-475,000
                         Cook County

White Oaks (4)           Long Grove,                                 1            0         1            0     $600,000-650,000
                         DuPage County

Indian Creek (4)         Buffalo Grove,                              7            0         7            0     $400,000-500,000
                         Lake County

Property Under           Kildeer,                                   13            0        13            0
Contract (4)             Lake County                             -----        -----     -----          ---

                         Sub-total                                 289          154       125           19
</TABLE>

                                       7
<PAGE>
 
<TABLE>
<CAPTION>
                                                                   Estimated                            Homes
                                                                    Homes at                              in
                                                 Fiscal Quarter    Completion    Homes      Homes      Backlog         Sales
   Project                      Location         Initial Closing       (1)       Closed   Remaining      (2)      Price Ranges (3)
   -------                      --------         ---------------   ----------    ------   ---------    -------    ----------------
<S>                       <C>                    <C>                <C>           <C>      <C>          <C>        <C>
Chicago Urban Properties, Inc.

St. Paul Townhomes        Chicago, Cook County    3rd Qtr. 1997          3           0         3           2      $290,000-319,000

Erie Center Lofts         Chicago, Cook County    4th Qtr. 1997        109         104         5           3      $ 92,900-399,900

Michigan Ave. Lofts       Chicago, Cook County    2nd Qtr. 1998         60          58         2           1      $140,535-198,650

Erie Tower                Chicago, Cook County    2nd Qtr. 1999        126           0       126          60      $141,000-535,000

Arthouse Lofts (4)        Chicago, Cook County                          28           0        28          15      $ 89,000-246,000

Plaza 32 (4)              Chicago, Cook County                         130           0       130          76      $137,000-305,000

Capitol Hill Lofts (4)    Chicago, Cook County                          90           0        90          39      $109,000-325,000

Properties Under          Chicago, Cook County                         210           0       210           0
Contract (4)                                                         -----       -----     -----         ---

                          Sub-total                                    756         162       594         196
                                                                     -----       -----     -----         ---

                          Total:                                     4,552       2,396     2,146         384
                                                                     =====       =====     =====         ===
</TABLE>
 

(1) The estimated number of homes to be built at completion is subject to change
    and there can be no assurance that the Company will build these homes.
(2) Homes in backlog refers to homes subject to sales contracts that, as of
    September 30, 1998, had not closed and there can be no assurance that
    closings of such homes will occur.
(3) Reflects base price, excluding any lot premiums and buyer-selected options,
    which vary from project to project.
(4) The Company does not currently have an estimate as to when an initial
    closing will occur.

Property Acquisition and Development

The Company selects property for acquisition and development based upon a
variety of factors, including: (i) financial and legal review as to the
feasibility of the proposed project, including projected profitability; (ii)
demographic and marketing studies; (iii) competition within the area of the
proposed project; (iv) proximity to concentrated job markets, quality of school
districts and local traffic corridors; (v) infrastructure requirements for
grading, drainage, utilities and streets; and (vi) management's judgment as to
the real estate market, economic trends and the Company's experience in a
particular area.  The development approach for the Company's suburban projects
varies from its urban projects due to the nature of the acquired property.

                                       8
<PAGE>
 
Suburban Development.  The Company seeks to minimize its overall land costs and
the risks associated with developing unentitled land, whenever possible, by
using options and other financing arrangements that allow the Company to control
land through the entitlement process but defer the payment for such land until
the entitlement process has been completed and the Company is prepared to
commence construction.  The Company strives to negotiate land purchase contracts
that allow the Company to purchase portions of a parcel as close as possible to
the commencement of construction.

After control of a parcel of unentitled land has been obtained, the Company
prepares preliminary and final plans for each project, providing for
infrastructure, neighborhoods, wetland preservation, educational and other
public facilities, as well as open space.  Once preliminary plans have been
prepared, the Company must obtain numerous governmental approvals, licenses,
permits and agreements, commonly referred to as "entitlements," before it can
commence development and construction.  In the Chicago metropolitan area,
obtaining the many necessary entitlements for large residential developments is
an extended process which generally takes one to two years and can involve a
number of different governmental jurisdictions and agencies and considerable
expense.  No assurance can be given, however, that the Company will be able to
obtain entitlements within originally projected time frames.  Unless and until
the requisite entitlements are received, a homebuilder generally does not have
any rights to develop a project.  For a description of the entitlement process,
see "Government Regulation and Environmental Controls."

The Company has occasionally used partnerships, where such arrangements were
advantageous, to acquire the land from the seller or where such arrangements
appeared to be otherwise economically advantageous to the Company.  The Company
will continue to consider partnerships and other financing arrangements with
landowners or other third parties.

In addition, the Company may purchase entitled land to the extent that the price
and terms of such purchase are believed by the Company to permit development
within acceptable profitability levels.  Through the purchase of entitled or
fully developed lots, the Company can reduce the amount of financial or market
risks inherent in the development process.

Sales of land and lots have not previously had a significant impact on the
Company's financial results.  However, the Company will maintain the flexibility
to sell land and lots to take advantage of market opportunities that may exist.

Urban Development.  The Company is developing two different products in the
downtown Chicago market. For the majority of the Company's urban development,
the Company targets for acquisition former or current manufacturing buildings
which are suitable for the conversion to residential loft-condominiums.  The
Company is also targeting for acquisition parcels for use in developing multi-
story apartment condominiums.  Typically, any building on a parcel of land of
this type would be torn down prior to new construction beginning.  Each of the
factors outlined in the acquisition process above is performed on these sites,
including assessing the Company's ability to obtain appropriate entitlements and
zoning.   Other factors evaluated are the Company's ability to provide adequate
parking capacity and access to public transportation, commercial centers, and
various City of Chicago amenities.

                                       9
<PAGE>
 
Prior to acquisition, the Company prepares architectural drawings, performs
environmental testing and assessments, reviews zoning and entitlement
requirements, and prepares feasibility studies based on projected absorption and
estimated construction costs.  The Company has been able to start initial
construction activities soon after acquisition and typically opens for sale
within six months after acquisition as the evaluation and zoning period is much
shorter than for suburban developments.

Home and Community Design

The Company continuously engages in market research in an effort to ensure that
its home designs, features, and selling strategies address the preferences of
potential home buyers.  The Company closely monitors new trends in the industry,
while carefully tracking the design features chosen by buyers of its homes as
well as those offered by competitors in the marketplace.

In 1998, the Company opened a state-of-the-art Design Center in Schaumburg,
Illinois to provide its suburban customers with the opportunity to make design
selections in a controlled, retail environment.  Each customer that visits the
Design center is surveyed in order to identify areas for improvement.  In
addition to surveying its customers during the purchasing process, the Company
conducts focus groups, exit interviews at its model home sites, telephone
surveys, and statistical demographic studies in an effort to produce the most
desirable architectural designs and home amenities.  The Company's marketing and
design teams develop detailed standards and specifications for each new product
line and then work closely with one of a select number of  unaffiliated
architectural firms to produce a product line that delivers the home designs and
features preferred by the target home buyers.

Within each suburban project, the Company seeks to create a sense of community
through the use of cul-de-sacs, landscaping and a variety of front elevations
and architectural designs that complement each other.  The Company also seeks to
create continuity within each suburban project by coordinating the exterior
colors and trim of neighboring homes.  The product lines offered in both
suburban and urban projects depend upon many factors including the housing
alternatives generally available in the area, the needs of the target home
buyers for such project and the Company's cost per unit in the project.

Construction

The Company typically acts as the general contractor for the development and
construction of its projects, employing project managers who supervise the land
development and construction within each project.  Typically, the Company relies
on two project superintendents to supervise construction for each product line
within a project.  The "rough" superintendent is responsible for each home
within a product line from excavation until the drywall is in place.  The "trim"
superintendent is then responsible for each home within the product line until
the home is delivered to the buyer.  Generally, each project superintendent
coordinates the activities of the subcontractors, suppliers and building
inspectors and is responsible for ensuring that the homes conform to the
Company's quality control standards.

                                       10
<PAGE>
 
The Company also typically acts as general contractor for its urban project
developments.  The Company employs a project construction managers who supervise
one or more building conversions, and construction superintendents who supervise
all phases of construction for a particular building.  The length of time of the
construction process for urban projects varies due to the amount of demolition,
environmental or other construction requirements.  Additionally, occupancy
requirements typically specify completion of an entire phase prior to the
initial closings, and as such will usually result in an approximate nine to
eighteen month construction cycle.  The Company hired an outside general
contractor to build the core building for its 24-story Erie Tower project.  The
Company plans on using its own supervisory personnel for all individual unit
trim work.

Subcontractors typically are retained on a project-by-project basis to complete
construction at a fixed price per model for a varying term, usually six months
to one year.  The Company generally uses a competitive bidding process among
competing subcontractors prior to entering into a subcontracting agreement.
Construction labor has generally been available to the Company, but the home-
building industry has in the past experienced occasional shortages of skilled
labor in certain markets.

The Company negotiates price and volume discounts with manufacturers and
suppliers on behalf of subcontractors to take advantage of its volume of
production.  Management believes that this strategy has given the Company an
advantage in producing quality homes at the lowest possible cost.

The Company typically obtains price guarantees from manufacturers and material
suppliers, but makes no long-term purchase commitments to material suppliers on
behalf of subcontractors.  Materials used in the construction of the Company's
projects are available from a number of sources, but material prices may
fluctuate due to various factors, including supply and demand imbalances.  In
light of such fluctuation, the Company continues to evaluate various alternative
sources of materials such as using metal frames and engineered lumber (i.e.,
soft woods in laminated form) instead of construction lumber for certain
purposes.  Although there is presently an adequate supply of labor and materials
for the Company's projects, it is possible that future shortages of skilled
workers and/or materials may occur.

For suburban developments, the Company generally clusters the homes sold within
a project, which management believes creates efficiencies in land development
and construction and improves customer satisfaction by reducing the number of
vacant lots surrounding a completed home.  The Company typically completes the
construction of a suburban home within four months from commencement of
construction, although the construction schedule for a home depends in large
part on the time of year, availability of labor, materials and supplies and
other factors.

In the Chicago urban market, the completion time of each project typically
ranges from nine months to eighteen months depending upon the size and number of
condo or loft units per project.

                                       11
<PAGE>
 
The Company has historically provided a one year limited warranty of workmanship
and materials and a two year limited warranty on the working systems for each of
its homes.  Beginning in 1995, the Company expanded its warranty policy to
include a  ten year limited warranty against certain structural defects.
Historically, the Company has not incurred any significant financial costs
relating to any warranty claims or defects in construction (see "Legal
Proceedings").

Marketing and Sales

The Company attracts initial interest in its communities/projects through a
comprehensive marketing program that employs various forms of media such as
newspaper, radio, television, direct mail, and billboards.  While the Company is
innovative in its use of media vehicles to market its products, it believes that
its reputation for building high-quality homes also assists in this process.
For that purpose, the Company complements its direct marketing in both the
suburban and urban markets with a buyer referral program in which buyers of the
Company's homes receive referral fees for introducing new buyers to the Company.

The Company believes that the effective use of model homes plays an integral
role in demonstrating the competitive advantages of its home designs and
features to prospective home buyers.  The Company has an exclusive relationship
with an award winning interior designer who is responsible for creating and
maintaining attractive model homes for each product line.

A majority of the Company's homes are sold by full-time, commissioned employees
who typically work from sales offices (open seven days a week) located within
each project.  Additionally, the Company sells homes through independent
brokers.  Employees assist prospective buyers throughout the home buying process
by providing them with information from a network database on the available
product lines, pricing, options and upgrades, mortgage financing (including
qualifying criteria), warranties and construction.  The concentration of the
Company's developments within the Chicago metropolitan area makes it possible
for the Company to retain sales employees for a long-term, rather than on a
project-by-project basis, which management believes results in reduced training
costs and a more knowledgeable and motivated sales force.

The Company's objective is to enter into sales contracts for all of its homes in
advance of construction, thereby greatly reducing the risk of unsold inventory.
The sales contracts for its homes generally provide for mortgage approval within
a specified period.  The Company attempts to minimize cancellations by requiring
a nonrefundable cash deposit of approximately 5% to 10% of the purchase price
for buyers using conventional financing and by training its sales force to
assess the qualification of potential home buyers.

Backlog

The Company's homes are generally offered for sale in advance of their
construction.  A majority of the Company's home sales during 1998 were sold
pursuant to standard sales contracts entered into prior to commencement of
construction.  The Company's standard sales contract generally requires the
customer to make an earnest money deposit upon signing.  This deposit may range
from a nominal amount for an FHA or VA financed purchase, to 5% to 10% of the
purchase price for a buyer using conventional financing.  Upon execution of the
contract and receipt of the deposit, the home sale is included in backlog.  The
Company recognizes revenue on residential sales at closing, when title to the
home has passed to the buyer.

                                       12
<PAGE>
 
The following table provides certain backlog information for the twelve month
periods presented:

<TABLE>
<CAPTION>
                                                            September 30,
                                             -----------------------------------------
                                               1998             1997            1996
                                             -----------------------------------------
                                                       (dollars in thousands)
<S>                                          <C>              <C>              <C>
Number of home sales closed during the           652              636              701
 twelve month period                                                  

Lots/units owned and available for             1,852            1,920            1,717
 development                                                          

Number of lots/units under contract              294            2,331            3,032

Backlog in lots/units                            384              247              197

Average sales price in backlog                  $194             $183             $168

Aggregate sales value in backlog             $74,419          $45,228          $33,193
</TABLE>
                                        
The Company's backlog at any particular date is subject to substantial variation
and is dependent upon several factors, including the number of homes then
available for sale and the length of time necessary to complete the closing of
home sales subject to pending contracts.  The Company anticipates that the
closing of most of the sales of homes in backlog as of September 30, 1998 will
occur in fiscal 1999.  However, no assurances can be given that homes in backlog
will result in actual closings.  The aggregate sales value of backlog increased
approximately $29 million from September 30, 1997 to September 30, 1998 due
primarily to the Company's entrance into five new suburban projects in the
southern suburbs of Chicago and its increasing presence in the Chicago urban
market.

Customer Financing

Substantially all home buyers utilize long-term mortgage financing to purchase a
home.  Lenders generally make loans only to borrowers who earn three to four
times the total amount of the mortgage payment plus insurance and property
taxes.  As a result, economic conditions, increases in unemployment or high
mortgage interest rates can eliminate a substantial number of potential home
buyers from the market.  Although mortgage financing for qualified home buyers
was readily available during the year ended September 30, 1998, there can be no
assurance that affordable mortgage financing will remain available to the
Company's customers in the future.

FHA and VA financing generally enable home buyers to purchase homes with lower
down payments than the down payments required through conventional financing,
allowing a purchaser to borrow from 90% to 95% of the value of the home.  The
Company believes that when conventional lending rates are higher, the
availability of FHA and VA financing broadens the group of potential purchasers
for the Company's homes.

If conventional rates increase substantially, the Company expects the percentage
of buyers applying for FHA or VA approval to increase.  As of September 30,
1998, the FHA financing limit for a one unit residence was $153,000.

                                       13
<PAGE>
 
Competition and Market Factors

The home-building industry is a highly competitive and fragmented market.  The
Company competes for residential sales with national, regional and local
developers and homebuilders, individual resales of existing homes and
condominiums, and available rental housing.  The Company also competes for the
acquisition of undeveloped land on which to build homes.  Sales of homes and
land at deeply discounted prices by competitors, lenders and similar
institutions in the markets where the Company operates could have a material
adverse effect on the Company.  The Company is one of the leading developers of
affordable homes in the Chicago metropolitan area, and believes it is
competitive as a result of its price structure, development expertise, knowledge
of the local real estate market and governmental permit and approval process,
and its favorable reputation in the Chicago metropolitan area home-building
industry.

The Chicago urban market is less fragmented than the suburban market.  While
there are fewer competitors active in the market, the number is quickly growing.
The Company believes that it is competitive as a result of its early entry into
the market, development expertise, product design, location and the size and
scope of its operation.

The home-building industry is cyclical and affected by consumer confidence
levels and prevailing economic conditions in general and by employment and
interest rate levels in particular.  A variety of other factors affect the home-
building industry and demand for new homes, including changes in costs
associated with home ownership such as increases in property taxes and energy
costs, changes in consumer preferences, demographic trends and the availability
of and changes in mortgage financing programs.

Government Regulation and Environmental Controls

Generally, the Company must obtain numerous government approvals, licenses,
permits and agreements, referred to as "entitlements," before it can commence
development and construction. Through options and other financing arrangements,
the Company typically controls unentitled land during the entitlement process
and only purchases the land after the planning and zoning process is complete.
However, obtaining the many necessary entitlements for residential developments
in the Chicago metropolitan area is an extended process which generally takes
one to two years and can involve a number of different governmental
jurisdictions and agencies and considerable expense.

No assurance can be given that the Company will be able to obtain entitlements
in such time frame in the future.  The Company generally does not have any
rights to develop a project until after it has received all required
entitlements.  Several governmental authorities in the Chicago metropolitan area
have imposed fees as a means of defraying the cost of providing certain
governmental services to developing areas, or have required developers to donate
land to the municipality or to make certain off-site land improvements.

Certain permits and approvals will be required to complete the residential
developments currently being planned by the Company.  The ability of the Company
to obtain necessary approvals and permits for these projects is often beyond the
Company's control and could restrict or prevent the development of otherwise
desirable property.

The length of time necessary to obtain permits and approvals increases the
carrying costs of unimproved property acquired for the purpose of development
and construction.

                                       14
<PAGE>
 
In addition, the continued effectiveness of permits already granted is subject
to factors such as changes in policies, rules and regulations and their
interpretation and application.

The Company is also subject to a variety of federal, state and local statutes,
ordinances, rules and regulations concerning protection of health and the
environment.  These laws may result in delays, cause the Company to incur
substantial compliance costs and prohibit or severely restrict development in
certain environmentally sensitive regions or areas.  Prior to purchasing a
parcel of land, the Company evaluates such land for the presence of hazardous or
toxic materials, wastes or substances.  To date, the Company has not experienced
any material delays as a result of these laws and the Company's operations have
not been materially affected by the presence or potential presence of such
materials.

Bonds and Other Obligations

The Company is frequently required, in connection with the development of its
projects, to obtain performance or maintenance bonds or letters of credit.  The
amount of such obligations outstanding at any time varies in accordance with the
Company's pending development activities.  In the event any such obligations are
drawn upon, the Company would be obligated to reimburse the issuing surety
company or bank.  At September 30, 1998, there were approximately $10.6 million
in performance or maintenance bonds and approximately $4.1 million in letters of
credit outstanding for such purposes (see "Management's Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources").

Employees

As of September 30, 1998, the Company employed 175 persons, 65 of whom were
involved in project management, land development, production, contract
management and contract administration, 51 of whom were sales and marketing
personnel, and 59 of whom were executive, accounting, systems and administrative
personnel.  Although none of the Company's employees are covered by collective
bargaining agreements, many of the subcontractors and suppliers which the
Company engages are represented by labor unions or are subject to collective
bargaining arrangements.  The Company believes that its relations with its
employees, subcontractors and suppliers are good.

Item 2. Properties

The Company currently occupies approximately 15,500 square feet of office space
for its Suburban Properties Division and its corporate headquarters in
Schaumburg, Illinois.  The lease for this office space began on April 1, 1998
and terminates on March 31, 2003.  In addition, the Company occupies
approximately 3,000 square feet of office space on a month to month basis at 201
North Wells, Chicago, Illinois for its Chicago Urban Properties Division.

                                       15
<PAGE>
 
Item 3. Legal Proceedings

The Company is involved in various routine legal proceedings incidental to the
conduct of its business.

In November, 1994, a lawsuit was brought against the Company and certain
directors and employees of the Company by the Board of Managers of Parkside on
the Green Condominium Association.  The complaint seeks damages against the
Company for alleged construction defects in the approximate amount of $4.8
million, together with punitive damages against the named individuals for
alleged breach of fiduciary duty.  The Company has assumed the defense of this
lawsuit on behalf of the individual defendants.  The lawsuit is in the discovery
process and various inspections of the project are underway.  The Company is
defending the lawsuit vigorously.

Management believes that none of these legal proceedings will have a material
adverse impact on the financial condition or results of operations of the
Company.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the
Company's fiscal quarter ended September 30, 1998.

                                       16
<PAGE>
 
                                    PART II
                                        

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

The Company's Common Stock has been quoted on the NASDAQ Stock Market's National
Market (the "National Market") under the symbol SUNH since July 9, 1993.  The
following table shows the high and low closing prices for the Common Stock for
the periods indicated as reported by the National Market:

<TABLE>
<CAPTION>
     Fiscal 1998                                          High     Low
     -----------                                         ------  -------
     <S>                                                 <C>      <C>
     Quarter ended September 30, 1998..................  $2.500   $1.313
     Quarter ended June 30, 1998.......................   3.000    2.125
     Quarter ended March 31, 1998......................   2.875    1.750
     Quarter ended December 31, 1997...................   1.750    1.031
 
     Fiscal 1997
     -----------
     Quarter ended September 30, 1997..................  $2.010   $1.500
     Quarter ended June 30, 1997.......................   2.375    1.750
     Quarter ended March 31, 1997......................   3.125    2.250
     Quarter ended December 31, 1996...................   4.000    2.250
</TABLE>

The closing price of the Company's Common Stock as reported on the National
Market on December 31, 1998 was $1.5625 per share.  As of December 31, 1998,
there were 41 holders of record of the Company's Common Stock.

Dividends

The Company intends to retain its future earnings to finance the continuing
development of its business.  Accordingly, the Company does not anticipate
paying any cash dividends on its Common Stock in the foreseeable future.  The
payment of any future dividends will be at the discretion of the Company's Board
of Directors and will depend upon, among other things, future earnings, the
success of the Company's development activities, capital requirements,
restrictions in financing arrangements, the general financial condition of the
Company and general business conditions.  At present, the Company is restricted
from paying any dividends as a result of the current defaults related to the
Loan Agreement. (as defined hereafter, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources").

                                       17
<PAGE>
 
Item 6. Selected Consolidated Financial Data

The following selected consolidated financial and operating data of the Company
is qualified by reference to and should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and other financial data
included elsewhere herein.  The data set forth below as of and for the years
ended September 30, 1998, 1997, and 1996, the nine months ended September 30,
1995 and the year ended December 31, 1994 have been derived from the Company's
audited consolidated financial statements.  Consolidated balance sheets at
September 30, 1998 and September 30, 1997 and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended September 30, 1998 and notes thereto
appear elsewhere herein.  These historical results are not necessarily
indicative of the results to be expected in the future (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations").

<TABLE>
<CAPTION>
                                                                                                   Nine Months 
                                                    Year ended      Year ended      Year ended        ended       Year ended
                                                   September 30,   September 30,   September 30,    September    December 31,
                                                       1998            1997            1996         30, 1995         1994
                                                   --------------------------------------------------------------------------
     Statement of Operations Data:                                 (in thousands, except per share amounts)
     <S>                                           <C>             <C>             <C>             <C>           <C>
     Total sales (1)                                 $131,556         $108,743         $120,948      $63,811       $118,659

     Income (loss) before minority interest and        (5,480)            (715)           2,176       (7,051)         3,643
     provision for income taxes (2)                                                                              

     Net income (loss)                                 (7,614)            (350)           1,235       (4,216)         1,930

     Net income (loss) per share                       ($0.98)          ($0.04)           $0.16       ($0.54)         $0.25
</TABLE>
<TABLE>
<CAPTION>
                                              September 30,   September 30,   September 30,   September 30,   December 31, 
                                                  1998            1997            1996            1995           1994   
                                              ----------------------------------------------------------------------------
     Balance Sheet Data:                                                   (in thousands)
     <S>                                      <C>             <C>             <C>             <C>             <C>
     Real estate inventories                    $102,088         $80,787         $76,101         $86,434         $86,721
                                   
     Total assets                                111,250          94,730          86,406          98,880          98,907
                                   
     Notes and mortgages payable                  55,249          33,087          23,027          42,787          34,280
                                   
     Minority interest (2)                             -               -             111             266           1,049
                                   
     Shareholders' equity                         20,432          28,043          28,393          27,153          31,369
</TABLE>

(1) Sales are recognized at closing, when title to the  home has passed to the
    buyer (see Note 1 of the Notes to Consolidated Financial Statements).

(2) The Company is the General Partner of The Sundance-Kaco Limited Partnership,
    with a 75% interest in said partnership.  Under the terms of the partnership
    agreement, the limited partner is entitled to 25% of all profits of the
    partnership and will receive cash distributions.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
        of Operations

Except for historical information, matters discussed in this Form 10-K contain
forward looking information and describe the Company's belief concerning future
business conditions and the outlook for the Company based on currently available
information.  The Company has identified these "forward looking" statements by
words such as "believes", "estimates", "should", "could", "expects",
"anticipates", and similar expressions.  Risks and uncertainties which could
cause the Company's actual results or performance to differ materially from
those expressed in these statements include the following: the Company's
substantial leverage, ability to comply with the terms of the proposed
Forbearance Agreement (as defined below), changes in general economic and market
conditions, changes in interest rates and the availability of mortgage
financing, changes in costs and availability of material, supplies and labor,
general competitive conditions, the availability of capital, and the ability to
successfully effect acquisitions.  The Company assumes no obligation to update
the information contained herein.

                                       18
<PAGE>
 
As previously announced, the Company has restated its quarterly results for the
quarters ended December 31, 1997, March 31, 1998 and June 30, 1998.  See Note 12
of the Notes to the Consolidated Financial Statements.

Overview

During the year ended September 30, 1998 as compared to the year ended September
30, 1997 the company's residential sales increased by $14.2 million or 13% to
$122.9 million.  In addition the average sales price per home closed increased
by $17,500 to $188,500 from $171,000 in fiscal 1997.  The Company closed 652
homes during fiscal 1998 compared to 636 in fiscal 1997.

The Company's aggregate sales value in backlog at September 30, 1998 increased
by $29.2 million or 65% to $74.4 million compared to $45.2 million at September
30, 1997.  In addition, the average sales price per home of the 384 homes in
backlog at September 30, 1998, increased by $10,700 per home to $193,800 from
$183,100 for the 247 homes in backlog at September 30, 1997.

During fiscal 1998 the Company sold its position in two separate land parcels
located in the City of Chicago and 10 fully developed lots in one of its
suburban projects for $6,950,000 and $1,700,000, respectively, totaling
$8,650,000 in land and building sales.

Urban Development.  The Company's division which develops property under the
name Chicago Urban Properties experienced significant growth in fiscal 1998.
Closings increased from 95 units in fiscal 1997 to 149 units in fiscal 1998.
Revenues increased from $15.6 million in fiscal 1997 to $27.3 million in fiscal
1998.

The St. Paul, Michigan Avenue and Erie Center Lofts projects were substantially
completed and closed out during the year.  The Company's 24-story building which
contains 124 condominium units and 251 parking spaces was over 80% completed by
September 30, 1998 with initial deliveries scheduled for early in 1999.

The Company's three new projects in the Chicago urban market ended the fiscal
year with 130 units in backlog.  These projects include two new loft conversion
projects located at 625 West Jackson Street and 942 West Madison Street in
Chicago, Illinois, and a 130 unit new construction mid-rise condominium project
at 3232 North Halsted, Chicago, Illinois.

Suburban Communities.  During the year ending September 30, 1998 the Company
significantly expanded its presence in the south suburbs of Chicago by
purchasing approximately 400 developed lots in Orland Park and Lockport, and
166 undeveloped lots in Bolingbrook.

The Company's custom home division, Rembrandt Homes, continued to expand by
completing the acquisition of 135 lots at Gregg's Landing, a golf course
community in Vernon Hills, Illinois. Of the 135 acquired lots, the Company
delivered 36 homes and sold 10 developed lots during the year ended September
30, 1998.

                                       19
<PAGE>
 
Results of Operations

The following table sets forth by each income statement line item presented as a
percentage of the Company's total sales (unless otherwise indicated) and certain
other information regarding the Company's operations for the periods indicated.

<TABLE>
<CAPTION>
                                                     Year ended September 30,
                                               ------------------------------------
                                                  1998          1997          1996
                                               ------------------------------------
<S>                                            <C>           <C>           <C>
Residential sales                                  93.4%        100.0%        100.0%
Land and building sales                             6.6            -             -
                                               --------      --------      --------
Total sales                                       100.0%        100.0%        100.0%
                                               
Cost of residential sales                          85.9          88.2          88.2
Cost of land and building sales                     5.4            -             -
                                               --------      --------      --------
Total cost of sales                                91.3          88.2          88.2
                                               --------      --------      --------
Gross profit                                        8.7          11.8          11.8
Selling expenses                                    9.3           8.8           6.1
General and administrative expenses                 3.7           4.0           4.1
Other (income) expense, net                        (0.1)         (0.2)         (0.2)
                                               --------      --------      --------
Income (loss) before minority interest         
     and provision (benefit) for income taxes      (4.2)         (0.8)          1.8
Minority interest                                    -           (0.1)          0.1
                                               --------      --------      --------
Income (loss) before provision                 
     (benefit) for income taxes                    (4.2)         (0.7)          1.7
Provision (benefit) for income taxes               (0.1)         (0.2)          0.7
                                               --------      --------      --------
Income (loss) before cumulative effect         
     of change in accounting policy                (4.1)         (0.5)          1.0
Cumulative effect of change in                 
     accounting policy, net of tax                 (1.7)           -             -
                                               --------      --------      --------
                                               
Net income (loss)                                  (5.8)%        (0.5)%         1.0%
                                               ========      ========      ========
                                               
New orders (net)                                    789           686           624
Homes closed-units                                  652           636           701
Average selling price-homes closed             $188,500      $171,000      $172,500
</TABLE>

Year Ended September 30, 1998 Compared to the Year Ended September 30, 1997

Residential Sales.  Residential sales, which are recognized upon the closing and
delivery of homes, increased $14.2 million or 13%, to $122.9 million, for the
year ended September 30, 1998 as compared to $108.7 for the prior year.  This
increase was due primarily to the increase in the number of units closed during
the year and the average selling price increase of $17,500 from $171,000 for the
year ended September 30, 1997 to $188,500 for the year ended September 30, 1998.

                                       20
<PAGE>
 
Land Sales.  During the year ended September 30, 1998 the Company sold the land
and the 28 story building located at 201 N. Wells in Chicago, Illinois.  In
February, 1997 the Company purchased the note and mortgage on this property and
on April 13, 1998 obtained title through a foreclosure sale.  In addition the
Company sold 10 developed lots in its Turtle Bay project in Vernon Hills,
Illinois and its contractual rights to purchase a land parcel located at 1300
West Diversey in Chicago, Illinois.  Revenue derived from these sales totaled
$8,650,000.  In fiscal 1997, no revenue was derived from land sales.

Cost of Residential Sales.  Cost of residential sales includes land acquisition
costs, development costs, construction costs and direct overhead, job oversight
supervision, customer service, warranty costs, interest and property taxes.
Cost of residential sales, as a percentage of residential sales, increased by
3.8 percentage points to 92.0% for the year ended September 30, 1998 as compared
to 88.2% for the year ended September 30, 1997.  Cost of residential sales
increased by $17.1 million to $113.0 million from $95.9 million for the year
ended September 30, 1997.  The primary reasons for the increase in the cost of
residential sales as a percentage of residential sales were increased costs
related to interest and production overheads as well as certain increases on
several of the Company's close-out projects in both its Suburban and Urban
Divisions.

Selling, General and Administrative Expenses.  Selling expenses include
advertising, sales commissions, payroll, amortization of the costs of non-
permanent upgrades to convert standard homes to model homes (draperies, wall-
hangings, decor items) and maintenance of model homes.  Certain expenses, such
as sales commissions and amortization of model home upgrades, are derived from
sales prices or the number of home sales closed and thus remain relatively
constant as a percentage of residential sales. Other expenses, such as
advertising costs and model home maintenance, may be significantly influenced in
any given period by the number of grand openings or special promotions and the
number of projects operating in that period.  Costs associated with upgrading
standard homes to model homes are capitalized and expensed as related home sales
are closed, while most other selling expenses are expensed as incurred.

Selling expenses as a percentage of total sales increased by 0.5 percentage
points to 9.3% for the year ended September 30, 1998 from 8.8% for the year
ended September 30, 1997.  Actual selling expenses increased by $2.7 million
from $9.5 million for the year ended September 30, 1997 to $12.2 million for the
year ended September 30, 1998.  This increase, for the year ended September 30,
1998, resulted primarily from variable costs associated with increased
deliveries, as well as increased advertising expenditures resulting from the
opening of several new communities.

General and administrative expenses increased by $0.6 million to $4.9 million
for the year ended September 30, 1998 compared to $4.3 million for the year
ended September 30, 1997.  As a percentage of total sales, general and
administrative expenses were 3.7% and 4.0% for the years ended September 30,
1998 and September 30, 1997, respectively.

                                       21
<PAGE>
 
Year Ended September 30, 1997 Compared to the Year Ended September 30, 1996

Sales.  Residential sales decreased $12.2 million to $108.7 million for the year
ended September 30, 1997, a decrease of 10.1% over the twelve months ended
September 30, 1996. The decrease was primarily due to an overall decline in the
suburban housing market of approximately 10%.  The average sales price of home
sales closed also decreased slightly from $172,500 in fiscal 1996 to $171,000 in
fiscal 1997.

There were 686 net new sales orders for the year ended September 30, 1997
representing an increase of 10%, or 62 orders, over the fiscal 1996 total of
624. The Company attributes the increase primarily to the expansion of its
market place to include the Chicago urban market.

Cost sales decreased $10.7 million to $95.9 million in fiscal 1997 primarily as
a result of lower sales volume.  Cost of sales as a percent of residential sales
was 88.2% in fiscal 1997 as compared to 88.2% of sales revenue in fiscal 1996.

Selling, General and Administrative Expenses.  Selling expenses increased by
$2.1 million from $7.4 million in fiscal 1996 to $9.5 million in fiscal 1997.
As a percent of residential sales, selling expenses increased from 6.1% in the
year ended September 30, 1996, to 8.8% in the year ended September 30, 1997.
This increase is primarily due to increased marketing activities for several
projects which did not deliver closed units and homes until fiscal 1998 and
additional costs incurred due to the decision by the Company to use commissioned
brokers.

General and administrative expenses decreased by $639,000 in the year ended
September 30, 1997 compared to the year ended September 30, 1996.  These costs
have decreased due to the Company's continued efforts to reduce such expenses.

Sundance - Kaco Limited Partnership

The Company is the general partner, with a 75.0% partnership interest, in the
Sundance-Kaco Limited Partnership, an Illinois limited partnership.  Also
participating in the partnership is Kaco, Inc,  the sole limited partner, which
is entitled to 25.0% of all profits from the Spring Lake Farm South project.
The limited partner's share of losses for 1997 was $131,000.  Pursuant to the
provisions of the partnership agreement, limited partner distributions of
$161,000 were paid during 1997.

Year 2000 Compliance

The Year 2000 or "Y2K" issue is the result of many legacy computer programs
using a two digit format, as opposed to a four digit format, to indicate the
year.  Many computer systems will not be able to interpret dates beyond the year
1999, which could cause a system failure or other errors, leading to disruptions
in operations.  In 1997, the Company developed a three phase plan to address
this issue.

                                       22
<PAGE>
 
Phase I of the plan, which began during the fiscal year ended September 30,
1998, is the identification of all the systems, services and key operating
infrastructures where the Company has exposure.  Phase II is the development and
implementation of the necessary steps to bring the systems, services and
infrastructures into compliance.  Phase II is scheduled to be completed by
spring of 1999.  Phase III, which is scheduled to be completed in mid to late
1999, is the testing and acceptance of each modification necessary to the
systems, service and infrastructure components identified in Phase I and
implemented in Phase II.  The Company has identified four major areas of focus
necessary to ensure successful Y2K compliance.  These are: (1) its integrated
suite of accounting, costing and job control applications, (2) all custom
developed enhancements to the base suite, (3) all operating infrastructure
components including, but not limited to various operating systems, personal
computers and their associated software tools, along with other hardware and
software necessary for the operation of the business and (4) third party
relationships and their respective Y2K readiness.

The Company's currently installed core accounting, costing and job control
applications are not Y2K compliant.  However a project is currently underway to
upgrade the suite to a version which is believed to be compliant.  The upgrade
plan will include a corresponding upgrade of the custom developed enhancements.
Many of the operating infrastructure components will require modifications to
achieve compliance.  These modifications are currently underway and do not
directly impact the upgrade of any other system.  The Company is in the process
of contacting all significant suppliers and other third party relationships to
obtain responses indicating compliance or plans to be compliant by the year
2000.

The Company has identified the potential for 1,000 man hours of project-related
work to achieve compliance.  The Company has hired outside consulting resources
to help facilitate the timely completion of the projects identified.  Y2K
specific costs incurred to date have not been significant.  Estimated future
costs will range from approximately $50,000-$150,000 and are scheduled to be
incurred in fiscal 1999.

A formal contingency plan has not been prepared at this time due to the variety
of alternatives available to the Company.

Income Taxes

The provision for income taxes for the years ended September 30, 1997 and 1996
reflects management's estimate of the Company's effective tax rate of
approximately 40.0%.  During the year ended September 30, 1998, the Company has
recorded a charge to earnings in fiscal 1998 of approximately $2.1 million to
establish a reserve against the net deferred income tax asset which resulted
from the current year net operating loss.

Seasonality and Variability in Quarterly Results

The Company has experienced, and expects to continue to experience, significant
seasonally and quarter to quarter variability in residential sales and net
income.  Generally, the receipt of sales contracts is highest during the first
six months of the calendar year.  Related closings typically peak in the July
through September period as homes contracted for earlier in the year are
delivered.  Management believes that this seasonality reflects the tendency of
home buyers to shop for a new home in the Spring with the goal of closing in the
Fall or Winter as well as the scheduling of construction to accommodate seasonal
weather conditions (see Note 12. "Quarterly Results of Operations" in the
Footnotes to Consolidated Financial Statements).

                                       23
<PAGE>
 
Inflation

The Company, as well as the home-building industry in general, may be adversely
affected during periods of high inflation, primarily because of higher land
acquisition, land development and construction costs.  In addition, higher
mortgage interest rates may significantly affect the affordability of mortgage
financing to prospective purchasers.  Inflation also increases the Company's
interest costs and the cost of labor and materials.  The Company attempts to
pass through to its buyers any increases in its costs through increased selling
prices.  Inflation did not have a material impact on fiscal 1998 or 1997
results.

Liquidity and Capital Resources

Net cash provided by or used for operating activities varies from period to
period, due primarily to the Company's housing inventory, land acquisition and
development requirements, and in lesser part to the Company's net income.  Net
cash used for operations in fiscal 1998 was $24.6 million, primarily due to the
acquisition of new projects.

On April 30, 1998, the Company entered into a new $80 million Revolving Credit
Loan Agreement (the "Loan Agreement") with LaSalle National Bank, American
National Bank and Trust Company of Chicago and BankBoston, NA (collectively,
"the Lenders"), which replaced the Company's previous credit loan agreement
which had provided for a $60 million line of credit.  The three banks
participate in the $80 million facility as follows: LaSalle National Bank, $35
million; American National Bank, $25 million; and BankBoston, $20 million.  The
borrowings are secured by the real estate assets of the Company with certain
exceptions.  Borrowings under the Loan Agreement bear interest at LIBOR plus 300
basis points for borrowings up to $70 million and prime plus 0.75% for
borrowings in excess of $70 million, plus certain customary fees. The Loan
Agreement was originally scheduled to mature on February 1, 2000.  Available
borrowings under the Loan Agreement are reduced by the amount of letters of
credit outstanding.  The Loan Agreement includes certain customary
representations and covenants, including restrictions on the Company's ability
to pay dividends and maintenance of certain financial ratios.  As of September
30, 1998, the Company had violated certain covenants as set forth in the Loan
Agreement, including certain financial covenants, specifically those  related to
net worth and net income. On December 1, 1998, the Company's Lenders declared a
"default" under the Loan Agreement and the outstanding balance of the loan is
due and payable, subject to the satisfactory modification of the Loan Agreement.
The Company and its Lenders are currently negotiating a Forbearance and Loan
Modification Agreement (the "Forbearance Agreement").  The Company believes that
this agreement, when finalized, will include at a minimum the following terms:
 
     1. Existing defaults will be waived.
     2. Significant limitations will be placed on the Company's ability to 
        acquire new land.
     3. The Lenders will not further fund the 130 unit condominium apartment
        project known as Plaza 32 in Chicago, Illinois.
     4. Interest rates will be increased from prime plus 0.75% to prime plus 
        3.0%.
     5. Certain financial penalties will be imposed if certain revised covenants
        are not met in the future.
     6. The maximum loan amount will be systematically reduced.
     7. Other various credit limiting and monitoring devices will imposed.

                                       24
<PAGE>
 
Following the successful execution of the Forbearance Agreement, the Company
intends to replace the existing credit line at more favorable rates and terms.
There can be no assurance though, that the Company will be able to enter into
the Forbearance Agreement on the terms described above or replace the existing
credit line on a timely basis or at all.  Failure by the Company to cure the
defaults, successfully negotiate the Forbearance Agreement or negotiate
replacement financing on a timely basis could have a material adverse effect on
the Company's operations.  As of September 30, 1998, the Company had borrowed
$53.7 million under the Loan Agreement and had $4.1 million outstanding letters
of credit, leaving $22.2 million available for future borrowings.  The Loan
Agreement was originally scheduled to mature on February 1, 2000, which date may
be modified in the Forbearance Agreement.

While the Company was securing its Loan Agreement, the Company entered into
certain interim financing arrangements to provide funding for certain projects
which were not provided for under the Company's prior credit agreement.

On March 16, 1998 the Company entered into $15 million Construction Loan
Agreement with LaSalle National Bank with a maturity date of February 20, 1999,
at a rate of Prime plus 1.0%.  Advances under this loan totaled $4,931,562 and
were used to provide construction funds for the Company's Erie Tower Project
located at 375 West Erie Street, Chicago, Illinois.  Concurrent with the funding
of the Loan Agreement on May 12, 1998, this Construction Loan Agreement was
repaid in full.

On March 17, 1998, the Company entered into an interim financing agreement with
Cohen Financial Corporation in the amount of $1.6 million at a rate of prime
plus 1.0% with a maturity date of October 1, 1998.  This promissory note was
secured by a mortgage on the property located at 3228-3244 North Halsted Street,
Chicago, Illinois.  Concurrent with the funding of the Loan Agreement on May 12,
1998, this note was repaid in full.

Secured Shareholder Note Payable

On May 1, 1998, Erie Center Lofts, Inc., a wholly owned subsidiary of the
Company, entered into a $2.5 million Secured Subordinated Promissory Note with a
maturity date of June 30, 1999, and an interest rate of 20% with Maurice
Sanderman, the Company's Chairman and Principal Shareholder.  The note is
secured by a junior mortgage on the property commonly known as Erie Tower
located at 421 West Erie Street in Chicago, Illinois.  Principal payments under
this note may only be paid out of net sales proceeds from the sale of units
within Erie Tower and only after all advances made under the New Loan Agreement
related to the Erie Tower project have been repaid.

Unsecured Shareholder Note Payable

On February 24, 1998, the Company borrowed $487,000 on an unsecured basis from
Maurice Sanderman.  The unsecured note was at a prime rate plus 3.0% with a
maturity date of October 1, 1998.  These funds were used to pay property taxes
for 1996 and 1997 which became due on a building owned by the Company at 201
North Wells, Chicago, Illinois.  The payment of these taxes was not provided for
under the terms of the prior credit agreement.  This loan was repaid on June 30,
1998 concurrently with the closing of the sale of the building.

                                       25
<PAGE>
 
On March 17, 1998, in order to acquire the property located at 3228-3244 North
Halsted, Chicago, Illinois, the Company borrowed $890,000 on an unsecured basis
from Maurice Sanderman.  The unsecured note was at a rate of prime plus 3.0%
with an expiration date of October 1, 1998.  The purchase of this property was
not provided for under the terms of the prior credit agreement.  Concurrent with
the funding of the Loan Agreement, on May 12, 1998, this note was repaid in
full.

On May 26, 1998 the Company borrowed $1,602,241 on an unsecured basis from
Maurice Sanderman.  The unsecured note was at a rate of prime plus 3.0% with a
maturity date of October 1, 1998.  These funds were used to pay property taxes
for 1990, 1991, and 1992, which became due through a court settlement on a
building owned by the Company at 201 N. Wells, Chicago, Illinois.  The payment
of these taxes were not provided for under the terms of the Loan Agreement.
This loan was repaid in full concurrent with the closing of the sale of the
building on June 30, 1998.

Transaction with the Principal Shareholder

As part of the public offering and recapitialization of the Company on July 9,
1993, the Company issued promissory notes to the Company's principal
shareholder, Maurice Sanderman.  The notes are subordinate to the Company's bank
indebtedness, bear interest at 7.5% per annum, compounded daily, and originally
matured in two equal annual payments on the first and second anniversaries of
the offering.  On April 30, 1998 concurrent with the execution of the Loan
Agreement these notes were extended to February 1, 2000.  Payment of the
outstanding principal balances are subject to certain restrictions under the
Loan Agreement.

Item 8. Financial Statements and Supplementary Data

The response to this item is submitted as a separate section of this report
beginning on page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure

None.

                                       26
<PAGE>
 
                                    PART III
                                        

Item 10. Directors and Executive Officers of the Registrant

Information with respect to the directors and officers of the Company is hereby
incorporated herein by reference to the sections, "Election of Directors--
Nominees," "Election of Directors --Other Directors" and "Executive Officers,"
in the Company's Proxy Statement which is expected to be filed with the
Securities and Exchange Commission (the "Commission") in definitive form no
later than February 2, 1999.

Information with respect to required Section 16(a) disclosure is hereby
incorporated herein by reference to the section "Executive Officers'--Compliance
with Section 16(a) of The Securities Exchange Act of 1934," in the Company's
Proxy Statement which is expected to be filed with the Commission in definitive
form no later than February 2, 1999.

Item 11. Executive Compensation

Information with respect to executive compensation is hereby incorporated herein
by reference to the sections, "Election of Directors" - "Compensation of
Directors", and "Executive Compensation," in the Company's Proxy Statement which
is expected to be filed with the Commission in definitive form no later than
February 2, 1999.

Item 12. Security Ownership of Certain Beneficial Owners and Management

Information with respect to security ownership of certain beneficial owners and
management is hereby incorporated herein by reference to the section "Security
Ownership of Principal Shareholders and Management," in the Company's Proxy
Statement which is expected to be filed with the Commission in definitive form
no later than February 2, 1999.

Item 13. Certain Relationships and Related Transactions

Information with respect to certain relationships and related transactions is
hereby incorporated herein by reference to the section "Certain Transactions,"
in the Company's Proxy Statement which is expected to be filed with the
Commission in definitive form no later than February 2, 1999.

                                       27
<PAGE>
 
PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) (1) and (2)  The response to this portion of Item 14 is submitted as a 
    separate section of this report beginning on page F-1.

    All other schedules have been omitted because they are inapplicable, not
    required, or the information is included elsewhere in the consolidated
    financial statements or notes thereto.

    (3)  Exhibits: The response to this Item is incorporated by reference to
    Item 14(c) below.

(b) No report on Form 8-K was filed by the Company during the last quarter of 
    the period covered by this report.

(c) The exhibits listed below are filed with this report or incorporated by
    reference, as set forth below.

                                       28
<PAGE>
 
The Company will furnish to any shareholder, upon written request, any of the
exhibits listed below upon payment by such shareholder of the Company's
reasonable expenses in furnishing any such exhibit.

<TABLE>
<CAPTION>

Exhibit
Number                                             Document Description
------              ------------------------------------------------------------------------------------
<S>                 <C>
3.1 a               Amended and Restated Articles of Incorporation of the Registrant
3.2 a               Amended and Restated Bylaws of the Registrant
4.1 c               Specimen stock certificate representing Common Stock
10.1 b              The Sundance Homes, Inc. 1993 Stock Incentive Plan
10.2 b              The Sundance Homes, Inc. 1993 Directors' Option Plan
10.3 b              Profit Sharing and Savings Plan
10.4 b              Form of Tax Indemnification Agreement
10.5 b              Form of Director's Indemnification Agreement
10.6 b              Form of Dividend Note
10.10 e             Employment Letter for Jon Tilkemeier, dated September 10, 1996
10.11 e             Employment Letter for Joseph Atkin, dated November 27, 1996
10.12 d             First Amendment to the Sundance Homes, Inc. Stock Incentive Plan
10.13 d             First Amendment to the Sundance Homes, Inc. Directors' Stock Option Plan
10.14 f             Revolving Loan Credit Agreement dated April 30, 1998 by and between the Company and
                    LaSalle National Bank, American National Bank and Trust of Chicago and BankBoston, NA
10.15 f             Secured Subordinated Promissory Note dated May 1, 1998 by and between Maurice Sanderman and Erie
                    Centre Lofts, Inc.
21.0                List of Subsidiaries
23.1                Consent of PricewaterhouseCoopers, LLP
27.1                Financial Data Schedule

           a        Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 33-96546.
           b        Incorporated by reference to the Company's Registration Statement on Form S-1, Registration Statement No. 
                    33-60988.
           c        Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended December 
                    31, 1994.
           d        Incorporated by reference to the Company's Registration Statement on Form S-8, Registration No. 333-
                    11087
           e        Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended
                    September 30, 1996.
           f        Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended
                    June 30, 1998.
</TABLE>

(d) The response to this Item is incorporated by reference to Item 14(a)(2).

                                       29
<PAGE>
 
                                   SIGNATURES
                                        

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this amendment to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 11th day of
January, 1999.

            SUNDANCE HOMES, INC.



        By:    /s/ Maurice Sanderman
            --------------------------------------------------------------------
            Maurice Sanderman, Chairman of the Board and Chief Executive Officer



Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.

<TABLE>
<CAPTION>
        Signature                                  Title                                        Date
--------------------------         -------------------------------------         ----------------------------------
--------------------------         -------------------------------------         ----------------------------------
<S>                                <C>                                           <C> 
                                      Chairman of the Board and Chief                      January 11, 1999
/s/ Maurice Sanderman                        Executive Officer
--------------------------             (Principal Executive Officer)
Maurice Sanderman

                                     Director, Vice President and Chief
/s/ Joseph Atkin                              Financial Officer                            January 11, 1999
--------------------------                (Principal Financial and
Joseph Atkin                                 Accounting Officer)


/s/ Dennis Bookshester                            Director                                 January 11, 1999
--------------------------
Dennis Bookshester


/s/ Charles Engles                                Director                                 January 11, 1999
--------------------------
Charles Engles


/s/ Gerald Ginsburg                               Director                                 January 11, 1999
--------------------------
Gerald Ginsburg


/s/ Thomas Small                                  Director                                 January 11, 1999
--------------------------
Thomas Small
</TABLE>

                                       30
<PAGE>
 
                              SUNDANCE HOMES, INC.
                         ITEM 8, ITEM 14(a) (1) and (2)
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE> 
<CAPTION> 

<S>                                                                               <C> 
Report of Independent Accountants.................................................F-2

Consolidated Balance Sheets as of September 30, 1998 and September 30, 1997.......F-3

Consolidated Statements of Operations for the Years Ended September 30, 1998,
1997 and 1996.....................................................................F-4

Consolidated Statements of Changes in Shareholders' Equity for the Years
September 30, 1998, 1997 and 1996.................................................F-5

Consolidated Statements of Cash Flows for the Years Ended September 30, 1998,
1997 and 1996.....................................................................F-6

Notes to Consolidated Financial Statements........................................F-7
</TABLE> 
                                      F-1
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
                                        

To the Board of Directors and
Shareholders of Sundance Homes, Inc.

In our opinion, the consolidated financial statements listed in the index
appearing on page F-1, present fairly, in all material respects, the financial
position of Sundance Homes, Inc. and its subsidiaries at September 30, 1998 and
1997, and the results of their operations and their cash flows for the each of
the three years in the period ended September 30, 1998, in conformity with
generally accepted accounting principles.  These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits.  We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation.  We believe that our
audits provide a reasonable basis for the opinion expressed above.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern.  As discussed in Note 5 to the
financial statements, the Company has violated certain loan covenants and
accordingly is in default of its revolving credit loan agreement.  The Company
has been unable to renegotiate the terms of the revolving credit loan agreement
or to secure alternative financing.  The inability of the Company to resolve the
loan default under its current loan agreement or to obtain alternative financing
to meet its obligations as they become due raises substantial doubt about the
Company's ability to continue as a going concern.  Management's plans in regard
to this matter are also described in Note 5.  The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.




/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
December 23, 1998


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

                                      F-2
<PAGE>
 
                             SUNDANCE HOMES, INC.
                          CONSOLIDATED BALANCE SHEETS
                       (in thousands, except share data)
 
<TABLE>
<CAPTION>
                                                      September 30,   September 30,
                                                          1998            1997
                                                      -------------   -------------
ASSETS
------
<S>                                                   <C>             <C>
Cash and cash equivalents                               $  1,947         $ 4,615
Real estate inventories                                  102,088          80,787
Prepaid expenses and other assets                          2,227           1,748
Property and equipment, net                                4,988           3,289
Deferred project start-up costs                                -           3,726
Income taxes receivable                                        -             565
                                                        --------         -------

   Total assets                                         $111,250         $94,730
                                                        ========         =======

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

Accounts payable and accrued construction               
 liabilities                                            $ 23,026         $23,711
Other accrued expenses                                     2,386           1,976
Customer deposits                                          3,464           2,116
Notes payable                                             55,249          33,087
Notes payable to Principal Shareholder                     2,500               -
Deferred income taxes                                          -           1,604
Subordinated notes payable to Principal                    
 Shareholder                                               4,193           4,193
                                                        --------         -------

   Total liabilities                                      90,818          66,687
                                                        --------         -------

Minority interest                                              -               -
                                                        --------         -------

Commitments and contingencies                                  -               -
                                                        --------         -------

Shareholders' equity:
   Preferred stock, $0.01 par value,
    1,000,000 shares authorized,
    none issued or outstanding                                 -               -
   Common stock, $0.01 par value, 20,000,000
    shares authorized, 7,809,125 shares
    issued and outstanding                                    78              78
   Additional paid-in capital                             26,980          26,977
   Retained earnings (deficit)                            (6,626)            988
                                                        --------         -------

   Total shareholders' equity                             20,432          28,043
                                                        --------         -------

   Total liabilities and shareholders' equity           $111,250         $94,730
                                                        ========         =======
</TABLE>
 
  The accompanying notes are an integral part of these financial statements.

                                      F-3
<PAGE>
 
                             SUNDANCE HOMES, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                         Year ended
                                                        September 30,
                                               --------------------------------
                                                 1998        1997        1996
                                               --------    --------    --------
<S>                                            <C>         <C>         <C>
Residential sales                              $122,906    $108,743    $120,948
Land and building sales                           8,650           -           -
                                               --------    --------    --------

Total sales                                     131,556     108,743     120,948

Cost of residential sales                       113,065      95,875     106,639
Cost of land and building sales                   7,069           -           -
                                               --------    --------    --------

Total cost of sales                             120,134      95,875     106,639
                                               --------    --------    --------

Gross profit                                     11,422      12,868      14,309

Selling expenses                                 12,227       9,547       7,386
General and administrative expenses               4,871       4,301       4,940
Other (income) expense, net                        (196)       (265)       (193)
                                               --------    --------    --------

Income (loss) before minority
  interest and provision (benefit) for
  income taxes                                   (5,480)       (715)      2,176
Minority interest                                    (3)       (131)        117
                                               --------    --------    --------

Income (loss) before provision
  (benefit) for income taxes                     (5,477)       (584)      2,059
Provision (benefit) for income taxes                (97)       (234)        824
                                               --------    --------    --------

Income (loss) before cumulative
  effect of change in accounting policy          (5,380)       (350)      1,235

Cumulative effect of change in
  accounting policy, net of related tax
  effect                                         (2,234)          -           -
                                               --------    --------    --------

Net income (loss)                              $ (7,614)   $   (350)   $  1,235
                                               ========    ========    ========

Net income (loss) per share                    $  (0.98)   $  (0.04)   $   0.16
                                               ========    ========    ========

Weighted average number
  of shares outstanding                           7,808       7,807       7,806
                                               ========    ========    ========
</TABLE>

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

                                      F-4
<PAGE>
 
                             SUNDANCE HOMES, INC.
          CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                (in thousands)

<TABLE> 
<CAPTION>  

                                           Common Stock         Additional     Retained
                                       -----------------------    Paid-In      Earnings
                                          Shares       Amount     Capital      (Deficit)      Total
                                       ------------  ---------  -----------   -----------   --------
<S>                                    <C>           <C>         <C>          <C>           <C>
Balance at September 30, 1995             7,805         $78       $26,972       $   103      $27,153

        Exercise of stock options             2           -             5             -            5

        Net income                            -           -             -         1,235        1,235
                                       ------------  ---------  -----------   -----------   --------

Balance at September 30, 1996             7,807          78        26,977         1,338       28,393

        Net loss                              -           -             -          (350)        (350)
                                       ------------  ---------  -----------   -----------   --------

Balance at September 30, 1997             7,807          78        26,977           988       28,043

        Exercise of stock options             2           -             3             -            3
   Loss before cumulative effect of
        change in accounting policy           -           -             -        (5,380)      (5,380)
   Cumulative effect of change
        in accounting policy                  -           -             -        (2,234)      (2,234)
                                       ------------  ---------  -----------   -----------   --------
Balance at September 30, 1998             7,809         $78       $26,980       $(6,626)     $20,432
                                       ============  =========  ===========   ===========   ========
</TABLE>

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

                                      F-5
<PAGE>
 
                             SUNDANCE HOMES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (in thousands)

<TABLE> 
<CAPTION>  
 
                                                                                             Year ended
                                                                                            September 30,
                                                                                ------------------------------------
                                                                                   1998          1997        1996
                                                                                ---------    ----------   ---------- 
<S>                                                                              <C>           <C>         <C>
Operating activities:
Net income (loss)                                                                $ (7,614)     $  (350)    $   1,235
   Adjustments to reconcile net income (loss) to net cash
      provided by (used for) operating activities:
        Depreciation and amortization                                               2,636        1,109           848
        Deferred income taxes                                                      (1,604)       2,065          (461)
        Changes in operating assets and liabilities:
           Real estate inventories                                                (22,949)      (4,686)       10,333
           Prepaid expenses and other assets                                         (479)        (946)          395
           Income tax receivables                                                     565         (565)        1,964
           Deferred project start up costs                                          3,726       (1,654)          628
           Accounts payable and accrued construction liabilities                     (685)         644         6,551
           Other accrued expenses                                                     410       (4,206)          866
           Customer deposits                                                        1,348          683        (1,216)
                                                                                ---------    ---------     --------- 
Net cash provided by (used for) operating activities                              (24,646)      (7,906)       21,143
                                                                                ---------    ---------     --------- 
Investing activities:
   Property and equipment, net                                                     (2,687)      (1,878)       (1,292)
   Exercise of stock options                                                            -            -            (5)
                                                                                ---------    ---------     --------- 
Net cash provided by (used for) investing activities                               (2,687)      (1,878)       (1,297)
                                                                                ---------    ---------     --------- 
Financing activities:
   Borrowings under notes payable                                                 141,199      111,275        99,392
   Repayments of notes payable                                                   (119,037)     (99,682)     (115,691)
   Borrowings under notes payable to Principal Shareholder                          5,479          650         1,340
   Repayments of notes payable to Principal Shareholder                            (2,979)      (2,183)       (4,801)
   Proceeds of stock options exercised                                                  3            -             -
   Contributions from minority interest                                                 -            -            73
   Distributions to minority interest                                                   -         (162)         (345)
                                                                                ---------    ---------     --------- 
Net cash provided by (used for) financing activities                               24,665        9,898       (20,032)
                                                                                ---------    ---------     --------- 
Net increase (decrease) in cash and cash equivalents                               (2,668)         114          (186)
Cash and cash equivalents:
   Beginning of period                                                              4,615        4,501         4,687
                                                                                ---------    ---------     --------- 
   End of period                                                                $   1,947    $   4,615     $   4,501
                                                                                =========    =========     =========  
</TABLE>

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

                                      F-6
<PAGE>
 
                              SUNDANCE HOMES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 1998
                                        

Note 1 - Summary of Significant Accounting Policies:
----------------------------------------------------

Nature of business

Sundance Homes, Inc. is engaged in the development of land and construction of
attached and detached single-family homes and urban residential buildings in the
Chicago metropolitan area.

Principles of consolidation

The consolidated financial statements include the accounts of Sundance Homes,
Inc., its wholly-owned subsidiaries (the "Company") and its investment in a
majority-owned limited partnership.  All significant intercompany accounts and
transactions have been eliminated in consolidation.

Revenue recognition

Residential sales are recognized at closing when title to the home has passed to
the buyer.  The Company's homes are generally offered for sale in advance of
their construction.  To date, most of the Company's homes have been sold
pursuant to standard sales contracts entered into prior to commencement of
construction.  The Company's standard sales contracts generally require the
customer to make an earnest money deposit.  This deposit may range from a
nominal amount for an FHA or VA financed purchase to 5% to 10% of the purchase
price for a buyer using conventional financing.

Land sales are recognized when the Company has received an adequate cash down
payment and all other conditions necessary for profit recognition have been
satisfied.

Real estate inventories and cost of sales

Real estate inventories are carried at cost, which is less than fair value, and
include land, land development, direct and certain indirect construction costs,
interest and real estate taxes.

At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and any estimate to complete, plus an allocation,
based upon relative sales value, of the total estimated cost of land and land
development, interest, real estate taxes and any other capitalizable common
costs.  The Company generally provides a one year limited warranty of
workmanship and materials and a two year limited warranty on the working systems
for each of its homes.  Accordingly, a warranty reserve, based on the Company's
historical experience, is provided as residential sales are closed.  This
reserve is reduced by the cost of subsequent work performed.

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

                                      F-7
<PAGE>
 
Interest capitalization

Interest and related debt issuance costs are capitalized to qualifying real
estate inventories as incurred, in accordance with Statement of Financial
Accounting Standards (SFAS) No. 34, "Capitalization of Interest Cost", and
charged to cost of sales as revenue from residential sales is recognized.

Property and equipment

Property and equipment are carried at cost less accumulated depreciation and are
depreciated using straight line and accelerated methods over the estimated
useful lives of the assets, except for model home upgrades and furnishings which
are amortized as related home sales in a development are closed.  Significant
additions and improvements are capitalized, while expenditures for maintenance
and repairs are charged to operations as incurred.  The cost and accumulated
depreciation of property and equipment sold or retired are removed from the
respective accounts and the resultant gains or losses, if any, are included in
current operations.

Advertising costs

The Company attracts initial interest in its projects through a comprehensive
advertising program using media such as newspapers, direct mail, telemarketing,
billboards and, to a lesser extent, radio and television. Advertising costs,
which are expensed as incurred, aggregated approximately $3.3 million, $3.6
million and $1.9 million during the years ended September 30, 1998, 1997 and
1996, respectively.

Income taxes

Deferred income taxes are determined under the asset and liability method in
accordance with SFAS No. 109 "Accounting for Income Taxes".  Under SFAS No. 109,
deferred income taxes arise from temporary differences between the income tax
basis of assets and liabilities and their reported amounts in the consolidated
financial statements.

Cash and equivalents

For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.

Supplemental disclosures of cash flow information are as follows (in thousands):

<TABLE>
<CAPTION>
                             Year ended      Year ended      Year ended 
                            September 30,   September 30,   September 30,
                                1998            1997            1996
                            ---------------------------------------------
<S>                         <C>             <C>             <C>
     Cash paid for:    

       Interest                $6,116          $5,975          $3,536

       Income taxes               -                75             -
</TABLE>

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

                                      F-8
<PAGE>
 
Use of estimates

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year
then ended.  Actual results could differ from those estimates.

Reclassification of Results of Operations

Certain amounts for 1997 and 1996 were reclassified to conform to the 1998
financial presentation.

Note 2 - Change in Accounting Policy
------------------------------------

Effective October 1, 1997 the company adopted Statement of Position (SOP) No 98-
5, Reporting on the Costs of Start-up Activities and Organization Costs.  Costs
of start up activities and organization costs are expensed as incurred.  The
cumulative effect of this change in accounting principle decreased net assets at
October 1, 1997 by $2,234,000, net of related tax effect of $1,490,000.

Note 3 - Real Estate Inventories:
---------------------------------

Real estate inventories are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                           September 30,   September 30,
                                               1998            1997
                                           -------------   -------------
     <S>                                   <C>             <C>
     Work-in-process:                   

       Land and land development             $ 41,696         $33,683

       Suburban inventory                      12,545          10,249

       Urban  construction inventory           30,983          19,482

     Completed homes:                                        

       Models                                   2,040           6,668

       Speculative homes                        3,590             912

     Capitalized overhead                       4,225           3,146

     Capitalized interest                       7,009           6,647
                                             --------         -------
                                             $102,088         $80,787
                                             ========         =======
</TABLE>

Completed homes include models constructed to help market a development and
include allocations of land, development and other common costs.  Speculative
homes represent non-model homes which are substantially complete and are not
subject to a sales contract.  During the year ended September 30, 1998, the
Company entered into a sale leaseback agreement with a third party. Sales
revenue derived from the 31 units sold subject to this agreement totaled $5.5
million. Annual lease payments due under the leaseback provisions of the
agreement will be approximately $.6 million for the year ended September 30,
1999.

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

                                      F-9
<PAGE>
 
Capitalized interest is included in real estate inventories as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                Year ended                       Year ended                      Year ended 
                                            September 30, 1998               September 30, 1997              September 30, 1996
                                         ------------------------         ------------------------        ------------------------
<S>                                     <C>                               <C>                             <C>
Interest capitalized, beginning
 of period                                        $ 6,647                          $ 5,427                         $ 5,418
Interest incurred and capitalized                   6,825                            4,534                           3,581
Interest amortized to cost of sales                (6,463)                          (3,314)                         (3,572)
                                         ------------------------         ------------------------        ------------------------
Interest capitalized, end of period               $ 7,009                          $ 6,647                         $ 5,427
                                         ========================         ========================        ========================
</TABLE>

A reserve is provided as a charge against earnings when the carrying amount of
any of the Company's inventories exceeds its fair value.  Fair value represents
the expected selling price a property will bring in the open market reduced by
(a) the estimated cost to complete and improve such property to the condition
expected in determining the selling price, (b) disposition costs, and (c)
estimated costs to hold the property to the point of sale, including interest
carrying costs and other net cash flow requirements of the project.  During the
year ended September 30, 1998, the Company recorded valuation reserves totaling
$850,000.

Note 4 - Property and Equipment:
--------------------------------

Property and equipment are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                      September 30, 1998           September 30, 1997
                                                    ---------------------         ---------------------
<S>                                                     <C>                         <C>
     Model home upgrades and furnishings                  $    8,047                    $    4,307
     Equipment and furniture                                   3,028                         3,147
     Vehicles                                                    270                           379
     Leasehold improvements                                      476                            52
                                                          ----------                    ----------
                                                              11,821                         7,885
     Accumulated depreciation                                  6,833                         4,596
                                                          ----------
                                                          $    4,988                    $    3,289
                                                          ==========                    ==========
</TABLE>
                                                                                
  The accompanying notes are an integral part of these financial statements.

                                     F-10                       
<PAGE>
 
Note 5 - Notes and Mortgages Payable:
------------------------------------ 

Notes and mortgages payable are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                         September 30,   September 30,
                                             1998            1997
                                         -------------   -------------
     <S>                                 <C>             <C>
     Revolving line of credit               $53,682         $30,818
     Notes payable to land sellers            1,567           2,269
                                            -------         -------
                                            $55,249         $33,087
                                            =======         =======
</TABLE>

On April 30, 1998, the Company entered into a new $80 million Revolving Credit
Loan Agreement (the "Loan Agreement") with LaSalle National Bank, American
National Bank and Trust Company of Chicago and BankBoston, NA (collectively,
"the lenders"), which replaced the Company's previous credit loan agreement
which had provided for a $60 million line of credit.  The three banks
participate in the $80 million facility as follows: LaSalle National Bank, $35
million; American National Bank and Trust Company of Chicago, $25 million; and
BankBoston, NA, $20 million.  The borrowings are secured by the real estate
assets of the Company with certain exceptions.  Borrowings under the Loan
Agreement bear interest at LIBOR plus 300 basis points for borrowings up to $70
million and prime plus 0.75% for borrowings in excess of $70 million, plus
certain customary fees. The Loan Agreement was originally scheduled to mature on
February 1, 2000.  Available borrowings under the Loan Agreement are reduced by
the amount of letters of credit outstanding.  The Loan Agreement includes
certain customary representations and covenants, including restrictions on the
Company's ability to pay dividends and maintenance of certain financial ratios.
As of September 30, 1998, the Company had violated certain covenants as set
forth in the Loan Agreement, including certain financial covenants, specifically
those related to net worth and net income.  On December 1, 1998, the Company's
Lenders declared a "default" under the Loan Agreement and the outstanding
balance of the loan is due and payable, subject to the satisfactory modification
of the Loan Agreement.  The Company and its Lenders are currently negotiating a
Forbearance and Loan Modification Agreement (the "Forbearance Agreement").

Following the successful execution of the Forbearance Agreement, the Company
intends to replace the existing credit line at more favorable rates and terms.
There can be no assurance though, that the Company will be able to enter into
the Forbearance Agreement on the terms described above or replace the existing
credit line on a timely basis or at all.  Failure by the Company to cure the
defaults, successfully negotiate the Forbearance Agreement or negotiate
replacement financing on a timely basis could have a material adverse effect on
the Company's operations.  As of September 30, 1998, the Company had borrowed
$53.7 million under the Loan Agreement and had $4.1 million outstanding letters
of credit, leaving $22.2 million available for future borrowings.  The Loan
Agreement was originally scheduled to mature on February 1, 2000, which date may
be modified in the Forbearance Agreement.

While the Company was securing its Loan Agreement, the Company entered into
certain interim financing arrangements to provide funding for certain projects
which were not provided for under the Company's prior credit agreement.

On March 16, 1998 the Company entered into $15 million Construction Loan
Agreement with LaSalle National Bank with a maturity date of February 20, 1999,
at a rate of Prime plus 1.0%.  

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

                                      F-11
<PAGE>
 
Advances under this loan totaled $4,931,562 and were used to provide
construction funds for the Company's Erie Tower Project located at 375 West Erie
Street, Chicago, Illinois. Concurrent with the funding of the Loan Agreement on
May 12, 1998, this Construction Loan Agreement was repaid in full.

On March 17, 1998, the Company entered into an interim financing agreement with
Cohen Financial Corporation in the amount of $1.6 million at a rate of prime
plus 1.0% with a maturity date of October 1, 1998.  This promissory note was
secured by a mortgage on the property located at 3228-3244 North Halsted Street,
Chicago, Illinois.  Concurrent with the funding of the Loan Agreement on May 12,
1998, this note was repaid in full.

The Company entered into interim financing agreements with the Principal
Shareholder as described in Note 6.

Notes payable to land sellers are non-interest bearing and are repaid through
application of agreed upon amounts from the proceeds of individual home sale
closings.

Scheduled maturities of notes and mortgages payable in future periods are as
follows (in thousands):

<TABLE>
<CAPTION>
                                         Year ending
                                        September 30,
                                        -------------
               <S>                      <C>
               1999....................    $   777
               2000....................     53,994
               2001....................        313
               2002....................        165
                                           -------
                                           $55,249
                                           =======
</TABLE>

Interest and related debt issuance costs incurred, all of which were
capitalized, during the year ended September 30, 1998, 1997 and 1996, aggregated
approximately $6.8 million, $4.5 million and $3.5 million, respectively.

Note 6 - Subordinated Notes and Notes Payable to Principal Shareholder:
-----------------------------------------------------------------------

Secured Note Payable

On May 1, 1998, Erie Center Lofts, Inc., a wholly owned subsidiary of the
Company, entered into a $2.5  million Secured Subordinated Promissory Note with
a maturity date of June 30, 1999, and an interest rate of 20% with Maurice
Sanderman, the Company's Chairman and President.  The note is secured by a
junior mortgage on the property commonly known as Erie Tower located at 421 West
Erie Street in Chicago, Illinois.  Principal payments under this note may only
be paid out of net sales proceeds from the sale of units within Erie Tower only
after all advances made under the New Loan Agreement related to the Erie Tower
project have been repaid.

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

                                      F-12
<PAGE>
 
Unsecured Notes Payable

On February 24, 1998, the Company borrowed $487,000 on an unsecured basis from
Maurice Sanderman. The unsecured note was at a prime rate plus 3.0% with a
maturity date of October 1, 1998.  These funds were used to pay property taxes
for 1996 and 1997 which became due on a building owned by the Company at 201
North Wells, Chicago, Illinois.  The payment of these taxes was not provided for
under the terms of the prior credit agreement.  This loan was repaid on June 30,
1998 concurrently with the closing of the sale of the building.

On March 17, 1998, in order to acquire the property located at 3228-3244 North
Halsted, Chicago, Illinois, the Company borrowed $890,000 on an unsecured basis
from Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with
an expiration date of October 1, 1998.  The purchase of this property was not
provided for under the terms of the prior credit agreement.  Concurrent with the
funding of the Loan Agreement, on May 12, 1998, this note was repaid in full.

On May 26, 1998 the Company borrowed $1,602,241 on an unsecured basis from
Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with a
maturity date of October 1, 1998.  These funds were used to pay property taxes
for 1990, 1991 and 1992, which became due through a court settlement on a
building owned by the Company at 201 N. Wells, Chicago, Illinois.  The payment
of these taxes were not provided for under the terms of the Loan Agreement.
This loan was repaid in full concurrent with the closing of the sale of the
building on June 30, 1998.

Prior to the Company completing the public offering on July 9, 1993, the Company
was recapitalized and reorganized into a parent-subsidiary structure, thereby
terminating its S Corporation status.  The Company declared aggregate
distributions of S Corporation earnings to its Principal Shareholder in an
aggregate amount such that beginning shareholders' equity as a C Corporation
would be $5 million.

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

                                      F-13
<PAGE>
 
During the twelve months ended December 31, 1993, such distributions aggregated
$9.1 million, of which $4.9 million was paid out of available cash, while the
remaining $4.2 million was paid in the form of promissory notes, which are
subordinate to the Company's bank indebtedness, bear interest at 7.50% which
compounds daily and originally matured in two equal annual installments on the
first and second anniversaries of the offering.  On April 30, 1998, the maturity
date of the notes was extended to February  1, 2000.  Payment of the annual
installments is subject to certain restrictions under the Company's Revolving
Credit Loan Agreement (see Note 5 - Notes and Mortgages Payable).

Note 7 - Income Taxes:
----------------------

The provision (benefit) for income taxes was as follows (in thousands):

<TABLE>
<CAPTION>
                                       Year Ended                       Year Ended                    Year Ended
                                      September 30,                    September 30,                 September 30,
                                          1998                             1997                          1996
                                 -----------------------          -----------------------       -----------------------
<S>                            <C>                               <C>                           <C>
Current
     Federal                           $         -                       $         -                   $       105
     State                                       -                                 -                            35
                                 -----------------------          -----------------------       -----------------------
                                                 -                                 -                           140
                                 -----------------------          -----------------------       -----------------------
Deferred
     Federal                                (1,842)                             (199)                          563
     State                                    (348)                              (35)                          121
                                 -----------------------          -----------------------       -----------------------
                                            (2,190)                             (234)                          684
                                 -----------------------          -----------------------       -----------------------
Valuation allowance                          2,093                                 -                             -
                                 -----------------------          -----------------------       -----------------------
Total                                  $       (97)                      $      (234)                  $       824
                                 =======================          =======================       =======================
</TABLE>


Reconciliation's of the statutory Federal income tax rate of 34% to the
effective income tax rate are as follows (in thousands):

<TABLE>
<CAPTION>
                                       Year Ended                       Year Ended                    Year Ended
                                      September 30,                    September 30,                 September 30,
                                          1998                             1997                          1996
                                 -----------------------          -----------------------       -----------------------
<S>                            <C>                               <C>                           <C> 
Income taxes at the Federal                      
 statutory rate                        $    (1,852)                      $      (206)                  $       700
State income taxes, net of                          
 Federal benefit                              (338)                              (23)                          150
Other                                            -                                (5)                          (26)
Valuation allowance                          2,093                               
                                 -----------------------          -----------------------       -----------------------
     Total                             $       (97)                      $      (234)                  $       824
                                 =======================          =======================       =======================
</TABLE>

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

                                     F-14
<PAGE>
 
The Company's net deferred tax asset is reserved through the establishment of a
tax valuation allowance.  The valuation allowance of $2.1 million was recorded
upon consideration of the recent operating results and related uncertainty
associated with realization of the tax benefit of the net operating loss
carryforward, which is ultimately dependent upon the generation of future
earnings of the Company.

The consolidated balance sheets included the following net deferred tax (assets)
or net deferred tax liabilities:

<TABLE>
<CAPTION>
                                             September 30,      September 30,      September 30,
                                                 1998                1997              1996
                                             -------------      -------------      -------------
<S>                                          <C>                 <C>               <C>
Deferred project start-up costs                $        -         $    1,538         $      843
Real estate inventories                               342              1,723             (1,378)
Partnership book to tax differences                     -                  -                176
Accrued expenses                                     (359)              (274)              (266)
Depreciation of property and equipment                (85)               117                164
Tax carry forward items                            (1,991)            (1,500)                 -
Valuation allowance                                 2,093
                                             -------------      -------------      -------------
                                               $        -         $    1,604         $     (461)
                                             =============      =============      =============
</TABLE>
                 
The Company has entered into a tax indemnification agreement with the Principal
Shareholder of the Company which provides for, among other things, the
indemnification of the Principal Shareholder for any losses or liabilities with
respect to any additional taxes (including interest, penalties and legal fees)
resulting from the Company's operations during the period in which it was an S
Corporation.


Note 8 - Minority Interest:
---------------------------

During 1993, one of the Company's subsidiaries, acting as general partner with a
75% ownership interest, entered into a limited partnership with a land seller.
Under the terms of this limited partnership agreement, the Company purchased the
land from the seller for approximately $1.4 million, payable over the term of
the agreement as home sales are closed.  This partnership began closing homes in
March, 1994.

The income(loss) from the limited partnership's operations is allocated to the
general and limited partner based upon their relative ownership interests.
Distributions with respect thereto are paid as outlined in the agreements.

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

                                     F-15
<PAGE>
 
A reconciliation of the minority interest balance as presented in the
Consolidated Balance Sheets is as follows (in thousands):

<TABLE>
<S>                                                                <C>  
Minority interest in net assets at September 30, 1995              $ 266
                                                                   -----
Contributions.....................................................    73
Limited partner's interest in 1996 net income of the partnership..   117
Distributions during 1996.........................................  (345)
                                                                   -----
Minority interest in net assets at September 30, 1996              $ 111
                                                                   -----
Contributions.....................................................    - 
Limited partner's interest in 1997 net loss of the partnership....  (131)
Distributions during 1997.........................................  (162)
                                                                   -----
Minority interest in net assets at September 30, 1997              $(182)
                                                                   -----
Contributions.....................................................    - 
Limited partner's interest in 1998 net loss of the partnership....    (3)
                                                                   -----
Minority interest in net assets at September 30, 1998              $(185)
                                                                   ===== 
The balances due from minority interest as of September 30, 1998
and 1997 were reclassified to Prepaid expenses and other assets.
</TABLE>
                                                                                
Note 9 - Stock Incentive Plan and Directors Options Plan
--------------------------------------------------------

Stock Incentive Plan

The Board of Directors and shareholders adopted the Sundance Homes, Inc. Stock
Incentive Plan (the "Stock Incentive Plan") effective as of April 7, 1993. The
purpose of the Stock Incentive Plan is to enable officers and key employees of
the Company to participate in the Company's future and to enable the Company to
attract and retain these persons by offering them proprietary interests in the
Company. The Stock Incentive Plan is administered by the Company's compensation
committee and authorizes the issuance of up to 525,000 shares of common stock
pursuant to the grant or exercise of stock options, stock appreciation rights,
restricted or deferred stock.

Prior to the offering in July of 1993, the Company granted stock options under
the Stock Incentive Plan to certain of its employees who were not previously
shareholders of the Company to purchase up to 250,000 shares of common stock in
the aggregate for a purchase price per share equal to the initial public
offering price. Options granted to these officers will vest 25% per year on the
anniversary of the grant date for four years and will expire after 10 years.

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

                                     F-16

<PAGE>
 
Directors Option Plan

Outside Directors are granted options by the Company's compensation committee
which is authorized to issue of up to 100,000 shares of common stock. Directors
are granted options to acquire 5,000 shares of Common Stock on each of: (1) the
date on which a person is elected as a Director, (2) the date of the first
annual meeting of shareholders held subsequent to such person's election and,
(3) the date of each succeeding annual meeting of shareholders after which the
person is still serving as a director (with a limit of options to acquire a
total of 25,000 shares to be granted to any Outside Director). All options
granted under the Director's Plan are exercisable on the one year anniversary
date of the grant and, at a price per share equal to the closing price of the
Common Stock as reported on the NASDAQ National Market on the date of the grant
or, if the market is closed on such date, the next business day. Options will
expire after ten years.

Option activity for both plans for the three years ended September 30, 1998 is
as follows:

<TABLE>
<CAPTION>
                                         1998                   1997                   1996
                                 --------------------    -------------------    -------------------
                                             Weighted               Weighted               Weighted
                                             Average                Average                Average
                                  Shares     Exercise     Shares    Exercise     Shares    Exercise
                                 --------------------    -------------------    -------------------
<S>                              <C>         <C>         <C>        <C>         <C>        <C>
Outstanding at beginning of year  400,500     $3.54      250,500     $4.08      146,500      $5.21
    Granted                       219,000      1.60      187,500      2.67      126,500       2.34
    Exercised                      (2,125)     1.63           -         -            -          -
    Forfeited                    (155,625)     3.03      (37,500)     2.83      (22,500)      1.63
                                 --------                -------                -------
Outstanding at end of year        461,750     $2.80      400,500     $3.54      250,000      $4.16
                                 ========                =======                =======

Exercisable at end of year        184,375                147,625                 83,750
                                 ========                =======                =======

Available for future grant
  at year end                     163,250                224,500                374,500
                                 ========                =======                =======
Weighted average per share fair
  value of options granted
  during year                                 $0.77                  $1.36                   $1.29
 </TABLE>

The fair value of each option grant was estimated on the date of the grant using
the Black-Scholes option-pricing model with the following assumptions:

<TABLE>
<CAPTION>
                            1998       1997       1996
                          --------    ------     ------- 
<S>                        <C>        <C>        <C>
Risk free interest rate      5.77%     6.44%       6.37%
Dividend yield                  0%        0%          0%
Expected lives             7 years    7 years    7 years
Expected volatility         34.51%     36.87%     37.30%
</TABLE>
                                                                                
  The accompanying notes are an integral part of these financial statements.

                                      F-17
<PAGE>
 
The following table summarizes information about stock options at September 30,
1998:

<TABLE>
<CAPTION>
Options Outstanding                                                      Range                       Range
---------------------------------------------------------------------------------------------------------------
<S>                                                               <C>                   <C>
Range of Exercise Price                                                $7.250 - 11.250           $1.125 - 3.625

Number of Outstanding  September 30, 1998                                       43,250                  418,500

Weighted Average Remaining Contractual Life                                  5.3 years                8.4 years

Weighted Average Exercise Price                                        $          8.74           $         2.19

Options Exercisable
---------------------------------------------------------------------------------------------------------------

Number Exercisable at September 30, 1998                                        43,250                  141,125

Weighted Average Exercise Price                                        $          8.74           $         7.79
</TABLE>

The Company has applied Accounting Principles Board Opinion No. 25 and related
interpretations in accounting for its Plan, accordingly, no compensation costs
have been recognized. Had compensation costs for the Company's Plan been
determined based on the fair value at the grant date for the options granted in
1998, 1997, and 1996 in accordance with the method required by Statement of
Financial Accounting Standards No. 123, the Company's net income per share would
have been reduced to the pro forma amounts as follows:

<TABLE>
<CAPTION>
                                                                  1998          1997        1996
                                                                --------       -------     ------
<S>                                                             <C>            <C>         <C>
Net income (loss) available to common shareholders
As reported                                                     $(7,614)       $ (350)     $1,235
Pro forma                                                       $(7,691)       $ (428)     $1,221
                                                                
Per share net income (loss) available to common shareholders

As reported Basic                                               $ (0.98)       $(0.04)     $ 0.16

Pro forma Basic                                                 $ (0.99)       $(0.05)     $ 0.16
</TABLE>

Note 10 - Employee Benefit Plan:
--------------------------------

The Company maintains a contributory profit sharing plan established pursuant to
the provisions of Section 401(k) of the Internal Revenue Code which provides
retirement benefits for eligible employees of the Company and its subsidiaries.
The Company may make annual discretionary contributions to the plan. There were
no discretionary contributions during the years ended September 30, 1998, 1997
and 1996.

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

                                     F-18
<PAGE>
 
Note 11 - Commitments and Contingencies:
----------------------------------------

The Company is frequently required, in connection with the development of its
projects, to obtain performance or other maintenance bonds or letters of credit
in lieu thereof.  The amount of such obligations outstanding at any time varies
in connection with the Company's pending development activities. In the event
any such obligations are drawn upon, the Company would be obligated to reimburse
the issuing surety company or bank.  At September 30, 1998, there were
approximately $10.6 million in performance or maintenance bonds and
approximately $4.1 million of letters of credit outstanding for such purposes.
There have been no such draws during the years ended September 30, 1998 and
1997.

The Company currently leases 15,500 square feet of office space in Schaumburg,
Illinois where its Suburban Properties Division is located.  The Company also
leases approximately 3,000 square feet of office space in Chicago, Illinois,
where the Chicago Urban Properties Division is located.  Certain equipment is
also currently leased under non-cancelable operating leases. Rent expense under
such leases aggregated $480,000, $436,000 and $380,000 during the years ended
September 30, 1998, 1997 and 1996, respectively.  As discussed in Note 3 to the
financial statements,  the Company sold certain model homes to an unrelated
third party and is leasing them back from the buyer.  Rent expense under the
sale leaseback agreement was $153,000 during the year ended September 30, 1998.

Additionally, the Company is involved in various routine legal proceedings which
the Company believes to incidental to the conduct of its business.
Specifically, In November, 1994, a lawsuit was brought against the Company and
certain directors and employees of the Company by the Board of Managers of
Parkside on the Green Condominium Association.  The complaint seeks damages
against the Company for alleged construction defects in the approximate amount
of $4.8 million, together with punitive damages against the named individuals
for alleged breach of fiduciary duty.  The Company has assumed the defense of
this lawsuit on behalf of the individual defendants.  The lawsuit is in the
discovery process and various inspections of the project are underway. The
Company is defending the lawsuit vigorously.  Management believes that none of
these legal proceedings will have a material adverse impact on the financial
condition or results of operations of the Company.

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

                                      F-19
<PAGE>
 
Note 12 - Quarterly Results of Operation (unaudited):
-----------------------------------------------------

The following table reflects the results of operations for the Company during
the four quarters of 1998 and 1997. Certain of the quarterly information has
been restated, as described below (dollars in thousands, except unit and per
share data):

<TABLE>
<CAPTION>

Fiscal 1998                                                          Quarter Ended
                                                12/31/97       3/31/98         6/30/98          9/30/98
                                              ===========================================================
<S>                                           <C>                <C>           <C>                <C>
Number of home sales closed                       107               137                186            222
Total sales, as reported                      $19,633           $25,244            $42,117            n/a
  Parking unit sales (1)                         (213)             (185)              (148)           n/a
                                              -----------------------------------------------------------
Total sales, as restated                      $19,420           $25,059            $41,969        $45,108
                                              ===========================================================
Gross profit, as reported                     $ 2,492           $ 2,550            $ 4,707            n/a
  Parking unit sales (1)                          (81)              (77)               (51)           n/a
  Change in construction costs                 (1,038)             (620)              (616)           n/a
  Change in accounting policy (3)                  71              (100)              (129)           n/a
                                              -----------------------------------------------------------
Gross profit, as restated                     $ 1,444           $ 1,753            $ 3,911        $ 4,314
                                              ===========================================================
Income (loss) before minority interest        $  (485)          $  (968)           $ 1,029            n/a
  and provision for income taxes, as
  reported
  Parking unit sales (1)                          (81)              (77)               (51)           n/a
  Change in construction costs (2)             (1,038)             (620)              (616)           n/a
  Change in accounting policy (3)                 264              (176)                (3)           n/a
                                              -----------------------------------------------------------
Income (loss) before minority interest        $(1,340)          $(1,841)           $   359        $(2,655)
  and provision for income taxes, as
  restated
                                              ===========================================================
Income (loss) before cumulative effect of     $  (291)          $  (581)           $   617            n/a
  change in accounting policy, as reported
  Parking unit sales (1)                          (48)              (46)               (30)           n/a
  Change in construction cost (2)                (623)             (372)              (370)           n/a
  Change in accounting policy (3)                 158              (106)                (2)           n/a
                                              -----------------------------------------------------------
Income (loss) before cumulative effect of        (804)           (1,105)               215            n/a
  change in accounting policy, as restated
                                              -----------------------------------------------------------
Cumulative effect of change in accounting      (2,234)                -                    -          n/a
  policy (3)
                                              -----------------------------------------------------------
Net income (loss), as restated                $(3,038)          $(1,105)           $     215      $(3,686)
                                              ===========================================================
Net income (loss) per share, as reported      $ (0.04)          $ (0.07)           $    0.08          n/a
  (basic and diluted)
Income (loss) per share, before
  cumulative effect of change in
  accounting policy (basic and diluted)       $ (0.10)                -                    -            -
Income (loss) per share, as restated          $ (0.39)          $ (0.14)           $    0.03      $ (0.42)
  (basic and diluted)
</TABLE>

(1)  Reversal of parking unit closings because the transfer of legal title was
     incomplete.

(2)  To reflect changes in construction costs that were not recognized on a
     timely basis.

(3)  To reflect the change in accounting policy related to the early adoption of
     SOP 98-5, Reporting on the costs of Start-up Activities and Organization
     Costs, refer to Note 2.

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

                                     F-20

<PAGE>
 
<TABLE>
<CAPTION>

Fiscal 1997+                                                      Quarter Ended                                              
                                              12/31/96        3/31/97        6/30/97      9/30/97
                                              =====================================================
<S>                                           <C>            <C>             <C>           <C>
Number of home sales closed                        131              91           140            274
Sales                                          $22,712         $15,131       $23,739        $47,161
Gross profit                                     1,837             695         2,876          7,460
Income (loss) before minority interest            (943)         (2,664)           33          2,859
  and provision (benefit) for income taxes                
Net income (loss)                              $  (575)        $(1,604)      $    22        $ 1,807
                                               ====================================================
Net income (loss) per share                    $ (0.07)        $ (0.21)      $  0.00        $  0.23
                                               ====================================================
</TABLE>


+ Quarterly Results of Operations have been reclassified to conform to the 1998
  financial presentation.

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

                                     F-21