<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K

           [X]  ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE
      SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1996

                         Commission File Number 1-9240

                    TRANSCONTINENTAL REALTY INVESTORS, INC.        
             (Exact Name of Registrant as Specified in Its Charter)

<TABLE>
<S>                                                               <C> 
           Nevada                                                    94-6565852      
-------------------------------                                  -------------------
(State or Other Jurisdiction of                                   (I.R.S. Employer
 Incorporation or Organization)                                  Identification No.)
</TABLE>

<TABLE>
<S>                                                                   <C>  
10670 North Central Expressway, Suite 300, Dallas, Texas              75231  
--------------------------------------------------------              -----
       (Address of Principal Executive Offices)                     (Zip Code)
</TABLE>

                                 (214) 692-4700                   
              (Registrant's Telephone Number, Including Area Code)

          Securities Registered Pursuant to Section 12(b) of the Act:

<TABLE>
<S>                                                                  <C>
                                                                       Name of each exchange on
     Title of each class                                                   which registered      
----------------------------                                          --------------------------
Common Stock, $.01 par value                                           New York Stock Exchange
</TABLE>

          Securities Registered Pursuant to Section 12(g) of the Act:

                                      NONE

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 at least the past 90 days.  Yes X   No___

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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 Form 10-K or any amendment to
this Form 10-K.  [X]

As of March 7, 1997, the Registrant had 3,926,445 shares of Common Stock
outstanding.  Of the total shares outstanding 2,220,491 were held by other than
those who may be deemed to be affiliates, for an aggregate value of $24,425,000
based on the last trade as reported on the New York Stock Exchange on March 7,
1997.  The basis of this calculation does not constitute a determination by the
Registrant that all of such persons or entities are affiliates of the
Registrant as defined in Rule 405 of the Securities Act of 1933, as amended.

                      Documents Incorporated by Reference:
 Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.
                           Commission File No. 1-9525





                                       1
<PAGE>   2
                                    INDEX TO
                           ANNUAL REPORT ON FORM 10-K




<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                         <C>
                                     PART I
                                     ------
Item 1.     Business.............................................            3

Item 2.     Properties...........................................            7

Item 3.     Legal Proceedings....................................           21

Item 4.     Submission of Matters to a Vote of Security
               Holders............................................          23


                                    PART II
                                    -------

Item 5.     Market for Registrant's Common Equity and Related
               Stockholder Matters................................          23

Item 6.     Selected Financial Data..............................           25

Item 7.     Management's Discussion and Analysis of Financial
               Condition and Results of Operations................          26

Item 8.     Financial Statements and Supplementary Data..........           34

Item 9.     Changes in and Disagreements with Accountants on
               Accounting and Financial Disclosure................          68


                                    PART III
                                    --------

Item 10.    Directors, Executive Officers and Advisor of the
               Registrant.........................................          68

Item 11.    Executive Compensation................................          77

Item 12.    Security Ownership of Certain Beneficial Owners and
               Management.........................................          80

Item 13.    Certain Relationships and Related Transactions........          81


                                    PART IV
                                    -------

Item 14.    Exhibits, Consolidated Financial Statements,
               Schedules and Reports on Form 8-K..................          83

Signature Page....................................................          85
</TABLE>





                                       2
<PAGE>   3
                                     PART I


ITEM 1.  BUSINESS

Transcontinental Realty Investors, Inc. (the "Company" or the "Registrant"), a
Nevada corporation, is the successor to a California business trust, which was
organized on September 6, 1983 and commenced operations on January 31, 1984.
The Company has elected to be treated as a Real Estate Investment Trust
("REIT") under Sections 856 through 860 of the Internal Revenue Code of 1986,
as amended (the "Code").  The Company has, in the opinion of the Company's
management, qualified for federal taxation as a REIT for each year subsequent
to December 31, 1983.

The Company's real estate at December 31, 1996 consisted of 45 properties held
for investment, six partnership properties and six properties held for sale
which were primarily obtained through foreclosure.  Six of the properties held
for investment were acquired during 1996.  The Company's mortgage notes
receivable portfolio at December 31, 1996 consisted of 24 mortgage loans.  In
addition, the Company has an interest in a partnership which holds a wraparound
mortgage loan.  The Company's real estate and mortgage notes receivable
portfolios are more fully discussed in ITEM 2.  "PROPERTIES."

Business Plan and Investment Policy

The Company's primary business and only industry segment is investing in equity
interests in real estate through direct acquisitions,  partnerships and
financing real estate and real estate related activities through investments in
mortgage loans, including first, wraparound and junior mortgage loans.  The
Company's real estate is located throughout the continental United States.
Information regarding the real estate and mortgage notes receivable portfolios
of the Company is set forth in ITEM 2. "PROPERTIES", and in Schedules III and
IV to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA."

The Company's business is not seasonal.  The Company has determined to pursue a
balanced investment policy, seeking both current income and capital
appreciation.  With respect to new investments, the Company's plan of operation
is to consider all types of real estate, but in an attempt to bring balance to
its real estate portfolio, the Company will focus on apartments, primarily
located in the Southeast and Southwest regions of the United States.  In making
any new investments, emphasis will be on acquiring properties generating
current cash flow.  As it has done in the past, the Company will then invest in
and improve these assets to maximize both their immediate and longer term
value.

The Company's operating strategy with regard to its properties is to maximize
each property's operating income by aggressive property  management through
closely monitoring expenses while at the same time making property renovations
and/or improvements where appropriate.  While such expenditures increase the
amount of revenue required to cover





                                       3
<PAGE>   4
ITEM 1.  BUSINESS (Continued)

Business Plan and Investment Policy (Continued)

operating expenses, the Company's management believes that such expenditures
are necessary to maintain or enhance the value of the Company's properties.

The Company has determined that it will no longer seek to fund or acquire new
mortgage loans.  It may, however, originate mortgage loans in conjunction with
providing purchase money financing of a property sale.  The Company does
intend, however, to service and hold for investment the mortgage notes
currently in its portfolio.  The Company also intends to pursue its rights
vigorously with respect to mortgage notes that are in default.  The Company's
Articles of Incorporation impose no limitations on the Company's investment
policy with respect to mortgage loans and do not prohibit the Company from
investing more than a specified percentage of its assets in any one mortgage
loan.

The Company's Board of Directors currently intends to continue its policy of
prohibiting the Company from incurring aggregate secured and unsecured
indebtedness in excess of 300% of the Company's net asset value (defined as the
book value of all assets of the Company minus all of its liabilities); however,
the Board of Directors may alter such policy at any time.

Management of the Company

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by Basic Capital Management,
Inc. ("BCM" or the "Advisor"), a contractual advisor under the supervision of
the Company's Board of Directors.  The duties of the Advisor include, among
other things, locating, investigating, evaluating and recommending real estate
and mortgage note investment and sales opportunities, as well as financing and
refinancing sources for the Company.  The Advisor also serves as a consultant
in connection with the Company's business plan and investment decisions made by
the Company's Board of Directors.

BCM is a company owned by a trust for the benefit of the children of Gene E.
Phillips.  Mr. Phillips served as a Director of the Company until December 31,
1992.  Mr. Phillips also served as a director of BCM  until December 22, 1989
and as Chief Executive Officer of BCM until September 1, 1992.  Mr. Phillips
serves as a representative of his children's trust which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input with
respect to its performance of advisory services to the Company.  BCM is more
fully described  in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE
REGISTRANT - The Advisor."

BCM has been providing advisory services to the Company since March 28, 1989.
Renewal of BCM's advisory agreement with the Company was approved  by the
Company's stockholders at the Company's annual meeting of stockholders held on
May 31, 1996.  BCM also serves as advisor to





                                       4
<PAGE>   5
ITEM 1.  BUSINESS (Continued)

Management of the Company (Continued)

Continental Mortgage and Equity Trust ("CMET") and Income Opportunity Realty
Investors, Inc. ("IORI").  The Directors of the Company are also trustees or
directors of CMET and IORI and the officers of the Company are also officers of
CMET and IORI.  Mr. Phillips is a general partner of Syntek Asset Management,
L.P. ("SAMLP"), the general partner of National Realty, L.P. ("NRLP") and
National Operating, L.P. ("NOLP"), the operating partnership of NRLP.  BCM
performs certain administrative functions for NRLP and NOLP on a
cost-reimbursement basis.  BCM also serves as advisor to American Realty Trust,
Inc. ("ART").  Mr. Phillips served as Chairman of the Board and as a director
of ART until November 16, 1992.  Randall M. Paulson, President of the Company,
also serves as President of BCM, CMET and IORI, Executive Vice President of
ART, and as the President and sole director of Syntek Asset Management, Inc.
("SAMI"), which is the managing general partner of SAMLP.  The officers of the
Company are also officers of ART.  As of March 7, 1997, the Company owned
approximately 22.5% of IORI's outstanding shares of common stock and ART owned
approximately 30.5% of the outstanding shares of the Company's Common Stock and
approximately 29.6% of IORI's outstanding shares of common stock.

Since February 1, 1990, affiliates of BCM have provided property management
services to the Company.  Currently, Carmel Realty Services, Ltd. ("Carmel,
Ltd.") provides such property management services.  Carmel, Ltd. subcontracts
with other entities for the provision of the property-level management services
to the Company.  The general partner of Carmel, Ltd. is BCM.  The limited
partners of Carmel, Ltd. are (i) Syntek West, Inc. ("SWI"), of which Mr.
Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the
benefit of the children of Mr. Phillips.  Carmel, Ltd.  subcontracts the
property-level management and leasing of 28 of the Company's commercial
properties and its hotel and the commercial properties owned by a real estate
partnership in which the Company and IORI are partners to Carmel Realty, Inc.
("Carmel Realty"), which is a company owned by SWI.  Carmel Realty is entitled
to receive property and construction management fees and leasing commissions in
accordance with the terms of its property-level management agreement with
Carmel, Ltd.

Carmel Realty is also entitled to receive real estate brokerage commissions in
accordance with the terms of a non-exclusive brokerage agreement as discussed
in ITEM 10.  "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The
Advisor."

The Company has no employees.  Employees of the Advisor render services to the
Company.

Competition

The real estate business is highly competitive and the Company competes with
numerous entities engaged in real estate activities (including certain entities
described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related
Party Transactions"), some of which may





                                       5
<PAGE>   6
ITEM 1.  BUSINESS (Continued)


Competition (Continued)

have greater financial resources than those of the Company.  The Company's
management believes that success against such competition is dependent upon the
geographic location of the property, the performance of property managers in
areas such as marketing, collections and the ability to control operating
expenses, the amount of new construction in the area and the maintenance and
appearance of the property.  Additional competitive factors with respect to
commercial properties are the ease of access to the property, the adequacy of
related facilities, such as parking, and sensitivity to market conditions in
setting rent levels.  With respect to apartments, competition is also based
upon the design and mix of the units and the ability to provide a community
atmosphere for the tenants.  The Company's management believes that general
economic circumstances and trends and new or renovated properties in the
vicinity of each of the Company's properties are also competitive factors.

To the extent that the Company seeks to sell any of its properties, the sales
prices for such properties may be affected by competition from other real
estate entities and financial institutions also attempting to sell their
properties located in areas in which the Company's properties are located.

As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Related Party Transactions", the officers and Directors of the
Company also serve as officers or trustees or directors of certain other
entities, each of which is also advised by BCM, and each of which has business
objectives similar to those of the Company.  The Company's Directors, officers
and Advisor owe fiduciary duties to such other entities as well as to the
Company under applicable law.  In determining to which entity a particular
investment opportunity will be allocated, the officers, directors or trustees
and the Advisor consider the respective investment objectives of each such
entity and the appropriateness of a particular investment in light of each such
entity's existing real estate portfolio.  To the extent that any particular
investment opportunity is appropriate to more than one of such entities, such
investment opportunity will be allocated to the entity which has had funds
available for investment for the longest period of time or, if appropriate, the
investment may be shared among all or some of such entities.

In addition, as also described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Certain Business Relationships," the Company also competes with
other entities which are affiliates of the Advisor and which may have
investment objectives similar to the Company's and that may compete with the
Company in purchasing, selling, leasing and financing real estate and real
estate related investments.  In resolving any potential conflicts of interest
which may arise, the Advisor has informed the Company that it intends to
continue to exercise its best judgment as to what is fair and reasonable under
the circumstances in accordance with applicable law.





                                       6
<PAGE>   7
ITEM 1.  BUSINESS (Continued)

Certain Factors Associated with Real Estate and Related Investments

The Company is subject to all the risks incident to ownership and financing of
real estate and interests therein, many of which relate to the general
illiquidity of real estate investments.  These risks include, but are not
limited to, changes in general or local economic conditions, changes in
interest rates and the availability of permanent mortgage financing which may
render the acquisition, sale or refinancing of a property difficult or
unattractive and which may make debt service burdensome, changes in real estate
and zoning laws, increases in real estate taxes, federal or local economic or
rent controls, floods, earthquakes, hurricanes and other acts of God and other
factors beyond the control of the Company's management or Advisor.  The
illiquidity of real estate investments may also impair the ability of the
Company to respond promptly to changing circumstances.  The Company's
management believes that such risks are partially mitigated by the
diversification by geographic region and property type of the Company's real
estate and mortgage notes receivable portfolios.  However, to the extent new
property investments are concentrated in any particular region, the advantages
of geographic diversification may be mitigated.

ITEM 2.  PROPERTIES

The Company's principal offices are located at 10670 North Central Expressway,
Suite 300, Dallas, Texas 75231.  In the opinion of the Company's management,
the Company's offices are suitable and adequate for its present operations.

Details of the Company's real estate and mortgage notes receivable portfolios
at December 31, 1996, are set forth in Schedules III and IV, respectively, to
the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA."  The discussions set forth below under the headings
"Real Estate" and "Mortgage Loans" provide certain summary information
concerning the Company's real estate and mortgage notes receivable portfolios.

The Company's real estate portfolio consists of properties held for investment,
investments in real estate entities and properties held for sale, primarily
obtained through foreclosure of the collateral securing mortgage notes
receivable.  The discussion set forth below under the heading "Real Estate"
provides certain summary information concerning the Company's real estate and
further summary information with respect to the Company's properties held for
investment, properties held for sale and investments in real estate entities.

At December 31, 1996, none of the Company's properties, mortgage notes
receivable or investments in real estate entities exceeded 10% or more of the
Company's total assets.  At December 31, 1996, 89% of the Company's assets
consisted of properties held for investment, 1% consisted of properties held
for sale, 3% consisted of mortgage notes and interest receivable and 2%
consisted of investments in real estate entities.  The remaining 5% of the
Company's assets at December 31, 1996 were invested in cash, cash equivalents
and other assets.  The percentage of the Company's assets invested in any one
category is





                                       7
<PAGE>   8
ITEM 2.  PROPERTIES (Continued)

subject to change and no assurance can be given that the composition of the
Company's assets in the future will approximate the percentages listed above.

The Company's real estate is geographically diverse.   At December 31, 1996,
the Company held investments in apartments and commercial properties in each of
the geographic regions of the continental United States, although its
apartments and commercial properties are concentrated in the Southeast and
Southwest regions, as shown more specifically in the table under "Real Estate"
below.  At December 31, 1996, the Company held mortgage notes receivable
secured by real estate located in each of the geographic regions, other than
the Midwest, Mountain and Pacific regions, of the continental United States,
with a concentration in the Southeast region, as shown more specifically in the
table under "Mortgage Loans" below.

To continue to qualify for federal taxation as a REIT under the Code, the
Company is required, among other things, to hold at least 75% of the value of
its total assets in real estate assets, government securities, cash and cash
equivalents at the close of each quarter of each taxable year.





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       8
<PAGE>   9
ITEM 2.  PROPERTIES (Continued)

Geographic Regions

The Company has divided the continental United States into the following six
geographic regions.

    Northeast region comprised of the states of Connecticut, Delaware,
    Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania,
    Rhode Island and Vermont, and the District of Columbia.  The Company owns 3
    apartments and 1 commercial property in this region.

    Southeast region comprised of the states of Alabama, Florida, Georgia,
    Mississippi, North Carolina, South Carolina, Tennessee and Virginia.  This
    Company owns 3 apartments and 10 commercial properties in this region.

    Southwest region comprised of the states of Arizona, Arkansas, Louisiana,
    New Mexico, Oklahoma and Texas.  The Company owns 10 apartments and 9
    commercial properties in this region.

    Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas,
    Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio,
    South Dakota, West Virginia and Wisconsin.  The Company owns 3 commercial
    properties in this region.

    Mountain region comprised of the states of Colorado, Idaho, Montana,
    Nevada, Utah and Wyoming.  The Company owns 1 commercial property in this
    region.

    Pacific region comprised of the states of California, Oregon and
    Washington.  The Company owns 2 apartments, 1 hotel and 2 commercial
    properties in this region.

Excluded from the above are five parcels of unimproved land and a single family
residence, as described below.

Real Estate

At December 31, 1996, over 90% of the Company's assets were invested in real
estate.  The Company invests in real estate located throughout the continental
United States, either on a leveraged or nonleveraged basis.  The Company's real
estate portfolio consists of properties held for investment, investments in
real estate entities and properties held for sale (which were primarily
obtained through foreclosure of the collateral securing mortgage notes
receivable).

Types of Real Estate Investments.  The Company's real estate consists of
commercial properties (a hotel, office buildings, industrial warehouses and
shopping centers) and apartments or similar properties having established
income-producing capabilities.  In selecting new real estate investments, the
location, age and type of property, gross rentals,





                                       9
<PAGE>   10
ITEM 2.   PROPERTIES (Continued)


Real Estate (Continued)

lease terms, financial and business standing of tenants, operating  expenses,
fixed charges, land values and physical condition are among the factors
considered.  The Company may acquire properties subject to or assume existing
debt and may mortgage, pledge or otherwise obtain  financing for its
properties.  The Company's Board of Directors may alter the types of and
criteria for selecting new real estate investments and for obtaining financing
without a vote of stockholders.

Although the Company has typically invested in developed real estate, and has
no current intentions to do otherwise, the Company may also invest in new
construction or development either directly or in partnership with
nonaffiliated parties or affiliates (subject to approval by the Company's Board
of Directors).  To the extent that the Company invests in construction and
development projects, the Company would be subject to business risks, such as
cost overruns and construction delays, associated with such higher risk
projects.

At December 31, 1996 the Company had no properties on which significant capital
improvements were in process.

In the opinion of the Company's management, the properties owned by the Company
are adequately covered by insurance.

The following table sets forth the percentages, by property type and geographic
region, of the Company's real estate (other than a hotel in the Pacific region
and five parcels of unimproved land, as described below) at December 31, 1996.


<TABLE>
<CAPTION>
                                                             Commercial
      Region                                 Apartments      Properties
     ---------                               ----------      ----------
     <S>                                        <C>             <C>
     Pacific.........................             2%              5%
     Midwest.........................             -              11
     Northeast.......................            22               3
     Southwest.......................            48              33
     Southeast.......................            28              45
     Mountain........................            -                3
                                                ---             ---
                                                100%            100%
</TABLE>

The foregoing table is based solely on the number of apartment units and amount
of commercial square footage owned by the Company and does not reflect the
value of the Company's investment in each region.  The Company also owns five
parcels of unimproved land, parcels of 4.7 acres and 80 acres in the Southeast
region and parcels containing 4.66 acres, 4.7 acres and .9976 acres in the
Southwest region, all of which, except for the 4.7 acre parcel in the
Southwest region, are held for sale or were under contract for sale at December
31, 1996.  See Schedule III to the Consolidated Financial Statements included
at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for a more detailed
description of the Company's real estate portfolio.





                                       10
<PAGE>   11
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

A summary of activity in the Company's owned real estate portfolio during 1996
is as follows:

<TABLE>
     <S>                                                                <C>
     Owned properties at January 1, 1996......................           48
     Properties acquired......................................            6
     Property obtained through foreclosure....................            1
     Properties sold..........................................           (4)
                                                                         -- 
     Owned properties at December 31, 1996....................           51
                                                                         ==
</TABLE>

Properties Held for Investment.  Set forth below are the Company's properties
held for investment and the monthly rental rate for apartments and the average
annual rental rate for commercial properties and occupancy thereof at December
31, 1996, 1995 and 1994:

<TABLE>
<CAPTION>
                                                                          Rent Per
                                                                        Square Foot                   Occupancy       
                                                  Units/        -------------------------      ------------------------
    Property             Location            Square Footage      1996     1995      1994       1996     1995      1994 
-----------------  ------------------        --------------     ------   ------    ------      -----   ------    ------
<S>                <C>                       <C>                <C>      <C>       <C>          <C>     <C>       <C>
Apartments
----------
Arbor Point        Odessa, TX                    195 Units/
                                             178,920 Sq. Ft.    $  .37   $    *    $   *         65%      *         *
Carseka            Los Angeles, CA                54 Units/
                                              37,068 Sq. Ft.       .93        *        *        100%      *         *
Coventry           Midland, TX                   120 Units/
                                             105,608 Sq. Ft.       .37        *        *         92%      *         *
Fountain Village   Tucson, AZ                    410 Units/
                                             363,079 Sq. Ft.       .65       .65       .64       93%      93%       95%
Gladstell Forest   Conroe, TX                    168 Units/
                                             121,536 Sq. Ft.       .65       .62       *         92%      94%       *
Harper's Ferry     Lafayette, LA                 122 Units/
                                             112,500 Sq. Ft.       .48       .47       .44       96%      94%       97%
Heritage           Tulsa, OK                     136 Units/
                                              92,464 Sq. Ft.       .62       .60       .60       95%      94%       93%
Monterey Bay       St. Petersburg, FL            368 Units/
                                             310,494 Sq. Ft.       .51       .49       .52       89%      91%       89%
Shadow Run         Pinellas Park, FL             276 Units/
                                             216,400 Sq. Ft.       .71       .70       .68       96%      98%       99%
South Cochran      Los Angeles, CA                64 Units/
                                              43,100 Sq. Ft.       .93       .93       .93       96%      97%       96%
Southgate          Odessa, TX                    180 Units/
                                             151,656 Sq. Ft.       .39        *        *         63%      *         *
Spa Cove           Annapolis, MD                 303 Units/
                                             305,989 Sq. Ft.       .75       .75       .74       93%      95%       96%
Summerfield        Orlando, FL                   224 Units/
                                             203,940 Sq. Ft.       .59       .56       .54       92%      89%       82%
Summerstone        Houston, TX                   242 Units/
                                             188,734 Sq. Ft.       .59       .57       .57       94%      96%       95%
Westgate of Laurel Laurel, MD                    218 Units/
                                             201,704 Sq. Ft.       .81       .80       .79       96%      94%       94%
Westwood           Odessa, TX                     79 Units/
                                              49,001 Sq. Ft.       .40        *        *         65%      *         *
Woodland Hills     San Antonio, TX                96 Units/
                                              57,800 Sq. Ft.       .66       .64       .59       90%      94%       97%
Woods Edge         Rockville, MD                 162 Units/
                                             146,460 Sq. Ft.       .93       .93       .91       93%      94%       94%
Office Buildings
----------------
74 New Montgomery  San Francisco, CA         114,952 Sq. Ft.     14.88     14.67     14.59       92%      89%       53%
Chesapeake Ridge   San Diego, CA             100,484 Sq. Ft.     13.28      9.76     12.84      100%     100%      100%
Corporate Pointe   Chantilly, VA              65,918 Sq. Ft.     13.41     13.07     12.74      100%     100%       81%
Forum              Richmond, VA               80,941 Sq. Ft.     14.02     13.38     11.46      100%      98%       86%
Hartford           Dallas, TX                174,727 Sq. Ft.      9.44      9.55      9.64       46%      50%       56%
</TABLE>





                                       11
<PAGE>   12
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)
<TABLE>
<CAPTION>
                                                                        Rent Per
                                                                      Square Foot/
                                                Units/              Average Room Rate                Occupancy       
                                            Square Footage/     ---------------------------    ------------------------
    Property            Location              Rooms/Acres        1996      1995       1994      1996     1995     1994 
-----------------  ------------------      ----------------     ------    ------     ------    ------   ------    -----
<S>                <C>                      <C>                  <C>       <C>       <C>      <C>      <C>       <C>
Office Buildings - Continued
----------------            
Institute Place
 Lofts             Chicago, IL               142,215 Sq. Ft.     12.31     13.14     12.49       75%      73%       70%
One Steeplechase   Sterling, VA              103,376 Sq. Ft.     14.75     14.32     13.91      100%     100%      100%
Plaza Towers       St. Petersburg, FL        188,218 Sq. Ft.     12.15     11.84     11.85       88%      82%       75%
Republic Towers    Dallas, TX              1,324,624 Sq. Ft.     12.01      8.71      8.84        8%       9%       17%
Town and Country   Houston, TX                64,089 Sq. Ft.      4.47      4.18      3.69       67%      62%       76%
Venture Center     Atlanta, GA                38,271 Sq. Ft.     12.67     12.10     11.65       94%      89%      100%
Waterstreet        Boulder, CO               106,211 Sq. Ft.     15.60     14.70     14.30       96%      99%       98%

Industrial Warehouses
---------------------
Corporate Center
 at Beaumeade      Ashburn, VA               178,492 Sq. Ft.      5.64      5.19      5.96       80%      51%       71%
Denton Drive       Dallas, TX                123,800 Sq. Ft.      1.34      1.34      1.34      100%     100%      100%
Parke Long         Chantilly, VA             222,197 Sq. Ft.      5.32      5.61      5.55       80%      71%       71%
Technology Trading
 Center            Sterling, VA              199,582 Sq. Ft.      5.26      4.83      4.69       78%      77%       74%
Texstar            Arlington, TX              97,846 Sq. Ft.      1.86      1.86      1.86      100%     100%      100%
Tricon Warehouses  Atlanta, GA               570,808 Sq. Ft.      3.29      3.05      3.17       93%      98%       92%

Shopping Centers
----------------
Dunes Plaza        Michigan City, IN         223,938 Sq. Ft.      4.49      4.40      4.31       82%      85%       77%
Northtown Mall     Dallas, TX                354,174 Sq. Ft.      3.13      3.85      3.07       82%      81%       83%
Parkway Center     Dallas, TX                 28,228 Sq. Ft.     12.01     11.24     11.09       94%      94%       95%
President's Square San Antonio, TX            46,509 Sq. Ft.      7.17      7.03      6.99      100%     100%       89%
Sadler Square      Amelia Island, FL          73,396 Sq. Ft.      6.54      6.14      5.90       95%      92%       96%
Shaw Plaza         Sharon, MA                103,482 Sq. Ft.      5.67      5.79      5.80       87%      87%       85%
Sheboygan          Sheboygan, WI              74,532 Sq. Ft.      1.99      1.99      1.99      100%     100%      100%

Hotel
-----
Majestic Inn       San Francisco, CA              60 Rooms      117.45    106.79    107.15       70%      56%       58%

Land
----
Las Colinas        Las Colinas, TX               4.7 Acres
</TABLE>

---------------
*  Property was acquired in either 1996 or 1995.

Occupancy presented here and throughout this ITEM 2. is without reference to
whether leases in effect are at, below or above market rates.

In March 1994, the Company borrowed $1.4 million from a Northtown Mall tenant,
secured by a second lien on the shopping center.  The loan proceeds were used
primarily for renovations and repairs to the shopping center.  In October 1994,
the tenant loaned the Company an additional $1.9 million, the proceeds of which
were used in part to repay the first mortgage secured by the property.  At
funding of the second loan, the two loans were combined into a new first
mortgage.  The new first mortgage, in the amount of $3.3 million, matured
December 31, 1995. In August 1996, the Company modified and extended the
mortgage.  In conjunction with the modification, the Company made $450,000 in
principal paydowns to extend the loan's maturity date to March 31, 1997.  The
mortgage had a principal balance of $2.8 million at December 31, 1996 which the
Company intends to pay off at maturity unless new financing is obtained.





                                       12
<PAGE>   13
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

In January 1996, the Company purchased the Las Colinas land, a 4.7 acre parcel
of partially developed land in Las Colinas, Texas, for $941,000 in cash.  The
parcel, within the Las Colinas Urban Center, is adjacent to developed office
buildings.  The Company paid a real estate brokerage commission of $38,000 to
Carmel Realty and a real estate acquisition fee of $9,000 to BCM based on the
$941,000 purchase price.

In May 1996, the Company refinanced the mortgage debt secured by Parkway Centre
Shopping Center in Dallas, Texas in the amount of $1.8 million.  The Company
received net cash of $771,000 after the payoff of $735,000 in existing mortgage
debt and the payment of various closing costs associated with the refinancing.
The new mortgage bears interest at 9.5625% per annum, requires monthly payments
of principal and interest of $16,024 and matures in June 2006.  The Company
paid a mortgage brokerage and equity refinancing fee of $18,000 to BCM based on
the $1.8 million refinancing.

In July 1996, the Company refinanced the matured mortgage debt secured by the
Westgate of Laurel Apartments in Laurel, Maryland in the amount of $7.7
million.  The Company received net cash of $126,000 after the payoff of $7.2
million in existing mortgage debt and the payment of various closing costs and
escrows associated with the refinancing.  The new mortgage bears interest at
9.1875% per annum, requires monthly payments of principal and interest of
$63,202 and matures in August 2006.  The Company paid a mortgage brokerage and
equity refinancing fee of $77,000 to BCM based upon the $7.7 million
refinancing.

In August 1996, in a single transaction, the Company purchased the Arbor Point
Apartments, a 195 unit apartment complex in Odessa, Texas, the Coventry
Apartments, a 120 unit apartment complex in Midland, Texas, the Southgate
Apartments, a 180 unit apartment complex in Odessa, Texas, and the Westwood
Apartments, a 79 unit apartment complex in Odessa, Texas, for a total of $4.1
million in cash.  The Company paid a real estate brokerage commission of
$144,000 to Carmel Realty and a real estate acquisition fee of $41,000 to BCM
based on the $4.1 million purchase price of the properties.  In November 1996,
the Company obtained mortgage financing in the amount of $2.0 million, on the
unencumbered apartments.  The Company received net cash of $1.7 million after
paying various closing costs associated with the financing.  The mortgage bears
interest at a variable rate, currently at 8.5% per annum, requires monthly
payments of principal and interest of $16,105 and matures December 1, 2001.
The Company paid a mortgage brokerage and equity financing fee of $20,000 to
BCM based on the $2.0 million financing.

In September 1996, as provided in the mortgage, the Company increased the
mortgage principal balance on the Plaza Towers Office Building in





                                       13
<PAGE>   14
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

St. Petersburg, Florida by $2.0 million.  The Company received net cash of $1.9
million after paying various costs associated with the additional borrowing.
The additional $2.0 million borrowing bears interest at a variable rate,
currently 9.22% per annum, requires monthly payments of principal and interest
of $18,741 and matures in May 2000.  The Company paid a mortgage brokerage and
equity refinancing fee of $20,000 to BCM based upon the $2.0 million mortgage
increase.

In November 1996, the Company purchased the Carseka Apartments, a 54 unit
apartment complex in Los Angeles, California, for $2.2 million in cash.  The
Company paid a real estate brokerage commission of $85,250 to Carmel Realty and
a real estate acquisition fee of $21,750 to BCM based on the $2.2 million
purchase price.

In January 1997, the Company refinanced the mortgage debt secured by 74 New
Montgomery, an office building in San Francisco, California in the amount of
$6.3 million.  The Company received net cash of $1.0 million after the payoff
of $5.2 million in existing mortgage debt.  The remainder of the refinancing
proceeds were used to fund a tax escrow and to pay various closing costs
associated with the refinancing.  The new mortgage bears interest at variable
rate, currently 9.25% per annum, requires monthly principal and interest
payments of $53,996 and matures in January  2004.  The Company paid a mortgage
brokerage and equity refinancing fee of $63,000 to BCM based on the $6.3
million refinancing.

Also in January 1997, the Company refinanced the mortgage debt secured by the
Woods Edge Apartments in Rockville, Maryland in the amount of $6.2 million.
The Company received no net cash.  The refinancing proceeds being used to pay
off $5.9 million in existing mortgage debt, to fund a tax escrow and to pay
various closing costs associated with the refinancing.  The new mortgage bears
interest at 8.125% per annum, requires monthly payments of principal and
interest of $46,035 and matures in February 2007.  The Company paid a mortgage
brokerage and equity refinancing fee of $62,000 to BCM based on the $6.2
million refinancing.

In February 1997, the Company refinanced the mortgage debt secured by the Spa
Cove Apartments in Annapolis, Maryland in the amount of $12.2 million.  The
Company received net cash of $249,000 after the payoff of $11.6 million in
existing mortgage debt.  The remainder of the refinancing proceeds were used to
fund a tax escrow and to pay various closing costs associated with the
refinancing.  The new mortgage bears interest at 8.015% per annum, requires
monthly payments of principal and interest of $89,529 and matures in March
2007.  The Company paid a mortgage brokerage and equity refinancing fee of
$122,000 to BCM based on the $12.2 million refinancing.

In March 1997, the Company purchased the Terrace Hills Apartments, a 310 unit
apartment complex in El Paso, Texas, for $6.2 million.  The Company paid $1.4
million in cash and obtained new mortgage financing of $4.8 million.  The
mortgage bears interest at 8.07% per annum, requires monthly principal and
interest payments of $35,086, and matures in April 2007.  The Company paid a
real estate brokerage commission of $193,000 to





                                       14
<PAGE>   15
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

Carmel Realty and a real estate acquisition fee of $62,000 to BCM based upon
the $6.2 million purchase price of the property.

Partnership Properties.  Set forth below are the properties owned by
partnerships which the Company accounts for using the equity method and the
monthly rental rate for apartments and the average annual rental rate for
commercial properties and occupancy thereof at December 31, 1996, 1995 and
1994:

<TABLE>
<CAPTION>
                                                                         Rent Per
                                                                        Square Foot                    Occupancy       
                                               Units/           --------------------------     -------------------------
    Property          Location             Square Footage        1996     1995      1994        1996     1995      1994 
-----------------  --------------          ---------------      ------   -------   -------     ------   ------    ------
<S>                <C>                     <C>                  <C>      <C>       <C>          <C>      <C>       <C>
Apartments
----------
Inwood Green       Houston, TX                 126 Units/
                                           105,960 Sq. Ft.      $  .45   $   .44   $   .43       93%      93%       91%
Lincoln Court      Dallas, TX                   55 Units/
                                            40,063 Sq. Ft.         .99       .96       .94       98%      94%       98%
Oaks of Inwood     Houston, TX                 198 Units/
                                           167,872 Sq. Ft.         .44       .43       .43       93%      91%       90%
Office Building
---------------
MacArthur Mills    Carrollton, TX           53,472 Sq. Ft.        8.38      7.80      6.99       94%      95%       88%

Shopping Centers
----------------
Chelsea Square     Houston, TX              70,275 Sq. Ft.        9.32      9.14      8.67       69%      77%       78%
Summit at
 Bridgewood        Fort Worth, TX           48,696 Sq. Ft.        8.67      9.23      8.92       62%      63%       62%
</TABLE>

The Company owns a combined 55% limited and general partnership interest in
Jor-Trans Investors Limited Partnership ("Jor-Trans") which owns the Lincoln
Court Apartments.

The Company owns a combined 63.7% limited and general partner interest and IORI
owns a 36.3% general partner interest in Tri-City Limited Partnership
("Tri-City") which owns the five other properties in the table above.  In 1996,
the Company made $115,000 in advances to the partnership and received $532,000
in operating distributions from the partnership.  See ITEM 13. "CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions."

Properties Held for Sale.  Set forth below are the Company's properties held
for sale, primarily obtained through foreclosure, and the average rental rate
for a commercial property and occupancy thereof at December 31, 1996, 1995 and
1994.

<TABLE>
<CAPTION>
                                                                        Rent Per
                                                                      Square Foot                   Occupancy       
                                               Units/          --------------------------    ------------------------
    Property          Location             Square Footage       1996     1995       1994      1996     1995     1994 
-----------------  --------------          --------------      ------   ------     ------    ------   ------   ------
<S>                <C>                        <C>               <C>       <C>       <C>       <C>      <C>       <C>
Shopping Center
---------------
Fiesta Mart        San Angelo, TX           29,000 Sq. Ft.      2.62      2.62      2.62       91%     100%      100%

Single Family
-------------
Residence
---------
Scottsdale         Scottsdale, AZ            5,557 Sq. Ft.

Land                                                                                              Acres/Lots      
----                                                                                         ------------------------
Moss Creek         Greensboro, NC                                                                  80         Acres
Fruitland          Fruitland Park, FL                                                               4.66      Acres
Live Oak           Dallas, TX                                                                        .9976    Acres
Maumelle           Maumelle, AR                                                                    70         Lots
</TABLE>





                                       15
<PAGE>   16
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

In January 1996, the Company sold the Cheyenne Mountain land, a 7 acre parcel
of foreclosed unimproved land in Colorado Springs, Colorado, for $330,000 in
cash.  The Company recognized a gain of $218,000 on the sale.

In March 1996, the Company sold the Park Forest Apartments, a 44 unit
foreclosed held for sale apartment complex in Dearborn Heights, Michigan, for
$4.7 million.  The Company received net cash of $1.6 million after paying off
the existing mortgage debt of $2.9 million and the payment of various closing
costs associated with the sale.  The Company recognized a gain of $1.4 million
on the sale.  The Company paid a real estate sales commission of $160,000 to
Carmel Realty based on the $4.7 million sales price.

In June 1996, the Company entered into a contract to sell Latham Square, a
106,067 square foot office building in Oakland, California, for $2.2 million in
cash.  The agreed sales price was $1.4 million less than the property's
carrying value.  Accordingly, at June 30, 1996, the Company recognized a
provision for loss of $1.6 million to reduce the property's carrying value to
its sales price less estimated costs of sale.  In July 1996, the Company
completed the sale receiving net cash of $2.0 million after the payment of
various closing costs associated with the sale.  The Company paid a real estate
sales commission of $85,000 to Carmel Realty based upon the $2.2 million sales
price.  The Company incurred a loss on the sale of $64,000 in excess of the
amount which had been previously provided.

In August 1996, the Company sold a 177 acre tract of the Moss Creek land, a 257
acre parcel of foreclosed land held for sale in Greensboro, North Carolina, for
$750,000 in cash.  The Company received net cash of $690,000 after paying
various closing costs associated with the sale. The Company recognized a gain
of $56,000 on the sale. In December 1996, the Company repurchased three lots in
Moss Creek, in Greensboro, North Carolina that secured three of the Company's
mortgage notes receivable, as more fully discussed under "Mortgage Loans,"
below.

As discussed more fully under "Mortgage Loans," below, in September 1996, the
Company obtained through, trustee sale, a single family residence that secured
one of the Company's mortgage notes receivable.

Also in September 1996, the Company sold the Byron land, a 522 acre parcel of
foreclosed land held for sale in Greensboro, North Carolina, for $1.6 million
in cash.  The Company paid a real estate sales commission of $33,000 to Carmel
Realty based on the $1.6 million sales price.  The Company recognized a loss of
$63,000 on the sale.


                                       16
<PAGE>   17
ITEM 2.   PROPERTIES (Continued)

Real Estate (Continued)

At December 31, 1996, the Fiesta Mart, a 29,000 square foot shopping center in
San Angelo, Texas, was under contract for sale. In February 1997, the Company
completed the sale for $544,000 in cash.  The Company received net cash of
$403,000 after the payoff of $90,000 in existing mortgage debt and various
closing costs associated with the sale.  The Company paid a real estate sales
commission of $22,000 to Carmel based upon the $544,000 sales price.  The
Company incurred no gain or loss on the sale.

Also at December 31, 1996, a .9976 acre parcel of land in Dallas, Texas, was
under contract for sale.  In February 1997, the Company completed the sale for
$2.7 million in cash.  The Company received net cash of $2.6 million after
paying various closing costs associated with the sale.  The Company will
recognize a gain of approximately $1.3 million on the sale.  The Company paid a
real estate sales commission of $102,000 to Carmel Realty based on the $2.7
million sales price.

Mortgage Loans

In addition to investments in real estate, a substantial portion of the
Company's assets are invested in mortgage notes receivable, principally
secured by income-producing real estate.  The Company expects that the
percentage of its assets invested in mortgage loans will decrease, as it has
determined that it will no longer seek to fund or acquire mortgage loans, other
than those which it may originate in conjunction with providing purchase money
financing of a property sale.  The Company does intend, however, to service and
hold for investment the mortgage notes currently in its portfolio.  The
Company's mortgage notes receivable consist of first, wraparound and junior
mortgage loans.

Types of Mortgage Activity.  In the past the Company has originated its own
mortgage loans, as well as acquired existing mortgage notes either directly
from builders, developers or property owners, or through mortgage banking
firms, commercial banks or other qualified brokers.  The Company is not
considering new mortgage lending, except in connection with purchase money
financing offered to facilitate the sale of Company owned  properties.  BCM, in
its capacity as a mortgage servicer, services the Company's mortgage notes.
The Company's investment policy is described in ITEM 1.  "BUSINESS - Business
Plan and Investment Policy."

Types of Properties Securing Mortgage Notes.  The properties securing the
Company's mortgage notes receivable portfolio at December 31, 1996, consisted
of an office building, a shopping center, 3 apartment complexes, a hotel, 36.3
acres of commercial land, 9 developed residential lots and a 34,847 square foot
parcel of unimproved land.  The Company's Board of Directors may alter the
types of properties  securing or collateralizing mortgage loans in which the
Company invests





                                       17
<PAGE>   18
ITEM 2.   PROPERTIES (Continued)

Mortgage Loans  (Continued)

without a vote of stockholders.  The Company's Articles of Incorporation impose
certain restrictions on transactions with related parties, as discussed in ITEM
13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."

At December 31, 1996, the Company's mortgage notes receivable portfolio
included 7 mortgage loans with an aggregate outstanding balance of $9.3 million
secured by income-producing real estate located throughout the United States,
17 loans with an aggregate outstanding balance of $775,000  which are secured
by collateral other than income-producing real estate and one unsecured note.
At December 31, 1996,3% of the Company's assets were invested in notes and
interest receivable (1% in first mortgage notes, 2% in wraparound mortgage
notes and less than 1% in junior and other mortgage notes).

The following table sets forth the percentages (based on the outstanding
mortgage note balance) by property type and geographic region, of the
properties (other than a hotel and unimproved land) that serve as collateral
for the Company's outstanding mortgage notes receivable at December 31, 1996.
See Schedule IV to the Consolidated Financial Statements included at ITEM 8.
"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for further details of the
Company's mortgage notes receivable portfolio.
<TABLE>
<CAPTION>
                                                             Commercial
       Region                                   Apartments   Properties   Total
       ------                                   ----------   ----------   -----
     <S>                                           <C>          <C>        <C>
     Northeast  ............................         25%          - %       25%
     Southwest  ............................         16           -         16
     Southeast  ............................          -           59        59 
                                                   ----         ----      ----
                                                     41%          59%      100%
</TABLE>

A summary of the activity in the Company's mortgage notes receivable portfolio
during 1996 is as follows:

<TABLE>
         <S>                                                                 <C>
         Loans in mortgage notes receivable portfolio at
           January 1, 1996...........................................        31
         Loans settled with borrower.................................        (6)
         Loans foreclosed on.........................................        (1)
                                                                             -- 
         Loans in mortgage notes receivable portfolio at
           December 31, 1996.........................................        24
                                                                             ==
</TABLE>

During 1996, a mortgage note receivable of $825,000 was collected and $82,000
in mortgage principal payments were received.

At December 31, 1996, less than 1% of the Company's assets were invested in
mortgage notes secured by non-income-producing real estate, comprised of a
first mortgage note secured by 36.3 acres of commercial land in Maumelle,
Arkansas, a first mortgage note secured by 34,847 square feet of unimproved
land in Milwaukee, Wisconsin and nine first mortgage notes secured by developed
residential lots in Greensboro, North Carolina.

First Mortgage Loans.  The Company has invested in first mortgage notes, with
short, medium or long-term maturities.  First mortgage loans generally provide
for level periodic payments of principal and interest





                                       18
<PAGE>   19
ITEM 2.  PROPERTIES (Continued)


Mortgage Loans (Continued)

sufficient to substantially repay the loan prior to maturity, but may involve
interest-only payments or moderate amortization of principal and a "balloon"
principal payment at maturity.  With respect to first mortgage loans, the
Company's general policy was to require that the borrower provide a mortgagee's
title policy or an acceptable legal title  opinion as to the validity and the
priority of the mortgage lien over all other obligations, except liens arising
from unpaid property taxes and other exceptions normally allowed by first
mortgage lenders in the relevant area.  The Company may grant to other lenders,
participations in first mortgage loans originated by the Company.

The following discussion briefly describes the events that affected previously
funded first mortgage loans during 1996.

In February 1994, the Company provided $6.7 million of purchase money financing
in conjunction with the sale of 1,406 acres of land in sixteen developed
residential and commercial subdivisions located in Maumelle,  Arkansas.  The
borrower did not make the scheduled February 1995 principal and interest
payments.  In September 1995, the Company reached a settlement with the
borrower that provided the following:  (i) the payment by the borrower of $2.5
million in cash; (ii) the Company's release of all land securing the note;
(iii) the Company's acceptance of a new $1.4 million note secured by 36.3 acres
of commercial land, such note bore interest at 9.0% and matured in January 1996
and (iv) the Company's receipt of 700,000 shares of the borrower's capital
stock, which the borrower has the option to repurchase at $5.00 per share for
two years from closing.  The original sale had been recorded under the cost
recovery method with gain being deferred until the note was collected.  With
the Company's receipt of $2.5 million in cash on September 12, 1995, it
recognized $1.6 million of the gain previously deferred.  The $1.4 million note
was not paid at maturity.  The Company is negotiating with the borrower in an
effort to correct the default and has also instituted foreclosure proceedings.
The Company does not expect to incur a loss on the note as the fair value of
the property exceeds the nominal carrying value of the note.

In March 1996, the Company accepted a discounted payoff of $825,000 in
settlement of a first mortgage note receivable with a principal balance  of
$875,000.  The Company recorded no loss on the note settlement in excess of the
reserve previously established.

In 1993, in conjunction with the sale of a foreclosed residence in Scottsdale,
Arizona, the Company provided purchase money financing of $725,000 with a
maturity date of August 1996.  In January 1996, the borrower ceased making
payments and in June 1996, filed for bankruptcy protection.  In September 1996,
the Company reacquired the property through trustee sale.  The fair market
value of the residence less, estimated costs of sale, exceeded the note's
principal balance and accrued interest of $691,000 at the date the property was
reacquired.  See "Real Estate," above.





                                       19
<PAGE>   20
ITEM 2.  PROPERTIES (Continued)


Mortgage Loans (Continued)

In December 1996, the Company repurchased three residential lots in Moss Creek,
in Greensboro, North Carolina for $44,000 in cash and cancellation of mortgage
each property secured.  The buyer was unable to obtain the necessary building
permits for the lots in the time required by his purchase contract.  See "Real
Estate," above.

Wraparound Mortgage Loans.  A wraparound mortgage loan, sometimes called an
all-inclusive loan, is a mortgage loan having an original principal balance
equal to the outstanding balance under the prior existing mortgage loan(s) plus
the amount actually advanced under the wraparound mortgage loan.  Wraparound
mortgage loans may provide for full, partial or no amortization of principal.
The Company's policy was to make wraparound mortgage loans in amounts and on
properties as to which it would otherwise make first mortgage loans.

The Company did not originate or acquire any wraparound mortgage loans in 1996.

Junior Mortgage Loans.  The Company has invested in junior mortgage loans.
Such loans are secured by mortgages that are subordinate to one or more prior
liens either on the fee or a leasehold interest in real estate.  Recourse on
such loans ordinarily includes the real estate on which the loan is made, other
collateral and personal guarantees by the borrower.  The Company's Board of
Directors restricts investment in junior mortgage loans, excluding wraparound
mortgage loans, to not more than 10% of the Company's assets.  At December 31,
1996, less than 1% of the Company's assets were invested in junior mortgage
loans.

The Company did not originate or acquire any junior mortgage loans in 1996.

Loans Secured by Collateral Other than Real Estate.  In June 1992, the Company
received ten notes receivable secured by collateral other than real estate in
satisfaction of a $622,000 obligation to the Company.  At December 31, 1996,
five of the notes with a combined principal balance of $374,000 remained
outstanding.  The Company's investment policy precludes  the origination of
loans secured by collateral other than real estate.  In June 1996, the Company
wrote off a mortgage note receivable with a balance of $47,000.  The Company
recorded no loss in excess of the reserve previously established. In July 1996,
the Company received $4,000 in settlement of a note receivable with a principal
balance of $20,000.  The Company recorded no  loss on the settlement in excess
of the reserve previously established.

Partnership mortgage loans.  The Company owns a 60% general partner interest
and IORI owns a 40% general partner interest in Nakash Income Associates
("NIA").  NIA in turn owns a wraparound  mortgage note receivable.  In 1996,
the partnership extended the maturity date to April 1, 1997, of the underlying
note payable secured by a building occupied by a Wal-Mart in Maulden, Missouri.





                                       20
<PAGE>   21
ITEM 3.  LEGAL PROCEEDINGS

Olive Litigation

In February 1990, the Company, together with CMET, IORI and National Income
Realty Trust ("NIRT"), three real estate entities with, at the time, the same
officers, directors or trustees and advisor as the Company, entered into a
settlement of a class and derivative action entitled Olive et al. v. National
Income Realty Trust et al., in the United States District Court for the
Northern District of California relating to the operation and management of
each of such entities.  On April 23, 1990, the Court granted final approval of
the terms of the settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Modification") which settled subsequent
claims of breaches of the settlement which were asserted by the plaintiffs and
modified certain provisions of the April 1990 settlement.  The Modification was
preliminarily approved by the Court on July 1, 1994 and final Court approval of
the Modification was entered on December 12, 1994.  The effective date of the
Modification was January 11, 1995.

The Modification, among other things, provided for the addition of new
unaffiliated members to the Company's Board of Directors and set forth new
requirements for the approval of any transactions with affiliates until April
28, 1999.  In addition, BCM, the Company's advisor, Gene E. Phillips and
William S. Friedman, who served as President and Director of the Company until
February 24, 1994, President of BCM until May 1, 1993 and director of BCM until
December 22, 1989, agreed to pay a total of $1.2 million to CMET, IORI, NIRT
and the Company, of which the Company's share was $150,000.

Under the Modification, the Company, CMET, IORI and NIRT and their stockholders
released the defendants from any claims relating to the  plaintiffs'
allegations.  The Company, CMET, IORI and NIRT also agreed to waive any demand
requirement for the plaintiffs to pursue claims on behalf of each of them
against certain persons or entities.  The Modification also requires that any
shares of the Company held by Messrs. Phillips, Friedman or their affiliates
shall be (i) voted in  favor of the reelection of all then current members of
the Company's Board of Directors that stand for reelection during the two
calendar years following the effective date of the Modification and (ii) voted
in favor of all new members of the Company's Board of Directors appointed
pursuant to the terms of the Modification that stand for reelection during the
three calendar years following the effective date of the Modification.

Pursuant to the terms of the Modification, certain related party transactions
which the Company may enter into prior to April 28, 1999, require the unanimous
approval of the Company's Board of Directors.  In addition, such related party
transactions are to be discouraged and may only be entered into in exceptional
circumstances and after a determination by the Company's Board of Directors
that the transaction is in the best interests of the Company and that no other
opportunity exists that is as good as the opportunity presented by such
transaction.





                                       21
<PAGE>   22
ITEM 3.  LEGAL PROCEEDINGS (Continued)

Olive Litigation (Continued)

For purposes of the Modification requirements, the term "related party
transaction" means and includes:  (i) any transaction between or among the
Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii)
any transaction between or among the Company, its affiliates or subsidiaries
and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and
(iii) any transaction between or among the Company or any of its affiliates or
subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr.
Friedman or any of their affiliates has an ongoing or contemplated business or
financial transaction or relationship of any kind, whether direct or indirect,
or has had such a transaction or relationship in the preceding one year.

The Modification requirements for related party transactions do not apply to
direct contractual agreements for services between the Company and the Advisor
or one of its affiliates (including the Advisory Agreement, the Brokerage
Agreement and the property management contracts).  These agreements require the
prior approval by two-thirds of the Directors of the Company, and if required,
approval by a majority of the Company's stockholders.  The Modification
requirements for related party transactions also do not apply to joint ventures
between or among the Company and CMET, IORI or NIRT or any of their affiliates
or subsidiaries and a third party having no prior or intended future business
or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any
affiliate of such parties.  Such joint ventures may be entered into on the
affirmative vote of a majority of the Directors of the Company.

The Modification also terminated a number of the provisions of the  settlement,
including the requirement that the Company, CMET, IORI and NIRT maintain a
Related Party Transaction Committee and a Litigation Committee of their
respective Boards.  The Court retained jurisdiction to enforce the
Modification, and during August and September 1996, the Court held evidentiary
hearings to assess compliance with the terms of the Modification by various
parties.  The Court issued no ruling or order with respect to the matters
addressed at the hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intends to assert that certain actions taken by the
Board of Directors breached the terms of the Modification.  On January 27,
1997, the parties entered into an Amendment to the Modification effective
January 9, 1997 (the "Amendment"), which was submitted to the Court for
approval on January 29, 1997.  The Amendment provides for the settlement of all
matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Company's Board of Directors.  As of March 20, 1997, the Court
had taken no action on the Amendment.

The Amendment provides for the addition of three new unaffiliated members to
the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999.  In
addition, the Company, CMET, IORI and their stockholders released the
defendants from any claims relating





                                       22
<PAGE>   23
ITEM 3.  LEGAL PROCEEDINGS (Continued)

Olive Litigation (Continued)

to the plaintiffs' allegations and matters which were the subject of the
evidentiary hearings.  The plaintiffs' allegations of any breaches of the
Modification shall be settled by mutual agreement of the parties or, lacking
such agreement, by an arbitration proceeding.

Under the Amendment, all shares of the Company owned by Mr. Phillips or any of
his affiliates shall be voted at all stockholders' meetings held until April
28, 1999 in favor of all new members of the Company's Board of Directors added
under the Amendment.  The Amendment also requires that, until April 28, 1999,
all shares of the Company owned by Mr. Phillips or his affiliates in excess of
forty percent (40%) of the Company's outstanding shares shall be voted in
proportion to the votes cast by all non-affiliated stockholders of the Company.

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

Not applicable.

                         ______________________________


                                    PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS

The Company's Common Stock is traded on the New York Stock Exchange ("NYSE")
using the symbol "TCI".  The following table sets forth the high and low sales
prices as reported in the consolidated reporting system of the NYSE.

<TABLE>
<CAPTION>

  QUARTER ENDED                                            HIGH               LOW   
------------------                                        --------         --------
<S>                                                       <C>               <C>
March 31, 1997.................................           $11 5/8           $10 3/4
 (through March 7, 1997)

March 31, 1996.................................            11 1/2             9 5/8
June 30, 1996..................................            10 1/2             9 1/4
September 30, 1996.............................            10 1/2             9 3/4
December 31, 1996..............................            11 1/8             9 7/8

March 31, 1995.................................            10 1/4*            9 3/4*
June 30, 1995..................................            10 3/8*            9 3/4*
September 30, 1995.............................            11    *            9 3/4*
December 31, 1995..............................            10 3/4*            9 5/8*
</TABLE>

*   Restated for the three for two forward stock split effected February 15,
    1996.

As of March 7, 1997, the closing price of the Company's Common Stock as report
in the consolidated reporting system of the NYSE was $11.00 per share.





                                       23
<PAGE>   24
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS (Continued)

As of March 7, 1997, the Company's Common Stock was held by 6,148 holders of
record.

In November 1995 the Company's Board of Directors approved the Company's
resumption of the payment of regular quarterly dividends.  The Company paid
dividends in 1996 and 1995 as follows:

<TABLE>
<CAPTION>
 Date Declared              Record Date                Payable Date              Amount 
----------------         -----------------           -----------------           -------
<S>                      <C>                         <C>                         <C>
March 1, 1996            March 15, 1996              March 31, 1996              $   .07
June 3, 1996             June 14, 1996               June 28, 1996                   .07
August 23, 1996          September 13, 1996          September 30, 1996              .07
December 2, 1996         December 13, 1996           December 31, 1996               .07

November 30, 1995        December 15, 1995           December 31, 1995           $   .07*
</TABLE>

*   Restated for the three for two forward stock split effected February 15, 
    1996.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1996 and 1995 represented a return of capital.

On December 5, 1989, the Company's Board of Directors approved a share
repurchase program.  The Company's Board of Directors has authorized the
Company to repurchase a total of 687,000 shares of its Common Stock pursuant to
such program.  Through March 7, 1997, the Company has repurchased 350,588
shares pursuant to such program at a cost to the Company of $1.7 million.  None
of such shares were repurchased in 1996 or 1997.

In August 1996, the Company announced an offer to buy back shares of its Common
Stock from stockholders owning 99 or fewer shares.  The Company paid a premium
of $.50 per share over the average closing price of its shares as reported in
the consolidated reporting system of the NYSE from August 8, 1996 through
September 30, 1996, the expiration date of the offer.  On October 17, 1996, the
Company repurchased 85,830 of its shares pursuant to such offer, at a total
cost of $903,790.

On March 24, 1989, the Company distributed one share purchase right for each
outstanding share of the Company's Common Stock.  The rights were terminated
effective March 24, 1992 upon the Company's Board of Directors having
determined that the rights were no longer necessary to protect the Company from
coercive tender offers.  In connection with this determination, Messrs.
Phillips and Friedman and their affiliates agreed not to acquire more than 49%
of the outstanding shares of the Company's Common Stock without prior action by
the Company's Independent Directors to the effect that they do not object to
such increased ownership.

In August 1994, the Company's Board of Directors reviewed the limitation and
determined that, due to the fact that Mr.  Friedman is no longer affiliated
with the stockholder group, and had disposed of any shares of the Company's
Common Stock which he or his affiliates may have owned,





                                       24
<PAGE>   25
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
         MATTERS (Continued)

the limitation should no longer apply to Mr. Friedman or his affiliates.  On
August 23, 1994, the Company's Board of Directors adopted a resolution to the
effect that in determining total ownership, shares of the Company's Common
Stock owned by Mr. Friedman and his affiliates are no longer to be included.
As of March 7, 1997, Mr. Phillips and his affiliates, primarily ART, owned
approximately 43.4% of the Company's outstanding shares of Common Stock.

On March 21, 1996, the Company's Board of Directors reconsidered the share
ownership limitation and determined that there was no reason to object to the
purchase by Mr. Phillips and his affiliates of additional shares in excess of
49% of the Company's outstanding shares of Common Stock.  Accordingly, there is
no longer any limitation on the percentage of shares of Common Stock of the
Company which may be acquired by Mr. Phillips and his affiliates.


ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                          For the Years Ended December 31,                       
                                   --------------------------------------------------------------------------------
                                        1996           1995             1994             1993             1992    
                                   -------------   ------------     ------------     -------------   --------------
                                                         (dollars in thousands, except per share)
<S>                                <C>             <C>              <C>              <C>             <C>
EARNINGS DATA
Revenues.................          $      46,878   $     48,272     $     37,983     $      32,242   $       27,069
Expenses.................                 56,499         58,174           47,154            42,168           33,937
                                   -------------   ------------     ------------     -------------   --------------

(Loss) from operations...                 (9,621)        (9,902)          (9,171)           (9,926)          (6,868)

Equity in (loss) of
 investees...............                    (20)        (1,083)             (90)             (262)            (716)
Gain on sale of partner-
 ship interests..........                     -             -              2,514               -                912
Gain on sale of
 real estate.............                  1,579          5,822            2,153                24              476
Extraordinary gain.......                    256          1,437            1,189             1,594              440
                                   -------------   ------------     ------------     -------------   --------------
Net (loss)...............          $      (7,806)  $     (3,726)    $     (3,405)    $      (8,570)  $       (5,756)
                                   =============   ============     ============     =============   ============== 
PER SHARE DATA
(Loss) before extra-
 ordinary gain...........          $       (2.02)   $     (1.29)     $     (1.15)    $       (2.52)   $       (1.32)
Extraordinary gain.......                    .06            .36              .30               .40              .09
                                   -------------    -----------      -----------     -------------    -------------
Net (loss)...............          $       (1.96)   $      (.93)     $      (.85)    $       (2.12)   $       (1.23)
                                   =============    ===========      ===========     =============    ============= 
Dividends per share......          $         .28    $       .07      $       -       $        -       $         -

Weighted average shares
 outstanding.............              3,994,687      4,012,275        4,012,275         4,033,332        4,673,183
</TABLE>





                                       25
<PAGE>   26
ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                   December 31,                       
                            ---------------------------------------------------------
                              1996       1995         1994          1993       1992   
                            --------   --------     --------      --------   --------
                                    (dollars in thousands, except per share)
<S>                         <C>        <C>          <C>           <C>        <C>
BALANCE SHEET DATA
Notes and interest
 receivable, net........    $  8,606   $ 10,017     $ 11,201      $ 12,447   $ 18,132
Real estate held for
 sale, net
 Foreclosed.............         910      2,460        8,032        11,277     22,592
 Other..................       2,089      3,415          341           596        598
Real estate held for
 investment, net........     217,410    220,249      213,445       178,857    132,208
Total assets.............    245,371    260,180      247,964       221,095    203,687
Notes and interest
 payable................     158,692    159,889      145,514       116,024     91,276
Stockholders' equity.....     79,359     89,184       93,177        96,582    105,625

Book value per share.....   $  20.21   $  22.23     $  23.22      $ 23.95    $  22.60
</TABLE>

Shares and per share data have been restated for the three for two forward
stock split effected February 15, 1996.

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

Introduction

Transcontinental Realty Investors, Inc. (the "Company") invests in real estate
through acquisitions, leases and partnerships and in mortgage loans on real
estate, including first, wraparound and junior mortgage loans.  The Company is
the successor to a California business trust organized on September 6, 1983
which commenced operations on January 31, 1984.

Liquidity and Capital Resources

Cash and cash equivalents at December 31, 1996 aggregated $1.0 million compared
with $9.6 million at December 31, 1995.  The principal reasons for this
decrease in cash are discussed in the paragraphs below.

The Company's principal sources of cash have been and will continue to be from
property operations, proceeds from property sales, the collection of mortgage
notes receivable, borrowings and to a lesser extent, distributions from
partnerships.  The Company expects that its cash balance at December 31, 1996,
and cash that will be generated in 1997 from the collection of mortgage notes
receivable, sales of properties, an insurance settlement received in January
1997, borrowings against certain of the Company's unencumbered properties and
refinancing or extension of certain of its mortgage debt will be sufficient to
meet all of the Company's cash requirements, including debt service obligations
coming due in 1997, dividend payments and property maintenance and
improvements, as more fully discussed in the paragraphs below.


                                       26
<PAGE>   27
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

The Company's cash flow from property operations (rents collected less payments
for property operating expenses) has increased over the last three years from
$8.6 million and $15.3 million in 1994 and 1995 to $12.6 million in 1996.  Of
this $4.0 million net increase from 1994 to 1996, $3.3 million is the result of
the Company having acquired additional income producing properties, both
through purchase and foreclosure, and the remaining $700,000 of the
increase is due to increased occupancy and rents, at its apartments and
commercial properties, and the Company's control of operating expenses.  The
Company's management believes that this trend will continue as a result of
increased rental rates at both the Company's apartments and commercial
properties and increased occupancy at its commercial properties.

The Company owns a combined 63.7% limited and general partner interest  in
Tri-City Limited Partnership which owns five properties in Texas.  In 1996, the
Company received net distributions of $417,000 from the partnership.  See NOTE
5.  "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."

In October 1996, the Company received a $1.5 million settlement from one of the
defendants in a lawsuit brought by the Company against the former owners of an
office building in New Jersey and their agents.  The Company had made a loan
secured by the building in 1987 and filed a foreclosure action which was
subsequently amended in 1990, to include claims of negligent misrepresentation
against the borrowers, their legal counsel, architect and engineers.

In 1996, the Company received cash of $907,000 from the payoff or collection of
mortgage notes receivable.  The Company also received a total of $13.6 million
from new mortgage financings and refinancings and $6.0 million net of debt
payoff from property sales during 1996.  In 1996, the Company expended $7.0
million in cash on property acquisitions and made a total of $11.6 million in
principal payoffs or paydowns on its mortgage debt.

Scheduled principal payments on notes payable of $19.6 million are due in 1997.
It is the Company's intention to either pay the mortgages that mature in 1997
when due, or seek to extend the due dates one or more years, or refinance the
debt on a long-term basis.  The Company's management believes it will continue
to be successful in obtaining loan extensions or refinancings.

As discussed in NOTE 3. "REAL ESTATE AND DEPRECIATION," also during 1996 the
Company funded $3.1 million for operating cash flow deficits of the Republic
Towers Office Building in Dallas, Texas due to minimal occupancy and operating
expenses far exceeding rents.  The Company expects to fund a greater amount for
this property in 1997 for tenant and capital improvements.  In January 1997,
the Company received a final insurance settlement totaling $10.0 million from
1995 hail storm and flood damage to the Republic Towers Office Building in
Dallas, Texas.


                                       27
<PAGE>   28
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Liquidity and Capital Resources (Continued)

In January and February 1997, the Company refinanced the mortgage debt secured
by three of its properties, totaling $22.5 million of which $11.0 million was
scheduled to mature in 1996, receiving net refinancing proceeds of $1.2 million
and sold two other of its properties receiving net cash of $3.1 million.  In
March 1997, the Company purchased an apartment complex, expending net cash of
$1.4 million.  See NOTE 17. "SUBSEQUENT EVENTS."

In August 1996, the Company announced an offer to buy back shares of its Common
Stock from stockholders owning 99 or fewer shares.  The Company paid a premium
of $.50 per share over the average closing price of its shares as reported in
the consolidated reporting system of the New York Stock Exchange from August 8,
1996 through September 30, 1996, the expiration date of the offer.  On October
17, 1996, the Company repurchased 85,830 of its shares pursuant to such offer,
at a total cost of $903,790.

Pursuant to a repurchase program originally announced by the Company on
December 5, 1989, the Company's Board of Directors has authorized the
repurchase of a total of 687,000 shares of the Company's Common Stock.  As of
March 7, 1997, the Company had purchased 350,588 shares of its Common Stock at
a total cost to the Company of $1.7 million.  None of such shares were
repurchased in 1996 or 1997.

During 1996, the Company declared and paid dividends of $1.1 million or $.28
per share.

The Company's management reviews the carrying values of the Company's
properties and mortgage note receivable at least annually and whenever events
or a change in circumstances indicate that impairment may exist.  Impairment is
considered to exist if, in the case of a property, the future cash flow from
the property (undiscounted and without interest) is less than the carrying
amount of the property.  For notes receivable impairment is considered to exist
if it is probable that all amounts due under the terms of the note will not be
collected.  In those instances  where impairment is found to exist, a provision
for loss is recorded by a charge against earnings.  The Company's mortgage note
receivable review includes an evaluation of the collateral property securing
such note.  The property review generally includes selective property
inspections, a review of the property's current rents compared to market rents,
a review of the property's expenses, a review of maintenance requirements, a
review of the property's cash flow, discussions with the manager of the
property and a review of properties in the surrounding area.

Results of Operations

1996 compared to 1995.  The Company's net loss for 1996 was $7.8 million
compared to a net loss of $3.7 million in 1995.  The Company's 1996 net loss
includes gains on sale of real estate of $1.6 million and extraordinary gains
of $256,000.  The Company's 1995 net loss includes gains on sale of real estate
of $5.8 million and extraordinary gains of $1.4 million.  Fluctuations in the
components of the Company's revenues and expenses between the 1996 and 1995 are
described below.





                                       28
<PAGE>   29
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)


Results of Operations (Continued)

Rents decreased $1.4 million in 1996 to $45.4 million compared to $46.8 million
in 1995.  A decrease of $5.3 million in rents is due to properties sold in 1995
and 1996.  Offsetting this decrease in rents is an increase of $538,000 due to
the acquisition of the remaining partnership interest in three partnerships in
1995; $926,000 is due to property acquisitions in late 1995 and 1996; and $2.4
million is due to increases in occupancy at several of the Company's commercial
properties primarily:  Corporate Center at Beaumeade Industrial Warehouse, a
29% increase; Park Long Industrial Warehouse, a 9% increase; Plaza Towers
Office  Building, a 6% increase; and 74 New Montgomery Office Building, a 3%
increase.

Property operating expenses decreased $1.7 million in 1996 to $28.5 million as
compared to $30.2 million in 1995.  Of this decrease, $3.1 million is due to
properties sold.  This decrease is partially offset by increases of $935,000
due to property acquisitions and $544,000 due to the acquisition of the
remaining partnership interest in three partnerships in 1995.

Rents and property operations expenses both are expected to increase in 1997
due to anticipated increases in rents at the Company's apartments and increased
occupancy of its commercial properties as a result of a full year of operations
of the properties acquired during 1996 and in the first quarter of 1997.

Interest income for 1996 of $1.5 million approximated the $1.5 million in 1995,
and is expected to remain constant in 1997.

Interest expense decreased to $15.0 million in 1996 as compared to $16.1
million in 1995.  Of this decrease, $1.7 million due to properties sold and
mortgages paid off.  This decrease is partially offset by increases of $180,000
attributable to the acquisition of the remaining partnership interests in three
partnerships during 1995, $107,000 attributable to properties acquired in 1996,
$488,000 attributable to property financings and refinancings during 1996, and
$107,000 attributable to increases in the interest rates on variable rate
mortgage debt. Interest expense is expected to increase in 1997 due to
anticipated property refinancings and the property acquired in the first 
quarter of 1997.

Depreciation expense decreased to $8.5 million in 1996 as compared to $8.6
million in 1995.  An increase of $36,000 is attributable to the acquisition of
the remaining partnership interests in three partnerships during 1995, an
increase of $57,000 is attributable to property acquisitions and an increase of
$570,000 is due to increased depreciation from property additions and tenant
improvements.  These increases were more than offset by a decreases of $645,000
due to properties sold and $179,000 due to assets becoming fully depreciated.
Depreciation expense is expected to increase in 1997 due to a full year of
depreciation of properties acquired in 1996 and the property acquired in the
first quarter of 1997. 





                                       29
<PAGE>   30
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

The advisory fee of $1.8 million in 1996 was comparable to the $1.8 million in
1995.  Such fee is expected to increase as the Company's average asset base 
increases.  See NOTE 9. "ADVISORY AGREEMENT."

General and administrative expenses increased to $2.7 million in 1996 from $2.0
million in 1995.  The increase is due to an increase in legal fees related to
the Olive litigation (see NOTE 15. "COMMITMENTS AND CONTINGENCIES") and
increased advisory cost reimbursements.

As described in "Liquidity and Capital Resources" above, in 1996 and 1995 the
Company received litigation settlements of $1.5 million and $500,000,
respectively.

In the second quarter of 1996, the Company recognized a provision for loss of
$1.6 million to reduce the carrying value of an office building to its agreed
sales price less estimated costs of sale.  Sale of the property was completed 
in July 1996.  No provision for loss was recognized in 1995.

Equity in losses of investees was $20,000 in 1996 compared to $1.1 million in
1995.  The decreased equity loss is primarily due to the 1995 modification of a
wraparound mortgage note receivable and underlying note payable by Nakash
Income Associates ("NIA"), a partnership in which the Company has a 60% general
partner interest, and the writedown of a wraparound mortgage note receivable to
the balance of an underlying first lien mortgage also by NIA.  The Company's
equity share of the loss on the note modification was $127,000 and its equity
share of the note writedown was $901,000.  See NOTE 5. "INVESTMENTS IN EQUITY
METHOD REAL ESTATE ENTITIES."  The Company expects its share of equity
investees' income or losses to be insignificant in 1997.

The Company recognized extraordinary gains totaling $256,000 in 1996 on the
modification of the mortgage debt secured by the Dunes Plaza Shopping Center.
See NOTE 14. "EXTRAORDINARY GAIN."  In 1995, the Company recognized
extraordinary gains totaling $1.4 million on the payoff of the mortgage debt
secured by the Fountain Village Apartments and a principal pay down and
modification of the mortgage debt secured by the Dunes Plaza Shopping Center.

In 1996, the Company recognized gains of $218,000, $1.4 million and $56,000
from the sales of Cheyenne Mountain land, Park Forest Apartments and Moss Creek
land.  In September 1996, the Company recognized a loss of $63,000 from the
sale of Byron land.  In 1995, the Company recognized a gain of $1.6 million on
the collection of the note receivable secured by the Maumelle land and a gain
of $4.1 million on the sale of the Summerchase Apartments.  See NOTE 3. "REAL
ESTATE AND DEPRECIATION."

1995 compared to 1994.  The Company's net loss for 1995 was $3.7 million
compared to a net loss of $3.4 million in 1994.  The Company's 1995 net loss
includes extraordinary gains of $1.4 million and a gain on sale of real estate
of $5.8 million and its 1994 net income includes a gain on


                                       30
<PAGE>   31
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

sale of partnership interests of $2.5 million, a gain on sale of real estate of
$2.2 million and an extraordinary gain of $1.2 million.  Fluctuations in the
components of the Company's revenues and expenses between the 1994 and 1995 are
described below.

Rents increased $10.3 million in 1995 compared to 1994.  Of this increase in
rents, $4.5 million is due to the acquisition of the remaining partnership
interest in three partnerships in 1995; $5.1 million is due to property
acquisitions in late 1994; and $1.6 million is due to increases in occupancy at
several of the Company's commercial properties:  Chesapeake Ridge Office
Building, a 24% increase; Forum Office Building, a 10% increase; President's
Square Shopping Center, a 19% increase; and 74 New Montgomery Office Building,
a 41% increase.  These increases are partially offset by a decrease of $1.1
million in rents due to properties sold.

Property operating expenses increased $3.3 million in 1995 as compared to 1994.
Of this increase, $2.1 million is due to the acquisition of the remaining
partnership interest in three partnerships in 1995 and $3.8 million is due to
property acquisitions in late 1994.  These increases are partially offset by a
decrease of $1.6 million due to decreases in replacements, utilities and
administrative expenses, primarily at Republic Towers Office Building as well
as a decrease of $800,000 due to the buyout of a tenant lease in 1994, and a
decrease of $524,000 due to property sales.

Interest income for 1995 of $1.5 million was comparable to the $1.5 million in
1994.

Interest expense increased to $16.1 million in 1995 as compared to $10.6
million in 1994.  Of this increase, $1.8 million is attributable to the
acquisition of the remaining partnership interests in three partnerships during
1995, $1.9 million is attributable to properties acquired in late 1994, $1.8
million is attributable to property financings and refinancings during 1995,
and $459,000 is attributable to increases in the interest rates on variable
rate mortgage debt.  These increases are partially offset by a decrease of
$431,000 due to properties sold.

Depreciation expense increased to $8.6 million in 1995 as compared to $6.1
million in 1994.  An increase of $638,000 is attributable to the acquisition of
the remaining partnership interests in three partnerships during 1995, an
increase of $787,000 is attributable to properties acquired in late 1994 and an
increase of $1.3 million is due to increased depreciation from property
additions and tenant improvements.  These increases are partially offset by a
decrease of $230,000 due to properties sold and $84,000 due to assets becoming
fully depreciated.

The advisory fee increased to $1.8 million in 1995 as compared to $1.7 million
in 1994.  The increase is due to the increase in the Company's gross assets,
the basis for such fee.





                                       31
<PAGE>   32
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Results of Operations (Continued)

General and administrative expenses increased to $2.0 million in 1995 from $1.8
million in 1994.  The increase is due to an increase in advisory cost
reimbursements.

Equity in losses of investees was $1.1 million in 1995 compared to $90,000 in
1994.  The increased equity loss is primarily due to the modification of a
wraparound mortgage note receivable and underlying note payable by Nakash
Income Associates ("NIA"), a partnership in which the Company has a 60% general
partner interest, and the writedown of a wraparound mortgage note receivable to
the balance of an underlying first lien mortgage also by NIA.  The Company's
equity share of the loss on the note modification was $127,000 and its equity
share of the note writedown was $901,000.  See NOTE 5. "INVESTMENT IN EQUITY
METHOD REAL ESTATE ENTITIES."

In 1995 the Company received a litigation settlement of $500,000.  Also in
1995, the Company recognized a gain of $1.6 million on the collection of the
note receivable secured by the Maumelle land and a gain of $4.1 million on the
sale of the Summerchase Apartments.  See NOTE 2. "NOTES AND INTEREST
RECEIVABLE" and NOTE 3. "REAL ESTATE AND DEPRECIATION."

The Company recognized extraordinary gains totaling $1.4 million in 1995, on
the payoff of the mortgage debt secured by the Fountain Village Apartments and
a principal pay down and modification of the mortgage debt secured by the Dunes
Plaza Shopping Center.  See NOTE 6. "NOTES PAYABLE."  In 1994, the Company
recognized a gain of $2.5 million on the sale of its interests in two
partnerships and a gain of $2.2 million on the sale of Cedar Creek Apartments,
and an extraordinary gain of $1.2 million on the disposition of a limited
partnership interest.

Environmental Matters

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

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

Inflation

The effects of inflation on the Company's operations are not quantifiable.
Revenues from property operations fluctuate proportion-





                                       32
<PAGE>   33
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS (Continued)

Inflation (Continued)

ately with inflationary increases and decreases in housing costs.  Fluctuations
in  the rate of inflation also affect sale values of properties, and
correspondingly, the ultimate realizable value of the Company's real estate and
notes receivable portfolios.  Inflation also has an effect on the Company's
earnings from short-term investments.

Tax Matters

For the years 1996, 1995 and 1994, the Company elected and in the opinion of
the Company's management, qualified to be taxed as a Real Estate Investment
Trust ("REIT") as defined under Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code").  To continue to qualify for
federal taxation as a REIT under the Code, the Company is required to hold at
least 75% of the value of its total assets in real estate assets, government
securities, cash and cash equivalents at the close of each quarter of each
taxable year.  The Code also requires a REIT to distribute at least 95% of its
REIT taxable income, plus 95% of its net income from foreclosure property, all
as defined in Section 857 of the Code, on an annual basis to stockholders.

Recent Accounting Pronouncement

In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No.  121 - "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of".
The statement requires that long-lived assets be considered impaired "...if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset."  If impairment exists,
an impairment loss shall be recognized, by a charge against earnings, equal to
"...the amount by which the carrying amount of the asset exceeds the fair value
of the asset."  If  impairment of a long-lived asset is recognized, the
carrying amount of the asset shall be reduced by the amount of the impairment,
shall be accounted for as the asset's "new cost" and such new cost shall be
depreciated over the asset's remaining useful life.

SFAS No. 121 further requires that long-lived assets held for sale "...be
reported at the lower of carrying amount or fair value less cost to sell."  If
a reduction in a held for sale asset's carrying amount to fair value less cost
to sell is required, a provision for loss shall be recognized by a charge
against earnings.  Subsequent revisions, either upward or downward, to a held
for sale asset's fair value less cost to sell shall be recorded as an
adjustment to the asset's carrying amount, but not in excess of the asset's
carrying amount when originally classified as held for sale.  A corresponding
charge or credit to earnings is to be recognized.  Long-lived assets held for
sale are not to be depreciated.  The Company adopted 121 effective January 1,
1996.

The effect of adopting SFAS No. 121 was the discontinuance of depreciation of
the Company's properties held for sale of $91,000 and a corresponding reduction
in the Company's reported net loss.





                                       33
<PAGE>   34

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS





<TABLE>
<CAPTION>
                                                                                                          Page
                                                                                                          ----
<S>                                                                                                          <C>
Report of Independent Certified Public Accountants  . . . . . . . . . . . . . . . . . . . .                  35

Consolidated Balance Sheets -
            December 31, 1996 and 1995  . . . . . . . . . . . . . . . . . . . . . . . . . .                  36

Consolidated Statements of Operations -
            Years Ended December 31, 1996, 1995 and 1994  . . . . . . . . . . . . . . . . .                  37

Consolidated Statements of Stockholders' Equity -
            Years Ended December 31, 1996, 1995 and 1994  . . . . . . . . . . . . . . . . .                  38

Consolidated Statements of Cash Flows -
            Years Ended December 31, 1996, 1995 and 1994  . . . . . . . . . . . . . . . . .                  39

Notes to Consolidated Financial Statements  . . . . . . . . . . . . . . . . . . . . . . . .                  42

Schedule III - Real Estate and Accumulated Depreciation . . . . . . . . . . . . . . . . . .                  64

Schedule IV  - Mortgage Loans on Real Estate  . . . . . . . . . . . . . . . . . . . . . . .                  65
</TABLE>



All other schedules are omitted because they are not required, are not
applicable or the information required is included in the Consolidated
Financial Statements or the notes thereto.





                                       34
<PAGE>   35


               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS





Board of Directors of
Transcontinental Realty Investors, Inc.



We have audited the accompanying consolidated balance sheets of
Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31,
1996 and 1995 and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996.  We have also audited the schedules listed in the
accompanying index.  These financial statements and schedules are the
responsibility of the Company's management.  Our responsibility is to express
an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
schedules are free of material misstatement.  An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and schedules.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements and schedules.
We believe our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31,
1996 and 1995, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.

Also, in our opinion, the schedules referred to above present fairly, in all
material respects, the information set forth therein.




                                                            BDO Seidman, LLP


Dallas, Texas
March 20, 1997





                                       35
<PAGE>   36
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                          CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                                 December 31,      
                                                                             ----------------------
                                                                                1996          1995   
                                                                             ----------    ----------
                                                                             (dollars in thousands)
<S>                                                                    <C>                       <C>
                       Assets
                       ------

Notes and interest receivable
 Performing   . . . . . . . . . . . . . . . . . . . . . . . . . . . .      $ 9,075                $9,916
 Nonperforming, nonaccruing   . . . . . . . . . . . . . . . . . . . .          457                 1,150
                                                                           -------                ------
                                                                             9,532                11,066

Less - allowance for estimated losses . . . . . . . . . . . . . . . .         (926)               (1,049)
                                                                           -------                ------ 
                                                                             8,606                10,017

Foreclosed real estate held for sale, net of accumu-
 lated depreciation ($33 in 1995)   . . . . . . . . . . . . . . . . .          910                 2,460

Real estate held for sale, net of accumulated
 depreciation ($76 in 1996 and $1,684 in 1995)  . . . . . . . . . . .        2,089                 3,415
                                                                           -------                ------
                                                                             2,999                 5,875

Real estate held for investment, net of
 accumulated depreciation ($50,310 in 1996 and
 $42,455 in 1995)   . . . . . . . . . . . . . . . . . . . . . . . . .      217,410               220,249
Investment in real estate entities  . . . . . . . . . . . . . . . . .        4,578                 5,086
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . .          960                 9,620
Other assets (including $960 in 1996 and $733 in
 1995 from affiliates)  . . . . . . . . . . . . . . . . . . . . . . .       10,818                 9,333
                                                                       -----------              --------
                                                                       $   245,371              $260,180
                                                                       ===========              ========           

        Liabilities and Stockholders' Equity
        ------------------------------------

Liabilities
Notes and interest payable  . . . . . . . . . . . . . . . . . . . . .      158,692               159,889
                                                                                                        
Other liabilities (including $535 in 1996 and $677
 in 1995 to affiliates)   . . . . . . . . . . . . . . . . . . . . . .        7,320                11,107
                                                                           -------                ------
                                                                           166,012               170,996

Commitments and contingencies

Stockholders' equity
Common Stock, $.01 par value; authorized, 10,000,000
 shares; issued and outstanding 3,926,445 shares
 in 1996 and 4,012,275 shares in 1995   . . . . . . . . . . . . . . .           39                    40
Paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . .      218,133               219,036
Accumulated distributions in excess of accumulated
 earnings   . . . . . . . . . . . . . . . . . . . . . . . . . . . . .     (138,813)             (129,892)
                                                                                                               
                                                                            79,359                89,184
                                                                       -----------              --------
                                                                       $   245,371              $260,180
                                                                       ===========              ========           
</TABLE>


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





                                       36
<PAGE>   37
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS




<TABLE>
<CAPTION>
                                                                            For the Years Ended December 31,
                                                                   ------------------------------------------------
                                                                     1996                 1995               1994
                                                                   --------            --------            --------
                                                                       (dollars in thousands, except per share)
<S>                                                                <C>                 <C>                   <C>
Revenues
 Rents      . . . . . . . . . . . . . . . . . . . . . . .          $ 45,405            $ 46,770             $36,494
 Interest   . . . . . . . . . . . . . . . . . . . . . . .             1,473               1,502               1,489
                                                                   --------            --------             -------
                                                                     46,878              48,272              37,983
  
Expenses
 Property operations (including
    $1,879 in 1996, $2,928 in 1995
    and $1,280 in 1994 to affiliates)   . . . . . . . . .            28,491              30,211              26,944
 Interest   . . . . . . . . . . . . . . . . . . . . . . .            14,999              16,114              10,642
 Depreciation   . . . . . . . . . . . . . . . . . . . . .             8,461               8,619               6,095
 Advisory fees to affiliate   . . . . . . . . . . . . . .             1,784               1,770               1,708
 General and administrative
    (including $1,047 in 1996, $877
    in 1995 and $706 in 1994 to
    affiliates)   . . . . . . . . . . . . . . . . . . . .             2,685               1,960               1,765
 Litigation settlement  . . . . . . . . . . . . . . . . .            (1,500)               (500)                -
 Provision for losses   . . . . . . . . . . . . . . . . .             1,579                 -                   -  
                                                                   --------            --------             -------
                                                                     56,499              58,174              47,154
                                                                   --------            --------             -------         

(Loss) from operations  . . . . . . . . . . . . . . . . .            (9,621)             (9,902)             (9,171)
Equity in (losses) of investees . . . . . . . . . . . . .               (20)             (1,083)                (90)
Gain on sale of partnership interests . . . . . . . . . .               -                   -                 2,514
Gains on sale of real estate  . . . . . . . . . . . . . .             1,579               5,822               2,153
                                                                   --------            --------             -------

(Loss) before extraordinary gain  . . . . . . . . . . . .            (8,062)             (5,163)             (4,594)
Extraordinary gain  . . . . . . . . . . . . . . . . . . .               256               1,437               1,189
                                                                   --------            --------             -------
Net (loss)  . . . . . . . . . . . . . . . . . . . . . . .          $ (7,806)           $ (3,726)            $(3,405)
                                                                   ========            ========             =======          

Earnings per share
(Loss) before extraordinary gain  . . . . . . . . . . . .          $  (2.02)           $  (1.29)            $ (1.15)
Extraordinary gain  . . . . . . . . . . . . . . . . . . .               .06                 .36                 .30
                                                                   --------            --------             -------
Net (loss)  . . . . . . . . . . . . . . . . . . . . . . .          $  (1.96)           $   (.93)            $  (.85)
                                                                   ========            ========             =======


Weighted average Common shares used
 in computing earnings per share  . . . . . . . . . . . .         3,994,687           4,012,275           4,012,275
                                                                  =========           =========           =========
                                                                                                                             
</TABLE>

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





                                       37
<PAGE>   38
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


 


<TABLE>
<CAPTION>
                                                                                          Accumulated
                                                                                         Distributions
                                                    Common Stock                          in Excess of
                                               --------------------       Paid-in         Accumulated        Stockholders'
                                                 Shares      Amount       Capital           Earnings             Equity
                                               ---------     ------       -------        -------------       -------------
                                                                        (dollars in thousands)
<S>                                            <C>            <C>         <C>              <C>                  <C>
Balance, January 1, 1994  . . . . . . . .      4,012,275      $  40      $219,036          $ (122,494)          $ 96,582
Net (loss)  . . . . . . . . . . . . . . .              -          -             -              (3,405)            (3,405)
                                               ---------      -----      --------          ----------           --------
Balance, December 31, 1994  . . . . . . .      4,012,275         40       219,036            (125,899)            93,177

Dividends paid ($.07 per share) . . . . .              -          -             -                (267)              (267)
Net (loss)  . . . . . . . . . . . . . . .              -          -             -              (3,726)            (3,726)
                                               ---------      -----      --------          ----------           --------
Balance, December 31, 1995  . . . . . . .      4,012,275         40       219,036            (129,892)            89,184

Repurchase of Common Stock  . . . . . . .        (85,830)        (1)         (903)                  -               (904)

Dividends paid.($.28 per share) . . . . .              -          -             -              (1,115)            (1,115)
Net (loss)  . . . . . . . . . . . . . . .              -          -                            (7,806)            (7,806)
                                               ---------      -----      --------          ----------           --------
Balance, December 31, 1996  . . . . . . .      3,926,445      $  39      $218,133          $ (138,813)          $ 79,359
                                               =========      =====      ========          ==========           ========
                                                                                                                        
</TABLE>

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





                                       38
<PAGE>   39
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                          For the Years Ended December 31,
                                                               ----------------------------------------------------- 
                                                                  1996                   1995                 1994
                                                               ----------              --------             --------
                                                                              (dollars in thousands)
<S>                                                            <C>                     <C>                  <C>
Cash Flows from Operating Activities
    Rents collected   . . . . . . . . . . . . . . . . . .      $   43,396              $ 46,511             $ 36,336
    Interest collected  . . . . . . . . . . . . . . . . .           1,232                 1,256                1,464
    Interest paid   . . . . . . . . . . . . . . . . . . .         (14,167)              (14,676)              (9,054)
    Payments for property operations
         (including $1,879 in 1996, $2,928 in
         1995 and $1,280 in 1994 to affiliates)   . . . .         (30,845)              (31,171)             (27,773)
    Advisory fee paid to affiliate  . . . . . . . . . . .          (1,784)               (1,770)              (1,733)
    General and administrative expenses paid
         (including $1,047 in 1996, $877 in 1995
         and $706 in 1994 to affiliates)  . . . . . . . .          (2,785)               (1,216)              (2,373)
    Distributions from operating cash flow of
         equity investees   . . . . . . . . . . . . . . .             649                   666                  811
    Litigation settlement   . . . . . . . . . . . . . . .           1,500                   500                    -
    Other       . . . . . . . . . . . . . . . . . . . . .          (1,373)                  834                2,261
                                                               ----------              --------             --------

         Net cash provided by (used in) operating 
               activities . . . . . . . . . . . . . . . .          (4,177)                  934                  (61)

Cash Flows from Investing Activities
    Collections on notes receivable   . . . . . . . . . .             907                 2,851                1,850
    Real estate improvements  . . . . . . . . . . . . . .          (3,406)               (8,024)              (5,354)
    Proceeds from sale of real estate   . . . . . . . . .           5,973                 7,749                3,285
    Proceeds from sale of partnership interests . . . . .               -                     -                2,076
    Acquisitions of real estate   . . . . . . . . . . . .          (6,963)               (1,059)              (9,790)
    Acquisition of partnership interests  . . . . . . . .               -                   (50)                   -
    Contributions to equity investees   . . . . . . . . .            (161)                 (443)                (947)
                                                               ----------              --------             --------

         Net cash provided by (used in) investing
             activities   . . . . . . . . . . . . . . . .          (3,650)                1,024               (8,880)
</TABLE>

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





                                       39
<PAGE>   40
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
               CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                                                          For the Years Ended December 31,
                                                               -----------------------------------------------------
                                                                  1996                   1995                 1994
                                                               ---------               --------             --------
                                                                              (dollars in thousands)
<S>                                                            <C>                     <C>                  <C>
Cash Flows from Financing Activities
    Distributions from financing cash flow of
         equity investees   . . . . . . . . . . . . . . .      $       -              $    853             $      -
    Payments on notes payable   . . . . . . . . . . . . .         (2,768)               (4,770)              (2,165)
    Payoffs of notes payable  . . . . . . . . . . . . . .         (8,828)              (13,739)              (9,545)
    Proceeds from notes payable   . . . . . . . . . . . .        (13,550)               26,072               16,102
    Dividends paid  . . . . . . . . . . . . . . . . . . .         (1,115)                 (267)                 -
    Shares of Common Stock repurchased  . . . . . . . . .           (904)                  -                    -
    Debt issue costs                                                (818)               (1,050)                (790)
                                                               ---------               -------              -------
         Net cash provided by (used in)
               financing activities . . . . . . . . . . .           (833)                7,099                3,602
                                                               ---------               -------              -------

Net increase (decrease) in cash and cash
    equivalents   . . . . . . . . . . . . . . . . . . . .         (8,660)                9,057               (5,339)

Cash and cash equivalents, beginning of year  . . . . . .          9,620                   563                5,902
                                                               ---------               -------              -------

Cash and cash equivalents, end of year  . . . . . . . . .      $     960               $ 9,620              $   563
                                                               =========               =======              =======
Reconciliation of net (loss) to net cash
    provided by (used in) operating activities
    Net (loss)  . . . . . . . . . . . . . . . . . . . . .      $  (7,806)              $(3,726)             $(3,405)
    Adjustments to reconcile net (loss) to net
         cash provided by (used in) operating
         activities
         Depreciation and amortization  . . . . . . . . .          8,857                 9,180                6,343
         Provision for losses . . . . . . . . . . . . . .          1,579                   -                    -
         Extraordinary gain . . . . . . . . . . . . . . .           (256)               (1,437)              (1,189)
         Equity in losses of equity investees . . . . . .             20                 1,083                   90
         Gain on sale of partnership interests  . . . . .            -                     -                 (2,514)
         Gain on sale of real estate  . . . . . . . . . .         (1,579)               (5,822)              (2,153)
         Distributions from operating cash flow
              of equity investees . . . . . . . . . . . .            649                   666                  811
         (Increase) decrease in interest
              receivable  . . . . . . . . . . . . . . . .             (5)                   (4)                 213
         Decrease in other assets . . . . . . . . . . . .          1,139                   897                1,830
         Increase in interest payable . . . . . . . . . .            200                   635                  881
         (Decrease) in other liabilities  . . . . . . . .         (6,975)                 (538)                (968)
                                                               ---------               -------              ------- 

    Net cash provided by (used in) operating
         activities   . . . . . . . . . . . . . . . . . .      $  (4,177)              $   934              $   (61)
                                                               =========               =======              ======= 
</TABLE>

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





                                       40
<PAGE>   41
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
               CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE>
<CAPTION>
                                                                         For the Years Ended December 31,
                                                               --------------------------------------------------
                                                                  1996                   1995               1994
                                                               ---------               -------             ------ 
                                                                              (dollars in thousands)
<S>                                                            <C>                     <C>                  <C>
Schedule of noncash investing and financing activities
    Carrying value of real estate acquired
         through foreclosure in satisfaction of
         notes receivable (with carrying value
         of $696)   . . . . . . . . . . . . . . . . . . .      $     691               $   -                $   -

Notes payable from acquisition of real
    estate      . . . . . . . . . . . . . . . . . . . . .            -                     -                 30,936

Real estate obtained in satisfaction of a
    note receivable with no carrying value

    Carrying value of real estate received  . . . . . . .            -                   2,519                  -

    Carrying value of debt assumed  . . . . . . . . . . .            -                   2,675                  -

Acquisition of remaining general partner
    interests in three partnerships

    Carrying value of assets received   . . . . . . . . .            -                  22,807                  -

    Carrying value of liabilities assumed   . . . . . . .            -                  21,481                  -

Notes receivable from sales of real estate  . . . . . . .            -                     -                  6,837

Transfer of limited partner interest to partnership's 
    lender in settlement of litigation  . . . . . . . . .            -                     -                  1,189
</TABLE>


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





                                       41
<PAGE>   42
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The accompanying Consolidated Financial Statements of Transcontinental Realty
Investors, Inc. and consolidated entities (the "Company") have been prepared in
conformity with generally accepted accounting principles, the most significant
of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES."
These, along with the remainder of the Notes to Consolidated Financial
Statements, are an integral part of the Consolidated Financial Statements.  The
data presented in the Notes to Consolidated Financial Statements are as of
December 31 of each year and for the year then ended, unless otherwise
indicated.  Dollar amounts in tables are in thousands, except per share
amounts.

Certain balances for 1995 and 1994 have been reclassified to conform to the
1996 presentation.  Shares and per share data have been restated for the three
for two forward stock split effected February 15, 1996.

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Company business.  Transcontinental Realty Investors, Inc.
("TCI"), a Nevada corporation, is successor to a California business trust
which was organized on September 6, 1983 and commenced operations on January
31, 1984.  The Company invests in real estate through direct equity ownership
and investments in real estate entities.  It also has invested in mortgage
loans on real estate, including first, wraparound and junior mortgage loans.

Basis of consolidation.  The Consolidated Financial Statements include the
accounts of TCI and subsidiaries and partnerships which it controls.  All
intercompany transactions and balances have been eliminated.

Accounting estimates.  In the preparation of the Company's Consolidated
Financial Statements in conformity with generally accepted accounting
principles it was necessary for the Company's management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the Consolidated
Financial Statements and the reported amounts of revenues and expense for the
year then ended.  Actual results could differ from these estimates.

Interest recognition on notes receivable.  It is the Company's policy to cease
recognizing interest income on notes receivable that have been delinquent for
60 days or more.  In addition, accrued but unpaid interest income is only
recognized to the extent that the net realizable value of the underlying
collateral exceeds the carrying value of the receivable.

Allowance for estimated losses.  Valuation allowances are provided for
estimated losses on notes receivable considered to be impaired.  Impairment is
considered to exist when it is probable that all amounts due under the terms of
the note will not be collected.  Valuation allowances are provided for
estimated losses on notes receivable to the





                                       42
<PAGE>   43
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

extent that the Company's investment in the note exceeds the Company's estimate
of net realizable value of the collateral securing such note, or fair value of
the collateral if foreclosure is probable.

Real Estate Held for Investment and Depreciation.  Real estate held for
investment is carried at cost.  Statement of Financial Accounting Standards No.
121 ("SFAS No. 121") requires that a property be considered impaired, if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the property.  If impairment
exists, an impairment loss is recognized, by a charge against earnings, equal
to the amount by which the carrying amount of the property exceeds the fair
value of the property.  If impairment of a property is recognized, the carrying
amount of the property is reduced by the amount of the impairment, and a new
cost for the property is established.  Such new cost is depreciated over the
property's remaining useful life.  Depreciation is provided by the
straight-line method over  estimated useful lives, which range from 3 to 40
years.

Real Estate Held for Sale.  Foreclosed real estate is initially recorded at new
cost, defined as the lower of original cost or fair value minus estimated costs
of sale.  SFAS No. 121 also requires that properties held for sale be reported
at the lower of carrying amount or fair value less costs of sale.  If a
reduction in a held for sale property's carrying amount to fair value less
costs of sale is required, a provision for loss shall be recognized by a charge
against earnings.  Subsequent revisions, either upward or downward, to a held
for sale property's estimated fair value less costs of sale is recorded as an
adjustment to the property's carrying  amount, but not in excess of the
property's carrying amount when originally classified as held for sale.  A
corresponding charge against or credit to earnings is recognized.  Properties
held for sale are not to be depreciated.

Present value discounts.  The Company provides for present value discounts on
notes receivable or payable that have interest rates that differ substantially
from prevailing market rates and amortizes such discounts by the interest
method over the lives of the related notes.  The factors considered in
determining a market rate for notes receivable include the borrower's credit
standing, nature of the collateral and payment terms of the note.

Revenue recognition on the sale of real estate.  Sales of real estate are
recognized when and to the extent permitted by Statement of Financial
Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No.
66").  Until the requirements of SFAS No. 66 for full profit recognition have
been met, transactions are accounted for using either the deposit, the
installment, the cost recovery or the financing method, whichever is
appropriate.

Investment in noncontrolled partnerships and equity investees.  The Company
uses the equity method to account for investments in partner-





                                       43
<PAGE>   44
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

ships which it does not control and for its investment in the shares of common
stock of Income Opportunity Realty Investors, Inc., formerly Income Opportunity
Realty Trust (collectively "IORI").  Under the equity method, the Company's
initial investment, recorded at cost, is increased by the Company's
proportionate share of the investee's operating income and additional advances
and decreased by the Company's proportionate share of the investee's operating
losses and distributions received.

Fair value of financial instruments.  The Company used the following
assumptions in estimating the fair value of its notes receivable, marketable
equity securities and notes payable.  For performing notes receivable, the fair
value was estimated by discounting future cash flows using current interest
rates for similar loans.  For nonperforming notes receivable, the estimated
fair value of the Company's interest in the collateral property was used.  For
marketable equity securities, fair value was based on the year end closing
market price of the security.  For notes payable, the fair value was estimated
using current rates for mortgages with similar terms and maturities.

Cash equivalents.  For purposes of the Consolidated Statements of Cash Flows,
the Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.

Earnings per share.  Loss per share is computed based upon the weighted average
number of shares of Common Stock outstanding during each year adjusted for the
three for two forward stock split effected February 15, 1996.

NOTE 2.  NOTES AND INTEREST RECEIVABLE

Notes and interest receivable consisted of the following:

<TABLE>
<CAPTION>
                                                           1996                               1995         
                                                -----------------------------       ----------------------------
                                                 Estimated                          Estimated
                                                   Fair                Book            Fair              Book
                                                   Value              Value            Value             Value  
                                                ----------          ---------       ----------         ---------
<S>                                               <C>               <C>              <C>               <C>
Notes receivable
     Performing   . . . . . . . . . . . . . .     $ 12,409          $   9,544        $  13,425         $  10,611
     Nonperforming, nonaccruing   . . . . . .        1,400                457            2,159             1,139
                                                  --------          ---------        ---------         ---------
                                                  $ 13,809             10,001        $  15,584            11,750
                                                  ========                           =========                  

     Interest receivable  . . . . . . . . . .                              47                                 84
     Unamortized (discounts)  . . . . . . . .                            (516)                              (768)
                                                                    ---------                            -------- 
                                                                    $   9,532                            $ 11,066
                                                                    =========                            ========
</TABLE>

The Company recognizes interest income on nonperforming notes receivable on a
cash basis only.  For the years 1996, 1995 and 1994, unrecognized interest 
income on nonperforming notes receivable aggregated $424,000, $231,000 and 
$256,000, respectively.





                                       44
<PAGE>   45
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)

Notes receivable at December 31, 1996, mature from 1997 through 2016 with
interest rates ranging from 3.9% to 12.5%, with a weighted average rate of
12.23%.  Discounts are based on imputed interest rates of 10.0%.  Notes
receivable are generally nonrecourse and are generally collateralized by real
estate.  Scheduled principal maturities of $479,000 are due in 1997.

In March 1996, the Company accepted a discounted payoff of $825,000 in
settlement of a mortgage note receivable with a principal balance of $875,000.
The Company recorded no loss on the note settlement in excess of the reserve
previously established.

In 1993 in conjunction with the sale of a foreclosed single family residence
in Scottsdale, Arizona, the Company provided purchase money financing of
$725,000 with a maturity date of August 1996.  In January 1996, the borrower
ceased making payments and in June 1996, filed for bankruptcy protection.  In
September 1996, the Company reacquired the property through trustee sale.  The
fair market value of the residence less estimated costs of sale, exceeded the
note's principal balance and accrued interest of $691,000 at the date the
property was reacquired. See NOTE 3. "REAL ESTATE AND DEPRECIATION."

In December 1996, the Company repurchased three residential lots in Moss Creek,
in Greensboro, North Carolina for $44,000 in cash and cancellation of  the 
mortgage each property secured.  The buyer was unable to obtain the necessary
building permits for the lots in the time required by his purchase contract. 
See NOTE 3. "REAL ESTATE AND DEPRECIATION."

In February 1994, the Company provided $6.7 million of purchase money financing
in conjunction with the sale of 1,406 acres of the land in sixteen developed
residential and commercial subdivisions secured by a first lien on the
properties sold.  The borrower did not make the scheduled February 1995
principal and interest payments.  In September 1995, the Company reached a
settlement with the borrower that provided the following:  (i) the payment by
the borrower of $2.5 million  in cash; (ii) the Company's release of all land
securing the note; (iii) the Company's acceptance of a new $1.4 million note
secured by 36.3 acres of commercial land, such note bore interest at 9.0% and
matured in January 1996 and (iv) the Company's receipt of 700,000 shares of the
borrower's capital stock, which the borrower has the option to repurchase at
$5.00 per share for two years from closing.  The original sale had been
recorded under the cost recovery method with gain being deferred until the note
was collected.  With the Company's receipt of $2.5 million on September 12,
1995, it recognized $1.6 million of the gain previously deferred.  The $1.4
million note was not paid at maturity.  The Company is negotiating with the
borrower in an effort to correct the default and has also instituted
foreclosure proceedings.  The Company does not expect to incur a loss on the
note as the fair value of the property exceeds the nominal carrying value of
the note.





                                       45
<PAGE>   46
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 2.  NOTES AND INTEREST RECEIVABLE (Continued)

In January 1995, the Company received $11,000 in settlement of a note
receivable with a principal balance of $20,000.  In April, May and October
1995, four mortgage notes receivable, secured by developed residential lots in
Moss Creek, in Greensboro, North Carolina, in the total amount of $43,000 were
paid in full.  Also in April 1995, a mortgage note receivable secured by an
office building with a principal balance of $100,000 was paid in full.

In June 1995, the Company obtained the Gladstell Forest Apartments, a 136 unit
apartment complex in Conroe, Texas, through foreclosure of a note receivable
which the  Company had received in December 1991 in satisfaction of a debtor's
guarantee of another obligation to the Company.  The Company had assigned no
value to the note receivable.  In conjunction with the foreclosure, the Company
refinanced the property's $2.7 million mortgage for a like amount with the
Company receiving no net refinancing proceeds.

NOTE 3.  REAL ESTATE AND DEPRECIATION

In January 1996, the Company purchased a 4.7 acre parcel of partially developed
land in Las Colinas, Texas, for $941,000 in cash.  The parcel, within the Las
Colinas Urban Center, is adjacent to developed office buildings.

Also in January 1996, the Company sold the Cheyenne Mountain land, a 7 acre
parcel of foreclosed undeveloped land held for sale in Colorado Springs, 
Colorado for $330,000 in cash.  The Company recognized a gain of $218,000 on
the sale.

In March 1996, the Company sold the Park Forest Apartments, a 44 unit
foreclosed held for sale apartment complex in Dearborn Heights, Michigan, for
$4.7 million.  The Company received net cash of $1.6 million after paying off
the existing mortgage debt of $2.9 million and the payment of various closing
costs associated with the sale.  The Company recognized a gain of $1.4 million
on the sale.

In July 1996, the Company entered into a contract to sell the Latham Square, a
106,067 square foot office building in Oakland, California for $2.2 million in
cash.  The agreed sales price was $1.4 million less than the property's
carrying value.  Accordingly, at June 30, 1996, the Company recognized a
provision for loss of $1.6 million to reduce the property's carrying value to
its sales price less estimated costs of sale.  In July 1996, the Company
completed the sale, receiving net cash of $2.0 million after the payment of
various closing costs associated with the sale.  The Company incurred a loss on
the sale of $64,000 in excess of the amount which had been previously provided.

In August 1996, the Company sold a 177 acre tract of the Moss Creek land, a 257
acre parcel of foreclosed land held for sale in Greensboro,





                                       46
<PAGE>   47
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 3. REAL ESTATE AND DEPRECIATION (Continued)

North Carolina, for $750,000 in cash.  The Company received net cash of
$690,000 after paying various closing costs associated with the sale. The
Company recognized a gain of $56,000 on the sale.

Also in August 1996, in a single transaction, the Company purchased the Arbor
Point Apartments, a 195 unit apartment complex in Odessa, Texas, the Coventry
Apartments, a 120 unit apartment complex in Midland, Texas, the Southgate
Apartments, a 180 unit apartment complex in Odessa, Texas, and the Westwood
Apartments, a 79 unit apartment complex in Odessa, Texas, for a total of $4.1
million in cash.

In September 1996, the Company obtained through trustee sale a single family
residence that secured one of the Company's mortgage notes receivable, as more
fully discussed in NOTE 2. "NOTES AND INTEREST RECEIVABLE."

In September 1996, the Company sold the Byron land, a 522 acre parcel of
foreclosed land held for sale in Greensboro, North Carolina, for $1.6 million
in cash.  The Company recognized a loss of $63,000 on the sale.

In November 1996, the Company purchased the Carseka Apartments, a 54 unit
apartment complex in Los Angeles, California, for $2.2 million in cash.

In December 1996, the Company repurchased three residential lots in Moss Creek,
in Greensboro, North Carolina, for $44,000 in cash, as more fully discussed in
NOTE 2. "NOTES AND INTEREST RECEIVABLE."

During 1995, the Company purchased (i) the remaining general partner interest
in the partnership which owns the Shadow Run Apartments for $50,000 in cash,
(ii) a 48.18% interest in 8,153 square feet of land in proximity to the
Company's Republic Towers Office Building ("Republic Towers") in Dallas, Texas
for $166,000 in cash, and (iii) a .9976 acre parking lot also in proximity to
Republic Towers for $1.1 million in cash. Also in 1995, the Company sold an
apartment complex in Norcross, Georgia, for $12.1 million, an office building
in Dallas, Texas for $4.8 million, and a shopping center in Tulsa, Oklahoma for
$418,000. The Company received net cash of $8.3 million from the sales after
the payoff of $9.0 million in mortgage debt.  The Company recognized a gain of
$4.2 million on such sales.

NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES

Activity in the allowance for estimated losses was as follows:

<TABLE>
<CAPTION>
                                                               1996                1995              1994  
                                                             -------             --------          --------
    <S>                                                       <C>                 <C>                <C>
    Balance January 1, ..............................         $1,049              $  960             $ 5,504
        Amounts charged off .........................           (123)                (12)             (4,544)
        Recoveries  .................................              -                 101                   -  
                                                              ------              ------              ------
    Balance December 31, ............................         $  926              $1,049              $  960
                                                              ======              ======              ======
</TABLE>





                                       47
<PAGE>   48
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 4.   ALLOWANCE FOR ESTIMATED LOSSES (Continued)

The 1996 provision for losses in the accompanying Consolidated Statements of
Operations is the June 1996 write down of the Latham Square Office Building to
its agreed sales price less estimated cost of sale.  The sale of the property 
was completed in July 1996. See NOTE 3. "REAL ESTATE AND DEPRECIATION."

NOTE 5.   INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES

The Company's investments in equity method real estate entities consist of the
following:

<TABLE>
<CAPTION>
                                                            1996                1995  
                                                          --------            --------
     <S>                                                  <C>                  <C>
     Income Opportunity Realty Investors, Inc.
         ("IORI")   . . . . . . . . . . . . . . . .       $    291             $    511
     Tri-City Limited Partnership ("Tri-City")  . .          5,123                5,409
     Nakash Income Associates ("NIA")   . . . . . .           (954)                (969)
     Other  . . . . . . . . . . . . . . . . . . . .            118                  135
                                                          --------             --------
                                                          $  4,578             $  5,086
                                                          ========             ========
</TABLE>

The Company owns an approximate 22.5% interest in IORI, a publicly held Real
Estate Investment Trust ("REIT"), with a market value of $3.9 million at
December 31, 1996.  IORI owns five apartments (three in Texas and one each in
California and Wisconsin) and four office buildings (three in California and
one in Florida).

The Company owns a combined 63.7% general and limited partner interest in
Tri-City which owns five properties in Texas.  The Tri-City partnership
agreement requires the consent of both the Company and IORI (a 36.3% general
partner) for any material changes in the operations of Tri-City's properties,
including sales, refinancings and changes in property management.  The Company,
as a noncontrolling partner, accounts for its investment in Tri-City using the
equity method.

The Company owns 60% general partner interest and IORI owns a 40% general
partner interest in NIA.  The NIA partnership agreement requires the consent of
both the Company and IORI for any material changes in the  operations of NIA.
The Company, as a noncontrolling partner, accounts  for its investment in NIA
on the equity method.  NIA owned two wraparound  mortgage notes receivable, one
of which was secured by a shopping center in Onandaga, New York.  In July 1995,
the owner of the shopping center informed NIA that it had determined that
further investment in the shopping center was not justified, and further that
it had offered to deed the property back to the first lienholder in lieu of
foreclosure making the wraparound note receivable held by NIA uncollectible.
NIA recorded a provision for loss of $1.5 million to write down its wraparound
note receivable to the balance of the mortgage.  The Company's equity share of
the loss was $901,000.  The property was returned to the lender in 1996.  In
September 1995, the Company received notice from NIA that the other of its
wraparound notes receivable had been modified in conjunction with the
modification of the





                                       48
<PAGE>   49
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 5.  INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES  (Continued)

underlying note payable.  NIA recorded a provision for loss of $212,000 on such
modification of which the Company's share is $127,000.  This note remained
outstanding at December 31, 1996.

Set forth below are summary financial data for the real estate entities
accounted for using the equity method:

<TABLE>
<CAPTION>
                                                              1996                 1995   
                                                           ----------          ------------
<S>                                                       <C>                   <C>
Real estate, net of accumulated
    depreciation ($11,467 in 1996
    and $9,781 in 1995). . . . . . . . . . . . . . . .    $    65,481           $  53,003
Notes receivable . . . . . . . . . . . . . . . . . . .          2,883               4,597
Other assets . . . . . . . . . . . . . . . . . . . . .          8,757               7,399
Notes payable. . . . . . . . . . . . . . . . . . . . .        (43,807)            (29,472)
Other liabilities. . . . . . . . . . . . . . . . . . .         (2,983)             (2,947)
                                                          -----------           ---------
Partners' capital. . . . . . . . . . . . . . . . . . .    $    30,331           $  32,580
                                                          ===========           ==========
</TABLE>


<TABLE>
<CAPTION>
                                                             1996                  1995              1994   
                                                          ----------            ----------        ----------
<S>                                                       <C>                  <C>               <C>
Rents and interest income. . . . . . . . . . . . . . .    $   12,319           $   10,862        $   15,362
Depreciation . . . . . . . . . . . . . . . . . . . . .        (1,685)              (1,748)           (2,118)
Operating expenses . . . . . . . . . . . . . . . . . .        (7,927)              (7,092)           (8,998)
Interest expense   . . . . . . . . . . . . . . . . . .        (3,086)              (2,677)           (4,477)
Provision for losses   . . . . . . . . . . . . . . . .            -                (1,714)               -  
                                                          ----------           ----------         ---------
Net (loss).                                               $     (379)          $   (2,369)        $    (231)
                                                          ==========           ==========         =========
</TABLE>

The Company's equity share of the above net losses for 1996, 1995 and 1994 was
$2,000, $1.1 million and $46,000, respectively, before amortization of
property acquisition costs discussed below.  The Company's share of the above
equity investee capital was $10.0 million in 1996 and $10.5 million in 1995.

The excess of the Company's investment over its respective share of the equity
in the underlying net assets of equity investees relates primarily to
unamortized property acquisition costs of $116,000 in 1996, $119,000 in 1995
and $715,000 in 1994.  These amounts are being amortized over the estimated
useful lives of the properties.

NOTE 6.   NOTES AND INTEREST PAYABLE

Notes and interest payable consisted of the following:

<TABLE>
<CAPTION>
                                                        1996                                   1995         
                                           ------------------------------         ----------------------------
                                            Estimated                              Estimated
                                              Fair                Book               Fair              Book
                                              Value               Value              Value             Value  
                                           ----------           ---------         ----------         ---------
 <S>                                       <C>                 <C>                <C>                <C>
 Notes payable . . . . . . . . . . . .     $  155,035           $ 157,309         $ 160,701          $ 158,679
                                           ==========                             =========                   
 Interest payable  . . . . . . . . . .                              1,383                                1,210
                                                                ---------                            ---------
                                                                $ 158,692                            $ 159,889
                                                                =========                            =========
</TABLE>





                                       49
<PAGE>   50
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 6.   NOTES AND INTEREST PAYABLE  (Continued)

Scheduled principal payments are due as follows:

<TABLE>
     <S>                                                       <C>
     1997   . . . . . . . . . . . . . . . . . . . . . . .      $  19,581
     1998   . . . . . . . . . . . . . . . . . . . . . . .          7,686
     1999   . . . . . . . . . . . . . . . . . . . . . . .         24,301
     2000   . . . . . . . . . . . . . . . . . . . . . . .          9,554
     2001   . . . . . . . . . . . . . . . . . . . . . . .          8,216
     Thereafter   . . . . . . . . . . . . . . . . . . . .         87,971
                                                                  ------
                                                               $ 157,309
                                                               =========
</TABLE>

Mortgage notes payable at December 31, 1996 bear interest at rates ranging from
7.88% to 12.0% per annum, and mature between 1997 and 2024.  The mortgages are
collateralized by deeds of trust on real estate with a net carrying value of
$203.7 million.

In May 1996, the Company refinanced the mortgage debt secured by Parkway Centre
Shopping Center in Dallas, Texas in the amount of $1.8 million.  The Company
received net cash of $771,000 after the payoff of $735,000 in existing mortgage
debt and the payment of various closing costs associated with the refinancing.
The new mortgage bears interest at 9.5625% per annum, requires monthly payments
of principal and interest of $16,024 and matures in June 2006.

In July 1996, the Company refinanced the matured mortgage debt secured by the
Westgate of Laurel Apartments in Laurel, Maryland in the amount of $7.7
million.  The Company received net cash of $126,000 after the payoff of $7.2
million in existing mortgage debt and the payment of various closing costs and
escrows associated with the refinancing.  The new mortgage bears interest at
9.1875% per annum, requires monthly payments of principal and interest of
$63,202 and matures in August 2006.

In August 1996, the Company modified and extended the matured mortgage debt
secured by the Northtown Mall Shopping Center in Dallas, Texas.  In conjunction
with the modification, the Company paid $450,000 in principal paydowns to
extend the loan's maturity date to March 31, 1997.

In September 1996, as provided in the original mortgage, the Company increased
the mortgage principal balance on the Plaza Towers Office Building in St.
Petersburg, Florida by $2.0 million.  The Company received net cash of $1.9
million after paying various costs associated with the additional borrowing.
The additional $2.0 million borrowing bears interest at a variable rate,
currently 9.22% per annum, requires monthly payments of principal and interest
of $18,741 and matures in May 2000.

In November 1996, the Company obtained mortgage financing in the amount of $2.0
million, on four previously unencumbered apartment complexes in Midland and
Odessa, Texas.  These apartments were purchased in a single





                                       50
<PAGE>   51
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 6.  NOTES AND INTEREST PAYABLE  (Continued)

transaction in August 1996.  See NOTE 3. "REAL ESTATE AND DEPRECIATION."  The
Company received net cash of $1.7 million after paying various closing costs
associated with the financing.  The mortgage bears interest at a variable rate,
currently at 8.5% per annum, requires monthly payments of principal and
interest of $16,105 and matures in December 2001.  The note agreement allows
for an additional advances of up to $2.6 million.

In 1995, the Company obtained mortgage financing totaling $10.5 million secured
by four previously unencumbered commercial properties.  The Company received
net cash of $8.7 million after the funding of various tax and insurance escrows
and the payment of various closing costs associated with the financings.  The
mortgages bear interest at rates ranging from 9% to 9.8% per annum and mature
from May 2000 to May 2005.  Also in 1995, the Company refinanced the mortgage
debt secured by two apartment complexes, in the total amount of $9.4 million.
The Company received net refinancing proceeds of $3.9 million after the payoff
of $6.6 million in existing mortgage debt and the funding of various tax and
insurance escrows and the payment of various closing costs associated with the
refinancings.  The mortgages bear interest at rates of 7.9% and 8.0% per annum
and mature in December 2005.  The Company also modified and extended three
mortgage loans, combining them into one loan with a principal balance of $4.6
million, bearing interest at 9.5% with the lender forgiving $144,000 of the
mortgage principal balance.

NOTE 7.  DIVIDENDS

In November 1995, the Company's Board of Directors approved the Company's
resumption of the payment of regular quarterly dividends.

In 1996, the Company declared and paid dividends of $.28 per share, or a total
of $1.1 million.  In 1995, the Company declared and paid dividends of $.07 per
share or a total of $267,000.

The Company reported to the Internal Revenue Service that 100% of the dividends
paid in 1996 and 1995 represented a return of capital.

NOTE 8.    RENTS UNDER OPERATING LEASES

The Company's operations include the leasing of office buildings,  industrial
warehouses and shopping centers.  The leases thereon expire  at various dates
through 2008.  The following is a schedule of minimum future rents on non-
cancelable operating leases at December 31, 1996:

<TABLE>
     <S>                                          <C>
     1997   . . . . . . . . . . . . . . . . .     $ 20,889
     1998   . . . . . . . . . . . . . . . . .       17,959
     1999   . . . . . . . . . . . . . . . . .       14,215
     2000   . . . . . . . . . . . . . . . . .       10,528
     2001   . . . . . . . . . . . . . . . . .        7,449
     Thereafter   . . . . . . . . . . . . . .       22,673
                                                  --------
                                                  $ 93,713
                                                  ========
</TABLE>





                                       51
<PAGE>   52
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9.  ADVISORY AGREEMENT

Basic Capital Management, Inc. ("BCM" or the "Advisor") has served as advisor
to the Company since March 28, 1989.  BCM is a company owned by a trust for the
benefit of the children of Gene E. Phillips.  Mr. Phillips served as a Director
of the Company until December 31, 1992, as  a director of BCM until December
22, 1989 and as Chief Executive Officer of BCM until September 1, 1992.  Mr.
Phillips serves as a representative of his children's trust which owns BCM and,
in such capacity, has substantial contact with the management of BCM and input
with respect to its performance of advisory services to the Company.

At the Company's annual meeting of stockholders held on May 31, 1996,  the
Company's stockholders approved the renewal of the Company's Advisory Agreement
with BCM through the next annual meeting of the Company's stockholders.
Subsequent renewals of the Advisory Agreement with BCM do not require the
approval of the Company's stockholders but do require the approval of the
Company's Board of Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve-month forecast of operations and cash
flow, a general plan for asset sales and acquisitions, lending, foreclosure and
borrowing activity and other investments.  The Advisor is required to report
quarterly to the Company's Board of Directors on the Company's performance
against the business plan.  In addition, all transactions or investments by the
Company shall require prior approval by the Company's Board of Directors
unless they are explicitly provided for in the approved business plan or are
made pursuant to authority expressly delegated to the Advisor by the Company's
Board of Directors.  The Advisory Agreement also requires prior approval of the
Company's Board of Directors for the retention of all consultants and third
party professionals, other than legal counsel.

The Advisory Agreement provides for BCM to be responsible for the day-to-day
operations of the Company and to receive an advisory fee comprised of a gross
asset fee of .0625% per  month (.75% per annum) of the average of the gross
asset value of the Company (total assets less allowance for amortization,
depreciation or depletion and valuation reserves) and an annual net income fee
equal to 7.5% per annum of the Company's net income.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee.  BCM or an affiliate of BCM is to receive an acquisition commission
for supervising the acquisition, purchase or long-term lease of real estate for
the Company.  BCM or an affiliate of BCM is to receive a mortgage or loan
acquisition fee with respect to the acquisition or purchase of any existing
mortgage loan by the Company.  BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the
Company or refinancing  on Company properties and BCM is to receive
reimbursement of certain expenses incurred by it in the performance of advisory
services to the Company.





                                       52
<PAGE>   53
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



NOTE 9.  ADVISORY AGREEMENT (Continued)

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company one-half of any compensation received from third parties with respect
to the origination, placement or brokerage of any loan made by the Company.

Under the Advisory Agreement, all or a portion of the annual advisory fee must
be refunded by the Advisor to the Company if the Operating Expenses of the
Company (as defined in the Advisory Agreement) exceed certain limits specified
in the Advisory Agreement.  The effect of this limitation was to require that
BCM refund $87,000 and $246,000 of the annual advisory fee for 1996 and 1995,
respectively. The operating expenses of the Company did not exceed such
limitation in 1994.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM will be separately compensated for such additional services on
terms to be agreed upon from time to time.  As discussed in NOTE 10. "PROPERTY
MANAGEMENT," the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to perform property management for the Company's
properties and as discussed in NOTE 11. "REAL ESTATE BROKERAGE," has engaged,
on a non-exclusive basis, Carmel Realty, Inc. ("Carmel Realty"), also an
affiliate of BCM, to provide brokerage services for the Company.

NOTE 10. PROPERTY MANAGEMENT

Carmel, Ltd. provides property management services to the Company for a fee of
5% or less of the monthly gross rents collected on the properties under its
management.  Carmel, Ltd. subcontracts with other entities for the
property-level management services to the Company at various rates.  The
general partner of Carmel, Ltd. is BCM.  The limited partners of Carmel, Ltd.
are (i) Syntek West, Inc. ("SWI"), of which Mr. Phillips is the sole
shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the
children of Mr. Phillips.  Carmel, Ltd. subcontracts the property-level
management and leasing of 28 of the Company's commercial properties, its hotel
and the commercial properties owned by Tri-City in which the Company and IORI
are partners to Carmel Realty, which is a company owned by SWI.  Carmel Realty
is entitled to receive property and construction management fees and leasing
commissions in accordance with the terms of its property-level management
agreement with Carmel, Ltd.

NOTE 11. REAL ESTATE BROKERAGE

Carmel Realty provides brokerage services to the Company on a non-exclusive
basis.  Carmel Realty is entitled to receive a commission for property
acquisitions and sales in accordance with a sliding scale of total fees to be
paid by the Company.





                                       53
<PAGE>   54
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 12.  ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.

Fees and cost reimbursements to BCM and its affiliates:

<TABLE>
<CAPTION>
                                                            1996             1995               1994   
                                                          ---------        ---------          ---------
<S>                                                       <C>                 <C>                  <C>
Fees
     Advisory   . . . . . . . . . . . . . . . . . .       $ 1,784             $ 1,770              $  1,708
     Property acquisition   . . . . . . . . . . . .           339                  56                   397
     Real estate brokerage  . . . . . . . . . . . .           283                 301                 1,687
     Mortgage brokerage and equity
         refinancing  . . . . . . . . . . . . . . .           136                 104                   163
     Property and construction
         management and leasing
         commissions*   . . . . . . . . . . . . . .         1,879               2,928                 1,280
                                                          -------             -------              --------
                                                          $ 4,421             $ 5,159              $  5,235
                                                          =======             =======              ========

Cost reimbursements                                       $ 1,047             $   877              $    706
                                                          =======             =======              ========
</TABLE>

____________________________

*  Net of property management fees paid to subcontractors, other than
   Carmel Realty.

NOTE 13.  INCOME TAXES

For the years 1996, 1995 and 1994, the Company has elected and qualified to be
treated as a REIT, as defined in Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code"), and as such, will not be taxed
for federal income tax purposes on that portion of its taxable income which is
distributed to stockholders, provided that at least 95% of its REIT taxable
income, plus 95% of its taxable income from foreclosure property as defined in
Section 857 of the Code, is distributed.  See NOTE 7. "DIVIDENDS."

The Company had a loss for federal income tax purposes in 1996, 1995 and 1994;
therefore, the Company recorded no provision for income taxes.

The Company's tax basis in its net assets differs from the amount at which its
net assets are reported for financial statement purposes, principally due to
the accounting for gains and losses on property sales, the difference in the
allowance for estimated losses, depreciation on owned properties and
investments in joint venture partnerships.  At December 31, 1996, the Company's
tax basis in its net assets exceeded its basis for financial statement purposes
by $10.5 million.  As a result, aggregate future income for income tax purposes
will be less than such amount for financial statement purposes, and the Company
would be able to maintain its REIT status without distributing 95% of its
financial statement income.  Additionally, at December 31, 1996, the Company
had tax net operating loss carryforwards of $51.6 million expiring through the
year 2011.





                                       54
<PAGE>   55
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 13.  INCOME TAXES

As a result of the Company's election to be treated as a REIT for income tax
purposes and of its intention to distribute its taxable income, if any, in
future years, no deferred tax asset, liability or valuation allowance was
recorded.

NOTE 14.  EXTRAORDINARY GAIN

In 1996, the Company recognized an extraordinary gain of $256,000 on the
principal reductions of the mortgage debt, granted for capital improvements
made to the Dunes Plaza Shopping Center.

In 1995, the Company recognized extraordinary gains totaling $1.4 million on
the payoff of the mortgage debt secured by the Fountain Village Apartments and
a principal pay down and modification of the mortgage debt secured by the Dunes
Plaza Shopping Center.

In 1994, the Company recognized an extraordinary gain of $1.2 million on the
conveyance of it's limited partner interest in a partnership owning an office
building in Philadelphia, Pennsylvania to the lender on a mortgage secured by
the property owned by the partnership, in settlement of all litigation between
the Company and the lender.

NOTE 15.  COMMITMENTS AND CONTINGENCIES

Olive Litigation. In February 1990, the Company, together with CMET, IORI and
National Income Realty Trust ("NIRT"), three real estate entities with, at the
time, the same officers, directors or trustees and advisor as the Company,
entered into a settlement of a class and derivative action entitled Olive et
al. v. National Income Realty Trust et al., relating to the operation and
management of each of such entities.  On April 23, 1990, the Court granted
final approval of the terms of the settlement.

On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Modification") which settled subsequent
claims of breaches of the settlement which were asserted by the plaintiffs and
modified certain provisions of the April 1990 settlement.  The Modification was
preliminarily approved by the Court on July 1, 1994 and final Court approval of
the Modification was entered on December 12, 1994.  The effective date of the
Modification was January 11, 1995.

The Modification, among other things, provided for the addition of new
unaffiliated members to the Company's Board of Directors and set forth new
requirements for the approval of any transactions with affiliates until April
28, 1999.  In addition, BCM, the Company's advisor, Gene E. Phillips and
William S. Friedman, who served as President and Director of the Company until
February 24, 1994, President of BCM until May 1,





                                       55
<PAGE>   56
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 15.  COMMITMENTS AND CONTINGENCIES (Continued)

1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2
million to CMET, IORI, NIRT and the Company, of which the Company's share was
$150,000.

Under the Modification, the Company, CMET, IORI and NIRT and their stockholders
released the defendants from any claims relating to the  plaintiffs'
allegations.  The Company, CMET, IORI and NIRT also agreed to waive any demand
requirement for the plaintiffs to pursue claims on behalf of each of them
against certain persons or entities.  The Modification also requires that any
shares of the Company held by Messrs. Phillips, Friedman or their affiliates
shall be (i) voted in  favor of the reelection of all then current members of
the Company's Board of Directors that stand for reelection during the two
calendar years following the effective date of the Modification and (ii) voted
in favor of all new members of the Company's Board of Directors appointed
pursuant to the terms of the Modification that stand for reelection during the
three calendar years following the effective date of the Modification.

Pursuant to the terms of the Modification, certain related party transactions
which the Company may enter into prior to April 28, 1999, require the unanimous
approval of the Company's Board of Directors.  In addition, such related party
transactions are to be discouraged and may only be entered into in exceptional
circumstances and after a determination by the Company's Board of Directors
that the transaction is in the best interests of the Company and that no other
opportunity exists that is as good as the opportunity presented by such
transaction.

For purposes of the Modification requirements, the term "related party
transaction" means and includes:  (i) any transaction between or among the
Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii)
any transaction between or among the Company, its affiliates or subsidiaries
and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and
(iii) any transaction between or among  the Company or any of its affiliates or
subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr.
Friedman or any of their affiliates has an ongoing or contemplated business or
financial transaction or relationship of any kind, whether direct or indirect,
or has had such a transaction or relationship in the preceding one year.

The Modification requirements for related party transactions do not apply to
direct contractual agreements for services between the Company and the Advisor
or one of its affiliates, (including the Advisory Agreement, the Brokerage
Agreement and the property management contracts).  These agreements require the
prior approval by two-thirds of the Directors of the Company, and if required,
approval by a majority of the Company's stockholders.  The Modification
requirements for related party transactions also do not apply to joint ventures
between or among the Company and CMET, IORI or NIRT or any of their affiliates





                                       56
<PAGE>   57
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 15.  COMMITMENTS AND CONTINGENCIES (Continued)

or subsidiaries and a third party having no prior or intended future business
or financial relationship with Mr.  Phillips, Mr. Friedman, the Advisor, or any
affiliate of such parties.  Such joint ventures may be entered into on the
affirmative vote of a majority of the Directors of the Company.

The Modification also terminated a number of the provisions under the
settlement, including the requirement that the Company, CMET, IORI and NIRT
maintain a Related Party Transaction Committee and a Litigation Committee of
their respective Boards.  The Court retained jurisdiction to enforce the
Modification, and during August and September 1996, the Court held evidentiary
hearings to assess compliance with the terms of the Modification by various
parties.  The Court issued no ruling or order with respect to the matters
addressed at the hearings.

Separately, in 1996, legal counsel for the plaintiffs notified the Company's
Board of Directors that he intends to assert that certain actions taken by the
Board of Directors breached the terms of the Modification.  On January 27,
1997, the parties entered into an Amendment to the Modification effective
January 9, 1997 (the "Amendment"), which was submitted to the Court for
approval on January 29, 1997.  The Amendment provides for the settlement of all
matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Company's Board of Directors.  As of March 20, 1997, the Court
had taken no action on the Amendment.

The Amendment provides for the addition of three new unaffiliated members to
the Company's Board of Directors and sets forth new requirements for the
approval of any transactions with certain affiliates until April 28, 1999.  In
addition, the Company, CMET, IORI and their stockholders released the
defendants from any claims relating to the plaintiffs' allegations and matters
which were the subject of the evidentiary hearings.  The plaintiffs'
allegations of any breaches of the Modification shall be settled by mutual
agreement of the parties or, lacking such agreement, by an arbitration
proceeding.

Under the Amendment, all shares of the Company owned by Mr. Phillips or any of
his affiliates shall be voted at all stockholders' meetings held until April
28, 1999 in favor of all new members of the Company's Board of Directors added
under the Amendment.  The Amendment also requires that, until April 28, 1999,
all shares of the Company owned by Mr. Phillips or his affiliates in excess of
forty percent (40%) of the Company's outstanding shares shall be voted in
proportion to the votes cast by all non-affiliated stockholders of the Company.

Other Litigation.  The Company is also involved in various other lawsuits
arising in the ordinary course of business.  Management of the  Company is of
the opinion that the outcome of these lawsuits will have no material impact on
the Company's financial condition, results of operations or liquidity.





                                       57
<PAGE>   58
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 15.  COMMITMENTS AND CONTINGENCIES (Continued)

Litigation settlement.  In October 1996 and June 1995, the Company received
$1.5 million and $500,000, respectively, from the defendants in a lawsuit
brought by the Company against the former owners of an office building in New
Jersey and their agents.  The Company made a loan secured by the building in
1987 and filed a foreclosure action which was subsequently amended in 1990, to
include claims of negligent misrepresentation against the borrowers, their
legal counsel, architect and engineers.

NOTE 16.  QUARTERLY RESULTS OF OPERATIONS

The following is a tabulation of the Company's quarterly results of operations
for the years 1996 and 1995:

<TABLE>
<CAPTION>
                                                                       Three Months Ended                  
                                               -----------------------------------------------------------------------
 1996                                          March 31,             June 30,        September 30,        December 31,
------                                         ---------             ---------       -------------        ------------
<S>                                            <C>                  <C>                 <C>                <C>
Income  . . . . . . . . . . . . . . . .         $ 11,570             $  11,341           $ 11,776           $   12,191
Expenses  . . . . . . . . . . . . . . .           14,296                15,296             14,055               12,852
                                                --------             ---------           --------           ----------

(Loss) from operations  . . . . . . . .           (2,726)               (3,955)            (2,279)                (661)

Equity in income (losses) of
     investees  . . . . . . . . . . . .              (45)                   (1)               (56)                  82
Gain on sale of partnership
     interests  . . . . . . . . . . . .               -                     -                  -                    -
Gain of sale of real estate . . . . . .            1,650                    -                 (71)                  -
Extraordinary gain  . . . . . . . . . .               48                    -                 208                   - 
                                                --------             ---------           --------           ---------- 
Net income (loss) . . . . . . . . . . .         $ (1,073)            $  (3,956)          $ (2,198)          $     (579)
                                                ========             =========           ========           ========== 

Earnings Per Share
Income (loss) before
     extraordinary gain   . . . . . . .         $   (.28)             $   (.99)          $   (.60)          $     (.15)
Extraordinary gain  . . . . . . . . . .              .01                   .-                 .05                  .- 
                                                --------              --------           --------           ----------  
Net income (loss) . . . . . . . . . . .         $   (.27)             $   (.99)          $   (.55)          $     (.15)
                                                ========              ========           ========           ==========  
</TABLE>

In the first and third quarters of 1996, extraordinary gains totaling $256,000
were recognized due to mortgage principal reductions granted for specified
capital improvements at the Dunes Plaza Shopping Center.  In the fourth quarter
of 1996, the Company received a $1.5 million litigation settlement.

In the first quarter of 1996, gains on sale of real estate of $218,000 and $1.4
million were recognized on the sale of Cheyenne Mountain Land and the Park
Forest Apartments, respectively.  In the third quarter of 1996, a gain of
$56,000 was recognized on the sale of a 177 acre parcel of the Moss Creek land,
a loss of $63,000 was recognized on the sale of the Byron Land and a loss of
$64,000 was recognized on the sale of the Latham Square Office Building, a
provision for loss of $1.6 million relating to such sale having been recognized
in the second quarter of 1996.





                                       58
<PAGE>   59
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 16.    QUARTERLY RESULTS OF OPERATIONS (Continued)

<TABLE>
<CAPTION>
                                                                       Three Months Ended                  
                                               ----------------------------------------------------------------------
 1995                                          March 31,            June 30,         September 30,        December 31,
------                                         ---------            ---------        -------------        ------------
<S>                                            <C>                  <C>                 <C>                <C>
Income  . . . . . . . . . . . . . . . .        $ 11,585             $  11,133           $ 12,192           $   13,362
Expenses  . . . . . . . . . . . . . . .          13,900                13,292             14,998               15,984
                                               ---------            ---------           --------           ----------

(Loss) from operations  . . . . . . . .          (2,315)               (2,159)            (2,806)              (2,622)
Equity in income (losses) of
     investees  . . . . . . . . . . . .              71                (1,070)              (153)                  69
Gain of sale of real estate . . . . . .               -                     -              1,636                4,186
Extraordinary gain. . . . . . . . . . .           1,293                    48                  -                   96
                                               ---------            ---------           --------           ----------

Net income (loss) . . . . . . . . . . .        $   (951)            $  (3,181)          $ (1,323)          $    1,729
                                               ========             =========           ========           ==========

Earnings Per Share
Income (loss) before
     extraordinary gain   . . . . . . .        $   (.56)            $    (.80)          $   (.33)          $       .41
Extraordinary gain  . . . . . . . . . .             .32                   .01                  -                   .02
                                               ---------            ----------          ---------          -----------

Net income (loss) . . . . . . . . . . .        $   (.24)            $    (.79)          $   (.33)          $       .43
                                               ========             =========           =========          ===========
</TABLE>

In the first quarter of 1995, an extraordinary gain of $1.3 million was
recognized on the payoff of the mortgage debt secured by the Fountain Village
Apartments.  In the second and fourth quarters of 1995, extraordinary gains
totaling $144,000 were recognized on the modification of the mortgage debt
secured by the Dunes Plaza Shopping Center.  In the third quarter of 1995, a
gain on sale of real estate of $1.6 million was recognized on the paydown of
the mortgage note receivable secured by land in Maumelle, Arkansas, such gain
having been previously deferred.  In the fourth quarter of 1995, a gain on sale
of real estate of $4.1 million was recognized on the sale of the Summerchase
Apartments and a gain on sale of real estate of $76,000 was recognized on the
sale of the Heritage Square Center.

NOTE 17.     SUBSEQUENT EVENTS

In January 1997, the Company received a final insurance settlement totaling
$10.0 million from 1995 hail storm and flood damage to the Republic Towers
Office Building in Dallas, Texas.

In January 1997, the Company refinanced the mortgage debt secured by 74 New
Montgomery, an office building in San Francisco, California, in the amount of
$6.3 million.  The Company received net cash of $1.0 million after the payoff
of $5.2 million in existing mortgage debt.  The remainder of the refinancing
proceeds were used to fund a tax escrow and to pay various closing costs
associated with the refinancing.  The new mortgage bears interest at a variable
rate, currently 9.25% per annum, requires monthly principal and interest of
$53,996 and matures in January  2004.





                                       59
<PAGE>   60
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


NOTE 17.     SUBSEQUENT EVENTS  (Continued)

Also in January 1997, the Company refinanced the mortgage debt secured by the
Woods Edge Apartments in Rockville, Maryland in the amount of $6.2 million.
The Company received no net cash.  The refinancing proceeds being used to
payoff $5.9 million in existing mortgage debt, fund a tax escrow and pay
various closing costs associated with the refinancing.  The new mortgage bears
interest at 8.125% per annum, requires monthly payments of principal and
interest of $46,035 and matures in February 2007.

At December 31, 1996, the Fiesta Mart, a 29,000 square foot shopping center in
San Angelo, Texas, was under contract for sale.  In February 1997, the Company
completed the sale for $544,000 in cash.  The Company received net cash of
$403,000 after the payoff of $90,000 in existing mortgage debt and various
closing costs associated with the sale.  The Company incurred no gain or loss
on the sale.

In February 1997, the Company also completed the sale of a .9976 acre parcel of
land,  in Dallas, Texas, under contract for sale at December 31, 1996 for $2.7
million.  The Company received net cash of $2.6 million after paying
various closing costs associated with the sale.  The Company will recognize a
gain of approximately $1.4 million on the sale.

Also in February 1997, the Company refinanced the mortgage debt secured by the
Spa Cove Apartments in Annapolis, Maryland in the amount of $12.2 million.  The
Company received net cash of $249,000 after the payoff of $11.6 million in
existing mortgage debt.  The remainder of the refinancing proceeds were used to
fund a tax escrow and pay various closing costs associated with the
refinancing.  The new mortgage bears interest at 8.015% per annum, requires
monthly payments of principal and interest of $89,529 and matures in March
2007.

In March 1997, the Company purchased the Terrace Hills Apartments, a 310 unit
apartment complex in El Paso, Texas, for $6.2 million.  The Company paid $1.4
million in cash and obtained new mortgage financing of $4.8 million.  The
mortgage bears interest at 8.07% per annum, requires monthly principal and
interest of $35,086 and matures in April 2007.





                                       60
<PAGE>   61
                                                                    SCHEDULE III

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               DECEMBER 31, 1996

<TABLE>
<CAPTION>
                                                                    Cost                                                    
                                                            Capitalized Subsequent         Gross Amounts of Which Carried
                                             Initial Cost      to Acquisition                       at End of Year              
                                         ------------------ ---------------------         ---------------------------------- 
                                                Buildings &                                       Buildings &          (1)   
Property/Location        Encumbrances    Land  Improvements Improvements    Other         Land    Improvements        Total  
-----------------        ------------    ----  ------------ ------------    -----         ----    ------------        -----  
PROPERTIES HELD FOR INVESTMENT                                             (dollars in thousands)
<S>                         <C>         <C>       <C>           <C>          <C>          <C>       <C>                <C>
APARTMENTS
----------
Arbor Point..............  $   825     $  321    $ 1,285      $  163      $     -       $   321      $ 1,448          $ 1,769
 Odessa, TX
Carseka .................        -        460      1,840          -             -           460        1,840            2,300
 Los Angeles, CA
Coventry ................      305        236        369          11            -           236          380              616
 Midland, TX
Fountain Village.........    8,091      1,518      8,352       1,834       (2,375)(2)     1,162        8,167            9,329
 Tucson, AZ
Gladstell Forest ........    2,626        504      2,015          37            -           504        2,052            2,556
 Conroe, TX
Harper's Ferry...........    1,821        349      1,398         160            -           349        1,558            1,907
 Lafayette, LA
Heritage ................    2,026        148        839          45         (300)(3)        88         644               732
 Tulsa, OK
Monterey Bay ............    3,938        716      4,059         342            -           716        4,401            5,117
 St. Petersburg, FL
Shadow Run ..............    7,127      1,503      8,229         134            -         1,503        8,363            9,866
 Pinellas Park, FL
South Cochran ...........      930        540      2,162          -             -           540        2,162            2,702
 Los Angeles, CA
Southgate ...............      828        335      1,338           84           -           335        1,422            1,757
 Odessa, TX
Spa Cove ................   11,506      2,254     10,297        3,871         682(4)      2,336       14,768           17,104
 Annapolis, MD
Summerfield .............    4,749      1,175      4,698           67           -         1,175        4,765            5,940
 Orlando, FL
Summerstone .............    4,887      1,155      4,618           22           -         1,155        4,640            5,795
 Houston, TX
Westgate of Laurel ......    7,709        849      9,391           55           -           849        9,446           10,295
 Laurel, MD
Westwood ................      217         85        341           17           -            85          358              443 
 Odessa, TX
Woodland Hills ..........    1,184        228        913          -             -           228          913            1,141
 San Antonio, TX
Woods Edge ..............    5,839      1,015      7,812          -             -         1,015        7,812            8,827
 Rockville, MD

OFFICE BUILDINGS
----------------
74 New Montgomery .......    5,159      2,277      9,105        3,739        (336)(2)     2,210       12,575           14,785
 San Francisco, CA
Chesapeake Ridge ........    5,417      3,663      4,098        1,570           -         3,663        5,668            9,331
 San Diego, CA
Corporate Pointe ........    2,858        830      3,321          307           -           830        3,628            4,458
 Chantilly, VA
Forum ...................    5,603      1,360      5,439          408           -         1,360        5,847            7,207
 Richmond, VA
Hartford ................    2,255        630      2,520          196           -           630        2,716            3,346
 Dallas, TX
Institute Place Lofts....    6,058        665      7,057          49            -           665        7,106            7,771

<CAPTION>
                                                                                   Life on Which
                                                                                    Depreciation
                                                                                     in Latest
                                                          Date                        Statement   
                                    Accumulated            of           Date         of Operation
Property/Location                   Depreciation      Construction     Acquired      is Computed
------------------                  ------------      ------------     --------     --------------
PROPERTIES HELD FOR INVESTMENT                                                        
<S>                                    <C>               <C>          <C>              <C>
APARTMENTS
----------
Arbor Point .....................        $15             1975          8/30/96         5 - 40 years
 Odessa, TX                                                                                        
Carseka .........................          8             1971         11/19/96             40 years
 Los Angeles, CA                                                                                   
Coventry ........................          3             1977         08/30/96         5 - 40 years
 Midland, TX                                                                                       
Fountain Village ................      3,247             1973         01/10/86         5 - 40 years
 Tucson, AZ                                                                                        
Gladstell Forest ................         87             1985         06/30/95             40 years
 Conroe, TX                                                                                        
Harper's Ferry ..................        221             1972         02/25/92             40 years
 Lafayette, LA                                                                                     
Heritage ........................         74             1966         05/14/90             40 years
 Tulsa, OK                                                                                         
Monterey Bay ....................        692             1972         06/28/91         5 - 40 years
 St. Petersburg, FL                                                                                
Shadow Run ......................      2,725             1985         04/10/95         5 - 40 years
 Pinellas Park, FL                                                                                 
South Cochran ...................        302             1928         05/29/91             40 years
 Los Angeles, CA                                                                                   
Southgate .......................         13             1976         08/30/96         5 - 40 years
 Odessa, TX                                                                                        
Spa Cove ........................      3,888             1965         02/27/87         5 - 40 years
 Annapolis, MD                                                                                     
Summerfield .....................        278             1971         11/02/94             40 years
 Orlando, FL                                                                                       
Summerstone .....................        352             1984         12/17/93             40 years
 Houston, TX                                                                                       
Westgate of Laurel ..............      3,278             1969         01/01/95         5 - 40 years
 Laurel, MD                                                                                        
Westwood ........................          3             1977         08/30/96         5 - 40 years
 Odessa, TX                                                                                        
Woodland Hills ..................        103             1972         05/01/92             40 years
 San Antonio, TX                                                                                   
Woods Edge ......................      3,102             1965         01/01/95             40 years
 Rockville, MD

OFFICE BUILDINGS
----------------
74 New Montgomery ...............      3,138             1914         09/21/90         4 - 40 years
 San Francisco, CA                                                                                 
Chesapeake Ridge ................      2,806             1985         06/30/85         5 - 40 years
 San Diego, CA                                                                                     
Corporate Pointe ................        301             1992         10/28/94         5 - 40 years
 Chantilly, VA                                                                                     
Forum ...........................        797             1987         10/30/92         2 - 40 years
 Richmond, VA                                                                                      
Hartford ........................        167             1980         11/10/94         4 - 40 years
 Dallas, TX                                                                                        
Institute Place Lofts............      3,146             1910         01/01/93         5 - 40 years
Chicago, IL
</TABLE>





                                       61
<PAGE>   62
                                                                    SCHEDULE III
                                                                    (Continued)

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               DECEMBER 31, 1996


<TABLE>
<CAPTION>
                                                                    Cost                                                    
                                                            Capitalized Subsequent         Gross Amounts of Which Carried
                                             Initial Cost      to Acquisition                      at End of Year              
                                         ------------------ ---------------------         ---------------------------------- 
                                                Buildings &                                       Buildings &          (1)   
Property/Location        Encumbrances    Land  Improvements Improvements    Other         Land    Improvements        Total  
-----------------        ------------    ----  ------------ ------------    -----         ----    ------------        -----  
PROPERTIES HELD FOR INVESTMENT - Continued                                 (dollars in thousands)

<S>                         <C>         <C>       <C>           <C>          <C>          <C>       <C>                <C>
                                                                                                                               
OFFICE BUILDINGS (Continued)
----------------            
One Steeplechase ........   $8,276     $1,380    $ 5,520        $2,807    $    72 (4)    $1,380       $ 8,399        $ 9,779 
 Sterling, VA                                                                                                                
Plaza Towers ............    4,889      1,760     12,617         6,355     (4,379)(2)     1,241        15,112         16,353 
 St. Petersburg, FL                                                                                                          
Republic Towers .........        -      3,082      5,441         3,771          -         3,082         9,212         12,294 
 Dallas, TX                                                                                                                  
Town & Country ..........        -        108        432           364          -           108           796            904 
 Houston, TX                                                                                                                 
Venture Center ..........    1,145        411      2,746           113          -           411         2,859          3,270 
 Atlanta, GA                                                                                                                 
Waterstreet .............    8,278      2,605     10,420           887          -         2,605        11,307         13,912 
 Boulder, CO                                                                                                                 
                                                                                                                             
INDUSTRIAL WAREHOUSES                                                                                                        
---------------------                                                                                                        
Corporate Center ........    4,691      1,259      5,038         1,025          -         1,259         6,063          7,322 
 Ashburn, VA              
Denton Drive  ...........      383        414        527            -           -           414           527            941 
 Dallas, TX                                                                                                                  
Parke Long  .............    7,883      1,838      7,361           334          -         1,838         7,695          9,533 
 Chantilly, VA                                                                                                               
Technology Trading ......    4,275      1,199      4,796            76          -         1,199         4,872          6,071 
 Sterling, VA                                                                                                                
Texstar  ................    1,150        333      1,331            -           -           333         1,331          1,664 
 Arlington, TX                                                                                                               
Tricon   ................    5,100      2,761      6,442           603          -         2,761         7,045          9,806 
 Atlanta, GA     
                                                                                                                             
SHOPPING CENTERS                                                                                                             
----------------                                                                                                             
Dunes Plaza  ............    4,116      1,230      5,430         1,172        (82)(5)     1,343         6,407          7,750 
 Michigan City, IN                                                                                                           
Northtown  ..............    2,798      1,786      7,143         1,354          -         1,786         8,497         10,283 
 Dallas, TX                                                                                                                  
Parkway Center ..........    1,816        273      1,876           354          -           273         2,230          2,503 
 Dallas, TX                                                                                                                  
President's Square ......    1,200        483      1,182           244          -           483         1,426          1,909 
 San Antonio, TX                                                                                                             
Sadler Square ...........    2,457        679      2,715            -           -           679         2,715          3,394 
 Amelia Island, FL                                                                                                           
Shaw Plaza  .............    2,606      1,066      4,262         1,024       (109)(6)     1,081         5,162          6,243 
 Sharon, MA                                                                                                                  
Sheboygan ...............      940        242      1,371            17          -           242         1,388          1,630 
 Sheboygan, WI

<CAPTION>


                                                                                    Life on Which
                                                                                    Depreciation
                                                                                      in Latest
                                                          Date                        Statement   
                                    Accumulated            of           Date         of Operation
Property/Location                   Depreciation      Construction     Acquired      is Computed
------------------                  ------------      ------------     --------     --------------
PROPERTIES HELD FOR INVESTMENT - Continued
<S>                                    <C>               <C>          <C>          <C>
OFFICE BUILDINGS (Continued)
----------------            
One Steeplechase ..................    $1,523             1987         12/22/92     5 - 40 years
 Sterling, VA
Plaza Towers  .....................     7,762             1979         11/14/85     3 - 40 years
 St. Petersburg, FL
Republic Towers ...................     1,879             1954         11/27/92     2 - 40 years
 Dallas, TX
Town & Country ....................       302             1982         05/01/92     3 - 40 years
 Houston, TX
Venture Center ....................       594             1981         07/04/89     5 - 40 years
 Atlanta, GA
Waterstreet .......................     1,922             1988         09/30/91     3 - 40 years
 Boulder, CO

INDUSTRIAL WAREHOUSES
--------------------- 
Corporate Center...................       499             1989         04/28/94     3 - 40 years
 Ashburn, VA                                                           10/28/94
Denton Drive ......................        48             1948-        05/13/93         40 years
 Dallas, TX                                               1952 
Parke Long  .......................       557             1989         06/16/94     3 - 40 years
 Chantilly, VA
Technology Trading ................       390             1987         12/21/93     3 - 40 years
 Sterling, VA
Texstar ...........................       101             1967         12/16/93         40 years
 Arlington, TX
Tricon ............................       941             1971-        02/11/93     2 - 40 years
 Atlanta, GA                                              1975

SHOPPING CENTERS
----------------
Dunes Plaza .......................       849             1978         03/17/92     5 - 40 years
 Michigan City, IN
Northtown   .......................     1,080             1967         02/25/92     5 - 40 years
 Dallas, TX
Parkway Center ....................       606             1979         11/01/91     3 - 40 years
 Dallas, TX
President's Square ................       209             1985         04/13/93     2 - 40 years
 San Antonio, TX
Sadler Square  ....................       273             1987         11/22/93         40 years
 Amelia Island, FL
Shaw Plaza ........................     1,085             1978         12/13/91     5 - 40 years
 Sharon, MA
Sheboygan .........................       157             1977         05/21/92         40 years
 Sheboygan, WI
</TABLE>


                                       62
<PAGE>   63
                                                                    SCHEDULE III
                                                                    (Continued)

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               DECEMBER 31, 1996


<TABLE>
<CAPTION>
                                                                    Cost                                                    
                                                            Capitalized Subsequent         Gross Amounts of Which Carried
                                             Initial Cost       to Acquisition                     at End of Year              
                                         ------------------ ---------------------         ---------------------------------- 
                                                Buildings &                                       Buildings &          (1)   
Property/Location        Encumbrances    Land  Improvements Improvements    Other         Land    Improvements        Total  
-----------------        ------------    ----  ------------ ------------    -----         ----    ------------        -----  
                                                                           (dollars in thousands)
<S>                         <C>         <C>       <C>           <C>          <C>          <C>       <C>                <C>
HOTEL
-----
Majestic Inn ..........   $    950     $ 1,139    $  4,555    $   371    $     -          $ 1,139    $  4,926      $  6,065  
 San Francisco, CA

LAND
----
Las Colinas ...........          -         995         -            5          -              995           5         1,000  
 Las Colinas, TX          --------     -------     -------    -------    --------         -------     --------     -------- 

PROPERTIES HELD FOR
 INVESTMENT ...........    154,911      47,859     192,701     33,987     (6,827)          47,067     220,653       267,720  
                           -------      ------     -------     ------     ------           ------     -------       -------  

PROPERTIES HELD FOR SALE
SINGLE FAMILY RESIDENCE
-----------------------
Scottsdale, Az Residence         -         138         552         -           -              138         552           690   

SHOPPING CENTERS
----------------
Fiesta Mart  ..........         95         116         466        75           -              116         541           657 
 San Angelo, TX                                                                                                              

LAND
----
Fruitland .............          -         253         -          -           -               253          -            253  
 Fruitland Park, FL
Live Oak  .............          -       1,171         -          -           -             1,171          -          1,171   
 Dallas, TX
Maumelle ..............          -       2,213         -          -       (1,994)(7)          219          -            219   
 Maumelle, AR
Moss Creek ............          -          85         -          -            -               85         -              85   
 Greensboro, NC
                
PROPERTIES HELD FOR
 SALE                           95       3,976       1,018         75     (1,994)           1,982       1,093         3,075
                          --------     -------    --------    -------    -------          -------    --------      --------
                          $155,006     $51,835    $193,719    $34,062    $(8,821)         $49,049    $221,746      $270,795   
                          ========     =======    ========    =======    =======          =======    ========      ========   

<CAPTION>


                                                                                   Life on Which
                                                                                    Depreciation
                                                                                      in Latest
                                                         Date                         Statement   
                                    Accumulated           of             Date        of Operation
Property/Location                   Depreciation      Construction     Acquired      is Computed
------------------                  ------------      ------------     --------     --------------
<S>                                    <C>               <C>          <C>          <C>

HOTEL
-----
Majestic Inn ...................        $787            1902          12/31/90     5 - 40 years
 San Francisco, CA

LAND
----
Las Colinas  ...................           -               -          01/25/96                -
 Las Colinas, TX                     -------          

PROPERTIES HELD FOR
 INVESTMENT  ...................      50,310
                                     -------          

PROPERTIES HELD FOR SALE
SINGLE FAMILY RESIDENCE
-----------------------
Scottsdale, Az Residence                   -            1978          09/30/96         40 years

SHOPPING CENTERS
----------------
Fiesta Mart  ...................          76            1976          12/13/91     5 - 40 years
 San Angelo, TX

LAND
----
Fruitland  .....................           -               -          05/01/92                -
 Fruitland Park, FL 
Live Oak  ......................           -               -          12/04/95                -
 Dallas, TX
Maumelle  ......................           -               -          05/11/93                -
 Maumelle, AR
Moss Creek  ....................           -               -          12/31/96                -
 Greensboro, NC
                                     -------
PROPERTIES HELD FOR
 SALE                                     76
                                     -------
                                     $50,386
                                     =======
</TABLE>

------------------
(1)          The aggregate cost for federal income tax purposes is $272.0
             million.

(2)          Writedown of property to estimated net realizable value.

(3)          Escrow deposits deducted from the basis of the property.

(4)          Construction period interest and taxes.

(5)          Cash from receiver deducted from the basis of the property, offset
             by land acquired in 1992.

(6)          Adjustment to purchase price.

(7)          Adjustment to purchase price, offset by the proceeds from the sale
             of all but 114 residential lots.


                                       63
<PAGE>   64

                                                                    SCHEDULE III
                                                                     (Continued)

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                    REAL ESTATE AND ACCUMULATED DEPRECIATION



<TABLE>
<CAPTION>
                                                         1996           1995            1994   
                                                      --------       ---------       ----------
                                                              (dollars in thousands)
<S>                                                   <C>              <C>             <C>
Reconciliation of Real Estate                                                         
                                                                                      
Balance at January 1,..............................   $ 270,296      $ 253,367       $ 223,388
                                                                                      
Additions                                                                             
 Acquisitions and improvements.                          11,097         38,664          47,218
 Foreclosures......................................         691          2,519             -
                                                                                      
Deductions                                                                            
 Sale of real estate...............................      (7,121)       (24,229)         (9,626)
 Sale of foreclosed properties.....................      (2,589)           -            (7,254)
 Deed given in lieu of taxes.......................         -              -              (335)
 Writedown due to permanent impairment of
   property .......................................      (1579)            -               -
 Other.............................................         -              (25)            (24)
                                                      ---------      ---------       --------- 
                                                                                      
Balance at December 31,............................   $ 270,795      $ 270,296       $ 253,367
                                                      =========      =========       =========
                                                                                      
                                                                                      
Reconciliation of Accumulated                                                         
 Depreciation                                                                         
                                                                                      
Balance at January 1,..............................   $  44,172      $   31,549      $  28,149
                                                                                      
Additions                                                                             
 Depreciation......................................       8,461           8,619          6,095
 Accumulated depreciation of                                                          
    partnership properties                                                            
    acquired through assumption                                                       
    of debt........................................         -             7,794              -
                                                                                      
Deductions                                                                            
 Sale of real estate...............................      (1,718)         (3,790)        (2,388)
 Sale of foreclosed properties.                            (529)            -             (307)
                                                      ---------      ----------       --------- 
                                                                                      
Balance at December 31,............................   $  50,386      $   44,172      $  31,549
                                                      =========      ==========      =========
</TABLE>





                                       64
<PAGE>   65
                                                                     SCHEDULE IV

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                         MORTGAGE LOANS ON REAL ESTATE
                               December 31, 1996
<TABLE>
<CAPTION>                    
                                                                                                                                
                                           Final                                                                    Carrying    
                              Interest   Maturity                  Periodic                  Prior  Face Amount      Amounts    
Description                     Rate       Date                  Payment Terms               Liens  of Mortgage   of Mortgage(1)
-----------                     ----       ----     --------------------------------------  ------- -----------  -------------- 
                                                                                                      (dollars in thousands)    
<S>                           <C>         <C>       <C>                                      <C>       <C>            <C>       
FIRST MORTGAGE LOANS                                                                                                            
                                                                                                                                
LANDMARK APARTMENTS..........   Varies    07/2002   Note receivable bearing interest at      $    -    $2,610        $ 2,110    
-------------------                                 10% to 11% from 8/1/95 through 7/31/99                                      
Secured by apartment                                and the greater of 12% or 3% over the                                       
complex in Erie, PA.                                10 year T-Bill rate through maturity.                                       
                                                    Interest-only payments due monthly,                                         
                                                    principal payments of $5,000 monthly                                        
                                                    beginning 8/1/99, at maturity all                                           
                                                    principal and unpaid interest are due.                                      
                                                    No prepayment penalty.                                                      
                                                                                                                                
                                                                                                                                
MILWAUKEE LAND...............  Varies     01/91     Note receivable bearing interest at           -       200             60    
--------------                                      prime plus 1%.  Monthly interest only                                       
Secured by 34,847 sq. ft. of                        payments due until maturity, at which                                       
land in Milwaukee, WI.                              time all principal and unpaid interest                                      
                                                    was due.  No prepayment penalty.                                            
                                                                                                                                
                                                                                                                                
MAUMELLE LAND................   9.0%      01/96     Note receivable bearing interest at           -     1,400              -    
-------------                                       9%. Principal and interest due at                                           
Secured by 36.3 acres of                            maturity.                                                                   
commercial land in                                                                                                              
Maumelle, AR                                                                                                                    
                                                                                                                                
MOSS CREEK LOTS .............   9.0%      06/2000   9 notes outstanding at 12/31/96.              -       256            198    
---------------               -12.0%                Monthly payments of principal and                                           
Secured by developed resi-                          interest ranging from $118 to $421.                                         
dential lots in Greensboro,                                                                                                     
NC.                                                                                                                             
                                                                                                                                
WRAPAROUND MORTGAGE LOANS                                                                                                       
                                                                                                                                
CHATEAU CHARLES..............   3.875%    02/2016   Note receivable bearing interest at         255     3,000            333    
---------------                                     3.85%.  Principal and interest pay-                                         
Secured by a hotel                                  ments of $13,327 due monthly.  Pre-                                         
in Lake Charles, LA.                                payment penalty of 1% of outstanding                                        
                                                    principal balance.                                                          
                                                                                                                                
                                                                                                                                
HOLCOMB #12..................  10.0%      01/98     Note receivable bearing interest at         887     2,900          2,900    
-----------                                         10% Monthly interest only                                                   
Secured by office                                   payments due until maturity, at which                                       
building located in                                 time all principal and unpaid interest                                      
Gwinnett County, GA.                                is due.  No prepayment penalty.                                             
                                                                                                                                
                                                                                                                                
K-MART, CARY.................  Varies     03/2012   Note receivable bearing interest at       2,159     3,400          2,514    
------------                                        prime plus 1%.  Monthly payments of                                         
Secured by a shopping center                        lesser of $37,277 or net cash flow of                                       
in Wake County, NC.                                 the collateral property.                                                    
                                                                                                                                
                                                                                                                                
<CAPTION>                                                                                                                       
                                  Principal Amount of                                                                           
                                    Loans Subject to                                                                            
                                   Delinquent Principal                                                                         
Description                            or Interest                                                                              
-----------                       --------------------                                                                          
                                                                                                                                
<S>                                   <C>                                                                                       
FIRST MORTGAGE LOANS                                                                                                            
                                                                                                                                
LANDMARK APARTMENTS..........         $     -                                                                                   
-------------------                                                                                                             
Secured by apartment                                                                                                            
complex in Erie, PA.                                                                                                            
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
                                                                                                                                
MILWAUKEE LAND...............              60      (2)                                                                          
--------------                                                                                                                  
Secured by 34,847 sq. ft. of                                                                                                    
land in Milwaukee, WI.                                                                                                          
                                                                                                                                
                                                                                                                                
                                                                                                                                
MAUMELLE LAND................           1,400                                                                                   
-------------                                                                                                                   
Secured by 36.3 acres of                                                                                                        
commercial land in                                                                                                              
Maumelle, AR                                                                                                                    
                                                                                                                                
MOSS CREEK LOTS .............               -                                                                                   
---------------                                                                                                                 
Secured by developed resi-                                                                                                      
dential lots in Greensboro,                                                                                                     
NC.                                                                                                                             
                                                                                                                                
WRAPAROUND MORTGAGE LOANS                                                                                                       
                                                                                                                                
CHATEAU CHARLES..............               -                                                                                   
---------------                                                                                                                 
Secured by a hotel                                                                                                              
in Lake Charles, LA.                                                                                                            
                                                                                                                                
                                                                                                                                
                                                                                                                                
HOLCOMB #12..................               -                                                                                   
-----------                                                                                                                     
Secured by office                                                                                                               
building located in                                                                                                             
Gwinnett County, GA.                                                                                                            
                                                                                                                                
                                                                                                                                
K-MART, CARY.................               -      (2)                                                                          
------------                 
Secured by a shopping center 
in Wake County, NC.          
</TABLE>





                                       65
<PAGE>   66
                                                                     SCHEDULE IV
                                                                     (Continued)

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                         MORTGAGE LOANS ON REAL ESTATE
                               December 31, 1995
<TABLE>
<CAPTION>                          
                                                                                                                             
                                                   Final                                                                     
                                      Interest   Maturity                  Periodic                        Prior                 
Description                             Rate       Date                  Payment Terms                     Liens                 
-----------                             ----       ----     ----------------------------------------      -------                
                                                                                                                                 
<S>                                   <C>       <C>         <C>                                           <C>                    
JUNIOR MORTGAGE LOANS                                                                                                            
                                                                                                                                 
HAMPTON ...........................   Varies         -      Note receivable bearing interest at           $     -                
-------                                                     prime plus 1%.  Monthly payments of                                  
Secured by two office                                       interest only required.  Principal                                   
buildings in Milwaukee, WI                                  is due upon demand.  No prepayment                                   
                                                            penalty.                                                             
                                                                                                                                 
                                                                                                                                 
LINCOLN COURT APARTMENTS...........   Varies     06/2004    Two notes receivable bearing interest           1,395                
------------------------                                    at prime plus 1%.  Interest only pay-                                
Secured by apartment                                        ments due monthly until maturity, at                                 
building in                                                 which time all principal and unpaid                                  
Dallas, TX.                                                 interest are due.  No prepayment                                     
                                                            penalty.                                      -------                
                                                                                                            4,696                
                                                                                                                                 
SECURED BY OTHER THAN REAL ESTATE                                                                                                
CRIVELLO #2........................   Varies     On Demand  Note receivable bearing interest at                 -                
-----------                                                 prime. Monthly payment of interest                                   
Secured by a mortgage                                       only.                                                                
note secured by real                                                                                                             
property in Milwaukee, WI.                                                                                                       
                                                                                                                                 
DENOTO.............................   10.0%      11/97      Note receivable bearing interest at                 -                
------                                                      10%.  Monthly payments of principal                                  
Secured by a general busi-                                  and interest.  No prepayment penalty.                                
ness security agreement.                                                                                                         
                                                                                                                                 
DOUBLE FEATURE VIDEO...............   Varies     07/98      Three notes outstanding. Quarterly                  -                
--------------------                                        payments due based on gross sales.                                   
Secured by a general                                        Unpaid accruals compounded to principal.                             
business security                                                                                                                
agreement.                                                                                                                       
                                                                                                                                 
HOPPER.............................   12.5%      11/95      Principal and interest payments of $480             -                
------                                                      due monthly.  No prepayment penalty.                                 
Secured by a general                                                                                                             
business security agreement.                                                                              -------                
Total                                                                                                     $ 4,696                
                                                                                                          =======                
Interest...........................                                                                               

Unamortized discount...............                                                                               
                                                                                                                  
Allowance for estimated                                                                                           
  losses...........................                                                                               

                                                                                                                  

<CAPTION>                          
                                                                        Principal Amount of 
                                                       Carrying           Loans Subject to  
                                        Face Amount     Amounts         Delinquent Principal
Description                             of Mortgage  of Mortgage(1)         or Interest     
-----------                             ----------- --------------      --------------------
                                          (dollars in thousands)                      
<S>                                       <C>           <C>                  <C>            
JUNIOR MORTGAGE LOANS                                                                       
                                                                                            
HAMPTON ...........................       $    400      $     92             $    95 (2)    
-------                                                                                     
Secured by two office                                                                       
buildings in Milwaukee, WI                                                                  
                                                                                            
                                                                                            
                                                                                            
LINCOLN COURT APARTMENTS...........          1,369         1,369                   -        
------------------------                                                                    
Secured by apartment                                                                        
building in                                                                                 
Dallas, TX.                                                                                 
                                          --------      --------            --------               
                                            15,535         9,576               1,555        
                                                                                            
SECURED BY OTHER THAN REAL ESTATE                                                           
CRIVELLO #2........................            879           193                 193 (2)    
-----------                                                                                 
Secured by a mortgage                                                                       
note secured by real                                                                        
property in Milwaukee, WI.                                                                  
                                                                                            
DENOTO.............................              7             7                   -        
------                                                                                      
Secured by a general busi-                                                                  
ness security agreement.                                                                    
                                                                                            
DOUBLE FEATURE VIDEO................           645           181                 181 (2)    
--------------------                                                                        
Secured by a general                                                                        
business security                                                                           
agreement.                                                                                  
                                                                                            
HOPPER.............................             44            44                  44 (2)    
------                                                                                      
Secured by a general                                                                        
business security agreement.              --------      --------            --------     

Total                                     $ 17,110        10,001              $1,973        
                                          ========      --------            ========
Interest...........................                           47                            
Unamortized discount...............                         (516)                           
                                                        --------                            
                                                           9,532                            
Allowance for estimated                                                                     
  losses...........................                         (926)                           
                                                        --------                            
                                                        $  8,606                            
                                                        ========
</TABLE>                           
_____________________

(1) The aggregate cost for federal income tax purposes is $10.0 million.

(2) An allowance for loss has been provided to reduce the carryin value of this
    loan to the Company's estimate of fair value of the underlying collateral
    minus estimated costs of sale.





                                      66


<PAGE>   67
                                                                     SCHEDULE IV
                                                                     (Continued)

                    TRANSCONTINENTAL REALTY INVESTORS, INC.
                         MORTGAGE LOANS ON REAL ESTATE




<TABLE>
<CAPTION>
                                                        1996          1995          1994   
                                                      --------      --------       --------
                                                            (dollars in thousands)
<S>                                                   <C>          <C>            <C>     
Balance at January 1,..............................   $ 11,166      $ 18,418       $ 13,787
                                                                                    
                                                                                    
Additions                                                                           
 New mortgage loans and                                                             
    additional fundings on                                                          
    mortgage loans.................................        -             -            6,837
                                                                                    
 Deferred interest.................................        -               4              4
                                                                                    
                                                                                    
                                                                                    
Deductions                                                                          
 Collections of principal..........................       (885)       (2,739)        (1,713)
 Foreclosed properties and                                                          
    deeds-in-lieu of foreclosure                          (683)          -              -
                                                                                    
 Write off of uncollectible                                                         
    mortgage loan..................................        (63)         (181)          (497)
 Write off of principal against                                                     
    deferred gain due to pay off                                                    
    of mortgage loans at a                                                          
    discount.......................................        -          (4,244)           -
                                                                                    
 Write off of principal due to                                                      
    discount for early payoff......................        (50)          -              -
                                                                                    
 Transfer of mortgage loan to                                                       
    unsecured status...............................        -             (92)           -
                                                      --------      --------       --------
                                                                                    
                                                                                    
                                                                                    
Balance at December 31,............................   $  9,485      $ 11,166       $ 18,418
                                                      ========      ========       ========
</TABLE>





                                       67
<PAGE>   68

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
           FINANCIAL DISCLOSURE

Not applicable.

                     ___________________________________


                                    PART III


ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT

Directors

The affairs of Transcontinental Realty Investors, Inc. (the "Company" or the
"Registrant") are managed by a Board of Directors.  The Directors are elected
at the annual meeting of stockholders or appointed by the incumbent Board of
Directors and serve until the next annual meeting of stockholders or until a
successor has been elected or approved.

The Directors of the Company are listed below, together with their ages, terms
of service, all positions and offices with the Company or its advisor, Basic
Capital Management, Inc. ("BCM" or the "Advisor"), their principal occupations,
business experience and directorships with other companies during the last five
years or more.  The designation "Affiliated", when used below with respect to a
Director, means that the Director is an officer, director or employee of the
Advisor or an officer of the Company.  The designation "Independent", when used
below with respect to a Director, means that the Director is neither an officer
of the Company nor a director, officer or employee of the Advisor, although the
Company may have certain business or professional relationships with such
Director as discussed in ITEM 13.  "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS - Certain Business Relationships."

TED P. STOKELY:  Age 63, Director (Independent) (since April 1990) and Chairman
of the Board (since January 1995).

           General Manager (since January 1995) of ECF Senior Housing
           Corporation, a nonprofit corporation; General Manager (since January
           1993) of Housing Assistance Foundation, Inc., a nonprofit
           corporation; Part-time unpaid Consultant (since January 1993) and
           paid Consultant (April 1992 to December 1992) of Eldercare Housing
           Foundation ("Eldercare"), a nonprofit corporation engaged in the
           acquisition of low income and elderly housing; President (April 1992
           to April 1994) of PSA Group (real estate management and consulting);
           Executive Vice President (1987 to 1991) of Key Companies Inc., a
           publicly traded company that develops, acquires and sells water and
           minerals; Trustee (since April 1990) and Chairman of the Board
           (since January 1995) of Continental Mortgage and Equity Trust
           ("CMET"); Director (since April 1990) and Chairman of the Board
           (since January 1995) of Income Opportunity Realty Investors, Inc.
           ("IORI"); and Trustee (April 1990 to August 1994) of National Income
           Realty Trust ("NIRT").





                                       68
<PAGE>   69
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

Directors (Continued)

EDWARD L. TIXIER:  Age 67, Director (Independent) (since July 1996).

           Executive President (since 1996) of Tasa American Homes; Vice
           Chairman Planning and Zoning Commission (since 1996) of Dripping
           Springs, Texas; Director (since 1995) of Ryokachi Corporation, a
           Japanese company; Cattle Rancher (since 1988); President (1988 to
           1994) of Tixier, Inc., an Austin, Texas based corporation; Senior
           Executive Advisor (1988 to 1994) to the President of Regency
           International Trading Company, a Japanese company; Commander (1984
           to 1988) of U.S. Forces, Japan and Commander, 5th Air Force; Retired
           (1988) Lt. General, United States Air Force; Trustee (since July
           1996) of CMET; and Director (since July 1996) of IORI.

MARTIN L. WHITE:  Age 57, Director (Independent) (since January 1995).

           Chairman and Chief Executive Officer (since 1993) of North American
           Trading Company Ltd.; President and Chief Operating Officer (since
           1992) of Community Based Developers, Inc.; Development Officer and
           Loan Manager (1986 to 1992) of the City of San Jose, California;
           Vice President and Director of Programs (1967 to 1986) of Arpact,
           Inc., a government contractor for small business development and
           trade; Trustee (since January 1995) of CMET; and Director (since
           January 1995) of IORI.

EDWARD G. ZAMPA:  Age 62, Director (Independent) (since January 1995).

           General Partner (since 1976) of Edward G. Zampa and Company; and
           Trustee (since January 1995) of CMET; and Director (since January
           1995) of IORI.

Board Committees

The Company's Board of Directors held thirteen meetings during 1996.  For such
year, no incumbent Director attended fewer than 75% of the aggregate of (i) the
total number of meetings held by the Company's Board of Directors during the
period for which he had been a Director and (ii) the total number of meetings
held by all committees of the Board of Directors on which he served during the
period that he served.

The Company's Board of Directors has an Audit Committee, the function of which
is to review the Company's operating and accounting procedures.  The current
members of the Audit Committee, all of whom are Independent Directors, are
Messrs.  Stokely, Tixier and White. The Audit Committee met twice during 1996.

The Company's Board of Directors has a Relationship with Advisor Committee and
a Board Development Committee.  The current members of the Relationship with
Advisor Committee are Messrs. Stokely and Zampa.  The





                                       69
<PAGE>   70
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)


Board Committees (Continued)

Relationship with Advisor Committee reviews and reports to the Company's Board
of Directors on the services provided to the Company by the Advisor and its
affiliates and the terms of any engagement or compensation of the Advisor or
its affiliates.  The Relationship with Advisor Committee met twice in 1996.
The Board Development Committee reviews and reports to the Company's Board of
Directors on the membership, compensation and functions of the Board of
Directors.  The current member of the Board Development Committee is Mr. White.
The Board Development Committee met twice in 1996.

The Company's Board of Directors does not have Nominating or Compensation
Committees.

Executive Officers

The following persons currently serve as executive officers of the Company:
Randall M. Paulson, President; Bruce A.  Endendyk, Executive Vice President;
and Thomas A. Holland, Executive Vice President and Chief Financial Officer.
Their positions with the Company are not subject to a vote of stockholders.
Their ages, terms of service, all positions and offices with the Company or
BCM, other principal occupations, business experience and directorships with
other companies during the last five years or more are set forth below.

RANDALL M. PAULSON:  Age 50, President (since August 1995)and Executive Vice
President (January 1995 to August 1995).

           President (since August 1995) and Executive Vice President (January
           1995 to August 1995) of CMET, IORI and Syntek Asset Management, Inc.
           ("SAMI"), the managing general partner of Syntek Asset Management,
           L.P. ("SAMLP"), which is the general partner of National Realty,
           L.P. and National Operating, L.P. ("NOLP") and (October 1994 to
           August 1995) of BCM; Director (since August 1995) of SAMI; Executive
           Vice President (since January 1995) of American Realty Trust, Inc.
           ("ART"); Vice President (1993 to 1994) of GSSW, LP, a joint venture
           of Great Southern Life and Southwestern Life; Vice President (1990
           to 1993) of Property Company of America Realty, Inc.; President
           (1990) of Paulson Realty Group; President (1983 to 1989) of
           Johnstown Management Company; and Vice President (1979 to 1982) of
           Lexton-Ancira.





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       70
<PAGE>   71
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)


Executive Officers (Continued)

BRUCE A. ENDENDYK:  Age 48, Executive Vice President (since January 1995).

           President (since January 1995) of Carmel Realty, Inc. ("Carmel
           Realty"), a company owned by Syntek West, Inc. ("SWI"); Executive
           Vice President (since January 1995) of BCM, SAMI, ART, CMET and
           IORI; Management Consultant (November 1990 to December 1994);
           Executive Vice President (January 1989 to November 1990) of
           Southmark Corporation ("Southmark"); President and Chief Executive
           Officer (March 1988 to January 1989) of Southmark Equities
           Corporation; and Vice President/Resident Manager (December 1975 to
           March 1988) of Coldwell Banker Commercial/Real Estate Services in
           Houston, Texas.

THOMAS A. HOLLAND:  Age 54, Executive Vice President and Chief Financial
Officer (since August 1995); Secretary (since February 1997); and Senior Vice
President and Chief Accounting Officer (June 1990 to August 1995).

           Executive Vice President and Chief Financial Officer (since August
           1995) and Senior Vice President and Chief Accounting Officer (July
           1990 to August 1995) of BCM, SAMI, ART, CMET and IORI; Secretary
           (since February 1997) of CMET and IORI; Senior Vice President and
           Chief Accounting Officer (July 1990 to February 1994) of NIRT and
           Vinland Property Trust ("VPT"); Vice President and Controller
           (December 1986 to June 1990) of Southmark; Vice President-Finance
           (January 1986 to December 1986) of Diamond Shamrock Chemical
           Company; Assistant Controller (May 1976 to January 1986) of Maxus
           Energy Corporation (formerly Diamond Shamrock Corporation); Trustee
           (August 1989 to June 1990) of Arlington Realty Investors; and
           Certified Public Accountant (since 1970).

Officers

Although not executive officers of the Company, the following persons currently
serve as officers of the Company:  Mark W. Branigan, Senior Vice President -
Residential Asset Management; Lynn W. Humphries, Senior Vice President -
Commercial Asset Management; Robert A. Waldman, Senior Vice President and
General Counsel; and Drew D. Potera, Vice President and Treasurer.  Their
positions with the Company are not subject to a vote of stockholders.  Their
ages, terms of service, all positions and





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       71
<PAGE>   72
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

Officers (Continued)

offices with the Company or BCM, other principal occupations, business
experience and directorships with other companies during the last five years or
more are set forth below.

MARK W. BRANIGAN:  Age 42, Senior Vice President - Residential Asset Management
(since December 1996) and Vice President (February 1994 to December 1996).

           Senior Vice President - Residential Asset Management (since December
           1996) and Vice President (February 1994 to December 1996) of SAMI,
           ART, CMET and IORI; Executive Vice President (since May 1995) and
           Real Estate Analyst (January 1992 to May 1995) of BCM; Executive
           Vice President (1984 to 1991) of Byron Investments, Inc.; Director
           (May 1989 to August 1990) and Manager of Treasury Services (May 1981
           to 1983) of Southmark; and Director (1977 to April 1981) of Investor
           Relations for Syntek Corp.


LYNN W. HUMPHRIES: Age 46, Senior Vice President - Commercial Asset Management
(since May 1996).

           Senior Vice President - Commercial Asset Management (since May 1996)
           of BCM, ART, IORI, TCI and SAMI; Vice President (January 1994 to May
           1996) of the Amend Group; Vice President (1980 to 1993) of Equitable
           Real Estate Investment Management, Inc.; and Senior Vice President
           (1975 to 1980) of Sanders Campbell & Company.


ROBERT A. WALDMAN:  Age 44, Senior Vice President and General Counsel (since
January 1995), Vice President (December 1990 to January 1995) and Secretary
(December 1993 to February 1997).

           Senior Vice President and General Counsel (since January 1995), Vice
           President (December 1990 to January 1995) and Secretary (December
           1993 to February 1997) of CMET and IORI; Senior Vice President and
           General Counsel (since January 1995), Vice President (January 1993
           to January 1995) and Secretary (since December 1989) of ART; Senior
           Vice President and General Counsel (since November 1994), Vice
           President and Corporate Counsel (November 1989 to November 1994),
           and Secretary (since November 1989) of BCM; Senior Vice President
           and General Counsel (since January 1995), Vice President (April 1990
           to January 1995) and Secretary (since December 1990) of SAMI; Vice
           President (December 1990 to February 1994) and Secretary (December
           1993 to February 1994) of NIRT and VPT; and Director (February 1987
           to October 1989) and General Counsel and Secretary (1985 to October
           1989) of Red Eagle Resources Corporation (oil and gas).





                                       72
<PAGE>   73
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

Officers (Continued)

DREW D. POTERA:  Age 37, Vice President (since December 1996) and Treasurer
(since December 1990).

           Vice President (since December 1996) and Treasurer (since December
           1990) of CMET and IORI; Treasurer (since August 1991) and Assistant
           Treasurer (December 1990 to August 1991) of ART; Vice President,
           Treasurer and Securities Manager (since July 1990) of BCM; Vice
           President and Treasurer (since February 1992) of SAMI; Treasurer
           (December 1990 to February 1994) of NIRT and VPT; and Financial
           Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated
           (June 1985 to June 1990).

In addition to the foregoing officers, the Company has several vice presidents
and assistant secretaries who are not listed herein.

Compliance with Section 16(a) of the Securities Exchange Act of 1934

Under the securities laws of the United States, the Company's Directors,
executive officers, and any persons holding more than ten percent of the
Company's shares of Common Stock are required to report their ownership of the
Company's shares and any changes in that ownership to the Securities and
Exchange Commission (the "Commission").  Specific due dates for these reports
have been established and the Company is required to report any failure to file
by these dates during 1996.  All of these filing requirements were satisfied by
the Company's Directors and executive officers and ten percent holders.  In
making these statements, the Company has relied on the written representations
of its incumbent Directors and executive officers and its ten percent holders
and copies of the reports that they have filed with the Commission.

The Advisor

Although the Company's Board of Directors is directly responsible for managing
the affairs of the Company and for setting the policies which guide it, the
day-to-day operations of the Company are performed by a contractual advisor
under the supervision of the Company's Board of Directors.  The duties of the
advisor include, among other things, locating, investigating, evaluating and
recommending real estate and mortgage note investment and sales opportunities
as well as financing and refinancing sources to the Company.  The advisor also
serves as a consultant to the Company's Board of Directors in connection with
the business plan for the Company and investment policy decisions.

BCM has served as the Company's advisor since March 1989.  BCM is a corporation
of which Messrs. Paulson, Endendyk and Holland serve as executive officers.
BCM is a company owned by a trust for the benefit of the children of Gene E.
Phillips.  Mr. Phillips served as a director of BCM until December 22, 1989,
and  as Chief Executive Officer of BCM until September 1, 1992.  Mr. Phillips
serves as a representative of his





                                       73
<PAGE>   74
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

The Advisor (Continued)

children's trust which owns BCM and, in such capacity, has substantial contact
with the management of BCM and input with respect to its performance of
advisory services to the Company.

At the Company's annual meeting of stockholders held on May 31, 1996, the
Company's stockholders approved the renewal of the Company's Advisory Agreement
with BCM through the next annual meeting of the Company's stockholders.
Subsequent renewals of the Advisory Agreement with BCM do not require the
approval of the Company's stockholders but do require the approval of the
Company's Board of Directors.

Under the Advisory Agreement, the Advisor is required to formulate and submit
annually for approval by the Company's Board of Directors a budget and business
plan for the Company containing a twelve-month forecast of operations and cash
flow, a general plan for asset sales or acquisitions, lending, foreclosure and
borrowing activity, and other investments, and the Advisor is required to
report quarterly to the Company's Board of Directors on the Company's
performance against the business plan.  In addition, all transactions or
investments by the Company shall require prior approval by the Company's Board
of Directors unless they are explicitly provided for in the approved business
plan or are made pursuant to authority expressly delegated to the Advisor by
the Company's Board of Directors.

The Advisory Agreement also requires prior approval of the Company's Board of
Directors for the retention of all consultants and third party professionals,
other than legal counsel.  The Advisory Agreement provides that the Advisor
shall be deemed to be in a fiduciary relationship to the Company's
stockholders; contains a broad standard governing the Advisor's liability for
losses by the Company; and contains guidelines for the Advisor's allocation of
investment opportunities as among itself, the Company and other entities it
advises.

The Advisory Agreement provides for BCM to be responsible for the day-to-day
operations of the Company and to receive an advisory fee comprised of a gross
asset fee of .0625% per  month (.75% per annum) of the average of the gross
asset value of the Company (total assets less allowance for amortization,
depreciation or depletion and valuation reserves) and an annual net income fee
equal to 7.5% per annum of the Company's net income.

The Advisory Agreement also provides for BCM to receive an annual incentive
sales fee equal to 10% of the amount, if any, by which the aggregate sales
consideration for all real estate sold by the Company during such fiscal year
exceeds the sum of:  (i) the cost of each such property as originally recorded
in the Company's books for tax purposes (without deduction for depreciation,
amortization or reserve for losses), (ii) capital improvements made to such
assets during the period owned by the Company, and (iii) all closing costs,
(including real





                                       74
<PAGE>   75
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

The Advisor (Continued)

estate commissions) incurred in the sale of such real estate; provided,
however, no incentive fee shall be paid unless (a) such real estate sold in
such fiscal year, in the aggregate, has produced an 8% simple annual return on
the Company's net investment including capital improvements, calculated over
the Company's holding period before depreciation and inclusive of operating
income and sales consideration and (b) the aggregate net operating income from
all real estate owned by the Company for each of the prior and current fiscal
years shall be at least 5% higher in the current fiscal year than in the prior
fiscal year.

Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is
to receive an acquisition commission for supervising the acquisition, purchase
or long-term lease of real estate for the Company equal to the lesser of (i) up
to 1% of the cost of acquisition, inclusive of commissions, if any, paid to
nonaffiliated brokers or (ii) the compensation customarily charged in
arm's-length transactions by others rendering similar property acquisition
services as an ongoing public activity in the same geographical location and
for comparable property, provided that the aggregate purchase price of each
property (including acquisition fees and real estate brokerage commissions) may
not exceed such property's appraised value at acquisition.

The Advisory Agreement requires BCM or any affiliate of BCM to pay to the
Company, one-half of any compensation received from third parties with respect
to the origination, placement or brokerage of any loan made by the Company;
provided, however, that the compensation retained by BCM or any affiliate of
BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed
by the Company or (ii) a loan brokerage and commitment fee which is reasonable
and fair under the circumstances.

The Advisory Agreement also provides that BCM or an affiliate of BCM is to
receive a mortgage or loan acquisition fee with respect to the acquisition or
purchase of any existing mortgage loan by the Company equal to the lesser of
(i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment
fee which is reasonable and fair under  the circumstances.  Such fee will not
be paid in connection with the origination or funding by the Company of any
mortgage loan.

Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive a
mortgage brokerage and equity refinancing fee for obtaining loans to the
Company or refinancing on Company properties equal to the lesser of (i) 1% of
the amount of the loan or the amount refinanced or (ii) a brokerage or
refinancing fee which is reasonable and fair under the circumstances; provided,
however, that no such fee shall be paid on loans from BCM or an affiliate of
BCM without the approval of the Company's Board of Directors.  No fee shall be
paid on loan extensions.  

Under the Advisory Agreement, BCM is to receive reimbursement of certain 
expenses incurred by it in the performance of advisory services to the Company.





                                       75
<PAGE>   76
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT 
           (Continued)

The Advisor (Continued)

Under the Advisory Agreement, all or a portion of the annual advisory fee must
be refunded by the Advisor to the Company if the Operating Expenses of the
Company (as defined in the Advisory Agreement) exceed certain limits specified
in the Advisory Agreement based on the book value, net asset value and net
income of the Company during such fiscal  year.  The effect of the limitation
was to require that BCM refund $87,000 of the annual advisory fee for 1996.

Additionally, if the Company were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM will be separately compensated for such additional services on
terms to be agreed upon from time to time.  As discussed below, under "Property
Management", the Company has hired Carmel Realty Services, Ltd. ("Carmel,
Ltd."), an affiliate of BCM, to provide property management services for the
Company's properties.  Also as discussed below, under "Real Estate Brokerage"
the Company has engaged, on a non-exclusive basis, Carmel Realty, also an
affiliate of BCM, to perform brokerage services for the Company.

BCM may only assign the Advisory Agreement with the prior consent of the
Company.

The directors and principal officers of BCM are set forth below.

<TABLE>
<S>                                   <C>
MICKEY N. PHILLIPS:                   Director

RYAN T. PHILLIPS:                     Director

RANDALL M. PAULSON:                   President

MARK W. BRANIGAN:                     Executive Vice President - Residential Asset
                                      Management

BRUCE A. ENDENDYK:                    Executive Vice President

THOMAS A. HOLLAND:                    Executive Vice President and Chief Financial
                                      Officer

COOPER B. STUART:                     Executive Vice President

CLIFFORD C. TOWNS, JR.:               Executive Vice President - Finance

LYNN W. HUMPHRIES:                    Senior Vice President - Commercial Asset
                                      Management

DAN S. ALLRED                         Senior Vice President - Land Development

ROBERT A. WALDMAN:                    Senior Vice President, Secretary and General
                                      Counsel

DREW D. POTERA:                       Vice President, Treasurer and Securities
                                      Manager
</TABLE>





                                       76
<PAGE>   77
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
           (Continued)

The Advisor (Continued)

Mickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E.
Phillips' son.  Gene E. Phillips serves as a representative of the trust
established for the benefit of his children which owns BCM and, in such
capacity, has substantial contact with the management of BCM and input with
respect to BCM's performance of advisory services to the Company.

Property Management

Since February 1, 1990, affiliates of BCM have provided  property management
services to the Company.  Currently, Carmel, Ltd. provides such property
management services for a fee of 5% or less of the monthly gross rents
collected on the properties under its management.  Carmel, Ltd. subcontracts
with other entities for the provision of the property-level management
services to the Company at various rates.  The general partner of Carmel, Ltd.
is BCM.  The limited partners of Carmel, Ltd. are (i) SWI, of which Mr.
Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the
benefit of the children of Mr. Phillips.  Carmel, Ltd. subcontracts the
property-level management and leasing of 28 of the Company's commercial
properties and its hotel and the commercial properties owned by a real estate
partnership in which the Company and IORI are partners to Carmel Realty, which
is a company owned by SWI.  Carmel Realty is entitled to receive property and
construction management fees and leasing commissions in accordance with the
terms of its property-level management agreement with Carmel, Ltd.

Real Estate Brokerage

Since December 1, 1992, Carmel Realty has been engaged, on a non-exclusive
basis, to provide brokerage services for the Company.  Carmel Realty is
entitled to receive a real estate commission for property acquisitions and
sales by the Company in accordance with the following sliding scale of total
fees to be paid by the Company:  (i) maximum fee of 5% on the first $2.0
million of any purchase or sale transaction of which no more than 4% would be
paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction
amounts between $2.0 million - $5.0 million of which no more than 3% would be
paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction
amounts between $5.0 million - $10.0 million of which no more than 2% would be
paid to Carmel Realty or affiliates; and (iv) maximum fee of 2% on transaction
amounts in excess of $10.0 million of which no more than 1.5% would be paid to
Carmel Realty or affiliates.

ITEM 11.   EXECUTIVE COMPENSATION

The Company has no employees, payroll or benefit plans and pays no compensation
to the executive officers of the Company.  The executive officers of the
Company, who are also officers or employees of BCM, the Company's Advisor, are
compensated by the Advisor.  Such executive officers of the Company perform a
variety of services for the Advisor and the amount of their compensation is
determined solely by the





                                       77
<PAGE>   78
ITEM 11.   EXECUTIVE COMPENSATION (Continued)


Advisor.  BCM does not allocate the cash compensation of its officers among the
various entities for which it serves as advisor.  See ITEM 10. "DIRECTORS,
EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor" for a more
detailed discussion of the compensation payable to BCM by the Company.

The only remuneration paid by the Company is to the Directors who are not
officers or directors of BCM or its affiliated companies.  The Independent
Directors (i) review the investment policies of the Company to determine that
they are in the best interest of the Company's stockholders, (ii) review the
Company's contract with the advisor, (iii) supervise the performance of the
Company's advisor and review the reasonableness of the compensation which the
Company pays to its advisor in terms of the nature and quality of services
performed, (iv) review the reasonableness of the total fees and expenses of the
Company and (v) select, when necessary, a qualified independent real estate
appraiser to appraise properties purchased by the Company.

Each Independent Director receives compensation in the amount of $15,000 per
year, plus reimbursement for expenses and the Chairman of the Board receives an
additional $1,500 per year for serving in such position.  In addition, each
Independent Director receives an additional fee of $1,000 per day for any
special services rendered by him to the Company outside of his ordinary duties
as Director, plus reimbursement of expenses.

During 1996, $128,170 was paid to the Independent Directors in total Directors'
fees for all services, including the annual fee for service during the period
January 1, 1996 through December 31, 1996, and 1996 special service fees as
follows:  Geoffrey C. Etnire, $20,833 John P. Parsons, $23,362; Bennett B.
Sims, $19,917; Ted P. Stokely, $18,167; Edward L. Tixier, $8,167; Martin L.
White, $21,057; and Edward G. Zampa, $16,667.





                     [THIS SPACE INTENTIONALLY LEFT BLANK.]





                                       78
<PAGE>   79
ITEM 11.   EXECUTIVE COMPENSATION (Continued)

Performance Graph

The following performance graph compares the cumulative total stockholder
return on the Company's shares of Common Stock with the Standard & Poor's 500
Stock Index ("S&P 500 Index") and the National Association of Real Estate
Investment Trusts, Inc.  Hybrid REIT Total Return Index ("REIT Index").  The
comparison assumes that $100 was invested on December 31, 1991 in the Company's
shares of Common Stock and in each of the indices and further assumes the
reinvestment of all dividends.  Past performance is not necessarily an
indicator of future performance.


                                    [CHART]




<TABLE>
<CAPTION>
                                  1991           1992            1993        . .  1994            1995           1996
  <S>                                  <C>             <C>             <C>              <C>            <C>           <C>
  THE COMPANY                          100             120             240              264            268           270

  S&P 500 INDEX                        100             108             118              120            165           203

  REIT INDEX                           100             117             141              147            181           234
</TABLE>





                                       79
<PAGE>   80
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Security Ownership of Certain Beneficial Owners.  The following table sets
forth the ownership of the Company's Common Stock, both beneficially and of
record, both individually and in the aggregate, for those persons or entities
known by the Company to be beneficial owners  of more than 5% of its shares of
Common Stock as of the close of business on March 7, 1997.
<TABLE>
<CAPTION>
                                                       Amount and Nature
    Name and Address of                                  of Beneficial         Percent of
     Beneficial Owner                                      Ownership            Class (1)
---------------------------                            -----------------       ----------
<S>                                                            <C>             <C>
American Realty Trust, Inc.                                    1,193,767       30.4%
10670 N. Central Expressway
Suite 300
Dallas, Texas 75231

Basic Capital Management, Inc.                                   406,212       10.3%
10670 N. Central Expressway
Suite 300
Dallas, Texas 75231
</TABLE>
___________________________

(1)   Percentage is based upon 3,926,445 shares of Common Stock outstanding at
      March 7, 1997.

Security Ownership of Management.  The following table sets forth the ownership
of the Company's Common Stock, both beneficially and of record, both
individually and in the aggregate, for the Directors and executive officers of
the Company as of the close of business on March 7, 1996.
<TABLE>
<CAPTION>
                                                         Amount and Nature
                                                           of Beneficial                          Percent of
 Name of Beneficial Owner                                   Ownership                              Class (1)
--------------------------                             -------------------                        ----------
<S>                                                            <C>         <C>                          <C>
All Directors and Executive                                    1,705,954   (2)(3)                       43.4%
Officers as a group
(7 individuals)
</TABLE>
___________________________

(1)   Percentage is based upon 3,926,445 shares of Common Stock outstanding at
      March 7, 1997.

(2)   Includes 79,500 shares owned by CMET of which the Company's Directors may
      be deemed to be beneficial owners by virtue of their positions as
      trustees of CMET.  The Directors of the Company disclaim beneficial
      ownership of such shares.

(3)   Includes 26,475 shares owned by SAMLP, 406,212 shares owned by BCM and
      1,193,767 shares owned by ART, of which the executive officers of the
      Company may be deemed to be beneficial owners by virtue of their
      positions as executive officers or directors of SAMI, BCM and ART.  The
      executive officers of the Company disclaim beneficial ownership of such
      shares.  Each of the directors of ART may be deemed to be beneficial
      owners of the shares owned by ART by virtue of their positions as
      directors of ART.  Each of the





                                       80
<PAGE>   81
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
              (Continued)

           directors of BCM may be deemed to be beneficial owners by virtue of
           their positions as directors of BCM.  The directors of ART and BCM
           disclaim such beneficial ownership.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Certain Business Relationships

In February 1989, the Company's Board of Directors voted to retain BCM as the
Company's advisor.  See ITEM 10.  "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO
THE REGISTRANT - The Advisor."  BCM is a corporation of which Messrs.  Paulson,
Endendyk and Holland serve as executive officers.  Gene E. Phillips served as a
director of BCM until December 22, 1989 and as Chief Executive Officer of BCM
until September 1, 1992.  BCM is owned by a trust for the benefit of the
children of Mr. Phillips.   Mr. Phillips serves as a representative of his
children's trust which owns BCM and, in such capacity, has substantial contact
with the management of BCM and input with respect to BCM's performance of
advisory services to the Company.

Since February 1990, affiliates of BCM have provided property management
services to the Company.  Currently, Carmel, Ltd. provides such property
management services.  The general partner of Carmel, Ltd. is BCM.  The limited
partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole
shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the
children of Mr. Phillips.  Carmel, Ltd. subcontracts the property-level
management and leasing of 28 of the Company's commercial properties and its
hotel and the commercial properties owned by a real estate partnership in which
the Company and IORI are partners to Carmel Realty, which is a company owned by
SWI.

Prior to December 1, 1992, affiliates of BCM provided brokerage services to the
Company and received brokerage commissions in accordance with the advisory
agreement.  Since December 1, 1992, the Company has engaged, on a non-
exclusive basis, Carmel Realty to perform brokerage services for the Company.
Carmel Realty is a company owned by SWI.

The Directors and officers of the Company also serve as trustees or directors
and officers of CMET and IORI.  The Directors owe fiduciary duties to such
entities as well as to the Company under applicable law.  CMET and IORI have
the same relationship with BCM as the Company.  The Company owned approximately
22.5% of the outstanding shares of common stock of IORI at December 31, 1996.
Gene E. Phillips is a general partner of SAMLP, the general partner of NRLP and
NOLP.  BCM performs certain administrative functions for NRLP and NOLP on a
cost-reimbursement basis.  BCM also serves as advisor to ART.  Mr. Phillips
served as Chairman of the Board and director of ART until November 16, 1992.
Messrs.  Paulson, Endendyk and Holland serve as executive officers of ART.

From April 1992 to December 31, 1992, Mr. Stokely was employed as a paid
Consultant and since January 1, 1993 as a part-time unpaid Consultant for
Eldercare, a nonprofit corporation engaged in the acquisition of low





                                       81
<PAGE>   82
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Certain Business Relationships (Continued)

income and elderly housing.  Eldercare has a revolving loan commitment  from
SWI, of which Mr. Phillips is the sole shareholder.  Eldercare filed for
bankruptcy protection in July 1993, and was dismissed from bankruptcy in
October 1994.  Eldercare filed again for bankruptcy protection in May 1995, and
was dismissed from bankruptcy in February 1996.

Related Party Transactions

Historically, the Company has engaged in and may continue to engage in business
transactions, including real estate partnerships, with related parties.  The
Company's management believes that all of the related party transactions
represented the best investments available at the time and were at least as
advantageous to the Company as could have been obtained from unrelated third
parties.

As more fully described in ITEM 2. "PROPERTIES - Real Estate," the Company is a
partner with IORI in the Tri-City Limited Partnership and Nakash Income
Associates.  The Company owns 341,500 shares of the common stock of IORI, an
approximate 22.5% interest.

In 1996, the Company paid BCM and its affiliates $1.8 million in advisory fees,
$136,000 in mortgage brokerage and equity refinancing fees, $339,000 in
property acquisition fees, $283,000 in real estate brokerage commissions and
$1.9 million in property and construction management fees and leasing
commissions, net of property management fees paid to subcontractors, other than
Carmel Realty.  In addition, as provided in the Advisory Agreement, BCM
received cost reimbursements from the Company of $1.0 million in 1996.

Restrictions on Related Party Transactions

Article FOURTEENTH of the Company's Articles of Incorporation provides that the
Company shall not, directly or indirectly, contract or engage in any
transaction with (i) any director, officer or employee of the Company, (ii) any
director, officer or employee of the advisor, (iii) the advisor or (iv) any
affiliate or associate (as such terms are defined in Rule 12b-2 under the
Securities Exchange Act of 1934, as amended) of any of the aforementioned
persons, unless (a) the material facts as to the relationship among or
financial interest of the relevant individuals or persons and as to the
contract or transaction are disclosed to or are known by the Board of Directors
or the appropriate committee thereof and (b) the Board of Directors or
committee thereof determines that such contract or transaction is fair to the
Company and simultaneously authorizes or ratifies such contract or transaction
by the affirmative vote of a majority of independent directors of the Company
entitled to vote thereon.

Article FOURTEENTH defines an "Independent Director" as one who is neither an
officer or employee of the Company nor a director, officer or employee of the
Company's advisor.





                                       82
<PAGE>   83
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)

Restrictions on Related Party Transactions (Continued)

Pursuant to the terms of the Modification of Stipulation of Settlement (the
"Modification") in the Olive Litigation, as more fully discussed in ITEM 3.
"LEGAL PROCEEDINGS - Olive Litigation," which became effective on January 11,
1995, certain related party transactions which the Company may enter into
prior to April 28, 1999, require the unanimous approval of the Company's Board
of Directors.  In addition, such related party transactions are to be
discouraged and may only be entered into in exceptional circumstances and after
a determination by the Company's Board of Directors that the transaction is in
the best interests of the Company and that no other opportunity exists that is
as good as the opportunity presented by such transaction.

The Modification requirements for related party transactions do not apply to
direct contractual agreements for services between the Company and the Advisor
or one of its affiliates (including the Advisory Agreement, the Brokerage
Agreement and the property management contracts).  These agreements, pursuant
to the specific terms of the Modification, require the prior approval by
two-thirds of the Directors of the Company, and if required, approval by a
majority of the Company's stockholders.  The Modification requirements for
related party transactions also do not apply to joint ventures between or among
the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries
and a third party having no prior or intended future business or financial
relationship with Mr. Phillips, William S. Friedman, the Advisor, or any
affiliate of such parties.  Such joint ventures may be entered into on the
affirmative vote of a majority of the Directors of the Company.


ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
                 FORM 8-K

(a) The following documents are filed as part of this Report:

1.  Consolidated Financial Statements

Report of Independent Certified Public Accountants

Consolidated Balance Sheets -
    December 31, 1996 and 1995

Consolidated Statements of Operations -
    Years Ended December 31, 1996, 1995 and 1994

Consolidated Statements of Stockholders' Equity -
    Years Ended December 31, 1996, 1995 and 1994

Consolidated Statements of Cash Flows -
    Years Ended December 31, 1996, 1995 and 1994

Notes to Consolidated Financial Statements





                                       83
<PAGE>   84
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
                 FORM 8-K (Continued)

2. Financial Statement Schedules

Schedule III -         Real Estate and Accumulated Depreciation

Schedule IV  -         Mortgage Loans on Real Estate

All other schedules are omitted because they are not applicable or because the
required information is shown in the Consolidated Financial Statements or the
Notes thereto.

3.  Incorporated Financial Statements

Consolidated Financial Statements of Income Opportunity Realty  Investors, Inc.
(Incorporated by reference to Item 8 of Income Opportunity Realty Investors,
Inc.'s Annual Report on Form 10-K for the year ended December 31, 1995).

4.  Exhibits

The following documents are filed as Exhibits to this Report:

<TABLE>
<CAPTION>
Exhibit
Number                                    Description                      
-------           ---------------------------------------------------------
<S>               <C>
 3.0              Articles of Incorporation of Transcontinental Realty Investors, Inc., as filed on December 20, 1991
                  (incorporated by reference to Exhibit No. 3.1 to the Registrant's Annual Report on Form 10-K for the
                  year ended December 31, 1991).

 3.1              Certificate of Amendment to the Articles of Incorporation of Transcontinental Realty Investors, Inc.,
                  as filed on June 3, 1996 (incorporated by reference to the Registrant's Current Report on Form 8-K,
                  dated June 3, 1996).

 3.2              By-Laws of Transcontinental Realty Investors, Inc. (incorporated by reference to Exhibit No. 3.2 to
                  the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991).

10.0              Advisory Agreement dated as of March 7, 1995, between Transcontinental Realty Investors, Inc. and
                  Basic Capital Management, Inc. (incorporated by reference to Exhibit 10.2 to the Registrant's Annual
                  Report on Form 10-K for the year ended December 31, 1994).

27.0              Financial Data Schedule, filed herewith.
</TABLE>


(b)               Reports on Form 8-K:

                  None.





                                       84
<PAGE>   85
                                   SIGNATURES


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

                                           TRANSCONTINENTAL REALTY
                                           INVESTORS, INC.
                                        
                                        
                                        
                                        
Dated:     March 26, 1997                  By: /s/ Randall M. Paulson     
       --------------------------              ------------------------------
                                               Randall M. Paulson
                                               President


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.






By: /s/ Ted P. Stokely                     By: /s/ Martin L. White       
    ------------------------------             ------------------------------
    Ted P. Stokely                             Martin L. White
    Chairman of the Board                      Director
    and Director




By: /s/ Edward L. Tixier                   By: /s/ Edward G. Zampa       
    ------------------------------             ------------------------------
    Edward L. Tixier                           Edward G. Zampa
    Director                                   Director





By: /s/ Thomas A. Holland      
    ------------------------------
    Thomas A. Holland
    Executive Vice President and
    Chief Financial Officer
    (Principal Financial and
    Accounting Officer)





Dated: March 26, 1997        
       ---------------------------





                                       85
<PAGE>   86
                    TRANSCONTINENTAL REALTY INVESTORS, INC.

                                  EXHIBITS TO
                           ANNUAL REPORT ON FORM 10-K

                      For the Year Ended December 31, 1996





<TABLE>
<CAPTION>
Exhibit
Number                            Description                                                      Page 
-------                        -----------------                                                  ------
<S>               <C>
27.0              Financial Data Schedule.
</TABLE>





                                       86