<PAGE>
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
                                  
                               FORM 10-K/A     
 
[X] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
 
                     For the Year Ended December 31, 1998
 
                         Commission File Number 1-9240
 
                               ----------------
 
                    Transcontinental Realty Investors, Inc.
            (Exact Name of Registrant as Specified in Its Charter)
 
                Nevada                               94-6565852
                                        (I.R.S. Employer Identification No.)
    (State or Other Jurisdiction of
     ncorporation or Organization)
 
 10670 North Central Expressway, Suite
          300, Dallas, Texas                           75231
    (Address of Principal Executive                  (Zip Code)
               Offices)
 
                                (214) 692-4700
             (Registrant's Telephone Number, Including Area Code)
 
          Securities Registered Pursuant to Section 12(b) of the Act:
 
<TABLE>
<S>                                            <C>
             Title of each class                 Name of each exchange on 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 5, 1999, the Registrant had 3,878,463 shares of Common Stock
outstanding. Of the total shares outstanding 2,144,193 were held by other than
those who may be deemed to be affiliates, for an aggregate value of
$27,472,000 based on the last trade as reported on the New York Stock Exchange
on March 5, 1999. 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. 1-14784
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>
 
                                    INDEX TO
                           ANNUAL REPORT ON FORM 10-K
 
<TABLE>   
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
                                 PART I
 
Item 1. Business.........................................................    3
 
Item 2. Properties.......................................................    6
 
Item 3. Legal Proceedings................................................   18
 
Item 4. Submission of Matters to a Vote of Security Holders..............   18
 
                                 PART II
 
Item 5. Market for Registrant's Common Equity and Related Stockholder
 Matters.................................................................   19
 
Item 6. Selected Financial Data..........................................   20
 
Item 7. Management's Discussion and Analysis of Financial Condition and
 Results of Operations...................................................   20
 
Item 7A. Quantitative and Qualitative Disclosures Regarding Market Risk..   27
 
Item 8. Financial Statements and Supplementary Data......................   28
 
Item 9. Changes in and Disagreements with Accountants on Accounting and
 Financial Disclosure....................................................   58
 
                                PART III
 
Item 10. Directors, Executive Officers and Advisor of the Registrant.....   58
 
Item 11. Executive Compensation..........................................   65
 
Item 12. Security Ownership of Certain Beneficial Owners and Management..   67
 
Item 13. Certain Relationships and Related Transactions..................   68
 
                                 PART IV
 
Item 14. Exhibits, Consolidated Financial Statements, Schedules and
 Reports on Form 8-K.....................................................   70
 
Signature Page...........................................................   72
</TABLE>    
<PAGE>
 
                                    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 management,
qualified for federal taxation as a REIT for each year subsequent to
December 31, 1983.
 
  The Company's real estate at December 31, 1998 consisted of 77 properties
held for investment, four partnership properties and four properties held for
sale which were primarily obtained through foreclosure. 22 of the properties
held for investment were purchased during 1998. The Company's mortgage notes
receivable portfolio at December 31, 1998 consisted of 16 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."
 
Proposed Merger with Continental Mortgage and Equity Trust
 
  On September 25, 1998, the Company and Continental Mortgage and Equity Trust
("CMET") jointly announced the agreement of their respective Boards for the
Company to acquire CMET. Under the proposal, the Company would acquire all of
CMET's outstanding shares of beneficial interest, in a tax free exchange, for
shares of its Common Stock. The Company will issue 1.181 shares of its Common
Stock for each outstanding share of beneficial interest of CMET. Upon the
exchange of shares CMET would merge into the Company. The share exchange and
merger are subject to a vote of shareholders of both entities. Approval
requires the vote of shareholders holding a majority of CMET's outstanding
shares of beneficial interest. As of March 5, 1999, the Company's advisor and
its affiliates held shares representing approximately 57.4% of the outstanding
shares of CMET and approximately 44.7% of the outstanding shares of the
Company. A date for the special meeting of the shareholders to vote on the
merger proposal has not been set. The Company has the same Board and advisor
as CMET.
 
Business Plan and Investment Policy
 
  The Company's business is investing in real estate through direct equity
ownership and 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
continue to pursue a balanced investment policy, seeking both current income
and capital appreciation. With respect to new real estate 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, it will focus on
apartments, primarily located in the Southeast and Southwest regions of the
United States. In making any new real estate investments, emphasis will be on
acquiring properties generating current cash flow. The Company expects to
continue to invest in and improve these assets to maximize both their
immediate and longer term value.
 
  The Company expects to consider property sales opportunities for properties
in stabilized real estate markets where its properties have reached their
potential. It may also be an opportunistic seller of properties in markets
that have become overheated, i.e. an abundance of buyers.
 
                                       3
<PAGE>
 
  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 operating expenses,
management believes that such expenditures are necessary to maintain or
enhance the value of the properties.
 
  The Company has determined that in 1999 it may seek to fund or acquire new
mortgage loans to take advantage of favorable interest rate spreads or profit
participation opportunities. It may also originate mortgage loans in
conjunction with providing purchase money financing of a property sale. The
Company intends to service and hold for investment the mortgage notes in its
portfolio. It may, however, borrow against its mortgage notes using the
proceeds from such borrowings to fund additional mortgage loans or for general
working capital needs. The Company also intends to pursue its rights
vigorously with respect to mortgage notes that are in default. The Articles of
Incorporation impose no limitations on the Company's investment policy with
respect to mortgage loans and do not prohibit it from investing more than a
specified percentage of its assets in any one mortgage loan.
 
Management of the Company
 
  Although the 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 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. The Advisor also serves as a consultant in connection with the
Company's business plan and investment decisions made by the 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 Trustee of the Company's predecessor
business trust and 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 was approved by stockholders at
their annual meeting held on May 8, 1997. BCM also serves as advisor to 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. BCM also serves as advisor to
American Realty Trust, Inc. ("ART"). Randall M. Paulson, President of the
Company, also serves as President of BCM, CMET and IORI, and as Executive Vice
President of ART. NRLP Management Corp. ("NMC"), a wholly-owned subsidiary of
ART, is 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. The officers of the Company are also officers of ART and NMC. As of
March 5, 1999, the Company owned approximately 22.7% of IORI's outstanding
shares of common stock and ART owned approximately 31.1% of the outstanding
shares of the Company's 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 property-level management services to
the Company. The general partner of Carmel, Ltd. is BCM. The limited partners
of Carmel, Ltd. are (1) First Equity Properties, Inc. ("First Equity"), which
is 50% owned by a subsidiary of BCM, (2) Gene E. Phillips and (3) a trust for
the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the
property-level management and leasing of
 
                                       4
<PAGE>
 
29 of the Company's commercial properties, its four hotels 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 First Equity. 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 have greater
financial resources than those of the Company. 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.
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
well as by aggressive buyers attempting to penetrate or dominate a particular
market.
 
  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
it in purchasing, selling, leasing and financing of real estate and real
estate related investments. In resolving any potential conflicts of interest
which may arise, the Advisor has informed management 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.
 
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
 
                                       5
<PAGE>
 
limited to, changes in general or local economic conditions, changes in
interest rates and the availability of permanent mortgage financing which may
render the purchase, 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 management or the Advisor. The
illiquidity of real estate investments may also impair the ability of
management to respond promptly to changing circumstances. 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 or
mortgage lending is concentrated in any particular region or property type,
the advantages of 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 management, the
offices are suitable and adequate for the Company's present operations.
 
  Details of the Company's real estate and mortgage notes receivable
portfolios at December 31, 1998, 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 real estate and mortgage notes receivable
portfolios.
 
  The Company's real estate portfolio consists of properties held for
investment, properties held for sale, primarily obtained through foreclosure
of the collateral securing mortgage notes receivable and investments in
partnerships. 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 properties held for
investment, properties held for sale and its investment in partnerships.
 
  At December 31, 1998, none of the Company's properties, mortgage notes
receivable or investment in a partnership exceeded 10% or more of the
Company's total assets. At December 31, 1998, 91% of the Company's assets
consisted of properties held for investment, less than 1% consisted of
properties held for sale, less than 1% consisted of mortgage notes and
interest receivable and 1% consisted of investments in partnerships. The
remaining 7% of the Company's assets at December 31, 1998 were invested in
cash, cash equivalents and other assets. The percentage of the Company's
assets invested in any one category is 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, 1998,
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, 1998, the Company held mortgage notes receivable
secured by apartments and commercial properties in the Southwest region of the
continental United States, 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.
 
                                       6
<PAGE>
 
Geographic Regions
 
  The Company has divided the continental United States into the following
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 in
this region.
 
  Southeast region comprised of the states of Alabama, Florida, Georgia,
Mississippi, North Carolina, South Carolina, Tennessee and Virginia. The
Company owns 4 apartments and 12 commercial properties in this region.
 
  Southwest region comprised of the states of Arizona, Arkansas, Louisiana,
New Mexico, Oklahoma and Texas. The Company owns 26 apartments and 8
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
and 3 hotels in this region.
 
  Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada,
Utah and Wyoming. The Company owns 2 commercial properties in this region.
 
  Pacific region comprised of the states of California, Oregon and Washington.
The Company owns 5 apartments, 1 hotel and 5 commercial properties in this
region.
 
  Excluded from the above are nine parcels of unimproved land, as described
below.
 
Real Estate
 
  At December 31, 1998, 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
partnerships 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 (office buildings, industrial warehouses and shopping
centers), hotels and apartments having established income-producing
capabilities. In selecting new real estate investments, the location, age and
type of property, gross rentals, lease terms, financials 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 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.
 
  The Company has typically invested in developed real estate. The Company
may, however also invest in new construction or development either directly or
in partnership with nonaffiliated parties or affiliates (subject to approval
by the Board of Directors). To the extent that the Company invests in
construction and development
 
                                       7
<PAGE>
 
projects, it will be subject to business risks, such as cost overruns and
construction delays, associated with such higher risk projects.
 
  At December 31, 1998, the Company had expended $1.9 million for the
construction of the 260 unit Limestone Canyon Apartments in Austin, Texas. The
Company expects to expend an additional $12.8 million to complete construction
in the fourth quarter of 1999. The Company has in place a construction loan
which will fund up to $13.0 million of such construction costs.
 
  In the opinion of 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 four hotels in the
Pacific and Midwest regions and nine parcels of unimproved land, as described
below) at December 31, 1998.
 
<TABLE>
<CAPTION>
                                                                      Commercial
   Region                                                  Apartments Properties
   ------                                                  ---------- ----------
   <S>                                                     <C>        <C>
   Pacific................................................      6%         9%
   Midwest................................................    --          14
   Northeast..............................................     10        --
   Southwest..............................................     69         22
   Southeast..............................................     15         50
   Mountain...............................................    --           5
                                                              ---        ---
                                                              100%       100%
</TABLE>
 
  The foregoing table is based solely on the number of apartment units and
amount of commercial square footage owned and does not reflect the value of
the Company's investment in each region. The Company also owns nine parcels of
unimproved land, 3 parcels of 65.79 acres, 4.66 acres and .67 acre in the
Southeast and Southwest region and 6 parcels of .9250 acres, 1.41 acres, 2.14
acres, 4.7 acres, 8.844 acres and 22.99 acres, in the Southwest region, all of
which, other than the last five parcels, are held for sale. 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.
 
  A summary of activity in the Company's owned real estate portfolio during
1998 is as follows:
 
<TABLE>
   <S>                                                                       <C>
   Owned properties in real estate portfolio at January 1, 1998.............  62
   Properties purchased.....................................................  22
   Properties sold..........................................................  (4)
   Property obtained through foreclosure....................................   1
                                                                             ---
   Owned properties in real estate portfolio at December 31, 1998...........  81
                                                                             ===
</TABLE>
 
 
                                       8
<PAGE>
 
  Properties Held for Investment. Set forth below are the Company's properties
held for investment and the monthly rental rate for apartments, the average
annual rental rate for commercial properties and the average daily room rate
and room revenue divided by total available rooms for hotels and occupancy at
December 31, 1998, 1997 and 1996 for apartments and commercial properties and
average occupancy during 1998, 1997 and 1996 for hotels:
 
<TABLE>
<CAPTION>
                                                                          Rent Per
                                                                         Square Foot    Occupancy %
                                                      Units/           --------------- --------------
Property                       Location           Square Footage       1998  1997 1996 1998 1997 1996
--------                  ------------------ ------------------------- ----- ---- ---- ---- ---- ----
<S>                       <C>                <C>                       <C>   <C>  <C>  <C>  <C>  <C>
Apartments
4400....................  Midland, TX          92 Units/94,472 Sq. Ft. $ .49 $  * $  *  98    *    *
Arbor Point.............  Odessa, TX         195 Units/178,920 Sq. Ft.   .42  .41  .37  78   85   65
Ashton Way..............  Midland, TX        178 Units/138,964 Sq. Ft.   .41    *    *  93    *    *
Bent Tree...............  Addison, TX        204 Units/196,300 Sq. Ft.   .70    *    *  93    *    *
Carseka.................  Los Angeles, CA      54 Units/37,068 Sq. Ft.  1.01  .97  .93  97   98  100
Cliffs of Eldorado......  McKinney, TX       208 Units/182,288 Sq. Ft.   .92    *    *  80    *    *
Country Bend............  Fort Worth, TX     166 Units/143,366 Sq. Ft.   .58  .54    *  94   92    *
Coventry................  Midland, TX        120 Units/105,608 Sq. Ft.   .42  .39  .37  91   96   92
Crescent Place..........  Houston, TX         120 Units/95,520 Sq. Ft.   .60  .57    *  97   93    *
Fairpark................  Los Angeles, CA      49 Units/43,431 Sq. Ft.   .93  .24    *  99   91    *
Fountain Village........  Tucson, AZ         410 Units/363,079 Sq. Ft.   .69  .65  .65  91   93   93
Fountains of Waterford..  Midland, TX        172 Units/129,200 Sq. Ft.   .35    *    *   2    *    *
Gladstell Forest........  Conroe, TX         168 Units/121,536 Sq. Ft.   .70  .67  .65  97   92   92
Harper's Ferry..........  Lafayette, LA      122 Units/112,500 Sq. Ft.   .55  .51  .48  95   97   96
Heritage................  Tulsa, OK           136 Units/92,464 Sq. Ft.   .69  .64  .62  94   95   95
Hunters Glen............  Midland, TX        212 Units/174,180 Sq. Ft.   .37    *    *  90    *    *
Limestone Canyon........  Austin, TX         260 Units/216,000 Sq. Ft.    **   **   **  **   **   **
Mariners Pointe.........  St. Petersburg, FL 368 Units/310,494 Sq. Ft.   .53  .51  .51  93   85   89
Mountain Plaza..........  El Paso, TX        188 Units/220,710 Sq. Ft.   .47    *    *  92    *    *
Sandstone...............  Mesa, AZ           238 Units/363,079 Sq. Ft.   .33  .30    *  94   93    *
Shadow Run..............  Pinellas Park, FL  276 Units/216,400 Sq. Ft.   .76  .74  .71  97   97   96
South Cochran...........  Los Angeles, CA      64 Units/43,100 Sq. Ft.  1.06  .96  .93  99   96   96
Southgate...............  Odessa, TX         180 Units/151,656 Sq. Ft.   .44  .43  .39  88   87   63
Southgreen..............  Bakersfield, CA      80 Units/66,000 Sq. Ft.   .17    *    *  95    *    *
Spa Cove................  Annapolis, MD      303 Units/305,989 Sq. Ft.   .81  .77  .75  95   94   93
Summerfield.............  Orlando, FL        224 Units/204,116 Sq. Ft.   .66  .63  .59  91   93   92
Summerstone.............  Houston, TX        242 Units/188,734 Sq. Ft.   .63  .61  .59  96   93   94
Sunchase................  Odessa, TX         300 Units/223,048 Sq. Ft.   .44  .43    *  92   90    *
Terrace Hills...........  El Paso, TX        310 Units/233,192 Sq. Ft.   .63  .58    *  97   95    *
Timbers.................  Tyler, TX          180 Units/101,666 Sq. Ft.   .54  .54    *  87   92    *
Treehouse...............  Irving, TX         160 Units/153,072 Sq. Ft.   .68  .62    *  96   99    *
Villas at Countryside...  Sterling, VA        102 Units/92,840 Sq. Ft.   .97  .94    *  99   96    *
Villa Piedra............  Los Angeles, CA     132 Units/81,790 Sq. Ft.  1.04  .30    *  98   89    *
Westgate of Laurel......  Laurel, MD         218 Units/201,704 Sq. Ft.   .85  .82  .81  95   96   96
Westwood................  Odessa, TX           79 Units/49,001 Sq. Ft.   .45  .45  .40  99   87   65
Woodland Hills..........  San Antonio, TX      96 Units/57,800 Sq. Ft.   .66  .66  .66  84   86   90
Woods Edge..............  Rockville, MD      162 Units/146,460 Sq. Ft.  1.02  .95  .93  96   94   93
Woodview................  Odessa, TX         232 Units/165,840 Sq. Ft.   .51    *    *  85    *    *
</TABLE>
 
                                       9
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                                  Total Room Revenues
                                                           Rent Per Square Foot/                      Divided By
                                              Units/         Average Room Rate     Occupancy %   Total Available Rooms
                                          Square Footage/ ----------------------- -------------- ---------------------
Property                   Location         Rooms/Acres    1998    1997    1996   1998 1997 1996  1998    1997   1996
--------             -------------------- --------------- ------- ------- ------- ---- ---- ---- ------- ------ ------
<S>                  <C>                  <C>             <C>     <C>     <C>     <C>  <C>  <C>  <C>     <C>    <C>
Office Buildings
74 New Montgomery..  San Francisco, CA    109,497 Sq. Ft. $ 20.46 $ 16.18 $ 14.88  98   97   92
Atrium.............  Palm Beach, FL        74,603 Sq. Ft.    8.86       *       *  99    *    *
Bonita Plaza.......  Bonita, CA            47,777 Sq. Ft.   16.59   20.81       *  88   61    *
Corporate Pointe...  Chantilly, VA         65,918 Sq. Ft.   14.92   13.69   13.41 100  100  100
Daley Plaza........  San Diego, CA         62,425 Sq. Ft.   14.69       *       *  92    *    *
Forum..............  Richmond, VA          79,791 Sq. Ft.   14.82   14.64   14.02  81   96  100
Hartford...........  Dallas, TX           174,513 Sq. Ft.    9.93    8.86    9.44  57   46   46
Institute Place....  Chicago, IL          144,915 Sq. Ft.   14.73   12.95   12.31  95   86   75
Lexington Center...  Colorado Springs, CO  74,603 Sq. Ft.   10.93    9.57       *  80   60    *
One Steeplechase...  Sterling, VA         103,376 Sq. Ft.   15.74   15.24   14.75 100  100  100
Parkway North......  Dallas, TX            71,041 Sq. Ft.   12.62       *       *  78    *    *
Plaza on Bachman
 Creek.............  Dallas, TX            80,278 Sq. Ft.   10.66       *       *  69    *    *
Plaza Towers.......  St. Petersburg, FL   186,281 Sq. Ft.   13.33   12.77   12.15 100   96   88
Savings of
 America...........  Houston, TX           68,634 Sq. Ft.    9.70   11.16       *  89   90    *
Town and Country...  Houston, TX           64,089 Sq. Ft.    5.06    4.80    4.47  68   76   67
Valley Rim.........  San Diego, CA         54,194 Sq. Ft.   15.81       *       *  88    *    *
Venture Center.....  Atlanta, GA           38,272 Sq. Ft.   14.74   13.07   12.67  71  100   94
Viewridge..........  San Diego, CA         25,062 Sq. Ft.    7.20       *       *  87    *    *
Waterstreet........  Boulder, CO          106,257 Sq. Ft.   17.56   16.73   15.60  98   99   96

Industrial
 Warehouses
Corporate Center...  Ashburn, VA          177,563 Sq. Ft.    6.32    5.93    5.64 100   98   80
Encon..............  Fort Worth, TX       256,410 Sq. Ft.    2.00    1.66       * 100  100    *
Parke Long.........  Chantilly, VA        217,132 Sq. Ft.    6.69    6.15    5.32  87   87   80
Technology
 Trading...........  Sterling, VA         197,659 Sq. Ft.    5.76    5.10    5.26  87   70   78
Texstar............  Arlington, TX         97,846 Sq. Ft.    2.11    2.11    1.86 100  100  100
Tricon.............  Atlanta, GA          570,877 Sq. Ft.    3.59    3.44    3.29  98   91   93

Shopping Centers
Dunes Plaza........  Michigan City, IN    223,869 Sq. Ft.    4.84    4.58    4.49  43   77   82
K-Mart.............  Cary, NC              92,033 Sq. Ft.    3.28     ***     *** 100  ***  ***
Parkway Center.....  Dallas, TX            28,374 Sq. Ft.   13.86   13.00   12.01  94  100   94
Sadler Square......  Amelia Island, FL     70,295 Sq. Ft.    6.90    6.76    6.54  95   96   95
Sheboygan..........  Sheboygan, WI         74,532 Sq. Ft.    1.99    1.99    1.99 100  100  100

Hotels
Belmont............  Chicago, IL                 45 Rooms  101.13       *       *  68    *    *  $ 67.93 $    * $    *
Brompton...........  Chicago, IL                 52 Rooms   98.08       *       *  50    *    *    46.54      *      *
Majestic Inn.......  San Francisco, CA           57 Rooms  148.96  136.08  117.45  71   73   70   112.54  93.26  76.50
Surf...............  Chicago, IL                 55 Rooms   98.85       *       *  57    *    *    56.12      *      *

Land
Eagle Crest........  Farmers Branch, TX       22.99 Acres
Las Colinas........  Las Colinas, TX            4.7 Acres
Laws...............  Dallas, TX                1.41 Acres
Lemmon Carlisle....  Dallas, TX                2.14 Acres
West End...........  Dallas, TX               8.844 Acres
</TABLE>
--------
*   Property was purchased in either 1997 or 1998.
**  Property was under construction at December 31, 1998.
*** Obtained through foreclosure in 1998.
 
                                       10
<PAGE>
 
  Occupancy presented here and throughout this ITEM 2. is without reference to
whether leases in effect are at, below or above market rates.
 
  In January 1998, the Company purchased the 188 unit Mountain Plaza
Apartments in El Paso, Texas, for $4.0 million, paying $1.0 million in cash
and obtaining mortgage financing of $3.0 million. The mortgage bears interest
at 8.2% per annum, requires monthly payments of interest only and matures in
January 2000. A real estate brokerage commission of $139,000 was paid to
Carmel Realty and a real estate acquisition fee of $39,000 was paid to BCM.
 
  Also in January 1998, the Company purchased the 212 unit Hunters Glen
Apartments in Midland, Texas, for $2.5 million, paying $600,000 in cash and
obtaining seller financing of $1.9 million. The financing bears interest at a
variable rate, currently 8.0% per annum, requires monthly payments of interest
only for the first twenty-four months and thereafter requires monthly payments
of principal and interest of $14,302 and matures in January 2003. A real
estate brokerage commission of $94,000 was paid to Carmel Realty and a real
estate acquisition fee of $25,000 was paid to BCM.
 
  Further in January 1998, the Company purchased the Laws Street land, a 1.41
acre parcel of land in Dallas, Texas, for $1.9 million in cash. A real estate
brokerage commission of $39,000 was paid to Carmel Realty and a real estate
acquisition fee of $19,000 was paid to BCM.
 
  In January 1998, the Company purchased the 204 unit Bent Tree Garden
Apartments in Addison, Texas, for $8.1 million, paying $1.7 million in cash
and obtaining mortgage financing of $6.4 million. The mortgage bears interest
at 7.2% per annum, requires monthly payments of principal and interest of
$46,054 and matures in February 2008. A real estate brokerage commission of
$232,000 was paid to Carmel Realty and a real estate acquisition fee of
$81,000 was paid to BCM.
 
  In February 1998, the Company purchased Parkway North, a 71,041 sq. ft.
office building in Dallas, Texas, for $5.4 million, paying $1.5 million in
cash and obtaining mortgage financing of $3.9 million. The mortgage bears
interest at a variable rate, currently 8.69% per annum, requires monthly
payments of interest only and matures in March 2000. A real estate brokerage
commission of $179,000 was paid to Carmel Realty and a real estate acquisition
fee of $54,000 was paid to BCM.
 
  Also in February 1998, the Company purchased the Lemmon Carlisle land, a
2.14 acre parcel of land in Dallas, Texas, for $3.4 million in cash. A real
estate brokerage commission of $54,000 was paid to Carmel Realty and a real
estate acquisition fee of $34,000 was paid to BCM.
 
  In March 1998, the Company purchased the Plaza on Bachman Creek, a 80,278
sq. ft. retail/office complex in Dallas, Texas, for $3.5 million, paying $1.1
million in cash and obtaining mortgage financing of $2.4 million. The mortgage
bears interest at a variable rate, currently 9% per annum, requires monthly
payments of principal and interest of $21,593 and matures in March 2018. A
real estate brokerage commission of $124,000 was paid to Carmel Realty and a
real estate acquisition fee of $35,000 was paid to BCM.
 
  Also in March 1998, the Company refinanced the mortgage debt secured by the
Tricon Warehouses in Atlanta, Georgia in the amount of $10.2 million,
receiving net cash of $5.4 million after paying off $4.8 million in mortgage
debt, funding of escrows and the payment of various closing costs. The new
mortgage bears interest at a variable rate, currently 7.53% per annum,
requires monthly payments of principal and interest of $75,576 and matures in
April 2008. A mortgage brokerage and equity refinancing fee of $102,000 was
paid to BCM.
 
  In April 1998, the Company purchased in a single transaction the 178 unit
Ashton Way Apartments in Midland, Texas, and the 92 unit 4400 Apartments also
in Midland, Texas, and in May 1998, the 232 unit Woodview Apartments in
Odessa, Texas, for a total of $6.8 million. The Company paid a total of $1.5
million in cash and obtained mortgage financing secured by all three
properties totaling $5.3 million. The first mortgage of $4.5 million bears
interest at 7.2% per annum and the second mortgage of $845,000 bears interest
at a variable
 
                                      11
<PAGE>
 
rate, currently 8.2% per annum. The mortgages require monthly payments of
principal and interest totaling $38,003 and mature in October 1999 and May
2008, respectively. A real estate brokerage commission of $244,000 was paid to
Carmel Realty and a real estate acquisition fee of $68,000 was paid to BCM.
 
  In May 1998, the Company purchased the Eagle Crest land, a 22.99 acre parcel
of land in Farmers Branch, Texas, for $2.5 million in cash. A real estate
brokerage commission of $95,000 was paid to Carmel Realty and a real estate
acquisition fee of $25,000 was paid to BCM.
 
  Also in May 1998, the Company purchased the 172 unit Fountains of Waterford
Apartments in Midland, Texas, for $1.5 million, paying $425,000 in cash,
assuming the existing mortgage of $584,000 and obtaining seller financing of
the remaining $491,000 of the purchase price. The mortgage bears interest at
9.91% per annum, and the seller financing at a variable rate, currently 7.5%
per annum, require monthly payments of principal and interest totaling $10,643
and mature in November 1999 and June 2008. A real estate brokerage commission
of $59,000 was paid to Carmel Realty and a real estate acquisition fee of
$15,000 was paid to BCM.
 
  Further in May 1998, the Company purchased in a single transaction, Daley
Plaza, a 62,425 sq. ft. office building and View Ridge, a 25,062 sq. ft.
office building, both in San Diego, California, for a total of $6.5 million.
The Company paid $1.7 million in cash and obtained mortgage financing totaling
$4.8 million. The mortgages bear interest at a variable rate, currently 9.5%
per annum, require monthly payments of principal and interest totaling $42,416
and mature in May 2005. A real estate brokerage commission of $200,000 was
paid to Carmel Realty and a real estate acquisition fee of $65,000 was paid to
BCM.
 
  In May 1998, the Company obtained mortgage financing in the amount of $2.2
million secured by its unencumbered Lemmon Carlisle land in Dallas, Texas,
receiving net cash of $2.1 million after the payment of various closing costs.
The mortgage bears interest at 9.25% per annum, requires monthly payment of
interest only and matures in May 2000. A mortgage brokerage and equity
refinancing fee of $22,000 was paid to BCM.
 
  Also in May 1998, the Company refinanced the mortgage debt secured by the
Plaza Towers Office Building in St. Petersburg, Florida in the amount of $7.4
million, receiving net cash of $2.6 million after paying off $4.8 million in
mortgage debt, funding of required escrows and the payment of various closing
costs. The new mortgage bears interest at 7.57% per annum, requires monthly
payments of principal and interest of $55,023 and matures in June 2008. A
mortgage brokerage and equity refinancing fee of $74,000 was paid to BCM.
 
  In June 1998, the Company purchased the Atrium, a 74,603 sq. ft. office
building in Palm Beach, Florida, for $5.4 million, paying $1.3 million in cash
and obtaining mortgage financing of $4.1 million. The mortgage bears interest
at a variable rate, currently 7.93% per annum, requires monthly payments of
principal and interest of $31,455 and matures in July 2001. A real estate
brokerage commission of $179,000 was paid to Carmel Realty and a real estate
acquisition fee of $54,000 was paid to BCM.
 
  In July 1998, the Company purchased Valley Rim, a 54,194 sq. ft. office
building in San Diego, California, for $5.1 million, paying $1.4 million in
cash and obtaining mortgage financing of $3.7 million. The mortgage bears
interest at a variable rate, currently 9.5% per annum, requires monthly
payments of principal and interest of $32,576 and matures in June 2005. A real
estate brokerage commission of $172,000 was paid to Carmel Realty and an
acquisition fee of $51,000 was paid to BCM.
 
  Also in July 1998, the Company purchased the Limestone Canyon land, a 27
acre parcel of unimproved land in Austin, Texas, for $1.8 million in cash. In
conjunction with the purchase, the Company obtained a financing commitment of
$13.0 million for the construction of a 260 unit apartment on the site. The
mortgage bears interest at a variable rate, currently 7.63% per annum,
requires monthly payments of interest only and matures in July 2000. A real
estate brokerage commission of $70,000 was paid to Carmel Realty and an
acquisition fee of $18,000 was paid to BCM. Construction was commenced in
August 1998 and is expected to be completed in the fourth quarter of 1999.
 
 
                                      12
<PAGE>
 
  Further in July 1998, the Company refinanced the matured mortgage debt
secured by the Villas at Countryside Apartments in Sterling, Virginia, in the
amount of $5.4 million, receiving net cash of $400,000 after paying off $5.0
million in mortgage debt, funding of required escrows and the payment of
various closing costs. The new mortgage bears interest at 6.85% per annum,
requires monthly payments of principal and interest of $35,692 and matures in
August 2005. A mortgage brokerage and equity refinancing fee of $54,000 was
paid to BCM.
 
  In August 1998, the Company obtained second lien financing of $1.8 million
secured by the Terrace Hills Apartments in El Paso, Texas, receiving net cash
of $1.7 million after the payment of various closing costs. The mortgage bears
interest at 7.275% per annum, requires monthly payments of principal and
interest of $11,968 and matures in September 2009. A mortgage brokerage and
equity refinancing fee of $18,000 was paid to BCM.
 
  At December 31, 1997, the Company held a wraparound mortgage note with a
principal balance of $2.5 million secured by a K-Mart in Cary, North Carolina.
In February 1998, the Company was informed that the first lien mortgage in the
amount of $2.0 million was in default. To protect its interest, the Company
foreclosed on the property in August 1998 and refinanced the first lien
mortgage in the amount of $2.0 million, paying $265,000 in cash to complete
the refinancing. The new mortgage bears interest at 7.51% per annum, requires
monthly payments of principal and interest of $15,721 and matures in September
2008. A mortgage brokerage and equity refinancing fee of $19,500 was paid to
BCM. No loss was recognized on the foreclosure as the fair value of the
property exceeded the carrying value of the note receivable. The property was
classified as held for investment as of December 31, 1998.
 
  In 1997, Montgomery Ward ("Ward"), a tenant at the Northtown Mall, a 354,174
sq. ft. shopping center in Dallas, Texas, filed for bankruptcy protection. In
an attempt to keep the Ward lease from being sold, Northtown Mall was placed
in administrative bankruptcy. Wards Northtown Mall lease, as well as other
Ward leases were, however, sold for the benefit of the Ward bankruptcy estate.
In September 1998, the Company bought back the lease concurrent with the $15.6
million sale of Northtown Mall. The Company received net cash of $12.1 million
after paying off $2.5 million of mortgage debt, $900,000 for the Ward lease
and the payment of various closing costs. In conjunction with the sale, the
Northtown Mall bankruptcy proceeding was dismissed. A real estate brokerage
commission of $135,000 was paid to Carmel Realty. A gain of $3.4 million was
recognized on the sale.
 
  In September 1998, the Company sold Chesapeake Ridge, a 100,484 sq. ft.
office building in San Diego, California, for $13.2 million, receiving net
cash of $7.6 million after paying off $5.3 million of mortgage debt and the
payment of various closing costs, including a real estate brokerage commission
of $317,000 paid to Carmel Realty. A gain of $5.9 million was recognized on
the sale.
 
  In October 1998, the Company sold Denton Drive, a 123,800 sq. ft. industrial
warehouse in Dallas, Texas, for $1.2 million, receiving net cash of $845,000
after paying off $309,000 in mortgage debt and the payment of various closing
costs, including a real estate brokerage commission of $46,000 paid to Carmel
Realty. A gain of $219,000 was recognized on the sale.
 
  Also in October 1998, the Company purchased the 208 unit Cliffs of Eldorado
Apartments in McKinney, Texas, for $12.8 million, paying $1.6 million in cash,
assuming the existing mortgage of $10.6 million and issuing 5,829 shares of
Series A Cumulative Convertible Preferred Stock with a total liquidation value
of $583,000. The assumed mortgage bears interest at 8.125% per annum, requires
monthly payments of principal and interest of $75,197 and matures in November
2037. A real estate brokerage commission of $312,000 was paid to Carmel Realty
and a real estate acquisition fee of $128,000 was paid to BCM.
 
  Further in October 1998, the Company refinanced the matured mortgage debt
secured by the Bonita Plaza Office Building in Bonita, California in the
amount of $5.2 million, receiving net cash of $1.2 million after paying off
$4.0 million in mortgage debt, funding of required escrows and the payment of
various closing costs. The new mortgage bears interest at a variable rate,
currently 7.4% per annum, requires monthly payments of principal and interest
of $37,722 and matures in November 2001. A mortgage brokerage and equity
refinancing fee of $52,000 was paid to BCM.
 
                                      13
<PAGE>
 
  In December 1998, the Company purchased the assets of the Neighborhood Inns
of Chicago, consisting of three hotels in Chicago, Illinois, the Belmont with
45 rooms, the Brompton with 52 rooms, and the Surf with 55 rooms, for $11.6
million. The Company paid $2.3 million in cash and obtained mortgage financing
secured by all three hotels of $9.2 million. The mortgage bears interest at a
variable rate, currently 9.376% per annum, requires monthly payments of
principal and interest of $94,108 and matures in December 2001. A real estate
brokerage commission of $293,000 was paid to Carmel Realty and a real estate
acquisition fee of $116,000 was paid to BCM.
 
  Also in December 1998, the Company purchased the 80 unit Southgreen
Apartments in Bakersfield, California for $3.6 million, paying $1.1 million in
cash and obtaining mortgage financing of $2.5 million. The mortgage bears
interest at a variable rate, currently 8.25% per annum, requires monthly
payments of principal and interest of $19,953 and matures in December 2005. A
real estate brokerage commission of $127,000 was paid to Carmel Realty and a
real estate acquisition fee of $36,000 was paid to BCM.
 
  In February 1999, the Company sold the 368 unit Mariner's Pointe Apartments
in St. Petersburg, Florida, for $6.7 million, receiving net cash of $2.6
million after paying off $3.9 million in mortgage debt and the payment of
various closing costs, including a real estate brokerage commission of
$204,000 paid to Carmel Realty. A gain will be recognized on the sale.
 
  In March 1999, the Company purchased the 264 unit Vista Hills Apartments in
El Paso, Texas, for $5.2 million, paying $1.6 million in cash and obtaining
mortgage financing of $3.6 million. The mortgage bears interest at a variable
rate, currently 7.625% per annum, requires monthly payments of principal and
interest of $26,897 and matures in April 2004. A real estate brokerage
commission of $173,000 was paid to Carmel Realty and a real estate acquisition
fee of $52,000 was paid to BCM.
 
  Also in March 1999, the Company purchased the Dominion land, a 14.39 acre
parcel of land in Dallas, Texas, for $3.6 million, paying $1.2 million in cash
and obtaining mortgage financing of $2.4 million. The mortgage bears interest
at 15% per annum, requires quarterly payments of interest only and matures in
March 2000. A real estate brokerage commission of $56,000 was paid to Carmel
Realty and a real estate acquisition fee of $36,000 was paid to BCM.
 
  Further in March 1999, the Company refinanced the matured mortgage debt
secured by the Lexington Center Office Building in Colorado Springs, Colorado
in the amount of $4.3 million, receiving net cash of $136,000 after paying off
$4.0 million in mortgage debt and the payment of various closing costs. The
new mortgage bears interest at a variable rate, currently 7.75% per annum,
requires monthly payments of principal and interest of $32,479 and matures in
April 2004. A mortgage brokerage and equity refinancing fee of $43,000 was
paid to BCM.
 
  Properties Held for Sale. Set forth below are the Company's properties held
for sale, primarily obtained through foreclosure.
 
<TABLE>
<CAPTION>
                                                                 Square Footage/
Property                                           Location           Acres
--------                                      ------------------ ---------------
<S>                                           <C>                <C>
Land
Fiesta....................................... San Angelo, TX       .6657 Acres
Fruitland.................................... Fruitland Park, FL    4.66 Acres
Moss Creek................................... Greensboro, NC       65.79 Acres
Republic land................................ Dallas, TX           .9250 Acres
</TABLE>
 
  In March 1998, the Company completed the sale of Shaws Plaza, a 103,482 sq.
ft. shopping center in Sharon, Massachusetts, which was under contract for
sale at December 31, 1997, for $3.8 million, receiving net
 
                                      14
<PAGE>
 
cash of $1.1 million after paying off $2.6 million in existing mortgage debt
and the payment of various closing costs, including a real estate brokerage
commission of $134,000 paid to Carmel Realty. No gain or loss was recognized
on the sale.
 
  In October 1998, the Company sold approximately 19 acres of land in
Greensboro, North Carolina, for $375,000, receiving net cash of $356,000 after
the payment of various closing costs, including a real estate brokerage
commission of $15,000 paid to Carmel Realty. A gain of $350,000 was
recognized.
 
  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, 1998, 1997 and
1996:
 
<TABLE>
<CAPTION>
                                                                    Rent Per
                                                                  Square Foot     Occupancy %
                                                Units/          ---------------- --------------
Property                    Location        Square Footage      1998  1997  1996 1998 1997 1996
--------                 -------------- ----------------------- ----- ----- ---- ---- ---- ----
<S>                      <C>            <C>                     <C>   <C>   <C>  <C>  <C>  <C>
Apartment
Lincoln Court........... Dallas, TX     55 Units/40,063 Sq. Ft. $1.08 $1.04 $.99  95   99   98

Office Building
MacArthur Mills......... Carrollton, TX          53,472 Sq. Ft.  9.84  9.35 8.38 100   97   94

Shopping Centers
Chelsea Square.......... Houston, TX             70,275 Sq. Ft.  8.61  9.21 9.32  81   49   69
Summit at Bridgewood.... Fort Worth, TX          48,696 Sq. Ft.  9.63  9.48 8.67  79   65   62
</TABLE>
 
  The Company owns a noncontrolling 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 noncontrolling 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 three other commercial properties in
the table above. In May 1998, Tri-City sold its two apartments for $3.3
million in cash. Tri-City received net cash of $1.4 million after paying off
$1.9 million in mortgage debt and the payment of various closing costs. The
Company received a distribution of $701,000 of such net cash. Tri-City
recognized a gain of $496,000 of which the Company's equity share was
$316,000. Tri-City paid a real estate brokerage commission of $119,000 to
Carmel Realty. In 1998, the Company made no advances to the partnership and
received $319,000 in operating distributions. See ITEM 13. "CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS--Related Party Transactions."
 
Mortgage Loans
 
  In addition to investments in real estate, a 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 may increase, as it has determined that in 1999 it
may seek to fund or acquire mortgage loans. It may also originate mortgage
loans in conjunction with providing purchase money financing of a property
sale. The Company intends to service and hold for investment the mortgage
notes in its portfolio. The Company's mortgage notes receivable consist of
first and junior mortgage loans.
 
  Types of Mortgage Activity. The Company may originate its own mortgage
loans, as well as acquire existing mortgage notes either directly from
builders, developers or property owners, or through mortgage banking firms,
commercial banks or other qualified brokers. 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, 1998, consisted
of an apartment, a hotel, 5 developed residential lots and a
 
                                      15
<PAGE>
 
34,847 sq. ft. parcel of unimproved land. The Board of Directors may alter the
types of properties securing or collateralizing mortgage loans in which the
Company invests 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, 1998, the Company's mortgage notes receivable portfolio
included 4 mortgage loans with an aggregate principal balance of $1.7 million
secured by income-producing real estate located in the Southeast and Southwest
regions of the continental United States and 12 loans with an aggregate
principal balance of $654,000 secured by collateral other than income-
producing real estate. At December 31, 1998, less than 1% of the Company's
assets were invested in notes and interest receivable (less than 1% in junior
and other mortgage notes).
 
  The following table sets forth the percentages (based on the mortgage note
principal balance) by property type and geographic region, of the properties
(other than unimproved land) that serve as collateral for the Company's
mortgage notes receivable at December 31, 1998. 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>
   Region                                                 Apartments Hotel Total
   ------                                                 ---------- ----- -----
   <S>                                                    <C>        <C>   <C>
   Southwest.............................................     79%      21%  100%
</TABLE>
 
  A summary of the activity in the Company's mortgage notes receivable
portfolio during 1998 is as follows:
 
<TABLE>
   <S>                                                                       <C>
   Loans in mortgage notes receivable portfolio at January 1, 1998..........  20
   Loan purchased...........................................................   1
   Loans paid off...........................................................  (4)
   Loan foreclosed..........................................................  (1)
                                                                             ---
   Loans in mortgage notes receivable portfolio at December 31, 1998........  16
                                                                             ===
</TABLE>
 
  During 1998, $2.9 million was collected in settlement of four mortgage notes
and $49,000 in principal payments were received.
 
  At December 31, 1998, 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 34,847 sq. ft. of unimproved land in Milwaukee,
Wisconsin and five first mortgage notes secured by residential lots in
Greensboro, North Carolina.
 
  First Mortgage Loans. The Company invests in first mortgage notes, with
short, medium or long-term maturities. First mortgage loans generally provide
for level periodic payments of principal and interest 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 borrower is
required to 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
that it originates.
 
  The following discussion briefly describes the events that affected
previously funded first mortgage loans during 1998.
 
  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 16
residential and commercial subdivisions in Maumelle, Arkansas, secured by a
 
                                      16
<PAGE>
 
first mortgage 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 for, among other things,
the payment by the borrower of $2.5 million in cash, and the acceptance of a
new $1.4 million note secured by 36.3 acres of commercial land. Such note
matured in January 1996. In April 1998, the Company received $2.1 million in
full settlement of its note and accrued but unpaid interest. The original sale
had been recorded under the cost recovery method with gain being deferred
until the note was collected. Accordingly, the previously deferred gain of
$2.1 million was recognized on collection of the note.
 
  In July 1998, a mortgage note receivable which had been written off in a
prior year, was collected. A gain of $671,000 was recognized.
 
  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 is to make wraparound mortgage loans in
amounts and on properties as to which it would otherwise make first mortgage
loans.
 
  The following discussion briefly describes the events that affected
previously funded wraparound mortgage loans during 1998.
 
  As discussed under "Real Estate" above, at December 31, 1997, the Company
held a wraparound mortgage note with a principal balance of $2.5 million
secured by a K-Mart in Cary, North Carolina. In February 1998, the Company was
informed that the first lien mortgage in the amount of $2.0 million was in
default. To protect its interest, the Company foreclosed on the property in
August 1998 and refinanced the first lien mortgage in the amount of $2.0
million, paying $265,000 in cash to complete the refinancing. No loss was
recognized on the foreclosure as the fair value of the property exceeded the
carrying value of the note receivable.
 
  Junior Mortgage Loans. The Company may invest 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 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, 1998,
less than 1% of the Company's assets were invested in junior mortgage loans.
 
  The following discussion briefly describes the events that affected
previously funded junior mortgage loans in 1998.
 
  In August 1998, a mortgage note receivable with a principal balance of $2.0
million and a carrying value of $207,000 and secured by a second lien on a
hotel in Lake Charles, Louisiana became delinquent. To protect its interest,
the Company purchased the first lien mortgage for $149,000. Foreclosure
proceedings have commenced and title to the property is expected to be
received in the second quarter of 1999. No loss is expected to be incurred on
foreclosure, as the estimated fair value of the property exceeds the carrying
value of the mortgage notes receivable.
 
  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. At December 31, 1998, 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.
 
  Partnership mortgage loans. The Company owns a 60% general partner interest
and IORI owns a 40% general partner interest in Nakash Income Associates
("NIA"), which owns a wraparound mortgage note receivable secured by a
building occupied by a Wal-Mart in Maulden, Missouri. The Company received
$9,000 in distributions from NIA in 1998 and advanced $14,000 to the
partnership.
 
                                      17
<PAGE>
 
ITEM 3. LEGAL PROCEEDINGS
 
Olive Litigation
 
  In February 1990, the Company, together with CMET, IORI and National Income
Realty Trust, 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 "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and modified certain provisions of the April 1990 settlement. The
Olive Modification was preliminarily approved by the Court on July 1, 1994 and
final Court approval was entered on December 12, 1994. The effective date of
the Olive Modification was January 11, 1995.
 
  The Court retained jurisdiction to enforce the Olive Modification, and
during August and September 1996, the Court held evidentiary hearings to
assess compliance with the terms of the Olive Modification by the 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 intended to assert that certain actions taken by
the Board of Directors breached the terms of the Olive Modification. On
January 27, 1997, the parties entered into an Amendment to the Olive
Modification effective January 9, 1997 (the "Olive Amendment"), which was
submitted to the Court for approval on January 29, 1997. The Olive 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.
On May 2, 1997, a hearing was held for the Court to consider approval of the
Olive Amendment. As a result of the hearing, the parties entered into a
revised Olive Amendment. The Court issued an order approving the Olive
Amendment on July 3, 1997.
 
  The Olive Amendment provides for the addition of four 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 Olive Modification shall be settled by
mutual agreement of the parties or, lacking such agreement, by an arbitration
proceeding.
 
  Under the Olive Amendment, all shares of the Company owned by Gene E.
Phillips or any of his affiliates shall be voted at all stockholder meetings
of the Company held until April 28, 1999 in favor of all new members of the
Company's Board of Directors added under the Olive Amendment. The Olive
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.
 
  In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley
and R. Douglas Leonhard were added to the Company's Board of Directors in
January 1998 and Murray Shaw was added to the Company's Board of Directors in
February 1998.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  Not applicable.
 
                                      18
<PAGE>
 
                                    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, 1999 (through March 5, 1999)..................... $16 3/8   $12
 
   March 31, 1998.............................................  18 1/4    14 1/4
   June 30, 1998..............................................  17 15/16  14 3/4
   September 30, 1998.........................................  16 1/4    12 1/2
   December 31, 1998..........................................  14 1/2    11 1/2
 
   March 31, 1997.............................................  14 7/8    10 3/4
   June 30, 1997..............................................  15 5/8    10 3/4
   September 30, 1997.........................................  21 1/4    14 1/2
   December 31, 1997..........................................  21 3/8    13 3/8
</TABLE>
 
  As of March 5, 1999, the closing price of the Company's Common Stock as
reported in the consolidated reporting system of the NYSE was $12.81 per
share.
 
  As of March 5, 1999, the Company's Common Stock was held by 5,025 holders of
record.
 
  The Company paid dividends in 1998 and in 1997 as follows:
 
<TABLE>
<CAPTION>
                                                                       Amount
     Date Declared         Record Date            Payable Date        Per Share
   -----------------    ------------------     ------------------     ---------
   <S>                  <C>                    <C>                    <C>
   February 16, 1998    March 13, 1998         March 31, 1998           $.15
   May 27, 1998         June 4, 1998           June 19, 1998             .15
   August 31, 1998      September 15, 1998     September 30, 1998        .15
   November 24, 1998    December 15, 1998      December 30, 1998         .15
 
   February 26, 1997    March 14, 1997         March 31, 1997            .07
   June 5, 1997         June 13, 1997          June 30, 1997             .07
   September 3, 1997    September 15, 1997     September 30, 1997        .07
   December 1, 1997     December 15, 1997      December 31, 1997         .07
</TABLE>
 
  The Company reported to the Internal Revenue Service that 100% of the
dividends paid in 1998 and 1997 represented capital gains.
 
  On December 5, 1989, the Board of Directors approved a share repurchase
program. The Board of Directors authorized the repurchase of a total of
687,000 shares of the Company's Common Stock pursuant to such program. Through
December 31, 1998, a total of 409,765 shares had been repurchased at a cost of
$3.3 million, 21,950 of such shares having been purchased in 1998, at a cost
of $336,000.
 
                                      19
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                  For the Years Ended December 31,
                          ---------------------------------------------------------
                            1998       1997           1996       1995       1994
                          ---------  ---------      ---------  ---------  ---------
                              (dollars in thousands, except per share)
<S>                       <C>        <C>            <C>        <C>        <C>
EARNINGS DATA
Revenues................  $  70,636  $  55,961      $  46,878  $  48,272  $  37,983
Expenses................     76,602     65,578         56,499     58,174     47,154
                          ---------  ---------      ---------  ---------  ---------
(Loss) from operations..    (5,966)     (9,617)        (9,621)    (9,902)    (9,171)
Equity in income (loss)
 of investees...........        288        812            (20)    (1,083)       (90)
Gain on sale of
 partnership interests..        --         --             --         --       2,514
Gain on sale of real
 estate.................     12,584     21,404          1,579      5,822      2,153
Extraordinary gain......        --         --             --       1,293      1,189
                          ---------  ---------      ---------  ---------  ---------
Net income (loss)
 applicable to common
 shares.................      6,906     12,599         (8,062)    (3,870)    (3,405)
Preferred dividend
 requirement............         (1)       --             --         --         --
                          ---------  ---------      ---------  ---------  ---------
                          $   6,905  $  12,599      $  (8,062) $  (3,870) $  (3,405)
                          =========  =========      =========  =========  =========
PER SHARE DATA
Income (loss) before
 extraordinary gain.....  $    1.78  $    3.22      $   (2.02) $   (1.29) $   (1.15)
Extraordinary gain......        --         --             --         .32        .30
                          ---------  ---------      ---------  ---------  ---------
Net income (loss)
 applicable to common
 shares.................  $    1.78  $    3.22      $   (2.02) $    (.97) $    (.85)
                          =========  =========      =========  =========  =========
Dividends per share.....  $     .60  $     .28(/1/) $     .28  $     .07  $      --
Weighted average Common
 shares outstanding.....  3,876,797  3,907,221      3,994,687  4,012,275  4,012,275
</TABLE>
--------
(/1/)  Does not include the special dividend of $1.00 per share
 
 
<TABLE>
<CAPTION>
                                                  December 31,
                                  --------------------------------------------
                                    1998     1997     1996     1995     1994
                                  -------- -------- -------- -------- --------
                                    (dollars in thousands, except per share)
<S>                               <C>      <C>      <C>      <C>      <C>
BALANCE SHEET DATA
Notes and interest receivable,
 net............................. $  1,493 $  3,947 $  8,606 $ 10,017 $ 11,201
Real estate held for sale, net
  Foreclosed.....................    1,356    1,356      910    2,460    8,032
  Other..........................      --     3,630    2,089    3,415      341
Real estate held for investment,
 net.............................  347,389  269,845  217,010  220,105  213,445
Total assets.....................  382,203  319,135  244,971  260,036  247,964
Notes and interest payable.......  282,688  222,029  158,692  159,889  145,514
Stockholders' equity.............   91,132   86,133   78,959   89,084   93,177
Book value per share............. $  23.35 $  22.15 $  20.11 $  22.19 $  23.22
</TABLE>
 
  The Company purchased 22 properties in 1998 for a total of $91.0 million, 15
properties in 1997 for a total of $60.0 million and six properties in 1996 for
a total of $7.7 million. The Company sold five properties in 1998 for a total
of $31.8 million, five properties in 1997 for a total of $29.1 million and
five properties in 1996 for a total $8.9 million. See ITEM 2. "PROPERTIES--
Real Estate" and ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA."
 
  Shares and per share data have been restated for the three for two forward
Common 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.
 
                                      20
<PAGE>
 
Liquidity and Capital Resources
 
  Cash and cash equivalents at December 31, 1998 totaled $10.5 million
compared with $24.7 million at December 31, 1997. The principal reasons for
the 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. Management expects that the Company's cash balance at
December 31, 1998, and cash that will be generated in 1999 from the collection
of mortgage notes receivable, sales of properties and refinancing or extension
of certain of its mortgage debt will be sufficient to meet all of its cash
requirements, including debt service obligations coming due in 1999, dividend
payments and property maintenance and improvements, as more fully discussed in
the paragraphs below.
 
  Net cash provided by operating activities decreased to $3.4 million in 1998
from $10.0 million in 1997. The primary factors contributing to the Company's
cash flow from operations are discussed in the following paragraphs.
 
  The Company's cash flow from property operations (rents collected less
payments for property operating expenses) increased to $29.8 million in 1998
from $16.2 million in 1997. An increase of $6.1 million was due to the
purchase of 15 income producing properties in 1997 and 18 income producing
properties in 1998, an increase of $6.2 million was due to the sale of
Republic Towers Office Building in 1997, and an increase of $2.2 million was
due to increased occupancy and rents at the Company's apartments and
commercial properties, and the Company's control of operating expenses. These
increases were partially offset by a decrease of $1.2 million due to the sale
of five other income producing properties in 1997 and 1998. Management
believes that this trend of increased cash flow from property operations 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.
 
  Interest collected decreased to $807,000 in 1998 from $1.1 million in 1997.
This decrease was due to seven mortgage notes receivable being collected in
1997 and 1998 and the foreclosure of the collateral property securing another
note in 1998.
 
  Interest paid increased to $21.2 million in 1998 from $16.0 million in 1997.
An increase of $5.7 million was due to 33 properties being purchased on a
leveraged basis in 1997 and 1998 and refinancings and financings of
unencumbered properties during 1997 and 1998. This increase was partially
offset by a decrease of $231,000 due to properties sold in 1998. Interest paid
will continue to increase as the Company purchases additional properties on a
leveraged basis.
 
  Advisory and net income fee paid to affiliate increased to $4.1 million in
1998 from $1.8 million in 1997. This increase was due to the 1997 accrued net
income fee not being paid until 1998 and an additional $574,000 was due to an
increase in the advisory fee paid as a result of an increase in the Company's
gross assets, the basis for such fee.
 
  General and administrative expenses paid increased to $2.7 million in 1998
from $2.5 million in 1997. This increase was due to legal fees related to the
Olive and other litigation accrued in 1997 but not paid until 1998 and an
increase in advisory cost reimbursements.
 
  In 1997, the Company received an insurance settlement of $9.6 million
relating to 1995 hail storm and flood damage to the Republic Towers Office
Building in Dallas, Texas.
 
  The Company received distributions from equity investees operating cash flow
of $482,000 in 1998 and $687,000 in 1997. See NOTE 5. "INVESTMENT IN EQUITY
METHOD REAL ESTATE ENTITIES."
 
  In 1998, the Company received cash of $2.9 million from the collection of
four mortgage notes receivable and an additional $671,000 from the collection
of a mortgage note written off as uncollectible in a previous year. The
Company received net cash of a total of $81.1 million from new mortgage
borrowings and refinancings and
 
                                      21
<PAGE>
 
an additional $31.8 million, after debt payoffs, from property sales during
1998. In 1998, the Company expended $77.4 million in cash on property
purchases and made a total of $34.6 million in principal payments on its
mortgage debt.
 
  Scheduled principal payments on notes payable of $25.6 million are due in
1999. For those mortgages that mature in 1999, it is the Company's intention
to either seek to extend the due dates one or more years, or refinance the
debt on a long-term basis, or pay them when due. Management believes it will
continue to be successful in obtaining loan extensions or refinancings.
 
  As discussed in NOTE 3. "REAL ESTATE AND DEPRECIATION," during 1998, the
Company funded $1.9 million for purchase of the land for the construction cost
of the 260 unit Limestone Canyon Apartments in Austin, Texas. Construction
commenced in August 1998 and is expected to be completed in the fourth quarter
of 1999. The Company has obtained a financing commitment of $13.0 million for
construction of the apartment.
 
  During 1999, the Company has continued to be an active buyer, purchasing the
264 unit Vista Hills Apartments and a parcel of undeveloped land for a total
of $8.8 million. The Company paid $2.8 million in cash, with the remainder of
the purchase prices financed through mortgage debt. The Company derived the
cash portions of these purchases from its cash on hand at December 31, 1998.
See NOTE 18. "SUBSEQUENT EVENTS."
 
  In March 1999, the Company sold the 368 unit Mariner's Point Apartments in
St. Petersburg, Florida for $6.7 million, receiving net cash of $2.6 million.
See NOTE 18. "SUBSEQUENT EVENTS."
 
  Pursuant to a repurchase program originally announced on December 5, 1989,
Board of Directors has authorized the repurchase of a total of 687,000 shares
of the Company's Common Stock. As of March 5, 1999, a total of 409,765 shares
had been repurchased at a total cost to the Company of $3.3 million, 21,950
shares having been repurchased in 1998 at a total cost to the Company of
$336,000.
 
  During 1998, the Company declared and paid dividends of $2.3 million or $.60
per share.
 
  Management reviews the carrying values of the Company's properties and
mortgage notes receivable at least annually and whenever events or a change in
circumstances indicate that impairment may exist. Impairment is considered to
exist if, in the case of a property, the future cash flow from the property
(undiscounted and without interest) is less than the carrying amount of the
property. For notes receivable impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be
collected. If impairment is found to exist, a provision for loss is recorded
by a charge against earnings. The mortgage note receivable review includes an
evaluation of the collateral property securing such note. The property review
generally includes: (1) selective property inspections; (2) a review of the
property's current rents compared to market rents; (3) a review of the
property's expenses; (4) a review of maintenance requirements; (5) a review of
the property's cash flow; (6) discussions with the manager of the property;
and (7) a review of properties in the surrounding area.
 
Results of Operations
 
  1998 Compared to 1997. The Company's net income for 1998 was $6.9 million
compared to $12.6 million in 1997. The Company's 1998 net income included
gains on the sale of real estate of $12.6 million. The Company's 1997 net
income included gains on sale of real estate of $21.4 million. Fluctuations in
the components of the Company's revenues and expenses between 1998 and 1997
are discussed below.
 
  Rents increased $15.3 million in 1998 to $69.8 million compared to $54.5
million in 1997. An increase of $16.1 million was due to properties purchased
or obtained through foreclosure in 1997 and 1998; and $2.2 million was due to
increased occupancy and rental rates at the Company's apartments and
commercial properties primarily: Spa Cove Apartments, Arbor Pointe Apartments,
Woods Edge Apartments, Plaza Towers Office
 
                                      22
<PAGE>
 
Building, 74 New Montgomery Office Building, Waterstreet Office Building,
Parke Long Warehouse and Hartford Office Building. These increases were
partially offset by a decrease of $3.0 million due to properties sold in 1997
and 1998.
 
  Property operating expenses increased $5.9 million in 1998 to $38.3 million
as compared to $32.4 million in 1997. Of the increase, $10.0 million was due
to properties purchased in 1997 and 1998. This increase was partially offset
by a decrease of $4.0 million due to properties sold in 1997 and 1998.
 
  Rents and property operations expenses both are expected to increase in 1999
due to anticipated increases in rents at the Company's apartments, increased
occupancy of its commercial properties and as a result of a full year of
operations of the properties acquired during 1998 and in the first quarter of
1999.
 
  Interest income decreased to $807,000 in 1998 from $1.5 million in 1997. The
decrease in interest income was due to seven mortgage notes receivable being
collected in 1997 and 1998 and the foreclosure of the collateral property
securing another note in 1998. Interest income in 1999 is expected to
approximate 1998.
 
  Interest expense increased to $22.8 million in 1998 from $16.8 million in
1997. Of this increase, $5.8 million was attributable to properties purchased
in 1998 and 1997 and $984,000 was attributable to property financings and
refinancings during 1998 and 1997. These increases were partially offset by a
decrease of $759,000 due to properties sold and mortgages paid off in 1998 and
1997. Interest expense is expected to increase in 1999 due to anticipated
property refinancings and the properties purchased in the first quarter of
1999 on a leveraged basis.
 
  Depreciation increased to $10.7 million in 1998 from $9.6 million in 1997.
An increase of $2.0 million was attributable to property purchases in 1998 and
1997 and an increase of $522,000 was due to increased depreciation from
property additions and tenant improvements. These increases were partially
offset by decreases of $1.4 million due to properties sold in 1998 and 1997
and $21,000 due to assets becoming fully depreciated. Depreciation expense is
expected to increase in 1999 due to a full year of depreciation of properties
acquired in 1998 and the income producing property purchased in the first
quarter of 1999.
 
  Advisory and net income fees decreased to $2.5 million in 1998 from $2.8
million in 1997. The decrease was due to a decrease in the net income fee in
1998 due to a decrease in net income partially offset by an increase in the
advisory fee due to an increase in gross assets, the basis for the fee. The
advisory fee is expected to increase as the Company's asset base increases.
See NOTE 10. "ADVISORY AGREEMENT."
 
  General and administrative expenses decreased to $2.3 million in 1998 from
$2.6 million in 1997. The decrease was primarily due to a decrease in legal
fees related to the Olive and other litigation (see NOTE 15. "COMMITMENTS AND
CONTINGENCIES").
 
  In the fourth quarter of 1997, the Company recognized a provision for loss
of $1.3 million to reduce the carrying value of a shopping center to its
agreed sales price less estimated costs of sale. Sale of the property occurred
in March 1998.
 
  Equity in income of investees decreased to $288,000 in 1998 from $812,000 in
1997. Included in equity earnings in 1998 were gains on the sale of real
estate of $316,000, the Company's equity share of the gain recognized by an
equity partnership on the sale of its two apartments. Included in equity
earnings in 1997 were gains on the sale of real estate of $890,000, the
Company's equity share of the gain recognized by Income Opportunity Realty
Investors, Inc. ("IORI") on the sale of three of its apartments. The Company
expects its share of equity investees' income or losses to be minimal in 1999.
See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
 
  In 1998, the Company recognized gains totaling $12.6 million; a $2.1 million
previously deferred gain upon collection of a mortgage note receivable related
to a property sale that had been recorded under the cost recovery method,
$671,000 from the collection of a mortgage note receivable which had been
written off in a prior year,
 
                                      23
<PAGE>
 
$3.4 million from the sale of a shopping center in Dallas, Texas, $219,000
from the sale of an industrial warehouse in Dallas, Texas, $5.9 million from
the sale of an office building in San Diego, California and $350,000 from the
sale of 19 acres of foreclosed land in Greensboro, North Carolina. In 1997,
the Company recognized gains totaling $21.4 million; $1.4 million from the
sale of a .9976 acre parcel of land in Dallas, Texas and $19.4 million from
the sale of an office building in Dallas, Texas, $55,000 from the sale of a
foreclosed single family residence in Scottsdale, Arizona and $554,000 from
the sale of a shopping center in San Antonio, Texas. See NOTE 3. "REAL ESTATE
AND DEPRECIATION."
 
  1997 Compared to 1996. The Company's net income for 1997 was $12.6 million
compared to a net loss of $8.1 million in 1996. The Company's 1997 net income
included gains on sale of real estate of $21.4 million. The Company's 1996 net
loss included gains on sale of real estate of $1.6 million. Fluctuations in
the components of the Company's revenues and expenses between the 1997 and
1996 are described below.
 
  Rents increased to $54.5 million in 1997 from $45.4 million in 1996. An
increase of $6.9 million in rents was due to property purchases in 1996 and
1997; and $3.1 million was due to increased occupancy and rental rates at the
Company's residential and commercial properties primarily: Plaza Tower Office
Building, a 1% increase; Waterstreet Office Building, a 2% increase; Institute
Place Office Building, a 10% increase; 74 New Montgomery Office Building, a 2%
increase; Corporate Center at Beaumeade Office Building, a 2% increase; and
Majestic Inn, a 3% increase. These increases were partially offset by a
decrease of $865,000 due to properties sold in 1997.
 
  Property operating expenses increased to $32.4 million in 1997 from $28.5
million in 1996. Of this increase, $4.3 million was due to properties
purchased in 1996 and 1997. This increase was partially offset by a decrease
of $504,000 due to properties sold in 1997.
 
  Interest income of $1.5 million in 1997 approximated that of 1996.
 
  Interest expense increased to $16.8 million in 1997 from $15.0 million in
1996. Of this increase $1.6 million was attributable to properties purchased
in 1997 and $316,000 was attributable to property financings and refinancings
during 1997. These increases were partially offset by decreases of $73,000 due
to properties sold and mortgages paid off and $71,000 due to a decrease in
interest rates on variable interest rate debt.
 
  Depreciation increased to $9.6 million in 1997 from $8.5 million in 1996. An
increase of $752,000 was attributable to property purchases and an increase of
$515,000 was due to increased depreciation from property additions and tenant
improvements. These increases were partially offset by decreases of $63,000
due to properties sold and $88,000 due to assets becoming fully depreciated.
 
  Advisory fee expense of $1.8 million in 1997 approximated that of 1996.
 
  General and administrative expenses decreased to $2.6 million in 1997 from
$2.7 million in 1996. The decrease was due to a decrease in legal fees related
to the Olive and other litigation (see NOTE 15. "COMMITMENTS AND
CONTINGENCIES") partially offset by an increase in advisory cost
reimbursements and other professional fees.
 
  As described in "Liquidity and Capital Resources" above, in 1997 the Company
received an insurance settlement of $9.6 million. In 1996, the Company
received a litigation settlement of $1.5 million.
 
  In the fourth quarter of 1997, the Company recognized a provision for loss
of $1.3 million to reduce the carrying value of a shopping center to its
agreed sales price less estimated costs of sale. Sale of the property was
completed in March 1998. 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.
 
 
                                      24
<PAGE>
 
  Equity in income of investees was $812,000 in 1997 compared to a loss of
$20,000 in 1996. Included in equity earnings in 1997 are gains on the sale of
real estate of $890,000, the Company's equity share of the gain recognized by
IORI on the sale of three of its apartments.
 
  In 1997, the Company recognized gains totaling $21.4 million, $1.4 million
from the sale of a .9976 acre parcel of land and $19.4 million from the sale
of an office building, both in Dallas, Texas, $55,000 from the sale of a
foreclosed single family residence in Scottsdale, Arizona and $554,000 from
the sale of a shopping center in San Antonio, Texas. See NOTE 3. "REAL ESTATE
AND DEPRECIATION."
 
  In 1996, the Company recognized gains totaling $1.6 million; $218,000 from
the sale of Cheyenne Mountain land, $1.4 million from the sale of Park Forest
Apartments and $56,000 from the sale of Moss Creek land. In September 1996,
the Company recognized a loss of $63,000 from the sale of Byron land. See NOTE
3. "REAL ESTATE AND DEPRECIATION."
 
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 for personal
injury associated with such materials.
 
  Management is not aware of any environmental liability relating to the above
matters that would have a material adverse effect on 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 tend to fluctuate proportionately with
inflationary increases and decreases in housing costs. Fluctuations in the
rate of inflation also affect sales values of properties and the ultimate gain
to be realized from property sales. To the extent that inflation affects
interest rates, the Company's earnings from short-term investments, the cost
of new financings as well as the cost of variable interest rate debt will be
affected.
 
Tax Matters
 
  For the years 1998, 1997 and 1996, the Company elected and in the opinion of
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.
 
Year 2000
 
  Basic Capital Management, Inc. ("BCM"), the Company's advisor, has informed
management that its computer hardware operating system and computer software
have been certified as year 2000 compliant.
 
  Further, Carmel Realty Services, Ltd. ("Carmel Ltd."), an affiliate of BCM
that performs property management services for the Company's properties, has
informed management that effective January 1, 1999, it began using year 2000
compliant computer hardware and property management software for the Company's
commercial properties. With regard to the Company's apartments, Carmel, Ltd.
has informed management that
 
                                      25
<PAGE>
 
its subcontractors either have in place or will have in place in the first
quarter of 1999, year 2000 compliant computer hardware and property management
software.
 
  The Company has not incurred, nor does it expect to incur, any costs related
to its computer hardware and accounting and property management software being
modified, upgraded or replaced in order to make them year 2000 compliant. Such
costs have been or will be borne by either BCM, Carmel, Ltd. or the property
management subcontractors of Carmel, Ltd.
 
  Management has completed its evaluation of the Company's computer controlled
building systems, such as security, elevators, heating and cooling, etc., to
determine what systems are not year 2000 compliant. Management believes that
necessary modifications to such systems are insignificant and do not require
significant expenditures, as such enhanced operating systems are readily
available.
 
  The Company has or will have in place the year 2000 compliant systems that
will allow it to operate. The risks the Company faces are that certain of its
vendors will not be able to supply goods or services and that financial
institutions and taxing authorities will not be able to accurately apply
payments made to them. The Company believes that other vendors are readily
available and that financial institutions and taxing authorities will, if
necessary, apply monies received manually. The likelihood of the above having
a significant impact on the Company's operations is negligible.
 
                                      26
<PAGE>
 
   
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK     
   
  The Company's future operations, cash flow and fair values of financial
instruments are partially dependent upon the then existing market interest
rates and market equity prices. Market risk is the changes in the market rates
and prices, and the affect of the changes on the future operations of the
Company. The Company manages its market risk by matching the property's
anticipated net operating income to an appropriate financing.     
   
  The following table contains only those exposures that existed at December
31, 1998. Anticipation of exposures of risk on positions that could possibly
arise was not considered. The Company's ultimate interest rate risk and its
affect on the operations will depend on future capital market exposures, which
cannot be anticipated with a probable assurance level. Dollars in Thousands.
    
<TABLE>   
<CAPTION>
Assets
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
Non-trading Instruments-
 Equity Price Risk
Notes receivable
  Variable interest
   rate-fair value                                                                $ 1,322
<CAPTION>
                           1999     2000    2001     2002     2003    Thereafter  Total
                          -------  ------  -------  -------  -------  ---------- --------
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
  Instrument's
   maturities             $   333  $  --   $  --12  $    12  $   --    $  1,369  $  1,702
  Instrument's
   amortization.........      --      --       --       --       --         --        --
   Interest.............      130     130      130      130      130         65       715
   Average rate.........      8.7%    9.5%     9.5%     9.5%     9.5%       9.5%      --
Fixed interest rate-fair
 value                                                                           $    804
<CAPTION>
                           1999     2000    2001     2002     2003    Thereafter  Total
                          -------  ------  -------  -------  -------  ---------- --------
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
  Instrument's
   maturities             $   593  $   78  $   --   $   --   $   --    $    --   $    671
  Instrument's
   amortization.........        4       1      --       --       --         --          5
   Interest.............        7       3      --       --       --         --         10
   Average rate.........      8.5%    7.0%     --       --       --         --        --
<CAPTION>
Liabilities
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
Non-trading Instruments-
 Equity Price Risk
Notes payable                                                                     $53,137
  Variable interest
   rate-fair value
<CAPTION>
                           1999     2000    2001     2002     2003    Thereafter  Total
                          -------  ------  -------  -------  -------  ---------- --------
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
  Instrument's
   maturities             $ 4,887  $5,504  $11,718  $ 5,134  $   --    $ 24,583  $ 51,826
  Instrument's
   amortization.........    1,963     903      735      684      746      2,028     7,059
   Interest.............    4,369   4,787    4,198    3,052    2,517      3,496    22,419
   Average rate.........      7.9%   13.1%    10.7%    10.1%     9.3%       9.0%      --
Fixed interest rate-fair
 value                                                                           $221,890
<CAPTION>
                           1999     2000    2001     2002     2003    Thereafter  Total
                          -------  ------  -------  -------  -------  ---------- --------
<S>                       <C>      <C>     <C>      <C>      <C>      <C>        <C>
  Instrument's
   maturities             $15,787  $8,359  $18,491  $23,037  $10,206   $106,297  $182,177
  Instrument's
   amortization.........    2,586   2,597    2,873      579    2,554     28,341    39,530
   Interest.............   17,810  18,673   17,665   15,700   13,527     68,794   152,169
   Average rate.........      8.4%    9.5%     9.7%     9.9%     9.6%       8.7%      --
</TABLE>    
 
 
                                      27
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>   
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Report of Independent Certified Public Accountants.......................   29
Consolidated Balance Sheets--December 31, 1998 and 1997..................   30
Consolidated Statements of Operations--Years Ended December 31, 1998,
 1997 and 1996...........................................................   31
Consolidated Statements of Stockholders' Equity--Years Ended December 31,
 1998, 1997 and 1996.....................................................   32
Consolidated Statements of Cash Flows--Years Ended December 31, 1998,
 1997 and 1996...........................................................   33
Notes to Consolidated Financial Statements...............................   35
Schedule III--Real Estate and Accumulated Depreciation...................   50
Schedule IV--Mortgage Loans on Real Estate...............................   55
</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.
 
                                      28
<PAGE>
 
              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,
1998 and 1997 and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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,
1998 and 1997, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, 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 24, 1999
 
                                      29
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                            December 31,
                                                       ------------------------
                                                          1998         1997
                                                       -----------  -----------
                                                       (dollars in thousands,
                                                          except per share)
<S>                                                    <C>          <C>
                       Assets
Notes and interest receivable
 Performing..........................................  $     1,429  $     4,388
 Nonperforming, nonaccruing..........................          950          450
                                                       -----------  -----------
                                                             2,379        4,838
Less--allowance for estimated losses.................         (886)        (891)
                                                       -----------  -----------
                                                             1,493        3,947
Foreclosed real estate held for sale.................        1,356        1,356
Real estate held for sale, net of accumulated
 depreciation ($1,350 in 1997).......................          --         3,630
                                                       -----------  -----------
                                                             1,356        4,986
Real estate held for investment, net of accumulated
 depreciation ($61,241 in 1998 and $55,487 in 1997)..      347,389      269,845
Investment in real estate entities...................        3,458        4,333
Cash and cash equivalents............................       10,505       24,733
Other assets (including $1,325 in 1998 and $497 in
 1997 from affiliates)...............................       18,002       11,291
                                                       -----------  -----------
                                                       $   382,203  $   319,135
                                                       ===========  ===========
        Liabilities and Stockholders' Equity
Liabilities
Notes and interest payable...........................  $   282,688  $   222,029
Other liabilities (including $62 in 1998 and $1,157
 in 1997 to affiliates)..............................        8,383       10,973
                                                       -----------  -----------
                                                           291,071      233,002
Commitments and contingencies
Stockholders' equity
Preferred Stock
 Series A; $.01 par value; authorized, 6,000 shares;
  issued and outstanding 5,829 shares in 1998
  (liquidation preference $583)......................          --           --
Common Stock, $.01 par value; authorized, 10,000,000
 shares; issued and outstanding 3,878,463 shares in
 1998 and 3,889,200 shares in 1997...................           39           39
Paid-in capital......................................      218,087      217,688
Accumulated distributions in excess of accumulated
 earnings............................................     (126,994)    (131,594)
                                                       -----------  -----------
                                                            91,132       86,133
                                                       -----------  -----------
                                                       $   382,203  $   319,135
                                                       ===========  ===========
</TABLE>
 
  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.
 
                                       30
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                       For the Years Ended December 31,
                                   -------------------------------------------
                                       1998           1997           1996
                                   -------------  -------------  -------------
                                   (dollars in thousands, except per share)
<S>                                <C>            <C>            <C>
Revenues
 Rents............................ $      69,829  $      54,462  $      45,405
 Interest.........................           807          1,499          1,473
                                   -------------  -------------  -------------
                                          70,636         55,961         46,878
Expenses
 Property operations (including
  $2,753 in 1998, $2,262 in 1997
  and $1,879 in 1996 to
  affiliates).....................        38,282         32,424         28,491
 Interest.........................        22,797         16,765         14,999
 Depreciation.....................        10,691          9,578          8,461
 Advisory fee to affiliate........         1,962          1,807          1,784
 Net income fee to affiliate......           558          1,022            --
 General and administrative
  (including $1,121 in 1998,
  $1,187 in 1997 and $1,047 in
  1996 to affiliates).............         2,312          2,645          2,685
 Litigation settlement............           --             --          (1,500)
 Provision for losses.............           --           1,337          1,579
                                   -------------  -------------  -------------
                                          76,602         65,578         56,499
                                   -------------  -------------  -------------
(Loss) from operations............        (5,966)        (9,617)        (9,621)
Equity in income (loss) of
 investees........................           288            812            (20)
Gain on sale of real estate.......        12,584         21,404          1,579
                                   -------------  -------------  -------------
Net income (loss).................         6,906         12,599         (8,062)
Preferred dividend requirement....            (1)           --             --
                                   -------------  -------------  -------------
Net income (loss) applicable to
 Common shares.................... $       6,905  $      12,599  $      (8,062)
                                   =============  =============  =============
Earnings per share
 Net income (loss) applicable to
  Common shares................... $        1.78  $        3.22  $       (2.02)
                                   =============  =============  =============
Weighted average common shares
 used in computing earnings per
 share............................     3,876,797      3,907,221      3,994,687
                                   =============  =============  =============
</TABLE>
 
 
  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.
 
                                       31
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                                Accumulated
                                                               Distributions
                         Series A    Common Stock              in Excess of
                         Preferred ----------------- Paid-in    Accumulated  Stockholders'
                           Stock    Shares    Amount Capital     Earnings       Equity
                         --------- ---------  ------ --------  ------------- -------------
                                    (dollars in thousands, except per share)
<S>                      <C>       <C>        <C>    <C>       <C>           <C>
Balance, January 1,
 1996...................   $ --    4,012,275   $ 40  $219,036    $(130,036)     $89,040
Repurchase of Common
 Stock..................     --      (85,830)    (1)     (903)         --          (904)
Dividends ($.28 per
 share).................     --          --     --        --        (1,115)      (1,115)
Net (loss)..............     --          --     --        --        (8,062)      (8,062)
                           -----   ---------   ----  --------    ---------      -------
Balance, December 31,
 1996...................     --    3,926,445     39   218,133     (139,213)      78,959
Fractional shares.......     --          (18)   --        --           --           --
Repurchase of Common
 Stock..................     --      (37,227)   --       (445)         --          (445)
Dividends ($.28 per
 share).................     --          --     --        --        (1,090)      (1,090)
Special dividend ($1.00
 per share) declared....     --          --     --        --        (3,890)      (3,890)
Net income..............     --          --     --        --        12,599       12,599
                           -----   ---------   ----  --------    ---------      -------
Balance, December 31,
 1997...................     --    3,889,200     39   217,688     (131,594)      86,133
Issuance of Series A
 Preferred Stock 5,829
 shares.................     --          --     --        583          --           583
Repurchase of Common
 Stock..................     --      (21,950)   --       (336)         --          (336)
Sale of Common Stock
 under dividend
 reinvestment plan......     --       11,213    --        152          --           152
Dividends ($.60 per
 share).................     --          --     --        --        (2,306)      (2,306)
Net income..............     --          --     --        --         6,906        6,906
                           -----   ---------   ----  --------    ---------      -------
Balance, December 31,
 1998...................   $ --    3,878,463   $ 39  $218,087    $(126,994)     $91,132
                           =====   =========   ====  ========    =========      =======
</TABLE>
 
 
  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.
 
                                       32
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                             For the Years Ended December 31,
                                             ----------------------------------
                                                1998        1997        1996
                                             ----------  ----------  ----------
                                                  (dollars in thousands)
<S>                                          <C>         <C>         <C>
Cash Flows from Operating Activities
 Rents collected...........................  $   69,307  $   57,144  $   43,401
 Interest collected........................         807       1,098       1,232
 Interest paid.............................     (21,179)    (16,016)    (14,167)
 Payments for property operations
  (including $2,753 in 1998, $2,262 in 1997
  and $1,879 in 1996 to affiliates)........     (39,474)    (40,984)    (30,738)
 Advisory and net income fee paid to
  affiliate................................      (4,125)     (1,807)     (1,784)
 General and administrative expenses paid
  (including $1,121 in 1998, $1,187 in 1997
  and $1,047 in 1996 to affiliates)........      (2,705)     (2,457)     (2,785)
 Distributions from operating cash flow of
  equity investees.........................         482         687         649
 Insurance/litigation settlement...........         --        9,633       1,500
 Other.....................................         306       2,684        (612)
                                             ----------  ----------  ----------
  Net cash provided by (used in) operating
   activities..............................       3,419       9,982      (3,304)
Cash Flows from Investing Activities
 Collections on notes receivable...........       2,892       5,048         952
 Acquisition of notes receivable...........        (149)        --          --
 Real estate improvements..................      (9,595)     (5,767)     (3,406)
 Proceeds from sale of real estate.........      31,807      29,081       8,922
 Deposits on pending purchase..............      (3,796)     (1,115)        --
 Deferred merger costs.....................        (519)        --          --
 Acquisitions of real estate (including
  $3,468 in 1998, $2,966 in 1997 and $339
  in 1996 to affiliates)...................     (77,395)    (46,433)     (7,689)
 Distributions from investing cash flow of
  equity investees.........................         701       1,101         --
 Contributions to equity investees.........         (21)       (731)       (161)
                                             ----------  ----------  ----------
  Net cash (used in) investing activities..     (56,075)    (18,816)     (1,382)
Cash Flows from Financing Activities
 Payments on notes payable.................  $  (34,555) $  (37,095) $  (14,545)
 Proceeds from notes payable...............      81,058      73,817      13,550
 Reimbursements to advisor.................         (61)       (450)       (142)
 Dividends paid............................      (6,196)     (1,090)     (1,115)
 Shares of Common Stock repurchased........        (336)       (445)       (904)
 Deferred financing costs..................      (1,634)     (2,130)       (818)
 Sale of Common stock under dividend
  reinvestment plan........................         152         --          --
                                             ----------  ----------  ----------
  Net cash provided by (used in) financing
   activities..............................      38,428      32,607      (3,974)
                                             ----------  ----------  ----------
Net increase (decrease) in cash and cash
 equivalents...............................     (14,228)     23,773      (8,660)
Cash and cash equivalents, beginning of
 year......................................      24,733         960       9,620
                                             ----------  ----------  ----------
Cash and cash equivalents, end of year.....  $   10,505  $   24,733  $      960
                                             ==========  ==========  ==========
</TABLE>
 
 
  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.
 
                                       33
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
               CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
 
<TABLE>
<CAPTION>
                                              For the Years Ended December 31,
                                              ----------------------------------
                                                 1998        1997        1996
                                              ----------  ----------  ----------
                                                   (dollars in thousands)
<S>                                           <C>         <C>         <C>
Reconciliation of net income (loss) to net
 cash provided by (used in) operating
 activities
 Net income (loss)..........................  $    6,906  $   12,599  $   (8,062)
 Adjustments to reconcile net income (loss)
  to net cash provided by (used in)
  operating activities
 Depreciation and amortization..............      11,488      10,005       8,857
 Provision for losses.......................         --        1,337       1,579
 Equity in (income) loss of equity
  investees.................................        (288)       (812)         20
 Gain on sale of real estate................     (12,584)    (21,404)     (1,579)
 Distributions from operating cash flow of
  equity investees..........................         482         687         649
 (Increase) in interest receivable..........         --         (244)         (5)
 (Increase) decrease in other assets........      (2,036)      5,305       1,901
 Increase in interest payable...............         821         165         200
 Increase (decrease) in other liabilities...      (1,370)      2,344      (6,864)
                                              ----------  ----------  ----------
  Net cash provided by (used in) operating
   activities...............................  $    3,419  $    9,982  $   (3,304)
                                              ==========  ==========  ==========
Schedule of noncash investing and financing
 activities
 Carrying value of real estate acquired
  through foreclosure in satisfaction of
  notes receivable (with carrying value of
  $2,514 in 1998 and $696 in 1996)..........  $    2,514  $      --   $      691
 Notes payable from purchase of real
  estate....................................      13,607      13,606         --
 Series A Preferred Stock issued in
  conjunction with purchase of real estate..         583         --          --
</TABLE>
 
 
 
  The accompanying notes are an integral part of these Consolidated Financial
                                  Statements.
 
                                       34
<PAGE>
 
                    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 1997 have been reclassified to conform to the 1998
presentation.
 
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 invests in mortgage loans on
real estate, including first, wraparound and junior mortgage loans.
 
Proposed Merger with Continental Mortgage and Equity Trust
 
  On September 25, 1998, the Company and Continental Mortgage and Equity Trust
("CMET") jointly announced the agreement of their respective Boards for the
Company to acquire CMET. Under the proposal, the Company would acquire all of
CMET's outstanding shares of beneficial interest, in a tax free exchange, for
shares of its Common Stock. The Company will issue 1.181 shares of its Common
Stock for each outstanding share of beneficial interest of CMET. Upon the
exchange of shares CMET would merge into the Company. The share exchange and
merger are subject to a vote of shareholders of both entities. Approval
requires the vote of a majority of the shareholders holding a majority of
CMET's outstanding shares of beneficial interest. As of March 5, 1999, the
Company's advisor and its affiliates held shares representing approximately
57.4% of the outstanding shares of CMET and approximately 44.7% of the
outstanding shares of the Company. A date for the special meeting of the
shareholders to vote on the merger proposal has not been set. The Company has
the same Board and advisor as CMET.
 
  Basis of consolidation. The Consolidated Financial Statements include the
accounts of TCI and controlled subsidiaries and partnerships. All significant
intercompany transactions and balances have been eliminated.
 
  Accounting estimates. In the preparation of the Consolidated Financial
Statements in conformity with generally accepted accounting principles it was
necessary for 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
 
                                      35
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
receivable to the extent that the Company's investment in the note exceeds the
Company's estimate of fair value of the collateral securing such note.
 
  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 1 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 is 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 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 partnerships which it
does not control and for its investment in the shares of common stock of
Income Opportunity Realty Investors, Inc., ("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 its proportionate share of the investee's
operating losses and distributions received.
 
  Operating segments. Management has determined that the Company's reportable
operating segments are those that are based on the Company's method of
internal reporting, which disaggregates its operations by type of real estate.
 
  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
 
                                      36
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
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. Income (loss) per share is presented in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share."
Income (loss) per share is computed based upon the weighted average number of
shares of Common Stock outstanding during each year.
 
NOTE 2. NOTES AND INTEREST RECEIVABLE
 
  Notes and interest receivable consisted of the following:
 
<TABLE>
<CAPTION>
                                                   1998              1997
                                             ----------------  ----------------
                                             Estimated         Estimated
                                               Fair     Book     Fair     Book
                                               Value   Value     Value   Value
                                             --------- ------  --------- ------
   <S>                                       <C>       <C>     <C>       <C>
   Notes receivable
    Performing..............................  $1,407   $1,429   $7,264   $4,389
    Nonperforming, nonaccruing..............     719      950    1,400      449
                                              ------   ------   ------   ------
                                              $2,126    2,379   $8,664    4,838
                                              ======            ======
   Interest receivable......................                3                 3
   Unamortized (discounts)..................               (3)               (3)
                                                       ------            ------
                                                       $2,379            $4,838
                                                       ======            ======
</TABLE>
 
  The Company does not recognize interest income on nonperforming notes
receivable. For the years 1998, 1997 and 1996, unrecognized interest income on
nonperforming notes totaled $175,000, $257,000 and $424,000, respectively.
 
  Performing notes receivable at December 31, 1998, mature from 1999 through
2004 with interest rates ranging from 8.75% to 12.0% per annum, with a
weighted average rate of 12.0%. Discounts were based on imputed interest rates
at the time of origination. Notes receivable are generally nonrecourse and are
generally collateralized by real estate. Scheduled principal maturities of
$930,000 are due in 1999.
 
  In 1998, $2.9 million was collected in settlement of four mortgage notes and
$49,000 in principal payments were received.
 
  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
residential and commercial subdivisions in Maumelle, Arkansas secured by a
first mortgage 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 for, among other things,
the payment by the borrower of $2.5 million in cash and the acceptance of a
new $1.4 million note secured by 36.3 acres of commercial land. Such note
matured in January 1996. In April 1998, the Company received $2.1 million in
full settlement of its note and accrued but unpaid interest. The original sale
had been recorded under the cost recovery method with the gain being deferred
until the note receivable was collected. Accordingly, the previously deferred
gain of $2.1 million was recognized on collection of the note.
 
 
                                      37
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  At December 31, 1997, the Company held a wraparound mortgage note with a
principal balance of $2.5 million, secured by a K-Mart in Cary, North
Carolina. In February 1998, the Company was informed that the first lien
mortgage in the amount of $2.0 million was in default. To protect its
interest, the Company foreclosed on the property in August 1998 and refinanced
the first lien mortgage in the amount of $2.0 million, paying $265,000 in cash
to complete the refinancing. No loss was recognized on the foreclosure as the
fair value of the property exceeded the carrying value of the note receivable.
See NOTE 6. "NOTES AND INTEREST PAYABLE."
 
  In July 1998, a mortgage note receivable which had been written off in a
prior year, was collected. A gain of $671,000 was recognized.
 
  In August 1998, a mortgage note receivable with a principal balance of $2.0
million and a carrying value of $207,000, secured by a second lien on a hotel
in Lake Charles, Louisiana became delinquent. To protect its interest, the
Company purchased the first lien mortgage for $149,000. Foreclosure
proceedings have commenced and title to the property is expected to be
received in the second quarter of 1999. No loss is expected to be incurred on
foreclosure, as the estimated fair value of the property exceeds the carrying
value of the mortgage notes.
 
  In 1997, the Company accepted discounted payoffs totaling $4.9 million in
settlement of two mortgage notes receivable with a combined principal balance
of $5.0 million. The Company recognized no loss on the note settlements in
excess of the reserves previously established.
 
NOTE 3. REAL ESTATE AND DEPRECIATION
 
  In January 1998, in separate transactions, the Company purchased (1) the 188
unit Mountain Plaza Apartments in El Paso, Texas, for $4.0 million, paying
$1.0 million in cash and obtaining mortgage financing of $3.0 million; (2) the
212 unit Hunters Glen Apartments in Midland, Texas, for $2.5 million, paying
$600,000 in cash and obtaining seller financing of the remaining $1.9 million
of the purchase price; (3) the Laws Street land, a 1.41 acre parcel of land in
Dallas, Texas, for $1.9 million in cash; and, (4) the 204 unit Bent Tree
Garden Apartments in Addison, Texas, for $8.1 million, paying $1.7 million in
cash and obtaining mortgage financing of $6.4 million.
 
  In February 1998, in separate transactions, the Company purchased (1)
Parkway North, a 71,041 sq. ft. office building in Dallas, Texas, for $5.4
million, paying $1.5 million in cash and obtaining mortgage financing of $3.9
million; and, (2) the Lemmon Carlisle land, a 2.14 acre parcel of land in
Dallas, Texas, for $3.4 million in cash.
 
  In February 1998, the Company obtained through foreclosure a 92,033 sq. ft.
K-Mart in Cary, North Carolina. As of December 31, 1998, the property was
classified as "real estate held for investment." See NOTE 2. "NOTES AND
INTEREST RECEIVABLE."
 
  In March 1998, the Company purchased the Plaza on Bachman Creek, a 80,278
sq. ft. retail/office complex in Dallas, Texas, for $3.5 million, paying $1.1
million in cash and obtaining mortgage financing of $2.4 million.
 
  Also in March 1998, the Company sold Shaws Plaza, a 103,482 sq. ft. shopping
center in Sharon, Massachusetts, for $3.8 million in cash. The Company
received net cash of $1.1 million after paying off $2.6 million in mortgage
debt and the payment of various closing costs. No gain or loss was recognized
on the sale.
 
  In April 1998 and May 1998, the Company purchased in a single transaction
the 178 unit Ashton Way Apartments in Midland, Texas, and the 92 unit 4400
Apartments, also in Midland, Texas, the 232 unit Woodview Apartments in
Odessa, Texas, for a total of $6.8 million. The Company paid a total of $1.5
million in cash and obtained mortgage financing secured by all three
properties totaling $5.3 million.
 
 
                                      38
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  In May 1998, in separate transactions, the Company purchased (1) the Eagle
Crest land, a 22.99 acre parcel in Farmers Branch, Texas, for $2.5 million in
cash; and, (2) the 172 unit Fountains of Waterford Apartments in Midland,
Texas, for $1.5 million, paying $425,000 in cash, assuming an existing
mortgage of $584,000 and obtaining seller financing of $491,000.
 
  Also in May 1998, the Company purchased in a single transaction, Daley
Plaza, a 62,425 sq. ft. office building and View Ridge, a 25,062 sq. ft.
office building, both in San Diego, California, for a total of $6.5 million.
The Company paid $1.7 million in cash and obtained mortgage financing totaling
$4.8 million.
 
  In June 1998, the Company purchased the Atrium, a 74,603 sq. ft. office
building in Palm Beach, Florida, for $5.4 million, paying $1.3 million in cash
and obtaining mortgage financing of $4.1 million.
 
  In July 1998, the Company purchased Valley Rim, a 54,194 sq. ft. office
building in San Diego, California, for $5.1 million, paying $1.4 million in
cash and obtaining mortgage financing of $3.7 million.
 
  Also in July 1998, the Company purchased the Limestone Canyon land, a 27
acre parcel of unimproved land in Austin, Texas, for $1.8 million in cash. In
conjunction with the purchase, the Company obtained a financing commitment of
$13.0 million for the construction of a 260 unit apartment on the site.
Construction commenced in August 1998 and is expected to be completed in the
fourth quarter of 1999.
 
  In 1997, Montgomery Ward ("Ward"), a tenant at the Northtown Mall, a 354,174
sq. ft. shopping center in Dallas, Texas, filed for bankruptcy protection. In
an attempt to keep the Ward's lease from being sold, Northtown Mall was placed
in administrative bankruptcy. Ward's Northtown Mall lease, as well as other
Ward leases, were, however, sold for the benefit of the Ward bankruptcy
estate. In September 1998, the Company bought back the lease concurrent with
the $15.6 million sale of Northtown Mall. The Company received net cash of
$12.1 million after paying off $2.5 million in mortgage debt, $900,000 for the
Ward lease and the payment of various closing costs. A gain of $3.4 million
was recognized on the sale.
 
  Also in September 1998, the Company sold Chesapeake Ridge, a 100,484 sq. ft.
office building in San Diego, California, for $13.2 million, receiving net
cash of $7.6 million after paying off $5.3 million of mortgage debt and the
payment of various closing costs. A gain of $5.9 million was recognized on the
sale.
 
  In October 1998, the Company sold Denton Drive, a 123,800 sq. ft. industrial
warehouse in Dallas, Texas, for $1.2 million, receiving net cash of $845,000
after paying off $309,000 in mortgage debt and the payment of various closing
costs. A gain of $219,000 was recognized on the sale.
 
  Also in October 1998, the Company purchased the 208 unit Cliffs of Eldorado
Apartments in McKinney, Texas, for $12.8 million, paying $1.6 million in cash,
assuming the existing mortgage of $10.6 million and issuing 5,829 shares of
Series A Cumulative Convertible Preferred Stock with a total liquidation value
of $583,000.
 
  Further in October 1998, the Company sold approximately 19 acres of
foreclosed land held for sale in Greensboro, North Carolina, for $375,000 in
cash, receiving net cash of $356,000 after the payment of various closing
costs. A gain of $350,000 was recognized on the sale.
 
  In December 1998, the Company purchased the assets of the Neighborhood Inns
of Chicago, consisting of three hotels in Chicago, Illinois, the Belmont with
45 rooms, the Brompton with 52 rooms and the Surf with 55 rooms, for $11.6
million. The Company paid $2.3 million in cash and obtained mortgage financing
secured by all three properties of $9.2 million.
 
 
                                      39
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Also in December 1998, the Company purchased the 80 unit Southgreen
Apartments in Bakersfield, California, for $3.6 million, paying $1.1 million
in cash and obtaining mortgage financing of $2.5 million.
 
  In 1997, the Company purchased three commercial properties for a total of
$12.6 million, ten apartments with a total of 1,757 units, for a total of
$42.1 million, an industrial warehouse for $4.7 million and a parcel of
unimproved land for $11.0 million. In connection with the purchases, the
Company either assumed existing mortgage debt or obtained new mortgage debt
totaling $49.5 million with the remainder of the purchase prices paid in cash.
Also in 1997, the Company sold three commercial properties for $27.1 million,
a parcel of land for $2.7 million, and a foreclosed single family residence
for $778,000. The Company received net cash of $27.8 million from the sales
after paying off $2.0 million in mortgage debt. In conjunction with such
sales, gains totaling $21.4 million were recognized.
 
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
 
  Activity in the allowance for estimated losses on notes and interest
receivable was as follows:
 
<TABLE>
<CAPTION>
                                                             1998  1997   1996
                                                             ----  ----  ------
     <S>                                                     <C>   <C>   <C>
     Balance January 1,..................................... $891  $926  $1,049
      Amounts charged off...................................   (5)  (35)   (123)
                                                             ----  ----  ------
     Balance December 31,................................... $886  $891  $  926
                                                             ====  ====  ======
</TABLE>
 
NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES
 
  Investments in equity method real estate entities consist of the following:
 
<TABLE>
<CAPTION>
                                                                  1998    1997
                                                                 ------  ------
     <S>                                                         <C>     <C>
     Income Opportunity Realty Investors, Inc. ("IORI")......... $  466  $  853
     Tri-City Limited Partnership ("Tri-City")..................  3,624   4,146
     Nakash Income Associates ("NIA")...........................   (717)   (770)
     Other......................................................     85     104
                                                                 ------  ------
                                                                 $3,458  $4,333
                                                                 ======  ======
</TABLE>
 
  The Company owns an approximate 22.7% interest in IORI, a publicly held Real
Estate Investment Trust ("REIT"), having a market value of $2.3 million at
December 31, 1998. At December 31, 1998, IORI had total assets of $88.7
million and owned four apartments in Texas and ten office buildings (six in
California, one in Florida, two in Texas and one in Virginia).
 
  The Company owns a non-controlling combined 63.7% general and limited
partner interest in Tri-City which owns three commercial properties in Texas,
consisting of two office buildings and a shopping center. In May 1998, Tri-
City sold its' two apartments for $3.3 million in cash, receiving net cash of
$1.4 million after paying off $1.9 million in mortgage debt and the payment of
various closing costs. The Company received a distribution of $701,000 of such
net cash. Tri-City recognized a gain of $496,000 on the sale of which the
Company's equity share was $316,000. 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 owns a non-controlling 60% general partner interest and IORI
owns a 40% general partner interest in NIA, which owns a wraparound mortgage
note receivable. The NIA partnership agreement requires the consent of both
the Company and IORI for any material changes in the operations of NIA.
 
                                      40
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  Set forth below are summarized financial data for the entities accounted for
using the equity method:
 
<TABLE>
<CAPTION>
                                                            1998      1997
                                                          --------  --------
   <S>                                                    <C>       <C>
   Real estate, net of accumulated depreciation ($12,117
    in 1998 and $9,967 in 1997).......................... $ 93,165  $ 94,145
   Notes receivable......................................      902     2,912
   Other assets..........................................    5,296     7,272
   Notes payable.........................................  (65,115)  (68,155)
   Other liabilities.....................................   (5,113)   (4,455)
                                                          --------  --------
   Partners' capital..................................... $ 29,135  $ 31,719
                                                          ========  ========
</TABLE>
 
<TABLE>
<CAPTION>
                                                      1998     1997     1996
                                                     -------  -------  -------
   <S>                                               <C>      <C>      <C>
   Rents and interest income........................ $18,062  $19,652  $12,319
   Depreciation.....................................  (2,703)  (2,139)  (1,685)
   Operating expenses...............................  (9,202)  (9,485)  (7,927)
   Interest expense.................................  (6,274)  (4,579)  (3,086)
                                                     -------  -------  -------
   Net income (loss)................................ $  (117) $ 3,449  $  (379)
                                                     =======  =======  =======
</TABLE>
 
  The Company's equity share of the above net income (loss) for 1998, 1997 and
1996 was $343,000, $835,000 and $(2,000), respectively, before amortization of
property acquisition costs discussed below. The Company's share of the above
equity investee capital was $8.8 million in 1998 and $9.9 million in 1997.
 
  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 $77,000 in 1998, $113,000 in 1997
and $116,000 in 1996. These amounts are being amortized over the estimated
useful lives of the properties.
 
NOTE 6. NOTES AND INTEREST PAYABLE
 
  Notes and interest payable consist of the following:
 
<TABLE>
<CAPTION>
                                                  1998               1997
                                           ------------------ ------------------
                                           Estimated          Estimated
                                             Fair      Book     Fair      Book
                                             Value    Value     Value    Value
                                           --------- -------- --------- --------
   <S>                                     <C>       <C>      <C>       <C>
   Notes payable.......................... $275,027  $280,592 $219,056  $220,437
                                           ========           ========
   Interest payable.......................              2,096              1,592
                                                     --------           --------
                                                     $282,688           $222,029
                                                     ========           ========
</TABLE>
 
  Scheduled principal payments are due as follows:
 
<TABLE>
   <S>                                                                  <C>
   1999................................................................ $ 25,588
   2000................................................................   17,363
   2001................................................................   33,816
   2002................................................................   29,434
   2003................................................................   13,506
   Thereafter..........................................................  160,885
                                                                        --------
                                                                        $280,592
                                                                        ========
</TABLE>
 
 
                                      41
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  Mortgage notes payable at December 31, 1998 bear interest at rates ranging
from 6.5% to 10.56% per annum, and mature between 1999 and 2037. The mortgages
are collateralized by deeds of trust on real estate having a net carrying
value of $341.1 million.
 
  In 1998, the Company purchased 10 apartments with a total of 1,566 units, 6
office buildings, 3 hotels and 3 parcels of land for a total of $91.0 million.
In conjunction with the purchases, the Company either assumed existing
mortgage debt or obtained mortgage financing totaling $58.9 million. The
mortgages bear interest at rates ranging from 7.2% to 9.5% per annum, require
monthly payments of principal and interest, currently totaling $478,000, and
mature from 2000 to 2037.
 
  In March 1998, the Company refinanced the mortgage debt secured by the
Tricon Warehouses in Atlanta, Georgia in the amount of $10.2 million,
receiving net cash of $5.4 million after paying off $4.8 million in mortgage
debt, funding of escrows and the payment of various closing costs. The new
mortgage bears interest at a variable rate, currently 7.53% per annum,
requires monthly payments of principal and interest of $75,576 and matures in
April 2008.
 
  In May 1998, the Company obtained mortgage financing in the amount of $2.2
million secured by its unencumbered Lemmon Carlisle land in Dallas, Texas,
receiving net cash of $2.1 million after the payment of various closing costs.
The mortgage bears interest at 9.25% per annum, requires monthly payments of
interest only and matures in May 2000.
 
  Also in May 1998, the Company refinanced the mortgage debt secured by the
Plaza Tower Office Building in St. Petersburg, Florida in the amount of $7.4
million, receiving net cash of $2.6 million after paying off $4.8 million in
mortgage debt, funding of required escrows and the payment of various closing
costs. The new mortgage bears interest at 7.57% per annum, requires monthly
payments of principal and interest of $55,023 and matures in June 2008.
 
  In July 1998, the Company refinanced the matured mortgage debt secured by
the Villas at Countryside Apartments in Sterling, Virginia, in the amount of
$5.4 million, receiving net cash of $400,000 after paying off $5.0 million in
mortgage debt, funding of required escrows and the payment of various closing
costs. The new mortgage bears interest at 6.85% per annum, requires monthly
payments of principal and interest of $35,692 and matures in August 2005.
 
  In August 1998, the Company obtained second lien financing of $1.8 million
secured by the Terrace Hills Apartments in El Paso, Texas, receiving net cash
of $1.7 million after the payment of various closing costs. The mortgage bears
interest at 7.275% per annum, requires monthly payments of principal and
interest of $11,968 and matures in September 2009.
 
  In August 1998, in conjunction with the foreclosure of the collateral
securing a wraparound mortgage note receivable, the Company refinanced the
first lien mortgage in the amount of $2.0 million. The new mortgage bears
interest at 7.51% per annum, requires monthly payments of principal and
interest of $15,721 and matures in September 2008. See NOTE 2. "NOTES AND
INTEREST RECEIVABLE."
 
  In October 1998, the Company refinanced the matured mortgage debt secured by
the Bonita Plaza Office Building in Bonita, California in the amount of $5.2
million, receiving net cash of $1.2 million after paying off $4.0 million in
mortgage debt, funding of required escrows and the payment of various closing
costs. The new mortgage bears interest at a variable rate, currently 7.4% per
annum, requires monthly payments of principal and interest of $37,722 and
matures in November 2001.
 
 
                                      42
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
  In December 1998, the mortgage debt in the amount of $4.0 million secured by
the Lexington Center Office Building in Colorado Springs, Colorado matured. In
March 1999, the Company refinanced the matured mortgage debt. See NOTE 18.
"SUBSEQUENT EVENTS."
 
  Also in December 1998, the mortgage debt in the amount of $1.2 million
secured by the Texstar Warehouse in Arlington, Texas matured. In January 1999,
the lender agreed to extend the mortgage's maturity date to March 1999, all
other items remain unchanged. The Company expects to have a refinancing of the
property completed prior to the March extended maturity date.
 
  In December 1998, the mortgage debt in the amount of $380,000 secured by the
Sadler Square Shopping Center in Amelia Island, Florida matured. In March
1999, the lender agreed to extend the mortgage's maturity date to April 1999,
all other terms remain unchanged. The Company expects to have a refinancing of
the property completed prior to the April extended maturity date.
 
  In 1997, the Company obtained mortgage financing totaling $5.6 million
secured by two unencumbered apartments and a unencumbered commercial property.
The Company received net cash of $5.0 million after funding escrows and the
payment of various closing costs. The mortgages bear interest ranging from
7.6% to 8.49% per annum and mature between July 2007 and October 2007. Also in
1997, the Company refinanced the mortgage debt secured by five commercial
properties and three apartments, in the total amount of $45.3 million. The
Company received net cash of $10.3 million after paying off $33.2 million in
mortgage debt, funding escrows and the payment of various closing costs. The
mortgages bear interest at rates ranging from 7.4% to 9.44% per annum and
mature between January 2004 and March 2009.
 
NOTE 7. PREFERRED STOCK
 
  The Company's Series A Cumulative Convertible Preferred Stock consists of a
maximum of 6,000 shares with a par value of $.01 per share and a liquidation
preference of $100.00 per share. Dividends are payable at the rate of $5.00
per year or $1.25 per quarter to stockholders of record on the 15th day of
each March, June, September and December when and as declared by the Board of
Directors. The Series A Preferred Stock may be converted, after November 1,
2003, into Common Stock of the Company at the daily average closing price of
the Company's Common Stock for the prior five trading days. At December 31,
1998, 5,829 shares of Series A Preferred Stock were issued and outstanding.
 
NOTE 8. DIVIDENDS
 
  The Company has paid quarterly dividends since the fourth quarter of 1995.
The Company paid dividends of $2.3 million ($.60 per share) in 1998, $1.1
million ($.28 per share) in 1997 and $1.1 million ($.28 per share) in 1996. In
addition, the Company declared a special dividend of $1.00 per share in
December 1997 that was paid in January 1998.
 
  The Company reported to the Internal Revenue Service that 100% of the
dividends paid in 1997 and 1998 represented capital gains and 100% of the
dividends paid in 1996 represented a return of capital.
 
                                      43
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
NOTE 9. RENTS UNDER OPERATING LEASES
 
  The Company's operations include the leasing of commercial properties
(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, 1998:
 
<TABLE>
   <S>                                                                  <C>
   1999................................................................ $ 25,865
   2000................................................................   22,183
   2001................................................................   17,885
   2002................................................................   13,016
   2003................................................................    9,067
   Thereafter..........................................................   13,039
                                                                        --------
                                                                        $101,055
                                                                        ========
</TABLE>
 
NOTE 10. 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 annual meeting of stockholders held on May 8, 1997, stockholders
approved the renewal of the Advisory Agreement with BCM through the next
annual meeting of stockholders. Subsequent renewals of the Advisory Agreement
with BCM do not require the approval of stockholders but do require the
approval of the Board of Directors.
 
  Under the Advisory Agreement, the Advisor is required to formulate and
submit annually for approval by the Board of Directors a budget and business
plan containing a twelve-month forecast of operations and cash flow, a general
plan for asset sales and purchases, lending, foreclosure and borrowing
activity and other investments. The Advisor is required to report quarterly to
the Board of Directors on the Company's performance against the business plan.
In addition, all transactions or investments require prior approval by the
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 Board of Directors. The Advisory Agreement also requires prior
approval of the 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 (total assets less allowance for amortization, depreciation or
depletion and valuation reserves) and an annual net income fee equal to 7.5%
of 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 purchase or long-term lease of real estate. BCM or an
affiliate of BCM is to receive a mortgage or loan acquisition fee with respect
to the 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 or refinancing on the Company's
properties. BCM also receives reimbursement of certain expenses incurred by it
in the performance of advisory services to the Company.
 
                                      44
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(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 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 $664,000, $206,000 and $87,000 of the annual advisory fee for 1998,
1997 and 1996, respectively.
 
  Additionally, if management were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM is separately compensated for such additional services on
terms to be agreed upon from time to time. As discussed in NOTE 11. "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 12.
"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 11. PROPERTY MANAGEMENT
 
  Carmel, Ltd. provides 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 property-level management
services at various rates. The general partner of Carmel, Ltd. is BCM. The
limited partners of Carmel, Ltd. are (1) First Equity Properties, Inc. ("First
Equity"), which is 50% owned by a subsidiary of BCM, (2) Gene E. Phillips and
(3) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd.
subcontracts the property-level management and leasing of 29 of the Company's
commercial properties, its four hotels 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 First Equity. 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 12. REAL ESTATE BROKERAGE
 
  Carmel Realty provides brokerage services on a non-exclusive basis. Carmel
Realty is entitled to receive a commission for property purchases and sales,
in accordance with a sliding scale of total brokerage fees to be paid by the
Company.
 
NOTE 13. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.
 
  Fees and cost reimbursements to BCM and its affiliates:
 
<TABLE>
<CAPTION>
                                                           1998   1997   1996
                                                          ------ ------ ------
   <S>                                                    <C>    <C>    <C>
   Fees
    Advisory............................................. $1,962 $1,807 $1,784
    Net income...........................................    558  1,022    --
    Property acquisition.................................  3,468  2,966    339
    Real estate brokerage................................    767    738    283
    Mortgage brokerage and equity refinancing............    341    517    136
   Property and construction management and leasing
    commissions*.........................................  2,753  2,262  1,879
                                                          ------ ------ ------
                                                          $9,849 $9,312 $4,421
                                                          ====== ====== ======
   Cost reimbursements................................... $1,121 $1,187 $1,047
                                                          ====== ====== ======
</TABLE>
  --------
  *Net of property management fees paid to subcontractors, other than Carmel
     Realty.
 
                                      45
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
NOTE 14. INCOME TAXES
 
  For the years 1998, 1997 and 1996, 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 8. "DIVIDENDS."
 
  The Company had a loss for federal income tax purposes (after utilization of
operating loss carryforwards) in 1998, 1997 and 1996; 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, 1998, the Company's tax basis in its net assets
exceeded their basis for financial statement purposes by $16.4 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, 1998, the Company had tax net operating
loss carryforwards of $60.4 million expiring through the year 2011.
 
  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 15. COMMITMENTS AND CONTINGENCIES
 
  Olive Litigation. In February 1990, the Company, together with CMET, IORI
and National Income Realty Trust, 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 "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and modified certain provisions of the April 1990 settlement. The
Olive Modification was preliminarily approved by the Court on July 1, 1994 and
final Court approval was entered on December 12, 1994. The effective date of
the Olive Modification was January 11, 1995.
 
  The Court retained jurisdiction to enforce the Olive Modification, and
during August and September 1996, the Court held evidentiary hearings to
assess compliance with the terms of the Olive Modification by the 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 intended to assert that certain actions taken by
the Board of Directors breached the terms of the Olive Modification. On
January 27, 1997, the parties entered into an Amendment to the Olive
Modification effective January 9, 1997 (the "Olive Amendment"), which was
submitted to the Court for approval on January 29, 1997. The Olive 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.
On May 2, 1997, a hearing was held by the Court to consider approval of the
Olive Amendment. As a result of the hearing, the parties entered into a
revised Olive Amendment. The Court issued an order approving the Olive
Amendment on July 3, 1997.
 
  The Olive Amendment provides for the addition of four 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
 
                                      46
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
relating to the plaintiffs' allegations and matters which were the subject of
the evidentiary hearings. The plaintiffs' allegations of any breaches of the
Olive Modification shall be settled by mutual agreement of the parties or,
lacking such agreement, by an arbitration proceeding.
 
  Under the Olive Amendment, all shares of the Company owned by Gene E.
Phillips or any of his affiliates shall be voted at all stockholder meetings
of the Company held until April 28, 1999 in favor of all new members of the
Company's Board of Directors added under the Olive Amendment. The Olive
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.
 
  In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley
and R. Douglas Leonhard were added to the Company's Board of Directors in
January 1998 and Murray Shaw was added to the Company's Board of Directors in
February 1998.
 
  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.
 
  Litigation settlement. In October 1996, the Company received $1.5 million
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. OPERATING SEGMENTS
 
  Significant differences among the accounting policies of the segments as
compared to the Company's consolidated financial statements principally
involve the calculation and allocation of administrative expenses. Management
evaluates the performance of the operating segments and allocates resources to
them based on net operating income, and cash flow. The Company based
reconciliation of expenses that are not reflected in the segments is $4.8
million of administrative expenses. There are no intersegment revenues and
expenses and the Company conducts all of its business in the United States.
 
  The Company has not disclosed prior years' operating segment data on a
comparative basis, because management found it impractical to obtain the
necessary data.
 
  The table below presents information about the reported operating income of
the Company for 1998. Asset information by operating segment is also presented
below.
 
                                      47
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
  Property sales:
 
 
<TABLE>
<CAPTION>
                                        Commercial
                                        Properties Apartments Hotels   Total
                                        ---------- ---------- ------- --------
   <S>                                  <C>        <C>        <C>     <C>
   Operating revenue...................  $ 31,282   $ 35,400  $ 3,147 $ 69,829
   Operating expenses..................    14,291     21,987    2,004   38,282
                                         --------   --------  ------- --------
   Net operating income................    16,991     13,413    1,143   31,547
   Depreciation and amortization.......     6,268      4,115      308   10,691
   Interest on debt....................    11,753     10,415      629   22,797
   Capital expenditures................     5,287      4,130      178    9,595
   Segment assets at December 31,
    1998...............................   173,936    156,933   17,876  348,745
<CAPTION>
                                                   Commercial
                                           Land    Properties
                                        ---------- ----------
   <S>                                  <C>        <C>        <C>     <C>
   Sales price.........................  $    375   $ 33,665
   Cost of sales.......................        25     24,234
   Gain on sales.......................       350      9,431
 
</TABLE>
 
NOTE 17. QUARTERLY RESULTS OF OPERATIONS
 
  The following is a tabulation of the Company's quarterly results of
operations for the years 1998 and 1997 (unaudited):
 
<TABLE>
<CAPTION>
                                               Three Months Ended
                                  ---------------------------------------------
                                             June
                                  March 31,   30,    September 30, December 31,
                                  --------- -------  ------------- ------------
   <S>                            <C>       <C>      <C>           <C>
   1998
   Income.......................   $16,272  $17,514     $18,221      $18,629
   Expenses.....................    17,460   18,264      20,605       20,273
                                   -------  -------     -------      -------
   (Loss) from operations.......    (1,188)    (750)     (2,384)      (1,644)
   Equity in income (loss) of
    investees...................       (18)     450         (90)         (54)
   Gain of sale of real estate..       --     2,132       9,883          569
                                   -------  -------     -------      -------
   Net income (loss) applicable
    to common shares............    (1,206)   1,832       7,409       (1,129)
   Preferred dividend required..       --       --          --           (1)
                                   -------  -------     -------      -------
                                   $(1,206) $ 1,832     $ 7,409      $(1,130)
                                   =======  =======     =======      =======
   Earnings Per Share
   Net income (loss) applicable
    to common shares............   $  (.31) $   .47     $  1.91      $  (.29)
                                   =======  =======     =======      =======
</TABLE>
 
  In the second quarter of 1998, a gain previously deferred on the sale of
real estate under the cost recovery method, of $2.1 million was recognized on
the collection of the mortgage note receivable. In the third quarter of 1998,
a gain of $671,000 was recognized on the collection of a mortgage note
receivable written off as uncollectible in a prior year. Also in the third
quarter of 1998, a gain on sale of real estate of $5.9 million was recognized
on the sale of Chesapeake Ridge Office Building and a gain of $3.4 million was
recognized on the sale of Northtown Mall Shopping Center. In the fourth
quarter of 1998 a gain on sale of real estate of $219,000 was recognized on
the sale of Denton Drive Warehouse and a gain of $350,000 was recognized on
the sale of an 19 acre parcel of land.
 
                                      48
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
 
 
<TABLE>
<CAPTION>
                                               Three Months Ended
                                  ---------------------------------------------
                                             June
                                  March 31,   30,    September 30, December 31,
                                  --------- -------  ------------- ------------
   <S>                            <C>       <C>      <C>           <C>
   1997
   Income.......................   $12,523  $13,674     $14,291      $15,473
   Expenses.....................    14,437   15,175      16,279       19,687
                                   -------  -------     -------      -------
   (Loss) from operations.......    (1,914)  (1,501)     (1,988)      (4,214)
   Equity in income (loss) of
    investees...................       348      429         (97)         132
   Gain of sale of real estate..     1,400       55         --        19,949
                                   -------  -------     -------      -------
   Net income (loss)............   $  (166) $(1,017)    $(2,085)     $15,867
                                   =======  =======     =======      =======
   Earnings Per Share
   Net income (loss)............   $  (.04) $  (.26)    $  (.53)     $  4.05
                                   =======  =======     =======      =======
</TABLE>
 
  In the first quarter of 1997, a gain on sale of real estate of $1.4 million
was recognized on the sale of a .9976 acre parcel of land. In the second
quarter of 1997, a gain on sale of real estate of $55,000 was recognized on
the sale of a foreclosed single family residence. In the fourth quarter of
1997, a gain on sale of real estate of $19.4 million was recognized on the
sale of the Republic Towers Office Building and a gain of $554,000 was
recognized on the sale of the President's Square Shopping Center. A provision
for loss of $1.3 million was recorded in the fourth quarter of 1997 to
writedown the Shaws Plaza Shopping Center to its agreed sales price less
estimated selling costs.
 
NOTE 18. SUBSEQUENT EVENTS
 
  In February 1999, the Company sold the 368 unit Mariner's Point Apartments
in St. Petersburg, Florida, for $6.7 million, receiving net cash of $2.6
million after paying off $3.9 million in mortgage debt and the payment of
various closing costs. A gain will be recognized on the sale.
 
  In March 1999, the Company purchased the 264 unit Vista Hills Apartments in
El Paso, Texas, for $5.2 million, paying $1.6 million in cash and obtaining
mortgage financing of $3.6 million. The mortgage bears interest at a variable
rate, currently 7.625% per annum, requires monthly payments of principal and
interest of $26,897 and matures in April 2004.
 
  Also in March 1999, the Company purchased the Dominion land a 14.39 acre
parcel of land in Dallas, Texas, for $3.6 million, paying $1.2 million in cash
and obtaining mortgage financing of $2.4 million. The mortgage bears interest
at 15% per annum, requires quarterly payment of interest only and matures in
March 2000.
 
  Further in March 1999, the Company refinanced the matured mortgage debt
secured by the Lexington Center in Colorado Springs, Colorado in the amount of
$4.3 million, receiving net cash of $136,000 after paying off $4.0 million in
mortgage debt and the payment of various closing costs. The new mortgage bears
interest at a variable rate, currently 7.75% per annum requires monthly
payments of principal and interest of $32,479 and matures in April 2004.
 
                                      49
<PAGE>
 
                                                                    SCHEDULE III
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                            Cost
                                                        Capitalized
                                                         Subsequent              Gross Amounts of Which
                                   Initial Cost        to Acquisition            Carried at End of Year
                                ------------------- --------------------       ---------------------------
                                       Buildings &                                    Buildings &    (1)   Accumulated
Property/Location  Encumbrances  Land  Improvements Improvements  Other         Land  Improvements  Total  Depreciation
-----------------  ------------ ------ ------------ ------------ -------       ------ ------------ ------- ------------
                                                                        (dollars in thousands)
<S>                <C>          <C>    <C>          <C>          <C>           <C>    <C>          <C>     <C>
Held for
Investment
Apartments
4400, Midland,
TX .............     $ 1,340    $  349   $ 1,396       $   --    $   --        $  349   $ 1,396    $ 1,745    $   23
Arbor Point,
Odessa, TX .....       1,101       321     1,285          526        --           321     1,811      2,132       244
Ashton Way,
Midland, TX.....       1,340       384     1,536           25        --           384     1,561      1,945        28
Bent Tree,
Addison, TX.....       6,321     1,702     6,808           85        --         1,702     6,893      8,595       181
Carseka, Los
Angeles, CA.....       1,509       460     1,840           75        --           460     1,915      2,375       123
Cliffs of
Eldorado,
McKinney, TX....      10,631     2,647    10,589          --         --         2,647    10,589     13,236        66
Country Bend,
Fort Worth, TX..       2,527       710     2,842           81        --           710     2,923      3,633       104
Coventry,
Midland, TX.....         450       236       369          184        --           236       553        789        81
Crescent Place,
Houston, TX.....       1,740       494     1,978          123        --           494     2,101      2,595       126
Fairpark, Los
Angeles, CA.....       1,509       425     1,701          --         --           425     1,701      2,126        46
Fountains of
Waterford,
Midland, TX.....       1,055       311     1,243          495        --           311     1,738      2,049        38
Fountain
Village, Tucson,
AZ..............       7,844     1,518     8,352        2,035     (2,375)(/2/)  1,162     8,368      9,530     3,734
Gladstell
Forest, Conroe,
TX..............       2,548       504     2,015          163        --           504     2,178      2,682       223
Harper's Ferry,
Lafayette, LA...       1,797       349     1,398          173        --           349     1,571      1,920       353
Heritage, Tulsa,
OK..............       1,991       148       839           83       (300)(/3/)     88       682        770       124
Hunters Glen,
Midland, TX.....       1,895       519     2,075          272        --           519     2,347      2,866        66
Limestone
Canyon, Austin,
TX..............       1,604     1,998       --           --       1,895 (/4/)  1,998     1,895      3,893       --
Mariners Pointe,
St. Petersburg,
FL..............       3,859       716     4,059          880        --           716     4,939      5,655     1,092
Mountain Plaza,
El Paso, TX.....       2,931       837     3,347           80        --           837     3,427      4,264        89
Sandstone, Mesa,
AZ..............       5,801     1,656     6,625           82        --         1,656     6,707      8,363       217
Shadow Run,
Pinellas Park,
FL..............       7,029     1,503     8,229          212        --         1,503     8,441      9,944     3,287
South Cochran,
Los Angeles,
CA..............       1,931       540     2,162           15        --           540     2,177      2,717       412
Southgate,
Odessa, TX......       1,021       335     1,338          318        --           335     1,656      1,991       178
Southgreen,
Bakersfield,
CA..............       2,500       755     3,021          --         --           755     3,021      3,776         7
Spa Cove,
Annapolis, MD...      12,001     2,254    10,297        3,961        682 (/4/)  2,337    14,857     17,194     4,673
Summerfield,
Orlando, FL.....       4,678     1,175     4,698          136        --         1,175     4,834      6,009       563
<CAPTION>
                                           Life on
                                            Which
                                         Depreciation
                                          in Latest
                                          Statement
                     Date of      Date   of Operation
Property/Location  Construction Acquired is Computed
-----------------  ------------ -------- ------------
<S>                <C>          <C>      <C>
Held for
Investment
Apartments
4400, Midland,
TX .............       1981     04/30/98    40 years
Arbor Point,
Odessa, TX .....       1975     08/30/96  5-40 years
Ashton Way,
Midland, TX.....       1978     04/30/98  5-40 years
Bent Tree,
Addison, TX.....       1979     01/28/98  5-40 years
Carseka, Los
Angeles, CA.....       1971     11/19/96  5-40 years
Cliffs of
Eldorado,
McKinney, TX....       1997     10/20/98    40 years
Country Bend,
Fort Worth, TX..       1981     09/25/97  5-40 years
Coventry,
Midland, TX.....       1977     08/30/96  5-40 years
Crescent Place,
Houston, TX.....       1984     03/28/97  5-40 years
Fairpark, Los
Angeles, CA.....       1991     12/22/97    40 years
Fountains of
Waterford,
Midland, TX.....       1977     05/21/98  5-40 years
Fountain
Village, Tucson,
AZ..............       1973     01/10/86  5-40 years
Gladstell
Forest, Conroe,
TX..............       1985     06/30/95  5-40 years
Harper's Ferry,
Lafayette, LA...       1972     02/25/92  5-40 years
Heritage, Tulsa,
OK..............       1966     05/14/90  5-40 years
Hunters Glen,
Midland, TX.....       1982     01/16/98  5-40 years
Limestone
Canyon, Austin,
TX..............       1997     07/10/98           -
Mariners Pointe,
St. Petersburg,
FL..............       1972     06/28/91  5-40 years
Mountain Plaza,
El Paso, TX.....       1972     01/14/98  5-40 years
Sandstone, Mesa,
AZ..............       1986     10/01/97  5-40 years
Shadow Run,
Pinellas Park,
FL..............       1985     04/10/95  5-40 years
South Cochran,
Los Angeles,
CA..............       1928     05/29/91  5-40 years
Southgate,
Odessa, TX......       1976     08/30/96  5-40 years
Southgreen,
Bakersfield,
CA..............       1985     12/23/98    40 years
Spa Cove,
Annapolis, MD...       1965     02/27/87  5-40 years
Summerfield,
Orlando, FL.....       1971     11/02/94  5-40 years
</TABLE>
 
                                       50
<PAGE>
 
                                                                    SCHEDULE III
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                           Cost
                                                        Capitalized
                                                        Subsequent              Gross Amounts of Which
                                   Initial Cost       to Acquisition            Carried at End of Year
                                ------------------- -------------------       ---------------------------
                                       Buildings &                                   Buildings &    (1)   Accumulated
Property/Location  Encumbrances  Land  Improvements Improvements Other         Land  Improvements  Total  Depreciation
-----------------  ------------ ------ ------------ ------------ ------       ------ ------------ ------- ------------
                                                                        (dollars in thousands)
<S>                <C>          <C>    <C>          <C>          <C>          <C>    <C>          <C>     <C>
Held for
Investment--
Continued
Apartments--
Continued
Summerstone,
Houston, TX.....      $4,887    $1,155    $4,618       $  210    $  --        $1,155   $ 4,828    $ 5,983    $  616
<CAPTION>
                                           Life on
                                            Which
                                         Depreciation
                                          in Latest
                                          Statement
                     Date of      Date   of Operation
Property/Location  Construction Acquired is Computed
-----------------  ------------ -------- ------------
<S>                <C>          <C>      <C>
Held for
Investment--
Continued
Apartments--
Continued
Summerstone,
Houston, TX.....       1984     12/17/93  5-40 years
Sunchase,
Odessa, TX......       2,111       742     2,967          449       --           742     3,416      4,158       149
Terrace Hills,
El Paso, TX.....       6,429     1,286     5,145          167       --         1,310     5,288      6,598       249
Timbers, Tyler,
TX..............       1,775       497     1,988          --        --           497     1,988      2,485        54
Treehouse,
Irving, TX......       2,732       716     2,865          260       --           716     3,125      3,841       172
Villas at
Countryside,
Sterling, VA....       5,428     1,323     5,290           30       --         1,323     5,320      6,643       229
Villa Piedra,
Los Angeles,
CA..............       3,481       979     3,915          --        --           979     3,915      4,894       106
Westgate of
Laurel, Laurel,
MD..............       7,599       849     9,391          202       --           849     9,593     10,442     3,801
Westwood,
Odessa, TX......         333        85       341          108       --            85       449        534        57
Woodland Hills,
San Antonio,
TX..............       1,149       228       913          --        --           228       913      1,141       148
Woods Edge,
Rockville, MD...       6,104     1,015     7,812          157       --         1,015     7,969      8,984     3,504
Woodview,
Odessa, TX......       2,606       716     2,864           67                    716     2,931      3,647        49
Sunchase,
Odessa, TX......       1981     10/08/97  5-40 years
Terrace Hills,
El Paso, TX.....       1985     03/05/97  5-40 years
Timbers, Tyler,
TX..............       1973     12/30/97    40 years
Treehouse,
Irving, TX......       1974     05/01/97  5-40 years
Villas at
Countryside,
Sterling, VA....       1985     05/15/97  5-40 years
Villa Piedra,
Los Angeles,
CA..............       1991     12/22/97    40 years
Westgate of
Laurel, Laurel,
MD..............       1969     01/01/95  5-40 years
Westwood,
Odessa, TX......       1977     08/30/96  5-40 years
Woodland Hills,
San Antonio,
TX..............       1972     05/01/92    40 years
Woods Edge,
Rockville, MD...       1965     01/01/95  5-40 years
Woodview,
Odessa, TX......       1974     05/01/98  5-40 years
 
Office Buildings
74 New
Montgomery,
San Francisco,
CA..............       6,219     2,277     9,105        4,107      (336)(/2/)  2,210    12,943     15,153     4,849
Atrium, Palm
Beach, FL.......       4,078     1,147     4,590          --                   1,147     4,590      5,737        67
Bonita Plaza,
Bonita, CA......       5,143     1,168     4,670          448       --         1,168     5,118      6,286       187
Corporate
Pointe,
Chantilly, VA...       3,973       830     3,321          411       --           830     3,732      4,562       609
Daley Plaza, San
Diego, CA.......       3,443       973     3,889          110                    973     3,999      4,972        80
Forum, Richmond,
VA..............       5,439     1,360     5,439          833       --         1,360     6,272      7,632     1,320
Hartford,
Dallas, TX......       2,214       630     2,520          501       --           630     3,021      3,651       432
Institute Place
Lofts, Chicago,
IL..............       6,058       665     7,057          393       --           665     7,450      8,115     3,574
Lexington
Center, Colorado
Springs, CO.....       4,000     1,103     4,413          367       --         1,103     4,780      5,883       148
One
Steeplechase,
Sterling, VA....       8,146     1,380     5,520        2,807        72 (/4/)  1,380     8,399      9,779     2,299
Plaza Towers,
St. Petersburg,
FL..............       7,354     1,760    12,617        6,762    (4,379)(/2/)  1,241    15,519     16,760     8,851
Savings of
America,
Houston, TX.....       1,260       338     1,353          341       --           338     1,694      2,032       111
Town & Country,
Houston, TX.....         --        108       432          508       --           108       940      1,048       456
Office Buildings
74 New
Montgomery,
San Francisco,
CA..............       1914     09/21/90  1-40 years
Atrium, Palm
Beach, FL.......       1985     06/26/98    40 years
Bonita Plaza,
Bonita, CA......       1991     09/16/97  5-40 years
Corporate
Pointe,
Chantilly, VA...       1992     10/28/94  5-40 years
Daley Plaza, San
Diego, CA.......       1981     05/29/98  5-40 years
Forum, Richmond,
VA..............       1987     10/30/92  2-40 years
Hartford,
Dallas, TX......       1980     11/10/94  2-40 years
Institute Place
Lofts, Chicago,
IL..............       1910     01/01/93  2-40 years
Lexington
Center, Colorado
Springs, CO.....       1986     12/30/97  3-40 years
One
Steeplechase,
Sterling, VA....       1987     12/22/92  5-40 years
Plaza Towers,
St. Petersburg,
FL..............       1979     11/14/85  1-40 years
Savings of
America,
Houston, TX.....       1979     03/31/97  3-40 years
Town & Country,
Houston, TX.....       1982     05/01/92  3-40 years
</TABLE>
 
                                       51
<PAGE>
 
                                                                    SCHEDULE III
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                           Cost
                                                       Capitalized
                                                        Subsequent             Gross Amounts of Which
                                   Initial Cost       to Acquisition           Carried at End of Year
                                ------------------- ------------------       ---------------------------
                                       Buildings &                                  Buildings &    (1)   Accumulated    Date of
Property/Location  Encumbrances  Land  Improvements Improvements Other        Land  Improvements  Total  Depreciation Construction
-----------------  ------------ ------ ------------ ------------ -----       ------ ------------ ------- ------------ ------------
                                                                       (dollars in thousands)
<S>                <C>          <C>    <C>          <C>          <C>         <C>    <C>          <C>     <C>          <C>
Held for
Investment--
Continued
Office
Buildings--
Continued
Valley Rim, San
Diego, CA.......     $ 3,662    $1,078   $ 4,311           13    $ --        $1,078   $ 4,324    $ 5,402    $   56        1988
Venture Center,
Atlanta, GA.....       1,117       411     2,746          228      --           411     2,974      3,385       770        1981
Viewridge, San
Diego, CA.......       1,318       393     1,572          --       --           393     1,572      1,965        26        1979
Waterstreet,
Boulder, CO.....       7,932     2,605    10,420          951      --         2,605    11,371     13,976     2,705        1988
Industrial
Warehouses
Corporate
Center, Ashburn,
VA..............       6,914     1,259     5,038        1,136      --         1,259     6,174      7,433     1,123        1989
Encon, Fort
Worth, TX.......       3,500       984     3,935          --       --           984     3,935      4,919       123        1958
Parke Long,
Chantilly, VA...       7,622     1,838     7,361        1,117      --         1,838     8,478     10,316     1,215        1989
Technology
Trading,
Sterling, VA....       4,044     1,199     4,796          857      --         1,199     5,653      6,852       725        1987
Texstar,
Arlington, TX...       1,150       333     1,331          159      --           333     1,490      1,823       202        1967
Tricon, Atlanta,
GA..............      10,114     2,761     6,442        1,602      --         2,761     8,044     10,805     1,636        1971-
                                                                                                                          1975
Shopping Centers
Dunes Plaza,
Michigan City,
IN..............       3,404     1,230     5,430        1,560     (482)(/5/)  1,071     6,667      7,738     1,475        1978
K-Mart, Cary,
NC..............       1,940     1,358     1,157          162      --         1,358     1,319      2,677       --         1981
Parkway Center,
Dallas, TX......       1,775       273     1,876          405      --           273     2,281      2,554       788        1979
Parkway North,
Dallas, TX......       3,900     1,173     4,692          182      --         1,173     4,874      6,047       135        1980
Plaza on Bachman
Creek, Dallas,
TX..............       2,327       734     2,935          255      --           734     3,190      3,924        76        1986
Sadler Square,
Amelia Island,
FL..............       2,368       679     2,715           77      --           679     2,792      3,471       433        1987
Sheboygan,
Sheboygan, WI...         781       242     1,371           17      --           242     1,388      1,630       224        1977
Hotels
Belmont,
Chicago, IL.....       3,568       950     3,847          --       --           950     3,847      4,797         9        1995
Brompton,
Chicago, IL.....       2,139       572     2,365           14      --           572     2,379      2,951         6        1995
Majestic Inn,
San Francisco,
CA..............       5,627     1,139     4,555          972      --         1,139     5,527      6,666     1,310        1902
Surf, Chicago,
IL..............       3,544       945     3,851          --       --           945     3,851      4,796         9        1995
Land
Eagle Crest,
Farmers Branch,
TX..............         --      2,500       --           134      --         2,634       --       2,634       --          --
<CAPTION>
                              Life on
                               Which
                            Depreciation
                             in Latest
                             Statement
                     Date   of Operation
Property/Location  Acquired is Computed
-----------------  -------- ------------
<S>                <C>      <C>
Held for
Investment--
Continued
Office
Buildings--
Continued
Valley Rim, San
Diego, CA.......   07/08/98  3-40 years
Venture Center,
Atlanta, GA.....   07/04/89  1-40 years
Viewridge, San
Diego, CA.......   05/29/98    40 years
Waterstreet,
Boulder, CO.....   09/30/91  2-40 years
Industrial
Warehouses
Corporate
Center, Ashburn,
VA..............   04/28/94  3-40 years
Encon, Fort
Worth, TX.......   10/01/97    40 years
Parke Long,
Chantilly, VA...   06/16/94  3-40 years
Technology
Trading,
Sterling, VA....   12/21/93  3-40 years
Texstar,
Arlington, TX...   12/16/93  5-40 years
Tricon, Atlanta,
GA..............   02/11/93  2-40 years
Shopping Centers
Dunes Plaza,
Michigan City,
IN..............   03/17/92  5-40 years
K-Mart, Cary,
NC..............   08/05/98         --
Parkway Center,
Dallas, TX......   11/01/91  1-40 years
Parkway North,
Dallas, TX......   02/18/98  2-40 years
Plaza on Bachman
Creek, Dallas,
TX..............   03/31/98  5-40 years
Sadler Square,
Amelia Island,
FL..............   11/22/93  3-40 years
Sheboygan,
Sheboygan, WI...   05/21/92    40 years
Hotels
Belmont,
Chicago, IL.....   12/02/98  5-40 years
Brompton,
Chicago, IL.....   12/02/98  5-40 years
Majestic Inn,
San Francisco,
CA..............   12/31/90  2-40 years
Surf, Chicago,
IL..............   12/02/98  5-40 years
Land
Eagle Crest,
Farmers Branch,
TX..............   05/15/98         --
</TABLE>
 
                                       52
<PAGE>
 
                                                                    SCHEDULE III
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                             Cost
                                                         Capitalized
                                                          Subsequent               Gross Amounts of Which
                                    Initial Cost        to Acquisition             Carried at End of Year
                                -------------------- --------------------       -----------------------------
                                        Buildings &                                     Buildings &    (1)    Accumulated
Property/Location  Encumbrances  Land   Improvements Improvements  Other         Land   Improvements  Total   Depreciation
-----------------  ------------ ------- ------------ ------------ -------       ------- ------------ -------- ------------
                                                                          (dollars in thousands)
<S>                <C>          <C>     <C>          <C>          <C>           <C>     <C>          <C>      <C>
Held for
Investment--
Continued
Land--Continued
Las Colinas, Las
Colinas, TX.....     $    --    $   995   $    --      $     5    $   --        $   995   $      5   $  1,000   $   --
Laws, Dallas,
TX..............          --      2,047        --          --         --          2,047        --       2,047       --
Lemon Carlisle,
Dallas, TX......        2,141     3,576        --           30        --          3,606        --       3,606       --
West End,
Dallas, TX......        8,716    11,405        --           57        --         11,405         57     11,462       --
                     --------   -------   --------     -------    -------       -------   --------   --------   -------
Investment
Properties......      280,517    88,855    285,823      39,175     (5,223)       87,965    320,665    408,630    61,241
                     --------   -------   --------     -------    -------       -------   --------   --------   -------
<CAPTION>
                                           Life on
                                            Which
                                         Depreciation
                                          in Latest
                                          Statement
                     Date of      Date   of Operation
Property/Location  Construction Acquired is Computed
-----------------  ------------ -------- ------------
<S>                <C>          <C>      <C>
Held for
Investment--
Continued
Land--Continued
Las Colinas, Las
Colinas, TX.....       --       01/25/96       --
Laws, Dallas,
TX..............       --       01/15/98       --
Lemon Carlisle,
Dallas, TX......       --       02/09/98       --
West End,
Dallas, TX......       --       08/05/97    5 year
Investment
Properties......
 
 
Properties Held
for Sale
Land
Fiesta, San
Angelo, TX......          --         44        --          --         --             44        --          44       --
Fruitland,
Fruitland Park,
FL..............          --        253        --          --        (100)(/6/)     153        --         153       --
Moss Creek,
Greensboro, NC..          --         85        --          --         --             85        --          85       --
Republic
Parking, Dallas,
TX..............          --      1,074        --          --         --          1,074        --       1,074       --
                     --------   -------   --------     -------    -------       -------   --------   --------   -------
Properties held
for sale........          --      1,456        --          --        (100)        1,356        --       1,356       --
                     --------   -------   --------     -------    -------       -------   --------   --------   -------
                     $280,517   $90,311   $285,823     $39,175    $(5,323)      $89,321   $320,665   $409,986   $61,241
                     ========   =======   ========     =======    =======       =======   ========   ========   =======
Properties Held
for Sale
Land
Fiesta, San
Angelo, TX......       --       12/31/91       --
Fruitland,
Fruitland Park,
FL..............       --       05/01/92       --
Moss Creek,
Greensboro, NC..       --       12/31/96       --
Republic
Parking, Dallas,
TX..............       --       11/27/92       --
Properties held
for sale........
 
</TABLE>
----
(1) The aggregate cost for federal income tax purposes is $412.6 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) Forgiveness of debt and cash received deducted from the basis of the
    property, offset by land acquired in 1992.
(6) Cash received for easement deducted from the basis of the property.
 
                                       53
<PAGE>
 
                                                                    SCHEDULE III
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                    REAL ESTATE AND ACCUMULATED DEPRECIATION
 
<TABLE>
<CAPTION>
                                                    1998      1997      1996
                                                  --------  --------  --------
                                                    (dollars in thousands)
<S>                                               <C>       <C>       <C>
Reconciliation of Real Estate
Balance at January 1,............................ $331,668  $270,395  $269,896
 Additions
  Purchases and improvements.....................  101,510    79,483    11,097
  Foreclosures...................................    2,514       --        691
 Deductions
  Sale of real estate............................  (25,706)  (15,860)   (7,121)
  Sale of foreclosed properties..................      --       (691)   (2,589)
  Writedown due to permanent impairment of
   property......................................      --     (1,337)   (1,579)
  Other..........................................      --       (322)      --
                                                  --------  --------  --------
Balance at December 31,.......................... $409,986  $331,668  $270,395
                                                  ========  ========  ========
Reconciliation of Accumulated Depreciation
Balance at January 1,............................ $ 56,837  $ 50,386  $ 44,172
 Additions
  Depreciation...................................   10,691     9,578     8,461
 Deductions
  Sale of real estate............................   (6,287)     (387)   (1,718)
  Sale of foreclosed properties..................      --     (2,740)     (529)
                                                  --------  --------  --------
Balance at December 31,.......................... $ 61,241  $ 56,837  $ 50,386
                                                  ========  ========  ========
</TABLE>
 
                                       54
<PAGE>
 
                                                                     SCHEDULE IV
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                         MORTGAGE LOANS ON REAL ESTATE
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                                                                       Principal Amount of
                                   Final                                                  Carrying       Loans Subject to
                    Interest     Maturity                           Prior  Face Amount     Amounts     Delinquent Principal
   Description        Rate         Date      Periodic Payment Terms Liens  of Mortgage of Mortgage (1)     or Interest
-----------------  ----------- ------------- ---------------------- ------ ----------- --------------- --------------------
                                                                             (dollars in thousands)
<S>                <C>         <C>           <C>                    <C>    <C>         <C>             <C>
FIRST MORTGAGE
 LOANS
 
MILWAUKEE LAND...    Varies        01/91      Note receivable       $ --     $  200         $  60              $60(/2/)
 Secured by                                   bearing interest at
 34,847 sq. ft.                               prime plus 1%.
 of land in                                   Monthly interest
 Milwaukee, WI.                               only payments due
                                              until maturity, at
                                              which time all
                                              principal and
                                              unpaid interest was
                                              due.
 
MOSS CREEK LOTS..  9.0%-12.0%     06/2000     5 notes outstanding      --       140            84               29
 Secured by                                   at 12/31/98.
 residential lots                             Monthly payments of
 in Greensboro,                               principal and
 NC.                                          interest ranging
                                              from $118 to $339.
 
Chateau Charles..  3.85%-10.0% 07/99-02/2016  First and second         --     4,550           356              356
 Secured by a                                 lien notes bearing
 hotel in Lake                                interest at 3.85%
 Charles, LA                                  to 10%. Monthly
                                              principal and
                                              interest. Payments
                                              of $21,658 due
                                              monthly.
 
JUNIOR MORTGAGE
 LOANS
 
HAMPTON..........    Varies      On Demand    Note bearing             --       400            92               92(/2/)
 Secured by two                               interest at prime
 office buildings                             plus 1%. Monthly
 in Milwaukee, WI                             payments of
                                              interest only
                                              required. Principal
                                              is due upon demand.
 
LINCOLN COURT
 APARTMENTS......    Varies       06/2004     Two notes bearing      1,326    1,369         1,369              --
 Secured by                                   interest at prime
 apartment                                    plus 1%. Interest
 building in                                  only payments due
 Dallas, TX.                                  monthly until
                                              maturity, at which
                                              time all principal
                                              and unpaid interest
                                              are due.
                                                                    ------   ------         -----              ---
                                                                     1,326    6,659         1,961              537
 
SECURED BY OTHER
 THAN REAL ESTATE
 
CRIVELLO #2......    Varies      On Demand    Note bearing             --       879           193              193(/2/)
 Secured by a                                 interest at prime.
 mortgage note                                Monthly payment of
 secured by real                              interest only.
 property in
 Milwaukee, WI.
 
DOUBLE FEATURE
 VIDEO...........    Varies        07/98      Three notes              --       645           181              181(/2/)
 Secured by a                                 outstanding.
 general business                             Quarterly payments
 security                                     due based on gross
 agreement.                                   sales. Unpaid
                                              accruals compounded
                                              to principal.
</TABLE>
 
                                       55
<PAGE>
 
                                                                     SCHEDULE IV
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                         MORTGAGE LOANS ON REAL ESTATE
                               December 31, 1998
 
<TABLE>
<CAPTION>
                                                                                                         Principal Amount of
                            Final                                                            Carrying      Loans Subject to
                  Interest Maturity                                    Prior  Face Amount    Amounts     Delinquent Principal
  Description       Rate     Date   Periodic Payment Terms             Liens  of Mortgage of Mortgage(1)     or Interest
----------------  -------- -------- ---------------------------------- ------ ----------- -------------- --------------------
                                                                                (dollars in thousands)
<S>               <C>      <C>      <C>                                <C>    <C>         <C>            <C>
SECURED BY OTHER
 THAN REAL
 ESTATE--
 Continued
 
HOPPER, Secured
 by a general
 business
 security
 agreements.....   12.5%    11/95   Principal and interest payments of $  --    $   44        $   44             $ 44(/2/)
                                    $480 due monthly.
                                                                       ------   ------        ------             ----
Total...........                                                       $1,326   $8,227         2,379             $955
                                                                       ======   ======                           ====
Interest........                                                                                   3
Unamortized
 discount.......                                                                                  (3)
                                                                                              ------
Allowance for
 estimated
 losses.........                                                                                (886)
                                                                                              ------
                                                                                              $1,493
                                                                                              ======
</TABLE>
-------
(1) The aggregate cost for federal income tax purposes is $2.2 million.
(2) An allowance for loss has been provided to reduce the carrying value of
    this loan to the Company's estimate of fair value of the underlying
    collateral minus estimated selling expenses.
 
                                       56
<PAGE>
 
                                                                     SCHEDULE IV
                                                                     (Continued)
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                         MORTGAGE LOANS ON REAL ESTATE
 
<TABLE>
<CAPTION>
                                                      1998     1997     1996
                                                     -------  -------  -------
                                                     (dollars in thousands)
<S>                                                  <C>      <C>      <C>
Balance at January 1,............................... $ 4,838  $ 9,485  $11,166
 Additions
  New mortgage loans................................     149      --       --
 Deductions
  Collections of principal..........................     (94)  (5,025)    (885)
  Foreclosed properties and deeds-in-lieu of
   foreclosure......................................  (2,514)     --      (683)
  Write off of uncollectible mortgage loan..........     --       --       (63)
  Write off of principal due to discount for early
   payoff...........................................     --      (135)     (50)
  Write off of unamortized discount for early
   payoff...........................................     --       513      --
                                                     -------  -------  -------
Balance at December 31,............................. $ 2,379  $ 4,838  $ 9,485
                                                     =======  =======  =======
</TABLE>
 
                                       57
<PAGE>
 
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 65, 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; President (April 1992 to April 1994) of PSA Group; Executive
  Vice President (1987 to 1991) of Key Companies Inc.; 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").
 
  RICHARD W. DOUGLAS: Age 51, Director (Independent) (since January 1998).
 
    Executive Vice President of The Staubach Company (since February 1999);
  President (1991 to 1999) of Dallas Chamber of Commerce; President (1988 to
  1991) of North Texas Commission; President (1978 to 1981) of Las Colinas
  Corporation and Southland Investment Properties, both affiliates of
  Southland Financial Corporation; Trustee (since January 1998) of CMET; and
  Director (since January 1998) of IORI.
 
  LARRY E. HARLEY: Age 58, Director (Independent) (since January 1998).
 
    President (1993 to 1997) and Executive Vice President (1992 to 1993) of
  U.S. Operations, Executive Vice President (1989 to 1992) and Senior Vice
  President (1986 to 1989) of Distribution Operations, Director of Marketing
  (1984 to 1986), and Manager of North Central Distribution Center (1974 to
  1984) of Mary Kay Cosmetics; Trustee (since January 1998) of CMET; and
  Director (since January 1998) of IORI.
 
                                      58
<PAGE>
 
  R. DOUGLAS LEONHARD: Age 62, Director (Independent) (since January 1998).
 
    Director (since November 1998) of Optel, Inc.; Senior Vice President
  (1986 to 1997) of LaCantera Development Company, a wholly-owned subsidiary
  of USAA; Senior Vice President (1980 to 1985) of The Woodlands Development
  Corporation; Vice President and Houston Projects Manager (1973 to 1979) of
  Friendswood Development Company; Manager in various capacities (1960 to
  1973) of Exxon Corp; Trustee (since January 1998) of CMET; and Director
  (since January 1998) of IORI.
 
  MURRAY SHAW: Age 67, Director (Independent) (since February 1998).
 
    Chairman of the Board of Regents (since 1997) of Stephen F. Austin
  University; Vice President (1967 to 1996) of Tracor, Inc.; Trustee (since
  February 1998) of CMET; and Director (since February 1998) of IORI.
 
  MARTIN L. WHITE: Age 59, Director (Independent) (since January 1995).
 
    Chief Executive Officer (since 1995) of Builders Emporium, Inc.; 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 64, 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 Board of Directors held ten meetings during 1998. For such year, no
incumbent Director attended fewer than 75% of the aggregate of (1) the total
number of meetings held by the Board of Directors during the period for which
he had been a Director and (2) 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 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, Leonhard and White. The Audit Committee met twice during 1998.
 
  The 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 Relationship with Advisor
Committee reviews and reports to the 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 did not meet in 1998. The Board Development Committee
reviews and reports to the 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 did not
meet in 1998.
 
  The Board of Directors does not have Nominating or Compensation Committees.
 
                                      59
<PAGE>
 
Executive Officers
 
  The following persons currently serve as executive officers of the Company:
Randall M. Paulson, President; Karl L. Blaha, Executive Vice President--
Commercial Asset Management; Bruce A. Endendyk, Executive Vice President;
Thomas A. Holland, Executive Vice President and Chief Financial Officer; and
Steven K. Johnson, Executive Vice President--Residential Asset Management.
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 52, 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");
  President (since August 1995) and Executive Vice President (October 1994 to
  August 1995) of BCM; President (since January 1998) and Director (January
  1998 to December 1998) of NRLP Management Corp. ("NMC") the general partner
  of National Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP");
  Director (August 1995 to November 1998) 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.; and President (1990) of Paulson Realty Group.
 
  KARL L. BLAHA: Age 51, Executive Vice President--Commercial Asset Management
(since July 1997).
 
    Executive Vice President--Commercial Asset Management (since July 1997),
  Executive Vice President and Director of Commercial Management (April 1992
  to August 1995) of BCM, CMET, IORI, and SAMI; Director (since June 1996),
  President (since October 1993) and Executive Vice President and Director of
  Commercial Management (April 1992 to October 1993) of ART; Executive Vice
  President (October 1992 to July 1997) of Carmel Realty, Inc. ("Carmel
  Realty"), a company owned by First Equity Properties, Inc. ("First
  Equity"), which is 50% owned by a subsidiary of BCM; Director and President
  (since 1996) of First Equity; Director (since November 1998) of SAMI;
  Executive Vice President (since January 1998) and Director (since December
  1998) of NMC; Executive Vice President and Director of Commercial
  Management (April 1992 to February 1994) of NIRT and Vinland Property Trust
  ("VPT"); Partner--Director of National Real Estate Operations (August 1988
  to March 1992) of First Winthrop Corporation; and Vice President (April
  1984 to August 1988) of Southmark Corporation ("Southmark").
 
  BRUCE A. ENDENDYK: Age 50, Executive Vice President (since January 1995).
 
    President (since January 1995) of Carmel Realty; Executive Vice President
  (since January 1995) of BCM, SAMI, ART, CMET, IORI and (since January 1998)
  of NMC; Management Consultant (November 1990 to December 1994); Executive
  Vice President (January 1989 to November 1990) of Southmark; and President
  and Chief Executive Officer (March 1988 to January 1989) of Southmark
  Equities Corporation.
 
  THOMAS A. HOLLAND: Age 56, 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, IORI; Executive Vice President and Chief
  Financial Officer (since January 1998) of NMC; Secretary (since February
  1997) of CMET and IORI; and Senior Vice President and Chief Accounting
  Officer (July 1990 to February 1994) of NIRT and VPT.
 
                                      60
<PAGE>
 
  STEVEN K. JOHNSON: Age 41, Executive Vice President--Residential Asset
Management (since August 1998) and Vice President (August 1990 to August
1991).
 
    Executive Vice President--Residential Asset Management (since August
  1998) and Vice President (August 1990 to August 1991) of BCM, SAMI, ART,
  CMET and IORI; Executive Vice President--Residential Management (since
  August 1998) of NMC; Chief Operating Officer (January 1993 to August 1998)
  of Garden Capital, Inc.; Executive Vice President (December 1994 to August
  1998) of Garden Capital Management, Inc.; Executive Vice President--
  Residential Asset Management (since January 1999) of NMC; and Vice
  President (August 1991 to January 1993) of SHL Properties Realty Advisors,
  Inc. and SHL Acquisition Corporation II and III.
 
Officers
 
  Although not executive officers of the Company, the following persons
currently serve as officers of the Company: 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 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.
 
  ROBERT A. WALDMAN: Age 46, 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; and Senior Vice President, Secretary and General Counsel (since
  January 1998) of NMC.
 
  DREW D. POTERA: Age 39, 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; Vice President and Treasurer (since January
  1998) of NMC; 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 Directors, executive
officers, and any persons holding more than ten percent of the Company's
shares of Common Stock are required to report their share ownership 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
1998. 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.
 
                                      61
<PAGE>
 
The Advisor
 
  Although the 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 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. The advisor also serves as a consultant to
the Board of Directors in connection with the business plan and investment
decisions made by the Board of Directors.
 
  BCM has served as the Company's advisor since March 1989. BCM is a
corporation of which Messrs. Paulson, Blaha, Endendyk, Holland and Johnson
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 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 annual meeting of stockholders held on May 8, 1997, stockholders
approved the renewal of the Advisory Agreement with BCM through the next
annual meeting of stockholders. Subsequent renewals of the Advisory Agreement
with BCM do not require the approval of stockholders but do require the
approval of the Board of Directors.
 
  Under the Advisory Agreement, the Advisor is required to formulate and
submit annually for approval by the Board of Directors a budget and business
plan containing a twelve-month forecast of operations and cash flow, a general
plan for asset sales or purchases, lending, foreclosure and borrowing
activity, and other investments, and the Advisor is required to report
quarterly to the Board of Directors on the Company's performance against the
business plan. In addition, all transactions or investments require prior
approval by the 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 Board of Directors.
 
  The Advisory Agreement also requires prior approval of the 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 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 (total assets less allowance for amortization, depreciation or
depletion and valuation reserves) and an annual net income fee equal to 7.5%
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: (1) 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), (2) capital improvements made to such
assets during the period owned, and (3) all closing costs, (including real
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 net investment including capital improvements, calculated over the holding
period before depreciation and inclusive of operating income and sales
consideration and (b) the aggregate net operating income from all real estate
owned 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.
 
                                      62
<PAGE>
 
  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 equal to the lesser of (1) up to 1%
of the cost of acquisition, inclusive of commissions, if any, paid to
nonaffiliated brokers or (2) 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 (1) 2% of the amount of the loan commitment
or (2) 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
(1) 1% of the amount of the loan purchased or (2) 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 of any mortgage loan by the
Company.
 
  Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive
a mortgage brokerage and equity refinancing fee for obtaining loans or
refinancing on properties equal to the lesser of (1) 1% of the amount of the
loan or the amount refinanced or (2) 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 receives reimbursement of certain expenses
incurred by it in the performance of advisory services.
 
  Under the Advisory Agreement, all or a portion of the annual advisory fee
must be refunded by the Advisor 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 $664,000 of the annual advisory fee for 1998.
 
  Additionally, if management were to request that BCM render services to the
Company other than those required by the Advisory Agreement, BCM or an
affiliate of BCM is 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.
 
                                      63
<PAGE>
 
  The directors and principal officers of BCM are set forth below.
 
<TABLE>
   <C>                     <S>
   Mickey N. Phillips:     Director
 
   Ryan T. Phillips:       Director
 
   Randall M. Paulson:     President
 
                           Executive Vice President--Commercial Asset
   Karl L. Blaha:          Management
 
   Bruce A. Endendyk:      Executive Vice President
 
   Thomas A. Holland:      Executive Vice President and Chief Financial Officer
 
                           Executive Vice President--Residential Asset
   Steven K. Johnson:      Management
 
   A. Cal Rossi, Jr.:      Executive Vice President
 
   Cooper B. Stuart:       Executive Vice President
 
   Clifford C. Towns, Jr.: Executive Vice President--Finance
 
   Dan S. Allred:          Senior Vice President--Land Division
 
   James D. Canon, III:    Senior Vice President--Portfolio Manager
 
   Robert A. Waldman:      Senior Vice President, Secretary and General Counsel
 
   Drew D. Potera:         Vice President, Treasurer and Securities Manager
</TABLE>
 
  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 (1) First Equity, which is
50% owned by a subsidiary of BCM, (2) Gene E. Phillips and (3) a trust for the
benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the
property-level management and leasing of 29 of the Company's commercial
properties and its four hotels 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 First Equity. 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 purchases and sales
in accordance with the following sliding scale of total fees to be paid: (1)
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; (2) 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; (3) 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 (4) 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.
 
                                      64
<PAGE>
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The Company has no employees, payroll or benefit plans and pays no
compensation to its executive officers. 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 perform a variety of
services for the Advisor and the amount of their compensation is determined
solely by the 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 (1) review the investment policies of the Company to determine that
they are in the best interest of stockholders, (2) review the advisory
contract, (3) supervise the performance of the advisor and review the
reasonableness of the compensation paid to the advisor in terms of the nature
and quality of services performed, (4) review the reasonableness of the total
fees and expenses of the Company and (5) select, when necessary, a qualified
independent real estate appraiser to appraise properties purchased.
 
  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 1998, $116,000 was paid to the Independent Directors in total
Directors' fees for all services, including the annual fee for service during
the period January 1, 1998 through December 31, 1998, and 1998 special service
fees as follows: Richard W. Douglas, $15,000; Larry E. Harley, $15,000; R.
Douglas Leonhard, $15,000; Murray Shaw, $13,750; Ted P. Stokely, $16,500;
Edward L. Tixier, $3,750; Martin L. White, $15,000; and Edward G. Zampa,
$22,000.
 
                                      65
<PAGE>
 
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, 1993 in the Company's
shares of Common Stock and in each of the indices and further assumes the
reinvestment of all distributions. Past performance is not necessarily an
indicator of future performance.
 
                              [GRAPH APPEARS HERE]
 
 
<TABLE>
<CAPTION>
                  1993   1994   1995    1996   1997   1998
                 ------ ------ ------- ------ ------ ------
  <S>            <C>    <C>    <C>     <C>    <C>    <C>
  The Company    100.00 110.19 111.890 126.48 188.82 166.28
  S&P 500 Index  100.00 101.31  139.22 171.19 228.29 293.54
  REIT Index     100.00 104.00  127.91 165.45 183.24 120.88
</TABLE>
 
 
                                       66
<PAGE>
 
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 to be beneficial owners of more than 5% of the outstanding shares of
Common Stock as of the close of business on March 5, 1999.
 
<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.....................     1,204,470        31.1%
   10670 N. Central Expressway
   Suite 300
   Dallas, Texas 75231
 
   Basic Capital Management, Inc..................       422,057        10.9%
   10670 N. Central Expressway
   Suite 300
   Dallas, Texas 75231
 
   Maurice A. Halperin............................       326,450         8.4%
   2500 North Military Trail
   Suite 225
   Boca Raton, Florida 33431
</TABLE>
  --------
  (1) Percentage is based upon 3,878,463 shares of Common Stock outstanding
      at March 5, 1999.
 
  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 5, 1999.
 
<TABLE>
<CAPTION>
                                          Amount and Nature
                                            of Beneficial          Percent of
   Name of Beneficial Owner                   Ownership            Class (/1/)
   ------------------------               -----------------       ------------
   <S>                                    <C>                     <C>
   All Directors and Executive Officers
    as a group (12 individuals)..........     1,734,270(/2/)(/3/)     44.7%
</TABLE>
  --------
  (1) Percentage is based upon 3,878,463 shares of Common Stock outstanding
      at March 5, 1999.
  (2) Includes 80,268 shares owned by CMET of which the 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. Also includes 1,000 shares owned directly by Ted P.
      Stokely.
  (3) Includes 26,475 shares owned by SAMLP, 422,057 shares owned by BCM and
      1,204,470 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 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.
 
                                      67
<PAGE>
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
Certain Business Relationships
 
  In February 1989, the 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,
Blaha, Endendyk, Holland and Johnson 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 1, 1991, 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 (1) First Equity, which is 50% owned by a
subsidiary of BCM, (2) Mr. Phillips and (3) a trust for the benefit of the
children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level
management and leasing of 29 of the Company's commercial properties and its
four hotels 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 First Equity.
 
  Prior to December 1, 1992, affiliates of BCM provided brokerage services for
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. Carmel Realty is a company
owned by First Equity.
 
  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 22.7% of the outstanding shares of common stock of IORI at
December 31, 1998. BCM also serves as advisor to ART. Messrs. Paulson, Blaha,
Endendyk, Holland and Johnson serve as executive officers of ART and NMC. NMC,
a wholly-owned subsidiary of ART, is the general partner of NRLP and NOLP. BCM
performs certain administrative functions for NRLP and NOLP on a cost-
reimbursement basis.
 
  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 income
and elderly housing. Eldercare has a revolving loan commitment from Syntek
West, Inc., 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 again filed for bankruptcy protection in May 1995, and
was reorganized in bankruptcy in February 1996, and has since paid all debts
as directed by the Bankruptcy Court.
 
Related Party Transactions
 
  Historically, the Company has engaged in and may continue to engage in
business transactions, including real estate partnerships, with related
parties. 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 345,728 shares of the common stock of IORI, an
approximate 22.7% interest.
 
  In 1998, the Company paid BCM and its affiliates $4.1 million in advisory
and net income fees, $341,000 in mortgage brokerage and equity refinancing
fees, $3.5 million in property acquisition fees, $767,000 in real estate
brokerage commissions and $2.8 million in property and construction management
fees and leasing
 
                                      68
<PAGE>
 
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 of $1.1 million in 1998.
 
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 (1) any director, officer or employee of the Company, (2) any
director, officer or employee of the advisor, (3) the advisor or (4) 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.
 
  Pursuant to the terms of the Modification of Stipulation of Settlement (the
"Olive 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 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 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 Olive 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 Olive Modification, require the prior
approval by two-thirds of the Directors of the Company, and if required,
approval by a majority of stockholders. The Olive 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 Gene E. 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.
 
  An Amendment to the Olive Modification (the "Olive Amendment") was approved
by the Court on July 3, 1997. The Olive Amendment requires that additional
requirements be met for certain transactions with affiliates ("Affiliated
Transaction") prior to April 28, 1999. Independent counsel to the Board must
review, advise and report to the Board of Directors on any Affiliated
Transaction prior to its consideration and approval by the Board of Directors
and the Board of Directors must unanimously approve the transaction after
receiving independent counsel's advice and report. In addition, a notice must
be given to the plaintiffs' counsel at least 10 days prior to the closing of
the transaction and during such 10 day period plaintiffs' counsel is entitled
to seek a Court order prohibiting consummation of the transaction. Neither BCM
nor any of its affiliates may receive any fees or commissions in connection
with an Affiliated Transaction.
 
                                      69
<PAGE>
 
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, 1998 and 1997
 
      Consolidated Statements of Operations--Years Ended December 31, 1998,
    1997 and 1996
 
      Consolidated Statements of Stockholders' Equity--Years Ended December
    31, 1998, 1997 and 1996
 
      Consolidated Statements of Cash Flows--Years Ended December 31, 1998,
    1997 and 1996
 
      Notes to Consolidated Financial Statements
 
    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, 1998).
 
                                      70
<PAGE>
 
    4. Exhibits
 
      The following documents are filed as Exhibits to this Report:
 
<TABLE>
<CAPTION>
       Exhibit
       Number                             Description
       -------                            -----------
       <C>     <S>
        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).
 
        3.3    Articles of Amendment to the Articles of Incorporation of
               Transcontinental Realty Investors, Inc., setting forth the
               Certificate of Designations, Preferences and Rights of Series A
               Cumulative Convertible Preferred Stock, dated October 20, 1998
               (incorporated by reference to Exhibit 3.1 to the Registrant's
               Quarterly Report on Form 10-Q for the quarter ended September
               30, 1998).
 
        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).
 
        10.1   Advisory Agreement dated as of October 15, 1998, between
               Transcontinental Realty Investors, Inc. and Basic Capital
               Management, Inc. (incorporated by reference to Exhibit 10.0 to
               the Registrant's Quarterly Report on Form 10-Q for the quarter
               ended September 30, 1998).
 
        27.0   Financial Data Schedule, filed herewith.
</TABLE>
 
  (b) Reports on Form 8-K:
 
    A Current Report on Form 8-K, dated October 20, 1998, was filed with
  respect to Item 2. "Acquisition or Disposition of Assets," and Item 7.
  "Financial Statements and Exhibits," which reports the acquisition of the
  Cliffs of Eldorado Apartments, filed December 4, 1998.
 
    A Current Report on Form 8-K, dated December 2, 1998, was filed with
  respect to Item 2. "Acquisition or Disposition of Assets," and Item 7.
  "Financial Statements and Exhibits," which reports the acquisition of
  Southgreen Apartments, Belmont Hotel, Brompton Hotel and Surf Hotel, filed
  February 18, 1999.
 
                                      71
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
 
                                          Transcontinental Realty Investors,
                                          Inc.
 
                                                   /s/ Randall M. Paulson
                                          By: _________________________________
                                                     Randall M. Paulson
                                                         President
   
Dated: May 12, 1999     
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
 
<TABLE>   
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----
 
<S>                                    <C>                        <C>
        /s/ Ted P. Stokely             Chairman of the Board and     May 12, 1999
______________________________________  Director
            Ted P. Stokely
 
      /s/ Richard W. Douglas           Director                      May 12, 1999
______________________________________
          Richard W. Douglas
 
       /s/ Larry E. Harley             Director                      May 12, 1999
______________________________________
           Larry E. Harley
 
     /s/ R. Douglas Leonhard           Director                      May 12, 1999
______________________________________
         R. Douglas Leonhard
 
         /s/ Murray Shaw               Director                      May 12, 1999
______________________________________
             Murray Shaw
 
       /s/ Martin L. White             Director                      May 12, 1999
______________________________________
           Martin L. White
 
       /s/ Edward G. Zampa             Director                      May 12, 1999
______________________________________
           Edward G. Zampa
 
      /s/ Thomas A. Holland            Executive Vice President      May 12, 1999
______________________________________  and Chief Financial
          Thomas A. Holland             Officer (Principal
                                        Financial and Accounting
                                        Officer)
</TABLE>    
 
                                      72
<PAGE>
 
                    TRANSCONTINENTAL REALTY INVESTORS, INC.
 
                                  EXHIBITS TO
                           ANNUAL REPORT ON FORM 10-K
 
                      For the Year Ended December 31, 1998
 
<TABLE>
<CAPTION>
Exhibit
Number                             Description                                                Page
-------                      ------------------------                                         ----
<S>                          <C>                                                              <C>
27.0                         Financial Data Schedule.
</TABLE>
 
 
                                       73