UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549


________________




Form 10-Q





(Mark
      One)R
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the quarterly period ended June 30, 2008or£
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the transition period from to





Commission
file number: 000-50805


________________




Hines
Real Estate Investment Trust, Inc.


(Exact
Name of Registrant as Specified in its Charter)





Maryland
            20-0138854(State
      or Other Jurisdiction of
            (I.R.S.
      EmployerIncorporation
      or Organization)
            Identification
      No.)2800
      Post Oak BoulevardSuite 5000Houston,
      Texas
            77056-6118(Address
      of principal executive offices)
            (Zip
      code)





Registrant’s
telephone number, including area code:


(888) 220-6121







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






Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
the Exchange Act (Check one):


Large
      accelerated filer   o
            Accelerated
      Filer   o
            Non-accelerated
      filer   ý
            Smaller
      Reporting Company   o




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).




Yes o   No x




As of
August 8, 2008, 195.4 million shares of the registrant’s common stock were
outstanding.





TABLE
OF CONTENTS





PART I –
      FINANCIAL INFORMATIONItem 1.
            Consolidated
      Financial Statements (Unaudited)Condensed Consolidated Balance
      Sheets
            
            
            2Condensed Consolidated Statements of
      Operations
            
            
            3Condensed Consolidated Statement of
      Shareholders’ Equity
            
            
            4Condensed Consolidated Statements of Cash
      Flows
            
            
            5Notes to the Condensed Consolidated Financial
      Statements
            
            
            6Item 2.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            
            
            22Item 3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            
            38Item 4T.
            Controls
      and Procedures
            
            
            39PART II –
      OTHER INFORMATIONItem 2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            
            40Item 6.
            Exhibits
            
            
            40SIGNATURESCertification
      of CEO pursuant to Section 302Certification
      of CFO pursuant to Section 302Certification
      of CEO & CFO pursuant to Section 906


1


PART I





FINANCIAL
INFORMATION





Item 1.Consolidated Financial
Statements.





HINES
REAL ESTATE INVESTMENT TRUST, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS


(UNAUDITED)





June
      30,2008
            
            
            December 31,2007(In
      thousands, except per share amounts)ASSETSInvestment
      property, net
            
            $
            2,283,656
            
            
            $
            1,798,924Investments
      in unconsolidated entities
            
            
            346,271
            
            
            
            361,157Cash
      and cash equivalents
            
            
            134,813
            
            
            
            152,443Restricted
      cash
            
            
            8,286
            
            
            
            3,463Distributions
      receivable
            
            
            6,887
            
            
            
            6,890Tenant
      and other receivables
            
            
            53,247
            
            
            
            28,518Intangible
      lease assets, net
            
            
            398,125
            
            
            
            296,766Deferred
      leasing costs, net
            
            
            40,354
            
            
            
            34,954Deferred
      financing costs, net
            
            
            8,200
            
            
            
            7,638Other
      assets
            
            
            2,935
            
            
            
            12,870TOTAL
      ASSETS
            
            $
            3,282,774
            
            
            $
            2,703,623LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilities:Accounts
      payable and accrued expenses
            
            $
            84,351
            
            
            $
            66,267Due
      to affiliates
            
            
            9,231
            
            
            
            8,968Intangible
      lease liabilities, net
            
            
            122,676
            
            
            
            79,465Other
      liabilities
            
            
            20,897
            
            
            
            17,128Interest
      rate swap contracts
            
            
            30,858
            
            
            
            30,194Participation
      interest liability
            
            
            35,618
            
            
            
            26,771Distributions
      payable
            
            
            29,002
            
            
            
            24,923Notes
      payable
            
            
            1,515,088
            
            
            
            1,216,631Total
      liabilities
            
            
            1,847,721
            
            
            
            1,470,347Commitments
      and contingencies (Note 9)Shareholders’
      equity:Preferred
      shares, $.001 par value; 500,000 preferred shares authorized, none
      issued or outstanding as of June 30, 2008 and December 31,
      2007
            
            
            —
            
            
            
            —Common
      shares, $.001 par value; 1,500,000 common shares authorized as of
      June 30, 2008 and December 31, 2007; 189,873 and 159,409 common shares
      issued and outstanding as of June 30, 2008 and December 31, 2007,
      respectively
            
            
            190
            
            
            
            159Additional
      paid-in capital
            
            
            1,594,383
            
            
            
            1,358,523Accumulated
      deficit
            
            
            (173,640
            )
            
            
            (137,915
            )Accumulated
      other comprehensive income
            
            
            14,120
            
            
            
            12,509Total
      shareholders’ equity
            
            
            1,435,053
            
            
            
            1,233,276TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            3,282,774
            
            
            $
            2,703,623





See notes
to the condensed consolidated financial statements.








2


HINES
REAL ESTATE INVESTMENT TRUST, INC.


CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


For
the Three and Six Months Ended June 30, 2008 and 2007


(UNAUDITED)





Three
      Months Ended June 30,
            Six
      Months Ended June 30,2008
            2007
            
            
            2008
            2007(In
      thousands, except per share amounts)Revenues:Rental
      revenue
            
            $
            78,278
            
            
            $
            35,251
            
            
            $
            143,078
            
            
            $
            64,606Other
      revenue
            
            
            6,942
            
            
            
            2,028
            
            
            
            12,276
            
            
            
            3,347Total
      revenues
            
            
            85,220
            
            
            
            37,279
            
            
            
            155,354
            
            
            
            67,953Expenses:Property
      operating expenses
            
            
            21,841
            
            
            
            9,704
            
            
            
            40,124
            
            
            
            16,833Real
      property taxes
            
            
            11,859
            
            
            
            5,982
            
            
            
            21,622
            
            
            
            10,718Property
      management fees
            
            
            1,786
            
            
            
            958
            
            
            
            3,371
            
            
            
            1,662Depreciation
      and amortization
            
            
            32,216
            
            
            
            13,083
            
            
            
            57,597
            
            
            
            24,641Asset
      management and acquisition fees
            
            
            9,284
            
            
            
            4,902
            
            
            
            17,694
            
            
            
            11,131Organizational
      and offering expenses
            
            
            1,695
            
            
            
            1,104
            
            
            
            3,614
            
            
            
            3,501General
      and administrative expenses
            
            
            1,813
            
            
            
            1,309
            
            
            
            3,093
            
            
            
            2,151Total
      expenses
            
            
            80,494
            
            
            
            37,042
            
            
            
            147,115
            
            
            
            70,637Income
      (loss) before other income (expenses), income tax expense and income
      allocated to minority interests
            
            
            4,726
            
            
            
            237
            
            
            
            8,239
            
            
            
            (2,684
            )Other
      income (expenses):Equity
      in losses of unconsolidated entities, net
            
            
            (2,181
            )
            
            
            (757
            )
            
            
            (4,116
            )
            
            
            (1,894
            )Gain
      (loss) on derivative instruments, net
            
            
            26,780
            
            
            
            15,209
            
            
            
            (665
            )
            
            
            15,847Gain
      (loss) on foreign currency transactions
            
            
            —
            
            
            
            —
            
            
            
            (2
            )
            
            
            134Interest
      expense
            
            
            (20,900
            )
            
            
            (10,399
            )
            
            
            (38,952
            )
            
            
            (19,832
            )Interest
      income
            
            
            361
            
            
            
            2,460
            
            
            
            1,610
            
            
            
            2,861Income
      (loss) before income tax expense and income allocated to minority
      interests
            
            
            8,786
            
            
            
            6,750
            
            
            
            (33,886
            )
            
            
            (5,568
            )Provision
      for income taxes
            
            
            51
            
            
            
            (268
            )
            
            
            (464
            )
            
            
            (334
            )Income
      allocated to minority interests
            
            
            (732
            )
            
            
            (326
            )
            
            
            (1,375
            )
            
            
            (395
            )Net
      income (loss)
            
            $
            8,105
            
            
            $
            6,156
            
            
            $
            (35,725
            )
            
            $
            (6,297
            )Basic
      and diluted income (loss) per common share:Income
      (loss) per common share
            
            $
            0.05
            
            
            $
            0.05
            
            
            $
            (0.21
            )
            
            $
            (0.06
            )Weighted
      average number of common shares outstanding
            
            
            178,536
            
            
            
            115,588
            
            
            
            171,840
            
            
            
            102,136








See notes
to the condensed consolidated financial statements.


3


HINES
REAL ESTATE INVESTMENT TRUST, INC.





CONDENSED CONSOLIDATEDSTATEMENT OF SHAREHOLDERS’
EQUITY


For
the Six Months Ended June 30, 2008


(UNAUDITED)





Common
              Shares
            
            
            Amount
            
            
            Additional
              Paid-In
              Capital
            
            
            Accumulated
              Deficit
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            Shareholders’
              Equity(In
      thousands)BALANCE,January
      1, 2008
            
            
            159,409
            
            
            $
            159
            
            
            $
            1,358,523
            
            
            $
            (137,915
            )
            
            $
            12,509
            
            
            $
            1,233,276Issuance
      of common shares
            
            
            32,260
            
            
            
            33
            
            
            
            338,650
            
            
            
            —
            
            
            
            —
            
            
            
            338,683Redemption
      of common shares
            
            
            (1,796
            )
            
            
            (2
            )
            
            
            (17,098
            )
            
            
            —
            
            
            
            —
            
            
            
            (17,100
            )Distributions
      declared
            
            
            —
            
            
            
            —
            
            
            
            (53,964
            )
            
            
            —
            
            
            
            —
            
            
            
            (53,964
            )Selling
      commissions and dealer manager fees
            
            
            —
            
            
            
            —
            
            
            
            (27,528
            )
            
            
            —
            
            
            
            —
            
            
            
            (27,528
            )Other
      offering costs
            
            
            —
            
            
            
            —
            
            
            
            (4,200
            )
            
            
            —
            
            
            
            —
            
            
            
            (4,200
            )Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (35,725
            )
            
            
            —Other
      comprehensive income — Foreign currency translation
      adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,611Total
      comprehensive loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (34,114
            )BALANCE,June
      30, 2008
            
            
            189,873
            
            
            $
            190
            
            
            $
            1,594,383
            
            
            $
            (173,640
            )
            
            $
            14,120
            
            
            $
            1,435,053





See notes
to the condensed consolidated financial statements.





4


HINES
REAL ESTATE INVESTMENT TRUST, INC.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)





Six
      Months Ended June 30,2008
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIES:
            
            (In
      thousands)Net
      loss
            
            $
            (35,725
            )
            
            $
            (6,297
            )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            57,405
            
            
            
            25,916Non-cash
      compensation expense
            
            
            14
            
            
            
            10Equity
      in losses of unconsolidated entities
            
            
            4,116
            
            
            
            1,894Distributions
      received from unconsolidated entities
            
            
            969
            
            
            
            —Income
      allocated to minority interests
            
            
            1,375
            
            
            
            395Accrual
      of organizational and offering expenses
            
            
            3,614
            
            
            
            3,501Loss
      (gain) on foreign currency transactions
            
            
            2
            
            
            
            (134
            )Loss
      (gain) on derivative instruments, net
            
            
            665
            
            
            
            (15,847
            )Net
      change in operating accounts
            
            
            (14,008
            )
            
            
            (2,278
            )Net
      cash provided by operating activities
            
            
            18,427
            
            
            
            7,160CASH
      FLOWS FROM INVESTING ACTIVITIES:Investment
      in unconsolidated entities
            
            
            —
            
            
            
            (28,896
            )Distributions
      received from unconsolidated entities in excess of equity in
      earnings
            
            
            13,246
            
            
            
            11,836Investments
      in property
            
            
            (433,750
            )
            
            
            (403,620
            )Investments
      in master leases
            
            
            (1,917
            )
            
            
            (4,520
            )Master
      lease rent receipts
            
            
            2,785
            
            
            
            2,220Additions
      to other assets
            
            
            —
            
            
            
            (64,955
            )Settlement
      of foreign currency hedge
            
            
            —
            
            
            
            939Increase
      in restricted cash
            
            
            (4,873
            )
            
            
            (4,848
            )Increase
      in acquired lease intangibles, net
            
            
            (86,042
            )
            
            
            (44,428
            )Net
      cash used in investing activities
            
            
            (510,551
            )
            
            
            (536,272
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Decrease
      in other liabilities
            
            
            (1,097
            )
            
            
            (1,359
            )Proceeds
      from issuance of common stock
            
            
            300,615
            
            
            
            573,903Redemption
      of common shares
            
            
            (17,100
            )
            
            
            (2,160
            )Payments
      of selling commissions and dealer manager fees
            
            
            (25,430
            )
            
            
            (48,563
            )Payments
      of organizational and offering expenses
            
            
            (8,319
            )
            
            
            (11,352
            )Distributions
      paid to shareholders and minority interests
            
            
            (23,361
            )
            
            
            (10,659
            )Proceeds
      from notes payable
            
            
            520,000
            
            
            
            493,415Payments
      on notes payable
            
            
            (269,238
            )
            
            
            (274,664
            )Additions
      to deferred financing costs
            
            
            (1,444
            )
            
            
            (1,093
            )Payments
      related to interest rate swap contracts
            
            
            —
            
            
            
            (731
            )Net
      cash provided by financing activities
            
            
            474,626
            
            
            
            716,737Effect
      of exchange rate changes on cash
            
            
            (132
            )
            
            
            306Net
      change in cash and cash equivalents
            
            
            (17,630
            )
            
            
            187,931Cash
      and cash equivalents, beginning of period
            
            
            152,443
            
            
            
            23,022Cash
      and cash equivalents, end of period
            
            $
            134,813
            
            
            $
            210,953





See notes
to the condensed consolidated financial statements


5


HINES REAL ESTATE INVESTMENT TRUST, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


For
the Three and Six Months Ended June 30, 2008 and 2007


(UNAUDITED)





1.  Organization





The accompanying interim unaudited
condensed consolidated financial information has been prepared according to the rules
and regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America (“GAAP”) have been condensed or omitted according to such rules and
regulations. For further information, refer to the financial statements and footnotes
for the year ended December 31, 2007 included in Hines Real Estate Investment
Trust, Inc.’s Annual Report on Form 10-K. In the opinion of management, all
adjustments and eliminations, consisting only of normal recurring adjustments,
necessary to present fairly and in conformity with GAAP the financial position of Hines Real
Estate Investment Trust, Inc. as of June 30, 2008 and December 31,
2007, and the results of operations for the three and six months ended June 30,
2008 and 2007, and cash flows for six months ended June 30,
2008 and 2007 have been included. The results of operations for such
interim periods are not necessarily indicative of the results for the full
year.





Hines
Real Estate Investment Trust, Inc., a Maryland corporation (“Hines REIT” and,
together with its consolidated subsidiaries, the “Company”), was formed on
August 5, 2003 under the General Corporation Law of the state of Maryland
for the purpose of engaging in the business of investing in and owning interests
in real estate. Beginning with the its taxable year ended December 31, 2004, the
Company operated and intends to continue to operate in a manner to qualify as a
real estate investment trust (“REIT”) for federal income tax purposes. The
Company is structured as an umbrella partnership REIT under which substantially
all of the Company’s current and future business is and will be conducted
through its majority-owned subsidiary, Hines REIT Properties, L.P. (the
“Operating Partnership”). Hines REIT is the sole general partner of the
Operating Partnership. Subject to certain restrictions and limitations, the
business of the Company is managed by Hines Advisors Limited Partnership (the
“Advisor”), an affiliate of Hines Interests Limited Partnership (“Hines”),
pursuant to the advisory agreement the Company entered into with the Advisor
(the “Advisory Agreement”).





Public
Offerings





On
June 18, 2004, Hines REIT commenced its initial public offering (the
“Initial Offering”). The Company raised $527.5 million in proceeds through the
Initial Offering, which expired on June 18, 2006. On June 19,
2006, the Company commenced its second public offering (the “Second Offering”),
through which it raised approximately $1.5 billion of gross proceeds prior to
its expiration on June 30, 2008.  The Company commenced its follow-on
offering (the “Third Offering”) on July 1, 2008 pursuant to which it is offering
a maximum of $3.5 billion in common shares. See Note 11 for additional
information regarding the Third Offering.





The
following table summarizes the sales activity from the Second Offering (in
millions):





Period
            
            #
      of Shares
            
            
            Gross
      ProceedsJune
      19, 2006 to December 31, 2006
            
            
            27.3
            (a)
            
            $
            282.7
            (a)Year
      ended December 31, 2007
            
            
            80.3
            (b)
            
            $
            834.8
            (b)Six
      Months Ended June 30, 2008
            
            
            32.3
            (c)
            
            $
            338.6
            (c)Total
            
            
            139.9
            
            
            $
            1,456.1


__________





(a)
            Amounts
      include $9.3 million of gross proceeds relating to approximately
      944,000 shares issued under the Company’s dividend reinvestment
      plan.(b)
            Amounts
      include $37.4 million of gross proceeds relating to approximately 3.8
      million shares issued under the Company’s dividend reinvestment
      plan.





(c)
            Amounts
      include $27.9 million of gross proceeds relating to approximately 2.8
      million shares issued under the Company’s dividend reinvestment
      plan.





Hines
REIT contributes all net proceeds from its public offerings to the Operating
Partnership in exchange for partnership units in the Operating Partnership. As
of June 30, 2008 and December 31, 2007, Hines REIT owned a 97.5% and 97.6%,
general partner interest in the Operating Partnership,
respectively.





From July
1 through August 8, 2008, Hines REIT received gross offering proceeds of
approximately $24.4 million from the sale of 2.4 million common
shares.




6


Minority
Interests





Hines
2005 VS I LP, an affiliate of Hines, owned a 0.6% and 0.7% interest in the
Operating Partnership as of June 30, 2008 and December 31, 2007, respectively.
As a result of HALP Associates Limited Partnership’s (“HALP”) ownership of the
Participation Interest (see Note 6), HALP’s percentage ownership in the
Operating Partnership was 1.9% and 1.7% as of June 30, 2008 and December 31,
2007, respectively.





Investment
Property





As of
June 30, 2008, the Company held direct and indirect investments in 46
properties. These properties consisted of 43 office properties located
throughout the United States, one industrial property located in Dallas, Texas,
one mixed-use office and retail property located in Toronto, Ontario, and a 50%
interest in an industrial property located in Rio de Janeiro, Brazil. The
Company’s interests in 25 of these properties are owned indirectly through its
investment in Hines US Core Office Fund LP (the “Core Fund”). As of June
30, 2008 and December 31, 2007, the Company owned an approximate 28.7% and 32.0%
non-managing general partner interest in the Core Fund,
respectively.  See Note 3 for further discussion.





2.  Summary
of Significant Accounting Policies





Use
of Estimates





The
preparation of the consolidated financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets,
liabilities and contingencies as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
periods.  The Company evaluates its assumptions and estimates on an
ongoing basis.  The Company bases its estimates on historical
experience and on various other assumptions that the Company believes to be
reasonable under the circumstances.  Additionally, application of the
Company’s accounting policies involves exercising judgments regarding
assumptions as to future uncertainties.  Actual results may differ
from these estimates under different assumptions or conditions.





Basis
of Presentation





The
consolidated financial statements of the Company included in this quarterly
report include the accounts of Hines REIT, the Operating Partnership (over which
Hines REIT exercises financial and operating control) and the Operating
Partnership’s wholly-owned subsidiaries (see Note 3), as well as the
related amounts of minority interest. All intercompany balances and transactions
were eliminated in consolidation.





The
Company evaluates the need to consolidate joint ventures based on standards set
forth in Financial Accounting Standards Board (“FASB”) Interpretation
No. 46R, Consolidation of
Variable Interest Entities (“FIN 46R”) and American Institute of
Certified Public Accountants’ Statement of Position 78-9, Accounting for Investments in Real
Estate Ventures (“SOP 78-9”) , as amended by Emerging Issues Task Force
Issue No. 04-5, Investor’s Accounting for an
Investment in a Limited
Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain
Rights.   In accordance with this accounting literature, the
Company consolidates joint ventures that are determined to be variable interest
entities for which it is the primary beneficiary. The Company also consolidates
joint ventures that are not determined to be variable interest entities, but for
which it exercises control over major operating decisions through substantive
participation rights, such as approval of budgets, selection of property
managers, asset management, investment activity and changes in
financing.





Reportable
Segments





Statement No. 131,
Disclosures about Segments of
an Enterprise and Related Information, establishes standards for
reporting financial and descriptive information about an enterprise’s reportable
segments. The Company’s investments in real estate are geographically
diversified and management evaluates operating performance at an individual
property level. The Company has determined it has two reportable segments: one
with activities related to investing in office properties and one with
activities related to investing in industrial properties. The office properties
segment consists of 19 office properties that the Company owns directly as well
as 25 office properties that are owned indirectly through the Company’s
investment in the Core Fund. The industrial segment consists of one
directly-owned industrial property located in Dallas, Texas and the Company’s
interest in one indirectly-owned industrial property located in Rio de Janeiro,
Brazil.





The
Company acquired its wholly-owned industrial property located in Dallas, Texas,
in May 2008. Total assets related to this property were $43.9 million as of June
30, 2008 out of the Company’s total assets of $3.3 billion. In addition, the
Company recorded revenues of approximately $490,000 and net income of $182,000
related to this property out of the Company’s total revenues of $155.4 million
and net loss of $35.7 million for the six-months ended June 30,
2008.





The
Company’s indirect investments are accounted for using the equity method of
accounting for investments. As such, the activities of these investments are
reflected in investments from unconsolidated entities in the condensed
consolidated balance sheets and equity in losses of unconsolidated entities in
the condensed consolidated statements of operations. See “Investments in
Unconsolidated Entities” in Note 3 for additional information regarding the
Company’s indirect investments.





Comprehensive
Loss





The
Company reports comprehensive loss in its condensed consolidated statements of
shareholders’ equity. Comprehensive loss was $34.1 million for the six months
ended June 30, 2008 resulting from the Company’s net loss of $35.7 million and
gain from foreign currency translation adjustment of $1.6 million.




7


International
Operations





The
Canadian dollar is the functional currency of the Company’s subsidiaries
operating in Toronto, Ontario and the Brazilian real is the functional currency
of the Company’s subsidiary operating in Rio de Janeiro, Brazil. The Company’s
foreign subsidiaries have translated their financial statements into
U.S. dollars for reporting purposes. Assets and liabilities are translated
at the exchange rate in effect as of the balance sheet date. The Company
translates income statement accounts using the average exchange rate for the
period and significant nonrecurring transactions using the rate on the
transaction date. As described above, these translation gains or losses are
included in accumulated other comprehensive income as a separate component of
shareholders’ equity.





The
Company’s international subsidiaries may have transactions denominated in
currencies other than their functional currency. In these instances, assets and
liabilities are remeasured into the functional currency at the exchange rate in
effect at the end of the period, and income statement accounts are remeasured at
the average exchange rate for the period. These gains or losses are included in
the Company’s results of operations.





The
Company or its subsidiaries also record gains or losses in the income statement
when a transaction with a third party, denominated in a currency other than the
entity’s functional currency, is settled and the functional currency cash flows
realized are more or less than expected based upon the exchange rate in effect
when the transaction was initiated.





Investment
Property and Lease Intangibles





Real
estate assets that the Company owns directly are stated at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method. The estimated useful lives for computing depreciation are generally
10 years for furniture and fixtures, 15-20 years for electrical and
mechanical installations and 40 years for buildings. Major replacements
that extend the useful life of the assets are capitalized. Maintenance and
repair costs are expensed as incurred.





Real
estate assets are reviewed for impairment if events or changes in circumstances
indicate that the carrying amount of the individual property may not be
recoverable. In such an event, a comparison will be made of the current and
projected operating cash flows of each property on an undiscounted basis to the
carrying amount of such property. Such carrying amount would be adjusted, if
necessary, to estimated fair values to reflect impairment in the value of the
asset. At June 30, 2008, management believes no such impairment has
occurred.





Acquisitions
of properties are accounted for utilizing the purchase method and, accordingly,
the results of operations of acquired properties are included in the Company’s
results of operations from their respective dates of acquisition. Estimates of
future cash flows and other valuation techniques that the Company believes are
similar to those used by independent appraisers are used to allocate the
purchase price of acquired property between land, buildings and improvements,
equipment and identifiable intangible assets and liabilities such as amounts
related to in-place leases, acquired above- and below-market leases, tenant
relationships, asset retirement obligations and mortgage notes payable. Initial
valuations are subject to change until such information is finalized, no later
than 12 months from the acquisition date.





The
estimated fair value of acquired in-place leases are the costs the Company would
have incurred to lease the properties to the occupancy level of the properties
at the date of acquisition. Such estimates include the fair value of leasing
commissions, legal costs and other direct costs that would be incurred to lease
the properties to such occupancy levels. Additionally, the Company evaluates the
time period over which such occupancy levels would be achieved. Such
evaluation includes an estimate of the net market-based rental revenues and net
operating costs (primarily consisting of real estate taxes, insurance and
utilities) that would be incurred during the lease-up period. Acquired in-place
leases as of the date of acquisition are amortized over the remaining lease
terms.





Acquired
above-and below-market lease values are recorded based on the present value
(using an interest rate that reflects the risks associated with the lease
acquired) of the difference between the contractual amounts to be paid pursuant
to the in-place leases and management’s estimate of fair market value lease
rates for the corresponding in-place leases. The capitalized above- and
below-market lease values are amortized as adjustments to rental revenue over
the remaining terms of the respective leases. Should a tenant terminate its
lease, the unamortized portion of the in-place lease value is charged to
amortization expense and the unamortized portion of out-of-market lease value is
charged to rental revenue.





Acquired
above- and below-market ground lease values are recorded based on the difference
between the present value (using an interest rate that reflects the risks
associated with the lease acquired) of the contractual amounts to be paid
pursuant to the ground leases and management’s estimate of fair market value of
land under the ground leases. The capitalized above- and below-market lease
values are amortized as adjustments to ground lease expense over the lease
term.





Management
estimates the fair value of assumed mortgage notes payable based upon
indications of current market pricing for similar types of debt with similar
maturities. Assumed mortgage notes payable are initially recorded at their
estimated fair value as of the assumption date, and the difference between such
estimated fair value and the note’s outstanding principal balance is amortized
over the life of the mortgage note payable.





Cash
and Cash Equivalents





The
Company considers all short-term, highly liquid investments that are readily
convertible to cash with an original maturity of three months or less at the
time of purchase to be cash equivalents.




8


Restricted
Cash





As of
June 30, 2008 and December 31, 2007, the Company had restricted cash of
approximately $8.3 million and $3.5 million, respectively, related to escrow
accounts required by certain of the Company’s mortgage agreements.




Deferred
Leasing Costs





Direct
leasing costs, primarily consisting of third-party leasing commissions and
tenant inducements, are capitalized and amortized over the life of the related
lease. Tenant inducement amortization is recorded as an offset to rental revenue
and the amortization of other direct leasing costs is recorded in amortization
expense.





The
Company considers a number of different factors to evaluate whether it or the
lessee is the owner of the tenant improvements for accounting purposes. These
factors include: 1) whether the lease stipulates how and on what a tenant
improvement allowance may be spent; 2) whether the tenant or landlord
retains legal title to the improvements; 3) the uniqueness of the
improvements; 4) the expected economic life of the tenant improvements
relative to the term of the lease; and 5) who constructs or directs the
construction of the improvements.





The
determination of who owns the tenant improvements for accounting purposes is
subject to significant judgment. In making that determination, the Company
considers all of the above factors. No one factor, however, necessarily
establishes any determination.





Tenant
inducement amortization was approximately $1.7 million and $868,000 for the six
months ended June 30, 2008 and 2007, respectively, and was recorded as an offset
to rental revenue. In addition, the Company recorded approximately $679,000 and
$280,000 as amortization expense related to other direct leasing costs for the
six months ended June 30, 2008 and 2007, respectively.





Tenant
inducement amortization was approximately $897,000 and $447,000 for the three
months ended June 30, 2008 and 2007, respectively, and was recorded as an offset
to rental revenue. In addition, the Company recorded approximately $377,000 and
$146,000 as amortization expense related to other direct leasing costs for the
three months ended June 30, 2008 and 2007, respectively.





On
December 8, 2006, Norwegian Cruise Line (NCL) signed a lease renewal for
its space in Airport Corporate Center, an office property located in Miami,
Florida. In connection with this renewal, the Company committed to funding
$10.4 million of construction costs related to NCL’s expansion and
refurbishment of its space, to be paid in future periods, beginning in the first
quarter of 2008. As a result, the Company has an $8.6 million liability recorded
in accounts payable and accrued expenses in the accompanying balance sheets as
of June 30, 2008.





On March
13, 2008, the Company acquired the Raytheon/DirecTV Buildings, a two-building
office complex located in El Segundo, California. In connection with this
acquisition, the Company assumed a commitment to fund $11.5 million of
construction costs to the Raytheon Corporation.





Derivative
Instruments





During
the years ended December 31, 2007 and 2006, the Company entered into
several forward interest rate swap transactions with HSH Nordbank AG, New York
Branch (“HSH Nordbank”). These swap transactions were entered into as economic
hedges against the variability of future interest rates on the Company’s
variable interest rate borrowings with HSH Nordbank. The Company has not
designated any of these contracts as cash flow hedges for accounting purposes.
The valuation of the interest rate swaps is determined using widely accepted
valuation techniques including discounted cash flow analysis on the expected
cash flows of each derivative. This analysis reflects the contractual terms of
the derivatives, including the period to maturity, and uses observable
market-based inputs, including interest rate curves. The fair values of interest
rate swaps are determined using the market standard methodology of netting the
discounted future fixed cash receipts (or payments) and the discounted expected
variable cash payments (or receipts). The variable cash payments (or receipts)
are based on an expectation of future interest rates (forward curves) derived
from observable market interest rate curves. The interest rate swaps have been
recorded at their estimated fair value in the accompanying condensed
consolidated balance sheets as of June 30, 2008 and December 31, 2007. See
Note 10 for additional discussion regarding fair value.





In
addition, the Company entered into a foreign currency contract in February 2007
related to the acquisition of Atrium on Bay, a mixed-use office and retail
property located in Toronto, Ontario. The contract was entered into as an
economic hedge against the variability of the foreign currency exchange rate
related to the Company’s equity investment and was settled at the close of this
acquisition on February 26, 2007.





The table
below contains additional information regarding the Company’s derivative
instruments (all amounts are in thousands):





Description
            
            Increase
      (Decrease) in Fair Value
            
            
            Transaction
      Fees
            
            
            Foreign
      Currency
              Gain
      (Loss)
            
            
            Gain
      (Loss) on
              Derivative
              Instrument,
      netQuarter
      Ended June 30, 2008
            
            $
            26,780
            
            
            
            —
            
            
            
            —
            
            
            $
            26,780Quarter
      Ended June 30, 2007
            
            $
            15,574
            
            
            $
            (365
            )
            
            
            —
            
            
            $
            15,209Six
      Months Ended June 30, 2008
            
            $
            (665
            )
            
            
            —
            
            
            
            —
            
            
            $
            (665
            )Six
      Months Ended June 30, 2007
            
            $
            15,639
            
            
            $
            (731
            )
            
            $
            939
            
            
            $
            15,847


9


Deferred
Financing Costs





Deferred financing costs consist of
direct costs incurred in obtaining debt financing (see Note 4). These costs
are being amortized into interest expense on a straight-line basis, which
approximates the effective interest method, over the terms of the
obligations.  For the six months ended June 30, 2008 and 2007,
approximately $791,000 and $563,000, respectively, was amortized into interest
expense in the accompanying condensed consolidated statements of
operations. For the three
months ended June 30, 2008 and 2007, approximately $412,000 and $267,000,
respectively, was amortized into interest expense in the accompanying condensed
consolidated statements of operations.




Other
Assets





Other
assets includes the following (in thousands):





June 30, 2008
            
            December 31, 2007Property
      acquisition escrow deposit
            
            $
            —
            
            $
            10,000Prepaid
      insurance
            
            
            875
            
            
            1,056Mortgage
      loan deposits
            
            
            901
            
            
            904Other
            
            
            1,159
            
            
            910Total
            
            $
            2,935
            
            $
            12,870




Organizational
and Offering Costs





Second
Offering





The
Company commenced the Second Offering on June 19, 2006. Certain
organizational and offering costs associated with the Second Offering have been
paid by the Advisor on the Company’s behalf. Pursuant to the terms of the
Advisory Agreement in effect for the Second Offering, the Company was obligated
to reimburse the Advisor in an amount equal to the amount of actual
organizational and offering costs incurred, so long as such costs, together with
selling commissions and dealer manager fees, did not exceed 15% of gross
proceeds from the Second Offering. As of June 30, 2008 and December 31, 2007,
the Advisor had incurred on the Company’s behalf organizational and offering
costs in connection with the Second Offering of $36.9 million and
$29.1 million, respectively (of which $15.6 million and
$12.1 million, respectively, relates to the Advisor or its affiliates). As
of June 30, 2008, $1.8 million of these costs remained unpaid and were included
in due to affiliates in the condensed consolidated balance sheet.





The
Advisor incurred approximately $3.6 million and $3.5 million of internal
offering costs, which have been expensed in the accompanying condensed
consolidated statements of operations for the six months ended June 30, 2008 and
2007. In addition, $4.2 million of third-party offering costs have been
offset against net proceeds of the Second Offering within additional paid-in
capital for the six months ended June 30, 2008.





The
Advisor incurred approximately $1.7 million and $1.1 million of internal
offering costs, which have been expensed in the accompanying condensed
consolidated statements of operations for the three months ended June 30, 2008
and 2007, respectively. In addition, $2.6 million of third-party offering
costs have been offset against net proceeds of the Second Offering within
additional paid-in capital for the three months ended June 30,
2008.





Third
Offering





As
mentioned above, the Second Offering was terminated on June 30, 2008 and
the Third Offering commenced on July 1, 2008. During the six months ended
June 30, 2008, the Advisor incurred approximately $1.9 million of organizational
and offering costs related to the Third Offering. Per the terms of the Advisory
Agreement in effect for the Third Offering, the Company will not reimburse the
Advisor for organizational and offering costs related to the Third Offering. The
Advisor is not a shareholder of the Company and pursuant to the terms of the
Third Offering, the Company is not obligated to reimburse the Advisor for any of
these costs. Accordingly, no such amounts have been recorded in the accompanying
condensed consolidated financial statements. See Note 11 for additional
information regarding the Third Offering.





Revenue
Recognition





The
Company recognizes rental revenue on a straight-line basis over the life of the
lease including rent holidays, if any. Straight-line rent receivable in the
amount of $21.2 million and $12.7 million as of June 30, 2008 and December
31, 2007, respectively, consisted of the difference between the tenants’ rents
calculated on a straight-line basis from the date of acquisition or lease
commencement over the remaining terms of the related leases and the tenants’
actual rents due under the lease agreements and is included in tenant and other
receivables in the accompanying condensed consolidated balance sheets. Revenues
associated with tenant reimbursements are recognized in the period in which the
expenses are incurred based upon the tenant lease provisions. Revenues relating
to lease termination fees are generally recognized at the time that a tenant’s
right to occupy the space is terminated and when the Company has satisfied all
obligations under the agreement.





10


Stock-based
Compensation





Under the
terms of the Employee and Director Incentive Share Plan, the Company grants each
independent member of its board of directors 1,000 restricted shares of common
stock annually. The restricted shares granted each year fully vest upon
completion of each director’s annual term. In accordance with the provisions of
Statement No. 123, Accounting for Stock-Based
Compensation (as amended), the Company recognizes the expense related to
these shares over the vesting period. The Company granted 1,000 restricted
common shares to each of its independent board members in November 2004, June
2005, June 2006 and July 2007. For the three and six months ended June 30, 2008
and 2007, amortization of stock compensation expense recorded by the Company was
immaterial.




Income
Taxes





Hines
REIT made an election to be taxed as a REIT under Sections 856 through 860
of the Internal Revenue Code of 1986, as amended (the “Code”), beginning with
its taxable year ended December 31, 2004. In addition, as of June 30, 2008
and 2007 the Company owned an investment in the Core Fund, which has invested in
properties through other entities that have elected to be taxed as REITs. Hines
REIT’s management believes that the Company and the applicable entities in the
Core Fund are organized and operate in such a manner as to qualify for treatment
as REITs and intend to operate in the foreseeable future in such a manner so
that they will remain qualified as REITs for federal income tax purposes.
Accordingly, no provision has been made for U.S. federal income taxes for
the six months ended June 30, 2008 and 2007 in the accompanying condensed
consolidated financial statements.





In connection with the
operation of Atrium on Bay, an office property located in Toronto, Ontario, the
Company has recorded an income tax provision for Canadian income taxes of
approximately $256,000 and $316,000 for the six months ended June 30, 2008 and
2007, respectively, in accordance with Canadian tax laws and regulations. In
addition, the Company has also recorded a benefit for Canadian income taxes of
approximately $251,000 for the three months ended June 30, 2008 and a provision
for Canadian income taxes of approximately $250,000 for the three months ended
June 30, 2007.




The Company also recorded
an income tax provision for the Texas Margin Tax related to its properties
located in Texas. As a result, the Company recorded approximately $196,000 and
$205,000, respectively, for the three and six months ended June 30, 2008. The
related income tax expense was insignificant for the three and six months ended
June 30, 2007.





As of
June 30, 2008, the Company had no significant temporary differences, tax
credits, or net operating loss carry-forwards.




Per
Share Data





Income/loss
per common share is calculated by dividing the net income/loss for each period
by the weighted average number of common shares outstanding during such period.
Income/loss per common share on a basic and diluted basis is the same because
the Company has no potentially dilutive common shares outstanding.





Reclassifications





The
Company has revised the presentation of investment property to exclude the value
associated with leases in place at the time an investment property is acquired
as shown in the condensed consolidated balance sheet to be consistent with a
majority of others in the industry. As a result, certain reclassifications have
been made to the 2007 condensed consolidated balance sheet and the condensed
consolidated statement of cash flows for the six months ended June 30, 2007 to
be consistent with the 2008 presentation. Specifically, $253.0 million of net
book value of in-place leases has been reclassified from investment property to
intangible lease assets as of December 31, 2007 in the condensed consolidated
balance sheet and $64.3 million was reclassified from investments in property to
increase (decrease) in intangible lease assets, net, in the condensed
consolidated statement of cash flows. Management believes this change in
presentation is appropriate given the practices of many of the Company’s
industry peers, although it does not believe this change is necessary for the
fair presentation of the Company’s financial statements.





Recent
Accounting Pronouncements




In December 2007, the FASB issued Statement No. 141 (Revised 2007), Business Combinations (“SFAS
No. 141R”). SFAS No. 141R will significantly change the accounting for business
combinations. Under SFAS No. 141R, an acquiring entity will be required to
recognize all the assets acquired and liabilities assumed in a transaction at
the acquisition-date fair value with limited exceptions. SFAS No. 141R will
change the accounting treatment for certain specific acquisition-related items
including: (1) expensing acquisition related costs as incurred; (2) valuing
noncontrolling interests at fair value at the acquisition date; and (3)
expensing restructuring costs associated with an acquired business. SFAS No.
141R also includes a substantial number of new disclosure requirements. SFAS No.
141R is to be applied prospectively to business combinations for which the
acquisition date is on or after January 1, 2009. Management expects SFAS No.
141R will have a significant impact in future periods to the extent that real
estate acquisitions are significant. For example, the Company acquired four
properties for $590.1 million during the six months ended June 30, 2008. The
Company capitalized approximately $925,000 in acquisition-related expenses
during this period that would have been expensed under FAS
141R.





11


In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in
Consolidated Financial Statements (“SFAS No. 160”). SFAS No. 160
establishes requirements for ownership interests in subsidiaries held by parties
other than the Company (sometimes called “minority interests”) be clearly
identified, presented, and disclosed in the consolidated statement of financial
position within equity, but separate from the parent’s equity. All changes in
the parent’s ownership interests are required to be accounted for consistently
as equity transactions and any noncontrolling equity investments in
deconsolidated subsidiaries must be measured initially at fair value. SFAS No.
160 is effective, on a prospective basis, for fiscal years beginning after
December 15, 2008. However, presentation and disclosure requirements must be
retrospectively applied to comparative financial statements. Management is
currently assessing the impact of SFAS No. 160 on the Company’s consolidated
statement of operations.




In
March 2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment to FASB Statement
No. 133 (“SFAS No. 161”).  This statement contains disclosure
requirements regarding an entity’s derivative instruments and hedging activities
such as: (i) how and why they are used; (ii) how they are accounted for and
(iii) how they affect an entity’s financial statements. SFAS No. 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company does not expect the adoption
of SFAS No. 161 to have a material impact on its consolidated financial
statements.





In
April 2008, the FASB issued Staff Position No. 142-3 Determination of the Useful Life of
Intangible Assets (“FSP 142-3”).  FSP 142-3 amends the factors that
should be considered in developing renewal and extension assumptions used to
determine the useful life of a recognized intangible asset and the period of
expected cash flows used to measure the fair value of assets considered in a
business combination.  FSP 142-3 is effective on January 1, 2009.  The
Company is currently evaluating the impact FSP 142-3 will have on its
consolidated financial statements.





In
May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“SFAS No. 162”). This statement identifies the
sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that
are presented in conformity with generally accepted accounting principles in the
United States. The issuance of SFAS No. 162 is not expected to have a
significant impact on the Company’s consolidated financial
statements.







3.  Investment
Property and Lease Intangibles





Investment
property consisted of the following as of June 30, 2008 and December 31, 2007
(in thousands):





June
      30, 2008
            
            
            December
      31, 2007Buildings
      and improvements
            
            $
            1,886,583
            
            
            $
            1,481,541Less:
      accumulated depreciation
            
            
            (53,368)
            
            
            
            (32,395)Buildings
      and improvements, net
            
            
            1,833,215
            
            
            
            1,449,146Land
            
            
            450,441
            
            
            
            349,778Investment
      property, net
            
            $
            2,283,656
            
            
            $
            1,798,924





Direct
Investments





Properties
that are wholly owned by the Operating Partnership are referred to as “direct
investments.” As of December 31, 2007, the Company owned direct investments in
16 properties through its interest in the Operating Partnership and acquired the
following properties during the six months ended June 30, 2008:





City
            Property
            Date
      Acquired
            
            Contract Purchase
      Price(in
      millions)Kansas
      City, Missouri
            2555
      Grand
            February
      2008
            
            $
            155.8El Segundo, California
            Raytheon/DirecTV
      Buildings
            March
      2008
            
            $
            120.0Houston,
      Texas
            Williams
      Tower
            May
      2008
            
            $
            271.5Dallas,
      Texas
            4050/4055
      Corporate Drive
            May
      2008
            
            $
            42.8





As of
June 30, 2008, the cost basis and accumulated amortization related to lease
intangibles was as follows (in thousands):





Lease
      IntangiblesIn-Place
      Leases
            
            
            Out-of-Market
              Lease
      Assets
            
            
            Out-of-Market
              Lease
      LiabilitiesCost
            $
            423,222
            
            
            $
            69,719
            
            
            $
            142,316Less:
      accumulated amortization
            
            (79,789
            )
            
            
            (15,027
            )
            
            
            (19,640
            )Net
            $
            343,433
            
            
            $
            54,692
            
            
            $
            122,676





12


As of
December 31, 2007, the cost basis and accumulated amortization related
to lease intangibles was as follows (in thousands):





Lease
      IntangiblesIn-Place Leases
            
            
            Out-of-Market
              Lease
      Assets
            
            
            Out-of-Market
              Lease
      LiabilitiesCost
            $
            302,530
            
            
            $
            52,450
            
            
            $
            91,455Less:
      accumulated amortization
            
            (49,564
            )
            
            
            (8,650
            )
            
            
            (11,990
            )Net
            $
            252,966
            
            
            $
            43,800
            
            
            $
            79,465





Amortization
expense was $35.8 million and $15.4 million for in-place leases for
the six months ended June 30, 2008 and 2007, respectively, and amortization of
out-of-market leases, net, was an increase to rental revenue of approximately
$3.1 million and $723,000, respectively.  Amortization expense was
$20.4 million and $8.0 million for in-place leases for the three months
ended June 30, 2008 and 2007, respectively. Amortization of out-of-market
leases, net, was an increase to rental revenue of approximately $1.1 million and
$571,000 for the three months ended June 30, 2008 and 2007,
respectively.




Anticipated
amortization of in-place, out-of-market leases, net and out-of-market ground
leases for the period from July 1 through December 31, 2008 and for each of
the years ended December 31, 2009 through 2012 is as follows
(in thousands):





In-Place Leases
            
            
            Out-of-Market
              Leases,
      netJuly
      1 through December 31, 2008
            
            $
            38,894
            
            
            $
            (2,096
            )2009
            
            
            58,525
            
            
            
            (13,955
            )2010
            
            
            48,974
            
            
            
            (12,630
            )2011
            
            
            42,195
            
            
            
            (11,674
            )2012
            
            
            32,849
            
            
            
            (10,566
            )




In
connection with its direct investments, the Company has entered into lease
agreements with tenants for office and retail space. As of June 30, 2008, the
approximate fixed future minimum rentals for the period from July 1 through
December 31, 2008, and each of the years ending December 31, 2009
through 2012 and thereafter are as follows (in thousands):





Fixed
      Future
              Minimum RentalsJuly 1
      through December 31, 2008
            
            $
            114,1822009
            
            
            209,9492010
            
            
            189,5572011
            
            
            174,4262012
            
            
            149,866Thereafter
            
            
            584,831Total
            
            $
            1,422,811





Pursuant
to the lease agreements with certain tenants in one of its buildings, the
Company receives fees for the provision of various telecommunication-related
services and the use of certain related facilities. The fixed future minimum
rentals expected to be received for such services for the period from July 1,
2008 through December 31, 2008 are approximately $1.4 million. In addition, the
fixed future minimum rentals expected to be received for such services for each
of the years ended December 31, 2009 through December 31, 2012
and thereafter are $2.6 million, $2.3 million, $2.0 million, $1.4 million
and $1.5 million, respectively. The Company has outsourced the provision of
these services to a tenant in the same building, to whom it pays fees for the
provision of such services. The fixed future minimum payments for such services
for the period from July 1, 2008 through December 31, 2008 are approximately
$454,000. In addition, the fixed future minimum payments for such services
for each of the years ended December 31, 2009 through December 31, 2012
and thereafter are approximately $880,000, $726,000, $519,000, $364,000 and
$276,000, respectively.





During
the six months ended June 30, 2008, no tenant leased space representing more
than 10% of the total rental revenue of the Company. Approximately 10% of the
rental revenue recognized during the six months ended June 30, 2007 was earned
from a tenant in the software industry, whose lease expires in 2013. No
other tenant provided more than 10% of the Company’s total rental revenue for
the six months ended June 30, 2007.





One of
the Company’s properties is subject to a ground lease, which expires on
March 31, 2032. Although the lease provides for increases in payments over
the term of the lease, ground rent expense accrues on a straight-line
basis.  The fixed future minimum rentals to be paid under the ground lease
for the period from July 1, 2008 through December 31, 2008 are approximately
$203,000. In addition, the fixed future minimum rentals for each of the years
ended December 31, 2009 through December 31, 2012 and thereafter are
approximately $412,000, $420,000, $428,000, $438,000 and $10.3 million,
respectively. Ground lease expense for the six months ended June 30, 2008 was
approximately $281,000.


13


Investments
in Unconsolidated Entities





The
Company owns indirect interests in real estate through its investments in the
Core Fund and HCB II River LLC. The carrying values of its investments in these
entities as of June 30, 2008 and December 31, 2007 are as follows (in
thousands):





June
      30, 2008
            
            
            December
      31, 2007Investment
      in the Core Fund
            
            $
            312,596
            
            
            $
            330,441Investment
      in HCB II River LLC
            
            
            33,675
            
            
            
            30,716Total
      investments in unconsolidated entities
            
            $
            346,271
            
            
            $
            361,157




The equity in income (losses) of the Company’s unconsolidated entities for the
six months ended June 30, 2008 and 2007 was as follows (in
thousands):





Six
      Months Ended June 30, 2008
            
            
            Six
      Months Ended June 30, 2007Equity
      in losses of the Core Fund
            
            $
            (5,085
            )
            
            $
            (1,894
            )Equity
      in earnings of HCB II River LLC
            
            
            969
            
            
            
            —Net
      equity in losses of unconsolidated entities
            
            $
            (4,116
            )
            
            $
            (1,894
            )




The equity in income (losses) of the Company’s unconsolidated entities for the
three months ended June 30, 2008 and 2007 was as follows (in
thousands):





Three
      Months Ended June 30, 2008
            
            
            Three
      Months Ended June 30, 2007Equity
      in losses of the Core Fund
            
            $
            (2,714
            )
            
            $
            (757
            )Equity
      in earnings of HCB II River LLC
            
            
            533
            
            
            
            —Net
      equity in losses of unconsolidated entities
            
            $
            (2,181
            )
            
            $
            (757
            )




14


Investment
in the Core Fund





The Core
Fund is a partnership organized in August 2003 by Hines to invest in existing
office properties in the United States that Hines believes are desirable
long-term holdings. The Core Fund owns interests in real estate assets through
certain limited liability companies and limited partnerships which have mortgage
financing in place. As of June 30, 2008 and December 31, 2007, respectively, the
Company owned a 28.7% and 32.0% non-managing general partnership interest in the
Core Fund, which held ownership interests in 25 and 24 properties across the
United States.





Condensed
consolidated financial information of the Core Fund as of June 30, 2008 and
December 31, 2007 and for the six months ended June 30, 2008 and 2007 is
summarized below (in thousands):





ASSETS





June 30, 2008
            
            
            December 31, 2007Cash
            
            $
            78,612
            
            
            $
            112,211Property,
      net
            
            
            3,980,731
            
            
            
            3,481,975Other
      assets
            
            
            365,587
            
            
            
            351,577Total
      Assets
            
            $
            4,424,930
            
            
            $
            3,945,763





LIABILITIES
AND PARTNERS’ CAPITAL





Debt
            
            $
            2,616,372
            
            
            $
            2,313,895Other
      liabilities
            
            
            241,846
            
            
            
            264,705Minority
      interest
            
            
            523,496
            
            
            
            426,128Partners’
      capital
            
            
            1,043,216
            
            
            
            941,035Total
      Liabilities and Partners’ Capital
            
            $
            4,424,930
            
            
            $
            3,945,763





OPERATIONS





Six Months Ended June
      30, 2008
            
            
            Six Months Ended June
      30, 2007Revenues,
      other income and interest income
            
            $
            253,365
            
            
            $
            202,696Operating
      expenses
            
            
            (107,399
            )
            
            
            (86,778
            )Interest
      expense
            
            
            (67,490
            )
            
            
            (47,183
            )Depreciation
      and amortization
            
            
            (94,878
            )
            
            
            (68,162
            )(Income)
      loss allocated to minority interest
            
            
            141
            
            
            
            (6,151
            )Net
      Loss
            
            $
            (16,261
            )
            
            $
            (5,578
            )





During
the six months ended June 30, 2008 and 2007, no tenant leased space representing
more than 10% of the total rental revenue of the Core Fund.


15




4.  Debt
Financing





The
following table includes all of the Company’s outstanding notes payable as of
June 30, 2008 and December 31, 2007 (in thousands, except interest
rates):





Description
            Origination Date
            Maturity
      Date
            
            Interest
      Rate
            
            
            Principal
      Outstanding at
              June
      30,2008
            
            
            Principal
      Outstanding at December 31,2007SECURED
      MORTGAGE DEBTWells
      Fargo Bank, N.A. — Airport Corporate Center
            1/31/2006
            3/11/2009
            
            
            4.775
            %
            
            
            90,446
            (4)
            
            
            90,039Metropolitan
      Life Insurance Company — 1515 S. Street
            4/18/2006
            5/1/2011
            
            
            5.680
            %
            
            
            45,000
            
            
            
            45,000Capmark
      Finance, Inc. — Atrium on Bay
            2/26/2007
            2/26/2017
            
            
            5.330
            %
            
            
            188,100
            (3)
            
            
            193,686The
      Prudential Insurance Company ofAmerica
      — One Wilshire
            10/25/2007
            11/1/2012
            
            
            5.980
            %
            
            
            159,500
            
            
            
            159,500IXIS
      Real Estate Capital Inc. — Raytheon/DirecTV
      Buildings
            3/13/2008
            12/5/2016
            
            
            5.675
            %
      (6)
            
            
            52,802
            
            
            
            —New
      York State Teachers’ Retirement
              System —
      2555 Grand
            4/24/2008
            5/1/2013
            
            
            5.375
            %
      (7)
            
            
            86,000
            
            
            
            —New
      York State Teachers’ Retirement
              System —
      Williams Tower
            5/29/2008
            6/1/2013
            
            
            5.500
            %
      (8)
            
            
            165,000
            
            
            
            —HSH
      POOLED MORTGAGE FACILITYHSH
      Nordbank — Citymark, 321 North Clark, 1900 and 2000
      Alameda
            8/1/2006
            8/1/2016
            
            
            5.8575
            %
      (2)
            
            
            185,000
            
            
            
            185,000HSH
      Nordbank — 3400 Data Drive, Watergate Tower IV
            1/23/2007
            1/12/2017
            
            
            5.2505
            %
      (2)
            
            
            98,000
            
            
            
            98,000HSH
      Nordbank — Daytona and Laguna Buildings
            5/2/2007
            5/2/2017
            
            
            5.3550
            %
      (2)
            
            
            119,000
            
            
            
            119,000HSH
      Nordbank — 3 Huntington Quadrangle
            7/19/2007
            7/19/2017
            
            
            5.9800
            %
      (2)
            
            
            48,000
            
            
            
            48,000HSH
      Nordbank — Seattle Design Center / 5th
      and Bell
            8/14/2007
            8/14/2017
            
            
            6.0300
            %
      (2)
            
            
            70,000
            
            
            
            70,000MET
      LIFE SECURED MORTGAGE FACILITYMet
      Life — JPMorgan Chase Tower/Minneapolis
            12/20/2007
            1/1/2013
            
            
            5.700
            %
            
            
            205,000
            
            
            
            205,000Office/Flex
      PortfolioOTHER
      NOTES PAYABLEKey
      Bank National Association — Revolving Credit Facility
            9/9/2005
            10/31/2009
            
            Variable
      (1)
            
            
            
            —
            
            
            
            —Atrium
      Note Payable
            9/1/2004
            10/1/2011
            
            
            7.390
            %
            
            
            3,240
            (5)
            
            
            3,406$
            1,515,088
            
            
            $
            1,216,631


__________





(1)
            The
      revolving credit facility with KeyBank National Association (“KeyBank”)
      provides a maximum aggregate borrowing capacity of $250.0 million.
      Borrowings under the revolving credit facility are at variable interest
      rates based on LIBOR plus 125 to 200 basis points based on prescribed
      leverage ratios.(2)
            The
      Company entered into an interest rate swap agreement which effectively
      fixed the interest rate of this borrowing at the specified
      rate.(3)
            The
      Company entered into mortgage financing in connection with its acquisition
      of Atrium on Bay. The mortgage agreement provides for an interest only
      loan with a principal amount of $190.0 million Canadian dollars. This
      amount was translated to U.S. dollars at a rate of $.9900 as of June
      30, 2008.(4)
            This
      mortgage is an interest-only loan in the principal amount of $91.0
      million, which the Company assumed in connection with its acquisition of
      Airport Corporate Center. At the time of acquisition, the fair value of
      this mortgage was estimated to be $88.5 million, resulting in a premium of
      $2.5 million. The premium is being amortized over the term of the
      mortgage.(5)
            Note
      with Citicorp Vendor Finance Ltd. Related to installation of certain
      equipment at Atrium on Bay. This amount was translated to U.S. dollars at
      a rate of $.9900 as of June 30,
2008.




16


(6)
            The
      Company assumed a mortgage note in the principal amount of $54.2 million
      in connection with its acquisition of the Raytheon/DirecTV Buildings. The
      mortgage agreement provides for monthly payments of principal and
      interest. This mortgage agreement contains customary events of default
      with corresponding grace periods, including payment defaults,
      cross-defaults to other agreements and bankruptcy-related defaults, and
      customary covenants, including limitations on liens and indebtedness and
      maintenance of certain financial ratios. At the time of acquisition, the
      fair value of this mortgage was estimated to be $52.9 million, resulting
      in a premium of $1.3 million. The premium is being amortized over the term
      of the mortgage.




(7)
            The
      Company entered into a loan with the New York State Teachers’ Retirement
      System (“NYSTRS”) in the principal amount of $86.0 million secured by its
      interest in 2555 Grand. The loan agreement provides for monthly payments
      of interest and a principal payment due upon debt maturity. This loan
      agreement contains customary events of default with corresponding grace
      periods, including payment defaults, cross-defaults to other agreements
      and bankruptcy-related defaults, and customary covenants, including
      limitations on liens and indebtedness and maintenance of certain financial
      ratios.(8)
            The
      Company entered into a loan with NYSTRS in the principal amount of $165.0
      million secured by its interest in Williams Tower. The loan agreement
      provides for monthly payments of interest and a principal payment due upon
      debt maturity. This loan agreement contains customary events of default
      with corresponding grace periods, including payment defaults,
      cross-defaults to other agreements and bankruptcy-related defaults, and
      customary covenants, including limitations on liens and indebtedness and
      maintenance of certain financial
ratios.




The
Company is contractually obligated to make principal payments on its
outstanding notes payable for the period from July 1, 2008 through December 31,
2008, for each of the years ended December 31, 2009 through December 31, 2012
and for the period thereafter of approximately $427,000, $91.9 million,
$957,000, $48.7 million, $160.4 million and $1.2 billion.




The
Company is not aware of any instances of noncompliance with financial covenants
as of June 30, 2008.




5.  Distributions





The
Company began declaring distributions (as authorized by its board of directors)
in November 2004, after the Company commenced business operations. From
July 1, 2006 through April 30, 2008, the Company declared daily
distributions (as authorized by the Company’s board of directors) equal to
$0.00170959 per share, per day and the Company recently increased the
dividend rate to $0.00175233 per share, per day for the months of May and June
2008. The distributions declared were authorized and set by the Company’s board
of directors at a level the board believed to be appropriate based upon the
board’s evaluation of its assets, historical and projected levels of cash flow
and results of operations, additional capital and debt anticipated to be raised
or incurred and invested in the future, the historical and projected timing
between receiving offering proceeds and investing such proceeds in real estate
investments, and general market conditions and trends. The Company has declared
the daily distributions on a monthly basis and aggregated and paid such
distributions quarterly. The Company intends to continue this distribution
policy for so long as its board of directors decides this policy is in the best
interests of its shareholders. The Company has declared the following aggregate
distributions to its shareholders and minority interests for each quarter during
the year ended December 31, 2007 and the six months ended June 30, 2008 (in
thousands):





Total
      Distribution for the Quarter Ended
            Date
      Paid
            
            Total DistributionJune
      30, 2008
            July
      1, 2008
            
            $
            29,002March
      31, 2008
            April 15,
      2008
            
            $
            26,337December 31,
      2007
            January 16,
      2008
            
            $
            24,923September
      30, 2007
            October
      15, 2007
            
            $
            23,059June
      30, 2007
            July
      20, 2007
            
            $
            18,418March
      31, 2007
            April 16,
      2007
            
            $
            14,012




6.  Related
Party Transactions





Due
to Affiliates





Due to
affiliates includes the following (in thousands):





June 30, 2008
            
            
            December 31, 2007Organizational
      and offering costs related to the Second Offering
            
            $
            1,754
            
            
            $
            2,260Dealer
      manager fees and selling commissions
            
            
            2,703
            
            
            
            605Asset
      management, acquisition fees and property-level fees and
      reimbursements
            
            
            4,429
            
            
            
            5,319Other
            
            
            345
            
            
            
            784Total
            
            $
            9,231
            
            
            $
            8,968





17


Advisory
Agreement





Pursuant
to the Advisory Agreement in effect through June 30, 2008, the Company was
required to pay the following fees and expense reimbursements (in addition to
the reimbursement of organizational and other costs described in Note 2
above):





Acquisition Fees  — The
Company paid an acquisition fee to the Advisor for services related to the due
diligence, selection and acquisition of direct or indirect real estate
investments. The acquisition fee was payable following the closing of each
acquisition in an amount equal to 0.50% of (i) the purchase price of real
estate investments acquired directly by the Company, including any debt
attributable to such investments, or (ii) when the Company made an
investment indirectly through another entity, such investment’s pro rata share
of the gross asset value of the real estate investments held by that entity. The
Advisor earned cash acquisition fees totaling $3.0 million and $2.3 million for
the six months ended June 30, 2008 and 2007, respectively, which have been
recorded as an expense in the accompanying condensed consolidated statements of
operations.  The Advisor earned cash acquisition fees totaling
approximately $1.6 million and $626,000 for the three months ended June 30, 2008
and 2007, respectively, which have been recorded as an expense in the
accompanying condensed consolidated statements of
operations.   See discussion of the Participation Interest below
for additional information concerning acquisition fees. As of June 30, 2008
and December 31, 2007, the Company had no liabilities for incurred and
unpaid acquisition fees.





On July
1, 2008, the Company executed a new advisory agreement related to the Third
Offering. See Note 11 for additional information.





Asset Management Fees — The
Company paid asset management fees to the Advisor for services related to
managing, operating, directing and supervising the operations and administration
of the Company and its assets. The asset management fee earned by the Advisor
monthly in an amount equal to 0.0625% multiplied by the net equity capital the
Company has invested in real estate investments as of the end of the applicable
month. The Advisor earned cash asset management fees totaling $5.8 million and
$3.3 million during the six months ended June 30, 2008 and 2007, respectively,
which have been recorded as an expense in the accompanying condensed
consolidated statements of operations.  The Advisor earned cash asset
management fees totaling approximately $3.1 million and $1.8 million during the
three months ended June 30, 2008 and 2007, respectively, which have been
recorded as an expense in the accompanying condensed consolidated statements of
operations.   See discussion of the Participation Interest below
for additional information concerning acquisition fees. As of June 30, 2008 and
December 31, 2007, the Company had liabilities for incurred and
unpaid asset management fees of $1.0 million and $2.5 million,
respectively, which have been included in due to affiliates in the accompanying
condensed consolidated balance sheets.




Dealer
Manager Agreement





The
Company retained HRES, an affiliate of the Advisor, to serve as dealer manager
for the Initial Offering and the Second Offering. The dealer manager
agreement for the Second Offering provides that HRES earned selling commissions
equal to 7.0% of the gross proceeds from sales of common stock, all of which is
reallowed to participating broker dealers, and earned no selling commissions
related to shares issued pursuant to the dividend reinvestment plan. It also
provided that HRES earned a dealer manager fee equal to 2.2% of gross proceeds
from the sales of common stock other than issuances pursuant to the dividend
reinvestment plan, a portion of which may be reallowed to participating broker
dealers. HRES earned selling commissions of $20.7 million and earned dealer
manager fees of $6.8 million for the six months ended June 30, 2008, which
have been offset against additional paid-in capital in the accompanying
condensed consolidated statement of shareholders’ equity.





On June
30, 2008, the Company executed a new dealer manager agreement with HRES to serve
as a dealer manager for the Third Offering. The terms of the new dealer manager
agreement for the Third Offering are comparable with those of the previous
dealer manager agreement as it relates to the selling commissions and dealer
manager fee earned by HRES. However, the new dealer manager agreement extends
the definition of shares exempted from selling commissions and the dealer
manager fee to include shares purchased by certain investors that have an
agreement with a licensed broker-dealer, investment advisor or bank trust
department pursuant to which the investor pays a fee based on asset under
management or a similar fee.




Property
Management and Leasing Agreements





The
Company has entered into property management and leasing agreements with Hines
to manage the leasing and operations of properties in which it directly invests.
As compensation for its services, Hines receives the following:





•
            A
      property management fee equal to the lesser of 2.5% of the annual gross
      revenues received from the properties or the amount of property management
      fees recoverable from tenants of the property under the leases. The
      Company incurred property management fees of approximately $3.3 million
      and $1.7 million for the six months ended June 30, 2008 and 2007,
      respectively, and approximately $1.8 million and $958,000 for the three
      months ended June 30, 2008 and 2007, respectively. As of June 30, 2008 and
      December 31, 2007, the Company had liabilities for incurred and unpaid
      property management fees of approximately $353,000 and $260,000,
      respectively, which have been included in due to affiliates in the
      accompanying condensed consolidated balance
  sheets.





•
            A
      leasing fee of 1.5% of gross revenues payable over the term of each
      executed lease, including any lease renewal, extension, expansion or
      similar event and certain construction management and re-development
      construction management fees, in the event Hines renders such services.
      The Company incurred leasing, construction management or redevelopment
      fees of approximately $2.0 million and $618,000 during the six months
      ended June 30, 2008 and 2007, respectively, and approximately $315,000 and
      $556,000 during the three months ended June 30, 2008 and 2007,
      respectively. As of June 30, 2008 and December 31, 2007, the Company had a
      related liability of approximately $948,000 and $654,000, respectively,
      which is included in due to affiliates in the accompanying condensed
      consolidated balance sheets.





18


•
            The
      Company generally will be required to reimburse Hines for certain
      operating costs incurred in providing property management and leasing
      services pursuant to the property management and leasing agreements.
      Included in this reimbursement of operating costs are the cost of
      personnel and overhead expenses related to such personnel who are located
      at the property as well as off-site personnel located in Hines’
      headquarters and regional offices, to the extent the same relate to or
      support the performance of Hines’ duties under the agreement. However, the
      reimbursable cost of these off-site personnel and overhead expenses are
      limited to the lesser of the amount that is recovered from the tenants
      under their leases and/or a limit calculated based on the rentable square
      feet covered by the agreement. The Company incurred reimbursable expenses
      of $7.4 million and $3.6 million for the six months ended June 30,
      2008 and 2007, respectively, and approximately $4.3 million and $2.3
      million for the three months ended June 30, 2008 and 2007, respectively.
      As of June 30, 2008 and December 31, 2007, the Company had related
      liabilities of $2.1 million and $1.7 million which were included in due to
      affiliates in the accompanying condensed consolidated balance
      sheets.





On May 1,
2008, the Company acquired Williams Tower, a 64-story office building located in
Houston, Texas. Williams Tower is managed by Hines. In addition, the Company is
headquartered in Williams Tower and Hines and its affiliates lease 9% of the
rentable area of Williams Tower. The Company recorded approximately $668,000 in
revenue related to space leased by Hines for the three and six-months ended June
30, 2008.





The
Participation Interest





Pursuant
to the Amended and Restated Agreement of Limited Partnership of the Operating
Partnership, HALP owns a profits interest in the Operating Partnership (the
“Participation Interest”). The percentage interest in the Operating Partnership
attributable to the Participation Interest was 1.9% and 1.7% as of June 30, 2008
and December 31, 2007, respectively. The Participation Interest entitles HALP to
receive distributions from the Operating Partnership based upon its percentage
interest in the Operating Partnership at the time of distribution.





As the
percentage interest of the Participation Interest is adjusted, the value
attributable to such adjustment related to acquisition fees and asset management
fees is charged against earnings and recorded as a liability until such time as
the Participation Interest is repurchased for cash or converted into common
shares of Hines REIT. This liability totaled $35.6 million and
$26.8 million as of June 30, 2008 and December 31, 2007, respectively, and
is included in the participation interest liability in the accompanying
condensed consolidated balance sheets. The related expense for asset management
and acquisition fees of $8.8 million and $5.6 million for the six months
ended June 30, 2008 and 2007, respectively, is included in asset management and
acquisition fees in the accompanying condensed consolidated statements of
operations.  For the three months ended June 30, 2008 and 2007,
respectively, the Company recorded $4.6 million and $2.5 million of asset
management and acquisition fess related to the Participation
Interest.




7.  Changes
in Assets and Liabilities





The
effect of changes in asset and liability accounts on cash flows from operating
activities for the six months ended June 30, 2008 and 2007 is as follows
(in thousands):





2008
            
            
            2007Changes
      in assets and liabilities:(Increase)
      decrease in other assets
            
            $
            (117
            )
            
            $
            (414
            )Increase
      in tenant and other receivables
            
            
            (10,733
            )
            
            
            (6,122
            )Additions
      to deferred leasing costs
            
            
            (11,340
            )
            
            
            (4,070
            )Increase
      (decrease) in accounts payable and accrued expenses
            
            
            (330
            )
            
            
            588Increase
      in participation interest liability
            
            
            8,847
            
            
            
            5,566Increase
      in other liabilities
            
            
            799
            
            
            
            2,261Decrease
      in due to affiliates
            
            
            (1,134
            )
            
            
            (87
            )Changes
      in assets and liabilities
            
            $
            (14,008
            )
            
            $
            (2,278
            )




19


8.  Supplemental
Cash Flow Disclosures





Supplemental
cash flow disclosures for the six months ended June 30, 2008 and 2007 are as
follows (in thousands):





2008
            
            
            2007Supplemental
      Disclosure of Cash Flow InformationCash
      paid for interest
            
            $
            36,191
            
            
            $
            19,678Cash
      paid for income taxes
            
            $
            444
            
            
            $
            —Supplemental
      Schedule of Non-Cash ActivitiesUnpaid
      selling commissions and dealer manager fees
            
            $
            2,703
            
            
            $
            3,575Deferred
      offering costs offset against additional paid-in-capital
            
            $
            4,200
            
            
            $
            4,593Distributions
      declared and unpaid
            
            $
            29,002
            
            
            $
            18,418Distributions
      receivable
            
            $
            6,887
            
            
            $
            6,044Distributions
      reinvested
            
            $
            27,899
            
            
            $
            14,633Stock
      subscriptions
            
            $
            10,153
            
            
            $
            —Non-cash
      net liabilities acquired upon acquisition of property
            
            $
            20,772
            
            
            $
            8,620Accrual
      of deferred financing costs
            
            $
            —
            
            
            $
            53Assumption
      of mortgage upon acquisition of property
            
            $
            52,938
            
            
            $
            —Accrued
      additions to deferred leasing costs
            
            $
            3,150
            
            
            $
            8,425Accrued
      additions to investment property
            
            $
            389
            
            
            $
            273




9.  Commitments
and Contingencies





The
Company is subject to various legal proceedings and claims that arise in the
ordinary course of business. These matters are generally covered by insurance.
While the resolution of these matters cannot be predicted with certainty,
management believes the final outcome of such matters will not have a material
adverse effect on the Company’s consolidated financial statements.





10.
Fair Value Disclosures





On
January 1, 2008 the Company adopted Statement No. 157, Fair Value Measurements ("SFAS No. 157"). The standard defines
fair value, establishes a framework for measuring fair value and also expands
disclosures about fair value measurements. The discussion below presents
information about the three-level fair value hierarchy described in SFAS No. 157
and the valuation techniques utilized by the Company to determine the fair value
of its interest rate swaps.





In
general, fair values determined by Level 1 inputs utilize quoted prices
(unadjusted) in active markets for identical assets or liabilities we have
the ability to access. Fair values determined by Level 2 inputs utilize inputs
other than quoted prices included in Level 1 that are observable for the asset
or liability, either directly or indirectly. Level 2 inputs include quoted
prices for similar assets and liabilities in active markets and inputs other
than quoted prices observable for the asset or liability, such as interest rates
and yield curves observable at commonly quoted intervals. Level 3 inputs are
unobservable inputs for the asset or liability, and include situations where
there is little, if any, market activity for the asset or liability. In
instances in which the inputs used to measure fair value may fall into different
levels of the fair value hierarchy, the level in the fair value hierarchy within
which the fair value measurement in its entirety has been determined is based on
the lowest level input significant to the fair value measurement in its
entirety. Our assessment of the significance of a particular input to the fair
value measurement in its entirety requires judgment, and considers factors
specific to the asset or liability.




As of June 30, 2008, the Company recorded a liability of $30.9 million
related to the fair value of its interest rate swap contracts in accordance with
SFAS No. 157. The fair value of these derivative instruments was determined
using pricing models. Pricing models take into account the contract terms as
well as other inputs where applicable, such as interest rate yield curves.
Although we have determined the majority of the inputs used to value our
derivatives fall within Level 2 of the fair value hierarchy, the credit
valuation adjustments associated with our derivatives utilize Level 3 inputs,
such as estimates of current credit spreads to evaluate the likelihood of
default by us and our counterparty, HSH Nordbank. In adjusting the fair value of
its derivative contracts for the effect of nonperformance risk, we have
considered the impact of netting and any applicable credit enhancements, such as
collateral postings, thresholds and guarantees. However, as of June 30, 2008, we
have assessed the significance of the impact of the credit valuation adjustments
on the overall valuation of our derivative positions and have determined that
the credit valuation adjustments are not significant to the overall valuation of
our derivatives. As a result, we have determined our derivative valuations in
their entirety are classified in Level 2 of the fair value
hierarchy.




To obtain
fair values, observable market prices are used if available. In some instances,
observable market prices are not readily available for certain financial
instruments and fair value is determined using present value or other techniques
appropriate for a particular financial instrument. These techniques involve some
degree of judgment and as a result are not necessarily indicative of the amounts
the Company would realize in a current market exchange. The use of different
assumptions or estimation techniques may have a material effect on the estimated
fair value amounts.




20


11. Subsequent
Events





Third
Offering





The
Company’s Third Offering was declared effective by the Securities and Exchange
Commission on July 1, 2008. Pursuant to the Third Offering, Hines REIT is
offering up to $3.0 billion in shares of common stock initially priced at $10.66
per share for shares purchased through commission-based financial advisors (with
discounts available for certain categories of purchasers).  Shares
purchased through fee-based financial advisors may qualify for a 9.2% discount,
or a $9.68 per share price, due to a waiver of the up-front selling commission
and dealer manager fees.  In addition, Hines REIT is offering up to
$500.0 million in shares of common stock under its dividend reinvestment plan,
initially priced at $10.13 per share, and will redeem shares through its share
redemption program at $9.68 per share.





Advisory
Agreement





On July
1, 2008, the Company executed a new advisory agreement (the “New Advisory
Agreement”) with the Advisor. The terms of the New Advisory Agreement are
comparable with those of the previous Advisory Agreement with the exception of
the changes to the fees described below.





With
respect to each real estate investment made after  the commencement of
the Third Offering up to an aggregate of $2.0 billion of gross real estate
investments, the Company will pay an acquisition fee to the Advisor
equal to 2.50% of: (i) the purchase price of real estate investments
acquired directly by the Company, including any debt attributable to such
investments or (ii) when the Company makes an investment indirectly through
another entity, such investment’s pro rata share of the gross asset value of
real estate investments held by that entity.  In addition, the Company
will pay an acquisition fee to the Advisor, with respect to investments
made after the initial $2.0 billion of gross real estate investments, equal to
0.50% of the amounts set forth in (i) and (ii). Additionally, the Company will
pay the Advisor a financing fee equal to 1.0% of the amount (i) obtained under
any property loan or (ii) made available to the Company under any other debt
financing.




In
addition, the Company will not be obligated to reimburse the Advisor for
organizational and offering costs in relation to the Third Offering. See Note 2
– “Third Offering” for further discussion.





The New
Advisory Agreement has a one-year term and may be renewed for successive
one-year periods upon the mutual consent of the parties. Renewals of the New
Advisory Agreement must be approved by the conflicts committee of the Hines REIT
board of directors.





Shareholder
Redemptions





For the
months of July and August, in accordance with its share redemption
plan, Hines REIT redeemed approximately 1.5 million common shares and made
corresponding payments totaling $14.7 million to shareholders who had
requested these redemptions. The shares redeemed were cancelled and will have
the status of authorized, but unissued shares.


21




Item 2. Management’s
Discussion and Analysisof Financial
Condition and Results of
Operations.





The following discussion and
analysis of our financial condition and results of operations should be read in
conjunction with our unaudited condensed consolidated financial statements, the notes
thereto, and the other unaudited financial data included elsewhere in this
Form 10-Q. The following discussion should also be read in conjunction with our
audited consolidated financial statements, and the notes thereto, and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” included in
our Annual Report on Form 10-K for the year ended December 31,
2007.





Cautionary
Note Regarding Forward-Looking Statements





This
Form 10-Q includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. Such statements include
statements concerning future financial performance and distributions, future
debt and financing levels, acquisitions and investment objectives, payments to
our advisor, Hines Advisors Limited Partnership (the “Advisor”), and its
affiliates and other plans and objectives of management for future operations or
economic performance, or assumptions or forecasts related thereto as well as all
other statements that are not historical statements. These statements are only
predictions. We caution that forward-looking statements are not guarantees.
Actual events or our investments and results of operations could differ
materially from those expressed or implied in forward-looking statements.
Forward-looking statements are typically identified by the use of terms such as
“may,” “should,” “expect,” “could,” “intend,” “plan,” “anticipate,” “estimate,”
“believe,” “continue,” “predict,” “potential” or the negative of such terms and
other comparable terminology.





The
forward-looking statements included in this Form 10-Q are based on our
current expectations, plans, estimates, assumptions and beliefs that involve
numerous risks and uncertainties. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control. Any
of the assumptions underlying forward-looking statements could be inaccurate. To
the extent that our assumptions differ from actual results, our ability to meet
such forward-looking statements, including our ability to generate positive cash
flow from operations, pay distributions to our shareholders and maintain the
value of the real estate properties in which we hold an interest, may be
significantly hindered.





The
following are some of the risks and uncertainties, although not all of the risks
and uncertainties, which could cause actual results to differ materially from
those presented in certain forward-looking statements:





•
            Our
      ability to invest offering and dividend reinvestment plan proceeds to
      acquire properties or other investments in a timely manner and at
      appropriate amounts that provide acceptable
  returns;





•
            The
      potential need to fund tenant improvements, lease-up costs or other
      capital expenditures, as well as increases in property operating expenses
      and costs of compliance with environmental matters or discovery of
      previously undetected environmentally hazardous or other undetected
      adverse conditions at our
properties;





•
            Risks
      associated with debt;





•
            Competition
      for tenants and real estate investment opportunities, including
      competition with affiliates of Hines Interests Limited Partnership
      (“Hines”);





•
            Risks
      associated with adverse changes in general economic or local market
      conditions, including terrorist attacks and other acts of violence, which
      may affect the markets in which we and our tenants
  operate;





•
            Catastrophic
      events, such as hurricanes, earthquakes and terrorist attacks; and our
      ability to secure adequate insurance at reasonable and appropriate
      rates;





•
            Risks
      associated with the currency exchange rate related to our international
      investments;





•
            Changes
      in governmental, tax, real estate and zoning laws and regulations and the
      related costs of compliance and increases in our administrative operating
      expenses, including expenses associated with operating as a public
      company;





•
            Risks
      relating to our investment in Hines US Core Office Fund LP (the “Core
      Fund”), such as its reliance on Hines for its operations and investments,
      and our potential liability for Core Fund
  obligations;





•
            The
      lack of liquidity associated with our
assets;





22


•
            Our
      reliance on our Advisor, Hines and affiliates of Hines for our day-to-day
      operations and the selection of real estate investments, and our Advisor’s
      ability to attract and retain high-quality personnel who can provide
      service at a level acceptable to
us;





•
            Risks
      associated with conflicts of interests that result from our relationship
      with our Advisor and Hines, as well as conflicts of interests certain of
      our officers and directors face relating to the positions they hold with
      other entities; and





•
            Our
      ability to continue to qualify as a real estate investment trust (“REIT”)
      for federal income tax purposes.




These
risks are more fully discussed in, and all forward-looking statements should be
read in light of, all of the factors discussed in Part I, “Item 1A.
Risk Factors” in our Annual Report on Form 10-K for the year ended December
31, 2007.





You are
cautioned not to place undue reliance on any forward-looking statements included
in this Form 10-Q. All forward-looking statements are made as of the date
of this Form 10-Q and the risk that actual results will differ materially
from the expectations expressed in this Form 10-Q may increase with the
passage of time. In light of the significant uncertainties inherent in the
forward-looking statements included in this Form 10-Q, the inclusion of
such forward-looking statements should not be regarded as a representation by us
or any other person that the objectives and plans set forth in this
Form 10-Q will be achieved. All subsequent written and oral forward-looking
statements attributable to us or persons acting on our behalf are expressly
qualified in their entirety by reference to these risks and uncertainties. Each
forward-looking statement speaks only as of the date of the particular
statement, and we do not undertake to update any forward-looking
statement.





Executive
Summary





Hines
Real Estate Investment Trust, Inc. (“Hines REIT” and, together with its
consolidated subsidiaries, “we”, “us” or the “Company”) and its subsidiary,
Hines REIT Properties, L.P. (the “Operating Partnership”) were formed in August
2003 for the purpose of investing in and owning interests in real estate. We
have invested and continue to invest in real estate to satisfy our primary
investment objectives, including preserving invested capital, paying regular
cash distributions and achieving modest capital appreciation of our assets over
the long term. We make investments directly through entities wholly owned by the
Operating Partnership, or indirectly through other entities, such as through our
investment in the Core Fund. As of June 30, 2008, we had direct and indirect
interests in 46 properties. These properties consist of 43 office properties
located throughout the United States, one mixed-use office and retail property
in Toronto, Ontario, and two industrial properties. In addition, we have made
and may make other real estate investments including, but not limited to,
properties outside of the United States, non-office properties, loans and ground
leases. Our principal targeted assets are office properties that have quality
construction, desirable locations and quality tenants. We intend to invest in
properties which will be diversified by location, lease expirations and tenant
industries.





In order
to provide capital for these investments, we sold shares to the public through
our initial public offering (the “Initial Offering”), which commenced on
June 18, 2004 and terminated on June 18, 2006 and our second public
offering (the “Second Offering”), which commenced on June 19, 2006 and
terminated on June 30, 2008. On July 1, 2008, we commenced our third public
offering (the “Third Offering”) pursuant to which we are offering a maximum of
$3.5 billion in common shares. We intend to continue raising significant amounts
of capital through our Third Offering prior to its expiration on July 1,
2010.





23


The
following table provides summary information regarding the properties in
which the Operating Partnership owned interests as of June 30, 2008:





Direct
      InvestmentsProperty
            City
            
            LeasableSquare Feet
            
            
            PercentLeased
            
            
            Our
      Effective
              Ownership(1)321
      North Clark
            Chicago,
      Illinois
            
            
            885,664
            
            
            
            99
            %
            
            
            100
            %JPMorgan
      Chase Tower
            Dallas,
      Texas
            
            
            1,244,522
            
            
            
            90
            %
            
            
            100
            %Citymark
            Dallas,
      Texas
            
            
            220,079
            
            
            
            100
            %
            
            
            100
            %4050/4055
      Corporate Drive
            Dallas,
      Texas
            
            
            643,429
            
            
            
            100
            %
            
            
            100
            %Raytheon/DirectTV
      Buildings
            El
      Segundo, California
            
            
            550,579
            
            
            
            100
            %
            
            
            100
            %Watergate
      Tower IV
            Emeryville,
      California
            
            
            344,433
            
            
            
            100
            %
            
            
            100
            %Williams
      Tower
            Houston,
      Texas
            
            
            1,480,623
            
            
            
            93
            %
            
            
            100
            %2555
      Grand
            Kansas
      City, Missouri
            
            
            595,607
            
            
            
            100
            %
            
            
            100
            %One
      Wilshire
            Los
      Angeles, California
            
            
            661,553
            
            
            
            99
            %
            
            
            100
            %3
      Huntington Quadrangle
            Melville,
      New York
            
            
            407,731
            
            
            
            84
            %
            
            
            100
            %Airport
      Corporate Center
            Miami,
      Florida
            
            
            1,021,397
            
            
            
            88
            %
            
            
            100
            %Minneapolis
      Office/Flex Portfolio
            Minneapolis,
      Minnesota
            
            
            766,240
            
            
            
            84
            %
            
            
            100
            %3400
      Data Drive
            Rancho
      Cordova, California
            
            
            149,703
            
            
            
            100
            %
            
            
            100
            %Daytona
      Buildings
            Redmond,
      Washington
            
            
            251,313
            
            
            
            93
            %
            
            
            100
            %Laguna
      Buildings
            Redmond,
      Washington
            
            
            464,701
            
            
            
            100
            %
            
            
            100
            %1515
      S Street
            Sacramento,
      California
            
            
            348,881
            
            
            
            100
            %
            
            
            100
            %1900
      and 2000 Alameda
            San Mateo,
      California
            
            
            253,141
            
            
            
            95
            %
            
            
            100
            %Seattle
      Design Center
            Seattle,
      Washington
            
            
            390,684
            
            
            
            90
            %
            
            
            100
            %5th
      and Bell
            Seattle,
      Washington
            
            
            197,135
            
            
            
            100
            %
            
            
            100
            %Atrium
      on Bay
            Toronto,
      Ontario
            
            
            1,071,517
            
            
            
            95
            %
            
            
            100
            %Total
      for Directly-Owned Properties
            
            
            11,948,932
            
            
            
            94
            %Indirect
      InvestmentsJoint VentureDistribution
      Park Rio
            Rio
      de Janeiro, Brazil
            
            
            693,115
            
            
            
            100
            %
            
            
            50
            %Core Fund InvestmentsOne
      Atlantic Center
            Atlanta,
      Georgia
            
            
            1,100,312
            
            
            
            81
            %
            
            
            23.27
            %The
      Carillon Building
            Charlotte,
      North Carolina
            
            
            470,942
            
            
            
            98
            %
            
            
            23.27
            %Charlotte
      Plaza
            Charlotte,
      North Carolina
            
            
            625,026
            
            
            
            96
            %
            
            
            23.27
            %One
      North Wacker
            Chicago,
      Illinois
            
            
            1,373,754
            
            
            
            98
            %
            
            
            23.27
            %Three
      First National Plaza
            Chicago,
      Illinois
            
            
            1,420,046
            
            
            
            95
            %
            
            
            18.62
            %333 West
      Wacker
            Chicago,
      Illinois
            
            
            844,773
            
            
            
            92
            %
            
            
            18.57
            %One
      Shell Plaza
            Houston,
      Texas
            
            
            1,230,395
            
            
            
            100
            %
            
            
            11.64
            %Two
      Shell Plaza
            Houston,
      Texas
            
            
            566,982
            
            
            
            95
            %
            
            
            11.64
            %425
      Lexington Avenue
            New
      York, New York
            
            
            700,034
            
            
            
            100
            %
            
            
            11.67
            %499
      Park Avenue
            New
      York, New York
            
            
            288,722
            
            
            
            100
            %
            
            
            11.67
            %600
      Lexington Avenue
            New
      York, New York
            
            
            283,995
            
            
            
            100
            %
            
            
            11.67
            %Renaissance
      Square
            Phoenix,
      Arizona
            
            
            965,508
            
            
            
            88
            %
            
            
            23.27
            %Riverfront
      Plaza
            Richmond,
      Virginia
            
            
            949,791
            
            
            
            100
            %
            
            
            23.27
            %Johnson
      Ranch Corporate Center
            Roseville,
      California
            
            
            179,990
            
            
            
            68
            %
            
            
            18.57
            %Roseville
      Corporate Center
            Roseville,
      California
            
            
            111,418
            
            
            
            94
            %
            
            
            18.57
            %Summit
      at Douglas Ridge
            Roseville,
      California
            
            
            185,128
            
            
            
            87
            %
            
            
            18.57
            %Olympus
      Corporate Center
            Roseville,
      California
            
            
            191,494
            
            
            
            59
            %
            
            
            18.57
            %Douglas
      Corporate Center
            Roseville,
      California
            
            
            214,606
            
            
            
            82
            %
            
            
            18.57
            %Wells
      Fargo Center
            Sacramento,
      California
            
            
            502,365
            
            
            
            96
            %
            
            
            18.57
            %525
      B Street
            San Diego,
      California
            
            
            446,738
            
            
            
            90
            %
            
            
            23.27
            %The
      KPMG Building
            San Francisco,
      California
            
            
            379,328
            
            
            
            100
            %
            
            
            23.27
            %101
      Second Street
            San Francisco,
      California
            
            
            388,370
            
            
            
            91
            %
            
            
            23.27
            %720
      Olive Way
            Seattle,
      Washington
            
            
            300,710
            
            
            
            94
            %
            
            
            18.57
            %1200
      19th Street
            Washington, D.C.
            
            
            328,154
            (2)
            
            
            28
            %
            
            
            11.67
            %Warner
      Center
            Woodland
      Hills, California
            
            
            808,274
            
            
            
            94
            %
            
            
            18.57
            %Total
      for Core Fund Properties
            
            
            14,856,855
            
            
            
            92
            %Total
      for All Properties
            
            
            
            27,498,902
            
            
            
            94
            %


__________





24


(1)
            This
      percentage shows the effective ownership of the Operating Partnership in
      the properties listed. On June 30, 2008, Hines REIT owned a 97.5% interest
      in the Operating Partnership as its sole general partner. Affiliates of
      Hines owned the remaining 2.5% interest in the Operating Partnership. As
      of June 30, 2008, we owned interests in 25 Core Fund investments through
      our interest in the Core Fund, in which we owned an approximate 28.7 %
      non-managing general partner interest as of June 30, 2008. The Core Fund
      does not own 100% of these buildings; its ownership interest in its
      buildings ranges from 40.6% to 81.0%. In addition, we owned a 50% interest
      in Distribution Park Rio through a joint venture with an affiliate of
      Hines.(2)
            This
      square footage amount includes three floors being added to the building,
      which are currently under construction. The construction is expected to be
      completed in 2009.





As of
June 30, 2008, we had primarily invested in institutional-quality office
properties in the United States. We expect to continue to focus primarily on
investments in institutional-quality office properties located in the United
States (whether as direct investments or as indirect investments through the
Core Fund or otherwise). However, we have expanded our focus to include other
real estate investments such as our investment in Toronto, Ontario, our
international joint venture investment in Rio de Janeiro, Brazil and our
industrial property in Dallas, Texas. We intend to continue to pursue
institutional-quality office properties as well as other real estate investments
that we believe will satisfy our long-term primary objectives of preserving
invested capital and achieving modest capital appreciation over the long term,
in addition to providing regular cash distributions to our shareholders. In the
future, our investments may include additional investments outside of the United
States, investments in non-office properties, non-core or development
investments, loans, ground leases and investments in other joint
ventures.





Critical
Accounting Policies





Each of
our critical accounting policies involves the use of estimates that require
management to make assumptions that are subjective in nature. In addition to the
policies set forth below, please see “Note 2 — Summary of Significant
Accounting Policies” in our unaudited condensed consolidated financial
statements included elsewhere in this Form 10-Q for a description of some
of these policies. Management relies on its experience, collects historical and
current market data, and analyzes these assumptions in order to arrive at what
it believes to be reasonable estimates. Under different conditions or
assumptions, materially different amounts could be reported related to the
accounting policies described below. In addition, application of these
accounting policies involves the exercise of judgments regarding assumptions as
to future uncertainties. Actual results could materially differ from these
estimates.





Investment
Property and Lease Intangibles





Real
estate assets that we own directly are stated at cost less accumulated
depreciation. Depreciation is computed using the straight-line method. The
estimated useful lives for computing depreciation are generally 10 years
for furniture and fixtures, 15-20 years for electrical and mechanical
installations and 40 years for buildings. Major replacements that extend
the useful life of the assets are capitalized. Maintenance and repair costs are
expensed as incurred.





Real
estate assets are reviewed for impairment if events or changes in circumstances
indicate that the carrying amount of the individual property may not be
recoverable. In such an event, a comparison will be made of the current and
projected operating cash flows of each property on an undiscounted basis to the
carrying amount of such property. Such carrying amount would be adjusted, if
necessary, to estimated fair values to reflect impairment in the value of the
asset. At June 30, 2008, we believe no such impairment has occurred. However,
given the current economic conditions, there can be no assurances about future
periods.





Acquisitions
of properties are accounted for utilizing the purchase method and, accordingly,
the results of operations of acquired properties are included in our results of
operations from their respective dates of acquisition. Estimates of future cash
flows and other valuation techniques that we believe are similar to those used
by independent appraisers are used to allocate the purchase price of acquired
property between land, buildings and improvements, equipment and identifiable
intangible assets and liabilities such as amounts related to in-place leases,
acquired above- and below-market leases, tenant relationships, asset retirement
obligations and mortgage notes payable. Initial valuations are subject to change
until such information is finalized, no later than 12 months from the
acquisition date.





The
estimated fair value of acquired in-place leases are the costs we would have
incurred to lease the properties to the occupancy level of the properties at the
date of acquisition. Such estimates include the fair value of leasing
commissions, legal costs and other direct costs that would be incurred to lease
the properties to such occupancy levels. Additionally, we evaluate the time
period over which such occupancy levels would be achieved. Such
evaluation includes an estimate of the net market-based rental revenues and
net operating costs (primarily consisting of real estate taxes, insurance and
utilities) that would be incurred during the lease-up period. Acquired in-place
leases as of the date of acquisition are amortized over the remaining lease
terms.





Acquired
above-and below-market lease values are recorded based on the present value
(using an interest rate that reflects the risks associated with the lease
acquired) of the difference between the contractual amounts to be paid pursuant
to the in-place leases and management’s estimate of fair market value lease
rates for the corresponding in-place leases. The capitalized above- and
below-market lease values are amortized as adjustments to rental revenue over
the remaining terms of the respective leases. Should a tenant terminate its
lease, the unamortized portion of the in-place lease value is charged to
amortization expense and the unamortized portion of out-of-market lease value is
charged to rental revenue.




25


Acquired
above- and below-market ground lease values are recorded based on the difference
between the present value (using an interest rate that reflects the risks
associated with the lease acquired) of the contractual amounts to be paid
pursuant to the ground leases and management’s estimate of fair market value of
land under the ground leases. The capitalized above- and below-market lease
values are amortized as adjustments to ground lease expense over the lease
term.





We
estimate the fair value of assumed mortgage notes payable based upon indications
of current market pricing for similar types of debt with similar maturities.
Assumed mortgage notes payable are initially recorded at their estimated fair
value as of the assumption date, and the difference between such estimated fair
value and the note’s outstanding principal balance is amortized over the life of
the mortgage note payable.





Deferred
Leasing Costs




Direct
leasing costs, primarily consisting of third-party leasing commissions and
tenant inducements, are capitalized and amortized over the life of the related
lease. Tenant inducement amortization is recorded as an offset to rental revenue
and the amortization of other direct leasing costs is recorded in amortization
expense.





We
consider a number of different factors to evaluate whether we or the
lessee is the owner of the tenant improvements for accounting purposes.
These factors include: 1) whether the lease stipulates how and on what a
tenant improvement allowance may be spent; 2) whether the tenant or
landlord retains legal title to the improvements; 3) the uniqueness of the
improvements; 4) the expected economic life of the tenant improvements
relative to the term of the lease; and 5) who constructs or directs the
construction of the improvements.





The
determination of who owns the tenant improvements for accounting purposes is
subject to significant judgment. In making that determination, we consider all
of the above factors. No one factor, however, necessarily establishes any
determination.





Organizational
and Offering Costs





Certain
organizational and offering costs related to our public offerings have been paid
by our Advisor on our behalf. Organizational and offering costs incurred by our
Advisor have been analyzed and segregated between those which are organizational
in nature, those which are offering-related salaries and other general and
administrative expenses of the Advisor and its affiliates, and those which
qualify as offering expenses in accordance with Staff Accounting Bulletin
(“SAB”) Topic 5.A, Miscellaneous Accounting —
Expenses of Offering. Organizational costs are expensed as incurred in
accordance with Statement of Position 98-5, Reporting on the Costs of Start-up
Activities. Offering-related salaries and other general and
administrative expenses of the Advisor and its affiliates are expensed as
incurred, and third-party offering expenses are taken as a reduction against the
net proceeds of the offerings within additional paid-in capital in accordance
with SAB Topic 5.A. In addition to the offering costs paid to the Advisor,
selling commissions and dealer manager fees are paid to Hines Real Estate
Securities, Inc. (“HRES” or the “Dealer Manager”). Such costs are netted against
the net offering proceeds within additional paid-in capital as
well.





Certain
organizational and offering costs associated with the Second Offering have been
paid by the Advisor on our behalf. Pursuant to the terms of the advisory
agreement entered into in June 2006 and renewed in June 2007, we are obligated
to reimburse the Advisor for the actual organizational and offering costs
incurred, so long as such costs, together with selling commissions and
dealer-manger fees, do not exceed 15% of gross proceeds from the Second
Offering.





On July
1, 2008, we entered into a new advisory agreement in connection with our Third
Offering. Pursuant to the terms of the new advisory agreement, we are not
obligated to reimburse the Advisor for organizational and offering costs related
to the Third Offering. Additionally, the Advisor is not a shareholder of Hines
REIT. Accordingly, no amounts of organizational and offering costs incurred by
the Advisor in connection with the Third Offering during the six months ended
June 30, 2008 have been recorded in the accompanying consolidated financial
statements. See “Subsequent Events” for additional information regarding the new
Advisory Agreement.





Revenue
Recognition and Valuation of Receivables





We
recognize minimum rent revenues on a straight-line basis over the terms of
tenant leases, including rent holidays, if any. Revenues associated with tenant
reimbursements are recognized in the period in which the expenses are incurred
based upon the tenant’s lease provision. Revenues relating to lease termination
fees are recognized at the time that the tenant’s right to occupy the space is
terminated and when we have satisfied all obligations under the lease. To the
extent our leases provide for rental increases at specified intervals, we will
record a receivable for rent not yet due under the lease terms. Accordingly, our
management must determine, in its judgment, to what extent the unbilled rent
receivable applicable to each specific tenant is collectible. We review unbilled
rent receivables on a quarterly basis and take into consideration the tenant’s
payment history, the financial condition of the tenant, business conditions in
the industry in which the tenant operates and economic conditions in the area in
which the property is located. In the event that the collectability of unbilled
rent with respect to any given tenant is in doubt, we would be required to
record an increase in our allowance for doubtful accounts or record a direct
write-off of the specific rent receivable, which would have an adverse effect on
our net income for the year in which the reserve is increased or the direct
writeoff is recorded and would decrease our total assets and shareholders’
equity.




26


Derivative
Instruments





During
the years ended December 31, 2007 and 2006, we entered into several forward
interest rate swap transactions with HSH Nordbank AG, New York Branch (“HSH
Nordbank”). These swap transactions were entered into as economic hedges against
the variability of future interest rates on the Company’s variable interest rate
borrowings with HSH Nordbank. We have not designated any of these contracts as
cash flow hedges for accounting purposes. The valuation of the interest rate
swaps is determined using widely accepted valuation techniques including
discounted cash flow analysis on the expected cash flows of each derivative.
This analysis reflects the contractual terms of the derivatives, including the
period to maturity, and uses observable market-based inputs, including interest
rate curves. The fair values of interest rate swaps are determined using the
market standard methodology of netting the discounted future fixed cash receipts
(or payments) and the discounted expected variable cash payments (or receipts).
The variable cash payments (or receipts) are based on an expectation of future
interest rates (forward curves) derived from observable market interest rate
curves.




The
interest rate swaps have been recorded at their estimated fair value in the
accompanying consolidated balance sheets as of June 30, 2008 and
December 31, 2007. Changes in the fair value of the interest rate swaps
have been recorded in the accompanying condensed consolidated statements of
operations for the three and six months ended June 30, 2008. We mark
the interest rate swaps to their estimated fair value as of each balance sheet
date, and the changes in fair value are reflected in our consolidated statements
of operations.




We
entered into a foreign currency contract in February 2007 related to the
acquisition of Atrium on Bay, a mixed-use office and retail property located in
Toronto, Ontario. The contract was entered into as an economic hedge against the
variability of the foreign currency exchange rate related to our equity
investment and was settled at the close of this acquisition on February 26,
2007.





Treatment of Management
Compensation, Expense Reimbursements and Operating Partnership Participation
Interest





We
outsource management of our operations to the Advisor and certain other
affiliates of Hines. Fees related to these services are accounted for based on
the nature of the service and the relevant accounting literature. Fees for
services performed that represent period costs of the Company are expensed as
incurred. Such fees include acquisition fees and asset management fees paid to
the Advisor and property management fees paid to Hines. In addition to cash
payments for acquisition fees and asset management fees paid to the Advisor, an
affiliate of the Advisor has received a participation interest, which represents
a profits interest in the Operating Partnership related to these services. As
the percentage interest of the participation interest is adjusted, the value
attributable to such adjustment is charged against earnings, and the
participation interest will be recorded as a liability until it is repurchased
for cash or converted into common shares of the Company. The conversion and
redemption features of the participation interest are accounted for in
accordance with the guidance in Emerging Issues Task Force (“EITF”) publication
95-7, Implementation Issues
Related to the Treatment of Minority Interests in Certain Real Estate Investment
Trusts . Redemptions for cash will be accounted for as a reduction to the
liability discussed above to the extent of such liability, with any additional
amounts recorded as a reduction to equity. Conversions into common shares of the
Company will be recorded as an increase to the outstanding common shares and
additional paid-in capital accounts and a corresponding reduction in the
liability discussed above. Redemptions and conversions of the participation
interest will result in a corresponding reduction in the percentage attributable
to the participation interest and will have no impact on the calculation of
subsequent increases in the participation interest.





Hines may
perform construction management services for us for both re-development
activities and tenant construction. These fees are considered incremental to the
construction effort and will be capitalized as incurred in accordance with
Statement No. 67, Accounting for Costs and
Initial Rental Operations of
Real Estate Projects.   These costs will be capitalized to the
associated real estate project as incurred. Costs related to tenant construction
will be depreciated over the estimated useful life. Costs related to
redevelopment activities will be depreciated over the estimated useful life of
the associated project. Leasing activities are generally performed by Hines on
our behalf. Leasing fees are capitalized and amortized over the life of the
related lease in accordance with the provisions of Statement No. 91,
Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases.





Income
Taxes





We
elected to be taxed as a REIT under Sections 856 through 860 of the
Internal Revenue Code beginning with our taxable year ended December 31, 2004.
In addition, we hold an investment in the Core Fund, which has invested in
properties through a structure that includes entities that have elected to be
taxed as REITs. In order to qualify as a REIT, an entity must meet certain
organizational and operational requirements, including a requirement to
distribute at least 90% of its annual ordinary taxable income to shareholders.
REITs are generally not subject to federal income tax on taxable income that
they distribute to their shareholders. It is our intention to adhere to these
requirements and maintain our REIT status, as well as to ensure that the
applicable entities in the Core Fund structure also maintain their REIT status.
As such, no provision for U.S. federal income taxes has been included in
the accompanying consolidated financial statements. As a REIT and indirectly
through our investment in the Core Fund, we still may be subject to certain
state, local and foreign taxes on our income and property and to federal income
and excise taxes on our undistributed taxable income. In addition, we are and
will indirectly be required to pay federal and state income tax on the net
taxable income, if any, from the activities conducted through the taxable REIT
subsidiary of the Core Fund.





27


In
connection with the operation of Atrium on Bay, an office property located in
Toronto, Ontario, we have recorded an income tax provision for Canadian income
taxes of approximately $256,000 and $316,000 for the six months ended June 30,
2008 and 2007, respectively, in accordance with Canadian tax laws and
regulations. In addition, the Company has also recorded a benefit for Canadian
income taxes of approximately $251,000 for the three months ended June 30, 2008
and a provision for Canadian income taxes of approximately $250,000 for the
three months ended June 30, 2007.









As of
June 30, 2008, we had no significant temporary differences, tax credits, or net
operating loss carry-forwards.




International
Operations





The
Canadian dollar is the functional currency of our subsidiaries operating in
Toronto, Ontario and the Brazilian real is the functional currency of our
subsidiary operating in Rio de Janeiro, Brazil. Our foreign subsidiaries have
translated their financial statements into U.S. dollars for reporting
purposes. Assets and liabilities are translated at the exchange rate in effect
as of the balance sheet date. We translate income statement accounts using the
average exchange rate for the period and significant nonrecurring transactions
using the rate on the transaction date. These gains or losses are included in
accumulated other comprehensive income as a separate component of shareholders’
equity.





Our
international subsidiaries may have transactions denominated in currencies other
than their functional currency. In these instances, assets and liabilities are
remeasured into the functional currency at the exchange rate in effect at the
end of the period, and income statement accounts are remeasured at the average
exchange rate for the period. These gains or losses are included in our results
of operations.





Our
subsidiaries also record gains or losses in the income statement when a
transaction with a third party, denominated in a currency other than the
entity’s functional currency, is settled and the functional currency cash flows
realized are more or less than expected based upon the exchange rate in effect
when the transaction was initiated.




Financial
Condition, Liquidity and Capital Resources





General




Our
principal cash requirements are for property acquisitions, property-level
operating expenses, capital improvements, debt service, organizational and
offering expenses, corporate-level general and administrative expenses and
distributions. We have three primary sources of capital for meeting our cash
requirements:





•
            proceeds
      from our public offerings, including our dividend reinvestment
      plan;





•
            debt
      financings, including secured or unsecured
      facilities; and





•
            cash
      flow generated by our real estate investments and
    operations.





For the
six months ended June 30, 2008, our cash needs for acquisitions have been met
primarily by proceeds from our public equity offerings and debt financing while
our operating cash needs have primarily been met through cash flow generated by
our properties and investments. We believe that our current capital resources
and cash flow from operations are sufficient to meet our liquidity needs for the
foreseeable future.





We raised
significant funds from our Second Offering during 2007 and for the six months
ended June 30, 2008, and we expect to continue to raise significant funds from
our Third Offering. We intend to continue making real estate investments with
these funds and funds available to us under our credit facilities and other
permanent debt. For mortgage debt expiring in the near term, we intend to
refinance such debt with new mortgage financing or our revolving credit
facility. We also intend to continue to pay distributions to our shareholders on
a quarterly basis.





Debt
capital has recently become less available and more expensive as financial
institutions and lenders have become capital constrained.  During the
second quarter we were able to secure attractive mortgage financing for our
acquisitions and, due to our financial strength and the quality nature of the
assets we acquire, we believe we will continue to be successful in obtaining
debt capital.  Should the reduced availability of debt and/or the
increased cost of borrowings continue, either by increases in the index rates or
by increases in lender spreads, we will need to consider such factors in the
evaluation of future acquisitions.




Additionally,
we have experienced, and may continue to experience, delays between raising
capital and acquiring real estate investments. Given the current economy and
state of the real estate markets, there are fewer quality assets being sold than
were sold in the last few years which could also result in delays in investing
our capital.  We temporarily invest unused proceeds from our public
offering in investments that typically yield lower returns when compared to our
real estate investments, which may put downward pressure on our distributions in
future periods.




28
 
  We also
expect that the current softening of the economy will have a dampening effect
on real estate fundamentals, including overall occupancies, leasing
velocity and rental rates.  Although our portfolio is not immune to
these factors, we believe that our portfolio is well positioned to withstand
this down cycle.  We will be proactively managing our portfolio in an
effort to minimize the negative impacts during this time however, these
weakening fundamentals may also put downward pressure on our distributions in
future periods and may cause declines in our real estate values.
 Cash
Flows from Operating Activities





Our
direct investments in real estate assets generate cash flow in the form of
rental revenues, which are reduced by debt service, direct leasing costs and
property-level operating expenses. Property-level operating expenses consist
primarily of salaries and wages of property management personnel, utilities,
cleaning, insurance, security and building maintenance costs, property
management and leasing fees, and property taxes. Additionally, we have incurred
corporate-level debt service, general and administrative expenses, asset
management and acquisition fees.




Net
cash provided by operating activities was approximately $18.4 million and $7.2
million for the six months ended June 30, 2008 and 2007, respectively. The
increase is due primarily to operating cash flows for acquisitions made in the
past year. Our operating net cash flows are primarily the result of the net loss
for the period partially offset by non-cash components of our net loss such as
depreciation and amortization, equity in losses of unconsolidated entities,
accrued costs of our Second Offering, gain or loss on derivative instruments,
and changes in operating accounts.




Cash
Flows from Investing Activities





During
the six months ended June 30, 2008, we had cash outflows of $519.8 million
primarily related to our acquisition of four properties and their related lease
intangibles. During the six months ended June 30, 2007, we made payments of
$476.9 million related to our acquisitions of four properties, including our
investment in an unconsolidated joint venture.





As of June 30, 2008, we owned an approximate 28.7% non-managing general
partner interest in the Core Fund, compared to the approximate
29.8% interest we owned at June 30, 2007. During the six months ended
June 30, 2008 and 2007, we received distributions from the Core Fund
totaling $12.8 million and $11.8 million, respectively.




As of June 30, 2008, we owned an approximate 50% interest in HCB II River LLC, a
joint venture with an affiliate of Hines. During the six months ended
June 30, 2008, we received distributions from HCB II River LLC totaling
$1.5 million, of which approximately $482,000 was recorded in cash flows from
investing activities as it exceeded our equity in earnings of the joint
venture.




During the six months ended June 30, 2007, we had cash outflows in other
assets of $65.0 million resulting from a $58.0 million capital contribution to
the Core Fund that was paid on June 29, 2007 and effective on July 2, 2007, and
a deposit of $7.0 million related to the acquisition of 3 Huntington Quadrangle
in July 2007.




During the six months ended June 30, 2008 and 2007, we had increases in
restricted cash of approximately $4.9 million and $4.8 million, respectively,
related to certain escrows required by our mortgage agreements.




During the six months ended June 30, 2008 we had cash inflows of approximately
$868,000, net of payments, for master leases entered into in connection with
certain of our acquisitions. During the six months ended June 30, 2007 we had
cash outflows of $2.3 million, net of receipts, for master leases entered into
in connection with certain of our acquisitions.





Cash
Flows from Financing Activities





Equity
Offerings





We offer
shares of our common stock for sale to the public, which provides us with the
ability to raise capital on a continual basis. On June 18, 2004, we
commenced our Initial Offering. We raised $527.5 million in gross proceeds
through the Initial Offering, which expired on June 18, 2006. On
June 19, 2006, we commenced our Second Offering, through which we raised
approximately $1.5 billion in gross proceeds prior to its termination on June
30, 2008.  We commenced our Third Offering on July 1,
2008.





The
following table summarizes the sales activity from our Second Offering (in
millions):





Period
            #
      of Shares
            
            
            Gross
      ProceedsJune
      19, 2006 to December 31, 2006
            27.3
            (a)
            
            $
            282.7
            (a)Year
      ended December 31, 2007
            80.3
            (b)
            
            
            834.8
            (b)Six
      Months Ended June 30, 2008
            32.3
            (c)
            
            
            338.6
            (c)Total
            139.9
            
            
            $
            1,456.1


__________




29
 
 (a)
                Amounts
      include $9.3 million of gross proceeds relating to approximately 944,000
      shares issued under the Company’s dividend reinvestment
    plan.(b)
                Amounts
      include $37.4 million of gross proceeds relating to approximately 3.8
      million shares issued under the Company’s dividend reinvestment
      plan.
 
 (c)
                Amounts
      include $27.9 million of gross proceeds relating to approximately 2.8
      million shares issued under the Company’s dividend reinvestment
      plan.


Payment
of Offering and Other Costs and Expenses





In
addition to making investments in accordance with our investment objectives, we
used our capital resources to pay our Dealer Manager and our Advisor for
services they provided to us during the various phases of our organization and
operations. During the offering stage, we pay the Dealer Manager selling
commissions and dealer manager fees, and during the Second Offering we
reimbursed the Advisor for organizational and offering costs. See
“Note 6 — Related Party Transactions” included elsewhere in this
Form 10-Q for additional information regarding our Advisory Agreements and
Dealer Manager agreements.





For the
six months ended June 30, 2008 and 2007, we paid the Dealer Manager selling
commissions of $18.6 million and $36.2 million, respectively, and dealer manager
fees of $6.8 million and $12.4 million, respectively. All such selling
commissions and a portion of such dealer manager fees were reallowed by HRES to
participating broker dealers for their services in selling our shares.
Commissions and dealer manager fees paid during the six months ended June 30,
2008 decreased, as compared to the six months ended June 30, 2007, as a result
of a decrease in capital raised during the period.





During
the six months ended June 30, 2008 and 2007, the Advisor incurred internal
organizational and offering costs related to the Second Offering totaling
approximately $3.6 million and $3.5 million, respectively, and third-party
offering costs of approximately $4.2 million and $4.6 million, respectively.
During the six months ended June 30, 2008 we made payments totaling $8.3 million
for Second Offering organizational and offering costs, all of which were
reimbursements made to our Advisor. During the six months ended June 30, 2007 we
made payments totaling $11.4 million for Second Offering organizational and
offering costs, of which $11.1 million were reimbursements made to our
Advisor.




See
“Critical Accounting Policies — Organizational and Offering Costs” above
for additional information.





Debt
Financings





We use
debt financing from time to time for acquisitions and investments as well as for
property improvements, tenant improvements, leasing commissions and other
working capital needs. We may obtain financing at the time an asset is acquired
or an investment is made or at such later time as determined to be appropriate,
depending on market conditions and other factors.





Subject
to market conditions and other factors we may consider, we expect that our debt
financing will generally be in the range of approximately 40 – 60% of
management’s estimate of the aggregate value of our real estate investments. The
amount of debt we place on an individual property, or the amount of debt
incurred by an individual entity in which we invest, however, may be less than
40% or more than 60% of the value of such property or the value of the assets
owed by such entity, depending on market conditions and other factors. In
addition, depending on market conditions and other factors, we may choose not to
use debt financing for our operations or to acquire properties. Our articles of
incorporation limit our borrowing to 300% of our net assets (equivalent to 75%
of the cost of our assets) unless any excess borrowing is approved by a majority
of our independent directors and is disclosed to our shareholders in our next
quarterly report. As of June 30, 2008 and December 31, 2007, our debt financing
was approximately 51% and 54%, respectively, of the aggregate value of our real
estate investments (including our pro rata share of the Core Fund’s real estate
assets and related debt).




30


The
following table includes all of our outstanding notes payable as of June 30,
2008 and December 31, 2007 (in thousands, except interest rates):





Description
            Origination Date
            Maturity
      Date
            
            Interest
      Rate
            
            
            Principal
      Outstanding at
              June
      30,2008
            
            
            Principal
      Outstanding at December 31,2007SECURED
      MORTGAGE DEBTWells
      Fargo Bank, N.A. — Airport Corporate Center
            1/31/2006
            3/11/2009
            
            
            4.775
            %
            
            
            90,446
            (4)
            
            
            90,039Metropolitan
      Life Insurance Company — 1515 S. Street
            4/18/2006
            5/1/2011
            
            
            5.680
            %
            
            
            45,000
            
            
            
            45,000Capmark
      Finance, Inc. — Atrium on Bay
            2/26/2007
            2/26/2017
            
            
            5.330
            %
            
            
            188,100
            (3)
            
            
            193,686The
      Prudential Insurance Company ofAmerica
      — One Wilshire
            10/25/2007
            11/1/2012
            
            
            5.980
            %
            
            
            159,500
            
            
            
            159,500IXIS
      Real Estate Capital Inc. — Raytheon/DirecTV
      Buildings
            3/13/2008
            12/5/2016
            
            
            5.675
            %
      (6)
            
            
            52,802
            
            
            
            —New
      York State Teachers’ Retirement
              System —
      2555 Grand
            4/24/2008
            5/1/2013
            
            
            5.375
            %
      (7)
            
            
            86,000
            
            
            
            —New
      York State Teachers’ Retirement
              System —
      Williams Tower
            5/29/2008
            6/1/2013
            
            
            5.500
            %
      (8)
            
            
            165,000
            
            
            
            —HSH
      POOLED MORTGAGE FACILITYHSH
      Nordbank — Citymark, 321 North Clark, 1900 and 2000
      Alameda
            8/1/2006
            8/1/2016
            
            
            5.8575
            %
      (2)
            
            
            185,000
            
            
            
            185,000HSH
      Nordbank — 3400 Data Drive, Watergate Tower IV
            1/23/2007
            1/12/2017
            
            
            5.2505
            %
      (2)
            
            
            98,000
            
            
            
            98,000HSH
      Nordbank — Daytona and Laguna Buildings
            5/2/2007
            5/2/2017
            
            
            5.3550
            %
      (2)
            
            
            119,000
            
            
            
            119,000HSH
      Nordbank — 3 Huntington Quadrangle
            7/19/2007
            7/19/2017
            
            
            5.9800
            %
      (2)
            
            
            48,000
            
            
            
            48,000HSH
      Nordbank — Seattle Design Center / 5th
      and Bell
            8/14/2007
            8/14/2017
            
            
            6.0300
            %
      (2)
            
            
            70,000
            
            
            
            70,000MET
      LIFE SECURED MORTGAGE FACILITYMet
      Life — JPMorgan Chase Tower/Minneapolis
            12/20/2007
            1/1/2013
            
            
            5.700
            %
            
            
            205,000
            
            
            
            205,000Office/Flex
      PortfolioOTHER
      NOTES PAYABLEKey
      Bank National Association — Revolving Credit Facility
            9/9/2005
            10/31/2009
            
            Variable
      (1)
            
            
            
            —
            
            
            
            —Atrium
      Note Payable
            9/1/2004
            10/1/2011
            
            
            7.390
            %
            
            
            3,240
            (5)
            
            
            3,406$
            1,515,088
            
            
            $
            1,216,631


__________




(1)
            The
      revolving credit facility with KeyBank National Association (“KeyBank”)
      provides a maximum aggregate borrowing capacity of $250.0 million.
      Borrowings under the revolving credit facility are at variable interest
      rates based on LIBOR plus 125 to 200 basis points based on prescribed
      leverage ratios.(2)
            We
      entered into an interest rate swap agreement which effectively fixed the
      interest rate of this borrowing at the specified rate.(3)
            We
      entered into mortgage financing in connection with our acquisition of
      Atrium on Bay. The mortgage agreement provides for an interest only loan
      with a principal amount of $190.0 million Canadian dollars. This amount
      was translated to U.S. dollars at a rate of $.9900 as of June 30,
      2008.(4)
            This
      mortgage is an interest-only loan in the principal amount of $91.0
      million, which we assumed in connection with our acquisition of Airport
      Corporate Center. At the time of acquisition, the fair value of this
      mortgage was estimated to be $88.5 million, resulting in a premium of $2.5
      million. The premium is being amortized over the term of the
      mortgage.(5)
            Note
      with Citicorp Vendor Finance Ltd. Related to installation of certain
      equipment at Atrium on Bay. This amount was translated to U.S. dollars at
      a rate of $.9900 as of June 30, 2008.(6)
            We
      assumed a mortgage note in the principal amount of $54.2 million in
      connection with our acquisition of the Raytheon/DirecTV Buildings. The
      mortgage agreement provides for monthly payments of principal and
      interest. This mortgage agreement contains customary events of default
      with corresponding grace periods, including payment defaults,
      cross-defaults to other agreements and bankruptcy-related defaults, and
      customary covenants, including limitations on liens and indebtedness and
      maintenance of certain financial ratios. At the time of acquisition, the
      fair value of this mortgage was estimated to be $52.9 million, resulting
      in a premium of $1.3 million. The premium is being amortized over the term
      of the mortgage.


31


(7)
            We
      entered into a loan with the New York State Teachers’ Retirement System
      (“NYSTRS”) in the principal amount of $86.0 million secured by our
      interest in 2555 Grand. The loan agreement provides for monthly payments
      of interest and a principal payment due upon debt maturity. This loan
      agreement contains customary events of default with corresponding grace
      periods, including payment defaults, cross-defaults to other agreements
      and bankruptcy-related defaults, and customary covenants, including
      limitations on liens and indebtedness and maintenance of certain financial
      ratios.(8)
            We
      entered into a loan with NYSTRS in the principal amount of $165.0 million
      secured by our interest in Williams Tower. The loan agreement provides for
      monthly payments of interest and a principal payment due upon debt
      maturity. This loan agreement contains customary events of default with
      corresponding grace periods, including payment defaults, cross-defaults to
      other agreements and bankruptcy-related defaults, and customary covenants,
      including limitations on liens and indebtedness and maintenance of certain
      financial ratios.





We are
not aware of any instances of noncompliance with financial covenants as of June
30, 2008.





Advances from Affiliates





Certain
costs and expenses associated with our organization and public offerings have
been paid by our Advisor on our behalf. See “Financial Condition, Liquidity and
Capital Resources — Payment of Offering Costs and Other Expenses” above for
a discussion of our repayment of these costs and expenses.





To the
extent that our operating expenses in any four consecutive fiscal quarters
exceed the greater of 2% of average invested assets or 25% of Net Income (as
defined in our Articles of Incorporation), our Advisor is required to reimburse
us the amount by which the total operating expenses paid or incurred exceed the
greater of the 2% or 25% threshold, unless our independent directors determine
that such excess was justified. For the quarter ended June 30, 2008, we did not
exceed this limitation.




How
Management Evaluates Distributions to our Shareholders and Minority
Interests





In order
to meet the requirements for being treated as a REIT under the Internal Revenue
Code of 1986 and to pay regular cash distributions to our shareholders, which is
one of our investment objectives, we have declared and intend to continue to
declare distributions to shareholders (as authorized by our board of directors)
as of daily record dates and aggregate and pay such distributions
quarterly.





From
July 1, 2006 through April 30, 2008, we declared distributions (as
authorized by our board of directors) equal to $0.00170959 per share, per
day. We recently increased the dividend rate to $0.00175233 per share, per day
for the months of May and June. The distributions declared were authorized and
set by our board of directors at a level the board believed to be appropriate
based upon the board’s evaluation of our assets, historical and projected levels
of cash flow and results of operations, additional capital and debt anticipated
to be raised or incurred and invested in the future, the historical and
projected timing between receiving offering proceeds and investing such proceeds
in real estate investments, and general market conditions and
trends.




32


Aggregate
distributions declared to our shareholders and minority interests related to the
six months ended June 30, 2008 were $55.3 million. The amount of our
distributions is based on funds generated by the operations of our real estate
investments. The table below summarizes the funds generated by the operations of
our real estate investments for the six months ended June 30, 2008, including
items that management considers in evaluating the performance of our real estate
investments and determining the amount of distributions to shareholders and
minority interests, and a reconciliation of such amount to our net loss for the
period (in thousands):





Revenues
            
            $
            155,354ExpensesProperty
      operating expenses, real property taxes and property management
      fees
            
            
            (65,117
            )Interest
      expense, net of interest income
            
            
            (37,342
            )General
      and administrative expenses
            
            
            (3,093
            )Cash
      asset management fees
            
            
            (5,829
            )OtherMaster
      lease rents (1)
            
            
            4,702Non-cash
      components of revenues and expenses (2)
            
            
            (8,722
            )Equity
      in losses of unconsolidated entities as adjusted for non-cash components
      (3)
            
            
            16,166Provision
      for income taxes
            
            
            (464
            )Total
            
            
            55,655Reconciliation
      to Net Loss:Depreciation
      and amortization
            
            
            (57,597
            )Loss
      on derivative instruments and foreign currency transactions
      (4)
            
            
            (667
            )Organizational
      and offering expenses (5)
            
            
            (3,614
            )Acquisition
      fees (5)
            
            
            (3,018
            )Participation
      Interest expense (6)
            
            
            (8,847
            )Income
      allocated to minority interests
            
            
            (1,375
            )Other
      non-cash components of net loss (7)
            
            
            (16,262
            )Net
      Loss
            
            $
            (35,725
            )


__________




1)
            Includes
      master lease rent related to master leases entered into in conjunction
      with certain asset acquisitions. In accordance with GAAP, these rents are
      not included in rental revenue; however, we consider this rent in
      determining the amount of distributions to our shareholders and minority
      interests.2)
            Includes
      non-cash components of revenue such as straight-line rent adjustments of
      $(8.6) million, amortization of lease incentives of $1.7 million and
      out-of-market lease amortization of $(3.1) million as well as non-cash
      components of expenses such as amortization of deferred financing costs of
      approximately $791,000 and other non-cash components of approximately
      $528,000.3)
            Represents
      net equity in losses of our unconsolidated entities of approximately $4.1
      million offset by approximately $20.3 million of depreciation and
      amortization and other non-cash components such as those described in Note
      2 above.4)
            These
      amounts represent non-cash components of net loss that we do not consider
      in determining the amount of distributions to our shareholders and
      minority interests.5)
            Organizational
      and offering expenses and acquisition fees paid to our Advisor are
      expensed in our condensed consolidated statement of operations. We fund
      such costs with proceeds from our offering and acquisition-related
      indebtedness and do not consider these expenses in the evaluation of the
      performance of our real estate investments and in determining the amount
      of distributions to our shareholders and minority
    interests.6)
            This
      represents the non-cash component of the acquisition and asset management
      fee, which we do not consider in determining the amount of distributions
      to our shareholders and minority interests. See “Critical Accounting
      Policies – Treatment of Management Compensation, Expense Reimbursements
      and Operating Partnership Participation Interest” for additional
      information.7)
            This
      includes the master lease rents as described in Note 1 above, the non-cash
      components of revenues and expenses described in Note 2 above as well as
      the non-cash components adjusting the equity in losses of our
      unconsolidated entities as described in Note 3
  above.




In
conjunction with our condensed consolidated financial statements, we believe
this analysis provides our shareholders with a clear description of how our
management evaluates the performance of our real estate investments and
determines the amount of distributions to our shareholders and minority
interests.





33


Results
of Operations




Property-level
      Operating Results




We owned
20 properties directly that were 94% leased as of June 30, 2008 compared to 12
properties that were 94% leased as of June 30, 2007. The following table
presents the property-level revenues and expenses for the three and six months
ended June 30, 2008, as compared to the same period in 2007. Same-store
properties for the six months ended June 30, 2008 include all properties owned
as of January 1, 2007 as well as the Laguna Buildings, which were acquired on
January 3, 2007. Revenues and expenses for properties acquired after January 3,
2007 are included in “Recent Acquisitions.” Same-store properties for the three
months ended June 30, 2008 include all properties owned as of April 1, 2007. All
amounts are in thousands, except for percentages:





Three
      Months Ended June 30,
            
            Change2008
            
            2007
            
            $
            
            
            
            %Property
      revenuesSame-store
      properties
            
            $
            38,680
            
            
            $
            37,046
            
            
            $
            1,634
            
            
            
            4.4
            %Recent
      acquisitions
            
            
            46,540
            
            
            
            233
            
            
            
            46,307
            
            
            
            19,874.2
            %Total
      property revenues
            
            $
            85,220
            
            
            $
            37,279
            
            
            $
            47,941
            
            
            
            128.6
            %Property
      expenses (1)Same-store
      properties
            
            $
            30,036
            
            
            $
            29,482
            
            
            $
            554
            
            
            
            1.9
            %Recent
      acquisitions
            
            
            37,666
            
            
            
            245
            
            
            
            37,421
            
            
            
            15,273.9
            %Total property
      expenses
            
            $
            67,702
            
            
            $
            29,727
            
            
            $
            37,975
            
            
            
            127.7
            %Six
      Months Ended June 30,
            
            Change2008
            
            2007
            
            
            
            $
            
            
            
            %Property
      revenuesSame-store
      properties
            
            $
            56,286
            
            
            $
            55,967
            
            
            $
            319
            
            
            
            0.6
            %Recent
      acquisitions
            
            
            99,068
            
            
            
            11,986
            
            
            
            87,082
            
            
            
            726.5
            %Total
      property revenues
            
            $
            155,354
            
            
            $
            67,953
            
            
            $
            87,401
            
            
            
            128.6
            %Property
      expenses (1)Same-store
      properties
            
            $
            43,104
            
            
            $
            43,755
            
            
            $
            (651
            )
            
            
            (1.5
            )%Recent
      acquisitions
            
            
            79,610
            
            
            
            10,099
            
            
            
            69,511
            
            
            
            688.3
            %Total property
      expenses
            
            $
            122,714
            
            
            $
            53,854
            
            
            $
            68,860
            
            
            
            127.9
            %


_________




(1)
            Property
      expenses include property operating expenses, real property taxes,
      property management fees, depreciation and amortization of real estate
      assets.




As
indicated above, revenues and expenses from our same-store properties remained
fairly constant with a slight trend upward between both periods presented as
compared to those from our recent acquisitions. Specifically, property revenues
in excess of property expenses for same-store properties increased 1.9% and
1.6%, respectively, for the three and six months ended June 30, 2008 as compared
to the same periods in 2007. Therefore, increases in total revenues and
property-level expenses between the periods presented are primarily the result
of acquisitions made. We expect to continue raising capital through our public
offerings and to utilize these proceeds in the acquisitions of additional
properties. As a result of these future potential acquisitions and our
recent acquisitions having a full period of operations, our results of
operations for the three and six months ended June 30, 2008 are not indicative
of what we expect our results of operations to be in future
periods.





Our
Interest in the Core Fund





As of
June 30, 2008, we owned a 28.7 % non-managing general partner interest in the
Core Fund, which held interests in 25 properties that were 92 % leased. By
comparison, we owned a 29.8 % interest in the Core Fund as of June 30, 2007,
which held interests in 22 properties that were 94 % leased.





Our
equity in losses related to our investment in the Core Fund for the six months
ended June 30, 2008 and 2007 was $5.1 million and $1.9 million, respectively.
Our equity in losses related to our investment in the Core Fund for the three
months ended June 30, 2008 and 2007 was approximately $2.7 million and $757,000,
respectively. The increase is due to the increase in the net loss of the Core
Fund, which increased to $16.3 million from $5.6 million, primarily as a result
of depreciation and amortization resulting from recent acquisitions. See
“Financial Condition, Liquidity and Capital Resources – Cash Flows from
Investing Activities” for additional information regarding our distributions
received from the Core Fund.


34


Our
Interest in HCB II River LLC





As of
June 30, 2008, we owned a 50% non-managing interest in HCB II River LLC.
Our equity in earnings related to our investment in HCB II River LLC for the
three and six months ended June 30, 2008 was approximately $533,000 and
$1.0 million, respectively. For the three and six months ended June 30,
2008, HCB II River LLC had net income of $1.0 million and $1.9 million,
respectively, on revenues of $2.1 million and $4.1 million,
respectively.





Asset
Management and Acquisition Fees





Asset
management fees earned by our advisor for the six months ended June 30, 2008 and
2007 were $11.7 million and $6.6 million, respectively. Asset management
fees for the three months ended June 30, 2008 and 2007 were $6.1 million
and $3.7 million, respectively. The increases in asset management fees
reflect the fact that we have a larger portfolio of assets under management.
Average net equity invested in real estate for the six months ended June
30, 2008 and 2007 was $1.6 billion and $877.9 million, respectively. Average net
equity invested in real estate for the three months ended June 30, 2008 and 2007
was $1.6 billion and $973.4 million, respectively.





Acquisition
fees for the six months ended June 30, 2008 and 2007 were $6.0 million and
$4.5 million, respectively. Acquisition fees for the three months ended
June 30, 2008 and 2007 were $3.1 million and $1.2 million, respectively. The
increases in acquisition fees are the result of a higher aggregated
purchase prices of assets acquired.





These
amounts include both the cash portion of the fees payable to our Advisor as well
as the corresponding increase in the Participation Interest. See
“Note 6 — Related Party Transactions” in our unaudited condensed
consolidated financial statements included elsewhere in this Form 10-Q for
a description of the Participation Interest.





General
and Administrative Expenses





General
and administrative expenses were $3.1 million and $2.2 million, respectively,
for the six months ended June 30, 2008 and 2007 and $1.8 million and $1.3
million, respectively, for the three months ended June 30, 2008 and 2007. These
costs include legal and accounting fees, insurance costs, costs and expenses
associated with our board of directors and other administrative expenses.
Certain of these costs are variable and may increase in the future as we
continue to raise capital and make additional real estate investments. The
increases in general and administrative expenses during the periods are
primarily due to increased audit fees, increased costs of shareholder
communications and transfer agent fees resulting from growth in our shareholder
base and additional costs related to compliance with the Sarbanes-Oxley Act of
2002.





Gain/Loss
on Derivative Instruments





During
the years ended December 31, 2007 and 2006, we entered into several forward
interest rate swap transactions with HSH Nordbank AG, New York Branch (“HSH
Nordbank”). These swap transactions were entered into as economic hedges against
the variability of future interest rates on our variable interest rate
borrowings with HSH Nordbank. We have not designated any of these contracts as
cash flow hedges for accounting purposes. The interest rate swaps have been
recorded at their estimated fair value in the accompanying consolidated balance
sheets as of June 30, 2008 and December 31, 2007.





In
addition, on February 8, 2007, we entered into a foreign currency contract
related to the acquisition of Atrium on Bay, an office property located in
Toronto, Ontario. The contract was entered into as an economic hedge against the
variability of the foreign currency exchange rate related to our equity
investment and was settled at the close of this acquisition on February 26,
2007, as described above.





The table
below contains additional information regarding our derivative instruments (all
amounts are in thousands):








Description
            
            Increase
      (Decrease) in Fair Value
            
            
            Transaction
      Fees
            
            
            Foreign
      Currency
              Gain
      (Loss)
            
            
            Gain
      (Loss) on
              Derivative
              Instruments,
      netQuarter
      Ended June 30, 2008
            
            $
            26,780
            
            
            
            —
            
            
            
            —
            
            
            $
            26,780Quarter
      Ended June 30, 2007
            
            $
            15,574
            
            
            $
            (365
            )
            
            
            —
            
            
            $
            15,209Six
      Months Ended June 30, 2008
            
            $
            (665
            )
            
            
            —
            
            
            
            —
            
            
            $
            (665
            )Six
      Months Ended June 30, 2007
            
            $
            15,639
            
            
            $
            (731
            )
            
            $
            939
            
            
            $
            15,847





See
“Critical Accounting Policies – Derivative Instruments” for further discussion
regarding the valuation of our derivatives.





35


Gain
on Foreign Currency Transactions





During
the six months ended June 20, 2008 and 2007, certain of our subsidiaries which
own Atrium on Bay, our property located in Toronto, Ontario, had transactions
denominated in currencies other than their functional currency (CAD). In these
instances, non-monetary assets and liabilities are reflected at the historical
exchange rate, monetary assets and liabilities are remeasured into the
functional currency at the exchange rate in effect at the end of the period, and
income statement accounts are remeasured at the average exchange rate for the
period. We recorded a loss of approximately $2,000 in the accompanying condensed
consolidated statement of operations for the six months ended June 30,
2008 as a result of such foreign currency transactions. In addition, we
recorded a gain of approximately $134,000 in the accompanying condensed
consolidated statement of operations for the six months ended June 30,
2007 as a result of such foreign currency transactions.





Interest
Expense





Interest
expense was $39.0 million and $19.8 million, respectively, for the six
months ended June 31, 2008 and 2007 and $20.9 million and $10.4 million,
respectively, for the three months ended June 30, 2008 and 2007. The increase in
interest expense during the periods is primarily due to increased borrowings
used to fund our acquisitions of directly-owned properties as our
weighted-average interest rate has not changed significantly. Average debt
outstanding during the six months ended June 30, 2008 and 2007 was $1.4 billion
and $598.6 million, respectively. Average debt outstanding during the three
months ended June 30, 2008 and 2007 was $1.4 billion and $702.8 million,
respectively.





Interest
Income





Interest
income was $1.6 million and $2.9 million, respectively, for the six months ended
June 30, 2008 and 2007 and approximately $361,000 and $2.5 million,
respectively, for the three months ended June 30, 2008 and 2007. The decreases
in interest income are primarily due to decreased cash we held in short-term
investments during delays between raising capital and acquiring real estate
investments and a decrease in interest rates earned on short-term investments.
These decreases are slightly offset by property-level increases in interest
income as result of our recent acquisitions.




Average
uninvested proceeds were $61.0 million during the six months ended June 30,
2008, compared to $90.4 million during the six months ended June 30, 2007. The
average interest rate we earned on these univested proceeds during these periods
decreased from 5.18% to 3.16%. Average uninvested proceeds were $25.1 million
during the three months ended June 30, 2008, down from $166.6 million during the
three months ended June 30, 2007. The average interest rate we earned on these
univested proceeds during these periods decreased from 5.18% to
2.58%.




Income
Taxes





The
provision for income taxes for the six months ended June 30, 2008 and 2007 was
approximately $464,000 and $334,000, respectively.  The benefit for
income taxes for the three months ended June 30, 2008 was approximately $51,000
and the provision for income taxes for the three months ended June 30, 2007 was
approximately $268,000. The provision for income taxes was primarily related to
our property in Toronto, Ontario, which we acquired during February
2007.




Income Allocated to Minority Interests





As of
June 30, 2008 and 2007, Hines REIT owned a 97.5% and a 98.0% interest,
respectively, in the Operating Partnership, and affiliates of Hines owned the
remaining 2.5% and 2.0% interests, respectively. We allocated income of
approximately $1.4 million and $395,000 to minority interests for the six months
ended June 30, 2008 and 2007, respectively. In addition, we allocated
income of approximately $732,000 and $326,000 to minority interests for the
three months ended June 30, 2008 and 2007, respectively.





Related-Party
Transactions and Agreements





We have
entered into agreements with the Advisor, Dealer Manager and Hines or its
affiliates, whereby we pay certain fees and reimbursements to these entities,
including acquisition fees, selling commissions, dealer manager fees, asset and
property management fees, construction management fees, reimbursement of
organizational and offering costs, and reimbursement of certain operating costs.
We also own Williams Tower, which is managed by Hines. Hines and its affiliates
lease 9% of the rentable area of Williams Tower. See “Note 6 — Related
Party Transactions” in our unaudited condensed consolidated financial statements
included elsewhere in this Form 10-Q for a discussion of the various
related-party transactions, agreements and fees.





Off-Balance
Sheet Arrangements





As of
June 30, 2008 and December 31, 2007, we had no off-balance sheet arrangements
that have or are reasonably likely to have a current or future effect on our
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital
resources.





36


Subsequent
Events





Third
Offering





Our Third
Offering was declared effective by the Securities and Exchange Commission on
July 1, 2008. Pursuant  to the Third Offering, we are offering up to
$3.0 billion in shares of common stock initially priced at $10.66 per share for
shares purchased through commission-based financial advisors (with discounts
available for certain categories of purchasers).  Shares purchased
through fee-based financial advisors were may qualify for a 9.2% discount, or a
$9.68 per share price, due to a waiver of the up-front selling commission and
dealer-manage fees.  In addition, we are offering up to $500.0 million
in shares of common stock under our dividend reinvestment plan, initially priced
at $10.13 per share, and will redeem shares through our share redemption program
at $9.68 per share.





Advisory
Agreement





On July
1, 2008, we executed a new advisory agreement (the “New Advisory Agreement”)
with the Advisor. The terms of the New Advisory Agreement are comparable to
those of the previous Advisory Agreement with the exception of the changes to
the fees described below.





With
respect to each real estate investment made after the commencement of the Third
Offering up to an aggregate of $2.0 billion of gross real estate
investments, we will pay an acquisition fee to the Advisor equal
to 2.50% of: (i) the purchase price of real estate investments acquired
directly by the Company, including any debt attributable to such investments or
(ii) when we make an investment indirectly through another entity, such
investment’s pro rata share of the gross asset value of real estate investments
held by that entity.  In addition, we will pay an acquisition fee to
the Advisor, with respect to investments made after the initial $2.0
billion of gross real estate investments, equal to 0.50% of the amounts set
forth in (i) and (ii). Additionally, we will pay the Advisor a financing fee
equal to 1.0% of the amount (i) obtained under any property loan or (ii) made
available to us under any other debt financing.





In
addition, we will not be obligated to reimburse the Advisor for organizational
and offering costs in relation to the Third Offering. See “Critical Accounting
Policies – Organizational and Offering Costs” for further
discussion.





The New
Advisory Agreement has a one-year term and may be renewed for successive
one-year periods upon the mutual consent of the parties. Renewals of the New
Advisory Agreement must be approved by the conflicts committee of the Hines REIT
board of directors.





Shareholder
Redemptions





For the
months of  July and  August 2008, in accordance with our share
redemption plan, we redeemed approximately 1.5 million common shares and
made corresponding payments totaling $14.7 million to shareholders who had
requested these redemptions. The shares redeemed were cancelled and will have
the status of authorized, but unissued shares.


37


Item 3.
Quantitative and Qualitative
Disclosures About Market Risk.





Market
risk includes risks relating to changes in interest rates, foreign currency
exchange rates, commodity prices, equity prices and other market changes that
affect market sensitive instruments. We are exposed to both interest rate risk
and foreign currency exchange rate risk.





The
commercial real estate debt markets have recently been experiencing volatility
as a result of certain factors including the tightening of underwriting
standards by lenders and credit rating agencies and the significant inventory of
unsold Collateralized Mortgage Backed Securities in the market. This has
resulted in lenders decreasing the availability of debt financing as well as
increasing the cost of debt financing. As our existing debt is either fixed rate
debt or floating rate debt with a fixed spread over LIBOR, we do not believe
that our current portfolio is materially impacted by the current debt market
environment. However, should the reduced availability of debt and/or the
increased cost of borrowings continue, either by increases in the index rates or
by increases in lender spreads, we will need to consider such factors in the
evaluation of future acquisitions. For example, during 2007, we borrowed
$893.2 million through various secured permanent financing vehicles at a
weighted average interest rate of 5.62%. If, in the future, interest rates of
these secured permanent financing vehicles increase by 1.0% and we obtained the
same level of financing as in 2007, we would incur additional interest charges
of $8.9 million annually. This may result in future acquisitions generating
lower overall economic returns and potentially reducing future cash flow
available for distribution.





In
addition, the state of the debt markets could have an impact on the overall
amount of capital investing in real estate which may result in price or value
decreases of real estate assets. Although this may benefit us for future
acquisitions, it could negatively impact the current value of our existing
assets.





We are
also exposed to the effects of interest rate changes primarily through
variable-rate debt, which we use to maintain liquidity and fund expansion of our
real estate investment portfolio and operations. Our interest rate risk
management objectives are to monitor and manage the impact of interest rate
changes on earnings and cash flows, and to use derivative financial instruments
such as interest rate swaps and caps in order to mitigate our interest rate risk
on variable rate debt. We do not enter into derivative or interest rate
transactions for speculative purposes. Please see “Debt Financings” above for
more information concerning the Company’s outstanding debt.




As of
June 30, 2008, we had $520.0 million of debt outstanding under our HSH Credit
Facility, which is a variable-rate pooled mortgage facility. However, as a
result of the interest rate swap agreements entered into with HSH Nordbank,
these borrowings effectively bear interest at fixed rates ranging from 5.2505%
to 6.0300%.





Derivative
financial instruments expose us to credit risk in the event of non-performance
by the counterparties under the terms of the interest rate swap agreements. We
minimized our credit risk on these transactions by dealing with
HSH Nordbank, a major creditworthy financial institution. We believe the
likelihood of realized losses from counterparty non-performance is
remote.





We are
exposed to foreign currency exchange rate variations resulting from our
subsidiaries located in Toronto, Ontario and Rio de Janeiro, Brazil. As of
June 30, 2008, $14.1 million of accumulated other comprehensive income
related to our international subsidiaries is included in our consolidated
statement of shareholders’ equity. Based on the Company’s current operational
strategies, management does not believe that variations in the foreign currency
exchange rates pose a significant risk to our consolidated results of operations
or financial position.




38


Item 4T.
Controls and Procedures.





In
accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of June 30, 2008, to provide reasonable assurance
that information required to be disclosed in our reports filed or submitted
under the Exchange Act is (i) recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission’s
rules and forms, and (ii) accumulated and communicated to our management,
as appropriate to allow timely decisions regarding required
disclosure.





Other
than those described below, no change occurred in our internal controls over
financial reporting (as defined in Rule 13a-15(f) of the Exchange Act)
during the quarter ended June 30, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting.





During
the three months ended June 30, 2008, we continued the implementation of an
upgrade to our financial and accounting systems and a new enterprise-wide
accounting and lease management system for Hines. We anticipate this
implementation will be completed by the end of 2008. This new software has
affected many aspects of our accounting and financial systems and procedures and
has resulted in significant changes to our internal controls. The implementation
of these systems upgrades had a material impact on our internal control over
financial reporting, but these upgrades were not implemented in response to an
identified significant control deficiency or material weakness. We believe that
these changes have improved and strengthened our overall system of internal
control.





During
the three months ended June 30, 2008, we named a new transfer agent and
completed the transition of shareholder recordkeeping, account statement
processing and other reporting to DST Systems, Inc., a provider of
information processing and computer software services.  While we believe
this change will not materially affect our overall system of internal controls,
there are inherent risks associated with implementing a change of service
providers.  We have modified our system of internal controls over financial
reporting in order to address the impact of this change, and believe that our
controls, as modified, continue to be designed appropriately and operate
effectively.




The
Company’s property-level accounting has historically been performed as a
decentralized function, with many of the associated accounting controls
performed at each property. Management has undertaken an initiative to evaluate
full or partial centralization of property accounting to identify potential
opportunities for efficiencies and/or control enhancements. The process is
currently in a pilot phase, with a select number of properties having been
converted or in the process of being converted to the centralized
accounting environment. The company is taking the necessary steps to monitor and
maintain appropriate internal controls during this period of change. These steps
include deploying resources to mitigate internal control risks and performing
additional verifications and testing to ensure data
integrity.




39







PART II – OTHER
INFORMATION





Item 2.
Unregistered Sales
of Equity Securities and Use of Proceeds.





On April
1, 2008, we issued 353.5 restricted common shares to Paul Murphy Jr. in
conjunction with his election to our board as an independent director as of that
date. These restricted shares were issued pursuant to our Employee and Director
Incentive Share Plan and without registration under the Securities Act of 1933
(the “Securities Act”) in reliance upon the exemption from registration
contained in Section 4(2) of the Securities Act. During the six months ended
June 30, 2008, we did not sell or issue any other equity securities that were
not registered under the Securities Act.





The
following table lists shares we redeemed under our share redemption plan during
the period covered by this report.





Period
            
            Total Number of
              Shares Purchased
            
            
            Average
      Price
              Paid
      per Share
            
            
            Total
      Number of
              Shares
      Purchased as
              Part
      of Publicly
              Announced Plans or Programs
            
            
            Maximum Number of Shares that May Yet be Purchased Under the
      Plans or Programs(1)April
      1, 2008 to April 30, 2008
            
            
            401,289
            
            
            
            9.52
            
            
            
            401,289
            
            
            
            9,177,697May
      1, 2008 to May 31, 2008
            
            
            403,548
            
            
            
            9.52
            
            
            
            403,548
            
            
            
            10,572,242June
      1, 2008 to June 30, 2008
            
            
            4,320
            
            
            
            9.52
            
            
            
            4,320
            
            
            
            11,922,361Total
            
            
            809,157
            
            
            
            9.52
            
            
            
            809,157


__________





(1)
            We
      may redeem shares under the program so long as the total number of shares
      redeemed during the calendar year does not exceed, as of the date of the
      redemption, 10% of our shares outstanding on the same date during the
      prior year. Our share redemption plan has been in effect since June 2004
      and has no definitive expiration date. However, the plan may be suspended
      or terminated at the discretion of the board of
  directors.





Item 6.
Exhibits.





The
exhibits required by this item are set forth on the Exhibit Index attached
hereto.




40







SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





HINES
REAL ESTATE INVESTMENT TRUST, INC.





August
14,
2008                                                                            By:  /s/ CHARLES N.
HAZEN


Charles
N. Hazen


President
and Chief Executive Officer








August
14,
2008                                                                           By:  /s/ SHERRIW.
SCHUGART


Sherri
W. Schugart


Chief
Financial Officer













41







EXHIBIT INDEX





Exhibit No.
            
            
            Description3.1
            
            —
            Second
      Amended and Restated Articles of Incorporation of Hines Real Estate
      Investment Trust, Inc. (filed as Exhibit 3.1 to the registrant’s
      Current Report on Form 8-K on July 13, 2007 and incorporated by reference
      herein).3.2
            
            —
            Second
      Amended and Restated Bylaws of Hines Real Estate Investment Trust, Inc.
      (filed as Exhibit 3.1 to the registrant’s Current Report on
      Form 8-K on August 3, 2006 and incorporated by reference
      herein).10.1
            
            —
            Dealer
      Management Agreement between Hines Real Estate Investment Trust, Inc. and
      Hines Real Estate Securities, Inc., dated June 30, 2008 (filed as Exhibit
      1.1 to the Registrant’s Current Report on Form 8-K on June 30, 2008, and
      incorporated by reference herein).10.2
            
            —
            Advisory
      Agreement between Hines REIT Properties, L.P., Hines Advisors Limited
      Partnership and Hines Real Estate Investment Trust, Inc. dated July 1,
      2008 (filed as Exhibit 1.2 to the Registrant’s Current Report on Form 8-K
      on June 30, 2008, and incorporated by reference
herein).31.1
            *
            —
            Certification
      of Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
            *
            —
            Certification
      of Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            *
            —
            Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to
      18 U.S.C., Section 1350, as adopted pursuant to Section 906
      of the Sarbanes-Oxley Act of 2002. Pursuant to SEC Release 34-47551 this
      Exhibit is furnished to the SEC and shall not be deemed to be
      “filed.”


__________





*
            Filed
      herewith








42