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 September 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
November 10, 2008, 205.1 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
            
            
            38PART II –
      OTHER INFORMATIONItem
      1A.
            Risk
      Factors
            
            
            39Item 2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            
            39Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            
            
            39Item 6.
            Exhibits
            
            
            40SIGNATURESCertificationCertificationCertification
      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)





September
      30, 2008
            
            
            December31,
      2007(In
      thousands, except per share amounts)ASSETSInvestment
      property, net
            
            $
            2,267,561
            
            
            $
            1,798,924Investments
      in unconsolidated entities
            
            
            330,404
            
            
            
            361,157Cash
      and cash equivalents
            
            
            184,659
            
            
            
            152,443Restricted
      cash
            
            
            7,830
            
            
            
            3,463Distributions
      receivable
            
            
            7,281
            
            
            
            6,890Tenant
      and other receivables
            
            
            47,124
            
            
            
            28,518Intangible
      lease assets, net
            
            
            372,731
            
            
            
            296,766Deferred
      leasing costs, net
            
            
            42,859
            
            
            
            34,954Deferred
      financing costs, net
            
            
            7,758
            
            
            
            7,638Other
      assets
            
            
            3,903
            
            
            
            12,870TOTAL
      ASSETS
            
            $
            3,272,110
            
            
            $
            2,703,623LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilities:Accounts
      payable and accrued expenses
            
            $
            90,454
            
            
            $
            66,267Due
      to affiliates
            
            
            4,746
            
            
            
            8,968Intangible
      lease liabilities, net
            
            
            118,279
            
            
            
            79,465Other
      liabilities
            
            
            16,885
            
            
            
            17,128Interest
      rate swap contracts
            
            
            41,388
            
            
            
            30,194Participation
      interest liability
            
            
            38,732
            
            
            
            26,771Distributions
      payable
            
            
            31,773
            
            
            
            24,923Notes
      payable
            
            
            1,510,018
            
            
            
            1,216,631Total
      liabilities
            
            
            1,852,275
            
            
            
            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 September 30, 2008 and December 31,
      2007
            
            
            —
            
            
            
            —Common
      shares, $.001 par value; 1,500,000 common shares authorized as of
      September 30, 2008 and December 31, 2007; 195,136 and 159,409 common
      shares issued and outstanding as of September 30, 2008 and December 31,
      2007, respectively
            
            
            195
            
            
            
            159Additional
      paid-in capital
            
            
            1,611,088
            
            
            
            1,358,523Accumulated
      deficit
            
            
            (198,236
            )
            
            
            (137,915
            )Accumulated
      other comprehensive income
            
            
            6,788
            
            
            
            12,509Total
      shareholders’ equity
            
            
            1,419,835
            
            
            
            1,233,276TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            3,272,110
            
            
            $
            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 Nine Months Ended September 30, 2008 and 2007


(UNAUDITED)





Three
      Months Ended September 30,
            Nine
      Months Ended September 30,2008
            2007
            
            
            2008
            2007(In
      thousands, except per share amounts)Revenues:Rental
      revenue
            
            $
            81,938
            
            
            $
            45,536
            
            
            $
            225,016
            
            
            $
            110,142Other
      revenue
            
            
            6,964
            
            
            
            4,151
            
            
            
            19,240
            
            
            
            7,498Total
      revenues
            
            
            88,902
            
            
            
            49,687
            
            
            
            244,256
            
            
            
            117,640Expenses:Property
      operating expenses
            
            
            23,849
            
            
            
            13,906
            
            
            
            63,974
            
            
            
            30,739Real
      property taxes
            
            
            11,477
            
            
            
            7,430
            
            
            
            33,099
            
            
            
            18,149Property
      management fees
            
            
            1,891
            
            
            
            1,135
            
            
            
            5,263
            
            
            
            2,797Depreciation
      and amortization
            
            
            32,888
            
            
            
            20,187
            
            
            
            90,485
            
            
            
            44,828Asset
      management and acquisition fees
            
            
            6,229
            
            
            
            10,883
            
            
            
            23,923
            
            
            
            22,014Organizational
      and offering expenses
            
            
            34
            
            
            
            1,614
            
            
            
            3,647
            
            
            
            5,115General
      and administrative expenses
            
            
            1,545
            
            
            
            839
            
            
            
            4,637
            
            
            
            2,989Total
      expenses
            
            
            77,913
            
            
            
            55,994
            
            
            
            225,028
            
            
            
            126,631Income
      (loss) before other income (expenses), income tax expense and income
      allocated to minority interests
            
            
            10,989
            
            
            
            (6,307
            )
            
            
            19,228
            
            
            
            (8,991
            )Other
      income (expenses):Equity
      in losses of unconsolidated entities, net
            
            
            (2,263
            )
            
            
            (5,029
            )
            
            
            (6,379
            )
            
            
            (6,922
            )Loss
      on derivative instruments, net
            
            
            (10,530
            )
            
            
            (21,252
            )
            
            
            (11,194
            )
            
            
            (5,405
            )Gain
      (loss) on foreign currency transactions
            
            
            —
            
            
            
            —
            
            
            
            (2
            )
            
            
            134Interest
      expense
            
            
            (22,153
            )
            
            
            (12,146
            )
            
            
            (61,105
            )
            
            
            (31,979
            )Interest
      income
            
            
            903
            
            
            
            1,317
            
            
            
            2,513
            
            
            
            4,178Loss
      before income tax expense and income allocated to minority
      interests
            
            
            (23,054
            )
            
            
            (43,417
            )
            
            
            (56,939
            )
            
            
            (48,985
            )Provision
      for income taxes
            
            
            (726
            )
            
            
            (247
            )
            
            
            (1,191
            )
            
            
            (580
            )Income
      allocated to minority interests
            
            
            (816
            )
            
            
            (286
            )
            
            
            (2,191
            )
            
            
            (680
            )Net
      loss
            
            $
            (24,596
            )
            
            $
            (43,950
            )
            
            $
            (60,321
            )
            
            $
            (50,245
            )Basic
      and diluted loss per common share:Loss
      per common share
            
            $
            (0.13
            )
            
            $
            (0.31
            )
            
            $
            (0.34
            )
            
            $
            (0.43
            )Weighted
      average number of common shares outstanding
            
            
            192,012
            
            
            
            143,386
            
            
            
            178,613
            
            
            
            116,037








See notes
to the condensed consolidated financial statements.





3





HINES
REAL ESTATE INVESTMENT TRUST, INC.





CONDENSED
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY


For
the Nine Months Ended September 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
            
            
            39,469
            
            
            
            40
            
            
            
            413,758
            
            
            
            —
            
            
            
            —
            
            
            
            413,798Redemption
      of common shares
            
            
            (3,742
            )
            
            
            (4
            )
            
            
            (35,827
            )
            
            
            —
            
            
            
            —
            
            
            
            (35,831
            )Distributions
      declared
            
            
            —
            
            
            
            —
            
            
            
            (84,920
            )
            
            
            —
            
            
            
            —
            
            
            
            (84,920
            )Selling
      commissions and dealer manager fees
            
            
            —
            
            
            
            —
            
            
            
            (32,316
            )
            
            
            —
            
            
            
            —
            
            
            
            (32,316
            )Other
      offering costs
            
            
            —
            
            
            
            —
            
            
            
            (4,206
            )
            
            
            —
            
            
            
            —
            
            
            
            (4,206
            )Shares
      tendered for redemption
            
            
            —
            
            
            
            —
            
            
            
            (3,924
            )
            
            
            —
            
            
            
            —
            
            
            
            (3,924
            )Comprehensive
      loss:Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (60,321
            )
            
            
            —Other
      comprehensive loss — Foreign currency translation
      adjustment
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,721
            )Total
      comprehensive loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (66,042
            )BALANCE,September
      30, 2008
            
            
            195,136
            
            
            $
            195
            
            
            $
            1,611,088
            
            
            $
            (198,236
            )
            
            $
            6,788
            
            
            $
            1,419,835





See notes
to the condensed consolidated financial statements.








4





HINES
REAL ESTATE INVESTMENT TRUST, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2008 and 2007


(UNAUDITED)





Nine
      Months Ended September 30,2008
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIES:
            
            (In
      thousands)Net
      loss
            
            $
            (60,321
            )
            
            $
            (50,245
            )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            91,314
            
            
            
            46,139Non-cash
      compensation expense
            
            
            22
            
            
            
            19Equity
      in losses of unconsolidated entities
            
            
            6,379
            
            
            
            6,922Distributions
      received from unconsolidated entities
            
            
            1,663
            
            
            
            —Income
      allocated to minority interests
            
            
            2,191
            
            
            
            680Accrual
      of organizational and offering expenses
            
            
            3,647
            
            
            
            5,115Loss
      (gain) on foreign currency transactions
            
            
            2
            
            
            
            (134
            )Loss
      on derivative instruments, net
            
            
            11,194
            
            
            
            5,405Net
      change in operating accounts
            
            
            (23,141
            )
            
            
            1,877Net
      cash provided by operating activities
            
            
            32,950
            
            
            
            15,778CASH
      FLOWS FROM INVESTING ACTIVITIES:Investment
      in unconsolidated entities
            
            
            —
            
            
            
            (86,851
            )Distributions
      received from unconsolidated entities in excess of equity in
      earnings
            
            
            20,042
            
            
            
            17,880Investments
      in property
            
            
            (423,601
            )
            
            
            (837,173
            )Investments
      in master leases
            
            
            (1,917
            )
            
            
            (6,968
            )Master
      lease rent receipts
            
            
            5,760
            
            
            
            3,919Settlement
      of foreign currency hedge
            
            
            —
            
            
            
            939Increase
      in restricted cash
            
            
            (4,463
            )
            
            
            (3,535
            )Increase
      in acquired lease intangibles, net
            
            
            (97,910
            )
            
            
            (72,091
            )Net
      cash used in investing activities
            
            
            (502,089
            )
            
            
            (983,880
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Decrease
      in other liabilities
            
            
            (1,371
            )
            
            
            (1,735
            )Proceeds
      from issuance of common stock
            
            
            369,368
            
            
            
            696,143Redemption
      of common shares
            
            
            (35,831
            )
            
            
            (4,569
            )Payments
      of selling commissions and dealer manager fees
            
            
            (32,976
            )
            
            
            (62,077
            )Payments
      of organizational and offering expenses
            
            
            (10,084
            )
            
            
            (15,366
            )Distributions
      paid to shareholders and minority interests
            
            
            (36,572
            )
            
            
            (18,862
            )Proceeds
      from notes payable
            
            
            520,000
            
            
            
            792,415Payments
      on notes payable
            
            
            (269,444
            )
            
            
            (389,664
            )Additions
      to deferred financing costs
            
            
            (1,460
            )
            
            
            (5,440
            )Payments
      related to interest rate swap contracts
            
            
            —
            
            
            
            (731
            )Net
      cash provided by financing activities
            
            
            501,630
            
            
            
            990,114Effect
      of exchange rate changes on cash
            
            
            (275
            )
            
            
            671Net
      change in cash and cash equivalents
            
            
            32,216
            
            
            
            22,683Cash
      and cash equivalents, beginning of period
            
            
            152,443
            
            
            
            23,022Cash
      and cash equivalents, end of period
            
            $
            184,659
            
            
            $
            45,705





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 Nine Months Ended September 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 theUnited 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 September 30, 2008 and
December 31, 2007, and the results of operations for the three and nine
months ended September 30, 2008 and 2007, and cash flows for nine months ended
September 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 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.





Public
Offerings





Hines
REIT commenced its initial public offering on June 18, 2004 through which
it raised $527.5 million. The Company commenced its second public offering on
June 19, 2006 through which it raised approximately $1.5 billion of
gross proceeds prior to its expiration on June 30,
2008.





The
Company commenced its third public offering (the “Third Offering”) on July 1,
2008 pursuant to which it is offering up to $3.5 billion in shares of common
stock including $500.0 million in shares of common stock under its dividend
reinvestment plan.  As of September 30, 2008, Hines REIT had raised
$75.1 million in proceeds through the Third Offering. In addition, from October
1 through November 10, 2008, Hines REIT received gross offering proceeds of
approximately $50.4 million from the sale of 4.8 million common
shares.





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 September 30, 2008 and December 31, 2007, Hines REIT owned a 97.4% and
97.6%, respectively, general partner interest in the Operating Partnership,
respectively.





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 September 30, 2008 and December 31, 2007,
respectively. In addition, another affiliate of Hines, HALP Associates Limited
Partnership (“HALP”) owned a 2.0% and 1.7% interest in the Operating Partnership
as of September 30, 2008 and December 31, 2007, respectively, through a profits
interest (the “Participation Interest”). See Note 6 for additional information
regarding the Participation Interest.





Investment
Property





As of
September 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
September 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.


6


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 owned directly by the Company as well
as 25 office properties 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 $44.7 million as of
September 30, 2008 out of the Company’s total assets of $3.3 billion. In
addition, the Company recorded revenues of $1.6 million and net income of
approximately $600,000 related to this property out of the Company’s total
revenues of $244.3 million and net loss of $60.3 million for the nine-months
ended September 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 $66.0 million for the nine months
ended September 30, 2008 resulting from the Company’s net loss of $60.3 million
and loss from foreign currency translation adjustment of $5.7
million.




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,
transactions are remeasured into the functional currency using the exchange rate
in effect on the date of the transaction. 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 Company’s results
of operations 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.


7


Investment
Property and Lease Intangibles





Real
estate assets owned directly by the Company 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 September 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, which includes periods covered by
bargain renewal options. 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.




Restricted
Cash





As of
September 30, 2008 and December 31, 2007, the Company had restricted cash of
$7.8 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.


8


Tenant
inducement amortization was $2.7 million and $1.4 million for the nine months
ended September 30, 2008 and 2007, respectively, and was recorded as an offset
to rental revenue. In addition, the Company recorded approximately $1.1 million
and $468,000 as amortization expense related to other direct leasing costs for
the nine months ended September 30, 2008 and 2007, respectively.





Tenant
inducement amortization was approximately $1.1 million and $493,000 for the
three months ended September 30, 2008 and 2007, respectively, and was recorded
as an offset to rental revenue. In addition, the Company recorded approximately
$432,000 and $188,000 as amortization expense related to other direct leasing
costs for the three months ended September 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 $11.0 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 of September 30, 2008, $7.1 million of this commitment
remained unfunded and was recorded in accounts payable and accrued expenses in
the accompanying balance sheet accordingly.





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. As a of September 30, 2008, $8.0
million of this commitment remained unfunded and was recorded in accounts
payable and accrued expenses in the accompanying balance sheet
accordingly.





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 September 30, 2008 and December 31, 2007.
See Note 10 for additional discussion regarding fair value. See Item 3. Quantitative and Qualitative Disclosures About Market
Risk included elsewhere in this Quarterly Report on Form 10-Q for
additional information regarding the risk of counterparty
non-performance.





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 September 30, 2008
            
            $
            (10,530
            )
            
            
            —
            
            
            
            —
            
            
            $
            (10,530
            )Quarter
      Ended September 30, 2007
            
            $
            (21,252
            )
            
            
            —
            
            
            
            —
            
            
            $
            (21,252
            )Nine
      Months Ended September 30, 2008
            
            $
            (11,194
            )
            
            
            —
            
            
            
            —
            
            
            $
            (11,194
            )Nine
      Months Ended September 30, 2007
            
            $
            (5,613
            )
            
            $
            (731
            )
            
            $
            939
            
            
            $
            (5,405
            )





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 nine months ended September 30,
2008 and 2007, approximately $1.2 million and $874,000, respectively, was
amortized into interest expense in the accompanying condensed consolidated
statements of operations. For the three months ended September 30, 2008 and
2007, approximately $446,000 and $311,000, respectively, was amortized into
interest expense in the accompanying condensed consolidated statements of
operations.




Other
Assets





Other
assets includes the following (in thousands):





September 30, 2008
            
            
            December 31, 2007Property
      acquisition escrow deposit
            
            $
            —
            
            
            $
            10,000Prepaid
      insurance
            
            
            1,757
            
            
            
            1,056Mortgage
      loan deposits
            
            
            —
            
            
            
            904Other
            
            
            2,146
            
            
            
            910Total
            
            $
            3,903
            
            
            $
            12,870


9


Organizational
and Offering Costs





Second
Offering





The
Company’s second public offering (the “Second Offering”) commenced on
June 19, 2006 and was terminated on June 30, 2008. 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 September 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 $37.0 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 September 30, 2008,
approximately $29,000 of these costs remained unpaid and were included in due to
affiliates in the condensed consolidated balance sheet.





The
Advisor incurred $3.6 million and $5.1 million of internal offering costs,
which have been expensed in the accompanying condensed consolidated statements
of operations for the nine months ended September 30, 2008 and 2007,
respectively. 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 nine months ended September 30, 2008.





The
Advisor incurred approximately $34,000 and $1.6 million of internal offering
costs, which have been expensed in the accompanying condensed consolidated
statements of operations for the three months ended September 30, 2008 and 2007,
respectively.





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 nine months ended
September 30, 2008, the Advisor incurred $5.9 million of organizational and
offering costs related to the Third Offering. Pursuant to the terms of the
Advisory Agreement in effect for the Third Offering, the Company is not
obligated to reimburse the Advisor for organizational and offering costs related
to the Third Offering. Additionally, the Advisor is not a shareholder of
the Company. 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 $25.4 million and $12.7 million as of September 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.





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 on the date of their election or re-election to the board. 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. For the three and nine months ended
September 30, 2008 and 2007, amortization of stock compensation expense recorded
by the Company was insignificant.




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 September 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 nine months ended September 30, 2008 and 2007 in the
accompanying condensed consolidated financial statements. Income tax expense
recorded by the Company is primarily comprised of a provision for Canadian
income taxes and a provision for the Texas margin tax, both of which are
discussed below.





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
$816,000 and $552,000 for the nine months ended September 30, 2008 and 2007,
respectively, in accordance with Canadian tax laws and regulations. In addition,
the Company has also recorded a provision for Canadian income taxes of
approximately $561,000 and $236,000 for the three months ended September 30,
2008 and 2007.


10


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 $175,000 and $380,000,
respectively, for the three and nine months ended September 30, 2008. The
related income tax expense was insignificant for the three and nine months ended
September 30, 2007.





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




Redemption
of Common Stock





The
Company has adopted Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity(“SFAS
No. 150”), which requires, among other things, that financial instruments that
represent a mandatory obligation of the Company to repurchase shares be
classified as liabilities and reported at settlement value.  As such,
SFAS No. 150 is not applicable until such shares are tendered for redemption by
the holder and the redemption of shares is approved.  At such time,
the Company will reclassify such obligations out of equity to a liability based
upon their respective settlement values. As of September 30, 2008, shares
tendered for redemption and approved by the Board of Directors and not yet
redeemed of $3.9 million are included in accounts payable and accrued expenses
in the accompanying condensed consolidated balance sheet.  This
represents approximately 405,000 shares tendered for redemption and approved by
the Board of Directors, but not yet redeemed as of September 30,
2008.




Per
Share Data





Loss per
common share is calculated by dividing the net loss for each period by the
weighted average number of common shares outstanding during such period. 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 nine months ended September 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 $109.0 million was reclassified from investments
in property to increase in acquired lease intangibles, net, in the condensed
consolidated statement of cash flows for the nine months ended September 30,
2007. 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 nine months ended September 30, 2008.
The Company capitalized approximately $925,000 in acquisition-related expenses
during this period that would have been expensed under FAS
141R.





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
financial statements.




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.


11


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.





In
October 2008, the FASB issued Staff Position No. 157-3 Determining the Fair Value of a
Financial Asset When the Market for That Asset is Not Active (“FSP
157-3”). FSP 157-3 clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a
market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. FSP 157-3 was effective upon
issuance, including prior periods for which financial statements have not been
issued. The issuance of FSP 157-3 did not 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 September 30, 2008 and December 31,
2007 (in thousands):





September
      30, 2008
            
            
            December
      31, 2007Buildings
      and improvements
            
            $
            1,883,445
            
            
            $
            1,481,541Less:
      accumulated depreciation
            
            
            (65,069)
            
            
            
            (32,395)Buildings
      and improvements, net
            
            
            1,818,376
            
            
            
            1,449,146Land
            
            
            449,185
            
            
            
            349,778Investment
      property, net
            
            $
            2,267,561
            
            
            $
            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.





On
May 1, 2008, the Company acquired: Williams Tower, a 64-story office
building with an adjacent parking garage located in the Galleria/West Loop
submarket of Houston, Texas; an interest in a 2.8-acre park and waterwall
adjacent to Williams Tower; and a 2.3-acre land parcel located across the street
from Williams Tower on Post Oak Blvd. The balance of the interest in the park
and waterwall is owned by an affiliate of Hines.





The total
purchase price for Williams Tower was $271.9 million,
including the contract purchase price of $271.5 million and
transaction costs of approximately $0.4 million, and was funded using proceeds
from the Company’s public offering and proceeds from its revolving line of
credit.





The
following table summarizes the estimated fair values of the assets and
liabilities acquired for Williams Tower (in thousands):




Property
            
            Land
            
            
            Buildings
      and Improvements
            
            
            Intangible
      Lease Assets
            
            
            Intangible
      Lease Liabilities
            
            
            Total
      Purchase PriceWilliams Tower
            
            $
            57,777
            
            
            $
            185,184
            
            
            $
            58,880
            
            
            $
            (29,987
            )
            
            $
            271,854





In
addition, the Company acquired the following properties during the nine months
ended September 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
            
            $
            120.0Dallas,
      Texas
            4050/4055
      Corporate Drive
            May
      2008
            
            $
            42.8





As of
September 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
            $
            420,712
            
            
            $
            69,255
            
            
            $
            142,364Less:
      accumulated amortization
            
            (98,219
            )
            
            
            (19,017
            )
            
            
            (24,085
            )Net
            $
            322,493
            
            
            $
            50,238
            
            
            $
            118,279


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 $56.4 million and $23.0 million for in-place leases for
the nine months ended September 30, 2008 and 2007, respectively, and
amortization of out-of-market leases, net, was an increase to rental revenue of
$3.9 million and $1.6 million, respectively.  Amortization expense was
$21.1 million and $8.2 million for in-place leases for the three months
ended September 30, 2008 and 2007, respectively. Amortization of out-of-market
leases, net, was an increase to rental revenue of approximately $765,000 and
$925,000 for the three months ended September 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 October 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,
      netOctober
      1 through December 31, 2008
            
            $
            18,223
            
            
            $
            (478
            )2009
            
            
            57,987
            
            
            
            (13,888
            )2010
            
            
            48,586
            
            
            
            (12,607
            )2011
            
            
            41,814
            
            
            
            (11,632
            )2012
            
            
            32,623
            
            
            
            (10,515
            )




In
connection with its direct investments, the Company has entered into lease
agreements with tenants for space. As of September 30, 2008, the approximate
fixed future minimum rentals for the period from October 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 RentalsOctober 1
      through December 31, 2008
            
            $
            57,7642009
            
            
            213,1222010
            
            
            193,1062011
            
            
            177,8382012
            
            
            153,219Thereafter
            
            
            602,687Total
            
            $
            1,397,736





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 October 1,
2008 through December 31, 2008 are approximately $712,000. 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, $1.5 million
and $1.6 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 October 1, 2008 through December 31, 2008 are approximately
$230,000. 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 $907,000, $749,000, $535,000, $372,000 and
$282,000, respectively.





During
the nine months ended September 30, 2008 and 2007, no tenant leased space
representing more than 10% of the total rental revenue of the
Company.





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 October 1, 2008 through December 31, 2008 are approximately
$101,000. 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, $437,000 and $10.3 million,
respectively. Ground lease expense for the nine months ended September 30, 2008
was approximately $422,000.


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 September 30, 2008 and December 31, 2007 are as follows (in
thousands):







September
      30, 2008
            
            
            December
      31, 2007Investment
      in the Core Fund
            
            $
            302,358
            
            
            $
            330,441Investment
      in HCB II River LLC
            
            
            28,046
            
            
            
            30,716Total
      investments in unconsolidated entities
            
            $
            330,404
            
            
            $
            361,157




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





Nine
      Months Ended
              September
      30, 2008
            
            
            Nine
      Months
              Ended
              September
              30,
      2007Equity
      in losses of the Core Fund
            
            $
            (8,042
            )
            
            $
            (6,864
            )Equity
      in earnings (losses) of HCB II River LLC
            
            
            1,663
            
            
            
            (58
            )Net
      equity in losses of unconsolidated entities
            
            $
            (6,379
            )
            
            $
            (6,922
            )




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





Three
      Months Ended
              September
      30, 2008
            
            
            Three
      Months Ended September  30, 2007Equity
      in losses of the Core Fund
            
            $
            (2,957
            )
            
            $
            (4,971
            )Equity
      in earnings (losses) of HCB II River LLC
            
            
            694
            
            
            
            (58)Net
      equity in losses of unconsolidated entities
            
            $
            (2,263
            )
            
            $
            (5,029
            )




The table
below presents the activity of the Company’s unconsolidated entities for the
nine months ended September 30, 2008 (in thousands):




Core
      Fund
              
              HCB
      II River LLC
              
              
              TotalBalance
      as of December 31, 2007
              
              $
              330,441
              
              $
              30,716
              
              $
              361,157Distributions
              
              
              (20,041
              )
              
              (2,055
              )
              
              (22,096
              )Net
      Income
              
              
              (8,042
              )
              
              1,633
              
              
              (6,379
              )Effect
      of Exchange Rate
              
              
              —
              
              
              (2,278
              )
              
              (2,278
              )Balance
      as of September 30, 2008
              
              $
              302,358
              
              $
              28,046
              
              $
              330,404


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 September 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 September 30, 2008 and
December 31, 2007 and for the nine months ended September 30, 2008 and 2007 is
summarized below (in thousands):





ASSETS





September 30, 2008
            
            
            December 31, 2007Cash
            
            $
            101,248
            
            
            $
            112,211Property,
      net
            
            
            3,944,087
            
            
            
            3,481,975Other
      assets
            
            
            361,032
            
            
            
            351,577Total
      Assets
            
            $
            4,406,367
            
            
            $
            3,945,763





LIABILITIES
AND PARTNERS’ CAPITAL





Debt
            
            $
            2,632,894
            
            
            $
            2,313,895Other
      liabilities
            
            
            257,783
            
            
            
            264,705Minority
      interest
            
            
            507,727
            
            
            
            426,128Partners’
      capital
            
            
            1,007,963
            
            
            
            941,035Total
      Liabilities and Partners’ Capital
            
            $
            4,406,367
            
            
            $
            3,945,763





OPERATIONS





Nine Months Ended September
      30, 2008
            
            
            Nine Months Ended September
      30, 2007Revenues,
      other income and interest income
            
            $
            387,148
            
            
            $
            312,566Operating
      expenses
            
            
            (166,724
            )
            
            
            (132,222
            )Interest
      expense
            
            
            (103,400
            )
            
            
            (75,779
            )Depreciation
      and amortization
            
            
            (144,360
            )
            
            
            (131,770
            )Loss
      allocated to minority interest
            
            
            1,150
            
            
            
            6,231Net
      Loss
            
            $
            (26,186
            )
            
            $
            (20,974
            )





During
the nine months ended September 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
September 30, 2008 and December 31, 2007 (in thousands, except interest
rates):




Description
            Origination Date
            Maturity
      Date
            
            Interest
      Rate
            
            
            Principal
      Outstanding at
              September
      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
            %
            
            
            90,649
            (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
            %
            
            
            183,084
            (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)
            
            
            52,664
            
            
            
            —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
            %
            
            
            3,121
            (5)
            
            
            3,406$
            1,510,018
            
            
            $
            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. See
      Item 3. Quantitative and Qualitative
      Disclosures About Market Risk included elsewhere in this Quarterly
      Report on Form 10-Q for additional information regarding the risk of
      counterparty non-performance.(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 $0.9636 as of
      September 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 $0.9636 as of September 30, 2008.(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.


16


(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 October 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 $218,000, $91.9 million,
$953,000, $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 September 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 increased the dividend rate
to $0.00175233 per share, per day for the months of May through November 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 nine months ended September 30, 2008
(in thousands):





Total
      Distribution for the Quarter Ended
            Date
      Paid
            
            Total DistributionSeptember
      30, 2008
            October
      1, 2008
            
            $
            31,773June
      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):





September 30, 2008
            
            
            December 31, 2007Organizational
      and offering costs related to the Second Offering
            
            $
            29
            
            
            $
            2,260Dealer
      manager fees and selling commissions
            
            
            —
            
            
            
            605Asset
      management, acquisition fees and property-level fees and
      reimbursements
            
            
            4,253
            
            
            
            5,319Other
            
            
            464
            
            
            
            784Total
            
            $
            4,746
            
            
            $
            8,968





Advisory
Agreement





Pursuant
to the advisory agreement in effect for the Second Offering, the Company was
required to pay fees and expense reimbursements (in addition to the
reimbursement of organizational and offering costs described in Note 2 above).
On July 1, 2008, the Company executed a new advisory agreement related to the
Third Offering. The fees specified by the Third Offering advisory agreement
are comparable with those of the previous advisory agreement with the exception
of changes to the acquisition fee calculation, the addition of the debt
financing fee and elimination of the requirement to reimburse organizational and
offering costs (See Note 2 above).


17


Acquisition Fees  —
Effective July 1, 2008 the Company will pay 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 is payable following
the closing of each acquisition up to an aggregate of $2.0 billion of gross real
estate investments in an amount equal to 2.5% 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). Pursuant
to prior advisory agreements in effect before July 1, 2008, the Company paid 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 $5.3 million for
the nine months ended September 30, 2008 and 2007, respectively, which have been
recorded as an expense in the accompanying condensed consolidated statements of
operations.  The Advisor earned no cash acquisition fees for the
three months ended September 30, 2008. The Advisor earned cash acquisition fees
totaling $3.1 million for the three months ended September 30, 2007 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
September 30, 2008 and December 31, 2007, the Company had no liabilities
for incurred and unpaid acquisition fees.





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 $8.9 million and
$5.7 million during the nine months ended September 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 $3.1 million and $2.4 million during the
three months ended September 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 asset management fees. As of
September 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.





Debt Financing Fee – 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. As the Company incurs the financing fees payable to the
Advisor, these fees will be deferred and amortized into interest expense using a
straight-line method, which approximates the effective interest method over the
life of the related debt. No financing fees were incurred by the Company as of
September 30, 2008.




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 provided that HRES earned selling commissions
equal to 7.0% of the gross proceeds from sales of common stock, all of which was
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 up 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 was reallowed to participating
broker dealers.





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 assets under
management or a similar fee.





HRES
earned selling commissions of $24.3 million and earned dealer manager fees of
$8.0 million for the nine months ended September 30, 2008, which have been
offset against additional paid-in capital in the accompanying condensed
consolidated statement of shareholders’ equity.




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 $5.2 million and $2.6 million
      for the nine months ended September 30, 2008 and 2007, respectively, and
      $1.8 million and $1.1 million for the three months ended September 30,
      2008 and 2007, respectively. As of September 30, 2008 and December 31,
      2007, the Company had liabilities for incurred and unpaid property
      management fees of approximately $418,000 and $260,000, respectively,
      which have been included in due to affiliates in the accompanying
      condensed consolidated balance
sheets.


18


•
            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 $2.6 million and $1.1 million during the nine months ended
      September 30, 2008 and 2007, respectively, and approximately $621,000 and
      $462,000 during the three months ended September 30, 2008 and 2007,
      respectively. As of September 30, 2008 and December 31, 2007, the Company
      had a related liability of approximately $1.1 million and $654,000,
      respectively, which is included in due to affiliates in the accompanying
      condensed consolidated balance
sheets.





•
            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 $11.3 million and $5.8 million for the nine months ended September
      30, 2008 and 2007, respectively, and $4.1 million and $2.5 million
      for the three months ended September 30, 2008 and 2007, respectively. As
      of September 30, 2008 and December 31, 2007, the Company had related
      liabilities of $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 $1.0 million and $1.7 million, respectively, in revenue related to
space leased by Hines for the three and nine-months ended September 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 2.0% and 1.7% as of September 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 $38.7 million and
$26.8 million as of September 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 $12.0 million and $11.0 million for the nine months
ended September 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 September 30, 2008 and 2007,
respectively, the Company recorded $3.1 million and $5.4 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 nine months ended September 30, 2008 and 2007 is as follows
(in thousands):





2008
            
            
            2007Changes
      in assets and liabilities:Increase
      in other assets
            
            $
            (459)
            
            
            $
            (940
            )Increase
      in tenant and other receivables
            
            
            (18,338
            )
            
            
            (11,556
            )Additions
      to deferred leasing costs
            
            
            (15,880
            )
            
            
            (6,300
            )Increase
      in accounts payable and accrued expenses
            
            
            3,562
            
            
            
            6,043Increase
      in participation interest liability
            
            
            11,962
            
            
            
            11,007(Decrease)
      increase in other liabilities
            
            
            (2,845
            )
            
            
            1,876Increase
      (decrease) in due to affiliates
            
            
            (1,143
            )
            
            
            1,747Changes
      in assets and liabilities
            
            $
            (23,141
            )
            
            $
            1,877


19


8.  Supplemental
Cash Flow Disclosures





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





2008
            
            
            2007Supplemental
      Disclosure of Cash Flow InformationCash
      paid for interest
            
            $
            57,525
            
            
            $
            31,722Cash
      paid for income taxes
            
            $
            444
            
            
            $
            —Supplemental
      Schedule of Non-Cash ActivitiesUnpaid
      selling commissions and dealer manager fees
            
            $
            —
            
            
            $
            784Deferred
      offering costs offset against additional
    paid-in-capital
            
            $
            4,206
            
            
            $
            6,889Distributions
      declared and unpaid
            
            $
            31,773
            
            
            $
            23,059Distributions
      receivable
            
            $
            7,281
            
            
            $
            7,481Distributions
      reinvested
            
            $
            43,690
            
            
            $
            24,849Stock
      subscriptions
            
            $
            718
            
            
            $
            —Non-cash
      net liabilities acquired upon acquisition of
property
            
            $
            20,995
            
            
            $
            11,831Accrual
      of deferred financing costs
            
            $
            —
            
            
            $
            132Assumption
      of mortgage upon acquisition of property
            
            $
            52,930
            
            
            $
            —Accrued
      additions to deferred leasing costs
            
            $
            5,080
            
            
            $
            12,038Accrued
      additions to investment property
            
            $
            563
            
            
            $
            1,360




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 September 30, 2008, the Company recorded a liability of $41.4
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 September 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





Denver
Industrial/Flex Portfolio





On
October 3, 2008, the Company entered into a contract to acquire the Denver
Industrial/Flex Portfolio (“Denver Industrial/Flex Portfolio”), a group of
industrial/flex buildings located throughout southeast Denver, Colorado. The
Denver Industrial/Flex Portfolio consists of 484,737 square feet of
rentable area that is 94% leased. The contract purchase price of the Denver
Industrial/Flex Portfolio is expected to be $66.5 million, exclusive of
transaction costs, financing fees and working capital reserves. In connection
with this acquisition, the Company is assuming three loans totaling $35.8
million. This acquisition is expected to be completed during the fourth quarter
of 2008. There can be no assurance that this transaction will be
completed.




Weingarten
Grocery-Anchored Portfolio


On November 13, 2008, the Company acquired a 70% interest in a joint venture
with Weingarten Reality Investors (NYSE:WRI)
(“Weingarten”).  Concurrently, the joint venture entered into an
agreement to acquire a portfolio of grocery-anchored retail centers owned by
Weingarten (the “Weingarten Portfolio”) for approximately $271.4
million.  The Weingarten Portfolio includes 12 retail properties
anchored by grocery stores located in Texas, Georgia, Tennessee, Florida and
North Carolina and consists of approximately 1.5 million square feet of
rentable area that is 96% leased. The initial closing included eight properties
for approximately $205.1 million. The Company funded its portion (approximately
$49.7 million) of equity required for the initial closing with proceeds from its
public offerings.  In addition to its 30% share of the joint venture
equity, Weingarten provided $134.0 million of debt financing in the form of 6%
preferred equity.  $100.0 million of the preferred equity will be
redeemed once the joint venture closes on its third-party debt financing, which
is currently expected to occur before December 31, 2008.  The closing
of the remaining four properties will be consummated upon the finalization of
their respective loan assumptions.  Weingarten will continue to manage
the properties for the joint venture.


Shareholder
Redemptions





For the
months of September and October 2008, in accordance with its share
redemption plan, Hines REIT redeemed 1.3 million common shares and made
corresponding payments (on October 1 and November 3, 2008, respectively)
totaling $12.8 million to shareholders who had requested these redemptions.
The shares redeemed were cancelled and will have the status of authorized, but
unissued shares. The Company recorded a $3.9 million liability for the shares
redeemed in October. See Note 2 – Redemption of Common Stock
for additional information.


21


Item 2. Management’s Discussion and Analysis of 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;




•
            The
      failure of any bank in which we deposit our funds could reduce the amount
      of cash we have available to pay distributions and make additional
      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;




22


•
            The
      lack of liquidity associated with our
assets;





•
            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 September 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, one industrial property in Dallas, Texas and an
interest in an industrial property in Rio de Janeiro, Brazil.





Our
principal targeted assets are office properties that have quality construction,
desirable locations and quality tenants. 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 also intend to continue to
pursue 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. To achieve these objectives, we intend to
invest in properties which will be diversified by location, lease expirations
and tenant industries. 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.





In order
to provide capital for these investments, we sold shares to the public through
our initial public offering (the “Initial Offering”) and our second public
offering  (the “Second Offering”), the latter of which 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.





Market
Update





The
financial markets are experiencing significant volatility, driven by continued
fallout from the credit crisis and overall weakening global economy. Economic
indicators in the U.S. continue to point toward a recession, though many
economists disagree about forecasts regarding its potential length or depth.
Regardless, we expect that the current downturn will have an adverse effect
on real estate market fundamentals, including tenant demand, overall
occupancies, leasing velocity and rental rates, and will lead to increased
subletting and tenant defaults.  We expect that this will have a
negative impact on our future income and cash flow earned, which support our
distributions paid to shareholders, as well as the values of our real estate
investments.  We are proactively managing our portfolio in an effort
to minimize the negative impacts during this time.  As with most
commercial real estate, our portfolio of assets is not immune to a weakening
economy; however, due to the quality and diversification of our portfolio, we
believe that our portfolio is relatively well positioned to limit the negative
impact from this down cycle.




To
date, our portfolio has not experienced significant direct effects resulting
from the events in the financial markets. As of September 30, 2008, our
portfolio was 93% leased to a diverse tenant base over a variety of industries,
with approximately 19% leased to approximately 250 different companies in the
financial and insurance industries and approximately 17% leased to approximately
130 different companies in the legal industry. Our portfolio has no exposure to
AIG or Lehman Brothers and limited exposure to certain troubled individual
tenants in the finance and insurance industries, including Bear Stearns and
Washington Mutual. Included in our portfolio at September 30, 2008 are several
tenants who have sought bankruptcy protection. Leases to these tenants comprise
approximately 0.5% of the leasable square feet in our portfolio based on our
effective ownership interests in our properties. We believe we have recorded
adequate reserves against receivables from these tenants in our financial
statements as of September 30, 2008 included elsewhere in this Form 10-Q. We
continue to be concerned about the ultimate impact of events in the financial
markets on our tenants in the finance, insurance and legal industries, and we
are monitoring them and managing potential adverse impact to our
portfolio.




We
have not invested in debt securities such as collateralized debt obligations
(CDO’s), and therefore do not have exposure to the impact current market
conditions may have on those securities.


23


The
capital and debt markets affecting commercial real estate have also continued to
deteriorate.  Financial institutions and lenders have become capital
constrained, and lenders and credit rating agencies have tightened underwriting
standards.  As a result, debt capital has become more expensive and
difficult to obtain.  We have managed our portfolio to date in an effort to
minimize our exposure to volatility in the debt capital markets.  We
have done this by using moderate levels of long-term fixed-rate debt and
minimizing our exposure to short-term variable rate debt which is more likely to
be impacted by market volatility.  Our portfolio was 54% leveraged as
of September 30, 2008, with 98% of our debt in the form of long-term, fixed-rate
mortgages (some of which are effectively fixed through the use of interest rate
swaps).  We have a minimal amount of debt ($90.6 million) which is
maturing in 2009, and thus have limited exposure to the potential negative
impacts of attempting to refinance assets in the current debt
markets.  While we expect to be able to refinance this debt under
acceptable terms, if we are unable to do so, we may use borrowings under our
revolving credit facility, proceeds from our Third Offering or, if necessary,
cash flow from operations to retire this instrument at maturity.
  Values
of commercial real estate assets and debt instruments have been impacted by the
events described above.  Values of assets have declined from the
values achieved over the last 24 months.  It is uncertain how much of
the declines are attributable to the current illiquidity and volatility in the
markets, the prospects of a recession and its impact on real estate or a
longer-term repricing of real estate assets.  While real estate values
have declined in recent months, existing, low-rate debt has seen the opposite
trend.  As debt is less available and more expensive, existing
long-term attractively-priced debt has increased in value.  Depending
on how the markets perform over the next several months, these events could
result in a decline in the value of our existing real estate portfolio. The
value of our real estate is one of many factors considered in determining our
share price, and we cannot assure you that our share price will not decrease in
the future.
  Looking
forward, we expect to continue to raise capital to pursue new investment
opportunities and maintain sufficient liquidity to meet our operating
needs.  We believe that the current market environment will result in
increased cap rates and decreased pricing of commercial real estate
assets.  This should result in investment opportunities which generate
higher returns than assets acquired 12 – 24 months ago.  We are
actively pursuing investment opportunities as we believe that during this time
of a severe lack of debt and capital, the current distress in the market may
allow us access to attractive real estate investment opportunities.
  We
continue to manage our strong lending relationships with banks, insurance
companies, pension funds and others that generally provide debt capital for
commercial real estate transactions.  During the first half of 2008,
we were able to secure nearly $300 million of attractive mortgage financing for
our acquisitions.  Although debt capital is scarcer and more expensive
than it was during the last several years, we expect that it will continue to be
available to us due to our financial strength and the quality of the assets we
acquire.  As we pursue new investment opportunities, we will continue
to factor into such opportunities the current availability and price of debt
capital. Notwithstanding the above, depending on market conditions and other
factors, we may choose not to borrow to finance future new acquisitions or to
place new debt on our existing portfolio or assets.
  Although
we cannot predict how the financial markets and broader economy will transform
from where they are today, we are actively managing our well-diversified
portfolio of quality real estate assets.  Our sponsor, advisor and
property manager have significant experience through several real estate and
economic cycles, and thus we believe we are well-positioned to manage through
these difficult and uncertain times.


24


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





Direct
      InvestmentsProperty
            City
            
            Leasable
      Square Feet
            
            
            Percent
      Leased
            
            
            Our
      Effective
              Ownership(1)321
      North Clark
            Chicago,
      Illinois
            
            
            885,664
            
            
            
            99
            %
            
            
            100
            %JPMorgan Chase Tower
            Dallas,
      Texas
            
            
            1,247,923
            
            
            
            88
            %
            
            
            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
            
            
            
            88
            %
            
            
            100
            %Airport
      Corporate Center
            Miami,
      Florida
            
            
            1,021,397
            
            
            
            90
            %
            
            
            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
            
            
            
            100
            %
            
            
            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
            
            
            
            94
            %
            
            
            100
            %Seattle Design Center
            Seattle,
      Washington
            
            
            390,684
            
            
            
            89
            %
            
            
            100
            %5th and
      Bell
            Seattle,
      Washington
            
            
            197,135
            
            
            
            100
            %
            
            
            100
            %Atrium
      on Bay
            Toronto,
      Ontario
            
            
            1,071,517
            
            
            
            98
            %
            
            
            100
            %Total
      for Directly-Owned Properties
            
            
            11,952,333
            
            
            
            95
            %Indirect
      InvestmentsCore
      Fund InvestmentsOne
      Atlantic Center
            Atlanta,
      Georgia
            
            
            1,100,312
            
            
            
            81
            %
            
            
            23.27
            %The
      Carillon Building
            Charlotte,
      North Carolina
            
            
            470,942
            
            
            
            97
            %
            
            
            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
            
            
            1,420,056
            
            
            
            93
            %
            
            
            18.62
            %333 West
      Wacker
            Chicago,
      Illinois
            
            
            845,210
            
            
            
            94
            %
            
            
            18.57
            %One
      Shell Plaza
            Houston,
      Texas
            
            
            1,230,395
            
            
            
            100
            %
            
            
            11.64
            %Two
      Shell Plaza
            Houston,
      Texas
            
            
            565,467
            
            
            
            97
            %
            
            
            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
            
            
            284,701
            
            
            
            97
            %
            
            
            11.67
            %Renaissance
      Square
            Phoenix,
      Arizona
            
            
            965,508
            
            
            
            89
            %
            
            
            23.27
            %Riverfront Plaza
            Richmond,
      Virginia
            
            
            951,421
            
            
            
            100
            %
            
            
            23.27
            %Johnson
      Ranch Corporate Center
            Roseville,
      California
            
            
            179,990
            
            
            
            67
            %
            
            
            18.57
            %Roseville
      Corporate Center
            Roseville,
      California
            
            
            111,418
            
            
            
            94
            %
            
            
            18.57
            %Summit
      at Douglas Ridge
            Roseville,
      California
            
            
            185,128
            
            
            
            78
            %
            
            
            18.57
            %Olympus
      Corporate Center
            Roseville,
      California
            
            
            191,494
            
            
            
            57
            %
            
            
            18.57
            %Douglas
      Corporate Center
            Roseville,
      California
            
            
            214,606
            
            
            
            81
            %
            
            
            18.57
            %Wells Fargo Center
            Sacramento,
      California
            
            
            502,365
            
            
            
            97
            %
            
            
            18.57
            %525
      B Street
            San Diego,
      California
            
            
            446,737
            
            
            
            85
            %
            
            
            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
            
            
            
            89
            %
            
            
            18.57
            %Total
      for Core Fund Properties
            
            
            14,858,122
            
            
            
            91
            %OtherDistribution Park Rio
            Rio
      de Janeiro, Brazil
            
            
            693,115
            
            
            
            100
            %
            
            
            50
            %Total
      for All Properties
            
            
            
            27,503,570
            
            
            
            93
            %


__________


25


(1)
            This
      percentage shows the effective ownership of the Operating Partnership in
      the properties listed. On September 30, 2008, Hines REIT owned a 97.4%
      interest in the Operating Partnership as its sole general partner.
      Affiliates of Hines owned the remaining 2.6% interest in the Operating
      Partnership. As of September 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 September
      30, 2008. The Core Fund does not own 100% of these buildings; its
      ownership interest in its buildings ranges from 40.5% 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.








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 September 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, which includes periods covered by
bargain renewal options. 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.





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.


26


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 Initial Offering and Second
Offering 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.





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 nine months ended September 30, 2008 have been
recorded in the accompanying consolidated financial statements.





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.





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 September 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 nine months ended September 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.


27


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.Subject to the terms of
the Third Offering, we will pay our Advisor a financing fee for all property
related loans and any other debt financing we obtain.  These fees will be
deferred and amortized into interest expense using the straight-line method,
which approximates the effective interest method, over the life of the related
debt. To date no debt financing fee has been paid to our Advisor.





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.





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 $816,000 and $552,000 for the nine months ended September
30, 2008 and 2007, respectively, in accordance with Canadian tax laws and
regulations. In addition, the Company has also recorded a provision for Canadian
income taxes of approximately $561,000 and $236,000 for the three months ended
September 30, 2008 and 2007, respectively.




We also
recorded an income tax provision for the Texas Margin Tax related to our
properties located in Texas. As a result, we recorded approximately
$175,000 and $380,000, respectively, for the three and nine months ended
September 30, 2008. The related income tax expense was insignificant for the
three and nine months ended September 30, 2007.





As of
September 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, transactions are
remeasured into the functional currency using the exchange rate in effect on the
date of the transaction. These gains or losses are included in our results of
operations.





Our
subsidiaries also record gains or losses in results of operations 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.


28


Financial
Condition, Liquidity and Capital Resources





General




Our
principal cash requirements are for property acquisitions, property-level
operating expenses, capital improvements, debt service, certain 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
nine months ended September 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 intend
to continue making real estate investments using proceeds from our public
offerings and funds available to us under our credit facilities and other
permanent debt. We intend to refinance mortgage debt expiring in the near term
with new mortgage financing or our revolving credit facility. We also intend to
continue to pay distributions to our shareholders on a quarterly
basis.





We have
experienced and may continue to experience, delays between raising capital and
acquiring real estate investments. Given the current state of the economy and
state of the real estate markets, there are fewer quality assets being sold than
were sold in the last few years.  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.





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 $33.0 million and $15.8 million for the
nine months ended September 30, 2008 and 2007, respectively. The increase is
primarily due to operating cash flows from acquisitions during 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, loss
on derivative instruments and changes in operating accounts.




Cash
Flows from Investing Activities





During
the nine months ended September 30, 2008, we had cash outflows of $521.5 million
primarily related to our acquisition of four properties (including $97.9 million
of related lease intangibles). During the nine months ended September 30, 2007,
we made payments of $909.3 million related to our acquisitions of seven
properties (including $72.1 million of related lease intangibles) and $86.9
million related to our additional investments in the Core Fund and our
unconsolidated joint venture.





As of September 30, 2008, we owned an approximate 28.7% non-managing
general partner interest in the Core Fund, compared to the approximate
32.0% interest we owned at September 30, 2007. During the nine months
ended September 30, 2008 and 2007, we received distributions from the Core
Fund totaling $19.7 million and $17.9 million, respectively. The increase in
distributions is due to an increase in distributable cash flow from the Core
Fund as a result of its acquisitions during the past year.




As of September 30, 2008, we owned an approximate 50% interest in HCB II River
LLC, a joint venture with an affiliate of Hines. During the nine months ended
September 30, 2008, respectively, we received distributions from HCB II
River LLC totaling approximately $2.1 million, of which approximately $391,000
was recorded in cash flows from investing activities as it exceeded our equity
in earnings of the joint venture.





During the nine months ended September 30, 2008 and 2007, we had increases in
restricted cash of $4.5 million and $3.5 million, respectively, related to
certain escrows required by our mortgage agreements.




During
the nine months ended September 30, 2008, we had cash inflows of $3.8 million
(net of payments) for master leases entered into in connection with certain of
our acquisitions. During the nine months ended September 30, 2007, we had cash
outflows of $3.0 million (net of receipts) for master leases entered into in
connection with certain of our acquisitions.


29


Cash
Flows from Financing Activities





Public
Offerings





We offer
shares of our common stock for sale through continuous public offerings, which
provides us with the ability to raise capital on an ongoing basis. We
raised $527.5 million in proceeds through our Initial Offering prior to its
expiration on June 18, 2006. We raised $1.5 billion in proceeds through our
Second Offering prior to its expiration on June 30,
2008.





We
commenced our Third Offering on July 1, 2008, pursuant to which we are
offering up to $3.5 billion in shares of common stock, including $500.0
million in shares of common stock under our dividend reinvestment
plan.  As of September 30, 2008, we had raised $75.1 million in
proceeds through the Third Offering.




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. As previously noted above, we are not obligated to
pay organizational and offering costs related to the Third Offering, other than
selling commissions and the dealer manager fee.





For the
nine months ended September 30, 2008 and 2007, we paid the Dealer Manager
selling commissions of $24.7 million and $46.8 million, respectively, and dealer
manager fees of $8.3 million and $15.3 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 nine months ended September
30, 2008 decreased, as compared to the nine months ended September 30, 2007,
primarily as a result of a decrease in capital raised during the
period.





During
the nine months ended September 30, 2008 and 2007, the Advisor incurred internal
organizational and offering costs related to the Second Offering totaling
approximately $3.6 million and $5.1 million, respectively, and third-party
offering costs of approximately $4.2 million and $6.9 million, respectively.
During the nine months ended September 30, 2008 we made payments totaling $10.1
million for Second Offering organizational and offering costs, of which $10.0
million were reimbursements made to our Advisor. During the nine months ended
September 30, 2007 we made payments totaling $15.4 million for Second Offering
organizational and offering costs, of which $15.1 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 September 30, 2008 and December 31, 2007, our debt
financing was approximately 54% 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 September
30, 2008 and December 31, 2007 (in thousands, except interest
rates):





Description
            Origination Date
            Maturity
      Date
            
            Interest
      Rate
            
            
            Principal
      Outstanding at
              September
      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
            %
            
            
            90,649
            (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
            %
            
            
            183,084
            (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)
            
            
            52,664
            
            
            
            —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
            %
            
            
            3,121
            (5)
            
            
            3,406$
            1,510,018
            
            
            $
            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. See Item 3. Quantitative and Qualitative Disclosures About
      Market Risk included elsewhere in this Quarterly Report on Form
      10-Q for additional information regarding the risk of counterparty
      non-performance.(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 $0.9636 as of September
      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 $0.9636 as of September 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
September 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 September 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 increased the dividend rate to $0.00175233 per share, per day for the
months of May through November 2008. 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
nine months ended September 30, 2008 were $87.1 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 nine months ended September 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 non-GAAP
financial measture to our net loss for the period (in
thousands):





Revenues
            
            $
            244,256ExpensesProperty
      operating expenses, real property taxes and property management
      fees
            
            
            (102,336
            )Interest
      expense, net of interest income
            
            
            (58,592
            )General
      and administrative expenses
            
            
            (4,637
            )Cash
      asset management fees
            
            
            (8,943
            )OtherMaster
      lease rents (1)
            
            
            5,760Non-cash
      components of revenues and expenses (2)
            
            
            (11,903
            )Equity
      in losses of unconsolidated entities as adjusted for non-cash components
      (3)
            
            
            24,239Provision
      for income taxes
            
            
            (1,191
            )Total
            
            
            86,653Reconciliation
      to Net Loss:Depreciation
      and amortization
            
            
            (90,485
            )Loss
      on derivative instruments and foreign currency transactions
      (4)
            
            
            (11,196
            )Organizational
      and offering expenses (5)
            
            
            (3,647
            )Acquisition
      fees (5)
            
            
            (3,018
            )Participation
      Interest expense (6)
            
            
            (11,962
            )Income
      allocated to minority interests
            
            
            (2,191
            )Other
      non-cash components of net loss (7)
            
            
            (24,475
            )Net
      Loss
            
            $
            (60,321
            )


__________




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
      $(12.8) million, amortization of lease incentives of $2.7 million and
      out-of-market lease amortization of $(3.9) million as well as non-cash
      components of expenses such as amortization of deferred financing costs of
      $1.2 million and other non-cash components of approximately
      $820,000.3)
            Represents
      net equity in losses of our unconsolidated entities of $6.4 million offset
      by approximately $30.6 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.  For the nine months ended September, 30, 2008, funds
generated from the operations of our real estate investments
were approximately $459,000 less than our distributions; therefore, we used
operating cash flows in excess of distributions from prior periods to fund this
amount.


33


Results
of Operations




Property-level
      Operating Results




We owned
20 properties directly that were 95% leased as of September 30, 2008 compared to
15 properties that were 93% leased as of September 30, 2007. The following table
presents the property-level revenues and expenses for the three and nine months
ended September 30, 2008, as compared to the same periods in 2007.
Same-store properties for the nine months ended September 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 September 30, 2008 and 2007 include all
properties owned as of July 1, 2007. All amounts are in thousands, except for
percentages:





Three
      Months Ended September 30,
            
            Change2008
            
            2007
            
            $
            
            
            
            %Property
      revenuesSame-store
      properties
            
            $
            42,315
            
            
            $
            40,526
            
            
            $
            1,789
            
            
            
            4.4
            %Recent
      acquisitions
            
            
            46,587
            
            
            
            9,161
            
            
            
            37,426
            
            
            
            408.6
            %Total
      property revenues
            
            $
            88,902
            
            
            $
            49,687
            
            
            $
            39,215
            
            
            
            78.9
            %Property
      expenses (1)Same-store
      properties
            
            $
            32,429
            
            
            $
            35,179
            
            
            $
            (2,750
            )
            
            
            (7.8
            )%Recent
      acquisitions
            
            
            37,676
            
            
            
            7,479
            
            
            
            30,197
            
            
            
            403.7
            %Total property
      expenses
            
            $
            70,105
            
            
            $
            42,658
            
            
            $
            27,447
            
            
            
            64.3
            %Nine
      Months Ended September 30,
            
            Change2008
            
            2007
            
            
            $
            
            
            
            
            %Property
      revenuesSame-store
      properties
            
            $
            85,269
            
            
            $
            83,968
            
            
            $
            1,301
            
            
            
            1.5
            %Recent
      acquisitions
            
            
            158,987
            
            
            
            33,672
            
            
            
            125,315
            
            
            
            372.2
            %Total
      property revenues
            
            $
            244,256
            
            
            $
            117,640
            
            
            $
            126,616
            
            
            
            107.6
            %Property
      expenses (1)Same-store
      properties
            
            $
            65,107
            
            
            $
            68,099
            
            
            $
            (2,992
            )
            
            
            (4.4
            )%Recent
      acquisitions
            
            
            127,714
            
            
            
            28,414
            
            
            
            99,300
            
            
            
            349.5
            %Total property
      expenses
            
            $
            192,821
            
            
            $
            96,513
            
            
            $
            96,308
            
            
            
            99.8
            %


_________




(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, the margin of
property revenues in excess of property expenses for same-store properties
increased from 13.2% to 23.4% for the three months ended September 30, 2008
as compared to the same period in 2007. In addition, the margin of property
revenues in excess of property expenses for same-store properties increased from
18.9% to 23.6% for the nine months ended September 30, 2008 as compared to
the same period in 2007. The primary reason for these increased margins is
decreased amortization of intangible lease assets at one of our properties as a
result of a tenant’s lease expiration.





Otherwise,
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 less than a
full period of operations, our results of operations for the three and nine
months ended September 30, 2008 are not indicative of what we expect our results
of operations to be in future periods.


34


Our
Interest in the Core Fund





As of
September 30, 2008, we owned a 28.7% non-managing general partner interest in
the Core Fund, which held interests in 25 properties that were 91% leased. By
comparison, we owned a 32.0% interest in the Core Fund as of September 30, 2007,
which held interests in 23 properties that were 92% leased.





Our
equity in losses related to our investment in the Core Fund for the nine months
ended September 30, 2008 and 2007 was $8.0 million and $6.9 million,
respectively. The increase is related to the net loss of the Core Fund, which
increased to $26.2 million from $21.0 million, primarily as a result of
depreciation and amortization resulting from recent acquisitions.





Our
equity in losses related to our investment in the Core Fund for the three months
ended September 30, 2008 and 2007 was $3.0 million and $5.0 million,
respectively. The decrease is related to the net loss of the Core Fund, which
decreased to $9.9 million from $15.4 million, primarily as a result of
accelerated depreciation resulting from a property commencing a redevelopment in
2007. See “Financial Condition, Liquidity and Capital Resources – Cash Flows
from Investing Activities” for additional information regarding our
distributions received from the Core Fund.





Our
Interest in HCB II River LLC





As of
September 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 nine months ended September 30, 2008 was approximately
$694,000 and $1.7 million, respectively. For the three and nine months ended
September 30, 2008, HCB II River LLC had net income of $1.4 million and
$3.3 million, respectively, on revenues of $2.2 million and $6.3 million,
respectively.





Our
equity in losses related to our investment in HCB II River LLC for the three and
nine months ended September 30, 2007 was approximately $58,000. For the
three and nine months ended September 30, 2007, HCB II River LLC had a net
loss of $145,000, on revenues of $1.6 million.





Asset
Management and Acquisition Fees





Asset
management fees earned by our Advisor for the nine months ended September 30,
2008 and 2007 were $17.9 million and $11.3 million, respectively. Asset
management fees for the three months ended September 30, 2008 and 2007 were
$6.2 million and $4.8 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 nine months
ended September 30, 2008 and 2007 was $1.6 billion and $1.0 billion,
respectively. Average net equity invested in real estate for the three months
ended September 30, 2008 and 2007 was $1.7 billion and $1.3 billion,
respectively.





Acquisition
fees for the nine months ended September 30, 2008 and 2007 were $6.0 million and
$10.7 million, respectively. There were no acquisition fees incurred during
the three months ended September 30, 2008 since no acquisitions were completed
during that period. Acquisition fees for the three months ended September 30,
2007 were $6.1 million.





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 $4.6 million and $3.0 million, respectively,
for the nine months ended September 30, 2008 and 2007 and approximately $1.5
million and $839,000, respectively, for the three months ended September 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. 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 September 30, 2008 and
December 31, 2007. See Item 3. Quantitative and Qualitative Disclosures About Market
Risk included elsewhere in this Quarterly Report on Form 10-Q for
additional information regarding the risk of counterparty
non-performance.





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.


35


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 September 30, 2008
            
            $
            (10,530
            )
            
            
            —
            
            
            
            —
            
            
            $
            (10,530
            )Quarter
      Ended September 30, 2007
            
            $
            (21,252
            )
            
            
            —
            
            
            
            —
            
            
            $
            (21,252
            )Nine
      Months Ended September 30, 2008
            
            $
            (11,194
            )
            
            
            —
            
            
            
            —
            
            
            $
            (11,194
            )Nine
      Months Ended September 30, 2007
            
            $
            (5,613
            )
            
            $
            (731
            )
            
            $
            939
            
            
            $
            (5,405
            )





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





Gain
on Foreign Currency Transactions





During
the nine months ended September 30, 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, transactions are remeasured into the functional
currency using the exchange rate in effect on the date of the transaction. We
recorded a loss of approximately $2,000 in the accompanying condensed
consolidated statement of operations for the nine months ended September 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 nine months ended September 30,
2007 as a result of such foreign currency transactions.





Interest
Expense





Interest
expense was $61.1 million and $32.0 million, respectively, for the nine
months ended September 30, 2008 and 2007 and $22.2 million and $12.1 million,
respectively, for the three months ended September 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 nine months ended September 30, 2008 and 2007 was $1.4
billion and $696.8 million, respectively. Average debt outstanding during the
three months ended September 30, 2008 and 2007 was $1.5 billion and $814.2
million, respectively.





Interest
Income





Interest
income was $2.5 million and $4.2 million, respectively, for the nine months
ended September 30, 2008 and 2007 and approximately $903,000 and
$1.3 million, respectively, for the three months ended September 30, 2008
and 2007. The decreases in interest income are primarily due to a decrease in
interest rates earned on cash held in short-term investments during delays
between raising capital and acquiring real estate investments. These decreases
are slightly offset by property-level increases in interest income as a result
of our recent acquisitions.




The
average interest rate we earned on univested proceeds during the nine months
ended September 30, 2008 and 2007, was 3.0% and 5.2%, respectively. The average
interest rate we earned on univested proceeds during the three months ended
September 30, 2008 and 2007 was 2.6% and 5.2%, respectively.




Income
Taxes





The
provision for income taxes for the nine months ended September 30, 2008 and 2007
was approximately $1.2 million and $580,000, respectively.  The
provision for income taxes for the three months ended September 30, 2008 and
2007 was approximately $726,000 and $247,000, respectively. Income tax
expense recorded by the Company is primarily comprised of a provision for
Canadian income taxes and a provision for the Texas margin tax.




Income Allocated to Minority Interests





As of
September 30, 2008 and 2007, Hines REIT owned a 97.4% and a 97.8% interest in
the Operating Partnership, respectively, and affiliates of Hines owned the
remaining 2.6% and 2.2% interests, respectively. We allocated income of
approximately $2.2 million and $680,000 to minority interests for the nine
months ended September 30, 2008 and 2007, respectively. In addition, we
allocated income of approximately $816,000 and $286,000 to minority interests
for the three months ended September 30, 2008 and 2007,
respectively.


36


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 certain
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
September 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.





Subsequent
Events





Denver
Industrial/Flex Portfolio





On
October 3, 2008, we entered into a contract to acquire the Denver
Industrial/Flex Portfolio (“Denver Industrial/Flex Portfolio”), a group of
industrial/flex buildings located throughout southeast Denver, Colorado. The
Denver Industrial/Flex Portfolio consists of 484,737 square feet of
rentable area that is 94% leased. The contract purchase price of the Denver
Industrial/Flex Portfolio is expected to be $66.5 million, exclusive of
transaction costs, financing fees and working capital reserves. In connection
with this acquisition, we are assuming three loans totaling $35.8 million. This
acquisition is expected to be completed during the fourth quarter of 2008. There
can be no assurance that this transaction will be completed.





Weingarten
Grocery-Anchored Portfolio
 On
November 13, 2008, we acquired a 70% interest in a joint venture with
Weingarten Reality Investors (NYSE:WRI) (“Weingarten”).  Concurrently,
the joint venture entered into an agreement to acquire a portfolio of
grocery-anchored retail centers owned by Weingarten (the “Weingarten Portfolio”)
for approximately $271.4 million.  The Weingarten Portfolio includes
12 retail properties anchored by grocery stores located in Texas, Georgia,
Tennessee, Florida and North Carolina and consists of approximately 1.5
million square feet of rentable area that is 96% leased. The initial
closing included eight properties for approximately $205.1 million. We
funded our portion (approximately $49.7 million) of equity required
for the initial closing with proceeds from our public
offerings.  In addition to its 30% share of the joint venture equity,
Weingarten provided $134.0 million of debt financing in the form of 6% preferred
equity.  $100.0 million of the preferred equity will be redeemed once
the joint venture closes on its third-party debt financing, which is currently
expected to occur before December 31, 2008.  The closing of the
remaining four properties will be consummated upon the finalization of their
respective loan assumptions.  Weingarten will continue to manage the
properties for the joint venture.


Shareholder
Redemptions





For the
months of September and October 2008, in accordance with our share redemption
plan, we redeemed 1.3 million common shares and made corresponding payments
(on October 1 and November 3, 2008, respectively) totaling $12.8 million to
shareholders who had requested these redemptions. The shares redeemed were
cancelled and will have the status of authorized, but unissued shares. We
recorded a $3.9 million liability for the shares redeemed in October. See “Note
2 – Redemption of Common Stock” included elsewhere in this Form 10-Q for
additional information.


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.





As
mentioned previously, debt capital has become less available and more expensive
as financial institutions and lenders have become capital constrained and
lenders and credit rating agencies have tightened underwriting standards. 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
September 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. In
the event of non-performance by our counterparty, we would be subject to the
variability of interest rates on approximately $520.0 million of variable rate
debt to which our outstanding interest rate swaps relate.


We are
exposed to foreign currency exchange rate variations resulting from our
subsidiaries located in Toronto, Ontario and Rio de Janeiro, Brazil. As of
September 30, 2008, $6.8 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.





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 September 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 September 30, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting.





During
the three months ended September 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.




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.


38


PART II – OTHER
INFORMATION




Item 1A. Risk
Factors.
  The failure of
any bank in which we deposit our funds could reduce the amount of cash we have
available to pay distributions and make additional
investments.
  The Federal Deposit
Insurance Corporation, or FDIC, only insures amounts up to $250,000 per
depositor per insured bank. We currently have cash and cash equivalents and
restricted cash deposited in certain financial institutions in excess of
federally insured levels. If any of the banking institutions in which we have
deposited funds ultimately fails, we may lose any amount of our deposits over
$250,000. The loss of our deposits could reduce the amount of cash we have
available to distribute or invest and could result in a decline in the value of
your investment.




We have
no other material changes to the risk factors discussed in our Annual Report on
Form 10-K for the year ended December 31, 2007.




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





On August
25, 2008, we issued 1,000 shares to George A. Davis, Thomas A. Hassard, Stanley
D. Levy and Paul Murphy Jr. in conjunction with their re-election to our board
as independent directors. 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
three months ended September 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)July
      1, 2008 to July 30, 2008
            
            
            666,815
            
            
            $
            9.68
            
            
            
            666,815
            
            
            
            11,700,193August
      1, 2008 to August 31, 2008
            
            
            857,709
            
            
            
            9.68
            
            
            
            857,709
            
            
            
            11,263,479September
      1, 2008 to September 30, 2008
            
            
            421,454
            
            
            
            9.68
            
            
            
            421,454
            
            
            
            11,176,363Total
            
            
            1,945,978
            
            
            $
            9.68
            
            
            
            1,945,978


__________





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




Our annual meeting of shareholders was held on August 25, 2008.  Management
proposals 1 and 2 were approved.  The results are as
follows:





Proposal
1





The
following directors were re-elected at the meeting to serve a one-year term as
directors:




For
            Against
            Authority
      Withheld or Abstained from VotingJeffrey
      C. Hines
            88,541,972
            —
            2,082,001C.
      Hastings Johnson
            88,527,682
            —
            2,096,292Charles
      M. Baughn
            88,555,608
            —
            2,068,366George
      A. Davis
            88,525,521
            —
            2,098,453Thomas
      A. Hassard
            88,549,687
            —
            2,074,287Stanley
      D. Levy
            88,536,369
            —
            2,087,605Paul
      B. Murphy Jr
            88,532,308
            —
            2,091,666




39


Proposal
2





Ratification
of the appointment of Deloitte & Touche LLP as the Company’s independent
registered public accounting firm for fiscal year 2008.




For
            Against
            Authority
      Withheld or Abstained from Voting88,417,824
            581,189
            1,624,961




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.





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


Charles
N. Hazen


President
and Chief Executive Officer








November
14,
2008                                                                                 By:  /s/ SHERRI W.
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
            
            —
            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.31.2
            *
            —
            Certification.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