---

---

|                                  
|----------------------------------
|UNITED STATES                     
|SECURITIES AND EXCHANGE COMMISSION
|Washington,
  D.C. 20549          

|          
|----------
|          
|FORM 10-K 
|(Mark One)

|  |                                                                                           
|- | ------------------------------------------------------------------------------------------
|x | ANNUAL REPORT
  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|  |                                                                                           
|  | For
  the fiscal year ended December 31, 2005                                             
|  |                                                                                           
|  | OR                                                                                        
|  |                                                                                           
|o | TRANSITION REPORT
  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  |                                                                                           
|  | For the transition
  period from _____________to _____________                            

Commission file number 001-32039

|                                                        
|--------------------------------------------------------
|                                                        
|                                                        
|CAPITAL LEASE FUNDING, INC.                             
|(EXACT NAME OF REGISTRANT AS SPECIFIED IN
  ITS CHARTER)

|                                           |  |                                       
|------------------------------------------ |  | --------------------------------------
|                                          
|Maryland                                   |  | 52-2414533                            
|(State or Other Jurisdiction of            |  | (I.R.S. Employer Identification
  No.)
|Incorporation or Organization)             |  |                                       
|                                           |  |                                       
|110 Maiden Lane, New York, NY              |  | 10005                                 
|(Address of Principal Executive
  Offices) |  | (Zip code)                            

(212) 217-6300(Registrants
Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:

|                                                                          |  |                                          
|------------------------------------------------------------------------- |  | -----------------------------------------
|Title of each Class                                                       |  | Name of each exchange on which registered
|                                                                          |  |                                          
|Common stock, $0.01 par value                                             |  | New York Stock Exchange                  
|8.125% Series A Cumulative Redeemable 
  Preferred Stock, $0.01 par value |  | New York Stock Exchange                  



---

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

Indicate by
check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. YesoNox

Indicate by
check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. YesoNox

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. YesxNoo

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

Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer
and large accelerated filer in Rule 12b-2 of the Exchange Act.

|                          |                     |                        
|------------------------- | ------------------- | -----------------------
|Large accelerated filer o | Accelerated filer x | Non-accelerated filer o

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

As of June
30, 2005, the aggregate market value of the common stock, $0.01 par value per
share, of Capital Lease Funding, Inc. (Common Stock), held by non-affiliates
(outstanding shares, excluding shares held by executive officers and directors)
of the registrant was approximately $287.7 million, based upon the closing
price of $10.85 on the New York Stock Exchange on such date.

As of
February 15, 2006, there were 27,868,480 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

|   |                                                                                                                                                                                                                                                                       
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Portions of the
  registrants definitive proxy statement for the registrants 2006 Annual
  Meeting, to be filed within 120 days after the close of the registrants
  fiscal year, are incorporated by reference into Part III of this Annual
  Report on Form 10-K.

---

---



TABLE OF CONTENTS

|            |                                                                                                                   |  |   
|----------- | ----------------------------------------------------------------------------------------------------------------- |  | --
|PART
  I.   |                                                                                                                   |  | 1 
|Item
1.     | Business.                                                                                                         |  | 1 
|Item
1A.    | Risk
  Factors.                                                                                                   |  | 15
|Item
1B.    | Unresolved
  Staff Comments.                                                                                      |  | 27
|Item
2.     | Properties.                                                                                                       |  | 27
|Item
3.     | Legal
  Proceedings.                                                                                              |  | 27
|Item
4.     | Submission
  of Matters to a Vote of Security Holders.                                                            |  | 27
|PART
  II.  |                                                                                                                   |  | 28
|Item
5.     | Market
  for Registrants Common Equity, Related Stockholder Matters and Issuer
  Purchases of Equity Securities. |  | 28
|Item
6.     | Selected
  Financial Data.                                                                                        |  | 30
|Item
7.     | Managements
  Discussion and Analysis of Financial Condition and Results of Operations.                          |  | 32
|Item
7A.    | Quantitative
  and Qualitative Disclosures about Market Risk.                                                     |  | 43
|Item
8.     | Financial
  Statements and Supplementary Data.                                                                    |  | 47
|Item
9.     | Changes
  in and Disagreements With Accountants on Accounting and Financial Disclosure.                           |  | 83
|Item
9A.    | Controls
  and Procedures.                                                                                        |  | 83
|Item
9B.    | Other
  Information.                                                                                              |  | 83
|PART
  III. |                                                                                                                   |  | 85
|Item
10.    | Directors
  and Executive Officers of the Registrant.*                                                            |  | 85
|Item
11.    | Executive
  Compensation.*                                                                                        |  | 85
|Item
12.    | Security
  Ownership of Certain Beneficial Owners and Management and Related Stockholder
  Matters.*              |  | 85
|Item
13.    | Certain
  Relationships and Related Transactions.*                                                                |  | 85
|Item
14.    | Principal
  Accounting Fees and Services.*                                                                        |  | 85
|PART IV.    |                                                                                                                   |  | 86
|Item
15.    | Exhibits
  and Financial Statement Schedules.                                                                     |  | 87
|PART
  V.   |                                                                                                                   |  | 91

* Items 10, 11, 12, 13 and 14 are incorporated by reference herein from
the Proxy Statement.

---



PART I.

|          |          
|--------- | ---------
|Item
  1. | Business.

Explanatory Note for Purposes of the Safe
Harbor Provisions of Section 21E of the Securities Exchange Act of 1934, as
amended

This Annual
Report on Form 10-K contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, which involve
certain risks and uncertainties. Our actual results or outcomes may differ
materially from those projected. Important factors that we believe might cause
such differences are discussed in Item 1A (Risk Factors) of this Form 10-K or
otherwise accompany the forward-looking statements contained in this Form 10-K.
In assessing all forward-looking statements, readers are urged to read carefully
all cautionary statements contained in this Form 10-K.

Overview

We are a
diversified real estate investment trust, or REIT, that owns and finances
primarily single tenant commercial real estate assets subject to long-term
leases to primarily investment grade tenants. We focus on properties that are
subject to a net lease, which we define as a lease that requires the tenant
(rather than the landlord) to pay for, or pay for and perform, all or
substantially all aspects of the property and its operations during the lease
term.

We invest
at all levels of the capital structure of net lease properties, including
equity investments in real estate (owned real properties), debt investments
(mortgage loans and net lease mortgage backed securities) and mezzanine
investments secured by net leased real estate collateral. Tenants underlying
our net lease investments are primarily large public companies or their
significant operating subsidiaries and governmental and quasi-governmental
entities with investment grade credit ratings.

A published
senior unsecured credit rating of BBB-/Baa3 or above from one or both of
Standard & Poors Corporation (S&P) and Moodys Investors Service
(Moodys) is considered investment grade. We also imply an investment grade
credit rating for tenants that are not publicly rated by S&P or Moodys but
(i) are 100% owned by an investment grade parent, (ii) for which we have
obtained a private investment grade rating from either S&P or Moodys, and
(iii) are governmental entity branches or units of another investment grade
rated governmental entity.

As of December 31, 2005, our investment portfolio
had a carry value of approximately $1.2 billion, and included the following
assets by type:

|                                                              |  |                |           |            |  |       |  
|------------------------------------------------------------- |  | -------------- | --------- | ---------- |  | ----- | -
|                                                              |  | Carry Value    |           |            | 
|                                                              |  | (in thousands) |           | Percentage | 
|                                                              |  |                |           |            | 
|Owned properties                                              |  | $              | 764,930   |            |  | 63.5  | %
|Debt investments                                              |  |                |           |            |  |       |  
|Loans                                                         |  |                |           |            |  |       |  
|Long-term mortgage
loans                                      |  |                | 240,333   |            |  | 20.0  | %
|Corporate credit
notes                                        |  |                | 14,933    |            |  | 1.2   | %
|Mezzanine and other
investments                               |  |                | 43,111    |            |  | 3.6   | %
|Commercial mortgage-backed and
other real
  estate securities |  |                | 137,409   |            |  | 11.4  | %
|Other                                                         |  |                | 3,862     |            |  | 0.3   | %
|                                                              |  |                |           |            |  |       |  
|Total                                                         |  | $              | 1,204,578 |            |  | 100.0 | %
|                                                              |  |                |           |            |  |       |  

We conduct
our business through two operating segments: operating net lease real estate
(including our investments in owned real properties), and lending investments
(including our loan investments as well as our investments in securities). See
Managements Discussion and Analysis of Results of Operations and Financial
Condition below, for financial data by segment.

We have
been in the net lease business since 1994. On March 24, 2004, we completed our
initial public offering of 23.0 million shares of our common stock priced to
the public at $10.50 per share. Prior to our initial public offering, we were
primarily a lender focused on originating net lease mortgage loan transactions
and selling substantially all of the loans we originated, either through
whole-loan or small pool sales or through gain-on-sale commercial mortgage-backed
securitizations.

Our senior
management team has worked together for over 10 years. Over this period, we
built a nationwide origination network and underwriting platform, initially
focused on net lease mortgage lending. Since 1996, we have originated and
underwritten more than $3.5 billion in net lease loan and owned property
transactions, involving more than 500 properties with more than 75 underlying
tenants.

Our
portfolio produces stable, high quality cash flows generated by long-term net
leases to primarily investment grade tenants.

1

---



Investment Strategy

Our primary
business objective is to generate stable, long-term and attractive returns
based on the spread between the yields generated by our assets and the cost of
financing our portfolio. We focus on the following core business strategies:

Investing
in High Quality Cash Flows. We invest primarily in owned net leased real
properties and real estate loans where the underlying tenant has an investment
grade credit rating or implied investment grade credit rating. As of December
31, 2005, our top ten credit exposures all carried investment grade or implied
investment grade credit ratings and had a weighted average credit rating of A+.
As of December 31, 2005, our portfolio had the following credit
characteristics:

|                                                |  |                |           |            |  |        |  
|----------------------------------------------- |  | -------------- | --------- | ---------- |  | ------ | -
|                                                |  | Total          |           |            | 
|Credit Rating (1)                               |  | (in thousands) |           | Percentage | 
|                                                |  |                |           |            | 
|Investment grade rating of A- or
  A3 and above |  | $              | 552,028   |            |  | 45.8   | %
|Investment grade rating of below
  A- or A3     |  |                | 283,660   |            |  | 23.5   | %
|Implied investment grade rating                 |  |                | 224,786   |            |  | 18.7   | %
|Non-investment grade rating                     |  |                | 100,992   |            |  | 8.4    | %
|Unrated (2)                                     |  |                | 43,111    |            |  | 3.6    | %
|                                                |  |                |           |            |  |        |  
|                                                |  | $              | 1,204,578 |            |  | 100.00 | %
|                                                |  |                |           |            |  |        |  

|    |                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Four of our owned
  real properties with an aggregate carry value of $261,011 are leased to more
  than one tenant and, for purposes of determining the underlying tenants
  credit rating on these properties, we have considered the credit rating of
  only our primary tenant.               
|    |                                                                                                                                                                                                                                                                                                   
|(2) | Includes our
  mezzanine and other investments as described under Our PortfolioLoan
  Investments. While the tenants on the underlying properties generally are
  rated by S&P and/or Moodys, we classify these investments as unrated
  because of the subordinated nature of our investment.

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Flexible Investment Approach. We invest at all levels of the
  net lease capital structure but remain flexible within that structure,
  investing where we see the greatest market opportunity to earn attractive
  returns. We have seen the greatest opportunity on the equity side of the
  business (owned real properties). As of December 31, 2005, owned real
  properties comprised approximately 64% of our portfolio, and we expect this
  percentage to increase in 2006.                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  | Long-Term Assets Held for Investment. We invest in commercial real
  estate assets subject to long-term net leases. We intend to hold our assets
  for the long-term, capturing the stable cash flows that will be produced from
  the underlying primarily investment grade credits. On a limited and
  opportunistic basis, we also continue to acquire and promptly resell net
  lease assets through our taxable REIT subsidiary.                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |  | Finance with Long-Term Fixed Rate Debt. We seek to borrow against, or
  leverage, our assets with long-term fixed rate debt, effectively locking in
  the spread we expect to generate on our assets. Our financing strategy allows
  us to invest in a greater number of assets and enhance our asset returns. We
  expect our leverage to average 70% to 85% of our assets in portfolio. We
  believe this leverage level is conservative given the primarily investment
  grade nature of the underlying tenants and the length and quality of the
  related leases.

Our Portfolio

Owned Properties

All of our
equity investments in real estate have been made since the closing of our
initial public offering. We invest in all commercial property types (e.g.,
office, retail or industrial), and our investment underwriting includes an
analysis of the credit quality of the underlying tenant and the strength of the
related lease. We also analyze the propertys real estate fundamentals,
including location and type of the property, vacancy rates and trends in
vacancy rates in the propertys market, rental rates within the propertys
market, recent sales prices and demographics in the propertys market. For more
detail on our underwriting process, please see Underwriting Process below. We
target properties that have one or more of the following characteristics:

| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | included in
  primary metropolitan markets such as New York/New Jersey, Chicago and
  Washington D.C./Northern Virginia;
| |   |                                                                                                                         
| |  | fungible asset
  type that will facilitate a re-let of the property if the tenant does not
  renew;                     
| |   |                                                                                                                         
| |  | barriers to entry
  in the propertys market, such as zoning restrictions or limited land for
  future development; and 
| |   |                                                                                                                         
| |  | core facility of
  the tenant.                                                                                          

2

---



As
of December 31, 2005, our owned property portfolio had a carry value of $764.9
million.  We believe the strength of our
portfolio is exhibited by the following:

| |   |                                                                            
| | - | ---------------------------------------------------------------------------
| |  | approximately 3.3
  million rentable square feet;                          
| |   |                                                                            
| |  | 27 properties in
  16 states leased to 16 different tenants;               
| |   |                                                                            
| |  | 100% investment
  grade or implied investment grade tenants;               
| |   |                                                                            
| |  | weighted average
  tenant credit rating of A+;                             
| |   |                                                                            
| |  | weighted average
  remaining lease term of approximately 13 years; and     
| |   |                                                                            
| |  | well diversified
  portfolio by property type, geography and credit rating.

The
following pie chart depicts the credit quality(1)of our owned property portfolio as
of December 31, 2005.

A- 16% A+ 13% AA 11% AAA 26% BBB13% BBB-4% BBB+ 17%


(1)  Reflects actual or implied
S&P rating or equivalent S&P rating if rated only by Moodys.

Our
owned property portfolio is expected to generate the following annual cash
flows(1)through the year 2025.

0 10,000,000 20,000,000 30,000,000 40,000,000 50,000,000 60,000,000 70,000,000 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Years Dollars


(1)
Reflects scheduled rent payments under all of our leases with all of our
tenants.  Does not reflect straight-line
rent adjustments required under Statement of Financial Accounting Standards (SFAS)
No. 13.  Also does not include expense
recoveries or above or below market rent amortization adjustments required by
SFAS No. 141.  Assumes no additions
to the portfolio and no lease renewals at expiration of the primary lease
term.  Actual results may differ
materially from those projected.  Please
see Risk Factors section.

3

---



The
following is a tabular presentation of our owned property portfolio as of
December 31, 2005:

|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   |  |   |         | 
|---------------------------------------------- |  | ----------------- |  | ---------------- |  | ------------- |  | --------------- |  | ---------------- |  | ------------------------------ | ------ | ----------------- | - | ----------------- |  | - | ------- | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  | (in thousands)                 |       
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |       
|Tenant or Guarantor                            |  | Location          |  | Property Type    |  | Square
  Feet |  | Purchase
  Date |  | Lease
  Maturity |  | 2006Estimated
  AnnualRent (1) |        | Purchase 
  Price |   | Carry
  Value (2) | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   | 
|                                              
|Abbott Laboratories                            |  | Columbus, OH      |  | Office           |  | 111,776       |  | 11/2004         |  | 10/2016          |  | $                              | 893    |                   | $ | 12,025            |  | $ | 11,680  | 
|Abbott Laboratories                            |  | Waukegan, IL      |  | Office           |  | 131,341       |  | 8/2005          |  | 8/2017           |  |                                | 1,338  |                   |   | 20,325            |  |   | 20,131  | 
|Allstate Insurance Company                     |  | Charlotte, NC     |  | Office           |  | 191,681       |  | 12/2005         |  | 12/2015          |  |                                | 1,869  |                   |   | 27,172            |  |   | 27,211  | 
|Allstate Insurance Company                     |  | Roanoke, VA       |  | Office           |  | 165,808       |  | 12/2005         |  | 12/2015          |  |                                | 1,990  |                   |   | 28,928            |  |   | 28,907  | 
|Aon Corporation (3)                            |  | Glenview, IL      |  | Office           |  | 412,409       |  | 8/2004          |  | 4/2017           |  |                                | 6,310  |                   |   | 85,750            |  |   | 83,653  | 
|Baxter International, Inc.                     |  | Bloomington, IN   |  | Office/Warehouse |  | 125,500       |  | 10/2004         |  | 9/2016           |  |                                | 790    |                   |   | 10,500            |  |   | 10,459  | 
|Cadbury Schweppes Holdings (US)                |  | Whippany, NJ      |  | Office           |  | 149,475       |  | 1/2005          |  | 3/2021           |  |                                | 3,400  |                   |   | 48,000            |  |   | 49,597  | 
|Capital One Financial Corporation              |  | Plano, TX         |  | Office           |  | 159,000       |  | 6/2005          |  | 2/2015           |  |                                | 1,664  |                   |   | 27,900            |  |   | 30,623  | 
|Choice Hotels International, Inc. (4)          |  | Silver Spring, MD |  | Office           |  | 223,912       |  | 11/2004         |  | 5/2013           |  |                                | 4,656  |                   |   | 43,500            |  |   | 44,166  | 
|Crozer-Keystone Health System (5)              |  | Ridley, PA        |  | Medical Office   |  | 22,708        |  | 8/2004          |  | 4/2019           |  |                                | 397    |                   |   | 4,477             |  |   | 5,606   | 
|CVS Corporation                                |  | Randolph, MA      |  | Retail Drug      |  | 88,420        |  | 9/2004          |  | 1/2014           |  |                                | 744    |                   |   | 10,450            |  |   | 13,856  | 
|Farmers New World Life Insurance Company       |  | Mercer Island, WA |  | Office           |  | 155,200       |  | 12/2005         |  | 12/2020          |  |                                | 2,328  |                   |   | 39,550            |  |   | 39,597  | 
|ITT Industries, Inc.                           |  | Herndon, VA       |  | Office           |  | 167,285       |  | 5/2005          |  | 3/2019           |  |                                | 3,600  |                   |   | 46,081            |  |   | 48,100  | 
|Lowes Companies, Inc. (6)                      |  | Aliso Viejo, CA   |  | Retail           |  | 181,160       |  | 5/2005          |  | 8/2024           |  |                                | 3,450  |                   |   | 52,860            |  |   | 52,378  | 
|Omnicom Group, Inc.                            |  | Irving, TX        |  | Office           |  | 101,120       |  | 6/2005          |  | 5/2013           |  |                                | 1,278  |                   |   | 18,100            |  |   | 17,750  | 
|Tiffany & Co                                   |  | Parsippany, NJ    |  | Office/Warehouse |  | 367,740       |  | 9/2005          |  | 9/2025           |  |                                | 4,613  |                   |   | 75,000            |  |   | 77,136  | 
|US Government (DEA)                            |  | Birmingham, AL    |  | Office           |  | 35,616        |  | 8/2005          |  | 12/2020          |  |                                | 1,225  |                   |   | 14,100            |  |   | 14,083  | 
|US Government (Department of Veterans
Affairs) |  | Ponce, PR         |  | Medical Center   |  | 56,500        |  | 11/2004         |  | 2/2015           |  |                                | 1,300  |                   |   | 13,600            |  |   | 13,236  | 
|US Government (EPA)                            |  | Kansas City, KS   |  | Office           |  | 71,979        |  | 8/2005          |  | 3/2023           |  |                                | 2,452  |                   |   | 29,250            |  |   | 32,952  | 
|US Government (FBI)                            |  | Birmingham, AL    |  | Office           |  | 86,199        |  | 8/2005          |  | 4/2020           |  |                                | 2,202  |                   |   | 23,500            |  |   | 23,952  | 
|US Government (NIH) (7)                        |  | N. Bethesda, MD   |  | Office           |  | 207,055       |  | 9/2005          |  | 5/2012           |  |                                | 7,714  |                   |   | 81,500            |  |   | 80,814  | 
|US Government (OSHA)                           |  | Sandy, UT         |  | Office           |  | 75,000        |  | 8/2005          |  | 11/2023          |  |                                | 1,717  |                   |   | 23,750            |  |   | 24,689  | 
|US Government (SSA)                            |  | Austin, TX        |  | Office           |  | 23,311        |  | 8/2005          |  | 12/2015          |  |                                | 657    |                   |   | 6,900             |  |   | 6,949   | 
|Walgreen Co.                                   |  | Pennsauken, NJ    |  | Retail Drug      |  | 18,500        |  | 11/2004         |  | 10/2016          |  |                                | 297    |                   |   | 3,089             |  |   | 3,160   | 
|Walgreen Co.                                   |  | Portsmouth, VA    |  | Retail Drug      |  | 13,905        |  | 11/2004         |  | 7/2018           |  |                                | 356    |                   |   | 4,164             |  |   | 4,245   | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   |  |   |         | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   |  |   |         | 
|Total                                          |  |                   |  |                  |  | 3,342,600     |  |                 |  |                  |  | $                              | 57,240 |                   | $ | 750,571           |  | $ | 764,930 | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   |  |   |         | 
|                                               |  |                   |  |                  |  |               |  |                 |  |                  |  |                                |        |                   |   |                   |  |   |         | 

|    |                                                                                                                                                                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Reflects scheduled
  rent due for 2006 under our lease with the tenant or tenants.  Does not reflect straight-line rent
  adjustments required under SFAS No. 13.
  Also does not include expense recoveries or above or below market rent
  amortization adjustments required by SFAS No. 141.                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(2) | Includes carry
  value of any related intangible assets under SFAS No. 141.                                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(3) | As of December 31,
  2005, approximately 2% of the property was leased to one other tenant.                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(4) | As of December 31,
  2005, approximately 28% of the property was leased to six other tenants.                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(5) | We own a leasehold
  interest in the land, or a ground lease, where an affiliate of our tenant
  owns the underlying land and improvements and has leased them to us through
  2032 with an option to extend through 2046.
  Our ground rent is prepaid through 2032.  At the end of the ground lease, unless extended, the land and
  improvements revert to the landowner.
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(6) | As of December 31,
  2005, approximately 18% of the property was leased to two other tenants.                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                             
|(7) | As of December 31,
  2005, approximately 11% of the property was leased to five other tenants.                                                                                                                                                                                                                                                                              

Loan
Investments

Our
loan products are targeted to owners of real properties net leased on a
long-term basis primarily to investment grade tenants.  Most of the loans we hold in portfolio are
fully amortizing over the primary lease term of the underlying tenant, thus
reducing our risk over time and eliminating the refinance risk associated with
a balloon payment at maturity.  We
target loans on real properties with strong real estate fundamentals and with a
strong long-term net lease in place.

Our
existing loan investments include long-term mortgage loans, corporate credit
notes and a small number of mezzanine and other investments.  The following describes each of these
investments.

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Long-Term
  Mortgage Loans.  We offer
  long-term fully amortizing (or nearly fully amortizing) or insured balloon
  loans secured by first mortgages on properties subject to long-term net
  leases.  This product enables a
  borrower to receive the highest proceeds that a propertys rent payments will
  support.  As of December 31, 2005, our
  portfolio included $240.3 million of long-term mortgage loans.                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | Corporate
  Credit Notes.  We also offer a 10-year
  non-fully amortizing loan product for net lease properties that do not meet
  the criteria for our long-term mortgage loan product.  We have received a United States patent
  for this product.  We typically split
  these loans into two notes, a non-fully amortizing real estate note which we
  generally sell promptly following origination, and a fully amortizing
  corporate credit note, which we retain in our portfolio.  The corporate credit note will generally
  range from 10% to 20% of the loan amount, and has a junior claim on the real
  estate collateral, but a senior claim on the rents in the event of a tenant
  bankruptcy.  As of December 31, 2005,
  our portfolio included $14.9 million of corporate credit notes.                                                    
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | Mezzanine and Other Investments.
  We also offer a variety of other loan and loan type products to owners
  of net leased properties, including mezzanine loans, bridge loans,
  development loans and preferred equity financings.  These investments are typically short-term in nature and are
  often subordinate to other financing on the property.  We typically make these investments in
  connection with the development of a property or an expected recapitalization
  of the property, giving us an advantage in providing the long-term financing
  on or purchasing the property.  As of
  December 31, 2005, we had $43.1 million of these investments, including a
  $27.7 million mezzanine loan at a weighted average coupon rate of
  approximately 8.7%, and an $8.7 million unsecured preferred equity
  investment, which is expected to

4

---



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | pay a current
  return of approximately 14.2%.  Both
  of these investments are scheduled to mature in June 2013, but are expected
  to be redeemed in early 2006 in connection with a recapitalization of the
  property.  We expect to participate in
  the recapitalization by making a first mortgage loan on the property and a
  corporate credit note investment.  Our
  investment in the property is expected to be less than $30 million upon
  completion of the recapitalization.

As
of December 31, 2005, our loan portfolio had a carry value of $298.4
million.  We believe the strength of our
loan portfolio is exhibited by the following:

| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | weighted average
  remaining lease term on the underlying leases of approximately 19 years;         
| |   |                                                                                                     
| |  | 72% investment
  grade or implied investment grade underlying tenants;                              
| |   |                                                                                                     
| |  | loan investments
  on 66 properties in 25 states with 22 different underlying tenant obligors;
  and
| |   |                                                                                                     
| |  | weighted average
  underlying tenant credit rating of BBB.                                          

The
following pie chart depicts the credit quality(1)of the long-term mortgage loans in
our loan portfolio as of December 31, 2005.
As of December 31, 2005, long-term mortgage loans comprised
approximately 81% of our loan portfolio.

A- 30% A+21% AA17% AA-2% AAA0% BBB11% BBB- 1% BBB+1% Non-Investment Grade17%


(1)  Reflects actual or implied
S&P rating or equivalent S&P rating if rated only by Moodys.

5

---



The
long-term mortgage loans in our loan portfolio are expected to generate the
following annual cash flows(1)through the year 2025.

0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Years Dollars


(1) Reflects
scheduled payments of interest and principal on our long-term mortgage
loans.  Actual results may differ
materially from those projected.  Please
see Risk Factors section.

6

---



The following is a tabular
  presentation of our loan portfolio as of December 31, 2005:

|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   |  | 
|--------------------------------------- |  | ------------------------ |  | ----------------------- |  | ------------- |  | ------ | ---- | ------------------ |  | --------------- |  | ------------------------------ | ------- | ------------------- |  | -------------- | - | -------------------------- |  |  |  | - | ------- |  |  |  | - | ------- |  |  | -- | - |  | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  | (in thousands) |   |                            |  | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  | 
|Tenant or Guarantor                     |  | Location                 |  | Property Type           |  | Square
  Feet |  | Coupon |      | Lease
  Expiration |  | Loan
  Maturity |  | Original
  Principal
  Balance |         | Principal
  Balance |  | Carry Value    |   | Loan to Realty
  Value (1) | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            | 
|Long-Term Mortgage
Loans                |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 
|Autozone, Inc.                          |  | Douglas and Valdosta, GA |  | Retail Auto Store       |  | 13,383        |  |        | 6.50 | %                  |  | 4/2024          |  |                                | 11/2022 |                     |  |                | $ | 2,108                      |  |  |  | $ | 2,039   |  |  |  | $ | 2,039   |  |  | 75 | % | 
|Best Buy Co., Inc.                      |  | Chicago, IL              |  | Retail                  |  | 45,720        |  |        | 6.40 | %                  |  | 3/2025          |  |                                | 3/2025  |                     |  |                |   | 18,522                     |  |  |  |   | 18,324  |  |  |  |   | 18,324  |  |  | 95 | % | 
|City of Jasper, Texas                   |  | Jasper, TX               |  | Office                  |  | 12,750        |  |        | 7.00 | %                  |  | 12/2024         |  |                                | 11/2024 |                     |  |                |   | 1,736                      |  |  |  |   | 1,706   |  |  |  |   | 1,654   |  |  | 86 | % | 
|CVS Corporation                         |  | Asheville, NC            |  | Retail Drug             |  | 10,880        |  |        | 6.53 | %                  |  | 1/2026          |  |                                | 1/2026  |                     |  |                |   | 2,360                      |  |  |  |   | 2,297   |  |  |  |   | 2,363   |  |  | 90 | % | 
|CVS Corporation                         |  | Athol, MA                |  | Retail Drug             |  | 13,013        |  |        | 6.46 | %                  |  | 1/2025          |  |                                | 1/2025  |                     |  |                |   | 1,502                      |  |  |  |   | 1,463   |  |  |  |   | 1,464   |  |  | 77 | % | 
|CVS Corporation                         |  | Bangor, PA               |  | Retail Drug             |  | 13,013        |  |        | 6.28 | %                  |  | 1/2026          |  |                                | 1/2026  |                     |  |                |   | 2,521                      |  |  |  |   | 2,414   |  |  |  |   | 2,371   |  |  | 86 | % | 
|CVS Corporation                         |  | Bluefield, WV            |  | Retail Drug             |  | 10,125        |  |        | 8.00 | %                  |  | 1/2021          |  |                                | 1/2021  |                     |  |                |   | 1,439                      |  |  |  |   | 1,324   |  |  |  |   | 1,453   |  |  | 78 | % | 
|CVS Corporation                         |  | Greensboro, GA           |  | Retail Drug             |  | 11,970        |  |        | 6.52 | %                  |  | 1/2030          |  |                                | 1/2030  |                     |  |                |   | 1,395                      |  |  |  |   | 1,379   |  |  |  |   | 1,379   |  |  | 81 | % | 
|CVS Corporation                         |  | Oak Ridge, NC            |  | Retail Drug             |  | 10,880        |  |        | 6.99 | %                  |  | 1/2025          |  |                                | 8/2024  |                     |  |                |   | 3,243                      |  |  |  |   | 3,163   |  |  |  |   | 3,163   |  |  | 82 | % | 
|CVS Corporation                         |  | Shelby
        Twp., MI  |  | Retail Drug             |  | 11,970        |  |        | 5.98 | %                  |  | 1/2031          |  |                                | 1/2031  |                     |  |                |   | 2,540                      |  |  |  |   | 2,540   |  |  |  |   | 2,540   |  |  | 89 | % | 
|CVS Corporation                         |  | Southington, CT          |  | Retail Drug             |  | 10,125        |  |        | 8.26 | %                  |  | 1/2020          |  |                                | 1/2020  |                     |  |                |   | 1,768                      |  |  |  |   | 1,733   |  |  |  |   | 1,944   |  |  | 85 | % | 
|CVS Corporation                         |  | Stow, OH                 |  | Retail Drug             |  | 10,125        |  |        | 8.26 | %                  |  | 1/2020          |  |                                | 1/2020  |                     |  |                |   | 2,407                      |  |  |  |   | 2,351   |  |  |  |   | 2,636   |  |  | 82 | % | 
|CVS Corporation                         |  | Sunbury, PA              |  | Retail Drug             |  | 10,125        |  |        | 7.50 | %                  |  | 1/2021          |  |                                | 1/2021  |                     |  |                |   | 1,829                      |  |  |  |   | 1,656   |  |  |  |   | 1,614   |  |  | 79 | % | 
|CVS Corporation                         |  | Washington, DC           |  | Retail Drug             |  | 7,920         |  |        | 8.10 | %                  |  | 1/2023          |  |                                | 1/2023  |                     |  |                |   | 2,781                      |  |  |  |   | 2,505   |  |  |  |   | 2,683   |  |  | 76 | % | 
|CVS Corporation                         |  | Willimantic, CT          |  | Retail Drug             |  | 10,125        |  |        | 8.26 | %                  |  | 1/2023          |  |                                | 1/2023  |                     |  |                |   | 2,028                      |  |  |  |   | 1,992   |  |  |  |   | 2,239   |  |  | 81 | % | 
|Harris Bankcorp, Inc.                   |  | Chicago, IL              |  | Bank                    |  | 4,750         |  |        | 6.81 | %                  |  | 8/2025          |  |                                | 8/2025  |                     |  |                |   | 4,467                      |  |  |  |   | 4,467   |  |  |  |   | 4,467   |  |  | 73 | % | 
|Home Depot USA, Inc.                    |  | Chelsea, MA              |  | Retail                  |  | 117,034       |  |        | 5.36 | %                  |  | 12/2035         |  |                                | 1/2031  |                     |  |                |   | 8,501                      |  |  |  |   | 8,501   |  |  |  |   | 8,501   |  |  | 92 | % | 
|Home Depot USA, Inc.                    |  | Tullytown, PA            |  | Retail                  |  | 116,016       |  |        | 6.62 | %                  |  | 1/2033          |  |                                | 1/2033  |                     |  |                |   | 8,447                      |  |  |  |   | 8,432   |  |  |  |   | 8,432   |  |  | 98 | % | 
|Kohls Corporation                       |  | Chicago, IL              |  | Dept. Store             |  | 133,000       |  |        | 6.69 | %                  |  | 9/2030          |  |                                | 5/2030  |                     |  |                |   | 48,270                     |  |  |  |   | 48,001  |  |  |  |   | 48,001  |  |  | 93 | % | 
|Koninklijke Ahold, N.V.                 |  | Bensalem, PA             |  | Grocery Store           |  | 67,000        |  |        | 7.24 | %                  |  | 5/2020          |  |                                | 5/2020  |                     |  |                |   | 3,153                      |  |  |  |   | 3,092   |  |  |  |   | 3,155   |  |  | 23 | % | 
|Koninklijke Ahold, N.V.                 |  | North Kingstown, RI      |  | Grocery Store           |  | 125,772       |  |        | 7.50 | %                  |  | 11/2025         |  |                                | 11/2025 |                     |  |                |   | 6,794                      |  |  |  |   | 6,646   |  |  |  |   | 6,625   |  |  | 73 | % | 
|Koninklijke Ahold, N.V.                 |  | Tewksbury, MA            |  | Grocery Store           |  | 58,450        |  |        | 7.50 | %                  |  | 1/2027          |  |                                | 1/2027  |                     |  |                |   | 6,625                      |  |  |  |   | 6,511   |  |  |  |   | 6,505   |  |  | 74 | % | 
|Koninklijke Ahold, N.V.                 |  | Upper Darby Township, PA |  | Grocery Store           |  | 54,800        |  |        | 7.29 | %                  |  | 4/2024          |  |                                | 4/2024  |                     |  |                |   | 6,867                      |  |  |  |   | 6,656   |  |  |  |   | 6,350   |  |  | 91 | % | 
|Lowes Companies, Inc.                   |  | Framingham, MA           |  | Retail                  |  | 156,543       |  |        | 5.87 | %                  |  | 9/2031          |  |                                | 9/2031  |                     |  |                |   | 27,864                     |  |  |  |   | 27,864  |  |  |  |   | 27,864  |  |  | 85 | % | 
|Lowes Companies, Inc.                   |  | Matamoras, PA            |  | Dept. Store             |  | 162,070       |  |        | 6.61 | %                  |  | 5/2030          |  |                                | 5/2030  |                     |  |                |   | 7,208                      |  |  |  |   | 7,159   |  |  |  |   | 7,159   |  |  | 95 | % | 
|National City Bank                      |  | Chicago, IL              |  | Bank Branch             |  | 5,274         |  |        | 5.89 | %                  |  | 12/2024         |  |                                | 12/2024 |                     |  |                |   | 3,114                      |  |  |  |   | 3,065   |  |  |  |   | 3,150   |  |  | 77 | % | 
|Natural Gas Pipeline Company of
America |  | Lombard, IL              |  | Office                  |  | 201,189       |  |        | 5.97 | %                  |  | 5/2008          |  |                                | 6/2007  |                     |  |                |   | 15,244                     |  |  |  |   | 8,151   |  |  |  |   | 8,151   |  |  | 33 | % | 
|Neiman Marcus Group, Inc.               |  | Las Vegas, NV            |  | Retail                  |  | 167,000       |  |        | 6.06 | %                  |  | 11/2022         |  |                                | 11/2021 |                     |  |                |   | 8,267                      |  |  |  |   | 7,381   |  |  |  |   | 8,029   |  |  | 78 | % | 
|United States Postal Service            |  | Scammon Bay, AK          |  | Post Office             |  | 2,080         |  |        | 7.05 | %                  |  | 10/2021         |  |                                | 10/2021 |                     |  |                |   | 1,015                      |  |  |  |   | 955     |  |  |  |   | 975     |  |  | 74 | % | 
|University of Connecticut Health
Center |  | Farmington, CT           |  | Medical Center          |  | 100,000       |  |        | 6.34 | %                  |  | 11/2029         |  |                                | 11/2024 |                     |  |                |   | 22,800                     |  |  |  |   | 22,164  |  |  |  |   | 23,019  |  |  | 89 | % | 
|Walgreen Co.                            |  | Dallas, TX               |  | Retail Drug             |  | 14,550        |  |        | 6.46 | %                  |  | 12/2029         |  |                                | 12/2029 |                     |  |                |   | 3,534                      |  |  |  |   | 3,481   |  |  |  |   | 3,481   |  |  | 81 | % | 
|Walgreen Co.                            |  | Montebello, CA           |  | Retail Drug             |  | 14,414        |  |        | 6.10 | %                  |  | 3/2030          |  |                                | 2/2030  |                     |  |                |   | 4,680                      |  |  |  |   | 4,633   |  |  |  |   | 4,633   |  |  | 68 | % | 
|Walgreen Co.                            |  | Rosemead, CA             |  | Retail Drug             |  | 12,004        |  |        | 5.99 | %                  |  | 12/2029         |  |                                | 12/2029 |                     |  |                |   | 4,700                      |  |  |  |   | 4,651   |  |  |  |   | 4,651   |  |  | 70 | % | 
|Xerox Corporation (2)                   |  | El
Segundo, CA           |  | Office                  |  | 330,266       |  |        | 7.54 | %                  |  | 11/2007         |  |                                | 11/2007 |                     |  |                |   | 16,483                     |  |  |  |   | 9,322   |  |  |  |   | 9,319   |  |  | 19 | % | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   | 256,212                    |  |  |  |   | 238,018 |  |  |  |   | 240,333 |  |  |    |   | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 
|Corporate Credit Notes                  |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 
|Albertsons, Inc.                        |  | Los Angeles, CA          |  | Retail Drug             |  | 16,475        |  |        | 6.50 | %                  |  | 7/2028          |  |                                | 9/2013  |                     |  |                |   | 437                        |  |  |  |   | 363     |  |  |  |   | 327     |  |  | 84 | % | 
|Albertsons, Inc.                        |  | Norwalk, CA              |  | Retail Drug             |  | 14,696        |  |        | 6.33 | %                  |  | 11/2028         |  |                                | 12/2013 |                     |  |                |   | 470                        |  |  |  |   | 399     |  |  |  |   | 394     |  |  | 75 | % | 
|Best Buy Co., Inc.                      |  | Olathe, KS               |  | Retail                  |  | 48,744        |  |        | 5.40 | %                  |  | 1/2018          |  |                                | 6/2013  |                     |  |                |   | 1,779                      |  |  |  |   | 1,462   |  |  |  |   | 1,395   |  |  | 83 | % | 
|Best Buy Co., Inc.                      |  | Wichita Falls, TX        |  | Retail                  |  | 30,038        |  |        | 6.15 | %                  |  | 1/2017          |  |                                | 11/2012 |                     |  |                |   | 743                        |  |  |  |   | 572     |  |  |  |   | 542     |  |  | 79 | % | 
|CVS Corporation                         |  | Clemmons, NC             |  | Retail Drug             |  | 10,880        |  |        | 5.54 | %                  |  | 1/2022          |  |                                | 1/2015  |                     |  |                |   | 285                        |  |  |  |   | 265     |  |  |  |   | 253     |  |  | 65 | % | 
|CVS Corporation                         |  | Commerce, MI             |  | Retail Drug             |  | 10,880        |  |        | 5.85 | %                  |  | 4/2025          |  |                                | 5/2013  |                     |  |                |   | 501                        |  |  |  |   | 412     |  |  |  |   | 396     |  |  | 86 | % | 
|CVS Corporation                         |  | Garwood, NJ              |  | Retail Drug             |  | 11,970        |  |        | 6.12 | %                  |  | 6/2025          |  |                                | 8/2013  |                     |  |                |   | 879                        |  |  |  |   | 720     |  |  |  |   | 698     |  |  | 85 | % | 
|CVS Corporation                         |  | Kennett Square, PA       |  | Retail Drug             |  | 12,150        |  |        | 6.40 | %                  |  | 1/2025          |  |                                | 10/2012 |                     |  |                |   | 857                        |  |  |  |   | 643     |  |  |  |   | 619     |  |  | 87 | % | 
|CVS Corporation                         |  | Knox, IN                 |  | Retail Drug             |  | 10,125        |  |        | 7.60 | %                  |  | 1/2024          |  |                                | 12/2011 |                     |  |                |   | 322                        |  |  |  |   | 222     |  |  |  |   | 221     |  |  | 73 | % | 
|CVS Corporation                         |  | Rockingham, NC           |  | Retail Drug             |  | 10,125        |  |        | 6.12 | %                  |  | 1/2025          |  |                                | 10/2013 |                     |  |                |   | 435                        |  |  |  |   | 362     |  |  |  |   | 353     |  |  | 79 | % | 
|CVS Corporation                         |  | Rutherford College, NC   |  | Retail Drug             |  | 10,125        |  |        | 6.12 | %                  |  | 1/2025          |  |                                | 10/2013 |                     |  |                |   | 346                        |  |  |  |   | 299     |  |  |  |   | 291     |  |  | 81 | % | 
|Federal Express Corporation             |  | Bellingham, WA           |  | Distribution            |  | 30,313        |  |        | 5.78 | %                  |  | 10/2018         |  |                                | 3/2015  |                     |  |                |   | 362                        |  |  |  |   | 343     |  |  |  |   | 335     |  |  | 73 | % | 
|FedEx Ground Package System,
Inc.       |  | McCook, IL               |  | Industrial Distribution |  | 159,699       |  |        | 5.89 | %                  |  | 1/2019          |  |                                | 2/2015  |                     |  |                |   | 2,737                      |  |  |  |   | 2,566   |  |  |  |   | 2,533   |  |  | 84 | % | 
|FedEx Ground Package System,
Inc.       |  | Reno, NV                 |  | Industrial Distribution |  | 106,396       |  |        | 5.90 | %                  |  | 9/2018          |  |                                | 10/2014 |                     |  |                |   | 1,374                      |  |  |  |   | 1,253   |  |  |  |   | 1,240   |  |  | 80 | % | 
|Lowes Companies, Inc.                   |  | N.
Windham, ME           |  | Retail                  |  | 138,134       |  |        | 5.28 | %                  |  | 2/2026          |  |                                | 9/2015  |                     |  |                |   | 1,140                      |  |  |  |   | 1,140   |  |  |  |   | 1,116   |  |  | 86 | % | 
|PerkinElmer, Inc.                       |  | Beltsville, MD           |  | Office/Industrial       |  | 65,862        |  |        | 7.35 | %                  |  | 11/2021         |  |                                | 12/2011 |                     |  |                |   | 707                        |  |  |  |   | 485     |  |  |  |   | 481     |  |  | 83 | % | 
|                                        |  |                          |  |                         |  |               |  |        |      |                    |  |                 |  |                                |         |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |    |   | 

7

---



|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|------------------------------- |  | ------------------ |  | ----------------- |  | ------------- |  | ------ | ----- | ------------------ |  | --------------- | ------- | ------------------------------ |  | ------------------- |  | -------------- | - | -------------------------- |  |  |  | - | ------- |  |  |  | - | ------- |  |  | --- | - | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  | (in thousands) |   |                            |  | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  | 
|Tenant or Guarantor             |  | Location           |  | Property Type     |  | Square
  Feet |  | Coupon |       | Lease
  Expiration |  | Loan
  Maturity |         | Original
  Principal
  Balance |  | Principal
  Balance |  | Carry Value    |   | Loan to Realty
  Value (1) | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            | 
|PerkinElmer, Inc.               |  | Daytona Beach, FL  |  | Office/Industrial |  | 34,196        |  |        | 7.35  | %                  |  |                 | 11/2021 |                                |  | 12/2011             |  |                |   | 321                        |  |  |  |   | 220     |  |  |  |   | 218     |  |  | 79  | % | 
|PerkinElmer, Inc.               |  | Phelps, NY         |  | Office/Industrial |  | 32,700        |  |        | 7.35  | %                  |  |                 | 11/2021 |                                |  | 12/2011             |  |                |   | 299                        |  |  |  |   | 205     |  |  |  |   | 200     |  |  | 86  | % | 
|PerkinElmer, Inc.               |  | Warwick, RI        |  | Office/Industrial |  | 95,720        |  |        | 7.68  | %                  |  |                 | 12/2021 |                                |  | 1/2012              |  |                |   | 939                        |  |  |  |   | 654     |  |  |  |   | 639     |  |  | 84  | % | 
|Staples, Inc.                   |  | Odessa, TX         |  | Retail Office     |  | 23,942        |  |        | 6.41  | %                  |  |                 | 6/2015  |                                |  | 9/2012              |  |                |   | 408                        |  |  |  |   | 310     |  |  |  |   | 293     |  |  | 80  | % | 
|Walgreen Co.                    |  | Delray Beach, FL   |  | Retail Drug       |  | 15,120        |  |        | 6.20  | %                  |  |                 | 1/2021  |                                |  | 1/2013              |  |                |   | 595                        |  |  |  |   | 458     |  |  |  |   | 455     |  |  | 77  | % | 
|Walgreen Co.                    |  | Jefferson City, TN |  | Retail Drug       |  | 14,266        |  |        | 5.49  | %                  |  |                 | 3/2030  |                                |  | 5/2015              |  |                |   | 786                        |  |  |  |   | 751     |  |  |  |   | 751     |  |  | 92  | % | 
|Walgreen Co.                    |  | Riverside, CA      |  | Retail Drug       |  | 12,804        |  |        | 6.10  | %                  |  |                 | 10/2028 |                                |  | 12/2013             |  |                |   | 571                        |  |  |  |   | 483     |  |  |  |   | 472     |  |  | 76  | % | 
|Walgreen Co.                    |  | Waterford, MI      |  | Retail Drug       |  | 14,490        |  |        | 5.50  | %                  |  |                 | 1/2023  |                                |  | 6/2013              |  |                |   | 953                        |  |  |  |   | 763     |  |  |  |   | 711     |  |  | 84  | % | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   | 18,246                     |  |  |  |   | 15,350  |  |  |  |   | 14,933  |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|Mezzanine and Other
Investments |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|CVS Corporation                 |  | Aliso Viejo, CA    |  | Retail Drug       |  | N/A           |  |        | 9.17  | %                  |  |                 | 9/2024  |                                |  | 2/2006              |  |                |   | 5,000                      |  |  |  |   | 5,000   |  |  |  |   | 5,000   |  |  | 46  | % | 
|Hercules Incorporated           |  | Wilmington, DE     |  | Office/Hdqr       |  | 155,000       |  |        | 8.54  | %                  |  |                 | 5/2013  |                                |  | 6/2013              |  |                |   | 14,000                     |  |  |  |   | 13,700  |  |  |  |   | 13,700  |  |  | 85  | % | 
|Hercules Incorporated           |  | Wilmington, DE     |  | Office/Hdqr       |  | 155,000       |  |        | 14.04 | %                  |  |                 | 5/2013  |                                |  | 6/2013              |  |                |   | 2,575                      |  |  |  |   | 2,575   |  |  |  |   | 2,575   |  |  | 85  | % | 
|Hercules Incorporated           |  | Wilmington, DE     |  | Office/Hdqr       |  | 155,000       |  |        | 8.79  | %                  |  |                 | 5/2013  |                                |  | 6/2013              |  |                |   | 14,000                     |  |  |  |   | 14,000  |  |  |  |   | 14,000  |  |  | 85  | % | 
|Hercules Incorporated           |  | Wilmington, DE     |  | Office/Hdqr       |  | 155,000       |  |        | 14.29 | %                  |  |                 | 5/2013  |                                |  | 6/2013              |  |                |   | 6,120                      |  |  |  |   | 6,120   |  |  |  |   | 6,120   |  |  | 85  | % | 
|Walgreen Co.                    |  | Bristol, CT        |  | Retail Drug       |  | N/A           |  |        | 10.00 | %                  |  |                 | N/A     |                                |  | 7/2007              |  |                |   | 21                         |  |  |  |   | 21      |  |  |  |   | 21      |  |  | N/A |   | 
|Walgreen Co.                    |  | Jackson, NJ        |  | Retail Drug       |  | N/A           |  |        | 10.00 | %                  |  |                 | N/A     |                                |  | 3/2007              |  |                |   | 312                        |  |  |  |   | 312     |  |  |  |   | 312     |  |  | N/A |   | 
|Walgreen Co.                    |  | Mansfield, NJ      |  | Retail Drug       |  | N/A           |  |        | 10.00 | %                  |  |                 | N/A     |                                |  | 5/2007              |  |                |   | 409                        |  |  |  |   | 409     |  |  |  |   | 409     |  |  | N/A |   | 
|Walgreen Co.                    |  | Staten Island, NY  |  | Retail Drug       |  | N/A           |  |        | 10.00 | %                  |  |                 | N/A     |                                |  | 7/2007              |  |                |   | 630                        |  |  |  |   | 630     |  |  |  |   | 630     |  |  | N/A |   | 
|Walgreen Co.                    |  | Tinley Park, IL    |  | Retail Drug       |  | N/A           |  |        | 10.00 | %                  |  |                 | N/A     |                                |  | 3/2007              |  |                |   | 344                        |  |  |  |   | 344     |  |  |  |   | 344     |  |  | N/A |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   | 43,411                     |  |  |  |   | 43,111  |  |  |  |   | 43,111  |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 
|Total                           |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                | $ | 317,869                    |  |  |  | $ | 296,479 |  |  |  | $ | 298,377 |  |  |     |   | 
|                                |  |                    |  |                   |  |               |  |        |       |                    |  |                 |         |                                |  |                     |  |                |   |                            |  |  |  |   |         |  |  |  |   |         |  |  |     |   | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | All percentages have been rounded to the
  nearest whole percentage.  Loan to
  realty value is the ratio of the principal balance of the loan as of December
  31, 2005 to the appraised value of the real estate that secures the loan at
  the time of the loan.  The current
  value of the real estate may be different.
  The loan to realty value for each corporate credit note includes the
  principal balance of the portion of the loan we have sold, and the loan to
  realty value of the mezzanine investments on the Hercules property include
  the principal balance of the senior debt on the property.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|(2) | The coupon on this
  loan resets monthly at LIBOR plus 3.25%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

8

---



Commercial
Mortgage-Backed and Other Real Estate Securities

We
also invest in commercial mortgage-backed securities, or CMBS, and other real
estate securities. Our CMBS investments include senior, subordinate and
interest-only classes of primarily net lease loan securitizations or pass
through trusts. Our real estate securities represent our pro rata investments
in a pool of mortgage loans on properties net leased to a single tenant. We
believe we are well-positioned to evaluate net lease CMBS investments and real
estate securities due to our expertise with net lease loan assets and our
experience in structuring CMBS investments. We structured four CMBS
securitizations aggregating approximately $1.5 billion prior to our initial
public offering. As a result of our familiarity with the collateral included in
these transactions, many of our CMBS investments to date have been made in
classes of our prior securitizations.

The
following pie chart depicts the credit quality(1)of our portfolio of CMBS and other
real estate securities as of December 31, 2005.

A-15% AAA 7% BBB4% BBB- 24% BBB+ 8% Non-Investment Grade 42%


(1) Reflects actual ratings on our CMBS securities and underlying
tenant ratings on our other real estate securities.

Our
CMBS and other real estate securities are expected to generate the following
annual cash flows(1)through the year 2025.

0 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 40,000,000 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Years Dollars


(1) Reflects
scheduled payments of interest and principal on all of our securities. Actual
results may differ materially from those projected. Please see Risk Factors
section.

9

---



Our CMBS
and other real estate securities as of December 31, 2005 are summarized in the
following table:

|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|--------------------------------------------------------- |  | --------- | --------- | ----------- | - | ----------- |  | ------ | ------- | --------- |  | ------------- | - |  | ----- | - |  | -------- | 
|(in
        thousands)                                   
|Security Description                                      |  | CUSIP No. |           | Face Amount |   | Carry Value |  | Coupon |         | Yield (1) |  | Maturity Date |  
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |  
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|Investments in
  Commercial Mortgage Loan Securitizations |  |           |           |             |   |             |  |        |         |           |  |               |  
|BSCMS 1999 CLF1, Class E                                  |  |           | 07383FCC0 |             | $ | 3,326       |  | $      | 2,280   |           |  | 7.11          | % |  | 11.58 | % |  | Nov 2023 | 
|BSCMS 1999 CLF1, Class F                                  |  |           | 07383FCD8 |             |   | 2,494       |  |        | 650     |           |  | 7.11          | % |  | 30.08 | % |  | Oct 2023 | 
|CALFS 1997-CTL1, Class D                                  |  |           | 140281AF3 |             |   | 6,000       |  |        | 5,937   |           |  | 6.16          | % |  | 6.35  | % |  | Nov 2018 | 
|CMLBC 2001-CMLB-1, Class E                                |  |           | 201736AJ4 |             |   | 9,526       |  |        | 11,269  |           |  | 7.85          | % |  | 6.21  | % |  | Jul 2022 | 
|CMLBC 2001-CMLB-1, Class G                                |  |           | 201736AL9 |             |   | 9,526       |  |        | 10,267  |           |  | 7.85          | % |  | 7.21  | % |  | Mar 2023 | 
|CMLBC 2001-CMLB-1, Class H                                |  |           | 201736AM7 |             |   | 11,907      |  |        | 7,646   |           |  | 6.25          | % |  | 10.95 | % |  | Apr 2024 | 
|CMLBC 2001-CMLB-1, Class J                                |  |           | 201736AN5 |             |   | 6,383       |  |        | 2,178   |           |  | 6.25          | % |  | 20.00 | % |  | Oct 2025 | 
|NLFC 1999-LTL-1, Class D                                  |  |           | 63859CCK7 |             |   | 5,000       |  |        | 5,138   |           |  | 6.45          | % |  | 6.21  | % |  | Feb 2021 | 
|NLFC 1999-LTL-1, Class E                                  |  |           | 63859CCL5 |             |   | 11,081      |  |        | 6,930   |           |  | 5.00          | % |  | 9.81  | % |  | Apr 2022 | 
|NLFC 1999-LTL-1, Class X (IO)                             |  |           | 63859CCG6 |             |   | 8,434       |  |        | 9,177   |           |  | 0.48          | % |  | 8.50  | % |  | Jan 2024 | 
|WBCMT 2004-C15 180D                                       |  |           | 929766YG2 |             |   | 15,000      |  |        | 14,304  |           |  | 5.58          | % |  | 6.87  | % |  | Nov 2009 | 
|WBCMT 2004-C15 180E                                       |  |           | 929766YH0 |             |   | 8,000       |  |        | 7,577   |           |  | 5.58          | % |  | 7.07  | % |  | Nov 2009 | 
|BACMS 2002-2, Class V-1 (7-Eleven, Inc.)                  |  |           | 05947UJE9 |             |   | 393         |  |        | 270     |           |  | 8.72          | % |  | 12.30 | % |  | Sep 2019 | 
|BACMS 2002-2, Class V-2 (Sterling Jewelers)               |  |           | 05947UJF6 |             |   | 602         |  |        | 405     |           |  | 8.68          | % |  | 12.30 | % |  | Jan 2021 | 
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|                                                          |  |           |           |             |   | 97,672      |  |        | 84,028  |           |  |               |   |  |       |   |  |          | 
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|Investments in Certificated Loan
  Transactions           |  |           |           |             |   |             |  |        |         |           |  |               |   |  |      
|CVS Corporation                                           |  |           | 126650BB5 |             |   | 20,000      |  |        | 20,184  |           |  | 5.88          | % |  | 5.84  | % |  | Jan 2028 | 
|Yahoo, Inc.                                               |  |           | 984332AC0 |             |   | 31,990      |  |        | 33,197  |           |  | 6.65          | % |  | 6.33  | % |  | Aug 2026 | 
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|                                                          |  |           |           |             |   | 51,990      |  |        | 53,381  |           |  |               |   |  |       |   |  |          | 
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 
|Total                                                     |  |           |           |             | $ | 149,662     |  | $      | 137,409 |           |  |               |   |  |       |   |  |          | 
|                                                          |  |           |           |             |   |             |  |        |         |           |  |               |   |  |       |   |  |          | 

|    |                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------
|(1) | Represents the yield to maturity,
  computed using the effective interest method, based on our carry value.

Portfolio Financing

Our
portfolio financing strategy is to finance our portfolio assets with long-term
fixed rate debt as soon as practicable after we invest.  We seek to finance our assets on a long-term
basis with debt of a like maturity, commonly referred to as
match-funding.  Since our initial
public offering, our long-term fixed rate financings have been in the form of
mortgage debt and collateralized debt obligations, or CDOs.  Most of our real property acquisitions have
been financed on a long-term basis with third party mortgage debt, with some of
our smaller owned real properties financed through our CDO.  Most of our loan and CMBS investments are
financed or we expect will be financed on a long-term basis through our
existing or a future CDO.  A limited
number of our generally higher yielding portfolio assets are not financed.

We have
short-term borrowing arrangements in place to facilitate our investment
activity while we arrange long-term financing.
We have a $250 million repurchase agreement with Wachovia Bank, N.A.,
and, in August 2005, we entered into a real property acquisition facility with
Wachovia Bank and one of its affiliates that affords us an additional $100
million of short-term financing availability for investments in owned real
properties.  Our interest cost on our
short-term borrowings is at floating rates.

Since our
initial public offering, all of our financings have been onbalance sheet
financings, meaning the assets we finance and liabilities we incur are reported
on our balance sheet for accounting purposes.

In March
2005, we completed our first CDO.  Our
CDO was an entirely fixed rate financing.
We aggregated approximately $300 million of assets into the pool, and we
created $285 million face amount of multi-class notes and $15 million of
preferred equity through the CDO trust.
The net amount of the debt we issued was $268.1 million, inclusive of a
$0.4 million discount to face, as we retained the three most junior note
classes aggregating a face amount of $16.5 million and the full $15 million of
preferred equity.  Each of the five note
classes of the CDO was rated investment grade.
During the first five years of the CDO term, we expect to reinvest
principal repayments on the underlying assets into qualifying replacement
collateral.  The CDO notes are expected
to mature in January 2015.  Our
effective blended financing rate (inclusive of original issue discount and debt
issuance and hedge costs) on our CDO is approximately 5.67%.

We are
currently aggregating assets for our next CDO financing.  We expect our next CDO issuance to occur in
the second or third quarter of 2006.

As of
December 31, 2005, the following statistics summarize our portfolio financing
position:

| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | leverage of approximately 79% (short-term
  and long-term secured debt divided by assets in portfolio);

10

---



| |   |                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                            
| |  | $551.8 million of total mortgage debt at a weighted average
  coupon of 5.37% and a weighted average effective financing rate of 5.52%; and
| |   |                                                                                                                                            
| |  | $268.2 million of CDO debt at an effective blended financing
  rate of approximately 5.67%.                                                

Hedging Strategy

We employ a
hedging and risk management strategy to protect our investments from interest
rate fluctuations prior to obtaining long-term fixed rate financing.  We have done so by having derivative and
other risk management transactions that react in a corresponding but opposite
manner to offset changes in the value of our investments due to changes in
underlying U.S. Treasury interest rates and, to a lesser degree, swap
spreads.  For example, as underlying
interest rates fall, the value of our fixed-rate investment increases, while
the value of our derivative and other risk management transaction
declines.  Conversely, as underlying interest
rates rise, the value of our fixed-rate investment falls while the value of our
derivative and other risk management transaction increases.  We use forward starting interest rate swaps
to hedge the variability of changes in the interest-related cash outflows on
our forecasted future borrowings.
Interest rate swaps are agreements between two parties to exchange, at
particular intervals, payment streams calculated on a specified notional
amount.  The interest rate swaps that we
have entered into are single currency interest rate swaps and, as such, do not
require the exchange of a notional amount.
As of December 31, 2005, we were hedging our exposure to such
variability through July 2016.

Some
assets, including development loans and subordinated CMBS securities, may not
be hedged at all.  We intend generally
to continue to seek to manage our interest rate exposure taking into account
the cost of such derivative and other risk management transactions and the
limitations on derivative and other risk management transactions imposed by the
REIT tax rules.

Revenue Concentrations in 2005

During
2005, Aon Corporation accounted for approximately $11.9 million, or 16.3%, of
our total revenues.  As we continue to
add assets to our portfolio and as those assets and existing assets begin to
generate income, we expect revenues from our lease with Aon to generate a
smaller percentage of our total revenues.
Any financial difficulty or bankruptcy resulting in nonpayment or delay
of rental payments and any other amounts due under our lease with Aon
Corporation could have a material adverse effect on our cash flows and
operating results.

Asset Pipeline

Owned Property
Pipeline.

Our owned
property pipeline includes potential acquisitions in various stages of
review.  We generally have from 5 to 10
potential transactions in different stages in our property acquisition
qualification, pricing and due diligence process at any given time.  Once we determine that a transaction meets
our criteria for purchase, we negotiate an expression of interest or proceed
directly to a purchase and sale agreement with the owner for the purchase of
the property.  The expression of
interest does not bind us to purchase, but may bind the seller not to accept
another offer to purchase the property during the negotiation of a purchase and
sale contract.  We generally seek to
negotiate a due diligence period during which we can terminate our obligations
for any reason and receive back any deposit we paid into escrow.  After that due diligence period, any deposit
we paid into escrow typically becomes non-refundable.  We seek to close our real property acquisitions within four to
eight weeks after the purchase and sale agreement is signed.

Loan Pipeline.

Our loan
pipeline includes potential loans in various stages of review.  We receive frequent requests for net lease
financing and have numerous potential transactions in different stages in our
loan origination qualification, pricing and due diligence process at any given
time.  Once we have reviewed and
determined that a lease is financeable under our program, we will, at the
borrowers request, issue a term sheet, which briefly outlines the pricing and
terms under which we propose to finance the property.  Upon acceptance of the term sheet by the borrower, we issue a
form of application, which sets forth the detailed terms of the
transaction.  Once the borrower signs an
application and delivers it to us with a deposit and the application is accepted,
we consider such loans to be committed loans, subject to our due diligence
process and final approval by our investment committee.  We generally close a committed loan within
four to eight weeks after the application is signed.  At any time from the date of acceptance of the application until
closing, the borrower may lock in the interest rate on the loan by submission
of an additional deposit, payment of an additional fee and execution of a rate
lock agreement.

Origination Network

We maintain
a comprehensive marketing, advertising and public relations program that
supports our origination efforts.  The
objective of the program is to establish and build our name recognition and
credibility and to promote our net lease

11

---



programs.  We believe, based
upon our experience and responses from customers, that we have been successful
in achieving our objectives of market awareness and prominence in the net lease
market.

Property
Acquisitions.

Since our
initial public offering, we have leveraged our relationships within our loan
origination business and our knowledge of the net lease business to develop
relationships with investment sale brokers, through which we primarily identify
real property for purchase.  We also
source property acquisition opportunities directly from developers and owners
or investors in real estate assets.
Because of the inherent synergies among our products, from time to time
we identify property acquisition opportunities through our loan origination
network and vice versa.

Our
property acquisition network is smaller and less specialized than our loan
origination network.  As a result, we
have found that our sources for property acquisition opportunities require less
marketing and training efforts than those required in our loan origination
business.  We frequently meet with
investment sale brokers to discuss our investment criteria.  We also include members of our property
acquisition network on distributions of our bimonthly newsletters, brochures
and other written marketing materials.

Loan
Origination.

Our
principal source of loan origination is our national network of independent
mortgage brokers.  We have established
and maintain relationships with over 2,000 individual mortgage brokers at over
200 mortgage brokerage companies and commercial banks, through which we
primarily originate loans.  We also
originate loans directly from developers and owners or investors in net leased
properties.  A significant portion of
our business is with repeat customers.

Mortgage
brokers working with net lease products need specialized knowledge and skills
not generally required for traditional real estate debt and equity activities.  We provide the brokers with ongoing training
regarding our products and we routinely meet with mortgage brokers to discuss
the latest developments in net lease financing.  As part of our efforts to educate our mortgage broker network
about net lease financing, we provide bimonthly newsletters, brochures and
other written material intended to keep mortgage brokers up to date on the
latest underwriting requirements for net lease financings and net leases, lease
enhancements, and changes in tenant credit ratings, as well as to provide
information on our latest programs.

In addition
to our training and marketing support of mortgage brokers, our executives and
staff periodically assist brokers by meeting with owners to explain various
aspects of our net lease financing programs, and by assisting in structuring
transactions to meet the owners requirements.
Based upon responses from these brokers as well as our experience, we
believe that our ongoing marketing efforts, combined with comprehensive
training programs, are key factors not only in creating and maintaining
relationships with productive mortgage brokers but also in improving their
productivity.  Furthermore, we believe
that we have streamlined our loan approval process and centralized asset
underwriting as well as many transactional and structuring matters to make the
origination of our net lease loan assets efficient for brokers.  As a result, we believe these mortgage
brokers can focus on identifying possible additional owners of net lease assets
and facilitating the loan closing process, rather than focusing solely on
underwriting each loan.

Underwriting Process

Once a
prospective net lease investment opportunity is identified, the potential
transaction undergoes a comprehensive underwriting and due diligence process
that is overseen by our investment committee, which consists of six of our key
employees, including the chief executive officer, president, chief financial
officer and chief investment officer.
The focus of our asset underwriting falls into three primary areas:

| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | credit and financial reviews of the tenant as well as an
  assessment of the tenants business, the overall industry segment and the
  tenants market position within the industry;
| |   |                                                                                                                                                                                     
| |  | lease quality, including an analysis of the term, tenant
  termination and abatement rights, landlord obligations and other lease
  provisions; and                                 
| |   |                                                                                                                                                                                     
| |  | a
  real estate fundamentals review and analysis.                                                                                                                                   

The credit
quality of the tenant under the net lease is an important aspect of the
underwriting of a net lease transaction. Prior to entering into any net lease
transaction, our underwriter, assisted by our chief investment officer and
chief financial officer as necessary, conducts a review of the tenants credit
quality.  This review may include
reviews of publicly available information, including any public credit ratings,
audited financial statements, debt and equity analyst reports, and reviews of
corporate credit spreads, stock prices and market capitalization.

While we
have no defined minimum credit rating or balance sheet size for tenants, we
anticipate that a significant majority of the tenants underlying our net lease
investments will have investment grade or implied investment grade credit
ratings. For those tenants that either are below investment grade or are
unrated, we may conduct additional due diligence,

12

---



including additional financial reviews of the tenant and a more
comprehensive review of the business segment and industry in which the tenant
operates.

In
addition, with respect to the underlying collateral, we may conduct, or engage
a third-party provider to conduct, a more comprehensive review of the real
estate, including evaluating alternative uses for the real estate and the costs
associated with converting to such alternative uses as well as examining the
surrounding real estate market in greater detail.

Assuming
that the credit of the tenant under the net lease is satisfactory, a thorough
review is then conducted into the quality of the lease, focusing primarily on
the landlords obligations under the lease and those provisions of the lease
that would permit the tenant to terminate or abate rent prior to the conclusion
of the primary lease term.  For our
owned property investments, we analyze the lease to ensure that all or
substantially all of the property expenses are borne by the tenant or that any
property expenses not borne by the tenant are sufficiently underwritten to
assure that we can isolate a predictable cash flow from the asset.  For our loan investments, we isolate any
lease provisions that provide for tenant abatement or termination rights or
landlords obligations, and determine whether to apply appropriate forms of
lease enhancements, including as necessary, specialized insurance, reserves or
debt service coverage covenants.  In
addition, each lease is reviewed by outside counsel and a lease summary is
provided to our underwriter for use in underwriting the transaction.

Finally, we
conduct a thorough review with respect to the quality of the real estate
subject to the net lease.  For our owned
properties, we thoroughly review the propertys real estate fundamentals,
including location and type of the property, vacancy rates and trends in vacancy
rates in the propertys market, rental rates within the propertys market,
recent sales prices and demographics in the propertys market.  As described in detail under Our
PortfolioOwned Properties above, we target properties with one or more of the
following: located in a primary metropolitan market, fungible asset type,
barriers to entry in the market, and a core facility of the tenant.

In the case
of a loan to a property owner, our real estate due diligence includes a review
of the background and financial capabilities of the owner.  In all cases, the property is also reviewed
from a traditional real estate perspective, including quality of construction
and maintenance, location and value of the real estate and technical issues such
as title, survey and environmental.  As
necessary, appraisals and environmental and engineering reports are obtained
from third-parties and reviewed by our underwriter and/or legal counsel.

In the case
of CMBS investments, our underwriter, assisted by our chief investment officer
and chief financial officer, thoroughly evaluate the credit, the legal and
financial structures and the collateral quality underlying the
transaction.

In addition
to our review of the quality of any individual transaction, our investment
committee also:

|  |                                                                                                                                                                                                                                                  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | evaluates our current portfolio, including consideration of how
  the subject transaction affects asset diversity and credit concentrations in
  the tenant, industry or credit level;                                                           
|  |                                                                                                                                                                                                                                                  
| | determines whether we can implement appropriate legal and
  financial structures, including our ability to control the asset in a variety
  of circumstances, including in the event of a default by the tenant or the
  borrower, as applicable;
|  |                                                                                                                                                                                                                                                  
| | evaluates the leveraged and unleveraged yield on the asset and
  how that yield compares to our target yields for that asset class and our
  analysis of the risk profile of the investment; and                                                 
|  |                                                                                                                                                                                                                                                  
| | determines our plans for financing and hedging the asset.                                                                                                                                                                                        

We use
integrated systems such as customized software and models to support our
decisions on pricing and structuring investments.  Before issuing any form of commitment to fund an investment
transaction, the transaction must be approved by our investment committee.  Our investment committee consists of our
chief executive officer, president, chief financial officer, chief investment
officer, senior vice president, investments and senior vice president,
origination.  The committee meets
frequently and on an as-needed basis to evaluate potential net lease investments.

In
addition, we have a four-member investment oversight committee of our board of
directors, which approves all transactions in excess of $50.0 million.  Only one member of this committee is an
employee of our company.  Our underwriting
standards are specifically tailored to our investments.  As we develop new products, we may emphasize
different criteria than we currently emphasize.  We also may modify our underwriting standards.

We believe
that our standardized underwriting and origination procedures and integrated
systems will enable us to manage a large and increasing volume of transactions
while maintaining underwriting quality and high levels of service to customers.
Most of our investments require minimal ongoing management.  For owned properties that require ongoing
management, we typically hire third party property managers.  We believe that we can grow our business
without significant expansion of our general and administrative costs.

13

---



Asset Surveillance System

We also have created an on-going asset surveillance system that allows
us to:

|  |                                                                                                                                            
|- | -------------------------------------------------------------------------------------------------------------------------------------------
| | track the status of our assets and asset opportunities;                                                                                    
|  |                                                                                                                                            
| | link into a management program that includes the underlying
  asset origination or acquisition documents;                                  
|  |                                                                                                                                            
| | load expected asset cash flows from our underwriting files into
  the system;                                                              
|  |                                                                                                                                            
| | monitor actual cash flows on each asset through servicer
  reports;                                                                        
|  |                                                                                                                                            
| | immediately identify issues such as non-payment of rent and
  servicer advances of rent or debt service through servicer exception reports;
|  |                                                                                                                                            
| | track credit ratings of underlying tenants; and                                                                                            
|  |                                                                                                                                            
| | compute coverage and compliance tests for our CDO transactions.                                                                            

Through this single system we are able to track and document the entire
lifecycle of our assets.

Closing Process

>From the
time we begin to consider a net lease investment until the investment is
closed, the prospective transaction undergoes a variety of defined steps and
procedures.  In connection with the
closing process, we will typically need to rely on certain third parties not
under our control, including tenants, borrowers, sellers, warehouse lenders,
brokers, outside counsel, insurance companies, title companies, environmental
consultants, appraisers, engineering consultants and other product or service
providers.  Our personnel carefully
manage the closing process and have developed a streamlined set of procedures,
checklists and relationships with many of the third-party providers with whom
we do business on an on-going basis.

As set
forth above under Underwriting Process above, each transaction goes through a
multi-stage underwriting process including review by our investment committee.  Transaction underwriting and the documentary
process surrounding it is supported by the use of standardized transaction
documents, including closing checklists and loan documents, and is further
supported by proprietary underwriting and pricing software.  All of our transactions are closed by our
in-house closing and underwriting staff, many of whom have more than five years
of experience with us.  That staff seeks
to close our loan transactions four to eight weeks after the application is
signed and close property acquisitions four to eight weeks after a purchase and
sale agreement is signed, while at the same time maintaining our underwriting
standards.

Competition

We are
subject to significant competition in each of our business segments.  We compete with specialty finance companies,
insurance companies, commercial banks, investment banks, savings and loan
associations, mortgage bankers, mutual funds, institutional investors, pension
funds, hedge funds, other lenders, governmental bodies and individuals and
other entities, including REITs.  We may
face new competitors and, due to our focus on net lease properties located
throughout the United States, and because many of our competitors are locally
and/or regionally focused, we will not encounter the same competitors in each
region of the United States.

Many of our
competitors will have greater financial and other resources and may have other
advantages over our company.  Our
competitors may be willing to accept lower returns on their investments and may
succeed in buying the assets that we have targeted for acquisition.  We may also incur costs on unsuccessful
acquisitions that we will not be able to recover.

Environmental Matters

Under
various federal, state and local environmental laws, a current owner of real
estate may be required to investigate and clean up contaminated property.  Under these laws, courts and government
agencies have the authority to impose cleanup responsibility and liability even
if the owner did not know of and was not responsible for the
contamination.  For example, liability
can be imposed upon us based on the activities of our tenants.  In addition to the cost of the cleanup,
environmental contamination on a property may adversely affect the value of the
property and our ability to sell, rent or finance the property, and may
adversely impact our investment in that property.

Prior to
acquisition of a property, we obtain Phase I environmental reports.  These reports are prepared in accordance
with an appropriate level of due diligence based on our underwriting standards
and generally include a physical site inspection, a review of relevant federal,
state and local environmental and health agency database records, one or more
interviews with appropriate site-related personnel, review of the propertys
chain of title and review of historic aerial photographs and other information
on past uses of the property and nearby or adjoining properties.  We may also require a Phase II investigation
which

14

---



may require limited subsurface investigations and tests for substances
of concern where the results of the Phase I environmental reports or other
information indicates possible contamination or where our consultants recommend
such procedures.

We believe
that our portfolio is in compliance in all material respects with all federal,
state and local laws and regulations regarding hazardous or toxic substances
and other environmental matters.

At December
31, 2005, we were not aware of any environmental concerns that would have a
material adverse effect on our financial position or results of operations.

Employees

As of
December 31, 2005, we had 21 employees. We have an experienced staff, many of
the members of which have been previously employed by the real estate
departments from major financial institutions, law firms and rating agencies.
We believe that our relations with our employees are good.  None of our employees are unionized.

Available Information

We are
required to file annual, quarterly and special reports, proxy statements and
other information with the SEC.
Investors may read and copy any document that we file, including this
Annual Report on Form 10-K, at the SECs Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Investors may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In
addition, the SEC maintains an Internet site at http://www.sec.gov that
contains reports, proxy and information statements, and other information regarding
issuers that file electronically with the SEC, from which investors can
electronically access our SEC filings.

We also
make available free of charge on or through our Web site (www.caplease.com),
our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the SEC.  Investors
can access our filings with the SEC by visiting www.caplease.com
/investor/sec.html.

The
information on our web site is not, and shall not be deemed to be, a part of
this report or incorporated into any other filings we make with the SEC.

Item 1A. Risk Factors.

Set
forth below and elsewhere in this annual report on Form 10-K and in other
documents we file or furnish with the SEC are risks and uncertainties that
could adversely affect our business and operations and cause actual results to
differ materially from the results contemplated by any forward-looking
statements made by us or on our behalf.

Risks Related to Operations

We may fail to
continue to invest in net lease assets.

Investment
in additional net lease assets is critical to the success of our business
strategy.  The net lease market is
highly competitive and we cannot assure you that we will be able to identify
net lease opportunities that meet our underwriting and return criteria.  This competition intensified during 2005,
putting downward pressure on yields and spreads on both property acquisitions
and our origination of loans for our portfolio.  If we are unable to continue to invest in additional net lease
assets that are acceptable to us, we may be unable to execute our business
plan, which could have a material adverse effect on the market price of our
stock.

We may fail to
invest in profitable assets.

Our
investment strategy contemplates investing in profitable assets, as determined
by our returns on those assets less our related financing cost.  We invest in long-term assets with generally
fixed cash flows and generally seek to finance those assets with lower coupon
long-term fixed rate debt, thus earning a profit or spread.

We
generally secure long-term financing for our assets after we agree to acquire
them.  Therefore, we price our assets at
origination or acquisition based on our assumptions about our expected future financing
cost.

If our cost
to finance our assets increases over our assumptions between the time we commit
to purchase the asset and when we obtain long-term financing, the profit or
spread we expected to earn on the asset and our overall portfolio will
erode.  Various factors could cause our
financing cost to increase, including:

|  |                                                           
|- | ----------------------------------------------------------
| | a
  decline in the credit rating of the underlying tenant;

15

---



|  |                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------
| | increases in long-term interest rates;                                                                                 
|  |                                                                                                                        
| | market dislocations caused by the failure or financial
  difficulties of a large financial institution or institutions;
|  |                                                                                                                        
| | ineffectiveness of our hedging strategies;                                                                             
|  |                                                                                                                        
| | weakening economic conditions; and                                                                                     
|  |                                                                                                                        
| | United States
  military activity and terrorist activities.                                                            

Our failure
to invest in profitable assets would have a material adverse effect on our cash
flows, results of operations and financial condition.

We conduct a
significant part of our business with Wachovia Bank, N.A. and its affiliates,
and their continued business with us is not guaranteed.

We rely on
Wachovia Bank, N.A. and its affiliates in various aspects of our business.  For example:

|  |                                                                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Wachovia Bank, N.A.
  and its affiliates provide us with short-term financing through a $250.0
  million repurchase agreement and a $100.0 million real property acquisition
  facility.                                   
|  |                                                                                                                                                                                                                            
| | Many of our real property
  acquisitions have been and we expect will continue to be financed with
  traditional mortgage debt obtained from Wachovia Bank.                                                                
|  |                                                                                                                                                                                                                            
| | Affiliates of
  Wachovia Bank, N.A. have performed investment banking services for us,
  including in connection with our initial public offering, our initial CDO
  transaction and our Series A preferred stock offering.
|  |                                                                                                                                                                                                                            
| | Wachovia Bank,
  N.A. acts as loan servicer of our net lease asset investments financed under
  our repurchase facility.                                                                                                   

These
parties are not obligated to do business with us, and any adverse developments
in their business or in our relationship with them could result in these
parties choosing not to do business with us or a significant reduction in our
business with them.  Termination of our
business with Wachovia Bank, N.A. or its affiliates or a significant reduction
in our business with these parties could have a material adverse effect on our
business, operating results and financial condition.

If we lower our
dividend, the market value of our common stock may decline.

The level
of our common stock dividend is established by our board of directors from time
to time based on a variety of factors, including our cash available for
distribution, our funds from operations and our maintenance of REIT
status.  Various factors could cause our
board of directors to decrease our common stock dividend level, including
tenant defaults resulting in a material reduction in our cash flows or a
material loss resulting from an adverse change in one or more of the tenants
underlying our investments.  If we are
required to lower our common stock dividend, the market value of common stock
in our company could be adversely affected.

An interruption
in or breach of our information systems could impair our ability to acquire
assets on a timely basis and may result in lost business.

We rely
heavily upon communications and electronic information systems to conduct our
business.  Any failure or interruption
or breach in security of our information systems or the third-party information
systems on which we rely could cause underwriting or other delays and could
result in reduced efficiency in asset servicing.  We cannot assure you that any failures or interruptions will not
occur or, if they do occur that we or the third parties on whom we rely will
adequately address them. The occurrence of any failures or interruptions could
significantly harm our financial condition and operating results.

Risks Related to Net Lease Assets

An adverse
change in the financial condition of one or more tenants underlying our net
lease investments could have a material adverse impact on us.

We make
investments in net lease assets based on the financial strength of the
underlying net lease tenant and our expectations of their continued payment of
rent under the lease.  We rely on rent
payments under the lease for our cash flows.
Therefore, adverse changes in the financial condition of the tenants or
the certainty of their ability to pay rents could have a material adverse
impact on us.  For example:

|  |                                                                                                                                                                                                                
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The bankruptcy,
  insolvency or failure to make rental payments by a tenant to whom we have
  significant exposure could result in a material reduction of our cash flows
  and material losses to our company.

16

---



|  |                                                                                                                                                                                                                                                                                                                                                                                                                       
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The value of our
  net lease investments is primarily driven by the credit quality of the
  underlying tenant or tenants, and an adverse change in the subject tenants
  financial condition or a decline in the credit rating of such tenant may
  result in a decline in the value of our net lease investments and a charge to
  our income statement.                                                            
|  |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | An adverse change
  in the financial condition of one or more tenants underlying our net lease
  investments or a decline in the credit rating of one or more tenants
  underlying our net lease investments could result in a margin call if the
  related asset is being financed on our short-term borrowing facilities, and
  could make it more difficult for us to arrange long-term financing for that
  asset.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                       
| | We own the
  subordinate classes in our CDO financings.
  If the underlying tenant on any asset financed in our CDO fails to
  make rental payments, we may fail to satisfy coverage tests under the CDO,
  which could result in our cash flows from the assets in the CDO being
  redirected to senior class owners.                                                                                                

We are subject
to tenant credit concentrations that make us more susceptible to adverse events
with respect to certain tenants.

We are
subject to the following tenant credit concentrations as of December 31, 2005:

| |   |                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |  | approximately $196.7 million, or 16.3%, of
  our assets in portfolio involve properties leased to the United States
  Government;               
| |   |                                                                                                                                                 
| |  | approximately $88.5 million, or 7.3%, of our assets in portfolio
  involve properties leased to, or leases guaranteed by, Lowes Companies Inc.;
| |   |                                                                                                                                                 
| |  | approximately $83.7 million, or 6.9%, of our assets in portfolio
  involve properties leased to, or leases guaranteed by, Aon Corporation;      
| |   |                                                                                                                                                 
| |  | approximately
  $77.1 million, or 6.4%, of our assets in portfolio involve properties leased
  to, or leases guaranteed by, Tiffany & Co.; and  
| |   |                                                                                                                                                 
| |  | approximately
  $67.7 million, or 5.6%, of our assets in portfolio involve properties leased
  to, or leases guaranteed by, CVS Corporation.    

Any
bankruptcy, insolvency or failure to make rental payments by, or any adverse
change in the financial condition of, one or more of these tenants or any other
tenant to whom we may have a significant credit concentration in the future,
could result in a material reduction of our cash flows or material losses to
our company.

We are subject
to tenant industry concentrations that make us more susceptible to adverse
events with respect to certain industries.

We are
subject to the following industry concentrations as of December 31, 2005:

|  |                                                                                                                                                                                                                                                                   
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | approximately $179.4 million, or 14.9%, of our assets in
  portfolio involve properties leased to, or leases guaranteed by, companies in
  the insurance industry (e.g., Aon Corporation, Allstate Insurance Company,
  Farmers New World Life Insurance Company);
|  |                                                                                                                                                                                                                                                                   
| | approximately $105.5 million, or 8.8%, of our assets in
  portfolio involve properties leased to, or leases guaranteed by, companies in
  the retail home improvements industry (e.g., Lowes Companies, Inc. and Home
  Depot USA, Inc.); and                    
|  |                                                                                                                                                                                                                                                                   
| | approximately $93.3 million, or 7.7%, of our assets in portfolio
  involve properties leased to, or leases guaranteed by, companies in the
  retail drug industry (e.g., CVS Corporation, Walgreen Co.).                                                          

Any
downturn in one or more of these industries or in any other industry in which
we may have a significant credit concentration in the future could have a
material adverse effect on our cash flows and operating results.

We are subject to geographic concentrations
that make us more susceptible to adverse events in these areas.

We are
subject to the following geographic concentrations as of December 31,
2005:

|  |                                                                                                                                                         
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | approximately
  $188.8 million, or 15.7%, of our assets in portfolio are investments in
  properties located in the Chicago, Illinois metropolitan area;
|  |                                                                                                                                                         
| | approximately $176.2 million, or 14.6%, of our assets in
  portfolio are investments in properties located in the Washington, D.C.
  metropolitan area; 

17

---



|  |                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | approximately $149.3 million, or 12.4%, of our assets in
  portfolio are investments in properties located in the New York City and
  Northern New Jersey area; and
|  |                                                                                                                                                                    
| | approximately $77.2 million, or 6.4%, of our assets in portfolio
  are investments in properties located in the Southern California area.                          

An economic
downturn or other adverse events or conditions such as terrorist attacks or
natural disasters in one or more of these areas, or any other area where we may
have a significant credit concentration in the future, could have a material
adverse effect on our financial condition and operating results.

Our investments
in assets backed by below investment grade credits have a greater risk of
default.

We invest
in net lease assets where the underlying tenants credit rating is below
investment grade (approximately $101.0 million, or 8.4%, of our assets in
portfolio as of December 31, 2005).
These investments will have a greater risk of default and bankruptcy
than investments on properties net leased exclusively to investment grade
tenants.

Our investments
in assets where we obtain private credit ratings expose us to certain risks.

In order to
effectively implement our financing strategy, we are required to have ratings
for all of the underlying tenants on our loans and properties.  When we invest in a loan or property where
the underlying tenant does not have a publicly available credit rating, we rely
on our own estimates of the tenants credit rating and later obtain a private
rating from S&P or Moodys to allow us to finance the asset as we had
planned.  If S&P or Moodys
disagrees with our ratings estimates, we may not be able to obtain our desired
level of leverage and/or our financing costs may exceed those that we
projected.  This outcome could have an
adverse impact on our returns on that asset and hence our operating results.

Risks Related to Ownership of Real Estate

Single tenant
leases involve significant risks of tenant default.

We focus
our real estate acquisition activities on properties that are net leased to
single tenants.  Therefore, a default by
the sole tenant is likely to cause a significant or complete reduction in the
operating cash flow generated by the property leased to that tenant and a
reduction in the value of that property.

Bankruptcy laws
will limit our remedies if a tenant becomes bankrupt and rejects our lease.

We rely on
rent payments under our lease with the tenant for the cash flows to fund our
financing of the property and to generate the spread, or profit, we earn on
the asset.  If the tenant becomes
insolvent or bankrupt, our lease may be rejected and rent payments could cease.  In such a case, our remedies will be limited
under the United States Bankruptcy Code.
We may not be able to recover the premises promptly from the tenant and
our claim for damages, which is limited to rent under the lease for the greater
of one year or 15 percent (but not more than three years) of the remaining
term, plus rent already due but unpaid, may not be sufficient to cover our debt
service and any other expenses with respect to the property.

The success of
our owned properties business will depend on our ability to obtain third-party
management for the real properties we purchase.

For many of
our owned properties, we retain property owner obligations under the
lease.  These obligations range from
structural repair of the building to common area maintenance.  In most of these instances, we retain third
party property managers to perform our obligations.  A failure of these managers or us to perform could trigger the
tenants right to terminate the lease or abate rent.  In addition, if the managers or us fail to perform our
obligations in a cost-effective manner, our net cash flows from the property
and hence our operating results and cash flows could be adversely affected.

Operating
expenses of our properties could reduce our cash flow and funds available for
future dividends.

For certain
of our owned properties, we are responsible for operating costs of the
property.  In these instances, our lease
requires the tenant to reimburse us for all or a portion of these costs, either
in the form of an expense reimbursement or increased rent.  Our reimbursement may be limited to a fixed
amount or a specified percentage annually.
To the extent operating costs exceed our reimbursement, our cash flows
and returns would be harmed and our ability to pay dividends may be harmed.

We have greater
exposure to operating costs when we invest in owned properties leased to the
United States Government.

Our leases
with the United States Government are typical Government Services
Administration, or GSA, type leases.
These leases do not provide that the United States Government is wholly
responsible for operating costs of the property, but include an operating cost
component within the rent we receive that increases annually by an agreed upon
percentage based

18

---



upon the Consumer Price Index, or CPI.
Thus, we have greater exposure to operating costs on our properties
leased to the United States Government because if the operating costs of the
property increase faster than CPI, we will bear those excess costs.

We may not be
able to renew our leases or re-lease our properties.

Upon the
expiration of leases on our properties, we may not be able to re-let all or a
portion of that property, or the terms of re-letting (including the cost of
concessions to tenants) may be less favorable to us than current lease terms.
If we are unable to re-let promptly or if the rental rates upon re-letting are
significantly lower than the current rates, our financial condition and
operating results will be adversely affected. There can be no assurance that we
will be able to retain tenants upon the expiration of their leases.

It may be
difficult for us to buy and sell real estate quickly.

Real estate
investments are relatively illiquid.
Our ability to vary our portfolio by selling and buying properties in
response to changes in economic and other conditions will be limited.  In addition, the mortgage debt we put on the
property and REIT tax requirements restrict our ability to quickly re-sell
properties we have purchased.  If we
must sell a property, we cannot assure you that we will be able to dispose of
the property in the time period we desire or that the sales price of the
property will recoup or exceed our cost for the property.

An uninsured
loss or a loss that exceeds the insurance policy limits on our owned properties
could subject us to lost capital or revenue on those properties.

Our
comprehensive loss insurance policies may include substantial deductibles and
certain exclusions.  For example, during
2005 we obtained earthquake insurance on one of our properties and our coverage
included a customary deductible of five percent of our insurable value.  If we are subject to an uninsured loss or a
loss that is subject to a substantial deductible, we could lose part of our
capital invested in, and anticipated revenue from, the property, which could
harm our operating results and financial condition and our ability to pay
dividends.

Noncompliance
with environmental laws could adversely affect our financial condition and
operating results.

The real
properties we own are subject to various federal, state and local environmental
laws. Under these laws, courts and government agencies have the authority to
require the current owner of a contaminated property to clean up the property,
even if the owner did not know of and was not responsible for the
contamination.  For example, liability
can be imposed upon us based on activities of one of our tenants.

Prior to
acquisition of a property, we obtain Phase I environmental reports and, in some
cases, a Phase II environmental report.
However, these reports may not reveal all environmental conditions at a
property and we may incur material environmental liabilities of which we are
unaware.  The costs incurred to clean up
a contaminated property, to defend against a claim, or to comply with
environmental laws could be material and could adversely affect our financial
condition and operating results.

Our real estate
investments are subject to risks particular to real property.

As an owner
of real property (including any real property we may acquire upon foreclosure),
we are subject to various additional risks not otherwise discussed in these
risk factor and generally incident to the ownership of the real estate.  These risks may include those listed
below:

| |   |                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | civil unrest, acts of God, including earthquakes, floods and
  other natural disasters, which may result in uninsured losses, and acts of
  war or terrorism, including the consequences of the terrorist attacks, such
  as those that occurred on September 11, 2001;
| |   |                                                                                                                                                                                                                                                                        
| |  | adverse changes in national and local economic and market
  conditions;                                                                                                                                                                                                
| |   |                                                                                                                                                                                                                                                                        
| |  | the
  costs of complying or fines or damages as a result of non-compliance with the
  Americans with Disabilities Act;                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                        
| |  | changes in governmental laws and regulations, fiscal policies
  and zoning ordinances and the related costs of compliance with laws and
  regulations, fiscal policies and ordinances;                                                                                 
| |   |                                                                                                                                                                                                                                                                        
| |  | the ongoing need
  for capital improvements, particularly in older structures; and                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                        
| |  | other circumstances beyond our control.                                                                                                                                                                                                                                

Should any of these events occur, our financial condition and operating
results could be adversely affected.

19

---



Risks Related to Debt Assets

Our investments
in commercial mortgage-backed securities may be subordinated.

As of
December 31, 2005, our CMBS investments included $57.8 million of below
investment grade bond classes.
Generally, these classes represent subordinate classes of the
securitization pool, meaning that we hold the first loss position or a near
first loss position in the event of losses on the assets within the
pool.  We may not be able to recover our
investment in these subordinated CMBS classes.
In addition, the value of these subordinated investments may be
adversely affected by decreases in the value of the underlying collateral,
increases in market rates for similar collateral pools or economic downturns,
and we may be required under GAAP to record an impairment loss on our
investment if any of these developments occur.

We may
experience losses on our mortgage loans.

We
originate mortgage loans as part of our investment strategy.  As a holder of mortgage loans, we are
subject to risks of tenant defaults, borrower defaults, bankruptcies, fraud,
losses and special hazard losses that may not be covered by standard hazard
insurance.  In the event of any default
under our mortgage loans, we will bear the risk of loss of principal to the
extent of any deficiency between the value of the mortgage collateral and the
principal amount of the mortgage loan plus all interest and other costs payable
on the loan.

The typical
net lease requires casualty insurance (which may be provided through self
insurance) to be maintained on the underlying property (generally by the
borrower or the tenant), with such coverages and in such amounts as are
customarily insured against with respect to similar properties, for fire,
vandalism and malicious mischief, extended coverage perils, physical loss
perils, commercial general liability, flood (when the underlying property is
located in whole or in material part in a designated flood plain area) and
worker injury.  There are, however,
certain types of losses (such as from earthquakes or wars) that may be either
uninsurable or not economically insurable.
Should an uninsured loss occur, we could lose some or all of our
investment in the net lease property.

We could be
subject to the risks incident to ownership of real property if the tenants
underlying our net lease loans fail to make their lease payments.

Our net
lease loans are generally non-recourse to the property owner, and, in the event
of default, we are entirely dependent on the loan collateral.  Rent payment by the underlying tenant is the
primary source of payment of these loans. To the extent the tenant does not
make its lease payments, repayment of the net lease loan will depend upon the
liquidation value of the underlying real property.  The liquidation value of a commercial property may be adversely
affected by risks generally incident to interests in real property, including
changes in general or local economic conditions and/or specific industry
segments, declines in real estate values, increases in interest rates, real
estate tax rates and other operating expenses including energy costs, changes
in governmental rules, regulations and fiscal policies, including environmental
legislation, acts of God, and other factors which are beyond our or our
borrowers control.  There can be no
assurance that our remedies with respect to the loan collateral will provide us
with a recovery adequate to recover our investment.

Our collateral
rights under our 10-year credit tenant loan program are limited.

As part of
our 10-year credit tenant loan program, we split a loan secured by a mortgage
on real estate and an assignment of the lease on the property into two notes, a
real estate note (which we generally sell promptly following origination), and
a corporate credit note (which we retain in our portfolio).  The corporate credit note has a junior claim
on the real estate mortgage.  Further,
while the corporate credit note has a first priority claim on the lease
assignment in a tenant bankruptcy, our claim for damages will be limited to an
amount defined under the Bankruptcy Code (the greater of one years rent or 15%
(but not more than three years) of rent over the remaining lease term, plus
rent already due but unpaid).
Therefore, in the event of a default on the loan, our collateral rights
on our corporate credit notes will be more limited than the collateral rights
we have under our mortgage loans.

Our mezzanine
investments have a greater risk of loss than mortgage loans.

We make
mezzanine and other generally subordinate investments.  These investments involve a higher degree of
risk than our first mortgage loans.
While we expect most of these investments will be secured, we expect our
right to payment and security interest will be subordinated to one or more
senior lenders.  Therefore, we may be
limited in our rights to collect scheduled payments on these investments and to
recover any of our investment through a foreclosure of collateral.

Our
mezzanine investments may also include an interest only payment schedule, with
the principal amount remaining outstanding and at risk until the maturity of
the obligation.  In this case, a
borrowers ability to repay its obligation may be dependent upon a liquidity
event, such as a sale or refinancing of the property.

20

---



Development
loans involve greater risk of loss than loans secured by income producing
properties.

We make
investments in development loans that involve a higher degree of risk than
long-term senior mortgage loans secured by income-producing real property, due
to a variety of factors.  These factors
include the subordinate status of our loan investment, dependence for repayment
on successful completion and operation of the project, difficulties in
estimating construction or rehabilitation costs, loan terms that often require
little or no amortization, and the possibility that a foreclosure by the holder
of the senior loan could result in a substantial decrease in the value of our
collateral.  Accordingly, in the event of
a borrower default, we may not recover some or all of our investment in our
development loans.

Fluctuating
interest rates may adversely affect the quantity of net lease loan assets we
can originate.

Higher
interest rates may reduce overall demand for net lease loans and accordingly
reduce our origination of loan assets, which could have a material adverse
effect on our financial condition and operating results.

Unscheduled
principal payments on our loans could adversely affect our financial condition
and operating results.

The rate
and timing of unscheduled payments of principal on our net lease loans is
impossible to predict accurately and will be affected by a variety of factors,
including the level of prevailing interest rates, restrictions on voluntary
prepayments contained in the loans, the availability of credit generally and
other economic, demographic, geographic, tax and legal factors. In general,
however, if prevailing interest rates fall significantly below the interest
rate on a loan, the borrower is more likely to prepay the then higher-rate loan
than if prevailing rates remain at or above the interest rate on the loan.

While our
loan documents generally prohibit prepayment without a premium to preserve our
yield, this premium may not be required or may not be recoverable under various
circumstances, including in the event of a casualty or condemnation of the
related property or a loan default.
Unscheduled principal prepayments could adversely affect our financial
condition and operating results to the extent we are unable to reinvest the
funds we receive at an equivalent or higher yield rate, if at all. In addition,
a large amount of prepayments, especially prepayments on loans with interest
rates that are high relative to the rest of our portfolio, will likely decrease
the net income we anticipate receiving from our assets.

We may be
required to repurchase assets that we have sold or to indemnify holders of our
CDOs.

If any of
the assets we originate or acquire and sell or pledge to obtain long-term
financing do not comply with representations and warranties that we make about
certain characteristics of the assets, the borrowers and the underlying
properties, we may be required to repurchase those assets or replace them with
substitute assets. In addition, in the case of assets that we have sold, we may
be required to indemnify persons for losses or expenses incurred as a result of
a breach of a representation or warranty.
Repurchased assets may require a significant allocation of working
capital to carry on our books, and our ability to borrow against such assets
may be limited.  Any significant
repurchases or indemnification payments could materially and adversely affect
our financial condition and operating results.

The success of
our net lease loan business will depend upon our ability to service
effectively, or to obtain effective third-party servicing for, the loans we
invest in.

We have
entered into a servicing arrangement with Wachovia Bank, N.A. for servicing of
our net lease loans.  We may in the
future undertake to retain the servicing of our loan assets in a taxable
subsidiary of ours.  We have no
experience servicing a large portfolio of loans for an extended period of
time.  We cannot assure you that our
third-party contractor or we will be able to service the loans according to
industry standards.  Failure to service
the loans properly could harm our financial condition and operating results.

Maintenance of
our Investment Company Act of 1940 exemption imposes limits on our operations.

We intend
to continue to conduct our business in a manner that allows us to avoid
registration as an investment company under the Investment Company Act of 1940
(the 1940 Act).  Under Section 3(c)(5)(C)
of the 1940 Act, entities that are primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests
in real estate are not treated as investment companies.  The position of the SEC staff generally
requires us to maintain at least 55% of our assets directly in qualifying real
estate interests in order for us to rely on this exemption (the 55%
Requirement).  To constitute a
qualifying real estate interest under this 55% Requirement, a real estate interest
must meet various criteria.  Mortgage
securities that do not represent all of the certificates issued with respect to
an underlying pool of mortgages may be treated as securities separate from the
underlying mortgage loans and, thus, may not qualify for purposes of the 55%
Requirement.  Our ownership of these
mortgage securities, therefore, is limited by the provisions of the 1940 Act
and SEC staff interpretations.  We cannot
assure you that efforts to pursue our investment strategy will not be adversely
affected by operation of the 1940 Act.

21

---



Risks Related to Lease Enhancements

Our lease
enhancement mechanisms may fail.

We have
developed certain lease enhancement mechanisms designed to reduce the risks
inherent in our net lease investments.
These lease enhancement mechanisms include:

|  |                                                                                                                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | casualty and condemnation insurance policies that protect us
  from any right the tenant may have to terminate the underlying net lease or
  abate rent as a result of a casualty or condemnation; and                                            
|  |                                                                                                                                                                                                                                                   
| | borrower reserve funds that protect us from any rights the
  tenant may have to terminate the underlying net lease or abate rent as a
  result of the failure of the property owner to maintain and repair the
  property or related common areas.

These lease enhancement mechanisms may not protect us against all losses.
For example, our casualty and condemnation policies typically contain
exclusions relating to war, insurrection, rebellion, revolution or civil riot
and radioactive matter, earthquakes (in earthquake zones) and takings (other
than by condemnation) by reason of danger to public health, public safety or
the environment. In addition, amounts in the borrower reserve fund may be
insufficient to cover the cost of maintenance or repairs, and the borrower may
fail to perform such maintenance or repairs at its own expense. The failure of
our lease enhancement mechanisms may result in the loss of our capital invested
in, and profits anticipated from, our investment, and could adversely affect
our financial condition and operating results.

We depend on
our insurance carriers to provide and honor lease enhancements.

We
presently obtain specialized lease enhancement insurance policies from two
carriers.  The limited number of
insurance carriers available to provide lease enhancements restricts our ability
to replace such insurers. Any of the following developments with respect to our
carriers may have a material adverse effect on our financial condition and
operating results:

|  |                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------
| | a
  deterioration in our relationship with one or both of our carriers;                                          
|  |                                                                                                                  
| | a
  bankruptcy or other material adverse financial development with respect to
  one or both of our carriers; and
|  |                                                                                                                  
| | a dispute as to
  policy coverage with one or both of our carriers.                                              

We may fail to
analyze leases adequately or apply appropriate lease enhancement
mechanisms.

In
determining whether a lease enhancement mechanism is appropriate, we examine
the costs and benefits of the lease enhancement mechanism in light of our
analysis of the risks associated with the underlying net lease.  As a result of this analysis, we may decline
to apply a lease enhancement mechanism that would otherwise protect us.  Our failure to analyze leases adequately or
apply appropriate lease enhancement mechanisms could cause a decline in the
value of our net lease asset and adversely affect our financial condition and
operating results.

Risks Related to Borrowings

Leveraging our
portfolio is an important component of our strategy and subjects us to
increased risk of loss.

A key
component of our strategy is to borrow against, or leverage, our assets to
allow us to invest in a greater number of assets and enhance our asset
returns.  However, leverage also
subjects us to increased risk of loss.
The use of leverage may result in increased losses to us in the
following ways:

|  |                                                                                                                                                                                                                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We will rely on
  the cash flows from the assets financed to fund our debt service
  requirements.  Therefore, in the event
  of a tenant default on its rent payments, our losses are expected to increase
  as we will need to fund our debt service requirements from other sources.                       
|  |                                                                                                                                                                                                                                                                                                               
| | To the extent we
  have financed our assets under our variable rate short-term borrowing
  facilities, our debt service requirements will increase as short-term rates
  rise.  Therefore, if short-term
  interest rates rise in excess of the yields on our assets financed, we will
  be subject to losses.
|  |                                                                                                                                                                                                                                                                                                               
| | Our lenders will
  have a first priority claim on the collateral we pledge and the right to
  foreclose on the collateral.
  Therefore, if we default on our debt service obligations, we would be
  at risk of losing some or all of our assets.                                                             
|  |                                                                                                                                                                                                                                                                                                               
| | Our short-term
  borrowing facilities are fully recourse lending arrangements.  Therefore, if we default on our debt
  service obligations, our lenders will have general recourse to our companys
  assets, rather than limited recourse to just the assets financed.                                       

22

---



We may not be
able to secure long-term financing for our assets.

We secure
long-term financing of our assets to enable us to invest in a greater number of
assets and enhance our asset returns.
We expect our leverage to average 70% to 85% of our assets in
portfolio.  Our ability to implement our
long-term financing strategy is subject to the following risks:

|  |                                                                                                                                                                                                                    
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not be able
  to achieve our desired leverage level due to decreases in the market value of
  our assets, increases in interest rates and other factors.                                                    
|  |                                                                                                                                                                                                                    
| | We are subject to
  conditions in the mortgage, CDO and other long-term financing markets which
  are beyond our control, including the liquidity of these markets and
  maintenance of attractive credit spreads. 
|  |                                                                                                                                                                                                                    
| | In the event of an
  adverse change in the financial condition of our underlying net lease tenant,
  it may not be possible or it may be uneconomical for us to obtain long-term
  financing for the subject asset.

Our
inability to implement our long-term financing strategy may cause us to
experience lower leveraged returns on our assets than would otherwise be the
case, and could have a material adverse effect on our operating results.

Hedging
transactions may not effectively protect us against anticipated risks and may
subject us to certain other risks and costs.

Our current
policy is to enter into hedging transactions primarily to protect us from the
effect of interest rate fluctuations on our portfolio of net lease assets from
the date on which we commit a rate or price to a borrower or seller and until
the date our cost to finance the asset on a long-term basis is fixed.  Our hedging policy exposes us to certain
risks, among them the following:

|  |                                                                                                                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | No hedging
  activity can completely insulate us from the risks associated with changes in
  interest rates and, therefore, our hedging strategy may not have the desired
  beneficial impact on our results of operations or financial condition.                         
|  |                                                                                                                                                                                                                                                                            
| | There will be many
  market risks against which we may not be able to hedge effectively, including
  changes in the spreads of corporate bonds, CMBS or CDOs over the underlying
  U.S. Treasury rates.                                                                    
|  |                                                                                                                                                                                                                                                                            
| | We may or may not
  hedge any risks with respect to certain of our asset investments.                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                            
| | Our hedging
  strategy may serve to reduce the returns which we could possibly achieve if
  we did not hedge certain risks.                                                                                                                                                
|  |                                                                                                                                                                                                                                                                            
| | Because we intend
  to structure our hedging transactions in a manner that does not jeopardize
  our status as a REIT, we will be limited in the type of hedging transactions
  that we may use.                                                                           
|  |                                                                                                                                                                                                                                                                            
| | Hedging costs
  increase as the period covered by the hedging increases and during periods of
  rising and volatile interest rates. We may increase our hedging activity and
  thus increase our hedging costs during periods when interest rates are
  volatile or rising.

We may fail to
qualify for hedge accounting treatment.

We record
derivative and hedge transactions in accordance with United States generally
accepted accounting principles, specifically Statement of Financial Accounting
Standards No. 133, Accounting for
Derivative Instruments and Hedging
Activities (SFAS 133).
Under these standards, we may fail to qualify for hedge accounting
treatment for a number of reasons, including, if we use instruments that do not
meet the SFAS 133 definition of a derivative (such as short sales), we fail to
satisfy SFAS 133 hedge documentation and hedge effectiveness assessment
requirements or our instruments are not highly effective.  If we fail to qualify for hedge accounting
treatment, our operating results may suffer because any losses on the
derivatives we enter into would be charged to our income statement without any
offset from the change in fair value of the related hedged transaction.

Our existing
short-term borrowing facilities may be unavailable to us.

We expect
to borrow money under short-term borrowing facilities to fund our net lease
asset investments.  These facilities are
uncommitted as the lender must agree to each asset financed.  We cannot assure you that we will be able to
finance assets on these facilities at any given time.

Our short-term
financings may expose us to interest rate risks and margin calls.

Our
borrowings under our short-term borrowing facilities are currently at variable
rates and will be adjusted monthly relative to market interest rates.  Increases in short-term rates will cause our
borrowing rates to rise and our net income to

23

---



decrease.  If interest rates on
our borrowings rise in excess of the yields on our assets financed, we will be
subject to losses on those assets.

The amount
available to us under our short-term borrowing facilities depends in large part
on the lenders valuation of the assets that secure our financings.  The facilities provide the lender the right,
under certain circumstances, to re-evaluate the collateral that secures our
outstanding borrowings.  In the event
the lender determines that the value of the collateral has decreased (for
example, in connection with a decline in the credit rating of the underlying
tenant), it has the right to initiate a margin call.  A margin call would require us to provide the lender with
additional collateral or to repay a portion of the outstanding borrowings at a
time when we may not have a sufficient portfolio of assets or cash to satisfy
the margin call.  Any failure by us to
meet a margin call could cause us to default on our short-term borrowing
facilities and otherwise have a material adverse effect on our financial
condition and operating results.

The use of CDO
financings with coverage tests may have a negative impact on our operating
results and cash flows.

We have
purchased, and expect to purchase in the future, subordinate classes of bonds
in our CDO financings.  The terms of the
CDO securities issued by us include and will include coverage tests that are
used primarily to determine whether and to what extent principal and interest
proceeds on the underlying assets may be used to pay principal of and interest
on the subordinate classes of bonds in the CDO.  In the event the coverage tests are not satisfied, interest and
principal that would otherwise be payable on the subordinate classes may be
re-directed to pay principal on the senior bond classes.  Therefore, failure to satisfy the coverage
tests could adversely affect our operating results and cash flows.

Risks Related to Business Strategy and
Policies

We face
significant competition that could harm our business.

We are
subject to significant competition in each of our business segments.  We compete with specialty finance companies,
insurance companies, investment banks, savings and loan associations, banks,
mortgage bankers, mutual funds, institutional investors, pension funds, hedge
funds, other lenders, governmental bodies and individuals and other entities,
including REITs. We may face new competitors and, due to our focus on net lease
properties located throughout the United States, and because many of our
competitors are locally and/or regionally focused, we may not encounter the
same competitors in each region of the United States.  Many of our competitors will have greater financial and other
resources and may have other advantages over our company.  Our competitors may be willing to accept
lower returns on their investments, may have access to lower cost capital and
may succeed in buying the assets that we target for acquisition.  We may incur costs on unsuccessful
acquisitions that we will not be able to recover.  Our failure to compete successfully could have a material adverse
effect on our financial condition and operating results.

Our network of
independent mortgage brokers and investment sale brokers may sell investment
opportunities to our competitors.

An
important source of our investments comes from independent mortgage brokers and
investment sale brokers. These brokers are not contractually obligated to do
business with us.  Further, our
competitors also have relationships with many of these brokers and actively
compete with us in our efforts to obtain investments from these brokers.  As a result, we may lose potential
transactions to our competitors, which could negatively affect the volume and
pricing of our investments, which would have a material adverse effect on our
financial condition and operating results.

Our ability to
grow our business will be limited by our ability to attract debt or equity
financing, and we may have difficulty accessing capital on attractive terms.

We expect
to fund future investments primarily from debt or equity capital.  Therefore, we are dependent upon our ability
to attract debt or equity financing from public or institutional lenders.  The capital markets have been, and in the
future may be, adversely affected by various events beyond our control, such as
the United States military involvement in the Middle East and elsewhere, the
terrorist attacks on September 11, 2001, the ongoing War on Terrorism by the
United States and the bankruptcy of major companies, such as Enron Corp.  Events such as an escalation in the War on
Terrorism, new terrorist attacks, or additional bankruptcies in the future, as
well as other events beyond our control, could adversely affect the
availability and cost of capital for our business.  As a REIT, we will also be dependent upon the availability and cost
of capital in the REIT markets specifically, which can be impacted by various
factors such as interest rate levels, the strength of real estate markets and
investors appetite for REIT investments.
We cannot assure you that we will be successful in attracting sufficient
debt or equity financing to fund future investments, or at an acceptable cost.

Future
offerings of debt and equity may adversely affect the market price of our
common stock.

During
2005, we raised additional capital through the issuance of preferred stock and
trust preferred securities.  We expect
to continue to increase our capital resources by making additional offerings of
equity and debt securities in the future, which would include classes of
preferred stock, common stock and senior or subordinated notes.  All debt securities and other

24

---



borrowings, as well as all classes of preferred stock, will be senior
to our common stock in a liquidation of our company. Additional equity
offerings could dilute our stockholders equity, reduce the market price of
shares of our common stock, or be of preferred stock having a distribution
preference that may limit our ability to make distributions on our common
stock. Our ability to estimate the amount, timing or nature of additional
offerings is limited as these factors will depend upon market conditions and
other factors.

We may fail to
manage our anticipated growth.

As of
December 31, 2005, our company had 21 employees.  As our asset base continues to grow, we may experience a
significant strain on our management, operational, financial and other
resources.  Our ability to manage growth
effectively will require us to continue to improve our operational and
financial systems, expand our employee base and train and manage our employees
and develop additional management expertise.
Management of growth is especially challenging for us due to our limited
financial resources.  Failure to increase
our business and manage growth effectively could have a material adverse effect
on our financial condition and operating results.

Temporary
investment in short-term investments may adversely affect our results.

Our results
of operations may be adversely affected during the period in which we are
implementing our investment and leveraging strategies or during any period
after which we have received the proceeds of a financing or asset sale but have
not invested the proceeds.  During this
time, we may be invested in short-term investments, including CMBS or CDO bonds,
corporate bonds, commercial paper, money market funds and U.S. agency debt.

The
concentration of our companys common stock could have an adverse impact on the
value of your investment.

As of
December 31, 2005, approximately 47.8% of our common stock was owned by six
unrelated institutional investors (based on SEC filings made by these
investors).  This concentration of
ownership could have an adverse impact on the value of your investment, including
as a result of the following:

|  |                                                                                                                                                                                                                                                  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Trading volume in
  our stock may be limited, which will reduce the liquidity of your
  investment.                                                                                                                                              
|  |                                                                                                                                                                                                                                                  
| | The sale of a
  significant number of our shares in the open market by a significant
  stockholder or otherwise could adversely affect our stock price.                                                                                          
|  |                                                                                                                                                                                                                                                  
| | Although none of
  these investors on its own controls a majority of our common stock, these
  owners could determine to act together and given their significant
  concentration may be able to take actions that are not in your best interest.

Our board of
directors may change our investment and operational policies without
stockholder consent.

Our board
of directors determines our investment and operational policies and may amend
or revise our policies, including our policies with respect to our REIT status,
investment objectives, acquisitions, growth, operations, indebtedness,
capitalization and distributions, or approve transactions that deviate from
these policies without a vote of or notice to our stockholders.  Investment and operational policy changes
could adversely affect the market price of stock in our company and our ability
to make distributions to our stockholders.

The federal
income tax laws governing REITs are complex, and our failure to qualify as a
REIT under the federal tax laws will result in adverse tax consequences.

We intend
to operate in a manner that will allow us to qualify as a REIT under the
federal income tax laws. The REIT qualification requirements are extremely
complex, however, and interpretations of the federal income tax laws governing
qualification as a REIT are limited.
Accordingly, we cannot be certain that we will be successful in
qualifying as a REIT. At any time, new laws, interpretations, or court
decisions may change the federal tax laws or the federal income tax
consequences of our qualification as a REIT.

If we fail
to qualify as a REIT in any taxable year, we will be subject to federal income
tax on our taxable income. Our taxable income would be determined without deducting
any distributions to our stockholders.
We might need to borrow money or sell assets in order to pay any such
tax.  If we cease to qualify as a REIT,
we no longer would be required to distribute most of our taxable income to our
stockholders.  Unless the federal income
tax laws excused our failure to qualify as a REIT, we could not re-elect REIT
status until the fifth calendar year after the year in which we failed to
qualify as a REIT.

Our ownership
limitations may restrict or prevent you from engaging in certain transfers of
our stock.

In order to
maintain our REIT qualification, no more than 50% in value of our outstanding
stock may be owned, directly or indirectly, by five or fewer individuals (as
defined in the federal income tax laws to include various kinds of entities)
during the last half of any taxable year.
Individuals for this purpose include natural persons, private
foundations, some employee benefit plans and trusts, and some charitable
trusts.  In order to preserve our REIT
qualification, our charter generally prohibits any

25

---



person from directly or indirectly owning more than 9.9% in value or in
number of shares, whichever is more restrictive, of any class or series of the
outstanding shares of our capital stock.

If anyone
transfers shares in a way that would violate our ownership limits, or prevent
us from continuing to qualify as a REIT under the federal income tax laws, we
will consider the transfer to be null and void from the outset and the intended
transferee of those shares will be deemed never to have owned the shares or
those shares instead will be transferred to a trust for the benefit of a
charitable beneficiary and will be either redeemed by us or sold to a person
whose ownership of the shares will not violate our ownership limits.  Anyone who acquires shares in violation of
our ownership limits or the other restrictions on transfer in our charter bears
the risk of suffering a financial loss when the shares are redeemed or sold if
the market price of our stock falls between the date of purchase and the date
of redemption or sale.

Provisions of
our charter and Maryland law may limit the ability of a third-party to acquire
control of our company.

Our
charter contains restrictions on stock ownership and transfer.

As
described above, our charter contains stock ownership limits.  These limits may delay, defer or prevent a
transaction or a change of control of our company that might involve a premium
price for stock of our company or otherwise be in the best interest of our
stockholders.

Our board of
directors may issue additional stock without stockholder approval.

Our charter
authorizes our board of directors to amend the charter to increase or decrease
the aggregate number of shares of stock we have authority to issue, without any
action by the stockholders. Issuances of additional shares of stock may delay,
defer or prevent a transaction or a change of control of our company that might
involve a premium price for stock of our company or otherwise be in the best
interest of our stockholders.

Other
provisions of our charter and bylaws may delay or prevent a transaction or
change of control.

Our charter
and bylaws also contain other provisions that may delay, defer or prevent a
transaction or a change of control of our company that might involve a premium
price for our common stock or otherwise be in the best interest of our
stockholders.  For example, our charter
and bylaws provide that:  a two-thirds
vote of stockholders is required to remove a director, vacancies on our board
may only be filled by the remaining directors, the number of directors may be
fixed only by the directors, our bylaws may only be amended by our directors
and a majority of shares is required to call a special stockholders meeting.

Increased
market interest rates may reduce the value of our stock.

We believe
that investors consider the dividend distribution rate on shares of REIT stock,
expressed as a percentage of the market price of the shares, relative to market
interest rates as an important factor in deciding whether to buy or sell the
shares.  If market interest rates go up,
prospective purchasers of REIT stock may expect a higher dividend distribution
rate.  Higher interest rates would also
likely increase our borrowing costs and might decrease cash available for
distribution.  Thus, higher market
interest rates could cause the market price of stock in our company to decline.

The market
price of our stock may vary substantially.

Various
factors can affect the market price of our stock including the following:

| |   |                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | actual or
  anticipated variations in our quarterly results of operations;                                                                                                                                                  
| |   |                                                                                                                                                                                                                             
| |  | the
  extent of institutional investor interest in our company;                                                                                                                                                             
| |   |                                                                                                                                                                                                                             
| |  | the
  reputation of REITs generally and the attractiveness of their equity
  securities in comparison to other equity securities, including securities
  issued by other real estate companies, and fixed income securities;
| |   |                                                                                                                                                                                                                             
| |  | changes in expectations of future financial performance or
  changes in estimates of securities analysts;                                                                                                                   
| |   |                                                                                                                                                                                                                             
| |  | fluctuations in stock market prices and volumes; and                                                                                                                                                                        
| |   |                                                                                                                                                                                                                             
| |  | announcements by
  us or our competitors of acquisitions, investments or strategic alliances.                                                                                                                               

We depend on our key personnel.

We depend
on the efforts and expertise of our senior management team.  Although we have entered into employment
agreements with most members of our senior management, there is no guarantee
that any of them will remain employed with

26

---



our company.  If any member of
our senior management team were to die, become disabled or otherwise leave our
employ, we may not be able to replace him with a person of equal skill, ability
and industry expertise.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our
corporate offices are located at 110 Maiden Lane, New York, New York
10005.  Our lease on this property
expires on May 31, 2006.  We are
currently in negotiations to lease new space and do not expect to have any
difficulty in securing the space prior to the time our current lease expires.

Our owned real properties are described above under BusinessOur
PortfolioOwned Properties.

Item 3. Legal Proceedings.

From
  time to time, we are involved in legal proceedings in the ordinary course of
  business. We do not believe any matter we are currently involved in will have
  a material adverse effect on our business, results of operations or financial
  condition.

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

No matters
were submitted to a vote of our stockholders during the fourth quarter ended
December 31, 2005.

27

---



PART II.

Item 5.     Market
for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.

Market Information and Holders of Record

Our
common stock has been listed for trading on the New York Stock Exchange
(NYSE) under the symbol LSE since our initial public offering on March 19,
2004. On February 15, 2006, the reported closing sale price per share of common
stock on the NYSE was $10.96 and there were approximately 40 holders of record
of our common stock. The table below sets forth the quarterly high and low
sales prices of our common stock on the NYSE for the periods indicated.

|                          |  |     |       |      |   |       | 
|------------------------- |  | --- | ----- | ---- | - | ----- | 
|Fiscal Year               |  | Low |       | High |  
|                          |  |     |       |      |  
|2004                      |  |     |       |      |   |       | 
|March 19-March 31,
  2004 |  | $   | 12.50 |      | $ | 13.50 | 
|Second Quarter            |  |     | 9.57  |      |   | 13.04 | 
|Third Quarter             |  |     | 9.10  |      |   | 11.70 | 
|Fourth Quarter            |  |     | 10.62 |      |   | 12.92 | 
|                          |  |     |       |      |   |       | 
|2005                      |  |     |       |      |   |       | 
|First Quarter             |  | $   | 10.60 |      | $ | 12.62 | 
|Second Quarter            |  |     | 10.07 |      |   | 11.43 | 
|Third Quarter             |  |     | 9.95  |      |   | 11.30 | 
|Fourth Quarter            |  |     | 9.38  |      |   | 11.05 | 

Dividends

We
paid our first quarterly common stock dividend for the quarter ended September
30, 2004. Our history of common stock dividends is as follows:

|                   |  |                       |                  |                    |  |   |      |  | 
|------------------ |  | --------------------- | ---------------- | ------------------ |  | - | ---- |  | 
|Quarter Ended      |  | Dividend Payment Date |                  | Dividend per Share | 
|                   |  |                       |                  |                    | 
|2004               |  |                       |                  |                    |  |   |     
|September 30, 2004 |  |                       | October 15, 2004 |                    |  | $ | 0.10 |  | 
|December 31, 2004  |  |                       | January 14, 2005 |                    |  |   | 0.15 |  | 
|                   |  |                       |                  |                    |  |   |      |  | 
|2005               |  |                       |                  |                    |  |   |      |  | 
|March 31, 2005     |  |                       | April 15, 2005   |                    |  |   | 0.18 |  | 
|June 30, 2005      |  |                       | July 15, 2005    |                    |  |   | 0.18 |  | 
|September 30, 2005 |  |                       | October 15, 2005 |                    |  |   | 0.18 |  | 
|December 31, 2005  |  |                       | January 17, 2006 |                    |  |   | 0.20 |  | 

We
generally intend to distribute each year all or substantially all of our REIT
taxable income (which does not necessarily equal net income as calculated in
accordance with generally accepted accounting principles) to our stockholders
so as to comply with the REIT provisions of the Internal Revenue Code and to
avoid federal income tax and the nondeductible excise tax. We intend to make
dividend distributions quarterly. Our dividend policy is subject to revision at
the discretion of our board of directors. All distributions will be made at the
discretion of our board of directors and will depend on our cash available for
distribution, our funds from operations, our maintenance of REIT status and other
factors as our board of directors deems relevant.

Tax Characteristics of 2005 Dividends

The
following table summarizes the taxable nature of our common dividends during
2005:

|                                              |  |   |        |  
|--------------------------------------------- |  | - | ------ | -
|Total common
  dividend per share (tax basis) |  | $ | 0.69   |  
|                                              |  |   |        |  
|Ordinary income                               |  |   | 3.53   | %
|Return of capital                             |  |   | 96.47  | %
|                                              |  |   |        |  
|                                              |  |   | 100.00 | %
|                                              |  |   |        |  

Use of Proceeds of Preferred Stock

On
October 19, 2005, we consummated the public offering of 1.4 million shares of
8.125% Series A cumulative redeemable preferred stock. The underwriters for the
transaction were Wachovia Capital Markets, LLC; Friedman, Billings, Ramsey
& Co., Inc.; A. G. Edwards & Sons, Inc.; and RBC Dain Rauscher Inc. The
shares of Series A preferred stock sold in

28

---



the offering were registered under the Securities Act of 1933, as
amended, on a Registration Statement (Registration No. 333-124003) on Form S-3
that was declared effective by the Securities and Exchange Commission on May
20, 2005. The shares of Series A preferred stock were sold at a price to the
public of $25.00 per share, generating gross proceeds of $35.0 million. The net
proceeds to us were approximately $33.7 million after deducting an aggregate of
approximately $1.3 million in underwriting discounts and commissions paid to
the underwriters and other offering expenses. Through December 31, 2005, we
have invested all of these net proceeds in additional net lease assets.

29

---



Item 6.     Selected
Financial Data.

The
following selected historical financial information for the five years ended
December 31, 2005 is derived from our audited consolidated financial statements
and those of our predecessor, Caplease, LP (the successor-in-interest to
Capital Lease Funding, LLC) and its consolidated subsidiaries. The data should
be read in conjunction with the consolidated financial statements, related
notes, and other financial information included in this Form 10-K.

|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|-------------------------------------------------------------------------- |  | ---------------------------------------- | -------- | ---- | - | -------- | - | ---- | ------- | ---- | - | ------- | - | - | -------- | -
|                                                                           |  | Year ended December 31,                  |         
|                                                                           |  |                                          |         
|                                                                           |  | 2005                                     |          | 2004 |   | 2003     |   | 2002 |         | 2001 |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |  
|                                                                           |  | (in thousands, except per share amounts) |         
|Income Statement data                                                      |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Revenues:                                                                  |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Rental revenue                                                             |  | $                                        | 37,956   |      | $ | 4,287    |   | $    |        |      | $ |        |   | $ |         |  
|Interest income from mortgage and other
real estate loans
  and securities |  |                                          | 27,899   |      |   | 13,589   |   |      | 7,317   |      |   | 8,092   |   |   | 9,313    |  
|Property expense recoveries                                                |  |                                          | 6,272    |      |   | 1,608    |   |      |        |      |   |        |   |   |         |  
|Gain-on-sales of mortgage and other real
estate loans and
  securities     |  |                                          | 447      |      |   | 794      |   |      | 11,652  |      |   | 10,051  |   |   | 21,565   |  
|Other revenue                                                              |  |                                          | 479      |      |   | 726      |   |      | 151     |      |   | 343     |   |   | 321      |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Total revenues                                                             |  |                                          | 73,052   |      |   | 21,004   |   |      | 19,120  |      |   | 18,486  |   |   | 31,199   |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Expenses:                                                                  |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Interest expense                                                           |  |                                          | 31,398   |      |   | 2,768    |   |      | 1,220   |      |   | 2,142   |   |   | 5,882    |  
|Interest expense to affiliates                                             |  |                                          |         |      |   |         |   |      | 838     |      |   | 659     |   |   | 1,273    |  
|Property expenses                                                          |  |                                          | 10,441   |      |   | 1,761    |   |      |        |      |   |        |   |   |         |  
|(Gain) loss on derivatives                                                 |  |                                          | (159     | )    |   | 724      |   |      | 3,129   |      |   | 7,729   |   |   | 11,954   |  
|Loss on securities                                                         |  |                                          | 2,372    |      |   | 247      |   |      |        |      |   |        |   |   |         |  
|General and administrative
expenses                                        |  |                                          | 10,140   |      |   | 8,833    |   |      | 7,186   |      |   | 6,966   |   |   | 7,794    |  
|General and administrative expenses -
stock based
  compensation           |  |                                          | 2,235    |      |   | 3,825    |   |      |        |      |   |        |   |   |         |  
|Depreciation and amortization expense on
real property                     |  |                                          | 11,273   |      |   | 1,281    |   |      |        |      |   |        |   |   |         |  
|Loan processing expenses                                                   |  |                                          | 283      |      |   | 196      |   |      | 114     |      |   | 158     |   |   | 232      |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Total expenses                                                             |  |                                          | 67,983   |      |   | 19,635   |   |      | 12,487  |      |   | 17,654  |   |   | 27,135   |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Income before minority interest and taxes                                  |  |                                          | 5,069    |      |   | 1,369    |   |      | 6,633   |      |   | 832     |   |   | 4,064    |  
|Minority interest in consolidated entities                                 |  |                                          | 55       |      |   |         |   |      |        |      |   |        |   |   |         |  
|Provision for income taxes                                                 |  |                                          |         |      |   | 9        |   |      |        |      |   |        |   |   |         |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Income from continuing operations                                          |  |                                          | 5,124    |      |   | 1,360    |   |      | 6,633   |      |   | 832     |   |   | 4,064    |  
|Income from discontinued operations                                        |  |                                          | 6        |      |   |         |   |      |        |      |   |        |   |   |         |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Net income                                                                 |  |                                          | 5,130    |      |   | 1,360    |   |      | 6,633   |      |   | 832     |   |   | 4,064    |  
|Dividends allocable to preferred shares                                    |  |                                          | (561     | )    |   |         |   |      |        |      |   |        |   |   |         |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Net income allocable to common stockholders                                |  | $                                        | 4,569    |      | $ | 1,360    |   | $    | 6,633   |      | $ | 832     |   | $ | 4,064    |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Earnings per share (pro forma for all years other than
  2004 and 2005):   |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Net income per common share, basic and
diluted                             |  | $                                        | 0.16     |      | $ | 0.06     |   | $    | 1.61    |      | $ | 0.20    |   | $ | 0.99     |  
|Weighted average number of common shares
outstanding,
  basic and diluted  |  |                                          | 27,784   |      |   | 22,125   |   |      | 4,108   |      |   | 4,108   |   |   | 4,108    |  
|Dividends declared per common
share                                        |  | $                                        | 0.74     |      | $ | 0.25     |   | $    |        |      | $ |        |   | $ |         |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Dividends declared per preferred
share                                     |  | $                                        | 0.48524  |      | $ |         |   | $    |        |      | $ |        |   | $ |         |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Other data                                                                 |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  
|Cash flows from operating
activities                                       |  | $                                        | (17,111  | )    | $ | 10,973   |   | $    | (10,743 | )    | $ | 3,774   |   | $ | 234,057  |  
|Cash flows from investing
activities                                       |  |                                          | (675,408 | )    |   | (349,576 | ) |      | (69     | )    |   | 846     |   |   | (1,084   | )
|Cash flows from financing
activities                                       |  |                                          | 681,114  |      |   | 362,802  |   |      | 11,948  |      |   | (10,773 | ) |   | (224,265 | )
|                                                                           |  |                                          |          |      |   |          |   |      |         |      |   |         |   |   |          |  

30

---



|                                                         |  |                    |           |      |   |         |  |      |         |      |   |         |  |   |         | 
|-------------------------------------------------------- |  | ------------------ | --------- | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | ------- | 
|                                                         |  | As of December 31, |          
|                                                         |  |                    |          
|                                                         |  | 2005               |           | 2004 |   | 2003    |  | 2002 |         | 2001 |  
|                                                         |  |                    |           |      |   |         |  |      |         |      |  
|                                                         |  | (in thousands)     |          
|Balance sheet data                                       |  |                    |           |      |   |         |  |      |         |      |   |         |  |   |         | 
|                                                         |  |                    |          
|Real estate investments, net                             |  | $                  | 764,930   |      | $ | 194,541 |  | $    |        |      | $ |        |  | $ |        | 
|Real estate investments consolidated
under FIN 46        |  |                    |          |      |   | 48,000  |  |      |        |      |   |        |  |   |        | 
|Mortgage and other real estate loans
held for investment |  |                    | 297,551   |      |   | 207,347 |  |      |        |      |   |        |  |   |        | 
|Mortgage loans held for sale                             |  |                    |          |      |   |        |  |      | 71,757  |      |   | 77,716  |  |   | 83,883  | 
|Securities available for sale                            |  |                    | 137,409   |      |   | 87,756  |  |      | 40,054  |      |   | 20,348  |  |   | 13,963  | 
|Cash and cash equivalents                                |  |                    | 19,316    |      |   | 30,721  |  |      | 6,522   |      |   | 5,386   |  |   | 11,539  | 
|Structuring fees receivable                              |  |                    | 3,862     |      |   | 4,426   |  |      | 5,223   |      |   | 4,794   |  |   | 5,231   | 
|Total assets                                             |  |                    | 1,286,488 |      |   | 581,702 |  |      | 125,773 |      |   | 112,276 |  |   | 129,473 | 
|Repurchase agreement
obligations                         |  |                    | 129,965   |      |   | 133,831 |  |      | 88,087  |      |   | 76,116  |  |   | 86,658  | 
|Mortgages on real estate
investments                     |  |                    | 551,844   |      |   | 111,539 |  |      |        |      |   |        |  |   |        | 
|Collateralized debt
obligations                          |  |                    | 268,156   |      |   |        |  |      |        |      |   |        |  |   |        | 
|Other long-term debt                                     |  |                    | 30,930    |      |   |        |  |      |        |      |   |        |  |   |        | 
|Stockholders equity/members
capital                    |  |                    | 270,031   |      |   | 253,264 |  |      | 34,045  |      |   | 27,775  |  |   | 25,066  | 

31

---



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

The following discussion should be read in
conjunction with the consolidated financial statements and the notes to those
financial statements, included elsewhere in this filing. Where appropriate, the
following discussion includes analysis of our predecessor entity.

Overview

We
are a diversified REIT that owns and finances primarily single tenant
commercial real estate assets subject to long-term leases to primarily
investment grade tenants. We focus on properties that are subject to a net
lease. See BusinessOverview for how we define a net lease.

We
invest at all levels of the capital structure of net lease properties,
including equity investments in real estate (owned real properties), debt
investments (mortgage loans and net lease mortgage backed securities) and
mezzanine investments secured by net leased real estate collateral.

The
principal sources of our revenues are rental income on our owned real
properties and interest income from our debt investments. The principal sources
of our expenses are interest expense on our assets financed, depreciation
expense on our real properties, general and administrative expenses and
property expenses (net of expense recoveries). While our focus is on net leased
properties, we also have made and expect to continue to make owned
property investments where we have exposure to property expenses when we
determine we can sufficiently underwrite that exposure and isolate a
predictable cash flow.

We rely on leverage to allow us to invest in a greater number of assets
and enhance our asset returns. We seek to finance our assets on a long-term
basis with fixed-rate debt of a like maturity. Through December 31, 2005, our
long-term financings have been in the form of traditional third party mortgage
financings (on most of our owned real properties) and our first CDO (completed
in March 2005). We have short-term floating rate borrowing arrangements in
place to facilitate our investment activity while we arrange long-term
financing. We employ a hedging strategy to mitigate our exposure to changes in
interest rates while our assets are financed under our short-term borrowing
arrangements. We expect our leverage to average 70% to 85% of our assets in
portfolio.

Our
primary business objective is to generate stable, long-term and attractive
returns based on the spread between the yields generated by our assets and the
cost of financing our portfolio.

We
rely primarily on equity and debt capital to fund our portfolio growth. The
following is a summary of our capital raising activities beginning with our
initial public offering in March 2004.

|              |  |  |                                                                                    |  |   |       |  |              |               | 
|------------- |  |  | ---------------------------------------------------------------------------------- |  | - | ----- |  | ------------ | ------------- | 
|Month/Year    |  |  | Securities Issued                                                                  |  |   | Price |  | Net Proceeds |              
|              |  |  |                                                                                    |  |   |       |  |              |              
|March 2004    |  |  | 23.0 million
  shares of 
  common stock                                           |  | $ | 10.50 |  | $            | 221.8 million | 
|              |  |  |                                                                                    |  |   |       |  |              |               | 
|October 2005  |  |  | 14.0 million
  shares of
  8.125% Series A cumulative
  redeemable preferred stock |  | $ | 25.00 |  | $            | 33.7 million  | 
|              |  |  |                                                                                    |  |   |       |  |              |               | 
|December 2005 |  |  | $30.9 million of
  junior
  subordinated notes                                     |  |   | N/A   |  | $            | 29.9 million  | 

Summary of Investment Activity in 2005

The
following summarizes certain aspects of our portfolio investment and financing
activity during the year ended December 31, 2005.

| |  |   |                                                                                                                                                                                                                                                                                                                                                                   
| |  | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | We originated
  assets of approximately $730.3 million, including the acquisition of 17 real
  properties for an aggregate purchase price of approximately $565.8 million
  and the origination of $103.9 million of loan investments (net of loans
  sold), comprised of mortgage loans, corporate credit notes and mezzanine
  investments.                     
| |  |   |                                                                                                                                                                                                                                                                                                                                                                   
| |  |  | We closed our
  first CDO financing in March 2005 and financed our real property acquisitions
  with $441.8 million of fixed rate mortgage debt (including $41.3 million of
  debt assumed at its fair market value). The net amount of financing we issued
  in our CDO was $268.1 million, and was secured by approximately $300 million
  of assets at closing.

32

---



Business Environment

The
markets have been and remain extremely competitive across each of our business
segments. We continue to see significant amounts of investment capital pursuing
transactions across the real estate spectrum which has put downward pressure on
yields and spreads on both property acquisitions and our origination of loans
for our portfolio. This trend has resulted in our making a limited number of
investments in net lease assets in 2005 with return characteristics at the
lower end of our target return criteria. If this trend continues in 2006, we
may continue to look to invest in net lease assets with return characteristics
at the lower end of our target return criteria, we may re-adjust our target
returns, or our asset origination activity may slow while we continue to pursue
only those assets at or above the returns being generated by our current
portfolio.

Winn-Dixie Bankruptcy

We
have exposure to Winn-Dixie through securities we own from our past
securitizations. During the year ended December 31, 2005, we took certain
actions to significantly reduce this exposure. We, as the owner of the most
subordinate security class in the CMLBC 2001-1 securitization transaction (the
Trust), directed the Trusts special servicer to sell all of the $22.4
million of pass through certificates included as collateral in the Trust. The
sales were made in the third quarter of 2005.

As
a result of these sales, the primary exposure to the Trust from Winn-Dixie
backed collateral was removed, and the Trust had realized losses that impacted
the carry value of the most junior classes of securities held by us. Accordingly,
we recognized a realized loss on these securities in the year ended December
31, 2005 of approximately $1.4 million, and a non-cash mark-to-market loss
attributed to the reduction in the carry value of these securities in the
amount of approximately $0.6 million.

During
the year ended December 31, 2005, we also recorded aggregate losses of
approximately $0.35 million on the most junior class (Class F) of the BSCMS
securitization transaction, based on our updated analysis of the likely value
of the future cash flows from this security. These write-downs are in addition
to the write-down of approximately $0.25 million we took at December 31, 2004.

As
a result of the actions described above, we have removed all of our expected
exposure to the Winn-Dixie bankruptcy in the CMLBC transaction and we have
dramatically reduced our exposure to Winn-Dixie overall. We believe that any
remaining credit risk we have to the Winn-Dixie bankruptcy is within the BSCMS
transaction that includes one store in Rainsville, Alabama where Winn-Dixie has
rejected the lease on that store and the loan on the property is in default.
The property is in the process of being liquidated, and we have estimated the
losses within the securitization based on our estimates of the net recovery
value of the property. We believe we have been reasonable with our estimates,
but our estimates may be inaccurate and, therefore, we cannot assure you that
we will not need to take additional losses or reserves or that our losses as a
result of the Winn-Dixie bankruptcy will not be greater than our current
estimates. We do not believe any additional losses that we will have to take as
a result of Winn-Dixie will be material.

Application of Critical Accounting Policies

Our
discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with United States generally accepted accounting principles, or
GAAP. The preparation of financial statements in conformity with GAAP requires
the use of judgments, estimates and assumptions that could affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities and the reported amounts of revenues and expenses. Actual results
could differ from these estimates. The following is a summary of our accounting
policies that are most affected by judgments, estimates and assumptions.

Mortgage
and Other Real Estate Loans Held for Investment.

Prior
to our initial public offering, our investments in mortgage loans were treated
as investments held for sale and carried on our balance sheet at the lower of
cost or market. Since our initial public offering, our loan investments have
been, and we expect in the future they will continue to be, accounted for as
long term investments, as our strategy contemplates that we hold the loans for
the foreseeable future or until maturity. Differences between the carrying
amount of the loan and its outstanding principal balance are recognized as an
adjustment to our yield by the effective interest method. We are required to
periodically evaluate each of our loans held for investment for possible
impairment. Impairment is indicated when it is deemed probable that we will be
unable to collect all amounts due according to the contractual terms of the
asset. Upon determination of impairment, we must establish a specific valuation
allowance with a corresponding charge to earnings. Significant judgment is
required both in determining impairment and in estimating the resulting loss
allowance. In determining impairment and any loan loss allowance, we will be
required to evaluate our assets, historical and industry loss experience,
economic conditions and trends, collateral values and quality, and other
relevant factors. As of December 31, 2005, we had no loss allowances on any of
the loans in our portfolio.

33

---



Purchase
Accounting for Acquisition of Real Estate.

We
allocate the fair value of real estate acquired to the following based on fair
value:

| |   |                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | acquired tangible
  assets, consisting of land, building and improvements; and                                                                                                          
| |   |                                                                                                                                                                                         
| |  | identified
  intangible assets and liabilities, consisting of the value of above-market
  and below-market leases, the value of in-place leases and the value of tenant
  relationships.

In
estimating the fair value of the tangible and intangible assets acquired, we
consider information obtained about each property as a result of our due
diligence activities and other market data, and utilize various valuation
methods, such as estimated cash flow projections utilizing appropriate discount
and capitalization rates, estimates of replacement costs, and available market
information. The fair value of the tangible assets of an acquired property
considers the value of the property as if it were vacant.

Above-market
and below-market lease values for acquired properties are recorded based on the
present value of the differences between (i) the contractual amounts to be paid
pursuant to each in-place lease and (ii) managements estimate of fair market
lease rates for each corresponding in-place lease. Fair market lease rates are
measured over a period equal to the remaining term of the lease for
above-market leases and the initial term plus the term of any below-market rate
renewal options for below-market leases. In computing present value, we use a
discount rate which reflects the risks associated with the leases acquired.

Other
intangible assets acquired include amounts for in-place lease values and tenant
relationship values which are based on managements evaluation of the specific
characteristics of each tenants lease and our overall relationship with the
respective tenant. Factors considered by management in its analysis of in-place
lease values include an estimate of carrying costs during the hypothetical
expected time it would take management to find a tenant to lease the space for
the existing lease term (a lease-up period) considering current market
conditions, and costs to execute similar leases. Management estimates carrying
costs, including such factors as real estate taxes, insurance and other
operating expenses during the expected lease-up period, considering current
market conditions and costs to execute similar leases. In estimating costs to
execute similar leases, management considers leasing commissions and other
related expenses. Characteristics considered by management in valuing tenant
relationships include the nature and extent of our existing business
relationships with the tenant, growth prospects for developing new business
with the tenant, the tenants credit quality and expectations of lease
renewals. Through December 31, 2005, we have assigned no value to tenant
relationships on any of our acquisitions.

Securities
Available for Sale.

We
treat our real estate securities as available for sale and account for them in
accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities. As such, they are carried at fair value with net
unrealized gains or losses reported on our balance sheet as a component of
other comprehensive income or loss. Fair value is based primarily upon our
estimates of value, based upon broker quotations where available, yields on assets
of similar credit quality and duration, or good faith estimates of those
yields. The indicated quotations may be subject to significant variability
based on market conditions, including interest rates and spreads. While a
liquid market for these securities typically exists, the securities may not be
frequently traded and, therefore, we may not be able to sell them at our
estimates of value. Changes in market conditions, as well as changes in the
assumptions or methodology used to determine fair value, could result in a
significant increase or decrease in the equity on our balance sheet. We must
also assess whether unrealized losses on securities, if any, reflect a decline
in value which is other than temporary. If so, we must write the impaired
security down to its value through a charge to our income statement.
Significant judgment is required in this analysis. In determining whether a
decline in value is other than temporary, we consider whether the decline is
due to factors such as changes in interest rates (typically temporary) or
credit downgrades or credit defaults (typically other than temporary).

For
the year ended December 31, 2005, we recorded aggregate write-downs of
approximately $0.35 million on one of our real estate securities, reflecting
our estimate of our losses on that security as a result of the Winn-Dixie
bankruptcy. We also recorded a $0.25 million write-down on the same security as
of December 31, 2004, again reflecting our estimated loss on the security as a
result of the Winn-Dixie bankruptcy at that time. Also during 2005, we
recognized an approximately $2.0 million loss on another real estate security,
including an approximately $1.4 million realized loss and an approximately $0.6
million mark to market loss resulting from the sale of Winn-Dixie collateral in
the related CMBS trust. See Winn-Dixie Bankruptcy above.

Income
on our securities is recognized using a level yield methodology based upon a
number of assumptions that are subject to uncertainties and contingencies.
These assumptions include the expected disposal date of the security and the
rate and timing of principal and interest receipts (which may be subject to
prepayments, delinquencies and defaults). These uncertainties and contingencies
are difficult to predict and are subject to future events and economic and
market conditions, which may alter the assumptions.

34

---



Impairment
on Owned Real Properties

We
own real properties for investment. We review these properties for impairment
whenever events or changes in circumstances indicate that the carrying value of
an asset may not be recoverable. Upon determination of impairment, we would
record a write-down of the asset, which would be charged to earnings.
Significant judgment is required both in determining impairment and in
estimating the resulting write-down. Through December 31, 2005, we have
determined that no write-downs have been necessary on any of our owned real
properties.

Derivative
Instruments and Other Risk Management Transactions.

Our
derivative instruments and other risk management transactions, which we hold
for hedging or other risk management purposes, are carried at fair value
pursuant to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
as amended. Fair value is based on market quotations. Fair values on such
derivatives are subject to significant variability based on many of the same
factors as our securities available for sale discussed above. Further, to the
extent the derivatives qualify as hedges under SFAS No. 133, net unrealized
gains or losses are reported as a component of accumulated other comprehensive
income (a component of stockholders equity on our balance sheet); otherwise
they are reported as a component of current income or loss on our income
statement. In order to qualify for hedge accounting treatment under SFAS 133,
our derivatives must meet various technical requirements under SFAS 133,
including satisfying hedge effectiveness testing at each reporting date. Failure
to meet these requirements would result in the change in value of the
derivative instrument being charged directly to our income statement without
any offset from the change in fair value of the related hedged transaction.

Revenue
Recognition.

As
part of our 10-year credit tenant loan program, we originate a loan and split
it into two notes, a real estate note and a corporate credit note. We generally
sell the real estate note to a third party and retain the corporate credit note
in our portfolio. During 2005, we sold three real estate notes for aggregate
proceeds of $12.1million, and recognized gains of $0.3 million. We
compute our gain by comparing our sales proceeds on the note to its cost basis.
We compute our cost basis on the note by allocating our entire basis in the
loan among the two notes based on the present value of expected cash flows on
each note. In computing present values, we estimate a discount rate based on a
benchmark United States Treasury rate plus a market spread based on the
underlying credit. Our estimates reflect market rates and we believe they are
reasonable. However, the use of different estimates could have an impact on our
gain on sale revenue.

Stock
Based Compensation.

Pursuant
to our 2004 stock incentive plan, we have made and expect to continue to make
awards of common stock to our employees with vesting subject to attainment of
performance criteria. Under SFAS No. 123 and SFAS No. 123R (revised 2004), Share-Based
Payment, we are and will be required to estimate the probability of
vesting of these shares quarterly and recognize expense (generally equal to the
fair market value of the shares awarded on the grant date) for any shares
deemed probable to vest over the period the employee is required to perform
services to receive the shares. We base our estimates of probability on an
assessment of our actual results against the relevant performance criteria.
These estimates may change over time as our actual results against the criteria
are re-assessed. Changes in these estimates could have a material impact on the
expense we recognize.

Property Acquisitions

During
the quarter ended December 31, 2005, we completed the following property
acquisitions (dollar amounts in thousands):

|               |  |                                            |  |                   |  |                  |        |               |               |                            |  |         |  |  |  | 
|-------------- |  | ------------------------------------------ |  | ----------------- |  | ---------------- | ------ | ------------- | ------------- | -------------------------- |  | ------- |  |  |  | 
|Month Acquired |  | Tenant or Guarantor                        |  | Location          |  | Purchase
  Price |        | Lease Expires |               | Net Rentable
  Square Feet | 
|               |  |                                            |  |                   |  |                  |        |               |               |                            | 
|December       |  | Allstate Insurance
  Company (1)           |  | Various           |  | $                | 59,000 |               | December 2015 |                            |  | 377,015 | 
|December       |  | Farmers New World
  Life Insurance Company |  | Mercer Island, WA |  |                  | 39,550 |               | December 2020 |                            |  | 155,200 | 

|    |                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Company
  acquired a portfolio of three properties, one located in each of Roanoke,
  Virginia, Charlotte, North Carolina, and Pittsburgh, Pennsylvania.

In
accordance with SFAS No. 144, we have classified the Allstate Pittsburgh
property as assets held for sale on our December 31, 2005 Consolidated Balance
Sheet, reflecting our intent to sell the property promptly following its
acquisition. We treated the revenues from the property as income from
discontinued operations on our Consolidated Income Statement for the year ended
December 31, 2005. Based on initial pricing expectations, we expect to
recognize a gain on the sale of the property and, therefore, no impairment loss
on the property has been recognized.

35

---



Business Segments

We
conduct our business through two operating segments:

| |  |   |                                                                                                   
| |  | - | --------------------------------------------------------------------------------------------------
| |  |  | operating net
  lease real estate (including our investments in owned real properties); and       
| |  |   |                                                                                                   
| |  |  | lending
  investments (including our loan investments as well as our investments in
  securities).

Segment
data for the year ended December 31, 2005 are as follows (amounts in
thousands):

|                                           |  |                           |         |                                     |   |                       |  |       |         |  |   |           | 
|------------------------------------------ |  | ------------------------- | ------- | ----------------------------------- | - | --------------------- |  | ----- | ------- |  | - | --------- | 
|                                           |  | Corporate /
  Unallocated |         | Operating Net
  Lease
  Real Estate |   | Lending
  Investments |  | Total |        
|                                           |  |                           |         |                                     |   |                       |  |       |        
|Total revenues                             |  | $                         | 1,090   |                                     | $ | 44,352                |  | $     | 27,609  |  | $ | 73,052    | 
|Total expenses
  & minority interest       |  |                           | 12,493  |                                     |   | 39,254                |  |       | 16,181  |  |   | 67,928    | 
|Income (loss) from
  continuing operations |  |                           | (11,402 | )                                   |   | 5,098                 |  |       | 11,428  |  |   | 5,124     | 
|Total assets                               |  |                           | 48,007  |                                     |   | 797,945               |  |       | 440,536 |  |   | 1,286,488 | 

Segment
data for the year ended December 31, 2004 are as follows (amounts in
thousands):

|                                           |  |                           |         |                                      |   |                       |  |       |         |  |   |         | 
|------------------------------------------ |  | ------------------------- | ------- | ------------------------------------ | - | --------------------- |  | ----- | ------- |  | - | ------- | 
|                                           |  | Corporate /
  Unallocated |         | Operating Net
  Lease 
  Real Estate |   | Lending
  Investments |  | Total |        
|                                           |  |                           |         |                                      |   |                       |  |       |        
|Total revenues                             |  | $                         | 603     |                                      | $ | 6,356                 |  | $     | 14,045  |  | $ | 21,004  | 
|Total expenses
  & minority interest       |  |                           | 11,869  |                                      |   | 4,206                 |  |       | 3,569   |  |   | 19,644  | 
|Income (loss) from
  continuing operations |  |                           | (11,266 | )                                    |   | 2,150                 |  |       | 10,476  |  |   | 1,360   | 
|Total assets                               |  |                           | 31,454  |                                      |   | 247,325               |  |       | 302,923 |  |   | 581,702 | 
|                                           |  |                           |         |                                      |   |                       |  |       |         |  |   |         | 

Prior
to our initial public offering in March 2004, we had no owned real property
investments and our net lease mortgage loan business was under a gain on sale
(rather than portfolio) business model.

Results of Operations

During
the year ended December 31, 2005, we continued to execute on our business plan
as a long-term holder of equity, debt and mezzanine investments in net lease
assets. Our focus during the year was on: (i) identifying and acquiring net
lease assets that met our investment criteria, (ii) financing our net lease
assets, including the closing of our first collateralized debt obligation,
(iii) raising additional capital to fund the growth of our portfolio, and (iv)
continuing to communicate our expanded capabilities to the net lease
marketplace.

Comparison of Year Ended December 31, 2005 to
the Year Ended December 31, 2004

The
following discussion compares our operating results for the year ended December
31, 2005 to the comparable period in 2004.

Revenue.

Total
revenue increased $52.0 million, or 248%, to $73.0 million. The increase was
primarily attributable to increases in rental income and property expense
recoveries and increases in interest income, offset in part by decreases in
gain on sale of loans and securities and other revenue.

Rental
income and property expense recoveries, in the aggregate, increased $38.3 million,
or 650%, to $44.2 million. We continued to make significant investments of
owned properties during 2005, and the significant increase in revenues
associated with these investments is a result of the large growth in this
portion of our overall investment portfolio. Rental income for the 2005 period
includes $3.5 million from assets consolidated under FIN 46. As described in
footnote 23 in our consolidated financial statements included elsewhere in this
Form 10-K, we were required under FIN 46 to recognize revenue and expense on
one of our real property purchases prior to our acquisition date because a
deposit we made on our purchase price had become non-refundable.

Interest
income increased $14.3 million, or 105%, to $27.9 million. The increase was due
to larger overall asset investments, including both loans and securities
investments.

36

---



Gain
on sale of loans and securities decreased from $0.8 million to $0.4 million.
The decrease was due to lower overall sales activity during 2005 compared with
2004.

Expenses.

Total
expenses increased $48.3 million, or 246%, to $67.9 million. The increase in
expenses was primarily attributable to increases in interest expense, property
related expenses and general and administrative expenses, offset in part by a
reduction in loss on derivatives.

Interest
expense increased $28.6 million, or 1,034%, from $2.8 million to $31.4 million.
The increase was primarily the result of $12.8 million of increased interest
expense on our property mortgages and $11.7 million of interest expenses on our
CDO borrowings. In addition, interest expense on our borrowings under our
repurchase agreement increased $2.2 million, or 118%, from $1.9 million to $4.1
million. This was the result of higher average borrowing levels and higher
rates of interest on our repurchase agreement borrowings in 2005. The 2005
results also include interest expense of $1.7 million from assets consolidated
under FIN 46.

Property
expense increased 493% from $1.8 million to $10.4 million. The net amount of
property expenses we incurred in 2005 (net of expense recoveries) was $4.2
million.The
growth in property expenses reflects the growth of our portfolio as well as our
purchase of properties with greater overall exposure to
property expenses under the lease provisions, primarily with respect to leases
with the United States Government. While our investment focus continues to be
on net leased properties, we expect to continue to pursue properties where we
have exposure to property expenses when we determine we can sufficiently
underwrite that exposure and isolate a predictable cash flow.Property expenses for the 2005 period include
$0.9 million of
expense from assets consolidated under FIN 46.

(Gain)
loss on derivatives was ($0.2) million for 2005, compared to $0.7 million in
2004. The 2005 gain represents hedge ineffectiveness related to open derivative
positions as of December 31, 2005. The 2004 expense represents carry costs of
hedges and short-sale positions that were in place prior to our initial public
offering. Prior to our initial public offering, we employed fair value hedges
of our assets, along with derivatives and short sales of securities that did
not qualify for hedge accounting treatment. After our initial public offering
date, we terminated all of the outstanding fair value hedges, derivative and
short sale positions, and converted to cash flow hedges against our expected
future financings.

Loss
on securities was $2.4 million related to a write-down on three of our real
estate securities, reflecting our actual and mark-to-market losses on those
securities as a result of the Winn-Dixie bankruptcy.

General
and administrative expense increased $1.3 million, or 15%, from $8.8 million to
$10.1 million, due primarily to increased expenses associated with our status
as a public company, including expenses associated with compliance with the
Sarbanes-Oxley Act of 2002, accounting and assurance expenses, personnel costs
and liability insurance.

General
and administrative expense-stock based compensation of $2.2 million was
recognized during the 2005 period. This represents 2005 vesting of stock awards
made in 2004 and 2005 under our stock plan. These shares vest through March
2008 and, as of December 31, 2005, $2.1 million of deferred compensation
expense was included on our Consolidated Balance Sheets as a component of
additional paid in capital. This amount is expected to be charged to our Income
Statement ratably over the remaining vesting period (through March 2008). The
amount of deferred compensation expense for awards of 133,333 shares made in
2005 has not yet been measured and included as a component of additional paid
in capital because the grant date (as defined under relevant accounting
guidance) has not yet occurred.

Depreciation
and amortization expense on real property increased $10.0 million, or 780% to
$11.3 million, as a result of the significant increases in real estate
investments made during 2005. Depreciation and amortization expense for the
2005 period includes $0.9 million of expense from assets consolidated under FIN
46.

Minority
interest.

Minority
interest in consolidated entities is $0.1 million as a result of the assets
consolidated under FIN 46 as discussed above.

Net
income.

Net
income increased from $1.4 million to $5.1 million, as a result of the factors
discussed above. Net income allocable to common stockholders was $4.6 million
in 2005.

Comparison of Year Ended December 31, 2004 to
the Year Ended December 31, 2003

The
following discussion compares our operating results for the year ended December
31, 2004 to the comparable period in 2003.

37

---



Revenue.

Total
revenue increased $1.9 million, or 10%, to $21.0 million. The increase was
primarily attributable to increases in interest income from mortgage loans and
securities and increases in rental revenue, offset by a decrease in gain on
sale of mortgage loans.

Interest
income increased $6.3 million, or 86%, to $13.6 million. The increase was due
to larger overall asset investments, including both mortgage loans and CMBS
investments.

Gain
on sale of mortgage loans and securities decreased from $11.7 million to $0.8
million. The decrease was due to curtailment on our loan sale activity during
2004, as we transitioned from a gain on sale to held for investment strategy
upon completion of our initial public offering.

Rental
revenue and property expense recoveries, in the aggregate, increased $5.9
million to $5.9 million, as we did not own any investments in real estate
during 2003.

Other
revenue increased $0.6 million to $0.7 million, primarily as a result of
receiving $0.4 million (after related expenses) as a deal cancellation fee on a
potential property acquisition.

Expenses.

Total
expenses increased $7.1 million, or 57%, to $19.6 million. The increase in
expenses was primarily attributable to higher levels of general and
administrative expenses as a result of our status as a public company, and
increases in property related expenses, offset by a reduction in loss on
derivatives.

Interest
expense, including interest expense to affiliates, increased $0.7 million, or
35%, from $2.1 million to $2.8 million. This primarily consisted of $0.9
million of interest expense related to property mortgages originated or assumed
in 2004. In addition, interest expense on our borrowings under our repurchase
agreements decreased $0.2 million, or 9%, from $2.1 million to $1.9 million.
This was the result of lower average borrowing levels in 2004. After the
completion of our initial public offering in March 2004, we repaid all of the
amounts outstanding under our repurchase agreements. We began borrowing under
these facilities again during August 2004.

Loss
on derivatives decreased $2.4 million, or 77%, from $3.1 million to $0.7
million. This was primarily the result of the change in the way we hedge
interest rates upon the completion of our initial public offering. Prior to our
initial public offering, we employed fair value hedges of our assets, along
with derivatives and short sales of securities that did not qualify for hedge
accounting treatment. After our initial public offering date, we terminated all
of the outstanding fair value hedges, derivative and short sale positions, and
converted to cash flow hedges against our expected future financings.

Loss
on securities was $0.2 million for a write-down on one of our real estate
securities, reflecting our estimate of loss on that security as a result of the
Winn-Dixie bankruptcy.

General
and administrative expense increased $1.6 million, or 23%, from $7.2 million to
$8.8 million, due primarily to increased expenses associated with our change to
operating as a public company, including liability insurance.

General
and administrative expense-stock based compensation of $3.8 million was
recognized during the 2004 period. $2.4 million related to 2004 vesting of
stock awards made in March 2004 under our stock plan. These shares vest through
March 2006 and, as of December 31, 2004, $1.7 million of deferred compensation
expense was included on our Consolidated Balance Sheets as a component of
additional paid in capital. This amount is expected to be charged to our Income
Statement ratably over the remaining vesting period (through March 2006). The
2004 expense also included $1.4 million recognized during the quarter ended
March 31, 2004 related to stock sold to certain current and former employees
during November 2003 at a discount to the initial public offering price.

Depreciation
and amortization expense on real property increased $1.3 million to $1.3
million, as we did not own any investments in real estate during 2003.

Net
income.

Net
income decreased from $6.6 million to $1.4 million, as a result of the factors
discussed above.

Funds from Operations

Funds
from operations, or FFO, is a non-GAAP financial measure. We believe FFO is a
useful additional measure of our performance because it facilitates an
understanding of our operating performance after adjustment for real estate
depreciation, a non-cash expense which assumes that the value of real estate
assets diminishes predictably over time. In addition, we believe that FFO
provides useful information to the investment community about our financial
performance as

38

---



compared to other REITs, since FFO is generally recognized as an industry
standard for measuring the operating performance of a REIT. FFO does not
represent cash generated from operating activities in accordance with GAAP and
is not indicative of cash available to fund cash needs. FFO should not be
considered as an alternative to net income or earnings per share determined in
accordance with GAAP as an indicator of our operating performance or as an
alternative to cash flow as a measure of liquidity. Since all companies and
analysts do not calculate FFO in a similar fashion, our calculation of FFO may
not be comparable to similarly titled measures reported by other companies.

We
calculate FFO in accordance with standards established by the National
Association of Real Estate Investment Trusts (NAREIT) which defines FFO as
net income (computed in accordance with GAAP) excluding gains (or losses) from
sales of property, plus depreciation and amortization, and after adjustments
for unconsolidated partnerships and joint ventures.

The
following table reconciles our net income to FFO for the years ended December
31, 2005 and December 31, 2004. FFO is not a relevant measure for us for years
prior to 2004 because we were not a REIT during those periods.

|                                                                         |  |                         |        |      |   |        | 
|------------------------------------------------------------------------ |  | ----------------------- | ------ | ---- | - | ------ | 
|                                                                         |  | Year ended December 31, |       
|                                                                         |  |                         |       
|(in thousands,
  except per share amounts)                               |  | 2005                    |        | 2004 |  
|                                                                         |  |                         |        |      |  
|Net income
  allocable to common stockholders                            |  | $                       | 4,569  |      | $ | 1,360  | 
|Adjustments:                                                             |  |                         |        |      |   |        | 
|Add: Depreciation and amortization
expense
  on real property            |  |                         | 11,273 |      |   | 1,281  | 
|                                                                         |  |                         |        |      |   |        | 
|Funds from
  operations                                                  |  | $                       | 15,842 |      | $ | 2,640  | 
|                                                                         |  |                         |        |      |   |        | 
|                                                                        
|Weighted average
  number of common shares oustanding, basic and diluted |  |                         | 27,784 |      |   | 22,125 | 
|Funds from
  operations per share                                        |  | $                       | 0.57   |      | $ | 0.12   | 
|                                                                         |  |                         |        |      |   |        | 
|Gain on sale of
  mortgage loans and securities                          |  | $                       | 447    |      | $ | 794    | 
|Depreciation on
  real estate investments consolidated under FIN46       |  | $                       | 935    |      | $ |       | 
|                                                                         |  |                         |        |      |   |        | 

Liquidity and Capital Resources

As
of December 31, 2005, we had $19.3 million in available cash and cash
equivalents. As a REIT, we are required to distribute at least 90% of our
taxable income to our stockholders on an annual basis, and we intend to
distribute all or substantially all of our REIT taxable income in order to
comply with the distribution requirements of the Code and to avoid federal
income tax and the nondeductible excise tax. We declared total dividends of
$0.74 per share of common stock during the year ended December 31, 2005,
including $0.18 in the first, second and third quarters and $0.20 in the fourth
quarter. We also declared a dividend of $.48524 per share of 8.125% Series A
cumulative redeemable preferred stock in the fourth quarter of 2005.

We
believe that our working capital and cash provided by operations will be
sufficient to fund our operations and pay our distributions necessary to enable
us to continue to qualify as a REIT. However, our strategy contemplates
additional net lease investments and, therefore, as we approach or reach our
target leverage level from time to time, we will need to raise additional
capital. We expect our leverage to average 70% to 85% of our assets in
portfolio. As of December 31, 2005, we had an effective shelf registration
statement under which we can offer an aggregate of $265.0 million of common
stock, preferred stock and/or senior or subordinated debt securities from time
to time.

We
raised additional equity capital through a public offering in October 2005 and
debt capital through a private placement in December 2005. In October 2005, we
issued 1,400,000 shares of 8.125% Series A cumulative redeemable preferred
stock in a public offering at a price to the public of $25.00 per share, and
raised net proceeds of approximately $33.7 million, after underwriting
discounts and commissions and other offering expenses. The shares were issued
pursuant to our shelf registration statement.

In
December 2005, we issued $30.9 million in junior subordinated notes to an
affiliate, Caplease Statutory Trust I, in exchange for $0.9 million of the trusts
common securities and $30.0 million received by the trust from issuing its
trust preferred securities to unrelated third party investors. The junior
subordinated notes, the common and the trust preferred securities have
substantially identical terms, requiring quarterly interest payments calculated
at a fixed interest rate equal to 7.68% per annum through January 30, 2016, and
subsequently at a variable interest rate equal to London Interbank Offered Rate
(LIBOR) plus 2.60% per annum. The notes mature on January 30, 2036, and may
be redeemed, in whole or in part, at par, at our option, beginning on January
30, 2011. The preferred and common securities do not have a stated maturity
date; however, they are subject to mandatory redemption upon the redemption or
maturity of the notes. Our investment in the trust is not eliminated from our
financial statements in consolidation.
Instead, we record our investment in the trusts common shares of $0.9
million as part of other assets on our Consolidated Balance Sheet.

39

---



We
expect the proceeds raised in the fourth quarter of 2005 will be sufficient to
enable us to continue to implement our growth strategy through the first
quarter of 2006. We expect to raise additional capital in the near future,
either in the form of common stock, preferred stock, trust preferred debt or a
combination thereof. Our ability to raise capital is influenced by market
conditions, and we cannot assure you conditions for raising capital will be
favorable for us at any time.

Short-Term
Liquidity and Financing.

We
expect to meet our short-term liquidity requirements generally through our
available cash and cash equivalents, cash provided by operations, as well as
through our short-term borrowing arrangements. Our short-term borrowing
arrangements are comprised of a repurchase agreement with Wachovia Bank
(aggregate borrowing capacity of $250.0 million) and a real property
acquisition facility with Wachovia Bank and one of its affiliates (two loan
agreements with aggregate borrowing capacity of $100.0 million). These
arrangements are uncommitted, meaning the lenders may decline to advance on any
asset we seek to finance.

We
had $130.0 million outstanding as of December 31, 2005 under our Wachovia
repurchase agreement, which borrowings were secured by loan investments with an
aggregate carry value of $116.9 million, and securities with a carry value of
$43.8 million. As of December 31, 2005, we had not yet drawn under our real
property acquisition facility. Our short-term borrowing arrangements are
co-terminus, and they expire in August 2006. We expect to renew these
arrangements prior to expiration. We had a repurchase agreement with Bank of
America that expired unused on March 1, 2005.

Our
short-term borrowing arrangements allow us to finance our assets on a
short-term basis while we arrange long-term financing. We pay interest at
prevailing short-term interest rates plus a spread. These borrowing arrangements
are secured by the assets financed and are fully recourse to our other assets.
Our lender also has the right to initiate a margin call if our assets financed
decline in value (including as a result of a tenant downgrade). We are required
to comply with various covenants under these arrangements, including financial
covenants of minimum liquidity, minimum consolidated net worth and maximum
leverage.

As
of December 31, 2005, we were in compliance with the terms of our short-term borrowing
arrangements. We do not currently anticipate any difficulty in maintaining
compliance with these terms in future periods. We believe our relationship with
Wachovia Bank is excellent. However, because our short-term borrowing
arrangements are uncommitted, we cannot make any assurance that these
facilities will continue to be available to us.

Long-Term
Liquidity and Financing.

We
expect to meet our long-term liquidity requirements generally through cash
provided by operations, long-term fixed-rate financings on our net lease asset
investments and issuances of debt and equity capital. As discussed in further
detail above, we issued preferred equity capital in October 2005 and debt
capital in December 2005.

We
finance our investments through short-term financing arrangements and, as soon
as practicable thereafter, we obtain long-term financing for these investments,
generally on a secured, non-recourse basis. Long-term financing can be in the
form of traditional mortgage debt, CDOs or other debt mechanisms. As of
December 31, 2005, we have financed on a long-term basis an aggregate of
approximately $984.3 million of assets in portfolio with third party mortgage
debt of $551.8 million and collateralized debt obligations of $268.2 million.
We expect our leverage to average 70% to 85% of our assets in portfolio.

Long-Term
Mortgage Financings.

During
the year ended December 31, 2005, we obtained $400.6 million of long-term third
party mortgage financing on our real property acquisitions. We also assumed
debt of an aggregate of $41.3 million (fair market value of debt assumed) in
connection with our acquisition of two of real properties.

Our
mortgage financings are fixed rate financings. The notes typically mature over
a long-term period of approximately ten years, and debt service is payable
monthly. The notes are generally non-recourse to us but are secured by a
mortgage on the property and an assignment of the underlying lease and rents on
the property. The notes generally include customary non-recourse exceptions.
The notes often include an interest only payment period and usually require a
balloon payment at maturity.

CDO
Financing.

In
March 2005, we completed our first CDO. Our CDO was an entirely fixed rate
financing. We aggregated approximately $300 million of assets into the pool,
and we created $285 million face amount of multi-class notes and $15 million of
preferred equity through the CDO trust. The net amount of the debt we issued
was $268.1 million, inclusive of a $0.4 million discount to face, as we
retained the three most junior note classes aggregating a face amount of $16.5
million and the full $15 million of preferred equity. Each of the five note
classes of the CDO was rated investment grade. During the first five years of
the CDO term, we expect to reinvest principal repayments on the underlying
assets into qualifying replacement collateral. The CDO notes are expected to
mature in January 2015. Our effective blended financing rate (inclusive of
original issue discount

40

---



and debt issuance and hedge costs) on our CDO is approximately 5.67%.
Our CDO debt is non-recourse to us but is secured by the assets in the pool.

We
are currently aggregating assets for our next CDO financing. We expect our next
CDO issuance to occur in the second or third quarter of 2006.

Statement of Cash Flows

We
used $17.1 million of cash in operating activities in 2005. Our net income as
adjusted for straight-lining of rents, various non-cash gains and losses and
depreciation and amortization charges was $14.6 million, but was offset by
increases in other assets of $18.8 million (net of $8.3 million increase in
accounts payable and accrued expenses), decreases in deposits and escrows of
$8.5 million and amounts due to servicers and dealers of $4.4 million. The
increase in other assets in 2005 was driven by $16.6 million of funds being
held by our CDO trustee at year end pending distribution or reinvestment, $5.7
million of cash being held in escrow by our mortgage lenders to fund various
property related costs (like tenant improvements, capital expenditures and
property expenses), and $4.4 million of rents receivable on several of our
owned properties. During 2005, most of the cash we had collected in 2004 in the
form of deposits and escrows and amounts due to servicers was paid back. Our
net cash provided by operating activities in 2004 was $11.0 million and
reflects adjustments for non-cash items of expenses for amortization of
stock-based compensation ($3.8 million) and depreciation and amortization ($1.4
million, including $1.3 million on real property). Our net cash provided by
operating activities in 2004 also reflects adjustments for non-cash items for
amortization of above and below market rents ($0.1 million), straight-lining of
rents ($0.5 million) and amortization of discounts/premiums, and origination
fees/costs ($0.2 million). Our net cash used in operating activities was $10.7
million in 2003. The change from 2003 to 2004 was primarily a result of our
transition to a portfolio business model in the first quarter of 2004. Prior to
our initial public offering, our loan and security investment activity was
classified as operating activities. Under our current strategy, these
investments are treated as investing activities.

Investing
activities used $675.4 million during the year ended December 31, 2005, which
primarily resulted from net investments in real estate of $534.4 million, net
investments in loans of $83.3 million and net investments in securities
available for sale of $58.8 million. Investing activities used $349.6 million
during the year ended December 31, 2004, which primarily resulted from net
investments in real estate of $174.4 million, net investments in mortgage loans
of $133.1 million and net investments in securities available for sale of $40.0
million. Investing activities used $0.1 million during the year ended December
31, 2003.

Cash
provided by financing activities during the year ended December 31, 2005 was
$681.1 million, reflecting net borrowings from mortgages on real estate
investments of $399.2 million, borrowings from collateralized debt obligations
of $268.1 million, proceeds from a preferred stock equity offering of $33.7
million, and borrowings from other long-term debt obligations of $30.9 million,
offset in part by, dividends paid on common shares of $19.2 million, funds used
in hedging and risk management activities of $11.2 million, a construction
escrow held with our mortgage lender of $9.5 million, debt issuance costs of
$7.1 million, and net repayments on repurchase agreement obligations of $3.9
million. Cash provided by financing activities during the year ended December
31, 2004 was $362.8 million, reflecting net proceeds from our initial public
offering of $222.8 million (before prepaid offering expenses of approximately
$1.0 million), net borrowings under long-term mortgage financings of $97.4
million, net borrowings under repurchase agreements of $45.7 million, partially
offset by dividends paid of $2.7 million. We used $88.1 million of our net
proceeds from the initial public offering to repay our repurchase agreement
borrowings. Cash provided by financing activities during the year ended
December 31, 2003 was $11.9 million and was primarily the result of net
repurchase agreement borrowings.

See
our consolidated statements of cash flows in the historical consolidated
financial statements included elsewhere in this filing for a reconciliation of
our cash position for the periods described above.

Derivative and Other Risk Management
Transactions

Since
our initial public offering, we have entered into derivative and other risk
management transactions in order to hedge the value of our future debt
obligations from changes in underlying interest rates during the period between
closing and obtaining long-term financing of our net lease assets. Our
derivative and other risk management activities during this period have
consisted primarily of interest rate swaps, and we expect they will continue to
consist primarily of interest rate swaps in the future. In accordance with SFAS
133, the interest rate swaps, to the extent that they have been designated and
qualify as part of a hedging relationship, are treated as cash flow hedges for
accounting purposes. Consistent with SFAS No. 133, open cash flow hedges are
marked to fair value at each reporting date, with a corresponding offset to
Other Comprehensive Income (a component of Stockholders Equity). The cost to
carry our open cash flow hedges and any gain or loss we realize upon closing
the cash flow hedge is amortized as part of interest expense over the term of
the related debt issuance.

Prior
to our initial public offering, we used risk management transactions to hedge
the interest rate risk associated with owning fixed rate mortgage loan assets
financed by floating rate debt. We did so primarily by entering into Treasury
and agency lock transactions and short sales of U.S. government and agency
obligations. In accordance with SFAS 133, these lock transactions and short
sales, to the extent that they were designated and qualified as part of a
hedging relationship, were treated as fair value hedges for accounting
purposes. Consistent with SFAS No. 133, open fair value hedges are marked to
fair

41

---



value at each reporting date, with the change in value as offset by any
gain or loss on the hedged item recognized in earnings currently. The cost to
carry our open fair value hedges appears on our Consolidated Income Statement
as part of gain or loss on derivatives.

For
the years ended December 31, 2005 and 2004, we had net realized losses of $11.2
million and $1.7 million, respectively, related to cash flow hedges. The net
realized losses are included in Other Comprehensive Income and will be
reclassified and amortized as part of interest expense on our Consolidated
Income Statement over the expected term of the related debt issuances. Within
the next twelve months, we estimate that $1.1 million of losses currently held
within Accumulated Other Comprehensive Income will be reclassified to earnings
as additional interest expense. The change in net unrealized gains and (losses)
of $8.1 million and $(7.3) million in the years ended December 31, 2005 and
2004, respectively, for derivatives designated as cash flow hedges is
separately disclosed in the statement of changes in stockholders equity.

(Gain)
loss on derivatives on our Consolidated Income Statement includes $0.1 million
of gain due to hedge ineffectiveness for the year ended December 31, 2005. For
the year ended December 31, 2005, we reclassified $0.9 million from accumulated
other comprehensive loss into interest expense related to the underlying debt
issuances.

We
do not use derivative and other risk management transactions for trading or
speculative purposes and we only enter into contracts or hedging arrangements
with major financial institutions.

We
settle our derivative and other risk management transactions in cash.
Therefore, upon settlement, we will pay or receive cash for the net amount due.
These amounts could be material and could have a material impact (positive or
negative) on our liquidity. We seek to settle these transactions simultaneous
with the closing of our financing transaction for the related hedged asset to
mitigate the possible adverse impact on our liquidity.

Contractual Obligations

The
following table outlines the timing of payment requirements related to our
contractual obligations as of December 31, 2005 (in thousands):

|                                       |  |       |         |                    |   |           |   |           |        |               |   |        |  |   |         | 
|-------------------------------------- |  | ----- | ------- | ------------------ | - | --------- | - | --------- | ------ | ------------- | - | ------ |  | - | ------- | 
|                                       |  | Total |         | Less than 1
  year |   | 2-3 years |   | 4-5 years |        | After 5 years |  
|                                       |  |       |         |                    |   |           |   |           |        |               |  
|Mortgages on real
  estate investments |  | $     | 551,844 |                    | $ | 2,601     |   | $         | 10,807 |               | $ | 17,692 |  | $ | 520,744 | 
|Collateralized
  debt obligations      |  |       | 268,156 |                    |   | (34       | ) |           | (75    | )             |   | 22,751 |  |   | 245,514 | 
|Other long-term debt                   |  |       | 30,930  |                    |   |          |   |           |       |               |   |       |  |   | 30,930  | 
|Operating leases                       |  |       | 384     |                    |   | 258       |   |           | 75     |               |   | 51     |  |   |        | 
|Repurchase
  agreement obligations     |  |       | 129,965 |                    |   | 129,965   |   |           |       |               |   |       |  |   |        | 
|                                       |  |       |         |                    |   |           |   |           |        |               |   |        |  |   |         | 
|Total                                  |  | $     | 981,279 |                    | $ | 132,790   |   | $         | 10,807 |               | $ | 40,494 |  | $ | 797,188 | 
|                                       |  |       |         |                    |   |           |   |           |        |               |   |        |  |   |         | 

Negative amounts shown with respect to our collateralized debt
obligations represent amortization of original issue discount.

Off-Balance Sheet Arrangements

As
of December 31, 2005, we had the following off-balance sheet arrangements.

We
are obligated under two letters of credit in the aggregate of $16.7 million in
connection with obtaining long-term financing on two real properties we
acquired during 2005. The letters of credit were issued to our lender for the
full amount of financing on each property. The lender may draw on the letters
of credit if it does not receive evidence that a certificate of occupancy for
the related property has been obtained, construction of the property has been
completed and there has been no default on the underlying lease by a fixed date
(April 21, 2006 in the case of our GSA/DEA property and June 22, 2006 in the
case of our GSA/SSA property). We do not expect any draw on either of these
letters of credit.

We
have funded a reserve account to fund expected property improvements on one of
the real properties we acquired during 2005. During the quarter ended June 30,
2005, we acquired a real property in Herndon, Virginia net leased to ITT
Industries, Inc., and agreed under the tenants lease to fund expected
improvements to the real property of approximately $9.5 million. During the
quarter ended June 30, 2005, we arranged long-term financing on this property
and funded a reserve account with our lender for the full amount of this
obligation. We expect these funds will be disbursed in full as improvements are
completed. As of December 31, 2005, approximately $1.6 million of these funds
have been disbursed.

We
are obligated under a letter of credit with respect to one of our prior
securitization transactions (BSCMS 1999-CLF1). The maximum potential amount of
future required payments under the letter of credit is $2.85 million. The
letter of credit expires on February 18, 2009. The trustee of the
securitization trust may draw the letter of credit if there are realized losses
on the mortgage loans in the collateral pool that would create a shortfall in
the interest or principal on any investment grade certificate. The letter of
credit may be withdrawn when the ratings of the investment grade certificates
are no longer dependent

42

---



upon the credit support provided by the letter of credit. During
February 2005, one of the mortgage loans in the securitization on a property
net leased to Winn-Dixie defaulted, in connection with the bankruptcy of
Winn-Dixie. However, we do not expect any draw on the letter of credit as a
result of this mortgage default, or otherwise.

Item 7A.     Quantitative
and Qualitative Disclosures about Market Risk.

Market
risk refers to the risk of loss from adverse changes in the level of one or
more market prices, rate indices or other market factors. We are exposed to
market risk primarily from changes in interest rates, credit spreads, tenant
credit ratings and equity prices. We attempt to mitigate certain of these risks
by entering into hedge and other risk management transactions during the
short-term and fixed-rate financings for the long-term. We seek to obtain
long-term fixed rate financing as soon as practicable after we make an asset
investment. There can be no assurance, however, that such mitigation strategies
will be completely or even partially successful. The level of our exposure to
market risk is subject to factors beyond our control, including political risk
(including terrorism), monetary and tax policy, general economic conditions and
a variety of other associated risks.

Interest
Rate Exposure

Substantially
all of our assets have exposures to long-term interest rate movements,
primarily the yields on long-term U.S. Treasuries. Our hedge and other risk
management transactions will also have exposures to movements in interest
rates. Changes in the general level of interest rates can affect our net
interest income, which is the difference between the interest income earned on
interest-bearing assets and the interest expense incurred in connection with
our interest-bearing liabilities. Changes in interest rates can also affect our
net income from any investments that we make in net leased real estate, which
is the difference between the rental income earned and the interest expense on
the liabilities associated with the properties. Changes in the level of
interest rates may also affect, among other things, our ability to originate or
acquire loans and securities, real estate properties, and the value of our
loans and other assets.

Credit
Spread Curve Exposure

Our
loans and real estate securities are subject to spread risk. The majority of
these assets are fixed-rate assets, which are valued based on a market credit
spread over the rate payable on fixed-rate U.S. Treasuries of like maturity. In
other words, their value is dependent on the yield demanded on such assets by
the market based on their credit relative to U.S. Treasuries. Changes in the
general credit markets can lead to changes in the required yield on these
assets, which would result in a higher or lower value for our loans and real
estate securities. If the required market yields increase as a result of these
general credit-market changes, the value of our fixed-rate assets would decline
relative to U.S. Treasuries. Conversely, if the required market yields decrease
as a result of these general credit-market changes, the value of our fixed-rate
assets would increase relative to U.S. Treasuries. These changes in the market
value of our fixed-rate asset portfolio may affect the equity on our balance
sheet or our results of operations directly through provisions for losses on loans
or through unrealized losses on available-for-sale securities. These value
changes may also affect our ability to borrow and access capital.

Furthermore,
shifts in the U.S. Treasury yield curve, which represents the markets expectations
of future interest rates, would also affect the yield required on our
fixed-rate assets. This would have similar effects on the fair value of our
fixed-rate assets, our financial position and results of operations, as would a
change in general credit spreads.

Tenant
Credit Rating Exposure

Our
loans and real estate securities are subject to risks due to credit rating
changes of the tenants under the related net lease obligations. The credit
quality of a particular net lease asset is highly dependent on the credit
rating of the related tenant obligor of the net lease. Deterioration in the
tenants credit rating can lead to changes in the required yield on the related
asset, which would result in a lower value for our net lease assets. This would
have similar effects on the fair value of our fixed-rate assets, our financial
position and results of operations, as would a change in general credit
spreads. In addition, precipitous declines in the credit rating of a particular
tenant prior to our obtaining long-term financing may significantly impede or
eliminate our ability to finance the asset. We manage this risk by maintaining
diversity among our credits and assessing our aggregate exposure to ratings
classes, in particular lower rated classes. We also seek to lock or procure
long-term financing on our assets as promptly as practicable after we commit to
invest.

Equity
Price Risk Exposure

We
may seek to raise capital by sale of our common stock. Our ability to do so is
dependent upon the market price of our common stock and general market
conditions.

Fair
Value

For
certain of our financial instruments, fair values are not readily available
since there are no active trading markets as characterized by current exchanges
between willing parties. Accordingly, we derive or estimate fair values using
various

43

---



valuation techniques, such as computing the present value of estimated
future cash flows using discount rates commensurate with the risks involved.
However, the determination of estimated cash flows may be subjective and
imprecise. Changes in assumptions or estimation methodologies can have a
material affect on these estimated fair values. The fair values indicated below
are indicative of the interest rate and credit spread environment as of
December 31, 2005, and may not take into consideration the effects of
subsequent interest rate, credit spread fluctuations, or changes in the ratings
of the tenants under related net leases.

The
following summarizes certain data regarding our interest rate sensitive
instruments (dollar amounts in thousands):

|                                                               |  |                 |         |                 |   |                                                |  |               |         |            |   |            |  |            |      |            |  |            |  |   |         |  |   |         | 
|-------------------------------------------------------------- |  | --------------- | ------- | --------------- | - | ---------------------------------------------- |  | ------------- | ------- | ---------- | - | ---------- |  | ---------- | ---- | ---------- |  | ---------- |  | - | ------- |  | - | ------- | 
|                                                               |  | Carrying Amount |         | Notional Amount |   | Weighted
  Average
  Effective
  Interest Rate |  | Maturity Date |         | Fair Value |  
|                                                               |  |                 |         |                 |   |                                                |  |               |         |            |  
|                                                               |  | 12/31/2005      |         | 12/31/2004      |   | 12/31/2005                                     |  | 12/31/2004    |         | 12/31/2005 |   | 12/31/2005 |  | 12/31/2005 |      | 12/31/2004 | 
|                                                               |  |                 |         |                 |   |                                                |  |               |         |            |   |            |  |            |      |            | 
|Assets:                                                        |  |                 |         |                 |   |                                                |  |               |         |            |   |            |  |            |      |            |  |            |  |   |         |  |   |         | 
|Mortgage and other real estate loans
held for investment
  (1) |  | $               | 298,377 |                 | $ | 207,893                                        |  | $             | 296,479 |            | $ | 206,735    |  |            | 6.86 | %          |  | Various    |  | $ | 307,829 |  | $ | 215,330 | 
|Securities available for sale
(2)                              |  |                 | 137,409 |                 |   | 87,756                                         |  |               | 149,662 |            |   | 101,771    |  |            | 8.21 | %          |  | 2009-2028  |  |   | 137,409 |  |   | 87,756  | 
|Structuring fees receivable                                    |  |                 | 3,862   |                 |   | 4,426                                          |  |               | N/A     |            |   | N/A        |  |            | 7.98 | %          |  | 2010-2020  |  |   | 3,862   |  |   | 4,426   | 
|Derivative assets (3)                                          |  |                 | 1,082   |                 |   | 42                                             |  |               | 82,852  |            |   | 4,868      |  |            | N/A  |            |  | N/A        |  |   | 1,082   |  |   | 42      | 
|                                                               |  |                 |         |                 |   |                                                |  |               |         |            |   |            |  |            |      |            |  |            |  |   |         |  |   |         | 
|Liabilities                                                    |  |                 |         |                 |   |                                                |  |               |         |            |   |            |  |            |      |            |  |            |  |   |         |  |   |         | 
|Repurchase agreement obligations
(4)                           |  |                 | 129,965 |                 |   | 133,831                                        |  |               | 129,965 |            |   | 133,831    |  |            | 5.02 | %          |  | Short-term |  |   | 129,965 |  |   | 133,831 | 
|Mortgages on real estate investments
(5)                       |  |                 | 551,844 |                 |   | 111,539                                        |  |               | 546,284 |            |   | 110,732    |  |            | 5.52 | %          |  | 2013-2024  |  |   | 545,289 |  |   | 111,539 | 
|Collateralized debt obligations
(5)                            |  |                 | 268,156 |                 |   |                                               |  |               | 268,500 |            |   |           |  |            | 5.67 | %          |  | 2015       |  |   | 262,955 |  |   |        | 
|Other long-term debt (6)                                       |  |                 | 30,930  |                 |   |                                               |  |               | 30,930  |            |   |           |  |            | 8.30 | %          |  | 2036       |  |   | 30,849  |  |   |        | 
|Derivative liabilities (3)                                     |  |                 | 298     |                 |   | 7,355                                          |  |               | 43,029  |            |   | 228,182    |  |            | N/A  |            |  | N/A        |  |   | 298     |  |   | 7,355   | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | With the exception
  of one loan, this portfolio of loans bears interest at fixed rates. We have
  estimated the fair value of this portfolio of loans based on sales of loans
  with similar credit and structural characteristics where available, and
  managements estimate of fair values where comparable sales information is
  not available. The maturity dates for the loans range from 2006 through 2033.                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(2) | Securities
  available for sale represent subordinate interests in securitizations (CMBS),
  as well as pass-through certificates representing our pro rata investments in
  a pool of mortgage loans. Structuring fees receivable represent cash flows
  receivable by us from the sale of loans to third-party purchasers. The
  notional values for the CMBS are shown at their respective face amounts. Fair
  value for the CMBS is based on third-party quotations, where obtainable, or
  our estimate of fair value, based on yields of comparably rated securities in
  the CMBS market. Fair value for the structuring fees receivable is shown at
  our amortized cost for these items. For the securities available for sale, we
  receive current monthly interest coupon payments, and contractual principal
  payments as scheduled.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(3) | These instruments
  represent hedging and risk management transactions involving interest rate
  swaps. They have been valued by reference to market quotations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(4) | Our repurchase
  agreement obligations bear interest at floating rates, and we believe that
  for similar financial instruments with comparable credit risks, the effective
  rates approximate market value. Accordingly, the carrying amounts outstanding
  are believed to approximate fair value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(5) | We estimate the
  fair value of mortgage notes on real estate investments and collateralized
  debt obligations using a discounted cash flow analysis, based on our
  estimates of market interest rates. For mortgages where we have an early
  payment right, we also consider the prepayment amount to evaluate the fair
  value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(6) | We estimate the
  fair value of our other long-term debt using a discounted cash flow analysis,
  based upon managements estimates of market interest rates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

Our
generally higher level of interest rate sensitive instruments at December 31,
2005 reflects our greater level of assets and liabilities as a result of our
continued rapid growth since completion of our initial public offering in March
2004.

44

---



Scheduled
maturities of interest rate sensitive instruments as of December 31, 2005 are
as follows:

|                                       |  |                                                                                     |         |      |   |        |   |      |       |      |   |            |   |   |        |  |   |         | 
|-------------------------------------- |  | ----------------------------------------------------------------------------------- | ------- | ---- | - | ------ | - | ---- | ----- | ---- | - | ---------- | - | - | ------ |  | - | ------- | 
|                                       |  | Expected Maturity Dates                                                             |        
|                                       |  |                                                                                     |        
|                                       |  | 2006                                                                                |         | 2007 |   | 2008   |   | 2009 |       | 2010 |   | Thereafter |  
|                                       |  |                                                                                     |         |      |   |        |   |      |       |      |   |            |  
|                                       |  | (in thousands, notional amounts
  where appropriate, 
  otherwise carrying amounts) |        
|Mortgage and other
  real estate loans |  | $                                                                                   | 23,782  |      | $ | 18,295 |   | $    | 7,502 |      | $ | 6,507      |   | $ | 7,112  |  | $ | 233,281 | 
|Securities
  available for sale        |  |                                                                                     | 1,183   |      |   | 1,342  |   |      | 1,454 |      |   | 24,540     |   |   | 1,641  |  |   | 119,502 | 
|Structuring fees
  receivable          |  |                                                                                     | 609     |      |   | 659    |   |      | 713   |      |   | 772        |   |   | 768    |  |   | 341     | 
|Derivative assets                      |  |                                                                                     | 1,082   |      |   |       |   |      |      |      |   |           |   |   |       |  |   |        | 
|Mortgages on real
  estate investments |  |                                                                                     | 2,601   |      |   | 4,295  |   |      | 6,511 |      |   | 8,056      |   |   | 9,636  |  |   | 520,745 | 
|Repurchase
  agreement obligations     |  |                                                                                     | 129,965 |      |   |       |   |      |      |      |   |           |   |   |       |  |   |        | 
|Collateralized
  debt obligations      |  |                                                                                     | (34     | )    |   | (36    | ) |      | (38   | )    |   | (41        | ) |   | 22,792 |  |   | 245,513 | 
|Other long-term
  debt                 |  |                                                                                     |        |      |   |       |   |      |      |      |   |           |   |   |       |  |   | 30,930  | 
|Derivative
  liabilities               |  |                                                                                     | 298     |      |   |       |   |      |      |      |   |           |   |   |       |  |   |        | 

Negative amounts shown with respect to our collateralized debt
obligations represent amortization of original issue discount.

The
expected maturity dates shown for loan investments, securities available for
sale and structuring fees receivable are based on the contractual terms of the
underlying assets. These assets, based on our current operating strategy, are
held for investment. Our liabilities with respect to our repurchase agreement
are short-term in nature and, accordingly, are listed in the current period.
The material assumptions used to determine fair value are included in footnotes
1 through 6 in the immediately preceding table.

45

---



MANAGEMENTS ANNUAL REPORT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING

Management
of Capital Lease Funding, Inc. (the Company) is responsible for establishing
and maintaining adequate internal control over financial reporting. Internal
control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under
the Securities Exchange Act of 1934, as amended, as a process designed by, or
under the supervision of, the Companys principal executive and principal
financial officers, and effected by the Companys board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States and includes those policies and procedures that:

| |   |                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | pertain to the
  maintenance of records that in reasonable detail accurately and fairly
  reflect the transactions and dispositions of assets of the Company;                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                           
| |  | provide reasonable
  assurance that transactions are recorded as necessary to permit preparation
  of financial statements in accordance with accounting principles generally
  accepted in the United States, and that receipts and expenditures of the
  Company are being made only in accordance with authorizations of management and
  directors of the Company; and
| |   |                                                                                                                                                                                                                                                                                                                                                                           
| |  | provide reasonable
  assurance regarding prevention or timely detection of unauthorized
  acquisition, use or disposition of the Companys assets that could have a
  material effect on the financial statements.                                                                                                                                                        

Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risks that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.

Management
assessed the effectiveness of the Companys internal control over financial
reporting as of December 31, 2005. In making the assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal ControlIntegrated Framework.

Based
on this assessment, management concluded that, as of December 31, 2005, the
Companys internal control over financial reporting is designed and operating
effectively.

McGladrey
& Pullen, LLP, the Companys independent registered public accounting firm,
has issued an attestation report on managements assessment of the Companys
internal control over financial reporting. This report appears at the beginning
of Item 8. Financial Statements and Supplementary Data.

46

---



Item 8.     Financial
Statements and Supplementary Data.

Index To Financial Statements
and Financial Statement Schedules

|                                                                                                                                     |  |           |   
|------------------------------------------------------------------------------------------------------------------------------------ |  | --------- | --
|                                                                                                                                     |  | Page     
|                                                                                                                                     |  | Reference
|                                                                                                                                     |  |          
|                                                                                                                                     |  |          
|Reports of Independent
  Registered Public Accounting Firms                                                                          |  |           | 48
|                                                                                                                                     |  |           |   
|Consolidated Balance
  Sheets as of December 31, 2005 and 2004                                                                       |  |           | 50
|                                                                                                                                     |  |           |   
|Consolidated Income
  Statements for the years ended December 31, 2005, 2004 and 2003                                                |  |           | 51
|                                                                                                                                     |  |           |   
|Consolidated Statements
  of Changes in Stockholders Equity/Members Capital for the years ended
  December 31, 2005, 2004 and 2003 |  |           | 52
|                                                                                                                                     |  |           |   
|Consolidated Statements
  of Cash Flows for the years ended December 31, 2005, 2004 and 2003                                         |  |           | 53
|                                                                                                                                     |  |           |   
|Notes to Consolidated
  Financial Statements                                                                                         |  |           | 55
|                                                                                                                                     |  |           |   
|Schedule III  Schedule of Real Estate and
  Accumulated Depreciation at December 31, 2005                                           |  |           | 78
|                                                                                                                                     |  |           |   
|Schedule IV  Schedule of Mortgage and
  Other Real Estate Loans at December 31, 2005                                                |  |           | 80

47

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM

To the
Board of Directors 
Capital Lease Funding, Inc.
New York, New York

We have
audited the accompanying consolidated balance sheet of Capital Lease Funding,
Inc. and subsidiaries as of December 31, 2005, and the related consolidated
income statements, statements of changes in stockholders equity/members
capital, and cash flows for the year then ended. Our audit also included the financial statement schedules listed in the
Index at Item 8. We also have audited managements assessment, included in the
accompanying Managements Annual Report on Internal Control over Financial
Reporting, that Capital Lease Funding, Inc. maintained effective internal
control over financial reporting as of December 31, 2005, based on criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
Capital Lease Funding, Inc.s management is responsible for these
financial statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over
financial reporting.  Our responsibility
is to express an opinion on these financial statements, an opinion on
managements assessment, and an opinion on the effectiveness of the Companys
internal control over financial reporting based on our audits.

We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement and whether effective internal control over financial
reporting was maintained in all material respects.  Our audit of financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation.  Our audit of internal
control over financial reporting included obtaining an understanding of
internal control over financial reporting, evaluating managements assessment,
testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered necessary in the
circumstances.  We believe that our
audit provides a reasonable basis for our opinion.

A
companys internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.
A companys internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and
that receipts and expenditures of the company are being made only in accordance
with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a
material effect on the financial statements.

Because of
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Capital Lease
Funding, Inc. and subsidiaries as of December 31, 2005, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.  Also in our opinion, managements assessment
that Capital Lease Funding, Inc. maintained effective internal control over
financial reporting as of December 31, 2005, is fairly stated, in all material
respects, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).  Furthermore, in our opinion, Capital Lease
Funding, Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2005, based on criteria established in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).

/s/ McGladrey & Pullen LLPNew York,
New York
March 16, 2006

48

---



Report
  of Independent Registered Public Accounting Firm

To the Stockholders of
  Capital Lease Funding, Inc.

We have audited the accompanying
  consolidated balance sheet of Capital Lease Funding, Inc. and subsidiaries (the
  Company) as of December 31, 2004 and the related consolidated statements
  of income, stockholders equity/members capital and cash flows for
  each of the two years in the period ended December 31, 2004. These financial
  statements are the responsibility of the Companys management. Our responsibility
  is to express an opinion on these financial statements based on our audits.

We conducted our audits in
  accordance with the standards of the Public Company Accounting Oversight Board
  (United States). Those standards require that we plan and perform the audit
  to obtain reasonable assurance about whether the financial statements are free
  of material misstatement. We were not engaged to perform an audit of the Companys
  internal control over financial reporting. Our audit included consideration
  of internal control over financial reporting as a basis for designing audit
  procedures that are appropriate in the circumstances, but not for the purpose
  of expressing an opinion on the effectiveness of the Companys internal
  control over financial reporting. Accordingly, we express no such opinion. An
  audit also includes examining, on a test basis, evidence supporting the amounts
  and disclosures in the financial statements, assessing the accounting principles
  used and significant estimates made by management, and evaluating the overall
  financial statement presentation. We believe that our audits provide a reasonable
  basis for our opinion.

In our opinion, the financial
  statements referred to above present fairly, in all material respects, the consolidated
  financial position of Capital Lease Funding, Inc. and subsidiaries at December
  31, 2004 and the consolidated results of their operations and their cash flows
  for each of the two years in the period ended December 31, 2004, in conformity
  with U.S. generally accepted accounting principles.

/s/ Ernst & Young LLP

New York, New YorkMarch 8, 2005

49

---



Capital Lease Funding, Inc. and SubsidiariesConsolidated Balance Sheets

|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | ---- | - | ------- | 
|                                                                                                                                                                                                                    |  | December 31, |          
|                                                                                                                                                                                                                    |  |             
|(Amounts in thousands, except share and per share
  amounts)                                                                                                                                                        |  | 2005         |           | 2004 |  
|                                                                                                                                                                                                                    |  |              |           |     
|Assets                                                                                                                                                                                                              |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Real estate investments, net                                                                                                                                                                                        |  | $            | 764,930   |      | $ | 194,541 | 
|Real estate investments
  consolidated under FIN46                                                                                                                                                                  |  |              |          |      |   | 48,000  | 
|Mortgage and other real estate
  loans held for investment                                                                                                                                                          |  |              | 297,551   |      |   | 207,347 | 
|Securities available for sale                                                                                                                                                                                       |  |              | 137,409   |      |   | 87,756  | 
|Cash and cash equivalents                                                                                                                                                                                           |  |              | 19,316    |      |   | 30,721  | 
|Assets held for sale                                                                                                                                                                                                |  |              | 2,942     |      |   |        | 
|Structuring fees receivable                                                                                                                                                                                         |  |              | 3,862     |      |   | 4,426   | 
|Other assets                                                                                                                                                                                                        |  |              | 60,478    |      |   | 8,911   | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Total Assets                                                                                                                                                                                                        |  | $            | 1,286,488 |      | $ | 581,702 | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Liabilities and
  Stockholders Equity                                                                                                                                                                              |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Accounts payable, accrued
  expenses and other liabilities                                                                                                                                                          |  | $            | 14,890    |      | $ | 25,916  | 
|Repurchase agreement obligations                                                                                                                                                                                    |  |              | 129,965   |      |   | 133,831 | 
|Mortgages on real estate
  investments                                                                                                                                                                              |  |              | 551,844   |      |   | 111,539 | 
|Mortgage on real estate
  investments consolidated under FIN46                                                                                                                                                      |  |              |          |      |   | 4,815   | 
|Collateralized debt obligations                                                                                                                                                                                     |  |              | 268,156   |      |   |        | 
|Other long-term debt                                                                                                                                                                                                |  |              | 30,930    |      |   |        | 
|Intangible liabilities on real
  estate investments                                                                                                                                                                 |  |              | 14,419    |      |   | 7,028   | 
|Dividends payable                                                                                                                                                                                                   |  |              | 6,253     |      |   | 4,124   | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Total
  liabilities                                                                                                                                                                                                 |  |              | 1,016,457 |      |   | 287,253 | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Minority interest in real estate
  investments consolidated under FIN46                                                                                                                                             |  |              |          |      |   | 41,185  | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Commitments and contingencies                                                                                                                                                                                       |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Stockholders equity:                                                                                                                                                                                               |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Preferred stock, $0.01 par value,
100,000,000 shares
  authorized, Series A cumulative redeemable preferred, liquidation preference
  $25.00 per share, 1,400,000 and 0 shares issued and outstanding, respectively |  |              | 33,657    |      |   |        | 
|Common stock, $0.01 par value,
500,000,000 shares
  authorized, 27,868,480 and 27,491,700 shares issued and outstanding,
  respectively                                                                             |  |              | 279       |      |   | 275     | 
|Common stock, additional paid in
capital                                                                                                                                                                            |  |              | 237,843   |      |   | 251,786 | 
|Accumulated other comprehensive
(loss) income                                                                                                                                                                       |  |              | (1,748    | )    |   | 1,203   | 
|Retained earnings                                                                                                                                                                                                   |  |              |          |      |   |        | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Total
  Stockholders Equity                                                                                                                                                                                        |  |              | 270,031   |      |   | 253,264 | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 
|Total
  Liabilities and Stockholders Equity                                                                                                                                                                        |  | $            | 1,286,488 |      | $ | 581,702 | 
|                                                                                                                                                                                                                    |  |              |           |      |   |         | 

See notes to consolidated financial statements.

50

---



Capital Lease Funding, Inc. and SubsidiariesConsolidated Income Statements

|                                                                           |  |                         |         |      |   |        |   |   |        | 
|-------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------ | - | - | ------ | 
|                                                                           |  | Year ended December 31, |        
|                                                                           |  |                         |        
|(Amounts in thousands, except per share amounts)                           |  | 2005                    |         | 2004 |   | 2003   |  
|                                                                           |  |                         |         |      |   |        |  
|Revenues:                                                                  |  |                         |         |      |   |        |   |   |        | 
|Rental revenue                                                             |  | $                       | 37,956  |      | $ | 4,287  |   | $ |       | 
|Interest income from mortgage and
other real estate loans
  and securities |  |                         | 27,898  |      |   | 13,589 |   |   | 7,317  | 
|Property expense
recoveries                                                |  |                         | 6,272   |      |   | 1,608  |   |   |       | 
|Gain on sales of mortgage and
other real estate loans and
  securities     |  |                         | 447     |      |   | 794    |   |   | 11,652 | 
|Other revenue                                                              |  |                         | 479     |      |   | 726    |   |   | 151    | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Total revenues                                                             |  |                         | 73,052  |      |   | 21,004 |   |   | 19,120 | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Expenses:                                                                  |  |                         |         |      |   |        |   |   |        | 
|Interest expense                                                           |  |                         | 31,398  |      |   | 2,768  |   |   | 1,220  | 
|Interest expense to
affiliates                                             |  |                         |        |      |   |       |   |   | 838    | 
|Property expenses                                                          |  |                         | 10,441  |      |   | 1,761  |   |   |       | 
|(Gain) loss on
derivatives                                                 |  |                         | (159    | )    |   | 724    |   |   | 3,129  | 
|Loss on securities                                                         |  |                         | 2,372   |      |   | 247    |   |   |       | 
|General and administrative
expenses                                        |  |                         | 10,140  |      |   | 8,833  |   |   | 7,186  | 
|General and administrative
expenses-stock based
  compensation             |  |                         | 2,235   |      |   | 3,825  |   |   |       | 
|Depreciation and amortization
expense on real property                     |  |                         | 11,273  |      |   | 1,281  |   |   |       | 
|Loan processing expenses                                                   |  |                         | 283     |      |   | 196    |   |   | 114    | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Total expenses                                                             |  |                         | 67,983  |      |   | 19,635 |   |   | 12,487 | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Income before minority interest
  and taxes                                |  |                         | 5,069   |      |   | 1,369  |   |   | 6,633  | 
|Minority interest in consolidated
  entities                               |  |                         | 55      |      |   |       |   |   |       | 
|Provision for income taxes                                                 |  |                         |        |      |   | (9     | ) |   |       | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Income from continuing operations                                          |  |                         | 5,124   |      |   | 1,360  |   |   | 6,633  | 
|Income from discontinued
  operations                                      |  |                         | 6       |      |   |       |   |   |       | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Net income                                                                 |  |                         | 5,130   |      |   | 1,360  |   |   | 6,633  | 
|Dividends allocable to preferred
  shares                                  |  |                         | (561    | )    |   |       |   |   |       | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Net income
  allocable to common stockholders                              |  | $                       | 4,569   |      | $ | 1,360  |   | $ | 6,633  | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|                                                                           |  |                         |         |      |   |        |   |   |        | 
|Earnings per share (pro forma for
  2003):                                 |  |                         |         |      |   |        |   |   |        | 
|Net income per common share, basic
and diluted                             |  | $                       | 0.16    |      | $ | 0.06   |   | $ | 1.61   | 
|Weighted average number of common
shares outstanding,
  basic and diluted  |  |                         | 27,784  |      |   | 22,125 |   |   | 4,108  | 
|Dividends declared per common
  share                                      |  | $                       | 0.74    |      | $ | 0.25   |   | $ |       | 
|Dividends declared per preferred
  share                                   |  | $                       | 0.48524 |      | $ |       |   | $ |       | 

See notes to consolidated financial
statements.

51

---



Capital Lease Funding, Inc. and SubsidiariesConsolidated Statements of Changes in Stockholders Equity/Members Capital

|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|------------------------------------------------------------- |  | -------------------------- | ------- | ----------------------------------------------------- | - | ----------------- | - | ----------------------- | ------ | --------------------------------------------- | - | ----------------------------------------------------- |  | ------------------------------- | ------- | ----- | - | ----------------------------- | - | - | ------ | - | - | ------- | - | - | ------- | -
|                                                              |  | Capital Lease Funding, LLC |         | Capital Lease Funding, Inc.                           |   |                   |   |                         |        |                                               |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |  
|(Amounts in thousands)                                        |  | Members
  Capital         |         | Accumulated
  Other
  Comprehensive
  Income
  (Loss) |   | Preferred
  Stock |   | Common
  Stock
  at Par |        | Common stock
  Additional
  Paid-In
  Capital |   | Accumulated
  Other
  Comprehensive
  Income
  (Loss) |  | Retained
  Earnings
  (Deficit) |         | Total |   | Comprehensive
  Income (Loss) |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |  
|Balance, December 31, 2002                                    |  | $                          | 25,324  |                                                       | $ | 2,451             |   | $                       |       |                                               | $ |                                                      |  | $                               |        |       | $ |                              |   | $ |       |   | $ | 27,775  |   |   |         |  
|Net income                                                    |  |                            | 6,633   |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   |       |   |   | 6,633   |   |   | 6,633   |  
|Unrealized change in value on securities available for
  sale |  |                            |        |                                                       |   | (363              | ) |                         |       |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   |       |   |   | (363    | ) |   | (363    | )
|Issuance of stock-founders shares                            |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   | 1                                                     |  |                                 | 13      |       |   |                              |   |   |       |   |   | 14      |   |   |         |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|Balance, December 31, 2003                                    |  | $                          | 31,957  |                                                       | $ | 2,088             |   | $                       |       |                                               | $ | 1                                                     |  | $                               | 13      |       | $ |                              |   | $ |       |   | $ | 34,059  |   | $ | 6,270   |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|Acquisition of Caplease LP                                    |  |                            | (31,957 | )                                                     |   | (2,088            | ) |                         |       |                                               |   | 40                                                    |  |                                 | 31,917  |       |   | 2,088                         |   |   |       |   |   |        |   |   |         |  
|Issuance of common stock-initial public
offering              |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   | 230                                                   |  |                                 | 241,270 |       |   |                              |   |   |       |   |   | 241,500 |   |   |         |  
|Initial public offering costs                                 |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | (19,723 | )     |   |                              |   |   |       |   |   | (19,723 | ) |   |         |  
|Issuance of stock-incentive stock plan at offering
date       |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   | 4                                                     |  |                                 | 1,357   |       |   |                              |   |   |       |   |   | 1,361   |   |   |         |  
|Adjust initial management share purchases to market
value     |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | 1,447   |       |   |                              |   |   |       |   |   | 1,447   |   |   |         |  
|Incentive stock plan compensation expense-                    |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|March 25- December 31, 2004                                   |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | 1,018   |       |   |                              |   |   |       |   |   | 1,018   |   |   |         |  
|Net income                                                    |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   | 1,360  |   |   | 1,360   |   |   | 1,360   |  
|Dividends declared                                            |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | (5,513  | )     |   |                              |   |   | (1,360 | ) |   | (6,873  | ) |   |         |  
|Unrealized change in value on securities available for
  sale |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | 8,121                         |   |   |       |   |   | 8,121   |   |   | 8,121   |  
|Unrealized loss on derivatives                                |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | (7,312                        | ) |   |       |   |   | (7,312  | ) |   | (7,312  | )
|Net realized loss on cash flow hedges                         |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | (1,694                        | ) |   |       |   |   | (1,694  | ) |   | (1,694  | )
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|Balance, December 31, 2004                                    |  | $                          |        |                                                       | $ |                  |   | $                       |       |                                               | $ | 275                                                   |  | $                               | 251,786 |       | $ | 1,203                         |   | $ |       |   | $ | 253,264 |   | $ | 475     |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|Issuance of preferred stock                                   |  |                            |        |                                                       |   |                  |   |                         | 33,657 |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   |       |   |   | 33,657  |   |   |         |  
|Incentive stock plan compensation expense                     |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | 2,235   |       |   |                              |   |   |       |   |   | 2,235   |   |   |         |  
|Incentive stock plan grants issued &
forfeited                |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   | 4                                                     |  |                                 | (4      | )     |   |                              |   |   |       |   |   |        |   |   |         |  
|Net income                                                    |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   | 5,130  |   |   | 5,130   |   |   | 5,130   |  
|Dividends declared-preferred                                  |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   |                              |   |   | (680   | ) |   | (680    | ) |   |         |  
|Dividends declared-common                                     |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 | (16,174 | )     |   |                              |   |   | (4,450 | ) |   | (20,624 | ) |   |         |  
|Unrealized change in value of securities available for
  sale |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | (561                          | ) |   |       |   |   | (561    | ) |   | (561    | )
|Unrealized change in value of derivatives                     |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | 8,098                         |   |   |       |   |   | 8,098   |   |   | 8,098   |  
|Realized gains (losses) on derivatives, net of
  amortization |  |                            |        |                                                       |   |                  |   |                         |       |                                               |   |                                                      |  |                                 |        |       |   | (10,488                       | ) |   |       |   |   | (10,488 | ) |   | (10,488 | )
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  
|Balance, December 31, 2005                                    |  | $                          |        |                                                       | $ |                  |   | $                       | 33,657 |                                               | $ | 279                                                   |  | $                               | 237,843 |       | $ | (1,748                        | ) | $ |       |   | $ | 270,031 |   | $ | 2,179   |  
|                                                              |  |                            |         |                                                       |   |                   |   |                         |        |                                               |   |                                                       |  |                                 |         |       |   |                               |   |   |        |   |   |         |   |   |         |  

See notes to consolidated financial statements.

52

---



Capital Lease Funding, Inc. and SubsidiariesConsolidated Statements of Cash Flows

|                                                                            |  |                         |          |      |   |          |   |   |          |  
|--------------------------------------------------------------------------- |  | ----------------------- | -------- | ---- | - | -------- | - | - | -------- | -
|                                                                            |  | Year ended December 31, |         
|                                                                            |  |                         |         
|(Amounts in thousands)                                                      |  | 2005                    |          | 2004 |   | 2003     |  
|                                                                            |  |                         |          |      |   |          |  
|                                                                            |  |                         |          |      |   |          |  
|Operating activities                                                        |  |                         |          |      |   |          |   |   |          |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Net income                                                                  |  | $                       | 5,130    |      | $ | 1,360    |   | $ | 6,633    |  
|Adjusts to reconcile net income to cash provided by
  operating activities: |  |                         |          |      |   |          |   |   |          |  
|Depreciation and amortization                                               |  |                         | 10,469   |      |   | 1,386    |   |   | 150      |  
|Amortization of stock based
compensation                                    |  |                         | 2,235    |      |   | 3,825    |   |   |         |  
|Amortization of above and below market
leases                               |  |                         | (583     | )    |   | (80      | ) |   |         |  
|Gain on sale of mortgage loans and
securities                               |  |                         | (447     | )    |   | (794     | ) |   | (11,652  | )
|Loss on securities available for
sale                                       |  |                         | 2,372    |      |   | 247      |   |   |         |  
|Change in provision for loss on mortgage
loans                              |  |                         |         |      |   |         |   |   | (1,917   | )
|(Gain) loss on derivatives and short
sales of securities                    |  |                         | (159     | )    |   | 724      |   |   | 3,129    |  
|Straight-lining of rents                                                    |  |                         | (5,581   | )    |   | (507     | ) |   |         |  
|Amortization of discounts/premiums, and
origination
  fees/costs            |  |                         | (514     | )    |   | (247     | ) |   |         |  
|Amortization of debt issuance costs and
FMV of debt
  assumed               |  |                         | 1,139    |      |   | 18       |   |   |         |  
|Changes in operating assets and
liabilities:                                |  |                         |          |      |   |          |   |   |          |  
|Proceeds from sale of mortgage
loans                                        |  |                         |         |      |   |         |   |   | 159,915  |  
|Net principal advanced to
borrowers                                         |  |                         |         |      |   |         |   |   | (141,185 | )
|Funds used in hedging and risk
management activities                        |  |                         |         |      |   | (4,485   | ) |   | (4,219   | )
|Origination costs on lending
investments                                    |  |                         |         |      |   |         |   |   | (61      | )
|Securities held for sale                                                    |  |                         |         |      |   |         |   |   | (20,175  | )
|Structuring fees receivable                                                 |  |                         | 563      |      |   | 797      |   |   | (429     | )
|Other assets                                                                |  |                         | (27,146  | )    |   | (6,676   | ) |   | (957     | )
|Accounts payable, accrued expenses and
other liabilities                    |  |                         | 8,271    |      |   | 843      |   |   | 602      |  
|Deposits and escrows                                                        |  |                         | (8,501   | )    |   | 10,550   |   |   | (515     | )
|Amounts due to servicer                                                     |  |                         | (4,359   | )    |   | 4,012    |   |   | (62      | )
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Net cash (used in) provided by operating
activities                         |  |                         | (17,111  | )    |   | 10,973   |   |   | (10,743  | )
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Investing activities                                                        |  |                         |          |      |   |          |   |   |          |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Proceeds from sale of mortgage and other
real estate loans                  |  |                         | 12,131   |      |   | 25,422   |   |   |         |  
|Additions to mortgage and other real
estate loans                           |  |                         | (115,852 | )    |   | (167,009 | ) |   |         |  
|Principal received from
borrowers                                           |  |                         | 20,372   |      |   | 8,520    |   |   |         |  
|Origination costs on lending
investments                                    |  |                         | 362      |      |   | 331      |   |   |         |  
|Purchase of securities available for
sale                                   |  |                         | (66,168  | )    |   | (95,867  | ) |   |         |  
|Sale of securities available for
sale                                       |  |                         | 5,787    |      |   | 55,868   |   |   |         |  
|Principal amortization on securities
available for sale                     |  |                         | 1,541    |      |   | 418      |   |   |         |  
|Purchases of real estate
investments                                        |  |                         | (530,593 | )    |   | (174,351 | ) |   |         |  
|Real estate improvements, additions and
construction in
  progress          |  |                         | (3,825   | )    |   | (174     | ) |   |         |  
|Deposits on potential equity
investments                                    |  |                         | (14,700  | )    |   | (2,500   | ) |   |         |  
|Return of deposit on equity
investment                                      |  |                         | 16,600   |      |   |         |   |   |         |  
|Purchase of other investments                                               |  |                         | (930     | )    |   |         |   |   |         |  
|Purchases of furniture, fixtures and
equipment                              |  |                         | (133     | )    |   | (234     | ) |   | (69      | )
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Net cash used in investing activities                                       |  |                         | (675,408 | )    |   | (349,576 | ) |   | (69      | )
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Financing activities                                                        |  |                         |          |      |   |          |   |   |          |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Borrowing under repurchase
agreements                                       |  |                         | 232,024  |      |   | 135,411  |   |   | 47,974   |  
|Repayment of repurchase
agreements                                          |  |                         | (235,890 | )    |   | (30,344  | ) |   | (71,103  | )
|Borrowings under repurchase agreements
to affiliates                        |  |                         |         |      |   |         |   |   | 62,865   |  
|Repayments under repurchase agreements
to affiliates                        |  |                         |         |      |   | (59,322  | ) |   | (27,765  | )
|Borrowings from mortgages on real estate
investments                        |  |                         | 400,552  |      |   | 97,547   |   |   |         |  
|Repayments of mortgages on real estate
investments                          |  |                         | (1,341   | )    |   | (191     | ) |   |         |  
|Borrowings from collateralized debt
obligations                             |  |                         | 268,130  |      |   |         |   |   |         |  
|Borrowings from other long-term debt
obligations                            |  |                         | 30,930   |      |   |         |   |   |         |  
|Repayments of notes payable                                                 |  |                         |         |      |   |         |   |   | (275     | )
|Debt issuance costs                                                         |  |                         | (7,050   | )    |   | (344     | ) |   |         |  
|Escrows held with mortgage
lender                                           |  |                         | (9,507   | )    |   |         |   |   |         |  
|Funds used in hedging and risk
management activities                        |  |                         | (11,206  | )    |   |         |   |   |         |  
|Common stock issued, net of offering
costs                                  |  |                         |         |      |   | 222,818  |   |   |         |  
|Preferred stock issued, net of offering
costs                               |  |                         | 33,657   |      |   |         |   |   |         |  
|Dividends paid                                                              |  |                         | (19,174  | )    |   | (2,749   | ) |   |         |  
|Reverse merger                                                              |  |                         |         |      |   | 14       |   |   |         |  
|Changes in amounts due from affiliates
and members                          |  |                         | (11      | )    |   | (38      | ) |   | 252      |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Net cash provided by financing activities                                   |  |                         | 681,114  |      |   | 362,802  |   |   | 11,948   |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Net (decrease) increase in cash                                             |  |                         | (11,405  | )    |   | 24,199   |   |   | 1,136    |  
|Cash and cash equivalents at beginning of
period                            |  |                         | 30,721   |      |   | 6,522    |   |   | 5,386    |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  
|Cash and cash equivalents at end of
  period                                |  | $                       | 19,316   |      | $ | 30,721   |   | $ | 6,522    |  
|                                                                            |  |                         |          |      |   |          |   |   |          |  

See notes to consolidated financial
statements.

53

---



Capital Lease Funding, Inc. and Subsidiaries
Consolidated Statements of Cash Flows  continued

|                                                                                    |  |                         |         |      |   |        |   |  |   |       |  | 
|----------------------------------------------------------------------------------- |  | ----------------------- | ------- | ---- | - | ------ | - |  | - | ----- |  | 
|                                                                                    |  | Year ended December 31, |        
|                                                                                    |  |                         |        
|(Amounts in thousands)                                                              |  | 2005                    |         | 2004 |   | 2003   |  
|                                                                                    |  |                         |         |      |   |        |   |  |   |      
|Supplemental disclosure of cash flow
  information                                  |  |                         |         |      |   |        |   |  |   |       |  | 
|Cash paid during the year for interest expense (excluding
  capitalized interest)   |  | $                       | 24,165  |      | $ | 2,647  |   |  | $ | 2,176 |  | 
|Cash paid for capitalized interest                                                  |  | $                       | 1,589   |      | $ |       |   |  | $ |      |  | 
|Cash paid during the year for income taxes                                          |  | $                       | 9       |      | $ |       |   |  | $ | 89    |  | 
|Dividends declared but not paid                                                     |  | $                       | 6,253   |      | $ | 4,124  |   |  | $ |      |  | 
|                                                                                    |  |                         |         |      |   |        |   |  |   |       |  | 
|Supplemental disclosure of noncash
  operating, investing and financing information |  |                         |         |      |   |        |   |  |   |       |  | 
|Prepaid expenses and other assets reclassified to public
  offering costs           |  | $                       |        |      | $ | 1,040  |   |  | $ |      |  | 
|Unrealized gain (loss) on cash flow hedges                                          |  | $                       | 8,098   |      | $ | (7,312 | ) |  | $ |      |  | 
|Value of in-place leases and above-market leases
acquired                           |  | $                       | 69,344  |      | $ | 13,518 |   |  | $ |      |  | 
|Value of below-market leases acquired                                               |  | $                       | 8,102   |      | $ | 7,108  |   |  | $ |      |  | 
|Securities reclassified to mortgage loans held for
  investment                     |  | $                       | 6,932   |      | $ |       |   |  | $ |      |  | 
|Mortgage notes payable assumed on properties
acquired                               |  | $                       | 41,276  |      | $ | 14,190 |   |  | $ |      |  | 
|Real estate investments consolidated under
FIN46                                    |  | $                       | 81,500  |      | $ | 48,000 |   |  | $ |      |  | 
|Real estate investments no longer consolidated under
FIN46                          |  | $                       | 129,500 |      | $ |       |   |  | $ |      |  | 
|Mortgage on real estate investments consolidated under
  FIN46                      |  | $                       | 50,887  |      | $ | 4,815  |   |  | $ |      |  | 
|Mortgage on real estate investments no longer consolidated
  under FIN46            |  | $                       | 55,702  |      | $ |       |   |  | $ |      |  | 
|Depreciation on real estate investments consolidated under
  FIN46                  |  | $                       | 935     |      | $ |       |   |  | $ |      |  | 

See notes to consolidated financial
statements.

54

---



Capital Lease Funding, Inc. and
SubsidiariesNotes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

1.Organization

Capital
Lease Funding, Inc. (CLF, Inc. and collectively with its wholly-owned
subsidiaries, the Company) was incorporated in the State of Maryland during
October 2003, and was formed for the purpose of continuing the existing
business operations and acquiring the assets and liabilities of Caplease, LP
(LP or the Predecessor). CLF, Inc. completed this acquisition through a
reverse merger and its initial public offering during March 2004.

The
Company invests in equity interests in real estate properties, real estate
mortgage loans, real estate securities and other real estate assets. The
Companys investments primarily consist of real estate related assets that are
backed by commercial properties typically subject to long-term net leases from
investment grade and near investment grade tenants.

The
accompanying financial statements include the historical results of operations
of the Predecessor prior to its acquisition by CLF, Inc. The Predecessors
principal activity was the origination and sale or securitization of commercial
mortgage loans. Since 1995, the Predecessor was primarily engaged in the
business of underwriting, originating and selling or securitizing mortgage
loans made to owners of real properties subject to long term leases to high
credit quality tenants. These loans were typically secured by a first lien on
the leased property and an assignment of the leases and all rents due under the
leases.

In
March 2004, CLF, Inc. sold 23,000,000 shares of its common stock in an initial
public offering at a price to the public of $10.50 per share, for net proceeds
of approximately $222,000. In October 2005, CLF, Inc. sold 1,400,000 shares of
its 8.125% Series A cumulative redeemable preferred stock in a public offering
at a price to the public of $25.00 per share, for net proceeds of approximately
$33,800. CLF, Inc. had 27,868,480 shares of common stock and 1,400,000 shares
of 8.125% Series A cumulative redeemable preferred stock outstanding at
December 31, 2005.

CLF,
Inc. is organized and conducts its operations to qualify as a real estate
investment trust (REIT) for federal income tax purposes. As such, it will
generally not be subject to federal income tax on that portion of its income
that is distributed to stockholders if it distributes at least 90% of its REIT
taxable income to its stockholders by prescribed dates and complies with
various other requirements.

2. Summary of Significant Accounting
Policies

Basis of
Presentation and Principles of Consolidation

The
accompanying consolidated financial statements include the assets, liabilities,
and results of operations of the Predecessor prior to March 24, 2004, and CLF,
Inc., its wholly-owned subsidiaries and other entities consolidated under FIN
46 thereafter (see Note 23). Results of operations of properties acquired are
included in the Consolidated Income Statements from the date of acquisition.
All significant intercompany transactions, balances and accounts have been
eliminated in consolidation.

Use of
Estimates

Management
of the Company has made a number of estimates and assumptions relating to the
reporting of assets and liabilities, revenues and expenses and the disclosure
of contingent assets and liabilities to prepare these consolidated financial
statements in conformity with accounting principles generally accepted in the
United States of America. Actual results could differ from those estimates.

Risks and
Uncertainties

In
the normal course of business, the Company encounters primarily two significant
types of economic risk: credit and market. Credit risk is the risk of default
on the Companys loans, leases and securities that results from a borrowers,
lessees or derivative counterpartys inability or unwillingness to make
contractually required payments. Market risk reflects changes in the value of
investments in loans and real estate or in hedging instruments due to changes
in interest rates or other market factors, including the value of the
collateral underlying loans and the valuation of real estate held by the
Company. Management believes that the carrying values of its investments are
reasonable taking into consideration these risks along with estimated
collateral values, payment histories, and other relevant information.

Investments
in Mortgage Loans

Mortgage
loans comprise the vast majority of the Companys loan portfolio. Mortgage
loans are secured by an assignment of the long-term real property leases (the
majority of whose tenants carry credit ratings of BBB- or better, commonly
referred to as investment grade) and mortgages on the underlying real estate.
Mortgage loans held for investment

55

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

are carried
at cost (unpaid principal balance adjusted for unearned discount and deferred
expenses), and are amortized using the effective interest method over the life
of the loan.

Purchase
Accounting for Acquisition of Real Estate

The
fair value of rental real estate acquired subject to existing leases is
allocated to the following based on fair values:

| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the acquired tangible assets,
  consisting of land, building and improvements; and                                                                                                    
| |   |                                                                                                                                                                                       
| |  | identified intangible assets and
  liabilities, consisting of the value of above-market and below-market leases,
  the value of in-place leases and the value of tenant relationships.

In
estimating the fair value of the tangible and intangible assets acquired, the
Company considers information obtained about each property as a result of its
due diligence activities and other market data, and utilizes various valuation
methods, such as estimated cash flow projections utilizing appropriate discount
and capitalization rates, estimates of replacement costs, and available market
information. The fair value of the tangible assets of an acquired property
considers the value of the property as if it were vacant.

Above-market
and below-market lease values for acquired properties are recorded based on the
present value of the differences between (i) the contractual amounts to be paid
pursuant to each in-place lease and (ii) managements estimate of fair market
lease rates for each corresponding in-place lease. Fair market lease rates are
measured over a period equal to the remaining term of the lease for
above-market leases and the initial term plus the term of any below-market rate
renewal options for below-market leases. In computing present value, the
Company uses a discount rate which reflects the risks associated with the leases
acquired. The capitalized above-market lease values are amortized as a
reduction of base rental revenue over the remaining term of the respective
leases, and the capitalized below-market lease values are amortized as an
increase to base rental revenue over the remaining initial terms plus the terms
of any below-market renewal options of the respective leases.

Other
intangible assets acquired include amounts for in-place lease values and tenant
relationship values which are based on managements evaluation of the specific
characteristics of each tenants lease and the Companys overall relationship
with the respective tenant. Factors considered by management in its analysis of
in-place lease values include an estimate of carrying costs during the
hypothetical expected time it would take management to find a tenant to lease
the space for the existing lease term (a lease-up period) considering current
market conditions, and costs to execute similar leases. Management estimates
carrying costs, including such factors as real estate taxes, insurance and
other operating expenses during the expected lease-up period, considering
current market conditions and costs to execute similar leases. In estimating
costs to execute similar leases, management considers leasing commissions,
legal and other related expenses. Characteristics considered by management in
valuing tenant relationships include the nature and extent of the Companys
existing business relationships with the tenant, growth prospects for
developing new business with the tenant, the tenants credit quality and
expectations of lease renewals. The value of in-place leases is amortized to
expense over the remaining initial terms of the respective leases. The value of
tenant relationship intangibles is amortized to expense over the anticipated
life of the relationships. Through December 31, 2005, the Company has assigned
no value to tenant relationships on any of its acquisitions.

For
property acquisitions where the Company assumes existing mortgage debt, the
debt is recorded at its fair value, based on managements estimate of current
market yields available for comparable financing. The Company amortizes any
discount or premium as part of interest expense on the related debt using the
effective interest method.

Real
estate taxes, insurance and interest expense on properties that are under
development are capitalized in accordance with the Financial Accounting
Standards Board (FASB) Statement of Financial Accounting Standards (SFAS)
No. 34, Capitalization of Interest Cost
and SFAS 67, Accounting for Costs and
Initial Rental Operations of Real Estate Projects.

Depreciation
is determined by the straight-line method over the remaining estimated economic
useful lives of the properties. The Company generally depreciates buildings and
building improvements over periods not exceeding 40 years. Direct costs
incurred in acquiring properties are capitalized. Expenditures for maintenance
and repairs are charged to operations as incurred. Significant renovations
which extend the useful life of the properties are capitalized.

56

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

Securities
Available for Sale

Securities
are classified as available-for-sale and are reported at fair value on the
Companys consolidated balance sheets, with unrealized gains and losses
included in other comprehensive income, and other than temporary impairments
included in current earnings on the Income Statement, in accordance with SFAS
No. 115, Accounting for Certain Investments
in Debt and Equity Securities.The Company has also adopted the
disclosure requirements of EITF Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments, regarding disclosures to be made when
held-to-maturity or available-for-sale investments are impaired at the balance
sheet date but for which an other than temporary loss has not been
recognized.

Structuring
Fees Receivable

Structuring
fees receivable are initially recorded at the discounted value of expected cash
receipts, and periodically evaluated for impairment. In accordance with Staff
Accounting Bulletin No. 104, fee revenue is recognized as earned when the
following criteria are met: (i) evidence of an arrangement exists; (ii)
services have been rendered; (iii) the fee is fixed or determinable; and (iv)
collectibility is reasonably assured. The Company amortizes the receivable
balance as cash is collected, allocating a portion of the cash received to
principal and interest.

Deferred
Origination Fees and Costs

In
accordance with SFAS No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases, the Company defers the recognition
of fees and expenses associated with the origination of its loans held for
investment. These items include lender fee income, rate lock income, certain
legal fees, insurance costs, rating agency fees and certain other expenses.
Deferred fees and costs are recognized as an adjustment to the effective yield
over the life of the related asset.

Sale of
Commercial Mortgage Loans

Prior
to its initial public offering in March 2004, the Company sold a majority of
its mortgage loans. Since its initial public offering, the Companys portfolio
business strategy has contemplated selling only a limited number of mortgage
loans. The Company does not retain servicing rights for sold loans. When the
Company sells mortgage loans, it derecognizes assets sold, records assets
received or retained and records a gain or loss on sale. The asset received is
generally cash. In certain sale transactions, the Company retains a small cash
flow interest in the loans being sold. The Company accounted for sales of
mortgage loans in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.

Derivative
and Other Risk Management Transactions

The
Company accounts for derivatives in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). The Company measures derivative instruments
at fair value and records each as an asset or liability, depending on the
Companys rights or obligations under the applicable derivative contract.

Prior
to the CLF, Inc.s conversion to a REIT on March 24, 2004, the Company used
derivatives consisting of U.S. Treasury and Agency lock transactions (Locks)
to hedge interest rate risk associated with owning fixed rate mortgage loan
assets financed by floating rate debt. These Locks, to the extent that the
Company has designated them and they qualify as part of a hedging relationship,
are treated as fair value hedges in accordance with SFAS 133. For derivatives
designated as fair value hedges, the changes in the fair value of both the
derivative instrument and the hedged item are recorded in earnings.

Subsequent
to REIT conversion, the Company began using forward starting interest rate
swaps to hedge the variable of changes in the interest-related cash outflows on
forecasted future borrowings. These interest rate swaps, to the extent that the
Company has designated them and they qualify as part of a hedging relationship,
are treated as cash flow hedges in accordance with SFAS 133. For derivatives
designated as cash flow hedges, the effective portions of the derivative are
reported in other comprehensive income (OCI) and are subsequently
reclassified into earnings when the hedged item affects earnings. Ineffective
portions of hedges are recognized in earnings in the affected period.

Revenue
Recognition

Rental
revenue on real estate is recognized in accordance with SFAS No. 13, Accounting for Leases. Rental revenue is
recognized on a straight-line basis over the non-cancelable term of the lease
unless another systematic and

57

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated
Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

rational
basis is more representative of the time pattern in which the use benefit is
derived from the leased property. This includes the effects of rent steps and
rent abatements under the leases.

Interest
income from loans, securities, and structuring fees receivable, is recognized
on the accrual basis of accounting. Interest income from securities (including
interest-only strips) is recognized over the life of the investment using the
effective interest method. The cost basis of interest-only strips is adjusted
to reflect any prepayments from underlying assets, using the initial
yield-to-maturity at the purchase date.

Gains
are recognized on the sale of loans and securities in accordance with the
requirements of SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
The Company may from time to time split its mortgage loan investments into two
notesa real estate note and a corporate credit note. In these instances, the
Company will generally sell the real estate note to a third party and retain
the corporate credit note in portfolio. The Company computes gain on these
sales by comparing the sales proceeds on the note sold to its cost basis. The
Company computes its cost basis on the note sold by allocating the entire basis
in the loan between the two notes based on the present value of expected cash
flows on each note. In computing present values, management estimates a
discount rate based on a benchmark rate plus a market spread based on the
credit of the underlying tenant. These estimates reflect market rates that
management believes are reasonable. However, the use of different estimates
could have an impact on the calculation of gain on sale revenue.

The
Company may periodically receive breakup fees on contracts in connection with
its investments in real estate. The Company recognizes revenues from contract
breakup fees when the contractual conditions have occurred to trigger the
receipt of such a fee, when the amounts of such revenue can be reasonably
determined, and when collection is probable.

Lease
Enhancement Mechanisms

The
Company utilizes the following lease enhancement mechanisms, primarily as part
of its lending programs:

| |   |                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | casualty and condemnation
  insurance policies that protect the Company from any right the tenant may
  have to terminate the underlying net lease or abate rent as a result of a
  casualty or condemnation; and                                                                                
| |   |                                                                                                                                                                                                                                                                                                  
| |  | with respect to a double
  net lease, borrower reserve funds that protect the Company from any rights
  the tenant may have to terminate the underlying net lease or abate rent as a
  result of the failure of the property owner to maintain and repair the property
  or related common areas.

Costs
incurred by the Company for lease enhancement mechanisms are typically charged
to the borrowers. In instances where costs are not fully absorbed by the
borrower, costs are treated in accordance with SFAS No. 91, as a cost of loan
origination.

Impairment
of Long-Lived Assets

In
accordance with SFAS No. 144 Accounting for
the Impairment or Disposal of Long-Lived Assets, the Company
reviews its investment in long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The Company began acquiring owned real properties in the third
quarter of 2004. The Company recognized no impairment losses on long-lived
assets during the years ended December 31, 2005, 2004 and 2003.

Marketing
and Advertising Costs

The
Company expenses marketing and advertising costs as incurred. Marketing and
advertising expense totaled $615, $688, and $544, in 2005, 2004, and 2003,
respectively.

Income
Taxes

CLF,
Inc. is subject to federal income taxation at corporate rates on its REIT
taxable income. However, CLF, Inc. is allowed a deduction for the amount of
dividends paid to its stockholders, thereby subjecting the distributed net
income of CLF, Inc. to taxation at the stockholder level only. CLF, Inc.
intends to continue to operate in a manner consistent with and it has elected
to be treated as a REIT for tax purposes. From time to time, the Company may
conduct a portion of its business through a taxable REIT subsidiary (TRS),
and the income from the activities of the TRS is subject to federal and state
taxation at the applicable corporate rates.

58

---



Capital Lease Funding, Inc. and
SubsidiariesNotes to Consolidated Financial Statements(Dollar amounts in thousands, except per
share amounts)

December 31, 2005, 2004 and 2003

Other
Comprehensive Income

In
accordance with SFAS No. 130, Reporting
Comprehensive Income, the Company recognizes the change in fair
value of its securities held for sale through other comprehensive income. In
accordance with SFAS No. 133, the Company recognizes the change in fair value,
and gains and losses from the effective portion of its cash flow hedges through
other comprehensive income. Realized gains and losses from the effective
portion of the cash flow hedges related to the Companys debt issuances are
amortized as a component of interest expense over the term of the related
financing, using the constant interest method.

Earnings
per Share

In
accordance with the Statement of Financial Accounting Standards No. 128 (SFAS
No. 128), the Company presents both basic and diluted earnings per share
(EPS). Basic EPS excludes dilution and is computed by dividing net income
allocable to common shareholders by the weighted average number of shares
outstanding for the period. Diluted earnings per share reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock, where such exercise or conversion
would result in a lower EPS amount. The Company has no dilutive securities or
other contracts outstanding and, therefore, there is no difference between
basic and diluted EPS results for the Company.

The
following summarizes the Companys EPS computations for the years ended
December 31, 2005, December 31, 2004 and December 31, 2003 (in thousands,
except per share amounts):

|                                                                                    |  |              |        |      |   |        |  |   |       | 
|----------------------------------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ |  | - | ----- | 
|                                                                                    |  | December 31, |       
|                                                                                    |  |              |       
|                                                                                    |  | 2005         |        | 2004 |   | 2003   | 
|                                                                                    |  |              |        |      |   |        | 
|Net income allocable to common stockholders                                         |  | $            | 4,569  |      | $ | 1,360  |  | $ | 6,633 | 
|Weighted average number of common shares
  outstanding, basic and diluted           |  |              | 27,784 |      |   | 22,125 |  |   | 4,108 | 
|Earnings per share, basic and diluted                                               |  | $            | 0.16   |      | $ | 0.06   |  | $ | 1.61  | 
|                                                                                    |  |              |        |      |   |        |  |   |       | 
|Non-vested shares included in weighted
  average number of shares outstanding above |  |              | 496    |      |   | 254    |  |   |      | 

Recently
Issued Accounting Pronouncements

On
December 16, 2004, the FASB issued SFAS No. 123R: (Revised 2004)  Share-Based Payment (SFAS No. 123R).
SFAS 123R replaces SFAS No. 123, which the Company adopted on January 1, 2003.
SFAS No. 123R requires that the compensation cost relating to share-based
payment transactions be recognized in financial statements and be measured
based on the fair value of the equity or liability instruments issued. SFAS No.
123R is effective as of the first interim or annual reporting period that
begins after December 31, 2005 (or as of January 1, 2006 for the Company). The
Company does not believe that the adoption of SFAS No. 123R will have a
material effect on the Companys consolidated financial statements.

On
December 16, 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets  An Amendment of APB Opinion No.
29. The amendments made by SFAS No. 153 are based on the principle
that exchanges of nonmonetary assets should be measured based on the fair value
of the assets exchanged. Further, the amendments eliminate the narrow exception
for nonmonetary exchanges of similar productive assets and replace it with a
broader exception for exchanges of nonmonetary assets that do not have
commercial substance. SFAS No. 153 is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The
adoption of SFAS No. 153 on its effective date did not have a material effect
on the Companys consolidated financial statements.

In
May 2005, the FASB issued SFAS No. 154, Accounting
Changes and Error Corrections  A Replacement of APB Opinion No. 20 and SFAS
No. 3. SFAS No. 154 changes the requirements for the accounting and
reporting of a change in accounting principle by requiring retrospective application
to prior periods financial statements of the change in accounting principle,
unless it is impracticable to do so. SFAS No. 154 also requires that a change
in depreciation or amortization for longlived, nonfinancial
assets be accounted for as a change in accounting estimate effected by a change
in accounting principle. SFAS No. 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The Company believes that the adoption of SFAS No. 154 will not have a material
effect on the Companys consolidated financial statements.

59

---



Capital Lease Funding, Inc. and
SubsidiariesNotes to Consolidated Financial Statements(Dollar amounts in thousands, except per
share amounts)

December 31, 2005, 2004 and 2003

Reclassification

Certain
prior year amounts have been reclassified to conform to the current
presentation. There was no effect on net income or equity related to these
reclassifications.

3. Cash
and Cash Equivalents

The
Company defines cash equivalents as highly liquid investments purchased with
maturities of three months or less at date of purchase. From time to time, the
Companys account balance held at financial institutions exceeds Federal
Depository Insurance Corporation (FDIC) insurance coverage and, as a result,
there is a concentration of credit risk related to the balance on deposit in
excess of FDIC insurance coverage. The Company believes that the risk of loss
is not significant.

4.
Mortgage and Other Real Estate Loans Held for Investment

Mortgage
and other real estate loans held for investment at December 31, 2005 and
December 31, 2004, are summarized in the following table. These investments
consist predominantly of mortgage loans on properties subject to leases to
investment grade tenants. As of December 31, 2005, credit ratings of the
underlying tenants ranged from AAA to B+ from Standard & Poors. As of
December 31, 2005, none of the Companys loans held for investment were
delinquent or in default.

|                                 |  |              |         |      |   |         |  
|-------------------------------- |  | ------------ | ------- | ---- | - | ------- | -
|                                 |  | December 31, |        
|                                 |  | 2005         |         | 2004 |  
|                                 |  |              |        
|Principal                        |  | $            | 296,479 |      | $ | 206,735 |  
|Premium (discount)               |  |              | 1,898   |      |   | 1,158   |  
|                                 |  |              |         |      |   |         |  
|Carrying amount of
  loans       |  |              | 298,377 |      |   | 207,893 |  
|Deferred
  origination fees, net |  |              | (826    | )    |   | (546    | )
|                                 |  |              |         |      |   |         |  
|Total                            |  | $            | 297,551 |      | $ | 207,347 |  
|                                 |  |              |         |      |   |         |  

The
Companys loans held for investment include a limited number of loan and loan
type investments in net lease properties, such as mezzanine loans, development
loans, bridge loans and preferred equity investments. These investments are
typically short-term in nature and are often subordinate to other financing on
the property. These investments aggregated $43,111 as of December 31, 2005, and
included the Companys investments in the Hercules Incorporated building in
Wilmington, Delaware, described below.

During
December 2005, the Company invested $20,120 in an office building in
Wilmington, Delaware net leased to Hercules Incorporated. Specifically, the
Company made a $14,000 mezzanine loan secured by the borrowers indirect
ownership interest in an entity that owns the building. The Company also made a
preferred equity investment of $6,120 in the borrower. The $20,120 invested in
the fourth quarter of 2005 is in addition to the $14,000 mezzanine loan and
$2,575 preferred equity investment in the same building made in July 2005. The
Companys security interest in the mezzanine loan is subordinated to a first
and second mortgage on the real property. The portion of the mezzanine loan
originated in December 2005 bears interest at 8.79%, and the portion of the
mezzanine loan originated in July 2005 bears interest at 8.54%. The mezzanine
loan matures in June 2013. The Companys preferred equity investment is
unsecured. The Company is entitled to a 14.29% current return on the portion of
its preferred equity investment funded in December 2005, and a 14.04% current
return on the portion of its preferred equity investment funded in July 2005.
The Companys preferred equity investment is mandatorily redeemable in December
2013. The mezzanine loan and preferred equity investments are expected to be
retired prior to maturity in 2006 in connection with a recapitalization of the
Hercules property. The Company expects to participate in the recapitalization
by making a first mortgage loan on the property and a corporate credit note
investment. The Companys investment in the property is expected to be less
than $30,000 upon completion of the recapitalization. As of December 31, 2005,
Hercules was rated BB and Ba2 by Standard & Poors and Moodys.

At
December 31, 2005, the mortgage and other real estate loans carried interest
rates ranging from 5.28% to 14.29%, and at December 31, 2004, the mortgage and
other real estate loans carried interest rates ranging from 4.71% to 10.00%. At
December 31, 2005 and December 31, 2004, the weighted average effective
interest rate on the mortgage and other real estate loans, as measured against
the Companys cost basis, was 6.86% and 6.56%, respectively.

During
2000, the Company recorded a valuation provision of $2,000 related to a group
of mortgage loans with Rite Aid Corporation as the tenant under the leases.
During 2002, the provision was reduced by $83 due to the prepayment of a Rite
Aid loan. During 2003, the provision was eliminated in connection with the sale
of the remaining Rite Aid loads held in

60

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

portfolio.  The sale included
loans with an aggregate principal amount of $24,920, and in connection with
this sale the Company recorded a gain-on-sale of $1,756.

5.Real
Estate Investments

During
the year ended December 31, 2005, the Company acquired 17 real estate
properties for an aggregate purchase price of approximately $566,000.  During the year ended December 31, 2004,
the
Company acquired 9 real estate properties for an aggregate purchase price of
approximately $188,000.  There were no
dispositions of real estate properties during 2005 or 2004.  As of December 31, 2005, one of the Companys
real estate properties was classified as held for sale (see Note 6).

Real
estate held for investment and related intangible liabilities on real estate
investments consisted of the following at December 31, 2005 and December 31,
2004:

|                                                       |  |              |         |      |   |         |  
|------------------------------------------------------ |  | ------------ | ------- | ---- | - | ------- | -
|                                                       |  | December 31, |        
|                                                       |  | 2005         |         | 2004 |  
|                                                       |  |              |         |      |  
|Real estate investments, at cost:                      |  |              |         |      |   |         |  
|Land and
improvements                                  |  | $            | 136,566 |      | $ | 28,226  |  
|Building and
improvements                              |  |              | 557,248 |      |   | 154,078 |  
|Intangible assets
under SFAS 141                       |  |              | 82,862  |      |   | 13,518  |  
|Less: Accumulated
depreciation and amortization        |  |              | (11,746 | )    |   | (1,281  | )
|                                                       |  |              |         |      |   |         |  
|Real estate
investments, net                           |  | $            | 764,930 |      | $ | 194,541 |  
|                                                       |  |              |         |      |   |         |  
|Intangible liabilities on real
  estate investments:   |  |              |         |      |   |         |  
|Intangible
liabilities under SFAS 141                  |  | $            | 15,210  |      | $ | 7,108   |  
|Less: Accumulated
amortization                         |  |              | (791    | )    |   | (80     | )
|                                                       |  |              |         |      |   |         |  
|Intangible
liabilities on real estate investments, net |  | $            | 14,419  |      | $ | 7,028   |  
|                                                       |  |              |         |      |   |         |  

Acquisition
costs capitalized as part of buildings and improvements were $2,082 for the
year ended December 31, 2005.  Interest
capitalized as part of buildings and improvements was $1,589 for the year ended
December 31, 2005.

Amounts
for accrued rental income and deferred rental income as of December 31, 2005
and December 31, 2004, were as follows:

| |                        |  |              |       |      |   |     | 
| | ---------------------- |  | ------------ | ----- | ---- | - | --- | 
| |                        |  | December 31, |      
| |                        |  | 2005         |       | 2004 |  
| |                        |  |              |       |      |  
| | Accrued Rental Income  |  | $            | 6,708 |      | $ | 507 | 
| | Deferred Rental Income |  |              | 620   |      |   |    | 

Accrued
rental income is included in other assets on the Companys Consolidated Balance
Sheet.  Deferred rental income is
included in accounts payable, accrued expenses and other liabilities on the
Companys Consolidated Balance Sheet.

Amortization
of intangible assets and liabilities for the years ended December 31, 2005 and
December 31, 2004 was as follows:

| |                                                                                       |  |                |       |      |   |     | 
| | ------------------------------------------------------------------------------------- |  | -------------- | ----- | ---- | - | --- | 
| |                                                                                       |  | December
  31, |      
| |                                                                                       |  | 2005           |       | 2004 |  
| |                                                                                       |  |                |       |      |  
| | Amortization of in-place leases
(included in depreciation
  and amortization expense) |  | $              | 2,925 |      | $ | 295 | 
| | Amortization of above-market leases
(included as a
  reduction of rental revenue)     |  |                | 128   |      |   |    | 
| | Amortization of below -market leases
(included as a
  component of rental revenue)    |  |                | 711   |      |   | 80  | 

61

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

As
of December 31, 2005, the Companys weighted average amortization period on
intangible assets was 12.6 years, and the weighted average amortization period
on intangible liabilities was 17.6 years.

Scheduled
amortization on existing intangible assets and liabilities on real estate
investments is as follows:

| |            |  |            |        |             |   |        | 
| | ---------- |  | ---------- | ------ | ----------- | - | ------ | 
| |            |  | Intangible |        | Intangible  |  
| |            |  | Assets     |        | Liabilities |  
| |            |  |            |        |             |  
| | 2006       |  | $          | 7,244  |             | $ | 1,072  | 
| | 2007       |  |            | 7,244  |             |   | 1,072  | 
| | 2008       |  |            | 7,244  |             |   | 1,072  | 
| | 2009       |  |            | 7,244  |             |   | 1,072  | 
| | 2010       |  |            | 7,244  |             |   | 1,072  | 
| | Thereafter |  |            | 43,294 |             |   | 9,059  | 
| |            |  |            |        |             |   |        | 
| |            |  | $          | 79,514 |             | $ | 14,419 | 
| |            |  |            |        |             |   |        | 

The
Companys analysis of intangible assets and liabilities acquired in connection
with the acquisition of real estate properties is preliminary.

All
of the Companys owned properties are pledged as collateral for its related
long-term financings.  The Company owns
and finances each owned property through a separate single purpose entity, or
SPE, with each property and the related lease or leases on the property
generally representing the sole assets of the SPE and the sole collateral
available to the Companys lender in the event the Company defaults on the debt
that finances the property.  Also see
Note 12.

During
the three months ended December 31, 2005, the Company completed the following
real estate acquisitions:

|               |  |                     |                                          |          |  |                   |  |               |        |                            |  |               |  |  |         | 
|-------------- |  | ------------------- | ---------------------------------------- | -------- |  | ----------------- |  | ------------- | ------ | -------------------------- |  | ------------- |  |  | ------- | 
|Month Acquired |  | Tenant or Guarantor |                                          | Location |  | Purchase
  Price  |  | Lease Expires |        | Net Rentable
  Square Feet | 
|               |  |                     |                                          |          |  |                   |  |               |        |                            | 
|December       |  |                     | Allstate Insurance Company (1)           |          |  | Various           |  | $             | 59,000 |                            |  | December 2015 |  |  | 377,015 | 
|December       |  |                     | Farmers New World Life Insurance Company |          |  | Mercer Island, WA |  |               | 39,550 |                            |  | December 2020 |  |  | 155,200 | 

|    |                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Company acquired a portfolio
  of three properties, one located in each of Roanoke, Virginia, Charlotte,
  North Carolina, and Pittsburgh, Pennsylvania.  See Note 6.

6. Discontinued
Operations

During
the fourth quarter of 2005, the Company acquired a portfolio of three office
properties from Allstate Insurance Company in a sale/leaseback
transaction.  The smallest of the three
buildings is an approximately 19,500 square foot office building located in
Pittsburgh, Pennsylvania.  Because of
the small size of this property, management concluded, prior to completing the
acquisition, to resell the property promptly following its acquisition.  The Company expects to resell the
property
in the second quarter of 2006.

In
accordance with SFAS No. 144, the Company reported the carrying value of the
Allstate Pittsburgh property as assets held for sale on the December 31, 2005
Consolidated Balance Sheet, and the revenues from the property as income from
discontinued operations on the Consolidated Income Statement for the year ended
December 31, 2005.  Revenue and net
income for the Allstate Pittsburgh property were $6 and $6, respectively, for
the year ended December 31, 2005.  Based
on initial pricing expectations, the Company expects to recognize a gain on the
sale of the property and, therefore, no impairment loss on the property has
been recognized.

7. Securities
Available for Sale and Structuring Fees Receivable

Securities
available for sale at December 31, 2005 and at December 31, 2004, consisted of
the following:

62

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

|                                                                       |  |                           |          |              |      |         |   |   |         |  
|---------------------------------------------------------------------- |  | ------------------------- | -------- | ------------ | ---- | ------- | - | - | ------- | -
|                                                                       |  | Scheduled
  Maturity Date |          | December 31, |     
|                                                                       |  |                           | 2005     |              | 2004 |        
|                                                                       |  |                           |          |              |      |         |  
|BSCMS 1999 CLF1, Class E rated (B+)
Face Amount                        |  |                           | Nov 2023 |              | $    | 3,326   |   | $ | 3,326   |  
|BSCMS 1999 CLF1, Class F rated (CCC)
Face Amount                       |  |                           | Oct 2023 |              |      | 2,494   |   |   | 2,494   |  
|CALFS 1997-CTL1, Class D rated (BB+)
Face Amount                       |  |                           | Nov 2018 |              |      | 6,000   |   |   | 3,000   |  
|CMLBC 2001-CMLB-1, Class E rated
(BBB+) Face Amount                    |  |                           | Jul 2022 |              |      | 9,526   |   |   | 9,526   |  
|CMLBC 2001-CMLB-1, Class G rated
(BB+) Face Amount                     |  |                           | Mar 2023 |              |      | 9,526   |   |   | 9,526   |  
|CMLBC 2001-CMLB-1, Class H rated (B+)
Face Amount                      |  |                           | Apr 2024 |              |      | 11,907  |   |   | 11,907  |  
|CMLBC 2001-CMLB-1, Class J rated (D)
Face Amount                       |  |                           | Oct 2025 |              |      | 6,383   |   |   | 7,144   |  
|CMLBC 2001-CMLB-1, Class K rated (NA)
Face Amount                      |  |                           | Oct 2025 |              |      |        |   |   | 4,766   |  
|NLFC 1999-LTL-1, Class D rated (BBB)
Face Amount                       |  |                           | Feb 2021 |              |      | 5,000   |   |   | 5,000   |  
|NLFC 1999-LTL-1, Class E rated (BB)
Face Amount                        |  |                           | Apr 2022 |              |      | 11,081  |   |   | 11,081  |  
|NLFC 1999-LTL-1, Class X (IO) rated
(AAA) Carry Value                  |  |                           | Jan 2024 |              |      | 8,434   |   |   | 9,908   |  
|WBCMT 2004-C15 180D rated (B+) Face
Amount                             |  |                           | Nov 2009 |              |      | 15,000  |   |   |        |  
|WBCMT 2004-C15 180E rated (B) Face
Amount                              |  |                           | Nov 2009 |              |      | 8,000   |   |   |        |  
|BACMS 2002-2, Class V-1 (7-Eleven,
Inc.) rated (BBB) Face
  Amount     |  |                           | Sep 2019 |              |      | 393     |   |   | 361     |  
|BACMS 2002-2, Class V-2 (Sterling
Jewelers) rated (BBB-)
  Face Amount |  |                           | Jan 2021 |              |      | 602     |   |   | 553     |  
|CVS Corporation rated (A-) Face
Amount                                 |  |                           | Jan 2023 |              |      |        |   |   | 6,180   |  
|CVS Corporation rated (A-) Face
Amount                                 |  |                           | Jan 2028 |              |      | 20,000  |   |   |        |  
|Yahoo, Inc. rated (BBB-) Face
Amount                                   |  |                           | Aug 2026 |              |      | 31,990  |   |   | 16,999  |  
|Unearned Discount                                                      |  |                           |          |              |      | (21,901 | ) |   | (24,224 | )
|                                                                       |  |                           |          |              |      |         |   |   |         |  
|Cost Basis                                                             |  |                           |          |              |      | 127,761 |   |   | 77,547  |  
|Net unrealized appreciation on
securities held for sale                |  |                           |          |              |      | 9,648   |   |   | 10,209  |  
|                                                                       |  |                           |          |              |      |         |   |   |         |  
|Total                                                                  |  |                           |          |              | $    | 137,409 |   | $ | 87,756  |  
|                                                                       |  |                           |          |              |      |         |   |   |         |  

The
Company recorded other-than-temporary declines in the fair value of two classes
of CMLBC 2001 CMLB-1 securities during the year ended December 31, 2005, and
one class of BSCMS 1999 CLF1 securities during the years ended December 31,
2005 and December 31, 2004.  In the
third quarter of 2005, the Company wrote off its entire investment in the CMLBC
2001 CMLB-1, Class K securities ($1,092), and $910 of its carry value on the
CMLBC 2001 CMLB-1, Class J securities.
These losses resulted primarily from the sale by the CMLBC trust of
$22,400 of Winn-Dixie certificates within the trust.  The trust undertook these sales to reduce its exposure to
assets
of Winn-Dixie, which declared bankruptcy in February 2005.  The Companys remaining carrying value of
$2,132 on the CMLBC, Class J securities is approximately equal to managements
estimate of the securities current fair value.

The
BSCMS trust includes mortgage loans on two Winn-Dixie stores, one of which
defaulted in February 2005.  As a
result, the Company recorded other-than-temporary declines in the fair value of
its BSCMS 1999 CLF1, Class F securities during 2005 and 2004.  The Company recorded aggregate losses of
$369 in 2005, and $247 in 2004.  The
Companys remaining carrying value of $616 on the BSCMS, Class F securities is
slightly below managements estimate of the securitys current fair value.

Unrealized
gains and losses on securities available for sale at December 31, 2005 and
December 31, 2004, included as a component of other comprehensive income
consisted of the following:

|                                                     |  |              |        |      |   |        |  
|---------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ | -
|                                                     |  | December 31, |       
|                                                     |  | 2005         |        | 2004 |  
|                                                     |  |              |        |      |  
|Unrealized gains on securities
  available for sale  |  | $            | 10,002 |      | $ | 10,266 |  
|Unrealized losses on securities
  available for sale |  |              | (354   | )    |   | (57    | )

The
unrealized losses on the Companys securities are primarily the result of
market factors, rather than credit impairment, and the Company believes the
securities carrying values are fully recoverable over their expected holding
period.

63

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

The
following table summarizes the Companys securities in an unrealized position
as of December 31, 2005.

|                                                  |  |                        |        |                               |   |                        |  |  |   | 
|------------------------------------------------- |  | ---------------------- | ------ | ----------------------------- | - | ---------------------- |  |  | - | 
|                                                  |  | Aggregate
  Fair Value |        | Aggregate
  Unrealized
  Loss |   | Number of
  Securities | 
|                                                  |  |                        |        |                               |   |                        | 
|                                                  |  |                        |        |                               |   |                        |  |  |   | 
|In unrealized loss position less
  than 12 months |  | $                      | 21,881 |                               | $ | 318                    |  |  | 2 | 
|In unrealized loss position 12 or
  more months   |  |                        | 270    |                               |   | 36                     |  |  | 1 | 

The
security with an unrealized loss in the 12 or more months category is a zero
coupon bond whose value increases over time as maturity approaches.  The Company expects the market value of this
security to increase over the next twelve months to an amount in excess of the
Companys carry value.

At
December 31, 2005 and December 31, 2004, the effective interest rate (yield to
maturity on adjusted cost basis) on securities available for sale was
approximately 8.2% and 9.9%, respectively.
The following summarizes our sales of securities during the years ended
December 31, 2005 and December 31, 2004.
There were no sales of securities during 2003.

|                       |  |      |       |      |   |        | 
|---------------------- |  | ---- | ----- | ---- | - | ------ | 
|                       |  | 2005 |       | 2004 |  
|                       |  |      |       |      |  
|Net proceeds from sale |  | $    | 5,787 |      | $ | 55,868 | 
|Net gain               |  |      | 174   |      |   |       | 

Structuring
fees receivable of $3,862 and $4,426 at December 31, 2005 and December 31,
2004, respectively, were earned by the Company in conjunction with the
structuring and subsequent sale of certain net lease loans.  Such fees are payable to the Company monthly
without interest through March 2020 and, accordingly, have been discounted
based on imputed interest rates estimated by management to approximate
market.  Structuring fees receivable are
shown at their amortized cost.

8. Fair
Value of Financial Instruments

For
certain of the Companys financial instruments, fair values are not readily
available since there are no active trading markets as characterized by current
exchanges between willing parties.
Accordingly, the Company derives or estimates fair values using various
valuation techniques, such as computing the present value of estimated future
cash flows using discount rates commensurate with the risks involved.  However, the determination of estimated
cash
flows may be subjective and imprecise.
Changes in assumptions or estimation methodologies can have a material
effect on these estimated fair values. In that regard, the derived fair value
estimates may not be substantiated by comparison to independent markets, and in
many cases, may not be realized in immediate settlement of the instrument.  The fair values indicated below are
indicative of the interest rate and credit spread environment as of December
31, 2005, and may not take into consideration the effects of subsequent
interest rate, credit spread fluctuations, or changes in the ratings of the
tenant obligors under related leases.

The
fair values of cash and cash equivalents, other assets, accounts payable,
accrued expenses and other liabilities, and dividends payable approximate their
carrying values due to the short maturities of these items.

64

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

The
carrying amounts and estimated fair values of the Companys other financial
instruments at December 31, 2005, are as follows:

|                                                         |  |                   |         |                   |   |                          |  |   |         | 
|-------------------------------------------------------- |  | ----------------- | ------- | ----------------- | - | ------------------------ |  | - | ------- | 
|                                                         |  | Carrying
  Amount |         | Notional
  Amount |   | Estimated
  Fair
  Value | 
|                                                         |  |                   |         |                   |   |                          | 
|Assets:                                                  |  |                   |         |                   |   |                          |  |   |         | 
|Mortgage and other
real estate loans held for investment |  | $                 | 298,377 |                   | $ | 296,479                  |  | $ | 307,829 | 
|Securities available
for sale                            |  |                   | 137,409 |                   |   | 149,662                  |  |   | 137,409 | 
|Structuring fees
receivable                              |  |                   | 3,862   |                   |   | N/A                      |  |   | 3,862   | 
|Derivative
assets                                        |  |                   | 1,082   |                   |   | 82,852                   |  |   | 1,082   | 
|Liabilities:                                             |  |                   |         |                   |   |                          |  |   |         | 
|Repurchase
agreements                                    |  |                   | 129,965 |                   |   | 129,965                  |  |   | 129,965 | 
|Mortgages on real
estate investments                     |  |                   | 551,844 |                   |   | 546,284                  |  |   | 545,289 | 
|Collateralized debt
obligations                          |  |                   | 268,156 |                   |   | 268,500                  |  |   | 262,955 | 
|Other long-term
debt                                     |  |                   | 30,930  |                   |   | 30,930                   |  |   | 30,849  | 
|Derivative
liabilities                                   |  |                   | 298     |                   |   | 43,029                   |  |   | 298     | 

The
methodologies used and key assumptions made to estimate fair values are as
follows:

Mortgage
and other real estate loans held for investmentThe fair value of our primarily
fixed-rate loan portfolio is estimated with a discounted cash flow analysis,
utilizing scheduled cash flows and discount rates estimated by management to
approximate those that a willing buyer and seller might use.

Securities
available for saleThe fair value of securities available for sale is
estimated by obtaining broker quotations, where available, based upon
reasonable market order indications or a good faith estimate thereof.  For securities where market quotes are not
readily obtainable, management may also estimate values, and considers factors
including the credit characteristics and term of the underlying security,
market yields on securities with similar credit ratings, and sales of similar
securities, where available.

Structuring
fees receivableThe fair value of structuring fees receivable is
estimated with a discounted cash flow analysis, utilized scheduled cash flows
and discount rates estimated by management to approximate those that a willing
buyer and seller might use.

Repurchase
agreementsManagement believes that the stated interest rates (all of which are
floating rate, based on short-term interest rates) approximate market rates
(when compared to similar credit facilities with similar credit risk).  As such, the fair value of the repurchase
agreement is estimated to be equal to the outstanding principal amount.

Mortgages
on real estate investments and collateralized debt obligationsThe fair value of
mortgages payable
on real estate investments and collateralized debt obligations is estimated
using a discounted cash flow analysis, based on managements estimates of
market interest rates.  For mortgages
where the Company has an early prepayment right, management also considers the
prepayment amount to evaluate the fair value.

Other
long-term debtThe fair value of the Companys other long-term debt is estimated
using
a discounted cash flow analysis, based on managements estimates of market
interest rates.

Derivative
assets and liabilitiesThe fair value of the Companys derivative assets
and liabilities is estimated using current market quotes and third-party
quotations, where available.

9. Other Assets

Other
assets as of December 31, 2005 consisted of the following:

65

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

| |                                                               |  |              |        | 
| | ------------------------------------------------------------- |  | ------------ | ------ | 
| |                                                               |  | December 31, |       
| |                                                               |  | 2005         |       
| |                                                               |  |              |       
| | Receivables and accrued interest                              |  | $            | 6,515  | 
| | Prepaid expenses and deposits                                 |  |              | 2,077  | 
| | Reserve accounts                                              |  |              | 8,131  | 
| | Escrow held with mortgage lender                              |  |              | 9,507  | 
| | Funds with CDO trustee pending
  distribution or reinvestment |  |              | 16,638 | 
| | Amounts held by servicer                                      |  |              | 1,483  | 
| | Derivative assets                                             |  |              | 1,082  | 
| | Accrued rental income                                         |  |              | 6,708  | 
| | Debt issuance costs, net                                      |  |              | 6,975  | 
| | Other                                                         |  |              | 1,362  | 
| |                                                               |  |              |        | 
| | Total                                                         |  | $            | 60,478 | 
| |                                                               |  |              |        | 

The
amounts included in other assets for the year ended 2004 were not material.

10. Repurchase
and Other Short-Term Financing Agreements

As
of December 31, 2005, the Company had a $250,000 repurchase agreement and a
$100,000 real property acquisition facility in place for short-term liquidity
requirements with Wachovia Bank, N.A. and its affiliate.  On March 1, 2005, the Companys repurchase
agreement with Bank of America (BofA) expired unused.

Amounts
related to the Companys repurchase agreements as of December 31, 2005 and
December 31, 2004, are as follows:

| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | ------------------------ |  | ---------------------------- | ------- | ----------------- | -------- | ------ | ----- | - | ------- |  | - | ------- | 
| |                          |  | December 31, 2005
  Wachovia |         | December 31, 2004 |         
| |                          |  |                              | BofA    |                   | Wachovia |        | Total |  
| |                          |  |                              |         |                   |          |        |       |   |        
| | Collateral
  carry value |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | Loans                    |  | $                            | 116,881 |                   | $        | 22,800 |       | $ | 136,477 |  | $ | 159,277 | 
| | Securities               |  |                              | 43,785  |                   |          |       |       |   | 41,130  |  |   | 41,130  | 
| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | Total                    |  | $                            | 160,666 |                   | $        | 22,800 |       | $ | 177,607 |  | $ | 200,407 | 
| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | Borrowings               |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | Loans                    |  | $                            | 94,341  |                   | $        |       |       | $ | 102,288 |  | $ | 102,288 | 
| | Securities               |  |                              | 35,624  |                   |          |       |       |   | 31,543  |  |   | 31,543  | 
| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 
| | Total                    |  | $                            | 129,965 |                   | $        |       |       | $ | 133,831 |  | $ | 133,831 | 
| |                          |  |                              |         |                   |          |        |       |   |         |  |   |         | 

The
Company pays interest on amounts borrowed under its repurchase agreement with
Wachovia Bank at prevailing short-term rates (30-day LIBOR) plus a pricing
spread (determined based upon the class and credit rating of the asset
financed).  Weighted average interest
rates on the Companys repurchase agreements for the years ended December 31,
2005 and December 31, 2004, are as follows:

| |                                                       |  |              |   |              |      |   | 
| | ----------------------------------------------------- |  | ------------ | - | ------------ | ---- | - | 
| |                                                       |  | Dec 31, 2005 |   | Dec 31, 2004 |     
| |                                                       |  |              |   |              |     
| | Bank of America-mortgage loan
  repurchase agreements |  | N/A          |   |              | 2.59 | % | 
| | Bank of America-CMBS repurchase
  agreements          |  | N/A          |   |              | 1.90 | % | 
| | Wachovia-mortgage loan repurchase
  agreements        |  | 4.13         | % |              | 2.64 | % | 
| | Wachovia-CMBS repurchase
  agreements                 |  | 4.12         | % |              | 2.48 | % | 

As
of December 31, 2005 and December 31, 2004, the 30-day LIBOR rate was 4.39% and
2.40%, respectively.

During
August 2005, the Company entered into a short-term borrowing facility with
aggregate borrowing capacity of $100,000 with Wachovia Bank, N.A. and its
affiliate.  The facility permits the
Company to finance its real property acquisitions for up to 90 days while
long-term financing is arranged.  The
facility consists of two loan agreements with a 364-day term (terminating on
August 25, 2006), and the Companys repurchase agreement is co-terminus with
the real property acquisition facility.
The Company expects to renew these agreements prior to expiration.  The Company is required to pay interest on
its

66

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

borrowings at prevailing short-term rates (30-day LIBOR) plus a pricing
spread (ranging from 95 to 225 basis points).
As of December 31, 2005, the Company had not yet drawn under the real
property acquisition facility.

The
Company is required to comply with the following financial covenants under its
short-term financing agreements: minimum liquidity, minimum tangible net worth
and maximum leverage.  As of December
31, 2005, the Company was in compliance with the terms of its short-term
financing agreements.

11. Risk
Management Transactions

The
Companys objectives in using derivatives include adding stability to interest
expense and managing its exposure to interest rate movements.  The Company uses forward starting interest
rate swaps to hedge the variability of changes in the interest-related cash
outflows on forecasted future borrowings.
As of December 31, 2005, the Company was hedging its exposure to such
variability through July 2016.  In
accordance with SFAS 133, the interest rate swaps, to the extent that they have
been designated and qualify as part of a hedging relationship, are treated as
cash flow hedges for accounting purposes.

Interest
rate swaps are agreements between two parties to exchange, at particular
intervals, payment streams calculated on a specified notional amount.  The interest rate swaps that the Company
has
entered into are single currency interest rate swaps and, as such, do not
require the exchange of a notional amount.

Amounts
related to open positions, as of December 31, 2005 and December 31, 2004, are
as follows:

|                    |  |                   |         |                   |   |                   |  |            |         |  |   |        |  
|------------------- |  | ----------------- | ------- | ----------------- | - | ----------------- |  | ---------- | ------- |  | - | ------ | -
|                    |  | December 31, 2005 |         | December 31, 2004 |  
|                    |  |                   |         |                   |  
|Description         |  | Notional
  Amount |         | Fair value        |   | Notional
  Amount |  | Fair value |        
|                    |  |                   |         |                   |   |                   |  |            |        
|Interest rate
swaps |  | $                 | 125,881 |                   | $ | 784               |  | $          | 228,182 |  | $ | (7,312 | )

At
December 30, 2005 and December 31, 2004, the Company had hedged the following
future borrowings:

|                                       |  |              |         |      |   |         | 
|-------------------------------------- |  | ------------ | ------- | ---- | - | ------- | 
|                                       |  | December 31, |        
|                                       |  | 2005         |         | 2004 |  
|                                       |  |              |         |      |  
|Future borrowings (principal
  amount) |  | $            | 125,881 |      | $ | 228,182 | 
|                                       |  |              |         |      |   |         | 

At
December 31, 2005 and December 31, 2004, derivatives with a fair value of
$(298) and $(7,355), respectively, were included in accounts payable, accrued
expenses and other liabilities on the Companys Consolidated Balance
Sheet.  At December 31, 2005 and December
31, 2004, derivatives with a fair value of $1,082 and $42, respectively, were
included in other assets on the Companys Consolidated Balance Sheet.  For the years ended December 31, 2005
and
December 31, 2004, the Company had net realized losses of $11,206 and $1,694,
respectively, related to cash flow hedges.
The net realized losses are included in Other Comprehensive Income and
will be reclassified and amortized as part of interest expense on the Companys
Consolidated Income Statement over the expected term of the Companys related
debt issuances.  Within the next twelve
months, the Company estimates that $1,173 of losses currently held within
Accumulated Other Comprehensive Income will be reclassified to earnings as
additional interest expense.  The change
in net unrealized gains and losses of $8,098 and $(7,312) in the years ended
December 31, 2005 and December 31, 2004, respectively, for derivatives
designated as cash flow hedges is separately disclosed in the Companys
Consolidated Statement of Changes in Stockholders Equity.

(Gain)
loss on derivatives on the Consolidated Income Statement includes $159 and $0
of net income due to hedge ineffectiveness for the years ended December 31,
2005 and December 31, 2004, respectively.
For the years ended December 31, 2005 and December 31, 2004, the Company
reclassified $877 and $24, respectively, from accumulated other comprehensive
loss into interest expense related to the underlying debt issuances.

Consistent
with the cash flows of the related financing, the Company classifies the cash
flows from derivatives that are accounted for as cash flow hedges as a
financing activity on the Consolidated Statements of Cash Flows.

12. Long-Term
Debt

Our
long-term debt consists of the following:

     mortgage
notes on real estate investments;

67

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

     collateralized
debt obligations; and

     trust
preferred securities.

Mortgages
Notes on Real Estate Investments

The
Company has financed most of its owned real properties with third party
mortgage debt.  The Companys mortgage
notes payable are as follows:

|                                                              |  |              |         |              |   |         |  |             |                      |        |   |         |          |  |      |   |  |      |   |  |        | 
|------------------------------------------------------------- |  | ------------ | ------- | ------------ | - | ------- |  | ----------- | -------------------- | ------ | - | ------- | -------- |  | ---- | - |  | ---- | - |  | ------ | 
|                                                              |  | Dec 31, 2005 |         | Dec 31, 2004 |   |         |  |             |                      |        |   |         |         
|                                                              |  |              |         |              |   |         |  |             | Effective
  Rate (1) |        |   |         |         
|Property Level Debt - Fixed Rate                              |  | Face         |         | Carry Value  |   | Face    |  | Carry Value |                      | Coupon |   |         | Maturity | 
|                                                              |  |              |         |              |   |         |  |             |                      |        |   |         |          |  |      |   |  |      |   |  |        | 
|                                                              |  |              |         |              |   |         |  |             |                      |        |   |         |          |  |      |   |  |      |   |  |        | 
|Choice Hotels International, Inc.,
Silver Spring, MD          |  | $            | 32,199  |              | $ | 32,199  |  | $           | 32,625               |        | $ | 32,625  |          |  | 5.30 | % |  | 5.34 | % |  | May-13 | 
|Omnicom Group, Inc., Irving,
TX                               |  |              | 13,575  |              |   | 13,575  |  |             |                     |        |   |        |          |  | 5.24 | % |  | 5.30 | % |  | May-13 | 
|Capital One Financial Corporation,
Plano, TX                  |  |              | 20,925  |              |   | 20,925  |  |             |                     |        |   |        |          |  | 5.24 | % |  | 5.29 | % |  | May-13 | 
|Aon Corporation, Glenview,
IL                                 |  |              | 64,800  |              |   | 64,800  |  |             | 64,800               |        |   | 64,800  |          |  | 5.23 | % |  | 5.75 | % |  | Nov-14 | 
|Cadbury
        Schweppes Holdings (US), Whippany, NJ         |  |              | 36,000  |              |   | 36,000  |  |             |                     |        |   |        |          |  | 5.26 | % |  | 5.34 | % |  | Mar-15 | 
|ITT Industries, Inc., Herndon,
VA                             |  |              | 41,700  |              |   | 41,700  |  |             |                     |        |   |        |          |  | 5.33 | % |  | 5.48 | % |  | Jun-15 | 
|Lowes Companies, Inc., Aliso Viejo,
CA                        |  |              | 42,125  |              |   | 42,125  |  |             |                     |        |   |        |          |  | 5.10 | % |  | 5.37 | % |  | Jul-15 | 
|Abbott Laboratories, Waukegan,
IL                             |  |              | 15,244  |              |   | 15,244  |  |             |                     |        |   |        |          |  | 5.11 | % |  | 5.16 | % |  | Aug-15 | 
|US Government (NIH), N. Bethesda,
MD                          |  |              | 65,188  |              |   | 65,188  |  |             |                     |        |   |        |          |  | 5.32 | % |  | 5.55 | % |  | Sep-15 | 
|US Government (SSA), Austin,
TX                               |  |              | 5,391   |              |   | 5,391   |  |             |                     |        |   |        |          |  | 5.23 | % |  | 5.44 | % |  | Sep-15 | 
|US Government (DEA), Birmingham,
AL                           |  |              | 11,280  |              |   | 11,280  |  |             |                     |        |   |        |          |  | 5.23 | % |  | 5.41 | % |  | Sep-15 | 
|US Government (FBI), Birmingham,
AL                           |  |              | 18,800  |              |   | 18,800  |  |             |                     |        |   |        |          |  | 5.23 | % |  | 5.31 | % |  | Sep-15 | 
|Tiffany & Co, Parsippany,
NJ                                  |  |              | 58,400  |              |   | 58,400  |  |             |                     |        |   |        |          |  | 5.33 | % |  | 5.34 | % |  | Oct-15 | 
|Farmers New World Life Insurance
Company, Mercer Island,
  WA |  |              | 30,200  |              |   | 30,200  |  |             |                     |        |   |        |          |  | 5.69 | % |  | 5.72 | % |  | Jan-16 | 
|Allstate Insurance Company,
Charlotte, NC                     |  |              | 20,209  |              |   | 20,209  |  |             |                     |        |   |        |          |  | 5.68 | % |  | 5.71 | % |  | Jan-16 | 
|Allstate Insurance Company, Roanoke,
VA                       |  |              | 21,516  |              |   | 21,516  |  |             |                     |        |   |        |          |  | 5.68 | % |  | 5.71 | % |  | Jan-16 | 
|US Government (Department of Veterans
Affairs), Ponce, PR     |  |              | 7,317   |              |   | 7,670   |  |             | 7,735                |        |   | 8,117   |          |  | 7.30 | % |  | 6.41 | % |  | Apr-16 | 
|Walgreen Co., Pennsauken,
NJ                                  |  |              | 2,046   |              |   | 2,208   |  |             | 2,162                |        |   | 2,347   |          |  | 7.65 | % |  | 6.04 | % |  | Oct-16 | 
|Walgreen Co., Portsmouth,
VA                                  |  |              | 3,304   |              |   | 3,525   |  |             | 3,410                |        |   | 3,650   |          |  | 7.20 | % |  | 6.18 | % |  | Jul-18 | 
|US Government (EPA), Kansas City,
KS                          |  |              | 21,395  |              |   | 25,151  |  |             |                     |        |   |        |          |  | 7.57 | % |  | 5.74 | % |  | Oct-22 | 
|US Government (OSHA), Sandy,
UT                               |  |              | 14,670  |              |   | 15,738  |  |             |                     |        |   |        |          |  | 6.28 | % |  | 5.52 | % |  | Jan-24 | 
|                                                              |  |              |         |              |   |         |  |             |                      |        |   |         |          |  |      |   |  |      |   |  |        | 
|Total                                                         |  | $            | 546,284 |              | $ | 551,844 |  | $           | 110,732              |        | $ | 111,539 |          |  |      |   |  |      |   |  |        | 
|                                                              |  |              |         |              |   |         |  |             |                      |        |   |         |          |  |      |   |  |      |   |  |        | 

|    |                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The effective rate is the Companys
  approximate borrowing cost, including the effect of hedge gains or losses and
  other deferred financing costs associated with the related borrowing.

The mortgage notes are secured by the respective properties and an
assignment of the relevant leases on the properties.  The Companys book value before accumulated
depreciation and
amortization on the mortgaged properties aggregated $776,676 at December 31,
2005.

Collateralized
Debt Obligations

In
March 2005, the Company completed its first collateralized debt obligation, or
CDO.  The CDO was an entirely fixed rate
financing.  The Company aggregated
approximately $300,000 of assets into the pool, and created $285,000 face
amount of multi-class notes and $15,000 of preferred equity through the CDO
trust.  The net amount of the debt the
Company issued was $268,130, inclusive of a $370 discount to face, as the
Company retained the three most junior note classes aggregating a face amount
of $16,500 and the full $15,000 of preferred equity.  Each of the five note classes of the CDO was rated
investment
grade.  During the first five years of
the CDO term, the Company expects to reinvest principal repayments on the
underlying assets into qualifying replacement collateral.  The CDO notes have a stated maturity in
January 2040, but are expected to mature in January 2015 when they become
subject to an auction call procedure.
The Companys effective blended financing rate (inclusive of original
issue discount and debt issuance and hedge costs) on its CDO is approximately
5.67%.  The CDO debt is non-recourse to
the Company but is secured by the assets in the pool.  The following table summarizes the assets in the
Companys
portfolio posted as CDO collateral as of December 31, 2005.

| |                                         |  |             |         | 
| | --------------------------------------- |  | ----------- | ------- | 
| |                                         |  | Carry Value |        
| |                                         |  |             |        
| | Long-Term Mortgage Loans                |  | $           | 168,091 | 
| | Corporate Credit Notes                  |  |             | 12,730  | 
| | CMBS and Other Real Estate
  Securities |  |             | 68,513  | 
| |                                         |  |             |         | 
| | Total                                   |  | $           | 249,334 | 
| |                                         |  |             |         | 

68

---



Capital Lease Funding, Inc. and Subsidiaries Notes
to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

The
table does not include approximately $37,725 of intercompany corporate credit
notes that are eliminated from the Companys balance sheet in consolidation.

Trust
Preferred Securities

On
December 13, 2005, the Companys operating partnership, Caplease, LP, completed
the issuance and sale in a private placement of $30,000 in aggregate principal
amount of fixed/floating rate preferred securities issued by the operating
partnerships wholly-owned subsidiary, Caplease Statutory Trust I.  The trust simultaneously issued 930 of
its
common securities to the operating partnership for a purchase price of $930,
which constitutes all of the issued and outstanding common securities of the
trust.  The trust used the proceeds from
the sale of the trust preferred securities together with the proceeds from the
sale of the common securities to purchase $30,930 in aggregate principal amount
of unsecured fixed/floating rate junior subordinated notes due January 30,
2036, issued by the operating partnership.
The junior subordinated notes, the common and the trust preferred
securities have substantially identical terms, requiring quarterly interest
payments calculated at a fixed interest rate equal to 7.68% per annum through
January 30, 2016, and subsequently at a variable interest rate equal to London
Interbank Offered Rate (LIBOR) plus 2.60% per annum.  The notes mature on January 30, 2036, and
may be redeemed, in whole or in part, at par, at the Companys option, beginning
on January 30, 2011.  The preferred and
common securities do not have a stated maturity date; however, they are subject
to mandatory redemption upon the redemption or maturity of the notes.

The
principal amount of the junior subordinated notes of $30,930 is reported as
other long-term debt on the Companys Consolidated Balance Sheet at December
31, 2005.  However, because the Company
is not deemed to be the primary beneficiary of the trust under FASB
Interpretation Number 46, Consolidation of Variable Interest Entities,
the Companys investment in the trust is not eliminated from the Companys
financial statements in consolidation.
Instead, the Company records its investment in the trusts common shares
of $930 as part of other assets on the Companys Consolidated Balance
Sheet.

The
Company incurred issuance costs associated with the offering of $972.  These costs are included as a component of
prepaid and other assets on the Companys Consolidated Balance Sheet, and are
being amortized into interest expense using the effective yield method through
the date the fixed interest period expires (the expected maturity date of the
trust preferred securities).  The
Companys effective borrowing rate on the trust preferred securities, inclusive
of deferred issuance costs, is approximately 8.32% per annum.

The
Company has entered into a parent guarantee agreementfor the purpose of guaranteeing the
payment, after the expiration of any grace or cure period, of any amounts
required to be paid by the operating partnership.  The obligations of the Company under the parent guarantee
agreement constitute unsecured obligations of the Company and rank subordinate
and junior to all senior debt of the Company.
The parent guarantee agreement will terminate upon the full payment of
the redemption price for the trust preferred securities or full payment of the
junior subordinated notes upon liquidation of the trust.

Scheduled
principal amortization and balloon payments for long-term debt for the next
five years and thereafter are as follows:

| |            |  |                          |         |                    |   |         |  |   |         | 
| | ---------- |  | ------------------------ | ------- | ------------------ | - | ------- |  | - | ------- | 
| |            |  | Scheduled
  Amortization |         | Balloon
  Payments |   | Total   | 
| |            |  |                          |         |                    |   |         | 
| | 2006       |  | $                        | 2,567   |                    | $ |        |  | $ | 2,567   | 
| | 2007       |  |                          | 4,259   |                    |   |        |  |   | 4,259   | 
| | 2008       |  |                          | 6,473   |                    |   |        |  |   | 6,473   | 
| | 2009       |  |                          | 8,015   |                    |   |        |  |   | 8,015   | 
| | 2010       |  |                          | 32,428  |                    |   |        |  |   | 32,428  | 
| | Thereafter |  |                          | 146,240 |                    |   | 650,948 |  |   | 797,188 | 
| |            |  |                          |         |                    |   |         |  |   |         | 
| |            |  | $                        | 199,982 |                    | $ | 650,948 |  | $ | 850,930 | 
| |            |  |                          |         |                    |   |         |  |   |         | 

13. Related
Party Transactions

One
of CLF, Inc.s Board members, Jeffrey Rogatz, owns approximately 1.5% of the
preferred equity of the owner of an office building in Wilmington, Delaware,
net leased to Hercules Incorporated, and has the right to share in an incentive
fee under certain circumstances upon a refinancing of the debt on the property
or a sale of the property.  During 2005,
the Company made a $28,000 mezzanine loan and a pari passu $8,695 preferred
equity investment to finance the owners purchase of the building.  As required by the Companys
conflict of
interest policy, the disinterested directors on CLF, Inc.s Board approved the
Companys investment in the property.

69

---



Capital Lease Funding, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

In
February 2001, the Company originated a net lease loan on a real property owned
by a limited partnership in which certain executive officers of the Company
have an indirect ownership interest. The loan was sold to Wachovia in February
2001, and the limited partnership agreed to pay the Company an advisory fee from
the rent payable by the tenant at the real property in the amount of
approximately $66 a month until November 2010. The Company recognized a gain on
the sale of the mortgage loan of $4,963. An affiliate of the limited
partnership is also a party to a management agreement with the tenant for the
operation of the property, and another affiliate of the limited partnership
subleases a portion of the leased building from the tenant at a nominal amount.
No failure to perform under the management agreement or sublease entitles the
tenant to any rent abatement or termination under the lease. Interest income
earned on the structuring fee receivable totaled approximately $273, $312, and
$350, during the years ended December 31, 2005, 2004, and 2003, respectively, and
is included in interest income in the Consolidated Income Statements.

The
chairman of CLF, Inc.s board of directors, Lewis S. Ranieri, is the chairman
and president, a director and majority stockholder of Hyperion Funding II
Corp., which is the sole general partner of Hyperion Ventures II L.P., which is
the sole general partner of Hyperion Partners II L.P. (HP). On November 1,
2004, Caplease, LP entered into two contracts of sale with HP. Under the terms
of the two contracts, the Company acquired HPs beneficial interest in two
trusts. Each trusts sole asset is a free-standing Walgreens retail store, one
located in Portsmouth, Virginia, and the second located in Pennsauken, New
Jersey. Caplease, LP paid HP an aggregate purchase price of approximately
$7,200 under the contracts, inclusive of the face amount of debt assumed of
approximately $5,600. As required by the Companys conflict of interest policy,
this transaction was approved by the Companys disinterested directors. The Company
recorded the mortgage loans assumed in this purchase transaction at their
respective fair values, totaling approximately $6,000.

Approximately
$41 was due to the Company from an affiliate of HP as of December 31, 2003. The
Company received this amount in full during the year ended December 31, 2004.

For
the year ended December 31, 2003, the Company classified Wachovia Bank as a
related party, because of its affiliates approximately 26.7% ownership in the
Predecessor. Subsequent to the Companys initial public offering, this
ownership was reduced to less than five percent, and as such, the Company no
longer classifies Wachovia Bank as a related party. The Company has entered
into a loan servicing arrangement with Wachovia Bank. Servicing fees paid to
Wachovia Bank during the years ended December 31, 2005, 2004, and 2003, were
$210, $32, and $41, respectively. From time to time, the Company sells mortgage
loans to affiliates of Wachovia Bank. Loans with aggregate face amounts of
approximately $9,702, $0, and $59,000 were sold to affiliates of Wachovia Bank
during the years ended December 31, 2005, 2004, and 2003, respectively.
Wachovia Bank has provided mortgage debt financing to the Company for certain
of the Companys owned real property investments. As of December 31, 2005, the
Company had outstanding mortgage debt owed to Wachovia Bank of approximately
$383,501. The Company has also entered into a repurchase agreement and real
property acquisition facility with Wachovia Bank and its affiliate (see Note 10
above). Affiliates of Wachovia Bank also provide investment banking services to
the Company from time to time, including in connection with the Companys
initial public offering, March 2005 CDO issuance and October 2005 preferred
stock offering.

Approximately
$92 and $81 in notes payable was due from employees as of December 31, 2005 and
2004, respectively.

14. Commitments and
Contingencies

The
Company is involved from time to time in litigation arising in the ordinary
course of business. The Company is not currently involved in any matter which
management believes will have a material adverse effect on its business,
results of operations or financial condition.

As
an owner of commercial real estate, the Company is subject to potential
environmental costs. At December 31, 2005, the Company was not aware of any
environmental concerns that would have a material adverse effect on the
Companys financial position or results of operations.

The
Company is obligated under two letters of credit in the aggregate of $16,671
issued to its mortgage lender in connection with obtaining long-term financing
of two of its owned real properties (the United States Government/DEA Property
and the United States Government/SSA Property). Each letter of credit was
issued for the full amount the Company borrowed from the lender on the property
($11,280 letter of credit in the case of the DEA Property and $5,391 letter of
credit in the case of the SSA Property). The lender may draw on the letters of
credit if it does not receive evidence that a certificate of occupancy for the
property has been obtained, construction of the property has been completed and
there has been no default on the underlying lease by April 21, 2006 (in the
case of the DEA Property) or by June 22, 2006 (in the case of the SSA
Property). The Company does not expect any draw on either of these letters of
credit.

70

---



Capital Lease Funding, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

During
May 2005, the Company acquired a real property in Herndon, Virginia net leased
to ITT Industries, Inc., and agreed under the tenants lease to fund expected
improvements to the real property of approximately $9,500. During May 2005, the
Company arranged long-term financing on this property and it funded a reserve
account with its lender for the full amount of this obligation. The Company
expects these funds will be disbursed in full as improvements are completed. As
of December 31, 2005, $1,567 of these funds have been disbursed.

The
Company is obligated under a letter of credit with respect to one of its 1999
securitization transactions (BSCMS 1999-CLF1). The maximum potential amount of
future required payments under the letter of credit is $2,850. The letter of
credit expires on February 18, 2009. The trustee may draw the letter of credit
if there are realized losses on the mortgage loans that would create a
shortfall in the interest or principal on any investment grade certificate. The
letter of credit may be withdrawn when the ratings of the investment grade
certificates are no longer dependent upon the credit support provided by the
letter of credit. During February 2005, one of the mortgage loans in the
securitization on a property net leased to Winn-Dixie defaulted, in connection
with the bankruptcy of Winn-Dixie. However, management does not expect any draw
on the letter of credit as a result of this mortgage default, or otherwise.
Letter of credit fees included in interest expense were $102, $100 and $117 for
the years ended December 31, 2005, 2004 and 2003, respectively.

The
Company had outstanding commitments to fund loans of approximately $2,101
related to certain of its development or joint-venture loans as of December 31,
2005. As of December 31, 2005, advances of $1,716 had been made against these
commitments.

As
of December 31, 2005, the Company was obligated under non-cancelable operating
lease agreements for office space and copy machines. The future minimum lease
payments under these lease agreements at December 31, 2005 were:

| |            |  |   |     |  | 
| | ---------- |  | - | --- |  | 
| | 2006       |  | $ | 258 |  | 
| | 2007       |  |   | 38  |  | 
| | 2008       |  |   | 36  |  | 
| | 2009       |  |   | 34  |  | 
| | 2010       |  |   | 17  |  | 
| | Thereafter |  |   |    |  | 
| |            |  |   |    
| |            |  | $ | 384 |  | 
| |            |  |   |    

Included
in general and administrative expense is rent expense of approximately $619, $510,
and $510 (net of sublease income of $5, $60, and $60) for the years ended
December 31, 2005, 2004 and 2003, respectively.

15.
Stockholders Equity

Stock
Issuances

CLF,
Inc.s authorized capital stock consists of 500,000,000 shares of common stock,
$0.01 per share, and 100,000,000 shares of preferred stock, $0.01 per share. As
of December 31, 2005, CLF, Inc. had issued and outstanding 27,868,480 shares of
common stock, and 1,400,000 shares of 8.125% Series A cumulative redeemable
preferred stock.

In
November 2003, CLF, Inc. issued 139,134 shares of its common stock to certain
current and former employees of the Predecessor.

In
March 2004, CLF, Inc. issued 23,000,000 shares of common stock in an initial
public offering. Also in March 2004, in connection with CLF, Inc.s acquisition
of the Predecessor, CLF, Inc. issued 3,968,800 shares of its common stock to
the former owners of the Predecessor.

Since
CLF, Inc.s initial public offering, it has issued an aggregate of 760,546
shares of common stock (net of forfeitures) to its directors, executive
officers and other employees pursuant to the Companys stock incentive plan
(see Note 16 below).

On
October 19, 2005, CLF, Inc. issued 1,400,000 shares of 8.125% Series A
cumulative redeemable preferred stock in a public offering at a price to the
public of $25.00 per share. The Company received net proceeds in the
transaction (after deducting underwriting discounts and commissions and
estimated offering expenses) of approximately $33,657.

The
Series A preferred stock ranks senior to CLF, Inc.s common stock and junior to
all of the Companys existing and future indebtedness. Investors in the Series
A preferred stock are entitled to receive cumulative cash distributions at a

71

---



Capital Lease Funding, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

rate of 8.125% per annum of the $25.00 liquidation preference per share
(equivalent to $2.03125 per annum per share). The annual dividend rate will
increase to 9.125% if the Series A preferred stock is delisted from the New
York Stock Exchange following a change of control of CLF, Inc.

If
CLF, Inc. liquidates, dissolves or wind ups its operations, the Series A
preferred stock holders will have the right to receive $25.00 per share, plus
all accrued and unpaid dividends (whether or not declared) to the date of
payment, before any payment is made to CLF, Inc.s common stock holders. The
Series A preferred stock does not have any stated maturity date and is not
subject to any sinking fund or mandatory redemption provisions. CLF, Inc. may
not redeem the Series A preferred stock prior to October 19, 2010, except in
certain limited circumstances relating to the ownership limitation necessary to
preserve CLF, Inc.s qualification as a REIT. On and after October 19, 2010,
CLF, Inc. may redeem the Series A preferred stock for cash at its option, in
whole or from time to time in part, at a redemption price of $25.00 per share,
plus accrued and unpaid dividends (whether or not declared) to the redemption
date.

Holders
of Series A preferred stock generally have no voting rights. However, Series A
preferred stock holders will have limited voting rights if CLF, Inc. fails to
pay dividends on the Series A preferred stock for six or more quarterly periods
(whether or not consecutive), or if CLF, Inc. issues shares of capital stock
senior to the Series A preferred stock or makes changes to the terms of the
Series A preferred stock that would be materially adverse to the rights of
holders of Series A preferred stock.

The
Series A preferred stock is not convertible into or exchangeable for CLF,
Inc.s common stock or any of the Companys other securities or property.

Dividends

On
October 15, 2004, CLF, Inc. paid a dividend of $0.10 per share to its common
stockholders. The dividend was declared on September 14, 2004, to common
stockholders of record as of September 30, 2004.

On
January 14, 2005, CLF, Inc. paid a dividend of $0.15 per share to its common
stockholders. The dividend was declared on December 20, 2004, to common
stockholders of record as of December 31, 2004.

On
April 15, 2005, CLF, Inc. paid a dividend of $0.18 per share to its common
stockholders. The dividend was declared on March 22, 2005, to common
stockholders of record as of March 31, 2005.

On
July 15, 2005, CLF, Inc. paid a dividend of $0.18 per share to its common
stockholders. The dividend was declared on June 15, 2005, to common stockholders
of record as of June 30, 2005.

On
October 17, 2005, CLF, Inc. paid a dividend of $0.18 per share to its common
stockholders. The dividend was declared on September 15, 2005, to common
stockholders of record as of September 30, 2005.

On
January 17, 2006, CLF, Inc. paid a dividend of $0.20 per share to its common
stockholders. The dividend was declared on December 6, 2005, to common
stockholders of record as of December 30, 2005.

On
January 17, 2006, CLF, Inc. paid a dividend of $0.48524 per share to its Series
A preferred stockholders. The dividend was declared on December 6, 2005, to
Series A preferred stockholders of record as of December 30, 2005.

16. Stock Based
Compensation

The
Company adopted a stock incentive plan for its employees and directors during
March 2004 in connection with its initial public offering. 1,073,000 shares of
common stock are authorized for issuance under the stock plan.

The
shares the Company issues under the stock plan are accounted for under
Statement of Financial Accounting Standards No. 123 (SFAS No. 123), Accounting for Stock Based
Compensation.
The Company accounts for stock based compensation using the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
(APB25) and related interpretations. APB25 requires compensation cost to be
measured as the fair value of the Companys stock less the amount, if any, that
the employee is required to pay. The Company measures compensation costs for
share awards under the stock plan as of the grant date and expenses such
amounts against earnings, either at the grant date (if no vesting period
exists) or ratably over the requisite service period. The Company has not
awarded any options, stock appreciation rights or other stock based
compensation under the stock plan.

72

---



Capital Lease Funding, Inc. and Subsidiaries Notes to
Consolidated Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

The
following is a summary of awards the Company has made under the stock plan
through December 31, 2005.

| |             |  |                        |         |                                                |  |                                                |  |                                             |         |  |  |         |     | 
| | ----------- |  | ---------------------- | ------- | ---------------------------------------------- |  | ---------------------------------------------- |  | ------------------------------------------- | ------- |  |  | ------- | --- | 
| |             |  | Total Shares
  Awarded |         | Shares Forfeited
  through December
  31, 2005 |  | Net Shares
  Awarded as of
  December 31, 2005 |  | Unvested Shares
  as of December
  31, 2005 |         | 
| |             |  |                        |         |                                                |  |                                                |  |                                             |         | 
| | 2004 Awards |  |                        | 387,396 |                                                |  | 6,350                                          |  |                                             | 381,046 |  |  | 116,154 | (1) | 
| | 2005 Awards |  |                        | 383,500 |                                                |  | 4,000                                          |  |                                             | 379,500 |  |  | 379,500 | (2) | 
| |             |  |                        |         |                                                |  |                                                |  |                                             |         |  |  |         |     | 
| |             |  |                        | 770,896 |                                                |  | 10,350                                         |  |                                             | 760,546 |  |  | 495,654 |     | 
| |             |  |                        |         |                                                |  |                                                |  |                                             |         |  |  |         |     | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Shares are scheduled to vest
  between March 2006 and July 2006, but will generally be forfeited if the
  recipient ceases either to be employed by the Company or to remain a member
  of CLF, Inc.s Board of Directors at any time prior to the vesting date.                                                                                                                                                                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(2) | Shares are scheduled to vest
  between February 2006 and March 2008, but will generally be forfeited if the
  recipient ceases either to be employed by the Company or to remain a member
  of CLF, Inc.s Board of Directors at any time prior to the vesting date.
  Vesting of an aggregate of 200,000 shares is also subject to satisfaction of
  objective and subjective performance criteria, to be determined by the CLF,
  Inc. Compensation Committee. On June 30, 2005, the CLF, Inc. Compensation
  Committee determined the performance criteria for 66,667 of these 200,000 shares.

As
of December 31, 2005, $2,104 of deferred compensation expense was included in
the Companys Consolidated Balance Sheet as a component of additional paid in
capital. This amount is expected to be charged to the Companys Consolidated
Income Statement over the remaining vesting period (through March 2008). The
amount of deferred compensation expense for awards of 133,333 shares made in
2005 has not yet been measured and included as a component of additional paid
in capital because the grant date (as defined under relevant accounting
guidance) has not yet occurred.

The
following summarizes the expense the Company recorded in its Consolidated
Income Statement during the years ended December 31, 2005 and December 31,
2004, for awards under the stock plan:

| |                                                                |  |              |       |      |   |       |  | 
| | -------------------------------------------------------------- |  | ------------ | ----- | ---- | - | ----- |  | 
| |                                                                |  | December 31, |       |     
| |                                                                |  |              |       |     
| |                                                                |  | 2005         |       | 2004 |   |      
| |                                                                |  |              |       |      |   |      
| |                                                                |  |              |       |      |   |       |  | 
| | General and administrative
  expenses-stock based compensation |  | $            | 2,235 |      | $ | 3,825 |  | 

On
November 17, 2003, CLF, Inc. sold 139,134 shares of its common stock to certain
current and former employees of the Predecessor for $0.10 per share. The
Company recorded no compensation expense in connection with the issuance of the
139,134 shares, since the fair value of the stock on the date of sale was equal
to the $0.10 per share purchase price. Upon completion of CLF, Inc.s initial
public offering on March 24, 2004, the difference between the public offering
price per share of $10.50 and the price at which these individuals purchased
the shares was recognized as a $1,447 expense (a component of General and
administrativestock based compensation expense) in the Companys Consolidated
Income Statement.

17. Rental Income

The
Company is the lessor to tenants under operating leases with expiration dates
ranging from 2007 to 2025 (not including incidental leases). The minimum rental
amounts due under the leases are generally subject to scheduled fixed
increases. The leases generally also require that the tenants pay for or
reimburse the Company for the occupancy and operating costs of the properties,
or in certain cases reimburse the Company for increases in certain operating
costs and real estate taxes above their base year costs. Approximate future
minimum rents to be received over the next five years and thereafter for
non-cancelable operating leases in effect at December 31, 2005, are as follows:

73

---



Capital Lease Funding, Inc. and Subsidiaries Notes to Consolidated
Financial Statements
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

|           |  |   |         | 
|---------- |  | - | ------- | 
|2006       |  | $ | 57,240  | 
|2007       |  |   | 59,640  | 
|2008       |  |   | 60,178  | 
|2009       |  |   | 58,287  | 
|2010       |  |   | 56,116  | 
|Thereafter |  |   | 490,829 | 
|           |  |   |         | 
|           |  | $ | 782,290 | 
|           |  |   |         | 

18. Concentration Risks

The
Company relies on Wachovia Bank to provide the majority of its cash for
financing its portfolio investments, including through a short-term repurchase
agreement and mortgage financings on owned real properties. Deterioration in the
financial condition of Wachovia Bank could have a negative impact on the
Companys ability to continue to make asset investments. However, management is
confident that alternative funding sources could be obtained with substantially
similar terms. As of December 31, 2005, Wachovia carried an A+ rating from
Standard & Poors.

During
2005, approximately 16.3% of the Companys total revenue was derived from one
tenant (Aon Corporation).

19. 401(k) Plan

The
Company has a 401(k) Savings/Retirement Plan (the 401(k) Plan) in place to
cover eligible employees of the Company. The 401(k) Plan permits eligible
employees of the Company to defer a portion of their annual compensation,
subject to certain limitations imposed by the Internal Revenue Code. The
employees elective deferrals are immediately vested and non-forfeitable upon
contribution to the 401(k) Plan. For the years ended December 31, 2005,
December 31, 2004, and December 31, 2003, the Company made matching contributions
of $68, $241, and $272, respectively.

20. Pro Forma Condensed Consolidated Income
Statements (Unaudited)

The
accompanying unaudited Pro Forma Condensed Consolidated Income Statements are
presented as if, at January 1, 2004, the Company acquired all real properties
purchased during 2005 and 2004. Earnings per share are presented using the
weighted average shares outstanding during the relevant periods. In
managements opinion, all adjustments necessary to reflect the effects of the
above transactions have been made.

The
unaudited Pro Forma Condensed Consolidated Income Statements are not
necessarily indicative of what the actual results of operations would have been
assuming the acquisition transactions had occurred at January 1, 2004, nor do
they purport to represent the Companys future results of operations.

|                                                                       |  |      |        |      |   |        | 
|---------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ------ | 
|                                                                       |  | 2005 |        | 2004 |  
|                                                                       |  |      |        |      |   |        | 
|Total revenues                                                         |  | $    | 98,083 |      | $ | 81,583 | 
|                                                                       |  |      |        |      |   |        | 
|Income from continuing operations                                      |  | $    | 7,106  |      | $ | 7,158  | 
|                                                                       |  |      |        |      |   |        | 
|Income per basic and diluted common share from continuing
  operations |  | $    | 0.26   |      | $ | 0.32   | 
|                                                                       |  |      |        |      |   |        | 

21. Segment Reporting

SFAS
No. 131, Disclosures about Segments of an
Enterprise and Related Information, establishes the manner in which
public businesses report information about operating segments in annual and
interim financial reports issued to stockholders. SFAS No. 131 defines a
segment as a component of an enterprise about which separate financial information
is available and that is evaluated regularly to allocate resources and assess
performance. The Company conducts its business through two segments: operating
net lease real estate (including its investments in owned properties) and
lending investments (including its loan investments as well as its investments
in securities). For segment reporting purposes, the Company does not allocate
interest income on short-term investments or general and administrative
expenses.

Selected
results of operations for the years ended December 31, 2005 are as follows:

74

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated
Financial Statements 
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

| |                                            |  |                             |         |                                       |   |                       |  |       |         |  |   |           | 
| | ------------------------------------------ |  | --------------------------- | ------- | ------------------------------------- | - | --------------------- |  | ----- | ------- |  | - | --------- | 
| |                                            |  | Corporate
  /
  Unallocated |         | Operating
  Net
  Lease
  Real Estate |   | Lending
  Investments |  | Total |        
| |                                            |  |                             |         |                                       |   |                       |  |       |        
| | Total revenues                             |  | $                           | 1,090   |                                       | $ | 44,352                |  | $     | 27,609  |  | $ | 73,052    | 
| | Total expenses & minority
  interest       |  |                             | 12,493  |                                       |   | 39,254                |  |       | 16,181  |  |   | 67,928    | 
| | Income (loss) from continuing
  operations |  |                             | (11,402 | )                                     |   | 5,098                 |  |       | 11,428  |  |   | 5,124     | 
| | Total assets                               |  |                             | 48,007  |                                       |   | 797,945               |  |       | 440,536 |  |   | 1,286,488 | 

Selected
results of operations for the year ended December 31, 2004 are as follows:

| |                                            |  |                             |         |                                       |   |                       |  |       |         |  |   |         | 
| | ------------------------------------------ |  | --------------------------- | ------- | ------------------------------------- | - | --------------------- |  | ----- | ------- |  | - | ------- | 
| |                                            |  | Corporate
  /
  Unallocated |         | Operating
  Net
  Lease
  Real Estate |   | Lending
  Investments |  | Total |        
| |                                            |  |                             |         |                                       |   |                       |  |       |        
| | Total revenues                             |  | $                           | 603     |                                       | $ | 6,356                 |  | $     | 14,045  |  | $ | 21,004  | 
| | Total expenses & minority
  interest       |  |                             | 11,869  |                                       |   | 4,206                 |  |       | 3,569   |  |   | 19,644  | 
| | Income (loss) from continuing
  operations |  |                             | (11,266 | )                                     |   | 2,150                 |  |       | 10,476  |  |   | 1,360   | 
| | Total assets                               |  |                             | 31,454  |                                       |   | 247,325               |  |       | 302,923 |  |   | 581,702 | 

22. Quarterly Financial Information
(Unaudited)

The
following table sets forth selected quarterly financial data for the Company
for 2005 and 2004.

|     |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|---- |  |  | ------------ | ------- | - | ------------------------------------------ |  | ----------------------------------------------- | ------ | - | - | ----- | -
|     |  |  |              | Revenue |   | Net income
  applicable to
  common shares |  | Basic and
  diluted income
  per common
  share |       
|     |  |  |              |         |   |                                            |  |                                                 |       
|2005 |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|     |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|     |  |  | December 31  |         | $ | 24,572                                     |  | $                                               | 1,067  |   | $ | 0.04  |  
|     |  |  | September 30 |         |   | 21,185                                     |  |                                                 | (273   | ) |   | (0.01 | )
|     |  |  | June 30      |         |   | 15,388                                     |  |                                                 | 1,554  |   |   | 0.06  |  
|     |  |  | March 31     |         |   | 11,907                                     |  |                                                 | 2,222  |   |   | 0.08  |  
|     |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|2004 |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|     |  |  |              |         |   |                                            |  |                                                 |        |   |   |       |  
|     |  |  | December 31  |         |   | 11,223                                     |  |                                                 | 3,101  |   |   | 0.11  |  
|     |  |  | September 30 |         |   | 5,017                                      |  |                                                 | 2,007  |   |   | 0.07  |  
|     |  |  | June 30      |         |   | 2,799                                      |  |                                                 | 443    |   |   | 0.02  |  
|     |  |  | March 31     |         |   | 1,966                                      |  |                                                 | (4,192 | ) |   | (0.71 | )

The totals
for the year may differ from the sum of the quarters as a result of weighting
and rounding.

23. Variable Interest Entities

In
January 2003, the FASB issued Interpretation Number 46, Consolidation of Variable Interest Entities.
FIN 46 was revised by FIN 46(R) in December 2003 (as revised, FIN 46). FIN 46
defines a variable interest entity (VIE) as an entity with one or more of the
following characteristics:

| |   |                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the equity investment at risk is
  not sufficient to permit the entity to finance its activities without
  additional subordinated financial support from other parties;                                                                                           
| |   |                                                                                                                                                                                                                                                                    
| |  | equity holders either (a) lack
  direct or indirect ability to make decisions about the entity, (b) are not
  obligated to absorb expected losses of the entity or (c) do not have the
  right to receive expected residual returns of the entity if they occur; or

75

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated
Financial Statements 
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

| |   |                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | equity holders have voting rights
  that are not proportionate to their economic interests, and the activities of
  the entity involve or are conducted on behalf of an investor with a
  disproportionately small voting interest.

If
an entity is deemed to be a VIE, an enterprise that absorbs a majority of the
expected losses of the entity is considered the primary beneficiary and must
consolidate the VIE.

As
part of the Companys developer loan program, the Company funds loans to an
entity that owns an undeveloped property. These loans are used to finance
pre-construction costs related to the property, such as due diligence costs and
land acquisition contract deposits, rather than costs to build on the property.
The Company has funded five such loans as of December 31, 2005, with an
aggregate unpaid principal amount of approximately $1,716 as of that date. The
Company has determined that its borrowers are VIEs under FIN 46. Each loan is
secured, in part, by a personal guarantee by the borrowing entitys owner. The
Company has concluded it is not the primary beneficiary of the VIE (and,
therefore, the Company has not consolidated the VIE under FIN 46). The
Companys maximum exposure to loss as a result of its involvement with these
VIEs is the amount funded on the loans.

During
2005, the Company invested $36,695 in an office building in Wilmington, Delaware
net leased to Hercules Incorporated, including a $28,000 mezzanine loan
investment and an $8,695 preferred equity investment. The Company has
determined that that its borrower is a VIE under FIN 46, but did not
consolidate the borrower because the Company concluded it was not the primary
beneficiary. The Companys maximum exposure to loss as a result of its
involvement with this VIE is the amount invested in the property.

The
Company previously treated the borrower under a mortgage loan it originated in
2004 on a Home Depot store in Westminster, Colorado, as a VIE, as the equity
owners of the borrower were required to pay the Company 25% of any gain on the
sale of the underlying property. The Company did not, however, consolidate the
VIE, as the Company was not the primary beneficiary of the VIE. During December
2005, the Companys mortgage loan was repaid in connection with a sale of the
property. The Companys share of the gain on sale was approximately $194.

Based
on the provisions of FIN 46, the Company concluded to consolidate at December
31, 2004 the Cadbury property in Whippany, New Jersey that it acquired in
January 2005, and to consolidate at June 30, 2005 the U.S. Government/National
Institutes of Health (NIH) property in North Bethesda, Maryland that it
acquired in September 2005. The Company did so because it concluded based on an
analysis of FIN 46 that the purchase price deposit that it had funded into
escrow under its purchase and sale agreement ($2,000 in the case of Cadbury and
$4,000 in the case of NIH) made the Company the primary beneficiary of the
expected losses of the property owner. The Companys maximum exposure to loss
as a result of its involvement with these VIEs is the amount of its deposit.
Creditors of the VIEs have no recourse against the Company.

As
of December 31, 2004, the Company recorded $48,000 of Real estate investments
consolidated under FIN 46 (representing the Companys purchase price for the
Cadbury property) on its Consolidated Balance Sheet. The Company also recorded
$4,815 of Mortgage on real estate investments consolidated under FIN 46
(representing the liabilities of the property owner). The Company also recorded
the net balance of the assets and liabilities consolidated as Minority
interest in real estate investments consolidated under FIN 46.

At
June 30, 2005, the Company recorded $81,500 of Real estate investments
consolidated under FIN 46 (representing the Companys purchase price for the
NIH property) on its Consolidated Balance Sheet. The Company also recorded
$50,887 of Mortgage on real estate investments consolidated under FIN 46
(representing the liabilities of the property owner). The Company also recorded
the net balance of the assets and liabilities consolidated as Minority
interest in real estate investments consolidated under FIN 46.

The
Companys Consolidated Income Statement for the year ended December 31, 2005,
includes total revenue of $3,460, total expenses of $3,515, and minority
interest in consolidated entities of ($55), associated with the NIH property
prior to the Companys acquisition of the property on September 9, 2005.

24. Subsequent Events

On
January 24, 2006, the Company entered into an agreement to purchase an
approximately one million square foot warehouse and distribution facility in
Philadelphia, Pennsylvania, for a purchase price of $90,125. The facility is
net leased to a subsidiary of TJX Companies, Inc. through June 2021. The
acquisition closed on March 10, 2006. The Company financed its acquisition at
the closing with $71,700 of mortgage debt secured by the TJX property at a
coupon rate of 5.57%.

76

---



Capital Lease Funding, Inc. and SubsidiariesNotes to Consolidated
Financial Statements 
(Dollar amounts in thousands, except per share amounts)

December 31, 2005, 2004 and 2003

On
January 27, 2006, the Company entered into an agreement to purchase two
adjacent office buildings aggregating approximately 260,000 square feet in
Denver, Colorado, for a purchase price of $69,300. Each of the buildings is
fully net leased to Invesco Funds Group, Inc., a subsidiary of AMVESCAP, PLC,
through October 2016.

77

---



Capital Lease Funding, Inc. and
Subsidiaries 
Real Estate and Accumulated Depreciation 
December 31, 2005 
(amounts in thousands)

Schedule III

|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|------------------------------------------------------------- |  | ------------ | ------- | ------------ | - | ---------------------------------------------- |  | -------------------------------------------------- | ------- | ------------------------------ | - | ---- |  | ------------------------------ | ----- | ------------------------------------------ | - | -------------------------- |  | ---------------------- | ------- | --------------- | - | ------- |  | - | ----- |  |  | ------------------------------------------------------------------ |  |  | ---------- |  |  | -------- | 
|                                                              |  |              |         | Initial Cost |   | Cost
  Capitalized Subsequent to
  Acquisition |  | Gross Amount at Which
  Carried at Close of Period |         |                                |   |      |  |                                |       | Life on Which
  Depreciation
  is Computed |  
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                           
|Description                                                   |  | Encumbrances |         | Land         |   | Building 
  and
  Improvements                 |  | Land                                               |         | Building 
  and
  Improvements |   | Land |  | Building 
  and
  Improvements |       | Total                                      |   | Accumulated
  Depreciation |  | Date of
  Construction |         | Date
  Acquired |   |        
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         | 
|Abbott Laboratories, Columbus, OH                             |  | $            | 8,187   |              | $ | 1,025                                          |  | $                                                  | 10,066  |                                | $ |     |  | $                              |      |                                            | $ | 1,025                      |  | $                      | 10,066  |                 | $ | 11,091  |  | $ | 291   |  |  | 1980                                                               |  |  | 11/5/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Abbott Laboratories, Waukegan, IL                             |  |              | 17,753  |              |   | 2,500                                          |  |                                                    | 15,430  |                                |   |     |  |                                |      |                                            |   | 2,500                      |  |                        | 15,430  |                 |   | 17,930  |  |   | 152   |  |  | 2000                                                               |  |  | 8/9/2005   |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Allstate Insurance Company, Charlotte, NC                     |  |              | 24,762  |              |   | 7,100                                          |  |                                                    | 14,594  |                                |   |     |  |                                |      |                                            |   | 7,100                      |  |                        | 14,594  |                 |   | 21,694  |  |   | 11    |  |  | 1973, renovated in the 1990s                                       |  |  | 12/21/2005 |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Allstate Insurance Company, Roanoke, VA                       |  |              | 26,363  |              |   | 3,200                                          |  |                                                    | 20,930  |                                |   |     |  |                                |      |                                            |   | 3,200                      |  |                        | 20,930  |                 |   | 24,130  |  |   | 15    |  |  | 1967/70, with an addition in 1982                                  |  |  | 12/21/2005 |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Aon Corporation, Glenview, IL                                 |  |              | 73,871  |              |   | 11,000                                         |  |                                                    | 68,591  |                                |   |     |  |                                |      |                                            |   | 11,000                     |  |                        | 68,591  |                 |   | 79,591  |  |   | 2,346 |  |  | 1975, renovated in 1999                                            |  |  | 8/19/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Baxter International, Inc., Bloomington, IN                   |  |              | 7,039   |              |   | 1,200                                          |  |                                                    | 9,181   |                                |   |     |  |                                |      |                                            |   | 1,200                      |  |                        | 9,181   |                 |   | 10,381  |  |   | 279   |  |  | 1996, renovation and warehouse
  addition in 2004                  |  |  | 10/13/2004 |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Cadbury Schweppes Holdings (US), Whippany, NJ                 |  |              | 39,714  |              |   | 6,300                                          |  |                                                    | 38,994  |                                |   |     |  |                                | 1,217 |                                            |   | 6,300                      |  |                        | 40,211  |                 |   | 46,511  |  |   | 502   |  |  | 2005                                                               |  |  | 1/6/2005   |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Capital One Financial Corporation, Plano, TX                  |  |              | 23,733  |              |   | 6,670                                          |  |                                                    | 18,816  |                                |   |     |  |                                |      |                                            |   | 6,670                      |  |                        | 18,816  |                 |   | 25,486  |  |   | 246   |  |  | 1999                                                               |  |  | 6/23/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Choice Hotels International, Inc., Silver Spring,
MD          |  |              | 32,199  |              |   | 5,500                                          |  |                                                    | 36,806  |                                |   |     |  |                                |      |                                            |   | 5,500                      |  |                        | 36,806  |                 |   | 42,306  |  |   | 1,017 |  |  | Building 10720 - 1981, 10750 - 1971,
  10770 - 1986                |  |  | 11/23/2004 |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Crozer-Keystone Health System, Ridley, PA                     |  |              | 4,272   |              |   |                                               |  |                                                    | 5,015   |                                |   |     |  |                                | 771   |                                            |   |                           |  |                        | 5,785   |                 |   | 5,785   |  |   | 179   |  |  | 1977, currently under renovation                                   |  |  | 8/9/2004   |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|CVS Corporation, Randolph, MA                                 |  |              | 9,156   |              |   | 6,300                                          |  |                                                    | 7,801   |                                |   |     |  |                                |      |                                            |   | 6,300                      |  |                        | 7,801   |                 |   | 14,101  |  |   | 245   |  |  | 1966, renovated in 1992-1993                                       |  |  | 9/29/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Farmers New World Life Insurance Company, Mercer Island,
  WA |  |              | 33,102  |              |   | 24,000                                         |  |                                                    | 10,035  |                                |   |     |  |                                |      |                                            |   | 24,000                     |  |                        | 10,035  |                 |   | 34,035  |  |   | 7     |  |  | 1982                                                               |  |  | 12/22/2005 |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|ITT Industries, Inc., Herndon, VA                             |  |              | 48,001  |              |   | 5,300                                          |  |                                                    | 40,221  |                                |   |     |  |                                | 1,568 |                                            |   | 5,300                      |  |                        | 41,789  |                 |   | 47,089  |  |   | 612   |  |  | 1998                                                               |  |  | 5/23/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Lowes Companies, Inc., Aliso Viejo, CA                        |  |              | 45,811  |              |   | 26,600                                         |  |                                                    | 20,829  |                                |   |     |  |                                |      |                                            |   | 26,600                     |  |                        | 20,829  |                 |   | 47,429  |  |   | 307   |  |  | 2004                                                               |  |  | 5/31/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Omnicom Group, Inc., Irving, TX                               |  |              | 15,012  |              |   | 2,620                                          |  |                                                    | 11,800  |                                |   |     |  |                                |      |                                            |   | 2,620                      |  |                        | 11,800  |                 |   | 14,420  |  |   | 154   |  |  | 1997                                                               |  |  | 6/23/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Tiffany & Co, Parsippany, NJ                                  |  |              | 62,914  |              |   | 7,400                                          |  |                                                    | 62,150  |                                |   |     |  |                                | 47    |                                            |   | 7,400                      |  |                        | 62,197  |                 |   | 69,597  |  |   | 402   |  |  | Warehouse Mezzanine - 2000, Garage
  2001, East Wing Office - 2002 |  |  | 9/28/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (DEA), Birmingham, AL                           |  |              | 12,609  |              |   | 1,000                                          |  |                                                    | 11,591  |                                |   |     |  |                                | 258   |                                            |   | 1,000                      |  |                        | 11,849  |                 |   | 12,849  |  |   | 14    |  |  | Nov-2005                                                           |  |  | 8/11/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (Department of Veterans Affairs), Ponce,
PR     |  |              | 7,670   |              |   | 2,120                                          |  |                                                    | 10,252  |                                |   |     |  |                                |      |                                            |   | 2,120                      |  |                        | 10,252  |                 |   | 12,372  |  |   | 299   |  |  | March 2000                                                         |  |  | 11/1/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (EPA), Kansas City, KS                          |  |              | 27,085  |              |   | 250                                            |  |                                                    | 29,476  |                                |   |     |  |                                |      |                                            |   | 250                        |  |                        | 29,476  |                 |   | 29,726  |  |   | 281   |  |  | 2003                                                               |  |  | 8/11/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (FBI), Birmingham, AL                           |  |              | 20,890  |              |   | 2,200                                          |  |                                                    | 20,171  |                                |   |     |  |                                |      |                                            |   | 2,200                      |  |                        | 20,171  |                 |   | 22,371  |  |   | 197   |  |  | 2005                                                               |  |  | 8/11/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (NIH), N. Bethesda, MD                          |  |              | 65,188  |              |   | 10,350                                         |  |                                                    | 61,512  |                                |   |     |  |                                |      |                                            |   | 10,350                     |  |                        | 61,512  |                 |   | 71,862  |  |   | 478   |  |  | 1989                                                               |  |  | 9/9/2005   |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (OSHA), Sandy, UT                               |  |              | 19,351  |              |   | 1,750                                          |  |                                                    | 18,484  |                                |   |     |  |                                |      |                                            |   | 1,750                      |  |                        | 18,484  |                 |   | 20,234  |  |   | 180   |  |  | 2004                                                               |  |  | 8/11/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|US Government (SSA), Austin, TX                               |  |              | 6,172   |              |   | 1,100                                          |  |                                                    | 4,313   |                                |   |     |  |                                | 138   |                                            |   | 1,100                      |  |                        | 4,451   |                 |   | 5,551   |  |   | 3     |  |  | Dec 2005                                                           |  |  | 8/11/2005  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Walgreen Co., Pennsauken, NJ                                  |  |              | 2,208   |              |   | 463                                            |  |                                                    | 2,629   |                                |   |     |  |                                |      |                                            |   | 463                        |  |                        | 2,629   |                 |   | 3,092   |  |   | 77    |  |  | 1996                                                               |  |  | 11/1/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|Walgreen Co., Portsmouth, VA                                  |  |              | 3,526   |              |   | 618                                            |  |                                                    | 3,563   |                                |   |     |  |                                |      |                                            |   | 618                        |  |                        | 3,563   |                 |   | 4,181   |  |   | 105   |  |  | 1998                                                               |  |  | 11/1/2004  |  |  | 40 years | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 
|                                                              |  | $            | 636,588 |              | $ | 136,566                                        |  | $                                                  | 553,250 |                                | $ |     |  | $                              | 3,999 |                                            | $ | 136,566                    |  | $                      | 557,248 |                 | $ | 693,814 |  | $ | 8,399 |  |  |                                                                    |  |  |            |  |  |          | 
|                                                              |  |              |         |              |   |                                                |  |                                                    |         |                                |   |      |  |                                |       |                                            |   |                            |  |                        |         |                 |   |         |  |   |       |  |  |                                                                    |  |  |            |  |  |          | 

78

---



Capital Lease Funding, Inc. and Subsidiaries
Real Estate and Accumulated Depreciation
December 31, 2005
(amounts in thousands)
Schedule III(Continued)

|                                              |  |  |         |  |   |         |    
|--------------------------------------------- |  |  | ------- |  | - | ------- | ---
|Real estate                                   |  |  |         |  |   |         |    
|Balance-January 1, 2004                       |  |  |         |  | $ |        |    
|                                              |  |  |         |  |   |         |    
|Additions during the year:                    |  |  |         |  |   |         |    
|Property
  acquisitions                       |  |  | 182,131 |  |   |         |    
|Costs
  capitalized subsequent to acquisition |  |  | 174     |  |   |         |    
|                                              |  |  |         |  |   |         |    
|Balance-December 31, 2004                     |  |  |         |  | $ | 182,305 | (1)
|                                              |  |  |         |  |   |         |    
|Property
  acquisitions                       |  |  | 508,597 |  |   |         |    
|Costs
  capitalized subsequent to acquisition |  |  | 2,912   |  |   |         |    
|                                              |  |  |         |  |   |         |    
|Balance-December 31, 2005                     |  |  |         |  | $ | 693,814 |    
|                                              |  |  |         |  |   |         |    
|                                              |  |  |         |  |   |         |    
|Accumulated depreciation                      |  |  |         |  |   |         |    
|Balance-January 1, 2004                       |  |  |         |  | $ |        |    
|                                              |  |  |         |  |   |         |    
|Additions during the year:                    |  |  |         |  |   |         |    
|Depreciation
  on property                    |  |  | 1,281   |  |   |         |    
|                                              |  |  |         |  |   |         |    
|Balance-December 31, 2004                     |  |  |         |  | $ | 1,281   |    
|                                              |  |  |         |  |   |         |    
|Additions during the year:                    |  |  |         |  |   |         |    
|Depreciation
  on property                    |  |  | 7,118   |  |   |         |    
|                                              |  |  |         |  |   |         |    
|Balance-December 31, 2005                     |  |  |         |  | $ | 8,399   |    
|                                              |  |  |         |  |   |         |    

(1) Last
years presentation included the balance of intangible assets under SFAS 141 of
$13,517. This years presentation excludes the balances related to intangible
assets under SFAS 141.

79

---



Capital Lease Funding, Inc. and
Subsidiaries
Schedule of Mortgage Loan on Real Estate
December 31, 2005
(amounts in thousands)

Schedule IV

|                           |  |                                  |  |              |   |                     |          |                        |                                                                                             |            |     |                          |   |                                  |  |                                                                       |   |        |  |  |  | 
|-------------------------- |  | -------------------------------- |  | ------------ | - | ------------------- | -------- | ---------------------- | ------------------------------------------------------------------------------------------- | ---------- | --- | ------------------------ | - | -------------------------------- |  | --------------------------------------------------------------------- | - | ------ |  |  |  | 
|Description                |  | Location                         |  | InterestRate |   | Final
Maturity
Date |          | Periodic Payment Terms |                                                                                             | PriorLiens |     | Face Amount
of Mortgages |   | Carrying
Amount of
Mortgages (2) |  | Principal Amount of
Loans Subject to
Delinquent Principal or
Interest |  
|                           |  |                                  |  |              |   |                     |          |                        |                                                                                             |            |     |                          |   |                                  |  |                                                                       |   |        |  |  |  | 
|                           |  |                                  |  |              |   |                     |          |                        |                                                                                             |            |     |                          |   |                                  |  |                                                                       |   |        |  |  |  | 
|Long-Term
  Mortgage Loans |  |                                  |  |              |   |                     |          |                        |                                                                                             |            |     |                          |   |                                  |  |                                                                       |   |        |  | 
|                           |  |                                  |  |              |   |                     |          |                        |                                                                                             |            |     |                          |   |                                  |  |                                                                       |   |        |  |  |  | 
|Autozone,
        Inc.     |  | Douglas
        and Valdosta, GA |  | 6.500        | % |                     | Nov 2022 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity   |            | N/A |                          | $ | 2,039                            |  |                                                                       | $ | 2,039  |  |  |  | 
|Best Buy Co., Inc.         |  | Chicago, IL                      |  | 6.403        | % |                     | Mar 2025 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 18,324                           |  |                                                                       |   | 18,324 |  |  |  | 
|City of Jasper, Texas      |  | Jasper, TX                       |  | 7.000        | % |                     | Nov 2024 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,706                            |  |                                                                       |   | 1,654  |  |  |  | 
|CVS Corporation            |  | Bangor, PA                       |  | 6.280        | % |                     | Jan 2026 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity   |            | N/A |                          |   | 2,414                            |  |                                                                       |   | 2,371  |  |  |  | 
|CVS Corporation            |  | Athol, MA                        |  | 6.460        | % |                     | Jan 2025 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,463                            |  |                                                                       |   | 1,464  |  |  |  | 
|CVS Corporation            |  | Asheville, NC                    |  | 6.530        | % |                     | Jan 2026 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 2,297                            |  |                                                                       |   | 2,363  |  |  |  | 
|CVS Corporation            |  | Washington, DC                   |  | 8.100        | % |                     | Jan 2023 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity   |            | N/A |                          |   | 2,505                            |  |                                                                       |   | 2,683  |  |  |  | 
|CVS Corporation            |  | Bluefield, WV                    |  | 8.000        | % |                     | Jan 2021 |                        | Principal and Interest are payable
  monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,324                            |  |                                                                       |   | 1,453  |  |  |  | 
|CVS Corporation            |  | Sunbury, PA                      |  | 7.500        | % |                     | Jan 2021 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,656                            |  |                                                                       |   | 1,614  |  |  |  | 
|CVS Corporation            |  | Oak Ridge, NC                    |  | 6.990        | % |                     | Aug 2024 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 3,163                            |  |                                                                       |   | 3,163  |  |  |  | 
|CVS Corporation            |  | Southington, CT                  |  | 8.260        | % |                     | Jan 2020 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,733                            |  |                                                                       |   | 1,944  |  |  |  | 
|CVS Corporation            |  | Willimantic, CT                  |  | 8.260        | % |                     | Jan 2023 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 1,992                            |  |                                                                       |   | 2,239  |  |  |  | 
|CVS Corporation            |  | Stow, OH                         |  | 8.260        | % |                     | Jan 2020 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 2,351                            |  |                                                                       |   | 2,636  |  |  |  | 
|CVS Corporation            |  | Greensboro, GA                   |  | 6.520        | % |                     | Jan 2030 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity   |            | N/A |                          |   | 1,379                            |  |                                                                       |   | 1,379  |  |  |  | 
|CVS Corporation            |  | Shelby Twp., MI                  |  | 5.980        | % |                     | Jan 2031 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 2,540                            |  |                                                                       |   | 2,540  |  |  |  | 
|Harris Bankcorp, Inc.      |  | Chicago, IL                      |  | 6.810        | % |                     | Aug 2025 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 4,467                            |  |                                                                       |   | 4,467  |  |  |  | 
|Home Depot USA, Inc.       |  | Chelsea, MA                      |  | 5.360        | % |                     | Jan 2031 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 8,501                            |  |                                                                       |   | 8,501  |  |  |  | 
|Home Depot USA, Inc.       |  | Tullytown, PA                    |  | 6.620        | % |                     | Jan 2033 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 8,432                            |  |                                                                       |   | 8,432  |  |  |  | 
|Kohls Corporation          |  | Chicago, IL                      |  | 6.690        | % |                     | May 2030 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 48,001                           |  |                                                                       |   | 48,001 |  |  |  | 
|Koninklijke Ahold, N.V.    |  | Bensalem, PA                     |  | 7.240        | % |                     | May 2020 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 3,092                            |  |                                                                       |   | 3,155  |  |  |  | 
|Koninklijke Ahold, N.V.    |  | Upper Darby Township, PA         |  | 7.290        | % |                     | Apr 2024 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 6,656                            |  |                                                                       |   | 6,350  |  |  |  | 
|Koninklijke Ahold, N.V.    |  | North Kingstown, RI              |  | 7.500        | % |                     | Nov 2025 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 6,646                            |  |                                                                       |   | 6,625  |  |  |  | 
|Koninklijke Ahold, N.V.    |  | Tewksbury, MA                    |  | 7.500        | % |                     | Jan 2027 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 6,511                            |  |                                                                       |   | 6,505  |  |  |  | 
|Lowes Companies, Inc.      |  | Framingham, MA                   |  | 5.870        | % |                     | Sep 2031 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 27,864                           |  |                                                                       |   | 27,864 |  |  |  | 
|Lowes Companies, Inc.      |  | Matamoras, PA                    |  | 6.610        | % |                     | May 2030 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity |            | N/A |                          |   | 7,159                            |  |                                                                       |   | 7,159  |  |  |  | 

80

---



Capital Lease Funding, Inc. and
Subsidiaries
Schedule of Mortgage Loan on Real Estate
December 31, 2005
(amounts in thousands)

Schedule IV

|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  |  |  | 
|--------------------------------------- |  | ---------------------- |  | ------------ | - | ------------------- | -------- | ---------------------- | ------------------------------------------------------------------------------------------------- | ---------- | --- | ------------------------ |  | -------------------------------- |  | --------------------------------------------------------------------- |  | ------- |  |  |  | 
|Description                             |  | Location               |  | InterestRate |   | Final
Maturity
Date |          | Periodic Payment Terms |                                                                                                   | PriorLiens |     | Face Amount
of Mortgages |  | Carrying
Amount of
Mortgages (2) |  | Principal Amount of
Loans Subject to
Delinquent Principal or
Interest | 
|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  |  |  | 
|National City Bank                      |  | Chicago, IL            |  | 5.890        | % |                     | Dec 2024 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 3,065                            |  |                                                                       |  | 3,150   |  |  |  | 
|Natural Gas Pipeline Company of America |  | Lombard, IL            |  | 5.970        | % |                     | Jun 2007 |                        | Principal and Interest are
  payable semi-annually at a varying amount, over the life to maturity |            | N/A |                          |  | 8,151                            |  |                                                                       |  | 8,151   |  |  |  | 
|Neiman Marcus Group, Inc.               |  | Las Vegas, NV          |  | 6.060        | % |                     | Nov 2021 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 7,381                            |  |                                                                       |  | 8,029   |  |  |  | 
|United States Postal Service            |  | Scammon Bay, AK        |  | 7.050        | % |                     | Oct 2021 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 955                              |  |                                                                       |  | 975     |  |  |  | 
|University of Connecticut Health Center |  | Farmington, CT         |  | 6.340        | % |                     | Nov 2024 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 22,164                           |  |                                                                       |  | 23,019  |  |  |  | 
|Walgreen Co.                            |  | Rosemead, CA           |  | 5.990        | % |                     | Dec 2029 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 4,651                            |  |                                                                       |  | 4,651   |  |  |  | 
|Walgreen Co.                            |  | Dallas, TX             |  | 6.460        | % |                     | Dec 2029 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 3,481                            |  |                                                                       |  | 3,481   |  |  |  | 
|Walgreen Co.                            |  | Montebello, CA         |  | 6.100        | % |                     | Feb 2030 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 4,633                            |  |                                                                       |  | 4,633   |  |  |  | 
|Xerox Corporation (1)                   |  | El Segundo, CA         |  | 7.541        | % |                     | Nov 2007 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 9,322                            |  |                                                                       |  | 9,319   |  |  |  | 
|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  |  |  | 
|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  | 238,018                          |  |                                                                       |  | 240,333 |  |  |  | 
|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  |  |  | 
|Corporate Credit Notes                  |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  | 
|                                        |  |                        |  |              |   |                     |          |                        |                                                                                                   |            |     |                          |  |                                  |  |                                                                       |  |         |  |  |  | 
|Albertsons, Inc.                        |  | Los Angeles, CA        |  | 6.500        | % |                     | Sep 2013 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 363                              |  |                                                                       |  | 327     |  |  |  | 
|Albertsons, Inc.                        |  | Norwalk, CA            |  | 6.330        | % |                     | Dec 2013 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 399                              |  |                                                                       |  | 394     |  |  |  | 
|Best Buy Co., Inc.                      |  | Wichita Falls, TX      |  | 6.150        | % |                     | Nov 2012 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 572                              |  |                                                                       |  | 542     |  |  |  | 
|Best Buy Co., Inc.                      |  | Olathe, KS             |  | 5.400        | % |                     | Jun 2013 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 1,462                            |  |                                                                       |  | 1,395   |  |  |  | 
|CVS Corporation                         |  | Garwood, NJ            |  | 6.120        | % |                     | Aug 2013 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 720                              |  |                                                                       |  | 698     |  |  |  | 
|CVS Corporation                         |  | Kennett Square, PA     |  | 6.400        | % |                     | Oct 2012 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 643                              |  |                                                                       |  | 619     |  |  |  | 
|CVS Corporation                         |  | Commerce, MI           |  | 5.850        | % |                     | May 2013 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 412                              |  |                                                                       |  | 396     |  |  |  | 
|CVS Corporation                         |  | Knox, IN               |  | 7.600        | % |                     | Dec 2011 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 222                              |  |                                                                       |  | 221     |  |  |  | 
|CVS Corporation                         |  | Rutherford College, NC |  | 6.120        | % |                     | Oct 2013 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 299                              |  |                                                                       |  | 291     |  |  |  | 
|CVS Corporation                         |  | Clemmons, NC           |  | 5.540        | % |                     | Jan 2015 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 265                              |  |                                                                       |  | 253     |  |  |  | 
|CVS Corporation                         |  | Rockingham, NC         |  | 6.120        | % |                     | Oct 2013 |                        | Principal and Interest are
  payable monthly at a level amount, over the life to maturity         |            | N/A |                          |  | 362                              |  |                                                                       |  | 353     |  |  |  | 
|Federal Express Corporation             |  | Bellingham, WA         |  | 5.780        | % |                     | Mar 2015 |                        | Principal and Interest are payable
  monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 343                              |  |                                                                       |  | 335     |  |  |  | 
|FedEx Ground Package System, Inc.       |  | Reno, NV               |  | 5.900        | % |                     | Oct 2014 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 1,253                            |  |                                                                       |  | 1,240   |  |  |  | 
|FedEx Ground Package System, Inc.       |  | McCook, IL             |  | 5.890        | % |                     | Feb 2015 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 2,566                            |  |                                                                       |  | 2,533   |  |  |  | 
|Lowes Companies, Inc.                   |  | N. Windham, ME         |  | 5.280        | % |                     | Sep 2015 |                        | Principal and Interest are
  payable monthly at a varying amount, over the life to maturity       |            | N/A |                          |  | 1,140                            |  |                                                                       |  | 1,116   |  |  |  | 

81

---



Capital Lease Funding, Inc. and Subsidiaries 
Schedule of Mortgage Loan on Real Estate 
December 31, 2005 
(amounts in thousands) 
Schedule IV

|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|------------------------------- |  | ------------------ |  | --------------- | - | ----------------------- | ---------- | ---------------------- | ------------------------------------------------------------------------------------------- | ----------- | --- | -------------------------- | ----------- | ---------------------------------- | ----------- | ----------------------------------------------------------------------- | 
|Description                     |  | Location           |  | Interest
  Rate |   | Final
  Maturity
  Date |            | Periodic Payment Terms |                                                                                             | Prior Liens |     | Face
  Amount of Mortgages |             | Carrying
  Amount of Mortgages (2) |             | Principal
  Amount of Loans Subject to Delinquent Principal or Interest
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                        
|PerkinElmer, Inc.               |  | Warwick, RI        |  | 7.680           | % |                         | Jan
  2012 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 654         |                                    | 639         |                                                                         | 
|PerkinElmer, Inc.               |  | Beltsville, MD     |  | 7.350           | % |                         | Dec
  2011 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 485         |                                    | 481         |                                                                         | 
|PerkinElmer, Inc.               |  | Daytona Beach, FL  |  | 7.350           | % |                         | Dec
  2011 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 220         |                                    | 218         |                                                                         | 
|PerkinElmer, Inc.               |  | Phelps, NY         |  | 7.350           | % |                         | Dec
  2011 |                        | Principal and Interest are payable monthly at a level amount, over
the
  life to maturity   |             | N/A |                            | 205         |                                    | 200         |                                                                         | 
|Staples, Inc.                   |  | Odessa, TX         |  | 6.410           | % |                         | Sep
  2012 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 310         |                                    | 293         |                                                                         | 
|Walgreen Co.                    |  | Delray Beach, FL   |  | 6.200           | % |                         | Jan
  2013 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 458         |                                    | 455         |                                                                         | 
|Walgreen Co.                    |  | Waterford, MI      |  | 5.500           | % |                         | Jun
  2013 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 762         |                                    | 711         |                                                                         | 
|Walgreen Co.                    |  | Riverside, CA      |  | 6.100           | % |                         | Dec
  2013 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 483         |                                    | 472         |                                                                         | 
|Walgreen Co.                    |  | Jefferson City, TN |  | 5.490           | % |                         | May 2015   |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 752         |                                    | 751         |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            | 15,350      |                                    | 14,933      |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|Mezzanine and Other Investments |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |            
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|CVS Corporation                 |  | Aliso Viejo, CA    |  | 9.170           | % |                         | Feb
  2006 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 5,000       |                                    | 5,000       |                                                                         | 
|Hercules Incorporated           |  | Wilmington, DE     |  | 8.540           | % |                         | Jun
  2013 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 13,700      |                                    | 13,700      |                                                                         | 
|Hercules Incorporated           |  | Wilmington, DE     |  | 14.040          | % |                         | Jun
  2013 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 2,575       |                                    | 2,575       |                                                                         | 
|Hercules Incorporated           |  | Wilmington, DE     |  | 8.790           | % |                         | Jun
  2013 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 14,000      |                                    | 14,000      |                                                                         | 
|Hercules Incorporated           |  | Wilmington, DE     |  | 14.290          | % |                         | Jun
  2013 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 6,120       |                                    | 6,120       |                                                                         | 
|Walgreen Co.                    |  | Jackson, NJ        |  | 10.000          | % |                         | Mar
  2007 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 312         |                                    | 312         |                                                                         | 
|Walgreen Co.                    |  | Bristol, CT        |  | 10.000          | % |                         | Jul
  2007 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 21          |                                    | 21          |                                                                         | 
|Walgreen Co.                    |  | Mansfield, NJ      |  | 10.000          | % |                         | May
  2007 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 409         |                                    | 409         |                                                                         | 
|Walgreen Co.                    |  | Staten Island, NY  |  | 10.000          | % |                         | Jul
  2007 |                        | Principal and Interest are payable monthly at a varying amount, over
  the life to maturity |             | N/A |                            | 630         |                                    | 630         |                                                                         | 
|Walgreen Co.                    |  | Tinley Park, IL    |  | 10.000          | % |                         | Mar
  2007 |                        | Principal and Interest are payable monthly at a level amount, over
  the life to maturity   |             | N/A |                            | 344         |                                    | 344         |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            | 43,111      |                                    | 43,111      |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 
|Total                           |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            | $   296,479 |                                    | $   298,377 |                                                                         | 
|                                |  |                    |  |                 |   |                         |            |                        |                                                                                             |             |     |                            |             |                                    |             |                                                                         | 

|    |                                                                                                   
|--- | --------------------------------------------------------------------------------------------------
|(1) | This loan
  carries interest at a variable rate, adjusted monthly, equal to 1 month
  LIBOR+3.25%.
|(2) | The
  aggregate cost for Federal income tax purposes is $298,377.                                 

82

---



Capital Lease Funding, Inc. and
Subsidiaries
Schedule of Mortgage Loan on Real Estate
December 31, 2005
(amounts in thousands)
Schedule IV(Continued)

|                                                                             |  |  |          |   |   |         | 
|---------------------------------------------------------------------------- |  |  | -------- | - | - | ------- | 
|Balance-December 31, 2002                                                    |  |  |          |   | $ | 77,992  | 
|                                                                             |  |  |          |   |   |         | 
|Additions during the year:                                                   |  |  |          |   |   |         | 
|New mortgage loans                                                           |  |  | 143,566  |   |   |         | 
|Reduction in valuation provision                                             |  |  | 1,917    |   |   |         | 
|Mark to fair value                                                           |  |  | (857     | ) |   |         | 
|Deductions during the year:                                                  |  |  |          |   |   |         | 
|Principal received                                                           |  |  | (2,381   | ) |   |         | 
|Loans sold                                                                   |  |  | (148,264 | ) |   |         | 
|                                                                             |  |  |          |   |   |         | 
|Balance-December 31, 2003                                                    |  |  |          |   | $ | 71,973  | 
|                                                                             |  |  |          |   |   |         | 
|Additions during the year:                                                   |  |  |          |   |   |         | 
|New mortgage loans                                                           |  |  | 167,009  |   |   |         | 
|Mark to fair value                                                           |  |  | (343     | ) |   |         | 
|Fair value hedges allocated to unearned
  origination discounts and premiums |  |  | 2,403    |   |   |         | 
|Deductions during the year:                                                  |  |  |          |   |   |         | 
|Principal received                                                           |  |  | (8,521   | ) |   |         | 
|Loans sold                                                                   |  |  | (24,628  | ) |   |         | 
|                                                                             |  |  |          |   |   |         | 
|Balance-December 31, 2004                                                    |  |  |          |   | $ | 207,893 | 
|                                                                             |  |  |          |   |   |         | 
|Additions during the year:                                                   |  |  |          |   |   |         | 
|New mortgage loans                                                           |  |  | 115,852  |   |   |         | 
|Securities reclassified to mortgage
loans                                    |  |  | 6,932    |   |   |         | 
|Deductions during the year:                                                  |  |  |          |   |   |         | 
|Principal received                                                           |  |  | (20,372  | ) |   |         | 
|Amortization of unearned discounts and
  premiums                            |  |  | (70      | ) |   |         | 
|Loans sold                                                                   |  |  | (11,858  | ) |   |         | 
|                                                                             |  |  |          |   |   |         | 
|Balance-December 31, 2005                                                    |  |  |          |   | $ | 298,377 | 
|                                                                             |  |  |          |   |   |         | 

83

---



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

None.

Item
9A.     Controls and Procedures.

Evaluation
of Disclosure Controls and Procedures

We
maintain disclosure controls and procedures (as defined under Rule 13a-15(e)
under the Securities Exchange Act of 1934, as amended (the Exchange Act))
that are designed to ensure that information required to be disclosed in our
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SECs rules and forms, and that such information
is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.

Pursuant
to Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, 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 upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective.

Changes
in Internal Controls

There
has been no change in our internal control over financial reporting during the
quarter ended December 31, 2005, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.

Managements
Report on Internal Control over Financial Reporting

Managements
Annual Report on Internal Control over Financial Reporting immediately precedes
Item 8. Financial Statements and Supplementary Data, and is incorporated herein
by reference.

Item 9B.     Other
Information.

The Company makes the following disclosure in lieu of filing a Current Report
on Form 8-K under Item 1.01.

Executive
Officer Compensation.

On
March 14, 2006, the Compensation Committee of our Board of Directors approved
base salary increases for certain of our executive officers and 2005 cash bonus
awards for all of our executive officers. The details of the awards are
summarized as Exhibit 10.46 to this Form 10-K, and are incorporated herein by
reference.

Non-Employee
Director Compensation

On
March 14, 2006, our Board of Directors approved a director compensation plan
for 2005 for our non-employee directors. The details of the program are
summarized as Exhibit 10.47 to this Form 10-K, and are incorporated herein by
reference. Stock awards will be made pursuant to our 2004 Stock Incentive Plan
(the Plan).

The
Company makes the following disclosure in lieu of filing a Current Report on
Form 8-K under Items 2.01 and 2.03.

Acquisition
of TJX Property

On
March 10, 2006, we completed the acquisition of an approximately one million
square foot warehouse and distribution facility from Liberty Property Limited
Partnership and Liberty Property Philadelphia Trust for a purchase price of
approximately $90.1 million. The facility is located in Philadelphia,
Pennsylvania, and is net leased to a subsidiary of TJX Companies, Inc. through
June 2021.

We
financed our acquisition at the closing with $71.7 million of mortgage debt
secured by the TJX property. The terms of our mortgage debt are summarized as
follows:

| |  |  |   |                                             
| |  |  | - | --------------------------------------------
| |  |  |  | $71.7 million face
  amount of note;        
| |  |  |   |                                             
| |  |  |  | 5.57% coupon rate;                          
| |  |  |   |                                             
| |  |  |  | maturity date in
  March 2016;              
| |  |  |   |                                             
| |  |  |  | $65.5 million
  balloon payable at maturity;

84

---



| |  |  |   |                                                                                                                                                        
| |  |  | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |  | debt service is
  payable monthly; interest-only period of six months;                                                                                 
| |  |  |   |                                                                                                                                                        
| |  |  |  | non-recourse note
  secured by mortgage on the property and an assignment of underlying lease and
  rents; customary non-recourse exceptions apply; and
| |  |  |   |                                                                                                                                                        
| |  |  |  | the note is
  subject to customary events of default.                                                                                                  

85

---



PART III.

Item
10.     Directors and Executive Officers of the
Registrant.*

The
information required by Item 10 is incorporated by reference herein to the
information contained in our definitive proxy statement related to our 2006
annual meeting of stockholders.

Because
our common stock is listed on the NYSE, Paul H. McDowell, our chief executive
officer, certified to the NYSE on July 8, 2005, pursuant to Section 303A.12 of
the NYSEs listing standards, that he was not aware of any violation by us of
the NYSEs corporate governance listing standards as of that date. We also have
filed as exhibits to this Annual Report on Form 10-K the certifications of our
chief executive officer and our chief financial officer required by Sections
302 and 906 of the Sarbanes-Oxley Act of 2002.

Item
11.     Executive Compensation.*

The
information required by Item 11 is incorporated by reference herein to the
information contained in our definitive proxy statement related to our 2006
annual meeting of stockholders.

Item 12.            Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.*

The
information required by Item 12 is incorporated by reference herein to the
information contained in our definitive proxy statement related to our 2006
annual meeting of stockholders.

Item 13.     Certain
Relationships and Related Transactions.*

The
information required by Item 13 is incorporated by reference herein to the
information contained in our definitive proxy statement related to our 2006
annual meeting of stockholders.

Item
14.     Principal Accounting Fees and Services.*

The
information required by Item 14 is incorporated by reference herein to the
information contained in our definitive proxy statement related to our 2006
annual meeting of stockholders.

86

---



PART IV.

Item
15.     Exhibits and Financial Statement Schedules.

(a)
and (c)

The
consolidated financial statements and supplementary data (including financial
statement schedules) are included in this report under Item 8 of Part II
hereof.

See
the exhibit index included herein for a list of exhibits to this report.

87

---



(b) Exhibits

The
following is a list of exhibits filed as part of this annual report on Form
10-K.  Where so indicated, exhibits that
were previously filed are incorporated by reference.

| |            |  |                                                                                                                                                                                                                                             
| | ---------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit    |  |                                                                                                                                                                                                                                             
| | No.        |  | Description                                                                                                                                                                                                                                 
| |            |  |                                                                                                                                                                                                                                             
| |            |  |                                                                                                                                                                                                                                             
| | 3.1(1)     |  | Articles of Amendment and
  Restatement of the registrant                                                                                                                                                                                   
|
| | 3.2(2)     |  | Articles Supplementary
  Establishing the Rights and Preferences of the 8.125% Series A Cumulative
  Redeemable Preferred Stock of the registrant                                                                                           
|
| | 3.3(1)     |  | Amended and Restated Bylaws of
  the registrant                                                                                                                                                                                             
|
| | 4.1(1)     |  | Form of Certificate evidencing
  the Common Stock, par value $0.01 per share, of the registrant                                                                                                                                             
|
| | 4.2(3)     |  | Junior Subordinated Indenture
  between Caplease, LP and JPMorgan Chase Bank, National Association, as
  trustee, dated December 13, 2005                                                                                                   
|
| | 4.3(3)     |  | Amended and Restated Trust
  Agreement among Caplease, LP, JPMorgan Chase Bank, National Association,
  Chase Bank USA, National Association and the Administrative Trustees named
  therein, dated December 13, 2005                       
|
| | 10.1(4)    |  | Contribution Agreement, dated as
  of November 20, 2003 between the registrant, Hyperion CLF LLC, LSR Capital
  CLF LLC, Wachovia Affordable Housing Community Development Corporation,
  Wachovia Investors, Inc. and CLF Management I, LLC
|
| | 10.2(4)    |  | Registration Rights Agreement,
  dated as of November 20, 2003 between the registrant and Hyperion CLF LLC,
  LSR Capital CLF LLC and Wachovia Investors, Inc.                                                                              
|
| | 10.3(5)    |  | Agreement of Purchase and Sale,
  dated July 14, 2004, between Caplease, LP and NEDA Puerto Rico, Inc.                                                                                                                                      
|
| | 10.4(5)    |  | First amendment of Purchase and
  Sale, dated August 13, 2004, between Caplease, LP and NEDA Puerto Rico, Inc.                                                                                                                              
|
| | 10.5(5)    |  | Second amendment of Purchase and
  Sale, dated September 15, 2004, between Caplease, LP and NEDA Puerto Rico,
  Inc.                                                                                                                        
|
| | 10.6(5)    |  | Third amendment of Purchase and
  Sale, dated September 29, 2004, between CLF VA Ponce LLC and NEDA Puerto
  Rico, Inc.                                                                                                                     
|
| | 10.7(5)    |  | Fourth amendment of Purchase and
  Sale, dated October 6, 2004, between CLF VA Ponce LLC and NEDA Puerto Rico,
  Inc.                                                                                                                       
|
| | 10.8(5)    |  | Fifth amendment of Purchase and
  Sale, dated October 28, 2004, between CLF VA Ponce LLC and NEDA Puerto Rico,
  Inc.                                                                                                                       
|
| | 10.9(6)    |  | Agreement of Purchase and Sale,
  dated July 15, 2004, between Caplease, LP and 1000 Milwaukee Avenue Owner
  Corp.                                                                                                                         
|
| | 10.10(7)   |  | Master Repurchase Agreement,
  dated September 22, 2004 between the registrant, Wachovia Bank, National
  Association, Caplease, LP and Certain Special-Purpose Entity Subsidiaries
  thereof                                               
|
| | 10.11(8)   |  | Promissory Note (Note A), dated
  October 28, 2004, of CLF 1000 Milwaukee Avenue LLC in favor of Wachovia Bank,
  National Association                                                                                                      
|
| | 10.12(9)   |  | Promissory Note, dated December
  9, 2004, of the registrant in favor of Wachovia Bank, National Association                                                                                                                                
|
| | 10.13(10)  |  | Agreement of Purchase and Sale,
  dated December 23, 2004, between Caplease, LP and WXV/Whippany, LLC                                                                                                                                       
|
| | *10.14(11) |  | Capital Lease Funding, Inc. 2004
  Stock Incentive Plan                                                                                                                                                                                     
|
| | *10.15(11) |  | Form of Non-Employee Director
  Restricted Stock Award Agreement                                                                                                                                                                            
|
| | *10.16(11) |  | Form of Executive Officer
  Restricted Stock Agreement                                                                                                                                                                                      
|
| | 10.17(12)  |  | Promissory Note, dated February
  25, 2005, of CLF Parsippany LLC in favor of Wachovia Bank, National
  Association                                                                                                                         
|
| | *10.18(13) |  | Form of Employment Agreement
  between each of Paul H. McDowell, William R. Pollert, Shawn P. Seale and
  Robert C. Blanz, and the registrant                                                                                               
|
| | 10.19(13)  |  | Purchase and Sale Agreement
  dated as of October 22, 2004 between Caplease, LP and 10720-10750-10770
  Columbia Pike Investors LLC                                                                                                         
|
| | 10.20(13)  |  | Contract of Sale dated as of
  November 1, 2004 between Caplease, LP and Hyperion Partners II L.P.
  (Portsmouth, VA)                                                                                                                       
|
| | 10.21(13)  |  | Contract of Sale dated as of
  November 1, 2004 between Caplease, LP and Hyperion Partners II L.P.
  (Pennsauken, NJ)                                                                                                                       
|
| | 10.22(14)  |  | Real Estate Purchase and Sale
  Agreement, dated March 2, 2005, by and among Capital Property Associates
  Limited Partnership, 6116 GP LLC, Capital Property Acceptance LLC, and                                                           

88

---



| |           |  |                                                                                                                                                                                                             
| | --------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit   |  |                                                                                                                                                                                                             
| | No.       |  | Description                                                                                                                                                                                                 
| |           |  |                                                                                                                                                                                                             
| |           |  |                                                                                                                                                                                                             
| |           |  | Caplease, LP                                                                                                                                                                                                
|
| | 10.23(14) |  | Indenture, dated as of March 10,
  2005, by and among Caplease CDO 2005-1, Ltd., Caplease CDO 2005-1 Corp.,
  Caplease Investment Management, LLC and LaSalle Bank National Association                     
|
| | 10.24(15) |  | Second Amendment to Purchase and
  Sale Agreement, dated as of April 15, 2005, by and between Caplease, LP and
  Aliso Commons at Town Center, LLC                                                          
|
| | 10.25(16) |  | Sales Agreement, dated as of August
  15, 2005, between Cantor Fitzgerald & Co. and Capital Lease Funding, Inc.                                                                                             
|
| | 10.26(16) |  | Sales Agreement, dated as of
  August 15, 2005, between Brinson Patrick Securities Corporation and Capital
  Lease Funding, Inc.                                                                            
|
| | 10.27(16) |  | Amendment No. 1 to Master
  Repurchase Agreement, dated as of August 16, 2005, by and between Caplease,
  LP, Capital Lease Funding, Inc., Caplease Services Corp. and Wachovia Bank,
  National Association
|
| | 10.28(17) |  | $75,000,000 Revolving Loan
  Agreement, dated August 26, 2005, by and among Capital Lease Funding, Inc.,
  Caplease Services Corp., Caplease, LP and Wachovia Bank, National Association                    
|
| | 10.29(17) |  | $25,000,000 Revolving Loan
  Agreement, dated August 26, 2005, by and among Capital Lease Funding, Inc.,
  Caplease Services Corp., Caplease, LP and Wachovia Investment Holdings, LLC                      
|
| | 10.30(18) |  | Real Estate Purchase and Sale
  Agreement, dated July 18, 2005, by and between Justice Center, LLC and CLF
  DEA Birmingham LLC                                                                             
|
| | 10.31(18) |  | Real Estate Purchase and Sale
  Agreement, dated July 18, 2005, by and between Birmingham Field Office, LLC
  and CLF FBI Birmingham LLC                                                                    
|
| | 10.32(18) |  | Real Estate Purchase and Sale
  Agreement, dated July 18, 2005, by and between Utah Tech Center, LLC and
  Caplease, LP                                                                                     
|
| | 10.33(18) |  | Real Estate Purchase and Sale
  Agreement, dated July 18, 2005, by and between Kansas EPA Laboratory, LLC and
  Caplease, LP                                                                                
|
| | 10.34(18) |  | Real Estate Purchase and Sale
  Agreement, dated July 18, 2005, by and between Austin SSA, LLC and Caplease,
  LP                                                                                           
|
| | 10.35(18) |  | Promissory Note, dated August
  16, 2005, of CLF FBI Birmingham LLC in favor of Wachovia Bank, National
  Association                                                                                       
|
| | 10.36(18) |  | Promissory Note, dated August
  16, 2005, of CLF DEA Birmingham LLC in favor of Wachovia Bank, National
  Association                                                                                       
|
| | 10.37(18) |  | Promissory Note, dated August
  16, 2005, of CLF SSA Austin, LP in favor of Wachovia Bank, National
  Association                                                                                           
|
| | 10.38(18) |  | Trust Indenture dated as of
  February 1, 2001 between Unified Government of Wyandotte County, Kansas City,
  Kansas, as issuer, and Security Bank of Kansas City, as trustee                               
|
| | 10.39(18) |  | Lease dated as of February 1,
  2001 between Unified Government of Wyandotte County, Kansas City, Kansas and
  Kansas EPA Laboratory, LLC                                                                   
|
| | 10.40(18) |  | Trust Indenture dated as of
  December 1, 2002 between Utah Tech Center, LLC, as issuer, and Security Bank
  of Kansas City, as trustee                                                                     
|
| | 10.41(18) |  | Promissory Note, dated as of
  September 9, 2005, of Caplease Credit LLC in favor of Wachovia Bank, National
  Association                                                                                  
|
| | 10.42(18) |  | Purchase and Sale Agreement
  dated September 23, 2005 between Tiffany and Company and Caplease, LP                                                                                                         
|
| | 10.43(18) |  | Promissory Note, dated as of
  September 28, 2005, of CLF Sylvan Way LLC in favor of Wachovia Bank, National
  Association                                                                                  
|
| | 10.44(3)  |  | Parent Guarantee Agreement
  between Capital Lease Funding, Inc. and JPMorgan Chase Bank, National
  Association, as guarantee trustee, dated December 13, 2005                                             
|
| | 10.45(3)  |  | Purchase Agreement among Capital
  Lease Funding, Inc., Caplease, LP, Caplease Statutory Trust I and Merrill
  Lynch International, dated December 13, 2005                                                 
|
| | *10.46    |  | Summary of Compensation for the
  Chief Executive Officer and each of the Named Executive Officers for Fiscal
  2006                                                                                        
|
| | *10.47    |  | Summary of Independent Director
  Compensation for Fiscal 2006                                                                                                                                              
|
| | 10.48     |  | Real Estate Sale Agreement
  between Caplease, LP and Allstate Insurance Company, dated November 22, 2005                                                                                                   
|
| | 10.49     |  | Promissory Note, dated as of
  December 21, 2005, of CLF McCullough Drive Charlotte LLC and CLF Electric
  Road Roanoke LLC in favor of LaSalle Bank National Association                                   
|
| | *10.50    |  | Employment Agreement, dated as
  of January 31, 2005, between Paul Hughes and the registrant                                                                                                                

89

---



| |         |  |                                                                                                                                                                                                                
| | ------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit |  |                                                                                                                                                                                                                
| | No.     |  | Description                                                                                                                                                                                                    
| |         |  |                                                                                                                                                                                                                
| |         |  |                                                                                                                                                                                                                
| | 12.1    |  | Computation of Ratio of Earnings
  to Fixed Charges and Preferred Stock Dividends                                                                                                                              
|
| | 21.1    |  | List of Subsidiaries                                                                                                                                                                                           
|
| | 23.1    |  | Consent of Ernst & Young LLP                                                                                                                                                                                   
|
| | 23.2    |  | Consent of McGladrey &
  Pullen LLP                                                                                                                                                                            
|
| | 31.1    |  | Certification of Chief Executive
  Officer required by Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act
  of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley
  Act of 2002    
|
| | 31.2    |  | Certification of the Chief
  Financial Officer required by Rule 13a-14(a)/15d-14(a) of the Securities
  Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the
  Sarbanes-Oxley Act of 2002
|
| | 32.1    |  | Certification of the
  registrants Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted
  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                 
|
| | 32.2    |  | Certification of the
  registrants Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted
  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                 

| |      |                                                                                                                                                                                                          
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     
| | *    | Denotes compensatory plans or
  arrangement or management contracts required to be filed as exhibits to this
  Annual Report on Form 10-K.                                                               
| |      |                                                                                                                                                                                                          
| | (1)  | Incorporated by reference from
  the registrants Amendment No. 4 to Registration Statement on Form S-11 filed
  with the Securities and Exchange Commission on March 8, 2004 (File No.
  333-110644).   
| |      |                                                                                                                                                                                                          
| | (2)  | Incorporated by reference from
  the registrants Registration Statement on Form 8-A filed with the Securities
  and Exchange Commission on October 17, 2005.                                            
| |      |                                                                                                                                                                                                          
| | (3)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on December 19, 2005.                                                   
| |      |                                                                                                                                                                                                          
| | (4)  | Incorporated by reference from
  the registrants Amendment No. 1 to Registration Statement on Form S-11 filed
  with the Securities and Exchange Commission on January 12, 2004 (File No.
  333-110644).
| |      |                                                                                                                                                                                                          
| | (5)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on November 5, 2004.                                                    
| |      |                                                                                                                                                                                                          
| | (6)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on September 3, 2004.                                                   
| |      |                                                                                                                                                                                                          
| | (7)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on September 24, 2004.                                                  
| |      |                                                                                                                                                                                                          
| | (8)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on November 3, 2004.                                                    
| |      |                                                                                                                                                                                                          
| | (9)  | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on December 15, 2004.                                                   
| |      |                                                                                                                                                                                                          
| | (10) | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and Exchange
  Commission on January 11, 2005.                                                    
| |      |                                                                                                                                                                                                          
| | (11) | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on February 17, 2005.                                                   
| |      |                                                                                                                                                                                                          
| | (12) | Incorporated by reference from
  the registrants Current Report on Form 8-K/A filed with the Securities and
  Exchange Commission on March 3, 2005.                                                     
| |      |                                                                                                                                                                                                          
| | (13) | Incorporated by reference from
  the registrants Annual Report on Form 10-K filed with the Securities and
  Exchange Commission on March 30, 2005.                                                      
| |      |                                                                                                                                                                                                          
| | (14) | Incorporated by reference from
  the registrants Quarterly Report on Form 10-Q filed with the Securities and
  Exchange Commission on May 16, 2005.                                                     
| |      |                                                                                                                                                                                                          
| | (15) | Incorporated by reference from
  the registrants Quarterly Report on Form 10-Q filed with the Securities and
  Exchange Commission on August 11, 2005.                                                  
| |      |                                                                                                                                                                                                          
| | (16) | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on August 17, 2005.                                                     
| |      |                                                                                                                                                                                                          
| | (17) | Incorporated by reference from
  the registrants Current Report on Form 8-K filed with the Securities and
  Exchange Commission on September 1, 2005.                                                   
| |      |                                                                                                                                                                                                          
| | (18) | Incorporated by reference from
  the registrants Quarterly Report on Form 10-Q filed with the Securities and
  Exchange Commission on November 14, 2005.                                                

90

---



PART
V.

SIGNATURES

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

|                     |  |                              
|-------------------- |  | -----------------------------
|                     |  | CAPITAL
  LEASE FUNDING, INC.
|                     |  | Registrant                   
|                     |  |                              
|Date: March 16, 2006 |  | /s/ PAUL H. MCDOWELL         
|                     |  |                              
|                     |  | Paul H. McDowell             
|                     |  | Chief Executive
  Officer    

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

|                           |  |                                                                                                                 |  |               
|-------------------------- |  | --------------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                  |  | Title                                                                                                           |  | Date          
|                           |  |                                                                                                                 |  |               
|/s/   LEWIS S.
RANIERI     |  | Chairman of the Board                                                                                           |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|LewisS. Ranieri            |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   PAULH.
McDOWELL      |  | Chief Executive Officer and Director
  (Principal Executive Officer)                                            |  | March 16, 2006
|                           |  |                                                                                                                 | 
|Paul H. McDowell           |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   WILLIAM R.
POLLERT   |  | President and Director                                                                                          |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|William R. Pollert         |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   SHAWN P.
SEALE       |  | Senior Vice President, Chief Financial 
  Officer and Treasurer 
  (Principal Financial and Accounting Officer) |  | March 16, 2006
|                           |  |                                                                                                                 | 
|Shawn P. Seale             |  |                                                                                                                 | 
|                           |  |                                                                                                                 |  |               
|/s/   MICHAEL E.
GAGLIARDI |  | Director                                                                                                        |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|Michael E. Gagliardi       |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   STANLEY
KREITMAN     |  | Director                                                                                                        |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|Stanley Kreitman           |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   JEFFREY F.
ROGATZ    |  | Director                                                                                                        |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|Jeffrey F. Rogatz          |  |                                                                                                                 |  |               
|                           |  |                                                                                                                 |  |               
|/s/   HOWARD A.
SILVER     |  | Director                                                                                                        |  | March 16, 2006
|                           |  |                                                                                                                 |  |               
|Howard A. Silver           |  |                                                                                                                 |  |               

91

---